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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] 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 0-23134
NB&T FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Ohio 31-1004998
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
48 N. South Street, Wilmington, Ohio 45177
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (513) 382-1441
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act:
Common Shares, without par value
(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 the 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [ ] No [X]
The issuer's common shares are not traded on any securities exchange and are not
quoted by a national quotation service. Management is aware of a sale of the
issuer's shares for $24.00 per share on February 25, 2003. Based upon such
price, the aggregate market value of the issuer's shares held by nonaffiliates
was $41,690,592.
As of March 19, 2003, 3,231,432 common shares were issued and outstanding.
1
DOCUMENTS INCORPORATED BY REFERENCE
The following sections of the definitive Proxy Statement for the 2003 Annual
Meeting of Shareholders of NB&T Financial Group, Inc. (the "Proxy Statement"),
are incorporated by reference into Part III of this Form 10-K:
1. Board of Directors;
2. Executive Officers;
3. Section 16(a) Beneficial Ownership Reporting Compliance;
4. Compensation of Executive Officers and Directors;
5. Voting Securities and Ownership of Certain Beneficial Owners and
Management; and
6. Certain Relationships and Related Transactions.
NB&T FINANCIAL GROUP, INC.
For the Year Ended December 31, 2002
Table of Contents
Page
----
PART I
Item 1: Business 3
Item 2: Properties 13
Item 3: Legal Proceedings 13
Item 4: Submission of Matters to a Vote of Security Holders 13
Part II
Item 5: Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6: Selected Financial Data 15
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 7A: Quantitative and Qualitative Disclosures About
Market Risk 26
Item 8: Financial Statements and Supplementary Data 27
Item 9: Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure 60
Part III
Item 10: Directors and Executive Officers of the Registrant 60
Item 11: Executive Compensation 60
Item 12: Security Ownership of Certain Beneficial Owners
and Management 60
Item 13: Certain Relationships and Related Transactions 60
Item 14: Controls and Procedures 60
Part IV
Item 15: Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 61
Exhibit Index 61
Signatures 62
Certifications 63
2
PART I
Item 1. Description of Business
GENERAL
NB&T Financial Group, Inc. ("NB&T Financial"), an Ohio corporation, is a bank
holding company which owns all of the issued and outstanding common shares of
The National Bank and Trust Company, chartered under the laws of the United
States (the "Bank"). The Bank is engaged in the commercial banking business in
Southwestern Ohio, providing a variety of consumer and commercial financial
services. The primary business of the Bank consists of accepting deposits,
through various consumer and commercial deposit products, and using such
deposits to fund consumer loans, including automobile loans, loans secured by
residential and non-residential real estate, and commercial and agricultural
loans. All of the foregoing deposit and lending services are available at each
of the Bank's 21 full-service offices. In addition, the Bank has one office
which has drive-in facilities only and two remote service units. The Bank has
also installed 65 cash dispensers in convenience stores in three states as of
the end of 2002. The Bank also has a trust department which presently
administers 696 accounts having combined assets of $196 million.
In December 2001, NB&T Financial acquired a majority of the assets, totaling $48
million, and assumed the deposit liabilities, totaling $42 million, of Sabina
Bank located in Sabina, Ohio, for an aggregate cash purchase price of
approximately $12.9 million.
The Bank operates its wholly-owned subsidiary NB&T Insurance Agency, Inc. ("NB&T
Insurance"). NB&T Insurance has four locations, with its principal office in
Wilmington, Ohio. During 2002, the Bank acquired one agency located in
Hillsboro, Ohio for a total of approximately $50,000 cash. This agency was
merged into NB&T Insurance. NB&T Insurance sells a full line of insurance
products, including: property and casualty, life, health, and annuities.
Because of its ownership of all the outstanding stock of the Bank, NB&T
Financial is subject to regulation, examination and oversight by the Board of
Governors of the Federal Reserve System (the "FRB") under the Bank Holding
Company Act of 1956, as amended (the "BHCA"). The Bank, as a national bank, is
subject to regulation, examination and oversight by the Office of the
Comptroller of the Currency (the "OCC") and special examination by the FRB. The
Bank is a member of the Federal Reserve Bank of Cleveland. In addition, since
its deposits are insured by the Federal Deposit Insurance Corporation (the
"FDIC"), the Bank is also subject to some regulation, oversight and special
examination by the FDIC. The Bank must file periodic financial reports with the
FDIC, the OCC and the Federal Reserve Bank of Cleveland. Examinations are
conducted periodically by these federal regulators to determine whether the Bank
and NB&T Financial are in compliance with various regulatory requirements and
are operating in a safe and sound manner.
Since its incorporation in 1980, NB&T Financial's activities have been limited
primarily to holding the common shares of the Bank. Consequently, the following
discussion focuses primarily on the business of the Bank.
FORWARD-LOOKING STATEMENTS
Statements preceded by, followed by or that otherwise include the words
"believes," "expects," "anticipates," "intends," "estimates," "plans," "may
increase," "may fluctuate," "will likely result," and similar expressions or
future or conditional verbs such as "will," "should," "would," and "could" are
generally forward-looking in nature and not historical facts. Results could
differ materially from those expressed in such forward-looking statements due to
a number of factors, including (1) the effect of economic conditions and
interest rates on a national, regional or international basis; (2) competitive
pressures in the retail banking, financial services, insurance and other
industries; (3) the financial resources of, and products available to,
competitors; (4) changes in laws and regulations, including changes in
accounting standards; (5) changes in policy by regulatory agencies; and (6)
changes in the securities markets. Any forward-looking statements are not
guarantees of future performance. They involve risks, uncertainties and
assumptions, and actual results could differ materially from those contemplated
by those forward-looking statements. Many of the factors that will determine
these results are beyond the Company's ability to control or predict. The
Company disclaims any duty to update any forward-looking statements, all of
which are qualified by the statements in this section.
3
Lending Activities
General. The Bank's income consists primarily of interest income generated by
lending activities, including the origination of loans secured by residential
and nonresidential real estate, commercial and agricultural loans, and consumer
loans.
Loan Maturity Schedule. The following table sets forth certain information at
December 31, 2002, regarding the net dollar amount of certain loans maturing in
the Bank's portfolio, based on contractual terms to maturity. Demand loans,
loans having no stated schedule of repayment and no stated maturity and
overdrafts are reported as due in one year or less (thousands):
Due 0-1 Year Due 1-5 Years Due 5+ Years Total
------------ ------------- ------------ --------
Commercial And Industrial $16,353 $36,925 $55,235 $108,513
Commercial Real Estate 278 5,746 22,155 28,179
Agricultural 8,977 4,517 7,363 20,857
------- ------- ------- --------
Total $25,608 $47,188 $84,753 $157,549
======= ======= ======= ========
The following table sets forth the dollar amount of certain loans, due after one
year from December 31, 2002, which have predetermined interest rates and
floating or adjustable interest rates (thousands):
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- --------
Commercial And Industrial $36,676 $55,484 $ 92,160
Commercial Real Estate 5,959 21,943 27,902
Agricultural 3,961 7,918 11,879
------- ------- --------
Total $46,596 $85,345 $131,941
======= ======= ========
Commercial and Industrial Lending. Commercial and industrial lending has been an
area of growth for the Bank. The Bank originates loans to businesses in its
market area, including "floor plan" loans to automobile dealers and loans
guaranteed by the Small Business Administration. The typical commercial borrower
is a small to mid-sized company with annual sales under $5,000,000. The majority
of commercial loans are made at adjustable rates of interest tied to the prime
rate. Commercial loans typically have terms of up to five years. At December 31,
2002 the Bank had $108.5 million, or 28% of total loans, invested in commercial
and industrial loans. Commercial and industrial lending entails significant
risks. Such loans are subject to greater risk of default during periods of
adverse economic conditions. Because such loans are secured by equipment,
inventory, accounts receivable and other non-real estate assets, the collateral
may not be sufficient to ensure full payment of the loan in the event of a
default.
Commercial Real Estate. The Bank makes loans secured by commercial real estate
located in its market area. Such loans generally are adjustable-rate loans for
terms of up to 20 years. The types of properties securing loans in the Bank's
portfolio include warehouses, retail outlets and general industrial use
properties. At December 31, 2002, the Bank had $28.2 million, or 7% of total
loans, invested in commercial real estate loans. Commercial real estate lending
generally entails greater risks than residential real estate lending. Such loans
typically involve larger balances and depend on the income of the property to
service the debt. Consequently, the risk of default on such loans may be more
sensitive to adverse economic conditions. The Bank attempts to minimize such
risks through prudent underwriting practices.
Agricultural Loans. The Bank makes agricultural loans, which include loans to
finance farm operations, equipment purchases, and land acquisition. The
repayment of such loans is significantly dependent upon income from farm
operations, which can be adversely affected by weather and other physical
conditions, government policies and general economic conditions. At December 31,
2002, the Bank had $20.9 million, or 5% of total loans, invested in agricultural
loans.
Residential Real Estate. The Bank makes loans secured by one- to four-family
residential real estate and multi-family (over four units) real estate located
in its market area. The Bank originates both fixed-rate mortgage loans and
adjustable-rate mortgage loans ("ARMs"). Fixed-rate loans with terms of 15 to 30
years are typically originated for sale in the secondary market. ARMs are held
in the Bank's portfolio. At December 31, 2002, the Bank had $141.4 million, or
37% of total loans, invested in residential real estate loans.
Installment Loans. The Bank makes a variety of consumer installment loans,
including home equity loans, automobile loans, recreational vehicle loans, and
overdraft protection. Consumer loans involve a higher risk of default than loans
secured by one- to four-family residential real estate, particularly in the case
of consumer loans which are unsecured or secured by rapidly depreciating assets,
such as automobiles. Repossessed collateral for a defaulted consumer loan may
not provide an adequate source of repayment of the outstanding loan balance as a
result of the greater likelihood of damage, loss or depreciation, and the
remaining deficiency may not warrant further substantial collection efforts
against the borrower. In addition, consumer loan collections depend on the
borrower's
4
continuing financial stability, and thus are more likely to be adversely
affected by job loss, illness or personal bankruptcy. Various federal and state
laws, including federal and state bankruptcy and insolvency laws, may also limit
the amount which can be recovered on such loans. Management believes that the
Bank's underwriting practices have resulted in a favorable delinquency ratio and
loan loss experience for this portion of the Bank's total loan portfolio.
At December 31, 2002, the Bank had $74.5 million, or 19% of total loans,
invested in installment loans. The Bank has reduced its efforts to originate new
and used automobile loans due to increased competition and narrowing interest
rate spreads. The Bank expects to continue, subject to market conditions, to
expand its other consumer lending activities as part of its plan to provide a
wide range of personal financial services to its customers.
Credit Card Service. The Bank offers credit card services directly through a
correspondent bank.
Loan Processing. Loan officers are authorized by the Board of Directors to
approve loans up to specified limits. Loans exceeding the loan officers'
approval authority are referred to the Bank's Senior Loan Committee. Any loans
made by the Bank in excess of the limits established for the Senior Loan
Committee must be approved by the Chairman of the Board and the President of the
Bank as representatives of the Board of Directors. All loans in excess of
$50,000 are reported to the Board on a monthly basis.
Loan Originations, Purchases and Sales. Although the Bank generally does not
purchase loans, purchases could occur in the future. Fixed-rate residential real
estate loans are originated for sale in the secondary market. From time to time,
the Bank sells participation interests in loans it originates.
Allowance for Loan Losses. Federal regulations require that the Bank establish
prudent general allowances for loan losses. Senior management, with oversight
responsibility provided by the Board of Directors, reviews on a monthly basis
the allowance for loan losses as it relates to a number of relevant factors,
including but not limited to, historical trends in the level of non-performing
assets and classified loans, current charge-offs and the amount of the allowance
as a percent of the total loan portfolio. While management believes that it uses
the best information available to determine the allowance for loan losses,
unforeseen market conditions could result in adjustments, and net earnings could
be significantly affected if circumstances differ substantially from the
assumptions used in making the final determination. At December 31, 2002, the
Bank's allowance for loan losses totaled $4.0 million, of which 61% was
allocated to specific credits, and the rest was allocated based on previous
charge-off experience, portfolio risk, economic conditions and anticipated loan
growth.
5
Because the loan loss allowance is based on estimates, it is monitored regularly
and adjusted as necessary to provide an adequate allowance.
The following table sets forth an analysis of the Bank's allowance for
losses on loans for the periods indicated (dollars in thousands):
December 31,
----------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Balance at beginning of period $ 3,810 $ 3,802 $ 3,222 $ 2,641 $ 2,761
Charge-offs:
Commercial and industrial (486) (691) (858) (200) (702)
Commercial real estate (53) (50) (15) (10) (45)
Agricultural (53) (119) (107) (10) --
Residential real estate (238) (150) (66) (9) --
Installment (1,346) (1,318) (825) (842) (681)
Other (9) (18) -- -- (7)
-------- -------- -------- -------- --------
Total charge-offs (2,185) (2,346) (1,871) (1,071) (1,435)
-------- -------- -------- -------- --------
Recoveries:
Commercial and industrial 49 33 62 27 7
Commercial real estate -- -- -- 9 --
Agricultural 10 9 5 -- --
Residential real estate 7 2 1 1 --
Installment 219 188 183 213 145
Other -- -- 1 2 13
-------- -------- -------- -------- --------
Total recoveries 285 232 252 252 165
-------- -------- -------- -------- --------
Net charge-offs (1,900) (2,114) (1,619) (819) (1,270)
Acquired in acquisition 622
Provision for possible loan losses 2,100 1,500 2,199 1,400 1,150
-------- -------- -------- -------- --------
Balance at end of period $ 4,010 $ 3,810 $ 3,802 $ 3,222 $ 2,641
======== ======== ======== ======== ========
Ratio of net charge-offs to average loans
outstanding during the period 0.49% 0.58% 0.44% 0.25% 0.44%
======== ======== ======== ======== ========
Average loans outstanding $385,324 $366,190 $367,419 $330,734 $287,674
======== ======== ======== ======== ========
The distribution of the Company's allowance for losses on loans at December 31,
2002 is as follows (thousands):
Loans in Each Category
as a Percentage of
Amount Total Loans
------ ----------------------
Commercial and industrial $ 314 28%
Commercial real estate 2,130 9
Agricultural 152 6
Residential real estate 332 37
Installment 896 19
Other 4 1
Unallocated 182 --
------ ---
Total $4,010 100%
====== ===
6
Investment Activities
The following table sets forth the composition of the Bank's securities
portfolio, based on amortized cost, at the dates indicated (thousands):
At December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Securities available for sale:
U.S. Treasuries & U.S. agency notes $ 44,315 $ 54,117 $ 49,641
U.S. agency mortgage-backed securities 101,495 96,071 39,857
Other mortgage-backed securities 3,077 5,021 11,164
Municipals 8,576 8,572 8,567
Other securities 8,010 8,010 10
-------- -------- --------
Total securities available for sale 165,473 171,791 109,239
-------- -------- --------
Securities held to maturity:
Municipals 44,490 44,430 44,374
-------- -------- --------
Total securities held to maturity 44,490 44,430 44,374
-------- -------- --------
Total securities $209,963 $216,221 $153,613
======== ======== ========
The following table sets forth the amortized cost of the Bank's securities
portfolio at December 31, 2002. U.S. agency mortgage-backed securities are
categorized according to their expected prepayment speeds. All other securities
are categorized based on contractual maturity. Actual maturities may differ from
contractual maturities when borrowers have the right to call or prepay
obligations. Yields do not include the effect of income taxes (dollars in
thousands).
Less than 1 Year 1 to 5 Years 5 to 10 Years Over 10 Years
-------------------- -------------------- -------------------- --------------------
Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield Cost Yield
--------- -------- --------- -------- --------- -------- --------- --------
Securities available for sale:
U.S. Treasuries & U.S. agency
notes $ -- 0% $ 40,075 3.57% $ 4,240 3.59% $ -- 0%
U.S. agency mortgage-backed
securities 3,306 6.48 64,343 5.33 33,193 4.85 654 6.20
Other mortgage-backed securities 3,046 2.04 30 2.57 -- -- -- --
Municipals -- -- -- -- -- -- 8,576 3.78
Other securities -- -- -- -- -- -- 8,010 3.18
------ -------- ------- -------
Total securities available for
sale 6,352 4.35 104,448 3.30 37,433 4.79 17,240 3.59
------ -------- ------- -------
Securities held to maturity:
Municipals 989 9.15 100 4.50 -- -- 43,401 5.04
------ -------- ------- -------
Total securities held to maturity 989 9.15 100 4.50 -- -- 43,401 5.04
------ -------- ------- -------
Total securities $7,341 5.00% $104,548 3.30% $37,433 4.79% $60,641 4.63%
====== ======== ======= =======
Total
--------------------
Weighted
Amortized Average
Cost Yield
--------- --------
Securities available for sale:
U.S. Treasuries & U.S. agency
notes $ 44,315 3.57%
U.S. agency mortgage-backed
securities 101,496 5.22
Other mortgage-backed securities 3,076 2.04
Municipals 8,576 3.78
Other securities 8,010 3.18
--------
Total securities available for
sale 165,473 3.75
--------
Securities held to maturity:
Municipals 44,490 5.13
--------
Total securities held to maturity 44,490 5.13
--------
Total securities $209,963 4.04%
========
7
Trust Services
The Bank received trust powers in 1922 and currently holds $196 million in net
assets held in 696 accounts on December 31, 2002 in the Trust Department. These
assets are not included in the Bank's balance sheet because, under federal law,
neither the Bank nor its creditors can assert any claim against funds held by
the Bank in its fiduciary capacity. In addition to administering trusts, the
services offered by the Trust Department includes investment management, estate
planning and administration, tax and financial planning and employee benefit
plan administration. The Trust Department also provides investment services to
customers of the Bank and others, enabling them to purchase fixed annuities,
variable annuities, mutual funds, and stocks and bonds. The Trust Department is
staffed by four officers and five staff members and generated $926,000 in fee
income during 2002.
Deposits and Borrowings
General. Deposits have traditionally been the primary source of the Bank's funds
for use in lending and other investment activities. In addition to deposits, the
Bank derives funds from interest payments and principal repayments on loans and
income on earning assets. Loan payments are a relatively stable source of funds,
while deposit inflows and outflows fluctuate more in response to general
interest rates and money market conditions.
Deposits. Deposits are attracted principally from within the Bank's market area
through the offering of numerous deposit instruments, including checking
accounts, regular passbook savings accounts, NOW accounts, money market deposit
accounts, term certificate accounts and individual retirement accounts ("IRAs").
Interest rates paid, maturity terms, service fees and withdrawal penalties for
the various types of accounts are established periodically by the Bank's
Asset/Liability Committee and the Executive Committee based on the Bank's
liquidity requirements, growth goals and market trends. The Company has not used
brokers in the past to attract deposits, although competition from banks and
other financial institutions has caused the Company to include this as a viable
alternative to funding needs. Currently the amount of deposits from outside the
Bank's market area is not significant.
The following table sets forth the dollar amount of time deposits
greater than $100,000 maturing in the periods indicated (thousands):
Maturity At December 31, 2002
-------------------------- --------------------
Three months or less $13,410
Over 3 months to 6 months 11,511
Over 6 months to 12 months 13,070
Over twelve months 4,642
-------
Total $42,633
=======
Borrowings. The Federal Reserve System functions as a central reserve bank
providing credit for its member banks and certain other financial institutions.
As a member in good standing of the Federal Reserve Bank of Cleveland, the Bank
is authorized to apply for advances, provided certain standards of
credit-worthiness have been met. The Bank is also a member of the Federal Home
Loan Bank system. The Bank currently has outstanding $108.3 million of
borrowings from the Federal Home Loan Bank used primarily to fund the purchase
of U.S. agency mortgage-backed securities and municipal bonds.
The following table sets forth certain information regarding the
Bank's outstanding borrowings at the dates and for the periods
indicated (dollars in thousands):
December 31,
---------------------------
2002 2001 2000
------- ------- -------
Maximum amount of short-term borrowings outstanding at any month
end during period $30,145 $44,158 $41,624
Average amount of short-term borrowings outstanding during period $23,445 $34,250 $33,486
Amount of short-term borrowings outstanding at end of period $19,240 $22,055 $40,148
Weighted average interest rate of short-term borrowings during period 1.33% 3.76% 6.05%
Weighted average interest rate of short-term borrowings at end of
period 0.87% 1.39% 6.14%
8
Average Balance Sheets
The following table presents, for the years indicated, the total dollar
amounts of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing
liabilities, expressed both in dollars and rates. The table does not
reflect any effect of income taxes and includes non-performing loans in the
calculations (dollars in thousands).
2002 2001
----------------------------------- -----------------------------------
Average Interest Average Interest
Outstanding Earned/ Outstanding Earned/
Balance Yield/Rate Paid Balance Yield/Rate Paid
----------- ---------- -------- ----------- ---------- --------
Loans (1) $385,324 7.55% $29,085 $366,190 8.33% $30,508
Securities available for sale 183,104 4.89 8,946 137,422 6.18 8,493
Securities held to maturity 44,456 5.13 2,281 44,398 5.12 2,275
Deposits in banks 893 1.57 14 461 2.39 11
Federal funds sold 10,270 1.53 157 19,073 3.70 706
-------- ------- -------- -------
Total interest-earning assets 624,047 6.49 40,483 567,544 7.40 41,993
Non-earning assets 56,778 47,082
Allowance for loan losses (3,865) (3,836)
-------- --------
Total assets $676,960 $610,790
======== ========
Savings deposits $ 40,487 1.08 437 $ 31,120 1.55 483
NOW and MMDA 173,392 1.39 2,410 136,002 2.71 3,679
CD's over $100M 40,497 3.57 1,444 53,125 5.45 2,895
Other time deposits 171,380 3.93 6,737 168,385 5.70 9,594
Short-term borrowings 25,571 1.32 339 34,250 3.76 1,287
Long-term debt 117,840 5.04 5,936 93,572 5.25 4,911
-------- ------- -------- -------
Total interest-bearing
liabilities 569,167 3.04 17,303 516,454 4.42 22,849
------- -------
Demand deposits 50,147 40,883
Other liabilities 3,593 2,778
Capital 54,053 50,675
-------- --------
Total liabilities and capital $676,960 610,790
======== ========
Net interest income $23,180 $19,144
======= =======
Interest rate spread 3.45% 2.98%
Net interest income margin 3.71% 3.37%
Ratio of interest-earning
assets to interest-bearing
liablilities 109.64% 109.89%
2000
-----------------------------------
Average Interest
Outstanding Earned/
Balance Yield/Rate Paid
----------- ---------- --------
Loans (1) $367,419 8.59% $31,549
Securities available for sale 104,483 6.77 7,073
Securities held to maturity 44,344 5.17 2,291
Deposits in banks 234 4.49 10
Federal funds sold 2,067 6.11 126
-------- -------
Total interest-earning assets 518,547 7.92 41,049
Non-earning assets 36,631
Allowance for loan losses (3,612)
--------
Total assets $551,566
========
Savings deposits $ 34,069 1.75 595
NOW and MMDA 109,935 3.24 3,565
CD's over $100M 43,672 5.95 2,600
Other time deposits 162,709 5.72 9,315
Short-term borrowings 33,482 6.05 2,024
Long-term debt 79,406 5.81 4,612
-------- -------
Total interest-bearing
liabilities 463,273 4.90 22,711
-------
Demand deposits 39,846
Other liabilities 2,725
Capital 45,722
--------
Total liabilities and capital $551,566
========
Net interest income $18,338
=======
Interest rate spread 3.02%
Net interest income margin 3.54%
Ratio of interest-earning
assets to interest-bearing
liablilities 111.93%
(1) Includes nonaccrual loans and loan fees.
9
The following table describes the extent to which the changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected the Bank's interest income and expense during the periods
indicated for each category of interest-earning assets and interest-bearing
liabilities. Information is provided on changes attributable to (i) changes
in volume (the difference between the average volume for the periods
compared, multiplied by the prior year's yield or rate paid), (ii) changes
in rate (the difference between the weighted average yield or rate paid for
the periods compared, multiplied by the prior year's average volume) and
(iii) changes not solely attributable to either volume or rate (thousands).
Years ended December 31,
2002 vs 2001
------------------------------------
Increase (decrease) due to
------------------------------------
Rate/
Volume Rate Volume Total
------- ------- ------ -------
Interest income attributable to:
Loans $1,484 $(2,704) $(203) $(1,423)
Securities available for sale 2,883 (1,942) (487) 454
Securities held to maturity 3 3 -- 6
Deposits in banks 11 (4) (4) 3
Federal funds sold (326) (414) 191 (549)
------ ------- ----- -------
Total interest-earning assets 4,055 (5,061) (503) (1,509)
------ ------- ----- -------
Interest expense attributable to:
Savings deposits 145 (147) (44) (46)
NOW and MMDA 1,012 (1,789) (492) (1,269)
CD's over $100,000 (688) (1,001) 238 (1,451)
Other time deposits 171 (2,975) (53) (2,857)
Short-term borrowings (326) (833) 211 (948)
Long-term debt 1,349 (197) (127) 1,025
------ ------- ----- -------
Total interest-bearing liabilities 1,663 (6,942) (267) (5,546)
------ ------- ----- -------
Net interest income $2,392 $ 1,881 $(236) $ 4,037
====== ======= ===== =======
Years ended December 31,
2001 vs 2000
-----------------------------------
Increase (decrease) due to
-----------------------------------
Rate/
Volume Rate Volume Total
------ ------- ------ -------
Interest income attributable to:
Loans $ (79) $ (869) $ (93) $(1,041)
Securities available for sale 2,273 (639) (214) 1,420
Securities held to maturity 3 (19) -- (16)
Deposits in banks 10 (5) (4) 1
Federal funds sold 1,040 (50) (410) 580
------ ------- ----- -------
Total interest-earning assets 3,247 (1,582) (721) 944
------ ------- ----- -------
Interest expense attributable to:
Savings deposits (52) (67) 7 (112)
NOW and MMDA 845 (590) (141) 114
CD's over $100,000 563 (220) (48) 295
Other time deposits 325 (44) (2) 279
Short-term borrowings 46 (767) (16) (737)
Long-term debt 823 (444) (80) 299
------ ------- ----- -------
Total interest-bearing
liabilities 2,550 (2,132) (280) 138
------ ------- ----- -------
Net interest income $ 697 $ 550 $(441) $ 806
====== ======= ===== =======
10
Competition
The Bank competes for deposits with other commercial banks, savings associations
and credit unions and with the issuers of commercial paper and other securities,
such as shares in money market mutual funds. The primary factors in competing
for deposits are interest rates and convenience of office location. In making
loans, the Bank competes with other commercial banks, savings associations,
mortgage bankers, consumer finance companies, credit unions, leasing companies,
insurance companies and other lenders. The Bank competes for loan originations
primarily through the interest rates and loan fees it charges and through the
efficiency and quality of services it provides to borrowers. Competition is
affected by, among other things, the general availability of lendable funds,
general and local economic conditions, current interest rate levels and other
factors which are not readily predictable. For years the Bank has competed
within its market area with several regional bank holding companies, each with
assets far exceeding those of the Bank. The size of these financial institutions
and others competing with the Bank is likely to increase further as a result of
changes in statutes and regulations eliminating various restrictions on
interstate and inter-industry branching and acquisitions. Community banks will
be challenged by these larger competitors and the greater capital resources they
control.
REGULATION
General
Because of its ownership of all the outstanding stock of the Bank, NB&T
Financial is subject to regulation, examination and oversight by the FRB as a
bank holding company under the BHCA. The Bank, as a national bank, is subject to
regulation, examination and oversight by the OCC and special examination by the
FRB. The Bank is a member of the Federal Reserve Bank of Cleveland and a member
of the Federal Home Loan Bank of Cincinnati. In addition, since its deposits are
insured by the FDIC, the Bank is also subject to some regulation, oversight and
special examination by the FDIC. The Bank must file periodic financial reports
with the FDIC, the OCC and the Federal Reserve Bank of Cleveland. Examinations
are conducted periodically by these federal regulators to determine whether the
Bank and NB&T Financial are in compliance with various regulatory requirements
and are operating in a safe and sound manner. In general, the FRB may initiate
enforcement actions for violations of law and regulations.
Bank Holding Company Regulation
The FRB has also adopted capital adequacy guidelines for bank holding companies,
pursuant to which, on a consolidated basis, NB&T Financial must maintain total
capital of at least 8% of risk-weighted assets. Risk-weighted assets consist of
all assets, plus credit equivalent amounts of certain off- balance sheet items,
which are weighted at percentage levels ranging from 0% to 100%, based on the
relative credit risk of the asset. At least half of the total capital to meet
this risk-based requirement must consist of core or "Tier 1" capital, which
includes common stockholders' equity, qualifying perpetual preferred stock (up
to 25% of Tier 1 capital) and minority interests in the equity accounts of
consolidated subsidiaries, less goodwill, certain other intangibles, and
effective April 1, 2001, portions of certain nonfinancial equity investments.
The remainder of total capital may consist of supplementary or "Tier 2 capital".
In addition to this risk- based capital requirement, the FRB requires bank
holding companies to meet a leverage ratio of a minimum level of Tier 1 capital
to average total consolidated assets of 3%, if they have the highest regulatory
examination rating, well-diversified risk and minimal anticipated growth or
expansion. All other bank holding companies are expected to maintain a leverage
ratio of at least 4% of average total consolidated assets. NB&T Financial was in
compliance with these capital requirements at December 31, 2002. For NB&T
Financial's capital ratios, see Note 13 to the Consolidated Financial Statements
in Item 8.
A bank holding company is required by law to guarantee the compliance of any
insured depository institution subsidiary that may become "undercapitalized"
(defined in the regulations as not meeting minimum capital requirements) with
the terms of the capital restoration plan filed by such subsidiary with its
appropriate federal banking agency.
The BHCA restricts NB&T Financial's ownership or control of the outstanding
shares of any class of voting stock of any company engaged in a nonbanking
business, other than companies engaged in certain activities determined by the
FRB to be closely related to banking. In addition, the FRB has the authority to
require a bank holding company to terminate any activity or relinquish control
of any nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the
determination by the FRB that such activity or control constitutes a serious
risk to the financial soundness and stability of any bank subsidiary of the bank
holding company. NB&T Financial currently has no nonbank subsidiaries, except
subsidiaries of the Bank. The ownership of subsidiaries of the Bank is regulated
by the OCC, rather than the FRB.
On November 12, 1999, President Clinton signed into law the Gramm-Leach- Bliley
Act (also known as the Financial Services Modernization Act of 1999). The
Financial Services Modernization Act permits, effective March 11, 2000, bank
holding companies to become financial holding companies and thereby affiliate
with securities firms and insurance companies and engage in other activities
that are financial in nature. A bank holding company may become a financial
holding company if each of its subsidiary banks is well capitalized under the
Federal Deposit Insurance Corporation Act of 1991 prompt corrective action
provisions, is well managed, and has at least a satisfactory rating under the
Community Reinvestment Act, by filing a declaration that the bank holding
company wishes to become a financial holding company. No regulatory approval
will be required for a financial holding company to acquire a
11
company, other than a bank or savings association, engaged in activities that
are financial in nature or incidental to activities that are financial in
nature, as determined by the Federal Reserve Board.
The Financial Services Modernization Act defines "financial in nature" to
include:
. securities underwriting, dealing and market making;
. sponsoring mutual funds and investment companies;
. insurance underwriting and agency;
. merchant banking; and
. activities that the Federal Reserve Board has determined to be closely
related to banking.
A national bank also may engage, subject to limitations on investment, in
activities that are financial in nature, other than insurance underwriting,
insurance company portfolio investment, real estate development and real estate
investment, through a financial subsidiary of the bank, if the bank is well
capitalized, well managed and has at least a satisfactory Community Reinvestment
Act rating. Subsidiary banks of a financial holding company or national banks
with financial subsidiaries must continue to be well capitalized and well
managed in order to continue to engage in activities that are financial in
nature without regulatory actions or restrictions, which could include
divestiture of the financial in nature subsidiary or subsidiaries. In addition,
a financial holding company or a bank may not acquire a company that is engaged
in activities that are financial in nature unless each of the subsidiary banks
of the financial holding company or the bank has a Community Reinvestment Act
rating of satisfactory or better. NB&T Insurance is a financial subsidiary.
Transactions between NB&T Financial and the Bank are subject to statutory limits
in Sections 23A and 23B of the Federal Reserve Act (the "FRA"). See National
Bank Regulation -- Office of the Comptroller of the Currency."
The FRB must approve the application of a bank holding company to acquire any
bank or savings association.
National Bank Regulation
Office of the Comptroller of the Currency. The OCC is an office in the
Department of the Treasury and is subject to the general oversight of the
Secretary of the Treasury. The OCC is responsible for the regulation and
supervision of all national banks, including the Bank. The OCC issues
regulations governing the operation of national banks and, in accordance with
federal law, prescribes the permissible investments and activities of national
banks. The Bank is authorized to exercise trust powers in accordance with OCC
guidelines. See "Description of Business-Trust Services." National banks are
subject to regulatory oversight under various consumer protection and fair
lending laws. These laws govern, among other things, truth-in-lending
disclosure, equal credit opportunity, fair credit reporting and community
reinvestment.
The Bank is required to meet certain minimum capital requirements set by the
OCC. These requirements consist of risk-based capital guidelines and a leverage
ratio, which are substantially the same as the capital requirements imposed on
NB&T Financial. The Bank was in compliance with those capital requirements at
December 31, 2002. For the Bank capital ratios, see Note 13 to the Consolidated
Financial Statements in Item 8. The OCC may adjust the risk-based capital
requirement of a national bank on an individualized basis to take into account
risks due to concentrations of credit or nontraditional activities.
The OCC has adopted regulations governing prompt corrective action to resolve
the problems of capital deficient and otherwise troubled national banks. At each
successively lower defined capital category, a national bank is subject to more
restrictive and numerous mandatory or discretionary regulatory actions or
limits, and the OCC has less flexibility in determining how to resolve the
problems of the institution. In addition, the OCC generally can downgrade a
national bank's capital category, notwithstanding its capital level, if, after
notice and opportunity for hearing, the national bank is deemed to be engaging
in an unsafe or unsound practice, because it has not corrected deficiencies that
resulted in it receiving a less than satisfactory examination rating on matters
other than capital or it is deemed to be in an unsafe or unsound condition. The
Bank's capital at December 31, 2002, met the standards for the highest capital
category, a well-capitalized bank.
A national bank is subject to restrictions on the payment of dividends,
including dividends to a holding company. A dividend may not be paid if it would
cause the bank not to meet its capital requirements. In addition, the dividends
that a Bank subsidiary can pay to its holding company without prior approval of
regulatory agencies is limited to net income plus its retained net income for
the preceding two years. Based on the current financial condition of the Bank,
these provisions are not expected to affect the current ability of the Bank to
pay dividends to NB&T Financial in an amount customary for the Bank.
OCC regulations generally limit the aggregate amount that a national bank can
lend to one borrower or aggregated groups of related borrowers to an amount
equal to 15% of the bank's unimpaired capital and surplus. A national bank may
loan to one borrower an additional amount not to exceed 10% of the association's
unimpaired capital and surplus, if the additional amount is fully secured by
certain forms of "readily marketable collateral." Loans to executive officers,
directors and principal shareholders and their related
12
interests must conform to the OCC lending limits. All transactions between
national banks and their affiliates, including NB&T Financial, must comply with
Sections 23A and 23B of the FRA, which limit the amounts of such transactions
and require that the terms of the transactions be at least as favorable to the
Bank as the terms would be of a similar transaction between the Bank and an
unrelated party. The Bank was in compliance with these requirements and
restrictions at December 31, 2002.
Federal Deposit Insurance Corporation. The FDIC is an independent federal agency
that insures the deposits, up to prescribed statutory limits, of federally
insured banks and thrifts and safeguards the safety and soundness of the banking
and thrift industries. The FDIC administers two separate insurance funds, the
BIF for commercial banks and state savings banks and the SAIF for savings
associations and for banks that have acquired SAIF deposits. The FDIC is
required to maintain designated levels of reserves in each fund.
The Bank is a member of the BIF, and, at December 31, 2002, it had $446 million
in deposits insured in the BIF, as well as $22.1 million, acquired in a merger,
insured in the SAIF.
The FDIC is authorized to establish separate annual assessment rates for deposit
insurance for members of each of the BIF and the SAIF. The FDIC may increase
assessment rates for either fund if necessary to restore the fund's ratio of
reserves to insured deposits to its target level within a reasonable time and
may decrease such rates if such target level has been met. The FDIC has
established a risk-based assessment system for both SAIF and BIF members. Under
this system, assessments vary based on the risk the institution poses to its
deposit insurance fund. The risk level is determined based on the institution's
capital level and the FDIC's level of supervisory concern about the institution.
Insurance of deposits may be terminated by the FDIC if it finds that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, rule, order or condition enacted or imposed by the institution's
regulatory agency.
Federal Reserve Board. The FRA requires national banks to maintain reserves
against their net transaction accounts (primarily checking and NOW accounts).
The amounts are subject to adjustment by the FRB. At December 31, 2002, the Bank
was in compliance with its reserve requirements.
Federal Home Loan Banks. The Federal Home Loan Banks (the FHLBs) provide credit
to their members in the form of advances. As a member, the Bank must maintain an
investment in the capital stock of the FHLB of Cincinnati in an amount equal to
the greater of 1% of the aggregate outstanding principal amount of the Bank's
residential real estate loans, home purchase contracts and similar obligations
at the beginning of each year, or 5% of its advances from the FHLB. The Bank is
in compliance with this requirement with an investment in FHLB of Cincinnati
stock having a book value of $6,871,600 at December 31, 2002. The FHLB advances
are secured by collateral in one or more specified categories. The amount a
member may borrow from the FHLB is limited based upon the amounts of various
assets held by the member. All long-term advances by each FHLB must be made only
to provide funds for residential housing finance.
Ohio Department of Insurance. The Bank's insurance agency operating subsidiary
is subject to the insurance laws and regulations of the State of Ohio and the
Ohio Department of Insurance. The insurance laws and regulations require
education and licensing of agencies and individual agents, require reports and
impose business conduct rules.
Item 2. Properties
NB&T Financial Group, Inc. and The National Bank and Trust Company own and
occupy their main offices located at 48 North South Street, Wilmington, Ohio.
The National Bank and Trust Company also owns or leases 21 full-service branch
offices, one remote drive-through ATM facility, and one remote drive-in
facility, all of which are located in Adams, Auglaize, Brown, Clermont, Clinton,
Fayette, Hardin, Highland, and Warren Counties in Ohio. The Bank also owns a
building at 52 E. Main Street, Wilmington, Ohio that houses the Bank's insurance
agency. Additionally, the Bank has acquired a building at 1600 West Main Street,
Wilmington, Ohio which will serve as an operation center for the Bank and house
the Bank's insurance agency. NB&T Financial's net book value of investments in
land and buildings was $10.5 million as of December 31, 2002.
Item 3. Legal Proceedings
Neither NB&T Financial nor the Bank is presently involved in any legal
proceedings of a material nature. From time to time, the Bank is a party to
legal proceedings incidental to its business to enforce its security interest in
collateral pledged to secure loans made by the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
There were 3,222,532 common shares of the Company outstanding on December 31,
2002 held of record by approximately 470 shareholders. There is presently no
active trading market for the Company's shares, nor are the prices at which
common shares have been traded published by any national securities association
or automated quotation service. Information about the Company's shares is posted
on the OTC Bulletin Board under the symbol NBTF. Dividends per share declared
were $.23 in each quarter in 2002 and were $.21 per share in each quarter in
2001.
The Company has a stock option plan under which the Company may grant options
that vest over five years to selected employees for up to 7% of the outstanding
shares of the Company, currently 267,326 shares. During 2002, the Company also
had a second stock option plan, pursuant to which all options awarded have been
exercised or expired. This second plan has been terminated by the Board of
Directors. The following table summarizes the securities authorized for issuance
at December 31, 2002 under all equity compensation plans still in existence.
- ---------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plan
outstanding options, options, warrants and (excluding securities
warrants and rights rights reflected in column (a))
Plan Category (a) (b) (c)
- ---------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security
holders 168,976 $18.95 98,350
- ---------------------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by security
holders -- -- --
- ---------------------------------------------------------------------------------------------------------------
Total 168,976 $18.95 98,350
- ---------------------------------------------------------------------------------------------------------------
14
Item 6. Selected Financial Data
The following table sets forth certain information concerning the
consolidated financial condition, earnings and other data regarding the
Company at the dates and for the periods indicated:
December 31,
(Dollars in thousands)
----------------------------------------------------
Statement of financial condition and other data: 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Total amount of:
Assets $664,803 $671,171 $579,232 $542,548 $520,553
Cash and due from banks 18,812 27,882 19,331 18,813 18,241
Securities 213,090 216,001 153,951 149,204 171,129
Loans receivable-net 380,661 378,904 370,299 347,733 302,471
Deposits 468,089 479,240 406,688 379,932 374,220
Short-term borrowings 19,240 22,055 40,148 40,358 22,702
Long-term debt 116,446 114,844 80,323 75,431 75,539
Shareholders' equity 57,304 50,976 49,482 44,031 44,723
Number of full service offices 21 21 17 17 16
Year ended December 31,
(in thousands)
-----------------------------------------------
Statement of income data: 2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Interest and loan fee income $40,483 $41,993 $41,049 $37,539 $35,273
Interest expense 17,303 22,849 22,711 19,150 18,540
------- ------- ------- ------- -------
Net interest income 23,180 19,144 18,338 18,389 16,733
Provision for loan losses 2,100 1,500 2,199 1,400 1,150
------- ------- ------- ------- -------
Net interest income after provision for loan losses 21,080 17,644 16,139 16,989 15,583
Non-interest income 9,001 7,987 4,051 5,227 5,526
Non-interest expense 22,159 18,138 15,372 15,227 13,846
------- ------- ------- ------- -------
Income before income taxes 7,922 7,493 4,818 6,989 7,263
Federal income taxes 1,391 1,476 772 1,281 1,889
------- ------- ------- ------- -------
Net income $ 6,531 $ 6,017 $ 4,046 $ 5,708 $ 5,374
======= ======= ======= ======= =======
Year ended December 31,
--------------------------------------
Selected financial ratios: 2002 2001 2000 1999 1998
----- ----- ----- ----- ------
Return on average equity 12.08% 11.87% 8.85% 12.85% 12.56%
Return on average assets 0.96 0.99 0.73 1.08 1.12
Equity-to-assets ratio 8.62 7.60 8.54 8.12 8.59
Dividend payout ratio(1) 43.60 43.98 58.27 37.57 29.71
Ratio of non-performing loans to total loans (2) 1.59 1.49 1.13 0.33 0.31
Ratio of loan loss allowance to total loans 1.04 1.00 1.02 0.91 0.87
Ratio of loan loss allowance to non-performing
loans (2) 65% 67% 90% 307% 280%
Earnings per share (3) $2.11 $1.91 $1.27 $1.81 $ 1.70
Dividends declared per share (3) $0.92 $0.84 $0.76 $0.68 $0.505
(1) Dividends paid per share divided by earnings per share.
(2) Non-performing loans include non-accrual loans, renegotiated loans and
accruing loans 90 days or more past due.
(3) All share information and per share data has been retroactively
restated to reflect a two-for-one stock split in the form of a stock
dividend effected on October 26, 1998.
15
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis comparing 2002 to prior years should be
read in conjunction with the audited consolidated financial statements at
December 31, 2002 and 2001 and for the three years ended December 31, 2002.
FORWARD-LOOKING STATEMENTS
Statements preceded by, followed by or that otherwise include the words
"believes," "expects," "anticipates," "intends," "estimates," "plans," "may
increase," "may fluctuate," "will likely result," and similar expressions or
future or conditional verbs such as "will," "should," "would," and "could" are
generally forward-looking in nature and not historical facts. Results could
differ materially from those expressed in such forward-looking statements due to
a number of factors, including (1) the effect of economic conditions and
interest rates on a national, regional or international basis; (2) competitive
pressures in the retail banking, financial services, insurance and other
industries; (3) the financial resources of, and products available to,
competitors; (4) changes in laws and regulations, including changes in
accounting standards; (5) changes in policy by regulatory agencies; and (6)
changes in the securities markets. Any forward-looking statements are not
guarantees of future performance. They involve risks, uncertainties and
assumptions, and actual results could differ materially from those contemplated
by those forward-looking statements. Many of the factors that will determine
these results are beyond the Company's ability to control or predict. The
Company disclaims any duty to update any forward-looking statements, all of
which are qualified by the statements in this section.
RESULTS OF OPERATIONS
OVERVIEW
Net income for 2002 was $6.5 million, or $2.11 per share, compared to $6.0
million, or $1.91 per share, for the year of 2001. Net interest income was $23.2
million for 2002, 21.1% above 2001. Non-interest income, excluding securities
gains and losses, was $8.6 million for 2002, 11.0% above 2001. Non-interest
expense was $22.2 million for 2002, 22.2% above 2001. Performance ratios for
2002 included a return on assets of .96% and a return on equity of 12.08%.
Net income for 2001 was $6.0 million, or $1.91 per share, compared to $4.0
million, or $1.27 per share, for the year of 2000. Net interest income was $19.1
million for 2001, 4.4% above 2000. Non-interest income, excluding securities
gains and losses, was $7.7 million for 2001, 26.2% above 2000. Non-interest
expense was $18.1 million for 2001, 18.0% above 2000. Performance ratios for
2001 included a return on assets of .99% and a return on equity of 11.87%.
TABLE 1 - SELECTED FINANCIAL HIGHLIGHTS
(in thousands, except per share data)
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Net interest income $ 23,180 $ 19,144 $ 18,338 $ 18,389 $ 16,733
Net income 6,531 6,017 4,046 5,708 5,374
Earnings per share 2.11 1.91 1.27 1.81 1.70
Dividends per share 0.92 0.84 0.76 0.68 0.51
AVERAGE BALANCES
Assets $676,960 $610,790 $551,566 $526,455 $478,900
Loans 385,324 366,190 367,419 330,734 287,674
Securities 227,560 181,819 148,827 162,744 155,155
Deposits 475,903 429,514 390,231 376,843 347,087
Long-term debt 117,840 93,572 79,406 75,539 53,753
Shareholders' equity 54,053 50,675 45,722 44,426 42,805
RATIOS AND STATISTICS
Net interest margin (tax equivalent) 3.86% 3.54% 3.72% 3.88% 3.82%
Return on average assets 0.96 0.99 0.73 1.08 1.12
Return on average equity 12.08 11.87 8.85 12.85 12.56
Loans to assets 56.92 57.02 64.59 64.98 58.61
Equity to assets 8.62 7.60 8.54 8.12 8.59
Total risk-based capital ratio 14.66 11.50 14.04 14.29 14.18
Efficiency ratio 67.75 65.20 60.47 61.25 62.20
Full service offices 21 21 17 17 16
16
NET INTEREST INCOME
Net interest income increased 21.1% in 2002 to $23.2 million from $19.1 million
in 2001. Average interest-earning assets for 2002 increased $56.5 million, or
10.0%, from 2001 while the tax equivalent yield decreased to 6.64% in 2002 from
7.56% in 2001. Interest and fees on loans decreased $1.4 million, or 4.7%, from
last year as the average loan balance increase of $19.1 million, or 5.2%, was
offset by a decrease in the average yield from 8.33% in 2001 to 7.55% in 2002.
Interest on securities increased 4.3%, or $556,000 in 2002 from 2001. The
average balance of the securities portfolio increased $45.7 million, or 25.2%,
from 2001, while the tax equivalent yield decreased 109 basis points from 6.43%
to 5.34%.
Interest expense decreased 24.3% in 2002 compared to 2001. Average interest-
bearing liabilities increased $52.7 million, or 10.2%, during 2002, while the
cost decreased from 4.42% in 2001 to 3.04% in 2002. The volume growth in average
interest-bearing liabilities was due to a $37.4 million, or 27.5%, increase in
NOW and money market accounts, a $9.3 million, or 30.1%, increase in savings
deposits, and a $20.1 million, or 21.6% increase in additional borrowing from
the Federal Home Loan Bank (FHLB). These increases were offset by a decrease in
average certificates of deposits of $9.6 million. All categories of
interest-bearing liabilities showed a decrease in cost in 2002 compared to 2001.
As a result, average tax equivalent net interest margin increased from 3.54% in
2001 to 3.86% in 2002.
Net interest income increased to $19.1 million in 2001 from $18.3 million in
2000, an increase of 4.4%. Average interest-earning assets for 2001 increased
$49.0 million, or 9.4%, from 2000 while the tax equivalent yield decreased to
7.56% in 2001 from 8.09% in 2000. Interest and fees on loans decreased 3.3% from
2000 as the average loan balance declined $1.2 million, or 0.3%, and the average
yield decreased from 8.59% in 2000 to 8.33% in 2001. Interest on securities
increased 15.7% in 2001 from 2000. The average balance of the securities
portfolio increased $33.0 million, or 22.2%, from 2000, while the tax equivalent
yield decreased from 6.91% to 6.43%.
Interest expense increased 0.6% in 2001 compared to 2000. Average interest-
bearing liabilities increased $53.2 million, or 11.5%, during 2001, while the
cost decreased from 4.90% in 2000 to 4.42% in 2001. The volume growth in average
interest-bearing liabilities was due to a 23.7% increase in NOW and money market
accounts, a 21.6% increase in large certificates of deposit, and an 18.1%
increase in additional long-term borrowing from the FHLB. All categories showed
a decrease in cost in 2001 compared to 2000. Average tax equivalent net interest
margin decreased from 3.72% in 2000 to 3.54% in 2001.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $2.1 million in 2002, an increase of $600,000
from the provision recorded in 2001, which was a decrease of $700,000 from the
provision recorded in 2000. Net charge-offs in 2002 were $1.9 million, compared
to $2.1 million in 2001 and $1.6 million in 2000. The increased provision in
2002 was based on management's evaluation of the loan portfolio and potential
weaknesses of specific loans. The 2001 provision was lower than 2000 as the 2000
provision was increased in contemplation of certain potential losses associated
with $6.0 million in loans to a longstanding Bank customer. The ratio of the
allowance for loan losses as a percent of total loans at December 31 was 1.04%
in 2002, 1.00% in 2001, and 1.02% in 2000.
17
NON-INTEREST INCOME
Table 2 details the components of non-interest income, excluding securities
gains and losses, and how they relate each year as a percent of average assets.
Total non-interest income was $8.6 million in 2002, $7.7 million in 2001, and
$6.1 million in 2000. Non-interest income represents a ratio of 1.27% of average
assets in 2002, 1.26% in 2001, and 1.11% in 2000. Trust income decreased 20.7%
in 2002 and 8.5% in 2001, which was a function of the decline in market value of
funds under management. At December 31 the market value of total assets in the
Trust Department was approximately $192 million in 2002, compared to $218
million in 2001 and $234 million in 2000. Service charges and fees have
increased over the last three years due to increased charges and growth in the
number of accounts. In 2002, the Company also introduced the Overdraft Honor
program that aids customers by paying more and returning fewer overdraft checks.
Standard fees still apply. As a result, their percentage of average assets has
increased to .38 % in 2002 compared to .32% in 2001 and .31% in 2000. ATM
network fees generated were $578,000 in 2002, $804,000 in 2001, and $725,000 in
2000. The decrease is a result of increased competition in the ATM network
business and the Company having fewer machines installed. At the end of 2002,
there were sixty-five machines installed in three states compared to eighty-two
machines installed at the end of 2001. Insurance agency commission income has
increased from $1,140,000 in 2000, to $1,689,000 in 2001, and $2,355,000 in
2002. In the second quarter of 2001, the Company acquired two insurance
agencies, and their commission income is included in the 2001 results of
operations since that time. The Company acquired another agency in March 2002,
and its commission income is included in the 2002 results of operations since
that time. Bank owned life insurance ("BOLI") income increased to $787,000 in
2002 compared to $632,000 in 2001 due to a death benefit claim. During 2002,
other income decreased to $1,081,000 from $1,164,000 in 2001 primarily due to a
$148,000 gain recognized on the sale of servicing on $28 million of real estate
loans during 2001.
TABLE 2 - NON-INTEREST INCOME
(in thousands)
2002 2001 2000
------------------- ------------------- -------------------
Percent of Percent of Percent of
average average average
Amount assets Amount assets Amount assets
------ ---------- ------ ---------- ------ ----------
Trust $ 926 0.14% $1,167 0.19% $1,276 0.23%
Service charges on deposits 2,589 0.38 1,961 0.32 1,731 0.31
Other service charges 265 0.04 310 0.05 306 0.06
ATM network fees 578 0.09 804 0.13 725 0.13
Insurance agency commissions 2,355 0.35 1,689 0.28 1,140 0.21
Income from BOLI 787 0.12 632 0.10 161 0.03
Other 1,081 0.15 1,164 0.19 782 0.14
------ ---- ------ ---- ------ ----
Total $8,581 1.27% $7,727 1.26% $6,121 1.11%
====== ==== ====== ==== ====== ====
Gain on sales of securities totaled $420,000 in 2002, compared to $260,000 in
2001. Proceeds from the sale of securities totaled $27.5 million in 2002,
compared to $12.5 million in 2001. In 2000, securities totaling $41.0 million
were sold for a net loss of $2.1 million as the Company restructured a portion
of the investment portfolio.
18
NON-INTEREST EXPENSE
Table 3 details the components of non-interest expense and how they relate each
year as a percent of average assets. Total non-interest expense has increased
from $15.4 million in 2000, to $18.1 million in 2001, and $22.2 million in 2002.
These figures represent a percent of average assets of 3.27% in 2002, 2.96% in
2001, and 2.79% in 2000.
Salaries and benefits expense, which is the largest component of non-interest
expense, increased to $11.5 million in 2002 from $9.0 million in 2001. This is
primarily due to the three new branches opened during 2001 being open the entire
year in 2002, the acquisition of the Sabina Bank in December 2001, and the three
insurance agencies acquired since the second quarter of 2001. In addition to the
salaries, officer bonus expense increased due to exceeding performance related
goals, health care costs increased with the increase in personnel, and a
supplemental executive retirement plan was started in 2002. Salaries and
benefits as a percent of average assets was 1.70% in 2002, 1.47% in 2001, and
1.37% in 2000. The average number of full-time equivalent employees was 269 in
2002, 236 in 2001, and 220 in 2000.
The three new branches opened during 2001 and the Sabina Bank acquisition also
contributed to equipment expense increasing 6.0% and occupancy expense
increasing 12.1% from last year. Amortization of intangibles is the amortization
of the core deposit intangible associated with the Sabina Bank acquisition.
Other expenses remained at similar levels as a percent of average assets in
2002, as compared to 2001.
TABLE 3 - NON-INTEREST EXPENSE
(in thousands)
2002 2001 2000
-------------------- -------------------- --------------------
Percent of Percent of Percent of
average average average
Amount assets Amount assets Amount assets
------- ---------- ------- ---------- ------- ----------
Salaries $ 9,627 1.42% $ 7,766 1.27% $ 6,415 1.16%
Benefits 1,885 0.28 1,240 0.20 1,167 0.21
Occupancy 1,171 0.17 1,045 0.17 866 0.16
Equipment 2,748 0.41 2,592 0.42 2,233 0.40
Data processing 146 0.02 170 0.03 152 0.03
Professional fees 1,420 0.21 1,342 0.22 1,187 0.22
Marketing 785 0.12 532 0.09 496 0.09
Printing and office supplies 547 0.08 495 0.08 388 0.07
State franchise tax 552 0.08 569 0.09 477 0.09
Amortization of intangibles 616 0.09 0 0.00 0 0.00
Other 2,662 0.39 2,387 0.39 1,991 0.36
------- ---- ------- ---- ------- ----
Total $22,159 3.27% $18,138 2.96% $15,372 2.79%
======= ==== ======= ==== ======= ====
INCOME TAXES
The effective tax rates were 17.6% for 2002, 19.7% for 2001, and 16.0% for 2000.
The effective tax rate being lower than the statutory rate was primarily due to
tax-exempt municipal bond interest income and BOLI income.
FINANCIAL CONDITION
ASSETS
Average total assets increased 10.8% during 2002 to $677.0 million. Average
interest-earning assets increased 10.0%, and were 92% of total average assets,
slightly less than the 93% for 2001 and 94% for 2000.
SECURITIES
The majority of the increases in the securities portfolio from 2000 and 2001 to
2002 were the result of purchases of U.S. agency callable bonds and U.S. agency
mortgage-backed securities with projected average lives of three to seven years.
Average securities as a percent of assets was 33.6% in 2002, 29.8% in 2001 and
27.0% in 2000. The securities portfolio at December 31, 2002 consisted of $168.6
million of securities available for sale and $44.5 million of securities that
management intends to hold to maturity. The available-for-sale portion of the
portfolio consisted primarily of fixed-rate securities with a projected average
life of 4.1 years, an average repricing term of 2.1 years, and an average
tax-equivalent yield of 4.73%. Of the total available-for-sale portion, 27%
consisted of callable U.S. agency bonds, 62% consisted of fixed-rate
mortgage-backed securities, 1% consisted of adjustable-rate
19
mortgage-backed securities, and 5% consisted of long-term fixed-rate tax-exempt
municipal securities, and 5% consisted of other securities. The held-to-maturity
portion of the portfolio consisted entirely of long-term fixed-rate tax-exempt
municipal securities with both an average life and a repricing term of 4.3
years. At December 31, 2002 the total security portfolio had approximately $4.3
million market value appreciation.
LOANS
Average total loans as a percent of average assets was 56.9% in 2002, 60.0% in
2001, and 66.6% in 2000. Table 4 shows loans outstanding at period end by type
of loan. The portfolio composition remained relatively consistent during the
last three years. Commercial and industrial loans grew from $92.3 million in
2000 to $107.0 million in 2001, and to $108.5 million in 2002 primarily as a
result of increased origination of working capital and equipment loans.
Commercial and industrial loans as a percent of the total loan portfolio ranged
from 25-28% during the five-year period ending 2002. Residential real estate
loans decreased $4.3 million in 2002 to $141.4 million. During 2002, loans
sales, prepayments and amortizations exceeded new residential real estate loan
originations. During 2002, the Company sold $4.8 million in residential real
estate loans, compared to $9.1 million in 2001. For interest rate risk
management purposes the Company currently sells, or holds for sale, the majority
of fixed-rate residential real estate loans originated, while holding the
adjustable-rate loans in the portfolio. The Company has experienced an increase
in residential real estate lending and commercial lending, both real estate and
industrial, because of the movement of the Company into new markets, such as
Clermont, Highland and Warren Counties. The Company continues to focus its
commercial lending on small- to medium-sized companies with established track
records in its market area.
Installment loans outstanding increased $4.2 million to $74.5 million in 2002
from $70.3 million at December 31, 2001. This increase occurred primarily in
indirect auto loans due to renewed sales efforts in that market. Installment
loans increased to 19% of the portfolio at December 31, 2002 from 18% at
December 31, 2001. The Company has avoided concentration of lending in any one
industry. As of December 31, 2002, the ratio of fixed-rate loans to total loans
was 41.7%, of which 66% matures within five years.
TABLE 4 - LOAN PORTFOLIO
(in thousands)
At December 31,
2002 2001 2000 1999
--------------------- --------------------- --------------------- ---------------------
Percent of Percent of Percent of Percent of
Amount Total Amount Total Amount Total Amount Total
-------- ---------- -------- ---------- -------- ---------- -------- ----------
Commercial & industrial $108,513 28% $106,976 28% $ 92,328 25% $ 86,521 25%
Commercial real estate 35,461 9 36,411 10 42,694 11 37,833 11
Agricultural 20,857 6 19,076 5 18,256 5 18,343 5
Residential real estate 141,417 37 145,755 38 145,582 39 117,392 33
Installment 74,533 19 70,345 18 71,414 19 87,996 25
Other 4,247 1 3,883 1 3,209 1 2,069 1
Deferred net origination
costs (357) 0 268 0 618 0 801 0
-------- --- -------- --- -------- --- -------- ---
Total $384,671 100% $382,714 100% $374,101 100% $350,955 100%
======== === ======== === ======== === ======== ===
1998
---------------------
Percent of
Amount Total
-------- ----------
Commercial & industrial $ 78,801 26%
Commercial real estate 29,936 10
Agricultural 17,925 6
Residential real estate 92,069 30
Installment 83,173 27
Other 2,402 1
Deferred net origination
costs 806 0
-------- ---
Total $305,112 100%
======== ===
ALLOWANCE FOR LOAN LOSSES
Table 5 shows selected information relating to the Company's loan quality and
allowance for loan losses. The allowance is maintained to absorb potential
losses in the portfolio. Management's determination of the adequacy of the
reserve is based on reviews of specific loans, loan loss experience, general
economic conditions and other pertinent factors. If, as a result of charge-offs
or increases in risk characteristics of the loan portfolio, the reserve is below
the level considered by management to be adequate to absorb possible future loan
losses, the provision for loan losses is increased. Loans deemed not collectible
are charged off and deducted from the reserve. Recoveries on loans previously
charged off are added to the reserve.
The allowance for loan losses was 1.04% of total loans as of December 31, 2002,
compared to 1.00% at the end of 2001, and has ranged from .87% to 1.02% for the
years 1998 through 2000. Net charge-offs as a percentage of average loans
decreased to .49% for the year 2002, compared to .58% for the year 2001. Net
charge-offs decreased approximately $200,000 during 2002, with the decrease
occurring primarily in commercial and industrial loans. The Company allocates
the allowance for loan losses to specifically classified loans and generally
based on three-year net charge-off history. In assessing the adequacy of the
allowance for loan losses, the
20
Company considers three principal factors: (1) the three-year rolling average
charge-off percentage applied to the current outstanding balance by portfolio
type; (2) specific percentage applied to individual loans estimated by
management to have a potential loss; and (3) estimated losses attributable to
economic conditions. Economic conditions considered include unemployment levels,
the condition of the agricultural business, and other local economic factors.
Non-accrual loans for the last five years are listed in Table 5. The amount of
non-accrual loans was $4.7 million at year-end 2002, compared to $4.9 million at
year-end 2001.
As of December 31, 2002 there were $3.0 million in twenty non-accrual small
business relationships. The majority of this amount consisted of two
relationships, one of which is $1.4 million in a nursing home business, which
has been making monthly payments since January 2002 following the signing of a
forbearance agreement. The second relationship amounts to $603,000 and is in the
construction business. The customer has signed a forbearance agreement and is
proceeding with an orderly liquidation of collateral, which should be adequate
to satisfy the balance owed to the Company.
Non-accrual residential real estate loans consisted of seventeen loans that
total $1,345,000 with the largest balance being $314,000. Non-accrual personal
loans consisted of ten loans that total $214,000, and home equity credit lines
consisted of 5 loans totaling $142,000.
All loans are expected to be resolved through term payments or through
liquidation of collateral in the normal course of business. In addition,
management identified three relationships totaling $1.2 million as impaired
loans that were less than 90 days past due and still accruing as of December 31,
2002. Management, through normal credit review procedures, became aware of
possible difficulties these borrowers could have complying with current loan
repayment terms. The anticipated loss in the year 2003 from all relationships is
not expected to be material. Anticipated losses are based on currently available
information and actual losses may differ significantly should the borrowers'
financial condition or collateral values significantly deteriorate.
TABLE 5 - ASSET QUALITY
(in thousands)
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
Allowance for loan losses $4,010 $3,810 $3,802 $3,222 $2,641
Provision for loan losses 2,100 1,500 2,199 1,400 1,150
Net charge-offs 1,900 2,114 1,619 819 1,270
Non-accrual loans $4,734 $4,859 $4,098 $ 955 $ 599
Loans 90 days or more past due 1,391 858 113 96 343
Renegotiated loans 0 0 0 0 0
Other real estate owned 226 143 67 80 0
------ ------ ------ ------ ------
Total non-performing assets $6,351 $5,860 $4,278 $1,131 $ 942
====== ====== ====== ====== ======
RATIOS
Allowance to total loans 1.04% 1.00% 1.02% 0.91% 0.87%
Net charge-offs to average loans 0.49 0.58 0.44 0.25 0.50
Non-performing assets to total loans
and other real estate owned 1.65 1.53 1.14 0.32 0.31
OTHER ASSETS
In September 2000, $10 million was used to purchase Bank Owned Life Insurance
with a cash surrender value that increases tax-free during future years at an
adjustable rate. At December 31, 2002, the cash surrender value was $11.1
million. The Company also operates a network of cash dispenser machines located
in convenience stores and supermarkets. There were 65 machines located in Ohio,
Kentucky and Indiana at the end of 2002. The Company's investment in this
segment of business includes $1.4 million in equipment cost and an average of
$3.3 million in cash to supply the machines. Due to changes in the market, the
Company anticipates a reduced commitment to this business in the future. The
Company charges a fee for withdrawals from anyone who does not have a
transaction account with the Company. The Company recorded a net book income
before taxes on this activity of $84,000 in 2002, compared to $92,000 in 2001,
and $82,000 for 2000.
21
In December 2001, the Company acquired the majority of the assets and assumed
the deposit liabilities of Sabina Bank (a subsidiary of Premier Financial
Bancorp, Inc.) located in Sabina, Ohio, for an aggregate cash purchase price of
approximately $12.9 million. This business combination is being accounted for as
a purchase transaction in accordance with SFAS No. 141, "Business Combinations".
In connection with the transaction, the Company acquired approximately $48
million in assets, consisting primarily of loans and investments, and assumed
deposit liabilities approximating $42 million, and recorded intangible assets of
$6.7 million. The intangible assets consisted of core deposit intangibles of
$3.1 million, which is amortized over the expected life of the related core
deposits, and goodwill of $3.6 million, which is not amortized in accordance
with SFAS No. 141, but is tested annually for impairment. In 2002, no goodwill
was expensed due to impairment of value.
DEPOSITS
Table 6 presents a summary of period end deposit balances. Deposit categories
have remained fairly constant as a percent of total deposits throughout the
five-year period. Interest-bearing NOW accounts have increased to 24% of
deposits due to the introduction of a high yielding, high balance checking
account early in 2000. Savings accounts continued to be 8-9% of deposits for the
last three years. Money market accounts decreased to 12%. Certificates of
deposit decreased to 35% of deposits by the end of 2002, as consumers are less
willing to extend maturities in the current low interest rate environment.
Certificates of $100,000 and over are primarily short-term public funds.
Balances of such large certificates fluctuate depending on the Company's pricing
strategy and funding needs at any particular time and were about the same
percent of total deposits in 2002 as in 2001. Deposits are attracted principally
from within the Company's market area through the offering of numerous deposit
instruments. Interest rates, maturity terms, service fees, and withdrawal
penalties for the various types of accounts are established periodically by
management based on the Company's liquidity requirements, growth goals and
market trends. The Company has not used brokers in the past to attract deposits,
although competition from banks and other financial institutions has caused the
Company to consider broker deposits as a viable alternative to funding needs.
The amount of deposits currently from outside the Company's market area is not
significant.
TABLE 6 - DEPOSITS
(in thousands)
At December 31,
2002 2001 2000 1999 1998
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Demand $ 52,273 11% $ 52,734 11% $ 42,965 11% $ 43,715 12% $ 41,748 11%
NOW 111,680 24% 103,905 22% 81,540 20% 67,027 18% 61,616 16%
Savings 41,853 9% 42,854 9% 32,628 8% 35,903 9% 36,213 10%
Money market 54,688 12% 59,990 13% 33,533 8% 42,780 11% 39,935 11%
CD's less than $100,000 164,962 35% 174,599 36% 172,982 43% 150,281 40% 147,003 39%
CD's $100,000 and over 42,633 9% 45,158 9% 43,040 10% 40,226 10% 47,705 13%
-------- --- -------- --- -------- --- -------- --- -------- ---
Total $468,089 100% $479,240 100% $406,688 100% $379,932 100% $374,220 100%
======== === ======== === ======== === ======== === ======== ===
OTHER BORROWINGS
Periodically during the past five years the Company has purchased investment
securities with funds borrowed from the FHLB. The effect of these transactions
has been an enhancement to earnings and an effective use of capital. At December
31, 2002, the Bank had outstanding $108.4 million of total borrowings from the
FHLB, $98.5 million of which consisted of seven fixed-rate notes with a weighted
average rate of 5.20% and with maturities in 2008, 2010 and 2011. At the option
of the FHLB, these notes can be converted at certain dates to instruments that
adjust quarterly at the three-month LIBOR rate. The note amount and nearest
optional conversion dates at December 31, 2002, are: $74.5 million in 2003; $12
million in 2004; and $12 million in 2006. The remaining $9.9 million consists of
a 4.67% fixed-rate monthly amortizing note with a final maturity in 2006.
During the second quarter of 2002, the Company participated in a securities sale
commonly referred to as a "pooled trust preferred securities offering." In that
offering, the Company issued to a trust controlled by the Company $8.2 million
in thirty-year debt securities at a rate of interest adjustable quarterly equal
to the three-month LIBOR rate plus 3.45% (currently 5.24%), and the trust issued
capital securities of $8.0 million to an unrelated party. The securities issued
by the Company are classified as Tier 1 capital for regulatory purposes, and the
interest is deductible for federal income tax purposes. The Company made a
capital contribution of $8 million of these funds to the Bank to improve its
regulatory capital ratios.
22
CAPITAL
The Federal Reserve Board has adopted risk-based capital guidelines that assign
risk weightings to assets and off-balance sheet items and also define and set
minimum capital requirements (risk-based capital ratios). Bank holding companies
must maintain total risk-based, Tier 1 risk-based and Tier 1 leverage ratios of
8%, 4% and 3%, respectively. At December 31, 2002, NB&T Financial Group, Inc.
had a total risk-based capital ratio of 14.66%, a Tier 1 risk-based capital
ratio of 13.68%, and a Tier 1 leverage ratio of 8.48%.
LIQUIDITY
Effective liquidity management ensures that the cash flow requirements of
depositors and borrowers, as well as Company cash needs, are met. The Company
manages liquidity on both the asset and liability sides of the balance sheet.
The loan to deposit ratio at December 31, 2002, was 82.2%, compared to 79.9% at
the same date in 2001. Loans to total assets were 56.9% at the end of 2002,
compared to 57.0% at the same time last year. Management strives to keep this
ratio below 70%. The securities portfolio is 79% available-for-sale securities
that are readily marketable. Approximately 53% of the available-for-sale
portfolio is pledged to secure public deposits, short-term and long-term
borrowings and for other purposes as required by law. The balance of the
available-for-sale securities could be sold if necessary for liquidity purposes.
Also, a stable deposit base, consisting of over 90% core deposits, makes the
Company less susceptible to large fluctuations in funding needs. The Company has
short- term borrowing lines of credit with several correspondent banks. The
Company also has both short- and long-term borrowing available through the FHLB.
The Company has the ability to obtain deposits in the brokered certificate of
deposit market to help provide liquidity to fund loan growth.
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to interest rate risk, exchange rate risk, equity
price risk and commodity price risk. The Company does not maintain a trading
account for any class of financial instrument, and is not currently subject to
foreign currency exchange rate risk, equity price risk or commodity price risk.
The Company's market risk is composed primarily of interest rate risk.
The Company's Asset/Liability Committee (ALCO) is responsible for reviewing the
interest rate sensitivity position of the Company and establishing policies to
monitor and limit exposure to interest rate risk. The Company's Board of
Directors approves the guidelines established by ALCO. The primary goal of the
asset/liability management function is to maximize net interest income within
the interest rate risk limits set by ALCO. Interest rate risk is monitored on a
quarterly basis through ALCO meetings. Techniques used include both interest
rate gap management and simulation modeling that measures the effect of rate
changes on net interest income and market value of equity under different rate
scenarios. The interest rate gap analysis schedule (Table 7) quantifies the
asset/liability static sensitivity as of December 31, 2002 for the Bank only. As
shown, the Bank was asset sensitive for periods zero through one year, and one-
to five-year period and liability sensitive within the over-five-year period.
The cumulative gap as a percent of total assets through one year at the end of
2002 was a positive 15.3% compared to a negative 7.2% at the end of 2001. The
balances of transaction type NOW and MMDA accounts are scheduled to run off over
their expected lives. Although the entire balance of these deposits is subject
to repricing or withdrawal in a relatively short period of time, they have been
a stable base of retail core deposits for the Bank. Also, historically their
sensitivity to changes in interest rates has been significantly less than some
other deposits, such as certificates of deposit. However, considering today's
low interest rate environment, the future rate sensitivity of these deposits
could be significantly different.
23
Table 7 - Interest Rate Gap Analysis
(in thousands)
At December 31, 2002
0-3 3-6 6-12 1-5 5+
Total Months Months Months Years Years
-------- -------- -------- -------- -------- ---------
Loans $384,671 $ 99,512 $ 40,874 $ 66,419 $171,902 $ 5,964
Securities 220,688 25,669 8,888 42,144 90,228 53,759
Short-term funds & BOLI 18,098 6,990 3 11,105 -- --
-------- -------- -------- -------- -------- ---------
Total Earning Assets 623.457 132,171 49,765 119,668 262,130 59,723
-------- -------- -------- -------- -------- ---------
Savings, NOW & MMDA 208,221 6,752 6,752 13,504 94,373 86,840
Other time deposits 207,595 43,157 45,243 52,827 65,060 1,308
Short term borrowings 19,240 19,240 -- -- -- --
Long term debt 108,338 615 610 1,242 7,371 98,500
-------- -------- -------- -------- -------- ---------
Total Interest Bearing Funds 543,394 69,764 52,605 67,573 166,804 186,648
-------- -------- -------- -------- -------- ---------
Period gap 80,063 62,407 (2,840) 52,095 95,326 (126,925)
Cumulative gap 62,407 59,567 111,662 206,988 80,063
Gap as a percent of assets 12.04% 9.39% 8.96% 16.80% 31.13% 12.04%
In the Company's simulation models, each asset and liability balance is
projected over a one-year horizon. Net interest income is then projected based
on expected cash flows and projected interest rates under a stable rate scenario
and analyzed on a quarterly basis. The results of this analysis are used in
decisions made concerning pricing strategies for loans and deposits, balance
sheet mix, securities portfolio strategies, liquidity and capital adequacy. The
Company's current one-year simulation models under stable rates indicate a
decreasing yield on both interest-earning assets and in the cost of
interest-bearing liabilities. This position could have a slightly negative
effect on projected net interest margin over the next twelve months.
Simulation models are also performed under an instantaneous parallel 300 basis
point increase or decrease in interest rates. The model includes assumptions as
to repricing and expected prepayments, anticipated calls, and expected decay
rates of transaction accounts under the different rate scenarios. The results of
these simulations include changes in both net interest income and market value
of equity. ALCO guidelines that measure interest rate risk by the percent of
change from stable rates, and capital adequacy, have been established, and as of
December 31, 2002, the results of 300 basis points increase simulations are
within those guidelines; however, the results of the 300 basis points decrease
simulations exceeded those guidelines. Interest rates have declined to
historically low levels. As a result, many of the Bank's deposits are within 300
basis points of a zero interest rate floor, and the Bank's inability to reduce
rates below the zero floor could negatively impact the Bank's future earnings
and market value of equity.
As with any method of measuring interest rate risk, certain shortcomings are
inherent in the simulation modeling. For example, although certain assets and
liabilities may have similar maturities or periods of repricing, they may react
in different degrees to changes in market rates. In addition, the interest rates
on certain types of assets and liabilities may fluctuate in advance of changes
in market rates, while interest rates on other types may lag behind changes in
market rates. Further, in the event of a change in interest rates, expected
rates of prepayment on loans and mortgage-backed securities and early
withdrawals from certificates of deposit may deviate significantly from those
assumed in making the risk calculations. The Company's rate shock simulation
models provide results in extreme interest rate environments and results are
used accordingly. Reacting to changes in economic conditions, interest rates and
market forces, the Company has been able to alter the mix of short- and
long-term loans and investments, and increase or decrease the emphasis on fixed-
and variable-rate products in response to changing market conditions. By
managing the interest rate sensitivity of its asset composition in this manner,
the Company has been able to maintain a fairly stable flow of net interest
income. Table 8 provides information about the Company's market sensitive
financial instruments other than cash and cash equivalents, FHLB and Federal
Reserve Bank stock, and demand deposit accounts as of December 31, 2002. The
information presented is based on repricing opportunities and projected cash
flows that include expected prepayment speeds and likely call dates.
24
Table 8 - Financial Instruments Market Risk
(in thousands)
December 31, 2002
Over 5
2003 2004 2005 2006 2007 Years Total Value
-------- ------- ------- ------- ------- ------- -------- --------
Fixed-rate loans $ 76,273 $42,930 $21,137 $10,154 $ 5,198 $ 5,866 $161,559 $164,995
Average interest rate 7.76% 8.13% 8.12% 8.05% 8.08% 8.71%
Adjustable-rate Loans 130,532 50,559 24,550 7,841 9,532 98 223,112 225,701
Average interest rate 6.43 6.90 6.68 6.70 6.23 6.01
Securities 76,701 34,737 23,972 16,206 15,313 53,759 220,688 214,230
Average interest rate 4.74 4.72 4.62 5.08 5.16 4.33
Savings, NOW & MMDA 208,221 -- --