Item 1. Business
General Description
The Company
First Bancorp (the "Company") is a bank holding company. The principal activity of the Company is the ownership and operation of First Bank (the "Bank"), a state chartered bank with its main office in Troy, North Carolina. The Company also owns and operates two nonbank subsidiaries: Montgomery Data Services, Inc. ("Montgomery Data"), a data processing company, and First Bancorp Financial Services, Inc. ("First Bancorp Financial"), which owns and operates various real estate. Each of these subsidiaries are fully consolidated for financial reporting purposes. The Company is also the parent to three statutory business trusts created under the laws of the State of Delaware, which have issued a total of $41.2 million in trust preferred debt securities. Under current accounting requirements, these three statutory business trusts are not consolidated for financial reporting purposes - see discussion of FIN 46 in "Current Accounting and Regulatory Matters" under Item 7 below.
The Company was incorporated in North Carolina on December 8, 1983, as Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common stock of the Bank through stock-for-stock exchanges. On December 31, 1986, the Company changed its name to First Bancorp to conform its name to the name of the Bank, which had changed its name from Bank of Montgomery to First Bank in 1985.
The Bank was organized in 1934 and began banking operations in 1935 as the Bank of Montgomery, named for the county in which it operated. As of December 31, 2004, the Bank operated in a 23 county area centered in Troy, North Carolina. Troy, population 3,400, is located in the center of Montgomery County, approximately 60 miles east of Charlotte, 50 miles south of Greensboro, and 80 miles southwest of Raleigh. The Bank conducts business from 59 branches located within a 120-mile radius of Troy, covering principally a geographical area from Latta, South Carolina to the southeast, to Wallace, North Carolina to the east, to Radford, Virginia to the north, to Wytheville, Virginia to the northwest, and Harmony, North Carolina to the west. Of the Bank's 59 branches, 53 are in North Carolina, with three branches each in South Carolina and Virginia (where the Bank operates under the name "First Bank of Virginia"). Ranked by assets, the Bank was the 7th largest bank in North Carolina as of December 31, 2004.
The Bank has two wholly owned subsidiaries, First Bank Insurance Services, Inc. ("First Bank Insurance") and First Montgomery Financial Services Corporation ("First Montgomery"). First Bank Insurance was acquired as an active insurance agency in 1994 in connection with the Company's acquisition of a bank that had an insurance subsidiary. On December 29, 1995, the insurance agency operations of First Bank Insurance were divested. From December 1995 until October 1999, First Bank Insurance was inactive. In October 1999, First Bank Insurance began operations again as a provider of non-FDIC insured investments and insurance products. Currently, First Bank Insurance's primary business activity is the placement of property and casualty insurance coverage. First Montgomery, a Virginia company incorporated on November 2, 2001, was formed to acquire real estate in Virginia and lease the property to the Bank. First Troy Realty Corporation ("First Troy") was incorporated on May 12, 1999 and is a subsidiary of First Montgomery. First Troy allows the Bank to centrally manage a portion of its residential, mortgage, and commercial real estate loan portfolio. As discussed in the last paragraph of "General Business" below, the Company intends to dissolve First Montgomery and First Troy in 2005.
The Company's principal executive offices are located at 341 North Main Street, Troy, North Carolina 27371-0508, and its telephone number is (910) 576-6171. Unless the context requires otherwise, references to the "Company" in this annual report on Form 10-K shall mean collectively First Bancorp and its consolidated subsidiaries.
General Business
The Bank engages in a full range of banking activities, providing such services as checking, savings, NOW and money market accounts and other time deposits of various types; loans for business, agriculture, real estate, personal uses, home improvement and automobiles; credit cards; debit cards; letters of credit; IRAs; safe deposit box rentals; bank money orders; and electronic funds transfer services, including wire transfers, automated teller machines, and bank-by-phone capabilities. In December 2004, the Bank also began offering its internet banking product, with on-line bill-pay and cash management features. Because the majority of the Bank's customers are individuals and small to medium-sized businesses located in the counties it serves, management does not believe that the loss of a single customer or group of customers would have a material adverse impact on the Bank. There are no seasonal factors that tend to have any material effect on the Bank's business, and the Bank does not rely on foreign sources of funds or income. Because the Bank operates primarily within the central Piedmont region of North Carolina, the economic conditions within that area could have a material impact on the Company. See additional discussion below in the section entitled "Territory Served and Competition."
Beginning in 1999, First Bank Insurance began offering non-FDIC insured investment and insurance products, including mutual funds, annuities, long-term care insurance, life insurance, and company retirement plans, as well as financial planning services (the "investments division"). In May 2001, First Bank Insurance added to its product line when it acquired two insurance agencies that specialized in the placement of property and casualty insurance. In October 2003, the "investment division" of First Bank Insurance became a part the Bank. The primary activity of First Bank Insurance is now the placement of property and casualty insurance products.
Montgomery Data's primary business is to provide electronic data processing services for the Bank. Ownership and operation of Montgomery Data allows the Company to do all of its electronic data processing without paying fees for such services to an independent provider. Maintaining its own data processing system also allows the Company to adapt the system to its individual needs and to the services and products it offers. Although not a significant source of income, Montgomery Data has historically made its excess data processing capabilities available to area financial institutions for a fee. At December 31, 2004, Montgomery Data had five outside customers that provided gross revenues of $416,000, $333,000, and $303,000 for the years ended December 31, 2004, 2003, and 2002, respectively. However, three of the five customers have notified Montgomery Data that they intend to terminate their services with Montgomery Data and switch to a lower cost provider during the first half of 2005. These three customers provided $328,000 in gross revenue to Montgomery Data in 2004.
First Bancorp Financial was organized under the name of First Recovery in September of 1988 for the purpose of providing a back-up data processing site for Montgomery Data and other financial and non-financial clients. First Recovery's back-up data processing operations were divested in 1994. First Bancorp Financial periodically purchases parcels of real estate from the Bank that were acquired through foreclosure or from branch closings. First Bancorp Financial actively pursues the sale of these properties.
First Bancorp Capital Trust I was organized in October 2002 for the purpose of issuing $20.6 million in debt securities. These borrowings are due on November 7, 2032 and were structured as trust preferred capital securities, which qualify as capital for regulatory capital adequacy requirements. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on November 7, 2007. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 3.45%. This rate may not exceed 12.50% through November 2007.
First Bancorp Capital Trust II and First Bancorp Capital Trust III were organized in December 2003 for the purpose of issuing $20.6 million in debt securities ($10.3 million were issued from each trust). These borrowings are due on December 19, 2033 and were also structured as trust preferred capital securities in order to qualify as
regulatory capital. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on January 23, 2009. The interest rate on these debt securities adjusts on a quarterly basis at a weighted average rate of three-month LIBOR plus 2.70%.
First Montgomery was incorporated on November 2, 2001. First Montgomery's business activities are currently limited to the selection and acquisition of real estate in Virginia that is leased to the Bank for use as bank branches. First Troy was incorporated on May 12, 1999 as a subsidiary of the Bank. Upon the formation of First Montgomery as a subsidiary of the Bank, the Bank contributed its interest in First Troy to First Montgomery, resulting in First Troy becoming a subsidiary of First Montgomery. First Troy allows the Bank to centrally manage a portion of its residential, mortgage, and commercial real estate loan portfolio. First Troy has elected to be treated as a real estate investment trust for tax purposes. In 2005, in response to evolving taxing authority developments (discussed in more detail in "Liquidity, Commitments, and Contingencies" under Item 7 below), the Company intends to dissolve and liquidate First Montgomery and First Troy by transferring the assets and liabilities of each of these subsidiaries up-stream to the Bank.
Territory Served and Competition
The Company's headquarters are located in Troy, Montgomery County, North Carolina. The Company serves primarily the south central area of the Piedmont region of North Carolina. The following table presents, for each county the Company operates in, the number of bank branches operated by the Company within the county, the approximate amount of deposits with the Company in the county as of December 31, 2004, the Company's approximate market share, and the number of bank competitors located in the county. The following table does not include the Company's approximately $50 million in wholesale brokered deposits.
No. of Deposits Market Number of County Branches (in millions) Share Competitors --------------- ---------- --------------- -------- ----------- Anson, NC 1 $ 10 4.4% 4 Cabarrus, NC 2 25 1.3% 8 Chatham, NC 2 49 9.3% 9 Davidson, NC 2 106 6.6% 8 Dillon, SC 3 61 26.3% 2 Duplin, NC 2 40 10.2% 7 Guilford, NC 1 34 0.5% 22 Harnett, NC 3 87 10.3% 7 Iredell, NC 1 20 1.3% 14 Lee, NC 4 117 16.5% 6 Montgomery, NC 5 89 39.1% 4 Montgomery, VA 1 3 0.1% 9 Moore, NC 10 305 24.3% 10 Randolph, NC 4 50 3.6% 14 Richmond, NC 1 20 4.9% 5 Robeson, NC 5 123 14.1% 9 Rockingham, NC 1 8 0.6% 9 Rowan, NC 2 35 2.9% 10 Scotland, NC 2 41 15.8% 5 Stanly, NC 4 73 10.5% 5 Wake, NC 1 11 0.1% 21 Washington, VA 1 10 1.4% 12 Wythe, VA 1 22 5.4% 8 ---- --------- Total 59 $ 1,339 ==== =========
The Company's 59 branches and facilities are primarily located in small communities whose economies are based primarily on services, manufacturing and light industry. Although the Company's market is predominantly small communities and rural areas, the area is not dependent on agriculture. Textiles, furniture, mobile homes, electronics, plastic and metal fabrication, forest products, food products and cigarettes are among the leading manufacturing industries in the trade area. Leading producers of lumber, socks, hosiery and area rugs are located
in Montgomery County. The Pinehurst area within Moore County is a widely known golf resort and retirement area. The High Point area is widely known for its furniture market. Additionally, several of the communities served by the Company are "bedroom" communities serving Charlotte, Raleigh and Greensboro in addition to smaller cities such as Albemarle, Asheboro, High Point, Pinehurst and Sanford.
Approximately 23% of the Company's non-brokered deposit base is in Moore County, and, accordingly, material changes in competition, the economy or population of Moore County could materially impact the Company. No other county comprises more than 10% of the Company's deposit base.
The Company competes in its various market areas with, among others, several large interstate bank holding companies that are headquartered in North Carolina. These large competitors have substantially greater resources than the Company, including broader geographic markets, higher lending limits and the ability to make greater use of large-scale advertising and promotions. A significant number of interstate banking acquisitions have taken place in the past decade, thus further increasing the size and financial resources of some of the Company's competitors, three of which are among the largest bank holding companies in the nation. Moore County, which as noted above comprises a disproportionate share of the Company's deposits, is a particularly competitive market, with at least ten other financial institutions having a physical presence. See "Supervision and Regulation" below for a further discussion of regulations in the Company's industry that affect competition.
The Company competes not only against banking organizations, but also against a wide range of financial service providers, including federally and state chartered savings and loan institutions, credit unions, investment and brokerage firms and small-loan or consumer finance companies. Competition among financial institutions of all types is virtually unlimited with respect to legal ability and authority to provide most financial services. The Company also experiences competition from internet banks, particularly in the area of time deposits.
However, the Company believes it has certain advantages over its competition in the areas it serves. The Company seeks to maintain a distinct local identity in each of the communities it serves and actively sponsors and participates in local civic affairs. Most lending and other customer-related business decisions can be made without delays often associated with larger systems. Additionally, employment of local managers and personnel in various offices and low turnover of personnel enable the Company to establish and maintain long-term relationships with individual and corporate customers.
Lending Policy and Procedures
Conservative lending policies and procedures and appropriate underwriting standards are high priorities of the Bank. Loans are approved under the Bank's written loan policy, which provides that lending officers, principally branch managers, have authority to approve loans of various amounts up to $100,000. Each of the Bank's regional senior lending officers has discretion to approve secured loans in principal amounts up to $350,000 and together can approve loans up to $2,000,000. Lending limits may vary depending upon whether the loan is secured or unsecured.
The Bank's board of directors reviews and approves loans that exceed management's lending authority, loans to executive officers, directors, and their affiliates and, in certain instances, other types of loans. New credit extensions are reviewed daily by the Bank's senior management and at least monthly by its board of directors.
The Bank continually monitors its loan portfolio to identify areas of concern and to enable management to take corrective action. Lending officers and the board of directors meet periodically to review past due loans and portfolio quality, while assuring that the Bank is appropriately meeting the credit needs of the communities it serves. Individual lending officers are responsible for pursuing collection of past-due amounts and monitoring any changes in the financial status of borrowers.
The Bank's internal audit department evaluates specific loans and overall loan quality at individual branches
as part of its regular branch reviews. The Bank also contracts with an independent consulting firm to review new loan originations meeting certain criteria, as well as to assign risk grades to existing credits meeting certain thresholds. The consulting firm's observations, comments, and risk grades, including variances with the Bank's risk grades, are shared with the audit committee of the Company's board of directors, and are considered by management in setting Bank policy, as well as in evaluating the adequacy of the allowance for loan losses. For additional information, see "Allowance for Loan Losses and Loan Loss Experience" under Item 7 below.
Investment Policy and Procedures
The Company has adopted an investment policy designed to optimize the Company's income from funds not needed to meet loan demand in a manner consistent with appropriate liquidity and risk objectives. Pursuant to this policy, the Company may invest in federal, state and municipal obligations, federal agency obligations, public housing authority bonds, industrial development revenue bonds, and Federal National Mortgage Association, Government National Mortgage Association, Federal Home Loan Mortgage Corporation and Student Loan Marketing Association securities. Additionally, during 2001 the Company's board of directors approved limited investments in corporate bonds. Except for corporate bonds, the Company's investments must be rated at least Baa by Moody's or BBB by Standard and Poor's. Securities rated below A are periodically reviewed for creditworthiness. The Company may purchase non-rated municipal bonds only if such bonds are in the Company's general market area and determined by the Company to have a credit risk no greater than the minimum ratings referred to above. Industrial development authority bonds, which normally are not rated, are purchased only if they are judged to possess a high degree of credit soundness to assure reasonably prompt sale at a fair value. In 2001, the Company's board of directors authorized the Company to invest a portion of its security portfolio in high quality corporate bonds, with the amount of bonds related to any one issuer not to exceed the Company's legal lending limit. Prior to purchasing a corporate bond, the Company's management performs due diligence on the issuer of the bond, and the purchase is not made unless the Company believes that the purchase of the bond bears no more risk to the Company than would an unsecured loan to the same company.
The Company's investment officers implement the investment policy, monitor the investment portfolio, recommend portfolio strategies, and report to the Company's investment committee. Reports of all purchases, sales, issuer calls, net profits or losses and market appreciation or depreciation of the bond portfolio are reviewed by the Company's board of directors each month. Once a quarter, the Company's interest rate risk exposure is evaluated by the board of directors. Once a year, the written investment policy is reviewed by the board of directors, and the Company's portfolio is compared with the portfolios of other companies of comparable size.
Mergers and Acquisitions
As part of its operations, the Company has pursued an acquisition strategy over the years to augment its internal growth. The Company regularly evaluates the potential acquisition of, or merger with, and holds discussions with, various financial institutions. The Company's acquisitions to date have generally fallen into one of three categories - 1) an acquisition of a financial institution or branch thereof within a market in which the Company operates, 2) an acquisition of a financial institution or branch thereof in a market contiguous to a market in which the Company operates, or 3) an acquisition of a company that has products or services that the Company does not currently offer.
The Company believes that it can enhance its earnings by pursuing these types of acquisition opportunities through any combination or all of the following: 1) achieving cost efficiencies, 2) enhancing the acquiree's earnings or gaining new customers by introducing a more successful banking model with more products and services to the acquiree's market base, 3) increasing customer satisfaction or gaining new customers by providing more locations for the convenience of customers, and 4) leveraging the Company's customer base by offering new products and services.
In the last four years, the Company has made acquisitions in all three of the aforementioned categories of
acquisitions. In 2001, acquisitions resulted in the Company adding $116.2 million in loans and $204.6 million in deposits, expanding into four contiguous markets (Lumberton, Pembroke, St. Pauls, and Thomasville), providing another branch for customers in one of the Company's newer markets (Salisbury), and giving the Company the ability to offer property and casualty insurance coverage. In 2002, the Company completed the acquisition of a branch within its market geography (Broadway, located in Lee County) with approximately $8.4 million in deposits and $3.1 million in loans. In 2003, the Company completed acquisitions that added approximately $72.5 million in loans and $160.8 million in deposits that were in the contiguous or nearly contiguous markets of Dillon County SC, Duplin County NC, Harmony NC, and Fairmont NC. In 2003, the Company also purchased another property and casualty insurance agency that provided efficiencies of scale when combined with the agency purchased in 2001. The Company did not complete any acquisitions during 2004.
The Company plans to continue to evaluate acquisition opportunities that could potentially benefit the Company and its shareholders. These opportunities may include acquisitions that do not fit the categories discussed above. For a further discussion of recent acquisition activity, see "Merger and Acquisition Activity" under Item 7 below.
Employees
As of December 31, 2004, the Company had 526 full-time and 74 part-time employees. The Company is not a party to any collective bargaining agreements and considers its employee relations to be good.
Supervision and Regulation
As a bank holding company, the Company is subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and the North Carolina Office of the Commissioner of Banks (the "Commissioner"). The Bank is subject to supervision and examination by the Federal Deposit Insurance Corporation (the "FDIC") and the Commissioner. For additional information, see also Note 15 to the consolidated financial statements.
Supervision and Regulation of the Company
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is required to register as such with the Federal Reserve Board. The Company is also regulated by the Commissioner under the Bank Holding Company Act of 1984.
A bank holding company is required to file quarterly reports and other information regarding its business operations and those of its subsidiaries with the Federal Reserve Board. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to making certain acquisitions of other institutions or voting securities. The Commissioner is empowered to regulate certain acquisitions of North Carolina banks and bank holding companies, issue cease and desist orders for violations of North Carolina banking laws, and promulgate rules necessary to effectuate the purposes of the Bank Holding Company Act of 1984.
Regulatory authorities have cease and desist powers over bank holding companies and their nonbank subsidiaries where their actions would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. Those authorities may compel holding companies to invest additional capital into banking subsidiaries upon acquisitions or in the event of significant loan losses or rapid growth of loans or deposits.
In 1999, the U.S. enacted legislation that allowed bank holding companies to engage in a wider range of non-banking activities, including greater authority to engage in securities and insurance activities. Under the Gramm-Leach-Bliley Act (the "Act"), a bank holding company that elects to become a financial holding company may engage in any activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury,
determines by regulation or order is (i) financial in nature, (ii) incidental to any such financial activity, or (iii) complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The Act made significant changes in U.S. banking law, principally by repealing certain restrictive provisions of the 1933 Glass-Steagall Act. The Act lists certain activities that are deemed to be financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment, or economic advisory services; underwriting, dealing in or making a market in, securities; and any activity currently permitted for bank holding companies by the Federal Reserve Board under Section 4(c)(8) of the Bank Holding Company Act. The Act does not authorize banks or their affiliates to engage in commercial activities that are not financial in nature. A bank holding company may elect to be treated as a financial holding company only if all depository institution subsidiaries of the holding company are well-capitalized, well-managed and have at least a satisfactory rating under the Community Reinvestment Act. At the present time, the Company does not anticipate applying for status as a financial holding company under the Act.
National and state banks are also authorized by the Act to engage, through "financial subsidiaries," in any activity that is permissible for a financial holding company (as described above) and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve Board, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking. The authority of a national or state bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank be well-managed and well-capitalized (after deducting from the bank's capital outstanding investments in financial subsidiaries).
The United States Congress and the North Carolina General Assembly have periodically considered and adopted legislation that has resulted in, and could result in further, deregulation of both banks and other financial institutions. Such legislation could modify or eliminate geographic restrictions on banks and bank holding companies and current restrictions on the ability of banks to engage in certain nonbanking activities. For example, the Riegle-Neal Interstate Banking Act, which was enacted several years ago, allows expansion of interstate acquisitions by bank holding companies and banks. This and other legislative and regulatory changes have increased the ability of financial institutions to expand the scope of their operations, both in terms of services offered and geographic coverage. Such legislative changes have placed the Company in more direct competition with other financial institutions, including mutual funds, securities brokerage firms, insurance companies, investment banking firms, and internet banks. The Company cannot predict what other legislation might be enacted or what other regulations might be adopted or, if enacted or adopted, the effect thereof on the Company's business.
After the September 11, 2001 terrorist attacks in New York and Washington, D.C., the United States government acted in several ways to tighten control on activities perceived to be connected to money laundering and terrorist funding. A series of orders were issued that identify terrorists and terrorist organizations and require the blocking of property and assets of, as well as prohibiting all transactions or dealings with, such terrorists, terrorist organizations and those that assist or sponsor them. The USA Patriot Act substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposed new compliance and due diligence obligations, created new crimes and penalties, compelled the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarified the safe harbor from civil liability to customers. In addition, the United States Treasury Department issued regulations in cooperation with the federal banking agencies, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Department of Justice to require customer identification and verification, expand the money-laundering program requirement to the major financial services sectors, including insurance and unregistered investment companies, such as hedge funds, and facilitate and permit the sharing of information between law enforcement and financial institutions, as well as among financial institutions themselves. The United States Treasury Department also has created the Treasury USA Patriot Act Task Force to work with other financial regulators, the regulated
community, law enforcement and consumers to continually improve the regulations. The Company has established policies and procedures to ensure compliance with the USA Patriot Act.
In 2002, the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") was signed into law. The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity or debt securities registered under the Securities Exchange Act of 1934, as amended. In particular, the Sarbanes-Oxley Act establishes: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for the reporting company and their directors and executive officers; and (v) new and increased civil and criminal penalties for violation of the securities laws. The most significant expense associated with compliance with the Sarbanes-Oxley Act has been the internal control documentation and attestation requirements of Section 404 of the Act. In 2004, the Company's incremental external costs associated with complying with Section 404 of the Sarbanes-Oxley Act amounted to approximately $190,000. The Company expects to incur an additional $350,000-$400,000 in external costs related to Section 404 in the first quarter of 2005 and an additional $150,000-$200,000 in the second quarter of 2005. The incremental costs relate to higher external audit fees and outside consultant fees. These amounts do not include the value of the significant internal resources devoted to compliance. As permitted by the Securities and Exchange Commission Release No. 34-50754, the registrant has not filed in this report the internal control reports required by Section 404 of the Sarbanes-Oxley Act. The Company expects to file these reports by May 2, 2005, as permitted by the aforementioned release.
Supervision and Regulation of the Bank
Federal banking regulations applicable to all depository financial institutions, among other things: (i) provide federal bank regulatory agencies with powers to prevent unsafe and unsound banking practices; (ii) restrict preferential loans by banks to "insiders" of banks; (iii) require banks to keep information on loans to major shareholders and executive officers; and (iv) bar certain director and officer interlocks between financial institutions.
As a state chartered bank, the Bank is subject to the provisions of the North Carolina banking statutes and to regulation by the Commissioner. The Commissioner has a wide range of regulatory authority over the activities and operations of the Bank, and the Commissioner's staff conducts periodic examinations of the Bank and its affiliates to ensure compliance with state banking regulations. Among other things, the Commissioner regulates the merger and consolidation of state chartered banks, the payment of dividends, loans to officers and directors, recordkeeping, types and amounts of loans and investments, and the establishment of branches. The Commissioner also has cease and desist powers over state chartered banks for violations of state banking laws or regulations and for unsafe or unsound conduct that is likely to jeopardize the interest of depositors.
The dividends that may be paid by the Bank to the Company are subject to legal limitations under North Carolina law. In addition, regulatory authorities may restrict dividends that may be paid by the Bank or the Company's other subsidiaries. The ability of the Company to pay dividends to its shareholders is largely dependent on the dividends paid to the Company by its subsidiaries.
The Bank is a member of the FDIC, which currently insures the deposits of member banks. For this protection, each bank pays a quarterly statutory assessment, based on its level of deposits, and is subject to the rules and regulations of the FDIC. The FDIC also is authorized to approve conversions, mergers, consolidations and assumptions of deposit liability transactions between insured banks and uninsured banks or institutions, and to prevent capital or surplus diminution in such transactions where the resulting, continuing, or assumed bank is an insured nonmember bank. In addition, the FDIC monitors the Bank's compliance with several banking statutes, such as the Depository Institution Management Interlocks Act and the Community Reinvestment Act of
1977. The FDIC also conducts periodic examinations of the Bank to assess its compliance with banking laws and regulations, and it has the power to implement changes in or restrictions on a bank's operations if it finds that a violation is occurring or is threatened.
Neither the Company nor the Bank can predict what other legislation might be enacted or what other regulations might be adopted, or if enacted or adopted, the effect thereof on the Bank's operations.
See "Capital Resources and Shareholders' Equity" under Item 7 below for a discussion of regulatory capital requirements.
Available Information
The Company maintains a corporate Internet site at www.firstbancorp.com which contains a link within the "Investor Relations" section of the site to each of its filings with the Securities and Exchange Commission, including its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These filings are available, free of charge, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. These filings can also be accessed at the Securities and Exchange Commission's website located at www.sec.gov. Information included on the Company's Internet site is not incorporated by reference into this annual report.
Item 2.
Item 2. Properties
The main offices of the Company, the Bank and First Bancorp Financial are owned by the Bank and are located in a three-story building in the central business district of Troy, North Carolina. The building houses administrative, training and bank teller facilities. The Bank's Operations Division, including customer accounting functions, offices and operations of Montgomery Data, and offices for loan operations, are housed in two one-story steel frame buildings approximately one-half mile west of the main office. Both of these buildings are owned by the Bank. The Company operates 59 bank branches. The Company owns all its bank branch premises except eleven branch offices for which the land and buildings are leased and four branch offices for which the land is leased but the building is owned. In addition, the Company leases one loan production office. There are no other options to purchase or lease additional properties. The Company considers its facilities adequate to meet current needs.
Item 3.
Item 3. Legal Proceedings
Various legal proceedings may arise in the ordinary course of business and may be pending or threatened against the Company and/or its subsidiaries. However, neither the Company nor any of its subsidiaries is involved in any pending legal proceedings that management believes could have a material effect on the consolidated financial position of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Shareholders
No matters were submitted to a vote of shareholders during the fourth quarter of 2004.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock, Related Shareholder Matters, and Issuer Purchases of Equity Securities
The Company's common stock trades on the NASDAQ National Market System of the NASDAQ Stock Market under the symbol FBNC. Table 22, included in "Management's Discussion and Analysis" below, set
forth the high and low market prices of the Company's common stock as traded by the brokerage firms that maintain a market in the Company's common stock and the dividends declared for the periods indicated. See "Business - Supervision and Regulation" above and Note 15 to the consolidated financial statements for a discussion of regulatory restrictions on the payment of dividends. As of December 31, 2004, there were approximately 2,600 shareholders of record and another 3,000 shareholders whose stock is held in "street name." There were no sales of unregistered securities during the year ended December 31, 2004.
Issuer Purchases of Equity Securities
Pursuant to authorizations by the Company's board of directors, the Company has repurchased shares of common stock in private transactions and in open-market purchases. The most recent board of director authorization was announced on July 30, 2004 and authorized the repurchase of 375,000 shares of the Company's stock. During 2004, the Company repurchased a total of 300,816 shares of its common stock at an average price of $21.65. The following table sets forth information about the Company's stock repurchases for the three months ended December 31, 2004.
Footnotes to the Above Table
(1) All amounts prior to November 15, 2004 have been adjusted to reflect the 3-for-2 stock split paid by the Company on November 15, 2004.
(2) All shares were repurchased pursuant to publicly announced share repurchase authorizations. On July 30, 2004, the Company announced that its Board of Directors had approved the repurchase of 375,000 shares of the Company's common stock. The repurchase authorization does not have an expiration date. There are no plans or programs the issuer has determined to terminate prior to expiration, or under which the issuer does not intend to make further purchases.
(3) The shares included in the table above do not include shares that were used by option holders to satisfy the exercise price of the Company's call options issued by the Company to its employees and directors pursuant to the 1994 First Bancorp Stock Option Plan. In October 2004, 3,200 shares of the Company's common stock with a weighted average price of $25.57 were used to satisfy the exercise price of employee option exercises. In November 2004, 477 shares of the Company's common stock, with a weighted average market price of $25.20 were used to satisfy such exercises. In December 2004, 842 shares of the Company's common stock, with a weighted average market price of $29.30 were used to satisfy such exercises.
Item 6.
Item 6. Selected Consolidated Financial Data
Table 1 sets forth selected consolidated financial data for the Company.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's discussion and analysis is intended to assist readers in understanding the Company's results of operations and changes in financial position for the past three years. This review should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page 54 of this report and the supplemental financial data contained in Tables 1 through 22 included with this discussion and analysis. All share data has been adjusted to reflect the 3-for-2 stock split paid on November 15, 2004.
CRITICAL ACCOUNTING POLICIES
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and/or use of estimates based on the Company's best assumptions at the time of the estimation. The Company has identified three policies as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to the Company's consolidated financial statements - 1) the allowance for loan losses, 2) tax uncertainties, and 3) intangible assets.
Allowance for Loan Losses
Due to the estimation process and the potential materiality of the amounts involved, the Company has identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to the Company's consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio.
Management's determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has two components. The first component involves the estimation of losses on loans defined as "impaired loans." A loan is considered to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that the Company expects to receive from the borrower discounted at the loan's effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral.
The second component of the allowance model is to estimate losses for all loans not considered to be impaired loans. First, loans that have been risk graded by the Company as having more than "standard" risk but are not considered to be impaired are assigned estimated loss percentages generally accepted in the banking industry. Loans that are classified by the Company as having normal credit risk are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on the historical losses, current economic conditions, and operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve estimated for all other loans. This becomes the Company's "allocated allowance." In addition to the allocated allowance derived from the model, management also evaluates other data such as the ratio of the allowance for loan losses to total loans, net loan growth information, nonperforming asset levels and trends in such data. Based on this additional analysis, the Company may determine that an additional amount of allowance for loan losses is necessary to reserve for probable losses. This additional amount, if any, is the Company's "unallocated allowance." The sum of the allocated allowance and the unallocated allowance is compared to the actual allowance for loan losses recorded on the books of the Company and any adjustment necessary for the recorded allowance to equal the computed allowance is recorded as a provision for loan losses. The provision for loan losses is a direct charge to earnings in the period recorded.
Although management uses the best information available to make evaluations, future adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on the examiners' judgment about information available to them at the time of their examinations.
For further discussion including a review of the range of provisions for loan losses and its impact on reported results in recent periods, see "Nonperforming Assets" and "Allowance for Loan Losses and Loan Loss Experience" under "Analysis of Financial Condition and Changes in Financial Condition."
Tax Uncertainties
The Company reserves for tax uncertainties in instances when it has taken a position on a tax return that may differ from the opinion of the applicable taxing authority. In accounting for tax contingencies, the Company assesses the relative merits and risks of certain tax transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company's tax position. For those matters where it is probable that the Company will have to pay additional taxes, interest or penalties and a loss or range of losses can be reasonably estimated, the Company records reserves in the consolidated financial statements. For those matters where it is reasonably possible but not probable that the Company will have to pay additional taxes, interest or penalties and the loss or range of losses can be reasonably estimated, the Company only makes disclosures in the notes and does not record reserves in the consolidated financial statements. The process of concluding that a loss is reasonably possible or probable and estimating the amount of loss or range of losses and related tax reserves is inherently subjective and future changes to the reserve may be necessary based on changes in management's intent, tax law or related interpretations, or other functions.
The section below entitled "Liquidity, Commitments, and Contingencies" and Note 12 to the consolidated financial statements includes the disclosure of a tax uncertainty that the Company has concluded requires disclosure, but not loss accrual.
Intangible Assets
Due to the estimation process and the potential materiality of the amounts involved, the Company has also identified the accounting for intangible assets as an accounting policy critical to the Company's consolidated financial statements.
When the Company completes an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. The Company must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to the Company's future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill.
For the Company, the primary identifiable intangible asset typically recorded in connection with a whole-bank or bank branch acquisition is the value of the core deposit intangible, whereas when the Company acquires an insurance agency, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs,
deposit servicing costs, and discount rates. The Company typically engages a third party consultant to assist in each analysis. For the whole-bank and bank branch transactions recorded to date, the core deposit intangible in each case has been estimated to have a ten year life, with an accelerated rate of amortization. For the 2003 insurance agency acquisition, the identifiable intangible asset related to the customer list was determined to have a ten year life, with amortization occurring on a straight-line basis.
Subsequent to the initial recording of the identifiable intangible assets and goodwill, the Company amortizes the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of the Company's reporting units to their related carrying value, including goodwill (the Company's community banking operation is its only material reporting unit). At its last evaluation, the fair value of the Company's community banking operation exceeded its carrying value, including goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, the Company would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions.
The Company reviews identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company's policy is that an impairment loss is recognized, equal to the difference between the asset's carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.
The foregoing accounting policy was adopted by the Company effective on January 1, 2002 in accordance with newly issued accounting standards for goodwill and other intangible assets. For acquisitions occurring prior to January 1, 2002, the Company generally did not separately identify its identifiable intangible assets from its goodwill, as all intangible assets were amortized under accounting standards then in effect. According to the transition provisions of the accounting standards that changed the Company's accounting policy to that described above, the entire amount of those combined intangible assets was accounted for entirely as non-amortizable goodwill.
MERGER AND ACQUISITION ACTIVITY
Over the past three fiscal years, the Company has completed several acquisitions, which have resulted in significant amounts of intangible assets being recorded by the Company, as detailed below. As noted above, the accounting for intangible assets changed significantly in 2002 with the Company being required under new accounting standards to cease the amortization of goodwill. See Note 2 and Note 6 to the consolidated financial statements for additional information regarding intangible assets.
The Company did not announce or complete any acquisitions in 2004. The Company completed the following acquisitions during 2003:
(a) On January 2, 2003, the Company completed the acquisition of Uwharrie Insurance Group, Inc. ("Uwharrie"), a Montgomery County based property and casualty insurance agency. Uwharrie was subsequently merged into First Bank Insurance. With eight employees, Uwharrie served approximately 5,000 customers, primarily from its Troy-based headquarters, and had annual commissions of approximately $500,000. The primary reason for the acquisition was to gain efficiencies of scale with the Company's existing property and casualty insurance business. The acquisition resulted in the Company recording an intangible asset of approximately $544,000. Based on an independent appraisal, $50,000 of the intangible asset recorded was determined to be attributable to the value of the noncompete agreement signed as part of the transaction and is being amortized over its two year life, $151,000 was determined to be attributable to the value of the customer
list and is being amortized on a straight-line basis over ten years, and the remaining $343,000 was determined to be goodwill and thus is not being systematically amortized, but rather is subject to an annual impairment test.
(b) On January 15, 2003, the Company completed the acquisition of Carolina Community Bancshares, Inc. ("CCB"), the parent company of Carolina Community Bank, a South Carolina community bank with three branches in Dillon County, South Carolina. This represented the Company's first entry into South Carolina. Dillon County, South Carolina is contiguous to Robeson County, North Carolina, a county where the Company already operated four branches. The Company's primary reason for the acquisition was to expand into a contiguous market with facilities, operations and experienced staff in place. In this transaction, the shareholders of CCB received 1.2 shares of the Company's stock and $20.00 in cash for each share of CCB stock they owned at the time of closing. The transaction was completed on January 15, 2003, with the Company paying cash of $8.3 million, issuing 499,332 shares of common stock that were valued at approximately $8.4 million, and assuming employee stock options with an intrinsic value of approximately $0.9 million. As of the date of the acquisition, CCB had approximately $48 million in loans, $59 million in deposits and $70 million in total assets. In connection with the acquisition of CCB, the Company recorded total intangible assets of $10.2 million, of which $771,000 was determined to be the value of the core deposit base and is being amortized on an accelerated basis over ten years, and $9.4 million was determined to be goodwill and thus is not being systematically amortized, but rather is subject to an annual impairment test.
(c) On October 24, 2003, the Company completed the acquisition of four branches of RBC Centura Bank located in Fairmont, Harmony, Kenansville, and Wallace, all in North Carolina. As of the date of the acquisition, the branches had a total of approximately $102 million in deposits and $25 million in loans. The primary reason for the acquisition was to expand into new markets and increase the Company's customer base. Subject to certain limitations, the Company paid a deposit premium of 14.1% for the branches, which resulted in the Company recording intangible assets relating to this purchase of $14.2 million. The identifiable intangible asset associated with the fair value of the core deposit base, as determined by an independent consulting firm, was valued at approximately $1.3 million and is being amortized as expense on an accelerated basis over a ten year period. The remaining intangible asset of $12.9 million has been classified as goodwill, and thus is not being systematically amortized, but rather is subject to an annual impairment test.
The following table contains a condensed balance sheet that indicates the amount assigned to each major asset and liability as of the respective acquisition dates for the 2003 acquisitions described above.
The Company completed one acquisition in 2002 as follows:
(a) On October 4, 2002, the Company completed the purchase of a branch of RBC Centura Bank located in Broadway, North Carolina. The Company assumed the branch's $8 million in deposits and $3 million in loans. The primary reason for this acquisition was to increase the Company's presence in Lee County, a market where the Company already had two branches with a large customer base. An intangible asset of $0.7 million, all of which was allocated to goodwill, was recorded in connection with this acquisition.
There are many factors that the Company considers when evaluating how much to offer for potential acquisition candidates - in the form of a purchase price comprised of cash and/or stock for a whole company purchase or a deposit premium in a branch purchase. Most significantly, the Company compares expectations of future earnings per share on a stand-alone basis with projected future earnings per share assuming completion of the acquisition under various pricing scenarios. Significant assumptions that affect this analysis include the estimated future earnings stream of the acquisition candidate, the amount of cost efficiencies that can be realized, and the interest rate earned/lost on the cash received/paid. In addition to the earnings per share comparison, the Company also considers other factors including (but not limited to): marketplace acquisition statistics, location of the candidate in relation to the Company's expansion strategy, market growth potential, management of the candidate, potential integration issues (including corporate culture), and the size of the acquisition candidate.
ANALYSIS OF RESULTS OF OPERATIONS
Net interest income, the "spread" between earnings on interest-earning assets and the interest paid on interest-bearing liabilities, constitutes the largest source of the Company's earnings. Other factors that significantly affect operating results are the provision for loan losses, noninterest income such as service fees and noninterest expenses such as salaries, occupancy expense, equipment expense and other overhead costs, as well as the effects of income taxes.
Overview - 2004 Compared to 2003
Net income for the year ended December 31, 2004 amounted to $20,114,000, or $1.40 per diluted share, a 3.6% increase in net income and a 3.7% increase in diluted earnings per share over the net income of $19,417,000, or $1.35 per diluted share, reported for 2003. All per share amounts have been adjusted to reflect the 3-for-2 stock split paid on November 15, 2004.
Total assets at December 31, 2004 amounted to $1.64 billion, 11.1% higher than a year earlier. Total loans at December 31, 2004 amounted to $1.37 billion, a 12.2% increase from a year earlier, and total deposits amounted to $1.39 billion at December 31, 2004, an 11.2% increase from a year earlier. Approximately $50 million of the total 2004 deposit increase of $139 million related to wholesale brokered deposits that the Company gathered in order to help fund the high loan growth experienced during 2004.
The increase in loans and deposits over the past twelve months resulted in an increase in the Company's net interest income from 2003 to 2004. Net interest income for the year ended December 31, 2004 amounted to $61.3 million, a 9.9% increase over the $55.8 million recorded in 2003. The positive impact on net interest income from the increases in loans and deposits more than offset a lower net interest margin realized in 2004 compared to 2003. The Company's net interest margin (tax-equivalent net interest income divided by average earning assets) for 2004 was 4.31% compared to the 4.52% in 2003. The Company's net interest margin was negatively impacted by the thirteen interest rate cuts initiated by the Federal Reserve from 2001 to 2003 and the Company's shift toward originating more adjustable rate loans compared to fixed rate loans to protect the Company from anticipated increases in interest rates. The Federal Reserve increased interest rates by 125 basis points in the second half of 2004 which was responsible for the Company's net interest margin increasing during the third and fourth quarters of 2004 after having decreased for the immediately preceding five consecutive quarters.
The Company's provision for loan losses did not vary significantly in 2004 compared to 2003, amounting to $2,905,000 in 2004 compared to $2,680,000 in 2003. The Company's asset quality ratios remained sound in 2004, with a net-charge off ratio (net charge-offs divided by average loans) of 0.14% in 2004 compared to 0.10% in 2003, and a December 31, 2004 nonperforming asset to total asset ratio of 0.32%, compared to 0.39% at the prior year end.
For the year ended 2004, noninterest income amounted to $15.9 million, a 6.3% increase from $14.9 million in 2003. Except for fees from presold mortgages, most components of noninterest income increased for the year ended 2004 compared to 2003 as a result of the Company's overall growth, particularly the Company's October 2003 acquisition of four bank branches with $102 million in deposits, which impacted the Company's noninterest income for all twelve months of 2004 compared to only three months in 2003. Fees from presold mortgages decreased significantly in 2004 as a result of a decline in mortgage refinancing activity caused by higher mortgage interest rates. Fees from presold mortgages decreased from $2.3 million in 2003 to $1.0 million in 2004. The Company realized securities gains and other gains of $648,000 in 2004 compared to $306,000 in 2003.
Noninterest expenses for the year ended December 31, 2004 amounted to $43.7 million, a 15.2% increase from the $38.0 million recorded in 2003. The increase in noninterest expenses is primarily attributable to growth in the Company's branch network, which increased by eight branches since October 2003.
The Company's effective tax rates were slightly lower for 2004 compared to 2003, amounting to 34.1% in 2004 compared to 35.3% for 2003. The lower effective tax rate in 2004 was caused by several factors including higher amounts of state tax exempt income, higher amounts of low income housing investment tax credits, and the reversal of an $89,000 tax liability that was recorded in connection with a previous corporate acquisition.
Overview - 2003 Compared to 2002
Net income for the year ended December 31, 2003 amounted to $19,417,000, or $1.35 per diluted share, a 12.7% increase in net income and a 9.8% increase in diluted earnings per share over the net income of $17,230,000, or $1.23 per diluted share, reported for the twelve months ended December 31, 2002.
The increase in net income in 2003 was primarily attributable to an increase in net interest income. Net interest income for the year ended December 31, 2003 amounted to $55.8 million, an increase of $6.4 million, or 12.9%, over the $49.4 million recorded in 2002. The increase in net interest income was caused primarily by growth in the Company's loans and deposits. Average loans outstanding during 2003 were $1.11 billion, or 16.6% higher than in 2002, while average deposits outstanding increased by 14.1% in 2003 to $1.15 billion.
The positive impact on net interest income from the increases in loans and deposits more than offset a slightly lower net interest margin realized in 2003 compared to 2002. The Company's net interest margin (tax-equivalent net interest income divided by average earning assets) for the year ended December 31, 2003 was 4.52% compared to the 4.58% net interest margin realized for 2002. The slight decrease in net interest margin was caused primarily by the negative impact of the interest rate cuts initiated by the Federal Reserve in the fourth quarter of 2002 and the second quarter of 2003.
The provision for loan losses did not vary significantly in 2003 compared to 2002, amounting to $2,680,000 and $2,545,000, respectively. The Company's asset quality ratios were sound in both years, with a net-charge off ratio (net charge-offs divided by average loans) of 0.10% in 2003 compared to 0.11% in 2002, and a December 31, 2003 nonperforming asset to total asset ratio of 0.39%, compared to 0.36% at the prior year end.
Most components of noninterest income and noninterest expense also increased in 2003 as a result of the Company's overall growth. Noninterest income for 2003 was also positively impacted by 1) high refinancing activity driven by a low interest rate environment that increased the amount of fees from presold mortgages, 2)
the acquisition of Uwharrie Insurance Group, which increased commissions from financial product sales, and 3) securities gains.
The Company's income taxes increased 14.4% from $9,282,000 in 2002 to $10,617,000 in 2003. The increase in income tax expense was a result of higher income before income taxes. The effective income tax rate for both years was approximately 35%.
Net Interest Income
Net interest income on a reported basis amounted to $61,290,000 in 2004, $55,760,000 in 2003, and $49,390,000 in 2002. For internal purposes and in the discussion that follows, the Company evaluates its net interest income on a tax-equivalent basis by adding the tax benefit realized from tax-exempt securities to reported interest income. Net interest income on a tax-equivalent basis amounted to $61,765,000 in 2004, $56,278,000 in 2003, and $49,925,000 in 2002.
Table 2 analyzes net interest income on a tax-equivalent basis. The Company's net interest income on a taxable-equivalent basis increased by 9.7% in 2004 and 12.7% in 2003. There are two primary factors that cause changes in the amount of net interest income recorded by the Company - 1) growth in loans and deposits, and 2) the Company's net interest margin (tax-equivalent net interest income divided by average interest-earning assets).
As illustrated in Table 3, in both 2004 and 2003, net interest income was positively impacted by higher amounts of average loans and deposits outstanding. In 2004, the average amount of loans outstanding increased 16.4%, and the average amount of deposits outstanding increased 13.3%. In 2003, the average amount of loans outstanding increased 16.6%, and the average amount of deposits outstanding increased 14.1%. The higher amounts of average loans and deposits outstanding in 2004 and 2003 were a result of both internal growth, as well as growth achieved in corporate acquisitions. Although the Company did not complete any acquisitions in 2004, the increases in the Company's average loan and deposit amounts in 2004 compared to 2003 were impacted by acquisitions completed in 2003, as the loans and deposits assumed in the 2003 acquisitions were outstanding for the full year in 2004 compared to only a partial year in 2003 (from the date of the respective acquisitions). For additional analysis regarding the nature of the Company's loan and deposit growth see "Analysis of Financial Condition and Changes in Financial Condition - Overview" below.
Table 3 also illustrates that changes in interest rates resulted in reductions in interest income and interest expense in 2003 and 2004. In 2003, interest rates earned/paid were both lower due to a lower interest rate environment. In 2004, although the average prime rate was slightly higher than in 2003, the average yields realized on earning assets and the average rates paid on interest-bearing liabilities for the year were both lower than in 2003. The average yield on earning assets was lower in 2004 than in 2003 due to a growing percentage of adjustable rate loans, which carry lower initial rates than fixed rate loans (see below for additional discussion), and lower renewal/reinvestment rates earned on fixed rate earning assets that matured during 2004 that had been originated during periods of higher interest rates. The average rate paid on interest-bearing liabilities was lower in 2004 than in 2003 due to the interest rates on deposits that are set by management not being increased at the same time, or by the full amount, as increases in the prime rate of interest that occurred in 2004. Also, interest expense on time deposits was otherwise lower as a result of time deposits that were originated prior to the increases in interest rates, with maturities subsequent to the dates of the rate changes. The reduction in interest income for both years was more than the reduction in interest expense, and thus changes in interest rates negatively impacted the Company's net interest income in both years. However, the positive impact of having higher amounts of loans and deposits more than offset the negative impact that rates had on the Company, resulting in the increases in net interest income experienced in 2003 and 2004.
The Company measures the spread between the yield on its earning assets and the cost of its funding primarily in terms of the ratio entitled "net interest margin" which is defined as tax-equivalent net interest income divided by average earning assets. The Company's net interest margin has declined in each of the past two years, amounting to 4.31% in 2004, 4.52% in 2003, and 4.58% in 2002.
The Company's net interest margin was negatively impacted by the interest rate environment and a shift towards originating more adjustable rate loans compared to fixed rate loans to protect the Company from an expected rise in interest rates. The mostly declining interest rate environment in effect from 2001 until June 30, 2004, and the level to which it dropped, resulted in the Company being unable to reset deposit rates by an amount that would offset the negative impact of the lower yields earned on the Company's interest earning assets. In the declining rate environment, the Company's interest-sensitive assets repriced sooner (most on the day following the interest rate cut) and by a larger percentage (generally by the same number of basis points that the Federal Reserve discount rate was decreased) than did the Company's interest-sensitive liabilities that were subject to repricing. Additionally, as fixed rate earning assets originated during periods of higher interest rates matured, they were generally replaced with lower yielding earning assets. The Company was unable to reset deposit rates by the full amount of the interest rate cuts because of their already near-zero rates and because of competitive pricing pressures. Also, interest rates paid on time deposits are generally fixed and are not subject to automatic adjustment. When time deposits mature, the Company has the opportunity, at the customers' discretion, to renew the time deposit at a rate set by the Company. Because time deposits that are interest-sensitive in a twelve month horizon mature throughout the twelve month period, any change in the renewal rate will affect only a portion of the twelve month period. Also, although changes in interest rates on renewing time deposits generally track rate changes in the interest rate environment, the Company found it especially difficult to decrease rates on renewing time deposits by the corresponding decreases in the Federal Reserve discount rate because of competitive pressures in the Company's market areas.
The shift in the Company's loan mix from fixed rate loans to adjustable rate loans has occurred primarily over the past three years. At December 31, 2001, the Company's loan portfolio was comprised of 57% fixed rate loans and 43% adjustable rate loans. Since that time, the ratio gradually shifted as the Company has originated more adjustable rate loans than fixed rate loans. At December 31, 2004, the Company's loan portfolio was comprised of 60% adjustable rate loans and 40% fixed rate loans. The primary reason for this shift was that with interest rates at historically low levels, the Company more attractively priced adjustable rate loans in order to avoid locking in fixed rate loans at a time when most economists believed that rates would inevitably rise. Although the Company believes that this strategy was prudent given the historically low interest rate environment, it has had a negative effect on the Company's recently realized net interest margins because adjustable rate loans carry lower initial rates than fixed rate loans of similar maturities. Additionally, the generally declining rate environment experienced from 2001 through June 2004 resulted in the Company's adjustable rate loans repricing to lower levels following each rate cut.
Another factor affecting the Company's net interest margin over the past two years has been an increased reliance on time deposit greater than $100,000 and borrowings. Time deposits greater than $100,000 and borrowings are generally the highest cost sources of funds for the Company and their increased usage has been necessary to fund high loan growth that has exceeded core retail deposit growth. The ratio of the average amount of time deposits greater than $100,000 and borrowings to total funding (total deposits plus borrowings) increased from 20.1% in 2002, to 22.7% in 2003, to 25.6% in 2004.
In the second half of 2004, the Federal Reserve increased interest rates by a total of 125 basis points, which was largely responsible for the Company's net interest margin increasing for each of last two quarters of 2004, rising from 4.26% in the second quarter of 2004 to 4.28% in the third quarter of 2004 and to 4.32% in the fourth quarter of 2004.
See additional information regarding net interest income in the section entitled "Interest Rate Risk."
Provision for Loan Losses
The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered appropriate to absorb probable losses inherent in the portfolio.
Management's determination of the adequacy of the allowance is based on the level of loan growth, an evaluation of the portfolio, current economic conditions, historical loan loss experience and other risk factors.
The provision for loan losses recorded by the Company did not vary significantly over the past three years, amounting to $2,905,000 in 2004 compared to $2,680,000 in 2003 and $2,545,000 in 2002. Internal loan growth was strong for each of those years, amounting to $148 million in both 2004 and 2003 and $105 million in 2002. There was no external/acquired loan growth in 2004, while in 2003 and 2002 there was acquired growth of $72.5 million and $3.1 million, respectively, for which a preexisting allocation for loan losses was already in place. Asset quality ratios were stable during each of the three years in the period ended December 31, 2004.
See the section entitled "Allowance for Loan Losses and Loan Loss Experience" below for a more detailed discussion of the allowance for loan losses. The allowance is monitored and analyzed regularly in conjunction with the Company's loan analysis and grading program, and adjustments are made to maintain an adequate allowance for loan losses.
Noninterest Income
Noninterest income recorded by the Company amounted to $15,864,000 in 2004, $14,918,000 in 2003, and $11,968,000 in 2002.
As shown in Table 4, core noninterest income, which excludes gains and losses from sales of securities, loans, and other assets, amounted to $15,216,000 in 2004, a 4.1% increase from $14,612,000 in 2003. The 2003 core noninterest income of $14,612,000 was 22.3% higher than the $11,946,000 recorded in 2002.
See Table 4 and the following discussion for an understanding of the components of noninterest income.
Service charges on deposit accounts in 2004 amounted to $9,064,000, a 14.2% increase compared to the $7,938,000 recorded in 2003. The 2003 amount of $7,938,000 was 15.8% higher than the 2002 amount of $6,856,000. The primary factors that have increased the amount of service charges on deposits have been 1) periodic rate increases, 2) service charges earned from internally generated deposit growth, and 3) service charges earned from acquired deposits. Deposit service charge rates are generally increased 2%-4% per year, while internal growth among deposit transaction accounts was 4%-5% in both 2004 and 2003. The deposits assumed in the acquisition of the four RBC Centura branches on October 24, 2003 generated approximately $720,000 in service charges for the full year of 2004 compared to $125,000 realized during the partial period in 2003 subsequent to the acquisition. This incremental income of $595,000 accounted for approximately 7.5% of the 14.2% increase in service charges on deposit accounts. In comparing 2003 to 2002, the $125,000 realized in 2003 from the four RBC Centura branches along with the $650,000 in deposit service charges realized from CCB subsequent to its January 15, 2003 acquisition date accounted for approximately 11.3% of the 15.8% increase in service charges on deposit accounts in 2003. The Company's income from service charges on deposit accounts in the fourth quarter of 2004 was essentially flat when compared to the fourth quarter of 2003, which was a result of a higher customer deposit base, the positive effects of which were offset by the negative impact that higher short term interest rates that occurred in the second half of 2004 had on service charges that the Company earned from its commercial depositors - in the Company's commercial account service charge rate structure, commercial depositors are given "earnings credits" (negatively impacting service charges) on their average deposit balances that are tied to short term interest rates. For this reason, the Company expects little or no growth in this category of income in 2005.
Other service charges, commissions and fees amounted to $3,361,000 in 2004, a 24.0% increase from the $2,710,000 earned in 2003. The 2003 amount of $2,710,000 was 16.0% higher than the $2,336,000 recorded in 2002. This category of noninterest income includes items such as credit card interchange income related to merchants and customers, debit card interchange income, ATM charges, safety deposit box rentals, fees from sales of personalized checks, and check cashing fees. This category of income grew primarily because of
increases in these activity-related fee services as a result of credit and debit card promotions that increased card use and the overall growth in the Company's total customer base, including growth achieved from corporate acquisitions.
Fees from presold mortgages amounted to $969,000 in 2004, a 58.4% decrease from the 2003 amount of $2,327,000. The 2003 amount was a 35.8% increase from the $1,713,000 recorded in 2002. Fees from presold mortgages peaked in 2003 as a result of a high level of mortgage loan refinancings caused by a very low residential mortgage interest rate environment. In 2004, the high levels of mortgage loan refinancings slowed because 1) many homeowners had already refinanced their mortgages in previous years, and 2) there was a slight rise in residential mortgage interest rates.
Commissions from sales of insurance and financial products amounted to $1,406,000 in 2004, $1,304,000 in 2003, and $738,000 in 2002. This line item includes commissions the Company receives from three sources - 1) sales of credit insurance associated with new loans, 2) commissions from the sales of investment, annuity, and long-term care insurance products, and 3) commissions from the sale of property and casualty insurance. The following table presents the contribution of each of the three sources to the total amount recognized in this line item:
2004 2003 2002 ($ in thousands) ------ ------ ------ Commissions earned from: ---------------------------------- Sales of credit insurance $ 291 300 326 Sales of investments, annuities, and long term care insurance 291 299 210 Sales of property and casualty insurance 824 705 202 ------ ------ ------ Total $1,406 1,304 738 ====== ====== ======
The increase in commissions from sales of investments, annuities, and long term care insurance from 2002 to 2003 is primarily due to the hiring of additional staff in this area during 2003. As it relates to commissions earned from the sale of property and casualty insurance, the significant increase in this income in 2003 was a result of the acquisition of Uwharrie Insurance Group, which was completed on January 2, 2003. See "Merger and Acquisition Activity" above for additional discussion.
Data processing fees amounted to $416,000 in 2004, $333,000 in 2003, and $303,000 in 2002. As noted earlier, Montgomery Data makes its excess data processing capabilities available to area financial institutions for a fee. At December 31, 2004, the Company processed for five area banks. These fees have increased as a result of an increase in the size and number of transactions generated by those clients. The Company has been notified by three of the five financial institutions that utilize this service that they intend to terminate their contracts with the Company effective in the first half of 2005 - each client is switching to a lower cost service provider. Fees from these three institutions amounted to $328,000 in 2004. Montgomery Data intends to continue to market this service to area banks, but does not currently have any near-term prospects for additional business.
Noninterest income not considered to be "core" amounted to net gains of $648,000 in 2004, $306,000 in 2003, and $22,000 in 2002. The 2004 net gain of $648,000 included securities gains of $299,000, which were effected primarily in order to realize current income. Also in 2004, the Company sold a former bank branch building that resulted in a gain of approximately $350,000. The 2003 net gain of $306,000 primarily related to securities gains of $218,000 effected primarily to realize current income and an $82,000 gain from a sale of vacant land located beside one of the Company's existing branches. The 2002 net gain of $22,000 primarily related to miscellaneous securities gains of $25,000.
Noninterest Expenses
Noninterest expenses for 2004 were $43,717,000, compared to $37,964,000 in 2003 and $32,301,000 in 2002. Table 5 presents the components of the Company's noninterest expense during the past three years.
Based on the recorded amounts noted above, noninterest expenses increased 15.2% in 2004 and 17.5% in 2003. The increases in noninterest expenses over the past two years have occurred in nearly every line item of expense and have been primarily as a result of the significant growth experienced by the Company, both internally and by acquisition. Over the past two years, the number of the Company's branches has increased from 48 to 59, and the number of full time equivalent employees has increased from 447 at December 31, 2002 to 563 at December 31, 2004. Additionally, from December 31, 2002 to December 31, 2004, the amount of loans outstanding increased 37% and deposits increased 32%. The incremental expense associated with the January 2003 acquisition of CCB was approximately $1.7 million for each of 2003 and 2004. The incremental expense associated with the acquisition of the four RBC Centura branches in October 2003 was approximately $380,000 in 2003 and $1.9 million in 2004. In 2004, the Company's incremental external costs associated with complying Section 404 of the Sarbanes-Oxley Act amounted to approximately $190,000. The Company expects to incur an additional $350,000-$400,000 in external costs related to Section 404 in the first quarter of 2005 and an additional $150,000-$200,000 in the second quarter of 2005. The incremental costs relate to higher external audit fees and outside consultant fees. These amounts do not include the value of the significant internal resources devoted to compliance.
Income Taxes
The provision for income taxes was $10,418,000 in 2004, $10,617,000 in 2003, and $9,282,000 in 2002.
The effective tax rate for 2004 was approximately 34% in 2004 compared to approximately 35% in each of 2003 and 2002. The slightly lower effective tax rate in 2004 was caused by several factors including higher amounts of state tax exempt income, higher amounts of low income housing investment tax credits, and the reversal of an $89,000 tax liability that was recorded in connection with a previous corporate acquisition.
The section below entitled "Liquidity, Commitments, and Contingencies" contains discussion regarding possible loss exposure related to taxes. As described in that section, the Company plans to discontinue certain elements of the Company's operating structure, which is expected to increase the Company's effective tax rate from approximately the 34%-35% experienced in recent years to approximately 39%. If the Company's effective tax rate had been 39% in 2004, the Company's net income would have been lower by approximately $1.3 million.
Table 6 presents the components of tax expense and the related effective tax rates.
Stock-Based Compensation
For the three years ended December 31, 2004, the Company was not required to record an expense for the value of stock options granted to employees. As discussed in more detail below in the next to last paragraph of the section entitled "Current Accounting and Regulatory Matters," a new accounting standard ("Statement 123(R)", as defined below) will require the Company to record the value of stock options as an expense in the income statement beginning July 1, 2005. Note 1(k) to the consolidated financial statements contains pro forma net income and earnings per share information as if the Company applied the fair value recognition provisions required by the new standard. Note 1(k) indicates that the Company's stock-based employee compensation expense would have been $1,291,000, $319,000, and $256,000 for the three years ended December 31, 2004, 2003, and 2002, respectively. The significant increase in expense in 2004 compared to 2003 and 2002 is primarily due to the Company granting 128,000 employee options in April 2004 with immediate vesting (under the new standard, expense related to the fair market value of options is recognized when the options vest). Prior to that grant, all previous employee option grants had five year vesting periods (20% vesting each year), and thus the amount of
expense related to options was generally spread over the five year vesting period. The Compensation Committee of the Board of Directors of the Company granted the April 2004 options without any vesting requirements for two reasons - - 1) the options were granted primarily as a reward for past performance and therefore had already been "earned" in the view of the Committee, and 2) to potentially minimize the impact that any change in accounting standards for stock options could have on future years' reported net income. The Company expects that future employee stock option grants will revert to having five year vesting periods.
As noted above, beginning on July 1, 2005, the Company will be required to expense, within its income statement, the value of stock option grants that vest from that date forward. The Company currently has outstanding stock options with a fair value of $103,000 that will vest on a pro-rata basis between July 1, 2005 and December 31, 2005, with $52,000 vesting in the third quarter of 2005 and $51,000 vesting in the fourth quarter of 2005. In 2006 and 2007, the Company's stock-based compensation expense related to options currently outstanding will be approximately $123,000 and $43,000, respectively. New stock option grants that vest after July 1, 2005 will increase the amount of stock-based compensation expense recorded by the Company. Except for grants to directors (see below), the Company cannot estimate the amount of future stock option grants at this time. In the past, stock option grants to employees have been irregular, generally falling into three categories - 1) to attract and retain new employees, 2) to recognize changes in responsibilities of existing employees, and 3) to periodically reward exemplary performance. As it relates to director stock option grants, the Company expects to continue to grant 2,250 stock options to each of the Company's directors on June 1 of each year until the 2014 expiration of the current stock option plan. In 2004, the amount of pro forma expense associated with the director grants was $126,000.
ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION
Overview
Over the past two years, the Company has achieved high increases in its levels of loans and deposits through a combination of internal growth and growth from acquisitions. The following table presents information regarding the nature of the Company's growth in 2004 and 2003:
As shown in the table above, the Company experienced high internal growth in loans in 2004 and 2003 with
internal growth of 12.2% and 14.8%, respectively. Growth from acquisitions increased the loan growth rate in 2003 to 22.1%.
Deposits increased 11.2% in 2004 and 18.3% in 2003. In 2004, of the $96 million in growth in the category "Deposits - Time>$100,000," $50 million related to brokered deposits that the Company attracted in order to fund the strong loan growth experienced. Excluding the brokered deposits, the Company's deposit growth in 2004 was 7.2%. In 2003, internal deposit growth was 3.1%, with deposits assumed in acquisitions boosting total deposit growth from 3.1% to 18.3%.
The Company believes the significantly higher internal growth rates for loans compared to deposits over the past two years is largely attributable to the type of customers the Company has been able to attract. Most of the Company's loan growth has come from small-business customers that need loans in order to expand their business, and have few deposits. Additionally, the Company has found it difficult to compete for retail deposits in recent years. The Company frequently competes against banks in the marketplace that either 1) are so large that they enjoy better economies of scale over the Company and can thus offer higher rates, or 2) are recently started banks that are focused on building market share, and not necessarily positive earnings, by offering high deposit rates. The Company enjoys advantages in the loan marketplace by having seasoned lenders in place that have the experience necessary to oversee the completion of a loan and the autonomy to be able to make timely decisions.
With loan growth exceeding deposit growth over each of the past two years, the Company's liquidity has been reduced. The Company increased its borrowings from $30 million at December 31, 2002 to $76 million at December 31, 2003 to $92 million at December 31, 2004 in order to help fund the excess loan growth. Additionally, the Company entered the brokered deposit market for the first time in 2004 and gathered $50 million in brokered deposits to help fund loan growth.
In 2004, regulatory capital ratios declined slightly as asset growth exceeded capital growth. In 2002 and 2003, as a result of the negative impact that acquisition growth had on the Company's regulatory capital ratios, the Company raised capital in each of the fourth quarters of 2002 and 2003 by issuing $20.6 million each year (for a total of $41.2 million) in trust preferred debt securities, which qualify as regulatory capital for the Company. All of the Company's capital ratios have significantly exceeded the minimum regulatory thresholds for all periods covered by this report.
Although the Company's market area, the central Piedmont region of North Carolina, has experienced recessionary times over most of the past several years, the Company's asset quality ratios have remained fairly stable over the past three years with net charge-offs to average loans ranging from 10 basis points to 14 basis points and nonperforming assets to total assets ranging from 32 basis points to 36 basis points.
Distribution of Assets and Liabilities
Table 7 sets forth the percentage relationships of significant components of the Company's balance sheets at December 31, 2004, 2003, and 2002.
The relative size of the components of the balance sheet has not varied significantly over the past two years with loans comprising 81%-82% of total assets and deposits comprising 84%-87%. The most significant variance in Table 7 is the increase in 2004 in the percentage of time deposits of $100,000 or more, which increased from 16% at December 31, 2003 to 21% at December 31, 2004. The Company aggressively attracted large time deposits in 2004, including gathering the $50 million in brokered deposits, in order to help fund the strong loan growth experienced that was not able to be fully funded with core retail deposits.
Securities
Information regarding the Company's securities portfolio as of December 31, 2004, 2003, and 2002 is presented in Tables 8 and 9.
The composition of the investment securities portfolio reflects the Company's investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits.
Total securities available for sale and held to maturity amounted to $102.6 million, $117.7 million, and $80.8 million at December 31, 2004, 2003, and 2002, respectively. The decrease in securities from December 31, 2003 to December 31, 2004 was primarily attributable to called and maturing bonds, as well as a high level of principal repayments on mortgage-backed securities due to the low interest rate environment. Instead of reinvesting the maturities/paydowns back into securities, the proceeds were used to fund loan growth. The increase in securities available for sale from December 31, 2002 to December 31, 2003 was primarily attributable to securities purchased with a portion of the $62 million in funds received from the October 2003 RBC Centura branch purchase.
The mix of the types of the Company's securities was similar at December 31, 2004 compared to December 31, 2003. In comparing 2003 to 2002, the mix of securities changed in 2003 due to the mix of new securities purchased with a portion of the $62 million in funds received in the acquisition of the four RBC Centura branches. The Company purchased primarily U.S. Government agency securities with these funds in order to assure a portfolio mix consistent with the Company's investment policy, which limits the amount of mortgage-backed securities and corporate bonds in which the Company can invest.
The majority of the Company's U.S. Government agency debt securities are issued by the Federal Home Loan Bank and carry one maturity date, often with an issuer call feature, while the mortgage-backed securities have been primarily issued by Freddie Mac and Fannie Mae and vary in their repayment in correlation with the underlying pools of home mortgage loans. The Company's investment in corporate bonds is primarily comprised of trust preferred securities issued by other North Carolina bank holding companies.
Included in mortgage-backed securities at December 31, 2004 were collateralized mortgage obligations ("CMOs") with an amortized cost of $15,928,000 and a fair value of $15,831,000. Included in mortgage-backed securities at December 31, 2003 were CMOs with an amortized cost of $21,649,000 and a fair value of $21,458,000. Included in mortgage-backed securities at December 31, 2002 were CMOs with an amortized cost of $12,590,000 and a fair value of $12,720,000. The CMOs that the Company has invested in are substantially all "early tranche" portions of the CMOs, which minimizes long-term interest rate risk to the Company.
At December 31, 2004, a net unrealized gain of $1,186,000 was included in the carrying value of securities classified as available for sale, compared to a net unrealized gain of $1,868,000 at December 31, 2003 and a net unrealized gain of $1,399,000 at December 31, 2002. The lower unrealized gain position at December 31, 2004 compared to December 31, 2003 was caused primarily by a higher interest rate environment in effect at year end 2004 compared to year end 2003. Higher interest rates negatively impact the value of fixed income securities. Another factor was the Company's sale of a portion of its bond portfolio that had unrealized gains at December 31, 2003. The increase in the unrealized gain position from 2002 to 2003 was a result of the lower interest rate environment in effect at year end 2003 compared to year end 2002. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates, not by concerns about the ability of the issuers to meet their obligations. Net unrealized gains, net of applicable deferred income taxes, of $723,000, $1,140,000, and $853,000 have been reported as part of a separate component of shareholders' equity (accumulated other comprehensive income) as
of December 31, 2004, 2003, and 2002, respectively.
The fair value of securities held to maturity, which the Company carries at amortized cost, was more than the carrying value at December 31, 2004 and 2003 by $426,000 and $700,000, respectively. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates, not by concerns about the ability of the issuers to meet their obligations.
Table 9 provides detail as to scheduled contractual maturities and book yields on securities available for sale and securities held to maturity at December 31, 2004. Mortgage-backed and other amortizing securities are shown maturing in the time periods consistent with their estimated lives based on expected prepayment speeds.
The weighted average taxable-equivalent yield for the securities available for sale portfolio was 4.50% at December 31, 2004. The expected weighted average life of the available for sale portfolio using the call date for above-market callable bonds, the maturity date for all other non-mortgage-backed securities, and the expected life for mortgage-backed securities, was 4.6 years.
The weighted average taxable-equivalent yield for the securities held to maturity portfolio was 5.65% at December 31, 2004. The expected weighted average life of the held to maturity portfolio using the call date for above-market callable bonds and the maturity date for all other securities, was 2.3 years.
As of December 31, 2004 and 2003, the Company held no investment securities of any one issuer, other than U.S. Treasury and U.S. Government agencies or corporations, in which aggregate book values and market values exceeded 10% of shareholders' equity.
Loans
Table 10 provides a summary of the loan portfolio composition at each of the past five year ends.
The loan portfolio is the largest category of the Company's earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans, and consumer loans. The Company restricts virtually all of its lending to its 23 county market area, which is located in the central Piedmont region of North Carolina, three counties in Virginia and one county in South Carolina. The diversity of the region's economic base has historically provided a stable lending environment.
In 2004, loans outstanding increased $148.2 million, or 12.2%, to $1.36 billion. All of the loan growth in 2004 was internally generated, as the Company did not complete any acquisitions during the year. In 2003, loans outstanding increased $220.3 million, or 22.1%, to $1.22 billion. Approximately $148 million of the 2003 growth was from net internal loan growth, while $73 million was assumed in acquisitions. The majority of the 2004 and 2003 loan growth occurred in loans secured by real estate, with approximately $143.1 million, or 96.6% in 2004, and $174.5 million, or 79.2%, in 2003 of the net loan growth occurring in real estate mortgage or real estate construction loans.
Over the years, the Company's loan mix has remained fairly consistent, with real estate loans (mortgage and construction) comprising approximately 85% of the loan portfolio, commercial, financial, and agricultural loans comprising 10%, and consumer installment loans comprising approximately 5% of the portfolio.
At December 31, 2004, $1.181 billion, or 86.4%, of the Company's loan portfolio was secured by liens on real property. Included in this total are $630.5 million, or 46.1% of total loans, in loans secured by liens on 1-4 family residential properties and $550.4 million, or 40.3% of total loans, in loans secured by liens on other types of real estate. At December 31, 2003, $1.038 billion, or 85.1%, of the Company's loan portfolio was secured by liens on real property. Included in this total are $549.9 million, or 45.1% of total loans, in loans secured by liens
on 1-4 family residential properties and $487.9 million, or 40.0% of total loans, in loans secured by liens on other types of real estate. The Company's $1.181 billion in real estate mortgage loans at December 31, 2004 can be further classified as follows - for comparison purposes, the classification of the Company's $1.038 billion real estate loan portfolio at December 31, 2003 is shown in parenthesis:
o $411.7 million, or 30.1% of total loans (vs. $360.8 million, or 29.6% of total loans), are traditional residential mortgage loans in which the borrower's personal income is the primary repayment source. o $389.0 million, or 28.5% of total loans (vs. $361.2 million, or 29.6% of total loans), are primarily dependent on cash flow from a commercial business for repayment. o $117.2 million, or 8.6% of total loans (vs. $98.2 million, or 8.1% of total loans), are real estate construction loans. o $120.6 million, or 8.8% of total loans (vs. $95.8 million, or 7.9% of total loans), are home equity loans. o $110.6 million, or 8.1% of total loans (vs. $93.3 million, or 7.7% of total loans), are personal consumer installment loans in which the borrower has provided residential real estate as collateral. o $31.8 million, or 2.3% of total loans (vs. $28.5 million, or 2.3% of total loans), are primarily dependent on cash flow from agricultural crop sales.
Table 11 provides a summary of scheduled loan maturities over certain time periods, with fixed rate loans and adjustable rate loans shown separately. Approximately 22% of the Company's loans outstanding at December 31, 2004 mature within one year and 73% of total loans mature within five years. The percentages of variable rate loans and fixed rate loans as compared to total performing loans were 59.8% and 40.2%, respectively, as of December 31, 2004. The Company intentionally makes a blend of fixed and variable rate loans so as to reduce interest rate risk. As noted in the section above entitled "Net Interest Income," the Company has experienced a significant shift in its loan mix over the past two years from fixed rate loans to variable rate loans.
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and other real estate. As a matter of policy the Company places all loans that are past due 90 or more days on nonaccrual basis, and thus there were no loans at any of the past five year ends that were 90 days past due and still accruing interest. Table 12 summarizes the Company's nonperforming assets at the dates indicated.
Nonaccrual loans are loans on which interest income is no longer being recognized or accrued because management has determined that the collection of interest is doubtful. Placing loans on nonaccrual status negatively impacts earnings because (i) interest accrued but unpaid as of the date a loan is placed on nonaccrual status is either deducted from interest income or is charged-off, (ii) future accruals of interest income are not recognized until it becomes probable that both principal and interest will be paid and (iii) principal charged-off, if appropriate, may necessitate additional provisions for loan losses that are charged against earnings. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms.
Nonperforming loans (which includes nonaccrual loans and restructured loans) as of December 31, 2004, 2003 and 2002 totaled $3,724,000, $4,295,000, and $3,017,000, respectively. Nonperforming loans as a percentage of total loans amounted to 0.27%, 0.35%, and 0.30%, at December 31, 2004, 2003, and 2002, respectively. The variances in nonperforming loans over the past two years have been primarily due to changes in nonaccrual loans, as restructured loans have not changed significantly. The increase in nonaccrual loans from December 31, 2002 to December 31, 2003 related primarily to five loans totaling $1,300,000 placed on nonaccrual basis during the year. Each of these unrelated loans had an outstanding loan balance of between $225,000 and $325,000, and each loan was secured by real estate. Each of the five loans was removed from
nonaccrual status in 2004 without material loss to the Company. Three of the five loans were liquidated, while the other two loans were foreclosed upon and the collateral transferred to other real estate. The decrease in nonaccrual loans from 2003 to 2004 was also impacted by the resolution of the Company's largest nonaccrual loan relationship during 2004. This nonaccrual relationship amounted to $663,000 at December 31, 2003. In 2004, the loan was reduced to zero through a combination of payments received, property foreclosures, and charge-offs. In total, the Company received payments of $65,000, foreclosed on property with a value of $100,000, and charged-off the remaining balance of $498,000. The Company's largest nonaccrual relationship at December 31, 2004 amounted to $404,000.
If the nonaccrual loans and restructured loans as of December 31, 2004, 2003 and 2002 had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period), gross interest income in the amounts of approximately $247,000, $319,000 and $246,000 for nonaccrual loans and $2,000, $2,000 and $6,000 for restructured loans would have been recorded for 2004, 2003 and 2002, respectively. Interest income on such loans that was actually collected and included in net income in 2004, 2003 and 2002 amounted to approximately $120,000, $102,000 and $55,000 for nonaccrual loans (prior to their being placed on nonaccrual status) and $2,000, $2,000 and $6,000 for restructured loans, respectively.
Management routinely monitors the status of certain large loans that, in management's opinion, have credit weaknesses that could cause them to become nonperforming loans. In addition to the nonperforming loan amounts discussed above, management believes that an estimated $5.5-$6.0 million of loans that were performing in accordance with their contractual terms at December 31, 2004 have the potential to develop problems depending upon the particular financial situations of the borrowers and economic conditions in general. Management has taken these potential problem loans into consideration when evaluating the adequacy of the allowance for loan losses at December 31, 2004 (see discussion below).
Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed in the problem loan amounts and the potential problem loan amounts discussed above do not represent or result from trends or uncertainties that management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information that causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
Other real estate includes foreclosed, repossessed, and idled properties. Other real estate has not varied materially at any of the past three year ends, amounting to $1,470,000 at December 31, 2004, $1,398,000 at December 31, 2003, and $1,384,000 at December 31, 2002. Other real estate represented 0.09%, 0.09%, and 0.11% of total assets at the end of 2004, 2003, and 2002, respectively. The Company's management believes that the fair values of the items of other real estate, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented.
Allowance for Loan Losses and Loan Loss Experience
The allowance for loan losses is created by direct charges to operations. Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. The recoveries realized during the period are credited to this allowance. The Company considers its procedures for recording the amount of the allowance for loan losses and the related provision for loan losses to be a critical accounting policy. See the heading "Critical Accounting Policies" above for further discussion.
The factors that influence management's judgment in determining the amount charged to operating expense include past loan loss experience, composition of the loan portfolio, evaluation of probable inherent losses and current economic conditions.
The Company uses a loan analysis and grading program to facilitate its evaluation of probable inherent loan losses and the adequacy of its allowance for loan losses. In this program, risk grades are assigned by management and tested by the Company's internal audit department and an independent third party consulting firm. The testing program includes an evaluation of a sample of new loans, loans that management identifies as having potential credit weaknesses, loans past due 90 days or more, nonaccrual loans and any other loans identified during previous regulatory and other examinations.
The Company strives to maintain its loan portfolio in accordance with what management believes are conservative loan underwriting policies that result in loans specifically tailored to the needs of the Company's market areas. Every effort is made to identify and minimize the credit risks associated with such lending strategies. The Company has no foreign loans, few agricultural loans and does not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of loans captioned in the tables discussed below as "real estate" loans are primarily various personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within the Company's principal market area.
The allowance for loan losses amounted to $14,717,000 at December 31, 2004 compared to $13,569,000 as of December 31, 2003 and $10,907,000 at December 31, 2002. This represented 1.08%, 1.11%, and 1.09%, of loans outstanding as of December 31, 2004, 2003, and 2002, respectively. As noted in Table 12, the Company's allowance for loan losses as a percentage of nonperforming loans ("coverage ratio") amounted to 395% at December 31, 2004, compared to 316% at December 31, 2003 and 362% at December 31, 2002. Due to the secured nature of virtually all of the Company's loans that are on nonaccrual status, the variance in the coverage ratio is not necessarily indicative of the relative adequacy of the allowance for loan losses.
Table 13 sets forth the allocation of the allowance for loan losses at the dates indicated. The portion of these reserves that was allocated to specific loan types in the loan portfolio increased to $14,643,000 at December 31, 2004 from $13,416,000 at December 31, 2003 and $10,883,000 at December 31, 2002. The 9.1% increase in the amount of the allocated allowance during 2004 is consistent with the 12.2% increase in total loans outstanding during the year. Similarly, the 23.3% increase in the amount of the allocated allowance during 2003 is consistent with the 22.1% increase in total loans outstanding during the year. In addition to the allocated portion of the allowance for loan losses, the Company maintains an unallocated portion that is not assigned to any specific category of loans, but rather is intended to reserve for the inherent risk in the overall portfolio and the intrinsic inaccuracies associated with the estimation of the allowance for loan losses and its allocation to specific loan categories. The amount of the unallocated portion of the allowance for loan losses did not vary materially at any of the past three year ends.
Management considers the allowance for loan losses adequate to cover probable loan losses on the loans outstanding as of each reporting date. It must by emphasized, however, that the determination of the allowance using the Company's procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to the amount reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowances for loan losses and losses on foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on the examiners' judgments about information available to them at the time of their examinations.
For the years indicated, Table 14 summarizes the Company's balances of loans outstanding, average loans outstanding, and a detailed rollforward of the allowance for loan losses. In addition to the increases to the allowance for
loan losses related to normal provisions, the increases in the dollar amounts of the allowance for loan losses in 2003 and 2002 were also affected by amounts recorded to provide for loans assumed in corporate acquisitions. In 2003, the Company recorded $1,083,000 to the allowance for loan losses related to loans assumed in two corporate acquisitions. Approximately $333,000 of the $1,083,000 related to $24.8 million in loans assumed in the October 2003 RBC Centura branch acquisition, while $750,000 related to the CCB acquisition. The $750,000 addition related to CCB represented the book value of CCB's allowance for loan losses on the date of the acquisition. In 2002, $50,000 was recorded for loans assumed in the Broadway branch acquisition in which the Company assumed approximately $3 million in loans.
The Company's net loan charge offs amounted to $1,757,000 in 2004, $1,101,000 in 2003, and $1,076,000 in 2002. This represents 0.14%, 0.10%, and 0.11% of average loans during 2004, 2003, and 2002 respectively. The slightly higher amount of net charge-offs in 2004 is largely attributable to the $498,000 charge-off recorded in 2004 related to the disposition of a large nonaccrual relationship that is discussed above in the section entitled "Nonperforming Assets."
Deposits
At December 31, 2004, deposits outstanding amounted to $1.390 billion, an increase of $139 million, or 11.2%, from December 31, 2003. In 2003, deposits grew from $1.056 billion to $1.249 billion, an increase of $193 million, or 18.3%. Although all of the deposit growth in 2004 was internally generated (the Company did not complete any acquisitions during the year), approximately $50 million of the increase related to wholesale brokered deposits that the Company gathered in order to help fund the high loan growth experienced during 2004. Prior to 2004, the Company had never utilized brokered deposits. In 2003, $161 million of the $193 million increase in deposits was related to acquisitions - the Company's January 2003 acquisition of CCB with $59 million in deposits and the October 2003 acquisition of four RBC Centura branches with $102 million in deposits.
The nature of the Company's deposit growth is illustrated in the table on page 25. The following table reflects the mix of the Company's deposits at each of the past three year ends:
2004 2003 2002 ------ ------ ------ Noninterest-bearing deposits 12% 12% 10% Savings, NOW and Money Market deposits 34% 37% 37% Time deposits > $100,000 24% 19% 19% Time deposits < $100,000 30% 32% 34% ------ ------ ------ Total deposits 100% 100% 100% ====== ====== ======
The slight shift in 2002 to 2003 from time deposits less than $100,000 to noninterest-bearing deposits was primarily the result of the mix of the deposits acquired in 2003, which had a high concentration of noninterest-bearing deposits. In 2004, there was a significant increase in the percentage of time deposits greater than $100,000. The increase in this category was largely a result of the Company offering competitive interest rates on this product and the $50 million in wholesale brokered deposits gathered by the Company. Both of the factors driving the increase in time deposits greater than $100,000 were necessitated by the combination of strong loan growth and modest core retail deposit growth experienced by the Company in 2004. As noted earlier, competition for deposits in the Company's market area is strong.
Table 15 presents the average amounts of deposits of the Company and the average yield paid for those deposits for the years ended December 31, 2004, 2003, and 2002.
As of December 31, 2004, the Company held approximately $334.8 million in time deposits of $100,000 or more. Table 16 is a maturity schedule of time deposits of $100,000 or more as of December 31, 2004. This table shows that 86.6% of the Company's time deposits greater than $100,000 mature within one year.
At each of the past three year ends, the Company had no deposits issued through foreign offices, nor did the
Company believe that it held any deposits by foreign depositors.
Borrowings
The Company had borrowings outstanding of $92.2 million at December 31, 2004 compared to $76.0 million at December 31, 2003. As shown in Table 2, average borrowings has increased over the past two years, amounting to $20.7 million in 2002, $42.1 million in 2003, and rising to $84.9 million in 2004. The increases in borrowings over the past two years has been necessary for two reasons - 1) to help fund the Company's high loan growth which has exceeded deposit growth and 2) to enhance the Company's regulatory capital ratios - as noted below, the Company's trust preferred security borrowings qualify as Tier I capital for regulatory capital adequacy requirements.
At December 31, 2004, the Company has three sources of readily available borrowing capacity - 1) an approximately $296 million line of credit with the FHLB, of which $51 million was outstanding at December 31, 2004 and $36 million was outstanding at December 31, 2003, 2) a $50 million overnight federal funds line of credit with a correspondent bank, none of which was outstanding at December 31, 2004 or 2003, and 3) an approximately $58 million line of credit through the Federal Reserve Bank of Richmond's (FRB) discount window, none of which was outstanding at December 31, 2004 or 2003.
The Company's line of credit with the FHLB totaling approximately $296 million can be structured as either short-term or long-term borrowings, depending on the particular funding or liquidity need and is secured by the Company's FHLB stock and a blanket lien on most of its real estate loan portfolio. The Company had $51 million outstanding under this line of credit at December 31, 2004, with $40 million outstanding on an overnight basis and the other $11 million maturing in $1 million to $5 million increments in each of the years from 2005 to 2009.
The Company's correspondent bank relationship allows the Company to purchase up to $50 million in federal funds on an overnight, unsecured basis. The Company had no borrowings outstanding under this line at December 31, 2004 or 2003. This line of credit was not drawn upon during any of the past three years.
The Company also has a line of credit with the FRB discount window. This line is secured by a blanket lien on a portion of the Company's commercial and consumer loan portfolio (excluding real estate). Based on the collateral owned by the Company as of December 31, 2004, the available line of credit is approximately $58 million. This line of credit was established primarily in connection with the Company's Y2K liquidity contingency plan and has not been drawn on since inception. The FRB has indicated that it would not expect lines of credit that have been granted to financial institutions to be a primary borrowing source. The Company plans to maintain this line of credit, although it is not expected that it will be drawn upon except in unusual circumstances.
In addition to the lines of credit described above, in which the Company had $51 million outstanding as of December 31, 2004, the Company also had a total of $41.2 million in trust preferred security debt outstanding at December 31, 2004. The Company issued $20.6 million of this debt on October 29, 2002 and an additional $20.6 million on December 19, 2003. These borrowings each have 30 year final maturities and were structured as trust preferred capital securities that qualify as Tier I capital for regulatory capital adequacy requirements. These debt securities are callable by the Company at par on any quarterly interest payment date five years after their issue date. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 3.45% for the securities issued in 2002 and three-month LIBOR plus 2.70% for the securities issued in 2003.
Average short-term borrowings for each of the past five years were less than 30% of total shareholders' equity at all times during each period.
Liquidity, Commitments, and Contingencies
The Company's liquidity is determined by its ability to convert assets to cash or to acquire alternative sources of funds to meet the needs of its customers who are withdrawing or borrowing funds, and its ability to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. The Company's primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. The Company's securities portfolio is comprised almost entirely of readily marketable securities which could also be sold to provide cash.
As noted above, in addition to internally generated liquidity sources, the Company has the ability to obtain borrowings from the following three sources - 1) an approximately $296 million line of credit with the FHLB, 2) a $50 million overnight federal funds line of credit with a correspondent bank, and 3) an approximately $58 million line of credit through the Federal Reserve Bank of Richmond's discount window.
The Company's on-balance-sheet liquidity declined in both 2004 and 2003 as a result of the strong loan growth that outpaced deposit growth during each year. The imbalance in loan growth compared to deposit growth increased the loan to deposit ratio from 94.6% at December 31, 2002 to 97.6% at December 31, 2003 to 98.4% at December 31, 2004. The increasing loan to deposit ratio has resulted in the Company relying more heavily on borrowings during each of the past two years in order to achieve internally targeted liquidity ratios. Average borrowings outstanding were $20.7 million in 2002, $42.0 million in 2003 and $84.9 million in 2004.
Despite the higher reliance on borrowings, the Company's management believes its liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet its operating needs in the foreseeable future. The Company will continue to monitor its liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate
In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows.
Table 18 reflects the contractual obligations and other commercial commitments of the Company outstanding as of December 31, 2004. Any of the Company's $51 million in outstanding borrowings with the FHLB may be accelerated immediately by the FHLB in certain circumstances, including material adverse changes in the condition of the Company or if the Company's qualifying collateral amounts to less than 1.25 times the amount of borrowings outstanding. At December 31, 2004, the Company's qualifying collateral amounted to 7.2 times the amount of borrowings outstanding.
In the normal course of business there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the financial statements. Table 18 also reflects other commercial commitments of the Company outstanding as of December 31, 2004. This table reflects that as of December 31, 2004, the Company had outstanding loan commitments of $232,248,000 (the sum of credit cards and lines of credit and loan commitments line items). Of that amount, $208,241,000 were at variable rates and $24,007,000 were at fixed rates. Included in outstanding loan commitments were unfunded commitments of $123,535,000 on revolving credit plans, of which $115,024,000 were at variable rates and $8,511,000 were at fixed rates.
In addition to the credit card and other loan commitments described above, at December 31, 2004 and 2003, the Company had $3,762,000 and $3,320,000 in standby letters of credit outstanding, respectively. The Company has no carrying amount for these standby letters of credit. The nature of the standby letters of credit is a guarantee made on behalf the Company's customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit have two to three year terms, and the payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) the Company could be required to make under the guarantees in the event of nonperformance by the parties to whom credit or financial
guarantees have been extended is represented by the contractual amount of the financial instruments discussed above. In the event that the Company is required to honor a standby letter of credit, a note, already executed with the customer, is triggered which provides repayment terms and any collateral requirements. Over the past ten years, the Company has had to honor one standby letter of credit, which was repaid by the borrower without any loss to the Company.
It has been the experience of the Company that deposit withdrawals are generally replaced with new deposits, thus not requiring any net cash outflow. Based on that assumption, management believes that it can meet its contractual cash obligations and existing commitments from normal operations.
The Company is not involved in any legal proceedings that, in management's opinion, could have a material effect on the consolidated financial position of the Company; however, the following paragraph describes a potential exposure related to taxes.
Based on consultations with the Company's tax advisors, the Company's organizational structure has been established in a way to minimize its tax liabilities. State taxing authorities have recently announced that they will vigorously pursue taxpayers who have engaged in activities deemed to be "income-shifting," and the Company is aware that state taxing authorities have recently challenged a bank holding company with a similar operating structure as the Company that they deem to result in "income-shifting." While the Company believes its tax position is sound, it has decided to discontinue certain elements of its operating structure during 2005 to avoid controversy with state taxing authorities. If the Company's position with regard to its operating structure were to be challenged by state taxing authorities for past years and resulted in an assessment, the Company estimates that its exposure could be $5.8 million (net of federal tax benefit), including interest and penalties. If such an assessment were to occur, the Company would vigorously contest the assessment based on the belief that it has fully complied with relevant tax laws. Accordingly, the Company has not accrued a liability for this possibility. As a result of discontinuing certain elements of the Company's operating structure, the Company estimates that its effective tax rate will increase from approximately 34% in 2004 to approximately 39% in 2005. If the Company's effective tax rate had been 39% in 2004, the Company's net income would have been lower by approximately $1.3 million.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements in which the Company has obligations or provides guarantees on behalf of an unconsolidated entity. The Company has no off-balance sheet arrangements of this kind other than repayment guarantees associated with its trust preferred securities.
Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. The Company has not engaged in significant derivatives activities through December 31, 2004 and has no current plans to do so.
Interest Rate Risk (Including Quantitative and Qualitative Disclosures About Market Risk - Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information responsive to this Item is found in Item 7 under the caption "Interest Rate Risk."
FORWARD-LOOKING STATEMENTS
The discussion in Part I and Part II of this report contains statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as "expect," "believe," "estimate," "plan," "project," or other statements concerning opinions or judgment of the Company and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of the Company's customers, the Company's level of success in integrating acquisitions, actions of government regulators, the level of market interest rates, and general economic conditions.
(1) Results for the year ended December 31, 2000 were significantly impacted by merger-related charges. (2) All share data has been adjusted to reflect the 3-for-2 stock split paid on November 15, 2004.
- --------------------------------------------------------------------------------
(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized loan fees in the amounts of $1,244,000, $1,235,000, and $938,000 for 2004, 2003, and 2002, respectively. (2) Includes tax-equivalent adjustments of $475,000, $519,000, and $535,000 in 2004, 2003, and 2002, respectively, to reflect the federal and state benefit of the tax-exempt securities, reduced by the related nondeductible portion of interest expense.
- --------------------------------------------------------------------------------
Changes attributable to both volume and rate are allocated equally between rate and volume variances.
- -------------------------------------------------------------------------------- Table 4 Noninterest Income - --------------------------------------------------------------------------------
Year Ended December 31, -------------------------------- (In thousands) 2004 2003 2002 -------- -------- -------- Service charges on deposit accounts $ 9,064 7,938 6,856 Other service charges, commissions, and fees 3,361 2,710 2,336 Fees from presold mortgages 969 2,327 1,713 Commissions from sales of insurance and financial products 1,406 1,304 738 Data processing fees 416 333 303 -------- -------- -------- Total core noninterest income 15,216 14,612 11,946 Loan sale gains 2 2 11 Securities gains, net 299 218 25 Other gains (losses), net 347 86 (14) -------- -------- -------- Total $ 15,864 14,918 11,968 ======== ======== ========
- ------------------------------------------------------------------------------- Table 5 Noninterest Expenses - -------------------------------------------------------------------------------
Year Ended December 31, ---------------------------------- (In thousands) 2004 2003 2002 -------- -------- --------
Salaries $ 20,116 17,756 15,079 Employee benefits 5,488 4,381 3,388 -------- -------- -------- Total personnel expense 25,604 22,137 18,467 Occupancy expense 2,754 2,366 2,077 Equipment related expenses 2,956 2,555 2,128 Amortization of intangible assets 378 224 31 Stationery and supplies 1,523 1,498 1,445 Telephone 1,345 1,229 932 Non-credit losses 187 198 97 Other operating expenses 8,970 7,757 7,124 -------- -------- -------- Total $ 43,717 37,964 32,301 ======== ======== ========
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- Table 6 Income Taxes - --------------------------------------------------------------------------------
(In thousands) 2004 2003 2002 -------- -------- --------
Current - Federal $ 10,407 9,578 8,964 - State 228 614 464 Deferred - Federal (192) 425 (146) - State (25) -- -- -------- -------- -------- Total $ 10,418 10,617 9,282 ======== ======== ========
Effective tax rate 34.1% 35.3% 35.0% ======== ======== ========
- --------------------------------------------------------------------------------
(1) Yields on tax-exempt investments have been adjusted to a taxable equivalent basis using a 35% tax rate.
- --------------------------------------------------------------------------------
(1) The majority of these loans are various personal and commercial loans where real estate provides additional security for the loan.
The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) Tax-exempt securities are reflected at a tax-equivalent basis using a 35% tax rate. (2) Securities and borrowings with call dates within 12 months of December 31, 2004 that have above market interest rates are assumed to mature at their call date for purposes of this table. Mortgage securities are assumed to mature in the period of their expected repayment based on estimated prepayment speeds. (3) Excludes nonaccrual loans. (4) Single-family mortgage loans are assumed to mature in the period of their expected repayment based on estimated prepayment speeds. All other loans are shown in the period of their contractual maturity.
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- Table 20 Return on Assets and Equity - --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) Per share amounts have been adjusted to reflect the 3-for-2 stock split paid on November 15, 2004.
Item 8.
Item 8. Financial Statements and Supplementary Data
First Bancorp and Subsidiaries Consolidated Balance Sheets December 31, 2004 and 2003
See accompanying notes to consolidated financial statements.
First Bancorp and Subsidiaries Consolidated Statements of Income Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
First Bancorp and Subsidiaries Consolidated Statements of Comprehensive Income Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
First Bancorp and Subsidiaries Consolidated Statements of Shareholders' Equity Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
First Bancorp and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 2004, 2003 and 2002
See accompanying notes to consolidated financial statements.
First Bancorp and Subsidiaries Notes to Consolidated Financial Statements December 31, 2004
Note 1. Summary of Significant Accounting Policies
(a) Basis of Presentation - The consolidated financial statements include the accounts of First Bancorp (the Company) and its wholly owned subsidiaries: First Bank (the Bank); Montgomery Data Services, Inc. (Montgomery Data); and First Bancorp Financial Services, Inc. (First Bancorp Financial). The Bank has two wholly owned subsidiaries: First Bank Insurance Services, Inc. (First Bank Insurance), and First Montgomery Financial Services Corporation (First Montgomery). First Montgomery has one wholly owned subsidiary - First Troy Realty Corporation (First Troy). All significant intercompany accounts and transactions have been eliminated.
The Company is a bank holding company. The principal activity of the Company is the ownership and operation of First Bank, a state chartered bank with its main office in Troy, North Carolina. Other subsidiaries include Montgomery Data, a data processing company whose primary client is First Bank, and First Bancorp Financial, a real estate investment subsidiary, both of which are headquartered in Troy. The Company is also the parent company for three statutory trusts that were formed in 2002 and 2003 for the purpose of issuing a total of $40 million in debt securities. These securities qualify as Tier I capital for regulatory capital adequacy requirements. As described further in Note 1(s), subsequent to the adoption of FIN 46 and FIN 46R in 2004, the Company does not consolidate these trusts in its consolidated financial statements. Although these trusts are reflected in the accompanying financial statements on a consolidated basis for all periods prior to 2004, the comparability of the accompanying financial statements is not materially impacted. First Bank Insurance is a provider of non-FDIC insured investment and insurance products. First Montgomery is a Virginia incorporated company that acquires real estate in Virginia and leases the property to the Bank. First Troy was formed in 1999 and allows the Bank to centrally manage a portion of its real estate loan portfolio. First Troy has elected to be treated as a real estate investment trust for tax purposes.
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 and disclosure of contingent 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 most significant estimates made by the Company in the preparation of its consolidated financial statements are the determination of the allowance for loan losses, the valuation of other real estate, and fair value estimates for financial instruments.
(b) Cash and Cash Equivalents - The Company considers all highly liquid assets such as cash on hand, noninterest-bearing and interest-bearing amounts due from banks and federal funds sold to be "cash equivalents."
(c) Securities - Debt securities that the Company has the positive intent and ability to hold to maturity are classified as "held-to-maturity" and carried at amortized cost. Securities not classified as held-to-maturity are classified as "available-for-sale" and carried at fair value, with unrealized gains and losses being reported as other comprehensive income and reported as a separate component of shareholders' equity.
A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Any equity security that is in an unrealized loss position for twelve consecutive months is presumed to be permanently impaired and an impairment charge is recorded.
Gains and losses on sales of securities are recognized at the time of sale based upon the specific identification method. Premiums and discounts are amortized into income on a level yield basis, with premiums being amortized to the earliest call date and discounts being accreted to the stated maturity date.
(d) Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Depreciation, computed by the straight-line method, is charged to operations over the estimated useful lives of the properties, which range from 5 to 40 years or, in the case of leasehold improvements, over the term of the lease, if shorter. Maintenance and repairs are charged to operations in the year incurred. Gains and losses on dispositions are included in current operations.
(e) Loans - Loans are stated at the principal amount outstanding, less unearned income and deferred nonrefundable loan fees, net of certain origination costs. Interest on loans is accrued on the unpaid principal balance outstanding. Net deferred loan origination costs/fees are capitalized and recognized as a yield adjustment over the life of the related loan. Unearned income for each of the reporting periods was immaterial.
A loan is placed on nonaccrual status when, in management's judgment, the collection of interest appears doubtful. The accrual of interest is discontinued on all loans that become 90 days or more past due with respect to principal or interest. The past due status of loans is based on the contractual payment terms. While a loan is on nonaccrual status, the Company's policy is that all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone. Loans are removed from nonaccrual status when they become current as to both principal and interest and when concern no longer exists as to the collectibility of principal or interest. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms.
Commercial loans greater than $100,000 that are on nonaccrual status are evaluated regularly for impairment. A loan is considered to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured using either 1) an estimate of the cash flows that the Company expects to receive from the borrower discounted at the loan's effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral is used to value the loan. While a loan is considered to be impaired, the Company's policy is that interest accrual is discontinued and all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone.
(f) Presold Mortgages in Process of Settlement and Loans Held for Sale - As a part of normal business operations, the Company originates residential mortgage loans that have been pre-approved by secondary investors. The terms of the loans are set by the secondary investors, and the purchase price that the investor will pay for the loan is agreed to prior to the funding of the loan by the Company. Generally within three weeks after funding, the loans are transferred to the investor in accordance with the agreed-upon terms. The Company records gains from the sale of these loans on the settlement date of the sale equal to the difference between the proceeds received and the carrying amount of the loan. The gain generally represents the portion of the proceeds attributed to service release premiums received from the investors and the realization of origination fees received from borrowers which were deferred as part of the carrying amount of the loan. Between the initial funding of the loans by the Company and the subsequent reimbursement by the investors, the Company carries the loans on its balance sheet at cost.
Periodically, the Company originates commercial loans that are intended for resale. The Company carries these loans at the lower of cost or fair value at each reporting date. There were no such loans held for sale as of December 31, 2004 or 2003.
(g) Allowance for Loan Losses - The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, current economic conditions, historical loan loss experience and other risk factors. While management uses the best information available to make evaluations, future adjustments may be necessary if economic and other conditions differ substantially from the assumptions used.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on the examiners' judgment about information available to them at the time of their examinations.
(h) Other Real Estate - Other real estate owned consists primarily of real estate acquired by the Company through legal foreclosure or deed in lieu of foreclosure. The property is initially carried at the lower of cost (generally the loan balance plus additional costs incurred for improvements to the property) or estimated fair value of the property less estimated selling costs. If there are subsequent declines in fair value, the property is written down to its fair value through a charge to expense. Capital expenditures made to improve the property are capitalized. Costs of holding real estate, such as property taxes, insurance and maintenance, less related revenues during the holding period, are charged to operations.
(i) Income Taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon available evidence. The Company's investment tax credits, which for the Company are low income housing tax credits, are recorded in the period that they are affirmed by the tax credit fund, which is in the year immediately subsequent to the period that they relate.
(j) Intangible Assets - Business combinations are accounted for using the purchase method of accounting. Identifiable intangible assets are recognized separately and are amortized over their estimated useful lives, which for the Company has generally been ten years and at an accelerated rate. Goodwill is recognized in business combinations to the extent that the price paid exceeds the fair value of the net assets acquired, including any identifiable intangible assets. As discussed in Note 1(n), goodwill is not amortized, but is subject to fair value impairment tests on at least an annual basis.
In accordance with applicable accounting standards, the Company records an intangible asset in connection with a defined benefit pension plan to fully accrue for its liability. This intangible asset is adjusted annually in accordance with actuarially determined amounts. The amount of this intangible asset was $84,000 and $93,000 at December 31, 2004 and 2003, respectively.
(k) Stock Option Plan - At December 31, 2004, the Company had six stock-based employee compensation plans, which are described more fully in Note 14. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB Opinion No. 25), "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation. For options with vesting requirements, the amount of compensation expense recognized in each period is on a straight-line basis over the vesting period.
(l) Per Share Amounts - Basic Earnings Per Share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted Earnings Per Share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Currently, the Company's only potential dilutive common stock issuances relate to options that have been issued under the Company's stock option plans. In computing Diluted Earnings Per Share, it is assumed that all such dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate Diluted Earnings Per Share for the Company.
The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Earnings Per Share:
For the years ended December 31, 2004, and 2003, there were no antidilutive options since the exercise price for each option outstanding was less that the average market price for the year. For the year ended December 31, 2002, there were 24,000 options that were antidilutive since the exercise price exceeded the average market price for the year. These options were omitted from the calculation of diluted earnings per share for 2002.
(m) Fair Value of Financial Instruments - Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" (SFAS No. 107), requires that the Company disclose estimated fair values for its financial instruments. Fair value methods and assumptions are set forth below for the Company's financial instruments.
Cash and Due from Banks, Federal Funds Sold, Presold Mortgages in Process of Settlement, Accrued Interest Receivable, and Accrued Interest Payable - The carrying amounts approximate their fair value because of the short maturity of these financial instruments.
Available for Sale and Held to Maturity Securities - Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, financial and agricultural, real estate construction, real estate mortgages and installment loans to individuals. Each loan category is further segmented into fixed and variable interest rate terms. For variable rate loans, the carrying value is a reasonable estimate of the fair value. For fixed rate loans, fair value is determined by discounting scheduled future cash flows using current interest rates offered on loans with similar risk characteristics. Fair values for impaired loans are estimated based on discounted cash flows or underlying collateral values, where applicable.
Deposits - The fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand as of the valuation date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Borrowings - The fair value of borrowings is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered by the Company's lenders for debt of similar remaining maturities.
Commitments to Extend Credit and Standby Letters of Credit - At December 31, 2004 and 2003, the Company's off-balance sheet financial instruments had no carrying value. The large majority of commitments to extend credit and standby letters of credit are at variable rates and/or have relatively short terms to maturity. Therefore, the fair value for these financial instruments is considered to be immaterial.
(n) Impairment - Goodwill is evaluated for impairment on at least an annual basis by comparing the fair value of its reporting units to their related carrying value. If the carrying value of a reporting unit exceeds its fair value, the Company determines whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeds the carrying value of the goodwill. If the carrying value of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recorded in an amount equal to that excess.
For all other long-lived assets, including identifiable intangible assets, the Company reviews them for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company's policy is that an impairment loss is recognized if the sum of the undiscounted future cash flows is less than the carrying amount of the asset. Any of long-lived assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell.
To date, the Company has not had to record any impairment write-downs of its long-lived assets or goodwill.
(o) Comprehensive Income - Comprehensive income is defined as the change in equity during a period for non-owner transactions and is divided into net income and other comprehensive income. Other comprehensive
income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of accumulated other comprehensive income for the Company are as follows:
December 31, December 31, December 31, 2004 2003 2002 ------------ ------------ ------------ Unrealized gain on securities available for sale $ 1,186 1,868 1,399 Deferred tax liability (463) (728) (546) ------- ------- ------- Net unrealized gain on securities available for sale 723 1,140 853 ------- ------- ------- Additional minimum pension liability (338) (292) (165) Deferred tax asset 132 114 64 ------- ------- ------- Net additional minimum pension liability (206) (178) (101) ------- ------- ------- Total accumulated other comprehensive income $ 517 962 752 ======= ======= =======
(p) Segment Reporting - SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" requires management to report selected financial and descriptive information about reportable operating segments. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. Generally, disclosures are required for segments internally identified to evaluate performance and resource allocation. The Company's operations are primarily within the banking segment, and the financial statements presented herein reflect the results of that segment. Also, the Company has no foreign operations or customers.
(q) Reclassifications - Certain amounts for prior years have been reclassified to conform to the 2004 presentation. The reclassifications had no effect on net income or shareholders' equity as previously presented, nor did they materially impact trends in financial information.
(r) Stock Split - The Company paid a 3-for-2 stock split on November 15, 2004. All previously reported share totals and per share amounts have been adjusted to retroactively reflect the effect of the split.
(s) Recent Accounting Pronouncements - In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities," which was subsequently revised in December 2003. FIN 46 addresses the consolidation by business enterprises of certain variable interest entities. The provisions of this interpretation became effective for the Company on January 31, 2003 as it relates to variable interest entities created or purchased after that date. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R), which clarified and interpreted certain of the provisions of FIN 46, without changing the basic accounting model in FIN 46. The provisions of FIN 46R were effective no later than March 31, 2004. The adoption of FIN 46 did not have an impact on the Company's financial position or results of operations, as the Company had no investments in variable interest entities that required consolidation under FIN 46. The application of FIN 46R during 2004 resulted in the de-consolidation of three trusts that the Company established in order to issue $40 million in trust preferred capital securities. The de-consolidation of the trusts resulted in the Company recording the amount of the junior subordinated debentures between the Company and the trust subsidiary in the amount of $1,239,000. Previously, the junior subordinated debentures were eliminated in consolidation. The impact of this change was to increase both securities (held-to-maturity) and borrowings by $1,239,000 each. Additional information regarding the Company's trust preferred securities is included in Note 9.
In November 2003, the FASB ratified a consensus reached by its Emerging Issues Task Force ("EITF") regarding quantitative and qualitative disclosures required by EITF Issue No. 03-1, "The Meaning of Other-Than-
Temporary Impairment and Its Application to Certain Investments." EITF Issue No. 03-1 requires certain quantitative and qualitative disclosures as it relates to investments that have unrealized losses that have not been recognized as other-than-temporary impairments and is effective for fiscal years ending after December 15, 2003. The additional disclosures required for the Company are included in Note 3. In March 2004, the EITF released Consensus 03-1 (EITF 03-1). EITF 03-1 as released, codified the provisions of SEC Staff Accounting Bulletin No. 59 and required additional information about unrealized losses associated with debt and equity securities and also provided more detailed criteria that must be followed in evaluating whether to record losses on impaired debt and equity securities. The disclosure requirements were applicable for annual reporting periods ending after June 15, 2004 and are presented in Note 3. The impairment accounting requirements were to have been effective for periods beginning after June 15, 2004. However, in September 2004, the FASB indefinitely delayed the effective date of the requirement to record impairment losses caused by the effect of increases in interest rates or "sector spreads."
In December 2003, the FASB issued Statement of Financial Accounting Standards No. 132 (revised 2003) (Statement 132(R)), "Employers' Disclosures about Pensions and Other Postretirement Benefits." Statement 132(R) revises employers' disclosures about pension plans and other postretirement plans, but does not change the measurement or recognition of those plans. Statement No. 132(R) requires additional disclosures about the assets, obligations, cash flows, and net periodic pension cost of defined benefit plans and other defined benefit postretirement plans. Most of the provisions of Statement 132(R) became effective for financial statements with fiscal years after December 15, 2003, with certain provisions becoming effective for fiscal years ending after June 15, 2004. The additional disclosures required for the Company are included in Note 11.
In March 2004, the SEC issued Staff Accounting Bulletin Number 105 (SAB 105), "Application of Accounting Principles to Loan Commitments." SAB 105 summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivatives, and its provisions were required for such loan commitments entered into subsequent to March 31, 2004. The adoption of SAB 105 did not have a material impact on the Company's consolidated financial statements.
Note 2. Completed Acquisitions
Since January 1, 2002, the Company has completed several acquisitions. There were no acquisitions during 2004.
The Company completed the following acquisitions during 2003. The results of each acquired company are included in First Bancorp's results for the period ended December 31, 2003 beginning on their respective acquisition dates.
(a) On January 2, 2003, the Company completed the acquisition of Uwharrie Insurance Group, a Montgomery County based property and casualty insurance agency. With eight employees, Uwharrie Insurance Group, Inc. serves approximately 5,000 customers, primarily from its Troy-based headquarters, and has annual commissions of approximately $500,000. The primary reason for the acquisition was to gain efficiencies of scale with the Company's existing property and casualty insurance business. In accordance with the terms of the merger agreement, the Company paid cash in the amount of $546,000 to complete the acquisition. In addition, the Company incurred $18,000 in other direct costs to complete the acquisition. As of the date of the acquisition, the value of the assets of Uwharrie Insurance Group amounted to $20,000 (consisting primarily of premises and equipment), which resulted in the Company recording an intangible asset of approximately $544,000. Based on an independent appraisal, the allocation among types of intangible assets and related amortization periods are:
Type of Intangible Asset Allocated Amount Amortization Period - ----------------------------- ------------------ --------------------------- Value of Noncompete Agreement $ 50,000 Two years - straight-line Value of Customer List 151,000 Ten years - straight-line Goodwill 343,000 Not applicable -------- Total Intangible Assets $544,000 ========
For tax purposes, each of the intangible assets recorded will result in tax-deductible amortization expense. No pro forma earnings information has been presented due to the immateriality of the acquisition.
(b) On January 15, 2003, the Company completed the acquisition of Carolina Community Bancshares, Inc. (CCB), the parent company of Carolina Community Bank, a South Carolina community bank with three branches in Dillon County, South Carolina. This represented the Company's first entry into South Carolina. Dillon County, South Carolina is contiguous to Robeson County, North Carolina, a county where the Company operates four branches. The Company's primary reason for the acquisition was to expand into a contiguous market with facilities, operations and experienced staff in place. The terms of the agreement called for shareholders of Carolina Community to receive 1.2 shares of First Bancorp stock and $20.00 in cash for each share of Carolina Community stock they own. The transaction was completed on January 15, 2003 with the Company paying cash of $8.3 million, issuing 499,332 shares of common stock that were valued at approximately $8.4 million, and assuming employee stock options with an intrinsic value of approximately $0.9 million. The value of the stock issued was determined using a Company stock price of $16.81, which was the average price of Company stock during the five day period beginning two days before the acquisition announcement and ending two days after the acquisition announcement (adjusted for the November 15, 2004 stock split). The value of the employee stock options assumed was determined using the Black-Scholes option-pricing model.
This acquisition has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of CCB were recorded based on estimates of fair values as of January 15, 2003. Except as noted beginning in the next sentence, the table below is a condensed balance sheet disclosing the amount assigned to each major asset and liability caption of CCB on January 15, 2003, and the related fair value adjustments recorded by the Company to reflect the acquisition. The "Other" category in the table below amounting to $755,000 consists solely of the net tax asset recorded in connection with the acquisition and was originally a liability of $243,000. In 2004, the Company recorded three adjustments to the purchase
price allocation totaling $998,000, each of which related to taxes, as explained in the following sentences. It was determined in 2004 that $895,000 of the amount originally recorded as goodwill at the acquisition date was deductible for tax purposes. The tax impact of these deductions was approximately $353,000. It was also determined in 2004 that a deferred tax valuation allowance that had been recorded by CCB in the amount of $224,000 was no longer necessary. Additionally the Company has realized $421,000 in tax benefits related to the exercise of nonqualified stock options that were assumed in the merger. Accordingly, in 2004, the Company reduced its tax liability by $998,000, with a corresponding decrease to goodwill. The table below includes the impact of the 2004 adjustments.
Explanation of Fair Value Adjustments - -------------------------------------
(a) This fair value adjustment represents the net unrealized gain of CCB's held-to-maturity securities portfolio. This fair value adjustment was recorded by the Company as a premium on securities and will be amortized as a reduction of investment interest income over the life of the related securities, which have an average life of approximately four years.
(b) This fair value adjustment represents the book value of certain equipment owned by CCB that became obsolete upon the acquisition.
(c) This fair value adjustment represents the value of the core deposit base assumed in the acquisition based on a study performed by an independent consulting firm. This amount was recorded by the Company as an identifiable intangible asset and will be amortized as expense on an accelerated basis over a ten year period based on an amortization schedule provided by the consulting firm.
(d) This fair value adjustment represents the net tax asset recorded related to the accounting for the acquisition.
(e) This fair value adjustment was recorded because the interest rates of CCB's borrowings exceeded current interest rates on similar borrowings. This amount will be amortized to reduce interest expense over the remaining lives of the related borrowings, which have a weighted average life of approximately 3.7 years.
(f) This fair value adjustment represents the carrying value of a retirement plan liability that was terminated in accordance with the terms of the merger agreement.
The following unaudited pro forma financial information presents the combined results of the Company and CCB as if the acquisition had occurred as of January 1, 2002, after giving effect to certain adjustments, including amortization of the core deposit intangible, an assumed cost of funds related to the cash paid of 6%, and related income tax effects. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and CCB constituted a single entity during such period. Because the acquisition took place on January 15, 2003, pro forma results for 2003 are not provided.
($ in thousands, except share data) Year Ended December 31, 2002 ----------------- Net interest income $ 52,200 Noninterest income 12,717 Net income 17,748 Earnings per share Basic 1.25 Diluted 1.22
The above pro forma results include charges recorded by CCB in the fourth quarter of 2002 related to the impending merger with the Company. These expenses amounted to $255,375 on a pretax basis and $198,432 on an after-tax basis.
(c) On October 24, 2003, the Company completed the acquisition of four branches of RBC Centura Bank located in Fairmont, Harmony, Kenansville, and Wallace, all in North Carolina. As of the date of the acquisition, the branches had a total of approximately $102 million in deposits and $25 million in loans. The primary reason for the acquisition was to expand into new markets and increase the Company's customer base. Subject to certain limitations, the Company paid a deposit premium of 14.1% for the branches, which resulted in the Company recording intangible assets relating to this purchase of $14.2 million, all of which is deductible for tax purposes. The identifiable intangible asset associated with the fair value of the core deposit base, as determined by an independent consulting firm, was determined to be approximately $1.3 million and is being amortized as expense on an accelerated basis over a ten year period based on an amortization schedule provided by the consulting firm. The remaining intangible asset of $12.9 million has been classified as goodwill, and thus is not being systematically amortized, but rather is subject to an annual impairment test. The primary factors that contributed to a purchase price that resulted in recognition of goodwill were the Company's desire to expand in four new markets with facilities, operations and experienced staff in place. These four branches' operations are included in the accompanying Consolidated Statements of Income beginning on the acquisition date of October 24, 2003. Historical financial information related to the four branches while owned by RBC Centura Bank is not available, and thus pro forma results of operations have not been presented.
The following table contains a condensed balance sheet that indicates the amount assigned to each major asset and liability as of the respective acquisition dates for the 2003 acquisitions described above.
Uwharrie Carolina RBC Insurance Community Centura Assets acquired Group Bank Branches Total - ------------------------------- ---------- --------- ---------- --------- (in millions) Cash $ -- 7.0 62.4 69.4 Securities -- 13.1 -- 13.1 Loans, gross -- 47.7 24.8 72.5 Allowance for loan losses -- (0.8) (0.3) (1.1) Premises and equipment -- 0.8 1.0 1.8 Other -- 2.5 0.2 2.7 ----- ----- ----- ----- Total assets acquired -- 70.3 88.1 158.4 ----- ----- ----- -----
Liabilities assumed - ------------------------------- Deposits -- 58.9 102.0 160.9 Borrowings -- 2.1 -- 2.1 Other -- 0.6 0.3 0.9 ----- ----- ----- ----- Total liabilities assumed -- 61.6 102.3 163.9 ----- ----- ----- ----- Value of cash paid and/or stock issued to stock-holders of acquiree 0.5 18.9 n/a 19.4 ----- ----- ----- ----- Intangible assets recorded $ 0.5 10.2 14.2 24.9 ===== ===== ===== =====
The Company completed one acquisition in 2002 as follows:
(a) On October 4, 2002, the Company completed the purchase of a branch of RBC Centura located in Broadway, North Carolina. The Company assumed the branch's $8 million in deposits and $3 million in loans. The primary reason for this acquisition was to increase the Company's presence in Lee County, a market in which the Company already had two branches with a large customer base. An intangible asset of $0.7 million, all of which is deductible for tax purposes, was recorded in connection with this acquisition. The entire intangible asset was determined to be goodwill. The primary factors that contributed to a purchase price that resulted in recognition of goodwill were the Company's desire to expand in Lee County with a facility, operations, and experienced staff in place. The Broadway branch's operations are included in the accompanying Consolidated Statements of Income beginning on the acquisition date of October 4, 2002.
Note 3. Securities
The book values and approximate fair values of investment securities at December 31, 2004 and 2003 are summarized as follows:
Included in mortgage-backed securities at December 31, 2004 were collateralized mortgage obligations with an amortized cost of $15,928,000 and a fair value of $15,831,000. Included in mortgage-backed securities at December 31, 2003 were collateralized mortgage obligations with an amortized cost of $21,649,000 and a fair value of $21,458,000.
The Company owned Federal Home Loan Bank stock with a cost and fair value of $5,247,000 at December 31, 2004 and $5,550,000 at December 31, 2003, which is included in equity securities above and serves as part of the collateral for the Company's line of credit with the Federal Home Loan Bank (see Note 9 for additional discussion). The investment in this stock is a requirement for membership in the Federal Home Loan Bank system.
The following table presents information regarding securities with unrealized losses at December 31, 2004:
In the above table, all of the non-equity securities that are in an unrealized loss position at December 31, 2004 are bonds that the company has determined are in a loss position due to interest rate factors, and not because of credit quality concerns. Therefore, the Company expects to collect the full par value of each bond upon maturity with no accounting loss. The Company has concluded that each of the equity securities in an unrealized loss position at December 31, 2004 is due to minor temporary fluctuations in the market prices of the securities. The Company will record an impairment charge for any of these equity securities that remains in an unrealized loss position for twelve consecutive months.
The aggregate carrying amount of cost-method investments was $6,508,000 and $6,876,000 at December 31, 2004 and 2003, respectively, which included the Federal Home Loan Bank stock discussed above. The Company determined that none of the its cost-method investments were impaired at either year end.
The book values and approximate fair values of investment securities at December 31, 2004, by contractual maturity, are summarized in the table below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
At December 31, 2004 and 2003, investment securities with book values of $43,315,000 and $37,719,000, respectively, were pledged as collateral for public and private deposits.
Sales of securities available for sale with aggregate proceeds of $12,060,000 in 2004, $7,750,000 in 2003, and $1,012,000 in 2002 resulted in gross gains of $299,000 and no gross losses in 2004, resulted in gross gains of $218,000 and no gross losses in 2003, and gross gains of $27,000 and gross losses of $2,000 in 2002.
Note 4. Loans and Allowance for Loan Losses
Loans at December 31, 2004 and 2003 are summarized as follows:
(In thousands) 2004 2003 ----------- ----------
Commercial, financial, and agricultural $ 122,501 117,287 Real estate - construction 117,158 98,189 Real estate - mortgage 1,063,694 939,578 Installment loans to individuals 63,913 64,444 ----------- ---------- Subtotal 1,367,266 1,219,498 Unamortized net deferred loan fees (213) (603) ----------- ---------- Loans, net of deferred fees $ 1,367,053 1,218,895 =========== ==========
Loans described above as "Real estate - mortgage" included loans in the amounts of $999,384,000 and $549,900,000 as of December 31, 2004 and 2003, respectively, which are being pledged as collateral for certain borrowings (see Note 9). The loans above also include loans to executive officers and directors and to their associates totaling approximately $13,764,000 and $9,775,000 at December 31, 2004 and 2003, respectively. During 2004, additions to such loans were approximately $5,715,000 and repayments totaled approximately $1,726,000. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other non-related borrowers. Management does not believe these loans involve more than the normal risk of collectibility or present other unfavorable features.
Nonperforming assets at December 31, 2004 and 2003 are as follows:
(In thousands) 2004 2003 ------ ------
Loans: Nonaccrual loans $3,707 4,274 Restructured loans 17 21 Accruing loans greater than 90 days past due -- -- ------ ------ Total nonperforming loans 3,724 4,295 Other real estate (included in other assets) 1,470 1,398 ------ ------ Total nonperforming assets $5,194 5,693 ====== ======
If the nonaccrual loans and restructured loans as of December 31, 2004, 2003 and 2002 had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period), gross interest income in the amounts of approximately $247,000, $319,000 and $246,000 for nonaccrual loans and $2,000, $2,000 and $6,000 for restructured loans would have been recorded for 2004, 2003 and 2002, respectively. Interest income on such loans that was actually collected and included in net income in 2004, 2003 and 2002 amounted to approximately $120,000, $102,000 and $55,000 for nonaccrual loans (prior to their being placed on nonaccrual status) and $2,000, $2,000 and $6,000 for restructured loans, respectively. At December 31, 2004 and 2003, the Company had no commitments to lend additional funds to debtors whose loans were nonperforming.
Activity in the allowance for loan losses for the years ended December 31, 2004, 2003 and 2002 is as follows:
(In thousands) 2004 2003 2002 -------- -------- --------
Balance, beginning of year $ 13,569 10,907 9,388 Provision for loan losses 2,905 2,680 2,545 Recoveries of loans charged-off 181 240 135 Loans charged-off (1,938) (1,341) (1,211) Allowance recorded related to loans assumed in corporate acquisitions -- 1,083 50 -------- -------- -------- Balance, end of year $ 14,717 13,569 10,907 ======== ======== ========
At December 31, 2004 and 2003, the recorded investment in loans considered to be impaired was $1,578,000 and $1,449,000, respectively, of which all were on a nonaccrual basis at each year end. The related allowance for loan losses for the impaired loans at December 31, 2004 and 2003 was $370,000 and $341,000, respectively. At December 31, 2004 and 2003, there was $532,000 and $242,000 in impaired loans for which there was no related allowance. The average recorded investments in impaired loans during the years ended December 31, 2004, 2003, and 2002 were approximately $1,317,000, $1,590,000, and $1,822,000, respectively. For the years ended December 31, 2004, 2003, and 2002, the Company recognized no interest income on those impaired loans during the period that they were considered to be impaired.
Note 5. Premises and Equipment
Premises and equipment at December 31, 2004 and 2003 consist of the following:
(In thousands) 2004 2003 -------- ------- Land $ 7,812 5,829 Buildings 21,725 18,492 Furniture and equipment 17,388 15,895 Leasehold improvements 1,236 645 -------- ------- Total cost 48,161 40,861 Less accumulated depreciation and amortization (17,843) (15,505) -------- ------- Net book value of premises and equipment $ 30,318 25,356 ======== =======
Note 6. Goodwill and Other Intangible Assets
The following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets as of December 31, 2004 and December 31, 2003 and the carrying amount of unamortized intangible assets as of December 31, 2004 and December 31, 2003.
The following table presents the estimated amortization expense for intangible assets for each of the five calendar years ending December 31, 2009 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets.
Estimated Amortization Expense (In thousands) -------------------- ---------------------------
2005 $ 290 2006 242 2007 220 2008 219 2009 218 Thereafter 810 -------- Total $ 1,999 ========
Note 7. Income Taxes
Total income taxes for the years ended December 31, 2004, 2003 and 2002 were allocated as follows:
The components of income tax expense (benefit) for the years ended December 31, 2004, 2003 and 2002 are as follows:
(In thousands) 2004 2003 2002 -------- -------- --------
Current - Federal $ 10,407 9,578 8,964 - State 228 614 464 Deferred - Federal (192) 425 (146) - State (25) -- -- -------- -------- -------- Total $ 10,418 10,617 9,282 ======== ======== ========
The sources and tax effects of temporary differences that give rise to significant portions of the deferred tax assets (liabilities) at December 31, 2004 and 2003 are presented below:
A portion of the annual change in the net deferred tax liability relates to unrealized gains and losses on securities available for sale. The related 2004 and 2003 deferred tax (benefit) expense of approximately ($265,000) and $183,000, respectively, has been recorded directly to shareholders' equity. Additionally, a
portion of the annual change in the net deferred tax liability relates to an additional pension charge. The related 2004 and 2003 deferred tax benefit of $18,000 and $50,000, respectively, has been recorded directly to shareholders' equity. Purchase acquisitions also increased the net deferred tax liability by $320,000 in 2003. The balance of the 2004 and 2003 increase (decrease) in the net deferred tax asset (liability) of ($217,000) and 425,000, respectively, is reflected as a deferred income tax expense (benefit) in the consolidated statement of income.
The valuation allowances for 2003 and 2004 relate primarily to state net operating loss carryforwards. It is management's belief that the realization of the remaining net deferred tax assets is more likely than not.
See Note 12 for discussion regarding possible state taxing authority exposure.
Retained earnings at December 31, 2004 and 2003 includes approximately $6,869,000 representing pre-1988 tax bad debt reserve base year amounts for which no deferred income tax liability has been provided since these reserves are not expected to reverse or may never reverse. Circumstances that would require an accrual of a portion or all of this unrecorded tax liability are a reduction in qualifying loan levels relative to the end of 1987, failure to meet the definition of a bank, dividend payments in excess of accumulated tax earnings and profits, or other distributions in dissolution, liquidation or redemption of the Bank's stock.
The following is a reconcilement of federal income tax expense at the statutory rate of 35% to the income tax provision reported in the financial statements.
Note 8. Deposits
At December 31, 2004, the scheduled maturities of time deposits are as follows:
(In thousands) 2005 $ 617,921 2006 59,703 2007 36,596 2008 19,966 2009 15,407 Thereafter 586 ------------ $ 750,179 ============
Note 9. Borrowings and Borrowings Availability
The following table presents information regarding the Company's outstanding borrowings at December 31, 2004 and 2003:
In the tables above, only the $5 million due to the FHLB on April 21, 2009 had a lender call provision, which allowed the FHLB, at their option, to call the bond on April 21, 2004. The call provision provided interest rate protection to the FHLB in the event that prevailing market interest rates were higher than the note rate on the date of the call. This call option was not exercised by the FHLB at the April 21, 2004 call date. In addition to the call option, all outstanding FHLB borrowings may be accelerated immediately by the FHLB in certain circumstances including material adverse changes in the condition of the Company or if the Company's qualifying collateral amounts to less than 1.25 times the amount of FHLB borrowings outstanding. At December 31, 2004, the
Company's qualifying collateral amounted to 7.2 times the amount of FHLB borrowings outstanding.
In the above table, the $20.6 million in borrowings due on November 7, 2032 relate to borrowings structured as trust preferred capital securities that were issued by First Bancorp Capital Trust I, an unconsolidated subsidiary of the Company, on October 29, 2002 and qualify as Tier I capital for regulatory capital adequacy requirements. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on November 7, 2007. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 3.45%. This rate may not exceed 12.50% through November 2007. The Company incurred approximately $615,000 in debt issuance costs related to the issuance that were recorded as prepaid expenses and are included in the "Other Assets" line item of the consolidated balance sheet. These debt issuance costs are being amortized as interest expense until the earliest possible call date of November 7, 2007.
In the above table, the $20.6 million in borrowings due on January 23, 2034 relate to borrowings structured as trust preferred capital securities that were issued by First Bancorp Capital Trusts II and III ($10.3 million by each trust), unconsolidated subsidiaries of the Company, on December 19, 2003 and qualify as Tier I capital for regulatory capital adequacy requirements. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on January 23, 2009. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 2.70%. The Company incurred approximately $580,000 of debt issuance costs related to the issuance that were recorded as prepaid expenses and are included in the "Other Assets" line item of the consolidated balance sheet. These debt issuance costs are being amortized as interest expense until the earliest possible call date of January 23, 2009.
At December 31, 2004, the Company has three sources of readily available borrowing capacity - 1) an approximately $296 million line of credit with the FHLB, of which $51 million was outstanding at December 31, 2004 and $36 million was outstanding at December 31, 2003, 2) a $50 million overnight federal funds line of credit with a correspondent bank, none of which was outstanding at December 31, 2004 or 2003, and 3) an approximately $58 million line of credit through the Federal Reserve Bank of Richmond's (FRB) discount window, none of which was outstanding at December 31, 2004 or 2003.
The Company's line of credit with the FHLB totaling approximately $296 million can be structured as either short-term or long-term borrowings, depending on the particular funding or liquidity need and is secured by the Company's FHLB stock and a blanket lien on most of its real estate loan portfolio.
The Company's correspondent bank relationship allows the Company to purchase up to $50 million in federal funds on an overnight, unsecured basis. The Company had no borrowings outstanding under this line at December 31, 2004 or 2003. This line of credit was not drawn upon during any of the past three years.
The Company also has a line of credit with the FRB discount window. This line is secured by a blanket lien on a portion of the Company's commercial and consumer loan portfolio (excluding real estate). Based on the collateral owned by the Company as of December 31, 2004, the available line of credit is approximately $58 million. This line of credit was established primarily in connection with the Company's Y2K liquidity contingency plan and has not been drawn on since inception. The FRB has indicated that it would not expect lines of credit that have been granted to financial institutions to be a primary borrowing source. The Company plans to maintain this line of credit, although it is not expected that it will be drawn upon except in unusual circumstances.
Note 10. Leases
Certain bank premises are leased under operating lease agreements. Generally, operating leases contain renewal options on substantially the same basis as current rental terms. Rent expense charged to operations under all operating lease agreements was $452,000 in 2004, $324,000 in 2003, and $280,000 in 2002.
Future obligations for minimum rentals under noncancelable operating leases at December 31, 2004 are as follows:
(In thousands) Year ending December 31: 2005 $ 379 2006 294 2007 248 2008 190 2009 157 Later years 990 ------- Total $ 2,258 =======
Note 11. Employee Benefit Plans
401(k) Plan. The Company sponsors a retirement savings plan pursuant to Section 401(k) of the Internal Revenue Code. Employees who have completed one year of service are eligible to participate in the plan. An eligible employee may contribute up to 15% of annual salary to the plan. The Company contributes an amount equal to 75% of the first 6% of the employee's salary contributed. Participants vest in Company contributions at the rate of 20% after one year of service, and 20% for each additional year of service, with 100% vesting after five years of service. The Company's matching contribution expense was $607,000, $528,000, and $450,000, for the years ended December 31, 2004, 2003 and 2002, respectively. Additionally, the Company made additional discretionary matching contributions to the plan of $175,000 in 2004, $175,000 in 2003, and $150,000 in 2002. The Company's matching and discretionary contributions are made in the form of Company stock. Employees are not permitted to invest their own contributions in Company stock.
Pension Plan. The Company sponsors a noncontributory defined benefit retirement plan (the "Pension Plan"), which is intended to qualify under Section 401(a) of the Internal Revenue Code. Employees who have attained age 21 and completed one year of service are eligible to participate in the Pension Plan. The Pension Plan provides for a monthly payment, at normal retirement age of 65, equal to one-twelfth of the sum of (i) 0.75% of Final Average Annual Compensation (5 highest consecutive calendar years' earnings out of the last 10 years of employment) multiplied by the employee's years of service not in excess of 40 years, and (ii) 0.65% of Final Average Annual Compensation in excess of "covered compensation" multiplied by years of service not in excess of 35 years. "Covered compensation" means the average of the social security taxable wage base during the 35 year period ending with the year the employee attains social security retirement age. Early retirement, with reduced monthly benefits, is available at age 55 after 15 years of service. The Pension Plan provides for 100% vesting after 5 years of service, and provides for a death benefit to a vested participant's surviving spouse. The costs of benefits under the Pension Plan, which are borne by First Bancorp and/or its subsidiaries, are computed actuarially and defrayed by earnings from the Pension Plan's investments. The compensation covered by the Pension Plan includes total earnings before reduction for contributions to a cash or deferred profit-sharing plan (such as the 401(k) plan described above) and amounts used to pay group health insurance premiums and includes bonuses (such as amounts paid under the incentive compensation plan). Compensation for the purposes of the Pension Plan may not exceed statutory limits; such limit was $205,000 in 2004 and $200,000 in 2003 and 2002.
The Company's contributions to the Pension Plan are based on computations by independent actuarial consultants and are intended to provide the Company with the maximum deduction for income tax purposes. The contributions are invested to provide for benefits under the Pension Plan. The Company estimates that its contribution to the Pension Plan will be $700,000 in 2005.
Funds in the Pension Plan are invested in a mix of investment types in accordance with the Pension Plan's investment policy, which is intended to provide a reasonable return while maintaining proper diversification. Except for Company stock, all of the Pension Plan's assets are invested in an unaffiliated bank money market account or mutual funds. The investment policy of the Pension Plan does not permit the use of derivatives,
except to the extent that derivatives are used by any of the mutual funds invested in by the Pension Plan. The following table presents information regarding the mix of investments of the Pension Plan's assets at December 31, 2004 and its targeted mix, as set out by the Plan's investment policy:
For the three years ended December 31, 2004, the Company used an expected long-term rate-of-return-on-assets assumption of 9.00%. The Company arrived at this rate based primarily on a third-party investment consulting firm's historical analysis of investment returns, which indicated that the mix of the Pension Plan's assets (generally 75% equities and 25% fixed income) can be expected to return approximately 9% on a long term basis.
The following table reconciles the beginning and ending balances of the Pension Plan's projected benefit obligation, as computed by the Company's independent actuarial consultants. The Pension Plan's accumulated benefit obligation is also presented:
The following table reconciles the beginning and ending balances of the Pension Plan's assets:
(In thousands) 2004 2003 2002 ------- ------ ------
Plan assets at beginning of year $ 8,498 5,126 4,893 Actual return on plan assets 816 1,387 (610) Employer contributions 650 2,045 880 Benefits paid (57) (60) (37) ------- ------ ------ Plan assets at end of year $ 9,907 8,498 5,126 ======= ====== ======
The following table presents information regarding the funded status of the Pension Plan, the amounts not recognized in the consolidated balance sheets, and the amounts recognized in the consolidated balance sheets:
(In thousands) 2004 2003 -------- -------- Funded status $ (2,538) (1,394) Unrecognized net actuarial loss 3,764 2,997 Unrecognized prior service cost 249 366 Unrecognized transition obligation 47 49 -------- -------- Prepaid pension cost $ 1,522 2,018 ======== ========
Net pension cost for the Pension Plan included the following components for the years ended December 31, 2004, 2003 and 2002:
The following table is an estimate of the benefits that will be paid in accordance with the Pension Plan during the indicated time periods:
(In thousands) Estimated benefit payments -------- Year ending December 31, 2005 $ 145 Year ending December 31, 2006 181 Year ending December 31, 2007 195 Year ending December 31, 2008 238 Year ending December 31, 2009 262 Years ending December 31, 2010-2014 2,884
Supplemental Executive Retirement Plan. The Company sponsors a Supplemental Executive Retirement Plan (the "SERP Plan") for the benefit of certain senior management executives of the Company. The purpose of the SERP Plan is to provide additional monthly pension benefits to ensure that each such senior management executive would receive lifetime monthly pension benefits equal to 3% of his or her final average compensation multiplied by his or her years of service (maximum of 20 years) to the Company or its subsidiaries, subject to a maximum of 60% of his or her final average compensation. The amount of a participant's monthly SERP benefit is reduced by (i) the amount payable under the Company's qualified Pension Plan (described above), and (ii) fifty percent (50%) of the participant's primary social security benefit. Final average compensation means the average of the 5 highest consecutive calendar years of earnings during the last 10 years of service prior to termination of
employment.
The Company's funding policy with respect to the SERP Plan is to fund the related benefits through investments in life insurance policies, which are not considered plan assets for the purpose of determining the SERP Plan's funded status. The cash surrender values of the life insurance policies are included in the line item "other assets."
The following table reconciles the beginning and ending balances of the SERP Plan's benefit obligation, as computed by the Company's independent actuarial consultants:
The following table presents information regarding the funded status of the SERP Plan, the amounts not recognized in the consolidated balance sheets, and the amounts recognized in the consolidated balance sheets:
(In thousands) 2004 2003 -------- --------
Funded status $ (2,553) (1,631) Unrecognized net actuarial loss 862 578 Unrecognized prior service cost 273 84 Additional minimum liability (422) (385) -------- -------- Accrued pension cost $ (1,840) (1,354) ======== ========
Net pension cost for the SERP Plan included the following components for the years ended December 31, 2004, 2003 and 2002:
The following table is an estimate of the benefits that will be paid in accordance with the SERP Plan during the indicated time periods:
(In thousands) Estimated benefit payments -------- Year ending December 31, 2005 $ 121 Year ending December 31, 2006 139 Year ending December 31, 2007 132 Year ending December 31, 2008 126 Year ending December 31, 2009 118 Years ending December 31, 2010-2014 1,075
The following assumptions were used in determining the actuarial information for the Pension Plan and the SERP Plan for the years ended December 31, 2004, 2003 and 2002:
Included in intangible assets at December 31, 2004 and 2003 is $84,000 and $93,000, respectively, that has been recognized in connection with the accrual of the additional minimum liability for the SERP Plan.
Note 12. Commitments and Contingencies
See Note 10 with respect to future obligations under noncancelable operating leases.
Based on consultations with the Company's tax advisors, the Company's organizational structure has been established in a way to minimize its tax liabilities. State taxing authorities have recently announced that they will vigorously pursue taxpayers who have engaged in activities deemed to be "income-shifting," and the Company is aware that state taxing authorities have recently challenged a bank holding company with a similar operating structure as the Company that they deem to result in "income-shifting." While the Company believes its tax position is sound, it has decided to discontinue certain elements of its operating structure during 2005 to avoid controversy with state taxing authorities. If the Company's position with regard to its operating structure were to be challenged by state taxing authorities for past years and resulted in an assessment, the Company estimates that its exposure could be $5.8 million (net of federal tax benefit), including interest and penalties. If such an assessment were to occur, the Company would vigorously contest the assessment based on the belief that it has fully complied with relevant tax laws. Accordingly, the Company has not accrued a liability for this possibility.
In the normal course of business there are various outstanding commitments and contingent liabilities such as commitments to extend credit, which are not reflected in the financial statements. As of December 31, 2004, the Company had outstanding loan commitments of $232,248,000, of which $208,241,000 were at variable rates and $24,007,000 were at fixed rates. Included in outstanding loan commitments were unfunded commitments of $123,535,000 on revolving credit plans, of which $115,024,000 were at variable rates and $8,511,000 were at fixed rates.
At December 31, 2004 and 2003, the Company had $3,762,000 and $3,320,000, respectively in standby letters of credit outstanding. The Company has no carrying amount for these standby letters of credit at either of those dates. The nature of the standby letters of credit is a guarantee made on behalf of the Company's customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit are generally for terms for one year, at which time they may be renewed for another year if both parties agree. The payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) the Company could be required to make under the guarantees in the event of nonperformance by the parties to whom credit or financial guarantees have been extended is represented by the contractual amount of the financial instruments discussed above. In the event that the Company is required to honor a standby letter of credit, a note, already executed with the customer, is triggered which provides repayment terms and any collateral. Over the past ten years, the Company has had to honor one standby letter of credit, which was repaid by the borrower without any loss to the Company. Management expects any draws under existing commitments
to be funded through normal operations.
The Bank grants primarily commercial and installment loans to customers throughout its market area, which consists of Anson, Cabarrus, Chatham, Davidson, Duplin, Guilford, Harnett, Iredell, Lee, Montgomery, Moore, Randolph, Richmond, Robeson, Rockingham, Rowan, Scotland, Stanly and Wake Counties in North Carolina, Dillon County in South Carolina, and Wythe, Washington, and Montgomery Counties in Virginia. The real estate loan portfolio can be affected by the condition of the local real estate market. The commercial and installment loan portfolios can be affected by local economic conditions.
The Company is not involved in any legal proceedings which, in management's opinion, could have a material effect on the consolidated financial position of the Company.
Note 13. Fair Value of Financial Instruments
Fair value estimates as of December 31, 2004 and 2003 and limitations thereon are set forth below for the Company's financial instruments. Please see Note 1 for a discussion of fair value methods and assumptions, as well as fair value information for off-balance sheet financial instruments.
Limitations Of Fair Value Estimates. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include net premises and equipment, intangible and other assets such as foreclosed properties, deferred income taxes, prepaid expense accounts, income taxes currently payable and other various accrued expenses. In addition, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
Note 14. Stock Option Plan
Pursuant to provisions of the Company's 2004 Stock Option Plan (the "Option Plan"), options to purchase up to 1,275,000 shares of First Bancorp's authorized but unissued common stock may be granted to employees ("Employee Options") and directors ("Nonemployee Director Options") of the Company and its subsidiaries. The purposes of the Option Plan are (i) to align the interests of participating employees and directors with the Company's shareholders by reinforcing the relationship between shareholder gains and participant rewards, (ii) to encourage equity ownership in the Company by participants, and (iii) to provide an incentive to employee participants to continue their employment with the Company.
Since the inception of the Option Plan and its predecessor plan (the 1994 Stock Option Plan), each nonemployee director has been granted 2,250 Nonemployee Director Options on June 1 of each year. Employee Options were granted to substantially all officers at the inception of the 1994 Stock Option Plan and since then have been granted to new officers, officers that have assumed increased responsibilities, and for performance rewards. For both Employee and Nonemployee Director Options, the option price is the fair market value of the stock at the date of grant. Employee Options may require a vesting period. Director Options are 100% vested on the date of grant. All options expire not more than 10 years from the date of grant. Forfeited options become available for future grants.
In addition to the Option Plan and its predecessor plan, the Company has four stock option plans that were assumed in connection with mergers and acquisitions of the companies that originally established those plans. As of December 31, 2004, a total of 96,040 shares of common stock were issuable upon exercise under those assumed plans. The weighted average exercise price of those outstanding options is $10.26 per share. No additional options may be granted under those assumed plans. The tables on the following page include these options.
At December 31, 2004, there were 1,253,090 additional shares available for grant under the Option Plan. The per share weighted-average fair value of options granted during 2004, 2003, and 2002 was $7.07, $5.03, and $4.50, respectively on the date(s) of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
2004 2003 2002 ------- ------- ------- Expected dividend yield 2.97% 3.73% 3.79% Risk-free interest rate 3.49% 3.30% 4.60% Expected life 7 years 8 years 8 years Expected volatility 36.67% 33.08% 33.50%
The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Note 1(k) reflects the pro forma effects had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123.
The following table sets forth a summary of the activity of the Company's outstanding options since December 31, 2001:
The following table summarizes information about the stock options outstanding at December 31, 2004:
Note 15. Regulatory Restrictions
The Company is regulated by the Board of Governors of the Federal Reserve System ("FED") and is subject to securities registration and public reporting regulations of the Securities and Exchange Commission. The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC") and the North Carolina Office of the Commissioner of Banks.
The primary source of funds for the payment of dividends by First Bancorp is dividends received from its
subsidiary, First Bank. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. As of December 31, 2004, the Bank had undivided profits of approximately $104,820,000 which were available for the payment of dividends. As of December 31, 2004, approximately $75,518,000 of the Company's investment in the Bank is restricted as to transfer to the Company without obtaining prior regulatory approval.
The average reserve balance maintained by the Bank under the requirements of the Federal Reserve was approximately $638,000 for the year ended December 31, 2004.
The Company and the Bank must comply with regulatory capital requirements established by the FED and FDIC. 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 Bank must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. These capital standards require the Company and the Bank to maintain minimum ratios of "Tier 1" capital to total risk-weighted assets ("Tier I Capital Ratio") and total capital to risk-weighted assets of 4.00% and 8.00% ("Total Capital Ratio"), respectively. Tier 1 capital is comprised of total shareholders' equity, excluding unrealized gains or losses from the securities available for sale, less intangible assets, and total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which for the Company and the Bank is the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Company and the Bank, adjusted for their related risk levels using formulas set forth in FED and FDIC regulations.
In addition to the risk-based capital requirements described above, the Company and the Bank are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets ("Leverage Ratio) of 3.00% to 5.00%, depending upon the institution's composite ratings as determined by its regulators. The FED has not advised the Company of any requirement specifically applicable to it.
In addition to the minimum capital requirements described above, the regulatory framework for prompt corrective action also contains specific capital guidelines applicable to banks for classification as "well capitalized," which are presented with the minimum ratios, the Company's ratios and the Bank's ratios as of December 31, 2004 and 2003 in the following table. Based on the most recent notification from its regulators, the Bank is well capitalized under the framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company's category.
Note 16. Supplementary Income Statement Information
Components of other operating expenses exceeding 1% of total income for any of the years ended December 31, 2004, 2003 and 2002 are as follows:
(In thousands) 2004 2003 2002 ------ ----- -----
Stationery and supplies $1,523 1,498 1,445 Telephone 1,345 1,229 932 Professional fees 989 650 662
Note 17. Condensed Parent Company Information
Condensed financial data for First Bancorp (parent company only) follows:
CONDENSED BALANCE SHEETS As of December 31, ---------------------- (In thousands) 2004 2003 -------- -------- Assets Cash on deposit with bank subsidiary $ 5,935 20,794 Investment in wholly-owned subsidiaries, at equity 184,316 162,224 Land 7 7 Other assets 2,170 1,056 -------- -------- Total assets $192,428 184,081 ======== =======
Liabilities and shareholders' equity Borrowings $ 41,239 40,000 Other liabilities 2,711 2,225 -------- -------- Total liabilities 43,950 42,225
Shareholders' equity 148,478 141,856 -------- --------
Total liabilities and shareholders' equity $192,428 184,081 ======== ========
Report of Independent Registered Public Accounting Firm -------------------------------------------------------
The Board of Directors and Shareholders First Bancorp:
We have audited the accompanying consolidated balance sheets of First Bancorp and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 First Bancorp and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Charlotte, North Carolina March 6, 2005
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
During the two years ended December 31, 2004, and any subsequent interim periods, there were no changes in accountants and/or disagreements on any matters of accounting principles or practices or financial statement disclosures.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports with the Securities and Exchange Commission. It should be noted that the design of any system of controls is 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, regardless of how remote. In addition, no change in our internal control over financial reporting has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
As permitted by the Securities and Exchange Commission Release No. 50754, the registrant has not filed in this report the following two reports - 1) Management's Annual Report on Internal Control Over Financial Reporting as required by Item 308(a) of Regulation S-K, and 2) the related Attestation Report of the Registered Public Accounting Firm as required by Item 308(b) of Regulation S-K. The Company expects to file these reports by May 2, 2005, as permitted by the aforementioned release.
Item 9B.
Item 9B. Other Information
On January 18, 2005, Frederick H. Taylor notified the Company that he would not stand for re-election to the Board of Directors at the next annual meeting of shareholders. Additionally, Jesse S. Capel confirmed his retirement from the Board of Directors, in accordance with Company policy, effective with the 2005 annual meeting of shareholders.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Incorporated herein by reference is the information under the captions "Directors, Nominees and Executive Officers," "Section 16(a) Beneficial Ownership Reporting Compliance," and "Corporate Governance" from the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
Item 11.
Item 11. Executive Compensation
Incorporated herein by reference is the information under the captions "Compensation of Executive Officers" and "Board Committees, Attendance, and Compensation" from the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated herein by reference is the information under the captions "Principal Holders of First Bancorp Voting Securities" and "Directors, Nominees and Executive Officers" from the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
Additional Information Regarding the Registrant's Equity Compensation Plans
At December 31, 2004, the Company had six equity compensation plans. Each of these plans is a stock option plan. Four of the six plans were assumed in corporate acquisitions. The Company's 2004 Stock Option Plan is the only one of the six plans for which new grants of stock options are possible.
The following table presents information as of December 31, 2004 regarding shares of the Company's stock that may be issued pursuant to the Company's stock options plans. The table does not include information with respect to shares subject to outstanding options granted under stock incentive plans assumed by the Company in connection with mergers and acquisitions of companies that originally granted those options. Footnote (2) to the table indicates the total number of shares of common stock issuable upon the exercise of options under the assumed plans as of December 31, 2004, and the weighted average exercise price of those options. No additional options may be granted under those assumed plans. The Company has no warrants or stock appreciation rights outstanding.
(1) Consists of (A) the Company's 2004 Stock Option Plan, which is currently in effect and (B) the Company's 1994 Option Plan, each of which was approved by shareholders.
(2) The table does not include information for stock incentive plans that the Company assumed in connection with mergers and acquisitions of the companies that originally established those plans. As of December 31,
2004, a total of 96,040 shares of common stock were issuable upon exercise under those assumed plans. The weighted average exercise price of those outstanding options is $10.26 per share. No additional options may be granted under those assumed plans.
Item 13.
Item 13. Certain Relationships and Related Transactions
Incorporated herein by reference is the information under the caption "Certain Transactions" from the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
Item 14.
Item 14. Principal Accountant Fees and Services
Incorporated herein by reference is the information under the caption "Principal Accountant Fees and Services" from the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements - See Item 8 and the Cross Reference Index on page 2 for information concerning the Company's consolidated financial statements and report of independent auditors.
2. Financial Statement Schedules - not applicable
3. Exhibits
The following exhibits are filed with this report or, as noted, are incorporated by reference. Management contracts, compensatory plans and arrangements are marked with an asterisk (*).
3.a Copy of Articles of Incorporation of the Company and amendments thereto were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2002, and are incorporated herein by reference.
3.b Copy of the Amended and Restated Bylaws of the Company was filed as Exhibit 3.b to the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and is incorporated herein by reference.
4 Form of Common Stock Certificate was filed as Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999, and is incorporated herein by reference.
10 Material Contracts
10.a Data Processing Agreement dated October 1, 1984 by and between Bank of Montgomery (First Bank) and Montgomery Data Services, Inc. was filed as Exhibit 10(k) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference.
10.b First Bancorp Annual Incentive Plan was filed as Exhibit 10(a) to the Form 8-K filed on January 26, 2005 and is incorporated herein by reference. (*)
10.c Indemnification Agreement between the Company and its Directors and Officers was filed as Exhibit 10(t) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference.
10.d First Bancorp Senior Management Supplemental Executive Retirement Plan was filed as Exhibit 10(d)
to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*)
10.e First Bancorp 1994 Stock Option Plan was filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*)
10.f First Bancorp 2004 Stock Option Plan was filed as Exhibit B to the Registrant's Form Def 14A filed on March 30, 2004 and is incorporated herein by reference. (*)
10.g Employment Agreement between the Company and James H. Garner dated August 17, 1998 was filed as Exhibit 10(l) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*)
10.h Employment Agreement between the Company and Anna G. Hollers dated August 17, 1998 was filed as Exhibit 10(m) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*)
10.i Employment Agreement between the Company and Teresa C. Nixon dated August 17, 1998 was filed as Exhibit 10(n) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*)
10.j Employment Agreement between the Company and Eric P. Credle dated August 17, 1998 was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and is incorporated herein by reference (Commission File Number 333-71431). (*)
10.k Employment Agreement between the Company and John F. Burns dated September 14, 2000 was filed as Exhibit 10.w to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and is incorporated herein by reference. (*)
10.l Employment Agreement between the Company and James G. Hudson, Jr. dated May 17, 2001 was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*)
10.m Employment Agreement between the Company and R. Walton Brown dated January 15, 2003, was filed as Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and is incorporated herein by reference. (*)
10.n Amendment to the employment agreement between the Company and R. Walton Brown dated March 8, 2005. (*)
10.o Copy of First Bancorp Long Term Care Insurance Plan was filed as Exhibit 10(o) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, and is incorporated by reference. (*)
10.p Description of Director Compensation pursuant to Item 601 (b)(10) (iii)(A) of Regulation S-K
21 List of Subsidiaries of Registrant was filed as Exhibit 21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and is incorporated herein by reference.
23.a Consent of Independent Auditors of Registrant, KPMG LLP
31.a Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.b Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.a Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.b Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Exhibits - see (a)(3) above
(c) No financial statement schedules are filed herewith.
Copies of exhibits are available upon written request to: First Bancorp, Anna G. Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, FIRST BANCORP has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Troy, and State of North Carolina, on the 8th day of March 2005.
First Bancorp
By: /s/ James H. Garner -------------------- James H. Garner President, Chief Executive Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on behalf of the Company by the following persons and in the capacities and on the dates indicated.
Executive Officers ------------------
/s/ James H. Garner ------------------- James H. Garner President, Chief Executive Officer and Treasurer
/s/ Anna G. Hollers /s/ Eric P. Credle - ------------------- ------------------ Anna G. Hollers Eric P. Credle Executive Vice President Senior Vice President Secretary Chief Financial Officer March 8, 2005 (Principal Accounting Officer) March 8, 2005
Board of Directors ------------------
/s/ David L. Burns /s/ William E. Samuels - ------------------ ---------------------- David L. Burns William E. Samuels Chairman of the Board Vice-Chairman of the Board Director Director March 8, 2005 March 8, 2005
/s/ Jack D. Briggs /s/ George R. Perkins, Jr. - ------------------ -------------------------- Jack D. Briggs George R. Perkins, Jr. Director Director March 8, 2005 March 8, 2005
/s/ R. Walton Brown /s/ Thomas F. Phillips - ------------------- ---------------------- R. Walton Brown Thomas F. Phillips Director Director March 8, 2005 March 8, 2005
/s/ H. David Bruton /s/ Edward T. Taws, Jr. - ------------------- ----------------------- H. David Bruton Edward T. Taws, Jr. Director Director March 8, 2005 March 8, 2005
/s/ John F. Burns /s/ Frederick H. Taylor - ----------------- ----------------------- John F. Burns Frederick H. Taylor Director Director March 8, 2005 March 8, 2005
/s/ Jesse S. Capel /s/ Virginia C. Thomasson - ------------------ ------------------------- Jesse S. Capel Virginia C. Thomasson Director Director March 8, 2005 March 8, 2005
/s/ Goldie H. Wallace-Gainey /s/ A. Jordan Washburn - ---------------------------- ---------------------- Goldie H. Wallace-Gainey A. Jordan Washburn Director Director March 8, 2005 March 8, 2005
/s/ James H. Garner /s/ Dennis A. Wicker ------------------ -------------------- James H. Garner Dennis A. Wicker Director Director March 8, 2005 March 8, 2005
/s/ James G. Hudson, Jr. /s/ John C. Willis - ------------------------ ------------------ James G. Hudson, Jr. John C. Willis Director Director March 8, 2005 March 8, 2005