FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934(Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended:
March 31,June 30, 2004--------------OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from:__________________ to __________________
Commission File Number: 0-19297
First Community Bancshares, Inc.
(Exact(Exact name of registrant as specified in its charter)Nevada 55-0694814 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) One Community Place, Bluefield, Virginia 24605 (Address of principal executive offices) (Zip Code)
Nevada
(State or other jurisdiction of
incorporation or organization)55-0694814
(I.R.S. Employer Identification No.)
One Community Place, Bluefield, Virginia 24605 (Address of principal executive offices) (Zip Code) (276) 326-9000
(Registrant's
(Registrant’s telephone number, including area code)Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 of 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.
YesX[X] No--- ---[ ]Indicate by check mark whether Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
YesX[X] No--- ---[ ]Indicate the number of shares outstanding of each of the
issuer'sissuer’s classes of common stock, as of the latest practicable date.Class Outstanding at April 30, 2004 Common Stock, $1 Par Value 11,244,894 ----------------------
Class Outstanding at July 30, 2004 Common Stock, $1 Par Value 11,228,357 1
First Community Bancshares, Inc.
FORM 10-Q
For the quarter endedMarch 31,June 30, 2004INDEX
REFERENCE Item 1. Financial Statements 3 4 5 6 7-15 16 17-29 29 30 30 31 31 32 32 33 35 Exhibit 10.13 Exhibit 15 Exhibit 31.1 Exhibit 31.2 Exhibit 32 2
PART I. ITEM 1.
FINANCIAL STATEMENTSFinancial StatementsFIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) - --------------------------------------------------------------------------------
MARCH 31 December 31 2004 2003 ASSETS (UNAUDITED) (Note 1) ----------- -----------CASH AND DUE FROM BANKS $ 38,482 $ 39,416 INTEREST-BEARING DEPOSITS WITH BANKS 40,157 22,136 FEDERAL FUNDS SOLD - - ----------- ----------- TOTAL CASH AND CASH EQUIVALENTS 78,639 61,552 SECURITIES AVAILABLE FOR SALE (AMORTIZED COST OF $432,733 AT MARCH 31, 2004; $436,194 AT DECEMBER 31, 2003) 443,844 444,491 SECURITIES HELD TO MATURITY (FAIR VALUE OF $39,629 AT MARCH 31, 2004; $40,060 AT DECEMBER 31, 2003) 37,425 38,020 LOANS HELD FOR SALE 28,656 18,152 LOANS HELD FOR INVESTMENT, NET OF UNEARNED INCOME 1,019,829 1,026,191 LESS ALLOWANCE FOR LOAN LOSSES 14,536 14,624 ----------- ----------- NET LOANS HELD FOR INVESTMENT 1,005,293 1,011,567 PREMISES AND EQUIPMENT 30,633 30,021 OTHER REAL ESTATE OWNED 2,571 2,091 INTEREST RECEIVABLE 8,448 8,345 OTHER ASSETS 18,792 17,762 GOODWILL 38,861 39,363 OTHER INTANGIBLE ASSETS 1,298 1,363 ----------- ----------- TOTAL ASSETS $ 1,694,460 $ 1,672,727 =========== =========== LIABILITIES DEPOSITS: NON-INTEREST-BEARING $ 197,330 $ 194,127 INTEREST-BEARING 1,045,374 1,031,490 ----------- ----------- TOTAL DEPOSITS 1,242,704 1,225,617 INTEREST, TAXES AND OTHER LIABILITIES 12,363 12,037 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 98,035 97,651 FHLB BORROWINGS AND OTHER INDEBTEDNESS 148,324 147,387 JUNIOR SUBORDINATED DEBT RELATED TO ISSUANCE OF TRUST PREFERRED SECURITIES 15,000 15,000 ----------- ----------- TOTAL LIABILITIES 1,516,426 1,497,692 ----------- ----------- STOCKHOLDERS' EQUITY PREFERRED STOCK, PAR VALUE UNDESIGNATED; 1,000,000 SHARES AUTHORIZED; NO SHARES ISSUED AND OUTSTANDING IN 2004 AND 2003 - - COMMON STOCK, $1 PAR VALUE; 15,000,000 SHARES AUTHORIZED; 11,449,841 AND 11,442,348 ISSUED IN 2004 AND 2003, AND 11,244,894 AND 11,242,443 OUTSTANDING IN 2004 AND 2003, 11,450 11,442 ADDITIONAL PAID-IN CAPITAL 108,243 108,128 RETAINED EARNINGS 58,241 56,894 TREASURY STOCK, AT COST (6,566) (6,407) ACCUMULATED OTHER COMPREHENSIVE INCOME 6,666 4,978 ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 178,034 175,035 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,694,460 $ 1,672,727 =========== ===========SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 3FIRST COMMUNITY BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) - --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31, March 31, 2004 2003 ----------- -----------INTEREST INCOME: INTEREST AND FEES ON LOANS HELD FOR INVESTMENT $ 17,130 $ 16,892 INTEREST ON LOANS HELD FOR SALE 203 629 INTEREST ON SECURITIES-TAXABLE 3,270 3,145 INTEREST ON SECURITIES-NONTAXABLE 1,636 1,657 INTEREST ON FEDERAL FUNDS SOLD AND DEPOSITS IN BANKS 199 215 ----------- ----------- TOTAL INTEREST INCOME 22,438 22,538 ----------- ----------- INTEREST EXPENSE: INTEREST ON DEPOSITS 4,315 5,317 INTEREST ON FHLB AND OTHER SHORT-TERM BORROWINGS 1,883 1,893 INTEREST ON OTHER INDEBTEDNESS 208 148 ----------- ----------- TOTAL INTEREST EXPENSE 6,406 7,358 ----------- ----------- NET INTEREST INCOME 16,032 15,180 PROVISION FOR LOAN LOSSES 532 589 ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 15,500 14,591 ----------- ----------- NON-INTEREST INCOME: FIDUCIARY INCOME 418 416 SERVICE CHARGES ON DEPOSIT ACCOUNTS 1,960 1,821 OTHER SERVICE CHARGES, COMMISSIONS AND FEES 559 513 MORTGAGE BANKING INCOME 507 2,964 OTHER OPERATING INCOME 295 297 GAIN ON SECURITIES 11 20 ----------- ----------- TOTAL NON-INTEREST INCOME 3,750 6,031 ----------- ----------- NON-INTEREST EXPENSE: SALARIES AND EMPLOYEE BENEFITS 7,213 6,333 OCCUPANCY EXPENSE OF BANK PREMISES 951 849 FURNITURE AND EQUIPMENT EXPENSE 673 530 CORE DEPOSIT AMORTIZATION 64 63 OTHER OPERATING EXPENSE 4,455 3,356 ----------- ----------- TOTAL NON-INTEREST EXPENSE 13,356 11,131 ----------- ----------- INCOME BEFORE INCOME TAXES 5,894 9,491 INCOME TAX EXPENSE 1,733 2,743 ----------- ----------- NET INCOME $ 4,161 $ 6,748 =========== =========== BASIC EARNINGS PER COMMON SHARE $ 0.37 $ 0.62 =========== =========== DILUTED EARNINGS PER COMMON SHARE $ 0.37 $ 0.62 =========== =========== WEIGHTED AVERAGE BASIC SHARES OUTSTANDING 11,245,465 10,857,307 =========== =========== WEIGHTED AVERAGE DILUTED SHARES OUTSTANDING 11,347,748 10,913,481 =========== ===========(Amounts in Thousands, Except Share Data)
June 30, December 31, 2004 2003 (Unaudited) (Note 1) $ 41,533 $ 37,173 14,799 22,136
56,332 59,309 429,478 444,194 36,209 38,020 774 424 1,186,954 1,026,191 16,160 14,624
1,170,794 1,011,567 35,071 29,816 2,166 2,091 8,653 8,327 25,566 17,266 59,297 37,978 2,706 1,363 22,192 22,372
$ 1,849,238 $ 1,672,727
$ 225,241 $ 194,046 1,169,788 1,031,490
1,395,029 1,225,536 11,501 11,897 109,252 97,651 125,941 129,616 15,000 15,000 21,130 17,992
1,677,853 1,497,692
— —
11,451,062 and 11,442,348 issued in 2004 and 2003, and
11,215,473 and 11,242,443 outstanding in 2004 and 200311,451 11,442 108,078 108,128 61,153 56,894 (7,321 ) (6,407 ) (1,976 ) 4,978
171,385 175,035
$ 1,849,238 $ 1,672,727
See Notes to Consolidated Financial Statements.
43
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in Thousands Except Share and Per Share Data) (Unaudited)
Six Months Ended Three Months Ended June 30 June 30 June 30 June 30 2004 2003 2004 2003 $ 36,242 $ 33,874 $ 19,112 $ 16,982 6,699 6,519 3,433 3,385 3,343 3,299 1,707 1,642 301 358 104 143
46,585 44,050 24,356 22,152
9,128 10,459 4,813 5,142 3,429 2,718 1,707 1,340 417 297 209 150
12,974 13,474 6,729 6,632
33,611 30,576 17,627 15,520 1,255 1,897 723 1,308
32,356 28,679 16,904 14,212
930 981 512 649 4,261 3,807 2,301 1,986 1,272 1,069 713 472 905 541 610 244 1,449 153 1,438 133
8,817 6,551 5,574 3,484
12,775 9,466 6,662 4,784 1,746 1,456 894 720 1,373 895 747 442 175 114 111 51 7,067 5,566 3,812 2,756
23,136 17,497 12,226 8,753
18,037 17,733 10,252 8,943 4,849 4,969 2,666 2,499
13,188 12,764 7,586 6,444 (4,265 ) 1,557 (2,374 ) 856 (952 ) 606 (502 ) 333
$ (3,313 ) $ 951 $ (1,872 ) $ 523
$ 9,875 $ 13,715 $ 5,714 $ 6,967
$ 0.88 $ 1.25 $ 0.51 $ 0.63
$ 0.87 $ 1.25 $ 0.50 $ 0.63
$ 1.17 $ 1.17 $ 0.67 $ 0.59
$ 1.16 $ 1.17 $ 0.67 $ 0.59
11,237,225 10,937,927 11,228,956 10,969,748
11,334,096 11,021,010 11,320,415 11,084,847
See Notes to Consolidated Financial Statements.
4
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS(AMOUNTS IN THOUSANDS) (UNAUDITED) - --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 2004 2003 --------- ---------OPERATING ACTIVITIES: CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 4,161 $ 6,748 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES: PROVISION FOR LOAN LOSSES 532 589 DEPRECIATION OF PREMISES AND EQUIPMENT 669 437 CORE DEPOSIT AMORTIZATION 65 63 PURCHASE PRICE ACCOUNTING ACCRETION (61) (12) NET INVESTMENT AMORTIZATION AND ACCRETION 618 510 NET GAIN ON THE SALE OF ASSETS (15) (60) NET GAIN ON SALE OF LOANS (2,201) (4,753) MORTGAGE LOANS ORIGINATED FOR SALE (124,549) (206,856) PROCEEDS FROM SALE OF MORTGAGE LOANS 116,246 226,599 INCREASE IN INTEREST RECEIVABLE (103) (313) INCREASE IN OTHER ASSETS (1,580) (2,109) INCREASE (DECREASE) IN OTHER LIABILITIES 375 (505) --------- --------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (5,843) 20,338 --------- --------- INVESTING ACTIVITIES: CASH FLOWS FROM INVESTING ACTIVITIES: PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 1 505 PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES AVAILABLE FOR SALE 46,416 27,074 PROCEEDS FROM MATURITIES AND CALLS OF SECURITIES HELD TO MATURITY 455 928 PURCHASE OF SECURITIES AVAILABLE FOR SALE (43,424) (101,316) NET DECREASE IN LOANS MADE TO CUSTOMERS 5,258 30,148 PURCHASE OF PREMISES AND EQUIPMENT (1,370) (948) SALE OF EQUIPMENT 35 58 NET CASH PROVIDED BY ACQUISITIONS - 30 --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 7,371 (43,521) --------- --------- FINANCING ACTIVITIES: CASH FLOWS FROM FINANCING ACTIVITIES: NET INCREASE IN DEMAND AND SAVINGS DEPOSITS 16,327 7,194 NET INCREASE IN TIME DEPOSITS 853 6,844 NET INCREASE (DECREASE) IN FHLB AND OTHER INDEBTEDNESS 1,357 (10,179) REPAYMENT OF OTHER BORROWINGS (5) (5) ACQUISITION OF TREASURY STOCK (159) (2,562) DIVIDENDS PAID (2,814) (2,565) --------- --------- NET CASH (PROVIDED BY) USED IN FINANCING ACTIVITIES 15,559 (1,273) --------- --------- CASH AND CASH EQUIVALENTS NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 17,087 (24,456) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 61,552 124,585 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 78,639 $ 100,129 ========= =========SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
(Amounts in Thousands) (Unaudited)
Six Months Ended June 30 2004 2003 $ 13,188 $ 12,764 1,255 1,897 1,297 853 175 114 (195 ) (49 ) 1,199 1,198 (1,544 ) (157 ) (11,206 ) (304 ) 10,856 — 606 (604 ) (2,419 ) (3,698 ) (1,693 ) 6,300
11,519 18,314
26,410 3,601 78,633 64,623 2,347 1,265 (74,177 ) (183,887 ) (32,068 ) 20,712 (2,936 ) (4,565 ) 329 56 (26,272 ) 1,339
(27,734 ) (96,856 )
26,021 12,188 (5,374 ) (444 ) (598 ) 27,282 (4 ) (4 ) (1,192 ) (3,062 ) (5,615 ) (5,223 )
13,238 30,737
1,125 (81 )
(1,852 ) (47,886 ) 61,552 124,585
$ 59,700 $ 76,699
$ 56,332 $ 74,229 3,368 2,470
$ 59,700 $ 76,699
See Notes to Consolidated Financial Statements.
5
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES INSTOCKHOLDERS'STOCKHOLDERS’ EQUITY- -------------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) (UNAUDITED)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE STOCK CAPITAL EARNINGS STOCK (LOSS) INCOME TOTAL --------- ----------- --------- --------- ------------- ----------BALANCE JANUARY 1, 2003 $ 9,957 $ 58,642 $ 79,084 $ (1,982) $ 6,761 $ 152,462 COMPREHENSIVE INCOME: NET INCOME - - 6,748 - - 6,748 OTHER COMPREHENSIVE INCOME, NET OF TAX: NET UNREALIZED GAINS ON SECURITIES AVAILABLE FOR SALE - - - - (725) (725) COMMON DIVIDENDS DECLARED ($.24 PER SHARE) - - (2,565) - - (2,565) PURCHASE 85,000 TREASURY SHARES AT $30.15 PER SHARE - - - (2,562) - (2,562) 8,409 SHARES ISSUED IN STONE CAPITAL ACQUISITION (SEE NOTE 3) 8 236 244 OPTION EXERCISE 11,000 SHARES @ $23.91 49 321 370 ISSUANCE OF TREASURY SHARES TO ESOP 43 680 723 --------- ----------- --------- --------- ----------- ---------- BALANCE MARCH 31, 2003 $ 9,965 $ 58,970 $ 83,267 $ (3,543) $ 6,036 $ 154,695 ========= =========== ========= ========= =========== ========== BALANCE JANUARY 1, 2004 $ 11,442 $ 108,128 $ 56,894 $ (6,407) $ 4,978 $ 175,035 COMPREHENSIVE INCOME: NET INCOME - - 4,161 - 4,161 OTHER COMPREHENSIVE INCOME, NET OF TAX: NET UNREALIZED GAINS ON SECURITIES AVAILABLE FOR SALE - - - - 1,688 1,688 COMMON DIVIDENDS DECLARED ($.25 PER SHARE) - - (2,814) - - (2,814) PURCHASE 5,000 TREASURY SHARES AT $32.05 PER SHARE - - - (159) - (159) SECOND PAYMENT OF STOCK RELATED TO THE ACQUISITION OF STONE CAPITAL:2,540 SHARES 3 85 88 OPTION EXERCISE 4,953 SHARES 5 30 - 35 --------- ----------- --------- --------- ----------- ---------- BALANCE MARCH 31, 2004 $ 11,450 $ 108,243 $ 58,241 $ (6,566) $ 6,666 $ 178,034 ========= =========== ========= ========= =========== ==========SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
(Amounts in Thousands, Except Share and Per Share Information) (Unaudited)
Accumulated Additional Other Common Paid-in Retained Treasury Comprehensive Stock Capital Earnings Stock (Loss) Income Total $ 9,957 $ 58,642 $ 79,084 $ (1,982 ) $ 6,761 $ 152,462 — — 13,715 — — 13,715 — — — — 1,750 1,750 — — (5,223 ) — — (5,223 ) — — — (3,062 ) — (3,062 ) 8 236 244 390 14,031 14,421 1,035 35,392 (36,427 ) — (58 ) 336 278 43 680 723
$ 11,390 $ 108,286 $ 51,149 $ (4,028 ) $ 8,511 $ 175,308
$ 11,442 $ 108,128 $ 56,894 $ (6,407 ) $ 4,978 $ 175,035 — — 9,875 — 9,875 — — — — (6,954 ) (6,954 ) — — (5,616 ) — — (5,616 ) — — — (1,192 ) — (1,192 ) 3 85 88 6 (135 ) 278 149
$ 11,451 $ 108,078 $ 61,153 $ (7,321 ) $ (1,976 ) $ 171,385
See Notes to Consolidated Financial Statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTENote 1.
UNAUDITED FINANCIAL STATEMENTSUnaudited Financial StatementsThe unaudited consolidated balance sheet as of
March 31,June 30, 2004, the unaudited consolidated statements of income for the six and three months endedMarch 31,June 30, 2004 and 2003 and the consolidated statements of cash flows and changes instockholders'stockholders’ equity for thethreesix months endedMarch 31,June 30, 2004 and 2003 have been prepared by the management of First Community Bancshares, Inc.("FCBI"(“FCBI” or the"Company"“Company”). In the opinion of management, all adjustments (including normal recurring accruals) necessary to present fairly the financial position of FCBI and subsidiaries atMarch 31,June 30, 2004 and its results of operations, cash flows, and changes instockholders'stockholders’ equity for the three months endedMarch 31,June 30, 2004 and 2003 have been made. These results are not necessarily indicative of the results of consolidated operations that might be expected for the full calendar year.The consolidated balance sheet as of December 31, 2003 has been extracted from the audited financial statements included in the
Company'sCompany’s 2003 Annual Report to Stockholders on Form 10-K. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with standards for the preparation of interim financial statements. These financial statements should be read in conjunction with the financial statements and notes thereto included in the 2003 Annual Report of FCBI on Form 10-K.A more complete and detailed description of
FCBI'sFCBI’s significant accounting policies is included within Footnote 1 to theCompany'sCompany’s Annual Report on Form 10-K for December 31, 2003. In addition, theCompany'sCompany’s required disclosure of the application of critical accounting policies is included within the"Application“Application of Critical AccountingPolicies"Policies” section of Part I, Item 2."Management's“Management’s Discussion and Analysis of Financial Condition and Results ofOperations"Operations” included herein.The following is an update of certain required disclosures pursuant to the requirements of Financial Accounting Standards Board
("FASB"(“FASB”) Statement 148.SUMMARY OF SIGNIFICANT ACCOUNTING POLICY UPDATE FOR CERTAIN REQUIRED DISCLOSURES: STOCK OPTIONSSummary of Significant Accounting Policy Update for Certain Required Disclosures: Stock Options
The Company has in existence a stock option plan for certain executives and directors accounted for under the intrinsic value
method in accordance with Accounting Principles Board ("APB") 25.method. Because the exercise price of theCompany'sCompany’s employee/director stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The effect of option shares on earnings per share relates to the dilutive effect of the underlying options outstanding. To the extent the granted exercise share price is less than the current market price("(“in themoney"money”) there is an economic incentive for the shares to be exercised and an increase in the dilutive effect on earnings per share results.In December 2002,A new Omnibus Stock Option Plan was approved at the
FASB issued Financial Accounting Standards ("FAS") 148, "Accountingannual 2004 shareholder meeting to be used in conjunction with retention, recruitment and hiring of employees. 42,000 option shares and an additional 5,000 stock awards were granted and reserved forStock-Based Compensation." This new standard provides alternative methodsfuture issuance in May 2004 subject to acceptance oftransition for a voluntary changeagreements by the optionees. The maximum number of grants and awards under this Plan is limited tothe fair value method of accounting for stock-based compensation. In addition, the Statement amends the disclosure requirements of FAS 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the underlying effect of the method used on reported results until exercised.200,000 shares.7
Assuming use of the fair value method of accounting for stock options, pro forma net income and earnings per share for the six and three month periods ended
March 31,June 30, 2004 and 2003 would have been estimated as follows:
THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, MARCH 31, 2004 2003 --------- --------- (AMOUNTS IN THOUSANDS)Net income as reported $ 4,161 $ 6,748 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (39) (39) --------- --------- $ 4,122 $ 6,709 ========= ========= Earnings per share from continuing operations: Basic as reported $ 0.37 $ 0.62 Basic pro forma $ 0.37 $ 0.62 Diluted as reported $ 0.37 $ 0.62 Diluted pro forma $ 0.36 $ 0.61At the annual shareholder meeting in April
Six Months Six Months Three Months Three Months Ended Ended Ended Ended June 30, June 30, June 30, June 30, 2004 2003 2004 2003 (Amounts in Thousands) Net income as reported $ 9,875 $ 13,715 $ 5,714 $ 6,967 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (86 ) (78 ) (48 ) (39 )
$ 9,789 $ 13,637 $ 5,666 $ 6,928
Income from continuing operations $ 13,188 $ 12,764 $ 7,586 $ 6,444 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (86 ) (78 ) (48 ) (39 )
$ 13,102 $ 12,686 $ 7,538 $ 6,405
Earnings per share: Basic as reported $ 0.88 $ 1.25 $ 0.51 $ 0.63 Basic pro forma $ 0.87 $ 1.24 $ 0.50 $ 0.62 Diluted as reported $ 0.87 $ 1.25 $ 0.50 $ 0.63 Diluted pro forma $ 0.86 $ 1.24 $ 0.50 $ 0.62 Earnings per share from continuing operations: Basic as reported $ 1.17 $ 1.17 $ 0.67 $ 0.59 Basic pro forma $ 1.17 $ 1.16 $ 0.67 $ 0.58 Diluted as reported $ 1.16 $ 1.17 $ 0.67 $ 0.59 Diluted pro forma $ 1.16 $ 1.15 $ 0.67 $ 0.58 Note 2. Discontinued Operations
On July 8, 2004
a new Omnibus Stock Option Plan was approved. The options and shares of this new plan will be used in conjunction with retention, recruitment and hiring of employees. The maximum number of grants and awards under this Plan was limited to 200,000 shares. NOTE 2. DIVESTITURES On April 27, 2004, the CompanyFirst Community announced theproposedtermination of a previously announced sale of its mortgage subsidiary. While the mortgage banking subsidiary continues to be held for sale, termination of the previously announced sale led to the elimination of the wholesale portion of the mortgagesubsidiary reflectingcompany’s business and a substantial downsizing of theCompany's strategic plans for exitingremaining retail division. In connection with the exit of its wholesale mortgage banking business and as previously reported, the Company recorded impairment charges of $933,000 in the second quarter of 2004 (bringing total impairment charges to $1,385,000 for the first six months of 2004) to reduce the carrying value of the subsidiary to its estimated fair value less costs to sell. To facilitate its decision to exit the wholesale mortgage banking business, First Community has provided management and professional resources to settle the mortgage company’s wholesale interest rate lock commitments; has overseen a transition in management at the mortgage company; and has taken steps to reduce overhead for the company’s remaining mortgage business, which willallow greaterbe offered through its retail network. The strategic decision to exit the wholesale mortgage business will reduce the Company’s exposure to risk associated with the large fluctuations previously experienced in the volume-driven, wholesale business and its hedged interest rate lock commitments and closed loans. The change in strategic direction and decision to exit the wholesale mortgage business will permit the Company to focus its resources onthe Company'sits core community bankingbusiness.business, which has continued to grow and perform. Theproposed transaction involves a saleresults of100% of the stock of UFM to certain members of UFM's present management. Although completion of the transaction remains subject to the execution of a definitive agreement and satisfaction of the conditions which will be set forth therein, the proposed sale did result in a charge to net income of $651,000 in the first quarter of 2004. The parties anticipate that the proposed saleoperations of the mortgagesubsidiary will close bycompany are reported as discontinued operations. The loss from discontinued operations was $1.9 million or $0.17 per diluted share for the second quarter of 2004 and $3.3 million or $0.29 per diluted share for the six months ended June 30, 2004.NOTEThe business related to UFM is accounted for as discontinued operations and, therefore, the results of operations and cash flows have been removed from the Company’s results of continuing operations in accordance with FAS 144 for all periods presented in this document. The results of UFM are presented as discontinued operations in a separate category on the income
8
statement following results from continuing operations. The income from discontinued operations for the six months and three months ended June 30, 2004 and 2003, respectively, is as follows:
(Amounts in Thousands) Six Months Ended Three Months Ended (Unaudited) June 30, June 30, 2004 2003 2004 2003 Interest & fees on loans held for sale $ 567 $ 1,284 $ 364 $ 655 Income on investments taxable 5 13 1 2 Interest on fed funds and time deposits 3 4 1 4
575 1,301 366 661 Interest on short term borrowings 451 1,109 290 594 Interest on other borrowings 1 1 1 0
452 1,110 291 594 Net interest income 123 191 75 67 Mortgage banking income 850 6,414 343 3,450
850 6,414 343 3,450 Salaries and benefits 2,326 3,306 1,226 1,655 Occupancy expense 180 216 81 103 Furniture and equipment expense 77 155 30 78 Other operating expense 2,655 1,371 1,455 825
5,238 5,048 2,792 2,661 (Loss) income before income taxes (4,265 ) 1,557 (2,374 ) 856 Applicable income taxes (952 ) 606 (502 ) 333
$ (3,313 ) $ 951 $ (1,872 ) $ 523
9
All assets and liabilities of UFM were classified as discontinued as of the June 30, 2004 and December 31, 2003 periods presented in this report. The major asset and liability categories of discontinued operations are as follows:
June 30, December 31, 2004 2003 (Amounts in Thousands) (Unaudited) Cash and due from banks $ 3,368 $ 2,243 Securities available for sale 190 297 Loans held for sale 18,384 17,728 Bank premises and equipment 126 205 Interest receivable 41 18 Other assets 83 496 Goodwill & other intangibles 0 1,385
$ 22,192 $ 22,372
Non-interest bearing deposits 77 81 Other liabilities 136 140 Borrowings 20,917 17,771
21,130 17,992
Common stock 305 305 Additional paid-in capital 4,914 4,914 Retained earnings (4,162 ) (848 ) Accumulated other comprehensive income 5 9
1,062 4,380
$ 22,192 $ 22,372
Note 3.
MERGERS AND ACQUISITIONSMergers, Acquisitions and Branch DevelopmentAfter the close of business on March 31, 2004, the Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company
("(“PCBBancorp"Bancorp”) headquartered in Johnson City, Tennessee. PCB Bancorphashad six full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. At acquisition, PCB Bancorp had total assets of$171$171.0 million, total loans of$128$128.0 million and total deposits of$150 million, which will be$150.0 million. These resources were included in theCompany'sCompany’s financial statements beginning with the second quarter of 2004.Under the terms of the merger agreement, shares of PCB Bancorp common stock were purchased for $40.00 per share in cash. The total deal value, including the cash-out of outstanding stock options, was approximately $36.0 million. Concurrent with the PCB Bancorp
merger,acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB Bancorp, was merged into First Community Bank, N.A., (the “Bank”) a wholly-owned subsidiary of First Community Bancshares,Inc (the "Bank").Inc. As a result of the acquisition and preliminary purchase price allocation, approximately $21.3 million in goodwill has been recorded which represents the excess of the purchase price over the fair market value of the net assets acquired and identified intangibles.On June 6, 2003, the Company acquired The CommonWealth Bank, a Virginia-chartered commercial bank
("CommonWealth"(“CommonWealth”).CommonWealth'sCommonWealth’s four branch facilities located in the Richmond, Virginia metro area were simultaneously merged with and into the Bank. The completion of this transaction resulted in the addition of $136.5 million in assets, including $120.0 million in loans and added an additional $105.0 million in deposits to the Bank. As a result of the purchase price allocation, approximately $14.1 millionexcessofpurchase price over the fair market value of the net assets acquired and identified intangiblesgoodwill wasrecorded as goodwill.recorded.In the second and third quarters of 2003, the Company opened three de novo branches in Winston-Salem, North Carolina. The Company also opened two additional loan production offices during the first quarter of 2004 in Mount Airy and Charlotte, North Carolina and opened, or were in the process of opening, two new loan production offices in Blacksburg and Norfolk, Virginia. The Company does not anticipate that these
branchesnew offices will be profitable until market development has proven10
successful and adequate loan balances and corresponding loan revenue are established to support the added facilities, infrastructure and other
8operating costs of these branches. The Company also opened two additional loan production offices during the first quarter of 2004 in Mount Airybranches andCharlotte, North Carolina.offices.In January 2003, the Bank completed the acquisition of Stone Capital Management, Inc. (“Stone Capital”), based in Beckley, West Virginia. This acquisition expanded the
Bank'sBank’s operations to include a broader range of financial services, including wealth management, asset allocation, financial planning and investment advice. Stone Capital at December 31, 2003 had total assets of $59 million under management and continues to operate under its name. Stone Capital was acquired through the issuance of 8,409 shares of Company common stock, which represented 50% of the total consideration. In 2003, Stone Capital exceeded the annual revenue requirement outlined in the acquisition agreement and another 2,541 shares were paid to the original shareholders subsequent to December 31, 2003. The balance of the remaining consideration ($175,000) is payable over the next two years in the form of Company common stock, subject to the achievement of minimum requirements set forth in the acquisition agreement.NOTEAs a result of the purchase price allocation, approximately $360,000 of goodwill was recorded.Note 4.
BORROWINGSBorrowingsFederal Home Loan Bank
("FHLB"(“FHLB”) borrowings and other indebtedness are comprised of$136.3$107.3 million in convertible and callable advances and$8.3$34.4 million of noncallable term advances from the FHLB of Atlanta. The callable advances may be redeemed at quarterly intervals after various lockout periods. These call options may substantially shorten the lives of these instruments. If these advances are called, the debt may be paid in full, converted to another FHLB credit product, or converted to an adjustable rate advance. Prepayment of the advances may result in substantial penalties based upon the differential between contractual note rates and current advance rates for similar remaining time periods.The following schedule details the contractual terms of outstanding FHLB advances, rates and corresponding final maturities at
March 31,June 30, 2004.NotAlso included in the table are the fair value adjustments related to debt obligations acquired in the CommonWealth Bankacquisition.and People’s Community Bank acquisitions. The unamortized premium of approximately$180,000 which$420,000 is being amortizedtoas interest expense over the anticipated life of the borrowingsreflectingand is reflected as an adjustment to the effective rate paid.
ADVANCE RATE MATURITY NEXT CALL DATE ------------------------------------------------------- (AMOUNTS IN THOUSANDS)Callable advances: $ 5,000 1.10% 03/10/06 03/10/04 25,000 0.67% 06/30/06 06/30/04 1,250 4.14% 05/02/07 05/02/05 5,000 1.41% 09/27/07 06/29/04 25,000 5.71% 03/17/10 03/17/04 25,000 6.11% 05/05/10 05/05/04 25,000 6.02% 05/05/10 05/05/04 25,000 5.47% 10/04/10 04/05/04 ------------------ $ 136,250 ================== Noncallable advances: $ 900 4.55% 11/23/05 N/A 379 5.01% 12/11/06 N/A 5,000 1.12% 01/30/07 N/A 2,000 6.27% 09/02/08 N/A ------------------ $ 8,279 ==================
Next Call Advance Rate Maturity Date (Amounts in Thousands) Callable advances: $ 1,287 4.14 % 05/02/07 05/02/05 25,000 5.71 % 03/17/10 03/17/10 25,000 6.11 % 05/05/10 08/05/04 25,000 6.02 % 05/05/10 05/05/10 25,000 5.47 % 10/04/10 10/04/10 6,070 4.75 % 01/31/11 07/01/04
$ 107,357
Noncallable advances: 964 4.55 % 11/23/05 N/A 431 5.01 % 12/11/06 N/A 5,000 1.17 % 01/30/07 N/A 2,000 6.27 % 09/02/08 N/A 25,000 1.90 % 06/30/06 N/A 1,335 2.95 % 7/1/2013 N/A
34,730
Debt related to discontinued operations included in the aggregate balance of liabilities related to discontinued operations (16,146 )
Advances related to continuing operations $ 125,941
11
In addition to the FHLB borrowings listed in the foregoing table, the Company issued through FCBI Capital Trust, a business trust subsidiary, $15.0 million of trust preferred securities in September 2003 at a variable rate indexed to the 3 Month LIBOR rate + 2.95%. The securities mature on October 8, 2033 and are callable beginning October 8, 2008.
The
Company'sCompany’s wholly owned mortgage subsidiary, United First Mortgage,("UFM"Inc. (“UFM”), alsomaintainsmaintained a warehouse line of creditused to fund mortgage loan inventorywith a third party which was entered into in the third quarter of2003.2003 and used to fund mortgage loan inventory. The maximum line available under this credit facilityiswas $15 million$3.6 millionwith a maturity ofwhich was outstanding at March 31, 2004. This line maturesAugust 10, 2004, and carries an interest rate of New York Prime, adjusting as the prime rate changes. UFM had an outstanding balance at June 30, 2004 of $4.7 million which was reported in liabilities related to discontinued operations. The outstanding amount on this line was paid off subsequent to June 30, 2004.Other various debt obligations of the Company were approximately
$30,000$26,000 atMarch 31,June 30, 2004.NOTENote 5.
COMMITMENTS AND CONTINGENCIESCommitments and ContingenciesIn the normal course of business, the Company is a defendant in various legal actions and asserted claims, most of which involve lending, collection and employment matters. While the Company and legal counsel are unable to assess the ultimate
9outcome of each of these matters with certainty, they are of the belief that the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on the financial condition, results of operations or cash flows of the Company. In
November, 2003May, 2004, the Company wassuednamed a party to an action filed in the Circuit Court of Nicholas County, West Virginia bytwo former employees of The CommonWealth Bank, alleging among other things, violation of employment law and breach of contract, stemming from their termination. TheFidelity & Guaranty Life Insurance Companyand counsel believe thatseeking to determine thelawsuit, which seeks damages of more than $180,000 in severance plus certain retirement and employee benefits and punitive damages for eachrights of thetwo former employeesCompany’s banking subsidiary and members of the LeRose family to $1,000,000 in life insurance proceeds paid on a life insurance policy previously assigned to the Bank as partial collateral for a multimillion indebtedness due and owing to the bank as a consequence of a kiting scheme. TheCommonWealth Bank is without merit, and intendslife insurance proceeds have been paid by the insurance company into a court-administered account for ultimate distribution tovigorously defend this matter.the rightful owner.The Company conducts mortgage banking operations through
UFM.UFM, which is discussed more fully under Note 2 “Discontinued Operations”. The majority of loans originated by UFM are sold to larger national investors on a service released basis. Loans are sold under loan sales agreements which contain various repurchase provisions. These repurchase provisions give rise to a contingent liability for loans which could subsequently be submitted to UFM for repurchase. The principal events which could result in a repurchase obligation arei.(i.) the discovery of fraud or material inaccuracies in a sold loan file andii.(ii.) a default on the first payment due after a loan is sold to the investor, coupled with a ninety day delinquency in the first year of the life of the loan. Other events and variations of these events could result in a loan repurchase obligation under terms of other loan sales agreements. The volume of contingent loan repurchases, if any, is largely dependent on the quality of loan underwriting and systems employed by UFM for quality control in the production of mortgage loans.UFM may remarket these loans to alternate investors after repurchase and cure of the loans' defects.To date, loans submitted for repurchase have not been material and have not had a material adverse effect on the results of operations, financial condition or liquidity of UFM or the Company.UFM also originates government guaranteed FHA and VA loans that are also sold to third party investors. The Department of Housing and Urban Development
("HUD"(“HUD”) periodically audits loan files of government guaranteed loans and may require UFM to execute indemnification agreements on loans which do not meet certain predefined underwriting guidelines or may require the repurchase of the underlying loan. To date, the number of required indemnification agreements, or loan repurchases have not been material and no subsequent losses have been incurred. Loan indemnifications and repurchases under the FHA,andVA and VHDA loan programs have not had a material adverse effect on the financial condition, results of operations or cash flows of UFM or the Company.UFM is subject to net worth requirements issued by HUD. Failure to meet these minimum capital requirements can result in certain mandatory and possibly additional discretionary actions that, if undertaken, could have a direct material effect on
UFM'sUFM’s operations. UFM was in compliance withHUD'sHUD’s minimum net worth requirement atMarch 31,June 30, 2004.UFM'sUFM’s adjusted tangible net worth for HUD purposes was$1.9 million$712,000 atMarch 31,June 30, 2004, which exceeded the HUD requirement.The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized on the balance sheet. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The
Company'sCompany’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.12
Commitments to extend credit are agreements to lend to a customer as long as there is not a 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 Company evaluates each
customer'scustomer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based onmanagement'smanagement’s credit evaluation of the counterparties. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.Standby letters of credit and written financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.
Financial instruments whose contract amounts represent credit risk at
March 31,June 30, 2004 are commitments to extend credit (including availability of lines of credit) of$97.2$128.4 million and standby letters of credit and financial guarantees written of$9.1$8.1 million. In addition, atMarch 31,June 30, 2004, UFM had commitments to originate loans of$137.7$44.6 million. Of these commitments, the fallout/pullthrough model employed by UFM identified$82.6$29.1 million that are anticipated to close.10In September 2003, the Company issued, through FCBI Capital Trust, $15.0 million of trust preferred securities in a private placement. In connection with the issuance of the preferred securities, the Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that FCBI Capital Trust has not made such payments or distributions and has the funds
therefor:therefore: (i) accrued and unpaid distributions, (ii) the redemption price, and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amountandincluding all accrued and unpaid distributionsandor the amount of assets of the trust remaining available for distribution.NOTENote 6.
OTHER COMPREHENSIVE INCOMEOther Comprehensive IncomeThe Company currently has one component of other comprehensive income, which is comprised of unrealized gains and losses on securities available for sale, detailed as follows:
THREE MONTHS ENDED MARCH 31, MARCH 31, 2004 2003 --------- --------- (AMOUNTS IN THOUSANDS)OTHER COMPREHENSIVE INCOME: Unrealized gain (losses) arising during the period $ 2,825 $(1,198) Related income (expense) benefit (1,130) 479 ------- ------- Unrealized gains (losses) arising during the period, net of tax 1,695 (719) Reclassification adjustment for gains realized in net income (11) (10) Tax expense of reclassification 4 4 ------- ------- Other comprehensive gain (loss) 1,688 (725) Beginning accumulated other comprehensive gain 4,978 6,761 ------- ------- Ending accumulated other comprehensive income $ 6,666 $ 6,036 ======= =======NOTE
Six Months Ended Three Months Ended June 30, June 30, June 30, June 30, 2004 2003 2004 2003 (Amounts in Thousands) (Amounts in Thousands) Unrealized (losses) gains arising during the period $ (10,149 ) $ 3,059 $ (12,974 ) $ 4,257 Related income tax benefit (expense) 4,060 (1,224 ) 5,190 (1,702 )
Unrealized (losses) gains arising during the period, net of tax (6,089 ) 1,835 (7,784 ) 2,555 Reclassification adjustment for gains realized in net income (1,441 ) (143 ) (1,430 ) (133 ) Tax expense of reclassification 576 58 572 53
Other comprehensive (loss) gain (6,954 ) 1,750 (8,642 ) 2,475 Beginning accumulated other comprehensive gain 4,978 6,761 6,666 6,036
Ending accumulated other comprehensive income $ (1,976 ) $ 8,511 $ (1,976 ) $ 8,511
Note 7.
SEGMENT INFORMATION The Company operates two business segments: community banking and mortgage banking. These segments are primarily identified by their products and services and the channels through which they are offered. The community banking segment consists of the Company's full-service bank that offers customers traditional banking products and services through various delivery channels. The mortgage banking segment consists of mortgage brokerage offices that originate, acquire, and sell residential mortgage products into the secondary market through national investors. Information for each of the segments is presented below.
THREE MONTHS ENDED MARCH 31, 2004 ------------------------------------------------------------------------- (AMOUNTS IN THOUSANDS) COMMUNITY MORTGAGE BANKING BANKING PARENT ELIMINATIONS TOTAL ---------- ---------- ---------- ------------ ----------NET INTEREST INCOME (LOSS) $ 16,199 $ 48 $ (119) $ (96) $ 16,032 PROVISION FOR LOAN LOSSES 532 - - - 532 ---------- ---------- ---------- ---------- ---------- NET INTEREST INCOME (LOSS) AFTER PROVISION FOR LOAN LOSSES 15,667 48 (119) (96) 15,500 OTHER INCOME 3,434 507 - (191) 3,750 OTHER EXPENSES 11,055 2,446 142 (287) 13,356 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES 8,046 (1,891) (261) - 5,894 INCOME TAX EXPENSE (BENEFIT) 2,334 (450) (151) - 1,733 ---------- ---------- ---------- ---------- ---------- NET INCOME (LOSS) $ 5,712 $ (1,441) $ (110) $ - $ 4,161 ========== ========== ========== ========== ========== AVERAGE ASSETS $1,666,330 $ 19,466 $ 193,354 $ (205,565) $1,673,585 ========== ========== ========== ========== ========== TOTAL ASSETS $1,686,955 $ 32,275 $ 194,016 $ (218,786) $1,694,460 ========== ========== ========== ========== ==========11
THREE MONTHS ENDED MARCH 31, 2003 ------------------------------------------------------------------------ (AMOUNTS IN THOUSANDS) COMMUNITY MORTGAGE BANKING BANKING PARENT ELIMINATIONS TOTAL ---------- ---------- ---------- ------------ ----------NET INTEREST INCOME $ 15,011 $ 124 $ 55 $ (10) $ 15,180 PROVISION FOR LOAN LOSSES 589 - - - 589 ---------- ---------- ---------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 14,422 124 55 (10) 14,591 OTHER INCOME 3,237 2,964 (4) (166) 6,031 OTHER EXPENSES 8,645 2,387 275 (176) 11,131 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES 9,014 701 (224) - 9,491 INCOME TAX EXPENSE (BENEFIT) 2,600 273 (130) - 2,743 ---------- ---------- ---------- ---------- ---------- NET INCOME (LOSS) $ 6,414 $ 428 $ (94) $ - $ 6,748 ========== ========== ========== ========== ========== AVERAGE ASSETS $1,510,362 $ 55,642 $ 154,576 $ (205,680) $1,514,900 ========== ========== ========== ========== ========== TOTAL ASSETS $1,523,133 $ 57,392 $ 155,093 $ (206,508) $1,529,110 ========== ========== ========== ========== ==========NOTE 8. RECENT ACCOUNTING DEVELOPMENTSRecent Accounting DevelopmentsOn March 9, 2004, the SEC issued SAB 105,
"Application“Application of Accounting Principles to LoanCommitments"Commitments” to inform registrants of theStaff'sStaff’s view that the fair value of the recorded loan commitments, that are required to follow derivative accounting under Statement 133,Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. Though the Companysellssold its loans through the discontinued segment on a servicing released basis, the Company adopted the provisions of SAB 105 on January 1, 2004 and this had the impact of reducing the fair value of such instruments by $252,000.In December 2003, the AICPA issued Statement of Position
("SOP"(“SOP”) 03-3"Accounting“Accounting for Certain Loans or Debt Securities Acquired in a Transfer". This statement, which is effective for loans acquired in fiscal years beginning after December 15, 2004, addresses accounting for differences between contractual cash flows and cash flows expected to be collected from aninvestor'sinvestor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. This standard will require a fair value measure of loans acquired and as such no corresponding loss13
reserve will be permitted on
allloans acquired in a transfer that are within the scope of SOP 03-3. The impact of the Standard is prospective and will require new recognition and measurement techniques upon adoption.In May 2003 the FASB issued Statement 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity", which established standards for classification and measurement of certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 subject to certain deferrals and modifications announced in February 2004. The adoption of this standard did not materially impact the financial statements of the Company. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities which provides guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company's consolidated financial statements. A company that holds variable interests in an entity is required to consolidate the entity if the company's interest in the VIE is such that the company will absorb a majority of the VIE's expected losses and/or receive a majority of the entity's expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. The provisions of this interpretation became effective upon issuance. In December 2003, the FASB reissued FIN 46. This guidance was effective for interests in certain VIE's as of December 31, 2003. The adoption of this Statement did not have a material adverse affect on the financial condition, results of operation or cash flows of the Company.In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include
thetrust preferred securities in their Tier 1 capital for regulatory capital purposes until notice12is given to the contrary. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance. ThereOn May 6, 2004, the Federal Reserve issued a proposed rule that would continue to allow trust preferred securities, such as the Trust, to constitute Tier 1 capital for bank holding companies. The proposed rules would impose stricter quantitative and qualitative limits on the Tier 1 treatment of trust preferred securities. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a holding company’s core capital elements. The proposed rule would amend the existing limit by providing that restricted core capital elements (including trust preferred securities and qualifying perpetual preferred stock) can be noassurancemore than 25% of core capital, net of goodwill. It is possible that the Federal Reserve rules will not be adopted as proposed and that the Federal Reserve willcontinue to allow institutions to includeconclude that trust preferred securitiesinshould no longer be treated as Tier 1capital forregulatorycapital purposes.capital. AtMarch 31,June 30, 2004, $15 million in trust preferred securities issued by FCBI Capital Trust were outstandingthat areand treated as Tier 1 capital for bank regulatory purposes. IfFCBI'sFCBI’s outstanding trust preferred securities atMarch 31,June 30, 2004 were not treated as Tier 1 capital at that date,FCBI'sFCBI’s Tier 1 leverage capital ratio would have declined from8.98%6.97% to8.071%6.14%, its Tier 1 risk-based capital ratio would have declined from13.41%10.20% to12.06%8.99%, and its total risk-based capital ratio would have declined from14.71%11.48% to13.35%10.26% as ofMarch 31,June 30, 2004. These reduced capital ratios would continue to meet the applicable"well capitalized"“well capitalized” Federal Reserve capital requirements.On May 6, 2004, the Federal Reserve released for comment its position stating that trust preferred securities will continue to be included in Tier 1 Capital up to 25% of capital less goodwill. NOTE 9. EARNINGS PER SHARENote 8. Earnings per Share
The following schedule details earnings and shares used in computing basic and diluted earnings per share for the six and three months ended
March 31,June 30, 2004 and 2003.
FOR THE THREE MONTHS ENDED MARCH 31, MARCH 31, 2004 2003 ----------- -----------Basic: Net income (in thousands) $ 4,161 $ 6,748 Weighted average shares outstanding 11,245,465 10,857,307 Earnings per share $ 0.37 $ 0.62 Diluted: Net income (in thousands) $ 4,161 $ 6,748 Weighted average shares outstanding 11,245,465 10,857,307 Dilutive shares for stock options 97,786 51,676 Contingently issuable shares for acquisition 4,497 4,498 Weighted average dilutive shares outstanding 11,347,748 10,913,481 Earnings per share-dilutive $ 0.37 $ 0.62NOTE 10. PROVISION AND ALLOWANCE FOR LOAN LOSSES
For the Six Months Ended For the Three Months Ended June 30, June 30, June 30, June 30, 2004 2003 2004 2003 Basic: Income (in thousands) continuing operations $ 13,188 $ 12,764 $ 7,586 $ 6,444 (Loss) income (in thousands) discontinued operations (3,313 ) 951 (1,872 ) 523
Net income (in thousands) $ 9,875 $ 13,715 $ 5,714 $ 6,967
Weighted average shares outstanding 11,237,225 10,937,927 11,228,956 10,969,748 Dilutive shares for stock options 94,330 78,959 88,918 110,602 Contingently issuable shares for acquisition 2,541 4,124 2,541 4,497 Weighted average dilutive shares outstanding 11,334,096 11,021,010 11,320,415 11,084,847 Basic: Earnings per share continuing operations $ 1.17 $ 1.17 $ 0.67 $ 0.59 (Loss) earnings per share discontinued operations (0.29 ) 0.08 (0.16 ) 0.04 Earnings per share 0.88 1.25 0.51 0.63 Diluted: Diluted earnings per share continuing operations $ 1.16 $ 1.17 $ 0.67 $ 0.59 Diluted (loss) earnings per share discontinued operations (0.29 ) 0.08 (0.17 ) 0.04 Diluted earnings per share 0.87 1.25 0.50 0.63 Note 9. Provision and Allowance for Loan Losses
The
Company'sCompany’s lending strategy stresses quality growth diversified by product, geography, and industry. All loans made by the Company are subject to common credit standards and a uniform underwriting system. Loans are also subject to an annual review process which varies based on the loan size and type. The Company utilizes this ongoing review process to evaluate loans for changes in credit risk. This process serves as the primary means by which the Company evaluates the adequacy of the loan loss allowance. The total loan loss allowance is divided into the following categories: i) specifically identified losses on loan relationships which are on non-accrual status, ninety days past due or more and loans with elements of credit weakness, and ii) formula allowances and special allocations addressing other qualitative factors including industry concentrations, economic conditions, staffing and other conditions.14
Specific allowances are established to cover loan relationships, which are identified as having significant cash flow weakness and for which a collateral deficiency may be present. The allowances established under the specific identification method are judged based upon the
borrower'sborrower’s estimated cash flow and projected liquidation value of related collateral.Formula allowances, based on historical loss experience, are available to cover homogeneous groups of loans not individually evaluated. The formula allowance is developed and evaluated against loans in general by specific category (commercial, mortgage, and consumer). The allowance is developed for each loan category based upon a review of historical loss percentages for the Company and other qualitative factors. The calculated percentage is considered in determining the estimated allowance excluding any relationships specifically identified and individually evaluated. While consideration is given to credit weaknesses for specific loans and classifications within the various categories of loans, the allowance is available for all loan losses.
In developing the allowance for loan losses, the Company also considers various inherent risk factors, such as current economic conditions, the level of delinquencies and non-accrual loans, trends in the volume and term of loans, anticipated impact from changes in lending policies and procedures, and any concentration of credits in certain industries or geographic areas. In addition, management continually evaluates the adequacy of the allowance for loan losses and makes specific adjustments to the allowance based on the results of risk analysis in the credit review process, the recommendation of regulatory agencies, and other factors, such as loan loss experience and prevailing economic conditions.
13INDEPENDENT ACCOUNTANTS' REVIEW REPORT15
Report of Independent Registered Public Accounting Firm
The Audit Committee of the Board of Directors
First Community Bancshares, Inc.We have reviewed the accompanying condensed consolidated balance sheet of First Community Bancshares, Inc. and subsidiary (the Company) as of
March 31,June 30, 2004, and the related consolidated statements of income for the three month and six month periods ended June 30, 2004 and 2003 and the consolidated statements of cash flows and changes instockholders'stockholders’ equity for thethreesix month periods endedMarch 31,June 30, 2004 and 2003. These financial statements are the responsibility of theCompany'sCompany’s management.We conducted our reviews in accordance with the standards
established byof theAmerican Institute of CertifiedPublicAccountants.Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance withauditingthe standardsgenerally accepted inof theUnited States, which will be performed for the full year withPublic Company Accounting Oversight Board, the objective ofexpressingwhich is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements referred to above for them to be in conformity with
accounting principlesU. S. generally acceptedin the United States.accounting principles.We have previously audited, in accordance with
auditingthe standardsgenerally accepted inof theUnited States,Public Company Accounting Oversight Board (United States) the consolidated balance sheet of the Company as of December 31, 2003, and the related consolidated statements of income, cash flows and changes instockholders'stockholders’ equity for the year then ended (not presented herein) and in our report dated March 9, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived./s//s/ Ernst & Young LLP
May 4,August 6, 2004
14FIRST COMMUNITY BANCSHARES, INC.16
First Community Bancshares, Inc.
PART I. ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSManagement’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis is provided to address information about the
Company'sCompany’s financial condition and results of operations. This discussion and analysis should be read in conjunction with the 2003 Annual Report to Shareholders on Form 10-K and the other financial information included in this report.The Company is a multi-state bank holding company headquartered in Bluefield, Virginia with total assets of
$1.7$1.85 billion atMarch 31,June 30, 2004.Through the Bank,FCBI provides financial,andtrust and investment advisory services to individuals and commercial customers through5152 full-service banking locations in the four states of Virginia, West Virginia,Virginia andNorth Carolinaas well asand Tennessee and two trust and investment management offices. First Community Bank is also the parent of Stone Capital Management, Inc., a SEC registered investment advisoryservices through Stone Capital, withfirm, which offers wealth management and investment advice and United First Mortgage, Inc., which operates 4 retail mortgage offices inBeckley and Bluefield, WestVirginia.At March 31, 2004,First Community Bancshares, Inc.’s common stock is traded on theCompany also engaged in mortgage brokerage and origination through a wholly-owned subsidiary ofNASDAQ National market under theBank, UFM, which has 8 offices throughout Virginia and North Carolina. However, as mentioned in this report, the Company's plans are to exit the mortgage brokerage and origination business. The Company has entered into a letter of intent with certain present executive officers of UFM and hopes to close the transaction in the second quarter of 2004, subject to execution of a definitive agreement and satisfaction of the conditions which will be set forth therein.symbol “FCBC”.FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral
"forward-looking statements"“forward-looking statements”, including statements contained in its filings with the Securities and Exchange Commission("SEC"(“SEC”) (including this Quarterly Report on Form 10-Q and the Exhibits hereto and thereto), in its reports to stockholders and in other communications which are made in good faith by the Company pursuant to the"safe harbor"“safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.These forward-looking statements include, among others, statements with respect to the
Company'sCompany’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (many of which are beyond theCompany'sCompany’s control). The words"may"“may”,"could"“could”,"should"“should”,"would"“would”,"believe"“believe”,"anticipate"“anticipate”,"estimate"“estimate”,"expect"“expect”,"intend"“intend”,"plan"“plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause theCompany'sCompany’s financial performance to differ materially from that expressed in such forward-lookingstatements;statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of competitive new products and services of the Company and the acceptance of these products and services by new and existing customers; the willingness of customers to substitutecompetitors'competitors’ products and services for theCompany'sCompany’s products and services and vice versa; the impact of changes in financialservices'services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions; the growth and profitability of theCompany'sCompany’s non-interest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
First
Community'sCommunity’s consolidated financial statements are prepared in accordance withaccounting principlesU. S. generally acceptedin the United States of Americaaccounting principles and conform to general practices within the banking industry. FirstCommunity'sCommunity’s financial position and results of operations are affected bymanagement'smanagement’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in FirstCommunity'sCommunity’s consolidated financial position and/or consolidated results of operations.Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third party sources, when available. When third party information
15is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal modeling techniques and/or appraisal estimates. 17
First
Community'sCommunity’s accounting policies are fundamental to understandingManagement'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations. The following is a summary of FirstCommunity'sCommunity’s more subjective and complex"critical“critical accounting policies."” In addition, the disclosures presented in the Notes to the Consolidated Financial Statements and inmanagement'smanagement’s discussion and analysis, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, the valuation of loans held for sale and the valuation of derivative instruments utilized in mortgage banking and hedging activity to be the accounting areas that require the most subjective or complex judgments.ALLOWANCE FOR LOAN LOSSES:Allowance for Loan Losses:The allowance for loan losses is established and maintained at levels management deems adequate to cover losses inherent in the portfolio as of the balance sheet date and is based on
management'smanagement’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. Estimates for loan losses are determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions ofFCBI'sFCBI’s regulators, changes in the size and composition of the loan portfolio and industry information. Also included inmanagement'smanagement’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain. These events may include, but are not limited to, a general slowdown in the economy, fluctuations in overall lending rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographic areas in which First Community conducts business.As more fully described in the Notes to the Consolidated Financial Statements and in the discussion included in the Allowance for Loan Losses section of
Management'sManagement’s Discussion and Analysis, the Company determines the allowance for loan losses by making specific allocations to impaired loans and loan pools that exhibit inherent weaknesses and various credit risk factors. Allocations to loan pools are developed giving weight to risk ratings, historical loss trends andmanagement'smanagement’s judgment concerning those trends and other relevant factors. These factors may include, among others, actual versus estimated losses, regional and national economic conditions, business segment and portfolio concentrations, industry competition and consolidation, and the impact of government regulations. The foregoing analysis is performed by theCompany'sCompany’s credit administration department to evaluate the portfolio and calculate an estimated valuation allowance through a quantitative and qualitative analysis that applies risk factors to those identified risk areas.This risk management evaluation is applied at both the portfolio level and the individual loan level for commercial loans and credit relationships while the level of consumer and residential mortgage loan allowance is determined primarily on a total portfolio level based on a review of historical loss percentages and other qualitative factors including concentrations, industry specific factors and economic conditions. The commercial and commercial real estate portfolios require more specific analysis of individually significant loans and the
borrower'sborrower’s underlying cash flow, business conditions, capacity for debt repayment and the valuation of secondary sources of payment (collateral). This analysis may result in specifically identified weaknesses and corresponding specific impairment allowances.The use of various estimates and judgments in the
Company'sCompany’s ongoing evaluation of the required level of allowance can significantly impact theCompany'sCompany’s results of operations and financial condition and may result in either greater provisions against earnings to increase the allowance or reduced provisions based uponmanagement'smanagement’s current view of portfolio and economic conditions and the application of revised estimates and assumptions.LOANS HELD FOR SALE, DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: UFM providesLoans Held for Sale, Derivative Instruments and Hedging Activities:UFM’s operations, currently included as discontinued operations, provided a distribution outlet for the sale of loans produced by
UFM'sUFM’s wholesale division (terminated in July 2004) and retail operations. It originates residential mortgage loans through its production offices located in Eastern Virginia and sells the majority of its loans through pooled commitments to national investors on a servicing released basis.In addition,Through June 30, 2004, UFMacquiresalso acquired loans from a network of wholesale brokers for subsequent resale to these national investors. UFM originates all loans with thepositiveintent to sell. Loans held for sale are stated at the lower of cost or market("LOCOM"(“LOCOM”). The LOCOM analysis on pools of homogeneous loans is applied on a net aggregate basis. Interest income with respect to loans held for sale is accrued on the principal amount outstanding. LOCOM valuation techniques applicable to loans held for sale are based on estimated market price indications for similar loans. Pricing estimates are established by participating mortgage purchasers and prevailing economic conditions. The majority of the loans held for sale have established market pricing indications. The loans held for sale portfolio originated by UFM atMarch 31,June 30, 2004 was$28.7$18.4 million compared to$18.2$17.7 million at December 31, 2003.Risks associated with this lending function include interest rate risk, which is mitigated through the utilization of financial instruments (commonly referred to as derivatives) to assist in offsetting the effect of changing interest rates. The Company accounts for these instruments in accordance with FASB Statement No. 133, as amended
"Accounting“Accounting for Derivative Instruments and Hedging Activity."” This Statement established accounting and reporting standards for derivative instruments16and for hedging activities. UFM uses forward mortgage contracts and options (short position sales and options) to manage interest rate risk in the pipeline of loans and interest rate lock commitments ("RLCs"(“RLCs”) from the point of the loan commitment18
to the subsequent allocation and delivery to outside investors. As a result of the timing from origination to sale, and the likelihood of changing interest rates, forward commitments and options are placed with counter-parties to attempt to counter the effect of changing interest rates. The options and forward commitments to sell securities are considered to be derivatives and, as such, are recorded on the consolidated balance sheets at fair value. The changes in the fair value of derivatives are reflected in the consolidated statements of income as gain or loss.
The fair value of the RLCs is based on prevailing interest rates, and the assumed probability of closing (pull-through). The assumption of a given pull-through percentage
alsoenters into the determination of the volume of derivative contracts. Pull-through assumptions are continually monitored for changes in the interest rate environment and characteristics of the pool of RLCs. Differences between pull-through assumptions and actual pull-through could result in a mismatch in the volume of security contracts corresponding to RLCs and lead to volatility in profit margins on the loan products ultimately delivered. As more fully described in Note8,7, to the Notes to Consolidated Financial Statements under Recent Accounting Developments, effective January 1, 2004, the Company adopted the valuation techniques used to measure loan commitments inarecent guidance issued by the SEC in Staff Accounting Bulletin("SAB"(“SAB”) 105. SAB 105 indicates that the value of internally generated loans has little or no value at inception separate from the servicing intangible that is created upon subsequent sale of the loan. Management applied SAB 105 in the first quarter of 2004 through the elimination of the servicing component of the sales price for the RLC valuation, which had a negative impact of $252,000 on the market value of the commitments outstanding.The valuation of RLCs is considered critical because of the impact of borrower behavior and the impact that this behavior pattern will have on the pull-through ratio during times of significant rate volatility. Customer behavior is modeled by a mathematical tool based upon historical pull-through experience; however, substantial volatility can be experienced, as has been the case over the last year, as a result of the general movement in mortgage rates. As a result, pull-through has varied significantly over this time period. While customer behavior is difficult to model, the mathematical tool utilized by UFM incorporates volatility derived from market data in an attempt to anticipate borrower reaction to market rate movements and the corresponding desired security coverage.
At
March 31,June 30, 2004, UFM held an investment in forward mortgage contracts with a notional value of$80.0$27.0 million and mortgage-backed security put options totaling $3.0 million. These instruments are collectively referred to as hedging instruments or securities. These contracts hedge interest rate risk associated with RLCs and closed loans not allocated to a forward commitment of$89.1$35.5 million. AtMarch 31,June 30, 2004, the fair value of the securities was a liability of$194,000,$267,000, which represents a$22,000$51,000 decrease in the fair value of the liability since December 31, 2003. The fair value of the RLCs atMarch 31,June 30, 2004 declined $288,000 from the fair value at December 31,2003.2003 including $252,000 related to the adoption of SAB 105.For the
threesix months endedMarch 31,June 30, 2004, the Companyincurred $695,000recognized $833,000 inthe cost ofgains on forward mortgage derivative contracts to originate and sell$111.4$282.4 million in loans, compared to the firstthreesix months of the prior year in which$223.2$472.3 million in loans were originated for sale with underlying forward mortgage contracts that cost$2.5$3.3 million. The lower cost of forward mortgage contracts between the two periods is reflective of the volatility of the pricing of these types of contracts during times of significant interest rate volatility. Although the pricing of the contracts was favorable to the Company in the current period,UFM'sUFM’s pricing and margin on loans sold were substantially less favorable as a result of the market pricing dynamics and significant competitive forces. The significant decrease in hedging cost as well as the market price of loans sold, demonstrate the potential volatility to earnings and the sensitivity to pull-through assumptions. The cost of these derivative contracts is included as a component ofmortgage bankingthe (loss) income from discontinued operations in the consolidated statements ofincome, which represents the net revenues associated with the origination, holding and sale of mortgage loans.income.RECENT ACQUISITIONS AND BRANCHING ACTIVITY
The Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company
("(“PCBBancorp"Bancorp”) after the close of business on March 31, 2004. PCB Bancorp has six full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. PCB Bancorp had total assets of $171 million, loans of $128 million and total deposits of $150 million as of the date of the merger. The assets, liabilities and results of operationswill behave been included in theCompany'sCompany’s financial statements beginning with the second quarter 2004.Under the terms of the
mergeracquisition agreement, shares of PCB Bancorp common stock were purchased for $40.00 per share in cash. The total deal value, including the cash-out of outstanding stock options, was approximately $36.0 million. Concurrent with the PCB Bancorpmerger,acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB Bancorp, was merged into First Community Bank,N.A,N.A., a wholly-owned subsidiary of the Company.17In June 2003, the Company acquired CommonWealth, a Virginia-chartered commercial bank for total consideration of approximately $23.2 million. The merger was accomplished through the exchange of .9015 shares of the
Company'sCompany’s common stock valued at $30.50, cash, or a combination of theCompany'sCompany’s stock and cash equivalent to $30.50 for each share of19
CommonWealth common stock. At acquisition, CommonWealth had total assets of $136.5 million, net loans of $120.0 million and total deposits of $105.0 million.
In February 2004, as part of the Company’s planned expansion into the Central Piedmont area of North Carolina, the Company opened two loan production offices in Charlotte and Mount Airy, North Carolina. The Charlotte office has since been converted to a full-service branch. Also, in the second quarter of 2004, two new loan production offices were opened, or were in the process of being opened in Norfolk and Blacksburg, Virginia.
In the second and third quarters of 2003, the Company opened three de novo branches in Winston-Salem, North Carolina. The Company does not anticipate that these branches will be profitable until market development has proven successful and adequate loan balances and corresponding loan revenue are established to support the added facilities, infrastructure and other operating costs of these branches.
As part of the Company's planned expansion into the Central Piedmont area of North Carolina, the Company also opened two loan production offices in Charlotte and Mount Airy, North Carolina in February 2004.In January 2003, the Bank completed the acquisition of Stone Capital, based in Beckley, West Virginia. This acquisition expanded the
Bank'sBank’s operations to include a broader range of financial services, including wealth management, asset allocation, financial planning and investment advice. Stone Capital atMarch 31,June 30, 2004 had total assets of$61$67.4 million under management and continues to operate under its name. Stone Capital was acquired through the issuance of 8,409 shares of Company common stock, which represents 50% of the total consideration. In 2003, Stone Capital exceeded the annual revenue requirement outlined in the acquisition agreement and another 2,541 shares were paid to the original shareholders subsequent to December 31, 2003. The balance of the remaining consideration ($175,000) is payable over the next two years in the form of Company common stock, subject to the achievement of minimum revenue requirements set forth in the acquisition agreement.RESULTS OF OPERATIONS
GENERALGeneral
Net income for the
first quarter ofsix months ended June 30, 2004totaled $4.2was $9.9 millionasor $0.87 per diluted share compared with$6.7$13.7 millionin the first quarter of 2003. Basic andor $1.25 per dilutedearnings pershare for thefirst quarter were $0.37, downsix months ended June 30, 2003. Income from$0.62continuing operations for the six months ended June 30, 2004 was $13.2 million, versus $12.8 million for the six months ended June 30, 2003. Contributing to this increase in income from continuing operations was a $3.0 million or 9.9% increase in net interest income and a $2.3 million or 34.6% increase in non-interest income. Return on average equity from continuing operations for the firstquartersix months of2003. When comparing2004 was 14.98% compared to 16.25% for the firstquartersix months of last year. Return on average assets from continuing operations was 1.52% compared to 1.73% for the first six months of 2003.On July 8, 2004
earnings with thatFirst Community announced the termination of2003,a previously announced sale of its mortgage subsidiary. While thereduction in the Company's earnings was largely attributable to a $1.9 million decline in net income from the mortgage-banking segment. Reduced loan production and margins in the segment, combined with an impairment charge of $651,000, produced the decline inmortgage bankingnet income. The community-banking segment reported segment net incomesubsidiary continues to be held for sale, termination of$5.7 million, which represents a decrease fromthecommunity banking segment net income of $6.4 million in the first quarter of 2003. The decrease is attributed, in part, to increased overhead and operating expense relativepreviously announced sale led to thedevelopment and growthelimination of theCompany into new markets. Thewholesale portion of the mortgagebanking segment losses ledcompany’s business and substantial downsizing of theBoard to pursue alternative strategies includingremaining retail division. In connection with the exit oftheits wholesale mortgage bankingbusiness. Inbusiness and as previously reported, thefirst quarter, the Company entered into negotiations with certain present executive officerscompany recorded impairment charges ofUFM which led to a letter of intent for the sale of the mortgage subsidiary being signed April 16, 2004. As a result, in the first quarter 2004, the aforementioned $651,000 impairment loss related to the planned disposal of that subsidiary was recorded. Plans are to close this transaction$933,000 in the second quarter of 2004subject(and $1,385,000 for the first six months of 2004) toexecution of a definitive agreement andreduce thesatisfactioncarrying value of theconditions set forth therein. NET INTEREST INCOME (SEE TABLEsubsidiary to its estimated fair value less costs to sell. To facilitate its decision to exit the wholesale mortgage banking business, First Community has provided management and professional resources to settle the mortgage company’s wholesale interest rate lock commitments; has overseen a transition in management at the mortgage company; and has taken steps to reduce overhead for the Company’s remaining mortgage business, which will be offered through its retail network. The strategic decision to exit the wholesale mortgage business will reduce the Company’s exposure to risk associated with the large fluctuations previously experienced in the volume-driven, wholesale business and its hedged interest rate lock commitments and closed loans. The change in strategic direction and decision to exit the wholesale mortgage business will permit the Company to focus its resources on its core community banking business, which has continued to grow and perform. The results of operations of the mortgage company are reported as discontinued operations. The loss from discontinued operations was $1.9 million or $0.17 per diluted share for the second quarter of 2004 and $3.3 million or $0.29 per diluted share for the six months ended June 30, 2004.Net Interest Income–Year-to-date Comparison (See Table I)
Net interest income, the largest contributor to earnings, was
$16.0$33.6 million for thethreesix months endedMarch 31,June 30, 2004 compared to$15.2$30.6 million for the corresponding period in 2003. For purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable. As indicated in Table I, tax equivalent net interest income totaled$16.9$35.8 million for thethreesix months endedMarch 31,June 30, 2004, an increase of$0.8$3.4 million from the$16.1$32.4 million reported in the firstthreesix months of 2003. This$0.8$3.4 million increase was based ona $6.6an $8.4 million increase in volume as earning assets were added to the portfolioat declining replacement rates,which was partially offset by a$5.8$5.0 million reduction due to rate changes on the underlying assets as asset yields fell in the declining rate environment. Management was able to help counter the effect of the declining asset yield through aggressive management of deposit rates. Average earning assets increased$134.4$220.3 million while interest-bearing liabilities20
increased
$109.6$201.2 million. As indicated in Table I, the yield on average earning assets decreased6861 basis points from6.76%6.69% for thethreesix months endedMarch 31,June 30, 2003 to 6.08% for thethreesix months endedMarch 31,June 30, 2004. However, this decrease was largely offset by a5247 basis point decline in the cost of funds during the same period leaving the net interest rate spread (the difference between interest income on earning assets and expense on interest bearing liabilities) lower at4.10%4.20% compared to4.24%4.34% for the same period last year. TheCompany'sCompany’s tax equivalent net interest margin of4.41%4.48% for thethreesix months endedMarch 31,June 30, 2004 decreased2325 basis points from4.64%4.73% in 2003.18The largest contributor to the decrease in the yield on average earning assets in 2004, on a volume-weighted basis, was the decrease in the overall tax equivalent yield on loans held for investment of
7877 basis points from the prior year to6.79%6.68%, as loans repriced downward in response to the declining rate environment while the average balance increased$109.5$172.3 million. The decline in asset yield is attributable to the current interest rate environment which creates refinancing or repricing incentives for fixed rate borrowers to lower their current borrowing costs. In addition, due to the volume of loans directly tied to prime and other indices that are either adjustable incrementally or are variable rate advances, asset yields have declined in response to rate cuts and drops in the prime loan rate which began in2001 and remain at a level not seen since 1959. The balance of average loans held for sale decreased by $34.5 million while the yield increased 25 basis points to 5.40%. The yield on loans held for sale is much more sensitive to interest rate change since these loans are only held for 30 to 60 days and are replenished with new loan volume at the then prevailing rates. The change in rate on this pool of loans is reflective of the volatility experienced in mortgage rates and the underlying mortgage-backed securities into which they are delivered.2001.During the
threesix months endedMarch 31,June 30, 2004, the taxable equivalent yield on securities available for sale decreased6450 basis points to4.79%4.65% while the average balance increased by$60.3$57.8 million. Consistent with the current rate environment, the Company and the securities industry as a whole have experienced rapid turnover in securities as higher yielding securities are either called or prepaid as the refinancing opportunity presents itself. Although the total portfolio grew by$60.3$57.8 million fromMarch 31,June 30, 2003, the relative rate on securities acquired since that time has declined substantially. The increasing average security balance is the result of continued reinvestment of available funds largelycreated by higher average deposit levels.through bank acquisitions. Thefirst quarterJune 30, 2004 average balance of investment securities held to maturity decreased by$3.0$2.9 million to$37.6$37.3 million while the yield decreased40only 10 basis points to7.65%7.99% compared to thefirst quarter 2003.June 30, 2003 year-to-date average yield of 8.09%.Compared to the
first three months ofJune 30, 2003 average interest-bearing balances with banks of$63.2$41.2 million,increased $4.6these funds decreased $4.2 million while the yield decreased189 basis points to1.27%1.47%.This average balance increase was largely the result of funds received from new deposit growth in existing markets and deposits obtained in the acquisition of CommonWealth in the second quarter of 2003 as well as the continued cash flow roll-off experience in the loan and investment portfolio.The Company actively manages its product pricing by staying abreast of the current economic climate and competitive forces in order to enhance repricing opportunities available with respect to the liability side of its balance sheet. In doing so, the cost of interest-bearing liabilities decreased by
5247 basis points from2.51%2.35% for thethreesix months endedMarch 31,June 30, 2003 to1.99%1.88% for the same period of 2004 while the average volume increased$109.6$201.2 million. Active deposit liability pricing management is performed weekly.When comparing the
threesix months endedMarch 31,June 30, 2004 to the corresponding period of the prior year, the 2004 average balance of FHLB and other short-term convertible and callable borrowings increased by$45.8$71.2 million in 2004 to$145.8$126.2 million while the rate decreased151228 basis points to4.39%4.47%, the result ofadditional FHLB borrowings (at lower rates) inthe additiontoof balances acquired with the CommonWealthBankand PCB acquisitions and the addition of new advances at lower rates which partially funded the PCB acquisition. The average balance of all other borrowings increased $7 million for the firstthreesix months of 2004vs.versus 2003 as a result of the issuance of $15 million in trust preferred securitiesandlate in therepaymentthird quarter ofan $8 million FHLB advance2003 while the rate paid decreased106105 basis points.Average fed funds and repurchase agreements increased
$3.1$9.1 million atMarch 31,June 30, 2004, while the average rate decreased6765 basis points compared to the same period in 2003. In addition, the average balances of interest-bearing demand and savings deposits increased$34.6$71.2 million and$11.5$26.4 million, respectively, for thefirst quartersix months ended June 30, 2004 while the corresponding average rate paid on these deposit categories declined1821 and2113 basis points, respectively. Average time deposits increased$7.7$16.4 million while the average rate paid decreased6559 basis points from3.14%3.05% in 2003 to2.49%2.46% in 2004. The level of average non-interest-bearing demand deposits increased$28.6$40.0 million to$186.1$204.3 million atMarch 31,June 30, 2004 compared to the corresponding period of the prior year. Average interest bearing deposits and non-interest bearing demand deposits for theformeracquired CommonWealth Bank branches totaled$60$64.9 million and$23.3$25.6 million at June 30, 2004 and $8.8 million and $4.9 million at June 30, 2003. Included in the June 30, 2004 average balances related to the PCB acquisition for interest-bearing and non-interest bearing deposits were $67.7 million and $9.0 million at June 30, 2004, respectively.Net Interest Income –Quarterly Comparison (See Table II)
Net interest income for the quarter ended June 30, 2004 was $17.6 million compared to $15.5 million for the same period in 2003, an increase of $2.1 million. Likewise, tax equivalent net interest income increased $2.5 million from $16.4 million for the quarter ended June 30, 2003, to $18.9 million for the quarter ended June 30, 2004 (refer to Table II). A 46 basis point decrease in the rate paid on interest-bearing liabilities partially offset a 53 basis point decline in the average rate earned on interest-earning assets, resulting in a decrease in the net interest margin of 18 basis points to 4.51% for the quarter ended June 30, 2004. While the net interest margin decreased, average earning assets increased $277.6 million in the second quarter of 2004 compared to the second quarter of 2003 resulting in the improvements in net interest income. The largest increases in average earning assets included increases in average loans held for investment of $240.9 million and securities available for sale of $55.5 million. In the second quarter of 2004, average interest-bearing deposits with banks decreased $13.2 million and Fed Funds Sold decreased $427,000. The $2.4 million increase in net
21
interest income was achieved through the combined effect of changes in volume and corresponding rates on the underlying assets and liabilities. Earnings attributable to the net volume increase in earning assets over paying liabilities was approximately $9.4 million while the effect of declining rates represented an offsetting net reduction of approximately $6.9 million for a combined effect on net interest income of $2.4 million. The volume driven increase in net interest income is largely attributable to the PCB acquisition which contributed $1.3 million in net interest income in the second quarter of 2004 following the March 31,
2004. 192004 consummation. As previously mentioned, the impact of the declining interest rate environment continued to reduce asset yields as assets repriced into lower interest rate products and as securities were replaced with lower yielding instruments reflecting the lower rate environment. This refinancing/repricing scenario is reflected in all categories of interest earning assets. Management continues to focus on margin enhancement by funding the balance sheet growth with lower priced deposits and borrowings without significantly extending balance sheet duration (the weighted average maturity) in anticipation of future rate increases.
Similar to the decline in asset yields created by the current interest rate cycle, deposit and borrowing costs also have been adjusted when possible to obtain this benefit on the liability side of the balance sheet. As previously mentioned, management continues to strive for lower cost funding in light of falling asset yields. Management monitors the overall performance of assets and interest-bearing liabilities through the Company’s product management group. Total interest-bearing liabilities increased $256.4 million with average interest-bearing deposits increasing $174.2 million. The average rate on paying liabilities and deposits dropped 46 and 51 basis points, respectively. For the same periods, average Fed Funds purchased and repurchase agreements increased $11.7 million while the average rate decreased 56 basis points. Average short-term borrowings increased $63.6 million while the rate decreased 163 basis points and long-term borrowings increased $7.0 million while the rate decreased 107 basis points.
22
TABLEAVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS (DOLLARS IN THOUSANDS) THREE MONTHS ENDED THREE MONTHS ENDED MARCH 31, 2004 MARCH 31, 2003 AVERAGE INTEREST YIELD/RATE AVERAGE INTEREST YIELD/RATE BALANCE(Dollars in Thousands)
Six Months Ended Six Months Ended June 30, 2004 June 30, 2003 Average Interest Yield/Rate Average Interest Yield/Rate Balance (1) (1) Balance (1) (1) Earning Assets: Loans (2): Held for Investment: Taxable $ 1,087,558 $ 36,148 6.69 % $ 914,231 $ 33,731 7.45 % Tax-Exempt 4,757 145 6.13 % 5,759 219 7.67 %
Total 1,092,315 36,293 6.68 % 919,990 33,950 7.45 % Allowance for Loan Losses (15,553 ) (14,163 )
Net Total 1,076,762 36,293 905,827 33,950 Securities Available for Sale: Taxable 342,468 6,687 3.93 % 296,094 6,501 4.43 % Tax-Exempt 105,917 3,674 6.98 % 94,480 3,482 7.43 %
Total 448,385 10,361 4.65 % 390,574 9,983 5.15 % Securities Held to Maturity: Taxable 426 12 5.66 % 626 18 5.80 % Tax-Exempt 36,838 1,469 8.02 % 39,567 1,594 8.12 %
Total 37,264 1,481 7.99 % 40,193 1,612 8.09 % Interest-Bearing Deposits 41,154 300 1.47 % 45,377 350 1.56 % Fed Funds Sold 120 1 0.90 % 1,376 8 1.17 %
Total Earning Assets 1,603,685 48,436 6.08 % 1,383,347 45,903 6.69 % Other Assets 146,394 103,938 Assets Related to Discontinued Operations 25,356 54,844
Total $ 1,775,435 $ 1,542,129
Interest-Bearing Liabilities: Demand Deposits $ 281,232 $ 683 0.49 % $ 210,077 $ 732 0.70 % Savings Deposits 208,893 569 0.55 % 182,515 611 0.68 % Time Deposits 619,519 7,576 2.46 % 603,163 9,116 3.05 %
Total Deposits 1,109,644 8,828 1.60 % 995,755 10,459 2.12 % Fed Funds Purchased & Repurchase Agreements 104,087 625 1.21 % 94,964 876 1.86 % FHLB Convertible and Callable Advances 126,172 2,804 4.47 % 54,996 1,842 6.75 % Other Borrowings 17,010 417 4.93 % 10,015 297 5.98 %
Total Interest-Bearing Liabilities 1,356,913 12,674 1.88 % 1,155,730 13,474 2.35 % Demand Deposits 204,264 164,243 Other Liabilities 15,053 15,370 Liabilities Related to Discontinued Operations 22,173 48,399 Stockholders’ Equity 177,032 158,387
Total $ 1,775,435 $ 1,542,129
Net Interest Income, Tax Equivalent $ 35,762 $ 32,429
Net Interest Rate Spread (3) 4.20 % 4.34 %
Net Interest Margin (4) 4.48 % 4.73 %
(1) (1) BALANCE (1) (1) ----------------------- ------------------------------------ -----------Earning Assets: Loans (2): Held for Sale $ 15,110 $ 203 5.40% $ 49,560 $ 629 5.15% Held for Investment:Fully Taxable 1,011,752 17,084 6.79% 900,732 16,814 7.57% Tax-Exempt 4,557 70 6.18% 6,124 120 7.95% ----------------------- ------------------------------------ ----------- Total 1,016,309 17,154 6.79% 906,856 16,934 7.57% Allowance for Loan Losses (14,728) (14,331) ----------------------- ------------------------ Net Total 1,001,581 17,154 892,525 16,934 Securities Available for Sale: Taxable 323,887 3,265 4.05% 271,864 3,135 4.68% Tax-Exempt 101,718 1,806 7.14% 93,464 1,753 7.61% ----------------------- ------------------------------------ ----------- Total 425,605 5,071 4.79% 365,328 4,888 5.43% Securities Held to Maturity: Taxable 495 5 4.06% 657 10 6.17% Tax-Exempt 37,146 711 7.69% 39,959 797 8.09% ----------------------- ------------------------------------ ----------- Total 37,641 716 7.65% 40,616 807 8.05% Interest Bearing Deposits 63,220 199 1.27% 58,627 209 1.45% Fed Funds Sold - - 0.00% 2,093 6 1.16% ----------------------- ------------------------------------ ----------- Total Earning Assets 1,543,157 23,343 6.08% 1,408,749 23,473 6.76% Other Assets 130,428 106,151 ------------- -------------- Total $ 1,673,585 $1,514,900 ============= ============== Interest-Bearing Liabilities: Demand Deposits $ 238,163 $ 326 0.55% $ 203,547 $ 365 0.73% Savings Deposits 192,636 239 0.50% 181,175 317 0.71% Time Deposits 606,177 3,750 2.49% 598,520 4,634 3.14% ----------------------- ------------------------------------ ----------- Total Deposits 1,036,976 4,315 1.67% 983,242 5,316 2.19% Fed Funds Purchased & Repurchase Agreements 97,316 292 1.21% 94,251 438 1.88% FHLB ConvertibleEquivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no related interest income during the period of non-accrual.
(3) Represents the difference between the yield on earning assets and Callable Advances 145,787 1,591 4.39% 100,000 1,456 5.90% Other Borrowings 17,033 208 4.91% 10,048 148 5.97% ----------------------- ------------------------------------ ----------- Total Interest-bearing liabilities 1,297,112 6,406 1.99% 1,187,541 7,358 2.51% Demand Deposits 186,056 157,504 Other Liabilities 12,380 14,633 Stockholders' Equity 178,037 155,222 ------------- -------------- Total $ 1,673,585 $1,514,900 ============= ============== Net Interest Income,cost of funds.
(4) Represents tax equivalent $16,937 $16,115 ========== ========== Net Interest Rate Spreadnet interest income divided by average interest earning assets.23
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(Dollars in Thousands)
Three Months Ended Three Months Ended June 30, 2004 June 30, 2003 Average Interest Yield/Rate Average Interest Yield/Rate Balance (1) (1) Balance (1) (1) Earning Assets: Loans (2): Held for Investment: Taxable $ 1,166,605 $ 19,064 6.57 % $ 926,881 $ 16,917 7.33 % Tax-Exempt 4,957 75 6.09 % 5,399 99 7.35 %
Total 1,171,562 19,139 6.57 % 932,280 17,016 7.33 % Allowance for Loan Losses (16,377 ) (13,998 )
Net Total 1,155,185 19,139 918,282 17,016 Securities Available for Sale: Taxable 361,184 3,426 3.82 % 320,356 3,379 4.23 % Tax-Exempt 110,116 1,868 6.82 % 95,485 1,729 7.26 %
Total 471,300 5,294 4.52 % 415,841 5,108 4.93 % Securities Held to Maturity: Taxable 423 7 6.66 % 595 6 4.04 % Tax-Exempt 36,606 758 8.33 % 39,180 797 8.16 %
Total 37,029 765 8.31 % 39,775 803 8.10 % Interest-Bearing Deposits 19,088 102 2.19 % 32,272 141 1.75 % Fed Funds Sold 239 2 0.90 % 666 2 1.20 %
Total Earning Assets 1,682,841 25,302 6.05 % 1,406,836 23,070 6.58 % Other Assets 163,931 108,462 Assets Related to Discontinued Operations 31,228 54,004
Total $ 1,878,000 $ 1,569,302
Interest-Bearing Liabilities: Demand Deposits $ 324,301 $ 357 0.44 % $ 216,535 $ 367 0.68 % Savings Deposits 225,149 330 0.59 % 183,840 294 0.64 % Time Deposits 632,861 3,826 2.43 % 607,755 4,483 2.96 %
Total Deposits 1,182,311 4,513 1.54 % 1,008,130 5,144 2.05 % Fed Funds Purchased & Repurchase Agreements 110,834 333 1.21 % 99,182 438 1.77 % FHLB Convertible and Callable Advances 122,474 1,374 4.51 % 58,890 901 6.14 % Other Borrowings 17,009 209 4.94 % 10,015 150 6.01 %
Total Interest-Bearing Liabilities 1,432,628 6,429 1.80 % 1,176,217 6,633 2.26 % Demand Deposits 222,759 167,396 Other Liabilities 17,786 16,472 Liabilities Related to Discontinued Operations 28,793 47,595 Stockholders’ Equity 176,034 161,622
Total $ 1,878,000 $ 1,569,302
Net Interest Income, Tax Equivalent $ 18,873 $ 16,437
Net Interest Rate Spread (3) 4.24 % 4.32 %
Net Interest Margin (4) 4.51 % 4.69 %
(1) Fully Taxable Equivalent at the rate of 35%.
(2) Non-accrual loans are included in average balances outstanding but with no related interest income during the period of non-accrual.
(3) 4.10% 4.24% ============ =========== Net Interest Margin (4) 4.41% 4.64% ============ ===========(1) Fully Taxable Equivalent at the rate of 35%. (2) Non-accrual loans are included in average balances outstanding but with no related interest income during the period of non-accrual. (3)Represents the difference between the yield on earning assets and cost of funds.
(4) Represents tax equivalent net interest income divided by average interest earning assets. 24
Provision and
cost of funds. (4) Represents tax equivalent net interest income divided by average interest earning assets. 20PROVISION AND ALLOWANCE FOR LOAN LOSSESAllowance for Loan LossesThe allowance for loan losses is maintained at a level sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provisions for loan losses and recoveries of prior loan charge-offs, and decreased by loans charged off. The provision for loan losses is calculated to bring the allowance to a level, which, according to a systematic process of measurement, reflects the amount needed to absorb probable losses within the portfolio.
Management performs monthly assessments to determine the appropriate level of allowance. Differences between actual loan loss experience and estimates are reflected through adjustments that are made by either increasing or decreasing the loss provision based upon current measurement criteria. Commercial, consumer and mortgage loan portfolios are evaluated separately for purposes of determining the allowance. The specific components of the allowance include allocations to individual commercial credits and allocations to the remaining non-homogeneous and homogeneous pools of loans.
Management'sManagement’s allocations are based on judgment of qualitative and quantitative factors about both macro and micro economic conditions reflected within the portfolio of loans and the economy as a whole. Factors considered in this evaluation include, but are not necessarily limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and non-accruals. While management has attributed the allowance for loan losses to various portfolio segments, the allowance is available for the entire portfolio.The allowance for loan losses was
$14.5$16.2 million onMarch 31,June 30, 2004, compared to $14.6 million at December 31, 2003 and$13.8$15.7 million onMarch 31,June 30, 2003. The allowance for loan losses represents405%614% of non-performing loans atMarch 31,June 30, 2004, versus488.6%489% and343%597% at December 31, 2003 andMarch 31,June 30, 2003, respectively. When other real estate is combined with non-performing loans, the allowance equals236%337% of non-performing assets atMarch 31, 2003June 30, 2004 versus 288% and210%290% at December 31, 2003 andMarch 31,June 30, 2003, respectively. The increase in the allowance sinceMarchJune 2003 and December 2003 is primarily attributable to the acquisition ofCommonWealth BankPCB and the application of various changes in risk factors specific to this portfolio. The allowance attributable to theCommonWealth BankPCB portfolio at the date of acquisition was$1.6$1.8 million.FCBI'sFCBI’s allowance for loan loss activity for the six and three month periods ended
March 31,June 30, 2004 and 2003 are as follows:
FOR THE THREE MONTHS ENDED MARCH 31, 2004 2003 -------- -------- (DOLLARS IN THOUSANDS)Beginning balance $ 14,624 $ 14,410 Provision 532 589 Charge-offs (911) (1,668) Recoveries 291 451 -------- -------- Ending Balance $ 14,536 $ 13,782 ======== ========
For the Six Months Ended For the Three Months Ended June 30, June 30, 2004 2003 2004 2003 (Dollars in Thousands) (Dollars in Thousands) Beginning balance $ 14,624 $ 14,410 $ 14,536 $ 13,782 Provision 1,255 1,897 723 1,308 Balance acquired in acquisitions 1,786 1,583 1,786 1,583 Charge-offs (2,144 ) (3,109 ) (1,233 ) (1,441 ) Recoveries 639 926 348 475
Ending Balance $ 16,160 $ 15,707 $ 16,160 $ 15,707
Based on the allowance for loan losses of approximately
$14.5$16.2 million, $14.6 million and$13.8$15.7 million atMarch 31,June 30, 2004, December 31, 2003, andMarch 31,June 30, 2003, respectively, the allowance to loans held for investment ratio was1.431.36% atboth March 31,June 30, 2004,and1.43% at December 31, 2003vs. 1.54and 1.53% forMarch 31,June 30, 2003. Management considers the allowance adequate based upon its analysis of the portfolio as ofMarch 31,June 30, 2004.The provision for loan losses for the
threesix month period endedMarch 31,June 30, 2004 decreasedslightlyto$532,000$1.3 million when compared to thethreesix month period endingMarch 31,June 30, 2003 at$589,000.$1.9 million. The decrease is largely attributable to improving asset quality and loan loss history, changes in risk factors assigned and a decline in volume within certain portfolio segments. Net charge-offs for the firstthreesix months of 2004andwere $1.5 million, down 31.8% from $2.2 million for the corresponding periodof 2003 were $620,000 and $1.2 million, respectively.in 2003. Expressed as a percentage of average loans held for investment, net charge-offs decreased from0.13%0.24% for thethree month period ofsix months ended June 30, 2003 to0.06%0.14% for the same period of 2004. The decrease in net charge-offs is primarily attributable to an approximate $1 million charge-off that occurred during the first quarter 2003.NON-INTEREST INCOMENet charge-offs for the quarters ended June 30, 2004 and June 30, 2003 were $885,000 and $966,000, or 0.08% and 0.10%, respectively, of average loans held for investment.Non-interest Income
Non-interest income consists of all revenues which are not included in interest and fee income related to earning assets. Total non-interest income
decreasedincreased approximately $2.3 million, or 37.8%, from$6.0$6.5 million for thethreesix months endedMarch 31,June 30, 2003 to$3.8$8.8 million for the corresponding period in 2004.WhileThe largest contributor to the increase was the result of security gains of25
$1.4 million realized upon the decision to capture appreciation inherent in a $25.0 million portion of the corporate bond sector of the Company’s available-for-sale investment portfolio, the market value of which continued to decline in step with the flattening of the Treasury yield curve. The proceeds from the sale of these securities provided sufficient liquidity to pay-off overnight borrowings and assisted the Company in funding increased loan demand. Along with an increase in deposits stemming from bank acquisitions, service charges on deposit accounts increased $454,000 or 11.9% while other service charges, commissions and fees reflected gains of $203,000 or 19% and all other operating income increased $364,000.
Total non-interest income of $5.6 million for the second quarter of 2004 increased $2.1 million compared to the second quarter of 2003. $1.4 million of this increase was the aforementioned security gains realized in June 2004. Service charges on deposit accounts and other service
21charges, commissions and fees reflected gains of 7.6% and 9%, respectively, theincreased $556,000 in aggregate while all other non-interest incomecategory decreased because ofincreased $366,000.As mentioned previously, UFM’s operating income was previously reported as non-interest income from the
decrease of $2.5 million inCompany’s mortgage bankingincome. Non-interest incomesegment but is now reported as discontinued operations in themortgage banking subsidiary, UFM, declined from $3.0 million in 2003 to $507,000 in 2004. The end of unprecedented refinance activity in the latter half of 2003, coupled with rate volatility and changes in price expectations by national investors who buy these loans and brokers who provide wholesale production, as well as the impact of SAB 105, caused a decline in the fair value of the mortgage pipeline, related securities and mortgage earnings. The following table details the components of UFM's mortgage banking income included in non-interest income for the periods ended March 31. MORTGAGE BANKING INCOME Loan Sales and Settlement Component:
MARCH 31, 2004 2003 --------- -------- (AMOUNTS IN THOUSANDS)Other Service Charges, Commissions & Fees $ 131 $ 360 Gain on Sale of Loans 952 4,752 Fee Income 334 620 Loss on Derivatives Settled (637) (2,520) Option Expense (58) - ------- ------- 722 3,212 Mark-to-Market Component: Mark to Market Losses on Loan Commitments(1) (238) (578) Mark to Market on Securities 23 330 ------- ------- (215) (248) ------- ------- TOTAL MORTGAGE BANKING INCOME $ 507 $ 2,964 ======= =======
MARCH 31, 2004 2003 --------- -------- (AMOUNTS IN THOUSANDS)Interest Rate Lock Commitments: Notional Value $82,609 $85,536 Fair Value(1) 60 1,805 Securities: Notional Value 83,000 80,000 Fair Value (194) (375)(1) Reflects the adoption of SAB 105, effective January 1, 2004. At March 31, 2004, UFM held an investment in forward mortgage contracts with a notional value of $80 million and mortgage-backed security put options totaling $3 million. These contracts are used in an attempt to hedge interest rate risk associated with RLCs and closed loans not allocated to a forward commitment of $89.1 million. At March 31, 2004, the fair value of the securities was a liability of $194,000, which represents a $22,000 reduction in the fair value of the liability since December 31, 2003. In addition, the fair value of the RLCs at March 31, 2004 was recorded in accordance with recent guidance issued by the SEC under SAB 105 was recorded as $60,000. The market valuation of RLCs at March 31, 2004 assumes a 63.81% RLC pull-through. If actual pull-through in succeeding months proves to be more or less than 63.81%, the full market value of RLCs may or may not be realized and/or the valuation of RLCs may change. For the period ended March 31, 2004, the Company incurred $695,000 in the cost of forward mortgage derivative contracts and options to originate and sell $111.4 million in loans compared to the prior year in which $223.2 million in loans were originated for sale with underlying forward mortgage contracts that cost $2.5 million. The cost of forward mortgage contracts between the two periods is reflective of the volatility of the pricing of these types of contracts during times of significant interest rate volatility. Although the pricing of the contracts was favorable to the Company in the current year, UFM's pricing and margin on loans sold were substantially less favorable as a result of the market pricing dynamics and significant competitive forces. The significant decrease in hedging cost, as well as the market price of loans sold, demonstrates the potential volatility to earnings and the sensitivity to pull-through assumptions. The cost of these derivative contracts is included as a component of mortgage banking income in the consolidated statements of income, which represents the net revenues associated with the origination, holding and sale of mortgage loans. 22NON-INTEREST EXPENSECompany’s Consolidated Financial Statements.Non-interest Expense
Non-interest expense totaled
$13.4$23.1 million for the six months ended June 30, 2004, increasing$2.2$5.6 million, or20%32.2% over thefirst quartersame period of 2003. This increase is primarily attributable toan $880,000a $3.3 million increase in salaries and benefits as a result of the addition of CommonWealth Bank in June 2003 ($431,000)836,000), the acquisition of PCB in the second quarter of 2004 ($589,000), the salaries and benefits associated with three North Carolina de novo branches opened in late 2003,as well asthe opening of two new North Carolina loan production offices in the first quarter of 2004 ($255,000)661,000), and two new loan production offices in Virginia ($41,000), as well as a general increase in salaries and benefits as staffing needs at several locations were satisfied in order to support added corporate services and continued branch growth.In 2004, occupancy and furniture and equipment expense increased by
$245,000$768,000 compared to 2003. The general level of occupancy cost grew largely as a result of the CommonWealth Bank acquisition ($90,000) as well as188,000), the PCB acquisition ($183,000), increases in depreciation and insurance costs associated with new de novo branches ($51,000)115,000) and depreciation associated witha significantcontinued investment in operating equipment and technology infrastructure.All other operating expense accounts increased
$1.1$1.5 million, compared to 2003.This increase included the previously discussed $651,000 impairment charge related to the mortgage banking segment andIncluded were increases in other operating expenses largely related to the additional costsand other operating expensesassociated with the opening of three new branches in Winston-Salem and two loan production offices in Charlotte and Mount Airy, North Carolina ($190,000), the opening of two loan production offices in Virginia, the acquisition of The CommonWealth Bank in Richmond,Virginia. INCOME TAXVirginia ($108,000) and the Tennessee acquisition of PCB ($173,000).As mentioned in the year-to-date discussion, other non-interest expenses were significantly impacted by the Company’s acquisition and branching activity. Total non-interest expense for the quarter ended June 30, 2004 increased $3.5 million over the same period in 2003. $1.9 million of this increase was an increase in salaries and benefits. Occupancy and furniture and fixtures increased $479,000 in aggregate, and amortization of intangibles increased $60,000. All other operating expenses increased $1.1 million.
Income Taxes
The effective income tax rate continues to benefit from the utilization of tax-exempt municipal securities. Municipal securities, which have offered an attractive tax equivalent yield, have assisted in
counteringmitigating the effect of the declining interest rate environment. TheCompany'sCompany’s effective tax rate was29.4%28.1% for the six months ended June 30, 2004 and 28.9% for the six months ended June 30, 2003. Tax benefit (expense) associated with discontinued operations was ($952,000) and $606,000 for the six months ended June 30, 2004 and 2003, respectively, and ($502,000) and $333,000 for the three months endedMarch 31,June 30, 2004 and28.9% for the three months ended March 31,2003.FINANCIAL POSITION
SECURITIESSecurities
Securities held to maturity totaled
$37.4$36.2 million atMarch 31,June 30, 2004, aslightdecrease of$595,000$1.8 million from December 31, 2003, the result of paydowns, maturities and calls within the portfolio during the firstthreesix months of 2004. The market value of investment securities held to maturity was105.9%103.8% and 105.4% of book value atMarch 31,June 30, 2004 and December 31, 2003, respectively. Recent trends in interest rates havehad littlethe effectonof reducing theunderlyingportfolio market value since December 31,2003.2003 since the market value of debt securities reacts inversely to rate movements. Securities available for sale were$443.8$429.5 million26
at
March 31,June 30, 2004 compared to$444.5$444.2 million at December 31, 2003, a decrease of$647,000.$14.7 million. This change reflects the purchase of$43.4$74.2 million in securities,$46.4$36.4 million in maturities and calls,andproceeds from sales of $25 million, the acquisition of $28 million with the PCB purchase, a market valueincreasedecrease of approximately$2.8$11.6 million,along withthe continuation of larger pay-downs of $42.3 million on mortgage-backed securities and collateralized mortgage obligations triggered by the low interest rateenvironment.environment and approximately $1.6 million bond premium amortization. Securities available for sale are recorded at their estimated fair market value. The unrealized gain or loss, which is the difference between amortized cost and estimated market value, net of related deferred taxes, is recognized in thestockholders'stockholders’ equity section of the balance sheet as either accumulated other comprehensive income or loss. The unrealizedgainslosses after taxes of$6.7$2.0 million atMarch 31,June 30, 2004, representan increasea decrease of$1.7$7.0 million from the $5.0 million gain at December 31, 2003,due tothe result of market valueincreasesadjustments in reaction to rate movements on similar instruments as well as gains realized on sales completed in the firstthreesix months of 2004.Although substantial
investmentreinvestment has been made in the available for sale security portfolio, the Company has attempted to maintain a shorter portfolio duration (the cash-weighted term to maturity of the portfolio) to reduce the sensitivity of thebondsbond’s price to changes in interest rates and lessen interest rate risk. The longer the duration, the greater the impact of changing market rates for similar instruments. AtMarch 31,June 30, 2004, the average estimated life of the investment portfolio was4.64.7 years (reflective of currently anticipated prepayments). This compares to 4.2 years at December 31, 2003. The approximate45 month increase in average duration reflects the substantial amount of portfolio replacement over the lasttwelvesix months and investment in longer-term municipal securities.LOAN PORTFOLIO LOANS HELD FOR SALE: The relative size ofLoan Portfolio
Loans Held for Sale:As mentioned previously in this report, the
portfolio of loans originated by the Company's mortgage brokerage division, UFM, and held for sale, was impacted significantly by the refinancing activity that occurred during 2003 and continues into 2004 as a result of the low interest rate environment. Loans held for sale fluctuate on a daily basis reflecting retail originations, wholesale purchases and sales to investors. At March 31, 2004,loans held for salewere $28.7 million comparedby UFM are carried as assets related to$18.2 23million at December 31, 2003. Averagediscontinued operations on the balance sheet and have been removed from continuing operations. The remaining balance of loans held for sale,(which$774,000, isa better indicator of volume maintained)held by the Bank through the newly acquired branches in Tennessee.Loans Held for
the first quarter 2004, was down by 17%, when comparing the first quarter 2004 average of $15.1 million to the trailing quarter average of $18.2 million and down 70% compared to the first quarter 2003 average of $49.6 million. LOANS HELD FOR INVESTMENT:Investment:Total loans held for investmentdecreased $6.4increased $160.8 million to$1.02$1.19 billion atMarch 31,June 30, 2004because of several large payoffs, but increased $122.6 million compared to Marchfrom the $1.03 billion level at both December 31, 2003as aand June 30, 2003, largely the result of theCommonWealth Bank acquisition.PCB acquisition ($134.3 million). Consideringa $17.1the $169.5 million increase in deposits ($152.8 million from the PCB acquisition) along with thedecrease$160.8 million increase in loans during the firstthreesix months of 2004, the loan to deposit ratiodecreasedincreased slightly atMarch 31,June 30, 2004 compared to the December 31, 2003 level. The loan to deposit ratiousing only loans held for investment (excluding loans held for sale),was82.1%85.1% onMarch 31,June 30, 2004, 83.7% on December 31, 2003 and77.8%81.7% onMarch 31,June 30, 2003.Intense competition for loans in the face of low interest rates and what appears2004 year to
be slower loan demand continue to impact this measure of loan production. Resulting liquidity during the period has been reinvested in the available for sale securities portfolio. 2004 first quarterdate average loans held for investment of$1.02$1.09 billiondecreased by $18.5 million compared to the trailing quarter 2003 average of $1.03 billion butincreased$109.5$172 million when compared to the average for the firstquarter averagesix months of2003.2003 of $920 million. This increasecompared to the first quarter 2003,was largely due to the June 6, 2003 CommonWealthBank acquisition;acquisition (approximately $105 million) as well as thebranches acquired reflected approximately $120 million in average loans held for investment.PCB acquisition (approximately $66 million).The held for investment loan portfolio continues to be diversified among loan types and industry segments. The following table presents the various loan categories and changes in composition as of
March 31,June 30, 2004, December 31, 2003 andMarch 31,June 30, 2003.
LOAN PORTFOLIO OVERVIEW (DOLLARS IN THOUSANDS) MARCH 31, 2004 DECEMBER 31, 2003 MARCH 31, 2003 ------------------------- ------------------------- ------------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ---------- ---------- ---------- ---------- ---------- ----------LOANS HELD FOR INVESTMENT: Commercial and Agricultural $ 63,322 6.21% $ 69,395 6.76% $ 59,724 6.66% Commercial Real Estate 320,032 31.39% 317,421 30.94% 270,004 30.10% Residential Real Estate 412,373 40.44% 421,288 41.05% 361,883 40.33% Construction 106,219 10.42% 98,510 9.60% 78,576 8.76% Consumer 115,631 11.34% 118,585 11.56% 126,241 14.07% Other 2,252 0.22% 992 0.10% 766 0.09% ---------- ---------- ---------- ---------- ---------- ---------- Total $1,019,829 100.00% $1,026,191 100.00% $ 897,194 100.00% ========== ========== ========== ========== ========== ========== LOANS HELD FOR SALE $ 28,656 $ 18,152 $ 50,753 ========== ========== ==========NON-PERFORMING ASSETSLoan Portfolio Overview
(Dollars in Thousands)
June 30, 2004 December 31, 2003 June 30, 2003 Amount Percent Amount Percent Amount Percent Commercial and Agricultural $ 64,768 5.46 % $ 69,395 6.76 % $ 58,501 5.70 % Commercial Real Estate 445,446 37.54 % 317,421 30.94 % 346,892 33.80 % Residential Real Estate 436,364 36.76 % 421,288 41.05 % 418,312 40.75 % Construction 113,314 9.55 % 98,510 9.60 % 73,314 7.14 % Consumer 124,742 10.51 % 118,585 11.56 % 128,833 12.55 % Other 2,320 0.20 % 992 0.10 % 791 0.08 %
Total $ 1,186,954 100.00 % $ 1,026,191 100.00 % $ 1,026,643 100.00 %
$ 774 $ 18,152 $ 46,743
27
Non-Performing Assets
Non-performing assets include loans on non-accrual status, loans contractually past due 90 days or more and still accruing interest,
andother real estate owned("OREO"(“OREO”).and repossessions. Non-performing assets were $4.9 million at June 30, 2004, $6.2 million at March 31, 2004$5.1and $5.6 million atDecember 31, 2003June 30, 2003. The percentage of non-performing assets to total loans, OREO and$6.6 million atrepossessions was 0.4% for the quarters ended June 30, 2004 and March 31,2003, or 0.6%,2004, compared to 0.5%and 0.7% of total loans and OREO, respectively.at June 30, 2003.The following schedule details non-performing assets by category at the close of each of the last five quarters:
(IN THOUSANDS OF DOLLARS) MARCH 31 DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31 2004 2003 2003 2003 2003 ------ ------ ------ ------ ------Nonaccrual $3,588 $2,993 $2,277 $2,547 $3,997 Ninety Days Past Due and Accruing - - 124 86 21 Other Real Estate Owned 2,571 2,091 2,403 2,787 2,544 ------ ------ ------ ------ ------ $6,159 $5,084 $4,804 $5,420 $6,562 ====== ====== ====== ====== ====== Restructured loans performing in accordance with modified terms $ 392 $ 356 $ 362 $ 368 $ 341 ====== ====== ====== ====== ======24
(In Thousands of Dollars) June 30 March 31 December 31 September 30 June 30 2004 2004 2003 2003 2003 Non-accrual $ 2,630 $ 3,588 $ 2,993 $ 2,277 $ 2,547 Ninety Days Past Due and Accruing — — — 124 86 Other Real Estate Owned 2,166 2,571 2,091 2,403 2,787 Repossessions 92 60 75 125 140
$ 4,888 $ 6,219 $ 5,159 $ 4,929 $ 5,560
Restructured loans performing in accordance with modified terms $ 382 $ 392 $ 356 $ 362 $ 368
At June 30, 2004, non-accrual loans decreased $958,000 from March 31, 2004,
non-accrual loans increased $595,000 from December 31, 2003,while ninety day past due and accruing loansoutstandingremained atzero for both periods.zero. Ongoing activity within the classification and categories of non-performing loans continues to include collections on delinquencies, foreclosures and movements into or out of the non-performing classification as a result of changing customer business conditions. The$595,000 increase$958,000 decrease in non-accrual loans during thefirstsecond quarter of 2004 is largely the result of anadditionelimination through write-down, foreclosure and sale of a commercial real estate loan in the amount of $903,000, while certain non-accrual loans were paid, moved to a current status as a result of improved performance, or were liquidated through foreclosure or repossession. OREOincreased $480,000 during the first quarter ofdecreased $405,000 at June 30, 2004 fromDecemberMarch 31,20032004 as a result offoreclosure on a commercialliquidation of real estateloan previously on non-accrual, in the amount of $500,000.or write-down to fair market value. Other real estate owned is carried at the lesser of estimated net realizable fair market value or cost.In addition to loans which are classified as non-performing and impaired, the Company closely monitors certain loans which could develop into problem loans. These potential problem loans present characteristics of weakness or concentrations of credit to one borrower. Among these loans at
March 31,June 30, 2004 was a loan of $12.8 million which warrants close monitoring of a borrower within the hospitality industry. The loan represents the retained portion of a $16 million total loan shared with a participating bank.As with other hospitality industry firms, the borrower has experienced reduced cash flow associated with declines in the level of hotel occupancy.The loan is secured by real estate improved with a national franchise hotel and parking building in a major southeast city. The loan is further secured by the guarantee of the principals of the borrowing entity. This loan, which was originated in 1999, performed according to terms until it displayed delinquency in February and March 2003 and was subsequently brought current. The loan remains current as to principal and interest atMarch 31,June 30, 2004. This loan does, however, represent one of theCompany'sCompany’s largest credits and is within an industry which has suffered from declining performance in recent years.The Company is also monitoring a $3.1 million loan to a hospitality borrower for a new property opened in 2003. The construction and opening of the hotel which secures this loan was delayed and occupancy has not reached projected levels necessary to adequately fund current debt service requirements. The loan is guaranteed by the principals and is senior to a $1.3 million loan by the SBA. The $3.1 million senior loan
was 79 days delinquent on April 30, 2004. A subsequent payment broughtexperienced delinquency during theloan to 57 days delinquent as of the filing date of this report.second quarter. The borrowerhasrequested conversion to interest only payments for a period of one year to allowtimefor stabilization of occupancy and cash flow for the property.Management does not consider this loan impaired.The Companyhasdelayed consideration of the modification request until the principalsrestorerestored the loan to currentstatusstatus. Subsequent payments of principal andpendinginterest were made by theCompany's requestborrower which brought the loan current. The Company has since modified the loan to allow foradditional collateral. The ultimate resolution ofinterest only payments and theissues dealing with the modification is not expected to have a material adverse effect on consolidated financial statements. There were no specific allocations of the allowance forloanlosses for the $12.8 million loan; however, a $300,000 allocation was assigned to the $3.1 million loan as of March 31, 2004.has remained current since modification.These loans were appropriately considered in evaluating the adequacy of the allowance for loan losses.
DEPOSITS AND OTHER BORROWINGSDeposits and Other Borrowings
Total deposits have grown
$17.1$169.5 million or1.4%13.8% since year-end2003.2003, largely the result of the PCB acquisition in April, 2004 ($152.8 million). In terms of composition, non-interest-bearing deposits increased$3.2$31.2 million ($17.8 million PCB acquisition) or1.7% while16.08%. Interest-bearing demand deposits increased $84.5 million ($79.2 million PCB), savings deposits increased $34.3 million ($31.2 million PCB) and time deposits increased $19.5 million ($24.6 million PCB) bringing total interest-bearingdeposits grew $13.9deposit growth to $138.3 million ($135.0 million PCB acquisition) or1.4%13.41% from December 31, 2003.Since March 31, 2003, non-interest bearing deposits grew $34.3 million and interest-bearing deposits grew $54.7 million, largely the result of the CommonWealth Bank acquisition in June 2003.28
The Company acquired an additional
$17.5$7.1 million in borrowed funds from the FHLB with the acquisition ofCommonWealth Bank and borrowed an additional $25 million from the FHLB in June 2003.PCB. These increases together with a decrease due to the repayment of a line of credit used to fund mortgages held by UFM brought theCompany'sCompany’s borrowings atMarch 31, 2003June 30, 2004 to$136.3$107.3 million in convertible and callable advances and$8.3$34.4 million of noncallable term advances from the FHLB of Atlanta. For further discussion of FHLB borrowings, see Note 4 to the unaudited consolidated financial statements included in this report. In addition, FCBI issued trust preferred securities in September 2003 of $15.0 million whichisare also included in the total borrowings of the Company.STOCKHOLDERS' EQUITYStockholders’ Equity
Total
stockholders'stockholders’ equityreached $178.0was $171.4 million atMarch 31,June 30, 2004,increasing $3decreasing $3.6 million from the $175.0 million reported at December 31, 2003 through earnings of$4.2$9.9 million less dividends paid of$2.8$5.6 million,an increasea decrease in other comprehensive income of$1.7$7 million, increases of$87,000$88,000 due to Stone Capital payments, a$34,000$149,000 increase due to stock option exercises and a net decrease due to treasury share transactions of$161,000.$1.2 million.The Federal
Reserve'sReserve’s risk based capital guidelines and leverage ratio measure capital adequacy of banking institutions. Risk-based capital guidelines weight balance sheet assets and off-balance sheet commitments based on inherent risks associated with the respective asset types. AtMarch 31,June 30, 2004, theCompany'sCompany’s total risk adjusted capital-to-asset ratio was14.71%11.48% versus2514.55% at December 31, 2003. The Company'sCompany’s leverage ratio atMarch 31,June 30, 2004 was8.98%6.97% compared with 8.83% at December 31, 2003. Both the risk adjusted capital-to-asset ratio and the leverage ratio exceed the current well-capitalized levels prescribed for banks of 10% and 5%, respectively.PART I. ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK LIQUIDITY AND CAPITAL RESOURCESQuantitative and Qualitative Disclosures about Market RiskLiquidity and Capital Resources
The Company maintains a significant level of liquidity in the form of cash and cash equivalent balances ($
78.656.3 million), investment securities available for sale ($443.8429.5 million) and Federal Home Loan Bank credit availability of approximately$361.8$411.2 million. Cash and cash equivalents as well as advances from the Federal Home Loan Bank are immediately available for satisfaction of deposit withdrawals, customer credit needs and operations of the Company. Investment securities available for sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. The Company also maintains approved lines of credit with correspondent banks as backup liquidity sources.The Company maintains a liquidity policy as a means to manage the liquidity risk process and associated risk. The policy includes a Liquidity Contingency Plan that is designed as a tool for the Company to detect liquidity issues promptly in order to protect depositors, creditors and shareholders. The Plan includes monitoring various internal and external indicators such as changes in core deposits and changes in market conditions. It provides for timely responses to a wide variety of funding scenarios ranging from changes in loan demand to a decline in the
Company'sCompany’s quarterly earnings to a decline in the market price of theCompany'sCompany’s stock. The Plan calls for specific responses designed to meet a wide range of liquidity needs based upon assessments on a recurring basis by management and the Board of Directors.INTEREST RATE RISKInterest Rate Risk (IRR)
AND ASSET/LIABILITY MANAGEMENTand Asset/Liability ManagementWhile the Company continues to strive to decrease its dependence on net interest income, the
Bank'sBank’s profitability is dependent to a large extent upon its ability to manage its net interest margin. The Bank, like other financial institutions, is subject to interest rate risk to the degree that its interest-earning assets reprice differently than its interest-bearing liabilities. The Bank manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds. Specific strategies for management of IRR have included shortening the amortized maturity of fixed-rate loans and increasing the volume of adjustable rate loans to reduce the average maturity of theBank'sBank’s interest-earning assets.The
Company'sCompany’s risk profile continues to reflect a position that is asset sensitive. The substantial level of prepayments and calls on loans and securities are consistent with the low rate environment that prevailed over the pastyear, as well asyear. In addition, the success of deposit funding campaignsinstituted havehas led to a strong liquidity position as reflected in the level of cash reserves and due from balances of approximately$78.6$56.3 million. The Company continues to reinvest the funds generated from asset paydowns and prepayments within a framework that attempts to maintain an acceptable net interest margin in the current interest rate environment.In addition, the29
The discontinued mortgage operations of UFM
useused investments commonly referred to as"forward"“forward” transactions and"options"“options” or derivatives to balance the risk inherent in interest rate lock commitments made to prospective borrowers. The pipeline of loans is hedged to mitigate unusual fluctuations in the cash flows derived upon settlement of the loans with secondary market purchasers and, consequently, to achieve a desired margin upon delivery. Thehedge transactions are used for risk mitigation and are not for trading purposes. Thederivative financial instruments represented by these hedging transactions are recorded at fair value in the Consolidated Balance Sheets and the changes in fair value are reflected in the Consolidated Statements of Income.In addition,Until June 30, 2004, UFMutilizesutilized mortgage derivative contracts as an interest rate risk management tool to hedge against exposure to changing interest rates as loan commitmentsarewere originated. A more complete discussion of loans held for sale, derivative instruments and hedging activities and the underlying impact is included within theApplication of Critical Accounting Policiessection of theManagement'sManagement’s Discussion and Analysis included herein. After the close of business on June 30, 2004, a plan was implemented in conjunction with the UFM wholesale line of business divestiture to cease using hedging instruments on loan production. TheCompany'sremaining securities in place at June 30, 2004 will be settled through normal business channels and ongoing rate lock commitments will be given to borrowers subject to the Company’s placement with a purchaser/investor.The Company’s earnings sensitivity measurements completed on a quarterly basis indicate that the performance criteria, against which sensitivity is measured, are currently within the
Company'sCompany’s defined policy limits. A more complete discussion of the overall interest rate risk is included in theCompany'sCompany’s annual report on Form 10-K for December 31, 2003.PART I. ITEM 4.
CONTROLS AND PROCEDURESControls and ProceduresAs of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the
Company'sCompany’s management, including theCompany'sCompany’s Chief Executive Officer along with theCompany'sCompany’s Chief Financial Officer, of the effectiveness of the design and operation of theCompany'sCompany’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934("(“ExchangeAct"Act”) Rule 13a-15(b). Based upon that evaluation, theCompany'sCompany’s Chief Executive Officer along with theCompany'sCompany’s Chief Financial Officer concluded that theCompany's 26Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company'sCompany’s periodic SEC filings. There has not been any change in theCompany'sCompany’s internal control over financial reporting that occurred during theCompany'sCompany’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, theCompany'sCompany’s internal control over financial reporting.Disclosure controls and procedures are Company controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the
SEC'sSEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to theCompany'sCompany’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is currently a defendant in various legal actions and asserted claims involving lending and collection activities and other matters in the normal course of business. While the Company and legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, they are of the belief that the resolution of these actions should not have a material adverse affect on the financial position of the Company.
In
November 2003,May, 2004, the Company wassuednamed a party to an action filed in the Circuit Court of Nicholas County, West Virginia bytwo former employees of The CommonWealth Bank, alleging among other things, violation of employment law and breach of contract, stemming from their termination. TheFidelity & Guaranty Life Insurance Companyand counsel believe thatseeking to determine thelawsuit, which seeks damages of more than $180,000 plus certain retirement and employee benefits along with punitive damages for eachrights of thetwo former employeesCompany’s banking subsidiary and members of the LeRose family to $1,000,000 in life insurance proceeds paid on a life insurance policy previously assigned to the Bank as partial collateral for a multimillion indebtedness due and owing to the bank as a consequence of a kiting scheme. TheCommonWealth Bank is without merit, and intendslife insurance proceeds have been paid by the insurance company into a court-administered account for ultimate distribution tovigorously defend this matter.the rightful owner.30
Item 2.
Unregistered SalesChanges in Securities, Use of Proceeds and Issuer Purchases of Equity Securitiesand Use
(a) Not Applicable
(b) Not Applicable (c) Issuer Purchases of
ProceedsEquity SecuritiesThe following table sets forth purchases by the Company (on the open market) of its equity securities during the
quarterthree months endedMarch 31,June 30, 2004.(c) ISSUER PURCHASES OF EQUITY SECURITIES
MAXIMUM NUMBER OF TOTAL NUMBER OF SHARES THAT TOTAL # OF AVERAGE SHARES PURCHASED MAY YET BE SHARES PRICE PAID AS PART OF PUBLICLY PURCHASED PURCHASED PER SHARE ANNOUNCED PLAN UNDER THE PLAN ------------- ------------ ---------------------- -----------------January 1-31, 2004 - - - 300,053 February 1-29, 2004 - - - 300,053 March 1-31, 2004 5,000 $ 32.05 5,000 295,053 ------------- ------------ ---------------------- Total 5,000 $ 32.05 5,000 ============= ============ ======================
Maximum Number of Total Number of Shares that Total # of Average Shares Purchased May yet be Shares Price Paid as Part of Publicly Purchased Purchased per Share Announced Plan Under the Plan April 1-30, 2004 — — — 295,053 May 1-31, 2004 38,500 26.19 38,500 313,333 June 1-30, 2004 900 26.99 900 314,411
Total 39,400 $ 26.87 39,400
The
Company'sCompany’s stock repurchase plan allowing the purchase of up to 436,000 shares was announced September 18, 2001,andamended by the Board to 500,000 shares on March 18, 2003 and again on May 18, 2004 to purchase up to500,000550,000 shares. The plan has no expiration date and no plans have expired during the reportingquarter.period. No determination has been made to terminate the plan or to stop making purchases.Item 3. Defaults Upon Senior Securities
Not Applicable
31
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable 27
(a) The Annual Meeting of Stockholders was held on April 27, 2004. (b) The following directors were elected to serve a three-year term through the date of the 2007 Annual Meeting of Stockholders: Allen T. Hamner, B. W. Harvey, and John M. Mendez (c) Three proposals were voted upon at the annual meeting, which included: 1) the election of the aforementioned directors as Class of 2007; 2) ratification of the 2004 Omnibus Stock Option Plan, and 3) ratification of the selection of Ernst & Young, Charleston, West Virginia, as independent auditors for the year ending December 31, 2004. The results of the proposals and voting are as follows: Proposal 1. Election of Directors:
Votes For Votes Withheld Allen T. Hamner 7,727,183 171,070 B. W. Harvey 7,788,181 110,073 John M. Mendez 7,806,628 91,626 Proposal 2. Ratification of the 2004 Omnibus Stock Option Plan:
Votes For 6,399,575 Votes Against 417,709 Votes Abstained 222,206 Broker Non-Vote 858,763 Proposal 3. Ratification of the selection of Ernst & Young LLP as independent auditors:
Votes For 7,827,595 Votes Against 9,190 Votes Abstained 61,468
(d) Not Applicable Item 5. Other Information
Not Applicable
Not Applicable 32
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
- -------------------- ------------------------------------------------------------------------------------------------ EXHIBIT NO. EXHIBIT - -------------------- ------------------------------------------------------------------------------------------------Exhibit No. Exhibit 2.1 Agreement and Plan of Merger dated as of January 27, 2003, and amended as of February 25, 2003, among First Community Bancshares, Inc., First Community Bank, National Association, and The CommonWealth Bank.(1) - -------------------- ------------------------------------------------------------------------------------------------3(i) Articles of Incorporation of First Community Bancshares, Inc., as amended.(2) - -------------------- ------------------------------------------------------------------------------------------------3(ii) Bylaws of First Community Bancshares, Inc., as amended.(2) - -------------------- ------------------------------------------------------------------------------------------------4.1 Specimen stock certificate of First Community Bancshares, Inc.(7) - -------------------- ------------------------------------------------------------------------------------------------4.2 Indenture Agreement dated September 25, 2003.(13) - -------------------- ------------------------------------------------------------------------------------------------4.3 Amended and Restated Declaration of Trust of FCBI Capital Trust dated September 25, 2003.(13) - -------------------- ------------------------------------------------------------------------------------------------4.4 Preferred Securities Guarantee Agreement dated September 25, 2003.(13) - -------------------- ------------------------------------------------------------------------------------------------10.1 First Community Bancshares, Inc. 1999 Stock Option Contracts(2)Contracts (2) and Plan.(3)- -------------------- ------------------------------------------------------------------------------------------------ 10.1.1*10.1.1 Amendment to the First Community Bancshares, Inc. 1999 Stock Option Plan - -------------------- ------------------------------------------------------------------------------------------------(14)10.2 First Community Bancshares, Inc. 2001 Non-Qualified Directors Stock Option Plan.(4) - -------------------- ------------------------------------------------------------------------------------------------10.3 Employment Agreement dated January 1, 2000 and amended October 17, 2000, between First Community Bancshares, Inc. and John M. Mendez.(2)(5) - -------------------- ------------------------------------------------------------------------------------------------10.4 First Community Bancshares, Inc. 2000 Executive Retention Plan.(3) - -------------------- ------------------------------------------------------------------------------------------------10.5 First Community Bancshares, Inc. Split Dollar Plan and Agreement.(3) - -------------------- ------------------------------------------------------------------------------------------------10.6 First Community Bancshares, Inc. 2001 Directors Supplemental Retirement Plan.(2) - -------------------- ------------------------------------------------------------------------------------------------10.7 First Community Bancshares, Inc. Wrap Plan.(7) - -------------------- ------------------------------------------------------------------------------------------------10.8 Employment Agreement between First Community Bancshares, Inc. and J. E. Causey Davis.(8) - -------------------- ------------------------------------------------------------------------------------------------10.9 Agreement and Plan of Merger dated as of December 31, 2003 among First Community Bancshares, Inc., First Community Bank, National Association and PCPPCB Bancorp.(9)- -------------------- ------------------------------------------------------------------------------------------------10.10 Form of Indemnification Agreement between First Community Bancshares, Inc., its Directors and Certain Executive Officers.(10) - -------------------- ------------------------------------------------------------------------------------------------10.11 Form of Indemnification Agreement between First Community Bank, N. A., its Directors and Certain Executive Officers.(10) - -------------------- ------------------------------------------------------------------------------------------------10.12 First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan.(12) - -------------------- ------------------------------------------------------------------------------------------------10.13* First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan-Stock Award Agreement 11.0 Statement regarding computation of earnings per share.(6) - -------------------- ------------------------------------------------------------------------------------------------ 12.114.1 Code of Ethics.(11) - -------------------- ------------------------------------------------------------------------------------------------15.0* ConsentAcknowledgement of Independent Auditors. - -------------------- ------------------------------------------------------------------------------------------------31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer - -------------------- ------------------------------------------------------------------------------------------------Officer.31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer - -------------------- ------------------------------------------------------------------------------------------------ 32*Officer.32 * Certification of Chief Executive and Chief Financial Officer Section 1350 - -------------------- ------------------------------------------------------------------------------------------------1350.* Furnished herewith. 28(1) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Form 8-K filed with the Commission on January 28, 2003 and February 26, 2003. (2) Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002 filed on August 14, 2002. (3) Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 1999 filed on March 30, 2000 as amended April 13, 2000. (4) The options agreements entered into pursuant to the 1999 Stock Option Plan and the 2001 Non-Qualified Directors Stock Option Plan are incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002 filed on August 14, 2002. (5) First Community Bancshares, Inc. has entered into substantially identical agreements with Messrs. Buzzo and Lilly, with the only differences being with respect to titles, salary and the use of a vehicle. (6) Incorporated by reference from Footnote 9 of the Notes to Consolidated Financial Statements included herein. (7) Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2002 filed on March 25, 2003 as amended on March 31, 2003. (8) Incorporated by reference from S-4 Registration Statement filed on March 28, 2003. (9) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Form 8-K filed with the Commission on December 31, 2003. (10) Form of indemnification agreement entered into by the Corporation and by First Community Bank N. A. with their respective directors and certain officers of each including, for the registrant and Bank: John M. Mendez, Robert L. Schumacher, Robert L. Buzzo, Kenneth P. Mulkey, E. Stephen Lilly and at the Bank level: Samuel L. Elmore. Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2002 filed on March 25, 2003 as amended on March 31, 2003. (11) Incorporated by reference from the Annual Report Filed on Form 10-K for the period ended December 31, 2003 filed on March 26, 2004. (12) Incorporated by reference from the 2004 First Community Bancshares Definitive Proxy filed on March 19, 2004. (13) Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended September 30, 2003 filed on November 10, 2003. (b) Reports on Form 8-K A report on Form 8-K was filed on January 27, 2004 announcing the Company's fourth quarter and year-to-date 2003 earnings. A report on Form 8-K was filed on March 4, 2004 announcing the declaration of the Company's first quarter dividend of $0.25 per share payable on or about March 29, 2004 to stockholders of record on March 15, 2004. 29
* Furnished herewith.
(1) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Form 8-K filed with the Commission on January 28, 2003 and February 26, 2003. 33
(2) Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002 filed on August 14, 2002. (3) Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 1999 filed on March 30, 2000, as amended April 13, 2000. (4) The option agreements entered into pursuant to the 1999 Stock Option Plan and the 2001 Non-Qualified Directors Stock Option Plan are incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002 filed on August 14, 2002. (5) First Community Bancshares, Inc. has entered into substantially identical agreements with Messrs. Buzzo and Lilly, with the only differences being with respect to title, salary and the use of a vehicle. (6) Incorporated by reference from Footnote 9 of the Notes to Consolidated Financial Statements included herein. (7) Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2002 filed on March 25, 2003, as amended on March 31, 2003. (8) Incorporated by reference from S-4 Registration Statement filed on March 28, 2003. (9) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Form 8-K filed with the Commission on December 31, 2003. (10) Form of indemnification agreement entered into by the Corporation and by First Community Bank, N. A. with their respective directors and certain officers of each including, for the registrant and Bank: John M. Mendez, Robert L. Schumacher, Robert L. Buzzo, Kenneth P. Mulkey, E. Stephen Lilly and at the Bank level: Samuel L. Elmore. Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2002 filed on March 25, 2003, as amended on March 31, 2003. (11) Incorporated by reference from the Annual Report Filed on Form 10-K for the period ended December 31, 2003 filed on March 26, 2004. (12) Incorporated by reference from the 2004 First Community Bancshares, Inc. Definitive Proxy filed on March 19, 2004. (13) Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended September 30, 2003 filed on November 10, 2003. (14) Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended March 31, 2004 filed on May 7, 2004. (b) Reports on Form 8-K A report on Form 8-K was filed on April 1, 2004 announcing the Company’s completion of the merger between the Company and PCB Bancorp, Inc. A report on Form 8-K was filed on April 27, 2004 announcing the Company’s first quarter 2004 earnings and proposed sale of the mortgage subsidiary. A report on Form 8-K was filed on May 19, 2004 announcing that the Company’s Board of Directors updated its authorization of the Stock Repurchase Program. A report on Form 8-K was filed on May 19, 2004 announcing the declaration of the Company’s second quarter dividend of $0.25 per share payable on or about June 30, 2004 to stockholders of record on June 15, 2004. 34
SIGNATURES
Pursuant to the requirements 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.
First Community Bancshares, Inc.
DATE:
May 7,August 6, 2004/s/ John M. Mendez - -------------------------------------------- John M. Mendez President & Chief Executive Officer (Duly Authorized Officer)
John M. Mendez
President & Chief Executive Officer
(Duly Authorized Officer)DATE:
May 7,August 6, 2004/s/ Robert L. Schumacher - -------------------------------------------- Robert L. Schumacher Chief Financial Officer (Principal Accounting Officer) 30
Robert L. Schumacher
Chief Financial Officer
(Principal Accounting Officer)35
Index to Exhibits
Exhibit No. 10.1.1 Amendement to10.13 First Community Bancshares, Inc. 19992004 Omnibus Stock OptionPlan.Plan-Stock Award Agreement15.0 ConsentAcknowledgement of Independent Auditors 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. 32.0 Certification of Chief Executive and Chief Financial Officer Section 1350. 3136