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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended Commission file number
June 30, 1999 015645
FCNB Corp
(Exact name of registrant as specified in its charter)
MARYLAND 52-1479635
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7200 FCNB Court, Frederick, Maryland 21703
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301) 6622191
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, $1 par value per
share, 10,077,953 shares outstanding as of July 31, 1999.
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<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
FCNB CORP AND SUBSIDIARY
<TABLE>
<CAPTION>
Consolidated Balance Sheets (Unaudited) (Unaudited)
(dollars in thousands, except per share amounts) June 30, 1999 December 31, 1998
- - ------------------------------------------------ ------------- -----------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 28,470 $ 30,500
Interest-bearing deposits in other banks 758 1,334
Federal funds sold 28,739 47,262
---------- ----------
Cash and cash equivalents 57,967 79,096
---------- ----------
Loans held for sale 4,135 5,087
---------- ----------
Investment securities held to maturity at amortized
cost-fair value of $23,834 in 1999 and $30,469
in 1998 23,764 30,045
Investment securities available for sale-at fair value 402,808 421,176
---------- ----------
Loans 761,799 727,589
Less: Allowance for credit losses (7,616) (7,198)
Unearned income (12) (23)
---------- ----------
Net loans 754,171 720,368
---------- ----------
Bank premises and equipment 24,751 25,280
Other assets 60,327 56,172
---------- ----------
Total assets $1,327,923 $1,337,224
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing deposits $ 142,811 $ 139,320
Interest-bearing deposits 725,981 712,499
---------- ----------
Total deposits 868,792 851,819
---------- ----------
Short-term borrowings:
Federal funds purchased and securities sold
under agreements to repurchase 77,442 92,287
Other short-term borrowings 243,131 248,155
Long-term debt:
Guaranteed preferred beneficial interests
in the Company's subordinated debenture 40,250 40,250
Accrued interest and other liabilities 12,038 14,103
---------- ----------
Total liabilities 1,241,653 1,246,614
---------- ----------
SHAREHOLDERS' EQUITY
Preferred stock, per share par value $1.00;
1,000,000 shares authorized; none outstanding -- --
Common stock, per share par value $1.00;
20,000,000 shares authorized: 10,077,953
shares in 1999 and 10,060,714 shares in 1998
issued and outstanding 10,078 10,061
Capital surplus 46,691 46,597
Retained earnings 32,769 30,082
Accumulated other comprehensive income (3,268) 3,870
---------- ----------
Total shareholders' equity 86,270 90,610
---------- ----------
Total liabilities and shareholders' equity $1,327,923 $ 1,337,224
========== ===========
</TABLE>
2
<PAGE>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Income and Comprehensive Income (Unaudited)
<TABLE>
<CAPTION>
For the 3 months ended For the 6 months ended
------------------------------ --------------------------------
(dollars in thousands, except per share amounts) June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
- - ------------------------------------------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $16,121 $15,570 $31,641 $30,712
Interest and dividends on investment securities:
Taxable 6,033 4,405 12,380 8,458
Tax exempt 92 80 184 149
Dividends 398 250 767 486
Interest on federal funds sold 189 336 348 751
Other interest income 22 23 34 34
------- ------- ------- -------
Total interest income 22,855 20,664 45,354 40,590
------- ------- ------- -------
Interest expense:
Interest on deposits 7,315 7,053 14,508 13,924
Interest on federal funds purchased and securities
sold under agreements to repurchase 646 727 1,379 1,581
Interest on other short-term borrowings 3,068 2,548 6,241 4,833
Interest on long-term debt 845 -- 1,689 --
------- ------- ------- -------
Total interest expense 11,874 10,328 23,817 20,338
------- ------- ------- -------
Net interest income 10,981 10,336 21,537 20,252
Provision for credit losses 300 400 708 570
------- ------- ------- -------
Net interest income after provision for credit losses 10,681 9,936 20,829 19,682
------- ------- ------- -------
Noninterest income:
Service fees 1,214 937 2,439 1,848
Insurance commissions 1,482 1,230 2,893 2,885
Net securities gains 264 163 646 688
Gain on sale of loans 187 180 453 332
Income from bank-owned life insurance 387 309 771 513
Other operating income 886 733 1,577 747
------- ------- ------- -------
Total noninterest income 4,420 3,552 8,779 7,013
------- ------- ------- -------
Noninterest expenses:
Salaries and employee benefits 5,998 5,145 11,740 10,344
Occupancy expenses 1,260 924 2,471 1,850
Equipment expenses 896 748 1,769 1,447
Merger-related expenses 50 49 172 53
Other operating expenses 2,418 2,352 4,698 4,678
----- ----- ----- -----
Total noninterest expenses 10,622 9,218 20,850 18,372
----- ----- ----- -----
Income before provision for income taxes 4,479 4,270 8,758 8,323
Income tax expense 1,482 1,407 2,863 2,740
----- ----- ----- -----
Net income 2,997 2,863 5,895 5,583
----- ----- ----- -----
Other comprehensive income loss, net of tax:
Unrealized gains (loss) on securities:
Unrealized holding gains (losses) arising during period,
net of taxes of ($3,178), $9, ($4,749) and
$89, respectively (4,674) 64 (6,740) 895
Less: reclassification adjustment for gain
(losses) included in net income, net of taxes of
$104, $64, $248 and $268, respectively. 160 99 398 420
</TABLE>
3
<PAGE>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Income and Comprehensive Income (Unaudited)
(Continued)
<TABLE>
Other comprehensive income loss, net of taxes of ($3,074), ($55),
<S> <C> <C> <C> <C>
($4,501) and $357, respectively (4,834) (35) (7,138) 475
---------- ---------- ---------- ----------
Comprehensive income $(1,837) $2,828 $(1,243) $6,058
---------- ---------- ---------- ----------
Net income - before merger-related expenses $3,057 $2,898 $6,029 $5,618
---------- ---------- ---------- ----------
Basic earnings per share (Note 4) $0.30 $0.29 $0.59 $0.56
---------- ---------- ---------- ----------
Diluted earnings per share (Note 4) $0.29 $0.28 $0.58 $0.55
---------- ---------- ---------- ----------
Basic earnings per share before merger-related expenses (Note 4) $0.30 $0.29 $0.60 $0.56
---------- ---------- ---------- ----------
Diluted earnings per share before merger-related expenses (Note 4) $0.30 $0.29 $0.60 $0.56
---------- ---------- ---------- ----------
Basic weighted-average number of shares outstanding (Note 4) 10,074,296 10,024,183 10,069,504 10,011,274
---------- ---------- ---------- ----------
Diluted weighted-average number of shares outstanding (Note 4) 10,107,953 10,122,880 10,106,568 10,106,221
---------- ---------- ---------- ----------
</TABLE>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
(dollars in thousands) 1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,895 $5,583
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,554 1,284
Provision for credit losses 708 570
Provision for foreclosed properties 45 50
Deferred income taxes (benefits) (436) (41)
Net premium amortization (discount accretion) on investment securities 268 (116)
Accretion of net loan origination fees (680) (504)
Net securities gains (646) (688)
Net loss on sale of foreclosed properties 34 23
Decrease (increase) in other assets (163) (2,572)
Decrease (increase) in loans held for sale (1) 952 (3,036)
Increase (decrease) in accrued interest and other liabilities (2,065) 346
------- --------
Net cash provided by operating activities 5,466 899
------- --------
Cash flows from investing activities:
Proceeds from sales of investment securities - available for sale 8,313 6,516
Proceeds from maturities of investment securities - available for sale 55,799 39,541
Proceeds from maturities of investment securities - held to maturity 6,157 9,523
Purchases of investment securities - held to maturity -- (1,349)
Purchases of investment securities - available for sale (56,880) (121,093)
Net decrease (increase) in loans (33,831) (18,498)
Purchases of bank premises and equipment (843) (1,492)
Proceeds from dispositions of bank premises and equipment -- 1
Purchase of foreclosed properties (60) (21)
Proceeds from dispositions of foreclosed properties 742 1,008
Purchase of investments in bank-owned life insurance -- (8,000)
------- --------
Net cash (used in) investing activities (20,603) (93,864)
</TABLE>
4
<PAGE>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 1999 and 1998
Continued
<TABLE>
<S> <C> <C>
Cash flows from financing activities:
Net increase (decrease) in noninterest-bearing deposits, NOW accounts,
money market account and savings accounts 18,942 52,408
Net increase (decrease) in time deposits (1,969) 17,387
Net increase (decrease) in short-term borrowings (19,869) 34,602
Proceeds from sale of stock 113 256
Repurchase of common stock -- --
Dividend reinvestment plan (38) (17)
Dividends paid (3,171) (2,070)
------- ------
Net cash provided by financing activities (5,992) 102,566
------- ------
Increase (decrease) in cash and cash equivalents (21,129) 9,601
Cash and cash equivalents:
Beginning of period 79,096 73,922
------- ------
End of period $57,967 $83,523
======= =====
</TABLE>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Cash Flows (Unaudited) continued For the six months
ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
(dollars in thousands) 1999 1998
---- ----
<S> <C> <C>
Supplemental disclosures
Interest paid $23,825 $20,122
======= =======
Income taxes paid $1,530 $3,769
======= =======
Supplemental schedule of noncash investing and financing activities:
Foreclosed properties acquired in settlement of loans -- $176
Seller financed disposition of property -- $725
Surplus from stock option transactions $47 $ 26
======= =======
</TABLE>
(1) Loans held for sale are generally held for periods of ninety days or less.
FCNB CORP AND SUBSIDIARY
Notes to Consolidated Financial Statements (Unaudited)
Note 1 The accompanying unaudited consolidated financial statements for FCNB
Corp (the "Company") have been prepared in accordance with the instructions for
Form 10Q and, therefore, do not include all information and footnotes required
by generally accepted accounting principles for complete financial statements.
The interim financial statements have been prepared utilizing the interim basis
of reporting and, as such, reflect all adjustments which are normal and
recurring in nature and are, in the opinion of management, necessary for a fair
presentation of the results for the periods presented. The financial data for
1998 has been restated to include the effects of the acquisitions of Capital
Bank, NA and Frederick Underwriters, Inc. in 1998, accounted for as a pooling of
interests. Per share data has been restated for the effects of a four-for-three
stock split effected in the form of a 33% stock dividend declared in July 1998
and paid in August 1998.
5
<PAGE>
Note 2 - On March 12, 1999, the Company entered into an Agreement and Plan of
Reorganization and Merger (the "Agreement") with First Frederick Financial
Corporation, Frederick, Maryland ("First"), pursuant to which First would be
merged (the "Merger) with the Company, with the Company surviving the Merger,
and First's wholly owned subsidiary, First Bank of Frederick, would be merged
into FCNB Bank, Frederick, Maryland, the Company's wholly-owned subsidiary bank
(the "Bank") with the Bank surviving the merger. The Merger is intended to be a
tax-free transaction in which each share of First common stock will be converted
into 1.0434 shares of FCNB Common Stock, and each outstanding option and warrant
to purchase First Common Stock will be converted into the number of shares of
FCNB Common Stock determined by (i) dividing the exercise price per share of
such First option or warrant by 20.125, and (ii) subtracting such quotient
(rounded to four decimal places) from the Conversion Ratio (1.0434), subject to
adjustment in certain circumstances as set forth in the Agreement.
The Company anticipates that it will issue approximately 1,981,125 shares in
connection with the transaction, subject to adjustment, for an aggregate deal
value of approximately $37 million, based upon the closing price of FCNB Common
Stock on March 12, 1999, the date of the Agreement. At June 30, 1999, First had
total assets of approximately $114 million, deposits of $99 million, and total
shareholders' equity of $9 million. It is anticipated that the merger will be
accounted for as a pooling of interests. The Company anticipates that it will
incur pretax one-time charges of approximately $2.7 million upon consummation of
the merger. The consummation of the Merger remains subject to shareholder
approvals, and the satisfaction of a number of other conditions. The Company
currently anticipates that the Merger would be consummated in the third quarter
of 1999.
Note 3 - Investments: Using the criteria specified in Statement 115, the Company
classifies its investments in debt and equity securities at June 30, 1999, and
December 31, 1998, into two categories: held-to-maturity and available-for-sale.
Securities classified as held-to-maturity are those debt securities the Company
has both the intent and ability to hold to maturity regardless of changes in
market conditions, liquidity needs or changes in general economic conditions.
These securities are carried at cost adjusted for amortization of premium and
accretion of discount, computed using the interest method over their contractual
lives.
Securities classified as available-for-sale are equity securities with readily
determinable fair values and those debt securities that the Company intends to
hold for an indefinite period of time but not necessarily to maturity. Any
decision to sell a security classified as available-for-sale would be based on
various factors, including significant movements in interest rates, changes in
the maturity mix of the Company's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors. These securities
are carried at fair value with any unrealized gains or losses included in
accumulated other comprehensive income, a component of shareholders' equity, net
of the related deferred tax effect.
As of June 30, 1999, the gross unrealized losses in the Company's investment
portfolio were $238,000 in the held-to-maturity investment portfolio and $10.47
million in the available-for-sale investment portfolio compared to $46,000 and
$2.17 million, respectively, as of December 31, 1998. As of June 30, 1999, the
gross unrealized gains in the Company's investment portfolio were $308,000 in
the held-to-maturity investment portfolio and $5.12 million in the
available-for-sale investment portfolio compared to $470,000 and $8.46 million,
respectively, as of December 31, 1998. Since the Company's held-to-maturity
investment portfolio includes fixed rate investment securities that have below
current market interest rates, the future operating results of the Company would
be negatively impacted in an increasing rate environment. This reduction in net
interest income would result because the cost of funding the Company's
operations increases, while the income earned on the held-to-maturity portfolio
remains constant.
The amortized cost and estimated fair value of securities classified as
held-to-maturity at June 30, 1999, are as follows:
HELD-TO-MATURITY PORTFOLIO
<TABLE>
<CAPTION>
Gross Gross
June 30, 1999 Amortized Unrealized Unrealized Estimated
(dollars in thousands) Cost Gains Losses Fair Value
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
U. S. Treasury and other U.S. government
agencies and corporations $ 11,001 $19 $ -- $11,020
State and political subdivision 5,748 243 42 5,949
Mortgage-backed debt securities 7,015 46 196 6,865
-------------- -------------- -------------- --------------
$23,764 $308 $238 $23,834
============== ============== ============== ==============
</TABLE>
6
<PAGE>
The amortized cost and estimated fair value of securities classified as
available-for-sale at June 30, 1999, are as follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE-PORTFOLIO
Gross Gross
June 30, 1999 Amortized Unrealized Unrealized Estimated
(dollars in thousands) Cost Gains Losses Fair Value
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
U. S. Treasury and other U.S. government agencies and
corporations $165,549 $ 189 $4,582 $161,156
Corporate bonds 67,243 469 1,928 65,784
Mortgage-backed debt securities 141,098 432 3,249 138,281
Equity securities 34,263 4,031 707 37,587
============== ============== ============== ==============
$408,153 $5,121 $10,466 $402,808
============== ============== ============== ==============
</TABLE>
The gross realized gains on securities sold from the available-for-sale
portfolio for the first six months of 1999 and 1998 are $646,000 and $688,000,
respectively. There were no losses realized in the available-for-sale portfolio
for the six months ended 1999 and 1998.
The amortized cost and estimated fair value of securities classified as
held-to-maturity and available-for-sale at June 30, 1999, summarized by
contractual maturity, are as follows:
<TABLE>
<CAPTION>
Held-to-maturity Available-for-sale
---------------------------------- ----------------------------------
June 30, 1999 Amortized Estimated Fair Amortized Estimated Fair
(dollars in thousands) Cost Value Cost Value
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Due in one year or less $ 740 $ 739 $34,978 $35,006
Due after one through five years 13,437 13,683 22,028 21,976
Due after five through ten years 501 517 106,515 102,362
Due after ten years 2,071 2,030 69,271 67,596
Mortgage-backed debt securities 7,015 6,865 141,098 138,281
Equity securities -- -- 34,263 37,587
====== ====== ====== ======
$23,764 $23,834 $408,153 $402,808
====== ====== ====== ======
</TABLE>
Actual maturities may differ from the contractual maturities reflected in the
preceding table because borrowers may have the right to call or prepay
obligations with or without prepayment penalties. Mortgage-backed securities
have no stated maturity and primarily reflect investments in various
Pass-through and Participation Certificates issued by the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation,
respectively. Repayment of mortgage-backed securities is dependent on the
contractual repayment terms of the underlying mortgages collateralizing these
obligations and the current level of interest rates.
The amortized cost and estimated fair value of securities classified as
held-to-maturity at December 31, 1998, are as follows:
HELD-TO-MATURITY PORTFOLIO
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
December 31, 1998
U.S. Treasury and other
U.S. government agencies $16,006 $48 $-- $16,054
and corporations
State and political subdivisions 5,670 357 -- 6,027
Mortgage-backed debt securities 8,369 65 46 8,388
------- --- --- -------
$30,045 $470 $46 $30,469
======= ==== === =======
</TABLE>
7
<PAGE>
The amortized cost and estimated fair value of securities available-for-sale at
December 31, 1998, are as follows:
AVAILABLE-FOR-SALE-PORTFOLIO
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
-------------- -------------- ----------------- ----------------
<S> <C> <C> <C> <C>
December 31, 1998
U.S. Treasury and other
U.S. government agencies $141,965 $1,125 $ 249 $142,841
and corporations
Mortgage-backed debt securities 172,437 1,190 407 173,220
Corporate bonds 69,398 1,377 1,102 69,673
Equity securities 31,082 4,771 411 35,442
------ ----- ------ ------
$414,882 $8,463 $2,169 $421,176
------ ----- ------ ------
</TABLE>
Note 4 - Earnings per share ("EPS") are disclosed as basic and diluted. Basic
EPS is generally computed by dividing net income by the weighted-average number
of common shares outstanding for the period, whereas diluted EPS essentially
reflects the potential dilution in basic EPS that could occur if other contracts
to issue common stock were exercised. Per share amounts are based on the
weighted-average number of shares outstanding during each period as follows:
<TABLE>
<CAPTION>
For the 3 months ended For the 6 months ended
June 30 June 30
--------------------------- ---------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic EPS weighted-average shares outstanding 10,074,296 10,024,183 10,069,504 10,011,274
Effect of dilutive securities - stock options 33,657 98,697 37,064 94,947
---------- ---------- ---------- ----------
Diluted EPS weighted-average shares outstanding 10,107,953 10,122,880 10,106,568 10,106,221
========== ========== ========== ==========
</TABLE>
Note 5 - Risk Management Instruments: Interest rate swaps used to achieve
interest rate risk management objectives are accounted for in a manner
consistent with the accounting basis of the related asset or liability. An
instrument designated to hedge an asset or liability carried at historical cost
is accounted for on an accrual basis, whereby the interest income or expense of
the related asset or liability is adjusted for the net amount of any interest
receivable or payable generated by the hedging instrument during the reporting
period. For such instruments, no amounts other than any accrued interest
receivable or payable are included in the accompanying consolidated balance
sheets.
Interest rate swaps involve the exchange of payments between counterparties
based on the interest differential between a fixed and a variable interest rate
applied to a notional balance. Under accrual accounting, this interest
differential is recognized as an adjustment to the interest income or expense of
the related asset or liability in the accompanying statements of income.
Upon early termination of derivative instruments accounted for under the accrual
method, the net proceeds received or paid are deferred, if material, in the
accompanying consolidated balance sheets and amortized to the interest income or
expense of the related asset or liability over the lesser of the remaining
contractual life of the instrument or the maturity of the related asset or
liability. At June 30, 1999, and December 31, 1998, there were no deferred gains
or losses in the accompanying consolidated balance sheets arising from the
termination of instruments qualifying for accrual accounting prior to maturity.
Note 6 - Comprehensive Income: The Company adheres to the provisions of
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." Comprehensive income, as defined by Statement 130, is the change in
equity of a business enterprise during a reporting period from transactions and
other events and circumstances from non-owner sources. In addition to an
enterprise's net income, change in equity components under comprehensive income
reporting would also include such items as the net change in unrealized gain or
loss on available-for-sale securities and foreign currency translation
adjustments. Statement 130 requires disclosure of comprehensive income and its
components with the same prominence as the Company's other financial statements.
Note 7 - Long-Term Debt: The guaranteed preferred beneficial interests in the
Company's subordinated debentures represent interests in 8.25% subordinated
debentures ("Subordinated Debentures"), due July 31, 2028, issued by the Company
to its subsidiary, FCNB Capital Trust, in connection with FCNB Capital's
Cumulative Trust Preferred Securities (the "Preferred Securities"). The
Subordinated Debentures and related payments are FCNB Capital's only assets.
The Preferred Securities meet the regulatory criteria for Tier I capital,
subject to Federal Reserve guidelines that limit the amount of the Preferred
Securities and cumulative perpetual preferred stock to an aggregate of 25% of
Tier I capital.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
This section of the report contains forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements relating to the Company's beliefs, expectations, anticipations and
plans regarding, among other things, general economic trends, interest rates,
product expansions and other matters. Such statements are subject to numerous
uncertainties, such as federal monetary policy, inflation, employment,
profitability and consumer confidence levels, both nationally and in the
Company's market area, the health of the real estate and construction market in
the Company's market area, the Company's ability to develop and market new
products and to enter new markets, competitive challenges in the Company's
market, legislative changes and other factors, and as such, there can be no
assurance that future events will develop in accordance with the forward looking
statements contained herein.
Additionally, the Company's future financial performance may be adversely
impacted by the inability of the Company to cause its information,
communications and environmental systems to be capable of correctly recognizing
and processing dates after December 31, 1999, ("Y2K Compliant") as currently
anticipated, and in any event, prior to January 1, 2000. Factors which may cause
actual results to differ from current Y2K Compliance plans include increased
costs of achieving Y2K Compliance, delayed timeframes for implementing and
testing Y2K Compliance measures, and delays by the Company's vendors in becoming
Y2K Compliant, or the inability of such vendors to become Y2K Compliant prior to
January 1, 2000. Additionally, the Company's performance may be adversely
affected by the failure of its customers or governmental authorities to become
Y2K Compliant prior to January 1, 2000. Because of these uncertainties and the
assumptions on which statements in this document are based, actual future
results may differ materially from those contemplated by such statements.
The following discussion and related financial data for the Company provides an
overview of the financial condition and results of operations of the Company and
its wholly-owned subsidiary, which is presented on a consolidated basis. The
principal subsidiary of the Company is FCNB Bank. For the first six months of
1999, the Company reported earnings of $5.90 million, an increase of 5.7%,
compared to earnings of $5.58 million in the first six months of 1998. However,
net income before specific one-time merger related costs ("core earnings") was
$6.03 million in the first six months of 1999, an increase of 7.3%, compared to
$5.62 million for the same period in 1998. For the second quarter, the Company
had core earnings of $3.06 million and earnings after one-time merger related
charges of $3.00 million in 1999, and in 1998 had core earnings of $2.90 million
and earnings after one-time merger related charges of $2.86 million.
Return on average assets and return on average equity are key measures of
earnings performance. Return on average assets measures the ability of a bank to
utilize its assets in generating income. Annualized return on average assets for
the six months ended June 30, 1999 was .92%, and was1.03% for the six months
ended June 30, 1998 in each case before specific one-time merger related costs.
The annualized return on average shareholders' equity, which measures the income
earned on the capital invested, for the six months ended June 30, 1999 was
13.51%, as compared to 12.51% for the six months ended June 30, 1998 in each
case before specific one-time merger related costs.
Annualized return on average assets for the quarter ended June 30, 1999 was
.95%, as compared to 1.06% for the same period in 1998, in each case before
specific one-time merger related costs. The annualized return on average
shareholders' equity for the three months ended June 30, 1999 was 13.77% and
12.87%, respectively, for the same period in 1998, in each case before specific
one-time merger related costs.
In the ordinary course of its business, the Company routinely explores
opportunities for additional growth and expansion of its core banking business
and related activities, by acquisition of existing branches, by merger with
other institutions, and by de novo branching, both within the Company's existing
market, and in new markets. There can be no assurance that any growth or
expansion will have a positive impact on the Company's earnings, dividends, book
value or market value.
BALANCE SHEET ANALYSIS
Year to Date
For the first six months of 1999, cash and cash equivalents decreased $21.1
million or 26.7%. Cash and cash equivalents were used to pay down short-term
borrowings, which for the first six months of 1999 decreased $19.90 million or
5.8%.
For the same period in 1999, investment securities held to maturity and
investment securities available for sale decreased $6.3 million or 20.9% and
$18.4 million or 4.4%, respectively. Bond calls and maturities in the portfolios
have contributed to this decrease in addition to a reduction in purchasing
activity.
9
<PAGE>
Net loans increased $33.80 million or 4.7% for the first six months of 1999.
This loan growth has been partially funded with a $16.97 million or 2.0%
increase in deposit growth for the same period.
Year to Year
From June 30, 1998 to June 30, 1999, cash and cash equivalents decreased $25.56
million and short-term borrowings increased $47.71 million. The proceeds of the
cash and borrowings were used to increase the available for sale investment
portfolio $93.47 million or 30.2%.
Net loans increased $68.01 million or 9.9% from June 30, 1998 to June 30, 1999,
which was funded primarily with a $52.01 million increase in deposits.
From June 30, 1998 to June 30, 1999, long-term borrowings increased $40.25
million as a result of FCNB Corp issuing cumulative trust preferred securities
on July 20, 1998 at a rate of 8.25% for a term of 30 years.
Summary
From June 30, 1998 to June 30, 1999, balance sheet growth has increased $136.42
million or 11.5% compared to earnings growth of $313,000 or 5.6% for the same
period ending June 30, 1999.
The disproportionate rates are the result of a period of declining interest
rates charged on loans along with declining yields on investment securities,
which have pulled the net interest margin down to 3.65% as of June 30, 1999 from
4.10% as of June 30, 1998. The interest paid on the addition of $40.25 million
of long-term debt at 8.25% has also had a negative impact on earnings.
NET INTEREST INCOME
Net interest income represents the Company's gross profit from lending and
investment activities, and is the most significant component of the Company's
earnings. Net interest income is the difference between interest and related fee
income on earning assets (primarily loans and investment securities) and the
cost of funds (primarily deposits and shortterm borrowings) supporting them. To
facilitate the analysis of net interest income, the table on page 14 is
presented on a taxable equivalent basis to adjust for the taxexempt status of
certain loans and investment securities. This adjustment, based on the statutory
federal income tax rate of 35%, increases the taxexempt income to an amount
representing an estimate of what would have been earned if that income were
fully taxable.
Taxable equivalent net interest income for the first six months of 1999 totaled
$21.68 million, increasing 6.3% from the $20.39 million recorded for the same
period in 1998. The Company's average interestearning assets increased 19.4% to
$1.19 billion from June 30, 1998. This increase was primarily funded with a
20.2% increase in the Company's average interestbearing liabilities.
For the second quarter, the taxable equivalent net interest income increased by
$661,000 (6.4%) to $11.05 million in 1999 from the same period in 1998.
The Company's net interest margin (taxable equivalent net interest income as a
percent of average interestearning assets) was 3.65% and 4.10% for the first
half of 1999 and 1998, respectively. The net interest margin is impacted by the
change in the spread between yields on earning assets and rates paid on
interestbearing liabilities. This spread decreased by 41 basis points in the
first six months of 1999 when compared to the same period in the prior year. The
yield on earning assets dropped 53 basis points to 7.66% from 8.19%, while the
rates paid on interest-bearing liabilities decreased by only 12 basis points to
4.51%.
For the second quarter of 1999 the net interest margin was 3.70% compared to
4.14% in 1998. The spread during the period decreased by 44 basis points which
was primarily caused by a decrease in the yields earned on the loan and
investment portfolios. The yield on earning assets dropped by 57 basis points to
7.68%, while the rates paid on interest-bearing liabilities decreased by only16
basis points to 4.49%.
The rate of interest earned on interest-earning assets and the rate paid on
interest-bearing liabilities, while significantly affected by the actions taken
by the Federal Reserve to control economic growth, are influenced by competitive
factors within the Company's market. Competitive pressures during early 1999 and
late 1998 for both loans and the funding sources needed to satisfy loan demand
within the Company's market area caused its net interest spread to narrow. The
management of the Company feels that the competitive pressures in this market
will cause the net interest spread to continue to be under pressure during 1999.
Therefore, the Company is currently pursuing operating efficiencies through
improved technology and is evaluating new products and services in an effort to
enhance its level of noninterest income. There can be no assurance that these
benefits will be realized.
10
<PAGE>
NONINTEREST INCOME
Noninterest income increased $1.77 million (25.2%) for the six months ended June
30, 1999, when compared to the same period in 1998. This increase was partially
attributable to the increase in service fee income of $591,000, which was due to
an increase in the volume of deposit accounts maintained. Loan sale gains
increased by $121,000. The Company's bank-owned life insurance program that
generates tax-exempt income to partially offset the cost of employee benefit
programs increased by $258,000 from June 30, 1998.
For the second quarter of 1999, noninterest income increased $868,000. This
increase was primarily caused by increased service fee income of $277,000,
additional insurance commissions of $252,000, and $101,000 of additional
securities gains.
The Company's management is committed to developing and offering innovative,
market-driven products and services that will generate additional sources of
noninterest income. However, the future results of any of these products or
services cannot be predicted at this time.
NONINTEREST EXPENSES
Noninterest expenses, excluding merger-related expenses, increased $2.36 million
(12.9%) for the first six months of 1999, when compared to the first six months
of 1998.
Total salaries and employee benefits increased $1.40 million (13.5%) over the
first six months of 1998. The increase in salaries and employee benefits
reflects general merit and cost-of-living adjustments, plus the additional
staffing of the seven branches acquired in June 1998. Additional increased
health care costs and pension expenses are the primary causes for the remaining
portion of this increase.
Occupancy expenses increased $621,000 (33.6%) and equipment expenses increased
$322,000 (22.3%) over the first six months of 1998. The increase in occupancy
expenses is primarily related to additional depreciation expense on the
facilities and increased utility costs. The increase in equipment expenses is
primarily associated with the additional depreciation expense incurred as a
result of implementing new technology.
Other operating expenses increased $20,000 (0.4%) compared to the first half of
1998.
For the second quarter of 1999, salaries and benefits increased $853,000
(16.6%), occupancy expenses increased $336,000 (36.4%), equipment expenses
increased $148,000 (19.8%), and other operating expenses increased $66,000
(2.8%). The increase in salaries and benefits costs is primarily related to the
increased number of full-time equivalent employees, which increased to 541 from
523 as of June 30, 1999. The increase in the number of employees primarily
reflects employees related to the acquisition of seven branches in June 1998.
Salary expense for the quarter ended June 30, 1998, reflected only six days of
First Virginia salary costs considering the acquisition occurred on June 24,
1998. Whereas the quarter ended June 30, 1999, First Virginia salary expense is
reflected for a full 91 days.
INCOME TAXES
The Company's effective tax rates for the first six months of 1999 and 1998 were
32.7% and 32.9%, respectively. The Company's income tax expense differs from the
amount computed at statutory rates primarily due to the taxexempt earnings from
certain loans, investment securities and the bank-owned life insurance program.
Additionally, the Company derives income tax benefits from a subsidiary located
in the state of Delaware that holds and manages a portion of its investment
portfolio.
ALLOWANCE FOR CREDIT LOSSES AND PROBLEM ASSETS
The Company follows the guidance of Statement of Financial Accounting Standards
No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan" as
amended by Statement No. 118, "Accounting by Creditors for Impairment of a
Loan-Income Recognition and Disclosures." It requires that impaired loans within
its scope be measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate, except that as a practical
expedient, a creditor may measure impairment based on a loan's observable market
price, or the fair value of the collateral if the loan is collateral dependent.
SFAS 114 excludes smaller balance and homogeneous loans from impairment
reporting. Therefore, the Company has designated consumer, credit card and
residential mortgage loans to be excluded for this purpose. From the remaining
loan portfolio, loans rated as doubtful or worse, classified as nonaccrual, and
troubled debt restructurings are considered to be impaired. Loans are placed on
nonaccrual when a loan is specifically determined to be impaired or when
principal or interest is delinquent for 90 days or more. Any unpaid interest
previously accrued on those loans is reversed from income. Interest income
generally is not recognized on specific impaired loans unless the likelihood of
further loss is remote. Interest payments received on such loans are applied as
a reduction of the loan principal balance. Interest income on other nonaccrual
loans is recognized only to the extent of interest payments received. Up to this
point, the Company considers slow payment on a loan, to only be a minimum delay.
The Company has identified commercial real estate and commercial and industrial
type loans as the major risk classifications to be used in the application of
SFAS 114.
11
<PAGE>
Selected information concerning the Company's recorded investment in impaired
loans and related interest income are summarized as follows:
<TABLE>
<CAPTION>
(dollars in thousands)
June 30, 1999 1998
---- ----
<S> <C> <C>
Impaired loans with specific allocation of allowance for credit losses $2,769 $3,063
Specific allocation of allowance for credit losses 1,084 1,093
Other impaired loans 4,200 1,423
Average recorded investment in impaired loans 7,215 4,143
Interest income recognized on impaired loans based on cash payments received 97 38
Additional information concerning the Company's recorded investment in
nonaccrual loans, for which impairment had not been recognized are as follows:
</TABLE>
<TABLE>
<CAPTION>
(dollars in thousands)
June 30, 1999 1998
---- ----
<S> <C> <C>
Nonaccrual loans -- 1,270
Interest income not recognized due to loans in nonaccrual status 4 30
--- -----
</TABLE>
The Company maintains its allowance for credit losses at a level deemed
sufficient to provide for estimated potential losses in the credit extension
process. Management reviews the adequacy of the allowance each quarter,
considering factors such as current and future economic conditions and their
anticipated impact on specific borrowers and industry groups, the growth and
composition of the loan portfolio, the level of classified and problem assets,
historical loss experience, and the collectability of specific loans. Allowances
for impaired loans are generally determined based on collateral values or the
present value of estimated cash flows.
The provision for credit losses is charged to income in an amount necessary to
maintain the allowance at the level management believes is appropriate.
<TABLE>
<CAPTION>
June 30, 1999 June 30, 1998 December 31, 1998
------------- ------------- ------------------
<S> <C> <C> <C>
Allowance for credit losses $7,616 $6,855 $7,198
====== ====== ======
% of total loans net of unearned income 1.00% 0.99% 0.99%
====== ====== ======
Nonaccrual loans $5,986 $5,137 $6,419
------ ------ ------
Past due loans 1,596 2,927 1,571
------ ------ ------
Nonperforming loans 7,582 8,064 7,990
------ ------ ------
Foreclosed properties 1,235 1,951 1,835
------ ------ ------
Nonperforming assets $8,817 $10,015 $9,825
====== ====== ======
Allowance for credit losses to nonperforming
loans 86.38% 85.01% 90.1%
====== ====== ======
Nonperforming assets to total assets .66% .84% 0.73%
====== ====== ======
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
ALLOWANCE FOR CREDIT LOSSES
Six months ended Year ended
June 30, 1999 December 31, 1998
---------------- ------------------
<S> <C> <C>
Average total loans outstanding during period $734,512 $694,237
-------- --------
Allowance at beginning of year $7,198 $6,701
-------- --------
Charge-offs:
Real estate - construction 55 --
Real estate - mortgage 54 177
Commercial and agricultural 266 625
Consumer 161 878
====== ======
Total charge-offs 536 1,680
====== ======
Recoveries:
Real estate - construction 55 --
Real estate - mortgage 55 50
Commercial and agricultural 79 113
Consumer 57 244
====== ======
Total recoveries 246 407
====== ======
Net charge-offs (recoveries) 290 1,273
====== ======
Additions to allowance charged to operating expenses 708 1,770
====== ======
Allowance at end of period $7,616 $7,198
====== ======
Ratio of net charge-offs to average total loans .04% .18%
====== ======
</TABLE>
<TABLE>
<CAPTION>
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
June 30, 1999 %(1) December 31, 1998 %(1)
--------------- -------- ------------------ ---------
<S> <C> <C> <C> <C>
Real estate - construction $1,290 15% $ 926 16%
Real estate - mortgage 2,488 59% 3,616 59
Commercial and agricultural 1,979 14% 1,639 16
Consumer 411 12% 337 9
Unallocated 1,448 -- 680 --
====== == ===== ==
Total Allowance $7,616 100% $7,198 100%
====== == ===== ==
</TABLE>
(1) Percent of loans in each category to total loans, net of unearned income.
The Company makes real estate-construction, real estate-mortgage, commercial and
agricultural, and consumer loans. The real estate-construction loans are
generally secured by the construction project financed, and have a term of one
year or less. The real estate-mortgage loans are generally secured by the
property with a maximum loan to value ratio of 75% and generally a term of one
to five years. The commercial and agricultural loans consist of secured and
unsecured loans. The unsecured commercial loans are made based on the financial
strength of the borrower and usually require personal guarantees from the
principals of the business. The collateral for the secured commercial loans may
be equipment, accounts receivable, marketable securities or deposits in the
subsidiary bank of the Company. These loans have a maximum loan to value ratio
of 75% and a term of one to five years. The consumer loan category consists of
secured and unsecured loans. The unsecured consumer loans are made on the
financial strength of the individual borrower. The collateral for the secured
consumer loans may be marketable securities, automobiles, recreational vehicles
or deposits in the Company's subsidiary bank. The usual term for these loans is
three to five years.
As of June 30, 1999, the Company had loans totaling $14.18 million that were
current but as to which there are concerns as to the ability of the borrowers to
comply with present loan repayment terms. While management of the Company does
not anticipate any loss not previously provided for on these loans, changes in
the financial condition of these borrowers may necessitate future modifications
in their loan repayment terms, additional charge-offs or provisions for loan
losses.
At June 30, 1999, the Company had no concentrations of loans in any one industry
exceeding 10% of its total loan portfolio. An industry for this purpose is
defined as a group of counterparties that are engaged in similar activities and
have similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or other
conditions.
There were no other interest-bearing assets at June 30, 1999, classifiable as
nonaccrual, past due, restructured or problem assets.
Distribution of Assets, Liabilities and Shareholders' Equity;
Interest Rates and Interest Differentials
The following table shows average balances of asset and liability categories,
interest income and paid, and average yields and rates for the periods
indicated:
13
<PAGE>
<TABLE>
<CAPTION>
Six months ended Six months ended
June 30, 1999 June 30, 1998
------------- -------------
Average Interest Average Average Interest Average
Daily Income(1)/ Yield/ Daily Income(1)/ Yield/
(dollars in thousands) Balance Paid Rate Balance Paid Rate
--------------- ------------ ----------- --------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning assets:
Interest-bearing deposits $ 2,094 $ 34 3.25% $ 964 $ 34 7.06%
--------------- ------------ ----------- --------------- ----------- ------------
Federal funds sold 15,017 348 4.63% 26,377 751 5.69%
--------------- ------------ ----------- --------------- ----------- ------------
Loans held for sale 5,301 193 7.28% 2,790 69 4.95%
--------------- ------------ ----------- --------------- ----------- ------------
Investment securities:
Taxable 424,551 13,147 6.19% 278,396 8,944 6.43%
Tax exempt 5,703 283 9.93% 4,118 229 11.13%
--------------- ------------ ----------- --------------- ----------- ------------
Total investment securities 430,254 13,430 6.24% 282,514 9,173 6.49%
--------------- ------------ ----------- --------------- ----------- ------------
Loans(2) 734,512 31,491 8.57% 682,055 30,696 9.00%
--------------- ------------ ----------- --------------- ----------- ------------
Total interest-earning assets 1,187,178 45,496 7.66% 994,699 40,723 8.19%
Noninterest-earning assets 99,057 84,678
Net Effect of SFAS 115 2,040 3,837
--------------- ------------ ----------- --------------- ----------- ------------
Total assets $1,288,275 $1,083,214
=============== ============ =========== =============== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits $ 708,492 14,508 4.10% $ 639,269 13,924 4.36%
Other short-term borrowings 306,611 7,620 4.97% 239,012 6,414 5.37%
Long-term debt 40,250 1,689 8.39% -- -- --
--------------- ------------ ----------- --------------- ----------- ------------
Total interest bearing liabilities 1,055,353 23,817 4.51% 878,281 20,338 4.63%
--------------- ------------ ----------- --------------- ----------- ------------
Noninterest-bearing deposits 131,040 105,021
Noninterest-bearing liabilities 12,609 10,070
--------------- ------------ ----------- --------------- ----------- ------------
Total liabilities 1,199,002 993,372
=============== ============ =========== =============== =========== ============
Shareholders' equity 87,232 86,005
Net effect of unrealized gains (losses)
on securities available for sale 2,040 3,837
--------------- ------------ ----------- --------------- ----------- ------------
Total shareholders' equity 89,272 89,842
--------------- ------------ ----------- --------------- ----------- ------------
Total liabilities and shareholders'
equity
$1,288,274 $1,083,214
--------------- ------------ ----------- --------------- ----------- ------------
Net interest income $21,679 $20,385
=============== ============ =========== =============== =========== ===========
Net interest spread 3.15% 3.56%
=============== ============ =========== =============== =========== ===========
Net interest margin 3.65% 4.10%
=============== ============ =========== =============== =========== ===========
</TABLE>
1 Taxable equivalent adjustments of $142,000 for 1999 and $133,000 for 1998
are included in the interest income for total interest-earning assets.
2 Nonaccruing loans, which include impaired loans, are included in the
average balances. Net loan fees included in interest income totaled $1.30
million in 1999, and $998,000 in 1998.
14
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset/liability management involves the funding and investment strategies
necessary to maintain an appropriate balance between interest sensitive assets
and liabilities. It also involves providing adequate liquidity while sustaining
stable growth in net interest income. Regular review and analysis of deposit and
loan trends, cash flows in various categories of loans, and monitoring of
interest spread relationships are vital to this process.
The conduct of our banking business requires that we maintain adequate liquidity
to meet changes in the composition and volume of assets and liabilities due to
seasonal, cyclical or other reasons. Liquidity describes the ability of the
Company to meet financial obligations that arise during the normal course of
business. Liquidity is primarily needed to meet the borrowing and deposit
withdrawal requirements of the customers of the Company, as well as for meeting
current and future planned expenditures. This liquidity is typically provided by
the funds received through customer deposits, investment maturities, loan
repayments, borrowings, and income. Management considers the current liquidity
position to be adequate to meet the needs of the Company and its customers.
The Company seeks to limit the risks associated with interest rate fluctuations
by managing the balance between interest sensitive assets and liabilities.
Managing to mitigate interest rate risk is, however, not an exact science. Not
only does the interval until repricing of interest rates on assets and
liabilities change from day to day as the assets and liabilities change, but for
some assets and liabilities, contractual maturity and the actual maturity
experienced are not the same. For example, mortgage-backed securities may have
contractual maturities well in excess of five years but, depending upon the
interest rate carried by the specific underlying mortgages and the current
prevailing rate of interest, these securities may be repaid in a shorter time
period. Accordingly, mortgage-backed securities and collateralized mortgage
obligations that have average stated maturities in excess of five years are
evaluated as part of the asset/liability management process using their expected
average lives due to anticipated prepayments. Loans held for sale which have a
contracted maturity of five to thirty years are included in the one year or less
time frame since they are available to be sold at any time and are carried at
the lower of cost or fair value.
Interest rate sensitivity is an important factor in the management of the
composition and maturity configurations of the Company's earning assets and
funding sources. An Asset/Liability Committee manages the interest rate
sensitivity position in order to maintain an appropriate balance between the
maturity and repricing characteristics of assets and liabilities that is
consistent with the Company's liquidity analysis, growth, and capital adequacy
goals. The Company sells fixed-rate real estate loans in the secondary mortgage
market. The Company believes that by selling certain loans rather than retaining
them in its portfolio, it is better able to match the maturities or repricing of
interest sensitive assets to interest sensitive liabilities. It is the objective
of the Asset/Liability Committee to maximize net interest margins during periods
of both volatile and stable interest rates, to attain earnings growth, and to
maintain sufficient liquidity to satisfy depositors' requirements and meet
credit needs of customers.
As noted, the Company assumes a degree of interest rate risk as a provider of
banking services to its customers. This risk can be reduced through derivative
interest rate contracts, such as interest rate swaps. At June 30, 1999, the
Company had one outstanding interest rate swap instrument which is used to
convert certain fixed rate assets to variable rates as part of its interest rate
risk management strategy. Because financial derivatives typically do not have
actual principal dollars transferred between the parties, notional principal
amounts are used to express the volume of such transactions. However, the
notional amount of derivative contracts does not represent direct credit
exposure, which the Company believes is a combination of current replacement
cost of those instruments with a positive market value plus an amount for
prospective market movement. The Company has established policies governing
derivative activities, and the counterparties used by the Company are considered
high quality credit risks. There were no past due amounts or reserves for
possible derivative credit losses at June 30, 1999, nor has the Company
experienced any charge-offs related to the credit risk of derivative
transactions.
The notional amount of the Company's interest rate swap was $10.0 million at
June 30, 1999. This instrument matures in November 2004.
The Company employs computer model simulations for monitoring interest rate
sensitivity. Interest rate risk ("IRR") management has various sources and it is
not simply the risk from rates rising and falling. In fact, there are four
sources of IRR: repricing risk, basis risk, yield curve risk, and option risk.
Gap modeling only focuses on repricing risk. Income simulations that incorporate
cash flow analyses: (1) measure the size and direction of interest rate exposure
under a variety of interest rate and yield curve shape scenarios; (2) provides
the opportunity to capture all critical elements such as volume, maturity dates,
repricing dates, prepayment volumes, and hidden options such as caps, floors,
puts, and calls; (3) utilizes the data to clearly focus attention on critical
variables; (4) are dynamic; and (5) reflect changes in prevailing interest rates
which affect different assets and liabilities in different ways. These
simulations are run on a monthly basis using an interest rate ramping technique
to determine the effects on the Company's net interest income, assuming a
gradual increase or decrease in interest rates. The Company has an interest rate
risk management policy that limits the amount of deterioration in net interest
income, associated with an assumed interest rate shock of +/-100, +/-200, and
+/-300 basis points change in interest rates, to no more than 7.5% (+/-100),
10.0% (+/-200), and 12.5% (+/-300) of net interest income. The model results as
of June 30, 1999 are as follows:
15
<PAGE>
<TABLE>
<CAPTION>
Change in Interest Rate Assumption
----------------------------------
(dollars in thousands) +100bp +200bp +300bp -100bp -200bp -300bp
----------- ----------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net interest income-increase
(decrease) $(1,162) $(2,435) $(3,321) $1,146 $2,044 $2,317
Net interest income - % change (2.66) (5.58) (7.61) 2.62 4.68 5.31
----------- ----------- ------------ ----------- ----------- -----------
</TABLE>
Risk Management Instruments: Interest rate swaps used to achieve interest rate
risk management objectives are accounted for in a manner consistent with the
accounting basis of the related asset or liability. An instrument designated to
hedge an asset or liability carried at historical cost is accounted for on an
accrual basis, whereby the interest income or expense of the related asset or
liability is adjusted for the net amount of any interest receivable or payable
generated by the hedging instrument during the reporting period. For such
instruments, no amounts other than any accrued interest receivable or payable
are included in the accompanying consolidated balance sheets.
Interest rate swaps involve the exchange of payments between counterparties
based on the interest differential between a fixed and a variable interest rate
applied to a notional balance. Under accrual accounting, this interest
differential is recognized as an adjustment to the interest income or expense of
the related asset or liability in the accompanying statements of income.
Upon early termination of derivative instruments accounted for under the accrual
method, the net proceeds received or paid are deferred, if material, in the
accompanying consolidated balance sheets and amortized to the interest income or
expense of the related asset or liability over the lesser of the remaining
contractual life of the instrument or the maturity of the related asset or
liability. At June 30, 1999, and December 31, 1998, there were no deferred gains
or losses in the accompanying consolidated balance sheets arising from the
termination of instruments qualifying for accrual accounting prior to maturity.
CAPITAL RESOURCES
The following table shows the riskbased capital and the leverage ratios for the
Company as of June 30, 1999:
<TABLE>
<CAPTION>
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes Prompt Corrective
Action Provisions:
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital
(to Risk-Weighted Assets):
FCNB Corp $133,532 13.92% $76,716 8.00% N/A N/A
FCNB Bank $104,067 11.07% $75,189 8.00% $93,986 10.00%
Tier I Capital
(To Risk-Weighted Assets):
FCNB Corp $114,188 11.91% $38,358 4.00% N/A N/A
FCNB Bank $96,282 10.24% $37,595 4.00% $56,392 16.00%
Tier I Capital
(To Average Assets):
FCNB Corp $114,188 8.91% $38,431 3.00% N/A N/A
FCNB Bank $96,282 7.63% $37,856 3.00% $63,093 5.00%
</TABLE>
16
<PAGE>
INFLATION
The effect of changing prices on financial institutions is typically different
than on non-banking companies since virtually all of a bank's assets and
liabilities are monetary in nature. In particular, interest rates are
significantly affected by inflation, but neither the timing nor magnitude of the
changes are directly related to price level indices; therefore, the Company can
best counter inflation over the long term by managing net interest income and
controlling net increases in noninterest income and expenses.
YEAR 2000
The Year 2000 problem involves computer processing problems and failures arising
from the fact that some existing computer programs use only the last two digits
to refer to a year, and therefore do not properly recognize a year that begins
with "20" instead of "19". This section will highlight how the Company is
currently addressing its business areas which may be affected by the Year 2000
problem.
YEAR 2000 READINESS PLANNING
The Company has prepared a Year 2000 plan which includes contacting all of the
software vendors that maintain the computer programs that the Company relies
upon. As of June 30, 1999, the Company has performed risk assessments of funds
providers, funds takers, fiduciary activities and systems and has assessed the
Year 2000 preparedness of suppliers of data processing services to the Company.
The Company's primary supplier of data processing services also has adopted a
Year 2000 readiness plan and timetable to make the changes necessary for it to
provide services in the Year 2000, and has provided written assurances to the
Company of its progress. That supplier has been examined for Y2K readiness by
federal bank examiners. The Company is also monitoring the progress of its other
suppliers of data processing services.
As of June 30, 1999, the Company has implemented its customer awareness program
which includes communications of Y2K readiness efforts through statement
stuffers, direct mailings, brochures, newspaper and television advertisements,
letters and our internet site. The Company has additionally assessed the Year
2000 preparedness of its large customers and has contacted large commercial loan
and deposit customers to determine their readiness.
As of June 30, 1999, the Company was in the process of testing and implementing
necessary changes in hardware and software. At this time, most of these changes
in hardware and software have been tested. The Company will continue to evaluate
its systems throughout the remainder of 1999. Additional steps must be taken to
achieve Y2K compliance.
The Company is in the banking industry, which is heavily regulated. The
Company's primary federal regulator is the Federal Reserve Bank. The Company is
on track to be in compliance with all Federal Reserve regulations related to the
Year 2000 issue.
YEAR 2000 RELATED COSTS
Since many of the programs used by the Company are "off-the-shelf" as compared
to "highly customized," the cost to address Year 2000 related issues for these
programs will not be as high as the costs for other companies that rely more on
"highly customized" software. The Company has a budget for software, hardware
and consulting costs of approximately $736,000. As of June 30, 1999, the Company
has expended $75,000 for these costs in 1999, and $149,000 in 1998 for the year.
The Company estimated it may incur an additional $344,000 in costs in 1999. The
Company estimates these costs will be made up of hardware and software upgrades,
consultant fees, human resources, lost earnings on additional cash buildup in
branch network, and testing fees. This area is changing very rapidly and the
actual costs incurred by the Company may differ from what has been anticipated.
YEAR 2000 RELATED RISKS
An estimation of the efforts of the Company in addressing the Year 2000 issue in
a successful and timely manner depends to a large extent, in addition to the
Company's own effort, on the efforts of the Company's data processing service
provider as well as the technology and services of other service providers. The
failure of the Company, its principal data processing provider, its customers,
or of other service providers, including utilities and government agencies, to
be Year 2000 compliant in a timely manner could have a negative impact on the
Company's business, including but not limited to an inability to provide
accurate processing of customer transactions, and delays in loan collection
practices. The Company's belief that it, and its primary suppliers of data
processing services, will achieve Year 2000 compliance, are based on a number of
assumptions and on statements made by third parties, involve events and actions
which may be beyond the control of the Company, and are subject to uncertainty.
While the Company has been making efforts to prepare those items under its
control, it is not able to predict the effects, if any, of the public's reaction
to the Year 2000 on the Company, financial markets or society in general.
17
<PAGE>
CONTINGENCY PLANNING
The Company has in place a Disaster Recovery Plan for its computer operations
facility and a business resumption plan for its various departments. This
Disaster Recovery Plan provides for mission-critical and support operations to
be conducted at our off-site disaster recovery facility. The mission-critical
systems will have been tested at the Disaster Recover site; therefore in the
event the Company cannot perform its own core business processes, the existing
FCNB Bank Disaster Recovery Plan would be followed in order to continue
operations.
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8K.
Exhibits
No. 11 - Statement Regarding the Computation of Per Share Earnings
No. 27 - Financial Data Schedule
Reports on Form 8-K
None.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FCNB CORP
(Registrant)
August 10, 1999 By:
------------------------------------------
A. Patrick Linton,
President, Chief Executive Officer and Director
August 10, 1999 By:
------------------------------------------
Mark A. Severson
Senior Vice President and Treasurer
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FCNB CORP
(Registrant)
August 10, 1999 By: /s/ A. Patrick Linton
------------------------------------------
A. Patrick Linton
President Chief Executive Officer and Director
August 10, 1999 By: /s/ Mark A. Severson
------------------------------------------
Mark A. Severson
Senior Vice President and Treasurer
Exhibit No. 11
Statement Regarding the Computation of Per Share Earnings
June 30,
1999 1998
------------ -----------
Basic earnings per common share $.59 $.56
Basic earnings per common share before
merger-related expenses .60 .56
Basic weighted average number of shares
outstanding 10,069,504 10,011,274
Diluted earnings per common share .58 .55
Diluted earnings per common share before
merger-related expenses .60 .56
Diluted weighted average number of shares
outstanding 10,106,568 10,106,221
The data shown for 1998 has been adjusted retroactively, to reflect the effects
of the four-for-three stock split effected in the form of a 33% stock dividend
declared in July 1998 and paid in August 1998.
The attached financial statements for 1998 have been restated to reflect the
effects of the acquisitions of Capital Bank, N.A. in November 1998 and Frederick
Underwriters, Inc. in December 1998, each accounted for as a pooling of
interests.
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