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
September 30, 1999 0-15645
FCNB Corp
(Exact name of registrant as specified in its charter)
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<S> <C>
MARYLAND 52-1479635
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
7200 FCNB Court, Frederick, Maryland 21703
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (301) 662-2191
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, 11,917,626 shares outstanding as of November 1, 1999.
<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
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FCNB CORP AND SUBSIDIARY
- --------------------------------------------------------------- ------------------------- --------------------------
Consolidated Balance Sheets (Unaudited) (Unaudited)
(dollars in thousands, except per share amounts) September 30, 1999 December 31, 1998
- --------------------------------------------------------------- ------------------------- --------------------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 32,601 $ 35,518
Interest-bearing deposits in other banks 4,045 9,358
Federal funds sold 26,042 47,262
- --------------------------------------------------------------- ------------------------- --------------------------
Cash and cash equivalents 62,688 92,138
- --------------------------------------------------------------- ------------------------- --------------------------
Loans held for sale 3,159 5,236
- --------------------------------------------------------------- ------------------------- --------------------------
Investment securities held to maturity at amortized
cost-fair value of $21,734 in 1999 and $30,469
in 1998 21,768 30,045
- --------------------------------------------------------------- ------------------------- --------------------------
Investment securities available for sale-at fair value 416,251 437,684
- --------------------------------------------------------------- ------------------------- --------------------------
Loans 874,485 818,084
Less: Allowance for credit losses (9,648) (8,237)
Unearned income (10) (23)
- --------------------------------------------------------------- ------------------------- --------------------------
Net loans 864,827 809,824
- --------------------------------------------------------------- ------------------------- --------------------------
Bank premises and equipment 25,975 26,902
Other assets 68,583 57,891
- --------------------------------------------------------------- ------------------------- --------------------------
Total assets $1,463,251 $1,459,720
=============================================================== ========================= ==========================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing deposits $ 158,069 $ 154,774
Interest-bearing deposits 845,734 808,025
- --------------------------------------------------------------- ------------------------- --------------------------
Total deposits 1,003,803 962,799
- --------------------------------------------------------------- ------------------------- --------------------------
Short-term borrowings:
Federal funds purchased and securities sold
under agreements to repurchase 60,958 94,117
Other short-term borrowings 252,270 248,719
Long-term debt:
Guaranteed preferred beneficial interests
in the Company's subordinated debenture 40,250 40,250
Accrued interest and other liabilities 14,551 14,980
- --------------------------------------------------------------- ------------------------- --------------------------
Total liabilities 1,371,832 1,360,865
- --------------------------------------------------------------- ------------------------- --------------------------
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;
50,000,000 shares authorized: 11,903,657
shares in 1999 and 11,598,626 shares in 1998
issued and outstanding 11,904 11,599
Capital surplus 52,064 52,174
Retained earnings 33,011 31,177
Accumulated other comprehensive income (5,560) 3,905
- --------------------------------------------------------------- ------------------------- --------------------------
Total shareholders' equity 91,419 98,855
- --------------------------------------------------------------- ------------------------- --------------------------
Total liabilities and shareholders' equity $1,463,251 $1,459,720
=============================================================== ========================= ==========================
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2
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<CAPTION>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Income and Comprehensive Income (Unaudited)
- ------------------------------------------------------------- ---------------------------------- ----------------------------------
For the 3 months ended For the 9 months ended
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
(dollars in thousands, except per share amounts) September 30, September 30, September 30, September 30,
1999 1998 1999 1998
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $18,898 $18,166 $55,329 $52,760
Interest and dividends on investment securities:
Taxable 6,288 5,119 19,005 14,065
Tax exempt 131 124 421 302
Dividends 378 263 1,145 749
Interest on federal funds sold 299 604 647 1,355
Other interest income 42 30 131 140
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total interest income 26,036 24,306 76,678 69,371
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Interest expense:
Interest on deposits 8,686 8,706 25,187 24,511
Interest on federal funds purchased and securities
sold under agreements to repurchase 892 528 2,301 2,129
Interest on other short-term borrowings 3,284 2,504 9,650 7,357
Interest on long-term debt 844 679 2,533 679
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total interest expense 13,706 12,417 39,671 34,676
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Net interest income 12,330 11,889 37,007 34,695
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Provision for credit losses:
Operating activities 390 450 1,278 1,073
Merger related 2,900 -- 2,900 --
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total provision for credit losses 3,290 450 4,178 1,073
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Net interest income after provision for credit losses 9,040 11,439 32,829 33,622
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Noninterest income:
Service fees 1,369 1,406 3,971 3,408
Insurance commissions 1,564 1,468 4,457 4,228
Net securities gains 159 281 805 993
Gain on sale of loans 343 243 832 690
Income from bank-owned life insurance 393 311 1,164 824
Other operating income 1,079 704 2,823 1,721
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total noninterest income 4,907 4,413 14,052 11,864
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Noninterest expenses:
Salaries and employee benefits 6,405 6,139 19,246 17,376
Occupancy expenses 1,523 1,308 4,348 3,475
Equipment expenses 985 919 3,002 2,519
Merger-related expenses 1,516 57 1,688 110
Other operating expenses 2,860 2,728 8,371 7,990
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Total noninterest expenses 13,289 11,151 36,655 31,470
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Income before provision for income taxes 658 4,701 10,226 14,016
Income tax expense 60 1,585 3,257 4,705
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Net income 598 3,116 6,969 9,311
- ------------------------------------------------------------- ----------------- ---------------- ----------------- ----------------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during period, net of taxes of ($1,397),
$626, ($6,287) and $1,266, respectively (2,062) 905 (8,971) 1,823
Less: reclassification adjustment for gain
(losses) included in net income, net of taxes of
$63, $109, $311 and $386, respectively. 96 173 494 607
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3
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FCNB CORP AND SUBSIDIARY
Consolidated Statements of Income and Comprehensive Income (Unaudited)
(Continued)
<S> <C> <C> <C> <C>
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Other comprehensive income (loss), net of taxes of ($1,334), $517,
($5,976) and $880, respectively (2,158) 732 (9,465) 1,216
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Comprehensive income $(1,560) $3,848 $(2,496) $10,527
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Net income - before merger-related expenses $3,355 $3,186 $9,943 $9,423
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Basic earnings per share (Note 4) $0.05 $0.27 $0.60 $0.81
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Diluted earnings per share (Note 4) $0.05 $0.26 $0.58 $0.79
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Basic earnings per share before merger-related expenses (Note 4) $0.29 $0.27 $0.85 $0.82
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Diluted earnings per share before merger-related expenses (Note 4) $0.28 $0.27 $0.83 $0.80
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Basic weighted-average number of shares outstanding (Note 4) 11,752,285 11,586,497 11,655,706 11,560,632
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
Diluted weighted-average number of shares outstanding (Note 4) 11,937,239 11,894,964 11,915,845 11,844,885
- ----------------------------------------------------------------------- ------------ ------------ ---------------- ----------------
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4
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FCNB CORP AND SUBSIDIARY
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 1999 and 1998
- --------------------------------------------------------------------------------- -------------------- ---------------------
(dollars in thousands) 1999 1998
- --------------------------------------------------------------------------------- -------------------- ---------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,969 $ 9,311
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 2,638 2,282
Provision for credit losses 4,178 874
Provision for foreclosed properties 75 50
Deferred income taxes (benefits) (437) (19)
Net premium amortization (discount accretion) on investment securities 291 (155)
Accretion of net loan origination fees (1,180) (828)
Net securities gains (805) (992)
Net loss on sale of foreclosed properties (12) (2)
Net gain (loss) on dispositions at bank premises and equipment 3 29
Decrease (increase) in other assets (5,406) (6,688)
Decrease (increase) in loans held for sale (1) 2,077 (2,718)
Increase (decrease) in accrued interest and other liabilities (429) 1,612
- --------------------------------------------------------------------------------- -------------------- ---------------------
Net cash provided by operating activities 7,962 2,756
- --------------------------------------------------------------------------------- -------------------- ---------------------
Cash flows from investing activities:
Proceeds from sales of investment securities - available for sale 14,293 27,028
Proceeds from maturities of investment securities - available for sale 112,272 103,531
Proceeds from maturities of investment securities - held to maturity 6,897 9,553
Purchases of investment securities - held to maturity -- (2,070)
Purchases of investment securities - available for sale (118,701) (239,545)
Net decrease (increase) in loans (58,001) (41,421)
Purchases of bank premises and equipment (1,342) (2,380)
Proceeds from dispositions of bank premises and equipment -- 1
Purchase of foreclosed properties (60) (27)
Proceeds from dispositions of foreclosed properties 795 1,094
Purchase of investments in bank-owned life insurance -- (15,000)
- --------------------------------------------------------------------------------- -------------------- ---------------------
Net cash (used in) investing activities (43,847) (159,236)
- --------------------------------------------------------------------------------- -------------------- ---------------------
Cash flows from financing activities:
Net increase (decrease) in noninterest-bearing deposits, NOW accounts,
money market account and savings accounts 12,326 83,614
Net increase (decrease) in time deposits 28,678 28,227
Net increase (decrease) in short-term borrowings (29,608) 21,457
Proceeds from long-term debt -- 40,250
Proceeds from sale of stock 174 402
Repurchase of common stock -- --
Dividend reinvestment plan (47) (38)
Dividends paid (5,088) (2,473)
- --------------------------------------------------------------------------------- -------------------- ---------------------
Net cash provided by financing activities 6,435 171,439
- --------------------------------------------------------------------------------- -------------------- ---------------------
Increase (decrease) in cash and cash equivalents (29,450) 14,959
Cash and cash equivalents:
Beginning of period 92,138 76,707
================================================================================= ==================== =====================
End of period $62,688 $ 91,666
================================================================================= ==================== =====================
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5
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<CAPTION>
FCNB CORP AND SUBSIDIARY
Consolidated Statements of Cash Flows (Unaudited) continued
For the nine months
ended September 30, 1999 and 1998
(dollars in thousands) 1999 1998
=============================================================== ================= ================
<S> <C> <C>
Supplemental disclosures
Interest paid $39,185 $33,534
=============================================================== ================= ================
Income taxes paid $ 4,570 $ 6,197
=============================================================== ================= ================
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 $ 49 $ 26
=============================================================== ================= ================
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(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 10-Q 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 and the first two quarters of 1999 have been restated to reflect the
effects of the acquisitions of Capital Bank, N.A. in November 1998, Frederick
Underwriters, Inc. in December 1998, and First Frederick Financial Corporation
in August 1999, which have all been accounted for using the pooling-of-interests
method.
Note 2 - On August 19, 1999, FCNB Corp (the "Company") consummated its
previously announced merger of First Frederick Financial Corp ("First"), the
holding company for First Bank of Frederick, with and into FCNB, and the merger
of First Bank of Frederick with and into FCNB's wholly-owned subsidiary, FCNB
Bank, all headquartered in Frederick, Maryland. FCNB and First executed a
definitive agreement on March 12, 1999.
As a result of the Merger, each share of the $1.00 par value outstanding common
stock of First was converted into 1.0434 shares of the Company's $1.00 par value
common stock resulting in the issuance of approximately 1,543,012 shares of FCNB
common stock, subject to adjustment to account for the elimination of fractional
shares.
The consummation of the acquisition of First, which has approximately $110
million of total assets, gives FCNB approximately $1.45 billion in total assets,
total deposits of approximately $972 million, and total shareholders' equity of
approximately $91 million.
Merger related expenses of $4.05 million are included in the consolidated
financial statements of income and consist principally of $306,000 for severance
payments to terminated employees, $99,000 for professional fees, and other
conversion related costs of $744,000. The allowance for credit losses was
increased an additional $2.9 million in order to align the accounting assumption
in analyzing the allowance for credit losses.
Note 3 - Investments: Using the criteria specified in Statement 115, the Company
classifies its investments in debt and equity securities at September 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.
6
<PAGE>
As of September 30, 1999, the gross unrealized losses in the Company's
investment portfolio were $248,000 in the held-to-maturity investment portfolio
and $12.81 million in the available-for-sale investment portfolio compared to
$46,000 and $2.18 million, respectively, as of December 31, 1998. As of
September 30, 1999, the gross unrealized gains in the Company's investment
portfolio were $214,000 in the held-to-maturity investment portfolio and $3.69
million in the available-for-sale investment portfolio compared to $470,000 and
$8.53 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 September 30, 1999, are as follows:
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<CAPTION>
HELD-TO-MATURITY PORTFOLIO
- ------------------------------------------------------ -------------- -------------- -------------- --------------
Gross Gross
September 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 $ 11,000 $ -- $ 37 $10,963
State and political subdivision 5,031 211 107 5,135
Mortgage-backed debt securities 5,737 3 104 5,636
- ------------------------------------------------------ -------------- -------------- -------------- --------------
$21,768 $214 $248 $21,734
====================================================== ============== ============== ============== ==============
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The amortized cost and estimated fair value of securities classified as
available-for-sale at September 30, 1999, are as follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE-PORTFOLIO
- ------------------------------------------------------ -------------- -------------- -------------- --------------
Gross Gross
September 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 $184,354 $ 237 $ 5,575 $179,016
Corporate bonds 68,394 554 2,610 66,338
Mortgage-backed debt securities 135,602 182 3,406 132,378
Municipal tax exempt bonds 4,786 -- 232 4,554
Equity securities 32,231 2,721 987 33,965
- ------------------------------------------------------ -------------- -------------- -------------- --------------
$425,367 $3,694 $12,810 $416,251
====================================================== ============== ============== ============== ==============
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The gross realized gains on securities sold from the available-for-sale
portfolio for the first nine months of 1999 and 1998 are $805,000 and $993,000,
respectively. There were no losses realized in the available-for-sale portfolio
for the nine months ended 1999 and 1998.
The amortized cost and estimated fair value of securities classified as
held-to-maturity and available-for-sale at September 30, 1999, summarized by
contractual maturity, are as follows:
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Held-to-maturity Available-for-sale
- ---------------------------------------- ----------------- ---------------- ----------------- ----------------
September 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 $ 355 $ 355 $ 39,986 $ 39,992
Due after one through five years 13,105 13,270 32,019 31,981
Due after five through ten years 500 510 112,172 107,039
Due after ten years 2,071 1,963 73,357 70,896
Mortgage-backed debt securities 5,737 5,636 135,602 132,378
Equity securities -- -- 32,231 33,965
- ---------------------------------------- ----------------- ---------------- ----------------- ----------------
$ 21,768 $ 21,734 $ 425,367 $ 416,251
======================================== ================= ================ ================= ================
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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.
7
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The amortized cost and estimated fair value of securities classified as
held-to-maturity at December 31, 1998, are as follows:
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HELD-TO-MATURITY PORTFOLIO
- ---------------------------------------------- ------------- --------------- ---------------- -----------------
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>
The amortized cost and estimated fair value of securities available-for-sale at
December 31, 1998, are as follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE-PORTFOLIO
- ---------------------------------------------- ------------- --------------- ---------------- -----------------
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 and corporations $149,438 $1,125 $ 249 $150,314
Mortgage-backed debt securities 177,137 1,190 407 177,920
Municipal tax-exempt bonds 4,021 70 14 4,077
Corporate bonds 69,398 1,377 1,102 69,673
Equity securities 31,340 4,771 411 35,700
- ---------------------------------------------- ------------- --------------- ---------------- -----------------
$431,334 $8,533 $2,183 $437,684
============================================== ============= =============== ================ =================
</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:
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<CAPTION>
- --------------------------------------------------------- --------------------------- ---------------------------
For the 3 months ended For the 9 months ended
September 30 September 30
- --------------------------------------------------------- ------------- ------------- ------------- -------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic EPS weighted-average shares outstanding 11,752,285 11,586,497 11,655,706 11,560,632
Effect of dilutive securities - stock options 184,954 308,467 260,139 284,253
- --------------------------------------------------------- ------------- ------------- ------------- -------------
Diluted EPS weighted-average shares outstanding 11,937,239 11,894,964 11,915,845 11,844,885
========================================================= ============= ============= ============= =============
</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 September 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.
8
<PAGE>
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.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
OVERVIEW
Forward Looking Statements 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 nine months of
1999, the Company reported earnings of $6.97 million, a decrease of 25.2%,
compared to earnings of $9.31 million in the first nine months of 1998. However,
net income before specific one-time merger related costs ("core earnings") was
$9.94 million in the first nine months of 1999, an increase of 5.5%, compared to
core earnings of $9.42 million for the same period in 1998. For the third
quarter, the Company had core earnings of $3.36 million and earnings after
one-time merger related charges of $598,000 in 1999, and in 1998 had core
earnings of $3.19 million and earnings after one-time merger related charges of
$3.12 million.
On August 19, 1999, FCNB Corp (the "Company") consummated its previously
announced merger of First Frederick Financial Corp ("First"), the holding
company for First Bank of Frederick, with and into FCNB, and the merger of First
Bank of Frederick with and into FCNB's wholly-owned subsidiary, FCNB Bank, all
headquartered in Frederick, Maryland. FCNB and First executed a definitive
agreement on March 12, 1999.
As a result of the Merger, each share of the $1.00 par value outstanding common
stock of First was converted into 1.0434 shares of the Company's $1.00 par value
common stock resulting in the issuance of approximately 1,543,012 shares of FCNB
common stock, subject to adjustment to account for the elimination of fractional
shares.
The consummation of the acquisition of First, which has approximately $110
million of total assets, gives FCNB approximately $1.45 billion in total assets,
total deposits of approximately $972 million, and total shareholders' equity of
approximately $91 million.
9
<PAGE>
Merger related expenses of $4.05 million are included in the consolidated
financial statements of income and consist principally of $306,000 for severance
payments to terminated employees, $99,000 for professional fees, and other
conversion related costs of $744,000. The allowance for credit losses was
increased an additional $2.9 million in order to align the accounting assumption
in analyzing the allowance for credit losses.
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 nine months ended September 30, 1999 was .94%, and was 1.03% for the nine
months ended September 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 nine months ended
September 30, 1999 was 13.94%, as compared to 12.71% for the nine months ended
September 30, 1998 in each case before specific one-time merger related costs.
Annualized return on average assets for the nine months ended September 30, 1999
was .66%, and was 1.02% for the nine months ended September 30, 1998 in each
case after specific one-time merger related costs. The annualized return on
average shareholders' equity, which measures the income earned on the capital
invested, for the nine months ended September 30, 1999 was 9.77%, as compared to
12.56% for the nine months ended September 30, 1998 in each case after specific
one-time merger related costs.
Annualized return on average assets for the quarter ended September 30, 1999 was
.95%, as compared to 1.00% 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 September 30, 1999 was 15.02%
and 12.70%, respectively, for the same period in 1998, in each case before
specific one-time merger related costs. Annualized return on average assets for
the quarter ended September 30, 1999 was .17%, as compared to . 98 for the same
period in 1998, in each case after specific one-time merger related costs. The
annualized return on average shareholders' equity for the three months ended
September 30, 1999 was 2.68% and 12.42%, respectively, for the same period in
1998, in each case after 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.
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 short-term 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 tax-exempt status of
certain loans and investment securities. This adjustment, based on the statutory
federal income tax rate of 35%, increases the tax-exempt 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 nine months of 1999 totaled
$37.30 million, increasing 6.99% from the $34.86 million recorded for the same
period in 1998. The Company's average interest-earning assets increased 16.3% to
$1.30 billion from September 30, 1998. This increase was primarily funded with a
17.2% increase in the Company's average interest-bearing liabilities.
For the third quarter, the taxable equivalent net interest income increased by
$964,000 to $13.36 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 interest-earning assets) was 3.80% and 4.15% for the first
nine months 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
interest-bearing liabilities. This spread decreased by 31 basis points in the
first nine months of 1999 when compared to the same period in the prior year.
The yield on earning assets dropped 44 basis points to 7.84% from 8.28%, while
the rates paid on interest-bearing liabilities decreased by only 11 basis points
to 4.59%.
For the third quarter of 1999 the net interest margin was 3.84% compared to
4.21% in 1998. The spread during the period decreased by 37 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 50 basis points to
7.96%, while the rates paid on interest-bearing liabilities decreased by only 9
basis points to 4.73%.
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 the
remainder of 1999. Therefore, the Company is
10
<PAGE>
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.
NONINTEREST INCOME
Noninterest income increased $2.19 million (18.4%) for the nine months ended
September 30, 1999, when compared to the same period in 1998. This increase was
partially attributable to the increase in service fee income of $563,000, which
was due to an increase in the volume of deposit accounts maintained, loan sale
gains of $142,000 and insurance commissions of $229,000 from the Company's
wholly-owned subsidiary, Frederick Underwriters Insurance, Inc. Income from the
Company's bank-owned life insurance program that generates tax-exempt income to
partially offset the cost of employee benefit programs increased by $340,000
from September 30, 1998.
For the third quarter of 1999, noninterest income increased $494,000. This
increase was primarily caused by increased insurance commissions of $96,000,
$100,000 of loan sale gains, and $82,000 from the Company's bank-owned life
insurance program.
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 $3.61 million
(11.5%) for the first nine months of 1999, when compared to the first nine
months of 1998.
Total salaries and employee benefits increased $1.87 million (10.8%) over the
first nine months of 1998. This increase in salaries is due in part to the full
year of salary and benefits expense incurred from the First Virginia Bank
acquisition on June 26, 1998. This acquisition was accounted for under the
purchase method of accounting. The period prior to June 26, 1998 was not
restated for salaries and benefits. Other increases in salaries and benefits are
attributable to continued branch integration and increases in health care and
pension expenses.
Occupancy expenses increased $873,000 (25.1%) and equipment expenses increased
$483,000 (19.2%) over the first nine months of 1998. The increase in these two
areas is directly attributable to the acquisition activity surrounding the
purchase of First Virginia Bank, Capital Bank and First Bank. Branch upgrading,
signage, computer and equipment upgrades in addition to extensive leasehold
improvements have resulted in increased depreciation, maintenance and utilities
expenses.
Other operating expenses increased $381,000 (4.8%) compared to the first nine
months of 1998.
For the third quarter of 1999, salaries and benefits increased $266,000 (4.3%),
occupancy expenses increased $215,000 (16.4%), equipment expenses increased
$66,000 (7.2%), and other operating expenses increased $132,000 (4.8%). The
increase in salaries and benefits costs is primarily related to the increased
number of full-time equivalent employees, which increased to 517 from 502 as of
September 30, 1999.
INCOME TAXES
The Company's effective tax rates for the first six months of 1999 and 1998 were
31.9% and 33.6%, respectively. The Company's income tax expense differs from the
amount computed at statutory rates primarily due to the tax-exempt 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
11
<PAGE>
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.
Selected information concerning the Company's recorded investment in impaired
loans and related interest income are summarized as follows:
<TABLE>
<CAPTION>
(dollars in thousands)
September 30, 1999 1998
- -------------------------------------------------------------------------------------- --------- ----------
<S> <C> <C>
Impaired loans with specific allocation of allowance for credit losses $4,215 $3,063
Specific allocation of allowance for credit losses 1,416 1,093
Other impaired loans 5,172 1,423
Average recorded investment in impaired loans 9,831 4,143
Interest income recognized on impaired loans based on cash payments received 145 38
</TABLE>
Additional information concerning the Company's recorded investment in
nonaccrual loans, for which impairment had not been recognized are as follows:
<TABLE>
<CAPTION>
(dollars in thousands)
September 30, 1999 1998
- -------------------------------------------------------------------------------------- ----------- -----------
<S> <C> <C>
Nonaccrual loans $5,172 $1,270
Interest income not recognized due to loans in nonaccrual status 21 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. The
allowance for credit losses was increase $2.9 million as a merger related
adjustment to align the accounting assumptions in analyzing the allowance for
credit losses. Charge-offs of $1.3 million in the commercial and agricultural
section of the allowance for credit losses reflect merger adjustments related to
First Bank.
<TABLE>
<CAPTION>
September 30, 1999 September 30, 1998 December 31, 1998
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
<S> <C> <C> <C>
Allowance for credit losses $ 9,648 $ 7,864 $8,237
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
% of total loans net of unearned income 1.10% 0.99% 1.01%
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
Nonaccrual loans $ 8,546 $ 5,158 $6,419
Past due loans 1,220 4,759 1,571
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
Nonperforming loans 9,766 9,917 7,990
Foreclosed properties 1,198 1,951 1,835
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
Nonperforming assets $10,964 $11,868 $9,825
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
Allowance for credit losses to nonperforming
loans 98.8% 79.3% 103.1%
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
Nonperforming assets to total assets .75% .87% 0.67%
- ----------------------------------------------- ------------------------ ----------------------- --------------------------------
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
ALLOWANCE FOR CREDIT LOSSES
- ---------------------------------------------------------------- ------------------------ -----------------------
Nine months ended Year ended
September 30, 1999 December 31, 1998
- ---------------------------------------------------------------- ------------------------ -----------------------
<S> <C> <C>
Average total loans outstanding during period $834,135 $775,314
- ---------------------------------------------------------------- ------------------------ -----------------------
Allowance at beginning of year $ 8,237 $ 7,611
- ---------------------------------------------------------------- ------------------------ -----------------------
Charge-offs:
</TABLE>
<TABLE>
<S> <C> <C>
Real estate - construction -- --
Real estate - mortgage 428 177
Commercial and agricultural 2,406 786
Consumer 359 947
- ---------------------------------------------------------------- ------------------------ -----------------------
Total charge-offs 3,193 1,910
- ---------------------------------------------------------------- ------------------------ -----------------------
Recoveries:
Real estate - construction -- --
Real estate - mortgage 163 50
Commercial and agricultural 150 130
Consumer 113 259
- ---------------------------------------------------------------- ------------------------ -----------------------
Total recoveries 426 439
- ---------------------------------------------------------------- ------------------------ -----------------------
Net charge-offs (recoveries) 2,767 1,471
- ---------------------------------------------------------------- ------------------------ -----------------------
Additions to allowance charged to operating expenses 4,178 2,097
================================================================ ======================== =======================
Allowance at end of period $ 9,648 $ 8,237
================================================================ ======================== =======================
Ratio of net charge-offs to average total loans .33% .19%
================================================================ ======================== =======================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
- ------------------------------------- ------------------------ -------- -------------------------- ---------
September 30, 1999 %(1) December 31, 1998 %(1)
- ------------------------------------- ------------------------ -------- -------------------------- ---------
<S> <C> <C> <C> <C>
Real estate - construction $1,279 13% $ 949 15%
Real estate - mortgage 3,411 62% 3,920 57%
Commercial and agricultural 3,139 16% 2,122 18%
Consumer 1,377 9% 396 10%
Unallocated 442 -- 850 --
- ------------------------------------- ------------------------ -------- -------------------------- ---------
Total Allowance $9,648 100% $ 8,237 100%
===================================== ======================== ======== ========================== =========
</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 September 30, 1999, the Company had loans totaling $37.21 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 September 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.
13
<PAGE>
There were no other interest-bearing assets at September 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:
<TABLE>
<CAPTION>
- --------------------------------------------- ---------------------------------------- ---------------------------------------
Nine months ended Nine months ended
September 30, 1999 September 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 $ 3,692 $ 131 4.73% $ 2,955 $ 140 6.32%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Federal funds sold 16,519 647 5.22% 32,113 1,355 5.63%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Loans held for sale 4,526 243 7.16% 2,841 112 5.26%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Investment securities:
Taxable 433,807 20,150 6.19% 308,109 14,814 6.41%
Tax exempt 10,091 648 8.56% 6,926 465 8.94%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total investment securities 443,898 20,798 6.25% 315,035 15,279 6.47%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Loans(2) 834,135 55,147 8.76% 767,065 52,648 9.15%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total interest-earning assets 1,302,770 76,966 7.84% 1,120,009 69,534 8.28%
Noninterest-earning assets 106,795 92,820
Net Effect of SFAS 115 (105) 3,826
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total assets $1,409,460 $1,216,655
============================================= =============== ============ =========== =============== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits $ 801,025 25,187 4.19% $ 737,930 24,511 4.43%
Other short-term borrowings 310,902 11,951 5.13% 234,780 9,486 5.39%
Long-term debt 40,250 2,533 8.39% 10,676 679 8.48%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total interest bearing liabilities 1,152,177 39,671 4.59% 983,386 34,676 4.70%
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Noninterest-bearing deposits 148,085 123,038
Noninterest-bearing liabilities 14,331 11,650
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total liabilities 1,314,593 1,118,074
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Shareholders' equity 94,972 94,755
Net effect of unrealized gains (losses)
on securities available for sale (105) 3,826
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total shareholders' equity 94,867 98,581
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Total liabilities and shareholders'
equity $1,409,460 $1,216,655
- --------------------------------------------- --------------- ------------ ----------- --------------- ----------- -----------
Net interest income $37,295 $34,858
============================================= =============== ============ =========== =============== =========== ===========
Net interest spread 3.27% 3.58%
============================================= =============== ============ =========== =============== =========== ===========
Net interest margin 3.80% 4.15%
============================================= =============== ============ =========== =============== =========== ===========
</TABLE>
1 Taxable equivalent adjustments of $288,000 for 1999 and $163,000 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 $2.51 million in
1999, and $1.75 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 September 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 September 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
September 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 September 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) $(1,614) $(3,333) $(4,498) $1,618 $3,100 $3,719
Net interest income - % change (3.28) (6.77) (9.14) 3.29 6.30 7.55
- ------------------------------------ ------------ ----------- ----------- ------------ ----------- -----------
</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 September 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 risk-based capital and the leverage ratios for the
Company as of September 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 September 30, 1999:
Total Capital
(to Risk-Weighted Assets):
FCNB Corp $142,843 13.26% $86,079 8.00% N/A N/A
FCNB Bank $114,865 10.87% $84,526 8.00% $105,657 10.00%
Tier I Capital
(To Risk-Weighted Assets):
FCNB Corp $124,152 11.54% $43,039 4.00% N/A N/A
FCNB Bank $105,112 9.95% $42,263 4.00% $63,394 6.00%
Tier I Capital
(To Average Assets):
FCNB Corp $124,152 8.84% $56,177 4.00% N/A N/A
FCNB Bank $105,112 7.59% $55,413 4.00% $69,266 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 that may be affected by the Year 2000
problem.
YEAR 2000 READINESS PLANNING
The Company has prepared a Year 2000 plan that includes contacting all of the
software vendors that maintain the computer programs that the Company relies
upon. As of September 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 September 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 September 30, 1999, the Company has tested all mission-critical systems
and implemented any necessary changes. The Company will continue to evaluate new
and existing systems throughout the remainder of 1999.
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
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 $835,000. As of September 30, 1999, the
Company has expended $126,000 for these costs in 1999, and $149,000 in 1998 for
the year. The Company estimated it may incur an additional $304,000 in costs in
1999. The Company estimates these costs will be made up of fees for increased
cash shipments, security guards, lost earnings on uninvested funds, and
increased cash theft insurance. 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 8-K.
Exhibits
No. 11 - Statement Regarding the Computation of Per Share Earnings
No. 27 - Financial Data Schedule
Reports on Form 8-K
On August 19, 1999, FCNB Corp (the "Company") consummated its previously
announced merger of First Frederick Financial Corp ("First"), the holding
company for First Bank of Frederick, with and into FCNB, and the merger of First
Bank of Frederick with and into FCNB's wholly-owned subsidiary, FCNB Bank, all
headquartered in Frederick, Maryland. FCNB and First executed a definitive
agreement on March 12, 1999.
As a result of the Merger, each share of the $1.00 par value outstanding common
stock of First was converted into 1.0434 shares of the Company's $1.00 par value
common stock resulting in the issuance of approximately 1,543,012 shares of FCNB
common stock, subject to adjustment to account for the elimination of fractional
shares.
The consummation of the acquisition of First, which has approximately $110
million of total assets, gives FCNB approximately $1.45 billion in total assets,
total deposits of approximately $972 million, and total shareholders' equity of
approximately $91 million.
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)
November 12, 1999 By: /s/ A. Patrick Linton
--------------------------------------------------
A. Patrick Linton,
President, Chief Executive Officer and Director
November 12, 1999 By: /s/ Mark A. Severson
--------------------------------------------------
Mark A. Severson
Senior Vice President and Treasurer
19
EXHIBIT NO. 11
Statement Regarding the Computation of Per Share Earnings
<TABLE>
<CAPTION>
September 30,
1999 1998
--------------------------------------
<S> <C> <C>
Basic earnings per common share $0.60 $0.81
Basic earnings per common share before
merger-related expenses $0.85 $0.82
Basic weighted average number of shares
outstanding 11,655,706 11,560,632
Diluted earnings per common share $0.58 $0.79
Diluted earnings per common share before
merger-related expenses $0.83 $0.80
Diluted weighted average number of shares
outstanding 11,915,845 11,844,885
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 000803644
<NAME> FCNB CORP
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
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<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
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<INT-BEARING-DEPOSITS> 4,045
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<TRADING-ASSETS> 0
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<ALLOWANCE> 9,648
<TOTAL-ASSETS> 1,463,251
<DEPOSITS> 1,003,803
<SHORT-TERM> 313,228
<LIABILITIES-OTHER> 14,551
<LONG-TERM> 40,250
0
0
<COMMON> 11,904
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<INCOME-PRETAX> 10,226
<INCOME-PRE-EXTRAORDINARY> 10,226
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,969
<EPS-BASIC> 0.60
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<YIELD-ACTUAL> 7.84
<LOANS-NON> 8,546
<LOANS-PAST> 1,220
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