UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 Commission File Number 0-15572 FIRST BANCORP ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) North Carolina 56-1421916 -------------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 341 North Main Street, Troy, North Carolina 27371-0508 ------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) (Registrant's telephone number, including area code) (910) 576-6171 -------------- 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 twelve 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. [ X ] YES [ ] NO As of September 30, 1998, 3,021,470 shares of the registrant's Common Stock, $5 par value, were outstanding. The registrant had no other classes of securities outstanding. EXHIBIT INDEX BEGINS ON PAGE 28
INDEX FIRST BANCORP AND SUBSIDIARIES Page Part I. Financial Information Item 1 - Financial Statements CONSOLIDATED BALANCE SHEETS - September 30, 1998 and 1997 (With Comparative Amounts at December 31, 1997) 3 CONSOLIDATED STATEMENTS OF INCOME - For the Periods Ended September 30, 1998 and 1997 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - For the Periods Ended September 30, 1998 and 1997 5 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - For the Periods Ended September 30, 1998 and 1997 6 CONSOLIDATED STATEMENTS OF CASH FLOWS - For the Periods Ended September 30, 1998 and 1997 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8 Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition 11 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 22 Part II. Other Information Item 5 - Other Information 25 Item 6 - Exhibits and Reports on Form 8-K 25 Signatures 27 Exhibit Cross Reference Index 28 -2-
Part I. Financial Information Item 1 - Financial Statements <TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Balance Sheets September 30, December 31, September 30, ($ in thousands-unaudited) 1998 1997 1997 --------- ------- ------- <S> <C> <C> <C> ASSETS Cash & due from banks, noninterest-bearing ......... $ 17,418 17,664 14,643 Due from banks, interest-bearing ................... 21,269 13,081 27 Federal funds sold ................................. 11,707 2,896 3,090 --------- ------- ------- Total cash and cash equivalents ............... 50,394 33,641 17,760 --------- ------- ------- Securities available for sale (costs of $39,171, $49,995, and $52,922) ......................... 39,535 50,277 53,193 Securities held to maturity (fair values of $19,375, $21,512, and $21,376) ......................... 18,589 20,856 20,814 Presold mortgages in process of settlement ......... 1,495 1,330 1,258 Loans .............................................. 345,295 280,513 260,699 Less: Allowance for loan losses ................ (5,391) (4,779) (4,728) --------- ------- ------- Net loans ....................................... 339,904 275,734 255,971 --------- ------- ------- Premises and equipment ............................. 8,832 8,839 8,457 Accrued interest receivable ........................ 2,980 2,866 2,744 Intangible assets .................................. 5,995 6,487 5,192 Other .............................................. 2,813 2,639 2,694 --------- ------- ------- Total assets ............................... $ 470,537 402,669 368,083 ========= ======= ======= LIABILITIES Deposits: Demand - noninterest-bearing.............. $ 58,337 50,921 46,836 Savings, NOW, and money market ........... 148,535 135,805 124,349 Time deposits of $100,000 or more ........ 54,613 40,200 35,484 Other time deposits ...................... 151,015 134,298 120,781 --------- ------- ------- Total deposits ........................... 412,500 361,224 327,450 Short-term borrowings .............................. 13,000 -- -- Accrued interest payable ........................... 3,003 2,299 2,047 Other liabilities .................................. 2,401 2,381 2,859 --------- ------- ------- Total liabilities ............................. 430,904 365,904 332,356 --------- ------- ------- </TABLE>
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Balance Sheets (continued) September 30, December 31, September 30, ($ in thousands-unaudited) 1998 1997 1997 --------- ------- ------- <S> <C> <C> <C> SHAREHOLDERS' EQUITY Common stock, $5 par value per share Authorized: 12,500,000 shares Issued and outstanding: 3,021,470, 3,020,370, and 3,016,370 shares ............ 15,107 15,102 15,082 Capital surplus .................................... 3,869 3,861 3,831 Retained earnings .................................. 20,435 17,616 16,629 Accumulated other comprehensive income ............. 222 186 185 --------- ------- ------- Total shareholders' equity .................... 39,633 36,765 35,727 --------- ------- ------- Total liabilities and shareholders' equity $ 470,537 402,669 368,083 ========= ======= ======= </TABLE> See notes to consolidated financial statements. -3-
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Income Three Months Ended Nine Months Ended September 30, September 30, ---------------------------- ---------------------------- ($ in thousands, except per share data-unaudited) 1998 1997 1998 1997 ----------- --------- ----------- --------- <S> <C> <C> <C> <C> INTEREST INCOME Interest and fees on loans .................... $ 7,882 6,196 $ 22,252 17,244 Interest on investment securities: Taxable interest income .................. 663 916 2,159 2,763 Tax-exempt interest income ............... 246 283 788 902 Other, principally overnight investments ...... 391 78 892 397 ----------- --------- ----------- --------- Total interest income .................... 9,182 7,473 26,091 21,306 ----------- --------- ----------- --------- INTEREST EXPENSE Savings, NOW and money market ................. 869 740 2,493 2,019 Time deposits of $100,000 or more ............. 869 499 2,236 1,437 Other time deposits ........................... 1,971 1,596 5,741 4,582 Short-term borrowings ......................... 106 -- 106 3 ----------- --------- ----------- --------- Total interest expense ................... 3,815 2,835 10,576 8,041 ----------- --------- ----------- --------- Net interest income ........................... 5,367 4,638 15,515 13,265 Provision for loan losses ..................... 250 125 740 325 ----------- --------- ----------- --------- Net interest income after provision for loan losses ............................ 5,117 4,513 14,775 12,940 ----------- --------- ----------- --------- NONINTEREST INCOME Service charges on deposit accounts ........... 655 627 1,912 1,854 Commissions from insurance sales .............. 62 69 180 218 Other service charges, commissions and fees ... 390 249 1,144 804 Data processing fees .......................... -- 74 -- 216 Loan sale gains ............................... 66 -- 213 -- Securities losses ............................. -- (12) (3) (12) ----------- --------- ----------- --------- Total noninterest income ................ 1,173 1,007 3,446 3,080 ----------- --------- ----------- --------- </TABLE>
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Income (continued) Three Months Ended Nine Months Ended September 30, September 30, ---------------------------- ---------------------------- ($ in thousands, except per share data-unaudited) 1998 1997 1998 1997 ----------- --------- ----------- --------- <S> <C> <C> <C> <C> NONINTEREST EXPENSES Salaries ...................................... 1,864 1,568 5,309 4,606 Employee benefits ............................. 416 317 1,191 1,021 ----------- --------- ----------- --------- Total personnel expense .................... 2,280 1,885 6,500 5,627 Net occupancy expense ......................... 270 247 758 715 Equipment related expenses .................... 231 223 666 652 Other operating expenses ...................... 1,222 1,246 3,889 3,598 ----------- --------- ----------- --------- Total noninterest expenses ............... 4,003 3,601 11,813 10,592 ----------- --------- ----------- --------- Income before income taxes .................... 2,287 1,919 6,408 5,428 Income taxes .................................. 805 651 2,230 1,795 ----------- --------- ----------- --------- NET INCOME .................................... $ 1,482 1,268 $ 4,178 3,633 =========== ========= =========== ========= Weighted average common shares outstanding - basic ........................ 3,020,703 3,016,370 3,020,481 3,016,370 =========== ========= =========== ========= Weighted average common shares outstanding - diluted ...................... 3,102,419 3,083,770 3,107,419 3,081,836 =========== ========= =========== ========= Earnings per share - basic .................... $ 0.49 0.42 $ 1.38 1.20 Earnings per share - diluted .................. 0.48 0.41 1.35 1.17 Cash dividends declared per share ............. 0.15 0.13 0.45 0.39 </TABLE> See notes to consolidated financial statements -4-
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Comprehensive Income Three Months Ended Nine Months Ended September 30, September 30, -------------------- -------------------- ($ in thousands-unaudited) 1998 1997 1998 1997 <S> <C> <C> <C> <C> Net income ............................. $ 1,482 1,268 $ 4,178 3,633 ------- ----- ------- ----- Other comprehensive income: Unrealized gains on securities available for sale: Unrealized holding gains arising during the period, pretax ...... 149 133 79 38 Tax expense .................. (69) (40) (45) (7) Reclassification to realized losses -- 12 3 12 Tax benefit .................. -- (4) (1) (4) ------- ----- ------- ----- Other comprehensive income ............ 80 101 36 39 ------- ----- ------- ----- Comprehensive income ................... $ 1,562 1,369 $ 4,214 3,672 ======= ===== ======= ===== </TABLE> See notes to consolidated financial statements. -5-
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Shareholders' Equity Accumulated Common Stock Other Share- ------------------- Capital Retained Comprehensive holders' (In thousands, except per share - unaudited) Shares Amount Surplus Earnings Income Equity - -------------------------------------------- ------ ------ ------- -------- ------ ------ <S> <C> <C> <C> <C> <C> <C> Balances, January 1, 1997 ............... 3,016 $ 15,082 3,831 14,173 146 33,232 Net income .............................. 3,633 3,633 Cash dividends declared ($0.39 per share) (1,177) (1,177) Other comprehensive income .............. 39 39 ----- -------- ----- ------ --- ------ Balances, September 30, 1997 ............ 3,016 $ 15,082 3,831 16,629 185 35,727 ===== ======== ===== ====== === ====== Balances, January 1, 1998 ............... 3,020 $ 15,102 3,861 17,616 186 36,765 Net income .............................. 4,178 4,178 Cash dividends declared ($0.45 per share) (1,359) (1,359) Common stock issued under stock option plans ................. 1 5 8 13 Other comprehensive income .............. 36 36 ----- -------- ----- ------ --- ------ Balances, September 30, 1998 ............ 3,021 $ 15,107 3,869 20,435 222 39,633 ===== ======== ===== ====== === ====== <CAPTION> As of As of September September 30, 1998 30, 1997 ---------- --------- <S> <C> <C> Supplemental disclosure of components of Accumulated Other Comprehensive Income: Unrealized gain on securities available for sale, pretax $ 364 271 Tax expense (142) (86) ------ --- Total Accumulated Other Comprehensive Income $ 222 185 ====== === </TABLE> See notes to consolidated financial statements. -6-
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Cash Flows Nine Months Ended September 30, ---------------------- ($ in thousands-unaudited) 1998 1997 -------- ------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income ................................................................ $ 4,178 3,633 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ............................................ 740 325 Net security premium amortization (discount accretion) ............... 138 (8) Securities losses .................................................... 3 12 Loan sale gains ...................................................... (213) -- Loan fees and costs deferred, net of amortization .................... 35 25 Depreciation of premises and equipment ............................... 554 532 Amortization of intangible assets .................................... 492 406 Realized and unrealized other real estate losses ..................... -- 16 Provision for deferred income taxes ................................. 37 (13) Increase in accrued interest receivable .............................. (114) (332) Decrease in intangible pension asset ................................. -- 236 Decrease (increase) in other assets .................................. (185) 119 Increase in accrued interest payable ................................. 704 165 Increase (decrease) in other liabilities ............................. (40) 324 -------- ------ Net cash provided by operating activities ............................ 6,329 5,440 -------- ------ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of securities available for sale ........................... (18,488) (28,754) Purchases of securities held to maturity ............................. (755) (1,222) Proceeds from sales of securities available for sale ................. 1,015 8,361 Proceeds from maturities/issuer calls of securities available for sale 28,171 21,209 Proceeds from maturities/issuer calls of securities held to maturity . 3,005 2,710 Proceeds from sales of loans ......................................... 7,060 -- Net increase in loans ................................................ (71,821) (38,097) Purchases of premises and equipment .................................. (753) (1,267) -------- ------ Net cash used in investing activities ................................ (52,566) (37,060) -------- ------ CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits ............................................. 51,276 29,589 Proceeds from short-term borrowings, net ............................. 13,000 -- Cash dividends paid .................................................. (1,299) (1,116) Proceeds from issuance of common stock ............................... 13 -- -------- ------ Net cash provided by financing activities ............................ 62,990 28,473 -------- ------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......................... 16,753 (3,147) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................ 33,641 20,907 -------- ------ CASH AND CASH EQUIVALENTS, END OF PERIOD .................................. $ 50,394 17,760 ======== ====== </TABLE>
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Cash Flows Nine Months Ended September 30, ---------------------- ($ in thousands-unaudited) 1998 1997 -------- ------- <S> <C> <C> SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest ............................................................. $ 9,872 7,876 Income taxes ......................................................... 2,201 1,700 Non-cash transactions: Foreclosed loans transferred to other real estate .................... 29 82 Increase in fair value of securities available for sale .............. 79 38 Premises and equipment transferred to other real estate .............. 206 -- Loans to facilitate sales of other real estate ....................... -- 17 </TABLE> See notes to consolidated financial statements. -7-
First Bancorp And Subsidiaries Notes To Consolidated Financial Statements (unaudited) For the Periods Ended September 30, 1998 and 1997 - -------------------------------------------------------------------------------- NOTE 1 In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the consolidated financial position of the Company as of September 30, 1998 and 1997 and the consolidated results of operations and consolidated cash flows for the periods ended September 30, 1998 and 1997. Reference is made to the Annual Report on Form 10-K filed with the SEC for a discussion of accounting policies and other relevant information with respect to the consolidated financial statements. NOTE 2 The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share," as of December 31, 1997. As required by the standard, all prior year earnings per share amounts have been restated and computed under the provisions of the new standard. Basic earnings per share were computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share includes the potentially dilutive effects of the Company's 1994 Stock Option Plan. The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per share: <TABLE> <CAPTION> For the Three Months Ended September 30, ----------------------------------------------------------------------------------- 1998 1997 --------------------------------------- ------------------------------------------ ($ in thousands except per Income Shares Income Shares share amounts) (Numer- (Denom- Per Share (Numer- (Denom- Per Share ator) inator) Amount ator) inator) Amount ---------- --------- -------- ---------- --------- ------------- <S> <C> <C> <C> <C> <C> <C> Basic EPS Net income ................ $ 1,482 3,020,703 $ 0.49 $ 1,268 3,016,370 $ 0.42 ======== ============= Effect of Dilutive Securities Effect of stock option plan -- 81,716 -- 67,400 ---------- --------- ---------- ---------- Diluted EPS Net income plus assumed exercises of options $ 1,482 3,102,419 $ 0.48 $ 1,268 3,083,770 $ 0.41 ========== ========= ======== ========== ========= ============= </TABLE>
<TABLE> <CAPTION> For the Nine Months Ended September 30, -------------------------------------------------------------------------------------- 1998 1997 --------------------------------------- --------------------------------------------- ($ in thousands except per Income Shares Income Shares share amounts) (Numer- (Denom- Per Share (Numer- (Denom- Per Share ator) inator) Amount ator) inator) Amount ---------- --------- -------- ---------- --------- ------------- <S> <C> <C> <C> <C> <C> <C> Basic EPS Net income ................ $ 4,178 3,020,481 $ 1.38 $ 3,633 3,016,370 $ 1.20 ======== ============= Effect of Dilutive Securities Effect of stock option plan -- 86,938 -- 65,466 --------- --------- -------- --------- --------- ------------- Diluted EPS Net income plus assumed exercises of options ... $ 4,178 3,107,419 $ 1.35 $ 3,633 3,081,836 $ 1.17 ========= ========= ======== ========= ========= ============= </TABLE> -8-
On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" which establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. Comprehensive income is defined as the change in equity during a period for non-owner transactions and is divided into net income and other comprehensive income. Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. This statement does not change or modify the reporting or display in the income statement. Comparative financial statements have been presented as required by the statement. The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement requires management to report selected financial data and descriptive information about reportable operating segments and is effective for periods beginning after December 15, 1997. This statement does not require application in interim financial statements in the initial year of adoption. The requirements of this standard will be applied in a manner relevant for the Company beginning with the financial statements for the year ended December 31, 1998. As of January 1, 1998, the Company also adopted Statement of Financial Accounting Standards No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits." This statement standardizes the disclosure requirements of pensions and other postretirement benefits. This statement does not change any measurement or recognition provisions, and thus has not and is not expected to materially impact the Company. The Financial Accounting Standards Board has also issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Because the Company has not historically and does not currently employ the use of derivatives, this Statement is not expected to impact the Company. NOTE 3 Certain amounts reported in the prior periods' financial statements have been reclassified to conform with the presentation for September 30, 1998. These reclassifications had no effect on net income or shareholders' equity for the periods presented, nor did they materially impact trends in financial information. NOTE 4 Based on management's evaluation of the loan portfolio, current economic conditions and other risk factors, the Company's allowance for loan losses was $5,391,000 as of September 30, 1998 compared to $4,779,000 and $4,728,000 as of December 31, 1997 and September 30, 1997, respectively. Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and foreclosed, repossessed and idled properties. For each of the periods presented, the Company had no loans past due 90 or more days and still accruing interest. Nonperforming assets are summarized as follows: -9-
<TABLE> <CAPTION> September 30, December 31, September 30, ($ in thousands) 1998 1997 1997 ---------------- ---- ---- ---- <S> <C> <C> <C> Nonperforming loans: Nonaccrual loans ...................... $ 575 957 1,148 Restructured loans ................... 251 326 291 --------- ----- ----- Total nonperforming loans ................ 826 1,283 1,439 Foreclosed, repossessed, and idled properties (included in other assets) 515 560 404 --------- ----- ----- Total nonperforming assets ............... $ 1,341 1,843 1,843 ========= ===== ===== Nonperforming loans to total loans ....... 0.24% 0.46% 0.55% Allowance for loan losses to nonperforming loans .................. 652.66% 372.49% 328.56% Nonperforming assets as a percentage of loans and foreclosed, repossessed, and idled properties .................. 0.39% 0.66% 0.71% Nonperforming assets to total assets ..... 0.28% 0.46% 0.50% Allowance for loan losses to total loans . 1.56% 1.70% 1.81% </TABLE> NOTE 5 Loans are shown on the Consolidated Balance Sheets net of approximately $10,000 of unearned income for each of the periods presented. -10-
Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition RESULTS OF OPERATIONS OVERVIEW Net income for the three months ended September 30, 1998 was $1,482,000, a 16.9% increase over the $1,268,000 reported in the third quarter of 1997. Basic earnings per share for the third quarter of 1998 amounted to $0.49, an increase of 16.7% over the $0.42 recorded in third quarter of 1997. Diluted earnings per share for the third quarter of 1998 amounted to $0.48, an increase of 17.1% over the $0.41 recorded in the third quarter of 1997. Net income for the nine months ended September 30, 1998 was $4,178,000, a 15.0% increase over the $3,633,000 reported for the first nine months of 1997. Basic earnings per share for the nine months ended September 30, 1998 increased 15.0% to $1.38 per share compared to $1.20 per share reported for the same nine month period in 1997. Earnings per share on a diluted basis amounted to $1.35 per share for the nine months ended September 30, 1998, a 15.4% increase over the $1.17 per share for the same nine months of 1997. The increase in net income for the three and nine month periods ended September 30, 1998 is primarily due to an increase in net interest income earned by the Company. Net interest income increased 15.7% and 17.0% for the three and nine month periods ended September 30, 1998, respectively, when compared to the same three and nine month periods of 1997. The increases in net interest income are largely attributable to loan and deposit growth, the effects of which were partially offset by lower net interest margins. Also partially offsetting the increases in net interest income were higher provisions for loan losses for the three and nine month periods ended September 30, 1998 as compared to the same periods of 1997, which were recorded in response to the high growth in loans experienced by the Company. Noninterest income increased by 16.5% and 11.9% for the three and nine month periods ended September 30, 1998, respectively, when compared to the same periods of 1997. The increases in noninterest income were partially due to gains of $66,000 and $213,000 recorded for the three and nine month periods ended September 30, 1998, respectively, realized from the sale of commercial loans. These loans were sold primarily to maintain a proper balance between the amount of loans and deposits that the Company maintains. Without these gains, noninterest income increased 9.9% for the three months ended September 30, 1998 and 5.0% for the nine months ended September 30, 1998. Noninterest expenses increased by 11.2% and 11.5% for the three and nine month periods ended September 30, 1998, respectively, when compared to the same periods of 1997, due primarily to the increase in the Company's branch network. COMPONENTS OF EARNINGS Net interest income is the largest component of earnings, representing the difference between interest and fees generated from earning assets and the interest costs of deposits and other funds needed to support those assets. Net interest income for the third quarter of 1998 increased by $729,000, or 15.7%, compared to the third quarter of 1997, while net interest income for the first nine months of 1998 increased by $2,250,000, or 17.0%, compared to the first nine months of 1997. The increase in net interest income was due to growth in the Company's loans and deposits. The Company's total loans at September 30, 1998 of $345.3 million were 32.4% higher than the $260.7 million recorded at September 30, 1997. Average loans outstanding for the third quarter of 1998 and the first nine months of 1998 were 32.9% and 33.5%, respectively, greater than the average loans outstanding for the comparable periods of -11-
1997. The Company's total deposits at September 30, 1998 of $412.5 million were 26.0% higher than the $327.5 million recorded at September 30, 1997. Average deposits outstanding for the third quarter of 1998 and the first nine months of 1998 were 25.5% and 23.8%, respectively, greater than the average deposits outstanding for the comparable periods of 1997. Contributing to the deposit growth was the Company's November 1997 branch purchase that included $14 million in deposits. No loans were acquired in the branch purchase. Partially offsetting the incremental net interest income earned on the loan and deposit growth was a reduction in the Company's net interest margin caused by a flatter yield curve and a highly competitive pricing environment. The Company's tax-equivalent net interest margin for the third quarter of 1998 decreased 55 basis points to 5.14% from the 5.69% margin realized in the third quarter of 1997, while the net interest margin for the first nine months of 1998 was 38 basis points lower than for the first nine months of 1997 (5.32% vs. 5.70%). The decrease in the Company's net interest margin was a result of lower yields on interest earning assets, as well as a higher cost of funds. The following table presents average rates earned/paid by the Company for the third quarter of 1998 compared to the third quarter of 1997: <TABLE> <CAPTION> For the Three For the Three Months Ended Months Ended September 30, September 30, 1998 1997 ---- ---- <S> <C> <C> Yield on loans .................................. 9.25% 9.67% Yield on taxable securities ..................... 6.21% 6.65% Yield on non-taxable securities (tax equivalent). 8.60% 8.69% Yield on other interest earning assets, primarily overnight funds ..................... 5.62% 5.41% Yield on all interest earning assets ............ 8.69% 9.04% Weighted average rate on savings, NOW, and money market deposits ..................... 2.37% 2.37% Rate on time deposits greather than $100,000 .... 5.88% 5.74% Rate on other time deposits ..................... 5.38% 5.30% Rate on short-term borrowings .................. 5.67% n/a Rate on all interest bearing liabilities ........ 4.24% 4.04% Interest rate spread ............................ 4.45% 5.00% </TABLE> Partially offsetting the effect of the increase in net interest income on net income was an increase in the provision for loan losses recorded by the Company, which was higher in 1998 for both the three and nine month periods ended September 30, 1998 than it was for the comparable periods of 1997. The $250,000 provision for loan losses for the third quarter of 1998 was twice the $125,000 recorded in the third quarter of 1997. The $740,000 provision for loan losses for the nine months ended September 30, 1998 was 127.7% higher than the $325,000 recorded in the nine months ended September 30, 1997. These increases in the provision for loan losses were primarily in response to the higher loan growth experienced by the Company in 1998 compared to 1997, and not credit quality concerns. Loans grew by $64.8 million in the first nine months of 1998 compared to $37.7 million for the first nine months of 1997, while credit quality ratios at September 30, 1998 are improved compared to September 30, 1997 (see discussion below). Provisions for loan losses are based on management's evaluation of the loan portfolio, as discussed under "Summary of Loan Loss Experience" below. -12-
Noninterest income increased $166,000, or 16.5%, to $1,173,000 in the third quarter of 1998 from $1,007,000 for the third quarter of 1997. Noninterest income for the first nine months of 1998 increased $366,000, or 11.9%, to $3,446,000 compared to $3,080,000 for the first nine months of 1997. The increases in noninterest income were partially due to the sales of commercial loans that resulted in pretax gains of $66,000 and $213,000 for the three and nine month periods in 1998, respectively. These loans were 1998 originations. There were no similar gains from loan sales recorded in 1997. These loans were sold primarily to maintain a proper balance between the amount of loans and deposits that the Company maintains. Without these gains, noninterest income increased 9.9% for the three months ended September 30, 1998 and 5.0% for the nine months ended September 30, 1998. The increases in noninterest income in 1998 not due to the loan sales were primarily a result of increases in fees collected on presold mortgage originations and ATM surcharges on non-customer transactions. The increases in these revenues were largely offset by the absence of data processing revenue that the Company earned in 1997 from its lone third-party data processing customer that was acquired by another financial institution and thus terminated its contract with the Company in the fourth quarter of 1997. Fees collected on presold mortgage originations increased by $157,000 to $365,000 for the first nine months of 1998 as a result of heavy mortgage loan origination volume. The Company began assessing a surcharge on non-customer ATM transactions in March 1998. This income amounted to $99,000 for the nine months ended September 30, 1998. The Company earned $216,000 in the first nine months of 1997 from the aforementioned data processing client that was not replaced in 1998. Noninterest expenses increased by $402,000, or 11.2%, from $3,601,000 to $4,003,000, for the third quarter of 1998 compared to the third quarter of 1997. Noninterest expenses for the first nine months of 1998 increased $1,221,000, or 11.5%, over the first nine months of 1997. The increases for both periods are due primarily to the Company's growth in its branch network, which has grown from 30 to 35 branches since January 1, 1997, as well as growth in its customer base and the corresponding expenses necessary to process, manage and service the Company's 32% increase in loans and 26% increase in deposits. Personnel expense, the single largest component of noninterest expense, increased 21.0% and 15.5% for the three and nine month periods ended September 30, 1998, respectively, compared to the same periods of 1997. These increases were primarily due to additional employees associated with the Company's growth as well as normal wage increases for substantially all Company employees that occurred in January 1998. Income taxes increased $154,000, or 23.7%, for the third quarter of 1998 over the third quarter of 1997. This reflects an effective tax rate of 35.2% for the third quarter of 1998 compared to 33.9% for the third quarter of 1997. The effective tax rate for the nine months ended September 30, 1998 was 34.8% compared to 33.1% for the same nine months of 1997. The increase in the effective tax rates for the respective periods was due to the Company deriving a smaller percentage of its earnings from tax-exempt securities. FINANCIAL CONDITION The Company's total assets were $470.5 million at September 30, 1998, an increase of $102.4 million, or 27.8%, from the $368.1 million at September 30, 1997. Interest-earning assets increased by 29.1%, from $339.1 million to $437.9 million, compared to September 30, 1997. Loans, the primary interest-earning asset, increased by $84.6 million, or 32.4% during this same period. Deposits increased $85.1 million, or 26.0%, to support the asset growth, of which approximately $14 million was acquired in the Company's November 1997 branch purchase in Lillington. The increase in deposits occurred in all significant categories with noninterest bearing demand deposits increasing by $11.5 million, or 24.6%; -13-
savings, NOW and money market accounts increasing by $24.2 million, or 19.5%; time deposits of $100,000 or more increasing by $19.1 million, or 53.9%; and other time deposits increasing by $30.2 million, or 25.0%. The 53.9% increase in time deposits of $100,000 or more was due to the Company more aggressively pricing these deposits to provide funding for the strong loan growth experienced. The Company has not traditionally engaged in obtaining deposits through brokers and had no such deposits during 1997 or 1998. Since December 31, 1997, the Company has experienced increases of 18.7%, 16.9%, and 14.2% in earning assets, total assets and deposits, respectively. NONPERFORMING ASSETS Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and foreclosed, repossessed and idled properties. For each of the periods presented, the Company had no loans past due 90 or more days and still accruing interest. Nonperforming assets are summarized as follows: <TABLE> <CAPTION> September 30, December 31, September 30, ($ in thousands) 1998 1997 1997 ---------------- ---- ---- ---- <S> <C> <C> <C> Nonperforming loans: Nonaccrual loans ..................... $ 575 957 1,148 Restructured loans ................... 251 326 291 --------- --- ----- Total nonperforming loans ............... 826 1,283 1,439 Foreclosed, repossessed, and idled properties (included in other assets) 515 560 404 --------- --- ----- Total nonperforming assets .............. $ 1,341 1,843 1,843 ========= ===== ===== Nonperforming loans to total loans ...... 0.24% 0.46% 0.55% Allowance for loan losses to nonperforming loans ................ 652.66% 372.49% 328.56% Nonperforming assets as a percentage of loans and foreclosed, repossessed, and idled properties ................. 0.39% 0.66% 0.71% Nonperforming assets to total assets .... 0.28% 0.46% 0.50% Allowance for loan losses to total loans 1.56% 1.70% 1.81% </TABLE> Management has reviewed the collateral for the nonperforming assets, including nonaccrual loans, and has included this review among the factors considered in the evaluation of the allowance for loan losses discussed below. A loan is placed on nonaccrual status when, in management's judgment, the collection of principal or interest appears doubtful. While a loan is on nonaccrual status, the Company's policy is that all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone. The accrual of interest is discontinued on all loans that become 90 days past due with respect to principal or interest. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms. Nonperforming loans are defined as nonaccrual loans and restructured loans. As of September 30, 1998, December 31, 1997 and September 30, 1997, nonperforming loans were approximately 0.24%, 0.46%, and 0.55%, respectively, of the total loans outstanding at such dates. Nonaccrual loans as of September 30, 1998 decreased $573,000, or 49.9%, from September 30, 1997 to approximately $575,000 -14-
and are lower by approximately $382,000, or 39.9%, since year-end. The decrease in nonaccrual loans at September 30, 1998 as compared to December 31, 1997 and September 30, 1997 is primarily attributable to generally improved loan quality, as well as the full payout of two nonaccrual relationships each totaling approximately $230,000 that occurred in the fourth quarter of 1997 and the first quarter of 1998 (one payout of $230,000 in each quarter). As of September 30, 1998, the borrower with the largest nonaccrual loan owed a balance of $220,000 while the average nonaccrual loan balance was approximately $24,000. If the nonaccrual loans and restructured loans as of September 30, 1998 and 1997 had been current in accordance with their original terms and had been outstanding throughout the nine month periods (or since origination or acquisition if held for part of the nine month periods), gross interest income in the amounts of approximately $42,000 and $79,000 for nonaccrual loans and $20,000 and $21,000 for restructured loans would have been recorded for the nine months ended September 30, 1998 and 1997, respectively. Interest income on such loans that was actually collected and included in net interest income in the nine months ended September 30, 1998 and 1997 amounted to approximately $7,000 and $31,000, respectively, for nonaccrual loans (prior to their being placed on nonaccrual status) and $19,000 and $16,000, respectively, for restructured loans. The FASB has issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which requires that all creditors value all specifically reviewed loans for which it is probable that the creditor will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. The FASB also has issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures," that amends Standard No. 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan and by requiring additional disclosures about how a creditor recognizes interest income related to impaired loans. SFAS No.'s 114 and 118 do not apply to large groups of smaller-balance homogenous loans that are collectively evaluated for impairment. For the Company, these loans include residential mortgage and consumer installment loans. Consistent with SFAS No. 114, management considers loans to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured using either the discounted expected cash flows or the value of collateral method. While a loan is considered to be impaired, the Company's policy is that all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone. At September 30, 1998, December 31, 1997, and September 30, 1997 the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $29,000, $398,000, and $512,000, respectively, all of which were on a nonaccrual basis. The changes in the level of impaired loans at the respective period ends is primarily attributable to improved loan quality, as well as the payouts of the two $230,000 loans mentioned above that occurred in the fourth quarter or 1997 and the first quarter of 1998. The related allowance for loan losses for these impaired loans as determined in accordance with SFAS No. 114 was $4,000, $60,000, and $107,000, respectively. There were no impaired loans for which there was no related allowance determined in accordance with the statement. The average recorded investments in impaired loans during the nine month period ended September 30, 1998, the year -15-
ended December 31, 1997, and the nine months ended September 30, 1997 were approximately $138,000, $654,000, and $718,000, respectively. For the same periods, the Company recognized no interest income on those impaired loans during the period that they were considered to be impaired. In addition to the nonperforming loan amounts discussed above, management believes that an estimated $1,300,000-$1,500,000 of loans that are currently performing in accordance with their contractual terms may potentially develop problems, depending upon the particular financial situations of the borrowers and economic conditions in general. These loans were considered in determining the appropriate level of the allowance for loan losses. See "Summary of Loan Loss Experience" below. Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed in the problem loan amounts above do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. As of September 30, 1998, December 31, 1997 and September 30, 1997, the Company owned foreclosed, repossessed, and idled assets totaling approximately $515,000, $560,000, and $404,000, respectively, which consisted principally of several parcels of foreclosed real estate. The Company's management has reviewed recent appraisals of these properties and believes that their fair values, less estimated costs to sell, exceed their respective carrying values as of the dates presented. SUMMARY OF LOAN LOSS EXPERIENCE The allowance for loan losses is created by direct charges to operations. Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management's judgment in determining the amount charged to operating expense include past loan loss experience, composition of the loan portfolio, evaluation of possible future losses and current economic conditions. The Company's bank subsidiary uses a loan analysis and grading program to facilitate its evaluation of possible future loan losses and the adequacy of its allowance for loan losses, otherwise referred to as its loan loss reserve. In this program, a "watch list" is prepared and monitored monthly by management and is tested quarterly by the bank's Internal Audit Department. The list includes loans that management identifies as having potential credit weaknesses in addition to loans past due 90 days or more, nonaccrual loans and remaining unpaid loans identified during previous examinations. Based on management's evaluation of the loan portfolio and economic conditions, a provision for loan losses of $250,000 was added to the allowance for loan losses during the three months ended September 30, 1998. The $250,000 provision for loan losses was double the $125,000 recorded in the third quarter of 1997. The $740,000 provision for loan losses for the nine months ended September 30, 1998 was 127.7% higher than the $325,000 recorded in the nine months ended September 30, 1997. The increase in the provision for loan losses was primarily in response to the higher loan growth experienced by the Company in 1998 compared to 1997, and not credit quality concerns. Loans grew by $64.8 million in the first nine months of 1998 compared to $37.7 million for the first nine months of 1997, while credit quality ratios at September 30, 1998 were improved compared to September 30, 1997. At September 30, 1998, the allowance stood at $5,391,000, compared to $4,779,000 at December 31, 1997 and $4,728,000 -16-
at September 30, 1997. At September 30, 1998, the allowance for loan losses was approximately 653% of total nonperforming loans, compared to corresponding percentages of 372% at December 31, 1997 and 329% at September 30, 1997. The allowance for loan losses was 1.56%, 1.70% and 1.81% of total loans as of September 30, 1998, December 31, 1997 and September 30, 1997, respectively. The allowance for loan losses as a percentage of total loans has been gradually decreasing since its high of 2.81% at September 30, 1994. The September 30, 1994 high of 2.81% was an increase from the 1.79% ratio at June 30, 1994 due primarily to an addition to the allowance of $2.5 million that was recorded in the third quarter of 1994 in connection with a corporate acquisition in which a higher risk loan portfolio was assumed. The general decrease in the ratio of allowance for loan losses to total loans since then has been largely due to charge-offs associated with that portfolio, strong recent loan growth, as well as generally improved overall loan quality. Management believes the reserve levels are adequate to cover possible loan losses on the loans outstanding as of each reporting date. It must be emphasized, however, that the determination of the reserve using the Company's procedures and methods rests upon various judgments and assumptions about future economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowances for loan losses and losses on other real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available at the time of such examinations. For the periods indicated, the following table summarizes the Company's balances of loans outstanding, average loans outstanding, changes in the allowance for loan losses arising from charge-offs and recoveries by category, and additions to the allowance for loan losses that have been charged to expense. -17-
<TABLE> <CAPTION> Nine Months Year Nine Months Ended Ended Ended September 30, Dec. 31, September 30, ($ in thousands) 1998 1997 1997 --------- ------- ------- <S> <C> <C> <C> Loans outstanding at period end ........... $ 345,295 280,513 260,699 ========= ======= ======= Average loans outstanding during period ... $ 317,155 245,596 237,485 ========= ======= ======= Allowance for loan losses at beginning of period .................... $ 4,779 4,726 4,726 Loans charged off: Commercial, financial and agricultural . (35) (61) (25) Real estate - mortgage ................. (44) (449) (336) Installment loans to individuals ....... (166) (311) (230) --------- ------- ------- Total charge-offs ................... (245) (821) (591) --------- ------- ------- Recoveries of loans previously charged-off: Commercial, financial and agricultural . 21 89 81 Real estate - mortgage ................. 16 38 21 Installment loans to individuals ....... 80 141 117 Other .................................. -- 31 49 --------- ------- ------- Total recoveries .................... 117 299 268 --------- ------- ------- Net charge-offs ........................... (128) (522) (323) Provision for loan losses ................. 740 575 325 --------- ------- ------- Allowance for loan losses at end of period $ 5,391 4,779 4,728 ========= ===== ===== Ratios: Annualized net charge-offs to average loans during period .................. 0.05% 0.21% 0.18% Allowance for loan losses to loans at end of period ............... 1.56% 1.70% 1.81% Allowance for loan losses as a multiple of annualized net charge-offs ........ 31.53x 9.16x 10.94x Provision for loan losses as a percent of net charge-offs ................... 578.13% 110.15% 100.62% Recoveries of loans previously charged- off as a percent of loans charged-off 47.76% 36.42% 45.35% </TABLE> Based on the results of the aforementioned loan analysis and grading program and management's evaluation of the allowance for loan losses at September 30, 1998, there have been no material changes to the allocation of the allowance for loan losses among the various categories of loans since December 31, 1997.
LIQUIDITY The Company's liquidity is determined by its ability to convert assets to cash or acquire alternative sources of funds to meet the needs of its customers who are withdrawing or borrowing funds, and to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. The Company's primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. In addition, the Company (through its bank subsidiary) has -18-
the ability, on a short-term basis, to purchase federal funds from other financial institutions and has an available line of credit with the Federal Home Loan Bank in place that can provide short or long term financing. The Company has not traditionally had to rely on these sources of credit as a source of liquidity. The Company has experienced an increase in its loan to deposit ratio (83.7% at September 30, 1998 compared to 79.6% a year earlier) as a result of the significant loan growth that has reduced the Company's liquidity sources. To ensure satisfactory liquidity, during the second quarter of 1998 the Company increased its available line of credit with the Federal Home Loan Bank of Atlanta (the "FHLB") from $36 million to $50 million. In addition, during the third quarter of 1998, the Company made periodic draws and repayments on this line of credit on an overnight basis to maintain liquidity ratios at levels complying with the Company's internal policies. At September 30, 1998, the Company had outstanding borrowings with the FHLB totaling $13 million, while the average amount outstanding for the third quarter was $7.4 million. The Company's management believes its liquidity sources are at an acceptable level and remain adequate to meet its operating needs. CAPITAL RESOURCES The Company is required by its own policies and by applicable federal regulations to maintain certain capital levels. The Company's ratio of stated capital to total assets exceeded 8% as of September 30, 1998 and 1997, and December 31, 1997. In an effort to achieve a measurement of capital adequacy that is sensitive to the individual risk profiles of financial institutions, the various financial institution regulators have minimum capital guidelines that categorize various components of capital and types of assets and measure capital adequacy in relation to the financial institution's relative level of those capital components and the level of risk associated with various types of assets of that financial institution. The guidelines call for minimum adjusted total capital of 8% of risk-adjusted assets. As of September 30, 1998, the Company's total risk-based capital ratio was 11.11%. In addition to the risk-based capital requirements described above, the Company is subject to a leverage capital requirement, which calls for a minimum ratio of leverage capital, as defined in the regulations, to quarterly average total assets of 3-5%. As of September 30, 1998, the Company's leverage capital ratio was 7.41%. The Company is not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on its liquidity, capital resources, or operations. -19-
As of September 30, 1998, December 31, 1997 and September 30, 1997, the Company was in compliance with all existing regulatory capital requirements, as summarized in the following table: <TABLE> <CAPTION> September 30, Dec. 31, September 30, ($ in thousands) 1998 1997 1997 - ---------------- ---- ---- ---- <S> <C> <C> <C> Tier I capital: Total stated shareholders' equity $ 39,633 36,765 35,727 Less: Intangible assets 5,995 6,487 5,192 Unrealized gain on securities available for sale, net of income taxes 222 186 185 ------------ ------- ------- Total Tier I leverage capital 33,416 30,092 30,350 Tier II capital: Allowable allowance for loan losses 4,178 3,466 3,217 ------------ ------- ------- Total capital $ 37,594 33,558 33,567 ============ ====== ====== Risk-adjusted assets $ 340,425 283,924 262,735 Tier I risk-adjusted assets (includes Tier I capital adjustments) 334,208 277,251 257,358 Tier II risk adjusted assets (includes Tiers I and II capital adjustments) 338,386 280,717 260,575 Quarterly average total assets 456,878 386,291 362,601 Adjusted quarterly average total assets (includes Tier I capital adjustments) 450,661 379,618 357,224 Risk-based capital ratios: Tier I capital 10.00% 10.85% 11.79% Minimum required Tier I capital 4.00% 4.00% 4.00% Total risk-based capital 11.11% 11.95% 12.88% Minimum required total risk-based capital 8.00% 8.00% 8.00% Leverage capital ratios: Tier I leverage capital ratio 7.41% 7.93% 8.50% Minimum required Tier I leverage capital 3-5.00% 3-5.00% 3-5.00% </TABLE> UPDATE ON YEAR 2000 The Company recognizes and is addressing the potentially severe implications of the "Year 2000 Issue." The "Year 2000 Issue" is a general term used to describe the various problems that may result from the improper processing of dates and date-sensitive calculations as the Year 2000 approaches. This issue is caused by the fact that many of the world's existing computer programs use only two digits to identify the year in the date field of a program. These programs were designed and developed without considering the impact of the upcoming change in the century and could experience serious malfunctions when the last two digits of the year change to "00" as a result of identifying a year designated "00" as the year 1900 rather than the year 2000.
This misidentification could prevent the Company from being able to engage in normal business operations, including, among other things, miscalculating interest accruals and the inability to process customer transactions. Because of the potentially serious ramifications of the Year 2000 Issue, the Company is taking the Year 2000 Issue very seriously. The Company's Technology Committee, which is comprised of a cross-section of the Company's employees, is leading the Company's Year 2000 efforts and involving all employees of the Company in -20-
ensuring that the Company is properly prepared for the Year 2000. The Company's Board of Directors has approved a plan submitted by the Technology Committee that was developed in accordance with guidelines set forth by the Federal Financial Institutions Examination Council. This plan has three primary phases related to internal Year 2000 compliance. The first phase of the Company's efforts to address the Year 2000 Issue was to inventory all known Company processes that could reasonably be expected to be impacted by the Year 2000 Issue and their related vendors, if applicable. This inventory of processes and vendors included not only typical computer processes such as the Company's transaction applications systems, but all known processes that could be impacted by micro-chip malfunctions. These include but are not limited to the Company's alarm system, phone system, check ordering process, and ATM network. This phase is complete, although it is periodically updated as necessary. The Company's second phase in addressing the Year 2000 Issue was to contact all third party vendors, request documentation regarding their Year 2000 compliance efforts, and analyze the responses. This was a significant phase because the Company does not perform in-house programming, and thus is dependent on external vendors to ensure and modify, if necessary, the hardware, software, or service they provide to the Company to be Year 2000 compliant. This phase is now virtually complete and the Company is currently following up on any issues or concerns identified in the responses received, as necessary. The next phase for the Company under the plan is to complete a comprehensive testing of all known processes. Initially, processes are to be tested on a stand-alone basis and then the testing will involve multiple interfacing processes. Testing of the Company's processes has begun and is scheduled to be substantially complete by the end of 1998. Management plans for any corrective actions to be implemented to ensure that the Company is fully prepared for the Year 2000 by the end of the first quarter of 1999. The most significant phase of testing is the testing of the Company's core software applications. Upgrades of the core software applications currently used by the Company were received from the software vendor in June 1998 and were represented to be Year 2000 compliant by the vendor. These applications were successfully loaded onto the Company's hardware system in early July 1998 and Year 2000 testing began in September 1998. While testing is not complete, to date the Company has not identified any significant problems or deficiencies in the applications. Another part of the Company's Year 2000 plan is to assess the Year 2000 readiness of its significant borrowers and depositors. Through the use of questionnaires and personal contacts, the Company has assessed the Year 2000 readiness of significant borrowers and depositors of the Company. Customers who the Company has Year 2000 concerns about are being counseled on the Year 2000 Issue, urged to take action, and placed on an internal watch list that will be updated on a quarterly basis and reviewed and monitored by the Company for any potential effects on the Company. The initial list of these customers will be completed in the fourth quarter of 1998 and evaluated by management. Based on the information gathered to date, management of the Company believes that the number and magnitude of customers with potential Year 2000 problems will not be significant. Prospective new loan customers are also assessed for Year 2000 compliance as a part of the underwriting process of significant loans.
In the Company's 1997 Form 10-K, the Company disclosed an estimated range of total costs to address the Year 2000 Issue to be from $100,000 to $150,000. During the second quarter of 1998, management determined that the estimated cost to modify the Company's automated teller machines (ATMs) would likely be higher than originally projected. As a result, the Company now projects the total costs to address the Year 2000 Issue to be from $175,000 to $200,000. Other than the estimated -21-
cost to make the Company's ATMs Year 2000 compliant, the Company has not identified any processes that will require significant expenditures to address the Year 2000 Issue. The majority of these costs are expected to be incurred and expensed by the Company during the fourth quarter of 1998 or the first quarter of 1999. Year 2000 project costs during the three and nine month periods ended September 30, 1998 amounted to $20,000. Although funding of the Year 2000 project costs will come from normal operating cash flow, the expenses associated with the Year 2000 Issue will directly reduce otherwise reported net income for the Company. Management of the Company believes that the potential effects on the Company's internal operations of the Year 2000 Issue can and will be addressed prior to the Year 2000. However, if required modifications or conversions are not made or are not completed on a timely basis prior to the Year 2000, the Year 2000 Issue could disrupt normal business operations. The most reasonably likely worst case Year 2000 scenarios foreseeable at this time would include the Company temporarily not being able to process, in some combination, various types of customer transactions. This could affect the ability of the Company to, among other things, originate new loans, post loan payments, accept deposits or allow immediate withdrawals, and, depending on the amount of time such a scenario lasted, could have a material adverse effect on the Company. Because of the serious implications of these scenarios, the primary emphasis of the Company's Year 2000 efforts is to correct, with complete replacement if necessary, any systems or processes whose Year 2000 test results are not satisfactory prior to the Year 2000. Nevertheless, should one of the most reasonably likely worst case scenarios occur in the Year 2000, the Company is also in the process of formalizing a contingency plan (that should be complete by January 1999) that would allow for limited transactions, including the ability to make certain deposit withdrawals, until the Year 2000 problems are remediated. The costs of the Year 2000 project and the date on which the Company plans to complete Year 2000 compliance are based on management's best estimates, which were derived using numerous assumptions of future events such as the availability of certain resources (including internal and external resources), third party vendor plans and other factors. However, there can be no guarantee that these estimates will be achieved at the cost disclosed or within the time frame indicated, and actual results could differ materially from these plans. Factors that might affect the timely and efficient completion of the Company's Year 2000 project include, but are not limited to, vendors' abilities to adequately correct or convert software and the effect on the Company's ability to test its systems, the availability and cost of personnel trained in the Year 2000 area, the ability to identify and correct all relevant computer programs and similar uncertainties. Item 3. Quantitative and Qualitative Disclosures About Market Risk INTEREST RATE RISK (INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK) Net interest income is the Company's most significant component of earnings. Notwithstanding changes in volumes of loans and deposits, the Company's level of net interest income is continually at risk due to the effect that changes in general market interest rate trends have on interest yields earned and paid with respect to the various categories of earnings assets and interest-bearing liabilities. It is the Company's policy to maintain portfolios of earning assets and interest-bearing liabilities with maturities and repricing opportunities that will afford protection, to the extent practical, against wide interest rate fluctuations. The Company's exposure to interest rate risk is analyzed on a regular basis by management using standard GAP reports, maturity reports, and an asset/liability software model that simulates future -22-
levels of interest income and expense based on current interest rates, expected future interest rates, and various intervals of "shock" interest rates. Over the years, the Company has been able to maintain a fairly consistent net yield on average earning assets (net interest margin). Over the past ten fiscal years the net interest margin has not varied by more than 25 basis points in any single fiscal year and the lowest net interest margin realized over that same period is within 60 basis points of the highest. While the Company can not guarantee similar stability in the net interest margin in the future, at this time management does not expect significant fluctuations. The Company has experienced a decrease in its net interest margin during 1998, and it is likely that the Company's net interest margin for fiscal 1998 will be more than 25 basis points lower than the 5.65% realized during 1997 - see additional discussion in the "Components of Earnings" section above. As of September 30, 1998, the Company had approximately $91 million more in interest-bearing liabilities that are subject to interest rate changes within one year than earning assets. This generally would indicate that net interest income would experience downward pressure in a rising interest rate environment and would benefit from a declining interest rate environment. However, this method of analyzing interest sensitivity only measures the magnitude of the timing differences and does not address earnings, market value, or management actions. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. In addition to the effects of "when" various rate-sensitive products reprice, market rate changes may not result in uniform changes in rates among all products. For example, included in interest-bearing liabilities at September 30, 1998 subject to interest rate changes within one year are deposits totaling $148.5 million comprised of NOW, savings, and certain types of money market deposits with interest rates set by management. These types of deposits historically have not repriced coincidentally with or in the same proportion as general market indicators. Thus, the Company believes that near term net interest income would not likely experience significant downward pressure from rising interest rates. Similarly, management would not expect a significant increase in near term net interest income from falling interest rates. As of September 30, 1998, approximately 88% of interest-earning assets could be repriced within five years and substantially all interest-bearing liabilities could be repriced within five years. The Company has no market risk sensitive instruments held for trading purposes, nor does it maintain any foreign currency positions. The following table presents the expected maturities of the Company's other than trading market risk sensitive financial instruments. The following table also presents the fair values of market risk sensitive instruments as estimated in accordance with Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments." -23-
<TABLE> <CAPTION> Expected Maturities of Market Sensitive --------------------------------------------------------------------------- Instruments Held at September 30, 1998 Average Estimated Interest Fair ($ in thousands) 1 Year 2 Years 3 Years 4 Years 5 Years Beyond Total Rate (1) Value - ---------------- ------ ------- ------- ------- ------- ------ ----- -------- ----- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Debt Securities- at amortized cost (2) $ 23,603 7,285 11,526 2,153 4,179 7,698 56,444 7.13% $ 57,597 Loans - fixed (3) .... 37,333 26,874 31,334 15,903 43,529 21,841 176,814 8.97% 176,823 Loans - adjustable (3) 80,071 19,493 19,066 12,631 21,121 15,524 167,906 9.10% 167,906 -------- ----- ------ ----- ----- ----- ------ -------- Total .............. $141,007 53,652 61,926 30,687 68,829 45,063 401,164 8.77% $402,326 ======== ====== ====== ====== ====== ====== ======= ==== ======== Savings, NOW, and money market deposits ........... $148,535 -- -- -- -- -- 148,535 2.24% $148,535 Time deposits ........ 172,099 22,653 6,424 1,936 2,506 10 205,628 5.46% 206,278 -------- ----- ------ ----- ----- ----- ------ -------- Total .............. $320,634 22,653 6,424 1,936 2,506 10 354,163 4.11% $354,813 ======== ====== ===== ===== ===== ===== ======= ==== ======== </TABLE> (1) Tax-exempt securities are reflected at a tax-equivalent basis using a 34% tax rate. (2) Callable securities with above market interest rates at September 30, 1998 are assumed to mature at their call date for purposes of this table. Mortgage-backed securities and collateralized mortgage obligations are assumed to mature, lump sum, in the year consistent with their estimated weighted average life. (3) Excludes nonaccrual loans and allowance for loan losses. The Company's fixed rate earning assets have estimated fair values that are slightly higher than their carrying value. This is due to the yields on these portfolios being slightly higher than market yields at September 30, 1998 for instruments with maturities similar to the remaining term of the portfolios due to a generally declining interest rate environment during the year. The estimated fair value of the Company's time deposits is higher than its book value for the same reason. FORWARD LOOKING STATEMENTS The foregoing discussion contains statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as "expect," "believe," "estimate," "plan," "project," or other statements concerning opinions or judgment of the Company and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of the Company's customers, actions of government regulators, the level of market interest rates, and general economic conditions. -24-
Part II. Other Information Item 5 - Other Information The bylaws of the Company establish an advance notice procedure for shareholder proposals to be brought before a meeting of shareholders of the Company. Subject to any other applicable requirements, only such business may be conducted at a meeting of the shareholders as has been brought before the meeting by, or at the direction of, the Board of Directors or by a shareholder who has given to the Secretary of the Company timely written notice, in proper form, of the shareholder's intention to bring that business before the meeting. The presiding officer at such meeting has the authority to make such determinations. To be timely, notice of other business to be brought before any meeting must generally be received by the Secretary of the Company within 60 to 90 days in advance of the shareholders' meeting. The notice of any shareholder proposal must set forth the various information required under the bylaws. The person submitting the notice must provide, among other things, the name and address under which such Shareholder appears on the Company's books and the class and number of shares of the Company's capital stock that are beneficially owned by such Shareholder. Any shareholder desiring a copy of the Company's bylaws will be furnished one without charge upon written request to the Secretary of the Company at the Company's headquarters. Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits The following exhibits are filed with this report or, as noted, are incorporated by reference. Management contracts, compensatory plans and arrangements are marked with an asterisk (*). 3.a.i Copy of Articles of Incorporation of the Registrant and amendments thereto, was filed as Exhibit 3(a) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 3.a.ii Copy of the amendment to Articles of Incorporation - adding a new Article Nine, filed as exhibit 3(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, and is incorporated herein by reference. 3.b.i Copy of the Bylaws of the Registrant and amendments thereto, was filed as Exhibit 3(b) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1994, and is incorporated herein by reference. 10 Material Contracts 10.a Data processing Agreement dated October 1, 1984 by and between Bank of Montgomery (First Bank) and Montgomery Data Services, Inc. was filed as Exhibit 10(k) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 10.b First Bank Salary and Incentive Plan, as amended, was filed as Exhibit 10(m) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. (*) -25-
10.c First Bancorp Savings Plus and Profit Sharing Plan (401(k) savings incentive plan and trust), as amended January 25, 1994 and July 19, 1994, was filed as Exhibit 10(c) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1994, and is incorporated herein by reference. (*) 10.d Directors and Officers Liability Insurance Policy of First Bancorp, dated July 16, 1991, was filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, and is incorporated herein by reference. 10.e Indemnification Agreement between the Company and its Directors and Officers was filed as Exhibit 10(t) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 10.f First Bancorp Employees' Pension Plan, as amended on August 16, 1994, was filed as Exhibit 10(g) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1994, and is incorporated herein by reference. (*) 10.g First Bancorp Senior Management Supplemental Executive Retirement Plan dated May 31, 1993, was filed as Exhibit 10(k) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, and is incorporated herein by reference. (*) 10.h First Bancorp Senior Management Split-Dollar Life Insurance Agreements between the Company and the Executive Officers, as amended on December 22, 1994, was filed as Exhibit 10(i) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1994, and is incorporated herein by reference. (*) 10.i First Bancorp 1994 Stock Option Plan was filed as Exhibit 10(n) to the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 1994, and is incorporated herein by reference. (*) 10.j Severance Agreement between the Company and Patrick A. Meisky dated December 29, 1995 was filed as Exhibit 10(o) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1995, and is incorporated by reference. (*) 10.k Amendment to the First Bancorp Savings Plus and Profit Sharing Plan (401(k) savings incentive plan and trust), dated December 17, 1996, was filed as Exhibit 10(m) to the Company's Annual Report on Form 10-KSB for the year ended December 31, 1996, and is incorporated herein by reference. (*) 10.l Employment Agreement between the Company and James H. Garner dated August 17, 1998. 10.m Employment Agreement between the Company and Anna G. Hollers dated August 17, 1998. 10.n Employment Agreement between the Company and Teresa C. Nixon dated August 17, 1998. 27.1 Financial Data Schedules pursuant to Article 9 of Regulation S-X for the nine months ended September 30, 1998. (b) There were no reports filed on Form 8-K during the quarter ended September 30, 1998. -26-
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST BANCORP November 10, 1998 BY: /s/ James H. Garner -------------------- James H. Garner President (Principal Executive Officer), Treasurer and Director November 10, 1998 BY: /s/ Anna G. Hollers ------------------- Anna G. Hollers Executive Vice President and Secretary November 10, 1998 BY: /s/ Eric P. Credle ------------------ Eric P. Credle Vice President and Chief Financial Officer -27-
<TABLE> <CAPTION> EXHIBIT CROSS REFERENCE INDEX Exhibit Page(s) - ------- ------- <S> <C> <C> 3.a.i Copy of Articles of Incorporation of the Registrant * 3.a.ii Copy of the amendment to Articles of Incorporation * 3.b.i Copy of the Bylaws of the Registrant * 10.a Data processing Agreement by and between Bank of Montgomery (First Bank) and Montgomery Data Services, Inc. * 10.b First Bank Salary and Incentive Plan, as amended * 10.c First Bancorp Savings Plus and Profit Sharing Plan (401(k) savings incentive plan and trust), as amended * 10.d Directors and Officers Liability Insurance Policy of First Bancorp * 10.e Indemnification Agreement between the Company and its Directors and Officers * 10.f First Bancorp Employees' Pension Plan * 10.g First Bancorp Senior Management Supplemental Executive Retirement Plan * 10.h First Bancorp Senior Management Split-Dollar Life Insurance Agreements between the Company and the Executive Officers * 10.i First Bancorp 1994 Stock Option Plan * 10.j Severance Agreement between the Company and Patrick A. Meisky * 10.k Amendment to the First Bancorp Savings Plus and Profit Sharing Plan (401(k) savings incentive plan and trust) * 10.l Employment Agreement between the Company and James H. Garner dated August 17, 1998. 29 10.m Employment Agreement between the Company and Anna G. Hollers dated August 17, 1998. 35 10.n Employment Agreement between the Company and Teresa C. Nixon dated August 17, 1998. 41 27.1 Financial Data Schedule pursuant to Article 9 of Regulation S-X for the nine months ended September 30, 1998 (SEC copy only) 47 * Incorporated herein by reference. </TABLE> -28-