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First Community Bancshares 10-K 2006 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d)
For the fiscal year ended December 31, 2005
Commission file number
000-19297
FIRST COMMUNITY BANCSHARES,
INC.
(276) 326-9000
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, $1.00 par value
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. o Yes þ No
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. o Yes þ No
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. þ Yes o No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated, an accelerated filer or a non-accelerated filer (as
defined in
Rule 12b-2
of the Exchange Act).
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). o Yes þ No
State the aggregate market value of the voting stock held by
non-affiliates of the registrant as of June 30, 2005.
$384,602,389 based on the closing sales price at that date
Indicate the number of shares outstanding of each of the
issuer’s classes of common stock, as of the latest
practicable date.
Class — Common Stock, $1.00 Par Value;
11,229,852 shares outstanding as of March 7, 2006
Portions of the Proxy Statement for the annual meeting of
shareholders to be held April 25, 2006, are incorporated by
reference in Part III of this
Form 10-K.
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First Community Bancshares, Inc. (the “Company”) is a
one-bank holding company incorporated in the State of Nevada and
serves as the holding company for First Community Bank, N. A.
(the “Bank”), a national association that conducts
commercial banking operations within the states of Virginia,
West Virginia, North Carolina and Tennessee. United First
Mortgage, Inc., acquired in the latter part of 1999, was a
wholly-owned subsidiary of the Bank and served as a wholesale
and retail distribution channel for the Bank’s mortgage
banking business segment. In August 2004, the Company sold 100%
of its interest in the mortgage banking subsidiary. Accordingly,
the Company’s financial statements have been reformatted to
segregate the assets, liabilities, operations and cash flows of
this “discontinued operating segment.” The required
information concerning discontinued operations is set forth in
Note 16 of the Consolidated Financial Statements included
herein. The Bank also owns Stone Capital Management (“Stone
Capital”), an investment advisory firm purchased in January
2003. The Company had total consolidated assets of approximately
$1.9 billion at December 31, 2005 and conducts
commercial and mortgage banking business through fifty-one
full-service banking locations, ten loan production offices, and
six trust and investment management offices.
Currently, the Company is a bank holding company, and the
banking operations are expected to remain the principal business
and major source of revenue. The Company provides a mechanism
for ownership of the subsidiary banking operations, provides
capital funds as required, and serves as a conduit for
distribution of dividends to stockholders. The Company also
considers and evaluates options for growth and expansion of the
existing subsidiary banking operations. The Company currently
derives substantially all of its revenues from dividends paid by
its subsidiary bank. Dividend payments by the Bank are
determined in relation to earnings, asset growth and capital
position and are subject to certain restrictions by regulatory
agencies as described more fully under Regulation and
Supervision of this item.
The Company and its subsidiaries employed 716 full-time
equivalent employees at December 31, 2005. Management
considers employee relations to be excellent.
The Company is a bank holding company and, as such, is subject
to regulation under the Bank Holding Company Act of 1956, as
amended (the “BHC Act”). The BHC Act requires the
prior approval of the Federal Reserve Board for a bank holding
company to acquire or hold more than a 5% voting interest in any
bank, and restricts interstate banking activities. The BHC Act
allows interstate bank acquisitions anywhere in the country and
interstate branching by acquisition and consolidation in those
states that had not opted out by January 1, 1997.
The BHC Act restricts the Company’s nonbanking activities
to those which are determined by the Federal Reserve Board to be
closely related to banking. The BHC Act does not place
territorial restrictions on the activities of nonbank
subsidiaries of bank holding companies. The Company’s
banking subsidiary is subject to limitations with respect to
transactions with affiliates.
The Federal Reserve Board has adopted capital adequacy
guidelines pursuant to which it assesses the adequacy of capital
in examining and supervising a bank holding company and in
analyzing applications to it under the BHC Act. The Federal
Reserve Board capital adequacy guidelines generally require bank
holding companies to maintain total capital equal to 8% of total
risk-adjusted assets, with at least one-half of that amount
consisting of Tier I or core capital and up to one-half of
that amount consisting of Tier II or supplementary capital.
Tier I capital for bank holding companies generally
consists of the sum of common stockholders’ equity and
perpetual preferred stock (subject in the case of the latter to
limitations on the kind and amount of such stocks which may be
included as Tier I capital), less goodwill and, with
certain exceptions, intangibles. Tier II capital generally
consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as Tier I
capital; term subordinated debt
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and intermediate-term preferred stock; and, subject to
limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account
different risk characteristics, with the categories ranging from
0% (requiring no additional capital) for assets such as cash to
100% for the bulk of assets which are typically held by a bank
holding company, including multi-family residential and
commercial real estate loans, commercial business loans and
consumer loans. Single-family residential first mortgage loans
which are not past-due (90 days or more) or non-performing
and which have been made in accordance with prudent underwriting
standards are assigned a 50% level in the risk-weighting system,
as are certain privately-issued mortgage-backed securities
representing indirect ownership of such loans. Off-balance sheet
items also are adjusted to take into account certain risk
characteristics. At December 31, 2005, the Company’s
Tier I capital and total capital ratios were 10.54% and
11.65%, respectively.
In addition to the risk-based capital requirements, the Federal
Reserve Board requires bank holding companies to maintain a
minimum leverage capital ratio of Tier I capital to total
assets of 3.0%. Total assets for this purpose does not include
goodwill and any other intangible assets and investments that
the Federal Reserve Board determines should be deducted from
Tier I capital. The Federal Reserve Board has announced
that the 3.0% Tier I leverage capital ratio requirement is
the minimum for the top-rated bank holding companies without any
supervisory, financial or operational weaknesses or deficiencies
or those which are not experiencing or anticipating significant
growth. Other bank holding companies are expected to maintain
Tier I leverage capital ratios of at least 4.0% to 5.0% or
more, depending on their overall condition. The Company’s
leverage ratio, at December 31, 2005, was 7.77%.
The enactment of the Graham-Leach-Bliley Act of 1999 (the
“GLB Act”) represented a pivotal point in the history
of the financial services industry. The GLB Act removed large
parts of a regulatory framework that had its origins in the
1930s. Since March 2000, banks, other depository institutions,
insurance companies, and securities firms have been permitted to
enter into combinations that allow a single financial services
organization to offer customers a more complete array of
financial products and services. The GLB Act provides a new
regulatory framework for financial holding companies, which have
as their primary regulator the Federal Reserve Board. Functional
regulation of a financial holding company’s separately
regulated subsidiaries is conducted by their primary functional
regulator. The GLB Act requires “satisfactory” or
higher Community Reinvestment Act compliance for insured
depository institutions and their financial holding companies in
order for them to engage in new financial activities. The GLB
Act also provides a federal right to privacy of non-public
personal information of individual customers. The Company and
its subsidiaries are also subject to certain state laws that
deal with the use and distribution of non-public personal
information.
The Bank is subject to the provisions of the National Bank Act,
is under the supervision of and is subject to periodic
examination by the Comptroller of the Currency (the
“OCC”), and is subject to the rules and regulations of
the OCC, Board of Governors of the Federal Reserve System, and
the Federal Deposit Insurance Corporation (“FDIC”).
The Bank is also subject to certain laws of each state in which
such bank is located. Such state laws may restrict branching of
banks within the state and acquisition or merger involving banks
located in other states. Virginia, West Virginia, North
Carolina, and Tennessee have all adopted nationwide reciprocal
interstate banking.
The Federal Deposit Insurance Corporation Act, as amended
(“FDICIA”), among other things, requires the federal
banking agencies to take “prompt corrective action” in
respect of depository institutions that do not meet minimum
capital requirements. FDICIA establishes five capital tiers:
“well capitalized,” “adequately
capitalized,” “undercapitalized,”
“significantly undercapitalized” and “critically
undercapitalized.” An FDIC-insured bank will be “well
capitalized” if it has a total capital ratio of 10% or
greater, a Tier 1 capital ratio of 6% or greater and a
leverage ratio of 5% or greater and is not subject to any order
or written directive by any such regulatory authority to meet
and maintain a specific capital level for any capital measure. A
depository institution’s capital tier will depend upon
where its capital levels compare to various relevant capital
measures and certain other factors, as established by
regulation. As of December 31, 2005, the Bank had capital
levels that qualify it as being “well capitalized”
under such regulations.
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The Bank is subject to capital requirements adopted by the OCC
similar to the capital requirements for the Company. The capital
ratios of the Bank are set forth in Note 13 to the
Consolidated Financial Statements included herewith.
The monetary policies of regulatory authorities, including the
Federal Reserve Board and the FDIC, have a significant effect on
the operating results of banks and holding companies. The nature
of future monetary policies and the effect of such policies on
the future business and earnings of the Company cannot be
predicted.
The USA Patriot Act of 2001 (the “Patriot Act”)
contains anti-money laundering measures affecting insured
depository institutions, broker-dealers and certain other
financial institutions. The Patriot Act requires such financial
institutions to implement policies and procedures to combat
money laundering and the financing of terrorism and grants the
Secretary of the Treasury broad authority to establish
regulations and to impose requirements and restrictions on
financial institutions’ operations. In addition, the
Patriot Act requires the federal bank regulatory agencies to
consider the effectiveness of a financial institution’s
anti-money laundering activities when reviewing bank mergers and
bank holding company acquisitions. Compliance with the Patriot
Act by the Company has not had a material impact on the
Company’s results of operations or financial condition.
The Sarbanes-Oxley Act of 2002 comprehensively revised the laws
affecting corporate governance, accounting obligations and
corporate reporting for companies with equity or debt securities
registered under the Securities Exchange Act of 1934, as
amended. In particular, the Sarbanes-Oxley Act established:
(i) new requirements for audit committees, including
independence, expertise, and responsibilities;
(ii) additional responsibilities regarding financial
statements for the Chief Executive Officer and Chief Financial
Officer of the reporting company; (iii) new standards for
auditors and regulation of audits; (iv) increased
disclosure and reporting obligations for reporting companies and
their directors and executive officers; and (v) new and
increased civil and criminal penalties for violation of the
securities laws.
In response to the Sarbanes-Oxley legislation, the Board of
Directors of the Company approved a series of actions to
strengthen and improve its already strong corporate governance
practices. Included in those actions was the adoption of a new
Code of Ethics, Corporate Governance Guidelines and new charters
for its Audit, Compensation, and Nominating Committees.
The Company makes available free of charge on its website at
www.fcbinc.com its Annual Report on
Form 10-K,
Quarterly Reports on
Form 10-Q
and Current Reports on
Form 8-K,
and all amendments thereto, as soon as reasonably practicable
after the Company files such reports with, or furnishes them to,
the Securities and Exchange Commission. Investors are encouraged
to access these reports and the other information about the
Company’s business on its website. Information found on the
Company’s website is not part of this Annual Report on
Form 10-K.
The Company will also provide copies of its Annual Report on
Form 10-K,
free of charge, upon written request of its Investor Relations
department at the Company’s main address, P.O.
Box 989, Bluefield, VA 24605.
Forward-Looking
Statements
This Annual Report on
Form 10-K
may include “forward-looking statements”, which are
made in good faith by the Company pursuant to the “safe
harbor” provisions of the Private Securities Litigation
Reform Act of 1995. These forward-looking statements include,
among others, statements with respect to the Company’s
beliefs, plans, objectives, goals, guidelines, expectations,
anticipations, estimates and intentions that are subject to
significant risks and uncertainties and are subject to change
based on various factors, many of which are beyond the
Company’s control. The words “may”,
“could”, “should”, “would”,
“believe”, “anticipate”,
“estimate”, “expect”, “intend”,
“plan” and similar expressions are intended to
identify forward-looking statements. The following factors,
among others, could cause the Company’s financial
performance to differ materially from that expressed in such
forward-looking statements: the strength of the United States
economy in general and the strength of the local economies in
which the Company conducts operations; the effects of, and
changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of
the Federal Reserve System; inflation, interest rate, market and
monetary fluctuations; the timely development of competitive new
products and services of the
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Company and the acceptance of these products and services by new
and existing customers; the willingness of customers to
substitute competitors’ products and services for the
Company’s products and services and vice versa; the impact
of changes in financial services’ laws and regulations
(including laws concerning taxes, banking, securities and
insurance); technological changes; the effect of acquisitions,
including, without limitation, the failure to achieve the
expected revenue growth
and/or
expense savings from such acquisitions; the growth and
profitability of the Company’s non-interest or fee income
being less than expected; unanticipated regulatory or judicial
proceedings; changes in consumer spending and saving habits; and
the success of the Company at managing the risks involved in the
foregoing.
The Company cautions that the foregoing list of important
factors is not exclusive. The Company does not undertake to
update any forward-looking statement.
We are unable to predict actual fluctuations of market interest
rates with complete accuracy. Rate fluctuations are affected by
many factors, including inflation, recession, a rise in
unemployment, a tightening of the money supply and domestic and
international disorder and instability in domestic and foreign
financial markets.
Changes in the interest rate environment may reduce profits. We
expect that the Company and the Bank will continue to realize
income from the differential or “spread” between the
interest earned on loans, securities and other interest-earning
assets, and interest paid on deposits, borrowings and other
interest-bearing liabilities. Net interest spreads are affected
by the difference between the maturities and repricing
characteristics of interest-earning assets and interest-bearing
liabilities. Changes in levels of market interest rates could
materially and adversely affect the Company’s net interest
spread, levels of prepayments and cash flows, the market value
of its securities portfolio, and overall profitability.
The Company is a separate legal entity from the Bank and its
subsidiaries and does not have significant operations of its
own. The Company currently depends on the Bank’s cash and
liquidity as well as dividends to pay the Company’s
operating expenses and dividends to shareholders. No assurance
can be made that in the future the Bank will have the capacity
to pay the necessary dividends and that the Company will not
require dividends from the Bank to satisfy the Company’s
obligations. The availability of dividends from the Bank is
limited by various statutes and regulations. It is possible,
depending upon the financial condition of the Company and other
factors that the OCC, the Bank’s primary regulator, could
assert that payment of dividends or other payments by the Bank
are an unsafe or unsound practice. In the event the Bank is
unable to pay dividends sufficient to satisfy the Company’s
obligations and the Bank is unable to pay dividends to the
Company, the Company may not be able to service its obligations
as they become due, including payments required to be made to
the FCBI Capital Trust, a business trust subsidiary of the
Company, or pay dividends on the Company’s common stock.
Consequently, the inability to receive dividends from the Bank
could adversely affect the Company’s financial condition,
results of operations, cash flows and prospects.
Like all financial institutions, the Bank maintains an allowance
for loan losses to provide for probable loan defaults and
non-performance. The Bank’s allowance for loan losses may
not be adequate to cover actual loan losses, and future
provisions for loan losses could materially and adversely affect
the Bank’s operating results. The Bank’s allowance for
loan losses is determined by analyzing historical loan losses,
current trends in delinquencies and charge-offs, plans for
problem loan resolution, the opinions of our regulators, changes
in the size and composition of the loan portfolio and industry
information. Also included in management’s estimates for
loan losses are considerations with respect to the impact of
economic events, the outcome of which are uncertain. The
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amount of future losses is susceptible to changes in economic,
operating and other conditions, including changes in interest
rates that may be beyond the Bank’s control, and these
losses may exceed current estimates. Federal regulatory
agencies, as an integral part of their examination process,
review the Bank’s loans and allowance for loan losses.
While we believe that the Bank’s allowance for loan losses
is adequate to provide for probable losses, we cannot assure you
that we will not need to increase the Bank’s allowance for
loan losses or that regulators will not require us to increase
this allowance. Either of these occurrences could materially and
adversely affect the Bank’s earnings and profitability.
Changes in economic conditions, particularly an economic
slowdown, could hurt the Company’s business. The
Company’s business is directly affected by political and
market conditions, broad trends in industry and finance,
legislative and regulatory changes, and changes in governmental
monetary and fiscal policies and inflation, all of which are
beyond the Company’s control. A deterioration in economic
conditions, in particular an economic slowdown within the
Company’s geographic region, could result in the following
consequences, any of which could hurt the Company’s
business materially:
The Company’s business activities and credit exposure are
concentrated in Virginia, West Virginia, North Carolina,
Tennessee and the surrounding southeast region. A downturn in
this regional real estate market could hurt the Company’s
business because of the geographic concentration within this
regional area. If there is a significant decline in real estate
values, the collateral for the Company’s loans will provide
less security. As a result, the Company’s ability to
recover on defaulted loans by selling the underlying real estate
would be diminished, and we would be more likely to suffer
losses on defaulted loans.
Commercial business and commercial real estate loans generally
are considered riskier than single-family residential loans
because they have larger balances to a single borrower or group
of related borrowers. Commercial business and commercial real
estate loans involve risks because the borrower’s ability
to repay the loan typically depends primarily on the successful
operation of the business or the property securing the loan.
Most of the commercial business loans are made to small business
or middle market customers who may have a heightened
vulnerability to economic conditions. Moreover, a portion of
these loans have been made or acquired by the Company in the
last several years and the borrowers may not have experienced a
complete business or economic cycle.
The Bank seeks to mitigate the risks inherent in the Bank’s
loan portfolio by adhering to specific underwriting practices.
These practices include analysis of a borrower’s prior
credit history, financial statements, tax returns and cash flow
projections, valuation of collateral based on reports of
independent appraisers and verification of liquid assets.
Although the Bank believes that its underwriting criteria are
appropriate for the various kinds of loans it makes, the Bank
may incur losses on loans that meet its underwriting criteria,
and these losses may exceed the amounts set aside as reserves in
the Bank’s allowance for loan losses.
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The Company and its subsidiaries’ operations are subject to
extensive regulation by federal, state and local governmental
authorities and are subject to various laws and judicial and
administrative decisions imposing requirements and restrictions
on part or all of the Company’s operations. The Company
believes that it is in substantial compliance in all material
respects with applicable federal, state and local laws, rules
and regulations. Because the Company’s business is highly
regulated, the laws, rules and regulations applicable to it are
subject to regular modification and change. There are various
laws, rules and regulations that impact the Company’s
operations, including, among other things, matters pertaining to
corporate governance, requirements for listing and maintenance
on national securities exchanges and over the counter markets,
Securities and Exchange Commission (“SEC”) rules
pertaining to public reporting disclosures and banking
regulations governing the amount of loans that a financial
institution, such as the Bank, can acquire for investment from
an affiliate. In addition, the Financial Accounting Standards
Board (“FASB”), made changes which require, among
other things, the expensing of the costs relating to the
issuance of stock options. These laws, rules and regulations, or
any other laws, rules or regulations, that may be adopted in the
future, could make compliance more difficult or expensive,
restrict the Company’s ability to originate, broker or sell
loans, further limit or restrict the amount of commissions,
interest or other charges earned on loans originated or sold by
the Bank and otherwise adversely affect the Company’s
business, financial condition or prospects.
The Company’s business operations are centered primarily in
Virginia, West Virginia, North Carolina, Tennessee and the
surrounding southeast region. Increased competition within this
region may result in reduced loan originations and deposits.
Ultimately, we may not be able to compete successfully against
current and future competitors. Many competitors offer the types
of loans and banking services that we offer. These competitors
include other savings associations, national banks, regional
banks and other community banks. The Company also faces
competition from many other types of financial institutions,
including finance companies, brokerage firms, insurance
companies, credit unions, mortgage banks and other financial
intermediaries. In particular, the Bank’s competitors
include other state and national banks and major financial
companies whose greater resources may afford them a marketplace
advantage by enabling them to maintain numerous banking
locations and mount extensive promotional and advertising
campaigns.
Additionally, banks and other financial institutions with larger
capitalization and financial intermediaries not subject to bank
regulatory restrictions have larger lending limits and are
thereby able to serve the credit needs of larger clients. These
institutions, particularly to the extent they are more
diversified than the Company, may be able to offer the same loan
products and services that the Company offers at more
competitive rates and prices. If the Company is unable to
attract and retain banking clients, the Company may be unable to
continue the Bank’s loan and deposit growth and the
Company’s business, financial condition and prospects may
be negatively affected.
The Company has no unresolved staff comments as of the filing
date of this 2005 Annual Report on
Form 10-K.
The Company generally owns its offices, related facilities, and
unimproved real property. The principal offices of the Company
are located at One Community Place, Bluefield, Virginia, where
the Company owns and occupies approximately 36,000 square
feet of office space. The Bank operates fifty-one full-service
branches and ten loan production offices throughout the
four-state region of Virginia, West Virginia, North Carolina and
Tennessee. The Bank also provides wealth management services
through two trust and investment management offices, as well as
Stone Capital, an investment advisory firm, which has four
offices. The Company’s banking subsidiary owns 42 of its
banking offices while others are leased or are located on leased
land. There are no mortgages or liens against any property of
the Bank or the Company. The Bank operates 50 Automated Teller
Machines (“ATM’s”).
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In Virginia, the Bank operates offices in Blacksburg, Bluefield,
Clintwood, Drakes Branch, Emporia, Max Meadows, Norfolk, Pound,
Richlands, Richmond, Tazewell, and Wytheville. In West Virginia,
the Bank operates offices in Athens, Beckley, Bluefield,
Bridgeport, Buckhannon, Cowen, Craigsville, Grafton, Hinton,
Linside, Man, Mullens, Oceana, Pineville, Princeton, Richwood,
Rowlesburg, Summersville, and Teays Valley. In North Carolina,
the Bank operates offices in Charlotte, Elkin, Hays, Mount Airy,
Sparta, Taylorsville, and Winston-Salem. In Tennessee, the Bank
operates offices in Fall Branch, Johnson City, Kingsport, and
Piney Flats. A complete listing of all branches and ATM sites
can be found on the Internet at www.fcbresource.com.
Information on such website is not part of this Annual Report on
Form 10-K.
The Company is currently a defendant in various legal actions
and asserted claims involving lending and collection activities
and other matters in the normal course of business. While the
Company and legal counsel are unable to assess the ultimate
outcome of each of these matters with certainty, they are of the
belief that the resolution of these actions should not have a
material adverse affect on the financial position of the Company.
No matters were submitted to a vote of security holders during
the fourth quarter of 2005.
The number of common stockholders of record on December 31,
2005 was 3,613 and outstanding shares totaled 11,251,803. The
number of common stockholders is measured by the number of
recordholders.
The Company’s common stock trades on the NASDAQ National
Market under the symbol FCBC. On December 31, 2005, the
Company’s year-end common stock price was $31.16, a 13.60%
decrease from the $36.08 closing price on December 31, 2004.
Book value per common share was $17.29 at December 31,
2005, compared with $16.29 at December 31, 2004, and $15.57
at the close of 2003. The year-end market price for the
Company’s common stock of $31.16 represents 180.2% of the
Company’s book value as of the close of the year and
reflects total market capitalization of $350.6 million.
Utilizing the year-end market price and 2005 diluted earnings
per share, First Community common stock closed the year trading
at a price/earnings multiple of 13.4 times diluted earnings per
share.
Cash dividends for 2005 totaled $1.02 per share, up $0.02
or 2.0% from the $1.00 paid in 2004. The 2005 dividends resulted
in a cash yield on the year-end market value of 3.27%. Total
dividends paid for the current and prior year totaled
$11.5 million and $11.2 million, respectively.
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The following table sets forth the high and low stock prices,
book value per share, and dividends paid per share on the
Company’s common stock during the periods indicated.
The Company’s stock repurchase plan, as amended, allows the
purchase and retention of up to 550,000 shares. The plan
has no expiration date, remains open and no plans have expired
during the reporting period. No determination has been made to
terminate the plan or to stop making purchases. The following
table sets forth open market purchases by the Company of its
equity securities during 2005. The repurchase of Company stock
has the effect of increasing earnings per share. During 2005,
the weighted-average increase in the number treasury shares had
an insignificant impact on earnings per share.
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This discussion should be read in conjunction with the
consolidated financial statements, notes and tables included
throughout this report. All statements other than statements of
historical fact included in this report, including statements in
this Management’s Discussion and Analysis of Financial
Condition and Results of Operations are, or may be deemed to be,
forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and
Section 21E of the Exchange Act. As discussed below, the
financial statements, footnotes, schedules and discussion within
this report have been reformatted to conform to the presentation
required for “discontinued operations” pursuant to the
Company’s sale of its mortgage banking subsidiary.
First Community Bancshares, Inc. is a bank holding company which
provides commercial banking services and has positioned itself
as a regional community bank and a financial services
alternative to larger banks which often provide less emphasis on
personal relationships, and smaller community banks which lack
the capital and resources to efficiently serve customer needs.
The Company has focused its growth efforts on building financial
partnerships and more enduring and complete relationships with
businesses and individuals through a very personal approach to
banking and financial services. The Company and its operations
are guided by a strategic plan which includes growth through
acquisitions and through office expansion in new market areas
including strategically identified metro markets in Virginia,
West Virginia, North Carolina and Tennessee. While the
Company’s mission remains that of a community bank,
management believes that entry into new markets will accelerate
the Company’s growth rate by diversifying the demographics
of its customer base and customer prospects and by generally
increasing its sales and service network.
Despite strong competition, the Company has succeeded in
establishing new offices in seven new market areas including
four new loan production offices in the last year and three new
full service offices since the second quarter of 2003. The
Company has also completed two bank acquisitions and one wealth
management acquisition since January 2003 and has grown total
assets by 17% over the last two years and 32% over the last four
years. The Company continues its pursuit of community banking
partners and is progressing with plans for new offices within
its established target markets. Additional details regarding
recent acquisitions and expansion are included under the heading
Recent Acquisitions and Branching Activity.
12
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Throughout 2005, short-term market interest rates increased
significantly, while long-term market rates remained largely
unchanged. Those changes have resulted in a flat interest rate
curve, an environment that has led to compression of net
interest margins.
The local economies in which the Company operates are diverse
and cover the majority portion of a four state region. West
Virginia and Southwest Virginia continue to benefit from
increasing crude oil prices. These economies have significant
exposure to extractive industries, such as coal and natural gas,
which become more active and lucrative when oil prices rise. The
local economies in the central portion of North Carolina have
suffered in recent years due to foreign competition in both
furniture and textiles as well as consolidation in the financial
services industry. Despite these detractions, the economies in
this region continue to benefit from strong real estate
development, good commercial occupancy rates and national
companies relocating and expanding in the Triad and Central
Piedmont areas. The Eastern Virginia local economies are
experiencing strong growth in residential and commercial
development as those areas continue to benefit from a wide array
of corporate activities and relocations.
As the Company competes for increased market share and growth in
both loans and deposits it continues to encounter strong
competition from many sources. Bank expansion through de novo
branches and Loan Production Offices has grown in popularity as
a means of reaching out to new markets. Many of the markets
targeted by the Company are also being entered by other banks in
nearby markets and, in some cases, from more distant markets.
Despite strong competition from other banks, credit unions and
mortgage companies, the Company has seen success in newly
established offices in Winston-Salem as well as other markets in
both Virginia and North Carolina. The Company attributes this
measure of success to its recruitment of local, established
bankers and loan personnel in those targeted markets.
Competitive forces do impact the Company through pressure on
interest yields, product fees and loan structure and terms;
however, the Company has countered these pressures with its
relationship style and pricing and a disciplined approach to
loan underwriting.
The Company’s consolidated financial statements are
prepared in accordance with U.S. generally accepted
accounting principles (“GAAP”) and conform to general
practices within the banking industry. The Company’s
financial position and results of operations are affected by
management’s application of accounting policies, including
judgments made to arrive at the carrying value of assets and
liabilities and amounts reported for revenues, expenses and
related disclosures. Different assumptions in the application of
these policies could result in material changes in the
Company’s consolidated financial position and consolidated
results of operations.
Estimates, assumptions, and judgments are necessary principally
when assets and liabilities are required to be recorded at
estimated fair value, when a decline in the value of an asset
carried on the financial statements at fair value warrants an
impairment write-down or valuation reserve to be established, or
when an asset or liability needs to be recorded based upon the
probability of occurrence of a future event. Carrying assets and
liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and
liabilities are based either on quoted market prices or are
provided by third party sources, when available. When third
party information is not available, valuation adjustments are
estimated by management primarily through the use of internal
modeling techniques and appraisal estimates.
The Company’s accounting policies are fundamental to
understanding Management’s Discussion and Analysis of
Financial Condition and Results of Operation. The following is a
summary of the Company’s more subjective and complex
“critical accounting policies.” In addition, the
disclosures presented in the Notes to the Consolidated Financial
Statements and in Management’s Discussion and Analysis
provide information on how significant assets and liabilities
are valued in the financial statements and how those values are
determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods,
assumptions, and estimates underlying those amounts, management
has identified i.) the determination of the allowance for loan
losses, ii.) accounting for acquisitions and intangible
assets, and iii.) accounting for income taxes as the accounting
areas
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that require the most subjective or complex judgments.
Derivatives hedging practices were previously included, but were
eliminated in August 2004 in connection with the disposition of
the Company’s mortgage banking subsidiary.
The allowance for loan losses is established and maintained at
levels management deems adequate to cover losses inherent in the
portfolio and is based on management’s evaluation of the
risks in the loan portfolio and changes in the nature and volume
of loan activity. In June 2005, the Company reclassified $392
thousand of its allowance for loan losses to a separate
allowance for lending-related commitments, which is included in
other liabilities. Estimates for loan losses are determined by
analyzing historical loan losses, current trends in
delinquencies and charge-offs, plans for problem loan
resolution, the opinions of the Company’s regulators,
changes in the size and composition of the loan portfolio and
industry information. Also included in management’s
estimates for loan losses are considerations with respect to the
impact of economic events, the outcome of which are uncertain.
These events may include, but are not limited to, a general
slowdown in the economy, fluctuations in overall lending rates,
political conditions, legislation that may directly or
indirectly affect the banking industry, and economic conditions
affecting specific geographic areas in which the Company
conducts business.
The Company determines the allowance for loan losses by making
specific allocations to impaired loans and loan pools that
exhibit inherent weaknesses and various credit risk factors.
Allocations to loan pools are developed giving weight to risk
ratings, historical loss trends and management’s judgment
concerning those trends and other relevant factors. These
factors may include, among others, actual versus estimated
losses, regional and national economic conditions, business
segment and portfolio concentrations, industry competition and
consolidation, and the impact of government regulations. The
foregoing analysis is performed by management to evaluate the
portfolio and calculate an estimated valuation allowance through
a quantitative and qualitative analysis that applies risk
factors to those identified risk areas.
This risk management evaluation is applied at both the portfolio
level and the individual loan level for commercial loans and
credit relationships while the level of consumer and residential
mortgage loan allowance is determined primarily on a total
portfolio level based on a review of historical loss percentages
and other qualitative factors including concentrations, industry
specific factors and economic conditions. The commercial
portfolio requires more specific analysis of individually
significant loans and the borrower’s underlying cash flow,
business conditions, capacity for debt repayment and the
valuation of secondary sources of payment, such as collateral.
This analysis may result in specifically identified weaknesses
and corresponding specific impairment allowances.
The use of various estimates and judgments in the Company’s
ongoing evaluation of the required level of allowance can
significantly impact the Company’s results of operations
and financial condition and may result in either greater
provisions against earnings to increase the allowance or reduced
provisions based upon management’s current view of
portfolio and economic conditions and the application of revised
estimates and assumptions.
The Company may, from time to time, engage in business
combinations with other companies. The acquisition of a business
is generally accounted for under purchase accounting rules
promulgated by the FASB. Purchase accounting requires the
recording of underlying assets and liabilities of the entity
acquired at their fair market value. Any excess of the purchase
price of the business over the net assets acquired and any
identified intangibles is recorded as goodwill. Fair values are
assigned based on quoted prices for similar assets, if readily
available, or appraisal by qualified independent parties for
relevant asset and liability categories. Financial assets and
liabilities are typically valued using discount models which
apply current discount rates to streams of cash flow. All of
these valuation methods require the use of assumptions which can
result in alternate valuations and varying levels of goodwill
and, in some cases, amortization expense or accretion income.
Management must also make estimates of useful or economic lives
of certain acquired assets and liabilities. These lives are used
in establishing amortization and accretion of some intangible
assets and liabilities, such as the intangible associated with
core deposits acquired in the acquisition of a commercial bank.
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Goodwill is recorded as the excess of the purchase price, if
any, over the fair value of the revalued net assets. Goodwill is
tested at least annually in the month of November for possible
impairment. This testing again uses a discounted cash flow model
applied to the anticipated stream of cash flows from operations
of the business or segment being tested. Impairment testing
necessarily uses estimates in the form of growth and attrition
rates, anticipated rates of return, and discount rates. These
estimates have a direct bearing on the results of the impairment
testing and serve as the basis for management’s conclusions
as to impairment.
The establishment of provisions for federal and state income
taxes is a complex area of accounting which also involves the
use of judgments and estimates in applying relevant tax
statutes. The Company operates in multiple state tax
jurisdictions and this requires the appropriate allocation of
income and expense to each state based on a variety of
apportionment or allocation bases. Management strives to keep
abreast of changes in tax law and the issuance of regulations
which may impact tax reporting and provisions for income tax
expense. The Company is also subject to audit by federal and
state tax authorities. Results of these audits may produce
indicated liabilities which differ from Company estimates and
provisions. The Company continually evaluates its exposure to
possible tax assessments arising from audits and records its
estimate of possible exposure based on current facts and
circumstances. The Company recently completed a state tax audit.
The results of that audit are discussed under the heading
“Results of Operations — Income Tax
Expense.”
On December 2, 2005, the Company completed the sale of its
Clifton Forge, Virginia, branch location to Sonabank, N. A. The
sale included deposits and repurchase agreements totaling
approximately $45 million and loans of approximately
$7 million. The transaction resulted in an approximate
$4.4 million pre-tax gain on sale.
The Company has plans to open five de novo branches, convert
three loan production offices to full service locations, and
open two new loan production offices in 2006 and 2007. Most of
these locations will be in the Richmond, Virginia and
Winston-Salem, North Carolina metropolitan areas.
The following schedule details branch and loan production office
openings since January 1, 2004.
After the close of business on March 31, 2004, PCB Bancorp,
Inc., a Tennessee-chartered bank holding company
(“PCB”) headquartered in Johnson City, Tennessee, was
acquired by the Company. PCB had five full service branch
offices located in Johnson City, Kingsport and surrounding areas
in Washington and Sullivan Counties in East Tennessee. At
acquisition, PCB had total assets of $171.0 million, total
net loans of $128.0 million and total deposits of
$150.0 million. These resources were included in the
Company’s financial statements beginning with the second
quarter of 2004.
Under the terms of the merger agreement, shares of PCB common
stock were purchased for $40.00 per share in cash. The
total deal value, including the cash-out of outstanding stock
options, was approximately $36.0 million. Concurrent with
the PCB acquisition, Peoples Community Bank, the wholly-owned
subsidiary of PCB, was merged into the Bank. As a result of the
acquisition and preliminary purchase price allocation,
approximately $21.3 million
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in goodwill was recorded which represents the excess of the
purchase price over the fair market value of the net assets
acquired and identified intangibles.
Net income for 2005 was $26.3 million, up $3.9 million
from $22.4 million in 2004. Basic and diluted earnings per
share for 2005 were $2.33 and $2.32, respectively, compared to
basic and diluted earnings per share of $1.99 and $1.97,
respectively, in 2004.
The Company’s key profitability ratios are return on
average assets (net income as a percentage of average assets)
and return on average equity (net income as a percentage of
average common shareholder’s equity). Returns on average
assets for the last two years were 1.37% and 1.24%. The returns
on average equity for the last two years were 13.79% and 12.53%.
The Company continues to compare favorably to national peer
returns of 1.16% and 13.51%, respectively, based on the
September 2005 Bank Holding Company Performance Report.
The primary source of the Company’s earnings is net
interest income, the difference between income on earning assets
and the cost of funds supporting those assets. Significant
categories of earning assets are loans and securities while
deposits and borrowings represent the major portion of
interest-bearing liabilities. For purposes of the following
discussion, comparison of net interest income is done on a tax
equivalent basis, which provides a common basis for comparing
yields on earning assets exempt from federal income taxes to
those which are fully taxable (see the table titled Average
Balance Sheets and Net Interest Income Analysis).
Net interest income was $73.6 million for 2005, compared to
$69.2 million for 2004. Tax-equivalent net interest income
totaled $77.7 million for 2005, an increase of
$4.8 million from the $72.9 million reported for 2004.
The increase reflects a $6.3 million increase due to
increased volume, which was partially offset by a
$1.5 million decrease due to rate changes on the underlying
assets and liabilities.
During 2005, average earning assets increased
$118.3 million while average interest-bearing liabilities
increased $100.5 million over the comparable period. The
yield on average earning assets increased 37 basis points
to 6.42% from 6.05% for 2004. The rate earned on assets was
positively impacted by the continued increases in short-term
market interest rates throughout 2005.
Total cost of average interest-bearing liabilities increased
47 basis points during 2005, as such liabilities were also
affected by increases in short-term market interest rates. The
net result was a decrease of 10 basis points to net
interest rate spread, or the difference between interest income
on earning assets and expense on interest-bearing liabilities.
2005 spread was 4.01% compared to 4.11% for the same period last
year. The Company’s tax-equivalent net interest margin of
4.39% for 2005 was essentially unchanged with a small decrease
of 2 basis points from 4.41% in 2004.
The largest contributor to the increase in the yield on average
earning assets in 2005, on a volume-weighted basis, was the
$142.9 million increase in loans held for investment. The
loan portfolio contributed approximately $13.1 million to
the change in interest income, while the portfolio’s
average yield increased 28 basis points from the prior year
to 6.91%. The yield on variable-rate loans tied to prime and
other indices increased in response to the recent increases in
short-term interest rates.
During 2005, the tax-equivalent yield on securities available
for sale increased 36 basis points to 4.98% while the
average balance decreased by $17.0 million. Although the
total portfolio decreased through the period, the average
tax-equivalent yield increased due to the addition of
higher-rate securities and the sale of lower-rate securities.
Funds received from the paydowns, maturities, calls, and sales
of investment securities helped fund loan growth.
Average interest-bearing balances with banks remained steady
during 2005, while the yield increased 154 basis points to
3.36%. The yield on those balances is directly correlated to the
increases in the target federal funds rate which occurred
throughout the year.
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The Company attempts to control the cost of deposited funds in
relation to the prevailing economic climate and competitive
forces. The Company achieves its balance sheet management goals
through its Asset/Liability Management Committee. Throughout
2005, the pressures of increasing short-term interest rates
resulted in an increase of 40 basis points in the average
cost of interest-bearing deposits. The average rate paid on
interest-bearing demand deposits remained consistent, while the
average rate paid on savings, which includes money market and
passbook accounts, increased 32 basis points. The Company
was successful in keeping rates paid on interest-bearing
checking accounts relatively stable and increased money market
account rates to remain competitive. Average time deposits
increased $46.2 million while the average rate paid
increased 48 basis points to 2.92%. During the first
quarter, the Company ran a successful certificate of deposit
campaign, which generated market-rate deposits centered mostly
in the Richmond and Winston-Salem markets. The level of average
non-interest-bearing demand deposits increased
$16.0 million to $228.8 million compared to the prior
year.
Average federal funds purchased and repurchase agreements
increased $19.3 million due mostly to increases in the
balances of customer repurchase agreements. The average rate
paid on those funds also increased, as they are closely tied to
the target federal funds rate. Average Federal Home
Loan Bank (“FHLB”) advances increased
$29.5 million as the Company borrowed $75 million
through the year. Interest paid on those borrowings increased
19 basis points as interest rates were increasing on
adjustable-rate borrowings. Other borrowings remained steady,
but the rate paid increased 198 points because the majority of
such borrowings consist of the Company’s trust preferred
borrowings, which are tied to LIBOR.
Average
Balance Sheets and Net Interest Income Analysis
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The following table recaps the adjustments incorporated when
converting net interest earnings to a tax-equivalent basis:
Rate and
Volume Analysis of Interest
The following table summarizes the changes in interest earned
and paid resulting from changes in volume of earning assets and
paying liabilities and changes in their interest rates. In this
analysis, the change in interest due to both rate and volume has
been allocated to the volume and rate columns in proportion to
absolute dollar amounts. This table will assist you in
understanding the changes in the Company’s principal source
of revenue, net interest income. The principal themes or trends
which are evident in this table include:
18
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The provision for loan losses for the year ended
December 31, 2005 was $3.7 million, an increase of
$1.0 million when compared to the year ended
December 31, 2004. The increase in loan loss provision
between the periods is primarily attributable to new or
increased specific allocations, increased commercial and
residential real estate loan volume, and changes in various
qualitative risk factors. Net charge-offs for 2005 and 2004 were
$4.9 million and $2.7 million, respectively. Expressed
as a percentage of average loans, net charge-offs increased from
0.24% for 2004, to 0.38% for 2005. The Company experienced a
loss from a previously disclosed credit to a hospitality
concern, which accounted for a large portion of the increase in
net charge-offs in 2005. During 2005, the $4.4 million loan
was charged down to its net realizable value of
$2.2 million. The note was sold to a third party and the
final net loss to the Company was $1.5 million.
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Details of non-interest income are summarized in the following
table:
Non-interest income consists of all revenues which are not
included in interest and fee income related to earning assets.
Non-interest income from continuing operations for 2005 was
$22.3 million compared to $17.3 million in the same
period of 2004. Wealth management income, which includes fees
for trust services and commission and fee income generated by
Stone Capital, increased $467 thousand in 2005, or 18.8%,
compared to 2004 as a result of the Company’s continued
focus on growth. Stone Capital has expanded its retail asset
management services through the addition of two investment
advisors and the licensing of a number of investment associates
within the bank branches.
Service charges on deposit accounts increased $973 thousand, or
10.7%, while other service charges, commissions and fees
reflected gains of $546 thousand, or 24.4%. Other service
charges, commissions and fees increased largely because of ATM
usage fees on foreign cards of $1.4 million and official
check commissions of $256 thousand.
Other operating income includes $4.4 million in gain from
the sale of the Clifton Forge, Virginia, branch location. The
remaining components of other operating income decreased $525
thousand compared to 2004. 2005 included securities gains of
$753 thousand, which were $851 thousand less than those
recognized in 2004.
Total non-interest expense from continuing operations was
$55.6 million, an increase of $7.6 million for 2005
over 2004. The single largest item contributing to the increase
was the $3.8 million prepayment penalty incurred in
connection with the early termination of $77.0 million of
FHLB advances in late December. Salaries and benefits increased
approximately $2.8 million due to increases in staffing to
support added corporate services, continued branch and loan
production office growth, and increased health benefits costs.
Occupancy and furniture and equipment expenses increased $344
thousand and $447 thousand, respectively, compared to 2004. The
general level of occupancy and furniture and equipment costs in
2005 grew largely as a result of increases in depreciation and
insurance costs associated with de novo branches and
depreciation associated with continued investment in operating
equipment and technology infrastructure.
All other operating expense accounts increased $100 thousand in
2005 compared to 2004. The most significant item within the
increase in other operating expense was the increase in audit
fees, which increased over $335 thousand
year-over-year.
The Company uses a traditional efficiency ratio that is a
non-GAAP financial measure of operating expense control and
efficiency of operations. Management believes this traditional
ratio better focuses attention on the core operating performance
of the Company over time than does a GAAP-based ratio, and is
highly useful in comparing
period-to-period
operating performance of the Company’s core business
operations. It is used by management as part of its assessment
of its performance in managing non-interest expenses. However,
this measure is supplemental and is not a substitute for an
analysis of performance based on GAAP measures. The reader is
cautioned that the traditional efficiency ratio used by the
Company may not be comparable to GAAP or non-GAAP efficiency
ratios reported by other financial institutions.
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In general, the efficiency ratio is non-interest expenses as a
percentage of net interest income plus non-interest income.
Non-interest expenses used in the calculation of the
traditional, non-GAAP efficiency ratio exclude amortization of
goodwill and intangibles and non-recurring expenses. Income for
the traditional ratio is increased for the favorable effect of
tax-exempt income (see Table I), and excludes securities gains
and losses, which vary widely from period to period without
appreciably affecting operating expenses, and non-recurring
gains. The measure is different from the GAAP based efficiency
ratio, which also is presented in this report. The GAAP based
measure is calculated using non-interest expense and income
amounts as shown on the face of the Consolidated Statements of
Income. The GAAP and traditional based efficiency ratios are
reconciled in the table below.
The traditional, non-GAAP efficiency ratios for continuing
operations for 2005, 2004, and 2003 were 53.9%, 53.2%, and
45.2%, respectively. Increases in the current year is reflective
of the higher direct costs associated with the new offices in
2005 and 2004 and added corporate overhead required to support
Company expansion. The following table details the components
used in calculation of the efficiency ratios.
GAAP
based and Traditional Efficiency Ratios
On January 1, 2006, the Company adopted the equity-based
compensation accounting provisions of Statement of Financial
Accounting Standards (“SFAS”) 123R. Through
December 31, 2005, the Company accounted for equity-based
compensation under APB Opinion No. 25, using the
intrinsic-value model. Under Opinion No. 25, the Company
recognized no compensation expense related to stock options
granted, and provided pro-forma disclosures of the effects of
accounting for stock options under the fair value model. The
Company has selected the modified prospective method of
transition. Management expects the adoption of the new
equity-based compensation accounting standard to result in
increased compensation expense. The total compensation cost
related to nonvested stock option awards that management expects
to recognize is approximately $721 thousand. The weighted
average period over which that compensation cost is expected to
be recognized is 1.9 years. Future awards of stock options
will increase the amount of compensation expense to be
recognized under SFAS 123R.
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Income tax expense is comprised of federal and state current and
deferred income taxes on pre-tax earnings of the Company. Income
taxes as a percentage of pre-tax income may vary significantly
from statutory rates due to items of income and expense which
are excluded, by law, from the calculation of taxable income.
These items are commonly referred to as permanent differences.
The most significant permanent differences for the Company
include i) income on state and municipal securities which
are exempt from federal income tax, ii) certain dividend
payments which are deductible by the Company, iii) tax
credits generated by investments in low income housing and
iv) for 2004, goodwill impairment expense which is not
deductible.
Consolidated income taxes for 2005 were $10.1 million, a
27.7% effective tax rate, compared to $7.7 million, an
effective tax rate of 25.6%, for 2004. The effective tax rate
for the 2004 was less than 2005 due to the tax benefits realized
from the divestiture of the mortgage banking subsidiary.
Specifically, the non-deductible impairment charges recognized
in 2003 and the first two quarters of 2004 reduced the book
carrying basis of the investment in the mortgage subsidiary and
resulted in a permanent difference during the third quarter of
2004 upon sale of the entity. This difference reduced the 2004
effective tax rate to 25.6% and is the primary cause of the
increase in the effective tax rate when comparing 2004 to 2005.
The previously disclosed state tax audit of state income,
franchise, and sales tax in one of the Company’s tax
jurisdictions was concluded during the fourth quarter of 2005.
The outcome of this audit was favorable to the Company and
resulted in total state income and franchise tax refunds of
approximately $473 thousand. During the fourth quarter the
company submitted the required claims of refund to the state.
The Company anticipates receiving these refunds during the first
quarter of 2006.
Net income for 2004 was $22.4 million, down
$2.8 million from $25.2 million in 2003. Basic and
diluted earnings per share for 2004 were $1.99 and $1.97,
respectively, compared to basic and diluted earnings per share
of $2.27 and $2.25, respectively, in 2003.
The Company’s key profitability ratios are return on
average assets (net income as a percentage of average assets)
and return on average equity (net income as a percentage of
average common shareholder’s equity). Return on average
assets for 2004 and 2003 were 1.24% and 1.56%, respectively. The
return on average equity for those years were 12.53% and 15.13%,
respectively. The returns compare with national peer returns of
1.20% and 14.00%, respectively, based on the September 2004 Bank
Holding Company Performance Report.
Net interest income from continuing operations was
$69.2 million for the year ended December 31, 2004
compared to $64.2 million for the corresponding period in
2003. Tax equivalent net interest income totaled
$72.9 million for 2004, an increase of $5.0 million
from the $67.9 million reported in 2003. This
$5.0 million increase includes a $9.5 million increase
due to an increase in earning assets, which were added to the
portfolio at declining replacement rates. This increase was
partially offset by a net $4.4 million reduction due to
rate changes on the underlying assets and liabilities as asset
yields fell in the declining rate environment. Average earning
assets increased $187.7 million while average
interest-bearing liabilities increased $175.4 million. The
yield on average earning assets decreased 39 basis points
from 6.44% for the year ended December 31, 2003 to 6.05%
for the year ended December 31, 2004. This decrease was
accompanied by a 24 basis point decline in the cost of
funds during the same periods. As a result, the net interest
rate spread at December 31, 2004 was lower at 4.11%
compared to 4.26% for the same period last year. The
Company’s tax equivalent net interest margin of 4.41% for
the year ended December 31, 2004 decreased 23 basis
points from 4.64% in 2003.
The largest contributor to the decrease in the yield on average
earning assets in 2004, on a volume-weighted basis, was the
decrease in the overall tax equivalent yield on loans held for
investment of 60 basis points from the prior year to 6.63%,
as loans repriced downward in response to the declining rate
environment of the preceding year and continued low rates in the
first half of 2004. The average balance of loans increased
$182.5 million, largely due to the PCB acquisition in
Tennessee and expansion offices in North Carolina. The decline
in asset yield is
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attributable to the recent interest rate environment which
created refinancing or repricing incentives for fixed-rate
borrowers to lower their borrowing costs. Strong competition for
commercial loans also held loan yields lower in 2004.
During 2004, the taxable equivalent yield on securities
available for sale decreased 24 basis points to 4.62% while
the average balance increased by $16.2 million. Consistent
with the current rate environment, the Company and the
securities industry as a whole have experienced rapid turnover
in securities as higher yielding securities are either called or
prepaid as refinancing opportunities arise. The increasing
average security balance is the result of continued reinvestment
of available funds. The average balance of investment securities
held to maturity decreased $3.7 million, while the average
yield decreased 23 basis points to 8.00%. Securities held
to maturity are largely comprised of tax-free municipal
securities. Compared to 2003, average interest-bearing balances
with banks decreased $6.6 million between 2003 and 2004,
while the yield increased 30 basis points to 1.82%.
The average cost of interest-bearing liabilities decreased by
24 basis points from 2.18% in 2003 to 1.94% in 2004 while
the average volume of interest-bearing liabilities increased
$175.4 million.
Compared to 2003, the average balance of FHLB and other
short-term convertible and callable borrowings increased in 2004
by $58.6 million to $240.6 million while the average
rate decreased 3 basis points to 3.15%, the result of the
addition of balances acquired with the CommonWealth and PCB
acquisitions, the addition of new advances at lower rates
partially offset by the maturity of a $25 million FHLB
advance in December 2004. The average balance of all other
borrowings increased $5.1 million in 2004 compared to 2003;
the result of the issuance of $15 million in subordinated
debentures late in the third quarter of 2003, while the rate
paid decreased 30 basis points.
In addition, the average balances of interest-bearing demand and
savings deposits increased $20.4 million and
$86.1 million, respectively. The average rate paid on
demand deposits decreased by 5 basis points while the
average rate paid on savings increased by 7 basis points
(the result of higher rates paid by PCB on certain money market
accounts). Average time deposits increased $5.1 million
while the average rate paid decreased 41 basis points from
2.85% in 2003 to 2.44% in 2004. The level of average
non-interest-bearing demand deposits increased
$33.8 million to $212.8 million at December 31,
2004 compared to 2003. Average interest-bearing deposits and
non-interest bearing demand deposits for CommonWealth Bank,
which was acquired in June 2003, totaled $66.1 million and
$25.1 million, respectively in 2004 and $35.9 million
and $18.1 million, respectively in 2003. Included in the
2004 average balances related to the PCB acquisition were
interest-bearing and non-interest bearing deposits of
$97.7 million and $14.2 million at December 31,
2004.
The provision for loan losses for the year ended
December 31, 2004 decreased $748 thousand compared to the
year ended December 31, 2003. The provision for loan losses
was $2.7 million in 2004 and $3.4 million in 2003. Net
charge-offs for 2004 and 2003 were $2.7 million and
$4.8 million, respectively. Expressed as a percentage of
average loans held for investment, net charge-offs decreased
from 0.49% for 2003, to 0.24% for 2004.
Total non-interest income increased approximately
$2.8 million, or 19.2%, from $14.5 million for the
year ended December 31, 2003 to $17.3 million for the
corresponding period in 2004. Service charges on deposit
accounts increased $1.1 million or 13.0% while other
service charges, commissions and fees reflected gains of
$226 thousand or 11.2%. Other operating income improved
70.3%, or $774 thousand, in 2004.
During 2004, the Company realized a gain on sale of securities
of approximately $1.6 million due largely to the sale of
$25.0 million of corporate bonds held in the Company’s
available for sale investment portfolio, the market value of
which had declined in step with the flattening of the Treasury
yield curve. The proceeds from the sale of these securities in
the second quarter of 2004 provided sufficient liquidity to
pay-off overnight borrowings and assisted the Company in funding
increased loan demand. These gains, along with smaller gains on
securities called, compared to those of the same period of 2003
reflect a year over year increase of $406 thousand.
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Wealth management revenues, which include fees for trust
services, increased $330 thousand in 2004 versus 2003. The
increase in fiduciary revenues in 2004 relates to both account
and asset growth within the trust division which came under new
management in early 2004. The increase in revenues includes an
increase of $106 thousand in mutual fund shareholder service
fees which were previously retained by an outsourced investment
advisor and increased estate fees of $52 thousand. Stone Capital
asset management fees grew from $371 thousand in 2003 to $531
thousand in 2004. This growth reflects the initial stages of
expansion of the retail asset management services under Stone
Capital and its addition of investment advisors and the
licensing of a number of investment associates within the bank
branches.
Total non-interest expense from continuing operations was
$48.0 million, an increase of 27.8% or $10.4 million
for 2004 over 2003. A $6.0 million or 29.1% increase in
salaries and benefits and a $2.8 million increase in other
operating expenses account for 85% of this increase, resulting
from the Company’s expansion into Blacksburg, Virginia,
Eastern Virginia, East Tennessee, and Charlotte, Winston-Salem
and Mount Airy, North Carolina. This expansion brings with it
the associated costs of additional branch personnel, corporate
services and support, added technology and infrastructure as
further detailed below.
The $6.0 million increase in salaries and benefits includes
the addition of CommonWealth Bank in June 2003
($1.0 million), the acquisition of PCB in the second
quarter of 2004 ($1.9 million), the salaries and benefits
associated with three North Carolina de novo branches opened in
late 2003 and the opening of two new North Carolina loan
production offices in the first quarter of 2004
($1.2 million), and three new loan production offices in
Virginia and West Virginia ($230 thousand), as well as a general
increase in salaries and benefits as staffing needs at several
locations were satisfied in order to support added corporate
services and continued branch growth.
Occupancy and furniture and equipment expenses increased $647
thousand and $878 thousand, respectively, compared to 2003 for a
total of $1.5 million. The general level of occupancy and
furniture and equipment costs grew largely as a result of the
CommonWealth acquisition ($156 thousand), the PCB Bancorp
acquisition ($477 thousand), increases in depreciation and
insurance costs associated with new de novo branches ($210
thousand) and depreciation associated with continued investment
in operating equipment and technology infrastructure.
All other operating expense accounts increased $2.8 million
in 2004 compared to 2003. Significant increases were related to
the additional costs associated with the opening of three new
branches in Winston-Salem and two loan production offices in
Charlotte and Mount Airy, North Carolina ($119 thousand), the
opening of three loan production offices in Virginia and West
Virginia ($68 thousand), the acquisition of CommonWealth in
Richmond, Virginia ($263 thousand) and the Tennessee acquisition
of PCB Bancorp ($616 thousand). Other operational and data
processing expenses also increased as a result of the
acquisition and branching activity, such as correspondent bank
fees, insurance, courier and OCC assessments.
The efficiency ratios for continuing operations for 2004 and
2003 were 53.2% and 45.2%, respectively. Increases in the
current year is reflective of the higher direct costs associated
with the acquisitions and new offices in 2003 and 2004 and added
corporate overhead required to support Company expansion.
Consolidated income taxes were $7.7 million for 2004, a
25.6% effective tax rate, compared with $10.3 million, an
effective tax rate of 29.1% in 2003. During 2004, the Company
sold its mortgage subsidiary. Prior to the disposition of the
mortgage subsidiary the Company recognized goodwill impairment
expense in 2003 and the first two quarters of 2004. Because the
goodwill impairment charges were not deductible, they increased
the effective tax rate for 2003 and for the first two quarters
of 2004. The impairment charges did, however, reduce the book
carrying basis of the mortgage subsidiary which resulted in a
tax benefit of $950 thousand at the time of sale. This
difference reduced the combined effective tax rate for 2004 to
25.6% from 29.1% in 2003.
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FINANCIAL
POSITION
Securities available for sale were $404.4 million at
December 31, 2005, compared to $376.0 million at
December 31, 2004, an increase of $28.4 million.
The Company attempts to maintain an acceptable level of interest
rate risk within its securities portfolio. At December 31,
2005, the average life and duration of the portfolio were
7.0 years and 5.4, respectively. Average life and duration
were somewhat higher than December 31, 2004, at
4.0 years and 3.5, respectively. However, the Company has
been shifting towards more floating-rate securities. At
December 31, 2005, 22% of the portfolio was floating-rate,
compared to 16% at December 31, 2004.
Available for sale and held to maturity securities are reviewed
quarterly for possible
other-than-temporary
impairment. This review includes an analysis of the facts and
circumstances of each individual investment such as the length
of time the fair value has been below cost, the expectation for
that security’s performance, the creditworthiness of the
issuer and the Company’s intent and ability to hold the
security to recovery or maturity. A decline in value that is
considered to be
other-than-temporary
would be recorded as a loss within non-interest income in the
Consolidated Statements of Income. At December 31, 2005,
the combined depreciation in value of the individual securities
in an unrealized loss position for more than 12 months was
less than 1% of the combined reported value of the aggregate
securities portfolio. Management does not believe any unrealized
loss, individually or in the aggregate, as of December 31,
2005, represents
other-than-temporary
impairment. The Company has the intent and ability to hold these
securities until such time as the value recovers or the
securities mature. Furthermore, the Company believes the decline
in value is attributable to changes in market interest rates and
not the credit quality of the issuer.
The following table details amortized cost and fair value of
securities available for sale December 31, 2005, 2004, and
2003.
Investment securities held to maturity are comprised primarily
of high-grade state and municipal bonds. These securities
generally carry AAA bond ratings, most of which also carry
credit enhancement insurance by major insurers of investment
obligations. The portfolio totaled $24.2 million at
December 31, 2005 compared to $34.2 million at
December 31, 2004. This decrease is reflective of
continuing paydowns, maturities and calls within the portfolio.
The market value of investment securities held to maturity was
102.9% and 104.1% of book value at December 31, 2005 and
2004, respectively. Recent trends in interest rates have had
little effect on the portfolio market value since
December 31, 2004, due to its larger percentage of
municipal securities which display less price sensitivity to
rate changes.
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The average final maturity of the held to maturity investment
portfolio decreased from 7.4 years in 2004 to
5.3 years in 2005 with the tax-equivalent yield decreasing
from 8.00% at year-end 2004 to 7.95% at the close of 2005. The
average maturity of the investment portfolio, based on market
assumptions for prepayment, is 1.6 years and
1.91 years at December 2005 and 2004, respectively. The
average maturity data differs from final maturity data because
of the use of assumptions as to anticipated prepayments.
The following table details amortized cost and fair value of
securities held to maturity at December 31, 2003.
To mitigate interest rate risk, the Company sells most of the
long-term, fixed-rate mortgage loans it originates in the
secondary market. At December 31, 2005, the Company held
$1.3 million of loans for sale to the secondary market. The
gross notional amount of outstanding commitments to originate
mortgage loans for customers at December 31, 2005, was
$9.2 million on 53 loans.
Total loans held for investment increased $92.3 million to
$1.33 billion at December 31, 2005, from
$1.24 billion at December 31, 2004 as a result of
increased loan production and contributions by new loan
production offices. Average loan to deposit ratio increased to
92.3% at December 31, 2005, compared with 86.3% at
December 31, 2004. 2005 average loans held for investment
of $1.30 billion increased $142.9 million when
compared to the average for 2004 of $1.16 billion. The
increase in average loans reflects the impact of the acquisition
of PCB on March 31, 2004 and growth through the
Company’s de novo and loan production office expansion
efforts, along with the existing branches.
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The held for investment loan portfolio continues to be
diversified among loan types and industry segments. The
following table presents the various loan categories and changes
in composition at year-end 2001 through 2005.
Loan
Portfolio Summary
The Company maintained no foreign loans in the periods presented.
The following table details the maturities and rate sensitivity
of the Company’s loan portfolio at December 31, 2005.
Maturities
and Rate Sensitivity of Loan Portfolio at December 31,
2005
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The allowance is increased by charges to earnings in the form of
provisions and by recoveries of prior charge-offs, and decreased
by charge-offs. The provisions are calculated to bring the
allowance to a level, which, according to a systematic process
of measurement, is reflective of the required amount needed to
absorb probable losses.
Management performs monthly assessments to determine the
appropriate level of the allowance. Differences between actual
loss experience and estimates are reflected through adjustments
that are made by either increasing or decreasing the loss
provision based upon current measurement criteria. Commercial,
consumer and mortgage loan portfolios are evaluated separately
for purposes of determining the loan loss portion of the
allowance. The specific components of the loan allowance include
allocations to individual commercial credits and allocations to
the remaining non-homogeneous and homogeneous pools of loans.
Management’s allocations are based on judgment of
qualitative and quantitative factors about both the macro and
micro economic conditions reflected within the portfolio of
loans and commitments and the economy as a whole. Factors
considered in this evaluation include, but are not necessarily
limited to, probable losses from loan and other credit
arrangements, general economic conditions, changes in credit
concentrations or pledged collateral, historical loan loss
experience, and trends in portfolio volume, maturity,
composition, delinquencies, and non-accruals. While management
has attributed the allowance for loan losses to various
portfolio segments, the allowance is available for the entire
portfolio.
The allowance for loan losses was $14.7 million at
December 31, 2005, compared to $16.3 million at
December 31, 2004. The decrease in the allowance since
December 2004 is primarily attributable to changes in various
qualitative risk factors specific to the portfolio and increased
charge-offs for 2005. Management considers the allowance
adequate based upon its analysis of the portfolio as of
December 31, 2005. However, no assurance can be made that
additions to the allowance for loan losses will not be required
in future periods.
The following table details loan charge-offs and recoveries by
loan type for the five years ended December 31, 2001
through 2005.
Summary
of Loan Loss Experience
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The following table details the allocation of the allowance for
loan losses for the five years ended December 31, 2005.
Non-performing assets include loans on non-accrual status, loans
contractually past due 90 days or more and still accruing
interest, other real estate owned, and repossessions. The levels
of non-performing assets for the last five years are presented
in the following table.
Summary
of Non-Performing Assets
Total non-performing assets were $4.8 million at
December 31, 2005 compared to $6.6 million at
December 31, 2004, a decrease of $1.7 million.
Non-accrual loans decreased by $1.8 million to
$3.4 million at December 31, 2005. Ongoing activity
within the classification and categories of non-performing loans
continues to include collections on delinquencies, foreclosures
and movements into or out of the non-performing classification
as a result of changing customer business conditions. Loans
90 days past due and still accruing at December 31,
2005 and 2004, were $11 thousand and $0, respectively. Other
real estate owned decreased $19 thousand to
$1.4 million in 2005 and is carried at the lesser of
estimated net realizable value or cost.
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Certain loans included in the non-accrual category have been
written down to the estimated realizable value or have been
assigned specific reserves within the allowance for loan losses
based upon management’s estimate of loss upon ultimate
resolution.
During 2005, 2004 and 2003, $1.3 million,
$2.1 million, and $1.6 million, respectively, of
assets were acquired through foreclosure and transferred to
other real estate owned.
In addition to non-performing loans reflected in the foregoing
table, the Company has identified certain performing loans as
impaired based upon management’s evaluation of credit
strength, projected ability to repay in accordance with the
contractual terms of the loans and varying degrees of dependence
on the sale of related collateral for liquidation of the loans.
The following table presents the Company’s investment in
loans considered to be impaired and related information on those
impaired loans.
The Company has considered all impaired loans in the evaluation
of the adequacy of the allowance for loan losses at
December 31, 2005. The following table presents detail of
non-performing loans for the five years ended December 31,
2005. Additional information regarding nonperforming loans can
be found in Note 5, Allowance for Loan Losses, included in
the Financial Statements under Item 8 of this report.
There are no outstanding commitments to lend additional funds to
borrowers related to restructured loans.
Potential Problems Loans — In addition to
loans which are classified as non-performing, the Company
closely monitors certain loans which could develop into problem
loans. These potential problem loans present characteristics of
weakness or concentrations of credit to one borrower. At
December 31, 2005, there were no significant potential
problem loans.
Although the Company’s loans are made primarily in the
four-state region in which it operates, the Company had no
concentrations of loans to one borrower or industry representing
10% or more of outstanding loans at December 31, 2005.
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Total deposits grew by $46.9 million, or 3.4%, during 2005.
Noninterest-bearing demand deposits increased by
$9.0 million, or 4.1%, while interest-bearing demand
deposits decreased $5.8 million, or 3.9%. Savings deposits,
which are made of up money market accounts and passbook savings,
decreased $30.0 million, or 7.8%, while time deposits
increased $73.6 million, or 12.2%. The attrition from
savings and the increase in time deposits reflects the continued
migration of new and current customer funds in response to the
upward movement in time deposit interest rates. Adding to the
increase in time deposits were the results of the Company’s
successful first quarter certificate of deposit marketing
campaign.
Average total deposits increased to $1.41 billion for 2005
versus $1.34 billion in 2004, an increase of 5.0%. Average
savings deposits increased by $2.3 million while average
time deposits increased by $46.2 million. Average
interest-bearing demand and non-interest bearing demand deposits
increased by $3.3 million and $16.0 million,
respectively. In 2005, the average rate paid on interest bearing
deposits was 2.03%, up from 1.63% in 2004.
Average
Deposits and Average Rates
Scheduled
Maturities of Certificates of Deposit Greater than $100,000 As
of December 31, 2005
The Company’s borrowings consist primarily of overnight
federal funds purchased from the FHLB and other sources,
securities sold under agreements to repurchase, and FHLB
borrowings. This category of liabilities represents wholesale
sources of funding and liquidity for the Company.
Federal funds purchased were $82.5 million and
$32.5 million, at year-end 2005 and 2004, respectively.
Securities sold under repurchase agreements were
$124.2 million and $109.9 million at December 31,
2005 and 2004, respectively. These agreements are sold to
customers as an alternative to available deposit products. The
underlying securities included in repurchase agreements remain
under the Company’s control during the effective period of
the agreements.
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Short-term borrowings include overnight federal funds, and
securities sold under agreements to repurchase. Balances and
rates paid on short-term borrowings for continuing operations
are summarized as follows:
Short-term borrowings increased on average approximately
$19.3 million compared to the prior year as a result of
continued loan demand and increases in portfolio assets. Funding
cost is managed by the Company’s Asset/Liability Management
Committee, which monitors, among other things, product and
pricing, overall cost of funds, and maintenance of an acceptable
net interest margin.
In December 2005, the Company prepaid certain of its highest
interest rate FHLB advances. The retired obligations had a
weighted-average interest rate and maturity of 5.96% and
4.3 years, respectively. In connection with the early
termination, the Company incurred prepayment penalties of
approximately $3.8 million. In January 2006, the Company
borrowed $75 million in new adjustable-rate advances from
the FHLB. $50 million of the advances were hedged by an
interest rate swap to approximate a fixed rate of 4.34%. The
remaining $25 million floats at an interest rate equal to
3-month
LIBOR less 45 basis points.
At December 31, 2005, FHLB borrowings included
$106.1 million in convertible and callable advances and
$7.7 million of noncallable advances for a total of
$113.8 million. The weighted-average interest rates of all
advances were 4.17% and 5.54% at December 31, 2005 and
2004, respectively. At December 31, 2005, the FHLB advances
had maturities between twelve months and 8 years. The
scheduled maturities of the advances are as follows:
Also included in other indebtedness is $15.5 million of
junior subordinated debentures issued by the Company in October
2003 to an unconsolidated trust subsidiary.
Liquidity represents the Company’s ability to respond to
demands for funds and is primarily derived from maturing
investment securities, overnight investments, periodic repayment
of loan principal, and the Company’s ability to generate
new deposits. The Company also has the ability to attract
short-term sources of funds and draw on credit lines that have
been established at financial institutions to meet cash needs.
Total liquidity of $681.0 million at December 31,
2005, is comprised of the following: cash on hand and deposits
with other financial institutions of $57.5 million;
securities available for sale of $404.4 million; securities
held to maturity due within one year of $1.8 million; and
FHLB credit availability of $217.3 million.
Liquidity management is both a daily and long-term function of
business management. Excess liquidity is generally used to pay
down short-term borrowings. On a longer-term basis, the Company
maintains a strategy of investing in securities, mortgage-backed
obligations and loans with varying maturities. The Company uses
sources of funds primarily to meet ongoing commitments, to pay
maturing savings certificates and savings withdrawals, fund loan
commitments and maintain a portfolio of securities. At
December 31, 2005, approved loan commitments
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outstanding amounted to $198.1 million. Certificates of
deposit scheduled to mature in one year or less totaled
$422.4 million. Management believes that the Company has
adequate resources to fund outstanding commitments and could
either adjust rates on certificates of deposit in order to
retain or attract deposits in changing interest rate
environments or replace such deposits with advances from the
FHLB or other funds providers if it proved to be cost effective
to do so.
The following table presents contractual cash obligations as of
December 31, 2005.
Cash
Obligations
The following table presents detailed information regarding the
Company’s off-balance sheet arrangements at
December 31, 2005.
Lines of credit with no stated maturity date are included in
commitments for less than one year.
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In January 2006, the Company entered into a pay fixed and
receive variable interest rate swap. The swap effectively fixes
$50 million of FHLB borrowings at 4.34% for a period of
five years. Management does not anticipate this derivative
transaction will have a significant impact on reported earnings
or cash flows.
Total stockholders’ equity increased $11.3 million to
$194.5 million at December 31, 2005, as the Company
continued to balance capital adequacy and returns to
stockholders. The increase in equity was due mainly to net
earnings of $26.3 million after dividends paid to
stockholders of $11.5 million.
Risk-based capital guidelines and leverage ratio measure capital
adequacy of banking institutions. At December 31, 2005, the
Company’s Tier I capital ratio was 10.54% compared
with 10.80% in 2004. The Company’s total risk-based
capital-to-asset
ratio was 11.65% at the close of 2005 compared with 12.09% in
2004. Both of these ratios are well above the current minimum
level of 8% prescribed for bank holding companies. The leverage
ratio is the measurement of total tangible equity to total
assets. The Company’s leverage ratio at December 31,
2005 was 7.77% versus 7.62% at December 31, 2004, both of
which are well above the minimum levels prescribed by the
Federal Reserve. See Note 12 of the Notes to Consolidated
Financial Statements.
As part of its community banking services, the Company offers
trust management and estate administration services through its
Trust and Financial Services Division (Trust Division). The
Trust Division reported market value of assets under
management of $487 million and $506 million at
December 31, 2005 and 2004, respectively. The
Trust Division manages inter vivos trusts and trusts under
will, develops and administers employee benefit plans and
individual retirement plans and manages and settles estates.
Fiduciary fees for these services are charged on a schedule
related to the size, nature and complexity of the account.
The Trust Division employs 18 professionals and full time
equivalent support staff with a wide variety of estate and
financial planning, investing and plan administration skills.
The Trust Division is located within the Company’s
banking offices in Bluefield, West Virginia. Services and trust
development activities are offered to other branch locations and
primary markets through the Bluefield-based division.
The Company’s profitability is dependent to a large extent
upon its net interest income, which is the difference between
its interest income on interest-earning assets, such as loans
and securities, and its interest expense on interest-bearing
liabilities, such as deposits and borrowings. The Company, like
other financial institutions, is subject to interest rate risk
to the degree that its interest-earning assets reprice
differently than its interest-bearing liabilities. The Company
manages its mix of assets and liabilities with the goals of
limiting its exposure to interest rate risk, ensuring adequate
liquidity, and coordinating its sources and uses of funds while
maintaining an acceptable level of net interest income given the
current interest rate environment.
The Company’s primary component of operational revenue, net
interest income, is subject to variation as a result of changes
in interest rate environments in conjunction with unbalanced
repricing opportunities on earning assets and interest-bearing
liabilities. Interest rate risk has four primary components
including repricing risk, basis risk, yield curve risk and
option risk. Repricing risk occurs when earning assets and
paying liabilities reprice at differing times as interest rates
change. Basis risk occurs when the underlying rates on the
assets and liabilities the institution holds change at different
levels or in varying degrees. Yield curve risk is the risk of
adverse consequences as a result of unequal changes in the
spread between two or more rates for different maturities for
the same instrument. Lastly, option risk is due to
“embedded options”, often called put or call options,
given or sold to holders of financial instruments.
In order to mitigate the effect of changes in the general level
of interest rates, the Company manages repricing opportunities
and thus, its interest rate sensitivity. The Company seeks to
control its interest rate risk (“IRR”) exposure to
insulate net interest income and net earnings from fluctuations
in the general level of interest rates. To measure its exposure
to IRR, quarterly simulations of net interest income are
performed using financial models that
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project net interest income through a range of possible interest
rate environments including rising, declining, most likely and
flat rate scenarios. The results of these simulations indicate
the existence and severity of IRR in each of those rate
environments based upon the current balance sheet position,
assumptions as to changes in the volume and mix of
interest-earning assets and interest-paying liabilities and
management’s estimate of yields to be attained in those
future rate environments and rates that will be paid on various
deposit instruments and borrowings. Specific strategies for
management of IRR have included shortening the amortized
maturity of new fixed-rate loans, increasing the volume of
adjustable-rate loans to reduce the average maturity of the
Bank’s interest-earning assets, and monitoring the term
structure of liabilities to maintain a balanced mix of maturity
and repricing to mitigate the potential exposure. The simulation
model used by the Company captures all earning assets,
interest-bearing liabilities and all off-balance sheet financial
instruments and combines the various factors affecting rate
sensitivity into an earnings outlook. Based upon the latest
simulation, the Company believes that it is biased slightly
toward liability sensitive position. Absent adequate management,
liability sensitive positions can negatively impact net interest
income in a rising rate environment or, alternatively,
positively impact net interest income in a falling rate
environment.
The Company has established policy limits for tolerance of
interest rate risk that allow for no more than a 10% reduction
in projected net interest income based on quarterly income
simulations compared to forecasted results. In addition, the
policy addresses exposure limits to changes in the Economic
Value of Equity according to predefined policy guidelines. The
most recent simulation indicates that current exposure to
interest rate risk is within the Company’s defined policy
limits as short-term rates are anticipated to remain relatively
stable throughout 2006.
The following table summarizes the impact of immediate and
sustained rate shocks in the interest rate environment on net
interest income and the economic value of equity as of
December 31, 2005 and 2004. The model simulates plus and
minus 200 basis points from the flat rate simulation at
December 31, 2005. This table, which illustrates the
prospective effects of hypothetical interest rate changes, is
based upon numerous assumptions including relative and estimated
levels of key interest rates over a twelve-month time period.
This type of modeling technique, although useful, does not take
into account all strategies that management might undertake in
response to a sudden and sustained rate shock as depicted. Also,
as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to prepayment and
refinancing levels likely deviating from those assumed, the
varying impact of interest rate change caps or floors on
adjustable rate assets, the potential effect of changing debt
service levels on customers with adjustable rate loans,
depositor early withdrawals and product preference changes, and
other internal and external variables.
Rate
Sensitivity Analysis
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FIRST
COMMUNITY BANCSHARES, INC.
See Notes to Consolidated Financial Statements.
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FIRST
COMMUNITY BANCSHARES, INC.
See Notes to Consolidated Financial Statements.
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FIRST
COMMUNITY BANCSHARES, INC.
(See Note 1 for detail of income taxes and interest paid
and Note 2 for supplemental information regarding detail of
cash paid in acquisitions.)
See Notes to Consolidated Financial Statements
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FIRST
COMMUNITY BANCSHARES, INC.
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