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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to _____________
Commission file number 0-13086
FNB FINANCIAL SERVICES CORPORATION
202 South Main Street
Reidsville, North Carolina 27320
(336) 342-3346
Incorporated in the State of North Carolina
IRS Employer Identification No. 56-1382275
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
None
SECURITIES REGISTERED UNDER PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, Par Value $1.00 Per Share
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ X ]
The registrant's revenues (total interest income) for the year ended
December 31, 1997 were approximately $21.0 million.
The aggregate market value of the registrant's Common Stock held by
non-affiliates at March 4, 1998, based on the average bid and asked price of the
Common Stock on that day, was approximately $53.0 million.
As of March 4, 1998, the registrant had outstanding 2,498,782 shares of
Common Stock, $1.00 par value.
Portions of the Registrant's Annual Report to Shareholders for the
fiscal year ended December 31, 1997 are incorporated by reference into Part II
of this report.
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held April 14, 1998 are incorporated by reference into Part
III of this report.
Transitional Small Business Disclosure Format Yes [ ] No [X]
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FORM 10-KSB TABLE OF CONTENTS
As indicated above, portions of (i) the registrant's Annual Report to
Shareholders for the fiscal year ended December 31, 1997 and (ii) the
registrant's Proxy Statement for the Annual Meeting of Shareholders to be held
April 14, 1998 are incorporated by reference into Parts II and III of this
report.
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INDEX PAGE
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PART I
Item 1. Description of Business............................................................................... 3
Item 2. Description of Property............................................................................... 15
Item 3. Legal Proceedings..................................................................................... 16
Item 4. Submission of Matters To a Vote of Security Holders................................................... 16
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.............................................. 17
Item 6. Management's Discussion and Analysis or Plan of Operation............................................. 17
Item 7. Financial Statements.................................................................................. 17
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.............................................................................. 17
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act..................................................................... 18
Item 10. Executive Compensation............................................................................... 18
Item 11. Security Ownership of Certain Beneficial Owners and Management....................................... 18
Item 12. Certain Relationships and Related Transactions....................................................... 18
Item 13. Exhibits and Reports on Form 8-K..................................................................... 18
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
FNB Financial Services Corporation (the "Company") is a North Carolina
bank holding company with total assets of $325.2 million, deposits of $272.3
million and shareholders' equity of $22.5 million, each as of December 31, 1997.
The Company's wholly-owned subsidiary, First National Bank Southeast (the
"Bank"), was chartered in 1918. Historically, the Bank has served the Rockingham
County area of North Carolina through three branches in Reidsville and two in
Eden, North Carolina. In 1995, the Company initiated a strategic growth plan
beginning with the hiring of a new chief executive officer. By the end of 1997,
the Bank increased its number of branches from five to ten by closing a branch
in Eden and opening new branches in the Rockingham County towns of Eden, Ruffin
and Madison and in the new markets of Greensboro and Wilmington, North Carolina.
As a result of this strategy, between 1995 and 1997, the Company's net interest
income, loans and deposits each increased at compound annual growth rates of
23.0%, 43.1% and 32.8%, respectively.
The Bank is community oriented and focuses primarily on offering
commercial, real estate and consumer loans, and deposit and other financial
services to individuals, small to medium-sized businesses and other
organizations in its market areas. The Bank emphasizes its individualized
services and community involvement, while at the same time providing its
customers with the financial sophistication and array of products typically
offered by a larger bank. Management believes that the Bank can compete
successfully with larger banks located within and outside of North Carolina by
retaining its personalized approach and community focus.
Under the leadership of Ernest J. Sewell, who became President and
Chief Executive Officer in January 1995, the Company adopted the following
three-part strategy: (i) increase market share and geographic reach through
opportunistic acquisitions in markets where the mix of economic, operational,
cultural and other factors are favorable; (ii) position the Company to manage
its planned growth by adding experienced personnel and upgrading its internal
systems and procedures; and (iii) generate internal growth at its existing
banking offices by offering new and complementary services and products. To
accomplish these objectives, during the past three years the Company has: (i)
increased the number of its branch offices to ten by opening new offices in
Eden, Ruffin, Madison, Greensboro and Wilmington; (ii) expanded by approximately
48% the number of its full-time personnel by adding 42 new employees, including
four new vice presidents and four new senior vice presidents; (iii) initiated a
systematic review and revision of its loan administration, loan policy and
credit procedures; and (iv) enhanced its mix of products and services by
broadening the scope of its commercial lending activities, updating and
extending its ATM terminals and network and establishing a department to provide
credit and debit cards to its customers.
The Company plans to continue to pursue these objectives by
strengthening its presence in existing markets and opportunistically reaching
into new markets in North Carolina, Virginia and South Carolina. The Company
will seek to hire qualified personnel to help manage its planned growth and to
develop new products that are uniquely consistent with the Company's service
orientation. The Company also plans, where appropriate, to upgrade its systems
and procedures and refine its ability to offer customers sophisticated services
without sacrificing its personalized approach.
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STRATEGY
Expand Banking Operations. Throughout most of its 80-year history, the
Company's banking activities were centered in Reidsville, North Carolina,
located in Rockingham County in the north central part of the State. Beginning
in 1995, however, the Company initiated a growth strategy to further penetrate
markets in which it has an existing market share and expand into and develop new
and contiguous markets, such as Wilmington and Greensboro. Management selects
its target markets based on a number of factors, including market size and
growth potential, banking relationships developed by members of management
during their careers and the ability to integrate the targeted market into the
Company's unique, community oriented culture.
The Company's expansion strategy, both within and outside of its
existing markets, involves three key elements: (i) install high-quality,
well-trained management to serve the market; (ii) ascertain that the market is
underserved by financial institutions whose primary focus is to cater to the
individualized needs of customers; and (iii) find reasonably priced facilities.
Management believes that it has been successful in implementing these strategic
elements in its expansion program to date.
In 1997, the Bank opened new branches in Wilmington, Greensboro, Ruffin
and Madison, North Carolina. The Wilmington branch represented the Company's
first foray outside of the north central part of North Carolina and at December
31, 1997, after ten months of operations, held deposits and loans totaling $35.3
million and $59.5 million, respectively. A major factor contributing to this
growth was the ability of existing loan officers to capitalize on prior
relationships. The Greensboro, Ruffin and Madison branches expand the Bank's
services in the Triad - Rockingham County area. Ruffin and Madison are each
located in Rockingham County, and Greensboro is in Guilford County, just south
of Rockingham County. At December 31, 1997, after less than a full year in
operation, the aggregate deposits and loans at these three branches were $39.4
million and $23.5 million, respectively. These figures do not necessarily
represent the rate of loan and deposit growth that may be achieved at these
branch locations in the future.
Seize Market Expansion Opportunities. The Company intends to capitalize
on opportunities to enter new and contiguous markets which it believes are
underserved as a result of banking consolidation and in which the Company's
community oriented philosophy and culture would flourish. The Company believes
that there is value to be added by providing the opportunity for greater
personalized banking relationships than exist with larger commercial banks in
its markets, although the Company also recognizes the need to carefully analyze
markets that are already well served by numerous institutions. The Company will
continue to distinguish itself by emphasizing high quality, sophisticated
services in a hometown environment.
Establish a Platform for Future Growth. The Company seeks to position
itself to manage its future expected growth in two fundamental ways: (i)
attract, retain and reward experienced personnel who are committed both to
conducting business in a friendly and personable manner and to the communities
in which they work and live; and (ii) continue a program to upgrade, modify and
expand its internal systems, procedures, equipment and software designed to
improve marketing and operating efficiencies. The Company will also continue to
analyze technological developments in the banking industry for opportunities to
improve or augment its services and products, although management will endeavor
to maintain the Company's personalized approach even as pressures to succumb to
technological advances mount.
Maintain a Friendly Environment for Employees and Customers. The
Company has instituted various programs to instill high morale among its
employees which the Company believes translates into exceptional customer
service. For example, in the "Tell on Your Buddy" program, employees are
encouraged to share with senior managers good ideas and thoughts put into
practice by fellow employees
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and, in the process, make themselves eligible for a significant reward. The
Company also holds lively weekly sales meetings to elicit ideas about products
and services to emphasize. The Company believes that the overall effect of these
programs is to improve morale, customer service and financial performance.
MARKET AREAS
For operational purposes, the Company groups its markets into two
regions, the Triad region and the Wilmington region. The Company's deposit
market share in Reidsville as of June 30, 1997, the most recent date for which
data are available, was 32.6%, which ranked first among banks, credit unions and
thrift institutions, and in all of Rockingham County equaled 20.5% as of the
same date, which ranked first. The following table summarizes the banking
offices, deposits and market share for the Company's offices, categorized by
city.
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DEPOSITS AT DECEMBER 31,
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REGION/CITY 1997 1996
- ----------- -------- --------
(IN THOUSANDS)
<S> <C> <C>
TRIAD REGION:
Reidsville(1) ........................ $152,221 $145,377
Eden(1) .............................. 45,305 34,003
Madison .............................. 14,611 Not open
Ruffin ............................... 5,014 Not open
Greensboro ........................... 19,822 Not open
-------- --------
Subtotal ....................... 236,973 179,380
-------- --------
WILMINGTON REGION:
Wilmington ........................... 35,301 Not open
-------- --------
Total .......................... $272,274 $179,380
======== ========
</TABLE>
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(1) Includes three banking offices.
The following is a summary description of the Triad and Wilmington
market areas.
Triad - Rockingham County. Rockingham County was formed in 1785 and is
located in the north central area of North Carolina. It has a land area of 568
square miles and a population of 87,672. Surrounding counties are Guilford to
the south, Caswell to the east and Stokes County to the west. The county is
bordered on the north by the Commonwealth of Virginia. Piedmont Triad
International Airport is located 20 miles away and Norfolk Southern has two rail
connection lines in the county. The county, which consists of several community
oriented towns, provides a full range of municipal services and extends
financial support to certain boards, agencies, and commissions to assist its
efforts to serve its citizens. Rockingham County's economy remained strong
through 1996 (the most recent year for which data are available) with average
unemployment of 4.6%. During 1996 industrial and commercial activity for
Rockingham County created $47.0 million in new investments that created 343
jobs.
Triad - Greensboro. Greensboro has a diverse economy attributable to a
blend of trade, manufacturing and service businesses. Local industry is
characterized by the production of a wide range of products, including textiles,
apparel, tobacco, machinery and electronics equipment. The area has access to
major domestic and international markets from Interstate Highways 40 and 85 and
the Piedmont Triad International Airport. Entrepreneur magazine recently ranked
the Triad area as fourth in a list of the top 20 cities in which to establish a
small business. According to the U.S. Department of Commerce, the Triad area
recorded export sales of $3.6 billion in 1996 and is ranked 37th nationally in
that category.
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Wilmington. Wilmington is the county seat and the industrial center of
New Hanover County and its recent rate of growth has been topped by only one
other city in North Carolina. The total population of New Hanover County is
approximately 125,000 and it is served by Interstate Highway 40 and U.S.
Highways 17 and 74. The area is serviced by national and regional airlines
through facilities at the New Hanover International Airport in New Hanover
County. The New Hanover County area has experienced extensive industrial
development and service/trade sector growth over the past 20 years. The
Wilmington area industries produce fiber optic cables for the communications
industry, aircraft engine parts, pharmaceuticals, nuclear fuel components and
various textile products. The New Hanover County area economy has become broadly
diversified and has developed into a major resort area, a busy sea port (one of
North Carolina's only two deep water ports), a light manufacturing center, a
chemical manufacturing center and the distribution hub of southeastern North
Carolina.
LENDING ACTIVITIES
General. The Bank offers a broad array of lending services, including
real estate, commercial and consumer loans, to individuals and small to
medium-sized businesses and other organizations that are located in or conduct a
substantial portion of their business in the Bank's market areas. The Bank's
total loans at December 31, 1997 were $228.7 million, or 74.3% of total earning
assets. The Bank also makes secured construction loans to home builders and
residential mortgagees, which are often secured by first and second real estate
mortgages. At December 31, 1997, the Bank had no large loan concentrations
(exceeding ten percent of its portfolio) in any particular industry.
Loan Composition. The following table sets forth, at the dates
indicated, the composition of the Bank's loan portfolio and the related
percentage composition.
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AT DECEMBER 31,
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1997 1996 1995
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(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
REAL ESTATE:
Commercial ............................ $ 51,022 22.3% $ 30,516 21.1% $ 27,208 24.4%
Residential ........................... 58,238 25.5 44,109 30.5 36,438 32.6
Construction and development .......... 19,083 8.3 13,407 9.3 4,531 4.1
-------- ----- -------- ----- -------- -----
Total real estate ...... 128,343 56.1 88,032 60.9 67,177 61.1
-------- ----- -------- ----- -------- -----
COMMERCIAL, FINANCIAL AND AGRICULTURAL 54,294 23.7 25,175 17.4 18,248 16.3
-------- ----- -------- ----- -------- -----
CONSUMER:
Direct .......................... 23,237 10.2 16,766 11.6 15,247 13.6
Home equity ..................... 19,740 8.6 13,516 9.3 9,579 8.6
Revolving ....................... 3,101 1.4 1,096 0.8 457 0.4
-------- ----- -------- ----- -------- -----
Total consumer ........... 46,078 20.2 31,378 21.7 25,283 22.6
-------- ----- -------- ----- -------- -----
Total .................... $228,715 100% $144,585 100% $111,708 100%
======== ===== ======== ===== ======== =====
</TABLE>
Real Estate Loans. Loans secured by real estate for a variety of
purposes constituted $128.3 million, or 56.1 %, of the Bank's total loans at
December 31, 1997. The Bank held at December 31, 1997 real estate loans of
various sizes ranging up to $2.9 million, secured by office buildings, retail
establishments, warehouses, motels, restaurants and other types of property.
Loan terms are typically limited to five years, although the installment
payments may be structured generally on a 15-year amortization basis. Interest
rates may be fixed or adjustable, based on market conditions, and the Bank
generally charges an origination fee. Management has attempted to reduce credit
risk in the real estate portfolio by emphasizing loans on owner occupied office
and retail buildings where the loan to value ratio, established by independent
appraisals, does not exceed 80% and net project cash flow available for debt
service equals 120% of the debt service requirement. The Bank also often
requires personal guarantees of the principal owners of the property and obtains
personal financial statements of the principal owners in
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such cases. The Bank experienced no net loan losses on commercial real estate
loans during 1997 and 1996.
The Bank originates residential loans for its portfolio on single and
multi-family properties, both owner occupied and non-owner occupied, and at
December 31, 1997 it held $58.2 million of such loans. Loan terms are typically
limited to five years, with payments through the date of maturity generally
based on a 15 or 30 year amortization schedule. Rates may be fixed or variable,
and the Bank typically charges an origination fee. The Bank attempts to minimize
credit risk by requiring a loan to value ratio of 80% or less. The Bank has
experienced minimal loan losses on residential real estate over the past ten
years.
The Bank also originates residential loans for sale into the secondary
market. Through its mortgage banking division, the Bank originates both fixed
and variable rate residential mortgage loans for sale with servicing released.
The Bank is able to generate loan origination fees, typically ranging from 1.0%
to 1.5% of the loan balance which are recognized in income when the loan is
sold. During 1997 and 1996, the Bank earned loan origination fees of $81,000 and
$32,000, respectively. At December 31, 1997, the Bank held none of such loans
for sale, and during 1997 the Bank sold an aggregate of $5.6 million of such
loans. The Bank sells these loans on a non-recourse basis.
The Bank's current strategy is for the majority of construction and
development loans on commercial and residential projects to be in the range of
$0.3 million to $2.5 million, not to exceed $2.5 million. At December 31, 1997
and 1996, the Bank held $19.1 million and $13.4 million, respectively, of such
loans. To reduce credit risk associated with such loans, the Bank limits its
lending to projects involving small commercial centers that have strong anchor
tenants and are otherwise substantially pre-leased, or residential projects that
are either presold or are being built by the proposed occupant. The leases on
commercial projects must generally result in a loan to capitalized lease value
of no greater than 75% and a net cash flow to debt service ratio of at least
120%. The Bank historically has required a personal guarantee from the developer
or builder. Loan terms are typically 12 to 15 months on a commercial project and
nine months on a residential project, although the Bank occasionally will make a
"mini-permanent" loan for purposes of construction and development up to a three
to five year term. Rates are typically variable and the Bank typically charges
an origination fee. During 1997 and 1996, the Bank experienced no net loan
losses on these types of loans.
Commercial Loans. The Bank makes loans for commercial purposes in
various lines of businesses. At December 31, 1997, the Bank held $54.3 million
of commercial loans, or 23.7% of its total loan portfolio. Equipment loans are
typically made on terms up to five years at fixed or variable rates, with the
financed equipment pledged as collateral to the Bank. The Bank attempts to
reduce its credit risk on these loans by limiting the loan to value ratio to
80%. Working capital loans are made on terms typically not exceeding one year.
These loans may be secured or unsecured, but the Bank attempts to limit its
credit risk by requiring the borrower to demonstrate the capacity to produce net
cash flow available for debt service of 125% to 150% of debt service
requirements. During 1997, the Bank experienced net loan losses on commercial
loans of $6,000 and in 1996 had no such net loan losses.
Consumer Loans. The Bank makes a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans originated directly by the Bank, home equity revolving lines of
credit, and unsecured revolving lines of credit. The home equity loans and
certain of the direct loans are secured by the borrower's residence, but the
Bank attempts to underwrite the credit independent of the collateral value. At
December 31, 1997, the Bank held $43.8 million of consumer loans, including home
equity revolving lines of credit. During 1997 and 1996, respectively, the Bank
experienced net consumer loan losses of $29,000 and $35,000.
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Credit Card Loans. In 1996, the Bank began offering credit card loans
to individuals and businesses who meet the Bank's underwriting standards with
respect to income, credit rating, established residence and employment. Credit
card loans are subject to seasonal fluctuations based on consumer spending
habits, with the outstanding balances of such loans rising at the end of each
calendar year. At December 31, 1997, credit card loans equaled approximately
$2.3 million, or approximately 1.0% of the Bank's total loan portfolio. Net
losses on credit card loans equaled $19,000 in 1997 and $0 in 1996.
Loan Approval and Review. The Bank's loan approval policies provide for
various levels of officer lending authority. When the aggregate outstanding
loans to a single borrower exceeds that individual officer's lending authority,
the loan request must be considered and approved by an officer with a higher
lending limit. Branch loan officers typically have lending limits up to
$100,000; loans in excess of that limit must be approved by the city executive.
If the lending request exceeds the city executive's lending limit, which is
$500,000, the loan must be submitted to and approved by the appropriate senior
credit officer. The senior credit officer has authority to approve a loan up to
$750,000. All loans in excess of $750,000 must be approved by the President and
Chief Executive Officer, who may approve loans of up to $2.5 million.
The Bank has a continuous loan review procedure involving multiple
officers of the Bank which is designed to promote early identification of credit
quality problems through its credit management committee. All loan officers are
charged with the responsibility of reviewing no less than annually all credit
relationships in excess of $100,000 in their respective portfolios. All new
relationships, that is, those not more than 60 days old, in excess of $100,000
are reviewed by a credit management committee comprised of loan officers and
senior management every two weeks. Loan officers also review all criticized and
classified assets in their portfolio quarterly with the senior loan officers of
the Bank. The officers are responsible for implementing, where appropriate,
approved action plans with respect to such criticized and classified assets
designed to improve the Bank's credit position for an early resolution of the
problem loan. As part of its overall strategy to improve policies and
procedures, the Bank has also engaged a third party consultant to review its
loan portfolio, the first examination of which is expected to occur in 1998.
The Bank's credit review system supplements the Bank's loan rating
system, pursuant to which the Bank may place the loan on its criticized asset
list or may classify the loan in one of various other classification categories.
A specified minimum percentage of loans in each adverse asset classification
category, based on the historical loss experience in the Bank in each such
category, is used to determine the adequacy of the Bank's allowance for loan and
lease losses quarterly. These credits are also individually reviewed by senior
credit officers of the Bank to determine whether a greater allowance allocation
is justified due to the facts and circumstances of a particular adversely
classified loan.
Outsourcing of Certain Operational Functions. The Company has
agreements with third parties to provide a variety of specialized functions to
the Bank in connection with its lending operations. In each of these
relationships, the Bank benefits from the service provider's expertise and
economies of scale while retaining the flexibility to take advantage of changes
in available technology without impacting customer service.
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DEPOSITS
The Bank offers a variety of deposit programs to individuals and to
small and medium-sized businesses and other organizations at interest rates
generally competitive with local market conditions. The following table sets
forth the mix of depository accounts at the Bank as a percentage of total
deposits at the dates indicated.
<TABLE>
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AT DECEMBER 31,
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1997 1996 1995
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<S> <C> <C> <C>
Non-interest bearing demand 11.6% 12.2% 12.5%
Savings/NOW/MMI ........... 19.4 27.3 28.8
Certificates of deposits .. 69.0 60.5 58.7
----- ----- -----
100.0% 100.0% 100.0%
</TABLE>
The Bank accepts deposits at its ten banking offices, eight of which
have automated teller machines. The Bank's memberships in the "HONOR", "CIRRUS"
and "PLUS" networks allow customers access to their depository accounts from
regional ATM facilities. The Bank charges a fee of $1.50 per transaction for the
use of its ATM facilities by those who are not depositors with the Bank. The
Bank also operates two free-standing ATM'S. See "Properties." The Bank controls
deposit flows primarily through the pricing of such deposits and to a certain
extent through promotional activities, such as its "Prestige" and "Priority"
accounts for deposits of $25,000 and $75,000, respectively, and the "FNB Club"
which extends special privileges and sponsors group excursions to sites and
performances of interest to account holders over the age of 55. The Bank also
offers as a convenience to come to a customers home or place of business to
pick-up a non-cash deposit the customer wishes to make. At December 31, 1997,
the Bank had $59.7 million in certificates of deposit of $100,000 or more. In
January 1998, the Bank joined an electronic network which allows it to post
interest rates and attract certificates of deposit nationally. The investors are
generally credit unions or commercial banks (no brokers funds are accepted) and
amounts are typically just under $100,000, to assure FDIC insurance coverage.
Deposit rates are set weekly by senior management of the Bank. Management
believes that the rates it offers are competitive with those offered by other
institutions in the Bank's market areas.
INVESTMENT SERVICES
The Bank offers the services of an investment advisor employed by
American Express Financial Advisors who splits his time among seven of the
Bank's branches and is available to depositors, as well as those who are not
account holders in the Bank. This advisor offers mutual fund services, tax and
estate planning and other financial services and the Bank receives a commission
based on the advisor's sales. The Bank benefits by attracting customers to its
branches who may not otherwise have reason to transact business there and by
earning additional fees. In 1997, the Bank earned fees in the amount of $23,000
from commissions generated from these services.
MARKETING
The Bank currently markets its services through advertising campaigns
and in printed material, such as newspapers, magazines and direct mailings, as
well as through promotional items, such as caps, pens, pencils and shirts. The
Bank's officers are also heavily involved in local civic affairs and
philanthropic organizations in order to focus customers on products and services
on a personal level. The Bank occasionally sponsors community events and holds
grand opening ceremonies for its new branches to which local dignitaries are
invited to speak and participate in the festivities. Since the Company does not
have a fully-staffed marketing department, the Bank's marketing, advertising and
public relations campaigns focus on the following two components:
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- Value. Among other things, the Bank offers attractive rates
for its financial products, including its certificates of
deposit and checking accounts. This pricing structure has been
successful in attracting depositors who are motivated by the
Bank's rates, as well as by the variety of individualized
services the Bank promotes and offers.
- Convenience and Service. All personnel of the Bank aim toward
serving the individual needs of the Bank's customers. For
example, senior personnel are accessible on very short notice,
even after normal banking hours, by way of pagers and other
means. In addition, all employees are eligible to earn
incentive compensation for sales and cross-sales to customers.
Management intends to continue to market the Bank's services through a
combination of advertising campaigns, public relations activities and local
affiliations. In most of its markets, the Bank has established advisory boards,
comprised of local community leaders, to promote the Bank. While the key
messages of value, convenience, service and reliability will continue to play a
major role in the Bank's marketing and public relations efforts, management may
also focus on targeted groups, such as professionals, in addition to small to
medium-sized local businesses.
A vital part of the Bank's marketing plan is the execution of a public
relations strategy. Many traditional public relations methods will be used in
promoting Bank services. Management intends to pursue media coverage, including
general press, industry periodicals and other media covering banking and
finance, consumer issues and special interests. Press releases, quarterly
shareholder reports, media alerts and presentations will announce new banking
services as they are added.
COMPETITION
Commercial banking in North Carolina is extremely competitive, due in
large part to statewide branching. Currently, many of the Bank's competitors are
significantly larger and have greater resources than the Bank. The Bank
continues to encounter significant competition from a number of sources,
including bank holding companies, commercial banks, thrift institutions, credit
unions, and other financial institutions and financial intermediaries. Among
commercial banks, the Bank competes in its market areas with some of the largest
banking organizations in the State, several of which have as many as 200 to 300
branches in North Carolina. Competition with the Bank is not limited to
financial institutions based in North Carolina. The enactment of federal
legislation authorizing nationwide interstate banking has greatly increased the
size and financial resources of some of the Bank's competitors. Consequently,
many of the Bank's competitors have substantially higher lending limits due to
their greater total capitalization, and many perform functions for their
customers, such as trust services that the Bank does not offer. As a result of
the interstate banking legislation, the Bank's market is open to future
penetration by banks located in other states provided the other state allows
acquisitions of its banking institutions by North Carolina banking institutions,
thereby increasing competition. To date, there is interstate branching among
banks in North Carolina, Virginia, South Carolina and Tennessee.
The management of the Bank believes banks compete in the following
areas: convenience of location, interest rates for deposits and loans, types of
accounts and services offered, and quality of the personnel providing services.
In its early years, the Bank sought to attract depositors and borrowers
primarily through offering competitive interest rates for both loans and
deposits. More recently, the Bank has determined to compete primarily through
the quality of its services, experience of its personnel and community oriented
approach. The Bank also relies on the personal contacts of its officers and
directors to attract depositors and borrowers in its target market of small to
medium-sized businesses. In addition to its central Board of Directors, the Bank
has established local advisory boards in most of the communities served to
promote contacts in the business communities.
10
<PAGE> 11
EMPLOYEES
As of December 31, 1997, the Company had approximately 129 full-time
and 19 part-time employees. None of the employees of the Company are represented
by any collective bargaining unit. The Company considers its relations with its
employees to be good.
SUPERVISION AND REGULATION
As a bank holding company, the Company is subject to the supervision,
examination and reporting requirements contained in the Bank Holding Company Act
of 1956 (the "BHCA") and the regulations of the Federal Reserve Board (the
"Federal Reserve"). The Company's subsidiary is organized as a national banking
association and is subject to the supervision, examination and reporting
requirements of the Office of the Comptroller of the Currency ("OCC"). The
following discussion sets forth certain of the material elements of the
regulatory framework applicable to bank holding companies and their subsidiaries
and provides certain specific information relevant to the Company. This
regulatory framework is intended primarily for the protection of depositors and
the federal deposit insurance funds and not for the protection of security
holders. To the extent that the following information describes statutory and
regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. A change in applicable statutes,
regulations or regulatory policy may have a material effect on the business of
the Company.
General. As a bank holding company, the Company is subject to the
supervision, examination and reporting requirements contained in the BHCA and
the regulations of the Federal Reserve. The Bank is organized as a national
banking association and is subject to the supervision, examination and reporting
requirements of the OCC.
Under the BHCA, bank holding companies may not directly or indirectly
acquire the ownership or control of more than five percent of the voting shares
or substantially all of the assets of any company, including a bank, without the
prior approval of, or a waiver of the requirement for such approval by, the
Federal Reserve.
In addition, the Company's activities, and those of companies which it
controls or in which it holds more than five percent of the voting stock, are
limited to banking or managing or controlling banks or furnishing services to or
performing services for its subsidiaries, or any other activity which the
Federal Reserve determines to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. In determining whether a
particular activity is permissible, the Federal Reserve must consider whether
the performance of such an activity can reasonably be expected to produce
benefits to the public, such as greater convenience, increased competition or
gains in efficiency that outweigh possible adverse effects, such as undue
concentration of resources, decreased or unfair competition, conflicts of
interest or unsound banking practices. For example, banking, operating a thrift
institution, acquiring or servicing loans, leasing personal property, conducting
discount securities brokerage activities, performing certain data processing
services, acting as agent or broker in selling credit life insurance and certain
other types of insurance in connection with credit transactions and certain
insurance underwriting activities have all been determined by the Federal
Reserve to be permissible activities.
The Federal Reserve has the authority to prevent the continuance or
development of unsafe or unsound banking practices or other violations of law
and to take certain remedial action. In particular, the Federal Reserve has the
power to order a holding company or its subsidiaries to terminate any activity
or terminate its ownership or control of any subsidiary, despite prior approval
of such activity or such
11
<PAGE> 12
ownership or control, when it has reasonable cause to believe that continuation
of such activity or such ownership or control constitutes a serious risk to the
financial safety, soundness or stability of any bank subsidiary of that bank
holding company.
The Company is also subject to the North Carolina Bank Holding Company
Act of 1984 ("NCBHCA"). This statute prohibits bank holding companies from
acquiring or controlling certain non-bank banking institutions (for example,
institutions which accept deposits but do not make commercial loans) which have
offices in North Carolina. As required by the NCBHCA, the Company, by virtue of
its ownership of the Bank, has registered as a bank holding company with the
Commissioner of Banks of the State of North Carolina.
The earnings of the Company are affected by the legislative and
governmental actions of various regulatory authorities, including the Federal
Reserve Board, the OCC and the Federal Deposit Insurance Corporation (the
"FDIC"). In addition, there are numerous governmental requirements and
regulations that affect the activities of the Company.
On November 13, 1997, the Company and the OCC entered into a Memorandum
of Understanding (the "MOU"). The MOU, which was signed by all of the Company's
directors, arose out of the OCC's regular examination of the Company in 1997.
The actions that the OCC requested the Company to take were, generally, in the
nature of improving the Company's internal procedures and policies, such as
revising its written loan policy, developing a program to strengthen its loan
administration and taking steps to increase its liquidity commensurate with its
past, and expected future, growth. Following the Company's implementation of the
recommendations set forth in the MOU, in February 1998 the OCC informed the
Company that no further action was being requested and the Company believes that
it is in compliance with the provisions of the MOU. See Note 17 to the Company's
Consolidated Financial Statements and "Risk Factors - Memorandum of
Understanding" in Exhibit 99.01 of this report.
Payment of Dividends. The Company is a legal entity separate and
distinct from the Bank. A major portion of the Company's revenues result from
amounts paid as dividends to the Company by the Bank. The prior approval of the
OCC is required for the payment of any dividend by a national bank if the total
of all dividends declared by the board of directors of such bank in any calendar
year will exceed the sum of such bank's net profits for that year and its
retained net profits for the preceding two calendar years, less any required
transfers to surplus. Furthermore, unless and until a bank's surplus fund is
equal to its common capital, no dividend may be declared until the bank has
carried to its surplus fund not less than one-tenth of its net profits for the
preceding half-year (in the case of quarterly or semiannual dividends), or at
least one-tenth of its net profits for the preceding two consecutive half-years
(in the case of annual dividends). Federal law also prohibits any national bank
from paying dividends which would be greater than such bank's undivided profits
after deducting statutory bad debt in excess of such bank's allowance for loan
losses.
Under the foregoing dividend restrictions, as of December 31, 1997, the
Bank, without obtaining affirmative governmental approvals, could pay aggregate
dividends of $4.9 million to the Company.
In addition, the Company and the Bank are subject to various general
regulatory policies and requirements relating to the payment of dividends,
including requirements to maintain adequate capital above regulatory minimums.
The appropriate federal regulatory authority has the power to determine, under
certain circumstances relating to the financial condition of a national bank or
bank holding company, that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment thereof. The OCC (the appropriate
agency with respect to the Bank) has indicated that paying dividends that
deplete a bank's capital base to an inadequate level would be an unsound and
unsafe banking practice. The OCC, the FDIC and the Federal Reserve have each
indicated that banking organizations should generally pay dividends only out of
current operating earnings.
12
<PAGE> 13
Borrowings. There are also various legal restrictions on the extent to
which the Company can borrow or otherwise obtain credit from the Bank. In
general, these restrictions require that any such extensions of credit must be
secured by designated amounts of specified collateral and are limited, as to the
Company, to ten percent of the Bank's capital stock and surplus.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require payment of the
deficiency by assessment upon the bank's stockholders, pro rata and, to the
extent necessary, if any such assessment is not paid by any stockholder after
three months notice, to sell the stock of such stockholder to make good the
deficiency.
Under Federal Reserve policy, the Company is expected to act as a
source of financial strength to the Bank and to commit resources to support such
subsidiary. This support may be required at times when, absent such Federal
Reserve policy, the Company may not find itself willing or able to provide it.
Any capital loans by a bank holding company to any of its subsidiary
banks are subordinate in right of payment to deposits and to certain other
indebtedness of such subsidiary banks. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and entitled to a priority of payment.
Capital Adequacy. The Federal Reserve, the FDIC and the OCC have
adopted substantially similar risk-based and leverage capital guidelines for
United States banking organizations. Under these risk-based capital standards,
the minimum consolidated ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) is 8%. At least half of the total capital is to be composed of common
stockholders' equity, retained earnings, a limited amount of qualifying
perpetual preferred stock and minority interests in the equity accounts of
consolidated subsidiaries, less goodwill and certain intangibles ("Tier I
Capital" and, together with Tier 2 Capital, "Total Capital"). The remainder of
Total Capital may consist of mandatory convertible debt securities and a limited
amount of subordinated debt, qualifying preferred stock and loan loss allowance
("Tier 2 Capital"). At December 31, 1997, the Company's Tier I and Total Capital
ratios were 8.92% and 9.88%, respectively.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
leverage ratio of Tier I Capital to adjusted average quarterly assets less
certain amounts ("Leverage Ratio") equal to three percent for bank holding
companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required
to maintain a Leverage Ratio of between four percent and five percent. The
Company's Leverage Ratio at December 31, 1997, was 7.02%. The guidelines also
provide that bank holding companies experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets. Furthermore, the guidelines indicate that the Federal Reserve Board will
continue to consider a "tangible Tier I Leverage Ratio" (deducting all
intangibles) in evaluating proposals for expansion or new activity. The Federal
Reserve has not advised the Company of any specific minimum Leverage Ratio or
tangible Tier I Leverage Ratio applicable to it.
The Bank is subject to similar capital requirements adopted by the OCC
or the FDIC. The Bank had a Leverage Ratio of 6.79% as of December 31, 1997. The
federal banking agencies have not advised the Bank of any specific minimum
Leverage Ratio applicable to it.
13
<PAGE> 14
Prompt Corrective Action. The Federal Deposit Insurance Act, as amended
(the "FDIA"), among other things, requires the federal banking agencies to take
"prompt corrective action" in respect of depository institutions that do not
meet minimum capital requirements. The FDIA establishes five capital tiers:
"well capitalized"; "adequately capitalized"; "undercapitalized"; "significantly
undercapitalized"; and "critically undercapitalized". A depository institution's
capital tier will depend upon how its capital levels compare to various relevant
capital measures and certain other factors, as established by regulation.
The federal bank regulatory agencies have adopted regulations
establishing relevant capital measures and relevant capital levels applicable to
FDIC-insured banks. The relevant capital measures are the Total Capital Ratio,
Tier I Capital Ratio and the Leverage Ratio. Under the regulations, a
FDIC-insured bank will be (i) "well capitalized" if it has a Total Capital Ratio
of ten percent or greater, a Tier I Capital Ratio of six percent or greater and
a Leverage Ratio of five percent or greater and is not subject to any order or
written directive by the OCC to meet and maintain a specific capital level for
any capital measure; (ii) "adequately capitalized" if it has a Total Capital
Ratio of eight percent or greater, a Tier I Capital Ratio of four percent or
greater and a Leverage Ratio of four percent or greater (three percent in
certain circumstances) and is not "well capitalized"; (iii) "undercapitalized"
if it has a Total Capital Ratio of less than eight percent, a Tier I Capital
Ratio of less than four percent or a Leverage Ratio of less than four percent
(three percent in certain circumstances); (iv) "significantly undercapitalized"
if it has a Total Capital Ratio of less than six percent, a Tier I Capital Ratio
of less than three percent or a Leverage Ratio of less than three percent; and
(v) "critically undercapitalized" if its tangible equity is equal to or less
than two percent of average quarterly tangible assets. An institution may be
downgraded to, or deemed to be in, a capital category that is lower than is
indicated by its capital ratios if it is determined to be in an unsafe or
unsound condition or if it receives an unsatisfactory examination rating with
respect to certain matters. As of December 31, 1997, the Company's subsidiary
bank had capital levels that qualifies it as being "adequately capitalized"
under such regulations.
The FDIA generally prohibits an FDIC-insured depository institution
from making any capital distribution (including payment of a dividend) or paying
any management fee to its holding company if the depository institution would
thereafter be "undercapitalized." "Undercapitalized" depository institutions are
subject to growth limitations and are required to submit a capital restoration
plan. The federal banking agencies may not accept a capital plan without
determining, among other things, that the plan is based on realistic assumptions
and is likely to succeed in restoring the depository institution's capital. In
addition, for a capital restoration plan to be acceptable, the depository
institution's parent holding company must guarantee that the institution will
comply with such capital restoration plan. The aggregate liability of the parent
holding company is limited to the lesser of: (i) an amount equal to five percent
of the depository institution's total assets at the time it became
"undercapitalized"; and (ii) the amount which is necessary (or would have been
necessary) to bring the institution into compliance with all capital standards
applicable with respect to such institution as of the time it fails to comply
with the plan. If a depository institution fails to submit an acceptable plan,
it is treated as if it is "significantly undercapitalized."
"Significantly undercapitalized" insured depository institutions may be
subject to a number of requirements and restrictions, including orders to sell
sufficient voting stock to become "adequately capitalized," requirements to
reduce total assets, and cessation of receipt of deposits from correspondent
banks. "Critically undercapitalized" institutions are subject to the appointment
of a receiver or conservator. A bank that is not "well capitalized" is subject
to certain limitations relating to so-called "brokered" deposits.
Depositor Preference Statute. Under federal law, deposits and certain
claims for administrative expenses and employee compensation against an insured
depository institution would be afforded a priority over other general unsecured
claims against such an institution, including federal funds and letters of
credit, in the "liquidation or other resolution" of such an institution by any
receiver.
14
<PAGE> 15
Interstate Banking and Branching Legislation. The Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") permits
interstate acquisitions of banks and bank holding companies without geographic
limitation, subject to any state requirement that the bank has been organized
for a minimum period of time, not to exceed five years, and the requirement that
the bank holding company, prior to, or following the proposed acquisition,
controls no more than ten percent of the total amount of deposits of insured
depository institutions in the U.S. and no more than 30% of such deposits in any
state (or such lesser or greater amount set by state law).
In addition, the IBBEA permits a bank to merge with a bank in another
state as long as neither of the states has opted out of interstate branching
prior to May 31, 1997. The state of North Carolina has "opted in" to such
legislation, effective June 22, 1995. In addition, a bank may establish and
operate a de novo branch in a state in which the bank does not maintain a branch
if that state expressly permits de novo interstate branching. As a result of
North Carolina's opt-in law, North Carolina law permits unrestricted interstate
de novo branching.
FDIC Insurance Assessments. Effective January 1, 1996, the FDIC reduced
the insurance premiums it currently charges on bank deposits insured by the Bank
Insurance Fund ("BIF") to the statutory minimum of $2,000 for "well capitalized"
banks.
Effects of Governmental Policies. The earnings and business of the
Company and the Bank are and will be affected by the policies of various
regulatory authorities of the United States, especially the Federal Reserve. The
Federal Reserve, among other things, regulates the supply of credit and deals
with general economic conditions within the United States. The instruments of
monetary policy employed by the Federal Reserve for those purposes influence in
various ways the overall level of investments, loans, other extensions of credit
and deposits, and the interest rates paid on liabilities and received on assets.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases or owns ten banking offices, as shown in the
following table:
<TABLE>
<CAPTION>
LOCATION OWNED OR LEASED ATM(1) YEAR OPENED/PURCHASED
-------- --------------- ------ ---------------------
<S> <C> <C> <C>
202 South Main Street
Reidsville, North Carolina.......... Owned (2) X 1918(3)
1646 Freeway Drive
Reidsville, North Carolina.......... Owned X 1972
202 Turner Drive
Reidsville, North Carolina.......... Owned X 1989
203 East Meadow Road
Eden, North Carolina................ Leased (expires 2001) X 1987
801 South Van Buren Road
Eden, North Carolina................ Owned(4) X 1996
151 North Fieldcrest Road
Eden, North Carolina................ Leased (expires 2008) 1996
605 North Highway Street
Madison, North Carolina............. Owned X 1997
</TABLE>
<PAGE> 16
<TABLE>
<S> <C> <C> <C>
9570 U.S. 29 Business
Ruffin, North Carolina.............. Leased (expires 2004) 1997
2132 New Garden Road
Greensboro, North Carolina......... Owned X 1997
704 South College Road
Wilmington, North Carolina.......... Leased (expires 2002) X 1997
</TABLE>
- --------------
(1) Two additional remote ATM's are located in Reidsville, North Carolina
pursuant to leases that expire in 1998 and 2001, respectively. Each of
the ATM's situated at a banking office is a drive-up ATM.
(2) Consists of 27,000 square feet in a two story building and includes the
Company's executive offices.
(3) Original office opened in different location in 1918. Current office
opened in 1980.
(4) Serves as the main banking office in Eden. In 1996, the Bank also
closed an office located in Eden upon the expiration of the lease for
such office.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of operations, the Company is a party
to various legal proceedings. In the opinion of management, there is no
proceeding pending, or to the knowledge of management threatened, in which an
adverse decision could result in a material adverse change in the business or
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security
holders of the Company during the fourth quarter of the Company's fiscal year
ending December 31, 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Ernest J. Sewell, age 57, is the President, Chief Executive Officer and
a Director of the Company and the Bank. He assumed his current position on
January 26, 1995 after the resignation of Willard B. Apple, Jr. from those
positions on that date. Prior to joining the Company and the Bank, Mr. Sewell
served as Senior Vice President of Branch Banking and Trust Company, with 26
years of previous banking experience. Mr. Sewell is a member of the Board of
Trustees of Annie Penn Memorial Hospital, Reidsville, North Carolina, and is
Chairman of its Investment Committee. He also serves on the boards of various
charitable organizations and is Vice Chairman of the Rockingham County Airport
Authority.
Robert F. Albright, age 61, is Senior Vice President, Secretary and
Chief Financial Officer of the Company and the Bank, and Treasurer of the
Company. He joined the Bank in 1980 as Vice President and was elected Senior
Vice President and Secretary in 1985.
Richard L. Powell, age 46, is Senior Vice President, Support Services,
of the Company and the Bank, and Assistant Secretary of the Company. He joined
the Bank in 1986 as Assistant Vice President and was promoted to Vice President
in 1988 and to Senior Vice President in 1993.
Howard E. Campbell, age 51, became Senior Vice President of the Bank in
November 1997. From 1986 to 1995, Mr. Campbell was a Vice President at Branch
Banking and Trust Company, when he became a partner in North State Financial
Management Corp., an investment advisory firm. He was with
16
<PAGE> 17
The Fidelity Bank, headquartered in Fuquay-Varina, North Carolina, as a Vice
President during September and October 1997.
C. Melvin Gantt, age 60, is Senior Vice President, Area Manager, of the
Bank. He joined the Bank in 1968, was promoted to Assistant Vice President in
1975, to Vice President in 1978, and to Senior Vice President in 1987.
Deborah S. Pryor, age 45, is Senior Vice President, Operations, of the
Bank. She joined the Bank in 1971, was promoted to Assistant Vice President in
1988, to Vice President in 1991, and to Senior Vice President in 1995.
Arnold F. Robertson, age 54, is Senior Vice President, Sales Manager
and Marketing, of the Bank. He joined the Bank in 1969, was promoted to
Assistant Vice President in 1975, to Vice President in 1980 and to Senior Vice
President in 1988.
Kenneth B. Yates, age 40, is Senior Vice President, Loan Administration
and Loan Review, of the Bank. He joined the Bank in 1982 as General Auditor, was
promoted to Vice President in 1988 and to Senior Vice President in 1995.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from page 17 of the Company's 1997
Annual Report to Shareholders included as Exhibit 13.01 to this report.
The Company did not sell any securities in the fiscal year
ended December 31, 1997 which were not registered under the Securities Act of
1933, as amended, except that during such fiscal year the Company granted
options to employees and directors to acquire an aggregate of 90,330 shares of
its Common Stock at a weighted average exercise price of $23.1562 per share
pursuant to the Company's Omnibus Equity Compensation Plan.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Incorporated by reference from pages 5 through 16 of the
Company's 1997 Annual Report to Shareholders included as Exhibit 13.01 to this
report.
ITEM 7. FINANCIAL STATEMENTS
Incorporated by reference from pages 18 through 37 of the
Company's 1997 Annual Report to Shareholders included as Exhibit 13.01 to this
report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
17
<PAGE> 18
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 13,
1998, with respect to the Annual Meeting of Shareholders to be held on April 14,
1998.
ITEM 10. EXECUTIVE COMPENSATION
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 13,
1998, with respect to the Annual Meeting of Shareholders to be held on April 14,
1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 13,
1998, with respect to the Annual Meeting of Shareholders to be held on April 14,
1998.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 13,
1998, with respect to the Annual Meeting of Shareholders to be held on April 14,
1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
3.01(1) Articles of Incorporation and Amendments thereto.
3.02 Form of Amended and Restated Articles of Incorporation (to be
filed following shareholder approval at 1998 Annual Meeting of
Shareholders scheduled for April 14, 1998).
3.03(2) Bylaws of the Company.
3.04(3) Amendment to Bylaws of the Registrant.
4.01(4) Specimen Common Stock Certificate.
10.01(5) Stock Compensation Plan of the Registrant approved April 11,
1989 by the Shareholders of the Registrant, with forms of
stock option and stock bonus agreements attached.
10.02(1) Omnibus Equity Compensation Plan of the Registrant.
10.03(1) Severance Policy for Senior Officers of the Registrant
(employed for five years or more).
10.04(6) Revised Severance Policy for Senior Officers of the Registrant
(employed for five years or more).
10.05(1) Severance Policy for Senior Officers of the Registrant
(employed for less than five years).
10.06(7) Equipment Sale Agreement and related agreements dated
September 24, 1992 by and among the Registrant and Information
Technology, Inc.
10.07(8) Benefit Equivalency Plan effective January 1, 1994.
10.08(8) Annual Management Incentive Plan.
10.09(8) Long Term Incentive Plan.
</TABLE>
18
<PAGE> 19
<TABLE>
<S> <C>
10.10(8) Employment Agreement dated May 18, 1995 between the Registrant
and First National Bank of Reidsville, jointly, as employer,
and Ernest J. Sewell, President and Chief Executive Officer of
the Registrant and the Bank.
10.11(9) Split-Dollar Agreement dated January 27, 1995 between the
Registrant and Ernest J. Sewell.
10.12(9) Split-Dollar Agreement dated September 26, 1994 between the
Registrant and Robert F. Albright.
10.13(9) Split-Dollar Agreement dated January 27, 1995 between the
Registrant and C. Melvin Gantt.
10.14(9) Split-Dollar Agreement dated December 8, 1995 between the
Registrant and Richard L. Powell.
10.15 Lease, dated January 31, 1997, between the Registrant and
Landmark Commercial, Inc., relating to the Wilmington branch
office.
13.01 Those portions of the Registrant's 1997 Annual Report to
Shareholders which have been incorporated by reference into
this Annual Report on Form 10-KSB.
21.01 Subsidiaries of the Registrant.
23.01 Consent of Cherry, Bekaert & Holland, L.L.P.
99.01 Risk Factors relating to the Registrant.
</TABLE>
- --------------------------
(1) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1996, filed with the Securities and Exchange Commission.
(2) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1988, filed with the Securities and Exchange Commission.
(3) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1991, filed with the Securities and Exchange Commission.
(4) Incorporated herein by reference the Registrant's Registration
Statement on Form S-14 (No. 2-90095), filed with the
Securities and Exchange Commission.
(5) Incorporated herein by reference to the Registrant's
Registration Statement on Form S-8 (No. 33-33186), filed with
the Securities and Exchange Commission.
(6) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1994, filed with the Securities and Exchange Commission.
(7) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1992, filed with the Securities and Exchange Commission.
(8) Incorporated herein by reference to the Registrant's Quarterly
Report on Form 10-QSB for the fiscal quarter ended June 30,
1995, filed with the Securities and Exchange Commission.
(9) Incorporated herein by reference to the Registrant's
Registration Statement on Form S-2 (File No. 333-47203) filed
with the Securities and Exchange Commission on March 3, 1998.
(b) Reports on Form 8-K.
None.
19
<PAGE> 20
FORWARD-LOOKING STATEMENTS
Information set forth in this Annual Report on Form 10-KSB under the
caption "Business" and incorporated by reference herein from the Company's
Annual Report to Shareholders contains various "forward looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, which statements represent the Company's
judgment concerning the future and are subject to risks and uncertainties that
could cause the Company's actual operating results and financial position to
differ materially. Such forward looking statements can be identified by the use
of forward looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," or "continue," or the negative thereof or other various thereof or
comparable terminology.
The Company cautions that any such forward looking statements are
further qualified by important factors that could cause the Company's actual
operating results to differ materially from those in the forward looking
statements, including without limitation, the effects of future economic
conditions, governmental fiscal and monetary policies, legislative and
regulatory changes, the risks of changes in interest rates on the level and
composition of deposits, the effects of competition from other financial
institutions, the failure of assumptions underlying the establishment of the
allowance for possible loan losses, the low trading volume of the Company's
Common Stock, other considerations described in connection with specific forward
looking statements and the other Risk Factors described in Exhibit 99.01
attached to this report.
20
<PAGE> 21
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FNB FINANCIAL SERVICES CORPORATION
Date: March 17, 1998
By: /s/ Ernest J. Sewell
-----------------------------------------
Ernest J. Sewell, President
and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
/s/ Ernest J. Sewell President, Chief Executive Officer and Director March 17, 1998
- ----------------------------- (Principal Executive Officer)
Ernest J. Sewell
/s/ Robert F. Albright Senior Vice President and Chief Financial Officer March 17, 1998
- ----------------------------- (Principal Financial Officer)
Robert F. Albright
/s/ Michael W. Shelton Vice President and Controller (Principal March 17, 1998
- ----------------------------- Accounting Officer)
Michael W. Shelton
/s/ Willard B. Apple, Jr. Chairman of the Board March 17, 1998
- -----------------------------
Willard B. Apple, Jr.
/s/ Charles A. Britt Director March 17, 1998
- -----------------------------
Charles A. Britt
/s/ Barry Z. Dodson Director March 17, 1998
- -----------------------------
Barry Z. Dodson
/s/ O. Eddie Green Director March 17, 1998
- -----------------------------
O. Eddie Green
Director March __, 1998
- -----------------------------
Joseph H. Kinnarney
/s/ Clifton G. Payne Director March 17, 1998
- -----------------------------
Clifton G. Payne
/s/ Elton H. Trent, Jr. Director March 17, 1998
- -----------------------------
Elton H. Trent, Jr.
Director March __, 1998
- -----------------------------
Kenan C. Wright
</TABLE>
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<S> <C>
3.02 Form of Amended and Restated Articles of Incorporation.
10.15 Lease, dated January 31, 1997, between the Registrant
and Landmark Commercial, Inc., relating to the
Wilmington branch office.
13.01 Those portions of the Registrant's 1997 Annual Report
to Shareholders which have been incorporated by
reference in this Annual Report on Form 10-KSB.
21.01 Subsidiaries of the Registrant.
23.01 Consent of Cherry, Bekaert & Holland, L.L.P.
99.01 Risk Factors relating to the Company.
</TABLE>
22
<PAGE> 1
EXHIBIT 3.02
FORM OF AMENDED AND RESTATED
ARTICLES OF INCORPORATION
1. The name of the corporation is FNB Financial Services
Corporation.
2. The period of duration of the corporation shall be perpetual.
3. The purposes for which the corporation is organized are:
(a) to purchase, own, and hold the stock of other corporations, and to
do every act and thing covered generally by the denomination "bank holding
corporation" or "holding corporation," and especially to direct the operations
of banks, banking associations or other corporations through the ownership of
stock therein;
(b) to purchase, subscribe for, acquire, own, hold, sell, exchange,
assign, transfer, create security interests in, pledge, or otherwise dispose of
shares of the capital stock, or any bonds, notes, securities, or evidences of
indebtedness created by any other corporation or corporations organized under
the laws of this state or any other state and also bonds or evidences of
indebtedness of the United States or of any state, district, territory or
subdivision or municipality thereof and to issue in exchange therefor shares of
the capital stock, bonds, notes, or other obligations of the corporation and
while the owner thereof to exercise all the rights, powers and privileges of
ownership including the right to vote on any shares of stock so owned;
(c) to promote, lend money to, and guarantee the dividends, stocks,
bonds, notes, evidences of indebtedness, contracts, or other obligations of, and
otherwise aid in any manner which shall be lawful, any corporation or
association of which any bonds, stocks or other securities or evidences of
indebtedness shall be held by or for this corporation, or in which, or in the
welfare of which, this corporation shall have any interest, and to do any acts
and things permitted by law and designed to protect, preserve, improve, or
enhance the value of any such bonds, stocks, or other securities or evidences of
indebtedness or the property of this corporation;
(d) To engage in any other lawful act or activity for which
corporations may be organized under Chapter 55 of the General Statutes of North
Carolina, entitled "Business Corporation Act", including, but not limited to,
manufacturing, purchasing or otherwise acquiring, owning, mortgaging, pledging,
selling, assigning and transferring, or otherwise disposing of, investing,
trading, dealing in and with, goods, wares and merchandise and property of every
class and description, whether real, personal, mixed, tangible, or intangible;
entering into or serving in any kind of management, investigative, advisory,
promotional, protective, insurance, guarantyship, suretyship, fiduciary or
representative relationship or capacity for any persons or corporations
whatsoever; and
(e) To engage in, conduct and operate any other business which may be
deemed adopted, directly or indirectly, to add to the profits of its business or
to increase the value of its property.
In furtherance and not in limitation of the power conferred by the laws
of the State of North Carolina upon corporations organized for the foregoing
purposes, the corporation shall have power to borrow money, to lend money, to
guarantee obligations, to purchase, construct, lease or otherwise acquire, own,
hold, use, maintain, operate or otherwise manage or control, sell, exchange,
lease, mortgage, pledge or
<PAGE> 2
otherwise dispose of, property of any kind or character, real, personal or
mixed, tangible or intangible, necessary, useful or convenient therefor, and to
acquire, hold, mortgage, pledge or dispose of shares, bonds and other evidences
of indebtedness and securities of the United States of America or any state or
municipality therein or of any domestic or foreign corporation.
The foregoing clauses shall be construed as enumerating specific
purposes and powers, but no recitation, expression or declaration of specific
purposes or powers herein enumerated shall be deemed to be exclusive, but it is
hereby expressly declared that all other lawful purposes and powers not
inconsistent therewith are hereby included.
The Board of Directors of the corporation shall have the authority to
adopt resolutions approving the indemnification, to the fullest extent permitted
by Chapter 55 of the North Carolina General Statutes, of any person made a party
to any action or proceeding, whether civil, criminal or administrative, by
reason of the fact that such person was serving as director, officer, employee
or agent of the corporation.
4. A. Classes of Stock. The corporation is authorized to issue
two classes of shares to be designated, respectively, "Common Stock" and
"Preferred Stock". The total number of shares of capital stock that the
corporation shall have authority to issue is fifty million (50,000,000). The
total number of shares of Common Stock the corporation shall have authority to
issue is forty million (40,000,000) shares, par value $1.00 per share. The total
number of shares of Preferred Stock the corporation shall have authority to
issue is ten million (10,000,000) shares, no par value.
B. Rights, Preferences and Restrictions of Preferred Stock.
The Preferred Stock authorized by these Articles of Incorporation may be issued
from time to time in one or more classes or series, the shares of each such
class or series to have such designations, preferences, relative rights, powers,
including voting powers, and par value, if any (or qualifications, limitations
or restrictions thereof) as are stated in the resolution or resolutions
providing for the issuance of such class or series adopted by the Board of
Directors of the corporation. Authority is expressly granted to the Board of
Directors, subject to the provisions hereof and to any limitations provided
under the North Carolina Business Corporation Act, to authorize the issuance of
one or more classes, or one or more series within a class, of Preferred Stock,
and with respect to each such class or series to determine and fix by resolution
or resolutions the designations, preferences, relative rights, powers, including
voting powers, full or limited, or no voting power, and the par value, if any,
of such shares, or the qualifications, limitations or restrictions of such
shares. This paragraph is intended to afford to the Board of Directors the
maximum authority under Section 55-6-02 of the North Carolina General Statutes.
5. The minimum amount of consideration to be received by the
corporation for its shares before it shall commence business is Five Hundred
Dollars ($500.00) in cash or property of equivalent value.
6. No holder of any stock or other securities of the corporation shall
be entitled to any preemptive right to purchase any stock or other securities of
the corporation.
7. The address of the initial registered office of the corporation is
202 South Main Street, Reidsville, Rockingham County, North Carolina, 27320 and
the name of the initial registered agent at such address is W.B. Apple, Jr.
8. The board of directors of the corporation shall be and is divided
into three classes, Class I, Class II and Class III, which shall be as nearly
equal in number as possible. Each director shall serve for a
<PAGE> 3
term ending on the date of the third annual meeting of stockholders following
the annual meeting at which the director was elected; provided, however, that
each initial director named herein shall hold office until the annual meeting of
shareholders shown as follows:
<TABLE>
<CAPTION>
Term of Office Expires
Directors In: With Annual Meeting In:
------------ ----------------------
<S> <C>
Class I 1985
Class II 1986
Class III 1987
</TABLE>
A director elected to fill a vacancy shall serve for the remainder of
their present term of office of the class to which he was elected.
9. The name and address of the sole incorporator are:
<TABLE>
<CAPTION>
Name Address
---- -------
<S> <C>
W. B. Apple, Jr 2307 Pine Lane
Reidsville, N. C. 27320
</TABLE>
10. The corporation shall not consolidate with, or merge with or into,
any other corporation or convey to any corporation or other person or otherwise
dispose of all or substantially all of the assets or dispose of by any means all
or substantially all of the stock or assets of any major subsidiary of the
corporation unless such consolidation, merger, conveyance or disposition is
approved (a) by the affirmative vote of not less than seventy-five percent (75%)
of the aggregate voting power of the outstanding stock entitled to vote thereon,
and (b) by the affirmative vote of not less than seventy-five percent (75%) of
the aggregate voting power of the outstanding stock entitled to vote thereon,
which shall include the affirmative vote of at least fifty percent (50%) of the
voting power of the outstanding stock of shareholders entitled to vote thereon
other than controlling shareholders, (i) if the shareholder entitled to vote
thereon is a person who, including affiliates of such person, is the beneficial
owner (as the terms are defined in the Securities and Exchange Act of 1934 and
in the rules thereunder) of more than twenty percent (20%) of the voting power
of the corporation (a "controlling shareholder") provided that shares held,
voted or otherwise controlled by a person as a trustee, plan administrator,
officer of the corporation or otherwise pursuant to an employee benefit plan of
the corporation or of an affiliate of the corporation shall not be deemed to be
beneficially owned by any person for the purpose of determining whether a person
is a controlling shareholder, and (ii) if, prior to the acquisition of twenty
percent (20%) of the voting power of the corporation by a shareholder, the Board
of Directors of the corporation had not unanimously approved such consolidation,
merger, conveyance or disposition. If there is a controlling shareholder, this
article can be amended only by the affirmative vote of the voting power of the
corporation then required to approve a consolidation, merger, conveyance or
disposition under this article.
11. No director of this corporation shall be liable for monetary
damages for breach of his duty as a director arising out of any legal action
whether by or in the right of the corporation or otherwise, except (i) acts or
omissions not made in good faith that the director at the time of such breach
knew or believed were in conflict with the best interests of the corporation,
(ii) any liability under Section 55-32 of the General Statutes of North
Carolina, (iii) any transaction from which the director derived an improper
personal benefit, or (iv) acts or omissions occurring prior to June 13, 1988.
<PAGE> 1
Exhibit 10.15
STATE OF NORTH CAROLINA
COUNTY OF NEW HANOVER LEASE
THIS LEASE, made this 31st day of January, 1997, by and between
Landmark Commercial, Inc., a North Carolina Corporation, whose address is P. O.
Box 4127, Wilmington, North Carolina, 28406, (hereinafter "Landlord"), and First
National Bank of Reidsville, a North Carolina Corporation (hereinafter "Tenant")
W I T N E S S E T H:
Upon the terms and conditions hereinafter set forth, the Landlord
leases to Tenant and Tenant leases from Landlord property referred to as the
Premises, all as follows:
1. PREMISES. The Premises shall consist of a single story steel frame
building together with appurtenant paved surfaces upon a tract of real property
located in Wilmington, New Hanover County, North Carolina, as shown on EXHIBIT
A, which is attached hereto and incorporated within this Lease by this
reference.
2. TERM. The initial term of this Lease shall be for a period of five
(5) year(s) and shall commence on the 3rd day of February, 1997 (the
"Commencement Date") and ending on the 2nd day of February, 2002 at midnight
unless sooner terminated as hereinafter provided.
Tenant's inability or failure to take possession of the Premises when
delivery is tendered by Landlord (with the tenant improvements substantially
completed) shall not delay the commencement of the term of the Lease or Tenant's
obligation to pay rent. Tenant acknowledges that Landlord shall incur
significant expenses upon the execution of this Lease, even if Tenant never
takes possession of the Premises, including without limitation legal and other
professional fees. Tenant acknowledges that all of said expenses shall be
included in measuring Landlord's damages should Tenant breach the terms of this
Lease.
3. RENTAL.
3.1 Base Rent. For the first year of the term of this Lease,
Tenant agrees to pay to Landlord as Rent for the Premises, the sum of SEVENTY
NINE THOUSAND TWO HUNDRED DOLLARS ($79,200.00) per year (subject to adjustment
as hereinafter provided). Said Rent shall be amortized and paid on a monthly
basis and each month's payment shall be paid in advance on the first day of each
and every calendar month during said term. In the event the term of this Lease
commences or ends on a day other than (the first day of a calendar month, then
the rental for the first and last months of the lease term shall be prorated in
the proportion that the number of days this Lease is in effect during such
months bears to Thirty (30), and such rental shall be paid at the commencement
of such months. Said rental shall be paid to Landlord, without deduction or
offset, in lawful money of the United States of America, which shall be legal
tender
<PAGE> 2
at the time of payment, at the office of Landlord or to such other person
or at such other place as Landlord may from time to time designate in writing.
(SEE SPECIAL STIPULATIONS)
3.2 Late Fees. Tenant hereby acknowledges that if any monthly
payment of rent or any monies due hereunder from Tenant shall not be received by
Landlord or the Managing Agent of Landlord within five (5) days after such
payment is due, then Tenant shall pay the Landlord a late charge equal to 5% of
such delinquent amount. Any amounts payable hereunder by Tenant to Landlord
which are not paid on or before the date due as provided in this Lease shall
bear interest at the rate of one and one-half percent (1 1/2%) per month (18%
per year) from said due date until paid.
3.3 First and Last Months' Rent in Advance. Upon execution of
this Lease by Tenant, Tenant shall pay the first and last months' rent, receipt
of which is acknowledged by Landlord. Interest shall not accrue on said monies
and in the event of any default by Tenant hereunder, such amounts may be applied
to any amounts owned by Tenant to Landlord.
3.4 Rent Adjustment. Commencing as of February 1, 1998, and as
of February 1 of each year thereafter (the "Adjustment Date"), the Base Rent set
forth in the foregoing Section 3.1, as the same may be adjusted as provided
herein, shall be adjusted increasing the Base Rent by three percent (3%) on each
Adjustment Date. (See Special Stipulations)
4. REAL PROPERTY TAXES.
4.1 Payment of Taxes. Tenant shall pay the real property tax,
as defined in paragraph 4.2, applicable to the Premises during the term of this
Lease. All such payments shall be made at least ten (10) days prior to the
delinquency date of such Payment. Tenant shall promptly furnish Landlord with
satisfactory evidence that such taxes have been paid within five (5) days of
having made such payment. If any such taxes paid by Tenant shall cover any
period of time prior to or after the expiration of the term hereof, Tenant's
share of such taxes shall be equitably prorated to cover only the period of time
within the calendar year during which this Lease shall be in effect, and
Landlord shall reimburse Tenant to the extent required. If Tenant shall fail to
pay any such taxes, Landlord shall have the right to pay the same, in which case
Tenant shall repay such amount to Landlord with Tenant's next rent installment
together with interest at the maximum rate then allowable by law.
4.2 Definition of "Real Property Tax". As used herein, the
term "real property tax" shall include any form of real estate tax or
assessment, imposed on the Premises by any authority having the direct or
indirect power to tax, including any city, state or federal government, or any
school, agricultural, sanitary, fire, street, drainage or other improvement
district thereof. Notwithstanding the foregoing, the term "real property tax"
shall not include any tax which is imposed as a result of a transfer, either
partial or total, of Landlord's interest in the Premises or which is added to a
tax or charge hereinbefore included within the definition of real property tax
by reason of such transfer, or which is imposed by reason of this transaction,
any modifications or changes hereto, or any transfers hereof.
<PAGE> 3
4.3 Personal Property Taxes. Tenant shall pay prior to
delinquency all taxes assessed against and levied upon fixtures, furnishings,
equipment and all other personal property of Tenant contained in the Premises or
elsewhere. When possible, Tenant shall cause said fixtures, furnishings,
equipment and all other personal property to be assessed and billed separately
from the real property of Landlord.
5. INSURANCE.
5.1. Property Insurance.
(a) Tenant, at its expense, shall obtain and keep in
force during the term of this Lease a policy of insurance covering loss or
damage to the Premises, in the amount of the full replacement value thereof, as
the same may exist from time to time, but in no event less than the total amount
required by lenders who have liens on the Premises, against all perils included
within the classification of fire and extended perils ("all risk" as such term
is used in the insurance industry). Said insurance shall provide for payment of
loss thereunder to Landlord or to the holders of mortgages or deeds of trust on
the Premises. Insurance required hereunder shall be obtained from companies
holding a "General Policyholders Rating" of at least A+, or such other rating as
may be required by a lender having a lien on the Premises, as set forth in the
most current issue of "Best Insurance Guide". Tenant shall provide Landlord with
proof of insurance prior to occupancy and at all other reasonable times as
requested by Landlord. If Tenant shall fail to pay any such taxes, Landlord
shall have the right to pay the same, in which case Tenant shall repay such
amount to Landlord with Tenant's next rent installment together with interest at
the maximum rate then allowable by law.
(b) Tenant shall insure its fixtures, equipment and
Tenant improvements. In addition thereto Tenant shall maintain loss of income
coverage as business peril coverage.
5.2 Liability Insurance. Tenant shall, at Tenant's expense,
obtain and keep in force during the term of this Lease a policy of Combined
Single Limit, Bodily Injury and Property Damage insurance insuring Landlord and
Tenant against any liability arising out of the ownership, use, occupancy or
maintenance of the Premises. Such insurance shall be a combined single limit
policy in an amount not less than $1,000,000.00 per occurrence.
6. UTILITIES. Tenant shall pay before delinquency, at its sole cost and
expense, all charges for water, gas, heat, air conditioning, electricity, power,
telephone service, sewer charges and all other charges for services or utilities
of whatsoever kind or nature used in, upon or about the Premises by Tenant or
any of its licensees or concessionaires during the term hereof.
7. MAINTENANCE AND REPAIRS. Tenant shall, at Tenant's sole cost and
expense, keep and maintain the Premises in good condition and repair; damage
thereto from causes beyond the reasonable control of Tenant and ordinary wear
and tear excepted. Tenant's obligations pursuant to this provision shall include
all janitorial, cleaning services and maintenance to the parking areas. Tenant
specifically acknowledges that its maintenance responsibility pursuant to this
paragraph
<PAGE> 4
shall include drive through teller window systems, vault doors, the security and
surveillance systems, electrical and lighting systems including light bulbs and
tubes, plumbing systems, heating, ventilating, and air conditioning systems
repairs. In addition, Tenant agrees to change all air filters for the heating
venting and air conditioning system at a minimum of each SIXTY (60) DAYS. Tenant
shall, upon the expiration or sooner termination of the term hereof, surrender
the Premises to Landlord in the same condition as upon occupancy of the Premises
was completed, ordinary wear and tear and damage from causes beyond the
reasonable control of Tenant excepted.
Tenant shall also repair and maintain at its sole cost and expense the
roof deck, exterior walls, foundation, and the structural support of the
building located on the Premises. Tenant shall undertake such maintenance and
repairs within a reasonable time after written notice of the need for such
maintenance or repairs is given by Tenant and received by Landlord, but in no
event longer than five (5) days after receipt of such notice.
Landlord shall administer all construction warranties, if any, for a
period of one (1) year after Commencement Date. Thereafter, Landlord shall
assign all continuing warranties to Tenant and shall have no further
responsibility for maintenance and repair.
8. RIGHT OF ENTRY. Tenant shall permit the Landlord or its authorized
representatives to enter the Premises at all reasonable times to inspect the
Premises and to make any necessary repairs, alterations, additions or
improvements thereto. Nothing contained in this paragraph shall be deemed to
create any duty upon the part of the Landlord to do any such work and the
performance of such work by the Landlord shall not constitute a waiver of the
Landlord's remedies in the event that such work should have been performed by
the Tenant.
9. ALTERATIONS. Tenant may, at its own expense, from time to time make
such alterations, additions or changes, structural or otherwise, in and to the
building or paved areas appurtenant to the building to be constructed as it may
deem necessary or suitable; provided, however, Tenant shall obtain Landlord's
prior written consent to such alterations, additions or changes of a structural
nature; provided, further, Landlord shall not withhold its consent thereto if
the structural integrity of the building will not be impaired by such work.
Landlord shall cooperate with Tenant in securing building or other permits or
authorizations required from time to time for any work permitted hereunder or
installations by Tenant.
10. USE OF PREMISES. The Premises are leased to Tenant for the purpose
of conducting therein banking services and office use. Tenant shall comply with
all governmental rules, regulations, ordinances, statutes and laws now or
hereafter in effect pertaining to the Premises or Tenant's use thereof. Tenant
shall at all times during the term hereof comply with all other reasonable rules
and regulations which Landlord or others may at any time or from time to time
establish concerning use of the Premises; provided, however, that any such rule
or regulation so made shall not be inconsistent with any part of this Lease,
shall not unreasonably interfere with Tenant's use and enjoyment of the
Premises.
<PAGE> 5
11. DEFAULTS; REMEDIES:
11.1 Defaults. The occurrence of any one or more of the
following events shall constitute a material default and breach of this Lease by
Tenant:
(a) The vacating or abandoning of the Premises by
Tenant.
(b) The failure by Tenant to make any payment of rent
or any other payment required to be made by Tenant hereunder, as and when due,
where such failure shall continue for a period of fifteen (15) days after
written notice thereof from Landlord to Tenant.
(c) The failure by Tenant to observe or perform any
of the covenants, conditions or provisions of this Lease to be observed or
performed by Tenant other than described in paragraph (b) above, where such
failure shall continue for a period of thirty (30) days after written notice
thereof from Landlord to Tenant; provided, however, that if the nature of
Tenant's default is such that more than thirty (30) days are reasonably required
for its cure, then Tenant shall not be deemed to be in default if Tenant
commenced such cure within said thirty (30) day period and thereafter diligently
prosecutes such cure to completion.
(d)(i) The making by Tenant of any general
arrangement or assignment for the benefit of creditors; (ii) Tenant becomes a
"debtor" as defined in 11 U.S.C. Section 101 or any successor statute thereto
(unless, in the case of a petition filed against Tenant, the same is dismissed
within sixty (60) days); (iii) the appointment of a trustee or receiver to take
possession of substantially all of Tenant's assets located at the Premises or of
Tenant's interest in this Lease, where possession is not restored to Tenant
within thirty (30) days; or (iv) the attachment, execution or other judicial
seizure of substantially all of Tenant's assets located at the Premises or of
Tenant's interest in this Lease, where such seizure is not discharged within
thirty (30) days.
11.2 Remedies. In the event of any such material default or
breach by Tenant, Landlord may at any time thereafter, with or without notice or
demand and without limiting Landlord in the exercise of any right or remedy
which Landlord may have by reason of such default or breach:
(a) Terminate Tenant's right to possession of the
Premises by any lawful means, in which case this Lease shall terminate and
tenant shall immediately surrender possession of the Premises to Landlord. In
such event Landlord shall be entitled to recover from Tenant all damages
incurred by Landlord by reason of Tenant's default including, but not limited
to, the cost of recovering possession of the Premises, expenses of reletting,
including necessary renovation and alteration of the Premises and reasonable
attorney's fees.
(b) Pursue any other remedy now or hereafter
available to Landlord under the laws or judicial decisions of the State of North
Carolina. Unpaid installments of rent and other unpaid monetary obligations of
Tenant under the terms of this Lease shall bear interest from the date due at
the maximum rate then allowable by law.
<PAGE> 6
12. EMINENT DOMAIN. If the whole of the Premises shall be taken, or
such part thereof shall be taken as shall substantially interfere with Tenant's
use and occupancy of the balance thereof, under power of eminent domain, or
sold, transferred, or conveyed in lieu thereof, either Tenant or Landlord may
terminate this Lease as of the date of such condemnation or as of the date
possession is taken by the condemning authority, whichever date occurs later. In
the event of a partial taking, or a sale, transfer, or conveyance in lieu
thereof, which does not result in a termination of this Lease, Landlord shall
restore the Premises substantially to their condition prior to such partial
taking.
13. DAMAGE OR DESTRUCTION. Except as otherwise provided for herein, if
at any time during the lease term or any renewal hereof, the Premises are
damaged or destroyed by any peril, the Landlord shall with due diligence, repair
and restore the Premises so far as practicable to their condition immediately
before such damage.
14. SUBORDINATION.
(a) Landlord hereby covenants, warrants and agrees that at all
times during the term of this Lease, provided Tenant is not in default
hereunder, Tenant shall have full, peaceful and quiet possession of the
Premises.
(b) Tenant agrees that this Lease shall automatically be and
remain subject and subordinate to all present and future mortgages, deeds to
secure debt or other security instruments (the "Security Deeds") affecting the
Premises. Tenant shall promptly execute and deliver to Landlord such certificate
or certificates in writing as Landlord may request, confirming the subordinate
nature of the Lease to such Security Deeds, and in default of Tenant so doing,
Landlord shall be and is hereby authorized and empowered to execute such
certificate in the name of and as the act and deed of Tenant, this authority
being hereby declared to be coupled with an interest and to be irrevocable.
(c) In the event any proceedings are brought for the
foreclosure of, or in the event of exercise of power of sale under, any first
mortgage covering Landlord's interest in the Premises, and such holder takes
possession of the Premises, either as the result of foreclosure of such mortgage
or by accepting a deed to the Premises in lieu of foreclosure, or the Premises
shall be purchased at such a foreclosure by a third party, and such holder or
third party shall furnish Tenant satisfactory evidence that it has acquired
title to the Premises subject to no liens or encumbrances superior to this
Lease, other than taxes not yet due and payable, Tenant shall attorn to such
holder or third party and recognize it as its landlord under this Lease, and
such holder or third party will in such event recognize and accept Tenant as its
tenant hereunder, whereupon this Lease shall continue in full force and effect
as a direct lease between such holder or third party and Tenant for the term of
this Lease and such holder or third party shall, henceforth, be subject to all
of the terms of this Lease and perform all of the obligations of Landlord
hereunder with (lie same force and effect as if it were originally named as
Landlord hereunder; provided, however, that if conflicting claims should be made
to the rent payable hereunder, Tenant shall have the right to institute an
interpleader suit for the purpose of determining who is entitled to payment of
such rent and to pay the rent in accordance with the judicial determination
rendered in such proceeding.
<PAGE> 7
15. HOLDING OVER. Should Tenant or any of its successors in interest
continue to hold the Premises after termination of this Lease, whether such
termination occurs by lapse of time or otherwise, with Landlord's acquiescence,
and without any distinct agreement between the parties, such holding over shall
constitute and be construed as a tenancy at sufferance at a monthly rental equal
to twice the monthly rental (including Base Monthly Rental and any adjusted and
Additional Rent) provided herein at the time of such termination, if Landlord
elects to accept such rent. During such time as Tenant shall continue to hold
the Premises after the termination hereof, Tenant shall be regarded as a tenant
at sufferance and not a tenant at will; subject, however, to all the terms,
provisions, covenants and agreements on the part of Tenant hereunder. No
payments of money by Tenant to Landlord after the termination of this Lease
shall reinstate, continue, renew or extend the Term and no extension of this
Lease after the termination hereof shall be valid unless and until the same
shall be reduced to writing and signed by both Landlord and Tenant. Tenant shall
be liable to Landlord for all damage which Landlord shall suffer by reason of
Tenant's holding over and Tenant shall indemnify, defend and hold Landlord
harmless against all claims made by any other tenant or prospective tenant
against Landlord resulting from delay by Landlord in delivering possession of
the Premises to such other tenant or prospective tenant. If Landlord accepts
rent pursuant to this Paragraph, Landlord shall always have the right to
terminate Tenant's possession under this Paragraph upon thirty (30) days prior
written notice to Tenant
16. ASSIGNMENT AND SUBLETTING. Limitations. Tenant shall have the right
to sublet the Premises or any part thereof upon written approval from Landlord
such approval not to be unreasonably withheld. Tenant may sublet or assign to
any of its subsidiaries or affiliates, provided, however, such assignment or
subletting shall in no way relieve Tenant of any liability under this Lease. In
the event that Tenant should sublease the Premises for an amount greater than
the then current Base Rent, then Landlord shall be entitled to FIFTY PERCENT
(50%) of the difference between the then current Base Rent and the sublease base
rent. Such difference shall be paid to Landlord in conjunction with Base Rents
as the sublease base rents are received. Under no circumstances shall any
provision provided for in this paragraph 16 relieve Tenant of its liabilities
under this Lease.
17. INDEMNITY. Except for losses, damages and claims arising out of the
acts or omissions of Landlord or Landlord's agents, contractors and employees,
Tenant shall indemnify and hold harmless Landlord from and against any and all
claims arising from Tenant's use of the Premises, or from the conduct of
Tenant's business or from any activity, work or things done, permitted or
suffered by Tenant in or about the Premises or elsewhere and shall further
indemnify and hold harmless Landlord from and against any and all claims arising
from any breach or default in the performance of any obligations on Tenant's
part to be performed under the terms of (his Lease, or arising from any
negligence of the Tenant, or any such claim or any action or proceeding brought
thereon; and in case any action or proceeding be brought against Landlord by
reason of any such claim, Tenant upon notice from Landlord shall defend the same
at Tenant's expense.
<PAGE> 8
18. TITLE TO IMPROVEMENTS. Title to the building, Landlord-provided
mechanical systems, Tenant-provided structural additions and paving shall remain
vested in Landlord throughout the term of this Lease. Title to trade fixtures
installed by Tenant shall remain vested in Tenant.
19. "FOR RENT" OR "FOR SALE" SIGNS. During the final twelve (12) months
of this Lease term, or at any time subsequent to notice from either party of the
intention to terminate this Lease, Landlord shall be entitled to place and keep
in a conspicuous place on the Premises "For Rent" and/or "For Sale" signs for
the information of the public. During such time, prospective purchasers or
tenants of the Premises may inspect the Premises during normal business hours
and upon reasonable notice to Tenant.
20. SIGNS. Landlord's approval must be obtained by Tenant before the
erection and placement of any signs on or about the Premises, which approval
shall not be unreasonably withheld.
21. ESTOPPEL CERTIFICATES. At any time and from time to time, upon not
less than fifteen (15) days prior written notice, both Landlord and Tenant shall
execute, acknowledge and deliver to the other a statement in writing certifying
that this Lease is unmodified and in full force and effect (or if modified,
stating the nature of such modification and certifying that this Lease, as so
modified, is in full force and effect) and the dates to which the rental, the
security deposit if any, and other charges, if any, are paid in advance, and
acknowledging that there are not any uncured defaults on the part of either the
Landlord or the Tenant.
22. NOTICES. All notices given pursuant to this Lease shall be mailed
to the following addresses:
If To Landlord: Grayson Powell
Landmark Commercial, Inc.
P. O. Box 4127
Wilmington, NC 28406
If To Tenant: Earnest Sewell
First National Bank
P. O. Box 2037
Reidsville, NC 27323-2037
23. ENTIRE AGREEMENT. This Lease contains the entire agreement between
the parties with respect to the Lease of the Premises, and it may not be
modified in any manner other than by an agreement in writing signed by both
parties or their successors in interest. All prior conversations or writings
between the parties or their successors in interest. All prior conversations or
writing between the parties or their representatives with respect to the
Premises are merged into this Lease.
<PAGE> 9
24. PROVISIONS SEVERABLE. If any term or provision of this Lease or the
application thereof to any person or circumstance shall, to any extent, be
invalid or unenforceable, the remainder of the Lease or the application of that
term or provision to persons or circumstances other than those as to which it is
held invalid or unenforceable, shall not be affected thereby, and each term and
provision of this Lease shall be valid and enforceable to the fullest extent
permitted by law.
25. SPECIAL STIPULATIONS. The Special Stipulations, if any, attached
hereto and initialed by Landlord and Tenant are hereby incorporated herein and
made a part hereof. In the event the Special Stipulations conflict with any of
the foregoing provisions of this Lease, the Special Stipulations shall control.
26. APPLICABLE LAW. The laws of the State of North Carolina shall
govern and be controlling in the determination of the validity, interpretation
and construction of this Lease, and in all questions relating to the performance
and consummation of this Lease.
27. TIME IS OF THE ESSENCE. Time is of the essence with the respect to
the performance of each of the covenants and agreements of this Lease; provided,
however, that failure of Landlord to provide Tenant with any notification
regarding adjustments in Base Monthly Rental, or any other charges provided for
hereunder, within the time periods prescribed in this Lease shall not relieve
Tenant of its obligation to make such payments, which payments shall be made by
Tenant at such time as notice is subsequently given.
28. RECORDING. This Lease shall not be recorded, however, upon or
before the Commencement Date, the Landlord agrees to execute and delivery a
memorandum hereof suitable for recording. Such recording shall be at the expense
of Tenant.
IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease in
triplicate originals, all as of the day and year first above written.
LANDLORD:
Landmark Commercial, Inc., a North
Carolina Corporation
(CORPORATE SEAL)
[signature illegible]
------------------------------------
President
Date: 1/31/97 Time: 11:00 am
--------- ----------
ATTEST:
/s/ H. Renae Hinnart
- -----------------------------
Asst. Secretary
<PAGE> 10
Tenant:
First National Bank, a North
Carolina Corporation
(CORPORATE SEAL)
/s/ Richard Powell
------------------------------------
Senior Vice President
Date: 1/6/97 Time: 10:15
-------- -------
ATTEST:
/s/ Shelby Baker
- -------------------------
______ Secretary
STATE OF NORTH CAROLINA
COUNTY OF NEW HANOVER
I, Betty S. Pope, a Notary Public in and for the State and County
aforesaid, certify that H. Renae Hinnart personally came before me this day and
acknowledged that he/she is Asst. Secretary of LANDMARK COMMERCIAL, INC., a
North Carolina corporation with its principal office in New Hanover County, and
that by authority duly given and as the act of the corporation, the foregoing
instrument was signed in its name by its ______ President, sealed with its
corporation seal, and attested by himself/herself as its Asst. Secretary.
Witness my hand and official stamp or seal, this the 31st day of
January, 1997.
/s/ Betty S. Pope
------------------------------
Notary Public
My Commission Expires: Nov. 8, 2001
---------------
<PAGE> 11
STATE OF NORTH CAROLINA
COUNTY OF ROCKINGHAM
I, Vickie B. Washburn, a Notary Public in and for the State and County
aforesaid, certify that R.F. Albright personally came before me this day and
acknowledged that he is Corp. Secretary of FIRST NATIONAL BANK, a North Carolina
corporation with its principal office in Rockingham County, and that by
authority duly given and as the act of the corporation, the foregoing instrument
was signed in its name by its SR. Vice President, sealed with its corporation
seal, and attested by himself/herself as its Corp. Secretary.
Witness my hand and official stamp or seal, this the 8 day of January,
1997.
/s/ Vickie B. Washburn
-----------------------------------
Notary Public
My Commission Expires: 5-3-97
---------
<PAGE> 12
[On this page, there appears Exhibit A to the Wilmington branch lease which is a
survey, performed in May of 1994, showing the tract of real property located in
Wilmington, New Hanover County, North Carolina and the building which is the
subject of the Lease.]
<PAGE> 13
SPECIAL STIPULATIONS
1. Landlord and Tenant agree that Tenant shall have the Tight to renew this
lease for TWO (2) additional terms of FIVE (5) years under the same terms and
conditions as set forth in this Lease, provided Tenant is not in default under
this Lease at the time of Tenant's exercise of said right. Tenant shall give
written notice to Landlord of Tenant's exercise of said option for the first
additional five year term (First Renewal Period) ONE HUNDRED EIGHTY (180) DAYS
prior to the expiration of the initial lease term or said right to renew shall
expire.
Tenant shall give written notice to Landlord of Tenant's exercise of said option
for the second additional five year term (Second Renewal Period) ONE HUNDRED
EIGHTY (180) DAYS prior to the expiration of the then current lease term or said
right to renew shall expire.
2. The rent payable during the First Renewal Period and the Second Renewal
Period shall be increased every year unless otherwise provided herein, during
the term hereof, in an amount equal to the greater of two and one half percent
(2.5%) over the Rent charged for the immediately preceding one year period, or,
an amount equal to the percentage increase in the U.S. Department of Labor,
Bureau of Labor Statistics Consumer Price Index For All Urban Consumers (1982-84
= 100) All Items, at each anniversary date over the corresponding index as it
existed one year earlier and applying such increase to the rent charged for the
prior year. In the event the Consumer Price Index is discontinued, a comparable
publication or index will be used to determine any increase. In no event shall
the rental computed above be more than seven percent (7.0%).
<PAGE> 1
EXHIBIT 13.01
1997 ANNUAL REPORT TO SHAREHOLDERS
<PAGE> 2
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SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE, RATIO AND OTHER DATA)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net interest income........................ $ 10,961 $ 8,598 $ 7,250 $ 6,641 $ 6,747
Provision for loan losses.................. 760 415 260 105 190
Non-interest income........................ 1,354 1,252 1,236 927 1,206
Non-interest expense....................... 7,903(1) 6,004 5,190 5,333 4,788
Net income................................. 2,477 2,410 2,170 1,592(2) 2,129
BALANCE SHEET DATA:
Assets..................................... $325,151 $209,796 $177,897 $169,231 $153,541
Loans(3)................................... 228,715 144,585 111,708 79,787 82,449
Allowance for loan losses.................. 2,331 1,638 1,258 1,052 1,174
Deposits................................... 272,274 179,380 154,400 132,474 134,121
Other borrowings........................... 28,720 8,650 3,152 21,130 2,591
Shareholders' equity....................... 22,518 20,386 18,982 14,920 16,153
PER COMMON SHARE DATA(4):
Net income, basic.......................... $ 1.00 $ 0.98 $ 0.89 $ 0.65 $ 0.87
Net income, diluted(5)..................... 0.93 0.96 0.88 0.65 0.87
Cash dividends declared.................... 0.39 0.34 0.30 0.27 0.26
Book value................................. 9.03 8.29 7.78 6.12 6.61
Tangible book value........................ 8.74 7.98 7.78 6.12 6.61
OTHER DATA:
Branch offices............................. 10 6 5 5 5
Full-time employees........................ 129 95 87 90 91
PERFORMANCE RATIOS:
Return on average assets................... 0.96% 1.23% 1.27% 1.03% 1.42%
Return on average equity................... 11.86 12.52 12.91 9.76 13.91
Net interest margin (taxable equivalent)... 4.57 4.84 4.72 4.84 5.09
Dividend payout............................ 39.00 35.17 33.92 41.30 29.55
Efficiency(6).............................. 63.22 58.93 58.16 66.61 56.86
ASSET QUALITY RATIOS:
Allowance for loan losses to period end
loans.................................... 1.02% 1.13% 1.13% 1.32% 1.42%
Allowance for loan losses to period end
non-performing loans(7).................. 180 299 2,859 670 136
Net charge-offs to average loans........... 0.04 0.03 0.06 0.28 0.21
Non-performing assets to period end loans
and foreclosed property(7)............... 0.58 0.40 0.21 0.43 1.01
CAPITAL AND LIQUIDITY RATIOS:
Average equity to average assets........... 8.09% 9.85% 9.80% 10.55% 10.18%
Leverage................................... 7.02 9.60 10.80 10.11 10.53
Tier 1 risk-based.......................... 8.92 13.49 15.80 18.24 17.78
Total risk-based........................... 9.88 15.10 16.70 19.39 19.03
Average loans to average deposits.......... 84.17 76.37 65.64 60.23 64.92
Average loans to average deposits and
borrowings............................... 79.06 73.81 61.42 58.20 64.15
</TABLE>
- ---------------
(1) Includes approximately $1.4 million of non-interest expense attributable to
the opening of four new branches in 1997.
(2) Includes: (i) a non-recurring expense of approximately $200,000 resulting
from an acquisition terminated by the Company; (ii) a write-down on
mortgages held for sale of approximately $214,000; and (iii) an expense of
approximately $129,000 associated with increased equipment expense.
(3) Loans exclusive of unearned income, before allowance for losses.
(4) Gives effect to the 1996 Stock Split and the 1997 Stock Splits.
(5) Assumes the exercise of outstanding options to acquire Common Stock. See
Note 13 to the Company's Consolidated Financial Statements.
(6) Computed by dividing non-interest expense by the sum of taxable equivalent
net interest income and non-interest income.
(7) Non-performing loans and non-performing assets include loans past due 90
days or more that are still accruing interest.
------------------
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Four
<PAGE> 3
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- -------------------------------------------------------------------------
The following discussion provides information about the major components of
the results of operations and financial condition, liquidity and capital
resources of the Company and should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto. See also "Forward Looking
Statements" on page thirty-nine of this Annual Report.
OVERVIEW
During 1997, management of the Company
placed particular emphasis on the Company's
strategic financial objectives of balance sheet
growth and improved earnings performance.
Efforts which had begun in 1995 to position the
Company for strong growth, both internally and
through opportunistic expansion into existing,
new and contiguous markets, accelerated in 1997
with the openings of the Wilmington, Greensboro,
[PASTE-UP NET INCOME GRAPH] Ruffin and Madison branch offices.
In 1997, the Company aimed to manage
balance sheet risk and reduce credit risk while,
at the same time, increase market share and
geographic reach. The Company's steady
improvement in earnings performance occurred
even though significant costs were incurred to
add experienced personnel and begin fundamental
improvements to the Company's systems, policies
and procedures. In 1998, management expects to
incur additional costs in these areas, but views
these costs as investments that will contribute
to strengthening the Company's financial
performance, as well as support its growth
objectives.
RESULTS OF OPERATIONS
During 1997, the Company achieved record
earnings despite simultaneously incurring
substantial expenses associated with entering
new markets. Net income was approximately $2.5
million, or $1.00 per share, compared to
approximately $2.4 million, or $0.98 per share,
in 1996. This increase of 2.8% in net income
occurred despite (i) a 31.6% increase in
non-interest expense from $6.0 million to $7.9
million principally associated with the opening
of four new locations during 1997, and (ii) an
increase in the provision for loan losses from
$415,000 to $760,000 related to the growth in
the loan portfolio. Of the increase in
non-interest expense, approximately $1.4 million
was attributable to expenses associated with
opening the new branches. Net income in 1996
represented an improvement of 11.1% over the
prior year. Strong local economic conditions in
the Company's markets, robust loan demand and
excellent asset quality experience have been
among the key factors driving the Company's
[PASTE-UP NET INCOME GRAPH] performance.
The Company's primary source of income is
net interest income, which is the difference
between (i) interest income and fees derived
from earning assets (primarily loans and
investment securities) and (ii) the cost of
funds (primarily deposits and other borrowings)
supporting them. Net interest income represents
the gross profit from the lending and investment
activities of a banking organization and is the
most significant factor affecting the earnings
of the Company. Net interest income is affected
by changes in interest rates, volume and the mix
of these various components. Net interest income
on a fully taxable equivalent basis was $11.1
million which represented a 24.7% increase over
the previous year. In 1996, taxable equivalent
net interest income increased to approximately
$8.9 million from approximately $7.7 million in
1995, an increase of 16.3%. Actual net interest
income was 27.5% higher in 1997, following an
18.6% improvement in 1996.
------------------
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Five
<PAGE> 4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 2
AVERAGE BALANCE AND NET INTEREST INCOME ANALYSIS
FULLY TAXABLE EQUIVALENT BASIS
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------- ------------------------------- -------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance(3) Expense Rate Balance(3) Expense Rate Balance(3) Expense Rate
---------- -------- ------- ---------- -------- ------- ---------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Loans, net(2).............. $185,829 $17,616 9.48% $129,150 $12,092 9.36% $ 94,692 $ 9,067 9.58%
Taxable investment
securities............... 47,669 2,800 5.87 42,214 2,480 5.87 50,859 3,222 6.34
Tax-exempt investment
securities............... 6,135 542 8.83(1) 10,985 995 9.06(1) 13,451 1,284 9.55(1)
Other securities........... 884 63 7.13 756 52 6.88 950 67 7.05
Deposits with FHLB......... 849 47 5.54 485 26 5.36 219 13 5.94
Federal funds sold and
securities purchased
under agreements to
resell................... 2,477 133 5.37 1,027 53 5.16 2,815 163 5.79
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total earning assets... 243,843 21,201 8.69 184,617 15,698 8.50 162,986 13,816 8.48
NON-EARNING ASSETS:
Cash and due from banks.... 6,845 5,201 4,417
Premises and equipment..... 6,166 4,042 3,438
Other assets............... 3,302 2,953 1,752
Less: Allowance for loan
loss..................... (1,882) (1,440) (1,104)
-------- -------- --------
Total assets........... $258,274 $195,373 $171,489
======== ======== ========
INTEREST BEARING LIABILITIES:
Savings and time
deposits................. 195,311 9,287 4.75 148,400 6,449 4.35 125,523 5,508 4.39
Federal funds purchased,
borrowed funds and
securities sold under
agreements to
repurchase............... 14,270 769 5.39 5,868 313 5.33 9,920 625 6.29
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest bearing
liabilities.......... 209,581 10,056 4.80 154,268 6,762 4.38 135,443 6,133 4.53
-------- -------- --------
OTHER LIABILITIES AND
SHAREHOLDERS' EQUITY:
Demand deposits............ 25,474 20,721 18,733
Other liabilities.......... 2,329 1,131 503
Shareholders' equity....... 20,890 19,253 16,810
-------- -------- --------
Total liabilities and
shareholders'
equity............... $258,274 $195,373 $171,489
======== ======== ========
Net interest income and net
yield on earning
assets(3)(4)............. $11,145 4.57% $ 8,936 4.84% $ 7,683 4.72%
======= ==== ======= ==== ======= ====
Interest rate spread(5).... 3.89% 4.12% 3.95%
==== ==== ====
</TABLE>
- ---------------
(1)The fully tax equivalent basis is computed using a federal tax rate of 34%.
(2)The average loan balances include non-accruing loans.
(3)The average balances for all years include market adjustments to fair value
for securities and loans available/held for sale, with such adjustments
excluded for purposes of computing average yield.
(4)Net yield on earning assets is computed by dividing net interest income by
average earning assets.
(5)Earning asset yield minus interest bearing liabilities rate.
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Six
<PAGE> 5
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
[PASTE-UP NET INCOME GRAPH] Fueling the growth in net interest income
in 1997 was a 43.9% increase in average loans.
Average loans outstanding during the year
equaled $185.8 million compared to $129.2
million in 1996, an increase of $56.6 million.
This followed a 36.4% increase in average loans
outstanding in 1996. A more aggressive focus on
lending opportunities in the Company's
established markets in Rockingham County,
together with the recruitment of experienced,
locally-based senior lenders in the Company's
new markets, such as Wilmington and Greensboro,
have generated this loan growth. Also
contributing to the increased loan demand has
been a relatively stable interest rate
environment, as well as favorable economic
conditions both nationally and in the Company's
lending markets. These factors have resulted in
increased economic activity evidenced by the
higher levels of new business formation,
expansions by existing businesses and
significant levels of new residential and
commercial real estate development. The average
yield on the Company's loan portfolio increased
12 basis points to 9.48% in 1997 compared to
9.36% in 1996. The 1996 average yield fell 22 basis points from 9.58% in 1995.
The prime rate which had averaged 8.85% in 1995, remained at 8.25% in 1996. In
1997, it increased 25 basis points to 8.50% in March and remained there for the
rest of the year. Approximately 62% of the Company's loan portfolio floats with
variable rate indices, such as the prime rate. When interest rates rise,
interest income on this segment of the portfolio tends to increase. Conversely,
interest income from loans generally declines if interest rates fall and these
variable rate loans reprice at lower rates.
Net interest income as a percentage of average earning assets declined 27
basis points in 1997, averaging 4.57% compared to 4.84% in 1996. In 1995, the
net yield on earning assets averaged 4.72%. The decline in 1997 was attributable
to a 42 basis point increase in the cost of interest bearing liabilities. The
average rate on interest bearing liabilities in 1997 was 4.80% compared to 4.38%
in 1996. Although the Company was able to increase average non-interest bearing
demand deposits to $25.5 million in 1997 from $20.7 million in 1996, an increase
of 22.9%, deposit growth was concentrated in the higher cost interest bearing
accounts, primarily certificates of deposit. Average savings and time deposits
in 1997 increased to $195.3 million from $148.4 million in 1996, an increase of
31.6%. Apart from the increase in the average yield on loans in 1997, changes in
the average yields on the other earning assets had a minimal impact on interest
income.
Table 2 on page six summarizes net interest income and average yields and
rates paid for the years indicated on a taxable equivalent basis. Table 3 on
page eight presents the changes in interest income and interest expense
attributable to volume and rate changes between 1997 and 1996 and 1996 and 1995.
NON-INTEREST INCOME AND EXPENSE
Non-interest income of $1.35 million in 1997 was $102,000, or 8.1%, more
than the prior year. Excluding securities gains for each year, non-interest
income increased $371,000, or 39.3%, in 1997 compared to 1996. In 1996,
non-interest income was relatively flat compared to 1995, having increased by
1.3%. Deposit service charges were 20.1% higher in 1997 due principally to
volume. Securities gains were $38,000 in 1997 compared to $307,000 in 1996.
During 1996, the Company restructured its investment portfolio to increase
liquidity and fund growth in loan demand. This presented opportunities to take
gains on the Available for Sale portion of its securities portfolio. While
mortgage lending remains a part of the Company's overall lending program, the
Company is not staffed, nor does it currently intend, to be an aggressive,
volume driven mortgage loan originator. This segment of the market is extremely
competitive and the Company competes with several large companies. The Company
offers a variety of mortgage products on a competitive basis in the markets in
which it operates and generally sells its fixed rate production in the secondary
market.
Non-interest expenses increased $1.9 million, or 31.6%, in 1997 to $7.9
million compared to $6.0 million in 1996. The Company also experienced a
significant increase of 15.7%, or $814,000, in these expenses in 1996 over 1995.
The underlying reason for these increases has been the additional investments,
particularly in adding experienced personnel, which were needed to position the
Company to manage its growth.
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Seven
<PAGE> 6
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 3
VOLUME AND RATE VARIANCE ANALYSIS
YEAR ENDED DECEMBER 31, 1997 AND 1996
FULLY TAXABLE EQUIVALENT BASIS
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
1997 1996
------------------------------- -------------------------------
Volume(2) Rate(2) Total Volume(2) Rate(2) Total
Variance Variance Variance Variance Variance Variance
--------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans, net............................... $5,303 $ 221 $5,524 $3,261 $(236) $3,025
Taxable investment securities............ 320 0 320 (525) (216) (741)
Tax exempt investment securities(1)...... (439) (14) (453) (154) (40) (194)
Other earning assets..................... 29 3 32 5 (7) (2)
Federal funds sold and securities
purchased under agreement to resell.... 75 5 80 (98) (13) (111)
------ ----- ------ ------ ----- ------
Total interest income.................. 5,288 215 5,503 2,489 (512) 1,977
------ ----- ------ ------ ----- ------
Interest expense:
Savings and time deposits................ 2,039 799 2,838 996 (56) 940
Federal funds purchased, borrowed funds
and securities sold under agreements to
repurchase............................. 448 8 456 (236) (75) (311)
------ ----- ------ ------ ----- ------
Total interest expense................. 2,487 807 3,294 760 (131) 629
------ ----- ------ ------ ----- ------
Inc/(dec) in net interest income......... $2,801 $(592) $2,209 $1,729 $(381) $1,348
====== ===== ====== ====== ===== ======
</TABLE>
- ---------------
(1)The fully tax equivalent basis is computed using a federal tax rate of 34%.
(2)Changes attributable to both volume and rate have been allocated
proportionately.
TABLE 4
INVESTMENT SECURITIES
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 December 31, 1995
------------------------------ ------------------------------ ------------------------------
Weighted Weighted Weighted
Amortized Market Average Amortized Market Average Amortized Market Average
Cost Value Yield Cost Value Yield Cost Value Yield
--------- ------- -------- --------- ------- -------- --------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury.................. $ 3,074 $ 3,092 5.98% $13,075 $13,076 5.32% $ 4,220 $ 4,226 5.98%
U.S. government agency......... 68,997 68,973 6.01 31,906 31,760 5.87 38,386 38,217 6.42
State and municipal
obligations(1)............... 4,953 5,281 9.11 6,693 7,093 9.45 13,064 13,993 9.84
Other.......................... 1,392 1,392 7.08 643 643 6.93 1,059 1,059 7.06
------- ------- ---- ------- ------- ---- ------- ------- -----
Total investment
securities(1)............ $78,416 $78,738 6.22 $52,317 $52,572 6.20 $56,729 $57,495 7.19
======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------------------------------------------------
After One After Five
Within Year to Years to After
One Year Five Years Ten Years Ten Years Weighted
--------------- --------------- -------------- -------------- Average
Amount Yield Amount Yield Amount Yield Amount Yield Total Yield(1)
------ ----- ------- ----- ------ ----- ------ ----- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury...................... $ 0 -- $ 3,074 5.98% $ 0 -- $ 0 -- $ 3,074 5.98%
U.S. government agency............. $2,001 5.63% 64,979 6.02 $2,017 5.89% 0 -- 68,997 6.01
State and municipal
obligations(1)................... 101 12.50 1,057 11.51 3,065 8.49 $ 730 7.85% 4,953 9.11
Other.............................. 0 -- 0 -- 0 -- 1,392 7.08 1,392 7.08
------ ----- ------- ----- ------ ----- ------ ----- ------- ----
Total investment
securities(1)................ $2,102 5.96 $69,110 6.10 $5,082 7.46 $2,122 7.34 $78,416 6.22
====== ======= ====== ====== =======
</TABLE>
- ---------------
(1) Yields stated on a tax equivalent basis.
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Eight
<PAGE> 7
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
Personnel costs rose $1.1 million, or 29.7%, in 1997 as the Company hired
experienced, senior commercial lenders and branch personnel to staff the four
new locations that were opened in 1997. At December 31, 1997, the Company had
approximately 129 full-time and 19 part-time employees compared to 95 and 9,
respectively at December 31, 1996. Also contributing to the increase in
personnel expense for both 1997 and 1996 were salary increases for existing
staff, increased funding for management incentive programs, higher employment
taxes and increased costs associated with the Company's benefit programs. In
1997 the non-interest expenses associated with opening new branches equalled
approximately $1.4 million, comprised of approximately $863,000 for personnel,
$238,000 for occupancy and equipment and $320,000 for other expenses.
Similar increases in occupancy and
furniture and fixtures expenses occurred in
1997. Occupancy expense rose $184,000, or 53.3%,
in 1997 and furniture and fixtures expense rose
$163,000, or 35.1%. In 1996, the combined
increase for these same items was $89,000 or
12.3% more than 1995. Factors causing the 1997
increase include additional depreciation expense
for premises and equipment, lease expenses,
utilities, and general operating expenses
associated with the new branches in Greensboro,
Madison, Wilmington and Ruffin, as well as
normal increases in operating the Company's
remaining branches. Occupancy and furniture and
fixtures expense in 1996 increased due
principally to the addition of a new main office
facility in Eden and the acquisition of a branch
[PASTE-UP NET INCOME GRAPH] in Eden from another financial institution.
All other non-interest expenses of $2.0
million in 1997 represented an increase of 30.2%
over 1996 and were related to the additional
offices opened, with printing, stationery and
supplies, postage, marketing and advertising,
telephone and travel all sharply higher. The
efficiency ratio, which measures non-interest
expense as a percentage of net interest income
plus non-interest income, was 63.2% for 1997
versus 58.9% the previous year, with the
increase largely caused by the high level of
non-interest expense in 1997.
FINANCIAL CONDITION
The Company's consolidated assets increased
55.0% and 17.9% during 1997 and 1996,
respectively. Asset growth occurred primarily in
loans and is directly related to deposit growth,
both at existing offices and through new branch
offices. During 1996, the Company completed a
branch acquisition in a community near Eden,
North Carolina which included approximately
$14.0 million in deposits. This acquired growth,
the internal growth generated with the Company's
existing markets and the anticipated increase in
market share for the four new 1997 branches are
expected to continue to produce positive results
[PASTE-UP NET INCOME GRAPH] for the Company.
The Company's commercial loan portfolio has
grown significantly over the past two years.
Loans secured by real estate equaled $128.3
million, or 56.1% of the loan portfolio at
December 31, 1997, compared to $88.0 million, or
60.9%, at December 31, 1996. Table 5 on page ten
provides a five year analysis of the loan
portfolio by major loan type. Management
believes the Company is not dependent on any
single customer or group of customers
concentrated in a particular industry, the loss
of whose deposits or whose insolvency would have
a material adverse effect on operations.
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Nine
<PAGE> 8
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 5
LOAN PORTFOLIO COMPOSITION
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Commercial.................... $ 51,022 22.3% $ 30,516 21.1% $ 27,208 24.4% $15,037 18.8% $13,611 16.5%
Residential................... 58,238 25.5 44,109 30.5 36,438 32.6 30,060 37.7 31,026 37.6
Construction and
development................. 19,083 8.3 13,407 9.3 4,531 4.1 681 0.9 1,927 2.4
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Total real estate.... 128,343 56.1 88,032 60.9 68,177 61.1 45,778 57.4 46,564 56.5
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Commercial, financial and
agricultural................ 54,294 23.7 25,175 17.4 18,248 16.3 11,272 14.1 10,916 13.2
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Consumer:
Direct........................ 23,237 10.2 16,766 11.6 15,247 13.6 12,619 15.8 15,130 18.4
Home equity................... 19,740 8.6 13,516 9.3 9,579 8.6 9,708 12.2 9,413 11.4
Revolving..................... 3,101 1.4 1,096 0.8 457 0.4 410 0.5 426 0.5
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Total consumer....... 46,078 20.2 31,378 21.7 25,283 22.6 22,737 28.5 24,969 30.3
-------- ----- -------- ----- -------- ----- ------- ----- ------- -----
Total................ $228,715 100.0% $144,585 100.0% $111,708 100.0% $79,787 100.0% $82,449 100.0%
======== ===== ======== ===== ======== ===== ======= ===== ======= =====
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------
Rate Structure for Loans
Maturity Maturing Over One Year
----------------------------------------- ---------------------------
One Over One Over Predetermined Floating or
Year or Year to Five Interest Adjustable
Less Five Years Years Total Rate Rate
------- ---------- ------- -------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Commercial, financial and
agricultural..................... $26,340 $22,006 $ 5,948 $ 54,294 $ 7,689 $20,265
Real estate -- construction........ 15,031 3,889 163 19,083 0 4,052
Real estate -- mortgage............ 13,649 44,303 51,308 109,260 52,494 43,117
Consumer........................... 10,584 24,775 10,719 46,078 15,787 19,707
------- ------- ------- -------- ------- -------
$65,604 $94,973 $68,138 $228,715 $75,970 $87,141
======= ======= ======= ======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------
1997 1996 1995 1994 1993
------ ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Non-performing assets:
Non-accrual(1).......................................... $1,263 $547 $ 44 $154 $634
Past due 90 days or more and still accruing interest.... 29 0 0 3 231
Other real estate....................................... 31 48 192 191 240
Renegotiated troubled debt.............................. 0 0 0 0 243
</TABLE>
- ---------------
(1) If nonperforming loans outstanding at December 31, 1997 had been performing
in accordance with their terms, $90,202 more in interest income would have
been recorded in 1997. Actual interest income recorded in 1997 was $30,022.
Refer to Note 1 -- Loans on page 23 for a discussion of discontinuance of
accruals on loans.
Other than amounts listed above, there were no other loans which (a)
represent or result from trends or uncertainties which management reasonably
expects will materially impact future operating results, liquidity, or
capital resources, or (b) represent material credits about which management
is aware of any information which causes management to have serious doubts
as to the ability of such borrowers to comply with the loan repayment terms.
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Ten
<PAGE> 9
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
The Company's entire securities portfolio has been categorized as Available
for Sale. While the Company has no plans to liquidate a significant amount of
any securities, the securities Available for Sale may be used for liquidity
purposes should management deem it to be in the best interests of the Company.
Due to declines in interest rates, and in order to maintain liquidity, the
majority of the securities purchased have been relatively short-term. United
States government agency securities continue to represent the majority of the
portfolio. At December 31, 1997, securities increased by $26.1 million, or
49.8%, over the prior year, ending the year at $78.7 million compared to $52.6
million at December 31, 1996. As a percentage of total assets, securities were
24.2% in 1997 compared to 25.1% in 1996. Table 4 on page eight presents the
composition of the securities portfolio for the last three years, as well as
information about cost, fair value and weighted average yield.
As interest rates reflected a flattening of the yield curve during 1996,
customers shortened the terms of their deposits. This allows depositors to react
more quickly to rising interest rates. The marketplace for deposits is extremely
competitive from both traditional financial institutions, such as banks, as well
as other more non-traditional and less regulated financial intermediaries such
as brokerage houses and mutual funds. The Company seeks to attract and retain
retail customers through competitive products and quality service. In the
commercial area, management is focused on building long-lasting relationships
that will foster deposit growth. In addition, the Company offers a broad range
of products including a commercial sweep account. This funding source increased
to $9.6 million at December 31, 1997, up from $5.7 million at December 31, 1996.
Growth in retail deposits was marked by significant increases in
certificates of deposit, with maturities of one year or less up 73.7% to $139.6
million and maturities of more than one year up 72.1% to $48.4 million. Given
its customers' reluctance to lock into current rates for an extended period, the
Company has recently joined an electronic network which allows it to post
interest rates and attract deposits nationally. The Company's early competitive
focus has been in certificates of deposit with a maturity of one year or more,
to achieve a greater balance in its overall certificates of deposit portfolio.
Another funding source the Company employed during 1997 was the Federal
Home Loan Bank of Atlanta. The Company has a $40.0 million line of credit and
had drawn down $15.0 million at December 31, 1997. Management believes that this
is a cost effective and prudent funding source as it is able to structure the
borrowings to meet its asset and liability, as well as liquidity, needs.
ASSET QUALITY
Management considers the Company's asset quality to be of primary
importance. The allowance for loan losses, which is utilized to absorb actual
losses in the loan portfolio, is maintained at a level sufficient to provide for
estimated potential charge-offs of non-collectible loans. The loan portfolio is
analyzed periodically in an effort to identify potential problems before they
actually occur. The Company's allowance for loan losses is also analyzed
quarterly by management. This analysis includes a methodology that segments the
loan portfolio by selected loan types and considers the current status of the
portfolio, historical charge-off experience, current levels of delinquent,
impaired and non-performing loans, as well as economic and inherent risk
factors. The provision for loan losses represents a charge against income in an
amount necessary to maintain the allowance at an appropriate level. The monthly
provision for loan losses may fluctuate based on the results of this analysis.
Table 6 on page twelve depicts a summary of the allowance for loan losses and
the allocation of the allowance for loan losses at December 31, 1997, 1996,
1995, 1994, and 1993. The allocation is based on management's grading of the
loan portfolio with the remaining portion allocated to the general category,
although the entire allowance is available to be used for write-offs in any
category.
The 1997 provision of $760,000 compares with $415,000 in 1996 and $260,000
in 1995, which represented an 83.1% increase in 1997 and a two year increase of
192.3%. The Company has continued to increase the dollar level of the allowance
due to the growth in loans despite the fact that asset quality indicators such
as net charge-offs and non-performing loans remain at very low levels. Net
charge-offs were $67,000 in 1997, or 0.04% of average loans outstanding,
compared with $35,000 in 1996 and $54,000 in 1995. At December 31, 1997, the
allowance for loan losses as a percent of year-end loans was 1.02% compared to
1.13% at year-end for both 1996 and 1995.
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Eleven
<PAGE> 10
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 6
SUMMARY OF ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance, beginning of period.................. $1,638 $1,258 $1,052 $1,174 $1,161
Charge-offs:
Commercial............................... 16 0 0 0 28
Real estate -- construction.............. 0 0 0 0 0
Real estate -- mortgage.................. 13 0 0 15 0
Consumer................................. 131 89 128 332 214
------ ------ ------ ------ ------
160 89 128 347 242
Recoveries:
Commercial............................... 10 0 2 52 5
Real estate -- construction.............. 0 0 0 0 0
Real estate -- mortgage.................. 0 0 0 0 0
Consumer................................. 83 54 72 68 60
------ ------ ------ ------ ------
93 54 74 120 65
Net charge-offs............................... 67 35 54 227 177
------ ------ ------ ------ ------
Provision charged to operations............... 760 415 260 105 190
------ ------ ------ ------ ------
Balance, end of period........................ $2,331 $1,638 $1,258 $1,052 $1,174
====== ====== ====== ====== ======
Ratio of net charge-offs to average loans..... 0.04% 0.03% 0.06% 0.28% 0.21%
====== ====== ====== ====== ======
Ratio of allowance to year-end loans.......... 1.02% 1.13% 1.13% 1.32% 1.42%
====== ====== ====== ====== ======
</TABLE>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------------------ ------------------ ------------------ ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
$ Loans $ Loans $ Loans $ Loans $ Loans
----- ---------- ----- ---------- ----- ---------- ----- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at end of
period applicable to:
Commercial........... 1,190 24% 826 17% 512 16% 546 14% 611 13%
Real estate --
construction....... 8 8 13 9 9 4 0 1 1 2
Real estate --
mortgage........... 154 48 151 52 131 57 50 57 51 55
Consumer............. 298 20 386 22 320 23 224 28 164 30
General.............. 681 0 262 0 286 0 232 0 347 0
----- --- ----- --- ----- --- ----- --- ----- ---
Total allocation....... 2,331 100% 1,638 100% 1,258 100% 1,052 100% 1,174 100%
===== === ===== === ===== === ===== === ===== ===
</TABLE>
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Twelve
<PAGE> 11
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
Non-performing assets include non-accrual loans, accruing loans
contractually past due 90 days or more, restructured loans, other real estate,
and other real estate under contract for sale. Loans are placed on non-accrual
when management has concerns relating to the ability to collect the loan
principal and interest, and generally when such loans are 90 days or more past
due. While non-performing assets represent potential losses to the Company,
management does not anticipate any aggregate material losses since most loans
are believed to be adequately secured. Management believes the allowance for
loan losses is sufficient to absorb known risks in the portfolio. No assurance
can be given that economic conditions will not adversely affect borrowers and
result in increased losses.
CAPITAL RESOURCES
Banks and bank holding companies, as regulated institutions, must meet
required levels of capital. The OCC and the Federal Reserve, the primary
regulators for the Bank and the Company, respectively, have adopted minimum
capital regulations or guidelines that categorize components and the level of
risk associated with various types of assets. Financial institutions are
expected to maintain a level of capital commensurate with the risk profile
assigned to its assets in accordance with the guidelines. As shown in table 7 on
page fourteen, in 1996, the Company and the Bank both maintained capital levels
exceeding the minimum levels for "well capitalized" banks and bank holding
companies, and in 1997, for "adequately capitalized" banks and bank holding
companies.
INTEREST RATE SENSITIVITY AND LIQUIDITY MANAGEMENT
A primary objective of interest rate sensitivity management is to ensure
the stability and quality of the Company's primary earning component, net
interest income. This process involves monitoring the Company's balance sheet in
order to determine the potential impact that changes in the interest rate
environment would have on net interest income. Rate sensitive assets and
liabilities have interest rates which are subject to change within a specific
time period, due to either maturity or contractual agreements which allow the
instruments to reprice prior to maturity. Interest rate sensitivity management
seeks to ensure that both assets and liabilities react to changes in interest
rates within a similar time period, thereby minimizing the risk to net interest
income.
The measurement of the Company's interest rate sensitivity, or "gap," is a
technique traditionally used in asset/liability management. The interest
sensitivity gap is the difference between repricing assets and repricing
liabilities for a particular time period. Table 8 on page fourteen indicates a
ratio of rate sensitive assets to rate sensitive liabilities within one year at
December 31, 1997 of 105%. This ratio indicates that net interest income would
decline in a falling interest rate environment, since a greater amount of assets
than liabilities would reprice more rapidly over the one year period. Included
in rate sensitive liabilities are certain deposit accounts (savings, NOW and
MMI) that are subject to immediate withdrawal and repricing, yet have no stated
maturity. These balances are presented in the category that management believes
best identifies their actual repricing patterns. This analysis assumes 20% of
these deposits reprice within one year and the remaining 80% reprice after one
year. The schedule also includes $36.5 million of securities which are callable
within the one year sensitivity time period. While these securities have
contractual maturities beyond one year, management believes these securities
will be called on the specified dates based upon the difference in the coupon
rate of the securities and the current level of interest rates. The overall risk
to net interest income is further mitigated by the Company's increased level of
variable rate loans. These are loans with a contractual interest rate tied to an
index, such as the prime rate. A portion of these loans may reprice on multiple
occasions during a one year period due to changes in the underlying rate index.
Approximately 62% of the total loan portfolio have variable rates, and reprice
in accordance with the underlying rate index subject to terms of individual note
agreements.
In addition to the traditional gap analysis, the Company also utilizes a
computer based interest rate risk simulation model. This comprehensive model
includes rate sensitivity gap analysis, rate shock net interest margin analysis,
and asset/liability term and rate analysis. The Company uses this model to
monitor interest rate risk on a quarterly basis and to detect trends that may
affect the overall net interest income for the Company. This simulation
incorporates the dynamics of balance sheet and interest rate changes and
reflects the related effect on net interest income. As a result, this analysis
more accurately projects the risk to net interest income over the upcoming
twelve month period. The Company has a policy establishing the maximum allowable
risk to net interest income caused by changes in interest rates. The modeling
results indicate that the Company is within the established parameters of the
interest rate risk policy.
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Thirteen
<PAGE> 12
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 7
REGULATORY CAPITAL
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------
1997 1996 1995
-------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Total capital to risk weighted assets
Consolidated.............................. $23,938 9.88% $21,868 15.10% $19,773 16.70%
Bank...................................... 23,248 9.59 21,442 14.80 19,439 25.20
Tier 1 capital to risk weighted assets
Consolidated.............................. 21,607 8.92 19,464 13.40 18,515 15.80
Bank...................................... 20,917 8.63 19,039 13.10 18,180 23.60
Tier 1 capital to average assets
Consolidated.............................. 21,607 7.02 19,464 9.60 18,515 10.80
Bank...................................... 20,917 6.79 19,039 9.40 18,180 10.40
</TABLE>
TABLE 8
INTEREST SENSITIVITY ANALYSIS
DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
Total Total
Sensitive Sensitive
1-90 91-180 181-365 Within Over
Day Day Day One One
Sensitive Sensitive Sensitive Year Year Total
--------- --------- --------- --------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Loans, net of non-accruals....... $134,281 $ 5,389 $ 15,104 $154,774 $ 72,679 $227,452
Taxable investment securities.... 5,750 7,000 12,365 25,115 46,957 72,072
Tax exempt investment
securities..................... 0 100 0 100 4,853 4,953
Other investment securities...... 1,392 0 0 1,392 0 1,392
Due from FHLB.................... 242 0 0 242 0 242
Federal funds sold............... 0 0 0 0 0 0
-------- -------- -------- -------- -------- --------
Total interest earning
assets...................... 141,665 12,489 27,469 181,623 124,489 306,111
-------- -------- -------- -------- -------- --------
Interest bearing liabilities:
Savings/NOW/MMI.................. 10,555 0 0 10,555 42,218 52,773
Other time deposits.............. 57,483 28,661 57,281 143,425 44,612 188,037
Overnight borrowings............. 13,720 0 0 13,720 0 13,720
Other borrowings................. 0 0 5,000 5,000 10,000 15,000
-------- -------- -------- -------- -------- --------
Total interest bearing
liabilities................. 81,758 28,661 62,281 172,700 96,830 269,530
-------- -------- -------- -------- -------- --------
Interest sensitivity gap......... $ 59,907 $(16,172) $(34,812) $ 8,923
======== ======== ======== ========
Ratio of interest sensitive
assets to interest sensitive
liabilities.................... 1.73 0.44 0.44 1.05
</TABLE>
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Fourteen
<PAGE> 13
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
Liquidity management refers to the ability to meet day-to-day cash flow
requirements based primarily on activity in loan and deposit accounts of the
Company's customers. Deposit withdrawals, loan funding, and general corporate
activity create a need for liquidity for the Company. Liquidity is derived from
sources such as deposit growth, maturity/calls/sales of investment securities,
principal and interest payment on loans, access to borrowed funds or lines of
credit, and profits.
The Company's primary source of funds has been derived from increased
deposit and sweep account balances. Liquidity is further enhanced by a $40.0
million line of credit with the FHLB collateralized by FHLB stock and qualifying
one to four family residential mortgage loans. There are unsecured overnight
borrowing lines available through several financial institutions. The Company
also has the ability to access the certificate of deposit market on a national
basis. Access to this market will complement local market activity and focus on
longer term deposits. The Company is able to survey and monitor interest rates
in both the local and national deposit markets, which assists in developing
rational pricing for all deposit products. Internal liquidity analysis indicates
the Company is well positioned to fund earning assets in the twelve month period
analyzed.
Interest rate risk management and liquidity management are both a part of
the Company's overall asset/ liability management process. The primary oversight
of asset/liability management rests with the Company's Asset and Liability
Committee, which is comprised of senior management and members of the Bank's
Board of Directors. The committee meets on a regular basis to review the
asset/liability management activities of the Company and monitor compliance with
established policies. A member of the Board of Directors chairs the committee
and reports on its activities to the full Board.
OTHER MATTERS
On November 13, 1997, the Company and the Office of the Comptroller of the
Currency ("OCC") entered into a Memorandum of Understanding (the "MOU") under
which the Company agreed to take certain actions to improve its infrastructure,
primarily necessitated by its rapid growth. In February 1998, the OCC informed
the Company that no further action was being requested and the Company believes
that it is in compliance with the MOU. See Note 17 to the Company's Consolidated
Financial Statements on page thirty-five of this report.
A critical issue affecting companies that rely extensively on electronic
data processing systems, such as the Company, is the Year 2000 issue. This issue
deals with the Company's ability to process year-date data accurately beyond the
year 1999. The Year 2000 issue has been a well publicized, but nevertheless
continually evolving issue. The Company is dependent upon electronic data
processing for nearly all of its major activities. During 1997, the Company
formed an internal task force chaired by the Senior Vice President, Operations
to address the Year 2000 issue, conduct a comprehensive review of the Company's
systems and ensure that the Company takes any necessary measures. The Company
does not currently expect that the cost of its Year 2000 compliance program will
be material to its business, financial condition or results of operations and
expects that it will satisfy such compliance program without material disruption
to its operations.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share," which establishes standards for computing and presenting earnings
per share. This new accounting standard applies to entities with publicly held
common stock or potential common stock, such as the Company. SFAS No. 128
simplifies the standards for computing earnings per share previously found in
other accounting standards, requires dual presentation of basic and diluted
earnings per share on the face of the income statement for entities with complex
capital structures such as the Company, and requires a reconciliation of the
numerator and denominator of the basic earnings per share computation to the
numerator and denominator of the diluted earnings per share computation. The
Company adopted this new accounting standard at December 31, 1997 and restated
all prior period earnings per share data presented.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general purpose financial statements.
The comprehensive income and related cumulative equity impact of comprehensive
income items will be required to be disclosed prominently as part of the notes
to the
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Fifteen
<PAGE> 14
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
financial statements. Only the impact of unrealized gains or losses on
securities available for sale is expected to be disclosed as an additional
component of the Company's income under the requirements of SFAS No. 130. This
statement is effective for fiscal years beginning after December 15, 1997.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which changes the way public companies
report information about segments of their business on their annual financial
statements and requires them to report selected segment information in their
quarterly reports issued to shareholders. It also requires entity wide
disclosures about the products and services an entity provides, the foreign
countries in which it holds assets and reports revenues, and its major
customers. This statement is effective for fiscal years beginning after December
15, 1997.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which revises employers'
disclosures about pension and other post-retirement benefit plans. The statement
does not change the measurement or recognition of those plans, but requires
additional information on changes in benefits obligations and fair values of
plan assets, and eliminates certain disclosures previously required by SFAS Nos.
87, 88 and 106. This statement is effective for fiscal years beginning after
December 15, 1997.
EFFECTS OF INFLATION
Inflation affects financial institutions in ways that are different from
most commercial and industrial companies, which have significant investments in
fixed assets and inventories. The effect of inflation on interest rates can
materially impact bank operations, which rely on net interest margins as a major
source of earnings. Non-interest expenses, such as salaries and wages, occupancy
and equipment cost are also negatively impacted by inflation.
RECENT EVENT
On March 3, 1998 the Company filed a Registration Statement on Form S-2 to
register with the Securities and Exchange Commission up to 747,500 shares of the
Company's Common Stock (including up to 97,500 shares subject to an
underwriters' over-allotment option) for the offer and sale by the Company of
such shares in a public offering. The offering, which is subject to market
conditions and other considerations, is expected to be completed in the second
quarter of 1998. If consummated, the proceeds from the offering to the Company
would equal approximately $15.9 million ($18.3 million if the underwriters'
over-allotment option is exercised in full), less underwriting discounts and
offering expenses.
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Sixteen
<PAGE> 15
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 9
STOCK PRICES AND DIVIDENDS DECLARED(1)
On May 4, 1995, the stock of the Company was listed on the National Market
System of The Nasdaq Stock Market under the symbol FNBF. Prior to that time, the
stock of the Company was not listed or traded on any exchange or established
over-the-counter market; however, J.C. Bradford & Co., Inc. of Reidsville, North
Carolina provided an informal match market for persons desiring to buy or sell
stock of the Company. The following table sets forth the range of high and low
dollar price for shares of the Company's stock traded on Nasdaq during the last
two calendar years (but does not reflect any retail mark-up, mark-down or
commissions related to such trades).
<TABLE>
<CAPTION>
1997 1996
Price Range Price Range
--------------- ---------------
Calendar Quarter High/Low High/Low
---------------- --------------- ---------------
<S> <C> <C>
First......................................... $15.19 / $11.81 $11.93 / $ 9.00
Second........................................ $24.75 / $13.50 $12.94 / $11.25
Third......................................... $29.00 / $21.75 $13.22 / $11.53
Fourth........................................ $28.25 / $24.75 $13.22 / $11.53
</TABLE>
There were approximately 772 record holders of the Company stock at
December 31, 1997. The following table shows the frequency and amount of cash
dividends (on a per share basis) declared on stock of the Company for the two
most recent calendar years.
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------
CALENDAR QUARTER 1997 1996
---------------- ---- ----
<S> <C> <C>
First....................................................... $.09 $.08
Second...................................................... .10 .08
Third....................................................... .10 .09
Fourth...................................................... .10 .09
---- ----
Total Annual Dividends................................. $.39 $.34
==== ====
</TABLE>
- ---------------
(1)The stock prices and dividends declared have been adjusted for the 1996 Stock
Split and the 1997 Stock Splits.
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Seventeen
<PAGE> 16
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INDEPENDENT AUDITORS' REPORT
- -----------------------------------------------
The Board of Directors
FNB Financial Services Corporation
and Subsidiary
Reidsville, North Carolina
We have audited the accompanying consolidated balance sheets of FNB
Financial Services Corporation and Subsidiary as of December 31, 1997 and 1996,
and the related consolidated statements of income, changes in shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
FNB Financial Services Corporation and Subsidiary as of December 31, 1997 and
1996, and the consolidated results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Cherry, Bekaert & Holland, L.L.P.
Reidsville, North Carolina
February 10, 1998
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<PAGE> 17
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 9,612 $ 6,467
Investment securities:
Available for sale (cost of $77,024 in 1997 and $51,674 in
1996).................................................. 77,346 51,929
Other (market value of $1,392 in 1997 and $643 in 1996)... 1,392 643
Loans, net of allowance for credit losses of $2,331 in 1997
and $1,638 in 1996........................................ 226,384 142,947
Property and equipment, net................................. 6,490 4,686
Accrued income and other assets............................. 3,927 3,124
-------- --------
Total assets...................................... $325,151 $209,796
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing....................................... $ 31,464 $ 21,914
Interest-bearing.......................................... 240,810 157,466
-------- --------
Total deposits.................................... 272,274 179,380
Federal funds purchased and securities sold under agreements
to repurchase............................................. 13,720 8,650
Other borrowings............................................ 15,000 --
Accrued expenses and other liabilities...................... 1,639 1,380
-------- --------
Total liabilities................................. 302,633 189,410
-------- --------
Commitments and contingent liabilities
Shareholders' equity
Common stock, $1.00 par value;
Authorized -- 3,000,000 shares; Outstanding --
2,493,680 in 1997 and 1,383,105 in 1996................. 2,494 1,383
Paid-in capital............................................. 3,287 2,728
Retained earnings........................................... 16,541 16,119
-------- --------
22,322 20,230
Net unrealized appreciation on securities available for
sale................................................... 196 156
-------- --------
Total shareholders' equity........................ 22,518 20,386
-------- --------
Total liabilities and shareholders' equity........ $325,151 $209,796
======== ========
</TABLE>
See notes to consolidated financial statements.
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Nineteen
<PAGE> 18
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
- ---------------------------------------------------------
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Interest income
Loans..................................................... $17,616 $12,092 $ 9,067
Federal funds sold........................................ 133 53 163
Investment securities:
Taxable................................................ 2,800 2,480 3,222
Tax exempt............................................. 358 657 851
Other..................................................... 110 78 80
------- ------- -------
Total interest income............................. 21,017 15,360 13,383
------- ------- -------
Interest expense
Deposits.................................................. 9,287 6,449 5,508
Federal funds purchased and other borrowings.............. 769 313 625
------- ------- -------
Total interest expense............................ 10,056 6,762 6,133
------- ------- -------
Net interest income......................................... 10,961 8,598 7,250
Provision for credit losses................................. 760 415 260
------- ------- -------
Net interest income after provision for credit losses....... 10,201 8,183 6,990
------- ------- -------
Other income
Service charges on deposit accounts....................... 896 746 694
Other service charges and fees............................ 381 183 243
Net gain on sales of loans................................ 39 16 211
Net gain on securities available for sale................. 38 307 88
------- ------- -------
Total other operating income...................... 1,354 1,252 1,236
------- ------- -------
Other expenses
Salaries and employee benefits............................ 4,709 3,630 3,082
Occupancy expense......................................... 529 345 297
Furniture and equipment expense........................... 628 465 424
Insurance expense, including FDIC assessment.............. 62 35 187
Marketing expense......................................... 154 97 110
Printing and supply expenses.............................. 251 205 160
Other expenses............................................ 1,570 1,227 930
------- ------- -------
Total other expenses.............................. 7,903 6,004 5,190
------- ------- -------
Income before income taxes.................................. 3,652 3,431 3,036
Income tax expense.......................................... 1,175 1,021 866
------- ------- -------
Net income.................................................. $ 2,477 $ 2,410 $ 2,170
======= ======= =======
Net income per share of common stock........................ $ 1.00 $ 0.98 $ 0.89
======= ======= =======
Net income per share of common stock -- assuming dilution... $ 0.93 $ 0.96 $ 0.88
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
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Twenty
<PAGE> 19
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Common stock
Balance at beginning of year.............................. $ 1,383 $ 1,098 $ 1,097
Stock split effected in the form of a stock dividend...... 1,082 275 --
Exercise of stock options................................. 11 7 --
Dividend reinvestment plan................................ 6 3 --
Employee 401(k) plan...................................... 12 -- --
Employee stock awards..................................... -- -- 1
------- ------- -------
Balance at end of year.................................... 2,494 1,383 1,098
------- ------- -------
Paid-in capital
Balance at beginning of year.............................. 2,728 2,580 2,562
Dividend reinvestment plan................................ 156 60 --
Exercise of stock options................................. 92 84 --
Employee 401(k) plan...................................... 308 -- --
Employee stock awards..................................... 3 4 18
------- ------- -------
Balance at end of year.................................... 3,287 2,728 2,580
------- ------- -------
Retained earnings
Balance at beginning of year.............................. 16,119 14,837 13,403
Net income................................................ 2,477 2,410 2,170
Cash paid for fractional shares........................... (14) (5) --
Cash dividends paid ($.39 per share in 1997, $.34 in 1996,
and $.30 in 1995)...................................... (959) (848) (736)
Stock split effected in the form of a stock dividend...... (1,082) (275) --
------- ------- -------
Balance at end of year.................................... 16,541 16,119 14,837
------- ------- -------
Net unrealized appreciation (depreciation) on available for
sale securities, net of tax effect
Balance at beginning of year.............................. 156 467 (2,142)
Net change................................................ 40 (311) 2,609
------- ------- -------
Balance at end of year.................................... 196 156 467
------- ------- -------
Total shareholders' equity........................ $22,518 $20,386 $18,982
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
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Twenty-One
<PAGE> 20
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received......................................... $ 19,247 $ 14,685 $ 13,335
Fees and commission received.............................. 1,951 1,627 1,209
Interest paid............................................. (9,499) (6,660) (6,162)
Noninterest expense paid.................................. (6,749) (5,264) (4,365)
Income taxes paid......................................... (1,538) (1,493) (983)
Proceeds from mortgage loans.............................. 3,963 3,122 2,685
--------- -------- --------
Net cash provided by operating activities.......... 7,375 6,017 5,719
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available for sale...... 55,427 43,707 44,183
Proceeds from maturities of securities available for
sale.................................................... 17,617 7,887 14,474
Purchases of securities................................... (99,330) (47,933) (34,858)
Capital expenditures...................................... (2,291) (1,532) (303)
Sales of assets........................................... 269 -- --
(Increase) decrease in other real estate owned............ 3 158 (1)
Net (increase) decrease in loans.......................... (88,505) (36,268) (34,132)
--------- -------- --------
Net cash used in investing activities.............. (116,810) (33,981) (10,637)
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand, savings and interest checking
accounts................................................ 12,381 4,217 3,013
Net increase in time deposits............................. 80,514 20,764 18,914
Net increase in borrowed funds............................ 15,000 -- --
Net increase in federal funds purchased................... 5,070 5,498 2,022
Repayments of proceeds from long-term debt................ -- -- (20,000)
Purchase of fractional shares............................. (14) (5) --
Proceeds from issuance of common stock.................... 588 158 --
Dividends paid............................................ (959) (848) (736)
--------- -------- --------
Net cash provided by financing activities.......... 112,580 29,784 3,213
--------- -------- --------
Net increase (decrease) in cash and cash equivalents........ 3,145 1,820 (1,705)
Cash and cash equivalents, beginning of year................ 6,467 4,647 6,352
--------- -------- --------
Cash and cash equivalents, end of year...................... $ 9,612 $ 6,467 $ 4,647
========= ======== ========
Supplemental disclosure of non-cash transactions
Non-cash transfers from loans to other real estate........ $ 107 $ 24 $ 135
========= ======== ========
Change in unrealized appreciation (depreciation) of
securities available for sale (net of tax effect of $25,
($199) and $1,669)...................................... $ 40 $ (311) $ 2,609
========= ======== ========
Employee stock awards..................................... $ 3 $ 4 $ 19
========= ======== ========
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income................................................ $ 2,477 $ 2,410 $ 2,170
Adjustments to reconcile net income to net cash provided
by operating activities
Provision for credit losses........................... 760 415 260
Depreciation.......................................... 474 376 346
Accretion and amortization............................ 282 288 324
Gain on sale of securities available for sale......... (38) (307) (88)
(Gain) loss on sale of mortgage loans................. (39) (16) (211)
Provision for loss on other real estate............... -- -- 64
Proceeds from mortgage loans.......................... 3,963 3,122 2,685
(Gain) loss on other assets........................... 39 84 --
Deferred tax (benefit) provision...................... (338) (384) (122)
(Increase) decrease in accrued income and other
assets............................................. (803) (631) (257)
Increase (decrease) in accrued expenses and other
liabilities........................................ 598 660 548
--------- -------- --------
Net cash provided by operating activities.......... $ 7,375 $ 6,017 $ 5,719
========= ======== ========
</TABLE>
See notes to consolidated financial statements.
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Twenty-Two
<PAGE> 21
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------------------------
DECEMBER 31, 1997, 1996 AND 1995
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The accompanying consolidated financial statements include the accounts of
FNB Financial Services Corporation (the Company) and its wholly-owned
subsidiary, First National Bank Southeast (the Bank). All significant
intercompany balances and transactions have been eliminated in consolidation.
Nature of operations
The Bank provides a variety of financial services to individual and
corporate customers through its ten full-service branches in Reidsville,
Madison, Eden, Ruffin, Greensboro, and Wilmington, North Carolina. A majority of
the Bank's customers are located in Rockingham, Guilford, and New Hanover
Counties. The Bank's primary deposit products are interest-bearing checking
accounts, certificates of deposit and individual retirement accounts. Its
primary lending products are commercial, real estate, and consumer loans.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and their reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for credit losses on loans. A
majority of the Bank's loan portfolio consists of loans in the Rockingham,
Guilford, and New Hanover County areas. The local economies of these areas
depend heavily on the industrial, agricultural, and service sectors.
Accordingly, the ultimate collectibility of a large portion of the Bank's loan
portfolio would be affected by changes in local economic conditions.
Cash and cash equivalents
For the purpose of presentation in the statement of cash flows, cash and
cash equivalents are defined as those amounts included in the balance sheet
caption cash and due from banks.
Investment Securities
The Company classifies its investment securities at time of purchase into
three categories as follows:
-- held-to-maturity -- reported at amortized cost,
-- trading securities -- reported at fair value with unrealized gains
and losses included in earnings, or
-- securities available-for-sale -- reported at fair value with
unrealized gains and losses reported as a separate component of
shareholders' equity (net of tax effect).
Other securities, which are carried at cost, include stock in the Federal
Reserve Bank and the Federal Home Loan Bank of Atlanta ("FHLB").
Gains and losses on sales of securities are recognized when realized on a
specific identification basis. Premiums and discounts are amortized into
interest income using the level yield method.
Loans
Interest on loans is accrued and credited to income based on the principal
amount outstanding. The accrual of interest on impaired loans is discontinued
when, in management's opinion, the borrower may be unable to meet payments as
they become due. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only to the
extent cash payments are received.
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<PAGE> 22
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
Mortgage loans held for sale are valued at the lower of cost or market as
determined by outstanding commitments from investors or current investor yield
requirements, calculated on the aggregate loan basis.
Allowance for credit losses
The allowance for credit losses is maintained at a level believed adequate
by management to absorb potential losses in the loan portfolio. Management's
determination of the adequacy of the allowance is based upon reviews of
individual credits, past loan loss experience, current economic conditions,
volume, growth and composition of the loan portfolio, and other relevant risk
factors. Losses are charged and recoveries are credited to the allowance for
credit losses at the time the loss or recovery is incurred.
While management uses the best available information to evaluate the
adequacy of the allowance for credit losses, future additions to the allowance
may be necessary based on changes in local economic conditions. In addition,
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for credit losses on loans and
foreclosed real estate. Such agencies may require the Bank to recognize changes
to the allowance based on their judgements about information available to them
at the time of their examination.
Other real estate
Other real estate, acquired through partial or total satisfaction of loans,
is carried at the lower of cost or fair market value, less estimated costs to
sell, which becomes the property's new basis. At the date of acquisition, losses
are charged to the allowance for loan losses, subsequent write downs are charged
to expense in the period they are incurred.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. The provision for depreciation and amortization is computed
principally by the straight-line method over the estimated useful lives of the
assets.
Expenditures for maintenance and repairs are charged to operations, and the
expenditures for major replacements and betterments are added to the property
and equipment accounts. The cost and accumulated depreciation of the property
and equipment retired or sold are eliminated from the property accounts at the
time of retirement or sale and the resulting gain or loss is reflected in
current operations.
Income taxes
Provisions for income taxes are based on taxes payable or refundable for
the current year (after exclusion of non-taxable income such as interest on
state and municipal securities) and deferred taxes on temporary differences
between the tax bases of assets and liabilities and their reported amounts in
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax asset and liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes.
Net income per share
At December 31, 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128 "Earnings per Share". SFAS No. 128 requires
disclosure of two earnings per share amounts: Net income per share of common
stock and net income per share of common stock -- assuming dilution. Net income
per share of common stock is computed by dividing net income available to common
shareholders by the weighted average number of shares of common stock
outstanding during each year. Net income per share of common stock -- assuming
dilution is computed by dividing net income plus any adjustments to net income
related to issuance of dilutive potential common shares by the weighted average
number of shares of common stock outstanding during each year plus the number of
dilutive potential common shares. All earnings per share amounts have been
restated in order to comply with the new accounting standard.
Loan origination fees and costs
Loan origination fees and certain direct origination costs are capitalized
and recognized as an adjustment of the yield on the related loan.
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Twenty-Four
<PAGE> 23
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
Sales of mortgage loans
Gains and losses on the sale of loans are accounted for by imputing gain or
loss on those sales where a yield rate guaranteed to the buyer is more or less
than the contract interest rate being collected. Such gains or losses are
recognized in the financial statements during the year of sale. The Bank
continues to service certain loans that have been sold. Such loan balances are
not included in the accompanying consolidated balance sheets.
Pension costs
Pension costs are charged to salaries and employee benefits expense.
Off balance sheet financial instruments
In the ordinary course of business the Bank enters into off balance sheet
financial instruments consisting of commitments to extend credit, commitments
under credit card arrangements, commercial letters of credit and standby letters
of credit. Such financial instruments are recorded in the financial statements
when they are funded or related fees are incurred or received.
Reclassification
Certain items for 1995 and 1996 have been reclassified to conform with the
1997 presentation. Such reclassifications had no effect on net income or
shareholders' equity as previously reported.
NOTE 2 -- RESTRICTION ON CASH AND DUE FROM BANKS
The Bank maintains average reserve balances with the Federal Reserve Bank.
The average amounts of these reserve balances for the years ended December 31,
1997 and 1996 were $362,000 and $625,000, respectively.
NOTE 3 -- INVESTMENT SECURITIES
Investment securities consists of the following:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Available for sale:
U.S. treasury notes.................. $ 3,074 $ 18 $ -- $ 3,092
U.S. government agency securities.... 68,997 75 99 68,973
State and municipal obligations...... 4,953 328 -- 5,281
------- ---- ---- -------
77,024 421 99 77,346
------- ---- ---- -------
Other securities....................... 1,392 -- -- 1,392
------- ---- ---- -------
Total investment
securities................. $78,416 $421 $ 99 $78,738
======= ==== ==== =======
DECEMBER 31, 1996
Available for sale:
U.S. treasury notes.................. $13,075 $ 4 $ 3 $13,076
U.S. government agency securities.... 24,126 -- 21 24,105
Mortgage-backed securities........... 7,780 14 139 7,655
State and municipal obligations...... 6,693 400 -- 7,093
------- ---- ---- -------
51,674 418 163 51,929
------- ---- ---- -------
Other securities....................... 643 -- -- 643
------- ---- ---- -------
Total investment
securities................. $52,317 $418 $163 $52,572
======= ==== ==== =======
</TABLE>
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<PAGE> 24
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
The amortized cost and estimated market value of debt securities at
December 31, 1997, by contractual maturities, are shown below. Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Securities available for sale
-----------------------------
Amortized Estimated
Cost Market Value
---------- -------------
(In thousands)
<S> <C> <C>
Due in one year or less..................................... $ 2,102 $ 2,103
Due after one through five years............................ 69,110 69,198
Due after five through ten years............................ 5,082 5,280
Due after ten years......................................... 730 765
------- -------
$77,024 $77,346
======= =======
</TABLE>
Proceeds from the sale of investment securities available for sale, gross
realized gains, gross realized losses, and the related income taxes on net
realized gains were as follows:
<TABLE>
<CAPTION>
Years ending December 31,
-----------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Proceeds from sales........................................ $55,427 $43,707 $44,183
Gross realized gains....................................... 226 376 163
Gross realized losses...................................... 188 69 75
Applicable income tax on net realized gains................ 15 120 34
</TABLE>
At December 31, 1997 and 1996, investment securities with a carrying value
of approximately $24,195,000 and $14,442,000 respectively, were pledged as
collateral to secure public deposits and for other purposes.
NOTE 4 -- LOANS
Major classifications of loans are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------
1997 1996
-------- --------
(In thousands)
<S> <C> <C>
Commercial, financial and agricultural...................... $ 54,294 $ 25,175
Consumer.................................................... 46,078 31,378
Real estate:
Residential mortgage...................................... 58,238 44,109
Commercial mortgage....................................... 51,022 30,516
Construction.............................................. 19,083 13,407
-------- --------
Total............................................. $228,715 $144,585
======== ========
</TABLE>
At December 31, 1997 and 1996, the recorded investment in loans that were
considered impaired was approximately $1,250,000 and $0, respectively. The
related allowance for loan losses on these impaired loans was approximately
$188,000 and $0, respectively. The average recorded investment in impaired loans
for the years ended December 31, 1997 and 1996 was approximately $625,000 and
$0, respectively. Loans on nonaccrual status, not considered impaired, amounted
to approximately $12,000 at December 31, 1997 and $547,000 at December 31, 1996.
Mortgage loans serviced for the Federal Home Loan Mortgage Corporation are
not included in the accompanying consolidated balance sheets. The unpaid
principal balances of those loans at December 31, 1997, 1996 and 1995 were
$18,816,000, $14,852,000 and $14,491,000, respectively.
Certain 1-4 family residential mortgage loans are held as collateral under
a blanket floating lien to secure a portion of the Bank's borrowings (see Note
8).
------------------
------------------------------------
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- --------------------------------------------------------------------------------
Twenty-Six
<PAGE> 25
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
NOTE 5 -- ALLOWANCE FOR CREDIT LOSSES
Changes in the allowance for credit losses for the three years ended
December 31 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year................................ $1,638 $1,258 $1,052
Provision for credit losses................................. 760 415 260
Recoveries.................................................. 93 54 74
Losses charged off.......................................... (160) (89) (128)
------ ------ ------
Balance at end of year...................................... $2,331 $1,638 $1,258
====== ====== ======
</TABLE>
NOTE 6 -- PROPERTY AND EQUIPMENT
Properties and equipment are summarized as follows:
<TABLE>
<CAPTION>
1997 1996
------ ------
(In thousands)
<S> <C> <C>
Land........................................................ $1,202 $ 870
Building and leasehold improvements......................... 4,724 3,690
Equipment................................................... 4,405 3,544
Construction in progress.................................... 28 39
------ ------
10,359 8,143
Less accumulated depreciation and amortization.............. 3,869 3,457
------ ------
$6,490 $4,686
====== ======
</TABLE>
NOTE 7 -- DEPOSITS
The aggregate amount of jumbo CDs, each with a minimum denomination of
$100,000, was approximately $59,700,000 and $21,200,000 in 1997 and 1996,
respectively.
At December 31, 1997 the scheduled maturities of CDs and IRAs are as
follows:
<TABLE>
<CAPTION>
(In thousands)
--------------
<S> <C>
1998..................................................... $139,632
1999..................................................... 31,705
2000..................................................... 11,954
2001..................................................... 3,613
2002..................................................... 483
Thereafter............................................... 650
--------
$188,037
========
</TABLE>
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- --------------------------------------------------------------------------------
Twenty-Seven
<PAGE> 26
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
NOTE 8 -- FEDERAL FUNDS PURCHASED, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS,
AND OTHER BORROWINGS
The following is a schedule of federal funds purchased, securities sold
under repurchase agreements, and FHLB borrowings:
<TABLE>
<CAPTION>
Interest Maximum
Balance Rate Average Outstanding
as of as of Average Interest at Any
December 31 December 31 Balance Rate Month-end
----------- ----------- ------- -------- -----------
(in thousands, except for percentages)
<S> <C> <C> <C> <C> <C>
1997
Federal funds purchased and securities
sold under agreements to
repurchase........................... $13,720 5.31% $9,749 5.18% $15,455
FHLB borrowings........................ 15,000 5.74 4,521 5.83 15,000
------- ------- -------
Total............................. $28,720 $14,270 $30,455
======= ======= =======
1996
Federal funds purchased and securities
sold under agreements to
repurchase........................... $ 8,650 5.73 $5,415 5.79 $ 8,650
FHLB borrowings........................ -- -- 452 5.61 5,000
------- ------- -------
Total................................ $ 8,650 $5,867 $13,650
======= ======= =======
</TABLE>
At December 31, 1997, the Bank had a $40 million line of credit with the
FHLB under which $15 million was outstanding. This line of credit is secured
with FHLB stock and a blanket floating lien on qualifying 1-4 family residential
mortgage loans. The outstanding amounts consist of $5 million maturing in 1998
and $10 million maturing in 2002. The borrowing maturing in 2002 has a one-time
call feature in 1999 whereby if called, the interest rate converts to a floating
rate based on the three month LIBOR.
Federal funds purchased represent unsecured overnight borrowings from other
financial institutions by the Bank. Securities sold under agreement to
repurchase represent short-term borrowings by the Bank with overnight maturities
collateralized by securities of the United States government or its agencies.
NOTE 9 -- INCOME TAXES
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -----
(In thousands)
<S> <C> <C> <C>
Current tax expense
Federal................................................. $1,448 $1,212 $ 787
State................................................... 149 193 201
------ ------ -----
Total current................................... 1,597 1,405 988
------ ------ -----
Deferred tax expense (benefit)
Federal................................................. (341) (308) (98)
State................................................... (81) (76) (24)
------ ------ -----
Total deferred.................................. (422) (384) (122)
------ ------ -----
Total income tax expense........................ $1,175 $1,021 $ 866
====== ====== =====
</TABLE>
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- --------------------------------------------------------------------------------
Twenty-Eight
<PAGE> 27
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
The sources of deferred tax assets and liabilities and the tax effect of
each are as follows:
<TABLE>
<CAPTION>
1997 1996
------ ----
(In thousands)
<S> <C> <C>
Deferred tax assets:
Allowance for credit losses............................... $ 754 $484
Non-qualified deferred compensation plans................. 391 255
------ ----
Total............................................. 1,145 739
------ ----
Deferred tax liabilities:
Depreciable basis of property and equipment............... 271 248
Net unrealized gain on securities available for sale...... 125 99
Other..................................................... 8 28
------ ----
Total............................................. 404 375
------ ----
Net deferred tax assets (liabilities)....................... $ 741 $364
====== ====
</TABLE>
There is no valuation allowance for deferred tax assets as management
believes that realization of the deferred tax assets is more likely than not
based upon the Bank's history of taxable income and estimates of future taxable
income.
The provision for federal income taxes is less than that computed by
applying the federal statutory rate of 34% as indicated in the following
analysis:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Tax based on statutory rates............................. $1,242 $1,166 $1,032
Increase (decrease) resulting from:
Effect of tax-exempt income............................ (104) (199) (255)
State income taxes, net of federal benefit............. 111 122 120
Other, net............................................. (74) (68) (31)
------ ------ ------
$1,175 $1,021 $ 866
====== ====== ======
</TABLE>
NOTE 10 -- LEASE COMMITMENTS
The minimum annual lease commitments under noncancelable operating leases
in effect at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Year Ending December 31, Amount
- ------------------------ --------------
(In thousands)
<S> <C>
1998........................................................ $143
1999........................................................ 138
2000........................................................ 138
2001........................................................ 133
2002........................................................ 46
Thereafter.................................................. 205
----
$803
====
</TABLE>
Rental expense was $131,000 in 1997, $71,000 in 1996, and $38,000 in 1995.
NOTE 11 -- RELATED PARTY TRANSACTIONS
The Bank had loans outstanding to principal officers and directors and
their affiliated companies of approximately $3,424,000 and $3,382,000 at
December 31, 1997 and 1996, respectively. During 1997, additions to such loans
were $1,378,000 and repayments were $1,336,000. Such loans were made
substantially on the same terms, including interest rates and collateral, as
those prevailing at the time for
------------------
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- --------------------------------------------------------------------------------
Twenty-Nine
<PAGE> 28
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
comparable transactions with other borrowers and do not involve more than the
normal risks of collectibility.
NOTE 12 -- SHAREHOLDERS' EQUITY
Stock Splits
In March, 1996, the Company paid a five-for-four split of the common stock
in the form of a 25% stock dividend. As a result, $275,000 ($1 for each share
issued pursuant to the stock split) was transferred from retained earnings to
the common stock account. Cash was paid in lieu of fractional shares.
In April and September, 1997, the Company paid a four-for-three split of
the common stock in the form of a 33 1/3% stock dividend. As a result, $462,000
and $620,000 ($1 for each share issued pursuant to the split) was transferred
from retained earnings to the common stock account for the April split and the
September split, respectively. Cash was paid in lieu of fractional shares for
both splits.
All per share data in the financial statements has been adjusted to reflect
these three splits.
Stock grants
During 1997, 1996, and 1995, stock grants to employees amounted to 75, 85,
and 1,130 common shares, respectively.
Stock option plans
In 1996, the Company adopted Statement of Financial Accounting Standard
(SFAS) No. 123, "Accounting for Stock-Based Compensation." Under SFAS No. 123,
the Company has elected to continue using the measurement prescribed in
Accounting Principles Board (APB) Opinion No. 25, and accordingly, SFAS No. 123
has no effect on the Company's financial position or results of operations.
The Company has issued stock under both incentive and non-qualified stock
options. The Company granted stock options under previously approved plans in
1997, 1996, 1995, 1992, and 1989 which authorize the granting of options with
respect to shares of the Company's common stock.
The following is a summary of stock option activity and related information
for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ------------------------- -------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- -------- -------------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding --
Beginning of
year............... 384,864 $10.66 164,101 $ 6.99 111,177 $ 6.83
Granted............ 90,330 23.11 233,942 12.80 52,924 7.20
Exercised.......... (13,001) 7.99 (13,179) 12.24 -- --
Forfeited.......... (9,275) 12.03 -- -- -- --
------- -------- --------
Outstanding -- End of
year............... 452,918 $13.25 384,864 $10.66 164,101 $ 6.99
======= ======== ========
Exercisable -- End of
year............... 155,378 $ 9.21 72,718 $ 6.90 48,544 $ 6.86
Weighted average fair
value of options
granted during the
year............... $ 6.73 $ 6.66 $ 3.65
</TABLE>
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================================================================================
- --------------------------------------------------------------------------------
Thirty
<PAGE> 29
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
The following is a summary of information concerning outstanding and
exercisable options at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------ ----------------------------
Weighted Average Weighted
Range of Number Remaining Contractual Weighted Average Number Average
Exercise Prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
- --------------- ----------- --------------------- ---------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$6.75-12.52 205,884 7.19 $ 9.06 116,202 $ 8.01
12.94-25.25 247,034 9.46 17.27 39,176 12.94
------- -------
452,918 155,378
======= =======
</TABLE>
Because the Company has adopted the disclosure-only provisions of SFAS No.
123, no compensation cost has been recognized for the stock option plans. Had
compensation cost for the Company's stock option plans been determined based on
the fair value at the grant date of the awards consistent with the provisions of
SFAS No. 123, the Company's net earnings and earnings per share would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net earnings -- as reported..................... $2,477,000 $2,410,000 $2,170,000
Net earnings -- pro forma....................... 2,068,000 2,153,000 2,145,000
Earnings per share -- as reported............... 1.00 0.98 0.89
Earnings per share -- pro forma................. 0.84 0.88 0.88
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997, 1996 and 1995: dividend yield of 3.20%,
expected volatility of 34.0%, risk-free interest rates of 5.70% for 1997, 6.20%
for 1996 and 5.40% for 1995, and expected lives of 4 years for 1997 and 1996
options and 5 years for 1995 options.
These plans provide that shares granted come from the Company's authorized
but unissued or reacquired common stock. The price of the options granted
pursuant to these plans will not be less than 100 percent of the fair market
value of the shares on the date of grant. The options granted in 1989, 1992, and
1995 vest ratably over a five year period, and the options granted in 1996 and
1997 vest ratably over a four year period; however, no option will be
exercisable after ten years from the date granted.
NOTE 13 -- NET INCOME PER SHARE
The following is a reconciliation of the numerator and denominator of net
income per share of common stock and net income per share of common
stock -- assuming dilution as required by SFAS No. 128:
<TABLE>
<CAPTION>
For the year ended December 31, 1997
-------------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
------------ ---------------- ---------
<S> <C> <C> <C>
Net income per share of common stock:
Income available to common shareholders... $2,477,000 2,472,760 $1.00
=====
Effect of Dilutive Securities:
Stock options............................. -- 182,717
---------- ---------
Net income per share of common stock --assuming
dilution:
Income available to common shareholders
and assumed conversion.................. $2,477,000 2,655,477 $0.93
========== ========= =====
</TABLE>
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- --------------------------------------------------------------------------------
Thirty-One
<PAGE> 30
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the year ended December 31, 1996
----------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ---------
<S> <C> <C> <C>
Net income per share of common stock:
Income available to common shareholders.... $2,410,000 2,453,529 $0.98
=====
Effect of Dilutive Securities:
Stock options.............................. -- 57,730
---------- ---------
Net income per share of common stock -- assuming
dilution:
Income available to common shareholders and
assumed conversion....................... $2,410,000 2,511,259 $0.96
========== ========= =====
</TABLE>
<TABLE>
<CAPTION>
For the year ended December 31, 1995
----------------------------------------
Weighted
Average
Income Common Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ---------
<S> <C> <C> <C>
Net income per share of common stock:
Income available to common shareholders.... $2,170,000 2,436,825 $0.89
=====
Effect of Dilutive Securities:
Stock options.............................. -- 24,615
---------- ---------
Net income per share of common stock -- assuming
dilution:
Income available to common shareholders and
assumed conversion....................... $2,170,000 2,461,440 $0.88
========== ========= =====
</TABLE>
NOTE 14 -- FNB FINANCIAL SERVICES CORPORATION (PARENT COMPANY)
The parent company's principal asset is its investment in its subsidiary,
the Bank. The significant source of income of the parent company is dividends
received from its subsidiary.
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
CONDENSED BALANCE SHEETS
Assets
Cash and due from banks................................... $ 653 $ 374 $ 316
Securities................................................ 12 13 12
Investment in wholly-owned subsidiary..................... 21,829 19,960 18,647
Other assets.............................................. -- 39 7
------- ------- -------
$22,494 $20,386 $18,982
======= ======= =======
Shareholders' equity...................................... $22,494 $20,386 $18,982
======= ======= =======
</TABLE>
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- --------------------------------------------------------------------------------
Thirty-Two
<PAGE> 31
================================================================================
- --------------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
CONDENSED STATEMENTS OF INCOME
Dividends from subsidiary................................... $ 698 $ 835 $ 731
Amortization and other expenses............................. (74) (74) (18)
------- ------- -------
Income before tax benefit................................... 624 761 713
Income tax benefit.......................................... 25 25 6
------- ------- -------
Income before equity in undistributed net income of
subsidiary................................................ 649 786 719
Equity in undistributed net income of subsidiary............ 1,828 1,624 1,451
------- ------- -------
Net income.................................................. $ 2,477 $ 2,410 $ 2,170
======= ======= =======
CONDENSED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Dividends received from subsidiary........................ $ 698 $ 835 $ 731
Cash paid for franchise tax, registration cost,
acquisition cost and other............................. (74) (74) (18)
Sales of assets........................................... 12 -- --
Loss on asset sales....................................... 2 -- --
Refundable income taxes................................... 25 6 71
------- ------- -------
Net cash provided by operating activities.............. 663 767 784
------- ------- -------
CASH USED IN INVESTING ACTIVITIES
Purchase of real estate................................... -- (14) --
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid, net of DRIP............................... (797) (785) (736)
Proceeds from Employee 401(k)............................. 320 -- --
Proceeds from employee stock awards....................... 4 4 19
Exercise of stock options................................. 103 91 --
Purchase of fractional shares............................. (14) (5) --
------- ------- -------
Net cash used in financing activities.................. (384) (695) (717)
------- ------- -------
Net increase (decrease) in cash............................. 279 58 67
Cash at beginning of year................................... 374 316 249
------- ------- -------
Cash at end of year......................................... $ 653 $ 374 $ 316
======= ======= =======
RECONCILIATION OF NET INCOME TO CASH PROVIDED BY OPERATING
ACTIVITIES
Net income.................................................. $ 2,477 $ 2,410 $ 2,170
Adjustments to reconcile net income to net cash provided
by operating activities
(Increase) decrease in other assets.................... 14 (19) 64
Equity in undistributed net income of subsidiary....... (1,828) (1,624) (1,450)
------- ------- -------
Net cash provided by operating activities................... $ 663 $ 767 $ 784
======= ======= =======
</TABLE>
NOTE 15 -- COMMITMENTS AND CONTINGENT LIABILITIES
The Bank's consolidated financial statements do not reflect various
commitments and contingent liabilities which arise in the normal course of
business and which involve elements of credit risk, interest rate risk and
liquidity risk. These commitments and contingent liabilities are commitments to
extend credit and standby letters of credit.
------------------
------------------------------------
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================================================================================
- --------------------------------------------------------------------------------
Thirty-Three
<PAGE> 32
================================================================================
- --------------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
A summary of the Bank's commitments and contingent liabilities at December
31, are as follows:
<TABLE>
<CAPTION>
Contract or
Notional Amount
--------------------
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Commitments to extend credit................................ $42,250 $27,272
Standby letters of credit................................... 13 216
------- -------
$42,263 $27,488
======= =======
</TABLE>
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
NOTE 16 -- EMPLOYEE BENEFIT PLANS
The Company's non-contributory defined benefit pension plan covers
substantially all of its employees. The plan calls for benefits to be paid to
eligible employees at retirement based primarily upon years of service with the
Company and a percentage of qualifying compensation during final years of
employment. Contributions to the plan are based upon the projected unit credit
actuarial funding method and comply with the funding requirements of the
Employee Retirement Income Security Act. Contributions are intended to provide
not only for benefits attributed to service to date but also for those expected
to be earned in the future. Plan assets consists primarily of cash and cash
equivalents, U. S. government securities, and common stocks.
<TABLE>
<CAPTION>
1997 1996
---- -----
<S> <C> <C>
Net pension cost includes the following components (in
thousands):
Service cost of the current period........................ $ 99 $ 60
Interest cost on the projected benefit obligation......... 177 158
Expected return on assets held in the plan................ (153) (148)
Net amortization of prior service......................... 11 11
---- -----
Pension expense........................................... $134 $ 81
==== =====
</TABLE>
The following sets forth the funded status of the plan and the amounts
shown in the accompanying balance sheet at December 31:
<TABLE>
<CAPTION>
1997 1996
------ ------
(In thousands)
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits
of $2,276,728 in 1997 and $1,439,658 in 1996........... $2,310 $2,116
Effect of anticipated future compensation levels.......... 451 293
------ ------
Projected benefit obligation.............................. 2,761 2,409
Fair value of assets held in the plan..................... 2,412 2,289
------ ------
Plan assets less than projected benefit obligation........ (349) (120)
Unrecognized prior service cost being recognized over 15
years.................................................. 121 132
Net unrecognized loss (gain) from past experience
different from that assumed and effects of changes in
assumption............................................. 106 (82)
------ ------
Pension liability......................................... $ (122) $ (70)
====== ======
</TABLE>
The weighted average discount rate used to measure the projected benefit
obligation is 7.00% for 1997 and 1996, the rate of increase in future
compensation levels is 5.00% for 1997 and 1996, and the expected
------------------
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Thirty-Four
<PAGE> 33
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
long-term rate of return on assets is 7.00% for 1997 and 1996. The Company uses
the straight-line method of amortization for prior service cost and unrecognized
gains and losses.
In 1994 the Company adopted a Supplemental Executive Retirement Plan
("SERP"). The SERP allows the Company to supplement the level for certain
executives' retirement income over that which is obtainable through the
tax-qualified retirement plan sponsored by the Bank. Contributions to the SERP
totaled $63,000 for 1997 and $44,000 for 1996.
The Bank also has a contributory 401(k) savings plan covering substantially
all employees. The plan allows eligible employees to contribute up to a fixed
percentage of their compensation, with the Bank matching a portion of each
employee's contribution. The Bank's contributions were $58,000, $49,000, and
$45,000 for 1997, 1996 and 1995, respectively.
A deferred compensation plan allows the directors and certain senior
officers of the Company and the Bank to defer the compensation they earn for
performance of their appointed duties for the Company and the Bank. Each
director elects annually to either receive that year's compensation currently or
to defer receipt until his death, disability or retirement as a director. Each
officer elects annually to either receive that year's compensation currently or
to defer receipt of a portion of his compensation until his death, disability or
retirement as an officer. The total liability for deferred compensation under
the plan was $304,000 and $207,000 at December 31, 1997 and 1996, respectively.
NOTE 17 -- REGULATORY MATTERS
On November 13, 1997, the Company and the Office of the Comptroller of the
Currency (the "OCC") entered into a Memorandum of Understanding ("MOU"), under
which the Company agreed to take certain actions to improve its infrastructure,
primarily necessitated by its rapid growth. In general, the OCC requested that
the Company improve its internal procedures and policies, such as revising its
written loan policy, developing a program to strengthen its loan administration,
and taking steps to increase its liquidity commensurate with its past, and
expected future, growth. In February 1998, the OCC informed the Company that no
further action was being requested and the Company believes that it is in
compliance with the MOU. Management believes that the actions taken by the
Company to address the concerns identified by the OCC in the MOU have not had a
material adverse effect on the business, results of operations, or financial
condition of the Company. While the Company expects the MOU to be terminated
after its next OCC examination, there is no assurance that the OCC will not in
the interim recommend supplemental actions to be taken by the Company.
The Bank, as a National Bank, is subject to the dividend restrictions set
forth by the OCC. Under such restrictions, the Bank may not, without the prior
approval of the OCC, declare dividends in excess of sum of the current year's
earnings (as defined) plus the retained earnings (as defined) from the prior two
years. The dividends, as of December 31, 1997 that the bank could declare
without the approval of the OCC, amounted to approximately $4,902,000.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory -- and possible additional
discretionary -- actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1997, that the Bank
meets all capital adequacy requirements to which it is subject.
The most recent notification from the OCC categorized the Bank as well
capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized the Bank must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the table. Since
that
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- --------------------------------------------------------------------------------
Thirty-Five
<PAGE> 34
================================================================================
- --------------------------------------------------------------------------------
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------------------------------------------------------
------------------------------------
------------------
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
notification, the Bank has continued to experience asset growth. As a result, at
December 31, 1997, the Bank's ratio of total capital to risk weighted assets was
9.6%, which places it into the adequately capitalized classification.
The Bank's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
To Be Well
Capitalized
Under
Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
(in thousands, except for percentages)
<S> <C> <C> <C> <C> <C> <C>
December 31, 1997:
Total Capital (To Risk Weighted Assets)
Consolidated............................. $23,938 9.9% $19,380 $8.0% $ N/A
Subsidiary Bank.......................... 23,248 9.6% 19,386 $8.0% 24,233 $10.0%
Tier I Capital (To Risk Weighted Assets)
Consolidated............................. 21,607 8.9% 9,690 $4.0% N/A
Subsidiary Bank.......................... 20,917 8.6% 9,693 $4.0% 14,540 $ 6.0%
Tier I Capital (To Average Assets)
Consolidated............................. 21,607 7.0% 10,319 $4.0% N/A
Subsidiary Bank.......................... 20,917 6.8% 12,344 $4.0% 15,430 $ 5.0%
December 31, 1996:
Total Capital (To Risk Weighted Assets)
Consolidated............................. 21,868 15.1% 11,609 $8.0% N/A
Subsidiary Bank.......................... 21,442 14.8% 11,628 $8.0% 14,535 $10.0%
Tier I Capital (To Risk Weighted Assets)
Consolidated............................. 19,464 13.4% 5,805 $4.0% N/A
Subsidiary Bank.......................... 19,039 13.1% 5,814 $4.0% 8,721 $ 6.0%
Tier I Capital (To Average Assets)
Consolidated............................. 19,464 9.6% 8,087 $4.0% N/A
Subsidiary Bank.......................... $19,039 9.4% $ 8,086 $4.0% $10,108 $ 5.0%
</TABLE>
NOTE 18 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
for each class of financial instruments.
Cash and cash equivalents. For cash on hand and amounts due from banks the
carrying value is considered to be a reasonable estimate of fair value.
Investment securities. The fair value of investment securities is based on
quoted market prices, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices for similar securities. The
fair value of equity investments in the restricted stock of the Federal Reserve
and Federal Home Loan Bank equals the carrying value.
Loans. The fair value of fixed rate loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities.
The fair value of residential mortgage loans held for sale is based on quoted
market prices and the fair value of variable rate loans with frequent repricing
and negligible credit risk approximates book value.
Deposits. The fair value of noninterest-bearing demand deposits and NOW,
savings and money market deposits is the amount payable on demand at the
reporting date. The fair value of time deposits is estimated using the rates
currently offered for deposits of similar remaining maturities.
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Thirty-Six
<PAGE> 35
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FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
Other interest-bearing liabilities. The carrying value of federal funds
purchased and retail repurchase agreements is considered to be a reasonable
estimate of fair value.
Commitments. The fair value of commitments to extend credit is considered
to approximate carrying value, since the large majority of these commitments
would result in loans that have variable rates and/or relatively short terms to
maturity. For other commitments, generally of a short-term nature, the carrying
value is considered to be a reasonable estimate of fair value. The various
commitment items were disclosed in Note 14.
The estimated fair values of financial instruments are as follows:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
---------------------- ----------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- ---------- -------- ----------
(In thousands)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and cash equivalents.............. $ 9,612 $ 9,612 $ 6,467 $ 6,467
Investment securities
Available for sale................... 77,346 77,346 51,929 51,929
Other equity securities.............. 1,392 1,392 643 643
Loans.................................. 228,715 227,998 144,585 144,267
FINANCIAL LIABILITIES:
Deposits............................... 272,274 269,068 179,380 179,630
Federal funds purchased and retail
repurchase agreements................ 13,720 13,720 8,650 8,650
</TABLE>
The fair value estimates are made at a specific point in time based on
relevant market and other information about the financial instruments. Because
no market exists for a significant portion of the Company's financial
instruments, fair value estimates are current economic conditions, risk
characteristics of various financial instruments, and such other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgement and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in the estimates.
NOTE 19 -- BRANCH ACQUISITION
During March, 1996, the Bank completed its purchase of a branch located in
Eden, North Carolina from another financial institution. The principal amounts
acquired included deposits of approximately $14,000,000, loans of approximately
$2,500,000 and net cash of approximately $11,500,000. The acquisition was
accounted for using the purchase method of accounting.
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Thirty-Seven
<PAGE> 1
EXHIBIT 21.01
FNB FINANCIAL SERVICES CORPORATION
SCHEDULE OF SUBSIDIARIES
<TABLE>
<CAPTION>
Name Jurisdiction of Organization
- ---- ----------------------------
<S> <C>
First National Bank Southeast North Carolina
</TABLE>
<PAGE> 1
EXHIBIT 23.01
CONSENT OF CHERRY, BEKAERT & HOLLAND, L.L.P.
We consent to the incorporation by reference in the Form 10-KSB of FNB Financial
Services Corporation of our report dated February 10, 1998, relating to the
consolidated balance sheets of FNB Financial Services Corporation and Subsidiary
as of December 31, 1997 and 1996, and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the years in
the three-year period ended December 31, 1997, which report appears in the
Registration Statement on Form S-2 (File No. 333-47203) and the 1997 Annual
Report to Shareholders of FNB Financial Services Corporation.
We also consent to the incorporation by reference in (i) the Registration
Statement on Form S-8 pertaining to the FNB Financial Services Corporation
Employees' Savings Plus and Profit Sharing Plan and (ii) the Registration
Statement on Form S-8 pertaining to the FNB Financial Services Corporation
Omnibus Equity Compensation Plan of our report dated February 10, 1998, relating
to the consolidated balance sheets of FNB Financial Services Corporation and
Subsidiary as of December 31, 1997 and 1996, and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1997, which report
appears in the Registration Statement on Form S-2 (File No. 333-47203) and the
1997 Annual Report to Shareholders of FNB Financial Services Corporation.
We also consent to the incorporation by reference in the Registration Statement
(Form S-3 No. 333-02437) pertaining to the FNB Financial Services Corporation
Dividend Reinvestment and Common Stock Purchase Plan of our report dated
February 10, 1998, relating to the consolidated balance sheets of FNB Financial
Services Corporation and Subsidiary as of December 31, 1997 and 1996, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997, which report appears in the Registration Statement on Form S-2 (File No.
333-47203) and the 1997 Annual Report to Shareholders of FNB Financial Services
Corporation.
Cherry, Bekaert & Holland, L.L.P.
Reidsville, North Carolina
March 17, 1998
<PAGE> 1
EXHIBIT 99.01
RISK FACTORS RELATING TO THE COMPANY
MANAGEMENT OF GROWTH
The Company has experienced rapid growth over the past three years. The
growth and expansion of the Company's business have placed, and the Company
believes will continue to place, a strain on its operational, human and
financial resources. In order to manage its growth, the Company must continue to
attract, retain and reward qualified and experienced management, loan and
clerical personnel who possess both the personal affiliations and leadership
traits the Company seeks. In particular, the Company relies on a number of key
executives, including Ernest J. Sewell, its President and Chief Executive
Officer. The Company maintains key man life insurance on Mr. Sewell in the
amount of $1 million. The loss of the services of any key executive could have a
material adverse effect on the Company. Failure to manage growth effectively or
to attract and retain qualified personnel could have a material adverse effect
on the Company's business and could restrain the Company's ability to
successfully implement its business strategy.
EXPANSION INTO NEW GEOGRAPHIC MARKETS
In pursuing its growth strategy, the Company may expand its presence
into new geographic markets, including markets outside the State of North
Carolina. When entering new geographic markets, the Company will need to
establish, or have in place, relationships with new or additional well-trained
local managers and will be reliant on such managers who have the local
affiliations the Company seeks. Therefore, it will be necessary for the Company
to give significant autonomy to its managers in any new branches. The Company
may also be required to comply with laws and regulations that differ from those
currently applicable to the Company, and may face competitors with greater
knowledge of such local markets. There can be no assurance that the Company will
be able to establish local affiliations, realize management and operating
efficiencies or otherwise establish a presence in these new geographic markets.
POTENTIAL RISKS ASSOCIATED WITH ACQUISITIONS
The Company intends to expand its business through selective
de novo branch openings and possible acquisitions. There can be no assurance
that the Company will be able to consummate, or if consummated, successfully
integrate, any future de novo branch opening or acquisition, and there can be no
assurance that the Company will not incur disruption and unexpected expenses in
integrating such transactions. Although the Company currently has no agreements
or understandings, either written or oral, in place, in the normal course of
business, the Company evaluates potential transactions that would complement or
expand the Company's business. In doing so, the Company competes with other
potential bidders, many of which have greater financial and operational
resources. There can be no assurance that the Company will be able to
successfully negotiate, finance or integrate any such transactions. Furthermore,
the process of evaluating, negotiating and integrating transactions may divert
management time and resources. There can be no
<PAGE> 2
assurance that any given de novo branch opening or acquisition, when
consummated, will not have a material adverse effect on the Company's business,
results of operations or financial condition.
COMPOSITION OF LOAN PORTFOLIO
At December 31, 1997, real estate loans comprised 56.1% of the Bank's
total loan portfolio, which includes residential mortgages and construction and
commercial loans secured by real estate. The Company generates a substantial
portion of its real estate mortgage loans in North Carolina. Therefore,
conditions of the real estate markets in North Carolina could strongly influence
the level of the Company's non-performing mortgage loans and the results of
operations and financial condition of the Company. Real estate values and the
demand for mortgages and construction loans are affected by, among other things,
changes in general or local economic conditions, changes in governmental rules
or policies, the availability of loans to potential purchasers, and acts of
nature. Although the Company's underwriting standards are intended to protect
the Company against adverse general and local real estate trends, declines in
real estate markets could adversely impact the demand for new real estate loans,
the value of the collateral securing the Company's loans and the business,
results of operations and financial condition of the Company.
MEMORANDUM OF UNDERSTANDING
On November 13, 1997, the Company and the Office of the Comptroller of
the Currency (the "OCC") entered into a Memorandum of Understanding (the "MOU")
pursuant to which the Company agreed to take certain actions to improve its
infrastructure, primarily necessitated by its rapid growth. In general, the OCC
requested that the Company improve its internal procedures and policies, such as
revising its written loan policy, developing a program to strengthen its loan
administration and taking steps to increase its liquidity commensurate with its
past, and expected future, growth. The Company addressed each of the areas
specified and the OCC has not requested any further action by the Company. As is
customary, the MOU will remain in effect until the next regularly scheduled Bank
examination when the Company expects the MOU to be terminated. An OCC Memorandum
of Understanding is not a formal enforcement procedure recognized by law, but is
an informal mechanism used to monitor compliance by national banks, such as the
Bank, with the OCC's published rules and regulations. An institution's failure
to comply with a Memorandum of Understanding can result in a formal enforcement
proceeding or other remedial action. Management believes that the actions taken
by the Company to address the concerns identified by the OCC in the MOU have not
had a material adverse effect on the business, results of operations or
financial condition of the Company. However, since the MOU has not been formally
terminated, the OCC could request the Company take additional steps which, if
required, could have a material adverse effect on its business, results of
operations or financial condition. See Note 17 to the Company's Consolidated
Financial Statements.
COMPETITION WITH OTHER FINANCIAL INSTITUTIONS
Commercial banking in North Carolina is extremely competitive, due in
large part to statewide branching. Currently, many of the Company's competitors
in certain markets are significantly larger and have greater resources than the
Company. The Company encounters significant competition from
<PAGE> 3
a number of sources, including other bank holding companies, commercial banks,
thrift institutions, credit unions and other financial institutions and
financial intermediaries. Among commercial banks, the Bank competes in its
market areas with some of the largest banking organizations in the country.
Moreover, competition is not limited to financial institutions based in North
Carolina. The enactment of federal legislation authorizing nationwide interstate
banking has greatly increased the size and financial resources of some of the
Company's competitors. Consequently, many of the Company's competitors have
substantially higher lending limits due to their greater total capitalization,
and many perform functions for their customers that the Bank does not offer. As
a result, the Company is likely to encounter increased competition, especially
as it expands into new markets, that may limit its ability to maintain or
increase its market share or otherwise materially and adversely affect its
business, results of operations and financial condition.
GOVERNMENTAL POLICIES AND REGULATION
The profitability of the Company depends to a large extent upon its net interest
income, which is the difference between interest income on interest-earning
assets, such as loans and investments, and interest expense on interest-bearing
liabilities, such as deposits and borrowings. The net interest income of the
Company would be adversely affected if changes in market interest rates caused
by governmental fiscal policies or otherwise resulted in the cost of
interest-bearing liabilities increasing faster than the increase in the yield on
the interest-earning assets of the Company. The operating results of the Company
are also affected by credit policies of monetary authorities, particularly the
Federal Reserve Board ("Federal Reserve"). The instruments of monetary policy
employed by the Federal Reserve include open market operations in U.S.
Government securities, changes in the discount rate on bank borrowings and
changes in reserve requirements against bank deposits. In view of changing
conditions in the national economy and in the money markets, as well as the
effect of action by monetary and fiscal authorities, including the Federal
Reserve, no prediction can be made as to possible future changes in interest
rates, deposit levels and loan demand on the results of operations and business
of the Company. In addition, the Company and the Bank are subject to extensive
supervision, regulation and control by several federal and state governmental
agencies, including the Federal Reserve, the OCC and the FDIC. Certain recently
enacted or proposed legislation or regulations, and future legislation or
regulations, could have an adverse effect on both the costs of doing business
and the competitive factors facing the financial institutions industry. Although
the impact of such legislation and regulation cannot be predicted, future
changes may alter the structure of and competitive relationships among financial
institutions and the cost of doing business.
IMPACT OF TECHNOLOGICAL ADVANCES; UPGRADE TO COMPANY'S INTERNAL SYSTEMS
The banking industry is undergoing, and management believes will
continue to undergo, technological changes with frequent introductions of new
technology-driven products and services. In addition to improving customer
services, the effective use of technology increases efficiency and enables
financial institutions to reduce costs. The Company's future success will
depend, in part, on its ability to address the needs of its customers by using
technology to provide products and services that will satisfy customer demands
for convenience as well as to enhance efficiencies in the Company's operations.
Management believes that keeping pace with technological advances is important
for the Company, as long as its emphasis on personalized services is not
adversely impacted. As a result, the
<PAGE> 4
Company intends to upgrade its internal systems, both through the efficient use
of technology (including software applications) and by strengthening its
policies and procedures. Many of the Company's competitors will have
substantially greater resources than the Company to invest in technological and
infrastructure improvements. There can be no assurance that the Company will be
able to effectively implement new technology-driven products and services
consistent with its emphasis on individualized attention to its customers'
needs.
YEAR 2000 COMPLIANCE
As the year 2000 approaches, an important business issue has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. Many existing application software products,
including the Company's, were designed to accommodate a two-digit year. For
example, "98" is stored on the system and represents 1998 and "00" represents
1900. The Bank primarily utilizes a third-party vendor for processing its
primary banking applications. In addition, the Bank also uses third-party vendor
application software for all ancillary computer applications. The third-party
vendor for the Company's banking applications is in the process of modifying,
upgrading or replacing its computer applications to insure Year 2000 compliance.
To assist in this effort, the Company has been advised by such vendor that the
vendor has hired the services of a consultant to review the plan and assist such
vendor in achieving Year 2000 compliance by December 31, 1998. In addition the
Company has instituted a Year 2000 compliance program whereby the Bank is
reviewing the Year 2000 issues that may be faced by its other third-party
vendors. Under such program, the Company will examine the need for modifications
or replacement of all non-Year 2000 compliant pieces of software. The Company
does not currently expect that the cost of its Year 2000 compliance program will
be material to its financial condition and expects that it will satisfy such
compliance program without material disruption of its operations. In the event
that the Bank's significant suppliers do not successfully and timely achieve
Year 2000 compliance, the Bank's business, results of operations or financial
condition could be adversely affected.
