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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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[ ] 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
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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 PURSUANT TO SECTION 12(B) OF THE EXCHANGE ACT:
None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT:
Common Stock, Par Value $1.00 Per Share
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers in response
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
The aggregate market value of the registrant's Common Stock at
February 15, 1999 held by those persons deemed by the registrant to be
non-affiliates, based on the average bid and asked price of the Common Stock on
that day, was approximately $53.9 million.
As of February 15, 1999 (the most recent practicable date), the
registrant had outstanding 3,377,415 shares of Common Stock, $1.00 par value.
DOCUMENTS INCORPORATED BY REFERENCE
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DOCUMENT WHERE INCORPORATED
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<S> <C>
1. Annual Report to Shareholders for the fiscal year ended December 31, 1998. Part II
2. Proxy Statement for the Annual Meeting of Shareholders to be held April 13, 1999. Part III
</TABLE>
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FORM 10-K TABLE OF CONTENTS
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INDEX PAGE
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PART I
Item 1. Business.............................................................................................. 1
Item 2. Properties............................................................................................ 18
Item 3. Legal Proceedings..................................................................................... 18
Item 4. Submission of Matters To a Vote of Security Holders................................................... 19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................. 20
Item 6. Selected Financial Data............................................................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.................. 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................... 20
Item 8. Financial Statements and Supplementary Data........................................................... 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 20
PART III
Item 10. Directors and Executive Officers of the Registrant................................................... 21
Item 11. Executive Compensation............................................................................... 21
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................... 21
Item 13. Certain Relationships and Related Transactions....................................................... 21
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................... 21
</TABLE>
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PART I
ITEM 1. BUSINESS
GENERAL
FNB Financial Services Corporation (the "Company") is a North Carolina
bank holding company with total assets of $421.7 million, deposits of $345.0
million and shareholders' equity of $44.6 million, each as of December 31,
1998. The Company was organized in 1984, although its predecessor and
wholly-owned subsidiary, FNB Southeast (the "Bank"), was originally chartered
in 1918. Effective March 15, 1999, the Bank changed its charter from a national
bank to a North Carolina state bank. 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 1994 and
1998, the Company's net interest income, loans and deposits each increased at
compound annual growth rates of 21.7%, 33.8%, and 27.0%, 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 four 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, North Carolina; (ii) expanded
by approximately 60% the number of its full-time personnel by adding 54 new
employees, including several new vice presidents and senior vice presidents;
(iii) completed 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 81-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 had 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 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, 1998, after about 22 months of operations, held deposits and
loans totaling $57.8 million and $76.5 million, respectively, compared to $35.3
million and $59.5 million at December 31, 1997. 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, 1998, after less than two full years in
operation, the aggregate deposits and loans at these three branches were $61.8
million and $37.0 million, respectively, compared to $39.4 million and $23.5
million at December 31, 1997. These figures do not necessarily represent the
rate of loan and deposit growth that may be achieved at these branch locations
in the future.
The Bank has acquired two parcels of property in Greensboro, North
Carolina and expects to lease property in Burgaw, North Carolina where, subject
to regulatory approval, the Bank anticipates opening branches in late 1999. The
eastern North Carolina town of Burgaw is contiguous to the Wilmington market,
and the Bank currently has one branch in Greensboro.
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) finalize a program to upgrade, modify and
expand its internal systems, procedures, equipment and software designed to
improve marketing and operating
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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 make every effort to
maintain the Company's personalized approach as pressures to succumb to
technological advances mount. The Company believes that the Bank's change from
a nationally-chartered institution to a state-chartered one in March 1999 is
one way in which the Company has positioned itself for future growth.
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 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, 1998, the most recent date for which
data are available, was 34.7%, which ranked first among banks, credit unions
and thrift institutions, and in all of Rockingham County equaled 25.6% as of
the same date, which also ranked first. The following table summarizes the
banking offices, deposits and market share for the Company's offices,
categorized by city.
<TABLE>
<CAPTION>
DEPOSITS AT DECEMBER 31,
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REGION/CITY 1998 1997 1996
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(IN THOUSANDS)
<S> <C> <C> <C>
TRIAD REGION:
Reidsville(1)........................................................ $171,389 $152,221 $145,377
Eden(1) ............................................................ 54,040 45,305 34,003
Madison 21,576 14,611 Not open
Ruffin............................................................... 7,418 5,014 Not open
Greensboro........................................................... 32,825 19,822 Not open
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Subtotal....................................................... 287,248 236,973 179,380
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WILMINGTON REGION:
Wilmington........................................................... 57,757 35,301 Not open
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Total.......................................................... $345,005 $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 approximately 90,000. 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
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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 1998 with average
unemployment of 5.2%. During 1998 industrial and commercial activity for
Rockingham County created $197.3 million in new investments that created 175
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 $4.1 billion in 1997 (the
most recent year for which data are available) and is ranked 34th nationally in
that category. According to the North Carolina Employment Security Commission,
the Triad area of North Carolina reported an unemployment rate of 2.3% as of
November 1998.
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. At November 1998, the North Carolina Employment
Security Commission reported a 3.7% unemployment rate for the Wilmington
metropolitan area.
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, 1998 were $255.8 million, or 63.7% 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, 1998, the Bank had no large loan concentrations
(exceeding ten percent of its portfolio) in any particular industry.
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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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1998 1997 1996
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(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C>
REAL ESTATE:
Commercial ................................ $ 83,202 32.6% $ 51,022 22.3% $ 30,516 21.1%
Residential ............................... 50,121 19.6% 58,238 25.5 44,109 30.5
Construction and development .............. 24,976 9.8% 19,083 8.3 13,407 9.3
-------- ------- -------- ------- -------- -------
Total real estate ............ 158,299 62.0% 128,343 56.1 88,032 60.9
-------- ------- -------- ------- -------- -------
COMMERCIAL, FINANCIAL AND AGRICULTURAL ... 45,141 17.6% 54,294 23.7 25,175 17.4
-------- ------- -------- ------- -------- -------
CONSUMER:
Direct .............................. 23,908 9.3% 23,237 10.2 16,766 11.6
Home equity ......................... 24,122 9.4% 19,740 8.6 13,516 9.3
Revolving ........................... 4,357 1.7% 3,101 1.4 1,096 0.8
-------- ------- -------- ------- -------- -------
Total consumer ............... 52,387 20.4% 46,078 20.2 31,378 21.7
-------- ------- -------- ------- -------- -------
Total ........................ $255,827 100% $228,715 100% $144,585 100.0%
======== ======= ======== ======= ======== =======
</TABLE>
Real Estate Loans. Loans secured by real estate for a variety of
purposes constituted $158.3 million, or 62.0%, of the Bank's total loans at
December 31, 1998. The Bank held at December 31, 1998 real estate loans of
various sizes ranging up to $4.9 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 such cases.
The Bank experienced no net loan losses on commercial real estate loans during
1998, 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, 1998 it held $50.1 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 net loan losses on residential real estate of $4,000,
$13,000 and $0 in 1998, 1997 and 1996, respectively.
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 1998, 1997 and 1996, the Bank earned loan origination fees of
$45,000, $81,000 and $32,000, respectively. At December 31, 1998, the Bank
held none of such loans for sale, and during 1998 the
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Bank sold an aggregate of $8.8 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, 1998,
1997 and 1996, the Bank held $25.0 million, $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
1998, the Bank experienced net loan losses of $48,000, and no such net loan
losses in 1997 and 1996.
Commercial Loans. The Bank makes loans for commercial purposes in
various lines of businesses. At December 31, 1998, the Bank held $45.1 million
of commercial loans, or 17.6% 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 1998, the Bank experienced net loan losses on commercial
loans of $537,000, during 1997, the Bank experienced net loan losses on
commercial loans of $6,000, and in 1996 the Bank 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, 1998, the Bank held $48.0 million of consumer loans, including
home equity revolving lines of credit. During 1998, 1997 and 1996,
respectively, the Bank experienced net consumer loan losses of $156,000,
$29,000 and $35,000.
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, 1998, credit card loans equaled approximately
$3.5 million, or approximately 1.4% of the Bank's total loan portfolio. Net
losses on credit card loans equaled $110,000 in 1998, $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
$250,000; loans in excess of that limit must be approved by the city executive.
If the lending request exceeds the city
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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. Under joint approval, the
senior credit officer and the senior vice president -- corporate
administration, may approve loans up to $1.5 million. All loans in excess of
$1.5 million 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 also engaged a third party consultant to
review its loan portfolio, the first examination of which occurred 1998. The
Bank has used the findings of the examination to further enhance credit quality
through improved credit administration policies and procedures.
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.
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>
<CAPTION>
AT DECEMBER 31,
--------------------------------
1998 1997 1996
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<S> <C> <C> <C>
Non-interest bearing demand ...................... 11.2% 11.6% 12.2%
Savings/NOW/MMI .................................. 21.6 19.4 27.3
Certificates of deposits ......................... 67.2 69.0 60.5
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
</TABLE>
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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 customer's home or place of
business to pick up a non-cash deposit the customer wishes to make. At December
31, 1998, the Bank had $86.9 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 1998, the Bank earned fees in the amount of $34,000
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 at 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:
- 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.
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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. The Bank's 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 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.
EMPLOYEES
As of December 31, 1998, the Company had approximately 144 full-time
and 17 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.
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<PAGE> 12
SUPERVISION AND REGULATION
The following discussion is intended to be a summary of the material
regulations and policies applicable to the Company and its wholly-owned
subsidiary, FNB Southeast, and does not purport to be a comprehensive
discussion. These regulations are 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
the applicable statutes, regulations or regulatory policy may have a material
effect on the business of the Company.
General. The Company is a bank holding company, registered with the
Board of Governors of the Federal Reserve ("Federal Reserve") under the Bank
Holding Company Act of 1956 ("BHC Act") and with the North Carolina
Commissioner of Banks (the "Commissioner") under the North Carolina Bank
Holding Company Act of 1984, as amended (the "North Carolina Act"). As such,
the Company and its subsidiaries are subject to the supervision, examination,
and reporting requirements of the BHC Act and the North Carolina Act and the
regulations of the Federal Reserve and the Commissioner.
Prior to March 15, 1999, the Bank was a national bank regulated by the
Office of the Comptroller of the Currency ("OCC"). Effective March 15, 1999,
the Bank converted its charter from a national bank to a North Carolina state
bank and became a member of the Federal Reserve.
The Bank is a member of the Federal Deposit Insurance Corporation
("FDIC"), and as such, its deposits are insured by the FDIC to the extent
provided by law. The Bank is also subject to numerous state and federal
statutes and regulations that affect its business, activities, and operations.
As a North Carolina bank and member of the Federal Reserve, the Bank is
supervised and examined by the Federal Reserve and the Commissioner, and is
also subject to the backup supervisory authority of the FDIC. Such agencies
regularly examine the operations of the Bank and are given authority to approve
or disapprove mergers, consolidations, the establishment of branches, and
similar corporate actions. Such agencies also have the power to prevent the
continuance or development of unsafe or unsound banking practices or other
violations of law.
On November 13, 1997, the Company and the OCC, which supervised the
Bank prior to its conversion to a North Carolina bank in March 1999, entered
into a Memorandum of Understanding (the "MOU"). 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. Because the Bank has converted to a North Carolina charter and
is no longer subject to the supervision and regulation of the OCC, the MOU no
longer binds the Bank; however, the Company believes that it is, in any event,
in compliance with the provisions of the MOU.
Regulation of Bank Holding Companies. The BHC Act requires every bank
holding company to obtain the prior approval of the Federal Reserve before (i)
it may acquire direct or indirect ownership or control of voting shares of any
company, including a bank, if, after such acquisition, the bank holding company
will directly or indirectly own or control more than five percent of the voting
shares of such company, (ii) it or any of its subsidiaries, other than a bank,
may acquire all or substantially all of the assets of any company, including a
bank, or (iii) it may merge or consolidate with any other bank holding company.
The BHC Act further provides that the Federal Reserve may not approve
any transaction that would result in a monopoly or would be in furtherance of
any combination or conspiracy to monopolize
10
<PAGE> 13
or attempt to monopolize the business of banking in any section of the United
States, or the effect of which may be substantially to lessen competition or to
tend to create a monopoly in any section of the country, or that in any other
manner would be in restraint of trade, unless the anti-competitive effects of
the proposed transaction are clearly outweighed by the public interest in
meeting the convenience and needs of the community to be served. The Federal
Reserve is also required to consider the financial and managerial resources and
future prospects of the bank holding companies and banks concerned and the
convenience and needs of the community to be served. Consideration of financial
resources generally focuses on capital adequacy and consideration of
convenience and needs issues includes the parties' performance under the
Community Reinvestment Act of 1977 (the "CRA"). Both capital adequacy and the
CRA are discussed below.
The BHC Act, as amended by the interstate banking provisions of the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Interstate Banking Act"), which became effective on September 29, 1995,
repealed the prior statutory restrictions on interstate acquisitions of banks
by bank holding companies, such that the Company and any other bank holding
company located in North Carolina may now acquire a bank located in any other
state, and any bank holding company located outside North Carolina may lawfully
acquire any North Carolina-based bank, regardless of state law to the contrary,
in either case subject to certain deposit-percentage limitations, aging
requirements, and other restrictions. The Interstate Banking Act also generally
provides that, after June 1, 1997, national and state-chartered banks may
branch interstate through acquisitions of banks in other states. By adopting
legislation prior to that date, states had the ability either to "opt in" and
accelerate the date after which interstate branching is permissible or "opt
out" and prohibit interstate branching altogether. Accordingly, the Bank is
able to establish and operate branches in other states, unless such states have
enacted "opt out" legislation. North Carolina has enacted "opt in" legislation
that now permits interstate branching in North Carolina on an unlimited basis.
The BHC Act generally prohibits the Company from engaging in
activities other than banking or managing or controlling banks or other
permissible subsidiaries and from acquiring or retaining direct or indirect
control of any company engaged in any activities other than those activities
determined by the Federal Reserve 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 reasonably can 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,
operating a thrift institution, factoring accounts receivable, 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 performing certain
insurance underwriting activities all have been determined by the Federal
Reserve to be permissible activities of bank holding companies. The BHC Act
does not place territorial limitations on permissible bank-related activities
of bank holding companies. Despite prior approval, the Federal Reserve has the
power to order a holding company or its subsidiaries to terminate any activity
or to terminate its ownership or control of any subsidiary 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.
Capital Adequacy. The Company and the Bank are required to comply with
the capital adequacy standards established by the Federal Reserve. There are
two basic measures of capital adequacy: a risk-
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<PAGE> 14
based measure and a leverage measure. All applicable capital standards must be
satisfied for an institution to be considered in compliance.
The risk-based capital standards are designed to make regulatory
capital requirements more sensitive to differences in risk profile among banks
and bank holding companies, to account for off-balance sheet exposure, and to
minimize disincentives for holding liquid assets. Assets and off-balance sheet
items are assigned to broad risk categories, each with appropriate weights. The
resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items.
The minimum guideline for the ratio ("Risk Based Capital Ratio") of
total capital ("Total Capital") to risk-weighted assets (including certain
off-balance-sheet items, such as standby letters of credit) is 8.0 percent. At
least half of the Total Capital must be composed of common equity, retained
earnings, minority interests in the equity accounts of consolidated
subsidiaries, non-cumulative perpetual preferred stock, and a limited amount of
cumulative perpetual preferred stock, less goodwill and certain other
intangible assets ("Tier 1 Capital"). The remainder may consist of mandatory
convertible debt securities and a limited amount of subordinated debt, other
preferred stock, and a limited amount of loan loss reserves ("Tier 2 Capital").
At December 31, 1998, the Company's Tier 1 and Total Capital ratios were 15.3%
and 16.3%, respectively.
In addition, the Federal Reserve has established minimum leverage
ratio guidelines for bank holding companies. These guidelines provide for a
minimum ratio of Tier 1 Capital to average assets, less goodwill and certain
other intangible assets (the "Leverage Ratio") of three percent for bank
holding companies that meet certain specified criteria, including having the
highest regulatory rating. All other bank holding companies generally are
required to maintain a Leverage Ratio of at least three percent plus an
additional cushion of 100 to 200 basis points. The Company's Leverage Ratio at
December 31, 1998 was 10.3%. 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 Federal Reserve has indicated that it will consider a
"tangible Tier 1 Capital leverage ratio" (deducting all intangibles) and other
indicia of capital strength in evaluating proposals for expansion or new
activities.
The Bank is subject to risk-based and leverage capital requirements
adopted by the Federal Reserve and was in compliance with applicable minimum
capital requirements as of December 31, 1998. Neither the Company nor the Bank
has been advised by any federal banking agency of any specific minimum Leverage
Ratio requirement applicable to it.
Failure to meet capital guidelines could subject a bank to a variety
of enforcement remedies, including the termination of deposit insurance by the
FDIC, and to certain restrictions on its business. See "Prompt Corrective
Action."
The federal bank regulators continue to indicate their desire to raise
capital requirements applicable to banking organizations beyond their current
levels. In this regard, the federal banking agencies have, pursuant to the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
proposed an amendment to the risk-based capital standards that would calculate
the change in an institution's net economic value attributable to increases and
decreases in market interest rates and would require banks with excessive
interest rate risk exposure to hold additional amounts of capital against such
exposures.
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<PAGE> 15
Support of Subsidiary Bank. Under Federal Reserve policy, the Company
is expected to act as a source of financial strength to, and to commit
resources to support, the Bank. This support may be required at times when,
absent such Federal Reserve policy, the Company may not be inclined to provide
it. In addition, any capital loans by a bank holding company to its subsidiary
bank are subordinate in right of payment to deposits and to certain other
indebtedness of the subsidiary bank. 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.
Payment of Dividends. The Company is a legal entity separate and
distinct from the Bank. The principal source of cash flow of the Company,
including cash flow to pay dividends to its shareholders, is dividends from the
Bank. There are statutory and regulatory limitations on the payment of
dividends by the Bank to the Company as well as the Company to its
shareholders.
Under North Carolina law, the Bank may pay cash dividends only out of
undivided profits and only if the Bank has surplus of a specified level. If a
bank having capital stock of $15,000 or more has surplus of less than 50% of
its paid-in capital stock, no cash dividend may be declared until the bank has
transferred from undivided profits to surplus 25% of its undivided profits or
any lesser percentage sufficient to raise the bank surplus to an amount equal
to 50% of its paid-in capital. Furthermore, if, in the opinion of the federal
regulatory agencies, a bank under its jurisdiction is engaged in or is about to
engage in an unsafe or unsound practice (which, depending on the financial
condition of the bank, could include the payment of dividends), such authority
may require, after notice and hearing, that such bank cease and desist from
such practice. The Federal Reserve and the FDIC have indicated that paying
dividends that deplete a bank's capital base to an inadequate level would be an
unsafe and unsound banking practice. Under the FDICIA an insured bank may not
pay any dividend if payment would cause it to become undercapitalized or once
it is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued
policy statements which provide that bank holding companies and insured banks
should generally only pay dividends out of current operating earnings.
The primary source of funds for the dividends paid by the Company to
its shareholders is dividends received from its banking subsidiary. The Bank is
restricted as to dividend payout by state laws applicable to banks and may pay
dividends only out of undivided profits. Additionally, dividends paid by the
Company may be limited due to maintaining minimum capital requirements imposed
by banking regulators. Management does not expect any of these restrictions to
materially limit its ability to pay dividends comparable to those paid in the
past. At December 31, 1998, the Bank had undivided profits of approximately
$21.0 million.
The payment of dividends by the Company and the Bank may also be
affected or limited by other factors, such as the requirement to maintain
adequate capital above regulatory guidelines.
Community Reinvestment Act ("CRA"). The Bank is subject to the
provisions of the CRA. Under the terms of the CRA, the appropriate federal bank
regulatory agency is required, in connection with its examination of a bank, to
assess such bank's record in meeting the credit needs of the communities served
by that bank, including low and moderate-income neighborhoods. The regulatory
agency's assessment of the bank's record is made available to the public.
Further, such assessment is required of any bank which has applied to (i)
charter a national bank, (ii) obtain deposit insurance coverage for a newly
chartered institution, (iii) establish a new branch office that will accept
deposits, (iv) relocate an office, or (v) merge or consolidate with, or acquire
the assets or assume the liabilities of, a federally regulated financial
institution. In the case of a bank holding company applying for approval
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<PAGE> 16
to acquire a bank or other bank holding company, the Federal Reserve will
assess the records of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
Under CRA regulations jointly adopted by all federal bank regulatory
agencies, the former process-based CRA assessment factors were replaced with a
new evaluation system that rates institutions based on their actual performance
in meeting community credit needs. The evaluation system used to judge an
institution's CRA performance consists of three tests: a lending test; an
investment test; and a service test. Each of these tests will be applied by the
institution's federal regulator in an assessment context that would take into
account such factors as: (i) demographic data about the community; (ii) the
institution's capacity and constraints; (iii) the institution product offerings
and business strategy; and (iv) data on the prior performance of the
institution and similarly-situated lenders. The new lending test -- the most
important of the three tests for all institutions other than wholesale and
limited purpose (e.g. credit card) banks -- will evaluate an institution's
lending activities as measured by its home mortgage loans, small business and
farm loans, community development loans, and, at the option of the institution,
its consumer loans. The institution's regulator will weigh each of these
lending categories to reflect its relative importance to the institution's
overall business and, in the case of community development loans, the
characteristics and needs of the institution's service area and the
opportunities available for this type of lending. Assessment criteria for the
lending test will include: (i) geographic distribution of the institution's
lending; (ii) distribution of the institution's home mortgage and consumer
loans among different economic segments of the community; (iii) the number and
amount of small business and small farm loans made by the institution; (iv) the
number and amount of community development loans outstanding; and (v) the
institution's use of innovative or flexible lending practices to meet the needs
of low-to-moderate income individuals and neighborhoods. At the election of an
institution, or if particular circumstances so warrant, the banking agencies
will take into account in making their assessments lending by the institution's
affiliates as well as community development loans made by the lending consortia
and other lenders in which the institution has invested. All financial
institutions will be required to report data on their small business and small
farm loans as well as their home mortgage loans.
The joint agency CRA regulations provide that an institution evaluated
under a given test would receive one of five ratings for that test:
outstanding; high satisfactory; low satisfactory; needs to improve; or
substantial non-compliance. The ratings for each test would then be combined to
produce an overall composite rating of either outstanding, satisfactory
(including both high and low satisfactory), needs to improve, or substantial
non-compliance. In the case of a retail-oriented institution, its lending test
rating would form the basis for its composite rating. That rating would then be
increased by up to two levels in the case of outstanding or high satisfactory
investment performance, increased by one level in the case of outstanding
service, and decreased by one level in the case of substantial non-compliance
in service. An institution found to have engaged in illegal lending
discrimination would be rebuttably presumed to have a less-than-satisfactory
composite CRA rating. The Bank's current CRA rating is satisfactory.
Prompt Corrective Action. The FDICIA establishes a system of prompt
corrective action to resolve the problems of undercapitalized institutions.
Under this system the federal banking regulators are required to rate
supervised institutions on the basis of five capital categories
("well-capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," and "critically undercapitalized") and to
take certain mandatory supervisory actions, and are authorized to take other
discretionary actions, with respect to institutions in the three
undercapitalized categories, the severity of
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<PAGE> 17
which will depend upon the capital category in which the institution is placed.
The federal banking agencies have specified by regulation the relevant capital
level for each category.
Under the Federal Reserve rule implementing the prompt corrective
action provisions, a bank that (i) has a Total Capital ratio of ten percent or
greater, a Tier 1 Capital ratio of six percent or greater, and a Leverage Ratio
of five percent or greater, and (ii) is not subject to any written agreement,
order, capital directive, or prompt corrective action directive issued by the
Federal Reserve, is deemed to be "well-capitalized." An institution with a
Total Capital ratio of eight percent or greater, a Tier 1 Capital ratio of four
percent or greater and a Leverage Ratio of four percent or greater (or three
percent or greater in the case of an institution rated composite 1 under the
CAMEL rating system) is considered to be "adequately capitalized." A bank that
has a Total Capital ratio of less than eight percent or a Tier 1 Capital ratio
of less than four percent or a Leverage Ratio that is less than four percent
(or less than three percent in the case of a bank rated composite 1 under the
CAMEL rating system) is considered to be "undercapitalized." A bank that has a
Total Capital ratio of less than six percent, a Tier 1 Capital ratio of less
than three percent, or a Leverage Ratio that is less than three percent is
considered to be "significantly undercapitalized" and an institution that has a
tangible equity capital to assets ratio equal to or less than two percent is
deemed to be "critically undercapitalized." For purposes of the regulation, the
term "tangible equity" includes core capital elements counted as Tier 1 capital
for purposes of the risk-based capital standards plus the amount of outstanding
cumulative perpetual preferred stock (including related surplus), minus all
intangible assets with certain exceptions. A bank may be deemed to be in a
capitalization category that is lower than is indicated by its actual capital
position if it receives an unsatisfactory examination rating.
At December 31, 1998, the Bank had the requisite capital levels to
qualify as well-capitalized.
An FDIC-insured depository institution is generally prohibited from
making any capital distribution (including the payment of a dividend) or
payment 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. Generally, subject to a narrow exception, FDICIA requires the banking
regulator to appoint a receiver or conservator for an institution that is
critically undercapitalized. A bank that is not "well capitalized" is subject
to certain limitations relating to so-called "brokered" deposits.
FDIC Insurance Assessments. Pursuant to FDICIA, the FDIC adopted a
risk-based assessment system for insured depository institutions that takes
into account the risks attributable to different
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<PAGE> 18
categories and concentrations of assets and liabilities. The risk-based system,
which went into effect January 1, 1994, assigns an institution to one of three
capital categories: (i) well-capitalized; (ii) adequately capitalized; and
(iii) undercapitalized. These three categories are substantially similar to the
prompt corrective action categories described above, with the
"undercapitalized" category including institutions that are undercapitalized,
significantly undercapitalized, and critically undercapitalized for prompt
corrective action purposes. An institution is also assigned by the FDIC to one
of three supervisory subgroups within each capital group. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by the institution's primary federal regulator
and information which the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds (which
may include, if applicable, information provided by the institution's state
supervisor). An institution's insurance assessment rate is then determined
based on the capital category and supervisory category to which it is assigned.
Under the final risk-based assessment system there are nine assessment
risk classifications (i.e., combinations of capital groups and supervisory
subgroups) to which different assessment rates are applied.
Under the Federal Deposit Insurance Act, ("FDIA") insurance of
deposits may be terminated by the FDIC upon a finding that the institution has
engaged in unsafe and unsound practices, is in an unsafe or unsound condition
to continue operations, or has violated any applicable law, regulation, rule,
order or condition imposed by the FDIC. Management does not know of any
practice, condition or violation that might lead to termination of deposit
insurance.
Safety and Soundness Standards. The FDIA, as amended by FDICIA and the
Riegle Community Development and Regulatory Improvement Act of 1994, requires
the federal bank regulatory agencies to prescribe standards, by regulations or
guidelines, relating to internal controls, information systems and internal
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, asset quality, earnings, stock valuation and
compensation, fees and benefits and such other operational and managerial
standards as the agencies deem appropriate. The federal bank regulatory
agencies have adopted a set of guidelines prescribing safety and soundness
standards pursuant to FDICIA, as amended. The guidelines establish general
standards relating to internal controls and information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset
growth and compensation, fees, and benefits. In general, the guidelines
require, among other things, appropriate systems and practices to identify and
manage the risks and exposures specified in the guidelines. The guidelines
prohibit excessive compensation as an unsafe and unsound practice and describe
compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director, or principal stockholders. The federal banking agencies determined
that stock valuation standards were not appropriate. In addition, the agencies
adopted regulations that authorize, but do not require, an agency to order an
institution that has been given notice by an agency that it is not satisfying
any of such safety and soundness standards to submit a compliance plan. If,
after being so notified, an institution fails to submit an acceptable
compliance plan, the agency must issue an order directing action to correct the
deficiency and may issue an order directing other actions of the types to which
an undercapitalized association is subject under the prompt correction action
provisions of FDICIA. If an institution fails to comply with such an order, the
agency may seek to enforce such order in judicial proceedings and to impose
civil money penalties. The federal bank regulatory agencies also proposed
guidelines for asset quality and earnings standards.
Depositor Preference. Legislation enacted by Congress establishes a
nationwide depositor preference rule in the event of a bank failure. Under this
arrangement, all deposits and certain other
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<PAGE> 19
claims against a bank, including the claim of the FDIC as subrogee of insured
depositors, would receive payment in full before any general creditor of the
bank would be entitled to any payment in the event of an insolvency or
liquidation of the bank.
Transactions with Related Parties. The Bank's authority to engage in
transactions with its "affiliates" is limited by Sections 23A and 23B of the
Federal Reserve Act ("FRA") and the regulations of the Federal Reserve
thereunder. In general, an affiliate of the Bank is any company that controls
the Bank or any other company that is under common control with the Bank,
excluding the Bank's subsidiaries. At present, the provisions of Sections 23A
and 23B apply to extensions of credit by the Bank to the Company. Section 23A
limits the aggregate amount of transactions with any individual affiliate to
10% of capital and surplus and also limits the aggregate amount of transactions
with all affiliates to 20% of capital and surplus. Extensions of credit to
affiliates are required to be secured by collateral in an amount of a type
described in Section 23A and purchase of low quality assets from affiliates is
generally prohibited. Section 23B provides that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards that are substantially the same or at
least as favorable to the Bank as those prevailing at the time for comparable
transactions with nonaffiliated companies.
The Bank's authority to extend credit to its directors, executive
officers and 10% shareholders, as well as to entities controlled by such
persons, is currently governed by the requirements of Sections 22(g) and 22(h)
of the FRA and Regulation O of the FRB thereunder. Among other things, these
provisions require that extensions of credit to insiders (a) be made on terms
that are substantially the same as, and follow credit underwriting procedures
that are not less stringent than, those prevailing for comparable transactions
with unaffiliated persons and that do not involve more than the normal risk of
repayment or present other unfavorable features and (b) do not exceed certain
limitations on the amount of credit extended to such persons, individually and
in the aggregate, which limits are based, in part, on the amount of the Bank's
capital.
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 in 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.
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ITEM 2. PROPERTIES
The Company leases or owns ten banking offices, as shown in the
following table:
<TABLE>
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
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 2001 and 2003. 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.
18
<PAGE> 21
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, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Ernest J. Sewell, age 58, 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. He is a member of the Board of Trustees
of Annie Penn Memorial Hospital, Reidsville, North Carolina, and is Chairman of
its Investment Committee. Mr. Sewell, who is an avid pilot, also serves on the
boards of various charitable organizations and is Vice Chairman of the
Rockingham County Airport Authority.
Robert F. Albright, age 62, is Executive 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 47, 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.
R. Michael Hendricks, age 35, is Senior Vice President, Corporate
Administration of the Bank. He joined the Bank in 1997 as Senior Vice President
and City Executive, prior to being promoted to his current position in
December, 1998. He had previously served as Vice President, Business Services
Manager at Branch Banking and Trust Company and had 11 years banking experience
prior to joining the Bank.
19
<PAGE> 22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from page 18 (Table 11) of the Company's
1998 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, 1998 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 95,100 shares of its Common
Stock at a weighted average exercise price of $24.87 per share pursuant to the
Company's Omnibus Equity Compensation Plan.
ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference from page 4 of the Company's 1998 Annual
Report to Shareholders included as Exhibit 13.01 to this report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
Incorporated by reference from pages 5 through 18 of the Company's
1998 Annual Report to Shareholders included as Exhibit 13.01 to this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Incorporated by reference from pages 15 through 16 of the Company's
1998 Annual Report to Shareholders included as Exhibit 13.01 to this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference from pages 19 through 39, and from page 18
(Table 10), of the Company's 1998 Annual Report to Shareholders included as
Exhibit 13.01 to this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As previously reported by the Company on a Current Report on Form 8-K,
on August 21, 1998 the Board of Directors of the Company and the Audit
Committee thereof approved the engagement of PricewaterhouseCoopers LLP as the
Company's independent public accountants for the year ended December 31, 1998,
to replace Cherry, Bekaert & Holland, L.L.P. Cherry, Bekaert & Holland, L.L.P.
was notified on August 21, 1998 that the Company was changing independent
public accountants.
The audit reports of Cherry, Bekaert & Holland, L.L.P. on the
consolidated financial statements of the Company for the years ended December
31, 1996 and 1997 did not contain any adverse opinion or disclaimer of opinion,
nor were they qualified or modified as to uncertainty, audit scope or
accounting principles.
20
<PAGE> 23
In connection with the audits of the Company's financial statements
for each of the two fiscal years ended December 31, 1997 and in the subsequent
interim period through August 21, 1998, there were no disagreements with
Cherry, Bekaert & Holland, L.L.P. on any matters of accounting principles or
practices, financial statement disclosure, or auditing scope and procedures
which, if not resolved to the satisfaction of Cherry, Bekaert & Holland, L.L.P.
would have caused Cherry, Bekaert & Holland, L.L.P. to make reference to the
matter in their report. Cherry, Bekaert & Holland, L.L.P. furnished a letter to
the Securities and Exchange Commission, a copy of which was filed as an exhibit
to the Form 8-K, stating that it agreed with these statements.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 16,
1999, with respect to the Annual Meeting of Shareholders to be held on April
13, 1999.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the Company's definitive proxy
statement, as filed with the Securities and Exchange Commission on March 16,
1999, with respect to the Annual Meeting of Shareholders to be held on April
13, 1999.
ITEM 12. 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 16,
1999, with respect to the Annual Meeting of Shareholders to be held on April
13, 1999.
ITEM 13. 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 16,
1999, with respect to the Annual Meeting of Shareholders to be held on April
13, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Index to Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- ------------
<S> <C>
3.02(1) Amended and Restated Articles of Incorporation.
3.03(1) Bylaws of Company, as amended.
4.01 Specimen Common Stock Certificate.
</TABLE>
21
<PAGE> 24
<TABLE>
<S> <C>
10.01(2) 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(3) Omnibus Equity Compensation Plan of the Registrant.
10.03(3) Severance Policy for Senior Officers of the Registrant
(employed for five years or more).
10.04(4) Revised Severance Policy for Senior Officers of the
Registrant (employed for five years or more).
10.05(3) Severance Policy for Senior Officers of the Registrant
(employed for less than five years). 10.06(5) Equipment
Sale Agreement and related agreements dated September 24,
1992 by and among the Registrant and Information Technology, Inc.
10.07(6) Benefit Equivalency Plan effective January 1, 1994.
10.08(6) Annual Management Incentive Plan.
10.09(6) Long Term Incentive Plan.
10.10(6) 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(7) Split-Dollar Agreement dated January 27, 1995 between the
Registrant and Ernest J. Sewell.
10.12(7) Split-Dollar Agreement dated September 26, 1994 between
the Registrant and Robert F. Albright.
10.13(7) Split-Dollar Agreement dated January 27, 1995 between the
Registrant and C. Melvin Gantt.
10.14(7) Split-Dollar Agreement dated December 8, 1995 between the
Registrant and Richard L. Powell.
10.15(8) Lease, dated January 31, 1997, between the Registrant and
Landmark Commercial, Inc.,
relating to the Wilmington branch office.
10.16 Amendment to Benefit Equivalency Plan effective January 1, 1998
13.01 Those portions of the Registrant's 1998 Annual Report to
Shareholders which have been incorporated by reference
into this Annual Report on Form 10-K.
16.01(9) Letter of Cherry, Bekaert & Holland, L.L.P.
21.01(8) Subsidiaries of the Registrant.
23.01 Consent of PricewaterhouseCoopers LLP
23.02 Consent of Cherry, Bekaert & Holland, L.L.P.
27.01 Financial Data Schedule (for SEC use only).
99.01 Risk Factors relating to the Registrant.
</TABLE>
- -----------------------------
(1) Incorporated herein by reference to the Registrant's
Quarterly Report on Form 10-Q for the fiscal quarter ended
March 31, 1998, filed with the Securities and Exchange
Commission.
(2) Incorporated herein by reference to the Registrant's
Registration Statement on Form S-8 (No. 33-33186), filed with
the Securities and Exchange Commission.
(3) 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.
(4) 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.
(5) 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.
22
<PAGE> 25
(6) 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.
(7) 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.
(8) Incorporated herein by reference to the Registrant's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1997.
(9) Incorporated herein by reference to Registrant's Current
Report on Form 8-K dated August 21, 1998, filed with the
Securities and Exchange Commission.
(b) Reports on Form 8-K.
None.
23
<PAGE> 26
FORWARD-LOOKING STATEMENTS
Information set forth in this Annual Report on Form 10-K 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.
24
<PAGE> 27
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 18, 1999
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 18, 1999
- --------------------------- (Principal Executive Officer)
Ernest J. Sewell
/s/ Robert F. Albright Executive Vice President and Chief Financial Officer March 18, 1999
- --------------------------- (Principal Financial Officer)
Robert F. Albright
/s/ Michael W. Shelton Senior Vice President and Controller (Principal March 18, 1999
- --------------------------- Accounting Officer)
Michael W. Shelton
/s/ Willard B. Apple, Jr. Chairman of the Board March 18, 1999
- ---------------------------
Willard B. Apple, Jr.
/s/ Charles A. Britt Director March 18, 1999
- ---------------------------
Charles A. Britt
/s/ Barry Z. Dodson Director March 18, 1999
- ---------------------------
Barry Z. Dodson
/s/ O. Eddie Green Director March 18, 1999
- ---------------------------
O. Eddie Green
/s/ Joseph H. Kinnarney Director March 18, 1999
- ---------------------------
Joseph H. Kinnarney
/s/ Clifton G. Payne Director March 18, 1999
- ---------------------------
Clifton G. Payne
/s/ Elton H. Trent, Jr. Director March 18, 1999
- ---------------------------
Elton H. Trent, Jr.
/s/ Kenan C. Wright Director March 18, 1999
- ---------------------------
Kenan C. Wright
</TABLE>
25
<PAGE> 28
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description
------- -----------
<S> <C>
4.01 Specimen Stock Certificate
13.01 Those portions of the Registrant's Annual Report to Shareholders for the
fiscal year ended December 31, 1998 which have been incorporated into this
Annual Report on Form 10-K.
10.16 Amendment to Benefit Equivalency Plan effective January 1, 1998
23.01 Consent of PricewaterhouseCoopers LLP
23.02 Consent of Cherry, Bekaert & Holland, L.L.P.
27.01 Financial Data Schedule (for SEC use only)
99.01 Risk Factors relating to the Registrant.
</TABLE>
<PAGE> 1
EXHIBIT 4.01
[Front Side of Certificate]
FNB
Financial Services Corporation
INCORPORATED UNDER THE LAWS OF THE STATE OF NORTH CAROLINA
Number Shares
FNB [ ]
CUSIP 302526 10 8
SEE REVERSE FOR CERTAIN DEFINITIONS
THIS IS TO CERTIFY that
SPECIMEN
is the owner of
FULLY PAID AND NON-ASSESSABLE SHARES OF COMMON STOCK OF THE PAR VALUE
OF ONE DOLLAR ($1.00) EACH OF FNB FINANCIAL SERVICES CORPORATION transferable
on the books of the Corporation by the holder hereof in person or by duly
authorized attorney upon surrender of this Certificate properly endorsed. This
Certificate is not valid until countersigned and registered by the Transfer
Agent and Registrar.
WITNESS the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
Dated:
<TABLE>
<S> <C> <C>
[FNB Financial Services Corporation
/s/ Robert F. Albright North Carolina /s/ Ernest J. Sewell
Secretary Corporate Seal President and
1983] Chief Executive
Officer
</TABLE>
Countersigned and Registered
REGISTRAR AND TRANSFER COMPANY
Transfer Agent
and Registrar
By
Authorized Officer
<PAGE> 2
[Reverse Side of Certificate]
The record holder of this Certificate may obtain from the Secretary of the
Corporation, upon request and without charge, a full statement of the
designation, relative rights, preferences and limitations of the shares of each
class authorized to be issued and the designation, relative rights, preferences
and limitations of each series of preferred shares authorized to be issued so
far as the same have been fixed and the authority of the Board of Directors to
designate and fix the relative rights, preferences and limitations of other
series.
The following abbreviations, when used in the inscription on the face
of this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM - as tenants in common UNIF GIFT MIN ACT________Custodian_________
(Cust) Minor
TEN ENT - as tenants by the entireties under Uniform Gifts to Minors
Act
--------------------------
JT TEN - as joint tenants with right (State)
of survivorship and not as
tenants in common
Additional abbreviations may also be used though not in the above list.
For value received, ________________________________ hereby sell,
assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------------
- --------------------------------------------
- -------------------------------------------------------------------------------
Please Print or Typewrite Name and Address including
Postal Zip Code of Assignee
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- ------------------------------------------------------------------------ shares
of the capital stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
- -------------------------------------------------------------------------------
Attorney to transfer the said stock on the books of the within-named
Corporation with full power of substitution in the premises.
Dated:
---------------------------
-------------------------
NOTICE: The signature to this assignment must correspond with the name as
written upon the face of the Certificate, in every particular, without
alternation or enlargement, or any change whatever.
<PAGE> 1
EXHIBIT 10.16
AMENDMENT #2
BENEFIT EQUIVALENT PLAN ("BEP")
FOR THE SENIOR MANAGEMENT EMPLOYEES OF
FNB FINANCIAL SERVICES CORPORATION
The Benefit Equivalent Plan ("BEP") for the Senior Management Employee's [sic]
of FNB Financial Services Corporation is amended effective January 1, 1998 as
follows:
SECTION 4.2(D) - is amended in its entirety as follows:
The Employer's President Ernest J. Sewell shall receive a supplemental benefit
[in addition to the benefit as provided in Section 4.2 (a)] determined as
follows:
Two and three quarter percent (2.75%) of his Final Average
Compensation multiplied by the number of his "Years of Service."
This supplemental benefit as determined in his Amendment shall be payable in
accordance with the Plan's provision on Normal Retirement ( Article 4), Early
Retirement (Article 3), Disability Retirement (Article 5) or Survivor Benefits
(Article 7).
This Amendment is adopted this 12th day of February, 1998
FNB Financial Services Corporation
by /s/ W.B. Apple, Jr., Chrmn.
----------------------------------------
Attest:
/s/ Robert F. Albright
- ------------------------------------
Secretary
<PAGE> 1
EXHIBIT 13.01
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE, RATIO AND OTHER DATA)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net interest income................... $ 14,558 $ 10,961 $ 8,598 $ 7,250 $ 6,641
Provision for loan losses............. 1,130 760 415 260 105
Other income.......................... 2,254 1,354 1,252 1,236 927
Other expenses........................ 9,970 7,903(1) 6,004 5,190 5,333
Net income............................ 3,847 2,477 2,410 2,170 1,592(2)
BALANCE SHEET DATA:
Assets................................ $421,709 $325,151 $209,796 $177,897 $169,231
Loans(3).............................. 255,827 228,715 144,585 111,708 79,787
Allowance for loan losses............. 2,606 2,331 1,638 1,258 1,052
Deposits.............................. 345,005 272,274 179,380 154,400 132,474
Other borrowings...................... 28,932 28,720 8,650 3,152 21,130
Shareholders' equity.................. 44,566 22,518 20,386 18,982 14,920
PER COMMON SHARE DATA(4):
Net income, basic..................... $ 1.23 $ 1.00 $ 0.98 $ 0.89 $ 0.65
Net income, diluted(5)................ 1.16 0.93 0.96 0.88 0.65
Cash dividends declared............... 0.40 0.39 0.34 0.30 0.27
Book value............................ 12.99 9.03 8.29 7.78 6.12
Tangible book value................... 12.83 8.74 7.98 7.78 6.12
OTHER DATA:
Branch offices........................ 10 10 6 5 5
Full-time employees................... 144 129 95 87 90
PERFORMANCE RATIOS:
Return on average assets.............. 0.98% 0.96% 1.23% 1.27% 1.03%
Return on average equity.............. 10.58 11.86 12.52 12.91 9.76
Net interest margin (taxable
equivalent)......................... 3.92 4.57 4.84 4.72 4.84
Dividend payout....................... 33.14 39.00 35.17 33.92 41.30
Efficiency(6)......................... 58.81 63.22 58.93 58.16 66.61
ASSET QUALITY RATIOS:
Allowance for loan losses to period
end loans........................... 1.02% 1.02% 1.13% 1.13% 1.32%
Allowance for loan losses to period
end non-performing loans(7)......... 735 180 299 2,859 670
Net charge-offs to average loans...... 0.34 0.04 0.03 0.06 0.28
Non-performing assets to period end
loans and foreclosed property(7).... 0.70 0.58 0.40 0.21 0.43
CAPITAL AND LIQUIDITY RATIOS:
Average equity to average assets...... 9.27% 8.09% 9.85% 9.80% 10.55%
Leverage.............................. 10.30 7.02 9.60 10.80 10.11
Tier 1 risk-based..................... 15.32 8.92 13.49 15.80 18.24
Total risk-based...................... 16.25 9.88 15.10 16.70 19.39
Average loans to average deposits..... 76.45 84.17 76.37 65.64 60.23
Average loans to average deposits and
borrowings.......................... 70.38 79.06 73.81 61.42 58.20
</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 net 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 14 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.
Four
<PAGE> 2
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 forty-one of this Annual Report.
OVERVIEW
The growth which began in 1997 with the
opening of four new branch offices continued
into 1998. Principally by increasing market
share at the new branches, the Company achieved
double-digit growth over last year in all the
important balance sheet categories. Significant
asset growth led to another record earnings
year, with these factors supporting the twin
strategic financial objectives of balance sheet
expansion and improved net income performance.
The year was further defined by a successful
public offering of stock in the spring, which
resulted in the issuance of an additional
897,000 shares and the generation of
approximately $18.5 million more in new capital,
after deducting underwriting fees and expenses.
This capital infusion will allow the Company to
continue its planned expansion into existing,
new and contiguous markets.
Plans for 1999 already include the addition
of an office in the eastern North Carolina town
of Burgaw, continguous to the Wilmington market,
as well as two new offices in Greensboro, NC, to
address the need for more locations to serve
those vibrant and growing communities. A new
administrative building is expected to be
constructed adjacent to the existing Reidsville
headquarters, to house an ever-growing number of
(CHART) people who were brought in to help manage the
Company's growth. The Company is continuing to
incur substantial expense in connection with its
expansion efforts, for experienced personnel,
occupancy costs and equipment, the latter to
update electronic systems and procedures.
Management believes that these costs are
necessary investments which will result in
enhanced financial performance and are integral
to the institution's growth objectives.
RESULTS OF OPERATIONS
During 1998, the Company achieved record
earnings, as the significant balance sheet
growth recorded in 1997 from entering new
markets continued into the next year. Net income
was $3.847 million, or $1.16 per share, fully
diluted, compared with $2.477 million, or $0.93
per share, in 1997. The increase of 55.3% in net
income was principally fueled by a 32.8%
increase in net interest income and a 66.5%
increase in non-interest income. Non-interest
expense, at the same time, was 26.2% higher and
the provision for loan losses was raised 48.7%
over last year, the latter as a result of
increased loan balances and higher net loan
losses. Net income in 1997 exceeded the prior
year by just 2.8%, as a result of $1.4 million
in expenses during 1997, which was associated
with the opening of new branches. Over the last
few years, markets in which the Company operates
have been characterized by excellent economic
conditions, resulting in healthy loan growth and
sound asset quality.
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)
(CHART) supporting them.
Five
<PAGE> 3
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>
1998 1997 1996
------------------------------- ------------------------------- -------------------------------
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).............. $248,397 $23,190 9.34% $185,829 $17,616 9.48% $129,150 $12,092 9.36%
Taxable investment
securities............... 116,238 6,912 5.97 47,669 2,800 5.86 42,214 2,480 5.82
Tax-exempt investment
securities............... 4,886 411 9.06(1) 6,135 542 9.37(1) 10,985 990 9.60(1)
Other securities........... 1,215 89 7.33 884 63 7.13 756 52 6.88
Deposits with FHLB......... 2,240 119 5.31 849 47 5.54 485 26 5.36
Federal funds sold and
retail repurchase
agreements............... 1,698 94 5.54 2,477 133 5.37 1,027 53 5.16
---------- -------- ---------- -------- ---------- --------
Total earning assets... 374,674 30,815 8.24 243,843 21,201 8.70 184,617 15,693 8.51
NON-EARNING ASSETS:
Cash and due from banks.... 7,747 6,845 5,201
Premises and equipment..... 6,849 6,166 4,042
Other assets............... 5,436 3,302 2,953
Less: Allowance for loan
loss..................... (2,591) (1,882) (1,440)
-------- -------- --------
Total assets........... $392,115 $258,274 $195,373
======== ======== ========
INTEREST BEARING LIABILITIES:
Savings and time
deposits................. 290,124 14,600 5.03 195,311 9,287 4.75 148,400 6,449 4.35
Federal funds purchased,
borrowed funds and
securities sold under
agreements to
repurchase............... 28,008 1,517 5.42 14,270 769 5.39 5,868 313 5.33
---------- -------- ---------- -------- ---------- --------
Total interest bearing
liabilities.......... 318,132 16,117 5.07 209,581 10,056 4.80 154,268 6,762 4.38
---------- -------- ---------- -------- ---------- --------
OTHER LIABILITIES AND
SHAREHOLDERS' EQUITY:
Demand deposits............ 34,782 25,474 20,721
Other liabilities.......... 2,852 2,329 1,131
Shareholders' equity....... 36,349 20,890 19,253
-------- -------- --------
Total liabilities and
shareholders'
equity............... $392,115 $258,274 $195,373
======== ======== ========
Net interest income and net
yield on earning
assets(3)(4)............. $14,698 3.92% $11,145 4.57% $ 8,931 4.84%
======= ==== ======= ==== ======= ====
Interest rate spread(5).... 3.17% 3.90% 4.13%
==== ==== ====
</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.
Six
<PAGE> 4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
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 influenced by changes in
interest rates, volume and the mix of these
various components. Net interest income on a
fully taxable equivalent basis was $14.7
million, which represented a 31.9% increase over
the previous year. In 1997, taxable equivalent
net interest income increased to approximately
$11.1 million from approximately $8.9 million in
1996, which was an increase of 24.7%. Actual net
interest income was 32.8% higher in 1998,
following an improvement of 27.5% in 1997.
Growth in net interest income for 1998 was
occasioned by significantly higher loan and
investment securities balances, supported by
deposit growth and additional capital as a
result of the public offering. Average loans
outstanding during the year equaled $248.4
(CHART) million compared to $185.8 million in 1997, an
increase of 33.7%. In the previous year, average
loans outstanding were 43.9% higher than 1996.
This outstanding loan growth is attributed to
generally favorable economic conditions in the
Company's lending
markets and a more aggressive focus on lending in new and existing areas.
Average investment securities during 1998 were $122.3 million, up 123.7% over
1997, following an increase of only 1.4% the previous year. Purchases during the
year were chiefly in relatively short term taxable securities, which serves the
dual purpose of improving liquidity and acting as a source of funds for future
loan growth. Average total deposits of $324.9 million were up 47.2% in 1998,
which followed a gain of 30.5% the previous year. Average shareholders equity
balances of $36.3 million represented a 74.0% increase over 1997, with the
amount outstanding at year end approximately double the previous year end.
Interest margins continued their recent decline in 1998, as the weighted
average yield on earning assets fell to 8.24%, from 8.70% in 1997, but the
weighted average rate paid on interest bearing liabilities rose to 5.07% in
1998, from 4.80% last year. Consequently, the interest rate spread fell to 3.17%
in 1998, from 3.90% the previous year. The prime rate on loans was reduced from
8.50% to 7.75% during the last quarter of 1998, which caused the weighted rate
on loans to fall from 9.48% in 1997 to 9.34% this year. Investment securities
yields were 6.09% on a taxable equivalent basis in 1998, down from 6.25% last
year, as significant purchases this year have occurred in a lower interest rate
environment. Even more meaningful to the decline in the average earning asset
yield was the effect of higher yielding loans averaging 76.2% of earning assets
in 1997, compared with only 66.3% in 1998, while lower yielding investment
security balances represented approximately 10.3% more this year than in 1997.
The weighted average rate paid on savings and time deposits increased from 4.75%
in 1997 to 5.03% this year, as deposit growth came principally from higher
yielding certificates of deposit, with the effect of greater cost tempered by
the increased stability of fixed maturities.
Table 2 on page six summarizes net interest income and average yields
earned and rates paid for the years indicated, on a tax equivalent basis. Table
3 on page eight presents the changes in interest income and interest expense
attributable to volume and rate changes between 1998 and 1997 and 1997 and 1996.
NON-INTEREST INCOME AND EXPENSE
Non-interest income of $2.254 million in 1998 was $900,000 or 66.5% more
than the previous year. Net securities gains represented the largest variance,
increasing $384,000 as gains were taken in connection with a restructuring of
the portfolio, which involved the sale of U. S. Government agency securities and
the purchase of mortgage-backed securities. In addition, gains were also taken
to enhance the total portfolio return during a period when interest rates were
historically low. Fees on bankcard transactions doubled to $427,000, while
deposit service charges were up $211,000, because of pricing changes and
increased deposit volume. The Company offers a variety of mortgage products in
its markets and generally sells the fixed rate production in the secondary
market which, because of the declining rate structure, generated gains on the
sales of $53,000 more than last year. In 1997, total non-interest income of
$1.354 million was $102,000 more than the prior year and included 20.1% more in
deposit service charges, but lower net security gains.
Seven
<PAGE> 5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 3
VOLUME AND RATE VARIANCE ANALYSIS
YEAR ENDED DECEMBER 31, 1998 AND 1997
FULLY TAXABLE EQUIVALENT BASIS
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
1998 1997
------------------------------- -------------------------------
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............................... $5,926 $ (352) $5,574 $5,303 $ 221 $5,524
Taxable investment securities............ 4,021 91 4,112 320 0 320
Tax exempt investment securities(1)...... (110) (21) (131) (439) (14) (453)
Other earning assets..................... 102 (4) 98 29 3 32
Federal funds sold and retail repurchase
agreements............................. (42) 3 (39) 75 5 80
------ ------- ------ ------ ----- ------
Total interest income.................. 9,897 (283) 9,614 5,288 215 5,503
------ ------- ------ ------ ----- ------
Interest expense:
Savings and time deposits................ 4,489 824 5,313 2,039 799 2,838
Federal funds purchased, borrowed funds
and securities sold under agreements to
repurchase............................. 740 8 748 448 8 456
------ ------- ------ ------ ----- ------
Total interest expense................. 5,229 832 6,061 2,487 807 3,294
------ ------- ------ ------ ----- ------
Inc/(dec) in net interest income......... $4,668 $(1,115) $3,553 $2,801 $(592) $2,209
====== ======= ====== ====== ===== ======
</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, 1998 December 31, 1997 December 31, 1996
------------------------------- ------------------------------ ------------------------------
Weighted Weighted Weighted
Amortized Fair Average Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield Cost Value Yield
--------- -------- -------- --------- ------- -------- --------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury................. $ 0 $ 0 0.00% $ 3,074 $ 3,092 5.98% $13,075 $13,076 5.32%
U.S. government agency........ 139,488 140,280 5.86 68,997 68,973 6.01 31,906 31,760 5.87
State and municipal
obligations(1).............. 3,815 4,111 9.33 4,953 5,281 9.11 6,693 7,093 9.45
Other equity.................. 1,335 1,335 7.16 1,392 1,392 7.08 643 643 6.93
-------- -------- ------- ------- ------- -------
Total investment
securities(1)........... $144,638 $145,726 5.97 $78,416 $78,738 6.22 $52,317 $52,572 6.20
======== ======== ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
------------------------------------------------------------------------------------------
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 -- $ 0 -- $ 0 -- $ 0 -- $ 0 --
U.S. government agency............ 0 -- 85,128 5.94% 42,645 5.61% 11,715 6.19% 139,488 5.86%
State and municipal
obligations(1).................. 60 13.03% 631 11.50 3,124 8.83 0 -- 3,815 9.33
--- ------- ------- ------- --------
Total investment
securities(1)............... $60 13.03 $85,759 5.98 $45,769 5.83 $11,715 6.19 $143,303 5.95
=== ======= ======= ======= ========
</TABLE>
- ---------------
(1) Yields stated on a tax equivalent basis.
Eight
<PAGE> 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
Non-interest expense increased $2.067 million, or 26.2%, in 1998 to $9.970
million, compared to $7.903 million in 1997. Last year, non-interest expense of
$7.903 million exceeded the previous year by $1.899 million, or 31.6%. The
primary reason for the significant increase in expense in 1998 has been the full
year effect of investments made during 1997, principally in adding experienced
personnel to manage the Company's growth.
Personnel expense of $5.939 million in 1998
exceeded the previous year by $1.230 million, or
26.1%. Full time salaries of officers and staff
of $3.950 million were $754,000 or 23.6% more
than 1997. At December 31, 1998, the Company had
approximately 144 full-time and 17 part-time
employees, compared with 129 full-time and 19
part-time employees at December 31, 1997.
Employee benefits of $1.126 million in 1998 were
up $296,000 or 35.6% over 1997 and included
additional costs for retirement and 401-k plans
and social security taxes, as well as the
various insurance plans, such as health, life,
disability and workmen's compensation.
Occupancy expense followed a 53.3% increase
in expense in 1997 with an additional 15.5% in
1998, the latter amounting to an increase of
$82,000. Premises rental, maintenance and
repairs, utilities and depreciation expense were
all higher in 1998, much of it attributed to the
new offices opened in 1997 being open for all
twelve months of 1998. Furniture and equipment
expense totaled $836,000 in the current year, up
$208,000 or 33.1%, following a 35.1% increase in
1997 over 1996. Depreciation on equipment of
$538,000 this year was up 55.8% over 1997, while
equipment rent, personal property taxes and
repairs also posted higher numbers in 1998. All
other expenses of $2.584 million were up
(CHART) $548,000, or 26.9% over 1997, with many of the
increases attributed to a full year of expenses
for the offices opened at various periods during
1997. Individual line items which increased at
least $25,000 and 25% over 1997 were insurance
(principally FDIC), director fees, legal and
professional, telephone, exams and audits,
travel and entertainment, bank card, other real
estate and miscellaneous. In 1997, all other
expenses were up 30.2% over the prior year,
which was also principally related to the office
openings during the year. The efficiency ratio,
which measures non-interest expense as a
percentage of net interest income plus
non-interest income, was 58.8% in 1998, an
improvement over the 63.2% posted the previous
year.
FINANCIAL CONDITION
The Company's consolidated assets of $421.7
million at year end increased 29.7% over the
previous year, following an increase of 55.0% in
1997. While the growth in earning assets in 1997
was heavily weighted toward loans, 1998 growth
occurred in both loans and investment
securities. Supporting that growth this year
were increases of 22.6% in non-interest bearing
deposits, 27.2% in interest bearing deposits and
a nearly 100% increase in shareholders' equity.
A major share of the balance sheet expansion
resulted from increases at the new offices and
it is expected that future growth will continue
in those markets through existing and new
branches, as well as other market areas the
(CHART) Company is currently evaluating.
Nine
<PAGE> 7
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,
-------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Commercial................... $ 83,202 32.6% $ 51,022 22.3% $ 30,516 21.1% $ 27,208 24.4% $15,037 18.8%
Residential.................. 50,121 19.6 58,238 25.5 44,109 30.5 36,438 32.6 30,060 37.7
Construction................. 24,976 9.8 19,083 8.3 13,407 9.3 4,531 4.1 681 0.9
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Total real estate... 158,299 62.0 128,343 56.1 88,032 60.9 68,177 61.1 45,778 57.4
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Commercial, financial and
agricultural............... 45,141 17.6 54,294 23.7 25,175 17.4 18,248 16.3 11,272 14.1
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Consumer:
Direct....................... 23,908 9.3 23,237 10.2 16,766 11.6 15,247 13.6 12,619 15.8
Home equity.................. 24,122 9.4 19,740 8.6 13,516 9.3 9,579 8.6 9,708 12.2
Revolving.................... 4,357 1.7 3,101 1.4 1,096 0.8 457 0.4 410 0.5
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Total consumer...... 52,387 20.4 46,078 20.2 31,378 21.7 25,283 22.6 22,737 28.5
-------- ----- -------- ----- -------- ----- -------- ----- ------- -----
Total............... $255,827 100.0% $228,715 100.0% $144,585 100.0% $111,708 100.0% $79,787 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======= =====
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------------------------------------------------------------
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...................... $24,961 $ 17,391 $ 2,789 $ 45,141 $ 6,712 $ 13,468
Real estate -- construction......... 12,504 11,209 1,263 24,976 967 11,505
Real estate -- residential.......... 7,674 12,170 30,277 50,121 31,751 10,696
Real estate -- commercial........... 11,135 54,171 17,896 83,202 26,617 45,450
Consumer............................ 11,264 24,704 16,419 52,387 15,628 25,495
------- -------- ------- -------- ------- --------
$67,538 $119,645 $68,644 $255,827 $81,675 $106,614
======= ======== ======= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1998 1997 1996 1995 1994
------ ------ ---- ---- ----
<S> <C> <C> <C> <C> <C>
Non-performing assets:
Non-accrual(1)......................................... $ 355 $1,263 $547 $ 44 $154
Past due 90 days or more and still accruing interest... 0 29 0 0 3
Other real estate...................................... 1,451 31 48 192 191
Renegotiated troubled debt............................. 0 0 0 0 0
</TABLE>
- ---------------
(1) If nonperforming loans outstanding at December 31, 1998 had been performing
in accordance with their terms, $22,963 more in interest income would have
been recorded in 1998. Actual interest income recorded in 1998 was $9,936.
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.
Ten
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
Loan growth during 1998 was less robust than in the recent past, with
outstanding loans up 11.9% at year end, following increases of 58.2% in 1997 and
29.4% in 1996. Loans secured by real estate were up 23.3% and represented 62.0%
of total loans, compared with 56.1% at year end 1997. Within the category,
commercial real estate loans increased 63.1%, to a level of $83.2 million.
Commercial, financial and agricultural loans were off 16.9%, representing 17.6%
of total loans, compared with 23.7% last year end. Consumer loans advanced
13.7%, led mainly by increases in home equity loans. 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.
Investment securities (at amortized cost) of $145.7 million at year end
were up $67.0 million or 85.1% over 1997. U. S. Government agency securities
continue to represent the major share of the total portfolio, increasing from
88.0% of the portfolio at the end of 1997 to 96.4% at year end 1998. Management
believes that the additional risk of owning Agencies over U. S. Treasury
securities is negligible and has capitalized on the favorable spreads available
on the former. However, the interest rate risk of purchasing longer term
municipal securities at their continued relatively low rates has kept us out of
that market for approximately the last two years. Our investment portfolio goals
are to achieve good total portfolio returns, within the context of remaining
relatively short in maturity to fund loan growth and mitigate the unfavorable
effect of interest rate increases. To this end, the Company has consistently
categorized the entire portfolio as Available for Sale, which it believes offers
the greatest amount of flexibility in managing a total return concept. 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.
During 1998, the yield curve remained relatively flat, with little
incentive for customers to choose longer deposit maturities at a minimal spread
difference from shorter, more liquid products. Accordingly, retail deposit
growth was concentrated in certificates of deposit with maturities of two years
or less, as well as products such as the Money Market Investment account, which
has superior liquidity and was re-priced higher to attract more funds during
1998. The market for deposits remains fiercely competitive and the Company
relies on appropriate pricing and quality customer service to retain and
increase its retail deposit base. For commercial customers, the Company is
focused on building a total relationship, which will foster growth in both loans
and deposits. In addition to traditional regular checking accounts, the Company
offers a cash management sweep account, with outstanding balances increasing
from $9.6 million at the end of 1997 to $10.4 million in 1998. In order to
attract longer term deposits, the Company joined an electronic network which
allows it to post interest rates and attract deposits nationally. Approximately
$11.5 million was attracted from this source during 1998, with a weighted
average maturity of approximately two years and rates comparable to those paid
in-market. Finally, the Company also utilized a portion of its $40 million line
with the Federal Home Loan Bank of Atlanta to fund earning assets, with a year
end balance outstanding of $15 million. Management continues to believe this is
a cost effective and prudent alternative to deposit balances, since a particular
amount and term may be selected to meet its current needs.
ASSET QUALITY
Management believes that asset quality is of the greatest 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 for the years ended December 31,
1994 through 1998. 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.
Eleven
<PAGE> 9
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,
--------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance, beginning of period.................. $2,331 $1,638 $1,258 $1,052 $1,174
Charge-offs:
Commercial............................... 597 16 0 0 0
Real estate -- construction.............. 0 0 0 0 0
Real estate -- mortgage.................. 4 13 0 0 15
Consumer................................. 347 131 89 128 332
------ ------ ------ ------ ------
948 160 89 128 347
Recoveries:
Commercial............................... 12 10 0 2 52
Real estate -- construction.............. 0 0 0 0 0
Real estate -- mortgage.................. 0 0 0 0 0
Consumer................................. 81 83 54 72 68
------ ------ ------ ------ ------
93 93 54 74 120
------ ------ ------ ------ ------
Net charge-offs............................... 855 67 35 54 227
------ ------ ------ ------ ------
Provision charged to operations............... 1,130 760 415 260 105
------ ------ ------ ------ ------
Balance, end of period........................ $2,606 $2,331 $1,638 $1,258 $1,052
====== ====== ====== ====== ======
Ratio of net charge-offs to average loans..... 0.34% 0.04% 0.03% 0.06% 0.28%
====== ====== ====== ====== ======
Ratio of allowance to year-end loans.......... 1.02% 1.02% 1.13% 1.13% 1.32%
====== ====== ====== ====== ======
</TABLE>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ------------------ -----
Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in
Each Each Each Each
Category Category Category Category
to Total to Total to Total to Total
$ Loans $ Loans $ Loans $ Loans $
----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at end of period
applicable to:
Commercial................ 1,427 18% 1,190 24% 826 17% 512 16% 546
Real
estate -- construction.. 4 10 8 8 13 9 9 4 0
Real estate -- mortgage... 27 52 154 48 151 52 131 57 50
Consumer.................. 1,066 20 298 20 386 22 320 23 224
General................... 82 0 681 0 262 0 286 0 232
----- --- ----- --- ----- --- ----- --- -----
Total allocation............ 2,606 100% 2,331 100% 1,638 100% 1,258 100% 1,052
===== === ===== === ===== === ===== === =====
<CAPTION>
1994
----------
Percent of
Loans in
Each
Category
to Total
Loans
----------
<S> <C>
Balance at end of period
applicable to:
Commercial................ 14%
Real
estate -- construction.. 1
Real estate -- mortgage... 57
Consumer.................. 28
General................... 0
---
Total allocation............ 100%
===
</TABLE>
Twelve
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
The 1998 provision of $1.130 million compares with $760,000 in 1997 and
$415,000 in 1996, which equals a 48.7% increase in 1998 and a two year increase
of 172.3%. The increase in the dollar level of the allowance was necessitated by
the growth in loans, while the level of non-performing loans and charge-offs has
remained at comparatively low levels. Net charge-offs did increase in 1998 to a
level of $855,000 or 0.34% of average loans outstanding, compared with $67,000
and 0.04% in 1997. Approximately 62% of the net charge-offs in 1998 were for
just two commercial loans, which had not performed well over an extended period
of time and were finally written off. At December 31, 1998, the allowance for
loan losses as a percentage of year end loans was 1.02%, which was equal to the
percentage the prior year end.
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
status 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, however, 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 Office of the Comptroller of the Currency
("OCC") and the Federal Reserve, who have been, respectively, the primary
regulators for the Bank and the Company, have adopted minimum capital
regulations or guidelines that categorize components and the level of risk
associated with various types of assets. Financial institutions are required 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 but,
because of the growth realized during 1997, the levels fell to "adequately
capitalized" by the end of 1997. In order to restore capital levels and position
the Company for future growth, a total of 897,000 additional shares of stock
were sold in a public offering during April/May, 1998, generating approximately
$18.5 million in new capital, which resulted in both the Bank and the Company
achieving a "well capitalized" level of capital at year end. Effective in March
1999, the Bank converted from a national bank, regulated by the OCC, to a North
Carolina bank, regulated by the North Carolina Commissioner of Banks
("Commissioner"). The Bank will continue to be required to meet certain levels
of capital.
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 to 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, 1998 to be 0.97%. This ratio indicates that net interest income
would decline in a rising interest rate environment, since a greater amount of
liabilities than assets would reprice more quickly over the one-year period.
Included in rate sensitive liabilities are certain deposit accounts (NOW, MMI
and savings) 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
45% of NOW and MMI accounts, and 15% of savings accounts reprice within one year
and the remaining balances reprice after one year. The schedule also includes
$29.5 million of securities that are callable within the one-year sensitivity
time period. While these securities have contractual maturities beyond one year,
management believes these securities will be
Thirteen
<PAGE> 11
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,
----------------------------------------------------
1998 1997 1996
--------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Total capital to risk weighted assets
Consolidated.............................. $45,928 16.25% $23,938 9.88% $21,868 15.10%
Bank...................................... 44,739 15.83 23,248 9.59 21,442 14.80
Tier 1 capital to risk weighted assets
Consolidated.............................. 43,322 15.32 21,607 8.92 19,464 13.40
Bank...................................... 42,133 14.90 20,917 8.63 19,039 13.10
Tier 1 capital to average assets
Consolidated.............................. 43,322 10.30 21,607 7.02 19,464 9.60
Bank...................................... 43,133 10.05 20,917 6.79 19,039 9.40
</TABLE>
TABLE 8
INTEREST SENSITIVITY ANALYSIS
DECEMBER 31, 1998
(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....... $160,544 $ 2,375 $ 6,098 $169,017 $ 86,455 $255,472
Taxable investment securities.... 10,707 6,007 15,523 32,237 107,251 139,488
Tax exempt investment
securities..................... 0 0 0 0 3,815 3,815
Other investment securities...... 1,335 0 0 1,335 0 1,335
Due from FHLB.................... 269 0 0 269 0 269
-------- -------- -------- -------- -------- --------
Total interest earning
assets...................... 172,855 8,382 21,621 202,858 197,521 400,379
-------- -------- -------- -------- -------- --------
Interest bearing liabilities:
Savings/NOW/MMI.................. 28,845 0 0 28,845 45,520 74,365
Other time deposits.............. 63,607 42,053 61,674 167,334 64,718 232,052
Overnight borrowings............. 13,932 0 0 13,932 0 13,932
Other borrowings................. 0 0 0 0 15,000 15,000
-------- -------- -------- -------- -------- --------
Total interest bearing
liabilities................. 106,384 42,053 61,674 210,111 125,238 335,349
-------- -------- -------- -------- -------- --------
Interest sensitivity gap......... $ 66,471 $(33,671) $(40,053) $ (7,253)
======== ======== ======== ========
Ratio of interest sensitive
assets to interest sensitive
liabilities.................... 1.62 0.20 0.35 0.97
</TABLE>
Fourteen
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
called on the specified dates based upon the difference in the coupon rate of
the securities and the current level of interest rates. Furthermore, 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 63% of the total loan portfolio have variable rates,
and reprices 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 an established policy to monitor interest
rate risk. The policy provides guidance for levels of interest rate risk and
potential remediations, if necessary, to mitigate excessive levels of risk. The
modeling results indicate the Company is subject to an acceptable level of
interest rate risk.
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 from increased deposit and
sweep account balances. Liquidity is further enhanced by a $40.0 million line of
credit with the Federal Home Loan Bank of Atlanta collateralized by FHLB stock
and qualifying 1-4 family residential mortgage loans. There are unsecured
overnight borrowing lines available through several financial institutions. An
additional source of liquidity for 1998 was the stock issuance. While this is
not an ongoing source of liquidity, the issuance netted $18.5 million in funds
for the Company. 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.
MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets, over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The Company is asset sensitive, which means that falling interest rates could
result in a reduced amount of net interest income. The monitoring of interest
rate risk is discussed in "Interest Rate Sensitivity and Liquidity Management"
on page thirteen. The Company is not subject to other types of market risk, such
as foreign currency exchange rate risk, commodity or equity price risk.
The following Table 9 presents the Company's financial instruments which
are considered to be sensitive to changes in interest rates, categorized by
contractual maturities, average interest rates and estimated fair values at
December 31, 1998.
Fifteen
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
TABLE 9
MARKET RISK OF FINANCIAL INSTRUMENTS
(IN THOUSANDS, EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
Contractual Maturities at December 31, 1998
----------------------------------------------------------------------- Average Estimated
Over Five Interest Fair
1999 2000 2001 2002 2003 Years Total Rate Value
-------- ------- ------- ------- ------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Financial assets
Debt securities......... $ 60 $ 9,022 $12,521 $27,475 $36,741 $ 57,484 $143,303 5.95% $144,391
Loans:
Fixed rate............ 9,131 14,218 13,327 11,492 9,403 36,736 94,307 9.08% 96,628
Variable rate......... 53,537 16,474 11,784 24,234 19,827 35,664 161,520 8.37% 161,216
-------- ------- ------- ------- ------- -------- -------- --------
Total............ $ 62,728 $39,714 $37,632 $63,201 $65,971 $129,884 $399,130 7.67% $402,235
======== ======= ======= ======= ======= ======== ======== ========
Financial liabilities
NOW..................... $ 23,235 $ -- $ -- $ -- $ -- $ -- $ 23,235 0.80% $ 23,235
MMI..................... 35,728 -- -- -- -- -- 35,728 4.11% 35,728
Savings................. 15,402 -- -- -- -- -- 15,402 1.75% 15,402
Time deposits 168,852 42,282 13,883 5,171 1,269 595 232,052 5.47% 232,615
Borrowings.............. -- -- -- 10,000 5,000 -- 15,000 5.63% 15,066
Federal funds purchased
and retail
repurchase............ 13,932 -- -- -- -- -- 13,932 4.21% 13,932
-------- ------- ------- ------- ------- -------- -------- --------
$257,149 $42,282 $13,883 $15,171 $ 6,269 $ 595 $335,349 4.79% $335,978
======== ======= ======= ======= ======= ======== ======== ========
</TABLE>
OTHER MATTERS
In November, 1997, the Company and the 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. The
Company believes that it has complied fully with all provisions of the MOU and,
since its conversion to a North Carolina-chartered bank in March, 1999, the Bank
is no longer subject to the supervision and regulation of the OCC and the MOU no
longer binds the institution.
YEAR 2000 DISCUSSION
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 application software products were designed to
accommodate a two-digit year. As the Year 2000 approaches, the Company has
taken, and continues to take, steps to address the Year 2000 issue.
The Company primarily utilizes a third party vendor for processing its
primary banking applications. In addition, the Company also utilizes 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 ensure Year 2000
compliance. The vendor has advised the Company that the vendor has hired the
services of a consultant to review the plan and assist such vendor in achieving
Year 2000 compliance.
The Federal Financial Institutions Examination Council recognizes five
phases that banks must complete to achieve Year 2000 readiness: 1) Awareness of
the potential risks associated with Year 2000; 2) Assessment of all information
and environmental systems needing enhancements; 3) Renovation of the systems
that are not Year 2000 ready; 4) Validation of the renovated systems to assure
Year 2000 readiness; and 5) Implementation of the renovated product into the
ongoing operations. The Company has established a Year 2000 committee that is
responsible for achieving Y2K preparedness. The committee meets on a regular
basis, and is chaired by a member of senior management.
By the end of September 1998, the Company had completed the awareness,
assessment, and renovation phases for its core processing systems. The Company
completed the validation and implementation phase for its core processing
applications, and other mission critical applications during the fourth quarter
of 1998. At year-end, the Company had completed the awareness, assessment, and
renovation phases for non-mission critical applications. The validation and
implementation phases are scheduled to be completed by March 31, 1999. The
Company also uses non-computer systems, such as ATMs, security systems,
Sixteen
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
telecommunications systems and alarm systems that may contain embedded
technology. The Company expects to complete the implementation phase for
non-computer systems by March 31, 1999.
Cost of Year 2000 compliance is not expected to be material to the result
of operations. Year 2000 expenses totaled $9,000 for 1998, and are budgeted at
$35,000 for the upcoming year. These costs only reflect external cost of Year
2000 compliance, and does not include personnel expense based on time devoted to
this effort by employees.
As a lending institution, the Company is also exposed to potential risk if
borrowers suffer Year 2000 related difficulties and are unable to repay their
loans. The Company is discussing the Year 2000 with borrowers as part of the
loan granting or renewal process. At this time, it is impossible to determine
what impact, if any, the Year 2000 will have on the loan payment performance of
the Company's borrowers. No single borrower is significant enough to materially
impact the financial position of the Company. Thus far, however, none of the
Company's borrowers have reported the expectation of material adverse impacts as
a result of the Year 2000.
In addition to the above noted efforts, the Company is also developing
contingency plans in the event one or more systems would fail. A Year 2000
Contingency Planning Team is developing procedures for key areas that does not
involve computer processing. By utilizing these procedures, management feels the
Company would be able to operate until the problems are resolved.
Our failure to anticipate and correct a material Year 2000 problem could
result in an interruption in, or a failure of certain normal business activities
or operations. In addition to internal computer systems, the Company is
dependent upon the operation of various infrastructure providers, such as power
utilities, voice and data transmission networks, government agencies and
correspondent banks. Although dependent upon these services, proper delivery by
such systems is not controlled by the Company. We believe that a failure of one
or more of these systems would be the mostly likely worst case scenario of any
year 2000 problems affecting us. The Company would implement its contingency
plan if such a failure were to occur. Under these conditions, it is likely that
there would be a temporary disruption of customer services, accompanied by
customer inconvenience and additional cost of implementing the contingency plan.
Such cost cannot be estimated due to the high level of uncertainty surrounding
the potential disruptions. Although the Company believes its contingency plan
will satisfactorily address these issues without a material adverse effect on
our business, there can be no assurances that the contingency plan will function
as expected, or that the results of operations for the Company will not be
adversely impacted in the event of a prolonged disruption of service.
NEW ACCOUNTING PRONOUNCEMENTS
In June of 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999. This standard
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. Based on its operations at December 31, 1998, management
does not expect this standard to have a material effect on the Company's
financial statements upon adoption.
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 affected by inflation.
RECENT EVENTS
In December, 1998, the Company announced that the Board of Directors had
authorized the purchase of up to 170,000 shares of the Company's common stock
through December 31, 2001. Through February 4, 1999, the Company had purchased a
total of 119,000 shares, or 70.0% of the total shares authorized, at an average
price per share of $17.51.
In March, 1999, the wholly-owned subsidiary of the Company, First National
Bank Southeast (the "Bank") converted from a national to a North
Carolina-chartered bank and, at the same time, changed its
Seventeen
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Continued
- --------------------------------------------------------------------------------
name to FNB Southeast. As a North Carolina bank and member of the Federal
Reserve, the Bank is supervised and examined by the Federal Reserve and the
Commissioner and is also subject to the supervisory authority of the Federal
Deposit Insurance Corporation.
TABLE 10
QUARTERLY FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
4TH QTR. 3RD QTR. 2ND QTR. 1st Qtr. 4th Qtr. 3rd Qtr. 2nd Qtr. 1st Qtr.
-------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income......................... $7,910 $8,083 $7,854 $6,828 $6,370 $5,509 $4,939 $4,199
Interest expense........................ 4,148 4,337 4,070 3,562 3,209 2,560 2,321 1,966
------ ------ ------ ------ ------ ------ ------ ------
Net interest income..................... 3,762 3,746 3,784 3,266 3,161 2,949 2,618 2,233
Provision for loan losses............... 205 345 315 265 300 230 150 80
------ ------ ------ ------ ------ ------ ------ ------
Net interest income after provision for
loan losses........................... 3,557 3,401 3,469 3,001 2,861 2,719 2,468 2,153
------ ------ ------ ------ ------ ------ ------ ------
Other income............................ 770 601 448 435 396 357 347 254
------ ------ ------ ------ ------ ------ ------ ------
Other expenses.......................... 2,753 2,494 2,466 2,257 2,309 2,033 1,886 1,675
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes.............. 1,574 1,508 1,451 1,179 948 1,043 929 732
Income taxes............................ 485 478 498 404 278 359 312 226
------ ------ ------ ------ ------ ------ ------ ------
Net income.............................. $1,089 $1,030 $ 953 $ 775 $ 670 $ 684 $ 617 $ 506
====== ====== ====== ====== ====== ====== ====== ======
Earnings per share:
Basic................................. $ .32 $ .30 $ .30 $ .31 $ .27 $ .28 $ .24 $ .21
Diluted............................... $ .30 $ .29 $ .28 $ .29 $ .25 $ .26 $ .23 $ .19
</TABLE>
TABLE 11
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>
1998 1997
Price Range Price Range
--------------- ---------------
Calendar Quarter High/Low High/Low
---------------- --------------- ---------------
<S> <C> <C>
First.................................................... $26.00 / $23.75 $15.19 / $11.81
Second................................................... $25.50 / $22.50 $24.75 / $13.50
Third.................................................... $25.25 / $17.75 $29.00 / $21.75
Fourth................................................... $19.75 / $16.00 $28.25 / $24.75
</TABLE>
There were approximately 889 record holders of the Company stock at
December 31, 1998. 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 1998 1997
---------------- ---- ----
<S> <C> <C>
First....................................................... $.10 $.09
Second...................................................... .10 .10
Third....................................................... .10 .10
Fourth...................................................... .10 .10
---- ----
Total Annual Dividends.................................. $.40 $.39
==== ====
</TABLE>
- ---------------
(1)The stock prices and dividends declared have been adjusted for the
four-for-three stock splits effected as 33% stock dividends on April 30, 1997
and September 12, 1997.
Eighteen
<PAGE> 16
REPORT OF INDEPENDENT ACCOUNTANTS
- ---------------------------------------------------------
February 5, 1999
The Board of Directors
FNB Financial Services Corporation
and Subsidiary
Reidsville, North Carolina
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and comprehensive income, changes in
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of FNB Financial Services Corporation and Subsidiary at
December 31, 1998, and the results of their operations and their cash flows for
the year ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of FNB
Financial Services Corporation as of December 31, 1997 and 1996, were audited by
other auditors whose report dated February 10, 1998, expressed an unqualified
opinion on those statements. We conducted our audit of the 1998 statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Raleigh, North Carolina
Nineteen
<PAGE> 17
[GRAPHIC OMITTED]
Independent Auditors' Report
The Board of Directors
FNB Financial Services Corporation
and Subsidiary
Reidsville, North Carolina
We have audited the accompanying consolidated balance sheet of FNB Financial
Services Corporation and Subsidiary as of December 31, 1997 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the two-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 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 the
consolidated results of their operations and their cash flows for each of the
years in the two-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
<PAGE> 18
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 8,854 $ 9,612
Investment securities:
Available for sale........................................ 144,391 77,346
Federal Home Loan Bank and Federal Reserve Bank stock..... 1,335 1,392
Loans, net of allowance for credit losses of $2,606 in 1998
and $2,331 in 1997........................................ 253,221 226,384
Property and equipment, net................................. 7,295 6,490
Accrued income and other assets............................. 6,613 3,927
-------- --------
Total assets...................................... $421,709 $325,151
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing....................................... $ 38,588 $ 31,464
Interest-bearing.......................................... 306,417 240,810
-------- --------
Total deposits.................................... 345,005 272,274
Federal funds purchased and retail repurchase agreements.... 13,932 13,720
Other borrowings............................................ 15,000 15,000
Accrued expenses and other liabilities...................... 3,206 1,639
-------- --------
Total liabilities................................. 377,143 302,633
-------- --------
Commitments and contingent liabilities
Shareholders' equity
Preferred stock, no par value; Authorized -- 10,000,000
shares; none issued....................................... -- --
Common stock, $1.00 par value;
Authorized -- 40,000,000 shares; Outstanding --
3,429,564 in 1998 and 2,493,680 in 1997................. 3,430 2,494
Paid-in capital............................................. 21,359 3,287
Retained earnings........................................... 19,113 16,541
-------- --------
43,902 22,322
Accumulated other comprehensive income...................... 664 196
-------- --------
Total shareholders' equity........................ 44,566 22,518
-------- --------
Total liabilities and shareholders' equity........ $421,709 $325,151
======== ========
</TABLE>
See notes to consolidated financial statements.
Twenty
<PAGE> 19
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Interest income
Loans..................................................... $23,190 $17,616 $12,092
Federal funds sold........................................ 213 133 53
Investment securities:
Taxable................................................ 6,912 2,800 2,480
Tax exempt............................................. 271 358 657
Other..................................................... 89 110 78
------- ------- -------
Total interest income............................. 30,675 21,017 15,360
------- ------- -------
Interest expense
Deposits.................................................. 14,600 9,287 6,449
Federal funds purchased and other borrowings.............. 1,517 769 313
------- ------- -------
Total interest expense............................ 16,117 10,056 6,762
------- ------- -------
Net interest income......................................... 14,558 10,961 8,598
Provision for credit losses................................. 1,130 760 415
------- ------- -------
Net interest income after provision for credit losses....... 13,428 10,201 8,183
------- ------- -------
Other income
Service charges on deposit accounts....................... 1,107 896 746
Other service charges and fees............................ 206 168 164
Bankcard fees............................................. 427 213 19
Net gain on sales of loans................................ 92 39 16
Net gain on securities available for sale................. 422 38 307
------- ------- -------
Total other operating income...................... 2,254 1,354 1,252
------- ------- -------
Other expenses
Salaries and employee benefits............................ 5,939 4,709 3,630
Occupancy expense......................................... 611 529 345
Furniture and equipment expense........................... 836 628 465
Insurance expense, including FDIC assessment.............. 97 62 35
Marketing expense......................................... 140 154 97
Printing and supply expenses.............................. 206 251 205
Bankcard processing....................................... 402 185 31
Other expenses............................................ 1,739 1,385 1,196
------- ------- -------
Total other expenses.............................. 9,970 7,903 6,004
------- ------- -------
Income before income taxes.................................. 5,712 3,652 3,431
Income tax expense.......................................... 1,865 1,175 1,021
------- ------- -------
Net income.................................................. 3,847 2,477 2,410
Other comprehensive income (loss)........................... 468 40 (311)
------- ------- -------
Comprehensive income........................................ $ 4,315 $ 2,517 $ 2,099
======= ======= =======
Net income per share, basic................................. $ 1.23 $ 1.00 $ 0.98
======= ======= =======
Net income per share, diluted............................... $ 1.16 $ 0.93 $ 0.96
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
Twenty-One
<PAGE> 20
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Common stock
Balance at beginning of year.............................. $ 2,494 $ 1,383 $ 1,098
Stock split effected in the form of a stock dividend...... -- 1,082 275
Stock issuance............................................ 897 -- --
Dividend reinvestment plan................................ 13 6 3
Exercise of stock options................................. 19 11 7
Employee 401(k) plan...................................... 6 12 --
Employee stock awards..................................... 1 -- --
------- ------- -------
Balance at end of year.................................... 3,430 2,494 1,383
------- ------- -------
Paid-in capital
Balance at beginning of year.............................. 3,287 2,728 2,580
Stock issuance............................................ 17,546 -- --
Dividend reinvestment plan................................ 266 156 60
Exercise of stock options................................. 52 92 84
Employee 401(k) plan...................................... 202 308 --
Employee stock awards..................................... 6 3 4
------- ------- -------
Balance at end of year.................................... 21,359 3,287 2,728
------- ------- -------
Retained earnings
Balance at beginning of year.............................. 16,541 16,119 14,837
Net income................................................ 3,847 2,477 2,410
Cash paid for fractional shares........................... -- (14) (5)
Cash dividends paid ($.40 per share in 1998, $.39 in 1997,
and $.34 in 1996)...................................... (1,275) (959) (848)
Stock split effected in the form of a stock dividend...... -- (1,082) (275)
------- ------- -------
Balance at end of year.................................... 19,113 16,541 16,119
------- ------- -------
Accumulated other comprehensive income
Balance at beginning of year.............................. 196 156 467
Other comprehensive income................................ 468 40 (311)
------- ------- -------
Balance at end of year.................................... 664 196 156
------- ------- -------
Total shareholders' equity........................ $44,566 $22,518 $20,386
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
Twenty-Two
<PAGE> 21
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received......................................... $ 28,374 $ 19,247 $ 14,685
Fees and commission received.............................. 2,427 1,951 1,627
Interest paid............................................. (15,945) (9,499) (6,660)
Noninterest expense paid.................................. (8,877) (6,749) (5,264)
Income taxes paid......................................... (1,831) (1,538) (1,493)
Proceeds from mortgage loans.............................. 13,220 3,963 3,122
--------- -------- --------
Net cash provided by operating activities.......... 17,368 7,375 6,017
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available for sale...... 93,200 55,427 43,707
Proceeds from maturities of securities available for
sale.................................................... 8,713 17,617 7,887
Purchases of securities................................... (168,345) (99,330) (47,933)
Capital expenditures...................................... (1,510) (2,291) (1,532)
Sales of assets........................................... -- 269 --
(Increase) decrease in other real estate owned............ (1,419) 3 158
Net (increase) decrease in loans.......................... (40,331) (88,505) (36,268)
--------- -------- --------
Net cash used in investing activities.............. (109,692) (116,810) (33,981)
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand, savings and interest checking
accounts................................................ 29,604 12,381 4,217
Net increase in time deposits............................. 44,017 80,514 20,764
Net increase in other borrowings.......................... -- 15,000 --
Net increase in federal funds purchased and retail
repurchase agreements................................... 212 5,070 5,498
Purchase of fractional shares............................. -- (14) (5)
Proceeds from issuance of common stock.................... 19,008 588 158
Dividends paid............................................ (1,275) (959) (848)
--------- -------- --------
Net cash provided by financing activities.......... 91,566 112,580 29,784
--------- -------- --------
Net increase (decrease) in cash and cash equivalents........ (758) 3,145 1,820
Cash and cash equivalents, beginning of year................ 9,612 6,467 4,647
--------- -------- --------
Cash and cash equivalents, end of year...................... $ 8,854 $ 9,612 $ 6,467
========= ======== ========
Supplemental disclosure of non-cash transactions
Non-cash transfers from loans to other real estate........ $ 1,448 $ 107 $ 24
========= ======== ========
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income................................................ $ 3,847 $ 2,477 $ 2,410
Adjustments to reconcile net income to net cash provided
by operating activities
Provision for credit losses........................... 1,130 760 415
Depreciation.......................................... 680 474 376
Accretion and amortization............................ 387 282 288
Gain on sale of securities available for sale......... (422) (38) (307)
(Gain) loss on sale of mortgage loans................. (92) (39) (16)
Proceeds from mortgage loans.......................... 13,220 3,963 3,122
(Gain) loss on other assets........................... 6 39 84
Deferred tax (benefit) provision...................... -- (338) (384)
Increase in accrued income and other assets........... (1,398) (803) (631)
Increase in accrued expenses and other liabilities.... 10 598 660
--------- -------- --------
Net cash provided by operating activities.......... $ 17,368 $ 7,375 $ 6,017
========= ======== ========
</TABLE>
See notes to consolidated financial statements.
Twenty-Three
<PAGE> 22
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------------------------
DECEMBER 31, 1998, 1997 AND 1996
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 the time of purchase
into three categories as follows:
-- held-to-maturity -- reported at amortized cost,
-- trading -- reported at fair value with unrealized gains and losses
included in earnings, or
-- available-for-sale -- reported at fair value with unrealized gains
and losses reported in other comprehensive income.
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.
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.
Twenty-Four
<PAGE> 23
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
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.
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 judgments 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 non-deductible expenses) 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: basic net income per share of
common stock and diluted net income per share of common stock. Basic 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. Diluted net income per share of common stock 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. 1996 earnings per share amounts have been restated in
order to comply with the new accounting standard.
Twenty-Five
<PAGE> 24
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.
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.
Segment Information
During the year ended December 31, 1998, the Bank adopted the provisions of
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." This Statement requires that public business enterprises report
certain information about operating segments in their annual financial
statements and in condensed financial statements for interim periods issued to
stockholders. It also requires that the public business enterprises report
related disclosures and descriptive information about products and services
provided by significant segments, geographic areas, and major customers,
differences between the measurements used in reporting segment information and
those used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The Company has determined that it has one significant operating
segment, the providing of general commercial financial services to customers
located in Reidsville, Madison, Eden, Ruffin, Greensboro and Wilmington, North
Carolina and surrounding communities. The various products are those generally
offered by community banks, and the allocation of resources is based on the
overall performance of the Company, versus the individual branches or products.
There are no differences between the measurements used in reporting segment
information and those used in the Company's general-purpose financial
statements.
New Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999. This standard establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. Based on its operations at December
31, 1998, management does not expect this standard to have a material effect on
the Company's financial statements upon adoption.
Reclassification
Certain items for 1996 and 1997 have been reclassified to conform with the
1998 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,
1998 and 1997 were $373,000 and $362,000, respectively.
Twenty-Six
<PAGE> 25
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
NOTE 3 -- INVESTMENT SECURITIES
Investment securities consist of the following:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In thousands)
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Available for sale:
U.S. government agency securities.... $139,488 $ 863 $ 71 $140,280
State and municipal obligations...... 3,815 296 -- 4,111
-------- ------ ---- --------
143,303 1,159 71 144,391
Federal Home Loan Bank and Federal
Reserve Bank stock................... 1,335 -- -- 1,335
-------- ------ ---- --------
Total investment
securities................. $144,638 $1,159 $ 71 $145,726
======== ====== ==== ========
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
Federal Home Loan Bank and Federal
Reserve Bank stock................... 1,392 -- -- 1,392
-------- ------ ---- --------
Total investment
securities................. $ 78,416 $ 421 $ 99 $ 78,738
======== ====== ==== ========
</TABLE>
The amortized cost and estimated market value of debt securities at
December 31, 1998, 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 Fair Value
---------- -------------
(In thousands)
<S> <C> <C>
Due in one year or less..................................... $ 60 $ 61
Due after one through five years............................ 85,759 86,418
Due after five through ten years............................ 45,769 46,220
Due after ten years......................................... 11,715 11,692
-------- --------
$143,303 $144,391
======== ========
</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>
Year ended December 31,
-----------------------------
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Proceeds from sales........................................ $93,200 $55,427 $43,707
Gross realized gains....................................... 424 226 376
Gross realized losses...................................... 2 188 69
Applicable income tax on net realized gains................ 164 15 120
</TABLE>
Twenty-Seven
<PAGE> 26
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
At December 31, 1998 and 1997, investment securities with a carrying value
of approximately $28,113,000 and $24,195,000 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,
--------------------
1998 1997
-------- --------
(In thousands)
<S> <C> <C>
Commercial, financial and agricultural...................... $ 45,141 $ 54,294
Consumer.................................................... 52,387 46,078
Real estate:
Residential mortgage...................................... 50,121 58,238
Commercial mortgage....................................... 83,202 51,022
Construction.............................................. 24,976 19,083
-------- --------
Total............................................. $255,827 $228,715
======== ========
</TABLE>
At December 31, 1998 and 1997, the recorded investment in loans that were
considered impaired was approximately $355,000 and $1,250,000, respectively. The
related allowance for loan losses on these impaired loans was approximately
$60,000 and $188,000, respectively. The average recorded investment in impaired
loans for the years ended December 31, 1998 and 1997 was approximately $703,000
and $625,000, respectively. There were no loans on nonaccrual status that were
not considered impaired at December 31, 1998. However, such loans totaled
$12,000 at December 31, 1997.
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, 1998 and 1997 were $23,241,000
and $18,816,000, 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).
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>
1998 1997 1996
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year................................ $2,331 $1,638 $1,258
Provision for credit losses................................. 1,130 760 415
Recoveries.................................................. 93 93 54
Losses charged off.......................................... (948) (160) (89)
------ ------ ------
Balance at end of year...................................... $2,606 $2,331 $1,638
====== ====== ======
</TABLE>
Twenty-Eight
<PAGE> 27
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
NOTE 6 -- PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Land........................................................ $ 1,657 $ 1,202
Building and leasehold improvements......................... 4,749 4,724
Equipment................................................... 5,396 4,405
Construction in progress.................................... 28 28
------- -------
11,830 10,359
Less accumulated depreciation and amortization.............. 4,535 3,869
------- -------
$ 7,295 $ 6,490
======= =======
</TABLE>
NOTE 7 -- DEPOSITS
The aggregate amount of jumbo CDs, each with a minimum denomination of
$100,000, was approximately $86,867,000 and $59,700,000 in 1998 and 1997,
respectively.
At December 31, 1998 the scheduled maturities of time deposits are as
follows:
<TABLE>
<CAPTION>
(In thousands)
--------------
<S> <C>
1999..................................................... $168,852
2000..................................................... 42,282
2001..................................................... 13,883
2002..................................................... 5,171
2003..................................................... 1,269
Thereafter............................................... 595
--------
$232,052
========
</TABLE>
NOTE 8 -- FEDERAL FUNDS PURCHASED, RETAIL 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>
1998
Federal funds purchased and securities
sold under agreements to
repurchase........................... $13,932 4.21% $13,008 4.92% $17,366
FHLB borrowings........................ 15,000 5.63 15,000 4.74 15,000
------- ------- -------
Total............................. $28,932 $28,008 $32,366
======= ======= =======
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
======= ======= =======
</TABLE>
At December 31, 1998, 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 $10 million maturing in 2002
and
Twenty-Nine
<PAGE> 28
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
$5 million maturing in 2003. 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. The borrowing maturing in 2003 has an identical
call feature in 2000.
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>
1998 1997 1996
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Current tax expense
Federal................................................ $1,825 $1,448 $1,212
State.................................................. 40 149 193
------ ------ ------
Total current.................................. 1,865 1,597 1,405
------ ------ ------
Deferred tax expense (benefit)
Federal................................................ -- (341) (308)
State.................................................. -- (81) (76)
------ ------ ------
Total deferred................................. -- (422) (384)
------ ------ ------
Total income tax expense....................... $1,865 $1,175 $1,021
====== ====== ======
</TABLE>
The sources of deferred tax assets and liabilities and the tax effect of
each are as follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Allowance for credit losses............................... $ 527 $ 754
Non-qualified deferred compensation plans................. 642 391
------ ------
Total............................................. 1,169 1,145
------ ------
Deferred tax liabilities:
Depreciable basis of property and equipment............... 329 271
Net unrealized gain on securities available for sale...... 370 125
Other..................................................... 28 8
------ ------
Total............................................. 727 404
------ ------
Net deferred tax assets (liabilities)....................... $ 442 $ 741
====== ======
</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 Company's history of taxable income and estimates of future
taxable income.
Thirty
<PAGE> 29
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
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>
1998 1997 1996
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Tax based on statutory rates............................. $1,942 $1,242 $1,166
Increase (decrease) resulting from:
Effect of tax-exempt income............................ (95) (104) (199)
State income taxes, net of federal benefit............. (40) 111 122
Other, net............................................. 58 (74) (68)
------ ------ ------
$1,865 $1,175 $1,021
====== ====== ======
</TABLE>
NOTE 10 -- LEASE COMMITMENTS
The minimum annual lease commitments under noncancelable operating leases
in effect at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ending December 31, Amount
- ------------------------ --------------
(In thousands)
<S> <C>
1999........................................................ $192
2000........................................................ 200
2001........................................................ 199
2002........................................................ 188
2003........................................................ 192
Thereafter.................................................. 982
----
</TABLE>
Rental expense was $206,000 in 1998, $131,000 in 1997, and $71,000 in 1996.
NOTE 11 -- RELATED PARTY TRANSACTIONS
The Bank had loans outstanding to principal officers and directors and
their affiliated companies of approximately $3,241,000 and $3,272,000 at
December 31, 1998 and 1997, respectively. During 1998, additions to such loans
were $1,951,000 and repayments were $1,982,000. Such loans were made
substantially on the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other borrowers
and do not involve more than the normal risks of collectibility.
NOTE 12 -- SHAREHOLDERS' EQUITY
Stock Splits
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.
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.
All per share data in the financial statements has been adjusted to reflect
these three splits.
Stock grants
During 1998, 1997, and 1996, stock grants to employees amounted to 95, 75,
and 85 common shares, respectively.
Thirty-One
<PAGE> 30
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
Stock option plans
In 1996, the Company adopted 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
1998, 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>
1998 1997 1996
------------------------ ------------------------ ------------------------
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.. 452,918 $13.25 384,864 $10.66 164,101 $ 6.99
Granted............ 95,100 24.87 90,330 23.11 233,942 12.80
Exercised.......... (26,378) 8.39 (13,001) 7.99 (13,179) 12.24
Forfeited.......... (10,273) 12.04 (9,275) 12.03 -- --
------- ------- -------
Outstanding -- End of
year............... 511,367 $15.64 452,918 $13.25 384,864 $10.66
======= ======= =======
Exercisable -- End of
year............... 218,491 $11.54 155,378 $ 9.21 72,718 $ 6.90
Weighted average fair
value of options
granted during the
year............... $ 7.09 $ 6.73 $ 6.66
</TABLE>
The following is a summary of information concerning outstanding and
exercisable options at December 31, 1998:
<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>
$ 6.75-12.52 179,899 6.48 $ 9.21 122,891 $ 8.57
12.94-25.25 331,468 8.85 19.13 95,600 15.35
------- -------
511,367 218,491
======= =======
</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 income and basic net income per share would have
been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net income -- as reported....................... $3,847,000 $2,477,000 $2,410,000
Net income -- pro forma......................... 3,270,000 2,068,000 2,153,000
Basic net income per share -- as reported....... 1.23 1.00 0.98
Basic net income per share -- pro forma......... 1.06 0.84 0.88
</TABLE>
Thirty-Two
<PAGE> 31
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
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 1998, 1997 and 1996: dividend yield of 3.20%,
expected volatility of 29.0% for 1998, 34.0%, for 1997 and 1996, risk-free
interest rates of 5.55% for 1998, 5.70% for 1997 and 6.20% for 1996, and
expected lives of 7 years for 1998 options, and 4 years for 1997 and 1996
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, 1997
and 1998 vest ratably over a four year period; however, no option will be
exercisable after ten years from the date granted.
NOTE 13 -- OTHER COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income". SFAS No. 130 establishes requirements for
the disclosure of comprehensive income in the Company's consolidated financial
statements. Comprehensive income is defined as net income plus transactions and
other occurrences which are the result of nonowner changes in equity. As
required by SFAS No. 130, prior period consolidated financial statements have
been reclassified to reflect application of the provisions of this statement.
Other comprehensive income is defined as comprehensive income exclusive of
net income. Unrealized gains (losses) on available for sale investment
securities represent the sole component of the Company's other comprehensive
income. Other comprehensive income (loss) consists of the following.
<TABLE>
<CAPTION>
1998 1997 1996
------ ---- -----
(In thousands)
<S> <C> <C> <C>
Unrealized holding gains (losses) arising during the year... $1,188 $105 $(203)
Reclassification adjustment for gains included in net
income.................................................... 422 38 307
------ ---- -----
Other comprehensive income (loss) before tax................ 766 67 (510)
Income tax expense (benefit) related to other comprehensive
income.................................................... 298 27 (199)
------ ---- -----
Other comprehensive income.................................. $ 468 $40 $(311)
====== ==== =====
</TABLE>
NOTE 14 -- NET INCOME PER SHARE
The following is a reconciliation of the numerator and denominator of basic
net income per share of common stock and diluted net income per share of common
stock as required by SFAS No. 128:
<TABLE>
<CAPTION>
For the year ended December 31, 1998
-------------------------------------------
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... $3,847,000 3,130,380 $1.23
=====
Effect of Dilutive Securities:
Stock options............................. -- 179,823
---------- ---------
Net income per share of common stock --assuming
dilution:
Income available to common shareholders
and assumed conversion.................. $3,847,000 3,310,203 $1.16
========== ========= =====
</TABLE>
Thirty-Three
<PAGE> 32
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
<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>
<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>
NOTE 15 -- 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>
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
CONDENSED BALANCE SHEETS
Assets
Cash and due from banks................................... $ 1,058 $ 653 $ 374
Securities................................................ 12 12 13
Investment in wholly-owned subsidiary..................... 43,407 21,829 19,960
Other assets.............................................. 89 -- 39
------- ------- -------
$44,566 $22,494 $20,386
======= ======= =======
Shareholders' equity...................................... $44,566 $22,494 $20,386
======= ======= =======
CONDENSED STATEMENTS OF INCOME
Dividends from subsidiary................................... $ 1,271 $ 698 $ 835
Amortization and other expenses............................. (92) (74) (74)
------- ------- -------
Income before tax benefit................................... 1,179 624 761
Income tax benefit.......................................... 30 25 25
------- ------- -------
Income before equity in undistributed net income of
subsidiary................................................ 1,209 649 786
Equity in undistributed net income of subsidiary............ 2,638 1,828 1,624
------- ------- -------
Net income.................................................. $ 3,847 $ 2,477 $ 2,410
======= ======= =======
</TABLE>
Thirty-Four
<PAGE> 33
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(In thousands)
<S> <C> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Dividends received from subsidiary........................ $ 1,271 $ 698 $ 835
Cash paid for franchise tax, registration cost,
acquisition cost and other............................. (92) (74) (74)
(Increase) decrease in other assets....................... (89) 12 --
Loss on asset sales....................................... -- 2 --
Refundable income taxes................................... 25 25 6
------- ------- -------
Net cash provided by operating activities.............. 1,115 663 767
------- ------- -------
CASH USED IN INVESTING ACTIVITIES
Investment in subsidiary.................................. (18,443) -- --
Purchase of real estate................................... -- -- (14)
------- ------- -------
Net cash used in investing activities.................. (18,443) -- (14)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from stock issuance.............................. $18,443 -- --
Dividends paid, net of DRIP............................... (996) (797) (785)
Proceeds from Employee 401(k)............................. 208 320 --
Proceeds from employee stock awards....................... 7 4 4
Exercise of stock options................................. 71 103 91
Purchase of fractional shares............................. -- (14) (5)
------- ------- -------
Net cash provided by (used in) financing activities.... 17,733 (384) (695)
------- ------- -------
Net increase in cash........................................ 405 279 58
Cash at beginning of year................................... 653 374 316
------- ------- -------
Cash at end of year......................................... $ 1,058 $ 653 $ 374
======= ======= =======
RECONCILIATION OF NET INCOME TO CASH PROVIDED BY OPERATING
ACTIVITIES
Net income.................................................. $ 3,847 $ 2,477 $ 2,410
Adjustments to reconcile net income to net cash provided
by operating activities
(Increase) decrease in other assets.................... (94) 14 (19)
Equity in undistributed net income of subsidiary....... (2,638) (1,828) (1,624)
------- ------- -------
Net cash provided by operating activities................... $ 1,115 $ 663 $ 767
======= ======= =======
</TABLE>
NOTE 16 -- 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.
A summary of the Bank's commitments and contingent liabilities at December
31, are as follows:
<TABLE>
<CAPTION>
Contract or
Notional Amount
--------------------
1998 1997
------- -------
(In thousands)
<S> <C> <C>
Commitments to extend credit................................ $56,245 $42,250
Standby letters of credit................................... 166 13
------- -------
$56,411 $42,263
======= =======
</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.
Thirty-Five
<PAGE> 34
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
NOTE 17 -- 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 consist primarily of cash and cash
equivalents, U. S. government securities, and common stocks.
The following table outlines the changes in the Company's pension plan
obligations, assets and funded status for the years ended December 31, 1998 and
1997 and the assumptions and components of net periodic pension cost for the
three years in the period ended December 31, 1998 (in thousands).
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year..................... $ 2,761 $2,409
Service cost................................................ 123 99
Interest cost............................................... 196 177
Actuarial loss.............................................. 101 168
Benefits paid............................................... (114) (92)
------- ------
Benefit obligation at end of year........................... 3,067 2,761
------- ------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year.............. 2,412 2,289
Actual return on plan assets................................ 248 21
Employer contribution....................................... 123 194
Benefits paid............................................... (114) (92)
------- ------
Fair value of plan assets at end of year.................... 2,669 2,412
------- ------
(398) (349)
FUNDED STATUS
Unrecognized net actuarial gain............................. 132 106
Unrecognized prior service cost............................. 110 121
------- ------
Pension liability........................................... $ (156) $ (122)
======= ======
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
WEIGHTED-AVERAGE ASSUMPTIONS
Discount rate............................................... 7.00% 7.00% 7.00%
Expected return on plan assets.............................. 7.00% 7.00% 7.00%
Rate of compensation increase............................... 5.00% 5.00% 5.00%
COMPONENTS OF NET PERIODIC PENSION COST
Service cost................................................ $ 123 $ 99 $ 60
Interest cost............................................... 196 177 158
Expected return on plan assets.............................. (173) (153) (148)
Amortization of prior service cost.......................... 11 11 11
----- ----- -----
Net periodic pension cost................................... $ 157 $ 134 $ 81
===== ===== =====
</TABLE>
In 1994 the Company adopted a Supplemental Executive Retirement Plan
("SERP"). The SERP allows the Company to supplement the level of certain
executives' retirement income over that which is obtainable through the
tax-qualified retirement plan. Contributions to the SERP totaled $170,000 for
1998, $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
Thirty-Six
<PAGE> 35
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
matching a portion of each employee's contribution. The Bank's contributions
were $80,000, $58,000, and $49,000 for 1998, 1997 and 1996, 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 $398,000, $304,000 and $207,000 at December 31, 1998, 1997 and
1996, respectively.
NOTE 18 -- 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. 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. In March 1999, the Bank converted to a state charter
and is no longer under the supervision and regulation of the OCC. Accordingly,
the MOU is no longer binding on the Company.
The primary source of funds for the dividends paid by the Company to its
shareholders is dividends received from its banking subsidiary. The Bank is
restricted as to dividend payout by state laws applicable to banks and may pay
dividends only out of undivided profits. Additionally, dividends paid by the
Company may be limited due to maintaining minimum capital requirements imposed
by banking regulators. Management does not expect any of these restrictions to
materially limit its ability to pay dividends comparable to those paid in the
past. At December 31, 1998, the Bank had undivided profits of approximately
$21.0 million.
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 to average assets (as
defined). Management believes, as of December 31, 1998, 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 notification, the Bank has continued to experience asset growth. As a
result, at December 31, 1998, the Bank's ratio of total capital to risk weighted
assets was 15.8%, which places it into the well capitalized classification.
Thirty-Seven
<PAGE> 36
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
The Bank's actual capital amounts and ratios, on a consolidated basis and
for the Bank alone, 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, 1998:
Total Capital (To Risk Weighted Assets)
Consolidated............................. $45,928 16.3% $22,617 >8.0% $ N/A
-
Subsidiary Bank.......................... 44,739 15.8% 22,614 >8.0% 28,268 >$10.0%
- -
Tier I Capital (To Risk Weighted Assets)
Consolidated............................. 43,322 15.3% 11,309 >4.0% N/A
-
Subsidiary Bank.......................... 42,133 14.9% 11,307 >4.0% 16,961 > 6.0%
- -
Tier I Capital (To Average Assets)
Consolidated............................. 43,322 10.3% 16,818 >4.0% N/A
-
Subsidiary Bank.......................... 42,133 10.1% 16,771 >4.0% 20,964 > 5.0%
- -
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%
- -
</TABLE>
NOTE 19 -- 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.
Federal Funds Purchased and Retail Repurchase Agreements. The carrying
value of federal funds purchased and retail repurchase agreements is considered
to be a reasonable estimate of fair value.
Thirty-Eight
<PAGE> 37
FNB FINANCIAL SERVICES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
- --------------------------------------------------------------------------------
Other borrowings. Other borrowings consists of FHLB borrowings with
varying maturities. The fair values of these liabilities are estimated using the
discounted values of the contractual cash flows. The discount rate is estimated
using the rates currently in effect for similar borrowings.
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 16.
The estimated fair values of financial instruments are as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------- ----------------------
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value
-------- ---------- -------- ----------
(In thousands)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and cash equivalents.............. $ 8,854 $ 8,854 $ 9,612 $ 9,612
Investment securities
Available for sale................... 143,303 144,391 77,346 77,346
Other equity securities.............. 1,335 1,335 1,392 1,392
Loans.................................. 255,827 257,844 228,715 227,998
FINANCIAL LIABILITIES:
Deposits............................... 345,005 345,567 272,274 269,068
Federal funds purchased and retail
repurchase agreements................ 13,932 13,932 13,720 13,720
Other borrowings....................... 15,000 15,066 15,000 14,907
</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 based on 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 20 -- 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.
Thirty-Nine
<PAGE> 1
EXHIBIT 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
FNB Financial Services Corporation on Form S-3D (File No. 333-02437) and
Forms S-8 (File Nos. 333-24755, 333-29679 and 333-67365) of our report dated
February 5, 1999, on our audit of the consolidated financial statements of
FNB Financial Services Corporation as of December 31, 1998 and for the year then
ended, which report has been included in this Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
March 24, 1999
<PAGE> 1
[GRAPHIC OMITTED]
INDEPENDENT AUDITORS' CONSENT
Board of Directors
FNB Financial Services Corporation
We consent to the incorporation by reference in the Form 10-K of FNB Financial
Services Corporation and in the registration statements of FNB Financial
Services Corporation on Form S-8, Commission File Nos. 333-24755, 333-29679 and
333-67365, and on Form S-3, Commission File No. 333-02437 of our report dated
February 10, 1998, relating to the consolidated balance sheet of FNB Financial
Services Corporation and Subsidiary as of December 31, 1997 and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the years in the two year period ended December 31, 1997,
which report appears in the December 31, 1998 annual report on form 10-K of FNB
Financial Services Corporation.
/s/ CHERRY, BEKAERT & HOLLAND, L.L.P.
Greensboro, North Carolina
March 25, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF FNB FINANCIAL SERVICES CORPORATION FOR THE YEAR ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,585
<INT-BEARING-DEPOSITS> 269
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 145,726
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 255,827
<ALLOWANCE> (2,608)
<TOTAL-ASSETS> 421,709
<DEPOSITS> 345,005
<SHORT-TERM> 13,932
<LIABILITIES-OTHER> 3,208
<LONG-TERM> 15,000
0
0
<COMMON> 3,430
<OTHER-SE> 41,138
<TOTAL-LIABILITIES-AND-EQUITY> 421,709
<INTEREST-LOAN> 23,190
<INTEREST-INVEST> 7,183
<INTEREST-OTHER> 302
<INTEREST-TOTAL> 30,675
<INTEREST-DEPOSIT> 14,600
<INTEREST-EXPENSE> 16,117
<INTEREST-INCOME-NET> 14,558
<LOAN-LOSSES> (1,130)
<SECURITIES-GAINS> 422
<EXPENSE-OTHER> 9,970
<INCOME-PRETAX> 5,712
<INCOME-PRE-EXTRAORDINARY> 5,712
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,847
<EPS-PRIMARY> 1.23
<EPS-DILUTED> 1.18
<YIELD-ACTUAL> 8.19
<LOANS-NON> 355
<LOANS-PAST> 746
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,331
<CHARGE-OFFS> (948)
<RECOVERIES> 93
<ALLOWANCE-CLOSE> 2,606
<ALLOWANCE-DOMESTIC> 2,524
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 82
</TABLE>
<PAGE> 1
EXHIBIT 99.01
RISK FACTORS RELATING TO THE COMPANY
OUR RAPID AND ACCELERATING GROWTH IS LIKELY TO CONTINUE STRAINING OUR RESOURCES
We have experienced rapid growth over the past four years. The growth
and expansion of our business have placed, and we believe will continue to
place, a strain on our operational, human and financial resources. In order to
manage our growth, we 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,
we rely on a number of key executives, including Ernest J. Sewell, our
President and Chief Executive Officer. We maintain 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 us. Failure to manage growth
effectively or to attract and retain qualified personnel could have a material
adverse effect on our business and could restrain our ability to successfully
implement our business strategy.
IF WE EXPAND INTO NEW MARKETS, OUR BUSINESS COULD BE IMPACTED IN WAYS WE DID
NOT ANTICIPATE
In pursuing our growth strategy, we may expand our presence into new
geographic markets, including markets outside the State of North Carolina. When
entering new geographic markets, we 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 that we seek.
Therefore, it will be necessary for us to give significant autonomy to our
managers in any new branches. We may also be required to comply with laws and
regulations that differ from those that currently apply to us, and may face
competitors with greater knowledge of such local markets. We cannot be sure if
we will be able to establish local affiliations, realize management and
operating efficiencies or otherwise establish a presence in these new
geographic markets.
IF WE COMPLETE ANY ACQUISITIONS, IT IS POSSIBLE THAT WE WILL NOT HAVE SUCCESS
IN INTEGRATING THE NEW BUSINESS INTO OURS
We intend to expand our business through selective de novo branch
openings and possible acquisitions. We may not be able to consummate, or if
consummated, successfully integrate, any future de novo branch opening or
acquisition, and we could incur disruption and unexpected expenses in
integrating such transactions. Although we currently have no agreements or
understandings, either written or oral, in place, in the normal course of
business, we evaluate potential transactions that would complement or expand
the Company's business. In doing so, we compete with other potential bidders,
many of which have greater financial and operational resources. There can be no
assurance that we will be able to successfully negotiate, finance or integrate
any such transactions. Furthermore, the process of evaluating, negotiating and
integrating transactions may divert our management time and resources. We
cannot assure you that any given de novo branch
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opening or acquisition, when consummated, will not have a material adverse
effect on our business.
OUR LOAN PORTFOLIO IS HEAVILY WEIGHTED TOWARD REAL ESTATE LOANS, SO OUR
PERFORMANCE MAY SHIFT WITH FLUCTUATIONS IN REAL ESTATE CONDITIONS
At December 31, 1998, real estate loans comprised 62.0% of FNB
Southeast's total loan portfolio, which includes residential mortgages and
construction and commercial loans secured by real estate. We generate a
substantial portion of our real estate mortgage loans in North Carolina.
Therefore, conditions of the real estate markets in North Carolina could
strongly influence the level of our non-performing mortgage loans and our
results of operations and financial condition. 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 our underwriting standards are
intended to protect us 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 our loans and our business.
WE FACE STRONG COMPETITION FROM COMPETITORS WITH GREATER RESOURCES THAN US
Commercial banking in North Carolina is extremely competitive, due in
large part to statewide branching. Currently, many of our competitors in
certain markets are significantly larger and have greater resources than we do.
We encounter significant competition from 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, our bank competes in its market areas with some of the largest banking
organizations in the country. More than that, competition is not just 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 our competitors. Consequently, many of
our competitors have substantially higher lending limits due to their greater
total capitalization, and many perform functions for their customers that our
bank does not offer. As a result, we are likely to meet increased competition,
especially as we expand into new markets, that may limit our ability to
maintain or increase our market share or otherwise materially and adversely
affect our business.
GOVERNMENT AGENCIES ACTIVELY REGULATE BANKS LIKE OURS AND WE NEED TO REACT
QUICKLY AND POSITIVELY WHEN THE REGULATORY ENVIRONMENT SHIFTS
Our profitability depends to a large extent upon our 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. Our net interest income 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 our interest-earning
assets. Our operating results are also affected by credit policies of monetary
authorities, particularly the Board of
<PAGE> 3
Governors of the Federal Reserve. The instruments of monetary policy 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 Board, we cannot predict possible
future changes in interest rates, deposit levels and loan demand on our
business.
In addition, we are subject to extensive supervision, regulation and
control by several federal and state governmental agencies, including the
Federal Reserve Board, the Commissioner of Banks in North Carolina, and the
Federal Deposit Insurance Corporation. 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 our industry. Although we cannot predict the impact of such
legislation and regulation, future changes may alter the structure of and
competitive relationships among financial institutions and the cost of doing
business.
WE MUST EFFECTIVELY RESPOND TO THE PACE OF TECHNOLOGICAL CHANGE AND RESULTING
CUSTOMER DEMANDS WITHOUT STRAYING FROM OUR BUSINESS PHILOSOPHY
The banking industry is undergoing, and we believe 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. Our future success will depend, in
part, on our ability to address your needs by using technology to provide
products and services that will satisfy customer demands for convenience as
well as to enhance efficiencies in our operations. We believe that keeping pace
with technological advances is important, as long as our emphasis on
personalized services is not adversely impacted. As a result, we have been
upgrading our internal systems, both through the efficient use of technology
(including software applications) and by strengthening our policies and
procedures. Many of our competitors will have substantially greater resources
to invest in technological and infrastructure improvements. We cannot assure
you that we will be able to effectively implement new technology-driven
products and services consistent with our emphasis on individualized attention
to customers' needs.
WE ARE ON SCHEDULE TO COMPLETE OUR WORK TO BE YEAR 2000 COMPLIANT, BUT
UNEXPECTED EVENTS COULD STILL OCCUR
As a lending institution, our need to have our systems, applications
and procedures Year 2000 compliant is especially important. We do not currently
expect that the cost of our Year 2000 compliance program will be material to our
financial condition, and we expect to satisfy our compliance program without
material disruption of our operations. Year 2000 expenses totaled $9,000 for
1998, and are budgeted at $35,000 for the upcoming year. These costs only
reflect the external cost of Year 2000 compliance. However, in the event that
our bank's significant suppliers do not successfully and timely achieve Year
2000 compliance, our business, could be adversely affected.
We are also exposed to potential risk if borrowers suffer Year
2000-related difficulties and are unable to repay their loans. FNB Southeast is
discussing the Year 2000 issue with borrowers as part of the loan
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granting or renewal process. At this time, we are unable to determine what
impact, if any, the Year 2000 will have on the loan payment performance of
borrowers. Thus far, however, none of the bank's borrowers have reported the
expectation of material adverse impacts as a result of the Year 2000.
