Item 1. Description of Business
THE COMPANY
Premier Financial Bancorp, Inc. (the "Company" or "Premier") is a multi-bank holding company that, as of March 15, 2005, operates ten banking offices in Kentucky, three banking offices in Ohio, and six banking offices in West Virginia. At December 31, 2004, Premier had total consolidated assets of $537.3 million, total consolidated deposits of $437.8 million and total consolidated shareholders' equity of $51.0 million. The banking subsidiaries (the "Banks" or "Affiliate Banks") consist of Citizens Deposit Bank & Trust, Vanceburg, Kentucky; Farmers Deposit Bank, Eminence, Kentucky; Ohio River Bank, Ironton, Ohio; First Central Bank, Inc., Philippi, West Virginia; and Boone County Bank, Inc., Madison, West Virginia.
On June 16, 2003 Premier announced that as a result of an ongoing internal investigation, it had uncovered a systematic disregard for its loan approval and credit administration policies at its Farmers Deposit Bank subsidiary and had accepted the resignation of the bank's former president. On November 7, 2003 Premier disclosed that the Securities and Exchange Commission had requested information about Premier's internal investigation. As the internal investigation progressed, many loans were charged off and additional provisions for loan losses were recorded. Premier's management, with the assistance of outside independent professionals, conducted a further review of those loans for which significant charge offs or additional provisions were required in 2003. The purpose of the review was to determine if the facts or circumstances that gave rise to additional charge offs or provisions had been improperly withheld from senior management or improperly considered in applying management's estimates and judgments as to the adequacy of the allowance for loan losses in financial statement periods prior to 2003. The review did identify instances in which collateral securing loans had been released without proper support or notation in loan files, instances in which obligors on notes had been released from their repayment obligation without proper support or notation in loan files and instances in which delinquent loan reporting systems had been manipulated to prevent problem loans from being identified on a timely basis. Premier's senior management determined that if these circumstances had been considered in evaluating the adequacy of the allowance for loan losses in prior periods then some of the loan charge offs and additional provisions for loan losses recorded in 2003 should have been reflected in prior periods. Therefore the financial statements for 2002 were restated, as reported in the 2003 Annual Report to Shareholders, to reflect the financial statement effect of the matters that occurred in those periods but which were improperly concealed by subsidiary management.
In the fourth quarter of 2003, the Company adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000, and on July 1, 2004 the sale transaction closed. In accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's financial statements and presented separately as "discontinued operations." See Note 2 to the consolidated financial statements included later in this report for a more detailed discussion of discontinued operations.
In 2000 Premier suspended its acquisition strategy in order to focus on improving operations, strengthening capital and management oversight and improving the profitability of the banks previously acquired. While Premier remains committed to its core strategy of rural banking with community oriented and locally named institutions, the Company may dispose of additional corporate assets that no longer meet Premier's geographic or operational performance goals. Effective January 3, 2005, Premier merged two of its subsidiary banks, Citizens Deposit Bank & Trust in Vanceburg, Kentucky and Bank of Germantown, in Germantown, Kentucky. Bank of Germantown was merged into Citizens Deposit Bank, with its facilities contining to operate as branches of Citizens Deposit Bank.
Premier is a legal entity separate and distinct from its Affiliate Banks and non-bank subsidiaries. Accordingly, the right of Premier, and thus the right of Premier's creditors and shareholders, to participate in any distribution of the assets or earnings of any of the Affiliate Banks or non-bank subsidiaries is necessarily subject to the prior claims of creditors of such subsidiaries, except to the extent that claims of Premier, in its capacity as a creditor, may be recognized. The principal source of Premier's revenue is dividends from its Affiliate Banks and non-bank subsidiaries. See "REGULATORY MATTERS -- Dividend Restrictions" for discussion of the restrictions on the Affiliate Banks' ability to pay dividends to Premier.
Premier was incorporated as a Kentucky corporation in 1991 and has functioned as a bank holding company since its formation. During 2002, Premier moved its principal executive offices from Georgetown, Kentucky to its present location at 2883 5th Avenue, Huntington, West Virginia, 25702. The purpose of the move was to be more centrally located among Premier's Affiliate Banks and its directorship. Premier's telephone number is (304) 525-1600.
BUSINESS General
Through the Banks and its data processing subsidiary, the Company focuses on providing quality, community banking services to individuals and small-to-medium sized businesses primarily in non-urban areas. By seeking to provide such banking services in non-urban areas, the Company believes that it can minimize the competitive effect of larger financial institutions that typically are focused on large metropolitan areas. Each Bank retains its local management structure which offers customers direct access to the Bank's president and other officers in an environment conducive to friendly, informed and courteous service. This approach also enables each Bank to offer local and timely decision-making, and flexible and reasonable operating procedures and credit policies limited only by a framework of centralized risk controls provided by the Company to promote prudent banking practices. See additional discussion under "Regulatory Matters" below.
Each Bank maintains its community orientation by, among other things, having selected members of its community as members of its board of directors, who assist in the introduction of prospective customers to the Bank and in the development or modification of products and services to meet customer needs. As a result of the development of personal banking relationships with its customers and the convenience and service offered by the Banks, the Banks' lending and investing activities are funded primarily by core deposits.
When appropriate and economically advantageous, the Company centralizes certain of the Banks' back office, support and investment functions in order to achieve consistency and cost efficiency in the delivery of products and services. The Company centrally provides services such as data processing, operations support, accounting, loan review, compliance and internal auditing to the Banks to enhance their ability to compete effectively. The Company also provides overall direction in the areas of credit policy and administration, strategic planning, marketing, investment portfolio management and other financial and administrative services. Each Bank participates in product development by advising management of new products and services needed by their customers and desirable changes to existing products and services.
Through Premier Data Services, Inc., the Company's data processing subsidiary, the Company currently provides centralized data processing services to four of the Banks. Beginning in late 2004 and continuing through the middle of 2005, the Company is converting its data processing system to an external third-party provider. Through the conversion process, Company senior management along with each Bank's management is reviewing and standardizing its offering of products and services, although pricing decisions will remain at the local Bank level. Furthermore, upon conversion, the Company through the Banks will offer more modern products, such as internet banking and check imaging, and will be well positioned to take advantage of emerging technologies such as image exchange to clear items.
Each of the Banks provides a wide range of retail and commercial banking services, including commercial, real estate, agricultural and consumer lending; depository and funds transfer services; collections; safe deposit boxes; cash management services; and other services tailored for both individuals and businesses. Farmers Deposit Bank in Eminence, Kentucky, also offers limited trust services and acts as executor, administrator, trustee and in various other fiduciary capacities.
The Banks' residential mortgage lending activities consist primarily of loans for purchasing personal residences or loans for commercial or consumer purposes secured by residential mortgages. Consumer lending activities consist of traditional forms of financing for automobile and personal loans. Commercial lending activities include loans to small businesses located primarily in the communities in which the Banks are located and surrounding areas. Commercial loans are secured by business assets including real estate, equipment, inventory, and accounts receivable. Some commercial loans are unsecured. Farmers Deposit Bank has previously extended loans to professional athletes and their agents and advisors. This lending activity was curtailed in 2003.
The Banks' range of deposit services includes checking accounts, NOW accounts, savings accounts, money market accounts, club accounts, individual retirement accounts, certificates of deposit and overdraft protection. Deposits of the Banks are insured by the Bank Insurance Fund administered by the FDIC.
Competition
The Banks encounter strong competition both in making loans and attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws that permit multi-bank holding companies as well as the availability of nationwide interstate banking have created a highly competitive environment for financial services providers. In one or more aspects of its business, each Bank competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies and other financial intermediaries operating in its market and elsewhere, many of which have substantially greater financial and managerial resources. While the Banks are smaller financial institutions, each of the Banks' competitors include large bank holding companies having substantially greater resources and offering certain services that Premier Banks may not currently provide. Each Bank seeks to minimize the competitive effect of larger financial institutions through a community banking approach that emphasizes direct customer access to the Bank's president and other officers in an environment conducive to friendly, informed and courteous service.
Management believes that each Bank is positioned to compete successfully in its respective primary market area, although no assurances as to ongoing competitiveness can be given. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of the banking facilities and, in the case of loans to commercial borrowers, relative lending limits. Management believes that the commitment of its Banks to personal service, innovation and involvement in their respective communities and primary market areas, as well as their commitment to quality community banking service, are factors that contribute to their competitiveness.
Regulatory Matters
The following discussion sets forth certain elements of the regulatory framework applicable to bank holding companies and their subsidiaries and provides certain specific information relevant to Premier. This regulatory framework is intended primarily for the protection of depositors and the federal deposit insurance funds and not for the protection of the holders of securities, including Premier common shares or PFBI Capital Trust preferred shares. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to those provisions. A change in the statutes, regulations or regulatory policies applicable to Premier or its subsidiaries may have a material effect on the business of Premier.
General - As a bank holding company, Premier is subject to regulation under the Bank Holding Company Act ("BHC Act"), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System ("Federal Reserve"). Under the BHC Act, bank holding companies generally may not acquire ownership or control of more than 5% of the voting shares or substantially all the assets of any company, including a bank, without the Federal Reserve's prior approval. Similarly, bank holding companies generally may not acquire ownership or control of a savings association without the prior approval of the Federal Reserve. Further, branching by the Affiliate Banks is subject to the jurisdiction, and requires the approval, of each Affiliate Bank's primary federal banking regulator and, if the Affiliate Bank is a state-chartered bank, the appropriate state banking regulator.
Under the BHC Act, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of the nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve's determination that such activity or control constitutes a risk to the financial soundness and stability of any bank subsidiary of the bank holding company. Premier and the Affiliate Banks are subject to the Federal Reserve Act, which limits borrowings by Premier and its nonbank subsidiaries from the Affiliate Banks and also limits various other transactions between Premier and its nonbank subsidiaries with the Affiliate Banks.
The two Affiliate Banks chartered in Kentucky are supervised, regulated and examined by the Kentucky Department of Financial Institutions, the Affiliate Bank chartered in Ohio is supervised, regulated and examined by the Ohio Division of Financial Institutions, and the two Affiliate Banks chartered in West Virginia are supervised, regulated and examined by the West Virginia Division of Banking. In addition, those Affiliate Banks that are state banks and members of the Federal Reserve System are supervised and regulated by the Federal Reserve, and those state banks that are not members of the Federal Reserve System are supervised and regulated by the Federal Deposit Insurance Corporation ("FDIC"). Each banking regulator has the authority to issue cease-and-desist orders if it determines that the activities of a bank regularly represent an unsafe and unsound banking practice or a violation of law.
Both federal and state law extensively regulates various aspects of the banking business, such as reserve and capital requirements, truth-in-lending and truth-in-savings disclosure, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Premier, the Affiliate Banks and Premier's nonbank subsidiaries are also affected by the fiscal and monetary policies of the federal government and the Federal Reserve and by various other governmental laws, regulations and requirements. Further, the earnings of Premier and Affiliate Banks are affected by general economic conditions and prevailing interest rates. Legislation and administrative actions affecting the banking industry are frequently considered by the United States Congress, state legislatures and various regulatory agencies. It is not possible to predict with certainty whether such legislation or administrative actions will be enacted or the extent to which the banking industry, in general, or Premier and the Affiliate Banks, in particular, would be affected.
Liability for Bank Subsidiaries - The Federal Reserve has a policy to the effect that a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to maintain resources adequate to support each such subsidiary bank. This support may be required at times when Premier may not have the resources to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to priority of payment.
Any depository institution insured by the FDIC may be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. In the event that such a default occurred with respect to a bank, any loans to the bank from its parent holding company will be subordinate in right of payment of the bank's depositors and certain of its other obligations.
Capital Requirements - Premier is subject to capital ratios, requirements and guidelines imposed by the Federal Reserve, which are substantially similar to the ratios, requirements and guidelines imposed by the Federal Reserve and the FDIC on the banks within their respective jurisdictions. These capital requirements establish higher capital standards for banks and bank holding companies that assume greater credit risks. For this purpose, a bank's or holding company's assets and certain specified off-balance sheet commitments are assigned to four risk categories, each weighted differently based on the level of credit risk that is ascribed to such assets or commitments. A bank's or holding company's capital is divided into two tiers: "Tier I" capital and "Tier II" capital. "Tier I" capital includes common shareholders' equity, noncumulative perpetual preferred stock, and related surplus (excluding auction rate issues), minority interests in equity accounts of consolidated subsidiaries and Trust Preferred Securities (subject to certain limitations.) Goodwill, certain identifiable intangible assets and certain other assets are subtracted from these sources of capital to calculate Tier I capital. "Tier 2" capital, which includes, among other items, perpetual preferred stock not meeting the Tier I definition, mandatory convertible securities, subordinated debt and allowances for loan and lease losses, subject to certain limitations, less certain required deductions.
Bank holding companies currently are required to maintain Tier I and total capital (the sum of Tier 1 and Tier 2 capital) equal to at least 4% and 8% of total risk-weighted assets, respectively. At December 31, 2004, Premier met both requirements, with Tier I and total capital equal to 16.6% and 18.9% of its total risk-weighted assets, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve requires bank holding companies to maintain a minimum "leverage ratio" (Tier I capital to adjusted total assets) of 3%, if the holding company has the highest regulatory ratings for risk-based capital purposes. All other bank holding companies are required to maintain a leverage ratio of 3% plus at least 100 to 200 basis points. At December 31, 2004, Premier's leverage ratio was 9.7%.
On June 9, 1997, PFBI Capital Trust (Trust), a statutory business trust created under Delaware law, issued $28,750,000 of 9.750% Preferred Securities ("Preferred Securities" or "Trust Preferred Securities") with a stated value and liquidation preference of $25 per share. A portion of the Preferred Securities issued by the Trust qualify as Tier 1 capital for the Company under the Federal Reserve Board's regulatory framework. The Federal Reserve Board recently re-evaluated whether trust preferred securities, in general, would continue to qualify as Tier 1 capital due to deconsolidation of the related trust preferred entity required by FASB Interpretation No. 46, . Its conclusion, issued in a report released on March 1 2005, was to continue to permit trust preferred securities to qualify as Tier I capital with certain restrictions phased in over five-years. Once completely phased-in, the dollar amount of trust preferred securities that will qualify as Tier I capital for bank holding companies of Premier's size will be limited to 25% of equity based Tier I capital net of goodwill. See Note 12 to the consolidated financial statements for additional details regarding the Company's Trust Preferred Securities.
The foregoing capital requirements are minimum requirements. The Federal Reserve may set capital requirements higher than the minimums described above for holding companies whose circumstances warrant it. For example, holding companies experiencing or anticipating significant growth may be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.
Additionally, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements.
An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee the bank's compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the Bank's assets at the time it became "undercapitalized" or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
Regulatory Agreements - On September 29, 2000, the Company entered into an agreement with the Federal Reserve that prohibited the Company from paying dividends or incurring any additional debt without the prior written approval of the Federal Reserve. Additionally, the agreement required the Company to develop and monitor compliance with certain operational policies designed to strengthen Board of Director oversight including credit administration, liquidity, internal audit and loan review.
On January 29, 2003, Premier entered into a written agreement with the Federal Reserve Bank of Cleveland in recognition of their common goal to restore the financial soundness of Premier. Among the provisions of the agreement was the continuation of the restriction on Premier's payment of dividends on its common stock (PFBI) without the express written consent of the Federal Reserve Bank of Cleveland and the continuation of the restriction on Premier's payment of quarterly distributions on its Trust Preferred Securities (PFBIP) without the express written consent of the Federal Reserve Bank of Cleveland. The written agreement supersedes and rescinds all previous agreements between Premier and the Federal Reserve Bank of Cleveland. Among other provisions, the agreement required(s) Premier to (i) retain an independent consultant to review its management, directorate and organizational structure, (ii) adopt a management plan responsive to such consultant's report, (iii) update its management succession plan in accordance with any recommendations in such consultant's report, (iv) monitor its subsidiary banks' compliance with bank policies and loan review programs, (v) conduct formal quarterly reviews of its subsidiary banks' allowances for loan losses, (vi) maintain sufficient capital, (vii) submit a plan to the Federal Reserve Bank of Cleveland for improving consolidated earnings over a three-year period, and (viii) submit to the Federal Reserve Bank of Cleveland annual projections of planned sources and uses of the parent company's cash, including a plan to service its outstanding debt and trust preferred securities. Premier's compliance with the written agreement is monitored by a committee consisting of at least three of its outside directors.
Two of the Company's subsidiaries, Citizens Deposit Bank & Trust and the Bank of Germantown, entered into similar agreements with their respective primary regulators which, among other things, prohibited the payment of dividends without prior written approval and required significant changes in their credit administration policies. The banks fully complied with the terms of the agreements in 2004 and the agreements were accordingly rescinded by the regulators.
On December 24, 2003, Premier announced that Farmers Deposit Bank had reached an agreement with the Federal Deposit Insurance Corporation ("FDIC") and the Kentucky Department of Financial Institutions ("KDFI") [collectively referred to as "Supervisory Authorities"] to consent to the issuance of a cease & desist order ("Order") from its Supervisory Authorities. The Order, effective January 1, 2004, requires the Bank to cease and desist from the following: (a) Operating with management whose policies and procedures are detrimental to Farmers Deposit and jeopardize the safety of its deposits; (b) Operating with an inadequate level of capital protection for the kind and quality of assets held by Farmers Deposit; (c) Operating with a large volume of adversely classified loans or assets and/or delinquent loans and/or non-accrued loans; (d) Operating with an inadequate allowance for loan and lease losses for the volume, kind and quality of loans and leases held by Farmers Deposit; (e) Engaging in hazardous lending and lax collection practices; (f) Operating with inadequate provisions for liquidity and funds management; (g) Operating with disregard of routine and controls policies; (h) Operating in such a manner as to produce operating losses; and (i) Violating laws and/or regulations cited in the most recent Report of Examination issued by the FDIC [prior to the Order]("Report").
The Order also outlines a number of steps to be taken by Farmers Deposit which are designed to remedy and/or prevent the reoccurrence of the items listed in the Order. These include 1) retaining qualified management and increasing the involvement of the Board of Directors of Farmers Deposit ("Board"); 2) developing and submitting to the Supervisory Authorities a capital plan that maintains the Farmers Deposit Tier I Leverage Ratio above a minimum 5.0% and increases that ratio to 8.0% by December 31, 2004; 3) restricting the payment of cash dividends; 4) requiring the Board to review the adequacy of the allowance for loan losses at least quarterly; 5) requiring Farmers Deposit to charge-off certain loans listed in the Report; 6) reviewing the system of internal loan review and system for assigning loan risk grades as well as revising the lending policies of Farmers Deposit to address items of criticism contained in the Report; 7) developing written plans for reducing and/or improving the level of adversely classified loans and correcting documentation exceptions on certain loans detailed in the Report; 8) generally prohibiting additional lending to borrowers who currently have uncollected adversely classified loans; 9) submitting an annual budget to the Supervisory Authorities outlining goals and strategies for improving and sustaining the earnings of Farmers Deposit; 10) adopting and implementing a policy for operating Farmers Deposit with adequate internal controls consistent with safe and sound banking practices and developing an internal audit program to ensure the integrity of these controls; 11) adopting and implementing a liquidity and funds management policy; and 12) providing notice of the Order to shareholders. Farmers Deposit is required to provide quarterly progress updates to the Supervisory Authorities.
The full text of the Order is available on the FDIC website at www.fdic.gov or by calling the FDIC Public Information Center at (877) 275-3342.
Farmers Deposit, under new management and with the assistance of Premier, has already completed most of the required steps, including hiring a Chief Executive Officer and a Chief Financial Officer, increasing the number of local directors, developing a capital plan and fulfilling its requirements by December 31, 2004, charging-off the loans listed in the Report, and developing action plans on the remaining classified loans. Bank management has also established a separate collections department which is actively working on reducing the level of classified and delinquent loans as well as trying to recover losses on the loans previously charged-off. Bank management and the Board worked with Premier to develop or revise the Bank's policies and procedures as required by the Order. As of February 28, 2005, Bank management has developed and submitted the required plans and updates due as a result of the Order. As of December 31, 2004, the Tier I Leverage Ratio of Farmers Deposit was 9.5% which exceeded the Order requirement of 8.0%
These agreements, which require periodic reporting, will remain in force until the regulators are satisfied that the company and the banks have fully complied with the terms of the agreement.
The Securities and Exchange Commission ("SEC") is investigating the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and has requested information about Premier's investigation. Premier is cooperating with the SEC.
Dividend Restrictions - Premier is dependent on dividends from its Affiliate Banks for its revenues. Various federal and state regulatory provisions limit the amount of dividends the Affiliate Banks can pay to Premier without regulatory approval. At December 31, 2004, approximately $2.5 million of the total shareholders' equity of the Affiliate Banks was available for payment of dividends to Premier without approval by the applicable regulatory authority.
On January 29, 2003, Premier entered into a written agreement with the Federal Reserve Bank of Cleveland in recognition of their common goal to restore the financial soundness of Premier. Among the provisions of the agreement was the continuation of the restriction on Premier's payment of dividends on its common stock (PFBI) without the express written consent of the Federal Reserve Bank of Cleveland and the continuation of the restriction on Premier's payment of quarterly distributions on its Trust Preferred Securities (PFBIP) without the express written consent of the Federal Reserve Bank of Cleveland.
In addition, federal bank regulatory authorities have authority to prohibit Premier's Affiliate Banks from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending upon the financial condition of the bank in question, could be deemed to constitute such an unsafe or unsound practice. The ability of the Affiliate Banks to pay dividends in the future is presently, and could be further, influenced by bank regulatory policies and capital guidelines as well as each Affiliate Bank's earnings and financial condition. Additional information regarding dividend limitations can be found in Note 20 of the accompanying audited consolidated financial statements.
Interstate Banking - Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), subject to certain concentration limits, (i) bank holding companies, such as Premier, are permitted to acquire banks and bank holding companies located in any state of the United States, subject to certain restrictions, and (ii) banks are permitted to acquire branch offices outside their home state by merging with out-of-state banks, purchasing branches in other states or establishing de novo branch offices in other states; provided that, in the case of any such purchase or opening of individual branches, the host state has adopted legislation "opting in" to the relevant provisions of the Riegle-Neal Act; and provided further, that, in the case of a merger with a bank located in another state, the host state has not adopted legislation "opting out" of the relevant provisions of the Riegle-Neal Act.
Gramm-Leach-Bliley Act - On November 12, 1999, the Gramm-Leach-Bliley Act (the "Act") was signed into law, eliminating many of the remaining barriers to full convergence of the banking, securities, and insurance industries. The major provisions of the Act took effect March 12, 2000.
The Act enables a broad-scale consolidation among banks, securities firms, and insurance companies by creating a new type of financial services company called a "financial holding company," a bank holding company with dramatically expanded powers. Financial holding companies can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. In addition, the Act permits the Federal Reserve and the Treasury Department to authorize additional activities for financial holding companies, but only if they jointly determine that such activities are "financial in nature" or "complementary to financial activities." Premier does not presently qualify to elect financial holding company status.
The Federal Reserve serves as the primary "umbrella" regulator of financial holding companies, with jurisdiction over the parent company and more limited oversight over its subsidiaries. The primary regulator of each subsidiary of a financial holding company depends on the activities conducted by the subsidiary. A financial holding company need not obtain Federal Reserve approval prior to engaging, either de novo or through acquisitions, in financial activities previously determined to be permissible by the Federal Reserve. Instead, a financial holding company need only provide notice to the Federal Reserve within 30 days after commencing the new activity or consummating the acquisition.
Number of Employees - The Company and its subsidiaries collectively had approximately 223 full-time equivalent employees as of December 31, 2004. Its executive offices are located at 2883 5th Avenue, Huntington, West Virginia 25702, telephone number (304) 525-1600 (facsimile number (304) 525-9701).
Item 2.
Item 2. Properties
The Company leases its principal executive offices located in Huntington, West Virginia. The Company also owns property located at 104 Jefferson Street, Brooksville, Kentucky, which serves as a branch for Citizen's Deposit Bank (formerly the Bank of Germantown). Except as noted, each of the Banks owns the real property and improvements on which their banking activities are conducted.
Citizens Deposit Bank & Trust, in addition to its main office at 400 Second Street in Vanceburg, Kentucky, has four branch offices in Lewis County, Kentucky, (including one leased facility), one leased branch office in Mason County, Kentucky and the two former locations of the Bank of Germantown, one branch located on Highway 10 in Germantown, Kentucky, and one branch located in Bracken County, Kentucky. Farmers Deposit Bank, in addition to its main office at 5230 South Main Street in Eminence, Kentucky, has two branches in Henry County, Kentucky. Ohio River Bank, in addition to its main office at 221 Railroad Street in Ironton, Ohio, has two branches, one leased facility in Lawrence County, Ohio and one in Scioto County, Ohio. First Central Bank, in addition to its main office at 2 South Main Street in Philippi, West Virginia, has a branch located in Buckhannon, West Virginia. Boone County Bank, in addition to its main office at 300 State Street, Madison, West Virginia, has one leased branch located in Lincoln County, West Virginia and two other branches, one each located in Boone and Logan Counties, West Virginia.
Item 3.
Item 3. Legal Proceedings
The Banks are respectively parties to legal actions that are ordinary routine litigation incidental to a commercial banking business. In management's opinion, the outcome of these matters, individually or in the aggregate, will not have a material adverse impact on the results of operations or financial position of the Company.
The Securities and Exchange Commission ("SEC") is investigating the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit Bank and has requested information about Premier's investigation. Premier is cooperating with the SEC.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders, through solicitation of proxies or otherwise during the fourth quarter of the fiscal year covered by this report.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ---------------------------------------------------------------------
The Company's common stock is listed on the NASDAQ National Market System under the symbol PFBI. At December 31, 2004, the Company had approximately 718 record holders of its common shares.
The following table sets forth on a quarterly basis cash dividends paid and the range of high and low sales prices on a per share basis during the quarters indicated.
Cash Sales Price Dividends Paid High Low -------------- ---- --- 2003: First Quarter $ - $ 9.50 $ 7.58 Second Quarter - 10.25 8.91 Third Quarter - 9.45 8.50 Fourth Quarter - 8.94 7.50 --------- $ - ========= First Quarter $ - $ 9.49 $ 8.31 Second Quarter - 10.20 8.41 Third Quarter - 10.28 8.50 Fourth Quarter - 13.35 8.80 --------- $ - ========= First Quarter (through March 16, 2005 $ - $12.75 $10.78
The Board of Directors suspended the payment of dividends during the second quarter of 2000. In September 2000, as a result of an agreement entered into with the Federal Reserve, the Company agreed not to declare additional dividends without the prior approval of the Federal Reserve. The September 2000 agreement was superceded by a January 29, 2003 written agreement between Premier and the Federal Reserve which continued the restriction on dividends. The Board of Directors anticipates paying dividends at some future date when, in its discretion, financial prudence allows and the Federal Reserve concurs in the payment of such dividends. The January 29, 2003 agreement also restricts Premier's payments of dividends on its PFBI Capital Trust preferred securities. These dividends are cumulative and all deferred distributions must be paid before dividends may be paid to holders of common shares. Even if the Company is able to resume the payment of dividends, there can be no assurance that the amount of the dividends will be what the Company paid before the payment of dividends was suspended.
The payment of dividends by the Company depends upon the ability of the Banks to declare and pay dividends to the Company because the principal source of the Company's revenue will be dividends paid by the Banks. At December 31, 2004, approximately $2.5 million was available for payment as dividends from the Banks to the Company without the need for regulatory approval. In considering the payment of dividends, the Board of Directors will take into account the Company's financial condition, results of operations, tax considerations, costs of expansion, industry standards, economic conditions and need for funds, as well as governmental policies and regulations applicable to the Company and the Banks. See "REGULATORY MATTERS - Capital Requirements" for discussion on capital guidelines.
Item 6.
Item 6. Selected Financial Data
The following table presents consolidated selected financial data for the Company. It does not purport to be complete and is qualified in its entirety by more detailed financial information and the audited consolidated financial statements contained elsewhere in this annual report. The data presented below reflects separately the impact of discontinued operations as more fully described in Note 2 to the consolidated financial statements.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
INTRODUCTION
Premier Financial Bancorp, Inc. ("Premier") is a multi-bank holding company headquartered in Huntington, West Virginia. It operates five community bank subsidiaries ranging in size from $80 million to $158 million, each with a local community name and orientation. On July 1, 2004, Premier sold one bank subsidiary, Citizens Bank (Kentucky), Inc. ("Citizens Bank"). As such, and in accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's consolidated financial statements and this Management's Discussion and Analysis, and are presented separately as "discontinued operations." Premier realized a net profit on the sale Citizens Bank of $4.7 million which is included in the income from discontinued operations. See Note 2 to the consolidated financial statements presented separately in this annual report for additional information concerning discontinued operations. The remaining banks operate in twenty communities within the states of West Virginia, Ohio and Kentucky and provide their customers with a full range of banking services. On January 3, 2005, Premier merged two of its banks, Citizen's Deposit Bank and Bank of Germantown. Premier is also the parent of a data processing subsidiary which currently provides the data processing and management services for four of Premier's affiliate banks and one other non-affiliated bank. As of December 31, 2004, Premier had approximately $537 million in total assets, $325 million in total loans and $438 million in total deposits.
The accompanying consolidated financial statements have been prepared by the management of Premier in conformity with accounting principals generally accepted in the United States of America. The audit committee of the Board of Directors engaged Crowe Chizek and Company LLC independent auditors, to audit the consolidated financial statements, and their report is included elsewhere herein. Financial information appearing throughout this annual report is consistent with that reported in the consolidated financial statements. The following discussion is designed to assist readers of the consolidated financial statements in understanding significant changes in Premier's financial condition and results of operations.
Management's objective of a fair presentation of financial information is achieved through a system of internal accounting controls. The financial control system of Premier is designed to provide reasonable assurance that assets are safeguarded from loss and that transactions are properly authorized and recorded in the financial records. As an integral part of that financial control system, the audit committee of the Board of Directors engaged Arnett & Foster, CPA's in 2004, 2003 and 2002 to perform internal audits of the financial records of each of the subsidiaries on a periodic basis. Their findings and recommendations were reported to Premier's audit committee as well as the audit committees of the subsidiaries. In 2005, Premier reduced its reliance on third-party internal audit and loan review providers and expanded its internal audit staff at the holding company level. Likewise, their findings and recommendations are reported to Premier's audit committee as well as the audit committees of the subsidiaries. Also, on a regular periodic basis, the subsidiary banks are examined by Federal and State banking authorities for safety and soundness as well as compliance with applicable banking laws and regulations. The activities of both the internal and external audit functions are reviewed by the audit committee of the Board of Directors.
FORWARD-LOOKING STATEMENTS
Management's discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties, and there are certain important factors that may cause actual results to differ materially from those anticipated. These important factors include, but are not limited to, economic conditions (both generally and more specifically in the markets in which Premier operates), competition for Premier's customers from other providers of financial services, government legislation and regulation (which changes from time to time), changes in interest rates, Premier's ability to originate quality loans, collect delinquent loans and attract and retain deposits, the impact of Premier's growth or lack thereof, Premier's ability to control costs, and new accounting pronouncements, all of which are difficult to predict and many of which are beyond the control of Premier.
CRITICAL ACCOUNTING POLICIES
General
The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements and management's discussion and analysis are, to a large degree, dependent upon our accounting policies. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.
Presented below is discussion of those accounting policies that management believes are the most important to the presentation and understanding of our financial condition and results of operations. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. See also Note 1 of the accompanying consolidated financial statements presented elsewhere in this annual report.
Allowance for Loan Losses
The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable incurred losses inherent in the loan portfolio. The Company maintains policies and procedures that address the systems of control over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance that the allowance for loan losses is maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.
The Company evaluates various loans individually for impairment as required by Statement of Financial Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due 90 days or more, restructured loans and other loans selected by management including loans graded as substandard or doubtful by the internal credit review process. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5, Accounting for Contingencies (SFAS 5), with a group of loans that have similar characteristics.
For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by SFAS 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.
The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of probable incurred loan losses. This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses exceeds the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses were below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable incurred losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.
Impairment of Goodwill
As required by applicable accounting guidance, goodwill is evaluated at least annually to determine if the amount recorded on the Company's balance sheet is impaired. If goodwill is determined to be impaired, the recorded amount would be reduced to estimated fair value by a charge to expense in the period in which impairment is determined. Impairment is evaluated in the aggregate for all of the Company's banking operations. Operating characteristics of the aggregate banking operations are derived and compared to a database of peer group banks that have been sold. Pricing valuation factors that are considered in estimating the fair value of the Company's aggregate banking operations include price-to-total assets, price-to-total book value, price-to-deposits and price-to earnings. Unusual events that have impacted the operating characteristics of the Company's aggregate banking operations are considered to assess the likelihood of recurrence and adjustments to historical performance may be made. Changes in assumptions regarding the likelihood of unusual historical events recurring or the use of different pricing valuation factors could have a material impact on management's impairment analysis.
Realization of Deferred Tax Assets
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Deferred tax assets for the Company primarily relate to the allowance for loan losses and net operating loss carryforwards. In considering the need for a valuation allowance to reduce deferred tax assets to the amount expected to be realized, management considers the amount of previously paid taxes that may be recoverable and the likelihood of generating sufficient future taxable income to fully utilize expected future tax deductions. At December 31, 2004 management's consideration of the need for a valuation allowance focused on the generation of future taxable income as all available previously paid taxes were recovered from the operating loss reported in 2003. In determining the likelihood of generating future taxable income management considered unusual events that have impacted the Company's historical earnings and whether these events will recur, the Company's operating budget and likely operating results in the near term. Changes in these assumptions could impact the carrying value of deferred tax assets and require a charge to tax expense.
SIGNIFICANT EVENT ARISING IN 2003
On June 16, 2003, Premier announced that as a result of an ongoing internal investigation it had uncovered a systematic disregard for its loan approval and credit administration policies at its wholly owned subsidiary Farmers Deposit Bank and had accepted the resignation of the bank's president. On June 4, 2003, senior management of Premier received from the bank's former president a request to charge-off over $2.0 million in loans. Concerned about the magnitude of the request and the impact on Premier's financial results, Premier management promptly notified the Federal Reserve Bank of Cleveland and the Federal Deposit Insurance Corporation ("FDIC") about the request. Premier's initial investigation indicated that the former president of Farmers Deposit had engaged in conduct which subverted the bank's internal controls and credit administration policies, conduct which appears to have been designed to avoid detection by management and those entities employed by Premier to perform independent reviews of its subsidiaries' accounting records, internal controls, and credit risk.
As a result of the ongoing investigation into the conduct of the former president of Farmers Deposit by Premier and the FDIC, Premier charged-off over $17.2 million of loans. The resulting depletion of the allowance for loan losses together with the current analysis of additional risk in the loan portfolio warranted significant additional provisions for loan losses at the Bank. In addition to the provision for loan losses, interest income reversals and other non-interest expenses, including bad check write-offs and loan review expenses, were recorded.
Premier's management, with the assistance of outside independent professionals, conducted a further review of those loans for which significant charge offs or additional provisions were required in 2003. The purpose of the review was to determine if the facts or circumstances that gave rise to the additional charge offs or provisions had been improperly withheld from senior management or improperly considered in applying management's estimates and judgments as to the adequacy of the allowance for loan losses in prior financial statement periods. The review did identify instances in which collateral securing loans had been released without proper support or notation in loan files, instances in which obligors on notes had been released from their repayment obligation without proper support or notation in loan files and instances in which delinquent loan reporting systems had been manipulated to prevent problem loans from being identified on a timely basis. Premier's senior management determined that if these circumstances had been considered in evaluating the adequacy of the allowance for loan losses in prior periods then some of the loan charge offs and additional provisions for loan losses recorded in 2003 should have been reflected in prior periods. Therefore, in 2003, the financial statements for 2002 and 2001 were restated to reflect the financial statement effect of the matters that occurred in those periods but which were improperly concealed by subsidiary management.
The Securities and Exchange Commission ("SEC") is investigating the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit and has requested information about Premier's investigation. Premier is cooperating with the SEC.
SUMMARY FINANCIAL RESULTS
Premier had net income from continuing operations of $1.963 million in 2004 compared to a $9.6 million net loss from continuing operations reported for the year 2003. Net income in 2004 is primarily the result of the continued earnings of Premier's profitable banks partially offset by expenses associated with rehabilitating its subsidiary, Farmers Deposit Bank, conducting Premier's own investigation, cooperating with the SEC investigation, and reducing debt at the holding company. The loss for 2003 is primarily due to large provisions for loan losses and bad check losses at Farmers Deposit Bank. The loss in 2003 follows a $2.2 million loss in 2002 which was due to large provisions for loan losses, writedowns of repossessed real estate to realizable values, and higher collection costs. Basic earnings per share from continuing operations was $0.37 in 2004, compared to a loss of ($1.84) in 2003, and a loss of ($0.42) in 2002.
The following table comparatively illustrates the components of ROA and ROE over the previous five years. Return on average assets (ROA) measures how effectively Premier utilizes its assets to produce net income. Premier's net income in 2004 resulted in an ROA of 0.36%, an increase over the (1.66%) net loss ROA in 2003 and the (0.37)% net loss ROA reported in 2002. As shown in the table, fully taxable equivalent net interest income (as a percent of average earning assets) has remained fairly consistent over the past five years with a high of 3.84% in 2002. The net losses in 2003 and 2002 were primarily the result of an increase in the provision for loan losses, resulting in negative net credit income for those years. In 2004, net credit income was once again positive, achieving the highest level over the five year period. This increase in net credit income (as a percent of average earning assets) was dampened somewhat by higher non-interest expenses (as a percent of average earning assets) when compared to the previous four years. As illustrated in the table, Premier's 2004 fully taxable net interest income as a percent of average earning assets was down slightly to 3.61% from the 3.63% recorded in 2003 as interest earned on loans declined slightly due to a lower balance of loans outstanding and lower yields on loans due to the interest rate environment. However, during the same time, net credit income increased as the provision for loan losses was 0.20% of average earning assets in 2004 compared to 3.81% in 2003. The net overhead ratio (non-interest expense less non-interest income as a percent of average earning assets) increased in 2004 to 2.83% compared to 2.64% in 2003, the lowest ratio reported in the five years presented in the table. The 2003 ratio declined from a 2.71% net overhead ratio reported in 2002. The increase in 2004 net overhead was the result of increases in non-interest expense related to the investigation of Farmers Deposit Bank, the loss on the sale of facilities formerly leased to Citizens Bank (which was sold in 2004), and accelerated amortization costs related to the early redemption of Premier's Trust Preferred Securities. The decline in 2003 compared to 2002 was the result of increases in non-interest income related to service charges on deposit accounts. In 2004, this trend continued, as non-interest income increased again due to revenue from service charges on deposit accounts.
Return on average equity (ROE), another measure of earnings performance, indicates the amount of net income earned in relation to the total equity invested. Premier's 2004 ROE was 4.06%, compared to (18.46%) realized in 2003 and (3.77%) reported for 2002. ROE increased primarily due the net income reported in 2004 versus the operating losses reported for 2003 and 2002.
A breakdown of Premier's financial results by quarter for the years ended December 31, 2004 and 2003 is summarized below.
SALE OF SUBSIDIARIES
In the fourth quarter of 2003, Premier adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000, which was completed on July 1, 2004.. The sale of this subsidiary helped to restore the financial position of Premier after the impact of the losses sustained at Farmers Deposit Bank during the second and third quarters of 2003. As a result of the sale, regulatory capital ratios of Premier were restored to the stronger levels management wishes to maintain; cash reserves of the holding company were replenished; a portion of the cash reserves were used to reduce outstanding debt by $9.4 million; and the profit from the sale allowed Premier to utilize a substantial portion of its Federal income tax net operating loss carryforward.
In 2000 Premier suspended its acquisition strategy in order to focus on improving its subsidiary bank operations by strengthening its management oversight. As part of this change in strategy, Premier elected to dispose of two of its subsidiary banks in 2001.
On January 26, 2001, the company disposed of all the deposits (approximately $110 million), the majority of loans (approximately $92 million) and the premises and equipment (approximately $1.6 million) of the Bank of Mt. Vernon under the terms of a Purchase and Assumption Agreement. As a result of this transaction, the banking charter of the Bank of Mt. Vernon was relinquished and Premier agreed not to compete in the markets previously served by the Bank of Mt. Vernon.
Also, on December 10, 2001, the Company disposed of certain assets and liabilities of The Sabina Bank. The sale included all the loans (approximately $31 million) and all the deposits (approximately $41 million), as well as the premises and equipment (approximately $1.2 million). Certain assets of the bank were retained by Premier pending liquidation of the bank, which occurred in 2002. The operating results of both the Bank of Mount Vernon and The Sabina Bank were included in Premier's 2001 operating results through the respective dates of the sale. However, the operating results subsequent to 2001 do not include any of the operations of these two banks. Comparisons of average balances and income statement categories to 2001 are all affected by the disposition of these two subsidiaries.
BALANCE SHEET ANALYSIS Summary
A financial institution's primary sources of revenue are generated by its earning assets, while its major expenses are produced by the funding of these assets with interest bearing liabilities. Effective management of these sources and uses of funds is essential in attaining a financial institution's optimal profitability while maintaining a minimum amount of interest rate risk and credit risk. Information on rate-related sources and uses of funds for each of the three years in the period ended December 31, 2004, is provided in the table below.
In 2004, average earning assets declined by 6.1% or $32.9 million from 2003, following a 2.9% or $16.3 million decline in 2003 from 2002. Average interest bearing liabilities, the primary source of funds supporting the earning assets, decreased 9.1% or $43.1 million from 2003, which follows a 4.7% or $23.5 million decline in 2003 from 2002. The decline in 2004 average earning assets was the result of the residual effect of the $16.5 million of loan charge-offs in 2003, the $7.0 million of loan charge-offs in 2004 (primarily at Farmers Deposit in both years), coupled with loan maturities and principal pay downs that were not renewed and the redeployment of other available funds to reduce debt. The decline in interest bearing liabilities was largely due to debt reduction strategies, a continued shift in customer deposits from interest bearing to non-interest bearing, and the non-renewal of certain certificates of deposit at Farmers Deposit Bank in conjunction with Premier's capital restoration plan for that Bank. Other than the effects of the capital restoration plan, the same factors were the result of the decline in average earning assets and average interest bearing liabilities in 2003 compared to 2002. Additional information on each of the components of earning assets and interest bearing liabilities is contained in the following sections of this report.
Loan Portfolio
Premier's loan portfolio is its largest and highest yielding component of average earning assets, totaling 64.4% of average earning assets during 2004. Average loans declined by $26.5 million or 7.5% in 2004. The decline is largely attributable to the high level of charge-offs and loan collections at Farmers Deposit. The average loans outstanding at Farmers Deposit declined by $30.5 million in 2004, $4.0 million more than Premier's total decline of $26.5 million. Of the remaining increase, Premier realized a 6.0% increase in loans in its West Virginia markets and an 11.1% increase in loans in its Ohio markets. These increases were partially offset by a 10.0% decline in average loans in Premier's other Kentucky markets. Due to the low interest rate environment, many borrowers sought to refinance their loans to reduce their interest costs. Due to the lackluster economy and the resulting lower demand for loans during much of 2003 and 2004, larger banks began competing more strongly by enticing borrowers with prime rate or below prime rate loans. Therefore, scheduled loan maturities were not necessarily renewed with Premier. In 2003, average loans outstanding decreased by $30.6 million or 8.0% compared to 2002. Again, the decline is partially attributed to the high level of charge-offs, primarily at Farmers Deposit (down $13.9 million on average), but also to stiffer competition from larger banks competing in Premier's markets and a general decline in economic growth. Of the total decline in 2003, Premier realized a 1.8% increase in loans in its West Virginia markets and a 3.3% increase in loans in its Ohio markets. These were more than offset by a 19.2% decline in loans in Premier's other Kentucky markets.
Total loans at December 31, 2004 decreased by $6.9 million or 2.1% from the total at December 31, 2003. This decrease follows a $41.3 million or 11.1% decrease in 2003 from total loans at December 31, 2002. The decline in 2004 period-end loans was the result of the $7.0 million of loan charge-offs recorded during the year, primarily at Farmers Deposit ($5.5 million). The decline in 2003 period-end loans was the result of the $16.5 million of loan charge-off recorded during the year, primarily at Farmers Deposit, and declines due to low loan demand resulting from the poor economy and heavy refinancing activity by borrowers to obtain lower interest rates.
The following table presents a five year comparison of loans by type. With the exception of those categories included in the comparison, there are no loan concentrations which exceed 10% of total loans. Additionally, Premier's loan portfolio contains no loans to foreign borrowers nor does it have a material volume of highly leveraged transaction lending.
Loans secured by real estate, which in total constituted approximately 73% of Premier's loan portfolio at December 31, 2004, consist of a diverse portfolio of predominately single family residential loans and loans for commercial purposes where real estate is part of the collateral, not the primary source of repayment. Residential real estate mortgage loans generally do not exceed 80% of the value of the real property securing the loan. The residential real estate mortgage loan portfolio primarily consists of adjustable rate residential mortgage loans. The origination of these mortgage loans can be more difficult in a low interest rate environment where there is a significant demand for fixed rate mortgages. Premier also participates in the solicitation of loans for the secondary market and recognizes the referral fees in non-interest income. Commercial loans are generally made to small-to-medium size businesses located within a defined market area and typically are secured by business assets and guarantees of the principal owners. Additional risks of loss are associated with commercial lending such as the potential for adverse changes in economic conditions or the borrowers' ability to successfully execute their business plan. Consumer loans generally are made to individuals living in Premier's defined market area who are known to the local bank's staff. Consumer loans are generally made for terms of up to seven years on a secured or unsecured basis; however longer terms may be approved in certain circumstances and for revolving credit lines. While consumer loans generally provide the Company with increased interest income, consumer loans may involve a greater risk of default.
In addition to the loans presented in the loan summary table, Premier also offers certain off-balance sheet products such as letters of credit, revolving credit agreements, and other loan commitments. These products are offered under the same credit standards as the loan portfolio and are included in the risk-based capital ratios used by the Federal Reserve to evaluate capital adequacy. Additional information on off-balance sheet commitments is contained in Note 18 to the consolidated financial statements.
Total non-performing assets, which consist of past-due loans on which interest is not being accrued ("non accrual loans"), foreclosed properties in the process of liquidation ("OREO"), loans with restructured terms to enable a delinquent borrower to repay and accruing loans past due 90 days or more, were $10.1 million, or 1.87% of total assets of continuing operations at year-end 2004. The amount is down significantly from the $19.4 million of non-performing assets (3.57% of total assets of continuing operations) at year-end 2003 and the $13.1 million of non-performing assets (2.21% of total assets of continuing operations) at year-end 2002. The decrease in 2004 was due to charge-offs of loans determined to be uncollectible, the sale of $4.5 million of OREO property, and the collection or rehabilitation of previously delinquent loans. The increase in 2003 was due to the loan underwriting issues uncovered at Farmers Deposit Bank. As management's efforts to collect these loans upon maturity continues, loans are only renewed using Premier's strengthened credit policies. Otherwise, loans may be placed on non-accrual status and foreclosure proceedings begun to obtain and liquidate any collateral securing the past due or matured loans. Premier is committed to continuing to reduce its high level of non-performing assets and implementing strong underwriting standards to help maintain a lower level of non-performing assets in the future. This effort is revealed in the decline in non-performing assets from the end of 2001 to the end of 2002, primarily related to the sale of OREO properties and the decline in loans 90+ days past due. Premier's efforts at its other affiliate banks in 2003 and 2004 are masked by the high level of non-performing assets at Farmers Deposit Bank, which alone totaled $12.5 million at December 31, 2003. At December 31, 2004, the non-performing assets at Farmers Deposit Bank had declined to $6.8 million, leaving $3.3 million of total non-performing assets at the other Affiliate Banks combined.
The Loan Summary table presents five years of comparative non-performing asset information. Other than these loans and the impaired loans discussed in Note 6 to the consolidated financial statements, Premier does not have a significant volume of loans whereby management has serious doubts about the borrowers ability to comply with the present repayment terms of the loan.
It is Premier's policy to place loans that are past due over 90 days on non-accrual status, unless the loans are adequately secured and in the process of collection. Premier had no commitments to provide additional funds on non- accrual loans at December 31, 2004. For real estate loans, upon repossession, the balance of the loan is transferred to "Other Real Estate Owned" (OREO) and carried at the lower of the outstanding loan balance or the fair value of the property based on current appraisals and other current market trends less estimated disposal costs. If a writedown of the OREO property is necessary at the time of foreclosure, the amount is charged against the allowance for loan losses. A periodic review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair market value less estimated disposal costs, additional writedowns of the property value are charged directly to operations.
During 2003 Premier recognized $466,000 of OREO writedowns compared to $1.0 million in 2002. During 2004, Premier realized a $125,000 net profit on the disposition of OREO properties, net of writedowns. Although loans may be classified as non-performing, some continue to pay interest irregularly or at less than original contracted terms. During 2004, approximately $159,000 of interest was recognized on non-accrual and restructured loans, while approximately $694,000 would have been recognized in accordance with their original terms.
The allowance for loan losses is maintained to absorb probable incurred losses associated with lending activities. Actual losses are charged against the allowance ("charge-offs") while collections on loans previously charged off ("recoveries") are added back to the allowance. Since actual losses within a given loan portfolio are difficult to predict, management uses a significant amount of estimation and judgment to determine the adequacy of the allowance for loan losses. Factors considered in determining the adequacy of the allowance include an individual assessment of risk on certain loans and total creditor relationships, historical charge-off experience, the type of loan, levels of non-performing and past due loans, and an evaluation of current economic conditions. Loans are evaluated for credit risk and assigned a risk grade. Premier's risk grading criteria are based upon Federal Reserve guidelines and definitions. In evaluating the adequacy of the allowance for loan losses, loans that are assigned passing grades are grouped together and multiplied by historical charge-off percentages to determine an estimated amount of potential losses and a corresponding amount of allowance. Loans that are assigned marginally passing grades are grouped together and allocated slightly higher percentages to determine the estimated amount of potential losses due to the identification of increased risk(s). Loans that are assigned a grade of "substandard" or "doubtful" are usually determined to be impaired.
A loan is categorized and reported as impaired when it is probable that the creditor will be unable to pay all of the principal and interest amounts according to the contractual terms of the loan agreement. In determining whether a loan is impaired, management considers such factors as past payment history, recent economic events, current and projected financial condition and other relevant information that is available at the time. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual basis for other loans. If a loan is deemed to be impaired an evaluation of the amount of estimated loss is performed assessing the present value of estimated future cashflows using the loan's existing rate or assessing the fair and realizable value of the loan collateral if repayment is expected solely from the collateral. The estimation of loss is assigned to the impaired loan and is used in determining the adequacy of the allowance for loan losses. For impaired loans, this estimation of loss is reevaluated quarterly and, if necessary, adjusted based upon the current known facts and circumstances related to the loan and the borrower. Additional information on Premier's impaired loans is contained in Note 6 to the consolidated financial statements. The sum of the calculations and estimations of the risk of loss in a given loan portfolio is compared to the recorded balance of the allowance for loan losses. If the total allowance is deemed to be inadequate a charge to earnings is recorded to increase the allowance. Conversely, should an evaluation of the allowance result in a lower estimate of the risk of loss in the loan portfolio and the allowance is deemed to be more than adequate, a reversal of previous charges to earnings ("a negative provision") may be warranted in the current period. Events that may lead to negative provisions included greater than anticipated recoveries, securing more collateral on an impaired loan during the collection process, or receiving payment in full on an impaired loan.
At December 31, 2004, the allowance for loan losses was $9.4 million or 2.89% to total year-end loans. This ratio is a decrease from the prior year's 4.31% but still higher than the 2.60% at the end of 2002. The decrease in the allowance in 2004 was the result of charge-offs of loans previously identified as impaired partially offset by $1.1 million of recoveries and $1.0 million of additional provisions for loan losses during 2004. The increase at year-end 2003 was the result of the significant allowance attributed to the loans at Farmers Deposit Bank. In management's opinion, the allowance for loan losses is adequate to absorb the current estimated risk of loss in the existing loan portfolio. The summary of the allowance for loan losses allocated by loan type is presented in the Loan Summary Table above.
The following table provides a detailed history of the allowance for loan losses, illustrating charge-offs and recoveries by loan type, and the annual provision for loan losses over the past five years. The provision for loan losses in 2004 was $1.0 million, down significantly from the $20.5 million provision in 2003 and the $9.5 million provision in 2002. The provision in 2004 was the result of newly identified impaired loans and increases in the volume of loans outstanding at the banks located in West Virginia. The high level of provision in 2003 was the result of the net charge-offs and increase in impaired loans at Farmers Deposit. The relatively high provision in 2002 was in response to management efforts to identify the level of probable incurred losses throughout Premier's troubled institutions using the best practices of its higher performing institutions. These efforts were circumvented or rendered ineffective by the disregard for controls by the former president of Farmers Deposit. Premier continually evaluates the adequacy of its allowance for loan losses, and changes in the provision are based on the estimated probable incurred loss of the loan portfolio.
Net charge-offs in 2004 decreased to $5.9 million, down $9.9 million or more than half of the $15.9 million of net charge-offs experienced in 2003. Approximately $4.8 million or 81% of the 2004 net charge-offs were at Farmers Deposit Bank. This level of net charge-offs compares to the $15.9 million of net charge-offs in 2003, up $8.8 million or more than double the $7.1 million of net charge-offs experienced in 2002. Approximately $14.3 million or 90% of the 2003 net charge-offs were at Farmers Deposit Bank. While all categories of loan charge-offs were down in 2004, consumer and real estate loan charge-offs continued to be higher than commercial loan charge-offs. Although management believes it has identified the significant remaining credit risk in the loan portfolio, additional charge-offs may be recorded in the coming months due to the high level of non-performing loans and the resolution of collection efforts on those loans. These factors are considered in determining the adequacy of the allowance for loan losses, which at December 31, 2004 was 2.89% of total loans outstanding and 120% of non-performing loans.
The following table presents the maturity distribution and interest sensitivity of selected loan categories at December 31, 2004. Maturities are based upon contractual terms.
Investment Portfolio and Other Earning Assets
Investment securities averaged $150.2 million in 2004, a $7.4 million or 5.2% increase from the $142.8 million averaged in 2003. This increase follows a 4.5% increase from the $136.7 million averaged in 2002. The increase in average investments in 2004 was the result of weak loan demand and funds from loan paydowns and payoffs at Farmers Deposit Bank. These funds were not used to fund new loans but were instead invested in high-quality debt and mortgage- backed securities. The increase in 2003 was the result of weak loan demand across the Company and stiffer competition from large banks in Premier's markets. Again, funds from loan payoffs and maturities were not used to fund new loans but were invested in high-quality debt securities.
The following table presents the carrying values of investment securities.
As sources of funds (deposits, federal funds purchased, and repurchase agreements with corporate customers) fluctuate, excess funds are initially invested in federal funds sold and other short-term investments. Based upon analyses of asset/liability repricing, interest rate forecasts, and liquidity requirements, funds are periodically reinvested in high-quality debt securities, which typically mature over a longer period of time. At the time of purchase, management determines whether the securities will be classified as trading, available-for-sale, or held-to-maturity. At December 31, 2004, all of Premier's investments were classified as available-for-sale and carried on the books at market value.
As shown in the following Securities Maturity and Yield Analysis table, the average maturity period of the securities available-for-sale at December 31, 2004 was 4 years 3 months, lengthened somewhat by the 11 year 1 month average final maturity of the mortgage-backed securities portfolio. The table uses a final maturity method to report the average maturity of mortgage-backed securities, which excludes the effect of monthly payments and prepayments. Approximately 75% of Premier's investment securities are U.S. Government agency or Treasury securities that have an average maturity of 2 years 3 months. The average maturity of the investment portfolio is managed at a level to maintain a proper matching with interest rate risk guidelines. During 2004, Premier sold a portion of the securities classified as available-for-sale as part of its management of interest rate risk, as shown in the Statements of Cash Flows. Premier does not have any securities classified as trading or held-to-maturity and it has no plans to establish such classifications at the present time. Other information regarding investment securities may be found in the following table and in Note 5 to the consolidated financial statements.
Premier's average investment in federal funds sold and other short-term investments decreased by 31.5% in 2004. This follows a 23.8% increase in 2003. Averaging $29.4 million in 2004, federal funds sold and other short-term investments decreased $13.5 million from the $42.8 million averaged in 2003, and were lower than the $34.6 million averaged during 2002. The decrease in average federal funds sold in 2004 was the result of investing more of Premier's available funds into higher yielding investments and using a portion of the funds to reduce outstanding debt. The increase in average federal funds sold in 2003 was the result of maintaining additional liquidity at Farmers Deposit Bank and the desire to keep more liquid funds on hand to take advantage of any potential rising interest rates. Fluctuations in federal funds sold and other short-term investments reflect management's goal to maximize asset yields while maintaining proper asset/liability structure, as discussed in greater detail above and in other sections of this report.
Funding Sources
In 2004, Premier once again decreased the rates paid on its interest bearing deposits in response to the decline in market interest rates. The average rate paid on interest bearing liabilities decreased to 2.32% in 2004, down from the 2.63% paid in 2003 and the 3.49% paid in 2002. The decrease is largely due to declines in rates paid on time deposits as higher rate certificates of deposits have either not renewed at maturity or were redeposited at lower rates in conjunction with the decline in market interest rates. Similarly, rates paid on NOW and money market transactional deposit accounts also declined. Due to alternative sources of investment and an ever increasing sophistication of customers in funds management techniques to maximize return on their money, competition for funds has become more intense. Premier's banks periodically offer special rate products to attract additional deposits.
Premier's deposits, on average, decreased by 5.6% or $26.4 million in 2004. The 2004 decrease follows a 1.6% or $7.6 million decrease in 2003 from the average in 2002. In 2004, $20.8 million of the decline in deposits was at Farmers Deposit Bank, partially due to Premier's capital restoration plan as certain deposits were not renewed as part of the plan to reduce the size of the Bank. The remaining $5.6 million decline in average deposits was largely due to the withdrawal of some public fund deposits which were reestablished as repurchase agreements. Average repurchase agreements at Affiliate Banks other than Farmers Deposit increased by $5.8 million during 2004 offsetting the remaining decline in average deposits in 2004.
In 2004, non-interest bearing deposits increased by 16.1% or $8.7 million on average when compared to 2003. In 2003, non-interest bearing deposits increased by 13.7% or $6.5 million on average when compared to 2002. Since no interest is paid on these deposits, an increase in non-interest bearing deposits helps to increase Premier's net interest margin and its profitability. Non-interest bearing deposits are more susceptible to withdrawal and therefore may provide challenges to maintaining adequate liquidity. (See the additional discussion on liquidity below.) In 2004, interest bearing deposits decreased by 8.3% or $35.0 million on average when compared to 2003. The decrease was primarily due to a $21.6 million decrease in average interest bearing deposits at Farmers Deposit Bank. The remaining decrease was the result of the non-renewal of certain high rate time deposits in 2003 that had a carryover effect on 2004 and a decrease in average interest bearing transaction deposits. In 2003, interest bearing deposits decreased by 3.2% or $14.1 million on average when compared to 2002. The decrease was primarily the result of planned non renewals of high rate time deposits which more than offset increases in average interest bearing transaction deposits and savings deposits.
The following table provides information on the maturities of time deposits of $100,000 or more at December 31, 2004
MATURITY OF TIME DEPOSITS $100,000 OR MORE December 31, 2004 (In thousands)
Maturing 3 months or less $ 6,723 Maturing over 3 months through 6 months 6,267 Maturing over 6 months through 12 months 10,369 Maturing over 12 months 16,854 -------- Total $ 40,213 ========
Other funding sources for Premier include short and long-term borrowings. Premier's short-term borrowings primarily consist of federal funds purchased from other banks, and securities sold under agreements to repurchase with commercial customers. These short-term borrowings fluctuate depending on near term funding needs and as part of Premier's management of its asset/liability mix. In 2004, short-term borrowings averaged $6.5 million, up $1.9 million from the average in 2003. Near the end of 2003, Farmers Deposit Bank reduced its short-term borrowings to zero as part of Premier's recapitalization plan. This event had the effect of reducing Premier's average short-term borrowings in 2004 by approximately $4.3 million. This decline in short-term borrowings was more than offset by the public fund repurchase agreements established at the Affiliate Banks in 2004 as discussed above. In 2003, short-term borrowings averaged $4.7 million, down $761,000 from the average in 2002. The decline in 2003 was largely the result of terminating the repurchase agreements at Farmers Deposit Bank in an effort to reduce the size of the bank.
Long-term borrowings consist of Federal Home Loan Bank (FHLB) borrowings by Premier's banks, other borrowings by the parent holding company and debt issued in the form of subordinated debentures to an unconsolidated trust subsidiary. FHLB advances, on average, declined by 37.2% or $5.9 million in 2004, following a 20.0% or $4.0 million decrease in 2003. Premier uses fixed rate FHLB advances from time-to-time to fund certain residential and commercial loans as well to maximize investment opportunities as part of its interest rate risk management. In 2003 and 2004, Premier elected not to renew most of its maturing FHLB advances and prepaid a limited number of other FHLB advances in order to reduce its outstanding debt. At December 31, 2004, FHLB advances totaled $9.3 million and had repayment schedules from five to eight years. Other borrowings, on average, declined by 36.5% or $3.0 million in 2004 and 21.8% or $2.3 million in 2003 as the parent company began using available funds to aggressively pay down its outstanding debt in late 2001. At December 31, 2004, other borrowings totaled $800,000 with a scheduled maturity in 2005. Premier fully repaid this borrowing in the first quarter of 2005. For more information on other borrowings, see Note 11 to the consolidated financial statements.
On December 20, 2004, Premier entered into a sixty-three month contract with Fiserv Solutions, Inc. (Fiserv) whereby Fiserve will provide data processing and item processing services to Premier. Conversions by Premier's subsidiary banks to Fiserv systems will begin on April 15, 2005 with a targeted completion by June 30, 2005. Based upon statistical data provided to Fiserv by Premier for proposal purposes, the estimated payments to Fiserv for these services will be approximately $412,000 in 2005, and $708,000 per year beginning in 2006. Actual results may vary depending upon the number and type of accounts actually converted and future customer activity.
Premier's Trust Preferred Securities represent beneficial interests in the assets of PFBI Capital Trust (NASDAQ/NMS-PFBIP). The trust holds $20.9 million of 9.75% Junior Subordinated Deferrable Interest Debentures ("Subordinated Debentures") due in 2027. This total is down from the $26.6 million outstanding at December 31, 2003 due to $5.7 million of early redemptions during the fourth quarter of 2004. Quarterly cash distributions on the Preferred Securities are made to the extent interest on the debentures is received by the trust.
As previously disclosed, pursuant to an agreement entered into with the Federal Reserve Bank of Cleveland on September 29, 2000, as superseded by an agreement with the Federal Reserve Bank of Cleveland dated January 29, 2003, Premier is required to request approval for the payment of distributions due on the Trust Preferred Securities. During the quarter ended June 30, 2002, Premier was notified by the Federal Reserve Bank of Cleveland that due to the deterioration of core earnings of the Company, among other issues, the FRB would not allow the payment of the distribution due June 30, 2002 on Premier's Trust Preferred Securities. In response, Premier reached an agreement with the Federal Reserve Bank of Cleveland whereby Premier's Chairman of the Board, who is also its largest shareholder, agreed to loan the company the amount of the distribution, $701,000, so that Premier, with the Federal Reserve Bank's approval, could make the distribution. The loan is unsecured at a zero interest rate with no defined maturity date. The loan cannot be repaid without the prior approval of the Federal Reserve Bank. A similar agreement was reached for the payment of the distribution due September 30, 2002. Premier's President and Chief Executive Officer, who is also a director, agreed to loan the Company the amount of the September 30 distribution, $701,000. This loan is also unsecured at a zero interest rate with no defined maturity date. The loan also cannot be repaid without the prior approval of the Federal Reserve Bank of Cleveland.
In December 2002, The Federal Reserve Bank of Cleveland ("FRB") denied Premier's request to make the fourth quarter distribution. Accordingly, Premier exercised its right to defer the payment of interest on the Subordinated Debentures related to the Trust Preferred Securities for an indefinite period (which can be no longer than 20 consecutive quarterly periods). Premier continued to defer the payment of interest throughout 2003 and 2004. In the first quarter of 2005, Premier sought and received approval from the FRB to make the first quarter 2005 distribution and all nine previously deferred quarterly distributions. During the deferral period, the deferred distributions also accrued interest at an annual rate of 9.75%. This interest, the deferred distributions, and the current quarterly distribution are all scheduled to be paid on March 31, 2005 to holders of record on March 15, 2005. Although the FRB approved the payment of the deferred and current distributions through March 31 ,2005, Premier is still bound by the Written Agreement and will be required to request the FRB's approval to pay future distributions. No assurance can be given that the FRB will grant such approval.
As part of a Debt Reduction and Profitability plan presented on January 6, 2003 to the Federal Reserve Bank of Cleveland ("Federal Reserve"), Premier requested and received approval from the Federal Reserve to redeem $3,000,000 of the then outstanding $28,750,000 Trust Preferred Securities. The goal of the redemption was to use a portion of Premier's cash on hand to reduce its total interest cost and thus improve profitability. The redemption reduced Premier's interest cost by approximately $292,000 per year. However, this benefit was partially offset due to the interest accrued in 2003 on the deferred quarterly distributions. In 2004, Premier requested and received approval from the Federal Reserve to redeem $4.5 million of Trust Preferred Securities on October 15, 2004 and another $1.0 million on December 31, 2004. These two redemptions will reduce Premier's future interest cost by approximately $536,000 per year. Future early redemptions, if any, will also require Federal Reserve approval, pursuant to a previously disclosed Written Agreement entered into with the Federal Reserve Bank of Cleveland on January 29, 2003.
Asset/Liability Management and Market Risk
Asset/liability management is a means of maximizing net interest income while minimizing interest rate risk by planning and controlling the mix and maturities of interest related assets and liabilities. Premier has established an Asset/Liability Management Committee (ALCO) for the purpose of monitoring and managing interest rate risk and to evaluate investment portfolio strategies. Interest rate risk is the earnings variation that could occur due to changes in market interest rates. The Board of Directors has established policies to monitor and limit exposure to interest rate risk. Premier monitors its interest rate risk through the use of an earnings simulation model prepared by an independent third party to analyze net interest income sensitivity.
The earnings simulation model uses assumptions, maturity patterns, and reinvestment rates provided by Premier and forecasts the effect of instantaneous movements in interest rates of both 100 (1.00%) and 200 (2.00%) basis points. The most recent earnings simulation model projects net interest income would increase by approximately 0.4% over the projected stable rate net interest income if interest rates rise by 100 basis points over the next year. Conversely, the simulation projects an approximate 0.9% decrease in net interest income if interest rates fall by 100 basis points over the next year. Within the same time frame, but assuming a 200 basis point movement in interest rates, the simulation projects that net interest income would increase by 0.8% over the projected stable rate net interest income in a rising rate scenario and would decrease by 1.9% in a falling rate scenario. Under both the 100 and 200 basis point simulations, the percentage changes in net interest income are within Premier's ALCO guidelines.
Another measure of a company's interest sensitivity is the measure of Economic Value at Risk (EVR). The EVR of a company's balance sheet at a given point in time is the discounted present value of asset cash flows minus the discounted present value of liability cash flows. Similar to net interest income, EVR can be simulated assuming changes in market interest rates. The resulting percentage change versus the stable rate EVR is an indication of the longer term repricing risk imbedded in the balance sheet. At December 31, 2004, a 200 basis point increase in rates is estimated to decrease Premier's EVR by 15.5% while a 200 basis point decrease would increase Premier's EVR by 25.7%. The percentage changes in EVR for the 200 basis point decrease are outside Premier's ALCO guidelines. However, the with market interest rates already at relatively low levels, the likelihood of an additional 200 basis point decrease is believed to be remote. Furthermore, the low interest rate environment in 2004 limits the change in the market value of liabilities in a declining rate simulation because rates paid on liabilities cannot fall below zero.
The model simulation calculations of present value have certain acceptable shortcomings. The discount rates and prepayment assumptions utilized are based on estimated market interest rate levels for similar loans and securities nationwide. The unique characteristics of Premier's loans and securities may not necessarily parallel those assumed in the model simulations, and therefore, actual results could likely result in different discount rates, prepayment experiences and present values. The discount rates used for deposits and borrowings are based upon available alternative types and sources of funds which may not necessarily be indicative of the present value of Premier's deposits and borrowings. Premier's deposits have customer relationship advantages that are difficult to simulate. A higher or lower interest rate environment will most likely result in different investment and borrowing strategies by Premier which would be designed to further mitigate any negative effects on the value of, and the net interest earnings generated on Premier's net assets.
The following table presents summary information about the simulation model's interest rate risk measures and results.
Year-End Year-End ALCO 2004 2003 Guidelines -------- -------- ----------
Projected 1-Year Net Interest Income -100 bp change vs. Base Rate -0.9% -1.5% 10% +100 bp change vs. Base Rate 0.4% 1.0% 10% Projected 1-Year Net Interest Income -200 bp change vs. Base Rate -1.9% -2.9% 10% +200 bp change vs. Base Rate 0.8% 2.0% 10% Economic Value Change -200 bp Change vs. Base Rate 25.7% 28.9% 20% +200 bp Change vs. Base Rate -15.5% -16.3% 20%
The improvement in the 2004 simulated change in EVR for a 200 basis point decline in interest rates is due to the current low interest rate environment. The low interest rate environment in 2004 limits the change in the market value of liabilities in a declining rate simulation because rates paid on liabilities cannot fall below zero.
Liquidity
Liquidity is the ability to satisfy demands for deposit withdrawals, lending commitments, and other corporate needs. Premier's liquidity is based on the stable nature of consumer core deposits held by the banking subsidiaries. Likewise, additional liquidity is available from holdings of investment securities and short-term investments which can be readily converted into cash. Furthermore, Premier's banks continue to have the ability to attract short-term sources of funds such as federal funds and repurchase agreements.
Premier generated $11.5 million of cash from operations in 2004, which compares to $12.2 million in 2003 and $10.3 million in 2002. These proceeds along with the proceeds from the sale and maturity of securities and the repayment of loans were used to purchase securities, satisfy deposit withdrawals, and reduce outstanding debt during those years. Net cash provided by liquidating investing activities totaled $7.5 million in 2004, $29.5 million in 2003 and $5.3 million in 2002. Net cash used to satisfy deposit withdrawals and reduce debt totaled $20.9 million in 2004, $39.5 million in 2003 and $17.4 million in 2002. Details on the sources and uses of cash can be found in the Consolidated Statements of Cash Flows in the consolidated financial statements.
At December 31, 2004, the parent company had nearly $7.7 million in cash held with its subsidiary banks. This balance along with cash dividends expected to be received from its subsidiaries is sufficient to cover the operating costs of the parent, service its existing other debt and to pay the deferred Trust Preferred distributions approved by the Federal Reserve in the first quarter of 2005. During 2004, the parent company received $14.3 million from the sale of its subsidiary, Citizens Bank and generated $2.3 million from operations. Premier used a portion of these proceeds to complete the necessary capital injections into Farmers Deposit Bank to maintain the Bank's capital ratios required by the FDIC in accordance with the Order. Premier used a substantial portion of the proceeds to reduce its borrowed funds and redeem a portion of the Trust Preferred Securities outstanding. The remainder was held for future use. Additional information on parent company cash flows and financial statements is contained in Note 21 to the consolidated financial statements.
Capital Resources
Premier's consolidated average equity-to-asset ratio increased to 8.23% during 2004, up from 7.87% in 2003 but down slightly from the 8.43% during 2002. The ratios for all three years are considered adequate for a company of Premier's size . The increase in 2004 was largely due to the decline in average total assets due to the sale of Citizen's Bank Kentucky on July 1, 2004. The decrease in 2003 was largely the result of the losses sustained during the year resulting from the operations of Farmers Deposit Bank The Federal Reserve's risk-based capital guidelines and leverage ratio measure the capital adequacy of banking institutions. The risk-based capital guidelines weight balance sheet assets and off-balance sheet commitments by prescribed factors relative to credit risk, thus eliminating disincentives for holding low risk assets and requiring more capital for holding higher risk assets. At year-end 2004, Premier's risk adjusted capital-to-assets ratio was 18.9% compared to 14.8% at December 31, 2003. Both of these ratios are well above the minimum level of 8.0% prescribed for bank holding companies of Premier's size. The leverage ratio is a measure of total tangible equity to total tangible assets. Premier's leverage ratio at December 31, 2004 was 9.7% compared to 6.4% at December 31, 2003. Both of these ratios are above the recommended 4.0% to 5.0% recommended by the Federal Reserve. The increase in the 2004 ratios was the result of the increase in total capital and decline in total assets resulting from the sale of Citizens Bank, coupled with a decrease in disallowed deferred tax assets. In accordance with Federal Reserve guidelines for all banks and bank holding companies, deferred tax assets are subtracted from Premier's available total equity ("disallowed") if they generally cannot be realized through available tax refunds in a next twelve month timeframe. Premier's capital ratios are the direct result of management's desire to maintain a strong capital position. Additional information on Premier's capital ratios and the capital ratios of its larger banks may be found in Note 20 to the consolidated financial statements.
The primary source of funds for dividends paid by Premier to its shareholders is the dividends received from its subsidiary banks. Banking regulations limit the amount of dividends that may be paid without prior approval of the regulatory agencies. Under these regulations, the amount of dividends that may be paid without prior approval in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years, subject to regulatory capital requirements and additional restrictions more fully described in Note 20 to the consolidated financial statements. During 2005, Premier's banks could, without prior approval, declare and pay to Premier dividends of approximately $2.5 million plus any 2005 net profits retained through the date of declaration by Ohio River Bank, Citizens Deposit Bank, Boone County Bank and First Central Bank.
Additional information on the capital position of Premier is included in the following table.
INCOME STATEMENT ANALYSIS Net Interest Income
Net interest income, the amount by which interest generated from earning assets exceeds the expense associated with funding those assets, is Premier's most significant component of earnings. Net interest income on a fully tax- equivalent basis was $18.3 million in 2004, down 6.9% from the amount earned in 2003 which follows a 8.1% decrease in 2003 from 2002. When net interest income is presented on a fully tax-equivalent basis, interest income from tax-exempt earning assets is increased by the amount equivalent to the federal income taxes which would have been paid if this income were taxable at the statutory federal tax rate of 34% for companies of Premier's size. The decrease in net interest income in 2004 is largely due to a decrease in the volume of loans outstanding coupled with a decline in loan interest income resulting from the high level of non-accrual loans at Farmers Deposit. As shown in the Rate Volume Analysis table below, decreases in the volume of earning assets (primarily loans) in 2004 reduced Premier's interest income by $1.8 million. This decrease was partially offset by the lower volume of interest bearing liabilities in 2004 resulting in a $1.3 million decline in interest expense. The net effect was to reduce net interest income by $571,000 for the year. Similarly, the lower interest rate environment in 2004, coupled with the decline in interest income for loans placed on non-accrual resulted in reduced interest income of $2.0 million. This decline was partially offset by reduced interest expense of $1.2 million which resulted primarily from the lower interest rate environment and the resulting lower rate paid on deposits. During the latter half of 2004, interest rates began to rise, which resulted in increases in the interest paid on Premier's long and short term borrowings. The overall effect of declining volumes and declining rates was a decrease in net interest income of $1.3 million in 2004 when compared to 2003.
Similarly, in 2003, a reduction in Premier's volume of earning assets reduced interest income by $1.9 million which was only partially offset by a $1.5 million decrease in interest expense due to a lower volume of interest bearing liabilities. The net result was a $429,000 decrease in net interest income from volume activity. Likewise, in 2003, the declining interest rate environment coupled with loan interest income reversals due to loans placed on non-accrual reduced Premier's interest income by $4.8 million. This decline was only partially offset by the decline in the rates paid on deposits in 2003. As a result of the lower interest rate environment, Premier's interest expense declined by $3.5 million in 2003 versus 2002. The overall effect of declining volumes and declining rates was a decrease in net interest income of $1.7 million in 2003 when compared to 2002.
As net interest income dollars declined in 2004, Premier's net interest margin also decreased. In 2004, the yield earned on investment securities declined 23 basis points to 3.18% while the yield on the loan portfolio declined 50 basis points to 7.10%. The net result on all earning assets was to reduce the yield 37 basis points to 5.60% in 2004, down from 5.97% earned in 2003 and 6.99% earned in 2001. Similarly, in 2004 Premier reduced the average rate paid on its deposits by 40 basis points by not renewing high rate certificates of deposit and by keeping the rates paid on other deposit products competitive with national and local market rates. As the interest rate began to increase late in 2004, the rates paid on Premier's variable rate borrowings also increased. The rate paid on short-term borrowings increased 71 basis points to 1.80% and the rate paid on other borrowings increased 13 basis points on average to 4.67%. Furthermore, due to the interest required to be accrued on the deferred Trust Preferred distributions, the effective rate on the outstanding principal balance of the debt increased by 107 basis points to 11.30%. The rate increase is magnified by the decline in the average balance outstanding due to Premier's early redemptions in 2003 and 2004. The net result on all interest bearing liabilities was to reduce the cost of funds 31 basis points to 2.32% in 2004, down from 2.63% in 2003 and 3.49% in 2002. As a result Premier's net interest spread decreased by only 6 basis points and its net interest margin decreased by only 2 basis points to 3.61% in 2004, down from 3.63% in 2003 and 3.84% in 2002. Further discussion of interest income is included in the section of this report entitled "Balance Sheet Analysis."
Non-interest Income and Expense
Non-interest income has been and will continue to be an important factor for improving profitability. Recognizing this importance, management continues to evaluate areas where non-interest income can be enhanced. As shown in the table of Non-interest Income and Expense below, total fees and other income increased by 1.7% or $58,000 in 2004. The increase in 2004 is largely due to an increase in service charges on deposit accounts, substantially offset by declines in insurance commissions and other sources of non-interest income. In 2003, total fees and other income increased by 23.6% or $658,000 from 2002. The increase in 2003 is also largely due to increases in service charges on deposit accounts. Service charges on deposit accounts increased to $2,513,000 in 2004, an increase of 16.0% or $346,000. This increase follows a 28.2% or $476,000 increase in 2003 over 2002. The increases are the result of changes in the way Premier charges customers for over drawing their checking accounts and a general increase in customers and activity. These increases were partially offset by declining insurance commissions. Insurance commissions declined by 56.5% or $70,000 in 2004 and 40.9% or $86,000 in 2003 largely due to lower new loan generations resulting from lower loan demand and stiffer competition from larger banks. Other income decreased 18.8% or $218,000 in 2004 from the high amount of other income reported in 2003. This is primarily the result of a lower volume of commissions from originating secondary market mortgage loans, lower data processing revenue from non-affiliate banks, and a high level of 2003 collections of loans retained from the Bank of Mt. Vernon and Sabina Bank sales. Other income increased by 30.2% or $268,000 in 2003. This is a result of increases in various other sources of income such as debit card fees, commissions from originating secondary market mortgage loans and collections of loans retained from the Bank of Mt. Vernon and Sabina Bank sales.
In 2004, Premier realized $100,000 in net gains on securities sales. These securities were sold as part of Premier's management of its asset/liability position and to liquidate certain tax exempt investments in order to generate future taxable income. In 2003, Premier realized $616,000 in net gains on securities sales. Again, these securities were sold as part of Premier's management of its asset/liability position and to liquidate the tax-exempt investments at Farmers Deposit Bank in order to generate taxable income in the future. In 2002, Premier realized $73,000 in net losses on securities sales.
The following table is a summary of non-interest income and expense for each of the years the three-year period ending December 31, 2004.
Just as management continues to evaluate areas where non-interest income can be enhanced, it strives to find ways to improve the efficiency of its operations and utilize the economies of scale of the consolidated entity to reduce its operating costs. Premier's 2004 net overhead ratio, or non-interest expense less non-interest income excluding securities transactions and other similar non-operating transactions to average earning assets was 2.82%, an increase from the 2.62% realized in 2003 and the 2.70% ratio realized in 2002. While the 2004 ratio increased by 20 basis points, the actual dollars of net overhead expense increased by only 0.7% or $95,000. The primary reason for the increase in the net overhead ratio is the 6.1% decrease in average earning assets without a corresponding decrease in operating costs. For the year 2004, net overhead was $14.3 million, up $95,000 from the $14.2 million of 2003 net overhead. The current year increase follows an $860,000 or 5.7% decrease in 2003 from the $15.0 million of net overhead in 2002.
Total non-interest expense in 2004 increased by $150,000, or 0.9% from 2003 as decreases in OREO losses, bad check losses and occupancy and equipment expenses were essentially offset by increased professional fees, taxes not on income and other operating expenses. This year's increase compares to a $199,000 or 1.1% decrease in 2003 versus 2002. The decrease in 2003 was generally the result of decreases in staff costs, OREO losses and expenses and taxes not on income which were only partially offset by increases in professional fees, bad check losses and other expenses.
Staff costs increased by only $13,000 or 0.2% in 2004 versus 2003. Increases in salaries and wages were essentially offset by reductions in medical insurance and other benefit costs. In 2003, staff costs decreased by $193,000 or 2.2% compared to 2002. Likewise, increases in salaries and wages were more than offset by reductions in medical insurance and other benefit costs. In the second quarter of 2003, employees were required to contribute a percentage of the overall medical insurance premium as Premier changed its benefit structure to be more in-line with its competitors. The percentage of employee contribution was phased in over the two year period.
Occupancy and equipment expenses decreased by $119,000 or 5.3% in 2004 as lower equipment depreciation and maintenance costs were complemented by lower occupancy costs. In 2003, occupancy and equipment expenses decreased by $23,000 or 1.0% as decreases in equipment expenses were substantially offset by an increase in occupancy costs.
Professional fees increased by $933,000 or 69.7% in 2004 versus 2003 primarily due to increased audit costs as well as legal fees and other professional fees associated with Premier's investigation of Farmers Deposit Bank and the related SEC investigation as disclosed in previous filings. Professional fees increased by $252,000 or 23.2% in 2003 versus 2002. The increase in 2003 was largely due to legal and audit costs related to the Farmers Deposit Bank investigation.
Taxes not on income increased by $55,000 or 10.3% in 2004 versus 2003. The increase in 2004 is due to an increase in franchise taxes imposed by the states in which the Banks operate. Taxes not on income decreased by $154,000 or 22.4% in 2003 versus 2002 largely due to employment of tax saving strategies resulting from the moving of the company headquarters to West Virginia.
OREO writedowns and expenses netted to a $45,000 benefit in 2004 as Premier realized $123,000 of net profit from the disposition of OREO properties in 2004. A majority of the gains on the disposition of OREO were on properties from which no previous writedowns had occurred. This profit more than offset the costs of maintaining the remaining OREO property held in 2004. The net benefit in 2004 is a $585,000 decrease from the $540,000 of OREO writedowns and expenses recorded in 2003. The decrease from 2003 follows a $620,000 or 53.5% decrease from the $1.2 million of these expenses in 2002. The high level in 2002 was largely due to writedowns of OREO property to net realizable values as management emphasized efforts to liquidate the properties.
Bad check losses totaled $94,000 in 2004, a $367,000 decrease from the $461,000 recorded in 2003. The 2003 losses were a $432,000 increase from the $29,000 of bad check losses recorded in 2002. The increase in 2003 was primarily the result of bad checks losses at Farmers Deposit Bank related to dishonored checks discovered during investigation. The collection of these checks is still being pursued by the bank.
Accelerated Trust Preferred issuance costs were recognized in 2003 and 2004. At the time of issuance, the costs to originate the Trust Preferred Securities were capitalized. The costs are being amortized over the 30 year life of the securities which mature in 2027 and are recorded as an adjustment to interest expense. In March 2003, Premier redeemed $3.0 million of the Trust Preferred Securities in accordance with the terms of the instrument. At that time an amount of the remaining unamortized issuance costs proportional to the $3.0 million of the then $28.8 million of Trust Preferred Securities outstanding was expensed to non-interest expense. This amount totaled $124,000 in 2003. Likewise, as a result of the $4.5 million early redemption on October 15, 2004 and the additional $1.0 million redeemed on December 31, 2004, Premier expensed $214,000 of the issuance costs. Additional information on the Trust Preferred Securities is contained in Note 12 to the consolidated financial statements.
Other expenses totaled $3.4 million in 2004, a 4.4% or $144,000 increase from the $3.3 million recorded in 2003. The increase in 2004 is largely due to a $165,000 writedown of the former headquarters of Premier located in Georgetown Kentucky prior to its sale. Other operating expenses in 2003 were approximately the same amount recorded in 2002.
An analysis of the allowance for loan losses and related provision for loan losses is included in the Loan Portfolio section of the Balance Sheet Analysis of this report.
Applicable Income Taxes
Premier recognized $899,000 of income tax expense related to continuing operations. This amount compares to the $5.3 million income tax benefit recognized in 2003 and the $1.5 million income tax benefit recognized in 2002. The benefit in 2003 and 2002 was due to the pretax losses realized by Premier. Premier's effective tax rate was 31.4% in 2004, down from the negative (35.5%) in 2003 and the negative (40.8%) in 2002. Premier's effective tax rates in 2003 and 2002 were increased by the benefits of holding tax-exempt investments and other tax saving instruments. These tax saving benefits helped to reduce Premier's positive tax rate in 2004 to 31.4% from the 34.0% statutory rate. Additional information regarding income taxes is contained in Note 13 to the consolidated financial statements.
Effects of Changing Prices
The results of operations and financial condition presented in this report are based on historical cost, unadjusted for the effects of inflation. Inflation affects Premier in two ways. One is that inflation can result in increased operating costs which must be absorbed or recovered through increased prices for services. The second effect is on the purchasing power of the corporation. Virtually all of a bank's assets and liabilities are monetary in nature. Regardless of changes in prices, most assets and liabilities of the banking subsidiaries will be converted into a fixed number of dollars. Non- earning assets, such as premises and equipment, do not comprise a major portion of Premier's assets; therefore, most assets are subject to repricing on a more frequent basis than in other industries.
Premier's ability to offset the effects of inflation and potential reductions in future purchasing power depends primarily on its ability to maintain capital levels by adjusting prices for its services and to improve net interest income by maintaining an effective asset/liability mix. Management's efforts to meet these goals are described in other sections of this report.
SUMMARY RESULTS OF OPERATIONS FOURTH QUARTER 2004
Income from continuing operations for the three months ended December 31, 2004 totaled $559,000, a $1.2 million improvement from the $596,000 loss from continuing operations reported for the fourth quarter of 2003. On a per share basis, Premier's income from continuing operations for the fourth quarter of 2004 was 11 cents per share, compared to a loss of 11 cents per share for the same quarter last year.
Net interest income totaled $4,802,000 for the fourth quarter of 2004, an increase of $322,000 or 7.2% from the net interest income earned in the same quarter of 2003. The increase is the result of lower interest expense on deposits and borrowings, primarily due to lower outstanding balances of both. The provision for loan losses was $355,000 in the fourth quarter of 2004, a decrease of $1.8 million or 83.3% when compared to the fourth quarter of 2003. The large provision in 2003 was primarily the result of additional credit risk identified in the loan portfolio as a result of the on-going investigation at Farmers Deposit Bank. Non-interest income excluding securities transactions totaled $870,000 in the fourth quarter of 2004, a decrease of $105,000 or 10.8% from the $975,000 in the fourth quarter of 2003. The decrease was largely due to decreased insurance commissions, secondary market fees and other income. Non-interest expense totaled $4,584,000 in the fourth quarter of 2004, a $108,000 or 2.3% decrease from the $4,692,000 reported for the fourth quarter of 2002. Increases in staff costs, professional fees and accelerated amortization of trust preferred issuance costs were more than offset by lower OREO expenses and writedowns, bad check losses, and collection expense. Additional quarterly financial data is provided in Note 21 to the consolidated financial statements.
ADOPTION OF NEW ACCOUNTING STANDARDS
Recently Issued Accounting Standards Not Yet Adopted - FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. As discussed in the Stock Compensation Expense disclosure above, the cost of stock options is measured at the fair value of the options when granted. This cost will be required to be expensed over the employee service period, which is normally the vesting period of the options. This Standard will apply to stock option awards granted or modified after the first quarter or year following June 15, 2005. Compensation cost will also be recorded for options already granted that have a vesting period beyond the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted. The effect of existing options that will continue to vest after the adoption date is anticipated to be immaterial. There will also be no significant effect on the financial position of the Company as total equity will not change as a result of the required recording of compensation cost.
Item 8.
Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The Company's Financial Statements and related Independent Auditors' Report are presented in the following pages. The financial statements filed in this Item 8 are as follows:
Report of Independent Registered Public Accounting Firm
Financial Statements: Consolidated Balance Sheets - December 31, 2004 and 2003 Consolidated Statements of Operations - Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Comprehensive Income - Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2004, 2003, and 2002 Consolidated Statements of Cash Flows - Years ended December 31, 2004, 2003, and 2002 Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors Premier Financial Bancorp, Inc. Huntington, West Virginia
We have audited the accompanying consolidated balance sheets of Premier Financial Bancorp, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Premier Financial Bancorp, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Crowe Chizek and Company LLC
Columbus, Ohio March 23, 2005
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED BALANCE SHEETS December 31, 2004 and 2003 (In Thousands, Except Per Share Data) - --------------------------------------------------------------------------------
2004 2003 ---------- ---------- ASSETS Cash and due from banks $ 14,474 $ 16,422 Federal funds sold 17,342 17,051 Securities available for sale 153,892 147,646 Loans 324,927 331,794 Allowance for loan losses (9,384) (14,300) ---------- ---------- Net loans 315,543 317,494 Federal Home Loan Bank and Federal Reserve Bank stock 2,611 2,490 Premises and equipment, net 7,257 7,956 Real estate and other property acquired through foreclosure 2,247 3,187 Interest receivable 2,740 3,448 Goodwill 15,816 15,816 Current year tax receivable 597 3,695 Other assets 4,736 8,024 Assets of discontinued operation - 79,163 ---------- ----------
Total assets $ 537,255 $ 622,392 ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 68,380 $ 59,001 Time deposits, $100,000 and over 40,213 42,780 Other interest bearing 329,205 353,693 ---------- ---------- Total deposits 437,798 455,474 Federal funds purchased 1,838 - Securities sold under agreements to repurchase 7,208 - Federal Home Loan Bank advances 9,288 10,705 Other borrowed funds 800 6,200 Notes payable 1,402 1,402 Guaranteed junior subordinated interest debentures 20,876 26,546 Interest payable 5,532 3,902 Other liabilities 1,484 1,227 Liabilities of discontinued operation - 71,396 ---------- ---------- Total liabilities 486,226 576,852
Stockholders' equity Preferred stock, no par value; 1,000,000 shares authorized; none issued or outstanding - - Common stock, no par value; 10,000,000 shares authorized; 5,232,230 shares issued and outstanding 1,103 1,103 Additional paid in capital 43,445 43,445 Retained earnings 7,008 311 Accumulated other comprehensive income (loss) (527) 681 ---------- ---------- Total stockholders' equity 51,029 45,540 ---------- ----------
Total liabilities and stockholders' equity $ 537,255 $ 622,392 ========== ==========
- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31 (In Thousands, Except Per Share Data)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) Years Ended December 31 (In Thousands, Except Per Share Data)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31 (In Thousands, Except Per Share Data)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2004, 2003 and 2002 (In Thousands, Except Per Share Data)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31 (In Thousands)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31 (In Thousands)
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- -------------------------------------------------------------------------------- See accompanying notes.
PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Premier Financial Bancorp, Inc. (the Company) and its wholly-owned subsidiaries:
The Company also has a data processing subsidiary, Premier Data Services, Inc. All material intercompany transactions and balances have been eliminated.
Nature of Operations: The subsidiary banks (Banks) operate under state bank charters and provide traditional banking services, including trust services, to customers primarily located in the counties and adjoining counties in Kentucky, Ohio, and West Virginia in which the Banks operate. Chartered as state banks, the Banks are subject to regulation by their respective state banking regulators and the Federal Deposit Insurance Corporation (FDIC) or the Federal Reserve Bank for member banks. The Company is also subject to regulation by the Federal Reserve Bank.
Estimates in the Financial Statements: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, the identification and evaluation of impaired loans, impairment of goodwill, realizability of deferred tax assets, and fair values of financial instruments are particularly subject to change.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cash Flows: For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and interest-earning balances with banks with an original maturity less than ninety days. Net cash flows are reported for loans, federal funds sold, deposits, and other borrowing transactions.
Securities: The Company classifies its securities portfolio as either securities available for sale or securities held to maturity. Securities held to maturity are carried at amortized cost.
Securities available for sale are carried at fair value. Adjustments from amortized cost to fair value are recorded in stockholders' equity, net of related income tax, under accumulated other comprehensive income on securities available for sale. Other securities such as Federal Home Loan Bank stock are carried at cost.
Interest income includes amortization of purchase premium or discount computed using the level yield method. Gains or losses on dispositions are based on the net proceeds and adjusted carrying amount of the securities sold using the specific identification method. Securities are written down to fair value when a decline in fair value is not temporary.
Loans: Net loans are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest income on loans is recognized on the accrual basis except for those loans in a non-accrual of income status. The accrual of interest on impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers' financial condition is such that collection of interest is doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The allowance for loan losses is a valuation allowance for probable incurred credit losses increased by a provision for loan losses charged to expense. The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Loans are charged against the allowance for loan losses when management believes that the collection of principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is recorded principally by the straight-line method with useful lives ranging from 7 to 40 years for premises and from 3 to 15 years for equipment.
Real Estate Acquired Through Foreclosure: Real estate acquired through foreclosure is carried at the lower of the recorded investment in the property or its fair value. The value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged to operating expenses. Certain parcels of real estate are being leased to third parties to offset holding period costs. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses.
Long-term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate that the carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Goodwill: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Impairment is evaluated using the aggregate of all banking operations. To evaluate impairment, management uses pricing valuation factors such as price-to-total assets and price-to-total deposits from databases of actual peer group bank sales. These valuation factors are applied to the comparable factors of the Company's aggregate banking operations to arrive at estimated fair value. The Company does not have any identifiable intangible assets such as core deposit intangibles.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Compensation: Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at the date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.
2004 2003 2002 -------- -------- --------
Income (loss) from continuing operations $ 1,963 $ (9,617) $ (2,207) Deduct: Stock-based compensation expense determined under fair value based method (33) (18) 98 -------- -------- -------- Pro forma income (loss) $ 1,930 $ (9,635) $ (2,109)
Basic earnings (loss) per share from continuing operations $ 0.37 $ (1.84) $ (0.42) Pro forma basic earnings (loss) per share 0.37 (1.84) (0.40)
Diluted earnings (loss) per share from continuing operations $ 0.37 $ (1.84) $ (0.42) Pro forma diluted earnings (loss) per share 0.37 (1.84) (0.40)
On February 18, 2004, 28,200 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $9.30. These options vest in three equal annual installments ending on February 18, 2007. On January 15, 2003, 28,650 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $7.96. These options vest in three equal annual installments ending on January 15, 2006. Proforma stock-compensation expense is being amortized over the three-year vesting period for each of these grants. There were no options granted during 2002. Future pro forma net income will be negatively impacted should the Company choose to grant additional options.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date. 2004 2003 2002 ---- ---- ----
Risk-free interest rate 3.15% 3.10% - Expected option life (yrs) 5.00 5.00 - Expected stock price volatility 0.25 0.42 - Dividend yield 0.00% 0.00% -
Weighted average fair value of options granted during the year $2.64 $3.30 -
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
Off Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issuance of the financial statements.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Business Segments: All of the Company's operations are considered by management to be aggregated into one reportable operating segment.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.
Recently Issued Accounting Standards Not Yet Adopted: FAS 123, Revised, requires all public companies to record compensation cost for stock options provided to employees in return for employee service. As discussed in the Stock Compensation Expense disclosure above, the cost of stock options is measured at the fair value of the options when granted. This cost will be required to be expensed over the employee service period, which is normally the vesting period of the options. This Standard will apply to stock option awards granted or modified after the first quarter or year following June 15, 2005. Compensation cost will also be recorded for options already granted that have a vesting period beyond the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted. The effect of existing options that will continue to vest after the adoption date is anticipated to be immaterial. There will also be no significant effect on the financial position of the Company as total equity will not change as a result of the required recording of compensation cost.
NOTE 2 - DISCONTINUED OPERATIONS
In the fourth quarter of 2003, the Company adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000. The sale was completed on July 1, 2004 and resulted in a gain of $6,664,000. In accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's financial statements and presented separately as "discontinued operations."
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 2 - DISCONTINUED OPERATIONS (Continued)
A condensed balance sheet and statement of operations for Citizens Bank follows (in thousands):
As of June 30 December 31 2004 2003 ----------- ----------- (unaudited) Assets Cash and federal funds sold $ 8,774 $ 6,473 Securities available for sale 11,600 12,082 Loans, net 49,141 53,886 Premises and equipment, net 3,006 3,026 Other assets 3,352 3,696 ----------- ----------- Total assets $ 75,873 $ 79,163 =========== ===========
Liabilities Deposits $ 62,440 $ 65,486 Federal Home Loan Bank advances 5,242 5,255 Other liabilities 543 655 ----------- ----------- Total liabilities 68,225 71,396 Equity 7,648 7,767 ----------- ----------- Total liabilities and equity $ 75,873 $ 79,163 =========== ===========
For the six months For the years ended ended June 30 December 31 2004 2003 2002 --------- --------- --------- (unaudited)
Interest income $ 2,021 $ 4,643 $ 5,927 Interest expense 732 1,873 2,701 --------- --------- --------- Net interest income 1,289 2,770 3,226 Provision for loan losses - 240 2,324 Non-interest income 434 938 836 Non-interest expense 1,718 3,595 3,460 Income tax (benefit) (1) 47) (592) --------- --------- ---------- Net income (loss) $ 4 $ (80) $ (1,130) ========= ========= ==========
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 2 - DISCONTINUED OPERATIONS (Continued)
Activity in the allowance for loan losses for Citizens Bank follows (in thousands):
2004 2003 2002 --------- --------- ---------
Balance, beginning of year $ 2,164 $ 2,685 $ 1,575 Loans charged off (283) (1,012) (1,520) Recoveries 124 251 306 Provision for loan losses - 240 2,324 Sale of subsidiary (2,005) - - --------- --------- ---------
Balance, end of year $ - $ 2,164 $ 2,685 ========= ========= =========
Nonperforming loans of Citizens Bank at year end were as follows (in thousands): 2003 2002 --------- ---------
Loans past due over 90 days still on accrual $ - $ 161 Nonaccrual loans 2,399 4,320 Restructured loans 46 164
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 3 - REGULATORY MATTERS
On September 29, 2000, the Company entered into an agreement with the Federal Reserve Bank (FRB) that prohibits the Company from paying dividends or incurring any additional debt without the prior written approval of the FRB. Additionally, the agreement required the Company to develop and monitor compliance with certain operational policies designed to strengthen Board of Director oversight including credit administration, liquidity, internal audit and loan review.
Subsequently, on January 29, 2003, the Company entered into a written agreement with the FRB which supersedes and rescinds all previous agreements between the Company and the FRB. Among the provisions of the agreement was the continuation of the restriction on the Company's payment of dividends on its common stock without the express written consent of the FRB and the continuation of the restriction on the Company's payment of quarterly distributions on its Trust Preferred Securities without the express written consent of the FRB. Among other provisions, the agreement required(s) the Company to retain an independent consultant to review its management, directorate and organizational structure, adopt a management plan responsive to such consultant's report, update its management succession plan in accordance with any recommendations in such consultant's report, monitor its subsidiary banks' compliance with bank policies and loan review programs, conduct formal quarterly reviews of its subsidiary Banks' allowances for loan losses, maintain sufficient capital, submit a plan to the FRB for improving consolidated earnings over a three-year period, and submit to the FRB annual projections of planned sources and uses of the Company's cash, including a plan to service its outstanding debt and trust preferred securities. The Company's compliance with the written agreement is monitored by a committee consisting of three of its outside directors. As of December 31, 2004, management believes the Company is operating in compliance with the provisions of the written agreement.
Two of the Company's subsidiaries, Citizens Deposit Bank & Trust and the Bank of Germantown, entered into similar agreements with their respective primary regulators which, among other things, prohibited the payment of dividends without prior written approval and required significant changes in their credit administration policies. The banks fully complied with the terms of the agreements in 2004 and, accordingly, the agreement with the Bank of Germantown was terminated in August 2004 and the agreement with Citizens Deposit Bank & Trust was terminated in October 2004.
The Securities and Exchange Commission ("SEC") is investigating the information disclosed in Premier's June 16 and July 31, 2003 Forms 8-K and the June 30, and September 30, 2003 Forms 10-Q regarding Farmers Deposit Bank and has requested information about Premier's investigation. Premier is cooperating with the SEC.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 3 - REGULATORY MATTERS (Continued)
On December 22, 2003, the Company's subsidiary Farmers Deposit Bank - Eminence, Kentucky (the Bank), was issued a Cease and Desist order (Order) by the Federal Deposit Insurance Corporation (FDIC) and the Kentucky Department of Financial Institutions (KDFI) [collectively referred to as "Supervisory Authorities"] related to activities of the bank's former president. The Order, effective January 1, 2004, requires the Bank to cease and desist from the following: (a) Operating with management whose policies and procedures are detrimental to the Bank and jeopardize the safety of its deposits; (b) Operating with an inadequate level of capital protection for the kind and quality of assets held by the Bank; (c) Operating with a large volume of adversely classified loans or assets and/or delinquent loans and/or non-accrual loans; (d) Operating with an inadequate allowance for loan and lease losses for the volume, kind and quality of loans and leases held by the Bank; (e) Engaging in hazardous lending and lax collection practices; (f) Operating with inadequate provisions for liquidity and funds management; (g) Operating with disregard of routine and controls policies; (h) Operating in such a manner as to produce operating losses; and (i) Violating laws and/or regulations cited in the most recent Report of Examination issued by the FDIC ("Report").
The Order also outlined a number of steps to be taken by the Bank which are designed to remedy and/or prevent the reoccurrence of the items listed in the Order. These include 1) retaining qualified management and increasing the involvement of the Bank's Board of Directors ("Board"); 2) developing and submitting to the Supervisory Authorities a capital plan that maintains the Bank's Tier I Leverage Ratio above a minimum 5.0% and increases that ratio to 8.0% by December 31, 2004; 3) restricting the payment of cash dividends; 4) requiring the Board to review the adequacy of the allowance for loan losses at least quarterly; 5) requiring the Bank to charge-off certain loans listed in the Report; 6) reviewing the system of internal loan review and system for assigning loan risk grades as well as revising the Bank's lending policies to address items of criticism contained in the Report; 7) developing written plans for reducing and/or improving the level of adversely classified loans and correcting documentation exceptions on certain loans detailed in the Report; 8) generally prohibiting additional lending to borrowers who currently have uncollected adversely classified loans; 9) submitting an annual budget to the Supervisory Authorities outlining goals and strategies for improving and sustaining the earnings of the Bank; 10) adopting and implementing a policy for operating the Bank with adequate internal controls consistent with safe and sound banking practices and developing an internal audit program to ensure the integrity of these controls; 11) adopting and implementing a liquidity and funds management policy; and 12) providing notice of the Order to shareholders. The Bank is required to provide quarterly progress updates to the Supervisory Authorities.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 3 - REGULATORY MATTERS (Continued)
In accordance with the Order, the Company contributed additional capital to Farmers to ensure a 5.00% leverage ratio at December 31, 2003 (see Note 20). The Company also submitted to the Supervisory Authorities a written capital restoration plan that incrementally increased the Bank's Tier I Leverage Ratio to 8.00% by December 31, 2004 as required. The Company met all of the targets specified in the capital restoration plan and at December 31, 2004, the Tier I Leverage Ratio of the Bank was 9.45%. The Company also believes the Bank is in compliance with all of the other provisions of the Order.
NOTE 4 - RESTRICTIONS ON CASH AND DUE FROM BANKS
Included in cash and due from banks are certain non-interest bearing deposits that are held at the Federal Reserve or maintained in vault cash in accordance with average balance requirements specified by the Federal Reserve Board of Governors. The balance requirement at December 31, 2004 and 2003 was $3.0 million and $2.6 million.
NOTE 5 -SECURITIES
The amortized cost and fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 5 -SECURITIES (Continued)
The amortized cost and fair value of securities at December 31, 2004 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair Cost Value ----------- ----------- (In Thousands) Available for sale Due in one year or less $ 25,588 $ 25,512 Due after one year through five years 93,622 92,867 Due after five years through ten years 391 406 Due after ten years 165 165 Mortgage-backed securities 34,921 34,942 ----------- -----------
Total available for sale $ 154,687 $ 153,892 =========== ===========
Proceeds from sales of securities during 2004, 2003 and 2002 were $1.9 million, $21.9 million and $5.8 million. Gross gains of $101,000, $653,000 and $40,000, and gross losses of $1,000, $37,000 and $113,000 were realized on those sales.
Securities with an approximate carrying value of $78.3 million and $76.1 million at December 31, 2004 and 2003 were pledged to secure public deposits, trust funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law.
Securities with unrealized losses at year-end 2004, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 5 -SECURITIES (Continued)
Securities with unrealized losses at year-end 2003, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
The investment portfolio is predominately high quality interest-bearing bonds with defined maturity dates backed by the U.S. Government or Government sponsored agencies. The unrealized losses at December 31, 2004 and December 31, 2003 are price changes resulting from changes in the interest rate environment and are not considered to be other than temporary declines in the value of the securities. Their fair value is expected to recover as the bonds approach their maturity date and/or market conditions improve.
NOTE 6 - LOANS
Loans at year-end were as follows (in thousands): 2004 2003 ------------ ------------
Commercial and agricultural, secured by real estate $ 101,567 $ 101,325 Commercial, other 40,923 38,063 Real estate construction 5,906 5,414 Residential real estate 128,243 126,134 Agricultural, other 2,380 3,032 Consumer and home equity 44,470 56,216 Other 1,438 1,610 ------------ ------------
$ 324,927 $ 331,794 ============ ============
Certain directors and executive officers of the Banks and companies in which they have beneficial ownership, were loan customers of the Banks during 2004 and 2003. Such loans were made in the ordinary course of business at the Banks' normal credit terms and interest rates.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 6 - LOANS (Continued)
An analysis of the 2004 activity with respect to all director and executive officer loans is as follows (in thousands):
Balance, December 31, 2003 $ 13,766 Additions, including loans now meeting disclosure requirements 6,062 Amounts collected, including loans no longer meeting disclosure requirements (4,714) ------------
Balance, December 31, 2004 $ 15,114 ============
Activity in the allowance for loan losses was as follows (in thousands):
Impaired loans were as follows (in thousands):
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 6 - LOANS (Continued)
Nonperforming loans at year end were as follows (in thousands):
Nonperforming loans include some impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. Loan impairment is reported when full payment under the loan terms is not anticipated, which can include loans that are current or less than 90 days past due.
NOTE 7 - PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows (in thousands): 2004 2003 ---------- ----------
Land and improvements $ 1,583 $ 1,567 Buildings and leasehold improvements 6,077 6,573 Furniture and equipment 7,402 7,836 ---------- ---------- 15,062 15,976 Less: accumulated depreciation (7,805) (8,020) ---------- ----------
$ 7,257 $ 7,956 ========== ==========
NOTE 8 - DEPOSITS
At December 31, 2004 the scheduled maturities of time deposits are as follows (in thousands):
2005 $ 100,269 2006 36,993 2007 21,069 2008 5,483 2009 2,675 Thereafter 956 ------------ $ 167,445 ============
Certain directors and executive officers of the Banks and companies, in which they have beneficial ownership, were deposit customers of the Banks during 2004 and 2003. The balance of such deposits at December 31, 2004 and 2003 were approximately $9,189,000 and $10,958,000.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase generally mature within one to ninety days from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows (in thousands):
2004 2003 ---- ----
Year-end balance $ 7,208 $ -
Average balance during the year $ 6,186 $ 4,674
Average interest rate during the year 1.82% 1.08%
Maximum month-end balance during the year $ 7,334 $ 6,255
Weighted average interest rate at year-end 2.66% -
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES
The Banks own stock of the Federal Home Loan Bank (FHLB) of Cincinnati, Ohio. This stock allows the Banks to borrow advances from the FHLB.
All advances are paid either on a monthly basis or at maturity, over remaining terms of six to eight years, with interest rates ranging from 4.10% to 6.64%, primarily at fixed rates with prepayment penalties for early repayment. Advances are secured by the FHLB stock, certain pledged investment securities and substantially all single family first mortgage loans of the participating Banks. Scheduled principal payments due on advances during the five years subsequent to December 31, 2004 are as follows (in thousands):
2005 $ 681 2006 717 2007 754 2008 793 2009 835 Thereafter 5,508 ----------
$ 9,288 ==========
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 11 - NOTES PAYABLE AND OTHER BORROWED FUNDS
In 2001, the Company entered into a promissory note with a commercial bank which is secured by Boone County Bank common stock. During 2004 the note was renewed for a period of one year. The interest rate is prime rate plus 1.00%. Accrued interest is due quarterly along with quarterly principal payments of $150,000 that began on September 27, 2003. Any remaining unpaid principal is due at maturity on April 27, 2005. The outstanding balance at December 31, 2004 was $800,000 and the interest rate was 6.25%.
The Company previously had a line of credit with a commercial bank of $20 million. During 2002, the line of credit expired, and the Company entered into a promissory note payable with the same commercial bank. The collateral for the note was the common stock of all of the Company's subsidiary banks except for Boone County Bank and a second lien on the common stock of Boone County Bank. The interest rate was prime rate plus 1.00%. The note matured on October 15, 2004 and was satisfied in full by the Company in September 2004.
In 2002, the Company also entered into notes payable with the Company's Chairman of the Board and President. Due to the restriction on the Company to pay its Trust Preferred distributions as discussed in Note 12, the Company reached an agreement with the FRB whereby the Company's Chairman of the Board, who is also the Company's largest shareholder, agreed to loan the Company the amount of the distribution, $701,000, so that the Company, with the FRB's approval, could make their second quarter 2002 distribution. A similar agreement was reached with the FRB for the payment of the distribution due for the third quarter 2002. The Company's President, who is also a director, agreed to loan the Company the amount of the distribution, $701,000. Thus, the balance of notes payable at December 31, 2004, was $1,402,000. Both loans are unsecured at a zero percent interest rate with no defined maturity date. The loans cannot be repaid without the prior approval of the FRB.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES
On June 9, 1997, PFBI Capital Trust (Trust), a statutory business trust created under Delaware law, issued $28,750,000 of 9.750% Preferred Securities ("Preferred Securities" or "Trust Preferred Securities") with a stated value and liquidation preference of $25 per share. The Trust's obligations under the Preferred Securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the Preferred Securities of the Trust, as well as the proceeds from the issuance of common securities to the Company, were utilized by the Trust to invest in $29,639,000 of 9.750% Junior Subordinated Deferrable Interest Debentures (the "Debentures") of the Company. The Debentures, which mature on June 30, 2027 are unsecured obligations and rank subordinate and junior to the right of payment to all senior indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Distributions on the Preferred Securities are payable at an annual rate of 9.750% of the stated liquidation amount of $25 per Preferred Security, payable quarterly. Cash distributions on the Preferred Securities are made to the extent interest on the Debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Debentures are redeemable in whole. Otherwise, the Debentures are generally redeemable by the Company in whole or in part on or after June 30, 2002 at 100% of the liquidation amount. Proceeds from any redemption of the Debentures would cause a mandatory redemption of the Preferred Securities and the common securities having an aggregate liquidation amount equal to the principal amount of the Debentures redeemed. Debt issuance costs of $1,478,000 have been capitalized by the Trust and are being amortized over the life of the debenture.
Prior to 2003, the Trust was consolidated in the Company's financial statements, with the Trust Preferred Securities issued by the Trust reported in liabilities as "guaranteed preferred beneficial interests in Company's debentures" and the subordinated debentures eliminated in consolidation. New accounting guidance, FASB Interpretation No. 46, as revised in December 2003, requires that subsidiaries defined as variable interest entities be consolidated by the enterprise that will absorb the majority of the entities' expected losses if they occur, receive a majority of the variable interest entities' residual returns if they occur, or both. The Company determined that the Trust meets the definition of a variable interest entity and that the Company is not the primary beneficiary of the Trust's activities. Accordingly, as of December 31, 2003, the Trust is no longer consolidated with the Company. The Company does not report the Preferred Securities issued by the Trust as liabilities, and instead reports as liabilities the Debentures issued by the Company and held by the Trust, as these are no longer eliminated in consolidation. The amounts previously reported as "guaranteed preferred beneficial interests in Company's debenture" in liabilities have been recaptioned "Guaranteed junior subordinated interest debentures" and continue to be presented in liabilities on the balance sheet. The deconsolidation of the Trust increased the Company's balance sheet by $796,000 at December 31, 2003, the difference representing the Company's common ownership
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES (Continued)
in the Trust. The deconsolidation has no impact on the Company's liquidity position since it continues to be obligated to repay the Debentures held by the Trust and guarantees repayment of the Preferred Securities issued by the Trust.
A portion of the Preferred Securities issued by the Trust qualify as Tier 1 capital for the Company under the Federal Reserve Board's regulatory framework. The Federal Reserve Board recently re-evaluated whether trust preferred securities would continue to qualify as Tier 1 capital due to deconsolidation of the related trust preferred entity. Its conclusion, issued in a press release on March 1, 2005, was to continue to permit trust preferred securities to qualify as Tier I capital with certain restrictions phased in over five-years. Once completely phased-in, the dollar amount of trust preferred securities that will qualify as Tier I capital will be limited to 25% of equity based Tier I capital net of goodwill. As of December 31, 2004, $17,185,000 of the Preferred Securities was included in the Company's Tier I capital. Had the Federal Reserve Board's new limitations been completely phased in at December 31, 2004, the amount of Preferred Securities includable in the Company's Tier I capital would have been limited to $11,913,000.
As previously disclosed, pursuant to an agreement entered into with the Federal Reserve Bank (FRB) described in Note 3 the Company is required to request approval for the payment of distributions due on the Debentures and Trust Preferred Securities. As part of a Debt Reduction and Profitability plan presented on January 6, 2003, the Company requested and received approval from the FRB to redeem $3,000,000 of the $28,750,000 outstanding Debentures and Trust Preferred Securities. Thus, on February 24, 2003, the Company announced its plans to redeem $3,000,000 (120,000 shares) of the 9.75% Trust Preferred Securities as of March 31, 2003. The FRB denied the Company's requests to make further distributions on the remaining Debentures and Trust Preferred Securities. During 2004, the Company requested and received approval from the FRB to redeem $4,500,000 (180,000 shares) on October 15, 2004 and an additional $1,000,000 (40,000 shares) on December 31, 2004. In conjunction with the fourth quarter 2004 redemptions, an additional $170,000 of the junior subordinated debenture was redeemed. The amount represents an equivalent percentage redemption of the Company's equity investment in the Trust.
Premier exercised its right to defer the payment of interest on the 9.75% Trust Preferred Securities for the quarter ending December 31, 2002 and all subsequent quarters through December 31, 2004, and for an indefinite period, which can be no longer than 20 consecutive quarterly periods. These deferred distributions accrued interest at an annual rate of 9.75%. In March 2005, Premier received approval from the FRB to pay the first quarter 2005 current distribution and all prior deferred distributions. The payment will be disbursed on March 31, 2005 to shareholders of record on March 15, 2005. The accrued interest on the deferred
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 12 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES (Continued)
distributions will be paid when the deferred distributions are ultimately paid on March 31, 2005. Although the FRB approved the payment of the deferred and current distributions through March 31, 2005, Premier is still bound by the Written Agreement and will be required to request the FRB's approval to pay future distributions. No assurance can be given that the FRB will grant such approval.
NOTE 13 - INCOME TAXES
The components of the provision (benefit) for income taxes are as follows (in thousands):
2004 2003 2002 -------- ------- -------- Current (2,452) $(3,589) $ (193) Deferred 3,351 (1,693) (1,329) -------- ------- -------- $ 899 $(5,282) $ (1,522) ======== ======= ========
The Company's deferred tax assets and liabilities at December 31 are shown below (in thousands). No valuation allowance for the realization of deferred tax assets is considered necessary.
2004 2003 --------- --------- Deferred tax assets Allowance for loan losses $ 3,191 $ 4,862 Net operating loss carryforward 250 1,486 AMT credit carryforward 442 469 Write-downs of other real estate owned 19 126 Unrealized loss on investment securities 268 - Other 119 95 --------- --------- Total deferred tax assets 4,289 7,038
Deferred tax liabilities Amortization of intangibles $ 1,320 $ 979 Depreciation 236 232 Federal Home Loan Bank dividends 206 201 Unrealized gain on investment securities - 284 Other 129 145 --------- --------- Total deferred tax liabilities 1,891 1,841 --------- ---------
Net deferred tax asset, included in other assets $ 2,398 $ 5,197 ========= =========
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 13 - INCOME TAXES (Continued)
An analysis of the differences between the effective tax rates and the statutory U.S. federal income tax rate is as follows (in thousands):
NOTE 14 - EMPLOYEE BENEFIT PLANS
The Company has qualified profit sharing plans that cover substantially all employees. Contributions to the plans consist of a Company match and additional amounts at the discretion of the Company's Board of Directors. Total contributions to the plans were $197,000, $197,000 and $177,000 in 2004, 2003 and 2002.
The Company also maintains Employee Stock Ownership Incentive Plans (the Plans) whereby certain employees of the Company are eligible to receive incentive stock options. The Plans are accounted for in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Pursuant to the Plans, a maximum of 600,000 shares of the Company's common stock may be issued through the exercise of these incentive stock options. The option price is the fair market value of the Company's shares at the date of the grant. The options are exercisable ten years from the date of grant. As of December 31, 2004, 516,350 shares were available for future grants under the terms of the Plans.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 14 - EMPLOYEE BENEFIT PLANS (Continued)
A summary of the Company's stock option activity is as follows:
Options outstanding at year-end 2004 were as follows:
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 15 - RELATED PARTY TRANSACTIONS
During 2004, 2003, and 2002, the Company paid approximately $358,000, $272,000, and $373,000 for printing, supplies, furniture, and equipment to a company affiliated by common ownership. The Company also paid another affiliate approximately $489,000, $892,000, and $1,200,000 in 2004, 2003, and 2002 to permit the Company's employees to participate in that entity's employee medical benefit plan.
During 2004, 2003 and 2002, the Company paid approximately $52,000, $51,000 and $17,000 to lease its headquarters facility at 2883 Fifth Avenue, Huntington, West Virginia from River City Properties, LLC, an entity 12.5% owned by Chairman of the Board of Directors Marshall T. Reynolds.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 16 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the earnings per common share and earnings per common share assuming dilution computations for 2004, 2003 and 2002 is presented below (in thousands, except per share data):
Stock options for 32,000 shares of common stock for 2004, 55,450 for 2003, and 35,000 for 2002 were not included in the computation of earnings per share assuming dilution because their impact was anti-dilutive.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 17 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of the Company's financial instruments at year-end are as follows (in thousands):
Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank and Federal Reserve Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The fair value of commitments to extend credit and standby letters of credit is not considered material.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 18 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include standby letters of credit and commitments to extend credit in the form of unused lines of credit. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments.
At December 31, 2004 and 2003, the Banks had the following financial instruments whose approximate contract amounts represent credit risk (in thousands):
2004 2003 ----------- -----------
Standby letters of credit $ 896 $ 671
Commitments to extend credit: Fixed $ 5,694 $ 4,988 Variable 17,118 13,284
Standby letters of credit represent conditional commitments issued by the Banks to guarantee the performance of a third party. The credit risk involved in issuing these letters of credit is essentially the same as the risk involved in extending loans to customers. Collateral held varies but primarily includes real estate and certificates of deposit. Some letters of credit are unsecured.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Outstanding commitments are at current market rates. Fixed rate loan commitments have interest rates ranging from 4.0% to 18.0%. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Banks evaluate each customer's creditworthiness on a case-by-case basis. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income producing properties.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 19 - LEGAL PROCEEDINGS
Legal proceedings involving the Company and its subsidiaries periodically arise in the ordinary course of business, including claims by debtors and their related interests against the Company's subsidiaries following initial collection proceedings. These legal proceedings sometimes can involve claims for substantial damages. At December 31, 2004 management is unaware of any legal proceedings for which the expected outcome would have a material adverse effect upon the consolidated financial statements of the Company.
NOTE 20 - STOCKHOLDERS' EQUITY
The Company's principal source of funds for dividend payments is dividends received from the subsidiary Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years, subject to the capital requirements and additional restrictions as discussed below. During 2005, the Banks could, without prior approval, declare dividends of approximately $2.5 million plus any 2005 net profits retained to the date of the dividend declaration.
The Company and the subsidiary Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.
These quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004, the Company and the Banks meet all quantitative capital adequacy requirements to which they are subject.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 20 - STOCKHOLDERS' EQUITY (Continued)
The capital amounts and classifications are also subject to qualitative judgments by the regulators. As a result of these qualitative judgments, the Company and one of the Company's subsidiaries have entered into agreements with the applicable regulatory authorities which provide for additional restrictions on their respective capital levels and the payment of dividends. The Company entered into an agreement with the Federal Reserve Bank (FRB), as discussed in Note 3, restricting the Company from declaring or paying dividends without prior approval from the FRB. An additional provision of this agreement requires prior approval from the FRB before the Company increases its borrowings or incurs any debt. This agreement is in effect until terminated by the FRB.
Citizens Deposit Bank (Citizens Deposit) entered into a Written Agreement with the FRB on September 29, 2000 restricting Citizens from declaring or paying dividends without prior approval. Having fully satisfied the provisions of the Written Agreement, the FRB terminated the agreement on October 29, 2004.
Bank of Germantown (Germantown) entered into an agreement with the Kentucky Department of Financial Institutions (KDFI) and the Federal Deposit Insurance Corporation (FDIC) on June 13, 2000 restricting Germantown from declaring or paying dividends, without prior approval, if its Tier I capital to average assets falls below 8%. Having complied with the terms of the agreement to the satisfaction of the KDFI and FDIC, the agreement was terminated on August 9, 2004.
Effective January 1, 2004, Farmers Deposit Bank (Farmers Deposit) was issued a C&D order by the FDIC and KDFI restricting Farmers Deposit from declaring or paying dividends, without prior approval, if its Tier I capital to average assets falls below 8.00%. The order also required Farmers Deposit to maintain a minimum 5.0% Tier I capital to average assets ratio and submit a written capital restoration plan to increase the ratio to 8.0% by December 31, 2004. This order is in effect until terminated by the KDFI and FDIC. Farmers Deposit's Tier I capital to average assets was 9.5% at December 31, 2004.
As of December 31, 2004, the most recent notification from the Federal Reserve Bank categorized the Company and its subsidiary banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Company's category.
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 20 - STOCKHOLDERS' EQUITY (Continued)
The Company's and the four largest subsidiary Banks' capital amounts and ratios as of December 31, 2004 and 2003 are presented in the table below (in thousands):
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS
Condensed Balance Sheets December 31 (In Thousands) 2004 2003 --------- --------- ASSETS Cash $ 7,666 $ 3,568 Investment in subsidiaries of continuing operations 70,683 70,248 Investment in subsidiary of discontinued operations - 7,767 Premises and equipment 514 956 Other assets 599 1,097 --------- ---------
Total assets $ 79,462 $ 83,636 ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities $ 5,355 $ 3,948 Notes payable 1,402 1,402 Subordinated debentures issued to trust 20,876 26,546 Other borrowed funds 800 6,200 --------- --------- Total liabilities 28,433 38,096
Stockholders' equity Preferred stock - - Common stock 1,103 1,103 Additional paid-in capital 43,445 43,445 Retained earnings 7,008 311 Accumulated other comprehensive income (527) 681 --------- --------- Total stockholders' equity 51,029 45,540 --------- ---------
Total liabilities and stockholders' equity $ 79,462 $ 83,636 ========= =========
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
Condensed Statements of Operations Years Ended December 31
(In Thousands) 2004 2003 2002 -------- -------- -------- Income Dividends from continuing subsidiaries $ 5,800 $ 7,853 $ 8,025 Interest and dividend income 46 14 - Other income 367 472 5 -------- -------- -------- Total income 6,213 8,339 8,030
Expenses Interest expense 3,117 3,121 3,313 Salaries and employee benefits 726 597 552 Professional fees 1,607 550 394 Accelerated trust preferred issuance costs 214 124 - Other expenses 514 295 832 -------- -------- -------- Total expenses 6,178 4,687 5,091 -------- -------- --------
Income from continuing operations before income taxes and equity in undistributed income of subsidiaries 35 3,652 2,939
Income tax benefit (2,071) (1,631) (1,729) -------- -------- --------
Income from continuing operations before equity in undistributed income of subsidiaries 2,106 5,283 4,668
Dividends in excess of net income of subsidiaries continuing in operation (143) (14,900) (6,875) -------- -------- --------
Net income (loss) from continuing operations 1,963 (9,617) (2,207) Net income (loss) from discontinued operations 4,734 (80) (1,130) -------- -------- --------
Net income (loss) $ 6,697 $ (9,697) $ (3,337) ======== ======== ========
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
Condensed Statements of Cash Flows Years Ended December 31
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PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004, 2003 and 2002 - --------------------------------------------------------------------------------
NOTE 21 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
The ability of the Company to fund its normal operating expenses, debt service requirements and subsidiary capital needs is dependent on its ability to raise cash through dividends from subsidiaries or sale of assets. As further discussed in Note 3, the Company's ability to obtain cash dividends from Farmers Deposit Bank is limited by formal regulatory agreement. Also as further described in Note 3, as a result of the Order issued to the Farmers Deposit Bank subsidiary, the Company has committed to maintain certain regulatory capital ratio thresholds by contributing additional capital to the bank as needed. Management plans for funding the additional capital contributions and other cash requirements consider projected dividends received in the normal course of business and special return of capital dividends that may require regulatory approval.
NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)
In 2004, interest income continued to be negatively impacted by the level of non-accrual loans at Farmers Deposit Bank. However, due to interest expense savings, net interest income began a gradual resurgence beginning with the second quarter. Net income was impacted positively in the fourth quarter by the improvement in the net interest margin and gains on the disposition of other real estate owned.
In 2003, interest income, net interest income and net income were all negatively impacted in all four quarters by the financial results of Farmers Deposit Bank. This included lower interest income and sharply higher provisions for loan losses due to loans charged-off and lower interest income from loans placed on non-accrual status. - --------------------------------------------------------------------------------
PART III
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure --------------------
There have been no changes in or disagreements with accountants on accounting or financial disclosure matters.
Item 9A.
Item 9A. Controls and Procedures
Premier management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-15c as of the end of the period covered by this annual report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this annual report has been made known to them in a timely fashion.
"Internal controls" are procedures, which are designed with the objective of providing reasonable assurance that (1) transactions are properly authorized; (2) assets are safeguarded against unauthorized or improper use; and (3) transactions are properly recorded and reported, all so as to permit the preparation of reports and financial statements in conformity with generally accepted accounting principles. Premier management uses the financial reports of its subsidiaries to make decisions about the allocation of the Company's resources, to implement strategies to improve the Company's performance, and to prepare the consolidated financial statements of the Company for its shareholders and regulatory authorities. However, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their cost. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Finally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.
It is this "management override of controls" that led to the significant charge-offs and provisions for loan losses at Farmers Deposit in 2003 and the financial statement restatement for years 2002 and 2001. Premier's policies and procedures related to the evaluation of a borrower's creditworthiness prior to making or renewing a loan, the reporting of new loan activity and delinquent loans to the bank's board of directors, and the guidelines for assessing the credit risk of existing loans were overridden by local management. The systematic disregard for these controls was sophisticated enough to avoid detection during routine reviews of that bank's records as directed by the Company and the regulatory authorities of the banking industry.
During late 2003 and throughout 2004, Premier management implemented corrective actions to remedy the deficiencies identified at Farmers Deposit. In addition to the steps identified in the cease and desist order of the FDIC and KDFI, Premier
* hired a new President and CEO of Farmers Deposit in 2003 who has experience restoring troubled banks to safe and sound banking practices, * hired a Chief Financial Officer for the bank in 2003, a new position, to segregate the lending and accounting functions of the bank, * formed a collections department to pursue delinquent borrowers and, when possible, to collect on loans previously charged-off, and * begun using system generated reports to the bank's board of directors rather than manually generated reports whenever possible.
Premier management also implemented additional processes and procedures throughout its network of banking subsidiaries in an effort to minimize the likelihood that improper management overrides go undetected. These included:
* hiring a credit analyst at the holding company level to review all loan requests over $400,000, * forming loan approval committees made up of the bank presidents and the President and Director of Risk Management of Premier to review all loan requests over $750,000, * incorporating "whistleblower" provisions into the employee code of ethics and conduct, * dispatching members of the Audit Committee of the Company's board of directors, at their request, to conduct employee meetings emphasizing the importance of each employee's responsibilities in maintaining the financial integrity of the Company's books and records, that overriding of internal controls will not be tolerated, and the employees' obligation to report improprieties to senior management or the Audit Committee in accordance with the employee code of ethics, * hiring an internal auditor at the holding company level to, among other duties assigned, conduct various tests for data integrity and compliance with internal control procedures, and * evaluating the internal audit program to incorporate tests designed to specifically detect the abuses uncovered during the Farmers Deposit investigation.
In 2005, Premier reduced its reliance on third-party internal audit and loan review providers and expanded its internal audit staff at the holding company level. Management believes a full-time internal audit and loan review staff will be able to provide more specific and more thorough testing of the books and records of the company and the effectiveness of its internal controls. Management also believes that having internal auditors on staff will provide more immediate reporting of findings to management, a source of on-location training of best practices for employees at the Affiliate Banks during the conduct of an audit and a rapid response team to address issues raised by employees under the "whistleblower" provisions of the employee code of ethics and conduct.
Beginning in late 2004 and continuing through June 2005, Premier's affiliate banks are converting to a third-party data processing and item processing provider. As part of the conversion process, system processes, workflows and procedures are being reviewed and potentially revised in an effort to standardize the way the Banks conduct business and record transactions in the various modules of the software. No significant changes to Premier's key controls are anticipated as a result of these reviews.
Other than the steps identified above, which are in various stages of implementation, there were no changes in internal controls over financial reporting during the fourth fiscal quarter that have materially affected or are reasonably likely to materially affect Premier's internal controls over financial reporting.
Item 10, 11, 12, 13 and 14. Directors and Executive Officers of the Registrant; - -------------------------------------------------------------------------------- Executive Compensation; Security Ownership of Certain Beneficial Owners ----------------------------------------------------------------------- and Management and Related Stockholder Matters; Certain Relationships ----------------------------------------------------------------------- and Related Transactions; and ----------------------------------------------------------------------- Principal Accountant Fees and Services -----------------------------------------------------------------------
The information required by these Items is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report which includes the required information. The required information contained in the Company's proxy statement is incorporated herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules - -------------------------------------------------------------------------
(a) The following documents are filed as part of this report:
1. Financial Statements:
2. Financial Statement Schedules:
No financial statement schedules have been included as part of this report because they are either not required or the information is otherwise included.
3. List of Exhibits:
The following is a list of exhibits required by Item 601 of Regulation S-K and by paragraph (c) of this Item 14.