SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the 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 [No Fee required]
For the transition period from _______ to _______.
Commission file number 33-66014
FNB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
COMMONWEALTH OF PENNSYLVANIA 23-2466821
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
101 Lincoln Way West, McConnellsburg, PA 17233___
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 717-485-3123
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding as of March 5, 2002
Common Stock, $0.315 Par Value 800,000
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 ( 229.405 of this chapter) 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 [ ].
The aggregate market value of the voting stock held by non-affiliates
of the registrants as of March 5, 2002:
Common Stock, $0.315 Par Value - $20,000,000.00
Page 1 of 17 Pages
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual shareholders report for the year ended December
31, 2001, are incorporated by reference into Parts I, II and IV.
Portions of the proxy statement for the annual shareholders meeting to
be held April 23, 2002, are incorporated by reference into Part III.
Portions of Form SB-2 Registration Statement No. 33-66014 as filed with
the Securities and Exchange Commission on September 8, 1993, are
incorporated by reference into Part IV.
The Executive Contract for the President and CEO of the Bank dated
August 1, 2000, is incorporated herein by reference into Part III.
The Executive Change of Control Agreement for the Senior Vice President
and CFO of the Bank dated August 1, 2000, is incorporated herein by
reference into Part III.
A copy of a Common Stock Certificate of FNB Financial Corporation as
filed with the Securities and Exchange Commission with Form 10-K for
the fiscal year ended December 31, 1995 is incorporated by reference
into Part IV.
Page 2 of 17 Pages
PART I
Item 1. Business
Description of Business
FNB Financial Corporation (the Company), a Pennsylvania
business corporation, is a bank holding company registered
with and supervised by the Board of Governors of the Federal
Reserve System (the "Federal Reserve Board"). The Company was
incorporated on June 22, 1987, under the business corporation
law of the Commonwealth of Pennsylvania for the purpose of
becoming a bank holding company. Since commencing operations,
the Company's business has consisted primarily of managing and
supervising The First National Bank of McConnellsburg (the
Bank) and its principal source of income has been dividends
paid by the Bank. The Company has one wholly-owned
subsidiary, the Bank.
The Bank was established in 1906 as a national banking
association under the supervision of the Comptroller of the
Currency, the Comptroller. The Bank is a member of the
Federal Reserve System and customers' deposits held by the
Bank are insured by the Federal Deposit Insurance Corporation
to the maximum extent permitted by law. The Bank is engaged
in a full service commercial and consumer banking business
including the acceptance of time and demand deposits and the
making of secured and unsecured loans. The Bank provides its
services to individuals, corporations, partnerships,
associations, municipalities and other governmental bodies.
As of December 31, 2001, the Bank had three (3) offices and
(1) drive-up ATM located in Fulton County, one (1) branch
office facility located in Fort Loudon, Franklin County
Pennsylvania and one (1) branch office facility located in
Hancock, Washington County, Maryland. During 1995 the Bank
received regulatory approval from The Comptroller to purchase
and assume the deposits, real estate and building of the Fort
Loudon Branch Office of Dauphin Deposit Bank located in
Franklin County, Pennsylvania. Due to the location of this
office, management and the Board felt the acquisition of this
office was strategically important in order to officially
expand the Bank's market area into the Franklin County, PA
area and diversify its current primary market of Fulton
County, PA. It is anticipated this office will generate new
loan and deposit demand for the Bank in the coming years.
During 1996 the Bank received regulatory approval from the
Comptroller to open its first interstate Branch office in
Hancock, Maryland after management became aware of the closing
of a branch office of First Federal Savings Bank of Western
Maryland. This office is known as "Hancock Community Bank, A
Division of The First National Bank of McConnellsburg". The
location of this office is felt to be strategically important
in order to expand the Bank's operations into Washington
County, Maryland and northern Morgan County, West Virginia.
This office is also the Bank's first supermarket branch
Page 3 of 17 Pages
office. In October 2000, the owner of the adjacent
supermarket completed extensive renovations at which time the
wall between the branch office and the supermarket was
removed, allowing customers to enter the branch directly from
the supermarket. This office is expected to enhance demand
for the Bank's loan and deposit products as well as retain
deposits of customers in southern Fulton County, Pennsylvania.
The Bank received permission from the Comptroller to expand
its main office facilities in downtown McConnellsburg to allow
for larger customer service, loan department and data
processing areas. This expansion was completed on September
1,1996, at a cost of approximately $1,700,000. In February
1999, the Bank purchased an adjacent property to the main
office facility at 115 Lincoln Way West in downtown
McConnellsburg from the Fulton Overseas Veterans Association.
This site is 54' by 218' and has situated on it a three story
building comprised of 4,577 usable square feet on the first
floor and a 28' by 60' finished basement. The second and
third stories of the building are not usable. The Bank has no
immediate plans for this facility but felt it was a wise
decision to purchase it for strategic planning purposes. The
Bank has one wholly-owned subsidiary, First Fulton County
Community Development Corporation, which is a Community
Development Corporation formed under 12USC24/2CFR24 whose
primary regulator is the Office of the Comptroller of the
Currency, The Comptroller. The First Fulton County Community
Development Corporation was incorporated with the Commonwealth
of Pennsylvania on May 30, 1995. The primary business of this
community development corporation is to provide and promote
community welfare through the establishment and offering of
low interest rate loan programs to stimulate economic
rehabilitation and development for the Borough of
McConnellsburg and the entire community of Fulton County, PA.
Competition
Our primary market area includes all of Fulton County and
portions of Huntingdon, Bedford and Franklin Counties,
portions of Washington County, Maryland and portions of Morgan
County, West Virginia. Our major competitor is a one bank
holding company headquartered in McConnellsburg, Pennsylvania
which has 7 branches located throughout Fulton, Franklin and
Huntingdon Counties. As of December 31, 2001, we were ranked
second in total deposits when compared to our major
competitor. Also, in this market area we compete with
regionally-based commercial banks (all of which have greater
assets, capital and lending limits), savings banks, savings
and loan associations, money market funds, insurance
companies, stock brokerage firms, regulated small loan
companies, credit unions and with issuers of commercial paper
and other securities.
Page 4 of 17 Pages
Although deregulation has allowed us to become more
Competitive in the market place in regard to pricing of loan
and deposit rates, there are disparities in taxing law which
give some of our nonbank competitors advantages which
commercial banks do not enjoy and many burdensome and costly
regulations with which we must comply. We meet these
challenges by developing and promoting our locally-owned
community bank image; by offering friendly and professional
customer service; and by striving to maintain competitive
interest rates for both loans and deposits.
Regulation and Supervision
Our operations are subject to the provisions of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding
Company Act"), and to supervision by the Federal Reserve
Board. The Bank Holding Company Act requires us to secure the
Prior approval of the Federal Reserve Board before we own or
control, directly or indirectly, more than five percent (5%)
of the voting shares of substantially all of the assets of an
institution, including another bank. The Bank Holding Company
Act prohibits acquisition by the Company of more than five
percent (5%) of the voting shares of, or interest in, all or
substantially all of the assets of any bank located outside of
Pennsylvania unless such acquisition is specifically
Authorized by the laws of the state in which such bank is
located.
Our operations are subject to federal and state statutes
applicable to banks chartered under the banking laws of the
United States, to members of the Federal Reserve System and to
banks whose deposits are insured by the FDIC. Our operations
are also subject to regulations of the Comptroller, the
Federal Reserve Board and the FDIC. Our primary supervisory
authority is the Comptroller, which regulates and examines us.
The Comptroller has authority to prevent national banks from
engaging in unsafe or unsound practices in conducting their
businesses.
Legislation and Regulatory Changes
From time to time, legislation is enacted which has the effect
of increasing the cost of doing business, limiting or
expanding permissible activities or affecting the competitive
balance between banks and other financial institutions.
Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and
other financial institutions are frequently made in Congress,
and before various bank regulatory agencies. No prediction
can be made as to the likelihood of any major changes or the
impact such changes might have on the Company and its
subsidiary, the Bank. Certain changes of potential
significance to the Company which have been enacted recently
are discussed below.
Page 5 of 17 Pages
The Federal Reserve Board, the FDIC and the Comptroller have
issued risk-based capital guidelines, which supplement
existing capital requirements. The guidelines require all
United States banks and bank holding companies to maintain a
minimum risk-based capital ratio of 8.0% (of which at least
3.0% must be in the form of common stockholders' equity).
Assets are assigned to five risk categories, with higher
levels of capital being required for the categories perceived
as representing greater risk. The required capital will
represent equity and (to the extent permitted) nonequity
capital as a percentage of total risk-weighted assets. On the
basis of an analysis of the rules and the projected
composition of the Company's consolidated assets, it is not
expected these rules will have a material effect on the
Company's business and capital plans. The company presently
has capital ratios exceeding all regulatory requirements.
The Financial Institution Reform, Recovery and Enforcement Act
of 1989 ("FIRREA") was enacted in August 1989. This law was
enacted primarily to improve the supervision of savings
associations by strengthening capital, accounting and other
supervisory standards. In addition, FIRREA reorganized the
FDIC by creating two deposit insurance funds to be
administered by the FDIC: the Savings Association Insurance
Fund and the Bank Insurance Fund. Customers' deposits held by
the Bank are insured under the Bank Insurance Fund. FIRREA
also regulated real estate appraisal standards and the
supervisory/enforcement powers and penalty provisions in
connection with the regulation of the Bank.
In December 1991 the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") became law. Under FDICIA,
institutions must be classified, based on their risk-based
capital ratios into one of five defined categories (well
capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically
undercapitalized) as outlined below:
Total
Risk-
Based
Ratio
Tier 1
Risk-
Based
Ratio
Under a
Tier 1
Leverage
Ratio
Capital
Order or
Directive
CAPITAL CATEGORY
Well capitalized
>10.0%
>6.0%
>5.0%
No
Adequately
capitalized
> 8.0%
>4.0%
>4.0%*
Undercapitalized
Significantly
< 8.0%
<4.0%
<4.0%*
Undercapitalized
< 6.0%
<3.0%
<3.0%
Critically
undercapitalized
<2.0%
*3.0% for those banks having the highest available
regulatory rating.
Page 6 of 17 Pages
Under FDICIA financial institutions are subject to increased
regulatory scrutiny and must comply with certain operational,
managerial and compensation standards to be developed by
Federal Reserve Board Regulations. FDICIA also required the
regulators to issue new rules establishing certain minimum
standards to which an institution must adhere including
standards requiring a minimum ratio of classified assets to
capital, minimum earnings necessary to absorb losses and
minimum ratio of market value to book value for publicly held
institutions. Additional regulations are required to be
developed relating to internal controls, loan documentation,
credit underwriting, interest rate exposure, asset growth and
excessive compensation, fees and benefits.
Annual full-scope, on-site examinations are required for all
FDIC-insured institutions except institutions with assets
under $100 million which are well capitalized, well managed
and not subject to a recent change in control, in which case,
the examination period is every eighteen (18) months. FDICIA
also required banking agencies to reintroduce loan-to-value
("LTV") ratio regulations which were previously repealed by
the 1982 Act. LTV's will limit the amount of money a
financial institution may lend to a borrower, when the loan
is secured by real estate, to no more than a percentage to be
set by regulation of the value of the real estate.
A separate subtitle within FDICIA, called the "Bank
Enterprise Act of 1991", requires "truth-in-savings" on
consumer deposit accounts so that consumers can make
meaningful comparisons between the competing claims of banks
with regard to deposit accounts and products. Under this
provision which became effective on June 21, 1993, the Bank
is required to provide information to depositors concerning
the terms and fees of their deposit accounts and to disclose
the annual percentage yield on interest-bearing deposit
accounts.
Federal regulators issued regulations to implement the
privacy provisions of the Gramm-Leach-Bliley Act (Financial
Services Modernization Act). This new law requires banks to
notify consumers about their privacy policies and to give
them an opportunity to "opt-out" or prevent the bank from
sharing "nonpublic personal information" about them with
nonaffiliated third parties. Regulations became effective
during 2001. We have developed privacy policies and
procedures to provide timely disclosure of such policies and
a convenient means for consumers to opt our of the sharing of
their information with unaffiliated third parties.
We do not anticipate compliance with environmental laws and
regulations to have any material effect on their respective
capital, expenditures, earnings, or competitive position.
Page 7 of 17 Pages
Employees
As of December 31, 2001, we employed 55 persons on a full-
time equivalent basis.
Statistical Data
Computation of our regulatory capital requirements for the
periods December 31, 2001, and December 31, 2000, on page 44
of the annual shareholders report for the year ended December
31, 2001, is incorporated herein by reference.
Loan Portfolio
We make loans to both individual consumers and commercial
entities. The types offered include auto, personal,
mortgage, home equity, school, home repair, small business,
commercial, and home construction loans. Within these loans
types, we make installment loans, which have set payments
allowing the loan to be amortized over a fixed number of
payments, demand loans, which have no fixed payment and which
are payable in full on demand and are normally issued for a
term of less than one year, and mortgage loans, which are
secured with marketable real estate and have fixed payment
amounts for a pre-established payment period.
We do not assume undue risk on any loan within the loan
portfolio, and take appropriate steps to secure all loans as
necessary.
We have adopted the following loan-to-value ratios, in
accordance with standards adopted by our bank supervisory
agencies:
Loan Category
Loan-to-Value Limit
Raw Land
65%
Land Development
75%
Construction:
Commercial, Multifamily,
and other Nonresidential 1
to 4 Family Residential
80%
Improved Property
85%
Owner-occupied 1 to 4 Family
and Home Equity
90%
We are neither dependent upon nor exposed to loan
concentrations to a single customer or to a single industry,
the loss of any one or more of which would have a material
adverse effect on the financial condition of the Bank;
however, a portion of the Bank's customers' ability to honor
their contracts is dependent upon the construction and land
development and agribusiness economic sector. As a majority
of our loan portfolio is comprised of loans to individuals
Page 8 of 17 Pages
and businesses in Fulton County, PA, a significant portion of
our customers' abilities to honor their contracts is
dependent upon the general economic conditions in ,South
Central Pennsylvania.
Loan Portfolio composition as of December 31, 2001, and
December 31, 2000, on page 13 of the annual shareholders
report for the year ended December 31, 2001, is incorporated
herein by reference.
Maturities of loans as of December 31, 2001, on page 14 of
the annual shareholders report for the year ended December
31, 2001, is incorporated herein by reference. Nonperforming
loans consist of nonaccruing loans and loans 90 days or more
past due. Nonaccruing loans are comprised of loans that are
no longer accruing interest income because of apparent
financial difficulties of the borrower. Interest on
nonaccruing loans is recorded when received only after past
due principal and interest are brought current. Our general
policy is to classify loans as nonaccrual when they become
past due in principal and interest for over 90 days and
collateral is insufficient to allow continuation of interest
accrual. At that time, the accrued interest on the
nonaccrual loan is reversed from the current year earnings
and interest is not accrued until the loan has been brought
current in accordance with contractual terms.
Nonaccrual, Past Due and Restructured Loans as of December
31, 2001, December 31, 2000, and December 31, 1999, on page
15 of the annual shareholders report for the year ended
December 31, 2001, are incorporated herein by reference.
Allowance for Loan Loss Analysis
The allowance for loan losses is maintained at a level to
absorb potential future loan losses contained in the loan
portfolio and is formally reviewed by us on a quarterly
basis. The allowance is increased by provisions charged to
operating expense and reduced by net charge-offs. Our basis
for the level of the allowance and the annual provisions is
our evaluation of the loan portfolio, current and projected
domestic economic conditions, the historical loan loss
experience, present and prospective financial condition of
the borrowers, the level of nonperforming assets, best and
worst case scenarios of possible loan losses and other
relevant factors. While we use available information to make
such evaluations, future adjustments of the allowance may be
necessary if economic conditions differ substantially from
the assumptions used in making the evaluation. Loans are
charged against the allowance for loan losses when we believe
that the collectability of the principal is unlikely.
Activity in the allowance for loan losses and a breakdown of
the allowance for loan losses as of December 31, 2001, and
December 31, 2000, on page 14 and 15 of the annual
Page 9 of 17 Pages
shareholders report for the year ended December 31, 2001, are
incorporated herein by reference.
Although loans secured by 1-4 family residential mortgages
comprise approximately 48% of the entire loan portfolio,
until recently these mortgages have historically resulted in
little or no loss. The allocation of the Allowance for Loan
Losses for these mortgages is based upon this historical
fact. Due to a more critical evaluation of our commercial,
industrial, and agricultural loan portfolio, the allocation
of the Allowance for Loan Losses for commercial, industrial,
and Agriculture loans has been accordingly increased.
Deposits
Time Certificates of Deposit of $100,000 and over as of
December 31, 2001, and December 31, 2000, totaled $12,696,000
and $12,383,000 respectively.
Maturities and rate sensitivity of total interest bearing
liabilities as of December 31, 2001, on page 43 of the annual
shareholders report for the year ended December 31, 2001, is
incorporated herein by reference.
Returns on Equity and Assets
Returns on equity and assets and other statistical data for
2001, 2000 and 1999 on page 24 of the annual shareholders
report for the year ended December 31, 2001, is incorporated
herein by reference.
Item 2. Properties
The physical properties where we conduct our business in the
Commonwealth of Pennsylvania are all owned by us while the
property where we conduct business in the State of Maryland
is leased. The properties owned by us are as follows: the
main office located at 101 Lincoln Way West, McConnellsburg,
Pennsylvania, has been attached by a two story brick and
frame addition, to a building located at 111 South Second
Street, McConnellsburg, Pennsylvania which houses the Bank's
consumer loan department on the first floor and commercial
loan department and future expansion space on the second
floor; a property adjacent to the main office facility at 115
Lincoln Way West in downtown McConnellsburg comprised of a
54' by 218' city lot which has situated on it a three story
building consisting of 4,577 usable square feet on the first
floor, a 28' by 60' finished basement, second and third
stories which are unusable and a detached garage; a branch
office located on Route 522 South, Needmore, Pennsylvania; a
property located at Routes 16 and 30 East, McConnellsburg,
Pennsylvania which contains a drive-up automatic teller
machine and a five (5) lane drive-up branch accessible from
both Route 30 and Route 16; and a branch office located at 30
Mullen Street, Fort Loudon, Pennsylvania, for which we
Page 10 of 17 Pages
received regulatory approval from the Office of the
Comptroller of the Currency to purchase effective November
13, 1995. The branch office leased by us in the state of
Maryland is located in the Hancock Shopping Center at 343
North Pennsylvania Avenue in Hancock, Maryland next to a
supermarket.
The main office located in downtown McConnellsburg is housed
in a two story brick and frame building, consisting of
approximately 28,277 square feet. It has been attached (by a
two story brick and frame addition which houses the data
processing/operations center on the first floor and executive
offices and a meeting room on the second floor) to the
building located at 111 South Second Street, a brick and
frame building situated on a one town lot which has been
expanded and renovated to house the consumer loan department
on the first floor and commercial loan department and future
offices and rest rooms on the second floor. The main office
contains one (1) external time and temperature sign, seven
(7) internal teller stations, a customer service office area,
executive offices, one (1) drive-up teller station, an
automatic teller machine, three (3) vaults (one containing
safe deposit boxes for customer use and one containing a fire
proof/data-secure vault in the operations center), a night
depository, a data processing center with a security
controlled computer operations center, a loan department with
a large file room, a kitchen and a 5,000 square foot basement
storage area.
The Needmore Branch Office, a brick and frame building
situated on approximately five (5) acres, consists of
approximately 3,000 square feet, of which 750 square feet is
rented as office space. The branch office houses three (3)
internal teller stations, one (1) drive-up teller station, a
customer service office area, one (1) vault which contains
safe deposit boxes for customer use, one (1) kitchen, and
storage areas.
The East End Express Banking Center, located on a property of
approximately 68,000 square feet at Routes 16 and 30, has
situated on it one (1) drive-up automatic teller machine and
one (1) night depository (both housed in a brick and frame
building of approximately 121 square feet), and a drive-up
branch office, a brick and frame building of approximately
576 square feet, which contains four (4) drive-up teller
stations with the potential for a total of five (5) drive-up
teller stations in the future.
The Fort Loudon Branch Office, which was expanded and
completely renovated in 1997 at an approximate cost of
$200,000, is a brick and frame building situated on
approximately .23 acres. It consists of approximately 1,035
square feet. The branch office houses three (3) internal
teller stations, one (1) drive-up teller station, one (1)
Page 11 of 17 Pages
vault which contains safe deposit boxes for customer use, a
manager's office, one (1) kitchen, storage areas and a
basement for storage which consists of approximately 620
square feet.
The leased office in Hancock, Maryland housing Hancock
Community Bank is approximately 1,400 square feet and is
leased from the owner of the shopping center next to a
supermarket. It contains two (2) offices, one (1) automated
teller machine, two (2) drive-up teller lanes, a lobby, a
safe deposit box vault for customers and three (3) teller
stations.
Item 3. Legal Proceedings
In our opinion, there are no proceedings pending to which we
are a party or to which our property is subject, which, if
determined adversely to us would be material in relation to
our retained earnings or financial condition. There are no
proceedings pending other than ordinary routine litigation
incident to our business. In addition, no material
proceedings are known to be threatened or contemplated
against the us by government authorities.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters
Our common stock is not traded on a national securities
exchange but is traded inactively in the over-the-counter
market and is only occasionally and sporadically traded
through local and regional brokerage houses.
The Stock Market Analysis and Dividends for 2001 and 2000 on
page 44 of the annual shareholders report for the year ended
December 31, 2001, is incorporated herein by reference.
Item 6. Selected Financial Data
The Selected Five-Year Financial Data on page 24 of the
annual shareholders report for the year ended December 31,
2001, is incorporated herein by reference.
Page 12 of 17 Pages
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Management's discussion and analysis of financial condition
and results of Operations on pages 29 through 44 of the
annual shareholders report for the year ended December 31,
2001, is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data, some of
which is required under Guide 3 (Statistical Disclosures by
Bank Holding Companies) are shown on pages 7 through 28 of
the annual shareholders report for the year ended December
31, 2001, are incorporated herein by reference.
The Summary of Quarterly Financial Data on page 25 of the
annual shareholders report for the year ended December 31,
2001, is incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
PART III
Item 10. Directors and Officers of the Registrant
The information contained on pages 3 through 15 of FNB
Financial Corporation's Proxy Statement For the Annual
Meeting of Shareholders to be Held April 23, 2002, with
respect to directors and executive officers of the Company,
is incorporated herein by reference in response to this item.
Item 11. Executive Compensation
The information contained on pages 12 through 16 of FNB
Financial Corporation's Proxy Statement For the Annual
Meeting of Shareholders to be Held April 23, 2002, with
respect to executive compensation, transactions and
contracts, is incorporated herein by reference in response to
this item. The Executive Employment Contract of the
President and CEO of the Bank and the Executive Change of
Control Agreement for the Senior Vice President and CFO of
the Bank both dated October 2000, are incorporated herein by
reference in response to this item.
Page 13 of 17 Pages
Item 12. Security Ownership of certain Beneficial Owners and
Management
The information contained on pages 3 through 5 and pages 18
and 19 of FNB Financial Corporation's Proxy Statement For the
Annual Meeting to be Held April 23, 2002, with respect to
security ownership of certain beneficial owners and
management, is incorporated herein by reference in response
to this item.
Item 13. Certain Relationships and Related Transactions
The information contained on page 16 of FNB Financial
Corporation's Proxy Statement For the Annual Meeting to be
Held April 23, 2002, with respect to certain relationships
and related transactions, is incorporated herein by reference
in response to this item.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports of Form
8-K.
(a) (1) - List of Financial Statements
The following consolidated financial statements of FNB
Financial Corporation and its subsidiary, included in the
annual report of the registrant to its shareholders for the
year ended December 31, 2001, are incorporated by reference
in Item 8:
Consolidated balance sheets - December 31, 2001, and 2000
Consolidated statements of income - Years ended December 31,
2001, 2000 and 1999
Consolidated statements of stockholders' equity - Years ended
December 31, 2001, 2000 and 1999
Consolidated statements of cash flows - Years ended
December 31, 2001, 2000 and 1999
Notes to consolidated financial statements - December 31,
2001
(2) - List of Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments
Schedule III - Condensed Financial Information of
Registrant
Schedule VIII - Valuation and Qualifying Accounts
Page 14 of 17 Pages
All other schedules for which provision is made in the
applicable accounting regulation of the Securities and
Exchange Commission are not required under the related
instructions or are inapplicable and therefore have
been omitted.
(3) - Listing of Exhibits
Exhibit (3)(i) Articles of incorporation
Exhibit (3)(ii) Bylaws
Exhibit (4) Instruments defining the rights of
security holders including indentures
Exhibit (10) Material Contracts
Exhibit (13) Annual Report to Security holders
Exhibit (22) Subsidiaries of the registrant
Exhibit (27) Financial data schedule
All other exhibits for which provision is made in the
applicable accounting regulation of the Securities
and Exchange Commission are not required under the
related instructions or are inapplicable and
therefore have been omitted.
(b) Reports on Form 8-K filed
None.
(c) Exhibits
Exhibit (3)(i) Articles of incorporation - Exhibit 3A of Form
SB-2 Registration Statement No. 33-66014 are incorporated
herein by reference.
Exhibit (3)(ii) Bylaws - Exhibit 3B of Form SB-2 Registration
Statement No. 33-66014 are incorporated herein by reference.
Exhibit (4) Instruments defining the rights of security
holders including debentures - Document #1 of Form 10-K for
FNB Financial Corporation for fiscal year ended December 31,
1995 is incorporated herein by reference.
Exhibit (10.1) Executive Supplemental Retirement Plan For
Select Officers - incorporated by reference to the Company's
Form 10-K for the year ended December 31, 1999.
Exhibit (10.2) Director Fee Continuation Agreement for Select
Directors - incorporated by reference to the Company's Form
10-K for the year ended December 31, 1999.
Exhibit (10.3) Executive Employment Contract for the
President and CEO of the Bank dated October 2000 is
incorporated by reference to the Company's Form 10-K for the
year ended December 31, 2000.
Page 15 of 17 Pages
Exhibit (10.4) Executive Change of Control Agreement for the
Senior Vice President and CFO of the Bank dated October 2000
is incorporated by reference to the Company's Form 10-K for
the year ended December 31, 2000.
Exhibit (13) Annual report to security holders - filed
herewith.
Exhibit (22) Subsidiaries of the registrant - As of this
report, The First National Bank of McConnellsburg is the only
subsidiary of the Registrant and is explained further within
the Business Section (Item 1) of this report. The First
National Bank of McConnellsburg has one subsidiary as of the
date of this report, First Fulton County Community
Development Corporation and is explained further within the
Business Section (Item 1) of this report.
(d) Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments
Schedules of Marketable Securities included on pages 12 and
13 of the annual report of the registrant to its shareholders
for the year ended December 31, 2001 are incorporated herein
by reference.
Schedule III - Condensed Financial Information of Registrant
Condensed Financial Information of the Registrant included on
page 19 and 20 of the annual report of the registrant to its
shareholders for the year ended December 31, 2001, is
incorporated herein by reference.
Schedule VIII - Valuation and Qualifying Accounts
The schedule of the Allowance for Loan losses included on
page 15 of the annual report of the registrant to its
shareholders for the year ended December 31, 2001, is
incorporated herein by reference.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
FNB FINANCIAL CORPORATION
(Registrant)
/s/John C. Duffey 3/25/2002
John C. Duffey Date
Director and President of the
Corporation
President & CEO of the Bank
(Principal Executive Officer)
Page 16 of 17 Pages
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
/s/H. Lyle Duffey 3/25/2002 /s/Henry W. Daniels 3/25/2002
H. Lyle Duffey Date Henry W. Daniels Date
Director, Chairman Director, Vice Chairman
/s/John C. Duffey 3/25/2002 /s/Harry D. Johnston 3/25/2002
John C. Duffey Date Harry D. Johnston, D. O. Date
Director, President Director, Vice President
/s/Patricia A. Carbaugh 3/25/2002 /s/Lonnie W. Palmer 3/25/2002
Patricia A. Carbaugh Date Lonnie W. Palmer Date
Director
/s/Harvey J. Culler 3/25/2002 /s/D.A. Washabaugh, III 3/14/2002
Harvey J. Culler Date D. A. Washabaugh, III Date
Director Director
/s/Paul T. Ott 3/25/2002 /s/Terry L. Randall 3/25/2002
Lonnie W. Palmer Date Terry L. Randall Date
Director Director
/s/Craig E. Paylor 3/25/2002
Craig E. Paylor Date
Director
Page 17 of 17 Pages
EXHIBIT 13
FNB FINANCIAL CORPORATION
2001 ANNUAL FINANCIAL REPORT
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS
Balance sheets 2
Statements of income 3
Statements of changes in stockholders' equity 4
Statements of cash flows 5 and 6
Notes to consolidated financial statements 7 - 23
ACCOMPANYING FINANCIAL INFORMATION
Selected five year financial data 24
Summary of quarterly financial data 25
Distribution of assets, liabilities and stockholders' equity, interest
rates, and interest differential 26
Changes in net interest income 27
Maturities of investment securities 28
Management's discussion and analysis of financial condition and
results of operations 29-44
INDEPENDENT AUDITOR'S REPORT
Board of Directors
FNB Financial Corporation
McConnellsburg, Pennsylvania
We have audited the accompanying consolidated balance sheets of FNB Financial Corporation
and its wholly-owned subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of
income, changes in stockholders' equity, and cash flows for each of the three years ended December 31, 2001.
These consolidated financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the
United States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of FNB Financial Corporation and its wholly-owned subsidiary as of
December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the three years
ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of
America.
/S/Smith Elliott Kearns & Company, LLC
Chambersburg, Pennsylvania
February 15, 2002
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
2001
2000
ASSETS
Cash and due from banks
$ 5,400,929
$ 4,020,479
Federal funds sold
6,000,000
0
Interest-bearing deposits with banks
2,572,574
778,546
Investment securities:
Available for sale
19,554,290
26,768,521
Held to maturity (fair value $ 1,088,459 - 2001; $ 1,135,971 -
2000)
1,114,764
1,207,835
Federal Reserve, Atlantic Central Banker's Bank and Federal Home
Loan Bank stock
833,700
833,700
Loans, net of unearned discount and allowance for loan losses
90,167,678
83,112,173
Bank building, equipment, furniture and fixtures, net
2,914,416
3,069,015
Accrued interest and dividends receivable
619,464
789,393
Deferred income taxes
160,529
291,325
Other real estate owned
103,568
168,653
Cash surrender value of life insurance
2,313,129
2,209,915
Other assets
405,475
376,680
Total assets
$ 132,160,516
$ 123,626,235
LIABILITIES
Deposits:
Demand deposits
$ 13,343,930
$ 11,798,431
Savings deposits
32,659,787
29,407,101
Time certificates
65,647,473
62,129,564
Other time deposits
311,190
297,392
Total deposits
111,962,380
103,632,488
Liability for borrowed funds
5,403,458
6,176,901
Accrued dividends payable
216,000
192,000
Accrued interest payable and other liabilities
1,190,681
1,076,819
Total liabilities
118,772,519
111,078,208
STOCKHOLDERS' EQUITY
Capital stock, common, par value $ .315; 12,000,000 shares
authorized; 800,000 shares issued and outstanding
252,000
252,000
Additional paid-in capital
1,789,833
1,789,833
Retained earnings
11,124,857
10,623,726
Accumulated other comprehensive income (loss)
221,307
( 117,532)
Total stockholders' equity
13,387,997
12,548,027
Total liabilities and stockholders' equity
$ 132,160,516
$ 123,626,235
The Notes to Consolidated Financial Statements are an integral part of these statements.
- -2-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2001, 2000 and 1999
2001
2000
1999
Interest and Dividend Income
Interest and fees on loans
$ 7,140,997
$ 6,902,812
$ 5,766,741
Interest on investment securities:
U. S. Treasury securities
0
0
1,585
Obligations of other U.S. Government agencies
845,914
1,296,141
1,366,191
Obligations of States and political subdivisions
416,998
421,345
485,198
Dividends on equity securities
59,123
61,901
33,995
Interest on deposits with banks
39,117
49,664
68,182
Interest on federal funds sold
265,496
22,725
80,297
8,767,645
8,754,588
7,802,189
Interest Expense
Interest on borrowed funds
333,299
455,828
88,932
Interest on deposits
4,343,347
4,240,673
4,030,292
Net interest income
4,090,999
4,058,087
3,682,965
Provision for Loan Losses
144,000
231,319
190,000
Net interest income after provision for loan losses
3,946,999
3,826,768
3,492,965
Other Income
Service charges on deposit accounts
217,431
181,902
123,731
Other service charges, collection and exchange charges,
commissions and fees
366,337
283,232
260,990
Other income, net
137,375
159,272
186,085
Securities gains (losses)
17,986
( 474)
49,655
739,129
623,932
620,461
Other Expenses
Salaries and wages
1,432,292
1,341,280
1,251,344
Pensions and other employee benefits
363,253
355,250
326,859
Net occupancy expense of bank premises
256,186
252,023
236,758
Furniture and equipment expenses
284,372
269,592
258,525
Other operating expenses
1,089,383
1,048,825
956,086
3,425,486
3,266,970
3,029,572
Income before income taxes
1,260,642
1,183,730
1,083,854
Applicable income taxes
255,511
229,149
180,572
Net income
$ 1,005,131
$ 954,581
$ 903,282
Earnings per share of common stock:
Net income
$ 1.26
$ 1.19
$ 1.13
Weighted average shares outstanding
800,000
800,000
800,000
The Notes to Consolidated Financial Statements are an integral part of these statements.
- -3-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2001, 2000, and 1999
Accumulated
Additional Other Total
Common Paid-In Retained Comprehensive Stockholders'
Stock Capital Earnings Income (Loss) Equity
Balance, December 31, 1998 252,000 1,789,833 9,621,863 252,870 11,916,566
Comprehensive income:
Net income 0 0 903,282 0 903,282
Changes in unrealized gain
(loss) on securities
available for sale, net
of taxes of ($ 628,026) 0 0 0 ( 1,219,111) ( 1,219,111)
Total comprehensive income (loss) ( 315,829)
Cash dividends declared on
common stock ($ .50
per share) 0 0 ( 400,000) 0 ( 400,000)
Balance, December 31, 1999 252,000 1,789,833 10,125,145 ( 966,241) 11,200,737
Comprehensive income:
Net income 0 0 954,581 0 954,581
Changes in unrealized gain
on securities available for
sale, net of taxes of
$ 437,213 0 0 0 848,709 848,709
Total comprehensive income 1,803,290
Cash dividends declared on
common stock ($ .57
per share) 0 0 ( 456,000) 0 ( 456,000)
Balance, December 31, 2000 $ 252,000 $ 1,789,833 $ 10,623,726 ($ 117,532) $ 12,548,027
Comprehensive income:
Net income 0 0 1,005,131 0 1,005,131
Changes in unrealized gain
on securities available for
sale, net of taxes of
$ 174,553 0 0 0 338,839 338,839
Total comprehensive income 1,343,970
Cash dividends declared on
common stock ($ .63
per share) 0 0 ( 504,000) 0 ( 504,000)
Balance, December 31, 2001 $ 252,000 $ 1,789,833 $ 11,124,857 $ 221,307 $ 13,387,997
The Notes to Consolidated Financial Statements are an integral part of these statements.
- -4-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
Cash flows from operating activities:
Net income $ 1,005,131 $ 954,581 $ 903,282
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 300,331 288,168 278,402
Provision for loan losses 144,000 231,319 190,000
Deferred income taxes ( 43,758) ( 52,037) ( 31,487)
Loss on sale of other real estate 19,038 805 12,281
Increase in cash surrender value of life insurance ( 103,214) ( 102,811) ( 81,594)
(Gain) loss on sales/maturities of investments ( 17,986) 474 ( 49,655)
(Gain) loss on disposal of equipment 0 ( 865) ( 554)
(Increase) decrease in accrued interest
receivable 169,929 ( 102,134) 31,285
Increase (decrease) in accrued interest
payable and other liabilities 113,862 215,305 ( 6,617)
(Increase) decrease in other assets ( 43,445) ( 84,490) 14,124
Net cash provided by operating activities 1,543,888 1,348,315 1,259,467
Cash flows from investing activities:
Net (increase) decrease in interest bearing
deposits with banks ( 1,794,028) ( 55,453) 1,296,518
Maturities of held-to-maturity securities 93,071 461,877 779,909
Proceeds from sales of available-for-sale securities 38,720 0 1,151,501
Maturities of available-for-sale securities 10,107,008 2,742,252 4,145,757
Purchases of available-for-sale securities ( 2,400,118) ( 140,076) ( 2,292,472)
Proceeds from sales of other real estate owned 46,047 274,087 207,527
Net (increase) in loans ( 7,199,505) ( 7,480,801) ( 14,466,397)
Purchase of other bank stock 0 ( 152,500) ( 287,100)
Purchases of bank premises and
equipment, net ( 131,082) ( 222,058) ( 187,627)
Proceeds from sale of equipment 0 1,206 1,054
Net cash (used) by investing activities ( 1,239,887) ( 4,571,466) ( 9,651,330)
Cash flows from financing activities:
Net increase in deposits 8,329,892 4,302,552 ( 1,173,998)
Cash dividends paid ( 480,000) ( 436,000) ( 336,000)
Net short-term borrowings 0 ( 2,933,000) 3,701,000
Proceeds from long-term borrowings 0 12,250,000 2,500,000
Principal payments on borrowings ( 773,443) ( 9,505,095) ( 4,768)
Net cash provided by financing activities 7,076,449 3,678,457 4,686,234
The Notes to Consolidated Financial Statements are an integral part of these statements.
- -5-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
Net increase (decrease) in cash and cash equivalents $ 7,380,450 $ 455,306 ($ 3,705,629)
Cash and cash equivalents, beginning balance 4,020,479 3,565,173 7,270,802
Cash and cash equivalents, ending balance $ 11,400,929 $ 4,020,479 $ 3,565,173
Supplemental disclosure of cash flows information:
Cash paid during the year for:
Interest $ 4,766,560 $ 4,610,819 $ 4,118,343
Income taxes 345,860 167,419 226,385
Supplemental schedule of noncash investing and
financing activities:
Unrealized gain (loss) on securities
available-for-sale, net of income tax effect $ 338,839 $ 848,709 ($ 1,219,111)
Other real estate acquired in settlement of loans 0 274,389 59,900
The Notes to Consolidated Financial Statements are an integral part of these statements.
- -6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Nature of Operations
FNB Financial Corporation's primary activity consists of owning and supervising its subsidiary,
The First National Bank of McConnellsburg, which is engaged in providing banking and bank
related services in South Central Pennsylvania, and Northwestern Maryland. Its five offices are
located in McConnellsburg (2), Fort Loudon and Needmore, Pennsylvania, and Hancock,
Maryland.
Principles of Consolidation
The consolidated financial statements include the accounts of the Corporation and its wholly-owned
subsidiary, The First National Bank of McConnellsburg. All significant intercompany transactions
and accounts have been eliminated.
First Fulton County Community Development Corporation (FFCCDC) was formed as a wholly-
owned subsidiary of The First National Bank of McConnellsburg. The purpose of FFCCDC is to
serve the needs of low-to-moderate income individuals and small business in Fulton County under
the Community Development and Regulatory Improvement Act of 1995.
Basis of Accounting
The Corporation uses the accrual basis of accounting.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination
of the allowance for losses on loans and the valuation of real estate acquired in connection with
foreclosures or in satisfaction of loans. In connection with the determination of the allowances for
losses on loans and foreclosed real estate, management obtains independent appraisals for
significant properties.
While management uses available information to recognize losses on loans and foreclosed real
estate, future additions to the allowances may be necessary based on changes in local economic
conditions. In addition, regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for losses on loans and foreclosed real estate. Such
agencies may require the Corporation to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination. Because of these
factors, management's estimate of credit losses inherent in the loan portfolio and the related
allowance may change in the near term.
- -7-
Note 1. Significant Accounting Policies (Continued)
Cash Flows
For purposes of the statements of cash flows, the Corporation has defined cash and cash equivalents
as those amounts included in the balance sheet captions "Cash and Due From Banks" and "Federal
Funds Sold". As permitted by Statement of Financial Accounting Standards No. 104, the
Corporation has elected to present the net increase or decrease in deposits in banks, loans and
deposits in the Statements of Cash Flows.
Investment Securities
In accordance with Statement of Financial Accounting Standards Number 115 (SFAS 115) the
Corporation's investments in securities are classified in three categories and accounted for as
follows:
? Trading Securities. Securities held principally for resale in the near term are classified as
trading securities and recorded at their fair values. Unrealized gains and losses on trading
securities are included in other income.
? Securities to be Held to Maturity. Bonds and notes for which the Corporation has the positive
intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums
and accretion of discounts which are recognized in interest income using the interest method
over the period to maturity.
? Securities Available for Sale. Securities available for sale consist of equity securities, and
bonds and notes not classified as trading securities nor as securities to be held to maturity.
These are securities that management intends to use as a part of its asset and liability
management strategy and may be sold in response to changes in interest rates, resultant
prepayment risk and other related factors. Unrealized holding gains and losses, net of tax, on
securities available for sale are reported as a net amount in other comprehensive income until
realized. Gains and losses on the sale of securities available for sale are determined using the
specific-identification method.
Fair values for investment securities are based on quoted market prices.
The Corporation had no trading securities in 2001 or 2000.
Federal Reserve Bank, Atlantic Central Banker's Bank, and
Federal Home Loan Bank Stock
These investments are carried at cost. The Corporation is required to maintain minimum
investment balances in these stocks, which are not actively traded and therefore have no readily
determinable market value.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially
recorded at the lower of carrying value or fair value of the underlying collateral less estimated cost
to sell. After foreclosure, valuations are periodically performed by management and the real estate
is carried at the lower of carrying amount or fair value less estimated cost to sell. Legal fees and
other costs related to foreclosure proceedings are expensed as they are incurred.
- -8-
Note 1. Significant Accounting Policies (Continued)
Loans and Allowance for Possible Loan Losses
Loans are stated at the amount of unpaid principal, reduced by unearned discount, deferred loan
origination fees, and an allowance for loan losses. Unearned discount on installment loans is
recognized as income over the terms of the loans by the interest method. Interest on other loans is
calculated by using the simple interest method on daily balances of the principal amount
outstanding. Amortization of premiums and accretion of discounts on acquired loans are
recognized in interest income using the interest method over the period to maturity. The allowance
for loan losses is established through a provision for loan losses charged to expense. Loans are
charged against the allowance for loan losses when management believes that the collectibility of
the principal is unlikely. The allowance is an amount that management believes will be adequate to
absorb possible losses on existing loans that may become uncollectible, based on evaluations of the
collectibility of loans and prior loan loss experience. The evaluations take into consideration such
factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of
specific problem loans, and current economic conditions that may affect the borrowers' ability to
pay.
In accordance with SFAS No. 91, loan origination fees and certain direct loan origination costs are
being deferred and the net amount amortized as an adjustment of the related loan's yield. The
Corporation is amortizing these amounts over the contractual life of the related loans. Deferred
loan origination fees were $ 217,739 and $ 225,776 at December 31, 2001 and 2000, respectively.
Deferred loan costs were $ 104,992 and $ 108,763 at December 31, 2001 and 2000, respectively.
Nonaccrual/Impaired Loans
The accrual of interest income on loans ceases when principal or interest is past due 90 days or
more and collateral is inadequate to cover principal and interest or immediately if, in the opinion of
management, full collection is unlikely. Interest accrued but not collected as of the date of
placement on nonaccrual status is reversed and charged against current income unless fully
collateralized. Subsequent payments received either are applied to the outstanding principal
balance or recorded as interest income, depending on management's assessment of the ultimate
collectibility of principal.
A loan is considered impaired when, based on current information and events, it is probable that
scheduled collections of principal or interest will not be made according to the contractual terms of
the loan agreement. Impairment is measured on a loan-by-loan basis (except for consumer loans,
which are collectively evaluated) by either the present value of expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value
of the underlying collateral.
Interest income generally is not recognized on specific impaired loans unless the likelihood of
further loss is remote. Interest payments received on such loans are applied as a reduction of the
loan principal balance. Interest income on other impaired loans is recognized only to the extent of
interest payments received.
- -9-
Note 1. Significant Accounting Policies (Continued)
Bank Building, Equipment, Furniture and Fixtures and Depreciation
Bank building, equipment, furniture and fixtures are carried at cost less accumulated depreciation.
Expenditures for replacements are capitalized and the replaced items are retired. Maintenance and
repairs are charged to operations as incurred. Depreciation is computed based on straight-line and
accelerated methods over the estimated useful lives of the related assets as follows:
Years
Bank building 5-40
Equipment, furniture and fixtures 3-20
Land improvements 10-20
Leasehold improvements 7-20
Earnings Per Share
Earnings per common share were computed based upon weighted average shares of common stock
outstanding of 800,000 for 2001, 2000, and 1999 after giving retroactive recognition to a two-for-
one stock split issued September 1, 2000.
Intangibles
Intangible costs are amortized on a straight-line basis over fifteen years.
Federal Income Taxes
As a result of certain timing differences between financial statement and federal income tax
reporting, deferred income taxes are provided in the financial statements. See Note 7 for further
details.
Advertising
The Corporation follows the policy of charging costs of advertising to expense as incurred.
Advertising expense was $ 80,238, $ 98,561, and $ 63,268 for 2001, 2000, and 1999,
respectively.
Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial
Instruments, requires disclosure of fair value information about financial instruments, whether or
not recognized in the balance sheet. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Statement No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating fair values of
financial instruments as disclosed herein:
? Cash and Short-Term Instruments. The carrying amounts of cash and short-term
instruments approximate their fair value.
? Securities to be Held to Maturity and Securities Available for Sale. Fair values for
investment securities are based on quoted market prices.
- -10-
Note 1. Significant Accounting Policies (Continued)
? Loans Receivable. For variable-rate loans that reprice frequently and have no significant
change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans
are estimated using discounted cash flow analyses, using interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality. Fair values for impaired
loans are estimated using discounted cash flow analyses or underlying collateral values, where
applicable.
? Deposit Liabilities. The fair values disclosed for demand deposits are, by definition, equal
to the amount payable on demand at the reporting date (that is, their carrying amounts). The
carrying amounts of variable-rate certificates of deposit, and fixed-term money market accounts
approximate their fair values at the reporting date. Fair values for fixed-rate certificates of
deposit and IRA's are estimated using a discounted cash flow calculation that applies interest
rates currently being offered to a schedule of aggregated expected monthly maturities on time
deposits.
? Short-Term Borrowings. The carrying amounts of federal funds purchased, borrowings under
repurchase agreements, and other short-term borrowings maturing within 90 days approximate
their fair values. Fair values of other short-term borrowings are estimated using discounted
cash flow analyses based on the Corporation's current incremental borrowing rates for similar
types of borrowing arrangements.
? Long-Term Borrowings. The fair value of the Corporation's long-term debt is estimated using
a discounted cash flow analysis based on the Corporation's current incremental borrowing rate
for similar types of borrowing arrangements.
? Accrued Interest. The carrying amounts of accrued interest approximate their fair values.
? Off-Balance-Sheet Instruments. The Corporation generally does not charge commitment fees.
Fees for standby letters of credit and other off-balance-sheet instruments are not significant.
Comprehensive Income
The Corporation has adopted Statement of Financial Accounting Standards (SFAS) No. 130 -
Reporting Comprehensive Income. Under SFAS No. 130, comprehensive income is defined as the
change in equity from transactions and other events from nonowner sources. It includes all changes
in equity except those resulting from investments by stockholders and distributions to stockholders.
Comprehensive income includes net income and certain elements of "other comprehensive income"
such as foreign currency transactions; accounting for futures contracts; employers accounting for
pensions; and accounting for certain investments in debt and equity securities.
The Corporation has elected to report its comprehensive income in the statement of stockholders'
equity. The only element of "other comprehensive income" that the Corporation has is the
unrealized gain or loss on available for sale securities.
The components of the change in net unrealized gains (losses) on securities were as follows:
2001 2000 1999
Gross unrealized holding gains (losses) arising
during the year $ 531,378 $ 1,285,448 ($ 1,797,482)
Reclassification adjustment for (gains)/losses
realized in net income ( 17,986) 474 ( 49,655)
Net unrealized holding gains (losses) before taxes 513,392 1,285,922 ( 1,847,137)
Tax effect ( 174,553) ( 437,213) 628,026
Net change $ 338,839 $ 848,709 ($ 1,219,111)
- -11-
Note 2. Investment Securities
The amortized cost and fair values of investment securities available for sale at December 31 were:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2001
Obligations of other U.S.
Government agencies $ 7,838,868 $ 214,912 ($ 2,034) $ 8,051,746
Obligations of states and
political subdivisions 9,849,481 165,522 ( 52,136) 9,957,867
Mortgage-backed securities 693,173 3,509 ( 539) 696,143
SBA Loan Pool certificates 663,184 2,704 ( 2,356) 663,532
Equities in local bank stock 179,271 18,231 ( 12,500) 185,002
Totals $19,218,977 $ 404,878 ($ 69,565) $ 19,554,290
2000
Obligations of other U.S.
Government agencies $ 16,669,612 $ 254,301 ($ 440,093) $ 16,483,820
Obligations of states and
political subdivisions 8,392,131 55,935 ( 46,492) 8,401,574
Mortgage-backed securities 881,099 382 ( 3,343) 878,138
SBA Loan Pool certificates 793,610 854 ( 5,897) 788,567
Equities in local bank stock 210,148 15,219 ( 8,945) 216,422
Totals $ 26,946,600 $ 326,691 ($ 504,770) $ 26,768,521
The amortized cost and fair values of investment securities held to maturity at December 31
were:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2001
SBA loan pool certificates $ 551,033 $ 2,255 ($ 3,111) $ 550,177
Obligations of other U.S.
government agencies 563,731 0 ( 25,448) 538,283
Totals $ 1,114,764 $ 2,255 ($ 28,559) $ 1,088,460
2000
SBA loan pool certificates $ 682,099 $ 971 ($ 8,494) $ 674,576
Obligations of other U.S.
government agencies 525,736 0 ( 64,341) 461,395
Totals $ 1,207,835 $ 971 ($ 72,835) $ 1,135,971
The amortized cost and fair values of investment securities available for sale and held to maturity at
December 31, 2001 by contractual maturity, are shown below. Contractual maturities will differ
from expected maturities because borrowers may have the right to call or repay obligations with or
without call or repayment penalties.
- -12-
Note 2. Investment Securities (Continued)
Securities Available Securities Held
- - - - - - for Sale - - - - - - - - - - - - to Maturity- - - - - -
Amortized Fair Amortized Fair
Cost Value Cost Value
Due in one year or less $ 1,175,532 $ 1,185,461 $ 0 $ 0
Due after one year but
less than five years 5,630,260 5,792,830 0 0
Due after five years but
less than ten years 7,298,957 7,460,695 0 0
Due after ten years 3,578,600` 3,570,627 563,731 538,283
17,683,349 18,009,613 563,731 538,283
Mortgage-backed securities 693,173 696,143 0 0
SBA loan pool certificates 663,184 663,532 551,033 550,177
Equities in local bank stock 179,271 185,002 0 0
Totals $ 19,218,977 $ 19,554,290 $ 1,114,764 $ 1,088,460
Proceeds from sales of investment securities available for sale during 2001 were $ 38,720. Gross
losses on these sales were $ 0 and gross gains were $ 7,843. Related taxes were $ 2,667.
There were no sales of investment securities available for sale during 2000.
Proceeds from sales of investment securities available for sale during 1999 were $ 1,151,501. Gross
losses on these sales were $ 4,101 and gross gains were $ 53,756. Related taxes were
$ 16,883.
There were no sales of investment securities held-to-maturity in 2001, 2000, or 1999.
Investment securities carried at $ 5,828,486 and $ 6,649,820 at December 31, 2001 and 2000,
respectively, were pledged to secure public funds and for other purposes as required or permitted by
law.
Note 3. Loans
Loans consist of the following at December 31:
2001 2000
(000 omitted)
Real estate loans:
Construction and land development $ 3,946 $ 1,583
Secured by farmland 5,216 5,428
Secured by 1-4 family residential properties 43,945 42,768
Secured by multi-family residential properties 538 524
Secured by nonfarmland nonresidential properties 14,360 11,943
Loans to farmers (except loans secured
primarily by real estate) 3,314 3,613
Commercial, industrial and state and political subdivision loans 10,392 9,440
Loans to individuals for household, family, or other personal
expenditures 7,848 7,640
All other loans 1,812 1,616
Total loans 91,371 84,555
Less: Unearned discount on loans 321 632
Allowance for loan losses 882 811
Net Loans $ 90,168 $ 83,112
- -13-
Note 3. Loans (Continued)
The following table shows maturities and sensitivities of loans to changes in interest rates based
upon contractual maturities and terms as of December 31, 2001.
(000 omitted)
Due Within
1 Year
Due Over
1 But
Within 5
Years
Due Over
5 Years
Nonaccruing
Loans
Total
Loans at pre-determined
interest rates
$ 2,567
$ 11,261
$ 30,973
$ 181
$ 44,982
Loans at floating or
adjustable interest rates
14,285
4,483
27,311
310
49,389
Total (1)
$ 16,852
$ 15,744
$ 58,284
$ 491
$ 91,371
(1) These amounts have not been reduced by the allowance for possible loan losses or
unearned discount.
The Corporation has granted loans to its officers and directors, and to their associates. Related party
loans are made on substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons and do not involve more
than normal risk of collectibility. The aggregate dollar amount of these loans was $ 1,139,616 and
$ 1,612,752 at December 31, 2001 and 2000, respectively. During 2001,
$ 2,362,817 of new loans were made and repayments totaled $ 2,835,935. During 2000,
$ 887,053 of new loans were made and repayments totaled $ 1,645,235.
Outstanding loans to Corporate employees totaled $ 1,289,035 and $ 1,311,611 at December 31,
2001 and 2000, respectively.
Note 4. Allowance for Loan Losses
Activity in the allowance for loan losses is summarized as follows:
2001 2000 1999
Allowance for loan losses, beginning of the year $ 811 $ 746 $ 732
Loans charged-off during the year:
Real estate mortgages 18 89 100
Installment loans 90 90 40
Commercial and all other loans 1 24 61
Total charge-offs 109 203 201
Recoveries of loans previously charged-off:
Real estate mortgages 18 12 0
Installment loans 18 24 24
Commercial and all other loans 0 1 1
Total recoveries 36 37 25
Net loans charged-off (recovered) 73 166 176
Provision for loan losses charged to operations 144 231 190
Allowance for loan losses, end of the year $ 882 $ 811 $ 746
- -14-
Note 4. Allowance for Loan Losses (Continued)
A breakdown of the allowance for loan losses as of December 31 is as follows:
- - - - - - - 2001 - - - - - - - - - - - - - - 2000 - - - - - - -
Percent of Percent of
Loans in Loans in
Allowance Each Allowance Each
(000 omitted) Amount Category Amount Category
Commercial, industrial
and agriculture loans $ 575 37.51% $ 529 33.78%
1-4 family residential
mortgages 131 41.65 92 42.30%
Consumer and
installment loan 58 7.44 69 7.65%
Off balance sheet commitments 69 13.40 121 16.36%
Unallocated 49 N/A 0 N/A
Total $ 882 100.00% $ 811 100.00%
Impairment of loans having a recorded investment of $ 859,974 and $ 1,228,633 at December 31,
2001 and 2000 respectively, was recognized in conformity with SFAS No. 114 as amended by
SFAS No. 118. The average recorded investment in impaired loans was $ 1,019,975 and
$ 1,272,272 during 2001 and 2000, respectively. The total allowance for loan losses related to these
loans was $ 120,000 at December 31, 2001 and 2000. Interest income on impaired loans of
$ 85,042 and $ 118,811 was recognized for cash payments received in 2001 and 2000, respectively.
There were no impaired loans in 1999.
Note 5. Nonaccrual, Past Due and Restructured Loans
The following table shows the principal balances of nonaccrual loans as of December 31:
2001 2000 1999
Nonaccrual loans $ 491,659 $ 323,337 $ 422,820
Interest income that would have been
accrued at original contract rates $ 43,468 $ 31,633 $ 39,444
Amount recognized as interest
income 28,545 22,933 16,181
Foregone revenue $ 14,924 $ 8,700 $ 23,263
Loans 90 days or more past due (still accruing interest) were as follows at December 31:
(000 omitted) 2001 2000 1999
Real estate mortgages $ 228 $ 30 $ 55
Installment loans 45 112 111
Demand and time loans 0 41 0
Total $ 273 $ 183 $ 166
Note 6. Bank Building, Equipment, Furniture and Fixtures
Bank building, equipment, furniture and fixtures consisted of the following at December 31:
Accumulated Depreciated
Description Cost Depreciation Cost
2001
Land $ 231,635 $ 0 $ 2,31,635
Bank building and improvements 3,282,293 1,220,619 2,061,674
Equipment, furniture and fixtures 2,419,952 1,847,084 572,868
Leasehold improvements 64,028 15,789 48,239
$ 5,997,908 $ 3,083,492 $ 2,914,416
- -15-
Note 6. Bank Building, Equipment, Furniture and Fixtures (Continued)
Accumulated Depreciated
Description Cost Depreciation Cost
2000
Land $ 231,635 $ 0 $ 231,635
Bank building and improvements 3,281,210 1,128,108 2,153,102
Equipment, furniture and fixtures 2,290,079 1,657,916 632,163
Leasehold improvements 64,028 11,913 52,115
$ 5,866,952 $ 2,797,937 $ 3,069,015
Depreciation expense amounted to $ 285,683, $ 271,803 and $ 262,036 for 2001, 2000 and 1999,
respectively.
Note 7. Income Taxes
The components of federal income tax expense are summarized as follows:
2001 2000 1999
Current year provision $ 299,269 $ 281,186 $ 212,058
Deferred income taxes resulting from:
Differences between financial
statement and tax depreciation charges ( 4,793) ( 14,708) ( 7,817)
Differences between financial
statement and tax loan loss
provision ( 24,758) ( 18,868) ( 4,904)
Differences between financial statement
and tax retirement benefit expense ( 14,207) ( 18,461) ( 18,765)
Applicable income tax $ 255,511 $ 229,149 $ 180,572
Federal income taxes were computed after adjusting pretax accounting income for nontaxable
income in the amount of $ 578,139, $ 570,394, and $ 620,660 for 2001, 2000, and 1999,
respectively.
A reconciliation of the effective applicable income tax rate to the federal statutory rate is as
follows:
2001 2000 1999
Federal income tax rate 34.0% 34.0% 34.0%
Reduction resulting from:
Nontaxable income 13.7 14.6 17.3
Effective income tax rate 20.3% 19.4% 16.7%
Deferred income taxes at December 31 are as follows:
2001 2000
Deferred tax assets $ 296,472 $ 318,054
Deferred tax liabilities ( 135,943) ( 26,729)
$ 160,529 $ 291,325
- -16-
Note 7. Income Taxes (Continued)
The tax effects of each type of significant item that gives rise to deferred taxes are:
2001 2000
Net unrealized (gains) losses on
securities available for sale ($ 114,007) $ 60,547
Depreciation expense ( 21,936) ( 26,729)
Retirement benefit reserve 60,694 46,487
Allowance for loan losses 235,778 211,020
$ 160,529 $ 291,325
The Corporation has not recorded a valuation allowance for the deferred tax assets as management
feels that it is more likely than not that they will be ultimately realized.
Note 8. Employee Benefit Plans
The Corporation has a 401-K plan which covers all employees who have attained the age of 20 and
who have completed six months of full-time service. The plan provides for the Corporation to
match employee contributions to a maximum of 5% of annual compensation. The Corporation also
has the option to make additional discretionary contributions to the plan based upon the
Corporation's performance and subject to approval by the Board of Directors. The Corporation's
total expense for this plan was $ 94,923, $ 105,078, and $ 84,909, for the years ended December 31,
2001, 2000, and 1999, respectively.
The Corporation adopted three supplemental retirement benefit plans for directors and executive
officers. These plans are funded with single premium life insurance on the plan participants. The
cash value of the life insurance policies is an unrestricted asset of the Corporation. The estimated
present value of future benefits to be paid totaled $ 178,512 and $ 136,727 at December 31, 2001
and 2000, respectively, which is included in other liabilities. Total annual expense for these plans
amounted to $ 55,656, $ 54,406, and $ 64,339 for 2001, 2000, and 1999, respectively.
Note 9. Deposits
Included in savings deposits are NOW and Super NOW account balances totaling $ 7,647,991 and
$ 6,192,804 at December 31, 2001 and 2000, respectively. Also included in savings deposits at
December 31, 2001 and 2000 are Money Market account balances totaling $ 11,179,592 and
$ 10,578,065, respectively.
Time certificates of $ 100,000 and over as of December 31 were as follows:
2001 2000
(000 omitted)
Three months or less $ 1,304 $ 1,444
Three months to six months 855 1,058
Six months to twelve months 1,533 3,970
Over twelve months 9,004 5,911
Total $ 12,696 $ 12,383
Interest expense on time deposits of $ 100,000 and over aggregated $ 726,092, $ 699,027, and
$ 688,565 for 2001, 2000, and 1999, respectively.
At December 31, 2001 the scheduled maturities of certificates of deposit are as follows (000
omitted):
2002 $ 31,028
2003 9,123
2004 13,282
2005 6,013
2006 6,200
Thereafter 2
$ 65,648
- -17-
Note 9. Deposits (Continued)
The Corporation accepts deposits of the officers, directors and employees of the corporation and its
subsidiary on the same terms, including interest rates, as those prevailing at the time for comparable
transactions with unrelated persons. The aggregate dollar amount of deposits of officers, directors
and employees totaled $ 2,367,738 and $ 2,006,103 at December 31, 2001 and 2000, respectively.
The aggregate amount of demand deposit overdrafts reclassified as loan balances were $ 24,846 and
$ 212,482 at December 31, 2001 and 2000, respectively.
Derivative Instruments
Included in time deposits at December 31, 2001 are Index Powered Certificates of Deposit
("IPCD's") totaling $ 1,055,108. The IPCD product is offered through a program with the Federal
Home Loan Bank (FHLB). The ultimate pay off at maturity, which is in five years, is the initial
deposited principal plus the appreciation in the S&P 500 Index ("S&P Call Option"). The S&P
Call Option is considered an embedded derivative designated as a non-hedging item. The change in
fair value of the S&P Call Option for 2001 resulted in a gain of $ 16,347 which is included in other
income.
In order to hedge its risk associated with the IPCD Product, the Corporation has entered into a
derivative contract with the FHLB whereby the Corporation pays FHLB a fixed rate interest charge
(ranging from 4.2% to 4.97%) in return for a guarantee that the FHLB will pay the Corporation the
cash equivalent of the growth in the S&P 500 Index due at the IPCD maturity date. The change in
fair value of the FHLB Derivative Contract for 2001 resulted in a loss of $ 7,615 which is included
in other income.
Note 10. Financial Instruments With Off-Balance-Sheet Risk
The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course
of business to meet the financial needs of its customers and to reduce its own exposure to
fluctuations in interest rates. These financial instruments include commitments to extend credit and
standby letters of credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of
those instruments reflect the extent of involvement the Corporation has in particular classes of
financial instruments.
The Corporation's exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of credit is represented by
the contractual amount of those instruments. The Corporation uses the same credit policies in
making commitments and conditional obligations as it does for on-balance-sheet instruments.
Contract or
Notional Amount
(000 omitted)
2001 2000
Financial instruments whose contract amounts
represent credit risk at December 31:
Commitments to extend credit $ 12,494 $ 14,897
Commercial and standby letters of credit 1,644 1,644
$ 14,138 $ 16,541
- -18-
Note 10. Financial Instruments With Off-Balance-Sheet Risk (Continued)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation
of any condition established in the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Corporation evaluates each customer's creditworthiness on
a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation
upon extension of credit, is based on management's credit evaluation of the customer. Collateral
held varies but may include accounts receivable, inventory, real estate, equipment, and income-
producing commercial properties.
Standby letters of credit are conditional commitments issued by the corporation to guarantee the
performance of a customer to a third party. Those guarantees are primarily issued to support public
and private borrowing arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers. The Corporation holds
collateral supporting those commitments when deemed necessary by management.
Note 11. Concentration of Credit Risk
The Corporation grants agribusiness, commercial and residential loans to customers located in
South Central Pennsylvania and Northwestern Maryland. Although the Corporation has a
diversified loan portfolio, a portion of its customers' ability to honor their contracts is dependent
upon the construction and land development and agribusiness economic sectors as disclosed in
Note 3.
The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount
of collateral obtained, if deemed necessary upon the extension of credit, is based on management's
credit evaluation of the customer. Collateral held varies but generally includes equipment and real
estate.
The Corporation maintains deposit balances at correspondent banks, which provide check
collection and item processing services to the Corporation. The balances with these correspondent
banks, at times, exceed federally insured limits, which management considers to be a normal
business risk.
Note 12. FNB Financial Corporation (Parent Company Only) Financial Information
The following are the condensed balance sheets, statements of income and statements of cash flows
for the parent company.
Balance Sheets
December 31
Assets 2001 2000
Cash $ 22,665 $ 64
Interest-bearing deposits with banks 6,395 299
Marketable equity securities
available for sale 185,002 216,422
Investment in the First National Bank
of McConnellsburg 13,368,499 12,526,464
Other assets 21,436 3,579
Total assets $ 13,603,997 $ 12,746,828
- -19-
Note 12. FNB Financial Corporation (Parent Company Only) Financial Information (Continued)
Liabilities and Stockholders' Equity
Dividends payable $ 216,000 $ 192,000
Other liabilities 0 6,801
216,000 198,801
Common stock, par value $ .315; 12,000,000
shares authorized; 800,000 shares issued
and outstanding 252,000 252,000
Additional paid-in capital 1,789,833 1,789,833
Retained earnings 11,124,857 10,623,726
Accumulated other comprehensive income (loss) 221,307 ( 117,532)
Total stockholders' equity 13,387,997 12,548,027
Total liabilities and stockholders' equity $ 13,603,997 $ 12,746,828
Statements of Income
Years Ended December 31
2001 2000 1999
Cash dividends from wholly-owned
subsidiary $ 542,000 $ 436,000 $ 364,000
Interest on deposits with banks 303 330 451
Dividend income - Marketable
equity securities 5,369 5,938 4,780
Securities gains 7,843 0 39,800
Miscellaneous income (loss) ( 4,168) 0 0
Equity in undistributed income of
subsidiary 503,389 540,277 520,400
1,054,736 982,545 929,431
Less: holding company expenses 49,605 27,964 18,378
Income before income taxes 1,005,131 954,581 911,053
Applicable income taxes 0 0 7,771
Net income $ 1,005,131 $ 954,581 $ 903,282
- -20-
Note 12. FNB Financial Corporation (Parent Company Only) Financial Information (Continued)
Statements of Cash Flows
Years Ended December 31
2001 2000 1999
Cash flows from operating activities:
Net income $ 1,005,131 $ 954,581 $ 903,282
Adjustments to reconcile net
income to cash provided by
operating activities:
Equity in undistributed income
of subsidiary ( 503,389) ( 540,277) ( 520,400)
(Gain) on sales of investments ( 7,843) 0 ( 39,800)
(Increase) decrease in other assets ( 17,857) ( 1,080) 445
Increase (decrease) in other liabilities ( 6,065) ( 10,238) 5,405
Net cash provided by operating activities 469,977 402,986 348,932
Cash flows from investing activities:
Net (increase) decrease in interest bearing
deposits with banks ( 6,096) 6,618 5,044
Purchase of marketable equity securities
available for sale 0 0 ( 71,002)
Sales of marketable equity securities
available for sale 38,720 0 74,200
Net cash provided by investing activities 32,624 6,618 8,242
Cash flows from financing activities:
Cash dividends paid ( 480,000) ( 436,000) ( 336,000)
Net increase (decrease) in cash 22,601 ( 26,396) 21,174
Cash, beginning balance 64 26,460 5,286
Cash, ending balance $ 22,665 $ 64 $ 26,460
Note 13. Regulatory Matters
Dividends paid by FNB Financial Corporation are generally provided from the dividends it receives
from its Subsidiary Bank. The Bank, as a National Bank, is subject to the dividend restrictions set
forth by the Office of the Comptroller of the Currency (OCC). Under such restrictions, the
Corporation may not, without prior approval of the OCC, declare dividends in excess of the sum of
the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two
years. The dividends that the Bank could declare without the approval of the OCC amounted to
approximately $ 3,056,386 and $ 2,302,058 at December 31, 2001 and 2000, respectively.
FNB Financial Corporation's balance of retained earnings at December 31, 2001 is $ 11,124,857
and would be available for cash dividends, although payment of dividends to such extent would not
be prudent or likely. The Federal Reserve Board, which regulates bank holding companies,
establishes guidelines which indicate that cash dividends should be covered by current period
earnings.
- -21-
Note 13. Regulatory Matters (Continued)
The Corporation is also subject to various regulatory capital requirements administered by federal
banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory,
and possibly additional discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's financial statements. Under capital adequacy guidelines, the
Corporation is required to maintain minimum capital ratios. The "leverage ratio" compares capital
to adjusted total balance sheet assets. "Tier I" and "Tier II" capital ratios compare capital to risk-
weighted assets and off-balance sheet activity. A comparison of the Corporation's capital ratios to
regulatory minimums at December 31 is as follows:
FNB Financial Corporation Regulatory Minimum
2001 2000 Requirements
Leverage ratio 9.88% 10.03% 4%
Risk-based capital ratios/
Tier I (core capital) 14.89% 16.09% 4%
Combined Tier I and
Tier II (core capital
plus allowance for loan
losses) 15.90% 17.15% 8%
As of December 31, 2001 the most recent regulatory exam from the Office of the Comptroller of the Currency
categorized the Corporation as well capitalized under the regulatory frame work for prompt corrective action.
There are no conditions or events since that notification that management believes have changed the
Corporation's category.
Note 14. Compensating Balance Arrangements
Required deposit balances at the Federal Reserve were $ 650,000 and $ 105,000 for 2001 and 2000,
respectively. Required deposit balance at Atlantic Central Banker's Bank was $ 425,000 at
December 31, 2001 and 2000. These balances are maintained to cover processing costs and service
charges.
Note 15. Fair Value of Financial Instruments
The estimated fair values of the Corporation's financial instruments were as follows at
December 31:
- - - - - - - 2001 - - - - - - - - - - - - - - 2000 - - - - - - - - -
Carrying Fair Carrying Fair
Amount Value Amount Value
FINANCIAL ASSETS
Cash and due from banks $ 5,400,929 $ 5,400,929 $ 4,020,479 $ 4,020,479
Federal funds sold 6,000,000 6,000,000 0 0
Interest-bearing deposits in banks 2,572,574 2,589,534 778,546 780,309
Securities available for sale 19,554,290 19,554,290 26,768,521 26,768,521
Securities to be held to maturity 1,114,764 1,088,460 1,207,835 1,135,971
Other bank stock 833,700 833,700 833,700 833,700
Loans receivable 90,167,678 92,256,899 83,112,173 82,085,602
Accrued interest receivable 619,464 619,464 789,393 789,393
FINANCIAL LIABILITIES
Time certificates 65,647,473 67,998,882 62,129,564 62,963,904
Other deposits 46,314,907 46,314,907 41,502,924 41,502,924
Accrued interest payable 586,433 586,433 677,632 677,632
Liability for borrowed funds 5,403,458 5,763,175 6,176,901 6,578,604
- -22-
Note 16. Liability for Borrowed Funds
Included in liabilities for borrowed funds at December 31 are borrowings from The Federal
Home Loan Bank as follows:
Type
Advance
Amount
Principal Outstanding
Interest
Rate
Maturity
Date
2001
2000
Convertible (1)
$ 2,250,000
$ 2,250,000
$ 2,250,000
6.23%
8/30/10
Convertible (1)
2,000,000
2,000,000
2,000,000
5.83
8/10/10
Convertible (1)
500,000
500,000
500,000
5.98
7/21/10
Convertible (1)
500,000
500,000
500,000
6.54
7/12/10
Credit Line
17,750,000
0
768,000
1.88 - 6.63
12/31/02
CIP/Term (2)
175,000
153,458
158,901
6.64
7/14/17
$ 5,403,458
$ 6,176,901
(1) Interest rates on Convertible Loans are fixed until the market rate reaches a pre-determined
Comparative Rate/Index or Strike Rate/Index, at which time the interest rate becomes
adjustable quarterly based upon the three month LIBOR rate. At the time any loan rate
becomes adjustable, the Corporation has the option to repay the debt entirely without penalty
or convert to a repayment schedule.
(2) The Corporation received Community Investment Program funding from the Federal Home
Loan Bank of Pittsburgh for $ 175,000 at a fixed rate of 6.64% and an amortization term of
20 years. Required payments on this loan are as follows:
2002
$ 5,816
2003
6,214
2004
6,639
2005
7,094
2006
7,737
Thereafter
119,958
$ 153,458
The total maximum borrowing capacity from Federal Home Loan Bank at December 31, 2001 was
$ 44,807,000. Collateral for borrowings at the Federal Home Loan Bank consists of various
securities and the Corporation's 1-4 family mortgages with a total value of approximately
$ 51,191,000.
Note 17. Operating Lease
The Corporation leases its Hancock, Maryland office. The original lease term is ten
years with three separate successive options to extend the lease for a term of five years
each. Monthly rent is $ 1,800 and the lessee pays a proportionate share of other operating
expenses. For the years ended December 31, 2001, 2000, and 1999 rent expense under this
operating lease was $ 21,600 for each year. Required lease payments for the next five years
are as follows:
2002
$ 21,600
2003
21,600
2004
21,600
2005
21,600
2006
16,200
$ 102,600
- -23-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
SELECTED FIVE YEAR FINANCIAL DATA
2001 2000 1999 1998 1997
Results of Operations (000 omitted)
Interest income $ 8,767 $ 8,755 $ 7,802 $ 7,721 $ 7,388
Interest expense 4,676 4,697 4,119 4,112 3,847
Provision for loan losses 144 231 190 475 233
Net interest income after
provision for loan losses 3,947 3,827 3,493 3,134 3,308
Other operating income 739 624 621 530 349
Other operating expenses 3,425 3,267 3,030 2,772 2,608
Income before income taxes 1,261 1,184 1,084 892 1,049
Applicable income tax 256 229 181 110 193
Net income $ 1,005 $ 955 $ 903 $ 782 $ 856
Common Share Data
Per share amounts are based on weighted average shares of common stock outstanding of 800,000 for 2001,
2000, 1999, 1998, and 1997 after giving retroactive recognition to a two-for-one stock split issued September 1,
2000.
Income before income taxes $ 1.58 $ 1.48 $ 1.36 $ 1.12 $ 1.31
Applicable income taxes .32 .29 .22 .14 .24
Net income 1.26 1.19 1.13 .98 1.07
Cash dividend declared .63 .57 .50 .405 .40
Book value (actual number
of shares outstanding
before FAS 115 adjustments) 16.46 15.83 15.21 14.58 14.00
Dividend payout ratio 50.14% 47.76% 44.28% 41.43% 37.39%
Year-End Balance Sheet Figures
(000 omitted)
Total assets 132,161 $ 123,626 $ 117,929 $ 113,565 $ 106,020
Net loans 90,168 83,112 76,137 61,901 59,124
Total investment securities -
Amortized cost 20,334 28,154 31,900 35,348 29,425
Deposits-noninterest bearing 13,344 11,798 10,959 10,819 9,988
Deposits-interest bearing 98,618 91,834 88,371 89,685 83,272
Total deposits 111,962 103,632 99,330 100,504 93,260
Total stockholders' equity (before
FAS 115 adjustments) 13,167 12,666 12,167 11,664 11,206
Ratios (calculated before FAS 115
adjustments)
Average equity/average assets 10.05% 10.15% 10.49% 10.53% 10.74%
Return on average equity 7.74% 7.67% 7.53% 6.85% 7.98%
Return on average assets .78% .78% .79% .72% .86%
- -24-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
SUMMARY OF QUARTERLY FINANCIAL DATA
The unaudited quarterly results of operations for the years ended December 31, 2001 and 2000 are as follows:
2001 2000
($ 000 omitted Quarter Ended Quarter Ended
except per share) Mar.31 June 30 Sept. 30 Dec. 31 Mar.31 June 30 Sept. 30 Dec. 31
Interest income $ 2,245 $ 2,222 $ 2,188 $ 2,112 $ 2,097 $ 2,173 $ 2,255 $ 2,230
Interest expense 1,236 1,217 1,160 1,063 1,115 1,159 1,202 1,221
Net interest income 1,009 1,005 1,028 1,049 982 1,014 1,053 1,009
Provision for loan losses 36 36 36 36 60 45 45 81
Net interest income
after provision for
loan losses 973 969 992 1,013 922 969 1,008 928
Other income 143 170 169 239 172 133 145 174
Security gains (losses) 6 4 4 4 0 0 0 0
Other expenses 844 863 833 885 795 794 822 856
Operating income
before
income taxes 278 280 332 371 299 308 331 246
Applicable income taxes 41 50 64 101 57 65 69 38
Net income $ 237 $ 230 $ 268 $ 270 $ 242 $ 243 $ 262 $ 208
Net income applicable
to common stock
Per share data:
Net income $ .30 $ .29 $ .33 $ .34 $ .30 $ .30 $ .33 $ .26
- -25-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS'
EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL
Years Ended December 31
- - - - - - - -2001 - - - - - - - - - - - - - - - -2000 - - - - - - - - - - - - - - - -1999 - - - - - - - -
Average Average Average
(000 omitted) Balance Interest Rate Balance Interest Rate Balance Interest Rate
ASSETS
Interest bearing
deposits with banks
and federal funds sold $ 8,614 $ 305 3.54% $ 1,200 $ 72 6.00% $ 2,975 $ 148 4.98%
Investment securities 24,037 1,322 5.50% 30,571 1,780 5.82% 33,114 1,887 5.70%
Loans 86,059 7,141 8.30% 80,900 6,903 8.53% 68,773 5,767 8.39%
Total interest
earning assets 118,710 8,768 7.39% 112,671 $ 8,755 7.77% 104,862 $ 7,802 7.44%
Cash and due from
banks 3,342 3,746 3,467
Bank premises and
equipment 3,017 3,072 3,213
Other assets 4,158 3,200 2,776
Total assets $ 129,227 $ 122,689 $ 114,318
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing
transaction accounts $ 8,118 $ 94 1.16% $ 8,148 $ 109 1.34% $ 8,985 $ 140 1.56%
Money market deposit
accounts 11,830 366 3.09% 8,460 332 3.92% 7,556 251 3.32%
Other savings deposits 10,995 215 1.96% 11,095 256 2.31% 11,770 270 2.29%
All time deposits 65,214 3,669 5.63% 61,863 3,544 5.73% 60,916 3,369 5.53%
Liability for borrowed
funds 5,410 333 6.16% 7,468 456 6.11% 1,460 89 6.10%
Total interest
bearing
liabilities 101,567 4,677 4.60% 97,034 $ 4,697 4.84% 90,687 $ 4,119 4.54%
Demand deposits 13,399 12,047 10,849
Other liabilities 1,274 1,149 786
Total liabilities 116,240 110,230 102,322
Stockholders' equity 12,987 12,459 11,996
Total liabilities
and stockholders'
equity $ 129,227 $ 122,689 $ 114,318
Net interest income/net
interest margin $ 4,091 3.45% $ 4,058 3.59% $ 3,683 3.51%
- -26-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CHANGES IN NET INTEREST INCOME
- - - - 2001 Compared to 2000 - - - - - - - - 2000 Compared to 1999 - - - -
Total Total
Average Average Increase Average Average Increase
(000 omitted) Volume Rate (Decrease) Volume Rate (Decrease)
Interest Income
Interest bearing deposits
with banks and
federal funds sold $ 445 ($ 212) $ 233 ($ 88) $ 12 ($ 76)
Investment securities ( 380) ( 78) ( 458) ( 144) 37 ( 107)
Loans 440 ( 202) 238 1,017 119 1,136
Total interest income $ 505 ($ 492) $ 13 $ 785 $ 168 $ 953
Interest Expense
Interest bearing
transaction accounts $ 0 ($ 15) ($ 15) ($ 13) ($ 18) ($ 31)
Money market
deposit accounts 132 ( 98) 34 30 51 81
Other savings ( 2) ( 39) ( 41) ( 15) 1 ( 14)
All time deposits 192 ( 67) 125 52 123 175
Liability for borrowed funds ( 126) 3 ( 123) 366 1 367
Total interest expense $ 196 ($ 216) ($ 20) $ 420 $ 158 $ 578
Net interest income $ 33 $ 375
- -27-
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
MATURITIES OF INVESTMENT SECURITIES
December 31, 2001
The following table shows the maturities of investment securities at amortized cost as of December 31,
2001, and weighted average yields of such securities. Yields are shown on a taxable equivalent basis,
assuming a 34% federal income tax rate.
(000 omitted)
Within 1
Year
1-5
Years
5-10
Years
Over 10
Years
Total
Obligations of other U.S.
Government agencies:
Amortized cost
$ 550
$ 3,401
$ 3,200
$ 1,252
$ 8,403
Yield
5.22%
5.70%
6.20%
6.97%
6.05%
Obligations of state and
political subdivisions:
Amortized cost
625
2,230
4,100
2,890
9,845
Yield
5.26%
5.34%
7.12%
7.15%
6.61%
Mortgage-Backed securities
and SBA Guaranteed Loan
Pool Certificates (1):
Amortized cost
0
91
41
1,775
1,907
Yield
0%
6.64%
5.73%
4.55%
4.67%
Subtotal amortized cost
1,175
5,722
7,341
5,917
20,155
Subtotal yield
5.25%
5.58%
6.71%
6.33%
6.19%
Equity Securities
$ 179
Yield
5.84%
Total investment
securities
$ 20,334
Yield
6.18%
(1) It is anticipated that these mortgage-backed securities and SBA Guaranteed Loan Pool Certificates will
be repaid prior to their contractual maturity dates.
- -28-
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section presents a discussion and analysis of the financial condition and
results of operations of FNB Financial Corporation (the Corporation) and its wholly-owned subsidiary, The
First National Bank of McConnellsburg (the Bank). This discussion should be read in conjunction with the
financial tables/statistics, financial statements and notes to financial statements appearing elsewhere in this
annual report.
RESULTS OF OPERATIONS
Overview
Consolidated net income for 2001 was $1,005,131, a $50,550, or 5.30% increase from the net
income for 2000 of $954,581, and an increase of $101,849 or 11.28% from the net income of $903,282 for
1999. On a per share basis net income for 2001 was $1.26, based upon average shares outstanding of
800,000, compared to $1.19 for 2000 and $1.13 for 1999.
Results of operations for 2001 as compared to 2000 were impacted by the following items:
? Net income was positively impacted by a 5.35% increase in average earning assets;
? Net income was positively impacted by an $87,319 decrease in the provision for loan losses.
? Net income was positively impacted by an increase in net gains on the sale of securities from a
net loss in 2000 of $474 to a net gain in 2001 of $17,986.
? Net income was negatively impacted by a decreasing net interest margin in 2001 of 0.14% from
3.59% in 2000 to 3.45%. The decrease in 2001 occurred due to a 0.37% decrease in the yield on
earning assets while the cost of interest bearing liabilities decreased 0.24%. In 2001 the yield on
earnings assets decreased 0.37% due to the following:
? a 0.22% decrease in the yield on loans from 8.53% in 2000 to 8.30% in 2001; a result of
decreasing interest rate indexes on adjustable rate loans during the entire year.
? a 0.32% decrease in the yield on investment securities from 5.82% in 2000 to 5.50% in
2001, the result of exercised call features and maturities of higher yielding securities.
? a 2.46% decrease in the yield on federal funds sold and interest-bearing deposits with
banks due to decreasing yields on federal funds sold throughout the year.
? Net income was positively impacted by a decreasing cost of interest bearing liabilities of 0.24%
from 4.84% in 2000 to 4.60% due mainly to the following:
? A decreasing cost of money market deposit accounts of 0.83% from 3.92% in 2000 to
3.09% in 2001.
? A decreasing cost of interest-bearing transaction accounts of 0.18% from 1.34% in 2000
to 1.16% in 2001.
? A decreasing cost of savings accounts of 0.35% from 2.31% in 2000 to 1.96% in 2001.
? A decreasing cost of time deposits of 0.10% from 5.73% in 2000 to 5.63% in 2001.
- -29-
? Net income was negatively impacted by an increase in wage and salary expenses of $91,012 or
6.79% and employee benefits of $8,003, or 2.25%, a direct result of:
? Officer and employee raises during the operating year.
? Increased participation in our 401K retirement program.
? Net income was negatively impacted by a $4,163 increase in net occupancy expenses and a
$14,780 increase in furniture and equipment expenses as a result of:
? A $3,524 increase in real estate taxes.
? An increase of $10,328 in depreciation expenses on furniture and equipment due to the
upgrade of our Local Area network.
? Net income was positively impacted by a $35,529 increase in the service charges on deposit
accounts as a result of increased overdraft and minimum balance charges.
? Net income was positively impacted by a $83,105 increase in other service charges and fees due
to:
? A $57,497 increase in annuity sale commissions.
? A $9,901 increase in late charges on customers' installment and mortgage loans.
? A $6,213 increase in debit card income.
? Net income was negatively impacted by a $21,897 decrease in other income, the result of net
losses on other real estate owned of $19,038.
? Net income was negatively impacted by a $26,362 increase in the current year income tax
provision resulting primarily from the increase in taxable income in relation to tax free income.
Net income as a percent of total average assets for 2001, also known as return on assets
(ROA), was .78% compared to .78% for 2000 and 0.79% for 1999. Net income as a percent of average
stockholders' equity for 2001, also known as return on equity (ROE), was 7.74% compared to 7.67% for 2000
and 7.53% for 1999. The ROA and ROE for these periods were impacted by the factors discussed in the
preceding paragraphs.
Net Interest Income
Net interest income is the amount by which interest income on loans and investments
exceeds interest incurred on deposits and other interest-bearing liabilities. Net interest income is our primary
source of revenue. The amount of net interest income is affected by changes in interest rates and by changes
in the volume and mix of interest-sensitive assets and liabilities.
Net interest income for 2001 increased $ 32,912 or 0.81% over 2000 and $ 408,034 or 11.1%
over 1999. Average earning assets for 2001 increased $ 6,039,000 over 2000 and $ 13,848,000 over 1999.
This increase in average earning assets from 2000 to 2001 was the result of:
? An increase in average loans in the amount of $5,159,000 or 6.38%.
? A decrease in average investment securities in the amount of $6,534,000 or 21.37%.
? An increase in interest-bearing deposits with banks and federal funds sold in the amount of
$7,414,000.
- -30-
The increase in loans at an average yield of 8.30% funded by the decrease in investment
securities directly contributed to the increase in net interest income.
Earning asset increases were funded by an increase in average interest-bearing deposits and
non-interest-bearing deposits. Average interest-bearing deposits increased $6,591,000 or 7.36% while non-
interest-bearing deposits increased $1,352,000 or 11.22%. These increases in funding by deposits resulted in
our ability to decrease average borrowings from the Federal Home Loan Bank of Pittsburgh in an amount of
$2,058,000, from $7,468,000 in 2000 to $5,410,000 in 2001.
The volume growth in earning assets and interest-bearing liabilities contributed to the
increase in net interest income in the amount of $196,000 in 2001 over 2000.
The year 2001 was defined by several interest rate decreases by the Federal Reserve Board.
Following a period of rising interest rates in 1999, the Federal Reserve continued to increase short term
interest rates during the first and second quarters of 2000. Beginning in early 2001, the Federal Reserve
began what would become the shortest period in recent history of rapidly decreasing interest rates which
continued throughout the year 2001. As we began the year 2001 the Federal Funds interest rate was targeted
at 6.50% and the Discount Rate was 6.00%. As of December 31, 2001, the Federal Reserve had drastically
and dramatically decreased short term rates to a 40 year low, having targeted the Federal Funds Rate at
1.75% and the Discount Rate at 1.25%. These decreases were justified by Federal Reserve officials due to
the strong indications of the beginning of national and local economic recessions which were further
intensified by the events of September 11, 2001.
As a result of these dramatic interest rate decreases, higher yielding investment securities
with call features were called and longer term fixed rate mortgages, both consumer and commercial, were
refinanced to lower interest rates. The proceeds from the called securities allowed us to pay down
borrowings at the Federal Home Loan Bank; however, these dramatic interest rate reductions resulted in the
yields on investments and loans to decrease dramatically.
On the asset side this decreasing interest rate environment resulted in a decrease in yield on
our earning assets. As lower yielding investments matured and were called and indexes on adjustable rate
loans and securities decreased, our yields on earning assets decreased:
? The yield on interest-bearing deposits and federal funds sold decreased 2.46% from 6.00% in
2000 to 3.54% in 2001.
? The yield on investment securities decreased 0.32% from 5.82% in 2000 to 5.50% in 2001.
? The yield on loans decreased 0.22% from 8.53% in 2000 to 8.30% in 2001.
In order to reduce the effect of these dramatic earning asset interest rate reductions, it was
necessary to dramatically decrease our cost of interest-bearing liabilities.
? The cost of interest-bearing transaction accounts decreased 0.18% from 1.34% in 2000 to 1.16%
in 2001.
? The cost of Money Market accounts decreased 0.83% from 3.92% in 2000 to 3.09% in 2001.
? The cost of savings deposits decreased 0.35% from 2.31% in 2000 to 1.96% in 2001.
? The cost of time deposits decreased 0.10% from 5.73% in 2000 to 5.63% in 2001.
- -31-
The net effect of all interest rate fluctuations was to decrease net interest income in the
amount of $276,000 in 2001 from 2000. Due to the overall decrease in the yield on earning assets by 0.38%,
a decreased cost of deposits of 0.24% in 2001 from 2000, and a change in the earning asset composition, the
result was an increase in net interest income of $ 33,000 and a 0.14% decrease in our net interest margin
from 3.59% in 2000 to 3.45% in 2001.
At the beginning of the year 2000 the Discount Rate was 5.00% and the Federal Funds Rates
was targeted at 5.50%. As of December 31, 2000, the Discount Rate had increased to 6.00% and the Federal
Funds rate was targeted at 6.50%, both rates reflecting the last increase which occurred on May 16, 2000. As
a result of these increasing interest rates security calls were non-existent during the year 2000 as government
agencies and municipalities chose not to exercise call options during this increasing interest rate
environment. The result was a reliance on deposit increases and borrowing from the Federal Home Loan
Bank to fund loan demand. In order to attract and retain deposits we increased interest rates on our premium
money market accounts and on our time deposits:
? Cost of Money Market deposits increased 60 basis points to 3.92% in 2000 from 3.32% in
1999.
? Cost of time deposits increased 20 basis points from 5.53% in 1999 to 5.73% in 2000.
Although our cost of borrowing increased only 1 basis point to 6.11%, our reliance on
borrowing to fund loan demand increased over 5 times to average borrowings of $7,468,000 in 2000 from
$1,460,000 in 1999. The overall result of increased borrowings and increased costs of these deposits, as
previously discussed, resulted in an increase in our cost of funding assets by 30 basis points to 4.84% in 2000
compared to 4.54% in 1999.
On the asset side the increasing interest rate environment resulted in an increase in yield on
our earning assets. As lower yielding investments matured and indexes on adjustable rate loans and
securities increased, our yields on earning assets increased:
? The yield on interest-bearing deposits and federal fund sold increased 1.02% from 4.98% in
1999 to 6.00% in 2000.
? The yield on investment securities increased 12 basis points to 5.82% in 2000 from 5.70% in
1999.
? The yield on loans increased 13 basis points from 8.39% in 1999 to 8.53% in 2000.
The net effect of all interest rate fluctuations was to increase net interest income in the
amount of $ 10,000 in 2000 from 1999. Due to the overall increase in the yield on earning assets by 0.33%, a
$12,127,000 increase in our average loan balance which is our highest earning asset and a decreased reliance
on our lower interest earning assets of investments and interest-bearing balances with banks, this
combination of increased yields and reallocation of earning asset balances was more than enough to offset
our increased cost of deposits of 30 basis points to 4.84% in 2000 from 4.54% in 1999. The result was a
.08% increase in our net interest margin from 3.51% in 1999 to 3.59% in 2000.
- -32-
As we began the 2002 year, the Federal Reserve has remained cautious and has retained
interest rates at their current levels during the month of January. We anticipate the yield on earning assets to
decrease during the next few quarters as indexes on adjustable rate securities and loans decrease and
commercial loan rates and residential lending rates continue to decrease. The decreases in yields in the loan
portfolio will result in lower yields on our earning assets. We will continue to decrease deposit rates on
deposits in order to retain our net interest margin. If necessary, to offset deposit losses and continued loan
demand, we will utilize our line of credit at the FHLB. This funding alternative is interest rate sensitive in
that the rate reprices on a daily basis. We have matched borrowings at the FHLB with specific loans and
have utilized term borrowings to tie up interest rates for longer periods in order to lock-in interest rate
spreads. During this period we anticipate a slight decrease in our interest margin; however, this decrease will
depend greatly upon present market conditions for both loans and deposits. Current strategies we are
utilizing to improve our interest spread are as follows:
? Promoting adjustable rate commercial and residential mortgage loan products.
? Matching borrowings at the FHLB with specific loan credits.
? Reducing the cost of interest-bearing transaction, money market and savings accounts.
Provision for Loan Losses
The loan loss provision is an estimated expense charged to earnings in anticipation of losses
attributable to uncollectible loans. The provision is based on our analysis of the adequacy of the allowance
for loan losses. The provision for 2001 was $144,000, compared to $231,319 for 2000, and $190,000 for
1999. The decrease in provision of $87,319 was due to the implementation of a more thorough and extensive
annual loan portfolio review and quarterly analysis of the allowance for loan losses which identified our
ability to decrease the allowance provision in 2001.
The increase in annual provision of $41,319 in 2000 from 1999 was the result of increasing
commercial loans balances which add more volatility and risk to the loan portfolio, as well as specific
provisions for loans we have determined to warrant specific provisions due to issues regarding their total and
complete collectability.
Total charged-off loans in 2001 were $109,000 compared to $203,000 in 2000 and $201,000
in 1999. Total recoveries in 2000 were $36,000 compared to $37,000 in 2000 and $25,000 in 1999. See
discussion on Allowance for Loan Losses.
Other Operating Income and Other Operating Expenses
Other operating income for 2001 was $739,129, a $115,197, or 18.46% increase over the
same period in 2000 and a $118,668, or 19.13% increase over the same period in 1999. This increase is
mainly attributable to the following:
? A $35,529 increase in the service charges on deposit accounts as a result of increased overdraft
and minimum balance charges.
? An $83,105 increase in other service charges and fees due to:
? A $57,497 increase in annuity sale commissions.
? A $9,901 increase in late charges on customers' installment and mortgage loans.
? A $6,213 increase in debit card income.
- -33-
Total other operating expenses for 2001 were $3,425,486, an increase of $158,516 or 4.85%
over 2000's expenses of $3,266,970 and an increase of $395,914 or 13.07%, over 1999's expenses for
$3,029,572. This increase was mainly the result of the following:
? An increase in wage and salary expenses of $91,012 or 6.79% and employee benefits of $8,003,
or 2.25%, a direct result of:
? Officer and employee raises during the operating year.
? Increased participation in our 401K retirement program.
? A $4,163 increase in net occupancy expenses and a $14,780 increase in furniture and equipment
expenses as a result of:
? A $3,524 increase in real estate taxes.
? A $10,328 increase in depreciation expenses on furniture and equipment due to the
upgrade of our Local Area network.
? A $7,400 increase in the Pennsylvania Shares Tax Expense
? A $10,700 increase in Professional Development Expenses
? A $6,200 increase in Dues and Subscriptions Expenses
? $10,100 in expenses incurred for the shareholder's banquet
Income Taxes
Our income tax provision for 2001 was $255,511 compared to $229,149 for 2000 and
$180,572 for 1999. The increase in the tax provision in 2001 over 2000 in the amount of $26,362 is the
result of an increase in income before income taxes of $76,912 and a decrease in taxable allowance for loan
losses from $175,825 in 2000 to $71,183 in 2001, a $104,642 or 59.51% decrease. The increase in the tax
provision in 2000 over 1999 in the amount of $48,577 was due to an increase in income before income taxes
of $99,876, and a decrease in tax-free income in the amount of $72,293 or 13.50%. We operated with a
marginal tax rate of 34% in 2001, 2000 and 1999. Our effective tax rate for 2001 was 20.27% compared to
19.36% for 2000 and 16.66% for 1999. This increase in the effective tax rate is due to the decrease in the
taxable allowance for loan losses as discussed.
Future Impact of Recently Issued Accounting Standards
Financial Accounting Standards Board (FASB) issues Statement No. 133 as amended by
SFAS No. 138, Accounting for Derivative Instruments and Hedging Activities, effective for fiscal years
beginning after June 15, 2000. This Statement establishes accounting and reporting standards for derivative
instruments and hedging activities, including certain derivative instruments embedded in other contracts, and
requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them
at fair value. If certain conditions are met, an entity may elect to designate a derivative as follows: (a) a
hedge of the exposure to changes in the fair value of a recognized asset or liability of an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of
the foreign currency exposure of an unrecognized firm commitment, an available-for-sale security, a foreign
currency denominated forecasted transaction, or a net investment in a foreign operation. The Statement
generally provides for matching the timing of the recognition of the gain or loss on derivatives designated a
hedging instruments with the recognition of the change in the fair value of the item being hedged. Depending
on the type of hedge, such recognition will be either net income or other comprehensive income. For a
derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in
the period of change. Management has evaluated the impact of adopting this Statement on the consolidated
financial statements, but does not anticipate that it will have a material impact.
- -34-
Future Impact of Recently Issued Accounting Standards (Continued)
Financial Accounting Standards Board (FASB) Standard 142, which is effective for years
beginning after December 12, 2001, addresses the financial accounting and reporting for acquired goodwill
and other intangible assets. It does not address intangibles acquired as part of business combinations which
is addressed by FASB 141. This statement also addresses how goodwill and intangibles are accounted for
after they have been initially recognized. Management is currently evaluating the impact this statement
would have on the consolidated financial statements when adopted, but does not anticipate that it will have a
material impact.
FINANCIAL CONDITION
Investment Securities
The book value of the investment security portfolio as of December 31, 2001 decreased by
$7,821,000 from December 31, 2000, representing a 27.78% decrease. This decrease occurred primarily due
to the calls of investment securities during the year as a result of the decreasing interest rate environment.
Proceeds from called securities were used to fund loan demand and were invested in federal funds sold.
Due to the implementation of SFAS No. 115, we have segregated securities as Held-to-Maturity (HTM),
Available-for-Sale (AFS) or Trading securities. This accounting standard requires HTM securities be
reported on the balance sheet at cost and AFS securities be reported at market value. As of December 31,
2001, we had in our portfolio HTM securities of $1,114,764 with a market value of $1,088,460 and AFS
securities of $19,554,290 with a book value of $19,218,977. No securities were classified as Trading
securities as of December 31, 2001. For the December 31, 2000 Balance Sheet presentations, we had
investment debt securities classified as HTM securities of $1,207,835 with a market value of $1,135,971 and
as AFS securities of $26,768,521, with at book value of $26,946,600. No securities were classified as
Trading as of December 31, 2000.
The general policy adopted by us segregates purchases of tax-free municipals with maturities
of 5 years or less as Held-to-Maturity securities while all other security purchases are classified as Available-
for-Sale. The Policy we adopted also allows us, on a case-by-case basis, to make a specific determination as
to the classification of a security purchase as Held-to-Maturity or Available-for-Sale depending upon the
reason for purchase. Management adheres to the philosophy that Held-to-Maturity classifications are
typically used for securities purchased specifically for interest rate management or tax-planning purposes
while Available-for-Sale classifications are typically used for liquidity planning purposes.
As of December 31, 2001, the net unrealized loss of the HTM portfolio was $26,304, a
2.36% decrease from book value and on the AFS portfolio a net unrealized gain of $ 335,313 or a 1.74%
increase over book value. As of December 31, 2000, the net unrealized loss on the HTM portfolio was
$71,864, a 5,95% decrease from book value, and on the AFS portfolio, a net unrealized loss of $178,079 or a
0.66% decrease from book value. We have reviewed the fluctuation of market value in each of these
portfolios and have determined that due to the recent increases in short term interest rates, the values of
securities contained within our investment debt portfolio are a direct result of the current interest rate
environment. We have therefore concluded that the net unrealized gains and/or losses in our investment debt
portfolio are a direct result of current monetary policy and therefore are temporary in that security values will
continue to fluctuate, either decrease or increase in value, in response to future changes in interest rates and
monetary policy.
- -35-
Investment Securities (Continued)
Due to the drastic changes in the interest rate environment during the year 2001, many
securities with call features were exercised. As a result of called securities and the changes in the interest
rate environment, liquidity sources available from the investment portfolio to fund loan demand increased
dramatically; however, at the same time, the overall yield on the investment portfolio decreased as higher
yielding securities were called. We have purchased for the portfolio mortgage-backed securities, but
presently we have no Collateralized Mortgage Obligations (CMOs) in our portfolio. The large portion of
these mortgage-backed securities have a variable rate coupon and all have scheduled principal payments.
During periods of rising interest rates, payments from variable rate mortgage-backed securities may
accelerate as prepayments of underlying mortgages occur as home-owners refinance to a fixed rate while
during periods of declining interest rates, prepayments on high fixed rate mortgage-backed securities may
accelerate as home-owners refinance to lower rate mortgages. These prepayments cause yields on mortgage-
backed securities to fluctuate as larger payments of principal necessitate the acceleration of premium
amortization or discount accretion. Due to the low dollar amount of mortgage-backed securities in relation to
the total portfolio, we feel the interest rate risk and prepayment risks associated with mortgage-backed
securities will not have a material impact on our financial condition.
Loans
The total investment in net loans was $90,167,678 at December 31, 2001, representing a
$7,055,505 or 8.49% increase from the December 31, 2000, investment of $83,112,173. The primary reasons
for the increase in the loan portfolio were due to the continued increases in real estate loans for the purpose
of construction and land development and in real estate loans secured by nonfarmland, nonresidential
properties, mainly commercial real estate lending. This increase in commercial lending is a direct result of
our organization's decision to strengthen our lending operations by hiring experienced loan personnel, with a
particular focus on commercial lending.
The composition of our loan portfolio has changed per the following:
? A $2,363,000 increase in real estate loans secured by construction and land development
activities.
? A $1,177,000 increase in real estate loans secured by 1 to 4 family residential properties.
? A $2,417,000 increase in loans secured by nonfarmland, nonresidential properties due
primarily to the new loans secured by commercial real estate.
? A $952,000 increase in loans to commercial, industrial and state and political subdivision
loans.
? A $208,000 increase in consumer installment loans.
Total new real estate mortgage lending increased $5,759,000 or 9.25% from December 31,
2000, compared to total new real estate mortgage loan lending for 1999 which increased $10,126,000 or
19.43% from December 31, 1999. This increase in the amount of real estate lending during the past two
years reflects the closing of several commercial real estate loans and an increase in residential 1-4 family
mortgage loans as highlighted above. Competitive loan mortgage rates of other institutions and mortgage
companies in our market area have resulted in the refinancing and payoff of mortgage loans within our loan
portfolio; however, we have been able to attract new mortgage customers through the competitive mortgage
products we offer.
- -36-
Loans (Continued)
Overall, loan demand during the past year decreased over that of 2000 due to the onset of an
economic recession and a falling interest rate environment which were encountered during the 2001
operating year. The effects of this decrease in interest rates, the onset of an economic recession, and the
events of September 11, 2001, resulted in a decrease in commercial lending activity and increased
aggressiveness of competing financial institutions, mortgage loan companies and financing companies to
retain and attract new loan customers. Through the efforts of experienced commercial lending staff, our
lending operation has been enhanced by commercial loan business in the Hagerstown market area. Our
operation in the Hagerstown market area and through the Fort Loudon office in Franklin County,
Pennsylvania and Hancock Community Bank in Washington County, Maryland greatly improves our ability
to generate new loan relationships. During the past few years, we have seen a decline in our consumer loan
generation. This decline is a direct result of increased competition for new and used car lending as well as all
consumer loans.
To encourage new loan demand, we anticipate offering additional loan promotions,
reviewing loan terms for customer "friendliness" and developing a commercial lending strategy to stimulate
lending throughout our market area. In addition, the continued operation of Hancock Community Bank is
anticipated to result in an increase in lending in the Washington County, Maryland area as well as in northern
Morgan County, West Virginia and southern Fulton County, Pennsylvania while the continued operation of
the Fort Loudon Office is anticipated to stimulate lending in the Franklin County, Pennsylvania market.
Non-performing/Impaired Assets
Non-performing loans consist of non-accruing loans and loans 90 days or more past due.
Non-accruing loans are comprised of loans that are no longer accruing interest income because of apparent
financial difficulties of the borrower. Interest on non-accruing loans is recorded when received only after
past due principal and interest are brought current.
Other real estate owned includes assets acquired in settlement of mortgage loan indebtedness
and loans identified as impaired loans. These assets are carried at the lower of cost or fair value. The other
real estate balance as of December 31, 2001, was $103,568 compared to $168,653 as of December 31, 2000.
The following actions during the past two years indicate we are actively pursuing the sale of all properties
contained in Other Real Estate as shown by the following:
? In February 2000, we sold a 1 to 4 family residential property in Hagerstown, Maryland.
? In June 2000, we sold a 1 to 4 family residential property in Waynesboro, PA.
? In February 2001, we sold a multi-family residential property in Chambersburg, PA.
? In April 2001, we sold a 1 to 4 family residential building lot in Chambersburg, PA.
Properties contained in Other Real Estate may be listed with a realty firm on a contractual
basis. The realty firm is evaluated every six months on its effectiveness in marketing and selling these
properties.
Impaired loans consist of those loans which we have determined, based upon review of
collateral values and ability to repay, may not be paid in full according to contractual terms and may require
additional specific provisions to the allowance for loans losses. As of December 31, 2001, the dollar amount
outstanding on impaired loans was $859,974; the underlying collateral values for these loans based upon
contractual lending terms was approximately $934,967. The specific amount allocated for these loans in the
allowance for loan losses was $120,000.
- -37-
Allowance for Loan Losses
The allowance is maintained at a level to absorb potential future loan losses contained in the
loan portfolio and is formally reviewed by us on a quarterly basis. The allowance is increased by provisions
charged to operating expense and reduced by net charge-offs. Our basis for the level of the allowance and
the annual provisions is our evaluation of the loan portfolio, current and projected domestic economic
conditions, the historical loan loss experience, present and prospective financial condition of the borrowers,
the level of non-performing assets, and other relevant factors. While we use available information to make
such evaluations, future adjustments of the allowance may be necessary if economic conditions differ
substantially from the assumptions used in making the evaluation.
The allowance for loan losses was increased to $882,330 from the prior year level of
$811,124. The ratio of the allowance to net loans was 0.97% at December 31, 2001, and 0.97% at December
31, 2000. After U. S. Government Agency, specifically the Small Business Administration (SBA) and Farm
Service Agency (FSA), guaranteed portions are subtracted from the net loan balance, the ratio of the
allowance to unguaranteed loans increases to 1.03. We believe the current level of the allowance for loan
losses of $882,330, is adequate to meet any potential loan losses; however, we have budgeted a monthly
addition during 2002 of $10,000 in anticipation of potential commercial loan problems and general increases
in the total loan portfolio.
Liquidity and Rate Sensitivity
Our optimal objective is to maintain adequate liquidity while minimizing interest rate risk.
Adequate liquidity provides resources for credit needs of borrowers, for depositor withdrawals, and for
funding corporate operations. Sources of liquidity are maturing/called investment securities; maturing
overnight investments in federal funds sold; maturing investments in time deposits at other banks; readily
accessible interest-bearing deposits at other banks; payments on loans, mortgage-backed securities and SBA
Guaranteed Loan Pool Certificates; a growing core deposit base; and borrowings from the FHLB.
In order to assure a constant and stable source of funds, we are a member of the Federal
Home Loan Bank of Pittsburgh. This membership assures us the availability of both short term and long
term fixed rate funds. As of December 31, 2001, we had borrowings of $5,403,458 from this institution and
had readily available to us over $39,400,000 in additional borrowing capacity. As of December 31, 2000, we
had borrowings of $6,176,901 from this institution and had readily available to us over $38,000,000 in
additional borrowing capacity.
- -38-
Liquidity and Rate Sensitivity (Continued)
Borrowings from the FHLB as of December 31, 2001, were comprised of the following:
? A $2,000,000 quarterly adjustable advance maturing on August 10, 2010, repricing on February
10, 2002.
? A $2,250,000 fixed rate advance with a 3 month LIBOR strike rate of 8.00% repricing February
28, 2002, with a final maturity of August 30, 2010.
? A $500,000 quarterly adjustable advance maturing on July 10, 2010, repricing on January 21,
2002.
? A $500,000 quarterly adjustable advance with a 3 month LIBOR strike rate of 8.00% repricing
on January 12, 2002, with a final maturity of July 12, 2010.
? A $153,458 fixed rate advance maturing on July 17, 2017.
Borrowings from the FHLB as of December 31, 2000, were comprised of the following:
? A $2,000,000 quarterly adjustable advance maturing on August 10, 2010, repricing on February
10, 2001.
? A $2,250,000 fixed rate advance with a 3 month LIBOR strike rate of 8.00% beginning August
28, 2001, with a final maturity of August 30, 2010.
? A $500,000 quarterly adjustable advance maturing on July 10, 2010, repricing on January 21,
2001.
? A $500,000 quarterly adjustable advance with a 3 month LIBOR strike rate of 8.00% beginning
on July 12, 2001, with a final maturity of July 12, 2010.
? A $768,000 advance on a line of credit which reprices on a daily basis.
? A $158,901 fixed rate advance maturing on July 17, 2017.
The objective of managing interest rate sensitivity is to maintain or increase net interest
income by structuring interest-sensitive assets and liabilities in such a way that they can be repriced in
response to changes in market interest rates. Based upon contractual maturities of securities and the
capability of NOW, Money Market, and Savings accounts, we have maintained a negative rate sensitivity
position, in that, rate sensitive liabilities exceed rate sensitive assets. Therefore, in a period of declining
interest rates our net interest income is generally enhanced versus a period of rising interest rates where our
net interest margin may be decreased. However, in a period of declining interest rates, more securities with
call features will most likely be called and be reinvested into lower yielding investments resulting in the loss
of higher interest earnings assets. Declining rate environments also result in the likelihood that residential
home mortgage customers will refinance their existing mortgages to lower interest rates. This movement of
securities and loans to lower interest rates during a declining rate environment has the effect of decreasing
our net interest margin.
Presently, interest rates are anticipated to possibly decrease further resulting in a decreasing
cost of deposits while a portion of our adjustable rate loans and securities are repricing to lower interest rates.
This decreasing interest rate environment and possibility of lower interest rates in the future have resulted in
increased liquidity in investment debt securities as call features of U. S. Government Agencies and State and
Municipal subdivisions in the U. S. are anticipated to be exercised by the issuer. The anticipated result of
this current position will be a decrease in the yield on earning assets. We have also undertaken the position
of decreasing the cost of our interest-bearing liabilities, specifically Time Certificates of Deposit. Following
these actions, we expect our net interest spread and interest margin to decrease slightly during the next few
months. We continually review interest rates on those deposits which can be changed immediately,
specifically NOW accounts, Money Market Accounts, and Savings Accounts to determine if interest rate
changes are necessary to maintain our net interest spread and net interest margin.
- -39-
Liquidity and Rate Sensitivity (Continued
Another impact on our net interest spread and interest margin has been the loan to deposit
ratio which indicates how much of our deposits are invested in the loan portfolio. This ratio is a primary
indicator of a Bank's liquidity position as the higher the ratio, the less liquid assets are available to fund
deposit withdrawals. At the same time, this ratio also indicates to us how many deposits are offset by our
highest yielding earning assets, loans; therefore, the higher the ratio, the more deposits are invested in loans
and the less invested in lower yielding investment debt securities. The result of a higher loan to deposit ratio
is usually a higher net interest spread and margin. We have targeted as our optimal loan to deposit ratio 75%
to 90% with a target of 81.17% by December 31, 2002. The loan to deposit ratio at December 31, 2001, was
80.53%; at December 31, 2000, it was 80.20%; and at December 31, 1999, it was 76.65%. The slight
increase of 0.33% from December 31, 2000, was a result of a loan increase of $7,055,505 or 8.49% while
deposits increased $8,329,983 or 8.04%. The increase of 3.55% from December 31, 1999, occurred due to
deposit increase during 2000 of $4,302,554 and loan growth of $6,975,093. The addition of an experienced
commercial lender has generated commercial lending which has resulted in this increased loan to deposit
ratio.
To minimize the risk of our rate sensitivity position, we employ many different methods to
diversify our risk both on the asset and the liability side of the Balance Sheet. The Bank offers both fixed
rate and floating/adjustable rate loans to our customers. At December 31, 2001, the Bank's floating and
adjustable rate loans totaled $49,389,000, or 54.05% of the total loan portfolio. At December 31, 2000, the
Bank's floating and adjustable rate loans totaled $37,183,000, or 43.97% of the total loan portfolio. As of
December 31, 1999 the Bank's floating and adjustable rate loans totaled $31,966,000, 40.86% of the total
loan portfolio. This percentage increase of adjustable rates is due in large part to the addition of adjustable
rate commercial loans to our loan portfolio.
The bank's debt security investment portfolio as of December 31, 2001, was comprised of a
book value of $1,483,000, or 7.36% of floating rate debt securities which reprice annually or more
frequently. The bank's debt security investment portfolio as of December 31, 2000, was comprised of a book
value of $1,852,000, or 6.63% of floating rate debt securities which reprice annually or more frequently
while at December 31, 1999 the Bank's debt security investment portfolio was comprised of a book value of
$2,341,556, or 7.55% of floating rate securities. Specific methods which we have employed to address the
rate sensitive position are the offering of the following deposit products to encourage the movement of short
term deposits to longer term deposits: special term certificates of deposit with competitive interest rates over
one year in term and three year annual adjustable certificates of deposit.
- -40-
Our interest rate sensitivity analysis as of December 31, 2001, based upon our historical
prepayment mortgage-backed securities, contractual maturities, and the earliest possible repricing
opportunity for loans and deposits is as follows:
December 31, 2001
Within 3
Months
After 3 But
Within 12
Months
After 1
But Within
5 Years
After 5
Years
Non-
Interest
Bearing
Total
Assets:
Federal funds sold
$ 6,000
$ 0
$ 0
$ 0
$ 0
$ 6,000
Investment securities
(book value)
1,180
1,345
6,795
11,855
0
21,175
Interest-bearing
balances due from
banks
1,821
95
657
0
0
2,573
Loans
7,658
13,556
36,393
33,293
491
91,371
Unearned discount &
allowance for loan
losses (1)
0
0
0
( 1,203)
0
( 1,203)
Noninterest-earning
assets
0
0
0
0
12,024
12,024
Total assets
$ 16,659
$ 14,996
$ 43,825
$ 43,945
$ 12,515
$ 131,940
Liabilities:
NOW accounts and
savings accounts
$ 32,660
$ 0
$ 0
$ 0
$ 0
$ 32,660
Time Deposits
13,450
28,677
23,830
2
0
65,959
Noninterest-bearing
deposits
0
0
0
0
13,344
13,344
Other borrowed
money
0
0
0
5,403
0
5,403
Other noninterest-
bearing sources to
fund earning
assets
0
0
0
0
1,407
1,407
Total liabilities
$ 46,110
$ 28,677
$ 23,830
$ 5,405
$ 14,751
$ 118,773
Interest sensitivity gap
($ 29,451)
($ 13,681)
$ 19,995
$ 38,540
Cumulative interest
sensitivity gap
( 29,451)
( 43,132)
( 23,137)
15,403
Gap ratio
( 0.36)
( 0.52)
1.84
N/A
Cumulative gap ratio
( 0.36)
( 0.42)
( 0.77)
1.15
(1) It has been arbitrarily assigned to the "after five years" category for purpose of analysis.
We have risk management policies to monitor and limit exposure to market risk. By
monitoring reports which assess our exposure to market risk, we strive to enhance our net interest margin and
take advantage of opportunities available in interest rate movements.
- -41-
The continual monitoring of liquidity and interest rate risk is a function of ALCO
reporting. Upon review and analysis of these reports, we determine the appropriate methods we should utilize to
reprice our products, both loans and deposits, and the types of securities we should purchase in order to achieve
desired net interest margin and interest spreads. We continually strive to attract lower cost deposits, and we
competitively price our time deposits and loan products in order to maintain favorable interest spreads while
minimizing interest rate risk.
The following table sets forth the projected maturities and average rate for all rate sensitive
assets and liabilities. The following assumptions were used in the development of this table:
? All fixed and variable rate loans were based on the original maturity of the note.
? All fixed and variable rate U. S. Agency and Treasury securities and obligations of state and political
subdivisions in the U.S. were based upon the contractual maturity date.
? All fixed and variable rate Mortgage-backed securities and SBA GLPCs were based upon original
maturity as the Bank has not experienced a significant prepayment of these securities.
? We have experienced very little run-off in its history of operations and have experienced net gains in
deposits.
? We have large business and municipal deposits in non-interest bearing checking and savings and
interest-bearing checking. These balances may fluctuate significantly. Therefore, a 50% maximum
runoff of both non-interest-bearing checking and savings and interest-bearing checking was used as
an assumption in this table.
? One large municipal deposit account alternates between the two local community banks every two
years. This deposit account, with an average balance in excess of $1,000,000, is anticipated to leave
in 2002 and return in 2004.
? Fixed and variable rate time deposits were based upon original contract maturity dates.
- -42-
Rate Sensitive Assets
(000 omitted)
2002
2003
2004
2005
2006
Thereafter
Total
Fair Value
Federal funds sold
$ 6,000
$ 0
$ 0
$ 0
$ 0
$ 0
$ 6,000
$ 6,000
Average interest rate
1.75%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Interest bearing deposits
1,922
460
83
0
108
0
2,573
2,589
Average interest rate
1.85%
5.74%
5.27%
0.00%
4.06%
0.00%
2.76%
Fixed interest rate loans
2,568
2,418
4,175
2,635
2,102
31,084
44,982
46,010
Average interest rate
9.17%
9.77%
9.09%
9.32%
8.78%
8.00%
8.38%
Variable interest rate loans
14,285
2,489
133
401
1,460
27,621
46,389
47,450
Average interest rate
7.01%
6.77%
8.53%
8.45%
7.36%
7.45%
7.29%
Fixed interest rate U.S.
Agency and Treasury
550
1,900
450
950
100
4,452
8,402
8,590
Average interest rate
5.23%
5.65%
5.43%
5.88%
6.25%
6.42%
6.05%
Fixed interest rate mortgage-
backed & SBA GLPC
securities
0
12
0
62
15
336
425
428
Average interest rate
0.00%
9.49$
0.00%
5.84%
8.25%
6.35%
6.43%
Variable interest rate
mortgaged-backed &
SBA GLPC securities
0
3
0
0
0
1,480
1,483
1,483
Average interest rate
0.00%
4.00%
0.00%
0.00%
0.00%
4.17%
4.17%
Fixed interest rate obligations
of state and political
subdivisions in the U.S.
625
705
1,095
240
190
6,990
9,845
9,957
Average interest rate
5.26%
4.13%
5.76%
6.03%
6.55%
7.13%
6.61%
Rate Sensitive Liabilities
(000 omitted)
Noninterest-bearing checking
3,336
834
834
834
834
0
6,672
6,672
Average interest rate
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Savings and interest-bearing
checking
8,165
2,041
541
2,042
3,541
0
16,330
16,330
Average interest rate
1.68%
1.68%
1.68%
1.68%
1.68%
1.68%
1.68%
Fixed interest rate time
deposits
28,354
7,873
3,744
5,939
5,961
2
51,873
53,730
Average interest rate
4.90%
5.20%
5.50%
6.25%
4.65%
4.65%
5.11%
Variable interest rate time
deposits
3,247
2,218
8,310
0
0
0
13,775
14,269
Average interest rate
5.25%
5.02%
4.33%
0.00%
0.00%
0.00%
4.66%
Fixed interest rate borrowing
0
0
0
0
0
153
153
156
Average interest rate
0.00%
0.00%
0.00%
0.00%
0.00%
06.64%
6.64%
Variable interest rate
borrowings
0
0
0
0
0
5,250
5,250
5,607
Average interest rate
0.00%
0.00%
0.00%
0.00%
0.00%
6.08%
6.08%
- -43-
Capital
The primary method by which we increase total stockholders' equity is through the accumulation
of earnings. We maintain ratios that are well above the minimum total capital levels required by federal
regulatory authorities including the new risk-based capital guidelines. Regulatory authorities have established
capital guidelines in the form of the "leverage ratio" and "risk-based capital ratios." Our leverage ratio, defined as
total stockholders' equity less intangible assets to total assets, was 9.88% as of December 31, 2001, compared to
10.03% as of December 31, 2000, and 9.36% as of December 31, 1999. The risk-based ratios compare capital to
risk-weighted assets and off-balance-sheet activity in order to make capital levels more sensitive to risk profiles
of individual banks. A comparison of our capital ratios to regulatory minimums at December 31 is as follows:
2001
2000
1999
Regulatory
Minimum
Requirements
Leverage ratio
9.88%
10.03%
9.36%
4.00%
Risk-based capital ratio Tier I (core capital)
14.89%
16.09%
15.39%
4.00%
Combined Tier I and Tier II (core capital
plus allowance for loan losses
15.90%
17.15%
16.43%
8.00%
We have traditionally been well-capitalized with ratios well above required levels and, we expect
equity capital to continue to exceed regulatory guidelines and industry averages.
Certain ratios are useful in measuring the ability of a company to generate capital internally. The
following chart indicates the growth in equity capital for the past three years.
2001
2000
1999
Equity capital at December 31 before FAS 115 adjustments and
reduced by intangible assets (000 omitted)
$ 13,035
$ 12,521
$ 12,167
Equity capital as a percent of assets at December 31
10.08%
10.12%
10.23%
Return on average assets
0.78%
0.78%
0.79%
Return on average equity
7.74%
7.67%
7.53%
Cash dividend payout ratio
50.14%
47.76%
44.28%
STOCK MARKET ANALYSIS AND DIVIDENDS
Our common stock is traded inactively in the over-the-counter market. As of December 31, 2001, the
approximate number of shareholders of record was 464.
2001
2000
Market Price
Cash
Dividend
Market Price
Cash
Dividend
All stock prices and dividends reflect
the 2-for-1 stock split effective on
September 1, 2000
HI
LOW
HI
LOW
First Quarter
$ 24.75 - $ 24.75
$ 0.11
$ 27.50 - $ 24.63
$ 0.10
Second Quarter
$ 25.00 - $ 24.50
$ 0.12
$ 27.50 - $ 25.00
$ 0.11
Third Quarter
$ 25.00 - $ 23.00
$ 0.13
$ 27.50 - $ 24.50
$ 0.12
Fourth Quarter
$ 25.00 - $ 23.00
$ 0.27
$ 25.00 - $ 25.00
$ 0.24
- -44-
EX-27
9
12-MOS
DEC-31-2001
DEC-31-2001
5,401
2,573
6,000
0
19,554
1,115
1,088
91,050
882
132,161
111,962
0
1,407
5,403
0
0
252
13,136
132,161
7,141
1,263
364
8,768
4,343
4,677
4,091
144
18
3,425
1,261
1,261
0
0
1,005
1.26
1.26
3.45
492
273
860
0
811
109
36
882
882
0
49