Item 10 -- See information that appears under the headings "Election of Directors" and "Executive Officers". Item 11
Item 11 -- See information that appears under the heading "Executive Compensation".
Item 12
Item 12 -- See information that appears under the headings "Voting Securities Outstanding and Principal Shareholders" and "Security Ownership of Management".
Item 13
Item 13 -- See information that appears under the heading "Indebtedness of Officers and Directors".
BUSINESS
GENERAL
FNB Corp. (the "Parent Company") is a bank holding company incorporated under the laws of the State of North Carolina in 1984. On July 2, 1985, through an exchange of stock, the Parent Company acquired its wholly-owned bank subsidiary, First National Bank and Trust Company (the "Bank"), a national banking association founded in 1907. The Parent Company and the Bank are collectively referred to as the "Corporation".
The Bank, a full-service commercial bank, currently conducts all of its operations in Randolph, Montgomery and Chatham counties in North Carolina. Four offices, including the main office, are located in Asheboro. Additional community offices are located in Archdale (two offices), Biscoe, Ramseur, Randleman, Seagrove and Siler City. Some of the major services offered include checking accounts, NOW accounts (including package account versions that offer a variety of products and services), money market accounts, savings accounts, certificates of deposit, holiday club accounts, individual retirement accounts, credit cards and loans, both secured and unsecured, for business, agricultural and personal use. The Bank also has automated teller machines and is a member of two national teller machine networks, Cirrus and Plus, and one regional network, Honor.
The Bank has a Trust and Investment Services Division that offers traditional trust and estate settlement services, investment management programs, brokerage services and tax-deferred annuities. Certain investment products and services are offered through "FNB Investor Services", a service provided by Liberty Securities Corporation.
On June 3, 1997, the Corporation entered into a definitive agreement to acquire a savings bank in Siler City, North Carolina. Under terms of the agreement, the savings bank shareholders were to receive $15.50 per share, either in FNB Corp. common stock or in cash or a combination thereof, subject to the limitation that FNB Corp. common stock issued in the merger would be not more than 60% and not less than 50% of the total consideration. On January 28, 1998, as permitted by the agreement, the Board of Directors of the savings bank exercised its right to terminate the proposed combination due to the increase in the market value of FNB Corp. common stock above a specified level.
The Corporation incurred certain costs in connection with the proposed acquisition. Those costs, which had been initially deferred, amounted to $305,000 and are included in merger expenses in the consolidated statement of income for the year ended December 31, 1997.
The Bank's data processing, item capture and statement rendering operations are currently outsourced under a service bureau arrangement. The Bank is presently in the process of converting these operations to an in-house basis. Conversion is expected to be complete by the end of March 1999. The total capital expenditure outlay for hardware and software is expected to amount to approximately $1,600,000, of which approximately one-half was recorded in 1998. In addition to capital expenditures for the new system, the Bank has incurred certain expenses in 1998, totaling approximately $302,000, related to the data processing conversion.
Commencing in 1995, the Bank significantly increased its investment in computer equipment through expanded use of personal computer networks. Capital expenditures in 1995, which totaled $1,302,000, related primarily to the increase in computer equipment. Approximately one-third of 1996 and one-half of 1997 capital expenditures, which totaled $1,019,000 and $478,000, respectively, also related to personal computer networks.
As of December 31, 1998, the Bank had received regulatory approval for establishment of a new branch office in Trinity, North Carolina. Construction and occupancy of the Trinity branch is expected to occur in 1999, resulting in a total capital outlay of approximately $950,000, of which approximately one-third was recorded in 1998.
YEAR 2000 ISSUE
The Corporation recognizes and is addressing the potentially serious implications of the "Year 2000 Issue", which has resulted from the use of two-digit year values in many existing computer programs. As the Year 2000 approaches, virtually every computer operation will be affected in some way by the rollover of the two-digit year value to "00". The issue is whether computer systems and other equipment incorporating computer components will properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or fail.
The Corporation, which relies on third-party vendors for all computer programming and equipment, has completed a thorough internal assessment in connection with its Year 2000 Plan and is utilizing both internal and external resources to identify, correct or reprogram, and test systems for Year 2000 compliance. Extensive consideration has been made in the
Year 2000 Plan for the conversion, now in process, of the Bank's data processing, item capture and statement rendering operations from a service bureau arrangement to an in-house basis, a project expected to be complete by the end of March 1999.
For additional information on Year 2000 matters, see "Year 2000 Readiness Disclosure" in "Management's Discussion and Analysis of Financial Condition and Results of Operations".
COMPETITION
The commercial banking industry within the Bank's marketing area is extremely competitive. The Bank faces direct competition in Randolph, Montgomery and Chatham counties from approximately eighteen different financial institutions, including commercial banks, savings institutions and credit unions. Although none of these entities is dominant, the Bank considers itself one of the major financial institutions in the area in terms of total assets and deposits. Further competition is provided by banks located in adjoining counties, as well as other types of financial institutions such as insurance companies, finance companies, pension funds and brokerage houses and other money funds.
SUPERVISION AND REGULATION
The Parent Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is registered as such with the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). A bank holding company is required to file with the Federal Reserve Board annual reports and other information regarding its business operations and those of its subsidiaries. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to acquiring, directly or indirectly, ownership or control of any voting shares of any bank if, after such acquisition, it would own or control, directly or indirectly, more than five percent of the voting stock of such bank, unless it already owns a majority of the voting stock of such bank. Furthermore, a bank holding company, with limited exceptions, is prohibited from acquiring direct or indirect ownership or control of more than five percent of the voting stock of any company which is not a bank or a bank holding company and must engage only in the business of banking or managing or controlling banks or furnishing services to or performing services for its subsidiary banks. One of the exceptions to this prohibition is the ownership of shares in a company the activities of which the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
The Federal Reserve Board has determined that certain activities are closely related to banking, and that bank holding companies may apply to the Federal Reserve Board for permission to form, retain or acquire an interest in a company engaging or proposing to engage in these activities. The permitted nonbanking activities include, without limitation: (1) making, acquiring or servicing loans or other extensions of credit such as consumer finance, credit card, mortgage, commercial finance and factoring companies would make; (2) acting as an investment or financial advisor; (3) leasing real or personal property or acting as agent, broker, or advisor in leasing such property if the lease is to serve as the functional equivalent of an extension of credit to the lessee of the property and certain other conditions are met; (4) providing bookkeeping or data processing services under certain circumstances; (5) acting as an insurance agent or broker with respect to insurance that is directly related to the extension of credit with other financial services; (6) acting as an underwriter for credit life insurance and credit accident and health insurance directly related to extensions of credit by the holding company system; and (7) providing securities brokerage services and related securities credit activities.
As a national banking association, the Bank is subject to regulatory supervision, of which regular bank examinations by the Comptroller of the Currency are a part. The Bank is a member of the Federal Deposit Insurance Corporation (the "FDIC") which currently insures the deposits of each member bank to a maximum of $100,000 per depositor. For this protection, each bank pays a quarterly statutory assessment and is subject to the rules and regulations of the FDIC. The Bank is also a member of the Federal Reserve System and is therefore subject to the applicable provisions of the Federal Reserve Act, which imposes restrictions on loans by subsidiary banks to a holding company and its other subsidiaries and on the use of stock or securities as collateral security for loans by subsidiary banks to any borrower.
The ability of the Parent Company to pay dividends depends to a large extent upon the amount of dividends the Bank pays to the Parent Company. Approval of the Comptroller of the Currency, or his designate, will be required for any dividend to the Parent Company by the Bank if the total of all dividends, including any proposed dividend, declared by the Bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of any preferred stock.
EFFECT OF GOVERNMENTAL POLICIES
The operations and earnings of the Bank and, therefore, of the Parent Company are affected by legislative changes and by the policies of various regulatory agencies. In particular, the Bank is affected by the monetary and fiscal policies of the Federal Reserve Board. The instruments of monetary policy used by the Federal Reserve Board include its open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements on member bank deposits. The actions of the Federal Reserve Board influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans or paid on deposits.
EMPLOYEES
As of December 31, 1998, the Parent Company had three officers, all of whom were also officers of the Bank. On that same date, the Bank had 131 full-time employees and 25 part-time employees. The Bank considers its relationship with its employees to be excellent. The Bank provides employee benefit programs, including a noncontributory defined benefit pension plan, matching retirement/savings (401(k)) plan, group life, health and dental insurance, paid vacations, sick leave, and health care and life insurance benefits for retired employees.
PROPERTIES
The main offices of the Bank and the principal executive offices of the Parent Company are located in an office building at 101 Sunset Avenue, Asheboro, North Carolina. The premises contain approximately 36,500 square feet of office space. The Bank also has other community offices in Asheboro (three offices), Archdale (two offices), Biscoe, Ramseur, Randleman, Seagrove and Siler City, North Carolina. Except as noted below, all premises are owned by the Bank in fee. The Randolph Mall office in Asheboro is under a lease expiring January 31, 2002. The Bush Hill office in Archdale is under a lease expiring January 31, 2002, with lease renewal options for up to an additional 20-year term. The land on which the Seagrove Office is situated is under a lease expiring June 30, 2016. At that time, the land is subject to a purchase option at a fixed price or lease renewal options for up to an additional 30-year term.
FNB CORP. AND SUBSIDIARY
FIVE YEAR FINANCIAL HISTORY
- --------- (1) All per share data has been retroactively adjusted to reflect the two-for-one common stock split effected in the form of a 100% stock dividend paid in the first quarter of 1998.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this discussion and analysis is to assist in the understanding and evaluation of the financial condition, changes in financial condition and results of operations of FNB Corp. (the "Parent Company") and its wholly-owned subsidiary, First National Bank and Trust Company (the "Bank"), collectively referred to as the "Corporation". This discussion should be read in conjunction with the consolidated financial statements and supplemental financial information appearing elsewhere in this report.
OVERVIEW
The Corporation earned $4,562,000 in 1998, an 11.3% increase in net income from 1997. Basic earnings per share, adjusted for the two-for-one common stock split in 1998, increased from $1.13 in 1997 to $1.25 in 1998 and diluted earnings per share increased from $1.11 to $1.20. Total assets were $356,623,000 at December 31, 1998, up 9.5% from year-end 1997. Loans amounted to $229,722,000 at December 31, 1998, up 5.6% from the prior year. Total deposits grew 8.6% to $304,690,000 in 1998.
The 1998 operating results were impacted by fourth quarter charges of $302,000 relating to a major data processing conversion. Similarly, 1997 operating results were affected by the fourth quarter recognition of $305,000 in merger expenses resulting from the termination of an agreement for the acquisition of a savings bank. These issues are discussed further in "Business Development Matters".
EARNINGS REVIEW
The Corporation's net income increased $462,000 in 1998, up 11.3% over 1997. Earnings were positively impacted in 1998 by increases of $889,000 or 6.4% in net interest income and $329,000 in noninterest income and by a $210,000 reduction in the provision for loan losses. These gains were significantly offset, however, by an increase of $800,000 in noninterest expense. The effect of special noninterest expense charges in each year, as discussed in the "Overview", tended to offset on a comparative basis.
In 1997, earnings increased $263,000 or 6.8% from 1996. Earnings were positively impacted in 1997 by increases of $1,295,000 or 10.2% in net interest income and $431,000 in noninterest income. These gains were significantly offset, however, by merger expenses of $305,000 as discussed in the "Overview", by an increase of $906,000 in noninterest expense exclusive of the merger expenses and by a $110,000 increase in the provision for loan losses.
Return on average assets improved from 1.30% in 1997 to 1.33% in 1998. Return on average assets declined in 1997 from 1.32% in 1996, reflecting the effect in 1997 of the merger expenses. Similarly, return on average shareholders' equity increased to 13.52% in 1998 after decreasing to 13.45% in 1997 from 13.97% in 1996.
NET INTEREST INCOME
Net interest income is the difference between interest income, principally from loans and investments, and interest expense, principally on customer deposits. Changes in net interest income result from changes in interest rates and in the volume, or average dollar level, and mix of earning assets and interest-bearing liabilities.
Net interest income was $14,820,000 in 1998 compared to $13,931,000 in 1997. The increase of $889,000 or 6.4% resulted primarily from a 9.0% increase in the level of average earning assets, the effect of which was partially offset by a decline in the net yield on earning assets, or net interest margin, from 4.99% in 1997 to 4.88% in 1998. In 1997, there was a $1,295,000 or 10.2% increase in net interest income reflecting both an improvement in the net interest margin from 4.90% in 1996 and an 8.1% increase in average earning assets. On a taxable equivalent basis, the increases in net interest income in 1998 and 1997 were $960,000 and $1,358,000, respectively, reflecting changes in the relative mix of taxable and non-taxable earning assets in each year.
Table 1 sets forth for the periods indicated information with respect to the Corporation's average balances of assets and liabilities, as well as the total dollar amounts of interest income (taxable equivalent basis) from earning assets and interest expense on interest-bearing liabilities, resultant rates earned or paid, net interest income, net interest spread and net yield on earning assets. Net interest spread refers to the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. Net yield on earning assets, or net interest margin, refers to net interest income divided by average earning assets and is influenced by the level and relative mix of earning assets and interest-bearing liabilities.
TABLE 1 AVERAGE BALANCES AND NET INTEREST INCOME ANALYSIS
- --------- (1) Interest income and yields related to certain investment securities and loans exempt from both federal and state income tax or from state income tax alone are stated on a fully taxable equivalent basis, assuming a 34% federal tax rate and applicable state tax rate, reduced by the nondeductible portion of interest expense.
(2) Nonaccrual loans are included in the average loan balance. Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the life of the loan as an adjustment of interest income.
Changes in the net interest margin and net interest spread tend to correlate with movements in the prime rate of interest. There are variations, however, in the degree and timing of rate changes, compared to prime, for the different types of earning assets and interest-bearing liabilities.
The prime rate of interest has been relatively stable in recent years, averaging 8.37%, 8.44% and 8.28% in 1998, 1997 and 1996, respectively. This general stability has tended to apply to the interest rates both earned and paid by the Bank. During the last three months of 1998, however, a significant change occurred in the level of the prime rate when the Federal Reserve took action on the level of interest rates in response to the downturn of the economies of certain Asian and Latin American countries and the effects or potential effects of those downturns on the U.S. economy. In rapid succession, three 25 basis point cuts were recorded in the prime rate, lowering it from 8.50% to 7.75%. This decrease in the prime rate has tended to negatively impact the Corporation's net interest margin and net interest spread.
In 1998, the net interest spread declined by 9 basis points from 4.22% in 1997 to 4.13% in 1998, reflecting a decrease in the average total yield on earning assets that was only partially offset by a decrease in the average rate paid on interest-bearing liabilities, or cost of funds. The yield on earning assets decreased by 10 basis points from 8.56% in 1997 to 8.46% in 1998, while the cost of funds decreased by 1 basis point in moving from 4.34% to 4.33%. In 1997, the 8 basis points increase in net interest spread resulted from a 16 basis points increase in the yield on earning assets as partially offset by an 8 basis points increase in the cost of funds.
The 1998 and 1997 changes in net interest income on a taxable equivalent basis, as measured by volume and rate variances, are analyzed in Table 2. Volume refers to the average dollar level of earning assets and interest-bearing liabilities.
TABLE 2 VOLUME AND RATE VARIANCE ANALYSIS
- --------- (1) The mix variance, not separately stated, has been proportionally allocated to the volume and rate variances based on their absolute dollar amount.
(2) Interest income related to certain investment securities and loans exempt from both federal and state income tax or from state income tax alone is stated on a fully taxable equivalent basis, assuming a 34% federal tax rate and applicable state tax rate, reduced by the nondeductible portion of interest expense.
PROVISION FOR LOAN LOSSES
This provision is the charge against earnings to provide an allowance or reserve for potential losses inherent in the loan portfolio. The amount of each year's charge is affected by several considerations including management's evaluation of various risk factors in determining the adequacy of the allowance (see "Asset Quality"), actual loan loss experience and loan portfolio growth. In 1998, earnings were positively impacted by a decrease in the provision of $210,000, due primarily to a lower rate of loan growth than in 1997 and a reduction in net loan charge-offs. In 1997, there was a negative impact from a $110,000 provision increase.
NONINTEREST INCOME
Noninterest income increased $329,000 or 11.4% in 1998 and $431,000 or 17.6% in 1997, reflecting in part the general increase in the volume of business. The increase in service charges on deposit accounts in 1997 was primarily due to the selected increases in service charges that became effective in the 1997 second quarter and to the income generated by a new NOW account version that provides a package of products and services for a stated monthly fee. The 1998 increase in service charges on deposit accounts resulted partially from the implementation for a full year of the service charge increases
that became effective in the 1997 second quarter. Further, there was increased revenue in 1998 from the new NOW account version as a result of increases in the number of such accounts and in the stated monthly fee, the new fee having become effective in the 1997 fourth quarter.
The decline in annuity and brokerage commissions in 1998 related to a general decrease in both sales of annuity products and the volume of brokerage services. The 1997 gain in annuity and brokerage commissions reflected a significant increase in the volume of brokerage services. The level of other service charges, commissions and fees was higher in 1997 due primarily to the implementation in the 1996 third quarter of a fee charged to noncustomers for usage of the Bank's automated teller machines. Other income was higher in both 1997 and 1998 due largely to increases in gains on loan sales and in fees for trust services. Other income also benefited in 1998 from a $39,000 recovery of a portion of the merger expenses recorded in the 1997 fourth quarter (see "Overview").
NONINTEREST EXPENSE
Noninterest expense was $800,000 or 7.8% higher in 1998 due in part to charges of $302,000 relating to a major data processing conversion (see "Overview"). The remaining net increase of $498,000 was due largely to increased personnel expense, new advertising and marketing programs and the continuing effects of inflation. Personnel expense was impacted by increased staffing requirements and normal salary adjustments. Advertising and marketing expense, included in other expense, increased $223,000 due primarily to new programs undertaken in 1998 that included an advertising campaign based on customer testimonials and a major marketing plan centered around the "YES YOU CAN, YES WE CAN(R)" program.
In 1997, noninterest expense was $1,211,000 or 13.3% higher due in part to merger expenses of $305,000. The remaining net increase of $906,000 was due mainly to costs associated with changes in operations, increased personnel expense and the continuing effects of inflation. Personnel expense was impacted by increased staffing requirements, normal salary adjustments and higher costs of fringe benefits. Net occupancy expense was affected by increased maintenance charges. The expanded use of personal computer networks has contributed to higher levels of equipment costs and data processing services.
INCOME TAXES
The effective income tax rate of 30.3% in 1998 did not significantly change from the 30.7% rate in 1997 and the 30.4% rate in 1996.
LIQUIDITY
Liquidity refers to the continuing ability of the Bank to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds to the Parent Company for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks, (b) the outstanding balance of federal funds sold, (c) lines for the purchase of federal funds from other banks, (d) the $37,000,000 line of credit established at the Federal Home Loan Bank and (e) the available-for-sale securities portfolio. Further, while available-for-sale securities are intended to be a source of immediate liquidity, the entire investment securities portfolio is managed to provide both income and a ready source of liquidity. All debt securities are of investment grade quality and, if the need arises, can be promptly liquidated on the open market or pledged as collateral for short-term borrowing.
Consistent with its approach to liquidity, the Bank as a matter of policy does not solicit or accept brokered deposits for funding asset growth. Instead, loans and other assets are based on a core of local deposits and the Bank's capital position. To date, the steady increase in deposits, retail repurchase agreements and capital has been adequate to fund loan demand in the Bank's market area, while maintaining the desired level of immediate liquidity and a substantial investment securities portfolio available for both immediate and secondary liquidity purposes.
ASSET/LIABILITY MANAGEMENT AND INTEREST RATE SENSITIVITY
One of the primary objectives of asset/liability management is to maximize net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps; however, this method addresses only the magnitude of timing differences and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios in order to more accurately measure interest rate risk.
The Bank's balance sheet was liability-sensitive at December 31, 1998. A liability-sensitive position means that in gap measurement periods of one year or less there will be more liabilities than assets subject to immediate repricing as market rates change. Because immediately rate sensitive interest-bearing liabilities exceed rate sensitive assets, the earnings position could improve in a declining rate environment and could deteriorate in a rising rate environment, depending on the correlation of rate changes in these two categories. Included in interest-bearing liabilities subject to rate changes within 90 days is a portion of the NOW, savings and money market deposits. These types of deposits historically have not repriced coincidentally with or in the same proportion as general market indicators.
As a specific asset/liability management tool and as further discussed in Note 15 to Consolidated Financial Statements, the Bank, at December 31, 1998, had entered into two interest rate floor agreements with a correspondent bank to protect certain variable-rate loans from the downward effects of their repricing in the event of a decreasing rate environment. The notional amount of each agreement is $10,000,000. The agreements require the correspondent bank to pay to the Bank the difference between the floor rate of interest of 7.50% in one agreement and 8.00% in the other agreement as compared to the prime rate of interest in the event that the prime rate is less. Any payments received under the agreements, net of premium amortization, will be treated as an adjustment of interest income on loans. At December 31, 1998, the unamortized premium related to the interest rate floor agreements amounted to $23,000 and had an estimated fair value of $30,000.
Table 3 presents information about the periods in which the interest-sensitive assets and liabilities at December 31, 1998 will either mature or be subject to repricing in accordance with market rates, and the resulting interest-sensitivity gaps. This table shows the sensitivity of the balance sheet at one point in time and is not necessarily indicative of what the sensitivity will be on other dates. As a simplifying assumption concerning repricing behavior, 50% of the NOW, savings and money market deposits are assumed to reprice immediately and 50% are assumed to reprice beyond one year.
TABLE 3 INTEREST RATE SENSITIVITY ANALYSIS
MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.
The Bank's market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of the Bank's loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. The Bank does not maintain a trading account nor is the Bank subject to currency
exchange risk or commodity price risk. Interest rate risk is monitored as part of the Bank's asset/liability management function, which is discussed in "Asset/Liability Management and Interest Rate Sensitivity" above.
Table 4 presents information about the contractual maturities, average interest rates and estimated fair values of financial instruments considered market risk sensitive at December 31, 1998.
TABLE 4 MARKET RISK ANALYSIS OF FINANCIAL INSTRUMENTS
- --------- (1) The average interest rate related to debt securities is stated on a fully taxable equivalent basis, assuming a 34% federal income tax rate and applicable state income tax rate, reduced by the nondeductible portion of interest expense.
(2) Debt securities are reported on the basis of amortized cost.
(3) Nonaccrual loans are included in the balance of loans. The allowance for loan losses is excluded.
CAPITAL ADEQUACY
Under guidelines established by the Board of Governors of the Federal Reserve System, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio. The risk-based capital ratios are determined by expressing allowable capital amounts, defined in terms of Tier I and Tier II, as a percentage of risk-weighted assets, which are computed by measuring the relative credit risk of both the asset categories on the balance sheet and various off-balance sheet exposures. Tier I capital consists primarily of common shareholders' equity and qualifying perpetual preferred stock, net of goodwill and other disallowed intangible assets. Tier II capital, which is limited to the total of Tier I capital, includes allowable amounts of subordinated debt, mandatory convertible securities, preferred stock and the allowance for loan losses. Under current requirements, the minimum total capital ratio, consisting of both Tier I and Tier II capital, is 8.00% and the minimum Tier I capital ratio is 4.00%. At December 31, 1998, FNB Corp. and the Bank had total capital ratios of 16.05% and 15.63%, respectively, and Tier I capital ratios of 14.98% and 14.55%.
The leverage capital ratio, which serves as a minimum capital standard, considers Tier I capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date. As currently required, the minimum leverage capital ratio is 4.00%. At December 31, 1998, FNB Corp. and the Bank had leverage capital ratios of 9.89% and 9.61%, respectively.
The Bank is also required to comply with prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. To be categorized as well-capitalized, the Bank must have a minimum ratio for total capital of 10.00%, for Tier I capital of 6.00% and for leverage capital of 5.00%. As noted above, the Bank met all of those ratio requirements at December 31, 1998 and, accordingly, is well-capitalized under the regulatory framework for prompt corrective action.
BALANCE SHEET REVIEW
Asset and deposit growth was higher in 1998 than in 1997. Total assets increased $30,968,000 or 9.5% in 1998 compared to $18,521,000 or 6.0% in 1997. Deposits grew $24,142,000 or 8.6% and $9,168,000 or 3.4%, respectively, in the same periods. Retail repurchase agreements funded $4,047,000 of the asset growth in 1998 and $3,712,000 in 1997. The average asset growth rates were 8.8% in 1998 and 7.9% in 1997. The corresponding average deposit growth rates were 7.2% and 7.0%.
INVESTMENT SECURITIES
Investments are carried on the consolidated balance sheet at estimated fair value for available-for-sale securities and at amortized cost for held-to-maturity securities. Table 5 presents information, on the basis of selected maturities, about the composition of the investment securities portfolio for each of the last three years.
TABLE 5 INVESTMENT SECURITIES PORTFOLIO ANALYSIS
- --------- (1) Yields are stated on a fully taxable equivalent basis, assuming a 34% federal income tax rate and applicable state income tax rate, reduced by the nondeductible portion of interest expense.
Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Because the growth in total assets exceeded that for loans in 1998, the level of investment securities was increased $17,890,000 or 20.6%. In 1997, when the growth in loans exceeded that for total assets, there was a reduction in the level of investment securities of $3,435,000 or 3.8%. Investable funds not otherwise utilized are temporarily invested on an overnight basis as federal funds sold, the level of which is affected by such considerations as near-term loan demand and liquidity needs. Based on funds requirements, the Bank was a net purchaser of funds at December 31, 1998.
LOANS
The Corporation's primary source of revenue and largest component of earning assets is the loan portfolio. Loans experienced growth of $12,271,000 or 5.6% in 1998 and $22,178,000 or 11.4% in 1997. Average loans increased $19,845,000 or 9.7% and $18,190,000 or 9.7%, respectively. The ratio of average loans to average deposits increased from 74.7% in 1997 to 76.4% in 1998. The ratio of loans to deposits at December 31, 1998 was 75.4%.
Table 6 sets forth the major categories of loans for each of the last five years. The maturity distribution and interest sensitivity of selected loan categories at December 31, 1998 are presented in Table 7.
TABLE 6 LOAN PORTFOLIO COMPOSITION
TABLE 7 SELECTED LOAN MATURITIES
The commercial and agricultural loan portfolio and the 1-4 family residential mortgage loan portfolio each experienced strong gains during 1998. Loan growth and the composition of the loan portfolio, however, have been affected by management's decision in March 1996 to discontinue the purchase of retail installment loan contracts from automobile and equipment dealers (see "Business Development Matters"). The outstanding balance of these loan contracts, which are primarily included in consumer loans, experienced net decreases in 1998 and 1997 of $5,929,000 and $10,681,000, respectively. Consequently, total consumer loans declined significantly during those periods.
ASSET QUALITY Management considers the Bank's asset quality to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. As part of the loan review function, a third party assessment group is employed to review the underwriting documentation and risk grading analysis. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, and economic conditions in the Bank's market area. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The unallocated portion of the allowance for loan losses represents management's estimate of the appropriate level of reserve to provide for potential losses inherent in the loan portfolio. Considerations in determining the unallocated portion of the allowance for loan losses include general economic and lending trends and other factors. Management's policy in regard to past due loans is conservative and normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a nonaccrual status are generally collateralized and the possibility of future losses is considered in the determination of the allowance for loan losses.
At December 31, 1998, the Bank had impaired loans with one borrower which totaled $467,000 and were also on nonaccrual status. The related allowance for loan losses on these loans amounted to $200,000. Table 8 presents an analysis of the changes in the allowance for loan losses and of the level of nonperforming assets for each of the last five years. Information about management's allocation of the allowance for loan losses by loan category is presented in Table 9.
TABLE 8 ALLOWANCE FOR LOAN LOSSES AND NONPERFORMING ASSETS
TABLE 9
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
DEPOSITS
The level and mix of deposits is affected by various factors, including general economic conditions, the particular circumstances of local markets and the specific deposit strategies employed. In general, broad interest rate declines tend to encourage customers to consider alternative investments such as mutual funds and tax-deferred annuity products, while interest rate increases tend to have the opposite effect.
The Bank's level and mix of deposits has been specifically affected by the following factors. The growth in money market accounts of $6,211,000 in 1998 and $5,165,000 in 1997 was due to a new high-yield product introduced in the 1996 fourth quarter. Time deposits of $100,000 or more accounted for $7,757,000 of total time deposit growth of $11,195,000 in 1998. Further, the level of time deposits obtained from governmental units fluctuates, amounting to $25,905,000, $24,431,000 and $21,602,000 at December 31, 1998, 1997 and 1996, respectively.
Table 10 shows the year-end and average deposit balances for the years 1998, 1997 and 1996 and the changes in 1998 and 1997.
TABLE 10 ANALYSIS OF DEPOSITS
BUSINESS DEVELOPMENT MATTERS
As discussed in Note 17 to Consolidated Financial Statements, the Corporation in 1997 entered into a definitive agreement to acquire a savings bank in Siler City, North Carolina. On January 28, 1998, as permitted by the agreement, the Board of Directors of the savings bank exercised its right to terminate the proposed combination due to the increase in the market value of FNB Corp. common stock above a specified level. Costs amounting to $305,000, initially deferred in connection with the proposed acquisition, were recognized as merger expenses in 1997.
The Bank's data processing, item capture and statement rendering operations are currently outsourced under a service bureau arrangement. The Bank is presently in the process of converting these operations to an in-house basis. Conversion is expected to be complete by the end of March 1999. The total capital expenditure outlay for hardware and software is expected to amount to approximately $1,600,000, of which approximately one-half was recorded in 1998. In addition to capital expenditures for the new system, the Bank has incurred certain expenses in 1998, totaling approximately $302,000, related to the data processing conversion.
Commencing in 1995, the Bank significantly increased its investment in computer equipment through expanded use of personal computer networks. Capital expenditures in 1995, which totaled $1,302,000, related primarily to the increase in computer equipment. Approximately one-third of 1996 and one-half of 1997 capital expenditures, which totaled $1,019,000 and $478,000, respectively, also related to personal computer networks.
As of December 31, 1998, the Bank had received regulatory approval for establishment of a new branch office in Trinity, North Carolina. Construction and occupancy of the Trinity branch is expected to occur in 1999, resulting in a total capital outlay of approximately $950,000, of which approximately one-third was recorded in 1998.
Management decided in March 1996 that the Bank would discontinue the purchase of retail installment loan contracts from automobile and equipment dealers, due largely to the declining yields being experienced in this loan program. Contracts of this nature included in loans at December 31, 1998, 1997 and 1996 amounted to $3,745,000, $9,674,000 and $20,355,000, respectively. While there will be no purchases of new contracts, current plans call for the collection of outstanding loans based on their contractual terms. The funds previously invested in this loan program are being redeployed, as loan payments occur, to other loan programs or to the investment securities portfolio.
YEAR 2000 READINESS DISCLOSURES
The Corporation recognizes and is addressing the potentially serious implications of the "Year 2000 Issue", which is a general term used to describe various problems that may result from the improper processing of dates and date-sensitive calculations by many existing computer programs when the Year 2000 is reached. This issue is ultimately caused by the fact that many of the world's existing computer programs use only two digits to identify the year in the date field of a program. These programs were designed and developed without considering the upcoming change in the century and could experience serious malfunctions when the last two digits of the year change to "00" as a result of identifying the "00" year as the year 1900 rather than the year 2000. This identification error could result in a disruption of normal business operations, including, among other things, the miscalculation of interest accruals and the inability to process customer transactions. In addition, non-banking systems, such as security alarms, elevators and telephones, are subject to malfunction due to their dependence upon computers for proper operation.
The Corporation first began to assess its Year 2000 readiness in August 1996, completing that assessment in January 1997. The Corporation then developed a Year 2000 Plan that follows guidelines outlined by the Federal Financial Institutions Council. The Year 2000 Project Team, which is responsible for execution of the Plan, includes members of senior management and departmental management from all areas of the organization. Additionally, an outside consulting firm has been engaged to assist with the Year 2000 project.
In the implementation of the Year 2000 Plan, a thorough inventory was first performed to determine all hardware, software and facilities that might be impacted by the Year 2000 Issue. Since all software is purchased and no separate in-house programming is performed, the Corporation is dependent upon its third-party vendors for modifications of its existing systems to correct any defects related to the Year 2000 Issue. Accordingly, written documentation has been solicited from all of the software and hardware vendors, as well as the providers of facilities using embedded chip technology, with respect to their Year 2000 compliance status. The validation phase of the Corporation's project includes the receipt and analysis of vendor-performed testing, as well as the testing of all hardware, software and facilities in the Corporate environment. Internal testing of mission critical systems is scheduled to be completed by June 30, 1999, with the testing of other applications to be completed by September 30, 1999.
The Corporation currently uses a service bureau for core processing and related items processing. Testing of this mission critical system for Year 2000 compliance was completed by December 31, 1998. In August 1998, however, the Corporation contracted with third-party vendors for the hardware and software necessary to convert this entire operation to an in-house basis. Conversion to the replacement systems is expected to be complete by late March 1999. Initial internal testing on a trial basis of these replacement systems for Year 2000 compliance was completed in November 1998. Final testing in the normal operating environment is to be completed by June 30, 1999.
The Corporation is informing its customers about the Year 2000 Issue in general and the efforts it is undertaking to ensure that banking services continue in the Year 2000 and beyond. Additionally, the Corporation is contacting its significant commercial customers to determine such customers' plans with respect to the Year 2000 Issue and the Corporation's vulnerability to the failure of any such customer to remediate its own problems that may result from the Year 2000 Issue. As most commercial customers depend on computer systems that must be Year 2000 compliant, a disruption in their businesses could result in potentially significant financial difficulties that could affect their creditworthiness. The Corporation is also initiating contact with key vendors to determine their plans with respect to the Year 2000 Issue. There can be no guarantee that customers and vendors will convert their systems on a timely basis or in a manner that is compatible with the Corporation's systems. Significant business interruptions or failures by significant commercial vendors, trading partners or governmental agencies resulting from the effects of the Year 2000 Issue could have a material adverse effect on the Corporation.
The Corporation's projected cost of Year 2000 compliance is estimated to be approximately $200,000, the majority of such estimated cost relating to computer equipment that may need be replaced. Actual Year 2000 project expenditures totaled $84,000 at December 31, 1998. Of this total, capital expenditures amounted to $69,000 and were all recorded in 1998. Project expenses amounted to $15,000 on a cumulative basis and $13,000 for the year ended December 31, 1998. Funding of Year 2000 project costs will come from normal operating cash flows; however, the expenses associated with the Year 2000 Issue will directly reduce otherwise reported net income for the Corporation.
Management believes that the potential effects on the Corporation's internal operations of the Year 2000 Issue can be mitigated on a timely basis. However, if required modifications or conversions are not made or are not completed on a timely basis, the Year 2000 Issue could disrupt normal business operations and have a material adverse impact on the Corporation.
Contingency plans are being developed to mitigate the potential effects of a disruption in normal business operations. Contingency planning includes developing alternative solutions should a vendor not become compliant, as well as plans for the resumption of business if, despite the Corporation's best efforts, there is a disruption in business operations. In the event of what could be described as a "worst case" scenario, the contingency plans will allow for limited transactions, including the ability to make certain deposits and withdrawals, until the Year 2000 problems are fixed.
The costs of the Year 2000 project and the schedule for achieving Year 2000 compliance are based on management's best estimates, which were derived using numerous assumptions of future events such as the availability of certain resources (including appropriately trained personnel and other internal and external resources), third-party vendor plans and other factors. However, there can be no guarantee that these estimates will be achieved at the cost disclosed or within the timeframes indicated, and actual results could differ materially from these plans. Factors that might affect the timely and efficient completion of the Corporation's Year 2000 project include, but are not limited to, vendors' abilities to adequately correct or convert software and the effect on the Corporation's ability to test its systems, the availability and cost of personnel trained in the Year 2000 areas, the ability to identify and correct all relevant computer programs, the readiness of key utilities, vendors and customers, and similar uncertainties.
ACCOUNTING PRONOUNCEMENT MATTERS
In July 1997, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The objective of SFAS No. 130 is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events during the period other than transactions with owners (therein defined as "comprehensive income"). Comprehensive income is the total of net income and all other nonshareholder changes in equity. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. If comparative financial statements are provided for earlier periods, those financial statements shall be reclassified to reflect application of the provisions of SFAS No. 130. The Corporation adopted SFAS No. 130 in 1998, resulting in comprehensive income disclosures in the consolidated balance sheets and consolidated statements of shareholders' equity and comprehensive income.
In July 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information, an Amendment of Statements No. 87, 88 and 106". SFAS No. 131 requires disclosures for each segment that are similar to those required under current standards with the addition of quarterly disclosure requirements and a finer partitioning of geographic disclosures. It requires limited segment data on a quarterly basis. It also requires geographic data by country, as opposed to broader geographic regions as permitted under current standards. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. As the Corporation has only one operating segment, adoption of SFAS No. 131 in 1998 did not have an effect on the consolidated financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits". SFAS No. 132 standardizes the disclosure requirements of pensions and other postretirement benefits and does not change any measurement or recognition provisions. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. The Corporation adopted SFAS No. 132 in 1998, resulting in the disclosures presented in Note 9 to the Consolidated Financial Statements.
In September 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. An entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. SFAS No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. At this time, the Corporation has not determined what effect, if any, that adoption of SFAS No. 133 will have on the consolidated financial statements.
In October 1998, the FASB issued SFAS No. 134, "Acounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise", which requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. SFAS No. 134 is effective for the first fiscal quarter beginning after December 31, 1998, with earlier application permitted. As the Corporation does not have any mortgage-backed securities or other retained interests resulting from the securitization of mortgage loans held for sale, adoption of SFAS No. 134 would not currently have any effect on the consolidated financial statements.
EFFECTS OF INFLATION
The operations of the Bank and therefore of the Corporation are subject to the effects of inflation through interest rate fluctuations and changes in the general price level of noninterest operating expenses. Such costs as salaries, fringe benefits and utilities have tended to increase at a rate comparable to or even greater than the general rate of inflation. Broadly speaking, all operating expenses have risen to higher levels as inflationary pressures have increased. Management has responded to this situation by evaluating and adjusting fees charged for specific services and by emphasizing operating efficiencies.
The level of interest rates is also considered to be influenced by inflation, rising whenever inflationary expectations and the actual level of inflation increase and declining whenever the inflationary outlook appears to be improving. Management constantly monitors this situation, attempting to adjust both rates received on earning assets and rates paid on interest-bearing liabilities in order to maintain the desired net yield on earning assets.
TABLE 11 QUARTERLY FINANCIAL DATA
- --------- (1) FNB Corp. common stock is traded on the NASDAQ National Market System under the symbol FNBN. At December 31, 1998, there were 1,143 shareholders of record.
(2) All per share data has been retroactively adjusted to reflect the two-for-one common stock split effected in the form of a 100% stock dividend paid in the first quarter of 1998.
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS FNB CORP.
We have audited the accompanying consolidated balance sheets of FNB Corp. and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Corporation'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 generally accepted auditing standards. 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 FNB Corp. and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Greensboro, North Carolina March 12, 1999
FNB CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
Commitments (Note 15)
See accompanying notes to consolidated financial statements.
FNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
FNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
See accompanying notes to consolidated financial statements.
FNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
FNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS/CONSOLIDATION
FNB Corp. is a one-bank holding company whose wholly-owned subsidiary is the First National Bank and Trust Company (the "Bank"). The Bank is an independent community bank that offers a complete line of financial services, including deposit, loan, investment and trust services, to individual and business customers primarily in the region of North Carolina that includes Randolph, Montgomery and Chatham counties.
The consolidated financial statements include the accounts of FNB Corp. and the Bank (collectively the "Corporation"). All significant intercompany balances and transactions have been eliminated. The Corporation adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information", in 1998 without any impact on the consolidated financial statements as the chief operating decision maker reviews the results of operations of the Corporation and its subsidiary as a single enterprise.
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Certain items for 1996 and 1997 have been reclassified to conform with the 1998 presentation. The reclassifications have no effect on the financial position or results of operations as previously reported.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
INVESTMENT SECURITIES
Investment securities are categorized and accounted for as follows:
o Held-to-maturity securities -- Debt securities that the Corporation has the positive intent and ability to hold to maturity are reported at amortized cost.
o Trading securities -- Debt and equity securities bought and held principally for the purpose of being sold in the near future are reported at fair value, with unrealized gains and losses included in earnings.
o Available-for-sale securities -- Debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value, with unrealized gains and losses, net of related tax effect, included as an item of other comprehensive income and reported as a separate component of shareholders' equity.
The Corporation intends to hold its securities classified as available-for-sale securities for an indefinite period of time but may sell them prior to maturity. All other securities, which the Corporation has the positive intent and ability to hold to maturity, are classified as held-to-maturity securities.
Interest income on debt securities is adjusted using the level yield method for the amortization of premiums and accretion of discounts. The adjusted cost of the specific security is used to compute gains or losses on the disposition of securities.
LOANS
Interest income on loans is generally calculated by using the constant yield method based on the daily outstanding balance. The recognition of interest income is discontinued when, in management's opinion, the collection of all or a portion of interest becomes doubtful.
Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the life of the loan as an adjustment of interest income. Residential mortgage loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents an amount considered adequate to absorb loan losses inherent in the portfolio. Management's evaluation of the adequacy of the allowance is based on a review of individual loans, historical loan loss experience, the value and adequacy of collateral, and economic conditions in the Bank's market area. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Losses are charged and recoveries are credited to the allowance for loan losses. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
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 changes to the allowance based on their judgments about information available to them at the time of their examination.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows: buildings and improvements, 10 to 50 years and furniture and equipment, 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated life of the improvement or the term of the lease.
INTANGIBLE ASSETS
Deposit base premiums, arising from deposit and branch purchase acquisitions, amounted to $24,000 and $67,000 at December 31, 1998 and 1997, respectively, and are included in other assets. The premium amounts are amortized on an accelerated basis over ten-year periods.
INCOME TAXES
Income tax expense includes both a current provision based on the amounts computed for income tax return purposes and a deferred provision that results from application of the asset and liability method of accounting for deferred taxes. Under the asset and liability method, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Corporation's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized 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.
EARNINGS PER SHARE
In 1997, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", which establishes standards for computing and presenting earnings per share (EPS) data. SFAS No. 128 simplifies the standards for computing EPS previously found in APB Opinion No. 15, "Earnings Per Share", and makes them comparable to international EPS standards. Under SFAS No. 128, basic EPS replaces the former presentation of primary EPS. Also, a dual presentation of basic and diluted EPS is required on the face of the income statement for all entities with complex capital structures, and a reconciliation must be provided of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. In accordance with SFAS No. 128, all prior period EPS data has been restated.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity of an enterprise during a period from transactions and other events and circumstances from nonowner sources and, accordingly, includes both net income and amounts referred to as other comprehensive income. SFAS No. 130 requires that an enterprise (a) classify items of other comprehensive income by their nature
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and surplus in the equity section of a statement of financial position. In accordance with the provisions of SFAS No. 130, comparative consolidated financial statements presented for earlier periods have been reclassified to reflect the provisions of the statement.
EMPLOYEE BENEFIT PLANS
The Corporation has a defined benefit pension plan covering substantially all full-time employees. Pension costs, which are actuarially determined using the projected unit credit method, are charged to current operations. Annual funding contributions are made up to the maximum amounts allowable for Federal income tax purposes.
Medical and life insurance benefits are provided by the Corporation on a postretirement basis under defined benefit plans covering substantially all full-time employees. Postretirement benefit costs, which are actuarially determined using the attribution method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet.
The Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits, an Amendment of Statements No. 87, 88, and 106", during 1998. SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets and eliminates certain disclosures previously required. The methods of measurement and recognition for such plans remain unchanged. Disclosures for earlier periods provided for comparative purposes have been restated to reflect the provisions of SFAS No. 132.
STOCK OPTIONS
Effective January 1, 1997, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation", which requires either (i) the fair value of employee stock-based compensation plans be recorded as a component of compensation expense in the statement of income as of the date of grant of awards related to such plans or (ii) the impact of such fair value on net income and earnings per share be disclosed in a footnote to financial statements for awards granted after December 15, 1994, if the accounting for such awards continues to be in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees". The Corporation has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation may use off-balance sheet derivative contracts for interest rate risk management purposes. The existing contracts are accounted for on the accrual basis and the net interest differential, including premiums paid, if any, is recognized as an adjustment to interest income or expense of the related asset or liability. The Corporation does not utilize derivative financial instruments for trading purposes.
RESTATEMENTS
Share and per share information in the consolidated financial statements and related notes thereto have been restated, where appropriate, to reflect the two-for-one common stock split effected in the form of a 100% stock dividend paid to shareholders on March 18, 1998.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- INVESTMENT SECURITIES Summaries of the amortized cost and estimated fair value of investment securities and the related gross unrealized gains and losses are presented below:
The amortized cost and estimated fair value of investment securities at December 31, 1998, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to prepay obligations with or without prepayment penalties.
Debt securities with an estimated fair value of $58,311,000 were pledged to secure public funds and trust funds on deposit and retail repurchase agreements at December 31, 1998.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- INVESTMENT SECURITIES -- (Continued)
There were no sales of investment securities in the three-year period ended December 31, 1998.
NOTE 3 -- LOANS
Major classifications of loans are as follows:
Loans as presented are reduced by net deferred loan fees of $443,000 and $270,000 at December 31, 1998 and 1997, respectively. Nonaccrual loans amounted to $731,000 at December 31, 1998 and $51,000 at December 31, 1997. Interest income that would have been recorded on nonaccrual loans for the year ended December 31, 1998, had they performed in accordance with their original terms, amounted to approximately $59,000. Interest income on all such loans included in the the results of operations for 1998 amounted to approximately $30,000. For the years ended December 31, 1997 and 1996, lost and recorded interest income on nonaccrual loans was not material. At December 31, 1998, the Bank had impaired loans with one borrower which totaled $467,000 and were also on nonaccrual status. The related allowance for loan losses on these loans amounted to $200,000. The average carrying value of impaired loans was $457,000 in 1998. Interest income on impaired loans in 1998 was not material. There were no loans considered to be impaired at December 31, 1997.
Loans are primarily made in the region of North Carolina that includes Randolph, Montgomery and Chatham counties. The real estate loan portfolio can be affected by the condition of the local real estate markets. Included in consumer loans at December 31, 1998 and 1997 are $3,745,000 and $9,674,000, respectively, of retail installment loan contracts purchased primarily from automobile dealers. In March 1996, the Bank discontinued the purchase of retail installment loan contracts from automobile and equipment dealers.
Loans have been made by the Bank to directors and executive officers of the Corporation and to the associates of such persons, as defined by the Securities and Exchange Commission. Such loans were made in the ordinary course of business on substantially the same terms, including rate and collateral, as those prevailing at the time in comparable transactions with other borrowers and do not involve more than normal risk of collectibility. A summary of the activity during 1998 with respect to related party loans is as follows (in thousands):
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses were as follows:
NOTE 5 -- PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
NOTE 6 -- INCOME TAXES
Income taxes as reported in the consolidated income statement included the following expense (benefit) components:
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- INCOME TAXES -- (Continued)
A reconciliation of income tax expense computed at the statutory Federal income tax rate to actual income tax expense is presented below:
The components of deferred tax assets and liabilities and the tax effect of each are as follows:
There is no valuation allowance for deferred tax assets as it is management's contention that realization of the deferred tax assets is more likely than not based upon the Corporation's history of taxable income and estimates of future taxable income.
NOTE 7 -- TIME DEPOSITS
The scheduled maturities of time deposits are as follows (in thousands):
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- BORROWED FUNDS Funds are borrowed on an overnight basis through retail repurchase agreements with Bank customers and federal funds purchased from other financial institutions. Retail repurchase agreement borrowings are collateralized by securities of the U.S. Treasury and U.S. Government agencies and corporations.
Information concerning retail repurchase agreements and federal funds purchased is as follows:
At December 31, 1998, the Bank had an available line of credit of $37,000,000 with the Federal Home Loan Bank (the "FHLB"). Any advances that the Bank may obtain under the FHLB line would be secured by a blanket collateral agreement on qualifying 1-4 family residential mortgage loans.
NOTE 9 -- EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Corporation has a noncontributory defined benefit pension plan covering substantially all full-time employees who qualify as to age and length of service. Benefits are based on the employee's compensation, years of service and age at retirement. The Corporation's funding policy is to contribute annually to the plan an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- EMPLOYEE BENEFIT PLANS -- (Continued)
Information concerning the status of the plan is as follows:
Net periodic pension cost included the following components:
OTHER POSTRETIREMENT DEFINED BENEFIT PLANS
The Corporation has postretirement medical and life insurance plans covering substantially all full-time employees who qualify as to age and length of service. The medical plan is contributory, with retiree contributions adjusted whenever medical insurance rates change. The life insurance plan is noncontributory.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- EMPLOYEE BENEFIT PLANS -- (Continued)
Information concerning the plans, which are unfunded, is as follows:
Increasing or decreasing the assumed medical cost trend rate by one percentage point would not have a significant effect on either the postretirement benefit obligation at December 31, 1998 or the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1998.
Net periodic postretirement benefit cost included the following components:
MATCHING RETIREMENT/SAVINGS PLAN
The Corporation has a matching retirement/savings plan which permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. A portion of the employee contributions are matched by the Corporation based on the plan formula. The matching contributions amounted to $96,000 in 1998, $85,000 in 1997 and $78,000 in 1996.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- LEASES Future obligations for minimum rentals under noncancellable operating lease commitments, primarily relating to premises, are as follows (in thousands):
Net rental expense for all operating leases amounted to $55,000 in 1998, $57,000 in 1997 and $58,000 in 1996. One operating lease for real property contains a purchase option considered to approximate fair market value.
NOTE 11 -- SUPPLEMENTARY INCOME STATEMENT INFORMATION
Significant components of other expense were as follows:
NOTE 12 -- FNB CORP. (PARENT COMPANY) FINANCIAL DATA
The Parent Company's principal asset is its investment in the Bank subsidiary, and its principal source of income is dividends from that subsidiary.
The Parent Company's condensed balance sheets as of December 31, 1998 and 1997, and the related condensed statements of income and cash flows for each of the years in the three-year period ended December 31, 1998 are as follows:
CONDENSED BALANCE SHEETS
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- FNB CORP. (PARENT COMPANY) FINANCIAL DATA -- (Continued)
CONDENSED STATEMENTS OF INCOME
CONDENSED STATEMENTS OF CASH FLOWS
NOTE 13 -- CAPITAL ADEQUACY REQUIREMENTS
Certain regulatory requirements restrict the lending of funds by the Bank to FNB Corp. and the amount of dividends which can be paid to FNB Corp. In 1999, the maximum amount of dividends the Bank can pay to FNB Corp., without the approval of the Comptroller of the Currency, is $5,921,000 plus an additional amount equal to the retained net income in 1999 up to the date of any dividend declaration.
The Bank is required to maintain average reserve balances with the Federal Reserve Bank based on a percentage of deposits. For the reserve maintenance period in effect at December 31, 1998, the average daily reserve requirement was $4,166,000.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- CAPITAL ADEQUACY REQUIREMENTS -- (Continued)
FNB Corp. and the Bank are required to comply with capital adequacy standards established by the Board of Governors of the Federal Reserve System. In addition, the Bank is required to comply with prompt corrective action provisions established by the Federal Deposit Insurance Corporation Improvement Act. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, there are minimum ratios of capital to risk-weighted assets. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a material effect on the consolidated financial statements.
Regulatory capital amounts and ratios are set forth in the table below. The risk-based capital ratios are determined by expressing allowable capital amounts, defined in terms of Tier I and Tier II, as a percentage of risk-weighted assets, which are computed by measuring the relative credit risk of both the asset categories on the balance sheet and various off-balance sheet exposures. Tier I capital consists primarily of common shareholders' equity and qualifying perpetual preferred stock, net of goodwill and other disallowed intangible assets. Tier II capital, which is limited to the total of Tier I capital, includes allowable amounts of subordinated debt, mandatory convertible securities, preferred stock and the allowance for loan losses. Total capital, for risk-based purposes, consists of both Tier I and Tier II capital.
The Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must meet minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no events or conditions since December 31, 1998 that management believes have changed the Bank's category.
NOTE 14 -- SHAREHOLDERS' EQUITY
EARNINGS PER SHARE (EPS)
Basic net income per share, or basic EPS, is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if the Corporation's dilutive stock options were exercised. The numerator of the basic EPS computation is the same as the numerator of the diluted EPS computation for all periods presented. A reconciliation of the denominators of the basic and diluted EPS computations is as follows:
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- SHAREHOLDERS' EQUITY -- (Continued)
STOCK OPTIONS
All information presented below has been restated to reflect the 1998 stock split disclosed in Note 1.
The Corporation adopted a stock compensation plan in 1993 that allows for the granting of incentive and nonqualified stock options to key employees and directors. Under terms of the plan, options are granted at prices equal to the fair market value of the common stock on the date of grant. Options become exercisable after one year in equal, cumulative installments over a five-year period. No option shall expire later than ten years from the date of grant. A maximum of 720,000 shares of common stock has been reserved for issuance under the stock compensation plan. At December 31, 1998, there were 294,900 shares available under the plan for the granting of additional options.
The Corporation applies APB Opinion No. 25 in accounting for the stock compensation plan and, accordingly, no compensation cost has been recognized for stock option grants in the consolidated financial statements. As required by Statement of Financial Accounting Standards (SFAS) No. 123, disclosures are presented below for the effect on net income and net income per share that would result from the use of the fair value based method to measure compensation costs related to stock option grants in 1995 and subsequent years. The effect on pro forma net income for 1998, 1997 and 1996 for options granted prior to 1995 has not been determined. Consequently, the effects of applying SFAS No. 123 pro forma disclosures during the initial phase-in period may not be representative of the effects on reported net income in future years.
The weighted-average fair value per share of options granted in 1998, 1997 and 1996 amounted to $11.17, $5.55 and $4.44, respectively. Fair values were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14 -- SHAREHOLDERS' EQUITY -- (Continued)
A summary of stock option activity is as follows:
At December 31, 1998, information concerning stock options outstanding and exercisable is as follows:
NOTE 15 -- COMMITMENTS
In the normal course of business, various commitments are outstanding that are not reflected in the consolidated financial statements. At December 31, 1998, a summary of significant commitments is as follows:
In management's opinion, these commitments will be funded from normal operations with not more than the normal risk of loss.
The Bank has entered into two interest rate floor agreements with a correspondent bank to protect certain variable-rate loans from the downward effects of their repricing in the event of a decreasing rate environment. The notional amount of each agreement is $10,000,000. The agreements require the correspondent bank to pay to the Bank the difference between the floor rate of interest of 7.50% in one agreement and 8.00% in the other agreement as compared to the prime rate of interest in the event that the prime rate is less. Any payments received under the agreements, net of premium amortization, will be treated as an adjustment of interest income on loans. The Bank's exposure to credit risk is limited to the ability of the counterparty to make potential future payments to the Bank that are required pursuant to the agreements. The Bank's exposure to market risk of loss is limited to the amount of the unamortized premium. At December 31, 1998, the unamortized premium related to the interest rate floor agreements amounted to $23,000 and had an estimated fair value of $30,000.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16 -- FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value for each class of financial instruments.
CASH AND CASH EQUIVALENTS. For cash on hand, amounts due from banks, and federal funds sold, the carrying value is considered to be a reasonable estimate of fair value.
INVESTMENT SECURITIES. The fair value of investment securities is based on quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
LOANS. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
DEPOSITS. The fair value of noninterest-bearing demand deposits and NOW, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.
BORROWED FUNDS. The carrying value of retail repurchase agreements and federal funds purchased is considered to be a reasonable estimate of fair value.
COMMITMENTS. The fair value of commitments to extend credit is considered to approximate carrying value, since the large majority of these commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value. The various commitment items are disclosed in Note 15.
The estimated fair values of financial instruments are as follows:
The fair value estimates are made at a specific point in time based on relevant market and other information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation's entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be considered in an actual sale considered. Because no market exists for a significant portion of the Corporation'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 such 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. In addition, the 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 the estimates.
FNB CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- TERMINATED ACQUISITION On June 3, 1997, the Corporation entered into a definitive agreement to acquire a savings bank in Siler City, North Carolina. Under terms of the agreement, the savings bank shareholders were to receive $15.50 per share, either in FNB Corp. common stock or in cash or a combination thereof, subject to the limitation that FNB Corp. common stock issued in the merger would be not more than 60% and not less than 50% of the total consideration. On January 28, 1998, as permitted by the agreement, the Board of Directors of the savings bank exercised its right to terminate the proposed combination due to the increase in the market value of FNB Corp. common stock above a specified level.
The Corporation incurred certain costs in connection with the proposed acquisition. Those costs, which had been initially deferred, amounted to $305,000 and are included in merger expenses in the consolidated statement of income for the year ended December 31, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of March 26, 1999.
FNB CORP. (Registrant)
By: /s/ MICHAEL C. MILLER ------------------------------------- MICHAEL C. MILLER CHAIRMAN AND PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, as of March 26, 1999.
INDEX TO EXHIBITS