Back to GetFilings.com
================================================================================
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-26016
-----------------
PALMETTO BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
South Carolina 74-2235055
(State or other jurisdiction of incorporation or (IRS Employer
organization) Identification No.)
301 Hillcrest Drive, Laurens, South Carolina 29360
(Address of principal executive offices) (Zip Code)
Registrant's telephone number--(864) palmettobank.com
984-4551 (Registrant's subsidiary's web site)
-----------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $5.00 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of February 19, 2002, $147,924,846--based on the most recent
sales price of $27.00 per share. There is no established public trading market
for the shares. See Part II, Item 5.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 6,284,623 -
February 19, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement dated March 16, 2002 with respect to an Annual
Meeting of Shareholders to be held April 16, 2002: Incorporated by reference in
Part III of this Form 10-K.
================================================================================
PALMETTO BANCSHARES, INC.
AND SUBSIDIARIES
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
PART I
Page No.
--------
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 8
Item 3. Legal Proceedings.............................................. 9
PART II
Item 5. Market for the Registrant's Common Stock and Related
Shareholder Matters............................................ 10
Item 6. Selected Financial Data........................................ 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 12
Item 7a. Quantitative and Qualitative Disclosures about Market Risk..... 30
Item 8. Financial Statements and Supplementary Data.................... 30
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 30
PART III
Item 10. Directors and Executive Officers of the Registrant............. 59
Item 11. Executive Compensation......................................... 59
Item 12. Security Ownership of Certain Beneficial Owners and Management. 59
Item 13. Certain Relationships and Related Transactions................. 59
PART IV
Item 14. Exhibits and Financial Statement Schedules and Reports on Form
8-K............................................................ 59
2
Part I
(Dollars in thousands, except share and per share data, throughout document)
Item 1. Business
Palmetto Bancshares, Inc. ("Bancshares" or the "Company") is a bank holding
company organized in 1982 under the laws of South Carolina. Through its
wholly-owned subsidiary, The Palmetto Bank (the "Bank"), and the Bank's
wholly-owned subsidiary, Palmetto Capital, Inc. ("Palmetto Capital"),
Bancshares engages in the general banking business in the upstate South
Carolina market of Laurens, Greenville, Spartanburg, Greenwood, Anderson,
Cherokee and Abbeville counties (the "Upstate"). The Bank was organized and
chartered under South Carolina law in 1906.
The Bank performs a full range of banking activities, including such
services as checking, savings, money market, and other time deposits of various
types of consumer and commercial depositors; loans for business, real estate,
and personal uses; safe deposit box rental and various electronic funds
transfer services. The Bank also offers both individual and commercial trust
services through an active trust department. Palmetto Capital is a brokerage
subsidiary of the Bank, which offers customers stocks, treasury and municipal
bonds, mutual funds and insurance annuities, as well as college and retirement
planning. The Bank's sales finance department establishes relationships with
Upstate automobile dealers to provide customer financing of automobile
purchases. The Bank's mortgage banking operation continues to meet a broader
range of its customers' financial service needs by originating, selling, and
servicing mortgage loans.
Financial Information
See Item 8, "Financial Statements and Supplementary Data."
Competition
The Upstate is a highly competitive banking market in which all of the
largest financial institutions in the state are represented. The competition
among the various financial institutions is based upon interest rates offered
on deposit accounts, interest rates charged on loans, credit and service
charges, the quality of service rendered and the convenience of banking
facilities. The Bank believes it competes effectively in its market.
South Carolina legislation permits banks and bank holding companies in
certain southern states to acquire banks in South Carolina to the extent that
such other states have reciprocal legislation applicable to South Carolina
banks and bank holding companies. As a result, a number of the Bank's
competitor banks continue to be purchased by large, out-of-state bank holding
companies. Size gives the larger banks certain advantages in competing for
business from larger corporations. These advantages include higher lending
limits and the ability to offer services in other areas of South Carolina and
the region. As a result, the Bank does not generally attempt to compete for the
banking relationships of larger corporations, but concentrates its efforts on
small and medium-size businesses and individuals. The Bank believes it competes
effectively in this market segment by offering quality, personalized service.
It is management's intention to remain a locally based, independent, South
Carolina Bank.
Customers
The majority of the Bank's customers are individuals and small to
medium-sized businesses headquartered within its service area. The Bank is not
dependent upon a single or a very few customers, the loss of which would have a
material adverse effect on the Bank. No customer accounts for more than 5% of
the Bank's total deposits at any time. Management does not believe that the
Bank's loan portfolio is dependent on a single customer or group of customers
concentrated in a particular industry whose loss or insolvency would have a
material adverse effect on the Bank.
3
Growth
Late in 2000, the South Carolina State Board of Financial Institutions
approved the Bank's application to open a branch in Travelers Rest in
Greenville County, South Carolina. The Company opened its new Travelers Rest
office on January 14, 2002.
During 2001, the Company began making plans to enter Oconee County, a new
market area. The Bank has purchased a building in Seneca in Oconee County,
South Carolina with plans to open a de novo branch in the Spring of 2002.
Management continually reviews opportunities to expand in the Upstate that
it believes to be in the best interest of the Bank, its customers and its
shareholders.
Employees
At December 31, 2001, the Bank had 366 full-time equivalent employees, none
of whom are subject to a collective bargaining agreement. Management believes
its relationship with its employees is excellent.
Monetary Policy
The results of operations of Bancshares and the Bank are affected by credit
policies of monetary authorities, particularly the Federal Reserve. The
instruments of monetary policy employed by the Federal Reserve include open
market operations in U.S. Government securities, changes in the discount rate
on member bank borrowings, changes in reserve requirements against member bank
deposits and limitations on interest rates which member banks may pay on time
and savings deposits. In view of changing conditions in the national economy
and in the money markets, as well as the effect of action by monetary and
fiscal authorities, including the Federal Reserve, no prediction can be made as
to possible future changes in interest rates, deposit levels, loan demand or
the business and earnings of Bancshares and the Bank.
Regulatory Environment
General
Bancshares and its subsidiaries are extensively regulated under federal and
state law. To the extent that the following information describes statutory or
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. Any change in applicable laws
may have a material effect on the business and prospects of Bancshares. The
operations of Bancshares may be affected by possible legislative and regulatory
changes and by the monetary policies of the United States.
Bancshares. As a bank holding company registered under the Bank Holding
Company Act of 1956, as amended (the "BHCA"), Bancshares is subject to
regulation and supervision by the Federal Reserve. Under the BHCA, Bancshares'
activities and those of its subsidiaries are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiaries or engaging in any other activity that the Federal Reserve
determines to be so closely related to banking, managing or controlling banks
as to be a proper incident thereto. The BHCA also restricts the ability of
Bancshares to acquire ownership or control of more than 5% of the outstanding
voting stock of any bank or certain other nonbanking businesses.
There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss exposure to the depositors
of such depository institutions and to the Federal Deposit Insurance
Corporation ("FDIC") insurance funds in the event the depository institution
becomes in danger of defaulting or in default under its obligations to repay
deposits. For example, under current federal law, to reduce the likelihood of
receivership of an insured depository institution subsidiary, a bank holding
company is required to guarantee the compliance of any insured
4
depository institution subsidiary that may become "undercapitalized:" with the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to
5% of the institution's total assets at the time the institution became
undercapitalized, or (ii) the amount that is necessary (or would have been
necessary) to bring the institution into compliance with all applicable capital
standards as of the time the institution fails to comply with such capital
restoration plan. Under a policy of the Federal Reserve with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such policy. The Federal Reserve also has the authority under
the BHCA to require a bank holding company to terminate any activity or
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of
a bank) upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the financial soundness or stability of any
subsidiary depository institution of the bank holding company. Further, federal
law grants federal bank regulatory authorities additional discretion to require
a bank holding company to divest itself of any bank or nonbank subsidiary if
the agency determines that divestiture may aid the depository institution's
financial condition.
As a bank holding company registered under the South Carolina Bank Holding
Company Act, Bancshares also is subject to regulation by the South Carolina
State Board of Financial Institutions ("State Board"). Bancshares must file
with the State Board periodic reports with respect to its financial condition
and operations, management and intercompany relationships between Bancshares
and its subsidiaries.
The Bank. The Bank is a FDIC-insured, South Carolina-chartered banking
corporation and is subject to various statutory requirements, rules and
regulations promulgated and enforced primarily by the State Board and the FDIC.
These statutes, rules and regulations relate to insurance of deposits, required
reserves, allowable investments, loans, mergers, consolidations, issuance of
securities, payment of dividends, establishment of branches and other aspects
of the business of the Bank. The FDIC has broad authority to prohibit the Bank
from engaging in what it determines to be unsafe or unsound banking practices.
In addition, federal law imposes a number of restrictions on state-chartered,
FDIC-insured banks and their subsidiaries. These restrictions range from
prohibitions against engaging as a principal in certain activities to the
requirement of prior notification of branch closings. The Bank also is subject
to various other state and federal laws and regulations, including state usury
laws, laws relating to fiduciaries, consumer credit and equal credit and fair
credit reporting laws. The Bank is not a member of the Federal Reserve System.
Dividends. The holders of Bancshares common stock are entitled to receive
dividends when and if declared by the Board of Directors out of funds legally
available therefor. Bancshares is a legal entity separate and distinct from the
Bank and Palmetto Capital and depends for its revenues on the payment of
dividends from the Bank. Current federal law would prohibit, except under
certain circumstances and with prior regulatory approval, an insured depository
institution, such as the Bank, from paying dividends or making any other
capital distribution if, after making the payment or distribution, the
institution would be considered "undercapitalized," as that term is defined in
applicable regulations. In addition, as a South Carolina-chartered bank, the
Bank is subject to legal limitations on the amount of dividends it is permitted
to pay. Please see page 10 for the amount currently available for the payment
of dividends.
Capital Adequacy
Bancshares. The Federal Reserve has adopted risk-based capital guidelines
for bank holding companies. Under these guidelines, the minimum ratio of total
capital to risk-weighted assets (including certain off-balance sheet
activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier 1 capital," principally consisting of
common shareholders' equity, noncumulative preferred stock, a limited amount of
cumulative perpetual preferred stock and minority interest in the equity
accounts of consolidated subsidiaries,
5
less certain goodwill items. The remainder (Tier 2 capital) may consist of a
limited amount of subordinated debt and intermediate-term preferred stock,
certain hybrid capital instruments and other debt securities, perpetual
preferred stock and a limited amount of the general loan loss allowance. In
addition to the risk-based capital guidelines, the Federal Reserve has adopted
a minimum Tier 1 (leverage) capital ratio under which a bank holding company
must maintain a minimum level of Tier 1 capital (as determined under applicable
rules) to average total consolidated assets of at least 3% in the case of bank
holding companies which have the highest regulatory examination ratios and are
not contemplating significant growth or expansion. All other bank holding
companies are required to maintain a ratio of at least 100 to 200 basis points
above the stated minimum. At December 31, 2001, Bancshares was in compliance
with both the risk-based capital guidelines and the minimum leverage capital
ratio.
The Bank. As a state-chartered, FDIC-insured institution that is not a
member of the Federal Reserve System, the Bank is subject to capital
requirements imposed by the FDIC. The FDIC requires state-chartered nonmember
banks to comply with risk-based capital standards substantially similar to
those required by the Federal Reserve, as described above. The FDIC also
requires state-chartered nonmember banks to maintain a minimum leverage ratio
similar to that adopted by the Federal Reserve. Under the FDIC's leverage
capital requirement, state nonmember banks that (a) receive the highest rating
during the examination process and (b) are not anticipating or experiencing any
significant growth are required to maintain a minimum leverage ratio of 3% of
Tier 1 capital to total assets; all other banks are required to maintain a
minimum leverage ratio of not less than 4%. As of December 31, 2001, the Bank
was in compliance with both the risk-based capital guidelines and the minimum
leverage capital ratio. For further discussion on the Bank's current capital
rating, see note 16 to consolidated financial statements.
Insurance
As a FDIC-insured institution, the Bank is subject to insurance assessments
imposed by the FDIC. Under current law, the insurance assessment to be paid by
insured institutions shall be as specified in a schedule required to be issued
by the FDIC that specifies, at semiannual intervals, target reserve ratios
designed to increase the FDIC insurance fund's reserve ratio to 1.25% of
estimated insured deposits (or such higher ratio as the FDIC may determine in
accordance with the statute) in 15 years. Further, the FDIC is authorized to
impose one or more special assessments in any amount deemed necessary to enable
repayment of amounts borrowed by the FDIC from the United States Department of
the Treasury (the "Treasury Department").
The FDIC uses a risk-based assessment schedule, having assessments ranging
from 0.00% to 0.27% of an institution's average assessment base as of December
31, 2001. The actual assessment to be paid by each FDIC-insured institution is
based on the institution's assessment risk classification, which is determined
based on whether the institution is considered "well capitalized," "adequately
capitalized" or "undercapitalized," as such terms have been defined in
applicable federal regulations adopted to implement the prompt corrective
action provisions of the Federal Deposit Insurance Corporation Insurance Act
("FDICIA") (see "Other Safety and Soundness Regulations--Prompt Corrective
Action" below), and whether such institution is considered by its supervisory
agency to be financially sound or to have supervisory concerns. For the years
ended December 31, 2001, 2000 and 1999, the Bank maintained a status of "well
capitalized". Premiums paid for FDIC insurance during each of those years
amounted to $110,000, $111,000 and $132,000, respectively. This further
decrease in the Bank's premium is due to the Bank's FICO assessment as
described below.
Under the Deposit Insurance Fund Act, BIF-assessable deposits are subject to
assessment for payment on the $780 million annual Financing Corporation
("FICO") bond obligation at 1/5 the rate of Savings Association Insurance
Fund-assessable deposits. Accordingly, the FDIC has estimated that the annual
FICO rate will be 1.30 basis points per $100 of BIF-assessable deposits in the
years 1997 - 1999. Starting in the year 2000 until the FICO bonds are retired,
banks and thrifts will pay the assessment on a pro rata basis (estimated at 2.5
basis points for banks). The Bank's actual assessment for 2001 was 1.82 basis
points.
6
Other Safety and Soundness Regulations
Prompt Corrective Action. Current law provides the federal banking agencies
with broad powers to take prompt corrective action to resolve problems of
insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized." Under uniform regulations defining such capital
levels issued by each of the federal banking agencies, a bank is considered
"well capitalized" if it has (i) a total risk-based capital ratio of 10% or
greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a
leverage ratio of 5% or greater, and (iv) is not subject to any order or
written directive to meet and maintain a specific capital level for any capital
measure. An "adequately capitalized" bank is defined as one that has (i) a
total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based
capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or greater (or
3% or greater in the case of a bank with a composite CAMELS rating of 1). A
CAMELS rating is a score given to a financial institution by its primary
regulator which represents a composite rating of the various areas examined:
Capital adequacy, Asset quality, Management, Earnings, Liquidity and
Sensitivity to market risk. A bank is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1
risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than
4% (or 3% in the case of a bank with a composite CAMELS rating of 1); (B)
"significantly undercapitalized" if the bank has (i) a total risk-based capital
ratio of less than 6%, or (ii) a Tier 1 risk-based capital ratio of less than
3%, or (iii) a leverage ratio of less than 3%; and (C) "critically
undercapitalized" if the bank has a ratio of tangible equity to total assets
equal to or less than 2%. At December 31, 2001, Bancshares and the Bank each
currently meet the definition of "well capitalized."
Brokered Deposits. Current federal law also regulates the acceptance of
brokered deposits by insured depository institutions to permit only a "well
capitalized" depository institution to accept brokered deposits without prior
regulatory approval. Under FDIC regulations, "well capitalized" insured
depository institutions may accept brokered deposits without restriction,
"adequately capitalized" insured depository institutions may accept brokered
deposits with a waiver from the FDIC (subject to certain restrictions on
payments of interest rates), while "undercapitalized" insured depository
institutions may not accept brokered deposits. The regulations provide that the
definitions of "well capitalized," "adequately capitalized" and
"undercapitalized" are the same as the definitions adopted by the agencies to
implement the prompt corrective action provisions of FDICIA (as described in
the previous paragraph). Bancshares does not believe that these regulations
will have a material adverse effect on its current operations.
Other FDICIA Regulations. To facilitate the early identification of
problems, FDICIA required the federal banking agencies to prescribe more
stringent reporting requirements. The FDIC final regulations implementing those
provisions, among other things, require that management report on the
institution's responsibility for preparing financial statements and
establishing and maintaining an internal control structure and procedures for
financial reporting and compliance with designated laws and regulations
concerning safety and soundness, and that independent auditors attest to and
report separately on assertions in management's reports concerning compliance
with such laws and regulations, using FDIC approved audit procedures. These
regulations apply to financial institutions with greater than $500 million in
assets at the beginning of their fiscal year. Accordingly, the Bank is subject
to these regulations.
Community Reinvestment Act
The Bank is subject to the requirements of the Community Reinvestment Act
("CRA"). The CRA requires that financial institutions have an affirmative and
ongoing obligation to meet the credit needs of their local communities,
including low-income and moderate-income neighborhoods, consistent with the
safe and sound operation of those institutions. Each financial institution's
efforts in meeting community credit needs are evaluated as part of the
examination process pursuant to twelve assessment factors. These factors are
also considered in evaluating mergers, acquisitions and applications to open a
branch or facility. The Bank received an "outstanding" rating in its most
recent evaluation dated May 3, 1999.
7
Transactions between Bancshares, Its Subsidiaries and Affiliates
Bancshares' subsidiaries are subject to certain restrictions on extensions
of credit to executive officers, directors, principal shareholders or any
related interest of such persons. Extensions of credit (i) must be made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unaffiliated persons;
and (ii) must not involve more than the normal risk of repayment or present
other unfavorable features. Aggregate limitations on extensions of credit also
may apply. Bancshares' subsidiaries also are subject to certain lending limits
and restrictions on overdrafts to such persons.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on extensions of credit to the
bank holding company or its nonbank subsidiary, on investments in their
securities and on the use of their securities as collateral for loans to any
borrower. Such restrictions may limit Bancshares' ability to obtain funds from
its bank subsidiary for its cash needs, including funds for acquisitions,
interest and operating expenses.
In addition, under the BHCA and certain regulations of the Federal Reserve,
a bank holding company and its subsidiaries are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit, lease
or sale of property or furnishing of services. For example, a subsidiary may
not generally require a customer to obtain other services from any other
subsidiary or Bancshares, and may not require the customer to promise not to
obtain other services from a competitor, as a condition to an extension of
credit to the customer.
Item 2. Properties
The corporate headquarters, the telephone banking center, and the finance,
operations, data processing, trust, human resources, loan administration,
internal audit and marketing departments are located in a facility at 301
Hillcrest Drive, Laurens, South Carolina ("Corporate Center"). The main office
of the Bank is located in a facility at 101 West Main Street, Laurens, South
Carolina, which also contains a three lane drive-in facility.
The Bank has twenty-eight full-service branches in the Upstate region of
South Carolina in the following locations: Laurens (3), Duncan, Clinton,
Greenwood (2), Ninety-Six, Fountain Inn, Hodges, Mauldin, Simpsonville,
Anderson (2), Greenville (5), Pendleton, Spartanburg (3), Inman, Blacksburg,
Gaffney, Abbeville and Greer.
The Bank has automatic teller machines at the following branches: Church
Street (Laurens), Clinton, Montague Avenue (Greenwood), South Main (Greenwood),
Ninety-Six, Abbeville, Fountain Inn, Mauldin, Simpsonville, Woodruff Road
(Greenville), Haywood Road (Greenville), East North Street at Howell Road
(Greenville), Grove Road (Greenville), Blackstock Road (Spartanburg), Hillcrest
(Spartanburg), Duncan, Inman, Greer, Blacksburg, Gaffney, Pendleton, Anderson
and North Anderson branches. The Bank also has ATM's at three non-branch
locations: the Flour Daniel office complex (Greenville), the Cato Corners
Shopping Center (Laurens) and the Westwood Plaza Shopping Center (Greenwood).
In addition, the Bank owns five limited service branches in various retirement
centers located in the Upstate.
The Bank owns all of its facilities except the following leased facilities,
which have annual rental expenses from $1 dollar to $173 thousand:
East North Street, Haywood Road, East North Street at Howell Road,
Woodruff Road, Greer offices--Greenville
Spartan Centre, Blackstock Road, Hillcrest offices--Spartanburg
Gaffney office--Gaffney
South Main Street and Ninety-Six offices--Greenwood
North Anderson office--Anderson
8
Offices range in size from branch locations of approximately 800 to 10,000
square feet, to the Corporate Center location of approximately 55,000 square
feet. All facilities are protected by alarm and security systems that meet or
exceed regulatory standards. Each facility is in good condition and capable of
handling increased volume. All of the locations are considered suitable and
adequate for their intended purposes.
Item 3. Legal Proceedings
On January 19, 2001, M. Snyder's, Inc., an automobile dealership that has
sold and assigned sales finance contracts to the Bank, filed suit against the
Bank and Richard O. Lollis, a former employee of the Bank who was the manager
of the sales finance department. The suit was filed in the Court of Common
Pleas for Greenville County, South Carolina. M. Snyder's claims arise from the
sales finance contracts and its business relationship with the Bank, including
causes of action for alleged breach of contract, breach of fiduciary duty,
fraud, negligent representation, breach of contract accompanied by fraudulent
acts, unfair trade practices, negligence and negligent supervision; M. Snyder's
seeks actual and consequential damages. The Bank has filed counterclaims
against M. Snyder's based on, among other things, alleged breach of contract
with fraudulent intent, fraud, misrepresentations, unfair trade practices, bad
faith, procurement of breach of contracts by customers and conversion of assets
properly belonging to the Bank. The Bank does not believe that M. Snyder's
claims are well-founded and is vigorously pursuing its counterclaims and its
defenses against the claims. In connection with the above lawsuit, the Bank has
also filed a third party complaint against an employee of M. Snyder's, Inc.
arising from his actions in dealing with sales finance contracts, including
causes of action for fraud, misrepresentation and conversion. The case is still
in the discovery stage. While the Bank does not anticipate a negative result
from this lawsuit, based on the apparent claims being asserted by the
plaintiff, there can be no assurance that a negative result might not have a
material adverse effect on the Company's financial condition.
Bancshares is not currently engaged in legal proceedings. In addition to the
matter described above, from time to time the Bank is involved in legal
proceedings incidental to its normal course of business as a bank. Management
believes that none of these proceedings is likely to have a materially adverse
effect on the business of Bancshares or the Bank.
9
Part II
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters
There is no public market for the common stock of Bancshares or the Bank.
The last known selling price of Bancshares' common stock, based on information
available to Bancshares' management, was $27.00 per share on February 19, 2002.
As of February 19, 2002, the Company had 1,034 shareholders with 6,284,623
shares outstanding.
Bancshares, or its predecessor, the Bank, has paid regular dividends on
common stock since 1909. For the years ended December 31, 2001, 2000 and 1999,
Bancshares paid cash dividends of $2.6 million or $0.41 per share, $2.3 million
or $0.37 per share, and $2.0 million or $0.32 per share, respectively. These
dollars equate to dividend payout ratios (dividends declared divided by net
income) of 30.58%, 32.96% and 24.24% in 2001, 2000 and 1999, respectively.
Certain other information concerning dividends and historical trading prices is
set forth below.
Quarterly Common Stock Data
Set forth below is information concerning high and low sales prices by
quarter for each of the last two fiscal years and dividend information for the
last two fiscal years. The Company's common stock is not traded on any
established public trading market. The Company acts as its own transfer agent,
and the information concerning sales prices set forth below is derived from the
Company's stock transfer records. As of December 31, 2001, there were 1,030
shareholders of record.
Sales Prices by Quarter
Fiscal Year 2001 High Low
---------------- ------ ------
First Quarter........................................ $25.50 $25.00
Second Quarter....................................... $26.00 $26.00
Third Quarter........................................ $26.00 $26.00
Fourth Quarter....................................... $27.00 $26.00
Fiscal Year 2000
----------------
First Quarter........................................ $24.50 $22.50
Second Quarter....................................... $24.50 $23.50
Third Quarter........................................ $25.00 $24.50
Fourth Quarter....................................... $25.00 $25.00
Dividends Paid Per Share
Fiscal Year 2001 Fiscal Year 2000
- ---------------- ----------------
March 31.......................... $.10 March 31.......................... $.09
June 29........................... $.10 June 30........................... $.09
September 28...................... $.10 September 29...................... $.09
December 28....................... $.11 December 27....................... $.10
The ability of Bancshares to pay dividends depends upon the amount of
dividends that is received from the Bank. The Company and the Bank are subject
to certain regulatory restrictions on the amount of dividends they are
permitted to pay. The Bank's current total risk-based capital ratio is 10.72%.
At December 31, 2001, the Bank had $11.7 million of excess retained earnings
available to pay out for dividends and still be considered "well-capitalized."
The Bank plans to continue its quarterly dividend payments.
10
Item 6. Selected Financial Data (Dollars in thousands)
5 Year Summary
------------------------------------------------------
2001 2000 1999 1998 1997
---------- --------- --------- --------- ---------
For the Year
Total interest income................................. $ 49,271 46,873 43,142 40,829 36,969
Total interest expense................................ 19,549 20,383 16,399 16,440 15,841
Net interest income................................... 29,722 26,490 26,743 24,389 21,128
Provision for loan losses............................. 4,038 3,880 2,431 1,877 1,331
Total non-interest income............................. 12,869 9,551 8,069 6,468 5,628
Total non-interest expense............................ 26,553 22,549 21,274 19,130 17,085
Income before income taxes............................ 12,000 9,612 11,107 9,850 8,340
Income tax provision.................................. 3,600 2,637 3,038 3,000 2,415
Net income............................................ 8,400 6,975 8,069 6,850 5,925
Per Common Share
Net income per share-basic, not subject to put/call... $ 1.34 1.12 1.30 1.05 0.98
Net income per share-dilutive, not subject to put/call 1.31 1.09 1.26 1.02 0.97
Cash dividends declared............................... 0.41 0.37 0.32 0.25 0.19
Book value at year end (1)............................ 9.40 8.41 7.33 6.79 5.93
Average common shares outstanding--basic (1).......... 6,263,031 6,241,775 6,208,750 6,178,318 6,109,754
At Year End
Total assets.......................................... $ 735,279 663,390 625,835 578,196 514,170
Investment securities................................. 95,095 98,601 106,772 112,542 97,731
Total Loans........................................... 553,821 498,242 445,757 413,266 367,585
Total deposits........................................ 645,300 572,666 538,324 500,469 450,353
Total shareholders' equity (2)........................ 59,068 52,593 45,627 42,085 36,616
Total shareholders' equity............................ 59,068 52,593 45,627 37,353 32,832
Common shares outstanding............................. 6,283,623 6,255,734 6,226,834 6,199,390 6,179,104
Full-time equivalent employees........................ 366 341 327 306 281
Average Balances
Assets................................................ $ 698,600 636,289 595,678 541,799 493,737
Investment securities................................. 94,796 108,591 110,546 102,635 97,136
Loans................................................. 542,024 470,381 430,960 390,776 350,493
Deposits.............................................. 603,187 542,259 512,405 467,749 432,031
Total shareholders' equity (2)........................ 56,696 48,906 45,094 39,552 33,858
Key Ratios (1)
Return on average assets.............................. 1.20% 1.10% 1.35% 1.26% 1.20%
Return on average equity.............................. 14.82% 14.26% 17.89% 17.32% 17.50%
Primary capital to assets at year end................. 8.74% 8.68% 8.22% 8.21% 8.06%
Net interest margin (fully tax-equivalent)............ 4.75% 4.73% 5.09% 5.07% 4.80%
Allowance for loan losses to total loans.............. 1.02% 1.09% 1.43% 1.40% 1.40%
Nonperforming assets to total assets.................. 0.66% 0.64% 0.49% 0.33% 0.25%
Net charge-offs to average loans...................... 0.71% 1.02% 0.43% 0.32% 0.26%
Average equity to average assets ratio................ 8.12% 7.69% 7.57% 7.30% 6.86%
- --------
(1) These numbers are calculated using balances and shares of total common
stock outstanding excluding reclassification of ESOP stock, for which
Bancshares had issued a put option, totaling $4,732, and $3,784 at December
31, 1998 and 1997, respectively. This put option expired in 1999.
(2) Excluding reclassification of ESOP stock, for which Bancshares had issued a
put option, totaling $4,732, and $3,784 at December 31, 1998 and 1997,
respectively.
11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with the
Selected Consolidated Financial Data in Item 6 of this report and the
Consolidated Financial Statements and accompanying notes in Item 8 of this
report. The consolidated financial statements of Palmetto Bancshares, Inc. and
subsidiaries (the "Company"), represent account balances for Palmetto
Bancshares, Inc., (the "Parent Company"), and its wholly-owned subsidiary, The
Palmetto Bank, (the "Bank"), and the Bank's wholly-owned subsidiary, Palmetto
Capital, Inc. Significant accounting policies are disclosed throughout
management's discussion and analysis and may involve uncertainties.
Forward-Looking Statements
This document may contain certain "forward-looking statements," within the
meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. Such
forward-looking statements are about matters that are inherently subject to
certain risks, uncertainties, and assumptions. Factors that could influence the
matters discussed in certain forward-looking statements include the relative
levels of market interest rates, loan prepayments and deposit decline rates,
the timing and amount of revenues that may be recognized by the Company,
continuation of current revenue, expense and charge-off trends, legal and
regulatory changes, and general changes in the economy. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those expected or
projected. These forward-looking statements speak only as of the date of the
document. The Company assumes no obligation to update any forward-looking
statements. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them.
Off-Balance Sheet Risk and Contractual Obligations
The Company, through the operations of the Bank, makes contractual
commitments to extend credit in the ordinary course of its business activities.
These commitments are legally binding agreements to lend money to customers of
the Bank at predetermined interest rates for a specified period of time. At
December 31, 2001, the Bank had issued commitments to extend credit of $92.3
million through various types of lending arrangements, described further in the
table below.
Home equity loans.............................................. $12,162
Credit cards................................................... 32,471
Commercial real estate development............................. 19,086
Other unused lines of credit................................... 28,601
-------
$92,320
=======
All unused loan commitments are at adjustable rates that fluctuate with
prime rate, or are at fixed rates that approximate market rates. The current
amounts of these commitments approximate their fair value.
Most of the commercial loan commitments expire in one year or less. Other
commitments, including consumer loans and credit cards, typically have a
maturity of more than one year. Past experience indicates that many of these
commitments to extend credit will expire unused. However, as described in
"Liquidity and Asset and Liability Management", the Company believes that is
has adequate sources of liquidity to fund commitments that are drawn upon by
the borrower.
In addition to commitments to extend credit, the Bank also issues standby
letters of credit which are assurances to a third party that they will not
suffer a loss if the Bank's customer fails to meet its contractual obligation
to the third party. Standby letters of credit totaled $2.1 million at December
31, 2001. Past experience
12
indicates that many of these standby letters of credit will expire unused.
However, through its various sources of liquidity, the Bank believes that it
will have the necessary resources to meet these obligations should the need
arise.
Neither the Company nor its subsidiaries is involved in other off-balance
sheet contractual relationships, unconsolidated related entities that have
off-balance sheet arrangements, or transactions that could result in liquidity
needs or other commitments or significantly impact earnings. Obligations under
noncancelable operating lease agreements totaled $3.5 million at December 31,
2001. These obligations are payable over several years as shown in Note 13 to
the Company's consolidated financial statements.
General
Palmetto Bancshares achieved record earnings in 2001 of $8.4 million,
increasing 20% from $7.0 million in 2000. Basic and dilutive earnings per share
in 2001 improved to $1.34 and $1.31, respectively, compared with $1.12 and
$1.09, respectively in 2000. Net income was $8.1 million in 1999. Basic and
dilutive earnings per share totaled $1.30 and $1.26 in 1999, respectively. Net
earnings resulted in a return on average assets of 1.20% in 2001, 1.10% in
2000, and 1.35% in 1999. The return on average equity for the three years ended
December 31, 2001 was 14.82%, 14.26%, and 17.89%, respectively.
The Company's earnings accelerated during 2001 principally as a result of
growth in net interest income. The Company's net interest margin improved from
4.53% in 2000 to 4.60% in 2001. Another important highlight in 2001 was the 35%
increase in non-interest income over 2000 principally due to the increase in
service charges on deposit accounts. During 2001, non-interest expense
increased by 18% due principally to the increase in salaries and other
personnel expenses. Provision for loan losses increased slightly from 2000 to
2001, as expected. There were significant charge-offs during 2001 that related
to the sales finance portfolio, as was also the case in 2000. (see further
discussion below) In 2001, a total of $4.0 million of loans was charged off,
56% of which were sales finance loans. Management has continued to reduce the
sales finance portfolio, which decreased 31% from $23.1 million in 2000 to
$15.9 million in 2001.
During 2000, net income decreased to $7.0 million from $8.1 in 1999. The
decrease was principally due to the decrease in the net interest margin and the
increase in the provision for loan losses. The net interest margin decreased 34
basis points, from 4.87% in 1999 to 4.53% in 2000. The Bank recorded
charge-offs of $5.0 million during 2000, 21/2 times that of the previous year.
Approximately 76% of those charge-offs related to sales finance loans. The
sales finance portfolio naturally includes loans with more inherent risk than
the loans in the Bank's direct lending portfolio. During mid 1999, management
noted deterioration in the performance of the portfolio which resulted in the
Bank redirecting its emphasis on indirect-lending in the sales finance area to
purchasing higher-quality indirect loans and reducing the number of
lower-quality loans in the portfolio. Management reduced the sales finance
portfolio from $36.8 million to $23.1 million at December 31, 1999 and 2000,
respectively. Management also made certain organizational changes in the sales
finance department to improve the asset quality. As the lower quality loans
seasoned, the level of charge-offs arising from these loans increased in 2000,
as expected. In addition to the increased charge-offs on the sales finance
loans, the Bank also experienced increased losses on the sale of the
automobiles repossessed in conjunction with the defaulted loans due to the high
volume of cars to be sold at auction.
13
Financial Condition
As of December 31, 2001, 2000 and 1999
At December 31, 2001, Bancshares had total assets of $735.3 million,
increasing by $71.9 million or 11% from December 31, 2000. Asset growth was
principally attributable to a $16.1 million increase in federal funds sold, a
$55.4 million increase in net loans and a $9.4 million increase in loans held
for sale. An $8.6 million decrease in cash and due from banks and a $3.5
million decrease in investment securities available for sale offset these
increases. Average assets increased by approximately 10% during the year while
average interest earning assets increased by almost 11%. During 2001, total
deposits increased $72.6 million principally in the transaction deposit
accounts and other time deposit accounts. Securities sold under repurchase
agreements and commercial paper decreased by $8.9 million as a result of lower
rates paid on these instruments.
At December 31, 2000, Bancshares had assets that totaled $663.4 million,
increasing by $37.6 million or 6% from December 31, 1999. Asset growth was
principally attributed to growth in net loans, which increased by $53.4 million
during 2000, offset by a decrease in cash and due from banks of $6.1 million
and a decrease in investment securities available for sale of $8.2 million.
The table on the following page shows the average balances and distributions
of the Company's assets and liabilities for each of the last four years.
14
TABLE 1
Distribution of Assets and Liabilities
(Dollars in Thousands)
Years Ended December 31,
----------------------------------------------------------------------
2001 2001 2000 2000 1999 1999 1998 1998
-------- ------ -------- ------ -------- ------ -------- ------
Average % of Average % of Average % of Average % of
Balance Total Balance Total Balance Total Balance Total
-------- ------ -------- ------ -------- ------ -------- ------
ASSETS
Cash and due from banks............... $ 24,974 3.57% $ 24,688 3.88% $ 25,416 4.27% $ 22,244 4.11%
Federal funds sold.................... 7,192 1.03% 3,340 0.52% 5,287 0.89% 3,876 0.72%
Federal Home Loan Bank stock.......... 1,733 0.25% 1,733 0.27% 1,691 0.28% 1,520 0.28%
Taxable investment securities......... 57,786 8.27% 44,770 7.04% 40,596 6.82% 53,756 9.92%
Non-taxable investment securities..... 37,010 5.30% 63,821 10.03% 69,950 11.74% 48,879 9.02%
Loans, net of unearned discount....... 542,024 77.59% 470,381 73.93% 430,960 72.35% 390,776 72.13%
Less: allowance for loan losses.... (5,527) -0.79% (5,921) -0.93% (6,085) -1.02% (5,393) -1.00%
-------- ------ -------- ------ -------- ------ -------- ------
Net loans...................... 536,497 76.80% 464,460 73.00% 424,875 71.33% 385,383 71.13%
Premises and equipment, net........... 17,791 2.55% 16,641 2.62% 15,230 2.56% 14,255 2.63%
Accrued Interest...................... 4,846 0.69% 4,657 0.73% 4,344 0.73% 4,065 0.75%
Other assets.......................... 10,771 1.54% 12,179 1.91% 8,289 1.39% 7,821 1.44%
-------- ------ -------- ------ -------- ------ -------- ------
Total assets................... $698,600 100.00% $636,289 100.00% $595,678 100.00% $541,799 100.00%
======== ====== ======== ====== ======== ====== ======== ======
LIABILITIES AND
SHAREHOLDERS' EQUITY
Liabilities
Deposits:
Non-interest-bearing deposits...... 92,792 13.28% 89,107 14.00% 82,921 13.92% 73,266 13.52%
Interest-bearing demand............ 204,983 29.34% 183,194 28.79% 165,370 27.76% 147,580 27.24%
Savings............................ 32,593 4.67% 32,578 5.12% 31,308 5.26% 28,718 5.30%
Time............................... 272,818 39.05% 237,380 37.31% 232,806 39.08% 218,185 40.27%
-------- ------ -------- ------ -------- ------ -------- ------
Total deposits................. 603,186 86.34% 542,259 85.22% 512,405 86.02% 467,749 86.33%
Federal funds purchased and
securities sold under agreements
to repurchase....................... 18,520 2.65% 26,396 4.15% 19,295 3.24% 18,747 3.46%
Commercial paper...................... 13,310 1.91% 15,945 2.51% 15,273 2.56% 12,668 2.34%
Other liabilities..................... 6,888 0.99% 2,783 0.44% 3,611 0.61% 3,083 0.57%
-------- ------ -------- ------ -------- ------ -------- ------
Total liabilities.............. 641,904 91.88% 587,383 92.31% 550,584 92.43% 502,247 92.70%
Shareholders equity:
Common stock--$5.00 par
value............................ 31,315 4.48% 31,123 4.89% 31,042 5.21% 30,890 5.70%
Capital surplus.................... 40 -- 19 -- -- -- 19 --
Retained earnings.................. 24,705 3.54% 19,898 3.13% 14,277 2.40% 8,385 1.55%
Less: Treasury stock............... -- -- -- -- -- -- -- --
Accumulated other
comprehensive income (loss)...... 636 0.09% (2,134) -0.34% (225) -0.04% 258 0.05%
-------- ------ -------- ------ -------- ------ -------- ------
Total shareholders' equity..... 56,696 8.12% 48,906 7.69% 45,094 7.57% 39,552 7.30%
-------- ------ -------- ------ -------- ------ -------- ------
Total liabilities and
shareholders' equity......... $698,600 100.00% $636,289 100.00% $595,678 100.00% $541,799 100.00%
======== ====== ======== ====== ======== ====== ======== ======
15
Loans and Asset Quality
Management of the Company believes that the loan portfolio is adequately
diversified. Commercial loans are spread through numerous types of businesses
with no particular industry concentrations. Loans to individuals are made
primarily to finance consumer goods purchased. At December 31, 2001, total
loans, net of unearned discounts, were 82% of total earning assets. Loans
secured by real estate accounted for 60% of total loans as of December 31,
2001. Most of the loans classified as real estate-mortgage are commercial loans
where real estate provides additional collateral.
At December 31, 2001, the sales finance portfolio was $15.9 million compared
to $23.1 million at December 31, 2000. The sales finance portfolio includes
loans with more inherent risk than the loans in the Bank's direct lending
portfolio. During mid 1999, management noted deterioration in the performance
of the portfolio that resulted in increased charge-offs during 2000 and 2001.
In estimating the allowance for loan losses at December 31, 2001 and in
allocating portions of the allowance to specific portions of the loan
portfolio, management has taken these factors into consideration and has
allocated what it believes to be an adequate portion of the allowance to the
sales finance portfolio.
Non-accrual loans are those loans which management, through its continuing
evaluation of loans, has determined offer a more than normal risk of
collectability of future interest. Interest income on non-accrual loans is
recognized only as received. Interest on past due loans continues to accrue
until such time that the loans are either charged-off or placed on non-accrual
status. The non-accrual loan policy provides that it is the responsibility of
the chief credit officer to administer the placing of loans on non-accrual
status. Loans that become ninety days past due will be placed on non-accrual.
Loans on which bankruptcy notices are received will also be placed on
non-accrual. In addition, other loans on which repayment appears doubtful may
be placed on non-accrual at the discretion of the chief credit officer.
Non-performing loans (which consist of loans on non-accrual and loans
greater than 90 days, but still accruing) for 2001, 2000 and 1999 were
approximately $4.0 million or 0.73% (of total loans), $3.2 million or 0.65% and
$1.6 million or 0.37%, respectively. For information on impaired loans, please
see footnote number 4.
Table 2 on page 17 sets forth, for each loan category, the amounts of total
loans 90 days or more past due and on non-accrual, the amounts of total loans
90 days or more past due and accruing, total loans outstanding, the percentage
of each type of loan 90 days or more past due and the amount of foregone
interest income for each of the five years for December 31, 1997 through
December 31, 2001.
16
TABLE 2
Nonperforming Loans
(Dollars in Thousands)
90 Days or Foregone
More Past Percentage Interest
Due and not 90 Days or Income
Non- on Total Loans More Past From
Accrual Non-Accrual Outstanding Due Non-Accrual
------- ----------- ----------- ---------- -----------
December 31, 2001:
Commercial, financial and agricultural. $ 811 139 154,069 0.62% $ 48
Real estate - construction............. -- -- 22,836 0.00 --
Real estate - mortgage................. 2,074 -- 310,981 0.67 171
Installment loans to individuals....... 514 491 65,935 1.52 106
------ --- ------- ---- ----
Total.............................. $3,399 630 553,821 0.73% $325
====== === ======= ==== ====
December 31, 2000:
Commercial, financial and agricultural. $ 873 -- 123,727 0.71% $ 68
Real estate - construction............. -- -- 14,321 0.00 --
Real estate - mortgage................. 1,103 -- 283,541 0.39 140
Installment loans to individuals....... 1,055 193 76,653 1.63 176
------ --- ------- ---- ----
Total.............................. $3,031 193 498,242 0.65% $384
====== === ======= ==== ====
December 31, 1999:
Commercial, financial and agricultural. $ 805 -- 107,934 0.75% $ 98
Real estate - construction............. -- -- 13,373 0.00 --
Real estate - mortgage................. 329 -- 231,637 0.14 21
Installment loans to individuals....... 387 109 92,813 0.53 121
------ --- ------- ---- ----
Total.............................. $1,521 109 445,757 0.37% $240
====== === ======= ==== ====
December 31, 1998:
Commercial, financial and agricultural. $ 223 -- 93,343 0.24% $ 26
Real estate - construction............. -- -- 10,341 0.00 --
Real estate - mortgage................. 445 -- 215,709 0.21 22
Installment loans to individuals....... 817 87 93,873 0.96 82
------ --- ------- ---- ----
Total.............................. $1,485 87 413,266 0.38% $130
====== === ======= ==== ====
December 31, 1997:
Commercial, financial and agricultural. $ 63 -- 81,678 0.08 $ 2
Real estate - construction............. -- -- 8,799 0.00 --
Real estate - mortgage................. 256 -- 195,462 0.13 26
Installment loans to individuals....... 399 144 81,646 0.67 38
------ --- ------- ---- ----
Total.............................. $ 718 144 367,585 0.23% $ 66
====== === ======= ==== ====
17
Allowance for Loan Losses
Management maintains an allowance for loan losses, which it believes is
adequate to cover inherent losses in the loan portfolio. The allowance for loan
losses is comprised of the allowance needed for specific loans and specific
loan portfolios. The Company performs periodic reviews of its loan portfolios
to identify and assess the overall risk in the portfolios. Homogeneous portions
of the loan portfolio, including residential mortgage loans, consumer loans,
credit card receivables and sales finance loans, are generally evaluated as a
group based on loan type. A risk factor is determined for each loan type based
on historical loss levels, delinquency data, economic trends, market conditions
and concentrations of credit. The allowance for the commercial loan portfolio
is based on loan grades. All loans in the commercial loan portfolio are graded
at inception and are reviewed on a periodic basis on performance, size and
other factors. Commercial loans are then assigned a risk factor based on the
loan grade, economic trends and other factors determined by management. The
risk factors are applied to the individual loans and loan portfolios in order
to provide a basis for establishing an adequate level of allowance for loan
losses. The allowance for loan losses is all allocated.
The following table sets forth the breakdown of the Company's allowance for
loan losses by loan category at the dates indicated. Management believes that
the allowance for loan losses can be allocated by category only on an
approximate basis. The allocation of the allowance to each category is not
necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.
2001 2000 1999 1998 1997
------------- ------------ ------------ ------------ ------------
% of % of % of % of % of
Total Total Total Total Total Total Total Total Total Total
------ ------ ----- ------ ----- ------ ----- ------ ----- ------
Balance applicable to:
Commercial,
financial
and agricultural... $1,266 22.38% 1,741 31.97% 2,022 31.78% 1,309 22.59% 1,145 22.22%
Real estate-
construction....... 130 2.30 32 0.59 31 .49 145 2.50 123 2.39
Real estate-
mortgage........... 2,507 44.30 1,123 20.62 778 12.23 3,025 52.20 2,739 53.17
Installment loans to
individuals........ 1,755 31.02 2,550 46.82 3,531 55.50 1,316 22.71 1,145 22.22
------ ------ ----- ------ ----- ------ ----- ------ ----- ------
Total............ $5,658 100.00% 5,446 100.00% 6,362 100.00% 5,795 100.00% 5,152 100.00%
====== ====== ===== ====== ===== ====== ===== ====== ===== ======
The process by which the Company determines the allowance for loan losses
requires considerable judgment. Factors considered in determining the allowance
for loan losses include lending trends, geographic and industry concentrations,
changes in type and mix of loans originated and overall economic trends.
Management's judgment is based upon a number of assumptions about future events
which are believed to be reasonable, but which may or may not prove valid.
Thus, there can be no assurance that charge-offs in future periods will not
exceed the allowance for loan losses or that additional increases in the
allowance for loan losses will not be required. The allowance for loan losses
is also subject to periodic evaluation by various regulatory authorities and
may be subject to adjustment, based upon information that is available to them
at the time of their examination.
18
The following table summarizes the activity in the allowance for loan losses
for the years indicated.
TABLE 3
Summary of Loan Loss and Recovery Experience
(Dollars in Thousands)
2001 2000 1999 1998 1997
-------- ------- ------- ------- -------
Average loans, net of unearned discount............... $542,024 470,381 430,960 390,776 350,493
======== ======= ======= ======= =======
Allowance for loan losses:
Beginning balance.................................. $ 5,446 6,362 5,795 5,152 4,729
Add provision for loan losses...................... 4,038 3,880 2,431 1,877 1,331
Loan charge-offs:
Commercial, financial and agricultural............. 809 390 532 344 158
Real estate-construction........................... 50 -- -- -- --
Real estate-mortgage............................... 28 -- -- -- --
Installment loans to individuals................... 3,146 4,597 1,441 1,018 891
-------- ------- ------- ------- -------
Total loan charge-offs................................ 4,033 4,987 1,973 1,362 1,049
Recoveries of loans previously charged-off:
Commercial, financial and agricultural............. 8 15 22 5 56
Real estate-construction........................... 9 -- -- -- --
Real estate-mortgage............................... -- -- -- -- --
Installment loans to individuals................... 190 176 87 123 85
-------- ------- ------- ------- -------
Total recoveries of loans previously charged-off...... 207 191 109 128 141
-------- ------- ------- ------- -------
Net charge-offs................................ 3,826 4,796 1,864 1,234 908
-------- ------- ------- ------- -------
Ending balance........................................ $ 5,658 5,446 6,362 5,795 5,152
======== ======= ======= ======= =======
Net charge-offs to average loans, net................. .71% 1.02% 0.43% 0.32% 0.26%
Allowance for loan losses to average loans, net....... 1.04 1.16 1.48 1.48 1.47
Allowance for loan losses to total loans at period-end 1.02 1.09 1.43 1.40 1.40
Losses and recoveries are charged or credited to the allowance at the time
realized.
Deposits
At December 31, 2001, the Company's total deposits increased $72.6 million
or 13% from $572.7 million to $645.3 million. Management believes that market
conditions in 2001 were more favorable for deposit growth. Factors such as the
lower returns on investments and mutual funds and the fluctuations in the stock
market may have contributed to the increase in deposits during 2001.
Retail deposits have traditionally been the primary source of funds for the
Company and also provide a customer base for the sale of additional financial
products and services. At December 31, 2001, transaction accounts made up 39%
of total deposits, while time deposits made up 45% of total deposits. Savings
and other money market accounts made up the remainder of total deposits. The
following table sets forth, by time remaining to maturity, domestic
certificates of deposit over $100, as of December 31, 2001, 2000 and 1999.
19
TABLE 4
Maturities of Time Deposits Over $100
2001 2000 1999
------- ------- -------
Maturities:
3 months or less.................................. $32,006 $26,187 $21,451
3 through 6 months................................ 16,755 8,553 17,901
6 through 12 months............................... 20,375 17,859 10,717
Over 12 months.................................... 7,900 11,245 3,768
------- ------- -------
$77,036 $63,844 $53,837
======= ======= =======
Capital Resources
Average shareholder's equity was $56.7 million during 2001, or 8.12% of
average assets, increasing from 7.69% during 2000. The Consolidated Statements
of Shareholders' Equity and Comprehensive Income contained in Item 8 herein
provide details of the changes in stockholders' equity during the year. At
December 31, 2001 and 2000 the Company and the Bank were each categorized as
"well capitalized," under the regulatory framework for prompt corrective
action. There are no current conditions or events that management believes
would change the Company's or the Bank's category. Please see notes to
consolidated financial statements number 16 for the Company's and the Bank's
various capital ratios at December 31, 2001.
Liquidity and Asset and Liability Management
Liquidity
The liquidity ratio is an indication of a company's ability to meet its
short-term funding obligations. The Company's policy is to maintain a liquidity
ratio between 10%-25%. At December 31, 2001 and 2000, the Company's liquidity
ratio was 17% and 13%, respectively. The Company's liquidity position is
dependent upon its debt servicing needs and dividends declared. The Company had
no outstanding debt at December 31, 2001 and 2000, respectively.
The Parent Company offers commercial paper as an alternative investment tool
for its commercial customers (Master note program). The commercial paper is
issued only in conjunction with the automated sweep account customer agreement
on deposits at the Bank level. At December 31, 2001, the Company had $11.1
million in commercial paper with a weighted average rate paid during the year
of 2.70%, as compared to $15.4 million in 2000 with a weighted average paid
during the year of 4.95% and $12.6 million in 1999 with a weighted average rate
paid during the year of 3.44%.
The Company's liquidity needs are met through the payment of dividends from
the Bank. At December 31, 2001, the Bank had available retained earnings of
$11.7 million for payment of dividends to remain "well capitalized." Prior
approval of the Office of the Commissioner of Banking, State Board of Financial
Institutions is required for any payment of dividends by a state bank.
The Bank's liquidity is affected by its ability to attract deposits, the
maturity of its loan portfolio, the flexibility of its investment securities,
alternative sources of funds, and current earnings. Sufficient liquidity must
be available to meet continuing loan demand and deposit withdrawal
requirements. Competition for deposits is intense in the markets served by the
Bank. However, the Bank has been able to attract deposits as needed through
pricing adjustments and expansion of its geographic market area. The deposit
base is comprised of diversified customer deposits with no one deposit or type
of customer accounting for a significant portion. Therefore, withdrawals are
not expected to fluctuate from historical levels. The loan portfolio of the
Bank is a source of liquidity through maturities and repayments by existing
borrowers. Loan demand has been constant and loan
20
originations can be controlled through pricing decisions. The investment
securities portfolio is a source of liquidity through scheduled maturities and
sales of securities, and prepayment of principal on mortgage-backed securities.
Approximately 72% of the securities portfolio was pledged to secure liabilities
as of December 31, 2001, as compared to 84% at December 31, 2000. If needed,
alternative funding sources have been arranged through federal funds lines at
correspondent banks, the FHLB, and the Federal Reserve Discount Window. At
December 31, 2001, the Bank has unused short-term lines of credit totaling
approximately $42 million (which are withdrawable at the lender's option). At
December 31, 2001, unused borrowing capacity from the FHLB totaled $71 million.
Management believes that its sources of liquidity are adequate to meet
operational needs and to maintain the liquidity ratio within policy guidelines.
The FHLB requires that securities, qualifying single family mortgage loans
and stock of the FHLB owned by the Bank be pledged to secure any advances from
the FHLB. The unused borrowing capacity currently available from the FHLB ($71
million as discussed above) assumes that the Bank's $1.7 million investment in
FHLB stock as well as certain securities and qualifying mortgages would be
pledged to secure any future borrowings. The Bank believes that it could obtain
additional borrowing capacity from the FHLB by identifying additional
qualifying collateral that could be pledged.
Asset-Liability Management and Market Risk Sensitivity
Market risk is the risk of loss from adverse changes in market prices and
rates. The Company's market risk arises principally from interest rate risk
inherent in its lending, deposit, borrowing and investing activities.
Management actively monitors and manages its inherent rate risk exposure.
Although the Company manages other risks, as in credit quality and liquidity
risk, in the normal course of business, management considers interest rate risk
to be its most significant market risk and could potentially have the largest
material effect on the Company's financial condition and results of operations.
Other types of market risks, such as foreign currency exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings. A sudden and substantial increase in
interest rates may adversely impact the Company's earnings to the extent that
the interest rates on interest-earning assets and interest-bearing liabilities
do not change at the same speed, to the same extent or on the same basis. The
Company monitors the impact of changes in interest rates on its net interest
income using several tools.
The Bank's goal is to minimize interest rate risk between interest bearing
assets and liabilities at various maturities through its Asset-Liability
Management (ALM). ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic
outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be
controlled by management. Understanding the current position and implications
of past decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.
Interest sensitivity management is part of the asset-liability management
process. Interest sensitivity gap (GAP) is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period. The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year. Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction accounts, time
deposits and borrowings. The profitability of the Company is influenced
significantly by management's ability to manage the relationship between rate
sensitive assets and liabilities. At December 31, 2001, approximately 28% of
the Company's earning assets could be repriced within one year compared to
21
approximately 96% of its interest-bearing liabilities. This compares to 24% and
92%, respectively, in 2000 and 25% and 95%, respectively, in 1999.
The Company's current GAP analysis reflects that in periods of increasing
interest rates, rate sensitive assets will reprice slower than rate sensitive
liabilities and at the interest repricing of one year, the Company's net
interest margin would be adversely impacted. On the flip side, the Company's
current GAP position would also be interpreted to mean that in periods of
declining interest rates, the Company's net interest margin would benefit. This
analysis, however, does not take into account the dynamics of the marketplace.
GAP is a static measurement that assumes if the prime rate increases or
decreases by 100 basis points, all assets and liabilities that are due to
reprice will increase or decrease by 100 basis points at the next opportunity.
The Company historically has experienced a benefit from rising rates in the
short term because deposit rates generally do not follow the national money
market. Usually, they are controlled by the local market. Traditionally, loans
do follow the money market; so when rates increase they reprice immediately,
but the Company is able to better manage the deposit side.
Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset-liability
strategies, which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point change over twelve months. At
December 31, 2001, this model shows that if interest rates rose by 300 basis
points over the next twelve months, net interest margin would be adversely
affected by approximately 16%. This model also shows that if interest rates
rose by only 100 or 200 basis points over the next twelve months, net interest
margin would be adversely affected by approximately 5% and 11%, respectively.
The model also shows that if interest rates dropped 300 basis points, the net
interest margin would benefit by approximately 2%. Similarly, if interest rates
dropped by only 100 or 200 basis points over the next twelve months, net
interest margin would benefit by approximately 4% under both scenarios. The
asset-liability committee meets weekly to address interest pricing issues, and
this model is reviewed monthly. Management will continue to monitor its
liability sensitive position in times of higher interest rates, which might
adversely affect its net interest margin.
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results. Further, the computations do not contemplate
any actions the Company could undertake in response to changes in interest
rates.
A market risk that does not directly affect net interest margin is the risk
of realizing the unrealized losses in the investment securities portfolio
($823,000 at December 31, 2001). Unrealized losses exist because current market
rates are higher than the weighted average rate on particular investment
instruments within the investment portfolio. Management does not intend to
liquidate the entire investment security portfolio, and therefore the
unrealized losses are not expected be realized. The Company has sufficient
liquidity without selling the investment security portfolio. The Company sees
the investment security portfolio as mainly an income source, not a liquidity
source.
On page 24, Table 5 shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity and
the instruments' fair values at December 31, 2001. Market risk sensitive
instruments are generally defined as on- and off-balance sheet derivatives and
other financial instruments.
Notes to Market Risk Sensitivity table:
. Expected maturities are contractual maturities adjusted for prepayments of
principal when possible. The Company uses certain assumptions to estimate
fair values and expected maturities.
22
. For loans, the Company has used contractual maturities due to the fact
that the Company has no historical information on prepayment speeds. Since
most of these loans are consumer and commercial loans, and since the
Company's customer base is community-based, the Company feels its
prepayment rates are insignificant.
. For mortgage-backed securities, expected maturities are based upon
contractual maturity, projected repayments and prepayment of principal.
The prepayment experience herein is based on industry averages as provided
by the Company's investment trustee.
. Loans receivable includes non-performing loans and unamortized deferred
loan costs, and is reduced by unamortized discounts. It does not include
Loans Held for Sale as those are not considered to be interest-sensitive
given that the Bank already has commitments to sell these loans at agreed
upon rates.
. Interest-bearing liabilities are included in the period in which the
balances are expected to be withdrawn as a result of contractual
maturities. For accounts with no stated maturities, the balances are
included in the one-day category.
. The interest rate sensitivity gap represents the difference between total
interest-earning assets and total interest-bearing liabilities.
An important aspect of achieving satisfactory net interest income is the
composition and maturities of rate sensitive assets and liabilities. Table 5
generally reflects that in periods of rising interest rates, rate sensitive
liabilities will reprice faster than rate sensitive assets, thus having a
negative effect on net interest income. It must be understood, however, that
such an analysis is as of December 31, 2001 and does not reflect the dynamics
of the market place. Therefore, management reviews simulated earnings
statements on a monthly basis to more accurately anticipate its sensitivity to
changes in interest rates.
23
TABLE 5
Market Risk Sensitivity
Expected Maturity/Repricing/Principal Repayments at December 31, 2001
2002
-----------------------------------------------
Average 2 Days to 3 to 6 6 to 12
Rate 1 Day 3 Months Months Months 2003 2004 2005 2006
------- --------- --------- -------- -------- -------- -------- -------- --------
Interest-sensitive assets:
Federal funds sold............ 4.48% $ 17,949 -- -- -- -- -- -- --
Federal Home Loan Bank
stock........................ 6.87% -- -- -- -- 1,733 -- --
Mortgage-backed
securities................... 6.27% -- 799 1,126 1,925 2,164 -- 2,425
Other investment securities... 5.73% -- 805 1,838 23,185 7,238 3,639 2,632 1,676
Loans receivable.............. 8.15% 98,265 10,038 25,169 6,811 51,668 44,239 126,126 27,179
---- --------- -------- -------- -------- -------- -------- -------- --------
Total interest-earning
assets...................... 7.63% $ 116,214 11,642 28,133 29,996 62,564 50,042 128,758 31,280
==== ========= ======== ======== ======== ======== ======== ======== ========
Interest-sensitive liabilities:
Interest-bearing demand....... 1.32% 151,211 -- -- -- -- -- -- --
Insured money markets......... 2.69% 69,149 -- -- -- -- -- -- --
Savings deposits.............. 1.41% 33,294 -- -- -- -- -- -- --
Time deposits over $100....... 437 31,419 16,755 20,524 4,803 838 1,841 419
Other time deposits........... 306 85,469 53,115 55,661 9,938 2,850 3,519 974
---- --------- -------- -------- -------- -------- -------- -------- --------
Total time deposits.......... 5.29% 743 116,888 69,870 76,185 14,741 3,688 5,360 1,393
==== ========= ======== ======== ======== ======== ======== ======== ========
Short-term borrowings......... 3.44% 26,389 -- -- -- -- -- -- --
---- --------- -------- -------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities................. 3.61% $ 280,786 116,888 69,870 76,185 14,741 3,688 5,360 1,393
==== ========= ======== ======== ======== ======== ======== ======== ========
Interest rate sensitivity gap. $(164,572) (105,246) (41,737) (46,189) 47,823 46,354 123,398 29,887
========= ======== ======== ======== ======== ======== ======== ========
Cumulative interest rate
sensitivity gap.............. $(164,572) (269,818) (311,555) (357,744) (309,921) (263,567) (140,169) (110,282)
========= ======== ======== ======== ======== ======== ======== ========
Cumulative interest rate
sensitive gap as a % of
total interest-earning
assets....................... -24.61% -40.36% -46.60% -53.51% -46.35% -39.42% -20.96% -16.49%
========= ======== ======== ======== ======== ======== ======== ========
Off-balance sheet items:
Commitments to extend
credit....................... * -- -- -- -- -- -- -- --
Unused lines of credit........ 5.07% -- -- -- -- -- -- -- --
There- Carrying Fair
after Value Value
------- -------- -------
Interest-sensitive assets:
Federal funds sold............ -- 17,949 17,949
Federal Home Loan Bank
stock........................ -- 1,733 1,733
Mortgage-backed
securities................... 1,375 9,814 9,814
Other investment securities... 44,268 85,281 85,281
Loans receivable.............. 164,326 553,821 552,630
------- ------- -------
Total interest-earning
assets...................... 209,969 668,598 667,407
======= ======= =======
Interest-sensitive liabilities:
Interest-bearing demand....... -- 151,211 151,211
Insured money markets......... -- 69,149 69,149
Savings deposits.............. -- 33,294 33,294
Time deposits over $100....... -- 77,036
Other time deposits........... 99 211,931
------- ------- -------
Total time deposits.......... 99 288,967 295,986
======= ======= =======
Short-term borrowings......... -- 26,389 26,389
------- ------- -------
Total interest-bearing
liabilities................. 99 569,010 576,029
======= ======= =======
Interest rate sensitivity gap. 209,870 99,588
======= =======
Cumulative interest rate
sensitivity gap.............. 99,588 --
======= =======
Cumulative interest rate
sensitive gap as a % of
total interest-earning
assets....................... 14.90% 0.00%
======= =======
Off-balance sheet items:
Commitments to extend
credit....................... 92,320 92,320 92,320
Unused lines of credit........ 18,449 18,449 18,449
- --------
* These rates will vary according to prime.
Please see Notes to Market Risk Sensitivity table on page 23.
NOTE: For information regarding how fair values were determined, please see
notes to consolidated financial statements, number 14.
24
The following table shows the amounts of loans included in Table 5,
excluding real estate-mortgage and installment loans to individuals, due to
mature and available for repricing within the time period stated.
TABLE 6
Maturities and Sensitivity of Selected Loans to Changes in Interest Rates
After 1 Year
----------------------------------
1 Year Through After 5
or Less Five Years Years Total
------- ---------- ------- -------
Commercial, financial and agricultural $56,233 80,871 16,965 154,069
Real estate-construction.............. 15,667 5,640 1,529 22,836
------- ------ ------ -------
Total.............................. $71,900 86,511 18,494 176,905
======= ====== ====== =======
The amounts of the preceding loans with maturity over one year, which have a
predetermined interest rate or a floating, or adjustable interest rate are as
follows:
December 31, 2001
-----------------
Predetermined interest rate.......................... $105,005
Floating or adjustable interest rate................. --
--------
Total............................................. $105,005
========
Twenty-five percent of total loans are repricable within one year.
Results of Operations
Three Years Ended December 31, 2001, 2000 and 1999
Net Interest Income
The largest component of the Company's net income is the Bank's net interest
income, defined as the difference between gross interest and fees on earning
assets (primarily loans and investment securities), and interest paid on
deposits and borrowed funds. Net interest income totaled $29.7 million in 2001
compared with $26.5 million in 2000 and $26.7 million in 1999. Changes in
interest earned on assets and interest paid on liabilities, the rate of growth
of the asset and liability base, the ratio of interest-earning assets to
interest-bearing liabilities and management of the balance sheet's interest
rate sensitivity all factor in to changes in net interest income. The Company
manages its net interest margin through strategic asset-liability management as
discussed in "Asset-Liability Management and Market Risk Sensitivity" above.
Net interest income increased by 12% to $29.7 million in 2001. During 2001,
the Company saw the yield on average interest earning assets decrease slower
than the cost of average interest-bearing liabilities. The net interest margin
was favorably impacted as a result of these market dynamics. At December 31,
2000, the tax equivalent yield on average earning assets was 8.21% and the cost
of average interest bearing liabilities was 4.11%. During 2001, the tax
equivalent yield on average earning assets decreased by 44 basis points to
7.77%, while the cost of average interest bearing liabilities decreased by 50
basis points to 3.61%.
Net interest income was relatively flat during 2000, decreasing a slight 1%
from $26.7 in 1999 to $26.5 in 2000. The tax equivalent yield on interest
earning assets increased from 8.08% in 1999 to 8.21% in 2000, while the average
effective rate paid on all interest bearing liabilities increased from 3.53% in
1999 to 4.11% in 2000.
As illustrated on Table 7 on page 26, for the year ended December 31, 2001,
the tax equivalent net interest margin was 4.75%, compared to 4.73% in 2000 and
5.09% in 1999.
During 2001, interest and fees on loans increased 9% from $40.4 million in
2000 to $44.1 million in 2001 primarily as a result of volume changes. Interest
on investment securities decreased 23% from $6.1 million to $4.7 million in
2001 due to both a decrease in volume and a decrease in the tax equivalent
weighted average rate on the security portfolio from 6.86% in 2000 to 5.81% in
2001. Interest and fees on loans increased 10% or $3.6 million from 1999 to
2000 primarily because of volume changes. Interest on investment securities
increased 2%, or $111,000 from 1999 to 2000 due to an increase in the tax
equivalent weighted average rate on the securities portfolio from 6.49% to
6.86%.
25
Rate/Volume Analysis
Table 7 includes, for the years ended December 31, 2001, 2000 and 1999
interest income earning assets and related average yields, as well as interest
expense on liabilities and related average rates paid. Also shown are the
dollar amounts of change due to rate and volume variances. The effect of the
combination of rate and volume change has been divided equally between the rate
change and volume change.
TABLE 7
Rate Volume Analysis
2001 2000
------------------------------------------ --------------------------------------
Average Yield/ Volume Rate Average Income/ Volume Rate
Balances Interest Rate Change Change Balances Expense Yield Change Change
-------- -------- ------ ------- ------- -------- ------- ----- ------ ------
Assets:
Interest-earning deposits............... $ 220 $ 8 3.64% $ 7 $ (4) $ 82 $ 5 6.10% $ (7) $ 1
Federal funds sold...................... 7,192 322 4.48% 225 (143) 3,340 240 7.19% (119) 90
Federal Home Loan Bank stock............ 1,733 120 6.92% -- (15) 1,733 135 7.79% 3 4
Taxable investment securities........... 57,786 2,005 3.47% 650 (1,565) 44,770 2,920 6.52% 268 79
Non-taxable investment securities (1)... 37,010 3,615 9.77% (2,201) 1,574 63,821 4,242 6.65% (404) 87
Non-taxable loans (2)................... 1,734 133 7.65% (17) 2 1,952 147 7.53% (37) (1)
Taxable Loans, net of unearned
discount (3).......................... 540,290 44,019 8.15% 6,018 (2,296) 468,429 40,297 8.60% 3,422 254
-------- ------- ---- ------- ------- -------- ------- ---- ------ ------
Total earning assets.............. 645,965 50,222 7.77% 4,683 (2,447) 584,127 47,986 8.21% 3,128 514
------- -------
Cash and due from banks................. 24,754 24,606
Allowance for loan losses............... (5,527) (5,921)
Premises and equipment, net............. 17,791 16,641
Accrued Interest........................ 4,846 4,657
Other assets............................ 10,771 12,179
-------- --------
Total assets...................... $698,600 $636,289
======== ========
Liabilities and Shareholders' Equity:
Interest-bearing demand deposits........ 204,983 3,584 1.75% 434 (953) 183,194 4,103 2.24% 366 658
Savings deposits........................ 32,593 458 1.41% 0 (180) 32,578 638 1.96% 25 (2)
Time deposits........................... 272,818 14,536 5.33% 1,936 (693) 237,380 13,293 5.60% 241 1,595
Federal funds purchased and securities
sold under agreements to repurchase.... 18,520 612 3.30% (363) (585) 26,396 1,560 5.91% 343 495
Commercial paper (Master notes)......... 13,310 359 2.70% (101) (329) 15,945 789 4.95% 28 235
Total interest-bearing liabilities... 542,224 19,549 3.61% 1,907 (2,741) 495,493 20,383 4.11% 1,003 2,981
Non-interest bearing demand deposits.... 92,792 89,107
Other liabilities....................... 6,888 2,783
Shareholders' equity.................... 56,696 48,906
-------- --------
Total liabilities and shareholders'
equity.............................. $698,600 $636,289
======== ========
Net interest income on a fully taxable
equivalent basis (1)/Net yield on
interest-earning assets (FTE).......... 30,673 4.75% 27,603 4.73%
1999
---------------------------------------
Average Income/ Volume Rate
Balances Expense Yield Change Change
-------- ------- ----- ------ -------
Assets:
Interest-earning deposits............... $ 211 $ 11 5.21% $ 6 $ --
Federal funds sold...................... 5,287 269 5.09% 74 (16)
Federal Home Loan Bank stock............ 1,691 128 7.57% 13 2
Taxable investment securities........... 40,596 2,573 6.34% (828) 44
Non-taxable investment securities (1)... 69,950 4,559 6.52% 1,421 (270)
Non-taxable loans (2)................... 2,442 185 7.57% 12 (2)
Taxable Loans, net of unearned
discount (3).......................... 428,518 36,621 8.55% 3,486 (1,334)
-------- ------- ---- ------ -------
Total earning assets.............. 548,695 44,346 8.08% 4,184 (1,577)
Cash and due from banks................. 25,205
Allowance for loan losses............... (6,085)
Premises and equipment, net............. 15,230
Accrued Interest........................ 4,344
Other assets............................ 8,289
--------
Total assets...................... $595,678
========
Liabilities and Shareholders' Equity:
Interest-bearing demand deposits........ 165,370 3,079 1.86% 334 (43)
Savings deposits........................ 31,308 615 1.96% 55 (103)
Time deposits........................... 232,806 11,457 4.92% 752 (1,001)
Federal funds purchased and securities
sold under agreements to repurchase.... 19,295 722 3.74% 21 (61)
Commercial paper (Master notes)......... 15,273 526 3.44% 98 (93)
Total interest-bearing liabilities... 464,052 16,399 3.53% 1,260 (1,301)
Non-interest bearing demand deposits.... 82,921
Other liabilities....................... 3,611
Shareholders' equity.................... 45,094
--------
Total liabilities and shareholders'
equity.............................. $595,678
========
Net interest income on a fully taxable
equivalent basis (1)/Net yield on
interest-earning assets (FTE).......... 27,947 5.09%
- --------
(1) Yields on non-taxable investment securities are stated on a fully taxable
equivalent basis, assuming a federal tax rate of 34% for the three years
reported on. The adjustments made to convert to a fully taxable equivalent
basis were $917, $1,076 and $1,157 for 2001, 2000 and 1999, respectively.
(2) Yields on non-taxable loans are stated on a fully taxable equivalent basis,
assuming a federal tax rate of 34% for the three years reported on. The
adjustments made to convert to a fully taxable equivalent basis were $34,
$37, and $47 for 2001, 2000 and 1999, respectively.
(3) The effect of foregone interest income as a result of loans on non-accrual
was not considered in the above analysis. All loans and deposits are
domestic.
26
Total interest expense decreased 4% during 2001 from $20.4 million to $19.5
million primarily as a result of rate changes, as the cost of interest bearing
liabilities adjusted downward 50 basis points during 2001. Although deposits
grew substantially during 2001, the decrease in the average interest rate paid
outpaced the interest expense increase due to volume. In 2000, the opposite was
true, as interest expense increased 24% from $16.4 million in 1999 to $20.4
million in 2000. The cost of interest bearing liabilities increased 58 basis
points during 2000, from 3.53% in 1999 to 4.11% in 2000.
Provision For Loan Losses
The provision for loan losses is a charge to earnings in a given period to
maintain the allowance at an adequate level. The provision for loan losses was
$4.0 million, $3.9 million and $2.4 million, respectively, for the years ended
December 31, 2001, 2000 and 1999. The progressive increase in the provision
over the last three years has been the result of higher charge-offs,
particularly in the sales finance area. Net charge-offs to average loans are
.71% or $3.9 million for 2001 as compared to 1.02% or $4.8 million for 2000 and
0.43% or $1.9 million for 1999. Charge offs in the sales finance portfolio
accounted for $2.3 million, or 58% of net charge-offs in 2001, and $3.8
million, or 79% of net charge-offs in 2000. Sales finance losses during 1999
were minimal. During 1999, the Bank redirected its emphasis on indirect-lending
in the sales finance area to purchasing higher-quality indirect loans and
reducing the number of lower-quality loans in the portfolio. Activities
associated with this process, as expected, contributed to the increase of
charge-offs as these lower quality loans were eliminated. The allowance for
loan losses totaled $5.6 million, $5.4 million and $6.4 million at December 31,
2001, 2000 and 1999, respectively. The level of the allowance for loan losses
to total loans outstanding is 1.02% at December 31, 2001. This compares to
1.09% as of December 31, 2000 and 1.43% as of December 31, 1999. Management
feels the 1.02% allowance for loan losses to total loans at December 31, 2001
is adequate because the allowance model described in the discussion on
allowance for loan losses takes into account the risk grades of loans,
delinquency trends, charge-off ratios and loan growth.
Non-Interest Income
Non-interest income increased by $3.3 million, or 35%, in 2001 to $12.9
million from $9.6 million in 2000. During 2000, non-interest income increased
by $1.5 million, or 18%, over 1999. The largest component of non-interest
income is service charges and fees on deposit accounts. Comprising 58% of total
non-interest income in 2001 and 49% in 2000, service charges on deposit
accounts improved to $7.4 million in 2001, from $4.6 million in 2000. The 59%
increase in 2001 was directly attributable to the introduction of an automatic
overdraft privilege offered to certain deposit customers. A $25.00 fee is
automatically charges to the customer's account each time an overdrawn check is
written, up to maximum overdraft amount of $500.00. Although management has
seen an increase in charge-offs of overdrawn accounts, the fee income generated
from this product more than offsets those increases. The increase in
charge-offs on overdrawn accounts was expected, as it is the Company's policy
to automatically charge off the account after it is 60 days past due.
Management views deposit fee income as a critical influence on profitability.
Periodic monitoring of competitive fee schedules and examination of alternative
opportunities insure that the Company realizes the maximum contribution to
profits from this area. Another principal increase during 2001 was the net
gains on sales of loans, increasing from $70,000 in 2000 to $684,000 in 2001.
Lower interest rates throughout the year improved fixed rate residential
mortgage production. The Bank typically sells a large majority of these loans
in the secondary market. Because interest rates are not expected to remain at
such low levels in subsequent quarters, the Company anticipates the possibility
of lower residential mortgage production and therefore smaller gains on the
sales of these loans.
During 2000, non-interest income increased by $1.5 million, or 18% over 1999
from $8.1 million to $9.6 million in 2000. Service charges on deposit accounts
increased 20% during 2000, from $3.9 million to $4.6 million in 2000. This
increase was a result of the increased collection of insufficient funds
associated with debit card transactions and the increase in the volume of
deposit relationships. Other income increased $774,000 or 39% due to increases
in several miscellaneous fees including ATM fees, mortgage service fees,
brokerage commissions and credit card fees.
27
Non-Interest Expense
Total non-interest expense increased $4.0 million, or 18%, in 2001 from
$22.5 million to $26.5 million. During 2000, these costs increased $1.3 million
or 6%. The largest component of non-interest expense, salaries and other
personnel, increased $2.9 million, or 27%, during 2001. The biggest portion of
salaries and other personnel expense is salary, which accounted for the biggest
increase during 2001 as a result of the increase in staff in various operation
and retail areas as well as normal raises throughout the year. Higher health
insurance costs were incurred as a result of the repricing of health insurance
plans effective January 2001. The Company experienced a 19.75% increase in the
monthly premiums for group medical/dental coverage. Also during 2001, incentive
compensation was higher as a direct result of the financial performance of the
Company during 2001. In 2000, salaries and other personnel expense did not have
significant increases over 1999 primarily as a result of lower incentive
compensation.
Combined net occupancy and furniture and equipment expense increased
$289,000 or 7% from 2000 to 2001 as compared to an increase of $181,000 or 5%
from 1999 to 2000. These increases are primarily related to remodeling and
expansion of current facilities, as well as improved technology during 2000 and
2001.
Sales finance losses on repossessed were significantly higher in 2000 than
2001. The losses were only $29,000 in 2001 compared to $557,000 in 2000. Losses
related to the sales finance portfolio prior to 2000 were immaterial due to the
low volume of repossessed automobiles. These losses included in the income
statement were a result of the sale of the repossessed autos. During 2001, the
Company valued repossessed automobiles more quickly and accurately through the
allowance for loan losses at the time of repossession. As a result, losses on
sales of the vehicles were lower.
Income Taxes
Income tax expense totaled $3.6 million in 2001, compared to $2.6 million in
2000 and $3.0 million in 1999. The Company's effective tax rate was 30.0% in
2001 and 27.4% in 2000 and 1999. The effective tax rate in future periods is
expected to range from 27% to 30%. Net income, income on tax-exempt investment
securities and loans, and the provision for loan losses affect taxable income.
For tax purposes, the Bank can recognize only actual loan losses. The Company
works actively with outside tax consultants to minimize tax expense.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in relative
purchasing power over time due to inflation. Virtually all of the assets and
liabilities of the Bank are monetary in nature and, as a result, its operations
can be significantly affected by interest rate fluctuations as discussed above.
Therefore, inflation will affect the Bank only to the extent that interest
rates change and according to the Bank's sensitivity to such changes. The
Company attempts to manage the effects of inflation through its asset-liability
management as described above in "Asset-Liability Management and Market Risk
Sensitivity."
Accounting and Reporting Matters
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an Amendment of FASB 133" establish accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and hedging activities. They require that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position, and measure those instruments at fair value. Changes in the fair
value of those derivatives will be reported in earnings or other comprehensive
income depending on the use of the derivative and whether the derivative
28
qualifies for hedge accounting. The Company adopted SFAS No. 133, as amended by
SFAS No. 138, on January 1, 1999. The adoption was not material to the
Company's consolidated financial statements except for in 1999 when the Company
transferred 100% of its held-to-maturity investment securities to the
available-for-sale category as allowed by the Statement.
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities--a replacement of FASB No. 125, " was issued
in September 2000. It revises the standards for accounting for securitizations
and other transfers of financial assets and collateral and requires certain
disclosures but carries over most of SFAS No. 125's provisions without
reconsideration. SFAS 140 is effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after March 31, 2001. This
statement is effective for recognition and reclassification of collateral and
for disclosures related to securitization transactions and collateral for
fiscal years ending after December 15, 2000. The adoption of the provisions of
SFAS No. 140 on April 1, 2001 did not have a material effect on the Company.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001.
SFAS 141 also specifies criteria intangible assets acquired in a purchase
method business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled workforce
may not be accounted for separately. The Company adopted SFAS No. 141 on July
1, 2001 and does not expect the Statement to have a material impact on the
financial statements in the future as the Company has always accounted for
business combinations through the purchase method.
SFAS No. 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."
Currently, it is the Company's understanding that SFAS No. 142 does not
apply to the acquisition of a commercial bank, a savings and loan association,
a mutual savings bank, a credit union, other depository institutions having
assets and liabilities of the same type as those instituions, and branches of
such enterprises. Intangible assets arising from these types of business
combinations must conform to the guidance in SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions", and are thus exlcuded
from the scope of SFAS No. 142. At December 31, 2001, the Company had
unamortized goodwill relating to core deposit premiums purchased of $408,000 as
well as unamortized goodwill defined in SFAS 72 as an unidentifiable intangible
asset ("Statement 72" goodwill) of $4.0 million. The Company plans to continue
amortizing these assets as directed in SFAS No. 72. It is the Company's
understanding that the FASB has undertaken a limited scope project to
reconsider part of the guidance in SFAS No. 72, particularly the p