First Community Bancshares, Inc.
Annual Report 2001

Plain-text annual report

T30290-Cover spread.qx4 3/8/02 12:23 PM Page 1 First Community Bancshares, Inc., One Community Place, Bluefield, VA 24605 276.326.9000 • www.fcbinc.com T30290-Cover spread.qx4 3/8/02 12:23 PM Page 2 Financial Highlights (Amount in Thousands. Except Percent and Per Share Data) Earnings and Dividends Net income from recurring operations Net income as reported Basic and diluted earnings per share (1) Cash earnings per share (1),(2) Cash dividends per share (1) Return on average equity Return on average assets 2001 2000 1999 $ 19,266 19,134 1.92 2.05 0.89 14.80 1.49 % % $ 17,166 17,063 1.78 1.96 0.86 % 15.70 1.51 % $ 15,748 16,852 1.75 1.93 0.80 % 16.23 % 1.62 (1) All share and per share data have been adjusted for a 10% stock dividend declared February 19, 2002, and payable March 28, 2002, to shareholders of record March 1, 2002. (2) Cash earnings per share represent earnings per share adjusted for noncash charges for amortization of goodwill and other intangibles. Balance Sheet Data at Year-End Total Assets Earning Assets Deposits Securities sold under agreements to repurchase Stockholders’ equity $1,478,235 1,366,168 1,078,260 79,262 133,041 $1,218,017 1,117,910 899,903 46,179 120,682 $1,088,162 996,366 833,258 41,062 103,488 Pictured from left to right: E. Stephen Lilly Chief Operating Officer, First Community Bancshares, Inc., SVP and COO, First Community Bank, N. A. John M. Mendez President and CEO, First Community Bancshares, Inc. Robert L. Buzzo President, First Community Bank, N. A. Vice President and Secretary, First Community Bancshares, Inc. Contents Message to Stockholders Management’s Discussion and Analysis Introduction Stock Dividend Recent Acquisitions Summary Financial Results Five-Year Selected Financial Data Common Stock and Dividends Net Interest Margin Net Interest Income Provision for Loan Losses Non-interest Income Non-interest Expense Franchise Map Income Tax Expense Securities Held to Maturity Securities Available for Sale Loan Portfolio Allowance for Loan Losses Non-performing Assets Deposits Short-Term Borrowings Other Indebtedness Stockholders’ Equity Trust and Investment Management Services Liquidity Interest Rate Sensitivity, Interest Rate Risk and Asset/Liability Management Bankers Insurance Recent Legislation Consolidated Financial Statements Report of Independent Auditors Report on Management’s Responsibilities Board of Directors Locations & Other Information 1 4 5 5 5 8 9 9 10 11 11 13 15 16 16 16 17 18 19 20 20 20 21 21 21 21 23 24 26 61 62 63 65 John Mendez, President & CEO T30290-Disc./Analysis.qx4 3/8/02 12:30 PM Page 1 Message to Stockholders Our recently completed 2001 fiscal year was marked by a number of achievements, and record performance. Record deposit growth, record earnings performance, new highs in asset quality, expansion of our branch network and record levels of total resources are but a few of the milestones achieved by our company this past year. These accomplishments are further magnified when viewed in light of declining interest rates, a weakening economy and uncertain markets. Financial results in 2001 resulted in another record year. Net income of $19.1 million represented a $2 million or 12% increase over our 2000 results. Current year earnings improved on the strength of an 8.25% increase in net interest income and a 62.3% increase in non-interest revenues, including a $4.9 million increase in mortgage origination revenues. Adjusted for a 10% stock dividend to be distributed on March 28, 2002, to shareholders of record March 1, 2002, basic and diluted earnings per share increased to $1.92, up from $1.78 in 2000, an increase of 7.9%. Return on assets was 1.49% in 2001, compared with 1.51% for 2000. Return on equity for 2001 was 14.8% versus 15.7% in 2000. Investor returns remained strong in 2001 with the 12% increase in net income; however, large increases in capital, derived from retained earnings, business combinations and comprehensive income on improving market values on available for sale securities resulted in a slight decline in return on equity. Deposit growth in 2001 was its strongest in years, with a 19.8% increase in total customer deposits. This growth to $1.1 billion in deposits is attributable, in part, to the branch acquisitions in the fourth quarter, but also reflects significant growth in existing markets as the company restructured its product set for improved marketability and initiated marketing campaigns designed to bolster the Company’s image and reach a broader base of retail customers. Combined with growth in equity and other financing sources, total assets grew by more than 21% for the year. Combined with the previous year’s double-digit growth rate, total assets reached $1.5 billion at year-end 2001. During 2001 First Community Bancshares, Inc. was able to achieve these record operating results while, at the same time, investing heavily for the future. Capital spending for facilities, technologies and equipment and for programs benefiting future periods totaled more than $3 million as the company continued its investment in technology, new branches, information systems, marketing programs and human resources. Technology investments were in the form of digital communications equipment and a company-wide frame relay network to speed communications and information transfer. Technology investment also included the acquisition and development of Resource–FCB Online Banking® for delivery of banking services via the Internet. Investment in new branches includes our new Athens, West 1 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 2 2 FCB Annual Report 2001 Virginia, branch which will serve additional portions of Mercer County and the acquisition of land for the upcoming development of new branches in Bluefield and Emporia, Virginia, and in Princeton, West Virginia. Investment in marketing programs includes the development of the company’s new tagline, “Your First Financial Resource,” and its promotion through an extensive advertising campaign focusing on the employees and customers of First Community Bank. In 2001, we began a program of branch development designed to improve the service level and increase access within our markets. In addition to our new Athens, West Virginia branch, we have acquired land for the construction of our new branches in Bluefield, Virginia and Princeton, West Virginia. We also acquired land in Emporia, Virginia where we will construct a new main office location to upgrade our existing branch networkin Greensville County. As we continue development in these areas, we are also exploring opportunities in Virginia, West Virginia and North Carolina. Our goal is to continue to be close to our customer, building on existing relationships and increasing market penetration. In 2001, we expanded the company by adding three new divisions. The acquisition of branches from BB&T and F&M resulted in the formation of our Southside, Virginia, and Alleghany County banking divisions and the start-up of wholesale mortgage operations in Richmond, Virginia, greatly expanded our reach and volume in the mortgage banking line of business. The combined work of our retail and wholesale mortgage divisions resulted in total mortgage origination volume of over $500 million. The mortgage operations proved very important to our company during 2001 as it contributed $1.3 million in net earnings for the year. Expectations for the two new banking divisions in Virginia are high as we believe these areas will be significant contributors for the upcoming year. Results in our new Raleigh County market were quite good in 2001. The new branches exceeded financial objectives set for its first year of operation. Pretax earnings for Raleigh County operations were just over $1.3 million and total resources in this market grew from $56.2 million at acquisition to $70 million at year-end 2001, an increase of 24.5%. Improvement in asset quality was an important part of our financial success in 2001. Attention to this critical element of our business resulted in maintenance of total delinquencies at 1.6% and a reduction in non-accrual loans to .40%. Total non-performing loans were .55% at year-end and were further reduced to another all-time low of .42% following the resolution of a $1.1 million ninety-day delinquency in January 2002. Improvement in asset quality through year-end brought our coverage ratio (loan loss reserves divided by non-performing loans) to 280%, up from 186% at year-end 2000. While the company has shown great improvement in asset quality in 2001, our efforts in this area will not diminish. T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 3 The market for First Community Bancshares, Inc. stock improved greatly this year with our NASDAQ® listing and the institution of our investor relations program in late 2000. At December 31, 2001, our stock closed at $29.47, ($26.79 adjusted for the 10% stock dividend), up from $17.75, ($16.14 adjusted for the stock dividend), per share at year-end 2000. This represents a 66% increase in market value for the year and a multiple of 15.4 times our last twelve months’ earnings, very much in line with other comparably sized financial institutions. The company is now regularly followed by two regional brokerage firms and is listed in a number of quarterly financial institution reviews. This increased visibility and the NASDAQ® listing makes investing in our stock more convenient and attracts a wider base of investment. With the increase in our market capitalization to over $260 million at mid-year, our company was added to the Russell 3000 index and this too has significantly increased interest in our company and has enhanced trading volume and liquidity for our stock. As we write this report, we are finalizing testing of our new Internet-based banking product known as Resource–FCB Online Banking®. With this Internet product accessed through www.fcbresource.com we have added another convenient point of access for our retail and business customers. We are quite excited about this new delivery channel and its 24-hour a day availability. Combined with our recent product alignment, new product development and consolidation of databases, customers throughout our banking network will have immediate access to current financial information and their accounts as well as bill payment services and discount brokerage. We would like to take this opportunity to thank the hundreds of employees throughout our organization who continue to produce record results year after year. We are extremely fortunate to have such a dedicated and capable team of professional bankers, managers, technicians and support personnel. Without them it would be impossible to achieve such consistently high results. We also thank you for your support as a customer and investor and we pledge our continued commitment to quality service and strategies to make First Community Bank and First Community Bancshares, Inc. a leader in financial services as well as a valued investment. Our annual meeting of Stockholders is scheduled for April 16, 2002, at Fincastle Country Club in Bluefield, Virginia, at 3:00 p.m. We look forward to reporting to you on these and other activities of the Company. Sincerely, John M. Mendez, President & Chief Executive Officer 3 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 4 Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction operating performance, events or developments looking statements. Some factors, which could This discussion should be read in conjunction that we expect or anticipate will occur in the negatively affect the results, include: (1) general with the consolidated financial statements, notes future—including statements relating to growth, economic conditions, either nationally or within and tables included throughout this report and share of revenues and earnings per share growth the Company’s markets, could be less favorable the First Community Bancshares, Inc. (the and statements expressing general optimism than expected, (2) changes in market interest “Company” or “First Community”) Annual Report about future operating results—are forward- rates could affect interest margins and on Form 10-K. All statements other than looking statements. Forward-looking statements profitability, (3) competitive pressures could be statements of historical fact included in this are subject to certain risks and uncertainties that greater than anticipated, (4) legal or accounting Annual Report, including statements in the could cause actual results to differ materially from changes could affect the Company’s results, Letter to Shareholders and in Management’s our Company’s historical experience and our (5) acquisition cost savings may not be realized or Discussion and Analysis of Financial Conditions present expectations or projections. As and when the anticipated income may not be achieved, and and Results of Operations are, or may be deemed made, management believes that these forward- (6) adverse changes could occur in the securities to be, forward-looking statements within the looking statements are reasonable. However, and investments markets. The foregoing list of meaning of Section 27A of the Securities Act of caution should be taken not to place undue important factors is not all inclusive. 1933 and Section 21E of the Exchange Act of 1934. reliance on any such forward-looking statements Forward-looking statements made herein Generally, the words “believe,” “expect,” since such statementsspeakonlyasto conditions reflect management’s expectations as of the date “intend,” “estimate,” “anticipate,” “project,” of the date when made. such statements are made. Such information is “will” and similar expressions identify forward- Many factors could cause the Company’s provided to assist stockholders and potential looking statements, which generally are not actual results to differ materially from investors in understanding current and historical in nature. All statements that address the results contemplated by the forward- anticipated financial operations of the Company Throughout this text, we have featured some of the internal projects that were initiated by First Community Bank to ensure continued customer satisfaction and to build on our promising future. First Community Bank’s 2001 fiscal year was marked by a number of achievements and record-breaking performance. 4 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 5 and is included pursuant to the safe harbor Stock Dividend Summary Financial Results provisions of the Private Securities Litigation On February 19, 2002, the Company declared Net income for 2001 was $19.1 million, up Reform Act of 1995. The Company undertakes no a 10% stock dividend payable on March 28,2002, $2.0 million from $17.1 million in 2000 and up obligation to publicly update or revise any to stockholders of record March 1, 2002. All $2.2 million from 1999 net income of $16.9 forward-looking statements, whether as a result share and per share amounts, with the exception million. Adjusted for a 10% stock dividend in of new information, future events or otherwise. of market pricing of the Company’s stock, within 2002, basic and diluted earnings per share also First Community is a multi-state holding this Management’s Discussion and Analysis increased to a record level of $1.92 per share, up company headquartered in Bluefield, Virginia. have been retroactively adjusted to give effect from $1.78 and $1.75 in 2000 and 1999, With total resources of $1.48 billion at December to the stock dividend payable. respectively. This represents an increase of 7.9% 31, 2001, First Community through its banking Recent Acquisitions subsidiary First Community Bank, N. A. (“FCBNA” or “Bank”), provides financial, mortgage brokerage and origination and trust services to individuals and commercial customers through On December 7, 2001, the Company completed the acquisition of four branch facilities of Branch Banking and Trust Company of Virginia (BB&T) and F&M Bank–Southern Virginia compared to 2000. Cash earnings per share for 2001 were $2.05, up from $1.96 in 2000 and $1.93 in 1999. Cash earnings per share represent earnings per share (EPS) adjusted for non-cash charges such as amortization of goodwill and 38 full-service banking locations in West Virginia, (F&M) located in Clifton Forge, Emporia and other intangibles. Virginia and North Carolina as well as eleven mortgage brokerage facilities operated by United First Mortgage, Inc. (“UFM”). UFM is a wholly- owned subsidiary of FCBNA. Drakes Branch, Virginia. The completion of this transaction resulted in the addition of $77 million in cash and securities, an additional $114 million in deposits and added $31 million to the loan portfolio. The increase in netincome between 2000 and 2001 of $2.0 million or 12.1% was driven by a $7.8 million increase in non-interest income and a $3.8 million increase in net interest income. The improvement in net interest income was the Corporate Center This strategic location has resulted in more effective communication and better execution of our strategies, which provides functional consistency for our entire company. “ Moving our Corporate Center to our new facility in Bluefield, VA, has helped create a stronger central organization which better supports our bank branches. – John Mendez, President & CEO ” 5 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 6 result of continued strong loan demand as of a combination of retail deposits, Federal Home acquired in the fourth quarter of 2000, additional indicated by the 7.4% increase in loans Loan Bankborrowings, and active product pricing banking facilities including the new Athens, West outstanding, excluding loans acquired from the and marketing strategies. Consistentwith the rate Virginia, branch and the four branches acquired BB&T and F&M branches in December 2001. In environment, the rate paid on interest-bearing from BB&T and F&M. addition, increased mortgage banking activity liabilities declined by 22 basis points to 4.21% The increase in net income between 1999 and stemming from the lower interest rate while the yield on earning assets declined 58 2000 was driven by a $2.3 million or 5.3% environment during 2001, caused loans held for basis points to 8.13%, resulting in a net yield of increase in net interest income and a $1.8 million sale at December 31, 2001, to increase by 466.4% 4.55% for the year compared to 4.86% in 2000. increase in noninterest income. Additionally, from December 31, 2000. As a result of these The current year operating costs include when excluding the impact of a $1.8 million pre- increases, interest and fees on loans outpaced depreciation and certain expenses which reflect a tax non-recurring gain recognized in 1999, net those of the preceding year, increasing $7.1 substantial investment in the future of the earnings on an operational basis were up by 9% million from $68.4 million in 2000 to $75.5 million Company as over $3 million was invested in or approximately $1.4 million in 2000 over 1999. in 2001. Total loans outstanding, net of technology upgrades, image campaigns and The improvement in net-interest income was the unearned income, including loans held for sale, marketing programs. Operating expense for 2001 result of strong loan volume and controlled reached a record level of $970.0 million at increased by $7.0 million from $31.0 million interest cost. Interest and fees on loans increased December 31, 2001. reported for 2000 to $38.0 million in 2001. The from $58.0 million in 1999 to $68.4 million in The Company’s cost of funds experienced a cost increases included the increased operating 2000, a $10.4 million, or 17.9% increase. $3.0 million dollar increase over 2000 as the level costs at UFM related to the substantial increase in Alternatively, the cost of funds increased $7.1 of deposits and borrowings also increased. the volume of loans originated and sold, the full- million over 1999. Consistent with the rate Interest expense was managed through the use year impact of Citizens Southern Bank, Inc. environment experienced during 1999, the rate EDP Steering Committee EDP Steering has been a driving force for technological improvements and enhancements. It creates a timely and efficient implementation of well developed strategic plans, while guaranteeing that customer impact guides all change. Pictured from left to right: William Bane, E. Stephen Lilly, Gary Mills. 6 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 7 paid on interest-bearing liabilities increased 43 compared to 1.51% in 2000 and 1.62% in 1999. basis points to 4.43% while the yield on earning ROE for the Company remained strong in 2001 assetsincreased 27 basispointsto 8.71%, leaving at 14.80%, compared to 15.70% in 2000 a net yield of 4.86% for 2000 compared to and 16.23% in 1999. The declining trend in 5.03% in 1999. ROE reflects the substantial growth in capital The Company’s key profitability ratios of as a result of earnings, the Citizens Southern Return on Average Assets (ROA) and Return on acquisition, and a $6.3 million addition to Average Equity (ROE) continue to reflect the average accumulated other comprehensive strong earnings performance of the Company and income on the Company’s Available for substantially exceeded the average of the Sale (AFS) securities portfolio. The improved Company’s national peers at 1.08% and mark-to-market on AFS securities is the principal 12.97%, respectively. ROA, which measures the reason for the 90 basis point decline in ROE Company’s stewardship of assets, was at 1.49%, between 2000 and 2001. Items Processing Center First Community’s state-of-the-art image capture processing center has significantly reduced the bank’s overhead. Our Items Processing Center not only provides increased capacity, but also provides the flexibility that allows customization of the product offering. Pictured from left to right: Peggy Clark, Charles Asbury, Garry Stutts, Mike Baker. 7 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 8 Five-Year Selected Financial Data (Amounts in Thousands, Except Percent and Per Share Data) Balance Sheet Summary (at end of period): Loans, net of unearned income Loans held for sale Allowance for loan losses Securities Total assets Deposits Other indebtedness Stockholders’ equity Summary of Earnings: Total interest income Total interest expense Provision for loan losses Non-interest income Non-interest expense Income tax expense Net income Per Share Data: Basic and diluted earnings per common share Cash earnings per share (1) Cash dividends Book value at year-end Selected Ratios: Return on average assets Return on average equity Dividend payout Average equity to average assets Risk based capital to risk adjusted assets Leverage ratio 2001 2000 1999 1998 1997 $ 904,496 65,532 13,952 395,891 1,478,235 1,078,260 145,320 133,041 $ 811,256 11,570 12,303 283,298 1,218,017 899,903 138,015 120,682 $ 704,096 N/A 11,900 290,873 1,088,162 833,258 10,218 103,488 $ 611,493 N/A 11,404 277,210 1,053,988 875,996 18,176 101,719 $ 671,817 N/A 11,406 270,969 1,042,304 853,507 24,330 97,842 92,829 42,409 5,134 20,275 38,025 8,402 19,134 1.92 2.05 0.89 13.39 85,958 39,379 3,986 12,492 30,968 7,054 17,063 1.78 1.96 0.86 12.14 76,492 32,250 2,893 10,732 27,457 7,722 16,852 1.75 1.93 0.80 10.78 81,213 38,128 6,250 11,182 28,752 6,164 13,101 1.35 1.54 0.76 10.55 75,834 32,890 4,963 8,661 24,672 6,876 15,094 1.55 1.68 0.75 10.07 % 1.49 % 1.51 % 1.62 % 1.24 % 1.59 16.05 16.23 48.54 45.83 9.90 9.96 11.96 13.22 6.96 8.25 15.70 48.72 9.64 12.93 8.37 13.02 56.38 9.50 13.25 7.37 14.80 46.23 10.05 12.10 7.93 (1) Cash earnings per share represent earnings per share adjusted for non-cash charges for amortization of goodwill and other intangibles. Trust and Financial Services Our Trust and Financial Services Division has remained up-to-date with modern technologies and increased productivity by combining electronic forms capability with workflow control in our trust accounting system. Customers can be assured of daily account evaluations and access to their account information at any time through the Internet. Pictured from left to right: Diana Coulthard, Joe Keatley. 8 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 9 Common Stock and Dividends Stock Performance The Company’s common stock has historically traded in the over-the-counter market; however, on March 1, 2001, the Company began trading on the NASDAQ® Small-Cap Market under the symbol FCBC. On December 31, 2001, First Community’s year-end common stock price was $29.47, a 66% increase over the $17.75 closing price on December 31, 2000. Book value per common share was $13.39 at December 31, 2001, compared with $12.14 at December 31, 2000, and $10.78 at the close 2001 First Quarter Second Quarter Third Quarter Fourth Quarter 2000 First Quarter Second Quarter Third Quarter Fourth Quarter Bid High Low Book Value Cash Dividends Per Share Per Share $ $ 18.88 $ 30.00 33.80 31.60 21.00 $ 18.88 16.13 17.00 17.13 17.85 29.75 23.75 17.25 15.00 15.00 14.00 $ $ 412.64 12.85 13.33 13.39 10.93 11.14 11.54 12.14 $ $ $ $ 0.21 0.21 0.21 0.26 0.89 0.20 0.21 0.21 0.24 0.86 of 1999. The year-end market price for First year trading at a price/earnings multiple of 15.4 Net Interest Margin Community common stock of $29.47 represents times basic earnings per share. Net interest margin measures net interest 220% of the Company’s book value as of the Dividends for 2001 totaled $.89 per share, up income as a percentage of average earning close of the year and reflects total market $.03 or 3.49% from the $.86 paid in 2000. The assets. In 2001, the net interest margin was capitalization of $292.8 million. Utilizing the year- 2001 dividends resulted in a cash yield on the 4.55% for the year, below the 4.86% and 5.03% end market price and 2001 basic earnings per year-end market value of 3.02%. Total dividends levels attained in 2000 and 1999, respectively. share, First Community common stock closed the paid for the current and prior year, totaled $8.9 The current year’s decrease was due in large part and $8.3 million, respectively. to the general decline in the interest rate Product Alignment FCB’s product alignment project followed the creation of a customized product set designed to meet all customers’ needs. This project enhanced the development of company-wide marketing campaigns. Pictured from left to right: Trish Malcomb, Doug Kennedy, Beverley Neal, Donna Clay. 9 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 10 environment during 2001 and associated deposits and short-term borrowings. The FHLB due to changes in rates on these assets and reductions in loan and investmentyields. Average provides a moderately priced funding source liabilities. The increase in net interest income in loans, which include loans held for sale, and is a significant component of the Company’s 2001 was primarily due to a $161.1 million or increased $95.3 million in volume and resulted in funding and liquidity plans. 15.7% increase in average earning assets over an additional $7.1 million in interest and fees on Net Interest Income loans despite the previously referenced decline in asset yield. The increase in average loan and securityvolume was partially offset by a reduction in yield on the underlying assets and, as a result, total interest income increased $6.9 million. Volume increases also led to increases in interest on total deposits of $1.2 million and interest expense on short-term borrowings of $1.9 million. Short-term borrowings, including retail repurchase agreements with existing bank customers and FHLB advances, increased $66.9 million, however, with a corresponding 22 basis point decline in the cost of these sources. In 2001, significant increases in the loan portfolio were funded with a combination of increased The primary source of the Company’s earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and short-term borrowings represent the major portion of interest-bearing liabilities. On a tax equivalent basis, net interest income increased $4.1 million, or 8.3% in 2001 compared to $2.2 million, or 4.6% in 2000 and $1.3 million, or 2.7% in 1999. The increase in 2001 was the net result of a $6.4 million increase due to the volume of interest-earning assets and interest-bearing liabilities and a $2.3 million decrease 2000. Also 2000 net interest income was boosted by a similar $78.1 million or 8.25% increase in average earning assets experienced over the previous corresponding level in 1999. The current year increase in average earning assets was the result of a $136.8 million increase in average total loans, an $8.5 million increase in average investment securities and a $16.1 million increase in other interest-bearing assets. The 2000 increase in average earning assets of $78.1 million was primarily the result of a $110.2 million increase in average loans with an offsetting $19.8 million decrease in average investment securities and a $12.3 million decrease in average interest- bearing balances with banks and fed funds sold. The net yield on earning assets was 8.13% in Database Merger FCB’s database merger verification team played an important role in the merging of our customers’ account records and information. This project enhanced efficiency while providing seamless customer service. Pictured from left to right: Brenda Rose, Pam Hinkle (seated), Amy Hall, Esther Fulford. 10 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 11 2001, compared to 8.71% in 2000, while the cost is attributable to the Company’s restructured loan volume, allowance for loan losses was of funds was 4.21% in 2001, compared to deposit set, new products and enhanced increased through provisions to maintain 4.43% in 2000. marketing campaigns. The branch acquisitions in reserves at levels reflecting historical loss rates. Average interest-bearing liabilities increased late 2001 contributed approximately $2.1 million The 2000 provision for loan losses of $4.0 million $118.9 million in 2001, which is largely in average earning assets for the current year. was elevated in comparison to 1999, primarily attributable to increases in deposits of $79.4 million. Reflected in the increase in average interest-bearing liabilities was a $76.4 million increase in interest-bearing deposits and a $42.5 million increase in short-term borrowings and other indebtedness. Additionally, there was a $17.6 million increase in average non-interest bearing demand deposits compared to the prior year. The acquisition of Citizens Southern Bank in late 2000 accounted for approximately $43 million of the 2001 average interest-bearing deposit gain but was supplemented by double- digit internal growth in deposits within existing markets in WestVirginia. Stronger internal growth Provision for Loan Losses The provision for loan losses was $5.1 million in 2001, $4.0 million in 2000 and $2.9 million in 1999. The provision and underlying allowance for loan losses is quantified through a series of objective measures, economic indications, and estimated levels of anticipated losses within various loan types that portray due to adjustments to the net realizable value of two commercial accounts that were in various stages of resolution, as well as, substantial increases in outstanding loan balances at December 31, 2000, in comparison to the volume of loans outstanding at December 31, 1999. See further discussion under “Allowance For Loan Losses” on Page 18. inherent weaknesses. Non-interest Income The current year provision of $5.1 million Non-interest income primarily consists of increased by $1.1 million from 2000 in response fiduciary income on trust services, service to current economic conditions that suggest, charges on deposit accounts and income derived through statistically compiled industry analysis, from the origination and sale of mortgages. The an increase in national charge-off trends. largest contributors to the current year increase in Additionally, due to the substantial increase in non-interest income were the origination and sale Wide Area Network FCB’s major infrastructure upgrade facilitates faster, more secure and efficient communications. This implementation has provided us with better management of our technical resources via a central control. Pictured: James Heath 11 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 12 of mortgages through United First Mortgage, Inc. by UFM. UFM added an additional $3.4 million in and can be cyclical in nature. Trust revenues, as and the effective utilization of the Company’s new revenues in 2000 versus 1999. When excluding described above, are comprised of fees for asset and restructured deposit product set, including the impact of the aforementioned $1.8 million management and estate settlement. Expenses “Overdraft Honor™”. UFM, acquired in the latter gain recorded in 1999, recurring non-interest associated with the operation of the Trust and part of 1999 and in the second full year of revenues increased by $3.6 million or 33.6% Financial Services Division are included in non- operations as a subsidiary of First Community’s during 2000. interest expense. banking subsidiary, generated a $4.9 million Fiduciary income totaled $1.8 million in both Service chargeson depositaccountsare one of increase in other income in comparison to the 2001 and 2000 versus $2.1 million in 1999. The the largest sources of noninterest income. Service prior year. Non-interest income totaled $20.3 level of trust and estate revenues remained charge income totaled $5.97 million in 2001, an million in 2001, a $7.8 million increase or 62.3% consistent in 2001 even though the total market increase of $1.96 million or 48.9% over 2000. The over the $12.5 million recognized in 2000 and a value of the assets managed declined in current year increase is largely attributed to a $9.6 million or 88.9% increase over the 1999 total conjunction with weaker valuations in the broad program developed for well managed demand of $10.7 million. Additionally, the increase in equity markets. The primary reason for the deposit accounts, “Overdraft HonorTM,” that allows service charges on deposit accounts, primarily variance between 2001 and 2000 revenues the customer greater flexibility in managing attributed to the “Overdraft Honor™” deposit versus 1999 was the difference in the number and overdrafts to their accounts. As a result of this account program, generated an additional $2.0 size of estates administered in the respective program, approximately $4.6 million in deposit million in non-interest income in 2001. years. The volume of revenue generated from account charges were recorded in 2001 in contrast The increase in total non-interest income in sources such as trust estate and asset to the $2.6 million recorded in 2000. The 2000 of $1.8 million in comparison to 1999 was management services is highly dependent upon aforementioned deposit account program was driven by the impact of the fee income generated the corresponding assets under management introduced in the latter part of 2000 and is the AS400 Upgrade The AS400 upgrade increases our ability to support growth of the FCB franchise. By taking advantage of the system’s advanced capabilities, the door is left open for other beneficial technologies. Pictured: Brian Broyles 12 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 13 primary reason for the recognition of $4.0 million increase in non-interest expense in 2001 of $7.0 2001. The $3.5 million increase in non-interest in service charges on deposit accounts recorded million relates, in part, to the increase in expense in 2000 relates largely to the impact of a in 2000, an increase of $0.4 million, or 10.0% operational costs experienced by UFM as a result full year’s operation of UFM, acquired in from 1999. of the substantial increase in production and the September 1999, and the two months of Other service charges, commissions and fees addition of new branches during the year. operation of Citizens. UFM and Citizens increased slightly by $74,000 in 2001 versus Operating costs at UFM increased by $3.1 million contributed additional operating costs of 2000. This increase was primarily a result of the over the prior year. This increase is largely related $3.8 million and $144,000, respectively, in increasing customer base serviced due to both to the variable operating cost of commissions and comparison to the 1999 year. During 2000, acquisitions of new branches and a general brokerage fees incurred in connection with the reductions of approximately $440,000 were increase in customer accounts experienced at increase in production levels. Additionally, achieved in the existing banking operations existing bank branches. Other service charges, operating cost increases were experienced in through the utilization of newer equipment and commissions and fees increased by $0.3 million relation to the full-year operations of new cost reductions achieved due to the sale of a or 24.3% in 2000 versus 1999. branches acquired in the Citizens Southern Bank portion of other real estate owned and under- Non-interest Expense Non-interest expenses consist of salaries and benefits, occupancy, equipment and all other operating expense incurred by the Company. Non-interest expense totaled $38.0 million in 2001, compared with $31.0 million and $27.5 million in 2000 and 1999, respectively. The acquisition (approximately $0.9 million), as well utilized banking facilities. as the opening of the new branch in Athens, West Salaries and employee benefits increased Virginia ($168,000), and the acquisition of four $3.8 million, or 23.6%, between 2000 and 2001 , branches from BB&T and F&M in December 2001. and $2.9 million in comparing 2000 to 1999. The Other increases include the cost of consolidating current year increase relates largely to the the Company’s customer databases and expenses of UFM operations and its significant substantial marketing campaigns undertaken in increase in production in 2001. Salary and Resource–FCB Online Banking With the Resource–FCB Online Banking, customers can take advantage of fast, convenient banking anytime and anywhere they choose. First Community Bank’s online banking service utilizes image technology to provide more feature functionality than most competing products. 13 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 14 benefit costs increased by $1.9 million as a result ($85,000) and UFM ($45,000). The $350,000 of its ability to manage and control costs. As of these increases in production levels during the increase between 1999 and 2000 is primarily this ratio decreases, more of the net interest current year. The addition of the Citizens’ attributed to the acquisition of UFM in 1999 which income earned is realized as net income. The net branches, which added $625,000 in salary and resulted in an increase of $270,000. The prior overhead ratios for 2001, 2000 and 1999 benefit cost to the current year as a result of the year also was impacted by two months of were 1.39%, 1.64% and 1.96%, respectively. first full year of operations of these facilities as operations of Citizens and existing facility cost Improvements in 2001 and 2000 ratios reflect well as a general increase in staffing levels of the increases of approximately $80,000. substantial increases in non-interest revenues bank to support the growth of the Company. Furniture and equipment cost increased associated with UFM and the Company’s During 2000, the effect of the full year of $116,000 or 6.8% as the Company continued to restructured product set. operations of UFM and three months of invest in the development of its technology The Company’s efficiency ratio also measures operations of Citizens added an additional $2.7 infrastructure. The prior year costs declined by management’s ability to control costs and million and $90,000, respectively, in additional $45,000 in comparison to 1999. Both years reflect maximize net revenues. The efficiency ratio is personnel cost. the reduced maintenance cost on newer computed by dividing non-interest expense by Occupancy expense increased $133,000 or equipment that has been added over the last the sum of net-interest income plus non-interest 5.4% between 2000 and 2001 and $350,000 or several years and new technology utilized in income (all non-recurring items and amortization 16.4% between 1999 and 2000. The current year check processing. of intangibles are excluded). The efficiency ratios increase relates to the full year maintenance of The Company’s net overhead ratio (non- for 2001, 2000 and 1999 were 47.8%, 45.8% and the additional branch facilities of Citizens as well interest expense less non-interest income 44.2%, respectively. The increase in the current as a general level of increased maintenance cost excluding security gains and non-recurring gains and prior year is reflective of the higher operating throughout the banking facilities of FCBNA divided by average earning assets) is a measure costs incurred by UFM in the development of a Branch Capture First Community Bank’s branch capture has allowed for acquisitions that are not geographically contiguous to our existing branches. Branch capture makes it possible for FCB to operationally assimilate acquisitions using the technology and capacity of image processing systems. This technology provides FCB with limitless expansion potential, and gives us the opportunity to target geographical areas that better fit our growth strategy. Pictured: Dawn Williams 14 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 15 FCB Franchise Map With 38 full service banking facilities strategically located in West Virginia, Virginia and North Carolina, along with 10 mortgage-brokerage facilities operated by United First Mortgage, Inc., headquartered in Richmond, VA. FCB positions itself as the first financial resource for more and more customers everyday. 15 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 16 new wholesale division which began production and industrial revenue bonds and tax-free reduced to 4.2 years and 4.5 years at December in the latter part of 2000, as well as the Bank’s loans. The effective tax rate for 2001 was 2001 and 2000, respectively. addition of new branch facilities, including the 30.5% as compared with 29.3% for 2000 and The held to maturity investment portfolio of Citizens branches acquired in the latter part of 31.6% in 1999. 2000, the BB&T and F&M branches acquired in December 2001, and the recently constructed branch facility in Athens, West Virginia. Securities Held to Maturity Investment securities held to maturity are comprised largely of U.S. Agency obligations Income Tax Expense and state and municipal bonds. U.S. Agency Income tax expense totaled $8.4 million in obligations include securities issued by various 2001, compared with $7.1 million in 2000 and government corporations and agencies, $7.8 million in 1999. The $1.3 million increase including Federal Home Loan Bank (FHLB), between 2000 and 2001 is reflective of the higher Federal National Mortgage Association (FNMA), level of pre-tax earnings and the earnings Government National Mortgage Association contribution from UFM. Pre-tax earnings (GNMA), and Federal Home Loan Mortgage increased $3.7 million between 2000 and 2001. Corporation (FHLMC). $41.9 million decreased by $33.9 million between 2000 and 2001. This decrease is primarily the result of the reclassification of $32.5 million of securities previously accounted for in the held to maturity portfolio to the available for sale portfolio at market value, as permitted upon adopting Financial Accounting Standards Board (FASB) Statement 133, Accounting for Derivative Instruments and Hedging Activities, on January 1, 2001. The netcash flow generated bythe portfolio during 2001 was invested in new loans as a result of the higher level of loan demand experienced in The slight decrease in the prior year is reflective of Obligations of state and political subdivisions, the current year. an increased level of tax-exempt earnings which represent the largest portion of the held to Securities Available for Sale generated from state and municipal bonds within maturity portfolio, totaled $39.8 million at Securitiesavailable for sale are used aspartof the Company’s investment portfolio. This change December 31, 2001. These are comprised of high- management’s asset/liability strategy. These is reflective of the general increase in the sector grade municipal securities generally carrying AAA securities may be sold in response to changes in distribution of investments into tax-exempt bond ratings, most of which also carry credit interest rates, changes in prepayment risk, for municipal securities and the development of tax enhancement insurance by major insurers of liquidity needs and other factors. These securities strategies that have enabled further reductions in investment obligations. The average final are recorded at market value. taxable earnings. maturity of the investment portfolio increased At December 31, 2001, the Company had The major difference between the statutory from 8.92 years in 2000 to 9.79 years in 2001 with $354.0 million in securities available for sale, tax rate and the effective tax rate (income tax the tax equivalent yield increasing from 8.54% at compared with $207.6 million at year-end 2000, expense divided by pre-tax book income) results year-end 2000 to 8.59% at the close of 2001. The an increase of $146.4 million or 70.5%. The from income not taxable for Federal income tax average maturity of the investment portfolio, increase in the portfolio was due primarily to the purposes. The primary category of non-taxable based on market assumptions for prepayment, is purchase of $232.1 million and the FAS 133 income is that of state and municipal securities reclassification of $32.5 million from the held to 16 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 17 maturity portfolio as discussed earlier. These substantially shorter because of callability and increases were offset by maturities, calls and prepayment provisions. The average maturity, mortgage-backed security principal payments based on market assumptions for prepayment, and prepayments of $102.5 million, and sales of changes to 5.4 years and 4.0 years, respectively, $18.7 million. at December 31, 2001 and 2000. The fair value of securities available for sale exceeded book value at year-end 2001 by $1.2 million. The increase in the fair value of the securities available for sale is a direct result of the inverse relationship between existing market rates and the pricing of the securities. When market rates decrease, as they did in 2001, for similar instruments that are currently in the portfolio, the corresponding price of the security rises and an opposite effect occurs as rates rise. The tax equivalent purchase yield on securities available for sale, which was relatively unchanged in the current year, was 6.52% in 2001 and 6.54% in 2000. The average final maturity of the available for sale portfolio was 14.8 years and 11.5 years at December 31, 2001, and 2000, respectively. The increase in average final maturity was the result of a $232 million investment in securities to achieve higher tax equivalent yields in response to the declining interest rate environment. The securities purchased consisted of callable agencies (78%), municipals (14%) and corporate notes (8%). The lives and average maturities of these longer-term securities are expected to be Loan Portfolio Loans Held for Sale Loans held for sale were $65.5 million at December 31, 2001, compared with $11.6 million at December 31, 2000, an increase of $53.9 million, or 466.40%. The increase is due to a substantial increase in mortgage refinance activity prompted by the lower interest rate environment during 2001. Loans originated for sale during the current year were $563.0 million versus $106.2 million in 2000. Loans Held for Investment The held for investment loan portfolio is geographically diversified among loan types and industry segments. Commercial and commercial real estate loans represent 46.6% of the total portfolio. During 2001, commercial real estate loans increased by $37.1 million to $260 million comprising 28.7% of total loans. Commercial loans experienced the largest dollar and percentage growth, increasing by $75.3 million and representing 17.9% of total loans. The combined commercialand commercialrealestate sectors increased by $112.4 million, or 36.3% in 17 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 18 2001. Real estate construction loans, which deposit base, declined slightly, in comparison, Managementperformsquarterlyassessments comprised 8.6% of the portfolio, grew $4.3 from the prior year level of 91% to 90% at to determine the appropriate level of allowance. million. This category includes both residential December 31, 2001. The decrease in the loan to Differences between actual loan loss experience and commercial construction with the increase deposit ratio is reflective of the $147.2 million and estimates are reflected through adjustments attributable to a number ofdevelopmentprojects. increase in the loan portfolio (including loans that are made by either increasing or decreasing Additionally, consumer loans increased by $2.7 held for sale) coupled with a larger and offsetting the loss provision based upon current million, or 2.1%, from $134.3 million at December increase in deposits of $178.4 million. In addition measurement criteria. Commercial, consumer 31, 2000, to $137.1 million at the close of 2001. to the previously mentioned increase in loans as and mortgage loan portfolios are separated for Consumer loans represented 15.3% and 16.6% of a result of the recent branch acquisitions purposes of determining the allowance. The the portfolio at the close of 2001 and 2000, completed in the fourth quarter of 2001, a similar specific components of the allowance include respectively. Residential real estate loans but larger increase in deposits was achieved allocations to individual commercial credits and increased by $27.4 million, or 9.0% in 2001 and in this acquisition of $113.5 million in deposits. allocations to the remaining non-homogeneous represented 29.5% of the total portfolio at the The additional deposits and loans acquired and homogeneouspoolsofloans. Management’s end of 2001. in the branch acquisition accounted for allocations are based on judgment of qualitative Loans held for investment, net of unearned approximately 12.6% and 3.8% of the total and quantitative factors about both the macro income, were $904.5 million at December 31, annual increase in deposits and loans held for and micro economic conditions reflected within 2001. The increase of $93.2 million represents investment respectively. the portfolio of loans and the economy as a 11.5% growth from the $811.3 million level at December 31, 2000. The fourth quarter acquisition of four branches from BB&T and F&M accounted for $31.0 million of this growth. The addition of these loans did not materially affect the distribution of loan product types within the portfolio. First Community continues to place a strategic emphasis on relationship management and development. This style has continued to result in substantial increases in the total loan portfolio. The total loan to deposit ratio, a measure of the volume of loans supported by the customer Allowance for Loan Losses The allowance for loan losses is maintained at a level sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provisions for loan losses and recoveries of prior loan charge-offs, and decreased by loans charged off. The provision for loan losses is calculated to bring the reserve to a level which, according to a systematic process of measurement, is reflective of the required amount needed to absorb probable losses inherent in the loan portfolio. whole. Factors considered in this evaluation include, but are not necessarily limited to, probable losses from loan and other credit arrangements, the general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, trends in portfolio volume, maturity, composition, delinquencies and non-accruals. The current economic climate and impacts of the events of September 11, 2001, have resulted in the need for enhanced portfolio scrutiny in certain sectors of the portfolio and, as a result, the necessity for a higher level of the allowance for loan losses. 18 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 19 Non-Performing Assets (Amounts in Thousands) Non-accrual Loans Loans 90 Days or more Past Due Other Real Estate Owned Non-performing loans as a percentage of total loans Non-performing assets as a percentage of total loans and other real estate owned Allowance for loan losses as a percentage of non-performing loans Allowance for loan losses as a percentage of non-performing assets December 31, 2001 2000 1999 1998 1997 $ 3,633 1,351 3,029 $ 8,013 $ 5,397 1,208 2,406 9,011 $ 7,889 1,259 1,950 $ 7,763 377 3,547 $ 9,988 4,391 1,472 11,098 11,687 15,851 % 0.6 % 0.8 % 1.3 % 1.3 % 2.1 0.9 279.9 % 174.1 1.1 186.3 2.4 79.3 % 136.5 % 107.2 % 97.6 % 72.0 1.9 140.1 1.6 130.1 As the fourth quarter progressed, with reports of combined with non-performing loans, the achieved despite the substantial increase in the business reductions and large-scale layoffs, it allowance equals 174% of non-performing assets size of the loan portfolio. Net charge-offs for 1999 became apparent that the general model for at the end of 2001 versus 137% and 107% at are reflective of the volume of loans outstanding quantifying the adequacy of the allowance December 31, 2000 and 1999, respectively. during that year and the level of charge-off required adjustment to reflect recessionary Net charge-offs were $4.0 million in 2001, activity experienced. pressures and economic uncertainty. As a result compared with $4.6 million in 2000 and $2.4 Non-performing Assets of this review, the allowance for loan losses million in 1999, respectively. The $0.6 million increased by approximately $1.6 million as of decrease in net charge-offs in 2001 is principally December 31, 2001, compared to December 31, attributable to a commercial loan charge-off in 2000. Included in this increase was $0.5 million 2000 relating to the foreclosure of a residential designated for loans acquired in the branch land development loan in Beckley, West Virginia, acquisition completed in the fourth quarter of as well as the write-down of a commercial loan in 2001. While management has attributed the 2000 to reflect the estimated current market allowance for loan losses to various portfolio value at that time of the real estate securing the segments, the allowance is available for the loan (a vacant convenience store) and Non-performing assets include loans on which interest accruals have ceased, loans contractually past due 90 days or more and still accruing interest, and other real estate owned (OREO) pursuantto foreclosure proceedings. Total non-performing assets were $8.0 million at December 31, 2001 compared to $9.0 million at December 31, 2000. The levels of non-performing assets for the last five years are presented in the entire portfolio. surrounding property. A subsequent, but smaller, table above. The allowance for loan losses represents write-down of this loan was effected again in late 280% of non-performing loans at year-end 2001 2001, based on the lack of resolution of the asset versus 186% and 130% at December 31, 2000, at the previously adjusted carrying value. The and 1999, respectively. When other real estate is current year decrease in net charge-offs was Non-performing assets decreased $998,000 between 2000 and 2001, led primarily by a $1.8 million or 32.7% decline in non-accrual loans; however, this decline was partially offset by an 19 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 20 increase of $623,000 in other real estate owned impact in 2001 of the deposits from Citizens interest margin, and to act as a resource in and an increase of$143,000 in loans90 dayspast Southern which was acquired in October 2000. developing new products and establishing due. The decrease in non-accrual loans resulted Average savings deposits decreased slightly by pricing guidelines. from the resolution or liquidation of a number of $3.7 million while time deposits increased by Other Indebtedness commercial loan relationships as well as the $66.5 million. Average interest-bearing demand write-down of a commercial loan to reflect the and noninterest bearing demand deposits net realizable value of the asset. Additionally, increased by $13.7 million and $17.7 loans past due over 90 days increased by only million, respectively. Also affecting the general $143,000 despite the substantial increases in increase in average deposits were the the loan portfolio over the past two years. branch acquisitions completed in the fourth Deposits quarter of 2001. FHLB borrowings and other indebtedness, which represent long-term advances from the FHLB, and structured term borrowings from the FHLB increased by $10.0 million in 2001. The increase is attributable to the substantial loan growth experienced throughout the current year. Fixed rate FHLB advances and applicable interest Total deposits at December 31, 2001, Short-Term Borrowings rates were $10.0 million (4.30%), $8.0 million increased $178.4 million or 19.8% when The Company’s short-term borrowings (5.95%) and $2.0 million (6.27%) maturing in compared to December 31, 2000. Approximately consist primarily of overnight Federal Funds 12/2002, 9/2003 and 9/2008, respectively. $113.5 million of the increase related to deposits purchased from the FHLB and securities sold Additional borrowings, which represent acquired through the branch acquisitions of under agreements to repurchase. This category of indebtedness of approximately $125.0 million, Clifton Forge, Emporia and Drakes Branch, funding is a source of moderately priced short- are comprised of structured term convertible Virginia, on December 7, 2001. Not considering term funds. Short-term borrowings increased on advances from the FHLB with final maturities the acquisition, deposits increased for the year by average approximately $3.6 million in between two and ten years. These convertible $64.7 million. The Company utilized short-term comparison to the prior year. The increase in advances are callable by the FHLB based upon advances from the Federal Home Loan Bank to average short-term borrowings in 2001, along predefined factors in quarterly increments after a supplement the funding needs of the Company with the increase in average deposits of $94.0 lockout period that may substantially shorten the throughout 2000 and 2001. In 2001, the average million was accompanied by an offsetting lives of these instruments. The callability of these rate paid on interest bearing liabilities was 4.21%, increase in total loans as these funds were used instruments is controlled by and at the option of down from the 4.43% in 2000. to finance the loan portfolio growth. The price the FHLB. The convertible advance with the Average deposits increased to $939.8 million sensitivity of funding cost is managed by the earliest maturity ($25.0 million) occurs in June for 2001 versus $845.8 million in 2000, an Company’s “Product Group”, which monitors 2002, while the remainder ($100.0 million) increase of 11.1%, reflecting the effectiveness of product and pricing initiatives including, among matures in 2010. new product offerings and marketing campaigns other things, the management of the overall cost introduced during the year as well as a full year’s offundsto assistin maintaining an acceptable net 20 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 21 Stockholders’ Equity Financial Services Division (Trust Division). The loan principal, and the Company’s ability to Risk-based capital ratios are a measure of the Trust Division reported market value of assets generate new deposits. The Company also has Company’s capital adequacy. At December 31, under management of $486 million and $495 the ability to attract short-term sources of funds 2001, the Company’s Tier 1 capital ratio was million at December 31, 2001, and 2000, and draw on credit lines that have been 10.82% compared with 11.68% in 2000. Federal respectively. The Trust Division manages established at financial institutions to meet regulatory agencies use risk-based capital ratios intervivos trusts and trusts under will, develops cash needs. and the leverage ratio to measure the capital and administers employee benefit plans and Total liquidity of $526.9 million at December adequacy of banking institutions. Risk-based individual retirement plans and manages and 31, 2001, is comprised of the following: cash on capital guidelines, risk weight balance sheet settles estates. Fiduciary fees for these services hand and deposits with other financial assets, and off-balance sheet commitments are are charged on a schedule related to the size, institutions of $47.8 million; securities available used in determining capital adequacy. The nature and complexity of the account. for sale of $354.0 million; investment securities Company’s total risk-based capital-to-asset ratio The Trust Division employs 17 professionals held to maturity due within one year of $1.0 was 12.10% at the close of 2001 compared with and support staff with a wide variety of estate million; and Federal Home Loan Bank credit 12.93% in 2000. Both of these ratios are well and financial planning, investing and plan availability of $124.1 million. above the current minimum level of 8% administration skills. Trust Division operating prescribed for bank holding companies as expenses totaled $1.3 million in 2001 and $1.4 Interest Rate Sensitivity, Interest Rate Risk and Asset/Liability Management depicted on Page 52 of the footnotes to the million in 2000. These costs are comprised The Bank’s profitability is dependent to a financial statements. primarily of salaries and related benefits, large extent upon its net interest income (NII), The leverage ratio is the measurement of total investment services, asset custody fees and the which is the difference between its interest tangible equity to total assets. The Company’s cost of information processing systems. The Trust income on interest-earning assets, such as loans leverage ratio at December 31, 2001 was Division is located within the Company’s banking and securities, and its interest expense on 7.93% versus 8.37% at December 31, 2000, offices in Bluefield, West Virginia. Services and interest-bearing liabilities, such as deposits and both of which are well above the minimum trust development activities to other branch borrowings. The Bank, like other financial levels prescribed by the Federal Reserve as locations and primary markets are provided as an institutions, is subject to interest rate risk to the depicted on Page 52 of the footnotes to the extension of this Bluefield location. degree that its interest-earning assets reprice financial statements. Liquidity Trust and Investment Management Services Liquidity represents the Company’s ability to As part of its community banking services, the respond to demands for funds and is primarily Company offers trust management and estate derived from maturing investment securities, administration services through its Trust and overnight investments, periodic repayment of differently than its interest-bearing liabilities. The Bankmanagesitsmixofassetsand liabilitieswith the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds while 21 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 22 maintaining an acceptable level of NII given the simulations of NII are performed using financial can negatively impact net interest income in a current interest rate environment. models that project NII through a range of falling rate environment or, alternatively, The Company’s primary component of possible interest rate environments including positively impact net interest income in a rising operational revenue, NII, is subject to variation as rising, declining, most likely and flat rate rate environment. a result of changes in interest rate environments scenarios. The results of these simulations The Company has established policy limits for in conjunction with unbalanced repricing indicate the existence and severity of IRR in each tolerance of interest rate risk that allow for no opportunities in earning assets and interest- of those rate environments based upon the more than a 10% reduction in projected net bearing liabilities. Interest rate risk has four currentbalance sheetposition, assumptionsasto interest income based on quarterly income primary components including repricing risk, changesin the volume and mixofinterest-earning simulations. The most recent simulation indicates basis risk, yield curve risk and option risk. assets and interest-paying liabilities and that current exposure to interest rate risk is within Repricing risk occurs when earning assets and management’s estimate of yields attained in the Company’s defined policy limits. paying liabilities reprice at differing times as those future rate environments and rates that will The following table summarizes the impact on interest rates change. Basis risk occurs when the be paid on various deposit instruments and NII and the Market Value of Equity (MVE) as of underlying rates on the assets and liabilities the borrowings. Specific strategies for management December 31, 2001, and 2000, respectively, of institution holds change at different levels or in of IRR have included shortening the amortized immediate and sustained rate shocks in the varying degrees. Yield curve risk is the risk of maturity of new fixed-rate loans, increasing the interest rate environment of plus and minus 100 adverse consequences as a result of unequal volume of adjustable rate loans to reduce the and 200 basis points from the flat rate simulation. changes in the spread between two or more rates average maturity of the Bank’s interest-earning The results of the rate shock analysis depicted for different maturities for the same instrument. assets and monitoring the term structure of below differ from the results in quarterly Lastly, option risk is due to “embedded options” liabilities to maintain a balanced mix of maturity simulations, in that all changes are assumed to often called put or call options given or sold to and repricing structures to mitigate the potential take effect immediately; whereas, in the quarterly holders of financial instruments. exposure. The simulation model used by the income simulations, changes in interest rates In order to mitigate the effectofchangesin the Company captures all earning assets, interest- take place over a 24-month horizon simulating a general level of interest rates, the Company bearing liabilities and all off balance sheet more likely scenario for a changing rate manages repricing opportunities and thus, its financial instruments and combines the various environment. This table, which illustrates the interest rate sensitivity. The Bank seeks to control factors affecting rate sensitivity into an earnings prospective effects of hypothetical interest rate its interest rate risk (IRR) exposure to insulate net outlook. Based upon the latest simulation, changes, is based upon numerous assumptions interest income and net earnings from the Company believes that it is slightly biased including relative and estimated levels of key fluctuations in the general level of interest rates. toward an asset sensitive position. Absent interest rates over a twelve-month time period. To measure its exposure to IRR, quarterly adequate management, asset sensitive positions This type of modeling technique, although useful, 22 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 23 Rate Shock Analysis (Amounts in Thousands) 2001 Increase (Decrease) in Interest Rates (Basis Points) Net Interest Income % Change Market Value of Equity % Change 200 100 (100) (200) Increase (Decrease) in Interest Rates (Basis Points) 200 100 (100) (200) $ $ 3.5 1.9 (1.6) (6.6) (4,674) (1,338) 637 1,396 (3.3) (1.0) 0.5 1.0 1,950 1,059 (907) (3,692) 2000 Net Interest Income % Change Market Value of Equity % Change 98 698 (2,301) (4,354) 0.2 1.5 (4.8) (9.1) (12,496) (6,275) 1,113 2,675 (9.8) (4.9) 0.9 2.1 income and MVE for 2001 and 2000. Consequently, the hypothetical changes in interest rates have a larger effect on net interest income and the market value of equity in the prior year. The Company began to experience a shift in the balance sheet toward asset sensitivity in 2000, which was attributed to the reduced life of certain assets and the control measures taken in prior years, which continued throughout 2001, to reduce deposit cost and identify opportunities for product and net interest income enhancement. Asa result, the depositrepricing led to a reduction in customer deposits during 1999, a corresponding increased reliance on non-core funding sources and an increase in the overall does not take into account all strategies that When comparing the impact of the rate shock duration of equity. Since 1999, the overall management might undertake in response to a analysis between 2001 and 2000, the 2001 duration of the balance sheet has declined and sudden and sustained rate shock as depicted. changes in net interest income reflect the impact the mix of assets and liabilities is more closely Also, as market conditions vary from those of the change in the balance sheet composition of matched; however, the Company continues to assumed in the sensitivity analysis, actual results assets and liabilities and as the structure moved use short-term borrowing sources, including the will also differ due to: prepayment/refinancing toward greater asset sensitivity. Much of the FHLB as a means of funding asset growth and levels likely deviating from those assumed, the change in balance sheetcomposition isattributed satisfying liquidity needs. varying impact of interest rate change caps to the declining interest rate environment and the Bankers Insurance or floors on adjustable rate assets, the increased level of asset prepayments; whereas, potential effect of changing debt service the prior year interest rate environment was levels on customers with adjustable rate almost an inverse relationship, which reflected loans, deposit or early withdrawals and increasing rates throughout the year and product preference changes, and other internal/ corresponding lower prepayment levels. The external variables. inverse relationship is also displayed, to a certain degree, in the variances in projected net interest To further enhance its community banking services, the Company in 1999 purchased an equity interest (currently 3.62%) in a company, which has now become known as Bankers Insurance, L.L.C. (Bankers Insurance). Bankers Insurance, a limited liability company, was formed through a consortium of banks with 23 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 24 physical presence in Virginia, WestVirginia, North to create and disclose privacy policies to The Act also authorizes the establishment of Carolina, Tennessee and Maryland. The pool of their customers. Financial Holding Companies and Financial capital developed was utilized to purchase five These policies, which institutions began Subsidiaries which are eligible to engage in insurance agencies to date. These acquisitions mailing in 2001, spell out how each bank collects, activities that are “financial in nature or incidental are enabling the participating banks to uses and safeguards customer information. to financial in nature,” or activities that are collectively enter the property, casualty, life and Banks which share information with an “complementary to financial activities.” In health insurance sales market. With 14 office unaffiliated company, in some cases, must offer addition, the Act blesses as “financial in nature” locations, Bankers Insurance is the fourth largest customers the right to “opt out.” The policies the acquisition of interests in, and control of, any insurance agency in Virginia. Insurance products explain how to opt out by providing a response company, “whether financial or not,” through are now available in the bank’s branches through form or special phone number consumers securities underwriting, merchant banking, or referrals to Bankers Insurance. The Company may call. insurance company investments. In the case of believes that through its extensive network of The protection of personal identifying securities affiliates, the investment must be part bank branches and its thousands of customer information is an ongoing challenge for of a bona fide underwriting or merchant or relationships, it will be in a position to market consumers, the government and the private investmentbanking activity, including investment significant volumes of insurance, particularly sector. Like other businesses, banks are using activities engaged in for the purpose of property and casualty insurance for homes and technologies to make their products and services appreciation and ultimate resale or disposition of automobiles. The Company’s entry into the more convenient than ever. At the same time, investment. In the case of insurance companies, insurance line of business is designed to provide banks are working to ensure their policies and the portfolio investment must be made in the new sources of fee revenue and further solidify practices are in sync with our customers’ ordinary course of business of the insurance the financial relationship between the company expectations of privacy. company in accordance with relevant state law and its present customers. Additionally, The Act also protects consumers governing such investments. The Act authorizes Recent Legislation Update on The Gramm-Leach-Bliley Act of 1999 The Gramm-Leach-Bliley Act of 1999 (The Act) added important new consumer protections related to financial privacy. The law, which modernized financial services by allowing commercial banks, securities firms and insurance industries to compete with each other, also requires banks and other financial institutions bydirecting regulators to establish standardsthat the Federal Reserve Board to determine, for bank ensure the security and confidentiality of holding company affiliates, what activities are customer information; prohibit the transfer of financial in nature or incidental to financial in credit card or other account numbers to third- nature, or complementary to a financial activity. party marketers; and outlawing pretext calling To date, First Community has not opted to qualify (which involves information brokers calling banks as a financial holding company and has not to obtain customer information with the intent to initiated any new financial subsidiaries. defraud the bank or customer). 24 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 25 First Community, as well as the industry, an advanced Internal Risk Based framework extends the reach of current laws applicable to supported these provisions in The Act and while ensuring that banking organizations banks to other sectors of the financial system. remains committed to continuing its tradition of remain competitive and adequately capitalized. In order to assist identification of certain safeguarding confidential financial information. However, the proposals are complex and are not transactions, the Federal Bureau of Investigation Basel Committee Capital Accord The Basel Committee continues to work toward the development of the “New Basel Accord.” The Accord provides the conceptual framework for assessing capital adequacy in a bank through three mutually reinforcing “pillars”. The pillars address the adequate capitalization of a bank through risk assessment capital charges fully developed; therefore, the full impact of this has developed a new model, which is intended to legislation is not entirely understood at this time spot suspicious activity and money laundering but will be studied in great detail to understand schemes. Rule 3162 entitled “Uniting and the necessary preplanning and implementation Strengthening America by Providing Appropriate concerns and their overall impact. Additionally, Tools Required to Intercept and Obstruct Terrorism continued consultations and lobbying relating to Actof2001,”or the USA PatriotAct, hasa number of the issues are anticipated as well as are provisions including enhanced domestic security subsequent proposals from the Basel Committee. against terrorism, enhanced surveillance for risk inherent in the balance sheet and off balance sheet positions held, the strength of the Anti-Terrorism Legislation and Developments as a Result of September 11, 2001 control environment operated by the institution Although there were a number of rules and and market discipline of the bank to adequately proposals that were introduced subsequent to disclose the risk and capital positions of the September 11, 2001, two that have a significant bank in such a way that these positions are impact upon the banking industry include House more transparent. Resolutions (H.R.) 3004 and 3162. Banks strongly The proposed implementation of the Basel support the legislative developments embodied Committee’s new Capital Accord (final document within H. R. 3004, the “Financial Anti-Terrorism Act anticipated in 2002) is not until 2005. However, of 2001” that intensifies efforts to thwart money financial institutions affected by the Accord are laundering and terrorist financing activities. The preparing to make systems and process changes Nation’s war on terrorism has had a major impact much sooner. The Accord is intended to provide on the urgency placed on understanding and banks with incentives to evolve toward knowing customers. Importantly, H.R. 3004 procedures, an act entitled “International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001,” provisions for protecting the borders, removing obstacles to investigating terrorism, providing for victims of terrorism and their families, the requirement for increased information sharing for critical infrastructure protection, strengthening the criminal laws against terrorism and improved intelligence, among other provisions. 25 T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 26 Consolidated Financial Statements Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Cash Flow Consolidated Statements of Stockholders’ Equity Notes to Consolidated Financial Statements Report of Independent Auditors Report on Management’s Responsibilities 27 28 29 31 32 61 62 26 FCB Annual Report 2001 T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 27 Consolidated Financial Statements Consolidated Balance Sheets (Amounts in Thousands, Except Share Data) Assets Cash and due from banks Interest-bearing balances – Federal Home Loan Bank Securities available for sale (amortized cost of $352,759, 2001; $210,126, 2000) Securities held to maturity (market value, $43,393, 2001; $78,030, 2000) Loans held for sale Loans held for investment, net of unearned income Less allowance for loan losses Net loans held for investment Premises and equipment Other real estate owned Interest receivable Other assets Intangible assets Total Assets Liabilities Deposits Non-interest-bearing deposits Interest-bearing deposits Total deposits Interest, taxes and other liabilities Federal funds purchased Securities sold under agreements to repurchase FHLB borrowings and other indebtedness Total Liabilities Stockholders’ Equity Common stock, $1 par value; 15,000,000 shares authorized in 2001 and 2000; 9,955,425 shares issued in 2001 and 9,052,112 in 2000; and 9,936,442 and 9,040,370 shares outstanding in 2001 and 2000, respectively Additional paid-in capital Retained earnings Treasury stock, at cost Accumulated other comprehensive income (loss) Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity See Notes to Consolidated Financial Statements. December 31, 2001 2000 $ 47,566 249 354,007 41,884 65,532 904,496 13,952 890,544 21,713 3,029 8,765 18,468 26,478 $ 1,478,235 $ 161,346 916,914 1,078,260 15,852 26,500 79,262 145,320 1,345,194 9,955 60,189 62,566 (424) 755 133,041 $ 1,478,235 $ $ $ $ 38,457 11,786 207,562 75,736 11,570 811,256 12,303 798,953 18,786 2,406 9,261 19,299 24,201 1,218,017 128,584 771,319 899,903 13,238 – 46,179 138,015 1,097,335 9,052 35,273 78,097 (202) (1,538) 120,682 1,218,017 27 T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 28 Consolidated Statements of Income (Amounts in Thousands, Except Share and Per Share Data) 28 FCB Annual Report 2001 Interest Income Interest and fees on loans held for investment Interest on loans held for sale Interest on securities-taxable Interest on securities-nontaxable Interest on federal funds sold and deposits in banks Total interest income Interest Expense Interest on deposits Interest on short-term borrowings Interest on other indebtedness Total interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest Income Fiduciary income Service charges on deposit accounts Other service charges, commissions and fees Mortgage banking income Net securities gains Other operating income Total non-interest income Non-interest Expense Salaries and employee benefits Occupancy expense of bank premises Furniture and equipment expense Goodwill and core deposit amortization Other operating expense Total non-interest expense Income before income taxes Income tax expense Net Income Weighted average basic shares outstanding Weighted average diluted shares outstanding Basic and diluted earnings per common share See Notes to Consolidated Financial Statements. 2001 Years Ended December 31, 2000 1999 $ 72,582 2,956 10,259 6,190 842 92,829 31,884 9,913 612 42,409 50,420 5,134 45,286 1,815 5,966 1,435 9,582 181 1,296 20,275 19,830 2,615 1,814 2,285 11,481 38,025 27,536 8,402 19,134 9,944,310 9,980,919 1.92 $ $ $ $ $ 68,132 281 11,543 5,575 427 85,958 30,718 8,045 616 39,379 46,579 3,986 42,593 1,804 4,007 1,361 4,651 1 668 12,492 $ 57,978 58 11,882 5,689 885 76,492 29,137 2,332 781 32,250 44,242 2,893 41,349 2,092 3,640 1,095 1,204 – 2,701 10,732 16,046 2,482 1,698 2,154 8,588 30,968 24,117 7,054 17,063 9,607,217 9,607,217 1.78 13,132 2,128 1,743 2,049 8,405 27,457 24,624 7,772 16,852 9,642,830 9,642,830 1.75 $ $ T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 29 Consolidated Statements of Cash Flow (Amounts in Thousands) Operating Activities Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for loan losses Depreciation of premises and equipment Amortization of intangibles Net investment amortization and accretion Net gain on the sale of assets Mortgage loans originated for sale Proceeds from sale of mortgage loans Decrease (increase) in interest receivable (Increase) decrease in other assets Increase (decrease) in other liabilities Other, net Net cash (used in) provided by operating activities Investing Activities Cash flows from investing activities: Proceeds from sales of securities available for sale Proceeds from maturities and calls of securities available for sale Proceeds from maturities and calls of investment securities Purchase of securities available for sale Net increase in loans made to customers Purchase of bank-owned life insurance Cash provided by (used in) branch acquisitions, net Purchase of premises and equipment Proceeds from sale of equipment Net cash used in investing activities 2001 Years Ended December 31, 2000 1999 $ 19,134 $ 17,063 $ 16,852 5,134 1,490 2,119 485 (7,659) (563,018) 516,812 874 (175) 2,728 (17) (22,093) 18,907 102,458 1,602 (232,056) (67,115) – 77,021 (3,462) 127 (102,518) 3,986 1,396 2,156 233 (2,517) (106,169) 100,148 (861) 8,454 66 (296) 23,659 2,163 17,849 3,016 (4,591) (66,918) (4,100) 3,065 (1,019) 466 (50,069) 2,893 1,413 2,020 483 (832) – – (1,060) (3,668) (754) 80 17,427 8,203 30,881 5,278 (69,611) (87,986) – (1,417) (2,222) 82 (116,792) 29 T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 30 Consolidated Statements of Cash Flow (continued) (Amounts in Thousands) Financing Activities Cash flows from financing activities: Net increase (decrease) in demand and savings deposits Net increase (decrease) in time deposits Net increase in short-term debt Repayment of long-term debt Acquisition of treasury stock Cash paid in lieu of fractional shares Dividends paid Net cash provided by financing activities Cash and Cash Equivalents Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year See Notes to Consolidated Financial Statements. 2001 Years Ended December 31, 2000 1999 $ $ 36,144 28,625 66,902 (14) (599) – (8,875) 122,183 (2,428) 50,243 47,815 $ $ (7,755) 22,731 35,126 (39) (2,869) – (8,338) 38,856 $ (23,154) (19,579) 80,082 (7,993) (1,542) (18) (7,730) 20,066 12,446 37,797 50,243 (79,299) 117,096 37,797 $ 30 FCB Annual Report 2001 T30290-ConFinSt.qx4 3/8/02 12:32 PM Page 31 Consolidated Statements of Stockholders’ Equity (Amounts in Thousands, Except Share and Per Share Information) Balance December 31, 1998 Comprehensive income: Net income Other comprehensive income Unrealized holding losses on securities available for sale, net of tax Less reclassification adjustment for gains realized in net income, net of tax Comprehensive income Common dividends declared ($.80 per share) Purchase 71,589 treasury shares at $21.54 per share Allocation of ESOP shares Balance December 31, 1999 Comprehensive income: Net income Other comprehensive income Unrealized holding gains on securities available for sale, net of tax Less reclassification adjustment for gains realized in net income, net of tax Comprehensive income Common dividends declared ($.86 per share) Retirement of treasury shares Issuance of common stock Purchase 145,682 treasury shares at $19.70 per share Allocation of ESOP shares Balance December 31, 2000 Comprehensive income: Net income Other comprehensive income Unrealized holding gains on securities available for sale, net of tax Less reclassification adjustment for gains realized in net income, net of tax Comprehensive income Common dividends declared ($.89 per share) Purchase 27,036 treasury shares at $22.17 per share Allocation of ESOP shares Effect of 10% stock dividend Balance December 31, 2001 See Notes to Consolidated Financial Statements. Common Stock Additional Paid-in Capital Retained Earnings Treasury Stock Accumulated Other Compre- hensive Income (Loss) Unallocated ESOP Shares Total $ 8,992 $ 34,306 $ 60,250 $ (1,403) $ (1,664) $ 1,238 $ 101,719 – – 16,852 – – – 16,852 – – – – – – 8,992 – – – – – (42) 34,264 – – 16,852 (7,730) – – 69,372 – – – – (1,542) – (2,945) – – – – – 942 (722) (6,711) – (6,711) – – – (5,473) (6,711) – 10,141 (7,730) (1,542) 900 103,488 – – 17,063 – – – – (374) 434 – – 9,052 – – – – (5,238) 6,343 – (96) 35,273 – – 17,063 (8,338) – – – – 78,097 – – – – 5,612 – (2,869) – (202) – – 17,063 – – – – – – – 722 – 3,935 – 3,935 – – – – – (1,538) 3,935 – 20,998 (8,338) – 6,777 (2,869) 626 120,682 – – 19,134 – – – 19,134 – – – – – – 903 – – – – – 29 24,887 – – 19,134 (8,875) – – (25,790) – – – – (599) 377 – $ 9,955 $ 60,189 $ 62,566 $ (424) $ – – – – – – – – $ 2,402 (109) 2,293 – – – – 2,402 (109) 21,427 (8,875) (599) 406 – 755 $ 133,041 31 T30290-Notes.qx4 3/8/02 12:35 PM Page 32 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies Basis of Presentation retroactively adjusted in accordance with intends to use as part of its asset/liability generally accepted accounting principles. management strategy, and that may be sold Principles of Consolidation in response to changes in interest rates, The accounting and reporting policies of The consolidated financial statements of First changes in prepayment risk, or other similar First Community Bancshares, Inc. (“First Community include the accounts of its wholly- factors are classified as available for sale and Community” or the “Company”) and owned subsidiary. All significant inter- are recorded at estimated fair value. subsidiary conform to accounting principles company balances and transactions have Unrealized appreciation or depreciation in generally accepted in the United States and to been eliminated in consolidation. fair value above or below amortized cost is predominant practices within the banking Cash and Cash Equivalents included in stockholders’ equity net of industry. In preparing financial statements, Cash and cash equivalents include cash and income taxes which is entitled “Other management is required to make estimates due from banks, federal funds sold, and Comprehensive Income.” Premiums and and assumptions that affect the reported interest-bearing balances on deposit with the discounts are amortized to expense or amounts of assets and liabilities as of the Federal Home Loan Bank that are available for accreted to income over the life of the date of the balance sheet and revenues and immediate withdrawal. Interest and income security. Gain or loss on sale is based on the expenses for the period. Actual results could taxes paid were as follows: specific identification method. differ from those estimates. Assets held in an agency or fiduciary capacity are not assets of the Company and are not included in the accompanying consolidated balance sheets. Certain amounts in the 2000 and 1999 financial statements have been reclassified to conform to the 2001 presentation. Subsequent to year-end, a 10% stock dividend was declared on February 19, 2002 for distribution on March 28, 2002 to shareholders of record March 1, 2002. As a result of the stock dividend, all per share amounts except stock prices have been Interest Income taxes 2001 2000 1999 (Amounts in Thousands) $ 42,968 6,945 $ 37,526 7,206 $ 33,175 8,195 Pursuant to agreements with the Federal Reserve Bank, the Company maintains a cash balance of approximately $1.0 million in lieu of charges for check clearing and other services. Securities Held to Maturity Investments in debt securities that management has the ability and intent to hold to maturity are carried at cost. Premiums and discounts are amortized to expense and Securities Available for Sale accreted to income over the lives of the Securities to be held for indefinite periods of securities. Gain or loss on the call or maturity time including securities that management of investment securities, if any, is recorded 32 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 33 based on the specific identification method. depending upon the nature of the hedge, at fair value in the Consolidated Balance At December 31, 2001 and 2000, no securities changes in the fair value of derivatives are Sheets and the changes in fair value are were held for trading purposes and no trading either offset against the changes in the reflected in the Consolidated Statements of account was maintained. fair value of assets, liabilities or firm Income. For the year ended December 31, Loans Held for Sale and Derivative Financial Investments commitments through earnings or 2001, the net accumulated derivative recognized in other comprehensive income expense reflected in the Consolidated Loans held for sale primarily consist of one to until the hedged item is recognized in Statements of Income was $1.2 million. four family residential loans originated for earnings. As required, the Company Allowance for Loan Losses sale in the secondary market and are carried adopted Statement 133 on January 1, 2001. The allowance for loan losses is maintained at at the lower of cost or fair value determined Because of the limited use of derivatives on a level to absorb probable losses inherent in on an aggregate basis. Gains and losses on January 1, 2001, the adoption did not have a the loan portfolio. The Company consistently sales of loans held for sale are included in material impact on the Company’s financial applies a monthly review process to mortgage banking income in the statements. Consolidated Statements of Income. For loans to be sold, the Company enters into In June 1998, the Financial Accounting forward commitments or derivatives to Standards Board (FASB) issued Statement manage the risk inherent in interest rate lock No. 133, Accounting for Derivative commitments made to potential borrowers. Instruments and Hedging Activities, as The inventory of loans and loan commitments amended. The Statement requires the (both retail and wholesale) are hedged to Company to recognize all derivatives on the protect the Company from unusual balance sheet at fair value. Statement 133 fluctuations in the cash flows derived upon also specifies new methods of accounting for settlement of the loans with secondary hedging transactions, prescribes the items market purchasers, and consequently, to and transactions that may be hedged, and achieve a desired margin upon delivery. The specifies detailed criteria to be met to qualify hedge transactions are used for risk for hedge accounting. Derivatives that are not mitigation and are not for trading purposes. continually evaluate loans for changes in credit risk. This process serves as the primary means by which the Company evaluates the adequacy of the allowance for loan losses. The Company’s recorded allowance for loan losses is comprised of two components that relate to: i) the allowance allocated to specifically identified loan relationships that are on nonaccrual status, 90 days past due or more and loans with elements of credit weakness and ii) an allowance allocated to the remaining loans, grouped by similar characteristics, based on historical loss factors. hedges must be adjusted to fair value The derivative financial instruments derived The allowance is allocated to specific loans to through income. If the derivative is a hedge, from these hedging transactions are recorded cover loan relationships identified with 33 T30290-Notes.qx4 3/8/02 12:35 PM Page 34 significant cash flow weakness and for which procedures, and any concentration of credits disposed of and certain intangibles are a collateral deficiency may be present. The in certain industries or geographic areas. evaluated for impairment. reserves established under the specific reserve method are judged based upon the borrower’s estimated cash flow and projected liquidation value of related collateral. The allowance is allocated to pools of loans based on historical loss experience to cover the homogeneous and nonhomogeneous loans not individually evaluated. Pools of loans are grouped by specific category and risk characteristics. To determine the amount of The allowance for loan losses related to impaired loans is based upon the discounted cash flows or fair value of collateral when it is probable that all amounts due pursuant to contractual terms of the loan will not be collected and the recorded investment in the loan exceeds the fair value. The impaired status of all loans designated as nonaccrual or which have been classified as “substandard” or “doubtful” is evaluated Income Recognition Accrual of interest on loans is based generally on the daily amount of principal outstanding. It is the Company’s policy to discontinue the accrual of interest on loans based on the payment status and evaluation of the related collateral and the financial strength of the borrower. The accrual of interest income is normally discontinued when a loan becomes 90 days past due as to principal or interest. allowance needed for each loan category, an through the Company’s loan review Management may elect to continue the estimated loss percentage is developed process. Certain smaller balance, accrual of interest when the loan is well based upon historical loss experience. The homogeneous loans, such as consumer secured and in process of collection. When calculated percentage is used to determine installment loans and residential mortgage interest accruals are discontinued, interest the estimated allowance excluding any loans, are evaluated for impairment on an accrued and not collected in the current year relationships specifically identified and aggregate basis in accordance with the is reversed and interest accrued and not evaluated. While allocations are made to Company’s policy. specific loans and classifications within the Premises and Equipment collected from prior years is charged to the reserve for possible loan losses. Consumer various categories of loans, the reserve is Premises and equipment are stated at cost revolving credit loans that become 180 days available for all loan losses. In developing the less accumulated depreciation. Depreciation past due are automatically charged to the allowance for loan losses, the Company also is computed on the straight-line method over allowance for loan losses. considers various inherent risk factors, such estimated useful lives. Maintenance and Loan Fee Income as current economic conditions, the level of repairs are charged to current operations Loan origination and underwriting fees are delinquencies and nonaccrual loans, trends while improvements are capitalized. recorded as a reduction of direct costs in the volume and term of loans, anticipated Disposition gains and losses are reflected in associated with loan processing, including impact from changes in lending policies and current operations. Long-lived assets to be salaries, review of legal documents, 34 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 35 obtainment of appraisals, and other direct the exercise price of the Company’s combinations initiated after June 30, 2001 be costs. Fees in excess of those related direct employee/director stock options equals the accounted for under the purchase method of costs are deferred and amortized over the life market price of the underlying stock on the accounting. Use of the pooling-of-interests of the related loan. Loan commitment fees are date of grant, no compensation expense is method is no longer permitted. While deferred and amortized over the related recognized. commitment period. Other Real Estate Owned Intangible Assets The excess of the cost of an acquisition over for, it had no effect on the Company’s Statement 141 will impact the way in which future business combinations are accounted Other real estate owned and acquired the fair value of the net assets acquired is financial position or results of operations. through foreclosure is stated at the lower of recorded as goodwill and amortized on a cost or fair value less estimated costs to sell. straight-line basis over varying periods of Loan losses arising from the acquisition of 15 to 20 years. The unamortized balance of such properties are charged against the goodwill was $25,349,000 and $23,794,000 reserve for possible loan losses. Expenses at December 31, 2001 and 2000, respectively. incurred in connection with operating the A portion of the cost of purchased properties, subsequent write-downs and subsidiaries has been allocated to values gains or losses upon sale are included in associated with the future earnings potential other noninterest income and expense. of acquired deposits and is being amortized Unallocated ESOP Shares The cost of unallocated employee stock ownership plan shares was included as a component of stockholders’ equity. The plan shares were allocated to participant accounts over a period not to exceed seven years based over the estimated lives of the deposits, ranging from seven to ten years. The unamortized balance of identified intangibles associated with acquired deposits was $1,128,000 and $407,000 at December 31, 2001 and 2000, respectively. Statement 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. This change is intended to provide investors with greater transparency regarding the economic value of goodwill and its impact on earnings. The amortization of goodwill, except for the portion of goodwill recorded and amortized in accordance with FASB Statement 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, ceases upon adoption of Statement 142 on January 1, 2002. During 2002, the Company will perform the required impairment tests of goodwill and indefinite lived intangible assets in upon relative employee compensation. In July 2001, the Financial Accounting accordance with the new standard. Stock Options Standards Board (FASB) issued Statement Application of the nonamortization provisions The Company has a stock option plan for 141, Business Combinations, and Statement of Statement 142 will result in the elimination certain executives and directors accounted 142, Goodwill and Other Intangible Assets. of goodwill amortization. Net income and for under the intrinsic value method. Because Statement 141 requires that all business basic and diluted earnings per share would 35 T30290-Notes.qx4 3/8/02 12:35 PM Page 36 have been $20.6 million, or $2.07 basic and In October 2001, the FASB issued Statement Earnings Per Share $2.06 diluted earnings per share for the year 144, Accounting for the Impairment or Basic earnings per share is determined by ended December 31, 2001. Since man- Disposal of Long-Lived Assets, that is dividing net income by the weighted average agement has not completed an impairment applicable to financial statements issued for number of shares outstanding. Diluted analysis, the potential for impairment cannot fiscal years beginning after December 15, earnings per share is determined by dividing currently be determined. Recent Accounting Developments In August 2001, the FASB issued Statement 143, Accounting for Asset Retirement Obligations, effective for fiscal years beginning after June 15, 2002 with earlier application encouraged. The standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, the entity either settles the obligation for its 2001 (January 2002 for calendar year-end companies). The FASB’s new rules on asset impairment supersede FASB Statement No. 121, Accounting for the Impairment of Long- Lived Assets and for Long-lived Assets to Be Disposed Of, and provide a single accounting model for long-lived assets to be disposed of. Implementation of Statement 144 is not expected to have a material impact on the Company’s financial position or results of operations. Income Taxes Deferred income taxes, which are included in other assets, are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates to the differences between the financial statement net income by the weighted average shares outstanding increased by the dilutive effect of stock options. The incremental shares for dilutive earnings per share related to the stock options were 36,609 in 2001. There was no such dilutive effect for 2000 and 1999. Note 2. Stock Dividend On February 19, 2002, the Company’s Board of Directors authorized a 10% stock dividend to shareholders of record March 1, 2002. Average shares outstanding and per share amounts included in the consolidated financial statements have been adjusted to give effect to the stock dividend. Note 3. Merger and Acquisitions On December 7, 2001, the Company completed the acquisition of several branches of Branch Banking and Trust recorded amount or incurs a gain or loss upon carrying amounts and the tax bases of Company of Virginia (“BB&T”) and F & M Bank settlement. Implementation of Statement 143 existing assets and liabilities. The – Southern Virginia (“F&M”) located in Clifton is not expected to have a material impact on components of other comprehensive income Forge, Emporia, and Drakes Branch, the Company’s financial position or results have been computed using a 40% effective Virginia. The total consideration paid of of operations. tax rate. $3.6 million resulted in an intangible 36 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 37 asset of approximately $3.8 million. The West Virginia. Upon acquisition, Citizens, was accounted for under the purchase consummation of this transaction resulted in formerly a state-chartered bank, had assets method of accounting. Accordingly, results of $77 million in cash, an additional $114 million of approximately $67.8 million with two operations of Citizens are included in the in deposits to the Bank, and $31 million in offices located in Beckley, West Virginia. consolidated results from the date of additional loans. Pursuant to the Agreement, the Company acquisition. Had Citizens been included in the On October 31, 2000, First Community Bank, N. A. (“FCBNA”), the Company’s wholly- owned banking subsidiary, acquired 100% of the common stock of Citizens Southern Bank, Inc., (“Citizens”), headquartered in Beckley, Note 4. Securities Available for Sale exchanged 1.74 shares of the Company’s Company’s results for the entire year of 2000, common stock for each of Citizens’ 250,000 results would not have been materially common shares. The total consideration paid different than those reported herein. resulted in an intangible asset of approximately $3.3 million. The acquisition As of December 31, the amortized cost and estimated fair value of securities classified as available for sale are as follows: U.S. Government agency securities States and political subdivisions Other securities Total U.S. Government agency securities States and political subdivisions Other securities Total 2001 Amortized Cost Unrealized Gains Unrealized Losses 195,689 97,683 59,387 352,759 $ 981 1,230 1,022 $ 3,233 $ (467) (1,464) (54) $ (1,985) 2000 Amortized Cost Unrealized Gains Unrealized Losses 135,459 34,664 40,003 210,126 $ 194 565 323 $ 1,082 $ (1,496) (581) (1,569) $ (3,646) $ $ $ $ Fair Value $ 196,203 97,449 60,355 $ 354,007 Fair Value $ 134,157 34,648 38,757 $ 207,562 37 T30290-Notes.qx4 3/8/02 12:35 PM Page 38 Securities available for sale with FCBNA is required to subscribe to a contractual maturities because issuers may estimated fair values of $180,086,000 minimum level of stock in the FHLB of have the right to call or prepay obligations and $156,389,000 at December 31, 2001 and Atlanta. At December 31, 2001, FCBNA owned with or without call or prepayment penalties. 2000, respectively, were pledged to secure approximately $8.6 million in stock which is During 2001, sales of securities available public deposits, securities sold under classified as available for sale. for sale resulted in gains of $209,000 and agreements to repurchase and other short- term borrowings and for other purposes. The amortized cost and estimated fair value of securities available for sale by contractual As a condition to membership in the maturity, at December 31, 2001, are shown Federal Home Loan Bank (“FHLB”) system, below. Expected maturities may differ from losses of $28,000; there were no sales of securities available for sale during 2000 and 1999. Amortized Cost Maturity: Within one year After one year through five years After five years through ten years After ten years Total amortized cost Tax equivalent purchase yield Average maturity (in years) Fair Value Maturity: Within one year After one year through five years After five years through ten years After ten years Total fair value U.S. Government Agencies & Corporations States and Political Subdivisions Other Securities Total Tax Equivalent Purchase Yield (Amounts in Thousands) $ – 21,388 53,662 120,639 $ 195,689 $ 846 20,646 19,601 56,590 $ 97,683 $ – 23,162 23,403 12,822 $ 59,387 $ 846 65,196 96,666 190,051 $ 352,759 5.84% 17.31 8.25% 12.39 5.91% 10.48 6.52% 14.80 $ – 21,395 53,842 120,966 $ 196,203 $ 858 21,194 20,064 55,333 $ 97,449 $ – 23,540 23,454 13,361 $ 60,355 $ 858 66,129 97,360 189,660 $ 354,007 8.38% 6.11% 6.46% 6.68% – – – – – – – – 38 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 39 Note 5. Securities Held to Maturity The following table presents amortized cost and approximate fair values of investment securities held to maturity at December 31: U.S. Government agency securities States and political subdivisions Other securities Total U.S. Government agency securities States and political subdivisions Other securities Total 2001 Amortized Cost Unrealized Gains Unrealized Losses (Amounts in Thousands) $ 743 39,768 1,373 $ 41,884 $ $ 16 1,487 6 1,509 $ $ – – – – 2000 Amortized Cost $ 2,103 72,264 1,369 $ 75,736 Unrealized Gains Unrealized Losses (Amounts in Thousands) $ $ 5 2,298 6 2,309 $ $ (14) – (1) (15) Fair Value 759 41,255 1,379 43,393 Fair Value 2,094 74,562 1,374 78,030 $ $ $ $ Various investment securities classified as held to maturity with an amortized cost of approximately $4,439,000 and $6,804,000 were pledged at December 31, 2001 and 2000, respectively, to secure public deposits and for other purposes required by law. As permitted upon adopting Statement 133 on January 1, 2001, the Company transferred securities with a carrying value of $31,954,000 from held to maturity to available for sale. At the date of transfer, these securities had an unrealized gain of approximately $792,000. 39 T30290-Notes.qx4 3/8/02 12:35 PM Page 40 The following table presents maturities of investments by type on both an amortized cost and estimated fair value basis at December 31, 2001: Amortized Cost Maturity: Within one year After one year through five years After five years through ten years After ten years Total amortized cost Tax equivalent purchase yield Average maturity (in years) Fair Value Maturity: Within one year After one year through five years After five years through ten years After ten years Total fair value Note 6. Loans Loans consist of the following at December 31: U.S. Government Agencies & Corporations States and Political Subdivisions Other Securities Total Tax Purchase Yield (Amounts in Thousands) $ $ $ $ – 562 181 – 743 6.22% 3.14 $ – 4,011 12,561 23,196 $ 39,768 8.67% 10.18 – 569 190 – 759 $ – 4,254 13,045 23,956 $ 41,255 $ $ $ $ 998 75 300 – 1,373 7.67% 2.00 1,004 75 300 – 1,379 $ $ $ $ 998 4,648 13,042 23,196 41,884 8.59% 9.79 1,004 4,898 13,535 23,956 43,393 8.07% 8.22% 8.60% 8.69% – – – – – – – – 2001 2000 (Amounts in Thousands) $ 259,717 77,402 267,139 162,173 137,104 961 $ 904,496 $ 222,571 73,087 293,732 86,887 134,330 649 $ 811,256 Real estate-commercial Real estate-construction Real estate-residential Commercial, financial and agricultural Loans to individuals for household and other consumer expenditures All other loans 40 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 41 The banking subsidiary of the Company is a there is not a violation of any condition held to secure customer performance under party to financial instruments with off- established in the contract. Commitments certain of those letters of credit outstanding balance sheet risk in the normal course of generally have fixed expiration dates or other at December 31, 2001. business to meet the financing needs of its termination clauses and may require customers. These financial instruments payment of a fee. Since many of the include commitments to extend credit, commitments are expected to expire without standby letters of credit and financial being drawn upon, the total commitment guarantees. These instruments involve, to amounts do not necessarily represent future varying degrees, elements of credit and cash requirements. The Company evaluates interest rate risk beyond the amount each customer’s creditworthiness on a case- recognized on the balance sheet. The by-case basis. The amount of collateral contractual amounts of those instruments obtained, if deemed necessary by the reflect the extent of involvement the Company Company, upon extension of credit is based has in particular classes of financial on management’s credit evaluation of the instruments. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments counterparts. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income- producing commercial properties. to extend credit and standby letters of credit Standby letters of credit and financial and financial guarantees written is guarantees written are conditional represented by the contractual amount of commitments issued by the Company to those instruments. The Company uses the guarantee the performance of a customer to a same credit policies in making commitments third party. The credit risk involved in issuing and conditional obligations as it does for on- letters of credit is essentially the same as that balance sheet instruments. involved in extending loan facilities to Commitments to extend credit are agreements to lend to a customer as long as customers. To the extent deemed necessary, collateral of varying types and amounts is Financial instruments whose contract amounts represent credit risk at Decem- ber 31, 2001 are commitments to extend credit (including availability of lines of credit) – $88.4 million, and standby letters of credit and financial guarantees written – $6.8 million. At December 31, 2001, FCBNA’s subsidiary, United First Mortgage, Inc. (“UFM”), had commitments to originate loans of $32.2 million. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral deemed necessary by the Company is based on management’s credit evaluation and underwriting guidelines for the particular loan. The total commitments outstanding at December 31, 2001 are summarized in the following table. 41 T30290-Notes.qx4 3/8/02 12:35 PM Page 42 Amount (Amounts in Thousands) 2001 Rate Real estate-commercial (fixed) Real estate-commercial (variable) Real estate-construction (fixed) Real estate-construction (variable) Real estate-residential (fixed) Real estate-residential (variable) Commercial, financial, agricultural (fixed) Commercial, financial, agricultural (variable) Loans to individuals for household and other consumer expenditures (fixed) Loans to individuals for household and other consumer expenditures (variable) Total *Includes $32.2 million in loan commitments by UFM $ 6,084 22,371 12,930 5,538 35,890* 12,894 10,642 15,219 4,863 953 $ 127,384 6.00 4.41 3.91 4.30 6.25 4.25 3.93 4.63 4.15 4.25 – 11.00% – 10.00% 10.50% – 9.00.% – – 18.00% – 14.00% – 18.00% 10.50% – – 18.50% 14.50% – Management analyzes the loan portfolio development, apartment building operators, basis depending on the size of the loan regularly for concentrations of credit risk, commercial real estate lessors, and relationship. including concentrations in specific hotel/motel developers. Management industries and geographic location. At believes that concentration risk from these December 31, 2001, commercial real estate loans is minimal, as these loans are loans comprised 43% of the total loan geographically diverse and are generally portfolio. Commercial loans include loans to located in economically strong metropolitan small to mid-size industrial, commercial and markets in Virginia and North Carolina. service companies that include but are Additionally, strict underwriting standards not limited to coal mining companies, requiring comprehensive reviews and manufacturers, automobile dealers, and independent evaluations are performed on retail and wholesale merchants. Commercial virtually all commercial loans by Credit The majority of the loans in the current portfolio, other than commercial and commercial real estate, were made and collateralized in West Virginia, Virginia, North Carolina and the surrounding mid-Atlantic area. Although sections of the West Virginia and Southwestern Virginia economies are closely related to natural resource production, they are supplemented by real estate projects represent several Administration and Loan Committees prior to service industries. The current economies of different sectors of the commercial real approval. Updates to these loan reviews are the Company’s markets are seen as relatively estate market, including residential land done periodically on a semiannual or annual stable and are not seen as highly subject to 42 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 43 volatile economic change. The Company’s Company and its subsidiary. All loans and The aggregate dollar amount of such loans presence in three states, West Virginia, commitments made to such officers and was $7.8 million and $10.2 million at Virginia, and North Carolina, provides directors and to companies in which they are December 31, 2001 and 2000, respectively. additional diversification against geographic officers, or have significant ownership Advances and repayments of these loans concentrations of credit risk. interest, have been made on substantially the during 2001 were $1.2 million and In the normal course of business, the banking subsidiary of the Company has made loans to directors and executive officers of the same terms, including interest rates and $3.6 million, respectively. collateral, as those prevailing at the time for comparable transactions with other persons. Note 7. Allowance for Loan Losses Activity in the allowance for loan losses was as follows: Balance, January 1 Recoveries credited to reserve Provision for loan losses Acquisition balance Loans charged-off Balance, December 31 2001 2000 1999 (Amounts in Thousands) $ $ 12,303 911 5,134 484 18,832 (4,880) 13,952 $ $ 11,900 902 3,986 1,051 17,839 (5,536) 12,303 $ $ 11,404 610 2,893 – 14,907 (3,007) 11,900 The following table presents the Company’s investment in loans considered to be impaired and related information on those impaired loans: Recorded investment in loans considered to be impaired Loans considered to be impaired that were on a nonaccrual basis Allowance for loan losses related to loans considered to be impaired Average recorded investment in impaired loans Total interest income recognized on impaired loans 2001 2000 (Amounts in Thousands) $ 5,129 1,229 1,310 5,674 255 $ 2,795 2,795 419 3,001 15 During 2001, 2000 and 1999, $2,116,000, $2,530,000 and $1,667,000 of assets were acquired through foreclosure and transferred to real estate owned. 43 T30290-Notes.qx4 3/8/02 12:35 PM Page 44 Note 8. Premises and Equipment Premises and equipment are comprised of the following as of December 31: Land Bank premises Equipment Less: accumulated depreciation and amortization Total 2001 2000 (Amounts in Thousands) $ 7,123 22,258 15,831 45,212 23,499 21,713 $ 5,807 20,703 15,199 41,709 22,923 18,786 Note 9. Other Indebtedness The Company’s banking subsidiary is a Additional indebtedness consists of term Other indebtedness includes structured term member of the FHLB which provides credit in borrowings with the FHLB of $10,000,000 as borrowings from the FHLB of $135,000,000 in the form of short-term and long-term of December 31, 2001 and 2000. This debt the form of convertible and callable advances advances collateralized by various mortgage has a weighted average interest rate of 6.01% of $125,000,000 and noncallable advances of assets. At December 31, 2001, credit and $8,000,000 matures in 2003, while $10,000,000. The callable advances may be availability with the FHLB totaled $2,000,000 matures in 2008. Other various called based on predefined factors in approximately $124.1 million. Advances from debt obligations of the Company quarterly increments after a lockout period, the FHLB are secured by stock in the FHLB of approximated $320,000 at December 31, which may substantially shorten the lives of Atlanta, qualifying first mortgage loans of 2001 and $3,015,000 at December 31, 2000. these instruments. If these advances are $382.7 million, mortgage-backed securities, called, the debt may be paid in full, converted and certain other investment securities. The to another FHLB credit product or converted FHLB advances are subject to restrictions or to an adjustable rate advance. Contractual penalties in the event of prepayment. maturities are $35,000,000 in 2002 and $100,000,000 in 2010. The weighted average rate for this debt is 5.86%. 44 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 45 Note 10. Deposits Time deposits, including Certificates of At December 31, 2001, the scheduled At December 31, 2001, the scheduled Deposit issued in denominations of $100,000 maturities of certificates of deposit of maturities of certificates of deposit are as or more, amounted to $173.0 million and $100,000 or more are as follows: follows: $136.6 million at December 31, 2001 and 2000, (In Thousands) (In Thousands) respectively. Interest expense on these certificates was $6.7 million, $6.5 million, and $5.4 million for 2001, 2000, and 1999, respectively. Three Months or Less Over Three to Six Months Over Six to Twelve Months Over Twelve Months Total 2002 2003 2004 2005 2006 and thereafter $ $ 476,725 69,806 13,155 15,115 15,589 590,390 Note 11. Income Taxes Income taxes are as follows: Income exclusive of securities gains Net securities gains Income tax provisions consist of: Current tax expense Deferred tax (benefit) expense Years Ended December 31, 2000 (Amounts in Thousands) $ $ 7,053 1 7,054 2001 8,330 72 8,402 Years Ended December 31, 2001 8,734 (332) 8,402 2000 (Amounts in Thousands) $ $ 7,150 (96) 7,054 $ $ $ $ $ $ $ $ $ $ 51,729 52,867 23,943 44,503 173,042 1999 7,772 – 7,772 1999 8,324 (552) 7,772 45 T30290-Notes.qx4 3/8/02 12:35 PM Page 46 Deferred income taxes reflect the net effects financial reporting purposes and the the Company’s net deferred tax assets as of of temporary differences between the amounts deducted for income tax purposes. December 31, 2001 and 2000 are as follows: carrying amounts of assets and liabilities for The tax effects of significant items comprising Deferred tax assets: Allowance for loan losses Unrealized losses on assets Deferred compensation Deferred insurance premiums Other Unrealized loss on securities available for sale Total deferred tax assets Deferred tax liabilities: Intangible and purchase accounting adjustments Fixed assets Deferred loan fees Unrealized gain on securities available for sale Other Total deferred tax liabilities Net deferred tax assets The reconciliation between the federal statutory tax rate and the effective income tax rate is as follows: 2001 2000 (Amounts in Thousands) $ $ $ $ 5,514 203 916 256 148 – 7,037 601 267 397 494 1,145 2,904 4,133 $ $ $ $ 4,834 161 908 253 – 1,025 7,181 970 287 93 – 962 2,312 4,869 Years Ended December 31, 2000 1999 2001 Tax at statutory rate (Reductions) increase resulting from: Tax-exempt interest on investment securities and loans State income taxes, net of federal benefit Amortization of purchase accounting adjustments Other, net Effective tax rate 35.00% 35.00 % 35.00 % (7.31)% 2.55 % 1.57 % (1.30)% 30.51 % (7.77)% 2.36 % 1.90 % (2.19)% 29.30 % (7.90)% 2.62 % 1.80 % 0.08 % 31.60 % 46 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 47 Note 12. Employee Benefits Employee Stock Ownership Plan Company matching rate was 50% for 2001, 2000, is being amortized over the average and 25% for 2000 and 1999. remaining life expectancy of the retirees. The Company maintains an Employee Stock Employee Welfare Plan Amortization expense approximated $37,000 Ownership and Savings Plan (“KSOP”). The Company provides various medical, in 2001, 2000 and 1999. Coverage under the plan is provided to all dental, vision, life, accidental death and Deferred Compensation Plans employees meeting minimum eligibility dismemberment and long-term disability The banking subsidiary of the Company has requirements. Annual contributions to the insurance benefits to all full-time employees deferred compensation agreements with stock portion of the plan are made at the who elect coverage under this program (basic certain current and former officers providing discretion of the Board of Directors, and are life, accidental death and dismemberment, for benefit payments over various periods allocated to plan participants on the basis of relative compensation. Substantially all plan assets are invested in common stock of the Company. Total expense recognized by the Company related to the Employee Stock Ownership Plan was $948,000, $992,000 and $918,000 in 2001, 2000 and 1999, respectively. Employee Savings Plan The Company provides a 401(k) Savings feature within the KSOP that is available to substantially all employees meeting minimum eligibility requirements. The cost of Company contributions under the Savings Plan component of the KSOP was $216,000, and long-term disability coverage are automatic). The health plan is managed by a third party administrator (“TPA”). Monthly employer and employee contributions are made to the trust, against which the TPA processes and pays claims. Stop loss insurance coverage limits the Company’s funding requirements and risk of loss to $50,000 and $1.9 million for individual and aggregate claims, respectively. Total cost incurred under the plan was $1.5 million, $1.20 million, and $0.95 million in 2001, 2000 and 1999, respectively. commencing at retirement or death. The liability at December 31, 2001 and 2000 was approximately $750,000 and $790,000, respectively. The expenses associated with this plan for 2001, 2000 and 1999 were $91,000, $138,000 and $76,000, respectively. The obligation is based upon the present value of the expected payments and estimated life expectancies. Executive Retention Plan The Company maintains an Executive Retention Plan for key members of senior management. This Plan provides for a benefit at normal retirement (age 65) targeted at 35% $66,000, and $149,000 in 2001, 2000 and The Company has a post-retirement of final compensation projected at an 1999, respectively. The Company’s matching obligation for a certain group of retirees that assumed 3% salary progression rate. contributions are at the discretion of the relates to benefits received prior to 1993. The Benefits under the Plan become payable at Board up to 100% of elective deferrals of no obligation, which approximated $186,000 age 62. Actual benefits payable under the more than 6% of compensation. The and $224,000 at December 31, 2001 and Retention Plan are dependant on an indexed 47 T30290-Notes.qx4 3/8/02 12:35 PM Page 48 retirement benefit formula which accrues and used to fund the newly created Directors Supplemental benefits equal to the aggregate after-tax Director Supplemental Retirement Plan Retirement Plan income of associated life insurance contracts referenced below. less the Company’s tax-effected cost of funds for that plan year. Benefits under the Plan are dependent on the performance of the insurance contracts and are not guaranteed by the Company. Additionally, during 2001, the Company entered into a similar retirement plan arrangement as described below with nonemployee board members of the Company. In connection with the Executive Retention Plan, the Company has also entered into Life Insurance Endorsement Method Split Dollar Agreements (the “Agreements”) with the individuals covered under the Plan. Under the Agreements, the Company shares 80% of death benefits (after recovery of cash surrender value) with the designated beneficiaries of the plan participants under The Company funded the contracts through life insurance contracts referenced in the the purchase of bank-owned life insurance, Plan. The Company as owner of the policies (BOLI), which is anticipated to fully fund the retains a 20% interest in life proceeds and a projected benefit payout after retirement. The 100% interest in the cash surrender value of total amount invested in BOLI for the the policies. Executive Retention Plan during 2000 and the corresponding cash surrender value at December 31, 2001 was $4.1 million and $4.5 million, respectively. The associated obligation expense incurred in connection with the Plan was $156,000 and $193,000 for 2001 and 2000, respectively. The income derived from policy appreciation was $240,000 and $184,000 in 2001 and 2000, respectively. A portion of the pre-existing life insurance contracts were reallocated The Plan also contain provisions for change of control, as defined, which allow the participants to retain benefits, subject to certain conditions, under the Plan in the event of a change in control. Because the Executive Retention Plan was designed to retain the future services of key executives, no benefits are payable under the Plan in the event of voluntary termination prior to retirement as defined within the Plan. In 2001, the Company established a Directors Supplemental Retirement Plan for its non- employee Directors. This Plan provides for a benefit upon retirement from service on the Board at specified ages depending upon length of service or death. Benefits under the Plan become payable at age 70, 75, and 78 depending upon the individual director’s age and original date of election to the Board. Actual benefits payable under the Plan are dependent on an indexed retirement benefit formula that accrues benefits equal to the aggregate after-tax income associated life insurance contracts less the Company’s tax- effected cost of funds for that plan year. Benefits under the Plan are dependent on the performance of the insurance contracts and are not guaranteed by the Company. In connection with the Directors Supplemental Retirement Plan, the Company has also entered into Life Insurance Endorsement Method Split Dollar Agreements (the “Agreements”) with the directors covered under the Plan. Under the Agreements, the Company shares 80% of death benefits (after recovery of cash 48 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 49 surrender value) with the designated Stock Options for a period of five years after the date of the beneficiaries of the executives under life In 1999, the Company instituted a Stock grantee’s retirement (provided retirement insurance contracts referenced in the Option Plan to encourage and facilitate occurs at or after age 62), and at disability, or Retention Plan. The Company, as owner of the investment in the common stock of the death. If employment is terminated other policies retains a 20% interest in life proceeds and a 100% interest in the cash surrender value of the policies. Because the Plan was designed to retain the future services of Board members, no benefits are payable under the Plan in the event of voluntary or involuntary termination prior to retirement age as defined in the Plan document. Company by key executives and to assist in than by retirement, disability, or death, the long-term retention of service by those vested options must be exercised within 90 executives. The Plan covers key executives as days after the effective date of termination. determined by the Company’s Board of Any option not exercised within such period Directors from time to time. Options under will be deemed cancelled. the Plan were granted in the form of non- statutory stock options with the aggregate number of shares of common stock available for grant under the Plan set at 302,500 (adjusted for the 10% stock dividend) shares. In the fourth quarter of 2001, the Company also granted stock options to nonemployee directors. The Director Option Plan was implemented to facilitate and encourage investment in the common stock of the The Plan also contains provisions for change The options granted under the Plan represent Company by nonemployee directors whose of control, as defined, which allow the the rights to acquire the option shares with Directors to retain benefits under the Plan in deemed grant dates of January 1 for each year the event of a termination of service, other beginning with the initial year granted and than for cause, during the 12 months prior to the following four anniversaries. All stock efforts, solely as a director, are expected to contribute to the Company’s future growth and continued success. The options granted pursuant to the Plan are exercisable at the a change in control or anytime thereafter, options granted pursuant to the Plan vest earlier of 10 years from the date of grant or unless the Director voluntarily terminates his ratably on the first through the seventh two years after the optionee ceases to serve service within 90 days following the change anniversary dates of the deemed grant date. as a director of the Corporation. Options not in control. The option price of each stock option is equal exercised within the appropriate time shall The Plan expense associated with the Directors Supplemental Retirement Plan for 2001 was $32,000. to the fair market value (as defined by the expire and be deemed cancelled. The Plan Plan) of the Company’s common stock on the covers nonemployee directors as determined date of each deemed grant during the five- by the Company’s Board of Directors. Options year grant period. Vested stock options under the Plan were granted in the form of granted pursuant to the Plan are exercisable non-statutory stock options with the 49 T30290-Notes.qx4 3/8/02 12:35 PM Page 50 aggregate number of shares of common stock rate of 5.15%, 6.00% and 6.25% for 2001, The effect of option shares on earnings per available for grant under the Plan set at 2000 and 1999, respectively; ii) a dividend share relates to the dilutive effect of the 99,000 (adjusted for the 10% stock dividend) yield of 3.40%, 5.21% and 4.50% for 2001, underlying options outstanding. To the extent shares. 2000 and 1999, respectively; iii) volatility the granted exercise share price is less than Pro forma disclosure information regarding net income and earnings per share is determined as if the Company had accounted for its employee stock options under the fair value method. The fair value of options was estimated at the date of grant using the Black- Scholes option pricing model using the following assumptions: i) risk-free interest factors for the expected market price of the the current market price, (“in the money”), Company’s common stock of 31.2%, 26.1% there is an economic incentive for the shares and 32.8% for 2001, 2000 and 1999, to be exercised and an increase in the dilution respectively; and iv) a weighted-average effect on earnings per share. expected life of the option of 12.2, 13.7 and 14.8 years, for 2001, 2000 and 1999, respectively. Pro forma net income and earnings per share for the years ended December 31 would have been estimated as follows: Net income Basic earnings per share Fully diluted earnings per share 2001 2000 1999 (Amounts in Thousands Except Per Share Data) $ 18,933 1.90 $ 1.90 $ $ $ $ 17,063 1.78 1.78 $ $ $ 16,852 1.75 1.75 A summary of the Company’s stock option activity, and related information for the years ended December 31 is as follows: 2001 Weighted- Average Exercise Price $ $ $ 19.69 17.90 – 15.33 18.65 23.91 Option Shares 84,451 120,601 – 2,750 202,302 49,500 Outstanding, beginning of year Granted Exercised Forfeited Outstanding, end of year Exercisable at end of year Weighted-average fair value of options granted during the year $5.28 50 FCB Annual Report 2001 2000 1999 Weighted- Option Average Shares Exercise Price 21.78 17.60 – 19.69 19.69 59,968 59,968 – 35,484 84,451 – $2.97 $ $ $ $ Option Shares 59,968 – – – 59,968 Weighted- Average Exercise Price 21.78 – – – 21.78 – $ $ $ $ – – $4.06 T30290-Notes.qx4 3/8/02 12:35 PM Page 51 The range of exercise prices for options by banking regulations. The most restrictive practices. The entity’s capital amounts and outstanding as of December 31, 2001 was provision of the regulations requires approval classifications are also subject to qualitative $15.33 to $23.91 and the estimate of the by the Office of the Comptroller of the judgments by the regulators about com- weighted-average remaining contractual life of all options is 12.21 years. The weighted average exercise price and the life of the exercisable options at year-end are $23.91 and five years, respectively. These options pertain to the nonemployee director option plan implemented in the current year. Note 13. Litigation In the normal course of business, the Company is a defendant in various legal actions and asserted claims most of which involve lending and collection activities. While the Company and legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, they are of the belief that the resolution of these actions should not have a material adverse affect on the financial position of the Company. Note 14. Regulatory Capital Requirements and Restrictions Currency if dividends declared in any year ponents, risk weightings, and other factors. exceed the year’s net income, as defined, plus retained net profit of the two preceding years. At December 31, 2001, subsidiary accumulated earnings available for distri- bution as dividends to the Company without prior approval were $27.9 million plus earn- ings for the period up to the dividend date. First Community Bancshares, Inc. and First Community Bank, N. A. (collectively referred to as “the Bank”) are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under the capital adequacy Quantitative measures established by regulation to ensure capital adequacy require First Community Bancshares, Inc. and the Bank to maintain minimum amounts and ratios (set forth in the following table on page 52 for total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As of December 31, 2001, the Company and banking subsidiary met all capital adequacy requirements to which they are subject. As of December 31, 2001 and 2000, the most recent notifications from the Federal Reserve Board categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be guidelines and the regulatory framework for categorized as well capitalized, the Bank prompt corrective action, which applies only must maintain minimum Total Risk-Based, to the Bank, the Bank must meet specific Tier 1 Risk-Based, and Tier 1 leverage ratios as The primary source of funds for dividends capital guidelines that involve quantitative set forth in the table. There are no conditions paid by the Company is dividends received measures of the entity’s assets, liabilities, or events since those notifications that from its subsidiary bank. Dividends paid by and certain off balance sheet items as management believes have changed the the subsidiary bank are subject to restrictions calculated under regulatory accounting institution’s category. 51 T30290-Notes.qx4 3/8/02 12:35 PM Page 52 December 31, 2001 Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio $ 118,296 106,957 12.10% 10.98% 78,234 77,933 8.00% 8.00% N/A 97,417 N/A 10.00% $ 105,809 94,753 10.82% 9.73% 39,117 38,967 $ 105,809 94,753 7.93% 7.13% 53,398 53,170 4.00% 4.00% 4.00% 4.00% N/A 58,450 N/A 66,462 N/A 6.00% N/A 5.00% December 31, 2000 Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio $ 108,535 96,717 12.93% 11.57% 67,162 66,858 8.00% 8.00% $ $ 98,019 86,247 11.68% 10.32% 33,581 33,429 4.00% 4.00% 98,019 86,247 8.37% 7.39% 46,827 46,684 4.00% 4.00% N/A 83,573 N/A 50,144 N/A 58,354 N/A 10.00% N/A 6.00% N/A 5.00% Total Capital to Risk-Weighed Assets First Community Bancshares, Inc. First Community Bank, N. A. Tier 1 Capital to Risk-Weighted Assets First Community Bancshares, Inc. First Community Bank, N. A. Tier 1 Capital to Average Assets (Leverage) First Community Bancshares, Inc. First Community Bank, N. A. Total Capital to Risk-Weighed Assets First Community Bancshares, Inc. First Community Bank, N. A. Tier 1 Capital to Risk-Weighted Assets First Community Bancshares, Inc. First Community Bank, N. A. Tier 1 Capital to Average Assets (Leverage) First Community Bancshares, Inc. First Community Bank, N. A. 52 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 53 Note 15. Other Operating Expenses exceeds one percent of combined interest Included in other operating expenses are income and noninterest income. Following certain functional costs, the total of which are such costs for the years indicated: Years Ended December 31, 2000 1999 2001 Advertising and public relations Other service fees $ 1,223 1,261 $ $ * * * * *Cost did not exceed the one percent requirement for the reported period. (Amounts in Thousands) Note 16. Fair Value of Financial Instruments either receive or deliver cash for another highly subjective and judgmental in nature financial instrument. Fair value is defined as and, therefore, the results may not be FASB Statement 107, Disclosures about Fair the amount at which a financial instrument precise. Subjective factors include, among Value of Financial Instruments, requires could be exchanged in a current transaction other things, estimates of cash flows, risk disclosure of fair value information about between willing parties, other than in a forced characteristics, credit quality, and interest financial instruments, whether or not sale or liquidation, and is best evidenced by a rates all of which are subject to change. Since recognized on the balance sheet, for which it quoted market price if one exists. the fair value is estimated as of the balance is practical to estimate the value. FASB The following summary presents the Statement 107 defines a financial instrument methodologies and assumptions used to as cash, evidence of ownership in an entity, or estimate the fair value of the Company’s sheet date, the amounts that will actually be realized or paid upon settlement or maturity on these various instruments could be a contract that conveys or imposes on an financial instruments presented below. The significantly different. entity that contractual right or obligation to information used to determine fair value is 53 T30290-Notes.qx4 3/8/02 12:35 PM Page 54 Assets: Cash and due from banks Securities available for sale Securities held to maturity Derivative financial instruments Loans held for sale Loans held for investment (net of allowance for loan loss) Interest receivable Liabilities: Demand deposits Interest-bearing demand deposits Savings deposits Time deposits Federal funds purchased Securities sold under agreements to repurchase Interest, taxes and other obligations Other indebtedness 2001 2000 Carrying Amount Fair Value Carrying Amount Fair Value (Amounts in Thousands) $ 47,815 354,007 41,884 480 65,532 890,544 8,765 $ 47,815 354,007 43,393 480 65,532 905,361 8,765 $ 50,243 207,562 75,736 – 11,570 798,953 9,261 $ 50,243 207,562 78,030 – 11,570 806,751 9,261 161,347 183,685 142,839 590,390 26,500 79,262 15,852 145,320 161,347 183,685 142,839 593,548 26,500 79,524 15,852 155,104 128,584 137,763 131,039 502,517 – 46,179 13,238 138,015 128,584 137,763 131,039 499,961 – 46,179 13,238 142,368 Financial Instruments with Book Value Equal to Fair Value The book values of cash and due from banks, federal funds sold and purchased, interest receivable, and interest, taxes and other liabilities are considered to be equal to fair value as a result of the short-term nature of these items. Securities Available for Sale Investment Securities For securities available for sale, fair value is For investment securities, fair value has been based on current market quotations, where based on current market quotations, where available. If quoted market prices are not available. If quoted market prices are not available, fair value has been based on the available, fair value has been based on the quoted price of similar instruments. quoted price of similar instruments. 54 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 55 Derivative Financial Instruments carrying value in accordance with Statement letters of credit, and financial guarantees is Derivative financial instruments are recorded No. 107. No value has been assigned to the considered equal to fair value. Because of the at estimated fair value based upon current franchise value of these deposits. For other uncertainty involved in attempting to assess market pricing for similar instruments. types of deposits with fixed maturities, fair the likelihood and timing of commitments Loans value has been estimated by discounting being drawn upon, coupled with the lack of an The estimated value of loans held for future cash flows based on interest rates established market and the wide diversity of investment is measured based upon currently being offered on deposits with fee structures, the Company does not believe discounted future cash flows and using the similar characteristics and maturities. it is meaningful to provide an estimate of fair current rates for similar loans. Loans held for Other Indebtedness value that differs from the given value of sale are recorded at lower of cost or estimated Fair value has been estimated based on the commitment. fair value. The fair value of loans held for sale interest rates currently available to the is determined based upon the market sales Company for borrowings with similar price of similar loans. characteristics and maturities. Deposits and Securities Sold Under Agreements to Repurchase Deposits without a stated maturity, including demand, interest-bearing demand, and Commitments to Extend Credit, Stand-by Letters of Credit, and Financial Guarantees The amount of off-balance sheet Note 17. Parent Company Financial Information Condensed financial information related to First Community Bancshares, Inc. as of December 31, 2001 and 2000, and for each of the three years in the period ended December 31, 2001, 2000 and 1999 is savings accounts, are reported at their commitments to extend credit, stand-by as follows: 55 T30290-Notes.qx4 3/8/02 12:35 PM Page 56 Condensed Balance Sheets Assets Cash Investment in subsidiary Other assets Total Assets Liabilities Other liabilities Stockholders’ Equity Common stock Additional paid-in capital Retained earnings Treasury stock Accumulated other comprehensive income Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity Condensed Statements of Income Cash dividends received from subsidiary banks Other Income Operating expense Income tax benefit (expense) Equity in undistributed earnings of subsidiary Net Income Basic and diluted earnings per share December 31, 2001 2000 (Amounts in Thousands) $ 5,820 121,679 6,056 $ 133,555 $ 8,515 108,722 3,746 $ 120,983 $ 514 $ 301 9,955 60,189 62,566 (424) 755 133,041 $ 133,555 9,052 35,273 78,097 (202) (1,538) 120,682 $ 120,983 2001 December 31, 2000 1999 (Amounts in Thousands, Except Per Share Data) $ $ $ 8,500 338 (559) 8,279 72 10,783 19,134 1.92 $ $ $ 7,000 339 (278) 7,061 (18) 10,020 17,063 1.78 $ 6,500 275 (468) 6,307 62 10,483 $ 16,852 1.75 $ 56 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 57 Condensed Statements of Cash Flows Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiary Decrease in other assets Gain on sale of assets Increase in other liabilities Net cash provided by operating activities Cash flows from investing activities: Purchase of securities available for sale Proceeds from sale of securities available for sale Proceeds from investment in subsidiary Net cash (used in) provided by investing activities Cash flows from financing activities: Repayment of long-term debt Acquisition of treasury stock Dividends paid Net cash used in financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Years Ending December 31, 2000 2001 1999 (Amounts in Thousands) $ 19,134 $ 17,063 $ 16,852 (10,783) 85 (9) 621 9,048 (2,855) 586 – (2,269) – (599) (8,875) (9,474) (2,695) 8,515 5,820 $ (10,020) 132 – 138 7,313 (1,038) 26 – (1,012) (10,483) 118 – 51 6,538 – – 24,719 24,719 – (2,869) (8,338) (11,207) (4,906) 13,421 8,515 $ (9,378) (1,542) (7,730) (18,650) 12,607 814 13,421 $ Note 18. Segment Information primarily identified by the products or full-service banks that offer customers The Company operates two business services offered and the channels through traditional banking products and services segments: community banking and which they are offered. The community through various delivery channels. The mortgage banking. These segments are banking segment consists of the Company’s mortgage banking segment consists of 57 T30290-Notes.qx4 3/8/02 12:35 PM Page 58 mortgage brokerage facilities that originate, Information for 2001 and 2000 for each of the as reported, is reflective of the community acquire, and sell mortgage products. The segments is included below. Information for banking segment. accounting policies for each of the business the mortgage banking segment is not segments are the same as those of the material for years prior to 2000 and the Company described in Note 1. consolidated financial information for 1999, December 31, 2001 Net interest income Provision for loan losses Net interest income after provision for loan losses Other income Other expenses Income (loss) before income taxes Income tax expense (benefit) Net income Average assets Net interest income Provision for loan losses Net interest income after provision for loan losses Other income Other expenses Income (loss) before income taxes Income tax expense (benefit) Net income Average assets Community Banking $ 49,379 5,134 44,245 10,839 29,285 25,799 7,806 17,993 $ $ 1,365,164 Community Banking $ 45,969 3,986 41,983 7,911 25,560 24,334 7,122 $ 17,212 $ 1,124,304 58 FCB Annual Report 2001 Mortgage Banking Parent (Amounts in Thousands) Eliminations Total $ 462 – 462 9,582 8,086 1,958 669 $ 1,289 $ 45,271 $ 315 – 315 16 552 (221) (73) (148) $ $ 128,732 $ 264 – 264 (162) 102 – – – $ $ (252,853) $ 50,420 5,134 45,286 20,275 38,025 27,536 8,402 19,134 $ $ 1,286,314 December 31, 2000 Mortgage Banking Parent (Amounts in Thousands) Eliminations $ $ $ 65 – 65 4,651 4,994 (278) (86) (192) 7,024 $ 339 – 339 – 278 61 18 $ 43 $ 108,133 $ 206 – 206 (70) 136 – – $ – $ (111,782) $ $ $ Total 46,579 3,986 42,593 12,492 30,968 24,117 7,054 17,063 1,127,679 T30290-Notes.qx4 3/8/02 12:35 PM Page 59 Note 19. Supplemental Financial Data (Unaudited) First Community Bancshares, Inc. – Quarterly Earnings Summary Quarterly earnings for the years ended December 31, 2001 and 2000 are as follows: Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for possible loan losses Other income Other expenses Income before income taxes Income taxes Net income Per share: Basic and diluted earnings Dividends Weighted average basic shares outstanding Weighted average diluted shares outstanding 2001 March 31 June 30 Sept 30 Dec 31 (Amounts in Thousands, Except Per Share Data) $ 22,901 10,986 11,915 747 11,168 4,218 8,953 6,433 1,977 4,456 $ $ 23,135 10,882 12,253 985 11,268 5,003 9,628 6,643 2,034 4,609 $ $ 23,390 10,580 12,810 1,282 11,528 5,486 9,703 7,311 2,311 5,000 $ $ $ 0.45 0.21 9,945 9,952 $ $ 0.46 0.21 9,948 9,967 $ $ 0.50 0.21 9,944 10,003 $ $ $ $ 23,403 9,961 13,442 2,120 11,322 5,568 9,741 7,149 2,080 5,069 0.51 0.26 9,940 9,992 59 T30290-Notes.qx4 3/8/02 12:35 PM Page 60 Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for possible loan losses Other income Other expenses Income before income taxes Income taxes Net income Per share: Basic and diluted earnings Dividends Weighted average basic and diluted shares outstanding 2000 March 31 June 30 Sept 30 Dec 31 (Amounts in Thousands, Except Per Share Data) $ 20,375 8,905 11,470 662 10,808 2,764 8,176 5,396 1,718 3,678 $ $ $ 0.38 0.20 9,587 $ $ 21,069 9,362 11,707 1,218 10,489 3,276 7,479 6,286 1,957 4,329 0.45 0.21 9,533 $ 21,632 10,032 11,600 842 10,758 3,054 7,691 6,121 1,836 4,285 $ 0.46 0.21 9,512 $ $ 22,882 11,080 11,802 1,264 10,538 3,398 7,622 6,314 1,543 4,771 0.49 0.24 9,797 60 FCB Annual Report 2001 T30290-Notes.qx4 3/8/02 12:35 PM Page 61 Report of Independent Auditors To the Board of Directors of First Community Bancshares, Inc. We have audited the accompanying consolidated balance sheet of First Community Bancshares, Inc. and subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of income, cash flow and changes in stockholders’ equity for the years then ended. 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. The accompanying consolidated statements of income, cash flow and changes in stockholders’ equity for the year ended December 31, 1999, were audited by other auditors whose report dated January 28, 2000, expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 audit provides a reasonable basis for our opinion. In our opinion, the 2001 and 2000 financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Community Bancshares, Inc. and subsidiary at December 31, 2001 and 2000, and the consolidated results of their operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Charleston, West Virginia February 8, 2002 61 T30290-Notes.qx4 3/8/02 12:35 PM Page 62 Report on Management’s Responsibilities The management of First Community Bancshares, Inc. is responsible for the integrity of its financial statements and their preparation in accordance with accounting principles generally accepted in the United States. To fulfill this responsibility requires the maintenance of a sound accounting system supported by strong internal controls. The Company believes it has a high level of internal control which is maintained by the recruitment and training of qualified personnel, appropriate divisions of responsibility, the development and communication of accounting and other procedures, and comprehensive internal audits. Our independent auditors, Ernst & Young LLP are engaged to audit, and render an opinion on, the fairness of our consolidated financial statements in conformity with accounting principles generally accepted in the United States. Our independent auditors obtain an understanding of our internal accounting control systems, review selected transactions and carry out other auditing procedures before expressing their opinion on our consolidated financial statements. The Board of Directors has appointed an Audit Committee, composed of outside directors, that periodically meets with the independent auditors, bank examiners, management and internal auditors to review the work of each. The independent auditors, bank examiners and the Company’s internal auditors have free access to meet with the Audit Committee without management’s presence. John M. Mendez President & Chief Executive Officer Kenneth P. Mulkey Acting Chief Financial Officer Robert L. Schumacher Senior Vice President, Finance 62 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 63 Board of Directors Board of Directors, First Community Bancshares, Inc. Robert E. Perkinson, Jr. Past Vice President–Operations, MAPCO Coal, Inc.– Virginia Region; Member Audit Committee Officers, First Community Bancshares, Inc. William P. Stafford President, Princeton Machinery Service, Inc. Chairman, First Community Bancshares, Inc. Member Executive Committee and Audit Committee William P. Stafford II Attorney at Law, Brewster, Morhous, Cameron, Mullins, Caruth, Moore, Kersey & Stafford, PLLC Member Executive Committee W. W. Tinder, Jr. Chairman of the Board and Chief Executive Officer, Tinder Enterprises, Inc.; CEO, Tinco Leasing Corporation (Real Estate Holdings); Member Executive Committee John M. Mendez President and Chief Executive Officer Robert L. Schumacher Senior Vice President-Finance Robert L. Buzzo Vice President and Secretary E. Stephen Lilly Chief Operating Officer Kenneth P. Mulkey Acting Chief Financial Officer Sam Clark Agent, State Farm Insurance Owner, Country Junction Company, Inc. Allen T. Hamner Professor of Chemistry, West Virginia Wesleyan College; Member Executive Committee and Audit Committee B. W. Harvey President, Highlands Real Estate Management, Inc. Member Executive Committee and Audit Committee I. Norris Kantor Partner, Katz, Kantor & Perkins, Attorneys at Law John M. Mendez President and Chief Executive Officer, First Community Bancshares, Inc.; Executive Vice President, First Community Bank, N. A. A. A. Modena Past Executive Vice President and Secretary, First Community Bancshares, Inc.; Past President & Chief Executive Officer, The Flat Top National Bank of Bluefield; Member Executive Committee 63 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 64 Richard G. Rundle Attorney at Law, Rundle and Rundle, LC William P. Stafford President, Princeton Machinery Service, Inc. William P. Stafford, II Attorney at Law, Brewster, Morhous, Cameron, Mullins, Caruth, Moore, Kersey & Stafford, PLLC W. W. Tinder, Jr. Chairman and Chief Executive Officer, Tinder Enterprises, Inc. Dale F. Woody President, Woody Lumber Company Allen T. Hamner, Ph.D. Professor of Chemistry, West Virginia Wesleyan College B. W. Harvey President, Highlands Real Estate Management, Inc. I. Norris Kantor Partner, Katz, Kantor & Perkins, Attorneys at Law John M. Mendez President and Chief Executive Officer, First Community Bancshares, Inc.; Executive Vice President, First Community Bank, N. A. A. A. Modena Past Executive Vice President and Secretary, First Community Bancshares, Inc. Past President and Chief Executive Officer, The Flat Top National Bank of Bluefield Robert E. Perkinson, Jr. Past Vice President—Operations, MAPCO Coal, Inc.— Virginia Region Clyde B. Ratliff President, Gasco Drilling, Inc. Board of Directors, First Community Bank, N. A. K. A. Ammar, Jr. President and Chief Executive Officer, Ammar’s Inc. and Magic Mart Dr. James P. Bailey Veterinarian, Veterinary Associates, Inc. Chairman, First Community Bank, N. A. W. C. Blankenship, Jr. Agent, State Farm Insurance D. L. Bowling, Jr. President, True Energy, Inc. Juanita G. Bryan Homemaker Robert L. Buzzo Vice President and Secretary, First Community Bancshares, Inc. President, First Community Bank, N. A. Sam Clark Agent, State Farm Insurance Owner, Country Junction Company, Inc. C. William Davis Attorney at Law, Richardson & Davis 64 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 65 Locations & Other Information First Community Bank, N. A. (A National Association-Member FDIC) 2 West Main Street Buckhannon, West Virginia 26201-0280 (304) 472-1112 1001 Mercer Street Princeton, West Virginia 24740-5939 (304) 487-9000 or (304) 327-5175 Pine Plaza Branch (304) 431-2225 211 Federal Street Bluefield, West Virginia 24701-0950 (304) 325-7151 Mercer Mall Branch (304) 327-0431 Blue Prince Road, Green Valley Bluefield, West Virginia 24701-6160 (304) 325-3641 Highway 52, Bluewell Bluefield, West Virginia 24701-3068 (304) 589-3301 101 Vermillion Street Athens, West Virginia 24712 (304) 384-9010 Corner of Bank & Cedar Streets Pineville, West Virginia 24874-0249 (304) 732-7011 East Pineville Branch (304) 732-7011 Mullens Shopping Plaza Route 54 Mullens, West Virginia 25882 (304) 294-0700 Route 10, Cook Parkway Oceana, West Virginia 24870-1680 (304) 682-8244 100 Market Street Man, West Virginia 25635 (304) 583-6525 77 North Morgan Boulevard Logan, West Virginia 25601 (304) 752-8102 Corner of Main & Latrobe Streets Grafton, West Virginia 26354-0278 (304) 265-1111 216 Lincoln Street Grafton, West Virginia 26354-1442 (304) 265-5111 Main Street Rowlesburg, West Virginia 26425 (304) 454-2431 16 West Main Street Richwood, West Virginia 26261 (304) 846-2641 Railroad and White Avenue Richwood, West Virginia 26261 (304) 846-2641 Route 20 & Williams River Road Cowen, West Virginia 26206 (304) 226-5924 Route 55, Red Oak Plaza Craigsville, West Virginia 26205 (304) 742-5101 111 Citizens Drive Beckley, West Virginia 25801-2970 (304) 252-9400 50 Brookshire Lane Beckley, West Virginia 25801-6765 (304) 254-9041 511 Main Street Clifton Forge, Virginia 24422 (540) 862-4251 643 E. Riverside Drive Tazewell, Virginia 24651 (276) 988-5577 302 Washington Square Richlands, Virginia 24641 (276) 964-7454 Chase Street & Alley 7 Clintwood, Virginia 24228 (276) 926-4671 874 Broad Street Summersville, West Virginia 26651 (304) 872-4402 747 Fort Chiswell Road Max Meadows, Virginia 24360 (276) 637-3122 65 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 66 United First Mortgage, Inc. (A Wholly-owned Subsidiary of First Community Bank, N. A.) 1503 Santa Rosa Road, Suite 109 P. O. Box K-177 Richmond, Virginia 23288 (804) 282-5631 Financial Information Corporate Headquarters One Community Place P.O. Box 989 Bluefield, Virginia 24605-0989 Phone: (276) 326-9000 Fax: (276) 326-9010 Stock Registrar and Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016-3572 (800) 368-5948 Form 10-K The Annual Report on Form 10-K, filed with the Securities and Exchange Commission, is available to shareholders upon request to the Senior Vice President–Finance of First Community Bancshares, Inc. Financial Contact Robert L. Schumacher Senior Vice President–Finance First Community Bancshares, Inc. P. O. Box 989 Bluefield, Virginia 24605-0989 (276) 326-9000 Internet Access Website: www.fcbinc.com E-mail: ir@fcbinc.com 8044 Main Street Pound, Virginia 24279 (276) 796-5431 910 East Main Street Wytheville, Virginia 24382 (276) 228-1901 101 Brookfall Dairy Road Elkin, North Carolina 28621 (336) 835-2265 5519 Mountain View Road Hays, North Carolina 28635 (336) 696-2265 57 N. Main Street Sparta, North Carolina 28675 (336) 372-2265 150 N. Center Street Taylorsville, North Carolina 28681 (828) 632-2265 4677 Main Street Drakes Branch, Virginia 23937 (434) 568-3301 401 Halifax Street Emporia, Virginia 23847 (434) 634-6555 431 South Main Street Emporia, Virginia 23847-2313 (434) 634-8866 66 FCB Annual Report 2001 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 67 Notes 67 T30290-Disc./Analysis.qx4 3/8/02 12:31 PM Page 68 Notes 68 FCB Annual Report 2001 T30290-Cover spread.qx4 3/8/02 12:23 PM Page 2 Financial Highlights (Amount in Thousands. Except Percent and Per Share Data) Earnings and Dividends Net income from recurring operations Net income as reported Basic and diluted earnings per share (1) Cash earnings per share (1),(2) Cash dividends per share (1) Return on average equity Return on average assets 2001 2000 1999 $ 19,266 19,134 1.92 2.05 0.89 14.80 1.49 % % $ 17,166 17,063 1.78 1.96 0.86 % 15.70 1.51 % $ 15,748 16,852 1.75 1.93 0.80 % 16.23 % 1.62 (1) All share and per share data have been adjusted for a 10% stock dividend declared February 19, 2002, and payable March 28, 2002, to shareholders of record March 1, 2002. (2) Cash earnings per share represent earnings per share adjusted for noncash charges for amortization of goodwill and other intangibles. Balance Sheet Data at Year-End Total Assets Earning Assets Deposits Securities sold under agreements to repurchase Stockholders’ equity $1,478,235 1,366,168 1,078,260 79,262 133,041 $1,218,017 1,117,910 899,903 46,179 120,682 $1,088,162 996,366 833,258 41,062 103,488 Pictured from left to right: E. Stephen Lilly Chief Operating Officer, First Community Bancshares, Inc., SVP and COO, First Community Bank, N. A. John M. Mendez President and CEO, First Community Bancshares, Inc. Robert L. Buzzo President, First Community Bank, N. A. Vice President and Secretary, First Community Bancshares, Inc. Contents Message to Stockholders Management’s Discussion and Analysis Introduction Stock Dividend Recent Acquisitions Summary Financial Results Five-Year Selected Financial Data Common Stock and Dividends Net Interest Margin Net Interest Income Provision for Loan Losses Non-interest Income Non-interest Expense Franchise Map Income Tax Expense Securities Held to Maturity Securities Available for Sale Loan Portfolio Allowance for Loan Losses Non-performing Assets Deposits Short-Term Borrowings Other Indebtedness Stockholders’ Equity Trust and Investment Management Services Liquidity Interest Rate Sensitivity, Interest Rate Risk and Asset/Liability Management Bankers Insurance Recent Legislation Consolidated Financial Statements Report of Independent Auditors Report on Management’s Responsibilities Board of Directors Locations & Other Information 1 4 5 5 5 8 9 9 10 11 11 13 15 16 16 16 17 18 19 20 20 20 21 21 21 21 23 24 26 61 62 63 65 T30290-Cover spread.qx4 3/8/02 12:23 PM Page 1 First Community Bancshares, Inc., One Community Place, Bluefield, VA 24605 276.326.9000 • www.fcbinc.com 

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