First Community Bancshares, Inc. Annual Report 2006

Plain-text annual report

One Community Place, Bluefield, VA 24605 (800) 425-0839 (cid:129) www.fcb .com 2006 annual report 2006 annual report www.raymondjames.com/ipc www.pcbresource.com www.fcbresource.com www.fcbinc.com www.fcb .com First Community Bank Your First Financial Resource RE-SOURCE (noun) A source of support, information or expertise The word “resource” plays a prominent role here at First Community Bank. It’s in our tag line, our web address, our online banking products and our mission statement. So what does it mean, exactly, for us to be “Your First Financial Resource”? We want First Community Bank to be the first place you think of when a financial need arises. With a full range of products and services available, we are ready to help you manage your assets, plan for major goals, and make the most of your time and money with a community bank feel. Our employees are also valuable resources for you. They have a thorough understanding and knowledge of financial and banking services, and they are always ready to help our customers make wise choices about their money. Our entire staff shares a commitment to personal service, so our customers enjoy one-on-one attention, expert advice, and plenty of friendly smiles. Our busy customers use our website as a resource on a regular basis. We provide helpful information on timely topics to help you get the most value from your money. And of course, we offer an array of online services such as Resource Online Banking, Resource Online Bill Pay, and Commercial Cash Manager. As you can see, the word “resource” defines First Community Bank in many different ways. We take pride in providing our customers with the very best in banking products and services, and we want to be your trusted financial partner for many years to come. OUR MISSION: Offering competitive products, impeccable service, building financial partnerships, and proving our value every day as Your First Financial Resource. CORPORATE HEADQUARTERS One Community Place P.O. Box 989 Bluefield, Virginia 24605-0989 ( 800 425-0839 (276) 326-9000 ) STOCK REGISTRAR AND TRANSFER AGENT Mellon Investor Services LLC 408 Washington Boulevard Jersey City, New Jersey 07310-1900 NASDAQ® GLOBAL SELECT: FCBC FINANCIAL CONTACT David D. Brown Chief Financial Officer First Community Bancshares, Inc. P.O. Box 989 Bluefield, Virginia 24605-0989 (276) 326-9000 INTERNET ACCESS Corporate Website: www.fcbinc.com Email: ir@fcbinc.com Bank Website: www.fcbresource.com Email: marketing@fcbinc.com FORM 10-K Upon request to the Chief Financial Officer of First Community Bancshares, Inc. or through the Company’s website, the Annual Report on Form 10-K, filed with the Securities and Exchange Commission, is available to shareholders. www.fcb .com First Community Bank Your First Financial Resource RE-SOURCE (noun) A source of support, information or expertise The word “resource” plays a prominent role here at First Community Bank. It’s in our tag line, our web address, our online banking products and our mission statement. So what does it mean, exactly, for us to be “Your First Financial Resource”? We want First Community Bank to be the first place you think of when a financial need arises. With a full range of products and services available, we are ready to help you manage your assets, plan for major goals, and make the most of your time and money with a community bank feel. Our employees are also valuable resources for you. They have a thorough understanding and knowledge of financial and banking services, and they are always ready to help our customers make wise choices about their money. Our entire staff shares a commitment to personal service, so our customers enjoy one-on-one attention, expert advice, and plenty of friendly smiles. Our busy customers use our website as a resource on a regular basis. We provide helpful information on timely topics to help you get the most value from your money. And of course, we offer an array of online services such as Resource Online Banking, Resource Online Bill Pay, and Commercial Cash Manager. As you can see, the word “resource” defines First Community Bank in many different ways. We take pride in providing our customers with the very best in banking products and services, and we want to be your trusted financial partner for many years to come. OUR MISSION: Offering competitive products, impeccable service, building financial partnerships, and proving our value every day as Your First Financial Resource. CORPORATE HEADQUARTERS One Community Place P.O. Box 989 Bluefield, Virginia 24605-0989 ( 800 425-0839 (276) 326-9000 ) STOCK REGISTRAR AND TRANSFER AGENT Mellon Investor Services LLC 408 Washington Boulevard Jersey City, New Jersey 07310-1900 NASDAQ® GLOBAL SELECT: FCBC FINANCIAL CONTACT David D. Brown Chief Financial Officer First Community Bancshares, Inc. P.O. Box 989 Bluefield, Virginia 24605-0989 (276) 326-9000 INTERNET ACCESS Corporate Website: www.fcbinc.com Email: ir@fcbinc.com Bank Website: www.fcbresource.com Email: marketing@fcbinc.com FORM 10-K Upon request to the Chief Financial Officer of First Community Bancshares, Inc. or through the Company’s website, the Annual Report on Form 10-K, filed with the Securities and Exchange Commission, is available to shareholders. www.fcb .com One Community Place, Bluefield, VA 24605 (800) 425-0839 (cid:129) www.fcb .com 2006 annual report 2006 annual report www.raymondjames.com/ipc www.pcbresource.com www.fcbresource.com www.fcbinc.com www.fcb .com Letter to Stockholders Our Mission Offering competitive products, impeccable service, building financial partnerships, proving our value every day as Your First Financial Resource. www.fcb .com One Community Place, Bluefield, VA 24605 (800) 425-0839 (cid:129) www.fcb .com We are very pleased to be able to continue to serve you as stockholders and customers of First Community Bank and we continue to work toward our goal of increasing the reach and impact of our bank and our company within the communities we serve as well as the investment community. We look forward to seeing those of you who can attend our annual meeting of stockholders which will be held at 11:30 on April 24, 2007 at the Fincastle , Country Club in Bluefield Virginia. Sincerely, John M. Mendez President and Chief Executive Officer First Community Bancshares, Inc. Dear Stockholders and Friends, Once again we are very pleased to be able to bring you a report of record results for First Community Bancshares. In a year marked with many challenges we were successful in achieving record profitability, growth in resources and achievement of other strategic objectives which should further our plan for growth and expansion. In 2006, our 134th year as a banking and financial services organization, we achieved record profitability with annual earnings of $28.9 million. This represents an increase of 10.05% versus the prior year and a five-year average growth rate of 10.26%. Likewise, diluted earnings per share represent a 10.78% increase over the preceding year’s results. Return on average assets and return on average equity reached three-year highs at 1.46% and 14.32%, respectively. These are results that, we believe, reflect favorably on our company and its ability to produce attractive returns, even in difficult market conditions. Throughout 2006 our company worked diligently on improvement of our efficiency through rationalization of branches and business processes. This led to the sale of three branches which were not viewed as strategic to our growth plan, the consolidation of a number of business processes to achieve economies and an ultimate reduction in total operating costs of over $2 million, excluding the impact of a 2005 debt restructuring charge. This reduction was led by a $2.6 million reduction in salaries and employee benefits as consolidation efforts in loan and deposit operations eliminated redundant costs and created very significant efficiencies throughout the company. Changes in employee benefits plans also yielded cost reductions as medical and retirement plans were restructured for better utilization and savings to the company. Asset quality measures for the company continued to be quite good throughout 2006 and resulted in a reduction in required provisions for possible loan losses of $1.0 million. Maintenance of low levels of non-performing loans and significant reductions in other real estate owned resulted in strong reserve coverage ratios of 381.6% on non-performing loans and 357.4% on non- performing assets. Both of these coverage ratios compare very favorably within the industry. In November 2006 we completed the acquisition of Investment Planning Consultants, a wealth management and investment advisory firm in Bluefield, West Virginia. IPC is the premier advisory firm in that region and will serve as an excellent platform for the further expansion of our wealth management services. When combined with our Trust Division, we now have over $800 million in customer assets under management. In March of 2007 we opened our two newest branches in the Winston-Salem, North Carolina area. These new branches boast a fresh look and customer friendly design which is part of our emphasis on the customer experience. We are looking forward to the opening of at least three additional branches on this design in the very near future. One of the three will be in Mechanicsville, Virginia and the two remaining will be in Daniels and Summersville, West Virginia. UNITEDSTATESSECURITIESANDEXCHANGECOMMISSIONWashington,D.C.20549Form10-KANNUALREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934ForthefiscalyearendedDecember31,2006Commissionfilenumber000-19297FIRSTCOMMUNITYBANCSHARES,INC.(Exactnameofregistrantasspecifiedinitscharter)Nevada(Stateorotherjurisdictionofincorporation)55-0694814(IRSEmployerIdentificationNo.)P.O.Box989Bluefield,Virginia(Addressofprincipalexecutiveoffices)24605-0989(ZipCode)(276)326-9000(Registrant’stelephonenumber,includingareacode)SecuritiesregisteredpursuanttoSection12(b)oftheAct:TitleofEachClassNameofExchangeonWhichRegisteredCommonStock,$1.00parvalueNASDAQGlobalSelectSecuritiesregisteredpursuanttoSection12(g)oftheAct:NoneIndicatebycheckmarkiftheregistrantisawell-knownseasonedissuer,asdefinedinRule405oftheSecuritiesAct.nYes¥NoIndicatebycheckmarkiftheregistrantisnotrequiredtofilereportspursuanttoSection13or15(d)oftheAct.nYes¥NoIndicatebycheckmarkwhethertheregistrant(1)hasfiledallreportsrequiredtobefiledbySection13or15(d)oftheSecuritiesExchangeActof1934duringthepreceding12months(orforsuchshorterperiodthattheregistrantwasrequiredtofilesuchreports),and(2)hasbeensubjecttosuchfilingrequirementsforthepast90days.¥YesnNoIndicatebycheckmarkifdisclosureofdelinquentfilerspursuanttoItem405ofRegulationS-Kisnotcontainedherein,andwillnotbecontained,tothebestoftheregistrant’sknowledge,indefinitiveproxyorinformationstatementsincorporatedbyreferenceinPartIIIofthisForm10-KoranyamendmenttothisForm10-K.nIndicatebycheckmarkwhethertheregistrantisalargeacceleratedfiler,anacceleratedfileroranon-acceleratedfiler.Seedefinitionof“acceleratedfilerand“largeaccelerated”filerinRule12b-2oftheExchangeAct.(Checkone):LargeacceleratedfilernAcceleratedfiler¥Non-acceleratedfilernIndicatebycheckmarkwhethertheregistrantisashellcompany(asdefinedinRule12b-2oftheExchangeAct).nYes¥NoStatetheaggregatemarketvalueofthevotingandnon-votingcommonequityheldbynon-affiliatescomputedbyreferencetothepriceatwhichthecommonequitywaslastsold,ortheaveragebidandaskedpriceofsuchcommonequity,asofthelastbusinessdayoftheregistrant’smostrecentlycompletedsecondfiscalquarter.Approximately$349,395,185basedontheclosingsalespriceatJune30,2006Indicatethenumberofsharesoutstandingofeachoftheissuer’sclassesofcommonstock,asofthelatestpracticabledate.Class—CommonStock,$1.00ParValue;11,268,552sharesoutstandingasofFebruary28,2007DOCUMENTSINCORPORATEDBYREFERENCEPortionsoftheProxyStatementfortheannualmeetingofshareholderstobeheldApril24,2007,areincorporatedbyreferenceinPartIIIofthisForm10-K.SBM 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17:06:26TABLEOFCONTENTSPagePARTIItem1Business...............................................................3Item1A.RiskFactors............................................................9Item1B.UnresolvedStaffComments.................................................12Item2.Properties..............................................................12Item3.LegalProceedings........................................................12Item4.SubmissionofMatterstoaVoteofSecurityHolders..............................12PARTIIItem5.MarketforRegistrant’sCommonEquity,RelatedStockholderMattersandIssuerPurchasesofEquitySecurities.......................................................12Item6.SelectedFinancialData....................................................15Item7.Management’sDiscussionandAnalysisofFinancialConditionandResultsofOperation....16Item7A.QuantitativeandQualitativeDisclosuresAboutMarketRisk.........................37Item8.FinancialStatementsandSupplementaryData...................................39Item9.ChangesinandDisagreementswithAccountantsonAccountingandFinancialDisclosure...84Item9A.ControlsandProcedures...................................................84Item9B.OtherInformation........................................................84PARTIIIItem10.Directors,ExecutiveOfficersandCorporateGovernance............................85Item11.ExecutiveCompensation...................................................87Item12.SecurityOwnershipofCertainBeneficialOwnersandManagementandRelatedStockholderMatters................................................................87Item13CertainRelationshipsandRelatedTransactions,andDirectorIndependence.............87Item14.PrincipalAccountingFeesandServices........................................87PARTIVItem15.Exhibits,FinancialStatementSchedules........................................88Signatures..............................................................902SBM 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17:06:26PARTIITEM1.BUSINESS.GeneralFirstCommunityBancshares,Inc.(the“Company”)isaone-bankholdingcompanyincorporatedintheStateofNevadaandservesastheholdingcompanyforFirstCommunityBank,N.A.(the“Bank”),aNationalAssociationthatconductscommercialbankingoperationswithintheStatesofVirginia,WestVirginia,NorthCarolinaandTennessee.TheBankownsInvestmentPlanningConsultants(“IPC”),aninvestmentadvisoryfirmpurchasedinNovember2006.TheCompanyhadtotalconsolidatedassetsofapproximately$2.03billionatDecember31,2006,andconductscommercialandmortgagebankingbusinessthroughforty-eightfull-servicebankinglocations,eightloanproductionoffices,andfourtrustandinvestmentmanagementoffices.TheCompanyisabankholdingcompany,andthebankingoperationsareexpectedtoremaintheprincipalbusinessandmajorsourceofrevenue.TheCompanyprovidesamechanismforownershipofthesubsidiarybankingoperations,providescapitalfundsasrequired,andservesasaconduitfordistributionofdividendstostockholders.TheCompanyalsoconsidersandevaluatesoptionsforgrowthandexpansionoftheexistingsubsidiarybankingoperations.TheCompanycurrentlyderivessubstantiallyallofitsrevenuesfromdividendspaidbyitssubsidiarybank.DividendpaymentsbytheBankaredeterminedinrelationtoearnings,assetgrowthandcapitalpositionandaresubjecttocertainrestrictionsbyregulatoryagenciesasdescribedmorefullyunderRegulationandSupervisionofthisitem.EmployeesTheCompanyanditssubsidiariesemployed602full-timeequivalentemployeesatDecember31,2006.Managementconsidersemployeerelationstobeexcellent.RegulationandSupervisionGeneralThesupervisionandregulationofbankholdingcompaniesandtheirsubsidiariesisintendedprimarilyfortheprotectionofdepositors,thedepositinsurancefundoftheFDIC,andthebankingsystemasawhole,andnotfortheprotectionofthebankholdingcompanyshareholdersorcreditors.Thebankingagencieshavebroadenforcementpoweroverbankholdingcompaniesandbanks,includingthepowertoimposesubstantialfinesandotherpenaltiesforviolationsoflawsandregulations.ThefollowingdescriptionsummarizessomeofthelawstowhichtheCompanyandtheBankaresubject.Referencesinthefollowingdescriptiontoapplicablestatutesandregulationsarebriefsummariesofthesestatutesandregulations,donotpurporttobecomplete,andarequalifiedintheirentiretybyreferencetosuchstatutesandregulations.TheCompanyTheCompanyisabankholdingcompanyregisteredundertheBankHoldingCompanyActof1956,asamended(“BHCA”).Accordingly,theCompanyissubjecttosupervision,regulationandexaminationbytheBoardofGovernorsoftheFederalReserveSystem(“FederalReserveBoard”).TheBHCA,theGramm-Leach-BlileyActandotherfederallawssubjectbankholdingcompaniestoparticularrestrictionsonthetypesofactivitiesinwhichtheymayengage,andtoarangeofsupervisoryrequirementsandactivities,includingregulatoryenforcementactionsforviolationsoflawsandregulations.RegulatoryRestrictionsonDividends;SourceofStrength.ItisthepolicyoftheFederalReserveBoardthatbankholdingcompaniesshouldpaycashdividendsoncommonstockonlyoutofincomeavailableoverthepastyearandonlyifprospectiveearningsretentionisconsistentwiththeorganization’sexpectedfutureneedsandfinancialcondition.Thepolicyprovidesthatbankholdingcompaniesshouldnotmaintainalevelofcashdividendsthatunderminesthebankholdingcompany’sabilitytoserveasasourceofstrengthtoitsbankingsubsidiaries.3SBM 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17:06:26UnderFederalReserveBoardpolicy,abankholdingcompanyisexpectedtoactasasourceoffinancialstrengthtoeachofitsbankingsubsidiariesandcommitresourcestotheirsupport.Suchsupportmayberequiredattimeswhen,absentthisFederalReserveBoardpolicy,aholdingcompanymaynotbeinclinedtoprovideit.Asdiscussedbelow,abankholdingcompanyincertaincircumstancescouldberequiredtoguaranteethecapitalplanofanundercapitalizedbankingsubsidiary.Intheeventofabankholdingcompany’sbankruptcyunderChapter11oftheU.S.BankruptcyCode,thetrusteewillbedeemedtohaveassumedandisrequiredtocureimmediatelyanydeficitunderanycommitmentbythedebtorholdingcompanytoanyofthefederalbankingagenciestomaintainthecapitalofaninsureddepositoryinstitution.Anyclaimforbreachofsuchobligationwillgenerallyhavepriorityovermostotherunsecuredclaims.ScopeofPermissibleActivities.UndertheBHCA,bankholdingcompaniesgenerallymaynotacquireadirectorindirectinterestinorcontrolofmorethan5%ofthevotingsharesofanycompanythatisnotabankorbankholdingcompanyorfromengaginginactivitiesotherthanthoseofbanking,managingorcontrollingbanksorfurnishingservicestoorperformingservicesforitssubsidiaries,exceptthatitmayengagein,directlyorindirectly,certainactivitiesthattheFederalReserveBoarddeterminedtobecloselyrelatedtobankingormanagingandcontrollingbanksastobeaproperincidentthereto.Notwithstandingtheforegoing,theGramm-Leach-BlileyAct,effectiveMarch11,2000,eliminatedthebarrierstoaffiliationsamongbanks,securitiesfirms,insurancecompaniesandotherfinancialserviceprovidersandpermitsbankholdingcompaniestobecomefinancialholdingcompaniesandtherebyaffiliatewithsecuritiesfirmsandinsurancecompaniesandengageinotheractivitiesthatarefinancialinnature.TheGramm-Leach-BlileyActdefines“financialinnature”toincludesecuritiesunderwriting,dealingandmarketmaking;sponsoringmutualfundsandinvestmentcompanies;insuranceunderwritingandagency;merchantbankingactivitiesandactivitiesthattheFederalReserveBoardhasdeterminedtobecloselyrelatedtobanking.Noregulatoryapprovalisgenerallyrequiredforafinancialholdingcompanytoacquireacompany,otherthanabankorsavingsassociation,engagedinactivitiesthatarefinancialinnatureorincidentaltoactivitiesthatarefinancialinnature,asdeterminedbytheFederalReserveBoard.UndertheGramm-Leach-BlileyAct,abankholdingcompanymaybecomeafinancialholdingcompanybyfilingadeclarationwiththeFederalReserveBoardifeachofitssubsidiarybanksiswell-capitalizedundertheFederalDepositInsuranceCorporationImprovementActof1991(“FDICIA”)promptcorrectiveactionprovisions,iswellmanagedandhasatleastasatisfactoryratingundertheCommunityReinvestmentActof1977(“CRA”).TheCompanyelectedfinancialholdingcompanystatusinDecember2006.Anti-TyingRestrictions.Bankholdingcompaniesandtheiraffiliatesareprohibitedfromtyingtheprovisionofcertainservices,suchasextensionsofcredit,tootherservicesofferedbyaholdingcompanyoritsaffiliates.StockRepurchases.AbankholdingcompanyisrequiredtogivetheFederalReserveBoardpriornoticeofanyredemptionorrepurchaseofitsownequitysecurities,iftheconsiderationtobepaid,togetherwiththeconsiderationpaidforanyrepurchasesorredemptionsintheprecedingyear,isequalto10%ormoreofthecompany’sconsolidatednetworth.TheFederalReserveBoardmayopposethetransactionifitbelievesthatthetransactionwouldconstituteanunsafeorunsoundpracticeorwouldviolateanylaworregulation.Aholdingcompanymaynotimpairitssubsidiarybank’ssoundnessbycausingittomakefundsavailabletononbankingsubsidiariesortheircustomersiftheFederalReserveBoardbelievesitisnotprudenttodoso.CapitalAdequacyRequirements.TheFederalReserveBoardhaspromulgatedcapitaladequacyguidelinesforuseinitsexaminationandsupervisionofbankholdingcompanies.Ifabankholdingcompany’scapitalfallsbelowminimumrequiredlevels,thenthebankholdingcompanymustimplementaplantoincreaseitscapital,anditsabilitytopaydividends,makeacquisitionsofnewbanksorengageincertainotheractivitiessuchasissuingbrokereddepositsmayberestrictedorprohibited.TheFederalReserveBoardcurrentlyusestwotypesofcapitaladequacyguidelinesforholdingcompanies,atwo-tieredrisk-basedcapitalguidelineandaleveragecapitalratioguideline.Thetwo-tieredrisk-basedcapitalguidelineassignsriskweightingstoallassetsandcertainoff-balancesheetitemsoftheholdingcompany’soperations,andthenestablishesaminimumratiooftheholdingcompany’sTier1capitaltotheaggregatedollaramountofrisk-weightedassets(whichamountisusuallylessthantheaggregatedollaramountofsuchassets4SBM 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17:06:26withoutriskweighting)andaminimumratiooftheholdingcompany’stotalcapital(Tier1capitalplusTier2capital,asadjusted)totheaggregatedollaramountofsuchrisk-weightedassets.Theleverageratioguidelineestablishesaminimumratiooftheholdingcompany’sTier1capitaltoitstotaltangibleassets(totalassetslessgoodwillandcertainidentifiableintangibles),withoutrisk-weighting.Underbothguidelines,Tier1capital(sometimesreferredtoas“corecapital”)isdefinedtoinclude:commonshareholders’equity(includingretainedearnings),qualifyingnon-cumulativeperpetualpreferredstockandrelatedsurplus,qualifyingcumulativeperpetualpreferredstockandrelatedsurplus,trustpreferredsecurities,andminorityinterestsintheequityaccountsofconsolidatedsubsidiaries(limitedtoamaximumof25%ofTier1capital).GoodwillandmostintangibleassetsaredeductedfromTier1capital.Forpurposesofthetotalrisk-basedcapitalguidelines,Tier2capital(sometimesreferredtoas“supplementarycapital”)isdefinedtoinclude:allowancesforloanandleaselosses(limitedto1.25%ofrisk-weightedassets),perpetualpreferredstocknotincludedinTier1capital,intermediate-termpreferredstockandanyrelatedsurplus,certainhybridcapitalinstruments,perpetualdebtandmandatoryconvertibledebtsecurities,andintermediate-termsubordinateddebtinstruments(subjecttolimitations).ThemaximumamountofqualifyingTier2capitalis100%ofqualifyingTier1capital.Forpurposesofthetotalcapitalguideline,totalcapitalequalsTier1capital,plusqualifyingTier2capital,minusinvestmentsinunconsolidatedsubsidiaries,reciprocalholdingsofbankholdingcompanycapitalsecurities,anddeferredtaxassetsandotherdeductions.TheFederalReserveBoard’scurrentcapitaladequacyguidelinesrequirethatabankholdingcompanymaintainaTier1risk-basedcapitalratioofatleast4%andatotalrisk-basedcapitalratioofatleast8%.AtDecember31,2006,theCompany’sratioofTier1capitaltototalrisk-weightedassetswas11.60%anditsratiooftotalcapitaltorisk-weightedassetswas12.69%.Inadditiontotherisk-basedcapitalguidelines,theFederalReserveBoardusesaleverageratioasanadditionaltooltoevaluatethecapitaladequacyofbankholdingcompanies.Theleverageratioisacompany’sTier1capitaldividedbyitsaveragetotalconsolidatedassets.Certainhighlyratedbankholdingcompaniesmaymaintainaminimumleverageratioof3.0%,butotherbankholdingcompaniesarerequiredtomaintainaleverageratioof4.0%ormore,dependingontheiroverallcondition.AtDecember31,2006,theCompany’sleverageratiowas8.50%.Thefederalbankingagencies’risk-basedandleverageratiosareminimumsupervisoryratiosgenerallyapplicabletobankingorganizationsthatmeetcertainspecifiedcriteria,assumingthattheyhavethehighestregulatoryrating.Bankingorganizationsnotmeetingthesecriteriaareexpectedtooperatewithcapitalpositionswellabovetheminimumratios.Thefederalbankregulatoryagenciesmaysetcapitalrequirementsforaparticularbankingorganizationthatarehigherthantheminimumratioswhencircumstanceswarrant.FederalReserveBoardguidelinesalsoprovidethatbankingorganizationsexperiencinginternalgrowthormakingacquisitionswillbeexpectedtomaintainstrongcapitalpositionssubstantiallyabovetheminimumsupervisorylevels,withoutsignificantrelianceonintangibleassets.AcquisitionsbyBankHoldingCompanies.TheBHCArequireseverybankholdingcompanytoobtainthepriorapprovaloftheFederalReserveBoardbeforeitmayacquireallorsubstantiallyalloftheassetsofanybank,orownershiporcontrolofanyvotingsharesofanybank,ifaftersuchacquisitionitwouldownorcontrol,directlyorindirectly,morethan5%ofthevotingsharesofsuchbank.Inapprovingbankacquisitionsbybankholdingcompanies,theFederalReserveBoardisrequiredtoconsiderthefinancialandmanagerialresourcesandfutureprospectsofthebankholdingcompanyandthebanksconcerned,theconvenienceandneedsofthecommunitiestobeserved,andvariouscompetitivefactors.TheBankTheBankisanationalbankingassociation.Asanationalbankingassociation,theBankissubjecttosupervisionandregulationbytheOfficeoftheComptrollerofCurrency(“OCC”).SincethedepositsoftheBankareinsuredbytheFederalDepositInsuranceCorporation(“FDIC”),theBankisarealsosubjecttosupervisionandregulationbytheFDIC.BecausetheFederalReserveBoardregulatestheCompany,andbecausetheBankisamemberoftheFederalReserveSystem,theFederalReserveBoardalsohasregulatoryauthoritywhichdirectlyaffectstheBank.5SBM 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17:06:26RestrictionsonTransactionswithAffiliatesandInsiders.TransactionsbetweentheBankanditsnonbankingsubsidiariesand/oraffiliates,includingtheCompany,aresubjecttoSection23AoftheFederalReserveAct.Ingeneral,Section23Aimposeslimitsontheamountofsuchtransactions,andalsorequirescertainlevelsofcollateralforloanstoaffiliatedparties.ItalsolimitstheamountofadvancestothirdpartieswhicharecollateralizedbythesecuritiesorobligationsoftheCompanyoritssubsidiaries.AffiliatetransactionsarealsosubjecttoSection23BoftheFederalReserveActwhichgenerallyrequiresthatcertaintransactionsbetweentheBankanditsaffiliatesbeontermssubstantiallythesame,oratleastasfavorabletotheBank,asthoseprevailingatthetimeforcomparabletransactionswithorinvolvingothernonaffiliatedpersons.TheFederalReserveBoardhasissuedRegulationWwhichcodifiespriorregulationsunderSections23Aand23BoftheFederalReserveActandinterpretiveguidancewithrespecttoaffiliatetransactions.Therestrictionsonloanstodirectors,executiveofficers,principalshareholdersandtheirrelatedinterestscontainedintheFederalReserveActandRegulationOapplytoallinsuredinstitutionsandtheirsubsidiariesandholdingcompanies.Theserestrictionsincludelimitsonloanstooneborrowerandconditionsthatmustbemetbeforesuchaloancanbemade.Thereisalsoanaggregatelimitationonallloanstosuchpersons.Theseloanscannotexceedtheinstitution’stotalunimpairedcapitalandsurplus,andtheFDICmaydeterminethatalesseramountisappropriate.RestrictionsonDistributionofSubsidiaryBankDividendsandAssets.DividendspaidbytheBankhaveprovidedtheCompany’soperatingfundsandfortheforeseeablefutureitisanticipatedthatdividendspaidbytheBanktotheCompanywillcontinuetobetheCompany’sprimarysourceofoperatingfunds.CapitaladequacyrequirementsoftheOCClimittheamountofdividendsthatmaybepaidbytheBank.TheBankcannotpayadividendif,afterpayingthedividend,itwouldbeclassifiedas“undercapitalized.”Inaddition,withouttheOCC’sapproval,dividendsmaynotbepaidbytheBankinanamountinanycalendaryearwhichexceedsitstotalnetprofitsforthatyear,plusitsretainedprofitsfortheprecedingtwoyears,lessanyrequiredtransferstocapitalsurplus.Nationalbanksalsomaynotpaydividendsinexcessoftotalretainedprofits,includingcurrentyear’searningsafterdeductingbaddebtsinexcessofreservesforloanlosses.Insomecases,theOCCmayfindadividendpaymentthatmeetsthesestatutoryrequirementstobeanunsafeorunsoundpractice.BecausetheCompanyisalegalentityseparateanddistinctfromitssubsidiaries,itsrighttoparticipateinthedistributionofassetsofanysubsidiaryuponthesubsidiary’sliquidationorreorganizationwillbesubjecttothepriorclaimsofthesubsidiary’screditors.Intheeventofaliquidationorotherresolutionofaninsureddepositoryinstitution,theclaimsofdepositorsandothergeneralorsubordinatedcreditorsareentitledtoapriorityofpaymentovertheclaimsofholdersofanyobligationoftheinstitutiontoitsshareholders,includinganydepositoryinstitutionholdingcompanyoranyshareholderorcreditorthereof.Examinations.UndertheFDICIA,allinsuredinstitutionsmustundergoregularon-siteexaminationbytheirappropriatebankingagencyandsuchagencymayassesstheinstitutionforitscostsofconductingtheexamination.TheOCCperiodicallyexaminesandevaluatesnationalbanks,suchastheBank.Theseexaminationsreviewareassuchascapitaladequacy,reserves,loanportfolioqualityandmanagement,consumerandothercomplianceissues,investments,informationsystems,disasterrecoveryandcontingencyplanningandmanagementpractices.Baseduponsuchanevaluation,theOCCmayrevaluetheassetsofabankandrequirethatitestablishspecificreservestocompensateforthedifferencebetweentheOCC-determinedvalueandthebookvalueofsuchassets.CapitalAdequacyRequirements.TheOCChasadoptedregulationsestablishingminimumrequirementsforthecapitaladequacyofinsurednationalbanks.TheOCCmayestablishhigherminimumrequirementsif,forexample,abankhaspreviouslyreceivedspecialattentionorhasahighsusceptibilitytointerestraterisk.TheOCC’srisk-basedcapitalguidelinesgenerallyrequirenationalbankstohaveaminimumratioofTier1capitaltototalrisk-weightedassetsof4.0%andaratiooftotalcapitaltototalrisk-weightedassetsof8.0%.ThecapitalcategorieshavethesamedefinitionsfortheBankasfortheCompany.AtDecember31,2006,theBank’sratioofTier1capitaltototalrisk-weightedassetswas10.73%anditsratiooftotalcapitaltototalrisk-weightedassetswas11.77%.6SBM 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17:06:26TheOCC’sleverageguidelinesrequirenationalbankstomaintainTier1capitalofnolessthan4.0%ofaveragetotalassets,exceptinthecaseofcertainhighlyratedbanksforwhichtherequirementis3.0%ofaveragetotalassets.AtDecember31,2006,theBank’sleverageratiowas7.85%.CorrectiveMeasuresforCapitalDeficiencies.Thefederalbankingregulatorsarerequiredtotake“promptcorrectiveaction”withrespecttocapital-deficientinstitutions.Agencyregulationsdefine,foreachcapitalcategory,thelevelsatwhichinstitutionsare“well-capitalized,”“adequatelycapitalized,”“undercapitalized,”“significantlyundercapitalized”and“criticallyundercapitalized.”A“well-capitalized”bankhasatotalrisk-basedcapitalratioof10.0%orhigher;aTier1risk-basedcapitalratioof6.0%orhigher;aleverageratioof5.0%orhigher;andisnotsubjecttoanywrittenagreement,orderordirectiverequiringittomaintainaspecificcapitallevelforanycapitalmeasure.An“adequatelycapitalized”bankhasatotalrisk-basedcapitalratioof8.0%orhigher;aTier1risk-basedcapitalratioof4.0%orhigher;aleverageratioof4.0%orhigher(3.0%orhigherifthebankwasratedacomposite1initsmostrecentexaminationreportandisnotexperiencingsignificantgrowth);anddoesnotmeetthecriteriaforawell-capitalizedbank.Abankis“undercapitalized”ifitfailstomeetanyoneoftheratiosrequiredtobeadequatelycapitalized.TheBankisclassifiedas“well-capitalized”forpurposesoftheFDIC’spromptcorrectiveactionregulations.Inadditiontorequiringundercapitalizedinstitutionstosubmitacapitalrestorationplan,agencyregulationscontainbroadrestrictionsoncertainactivitiesofundercapitalizedinstitutionsincludingassetgrowth,acquisitions,branchestablishmentandexpansionintonewlinesofbusiness.Withcertainexceptions,aninsureddepositoryinstitutionisprohibitedfrommakingcapitaldistributions,includingdividends,andisprohibitedfrompayingmanagementfeestocontrolpersonsiftheinstitutionwouldbeundercapitalizedafteranysuchdistributionorpayment.Asaninstitution’scapitaldecreases,thefederalregulators’enforcementpowersbecomemoresevere.Asignificantlyundercapitalizedinstitutionissubjecttomandatedcapitalraisingactivities,restrictionsoninterestratespaidandtransactionswithaffiliates,removalofmanagementandotherrestrictions.TheFDIChaslimiteddiscretionindealingwithacriticallyundercapitalizedinstitutionandisgenerallyrequiredtoappointareceiverorconservator.Similarly,within90daysofanationalbankbecomingcriticallyundercapitalized,theOCCmustappointareceiverorconservatorunlesscertainfindingsaremadewithrespecttotheinstitution’scontinuedviability.Bankswithrisk-basedcapitalandleverageratiosbelowtherequiredminimumsmayalsobesubjecttocertainadministrativeactions,includingtheterminationofdepositinsuranceuponnoticeandhearing,oratemporarysuspensionofinsurancewithoutahearingintheeventtheinstitutionhasnotangiblecapital.DepositInsuranceAssessments.TheBank’sdepositsareinsureduptoapplicablelimitsbytheDepositInsuranceFund(“DIF”)oftheFDICandaresubjecttodepositinsuranceassessmentstomaintaintheDIF.TheDIFwascreatedbythemergeroftheBankInsuranceFundandSavingsAssociationInsuranceFundprovidedforintheFederalDepositInsuranceReformActof2005(“FDIRA”),asenactedinFebruary2006.OnNovember2,2006,theFDICadoptedfinalregulationsimplementingtheFDIRA,whichestablishedarisk-basedassessmentsystemthatwillenabletheFDICtomorecloselytieeachfinancialinstitution’spremiumstotheriskitposestothedepositinsurancefund.Underthenewrisk-basedassessmentsystem,whichbecameeffectiveJanuary1,2007,theFDICwillevaluatetheriskofeachfinancialinstitutionbasedonthreeprimarysourcesofinformation:(1)itssupervisoryrating,(2)itsfinancialratios,and(3)itslong-termdebtissuerrating,iftheinstitutionhasone.TheFDICalsoadoptedanewbasescheduleofratesthatitcanadjustupordown,dependingontheneedsoftheDIF,andsetinitialpremiumsfor2007thatrangefrom5centsper$100ofdomesticdepositsinthelowestriskcategoryto43centsper$100ofdomesticdepositsforbanksinthehighestriskcategory.TheFDICregulationsdesignatedthereserveratiofortheDIFduring2007at1.25%ofestimatedinsureddeposits.TheFDIRAalsoprovidesforaone-timeassessmentcreditforeligibleinsureddepositoryinstitutions(thoseinstitutionsthatwereinexistenceonDecember31,1996andpaidadepositinsuranceassessmentpriortothatdate,orareasuccessortoanysuchinstitution).ThecreditisdeterminedbasedontheassessmentbaseoftheinstitutionasofDecember31,1996ascomparedwiththecombinedaggregateassessmentbaseofalleligibleinstitutionsasofthatdate.Thecreditmaybeusedtooffsetupto100%ofthe2007DIFassessment,andifnotcompletelyusedin2007,maybeappliedtonotmorethan90%ofeachoftheaggregate2008,2009and2010DIFassessments.7SBM 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17:06:26EnforcementPowers.TheFDICandtheotherfederalbankingagencieshavebroadenforcementpowers,includingthepowertoterminatedepositinsurance,imposesubstantialfinesandothercivilandcriminalpenaltiesandappointaconservatororreceiver.Failuretocomplywithapplicablelaws,regulationsandsupervisoryagreementscouldsubjecttheCompanyortheBank,aswellasofficers,directorsandotherinstitution-affiliatedpartiesoftheseorganizations,toadministrativesanctionsandpotentiallysubstantialcivilmoneypenalties.TheappropriatefederalbankingagencymayappointtheFDICasconservatororreceiverforabankinginstitution(ortheFDICmayappointitself,undercertaincircumstances)ifanyoneormoreofanumberofcircumstancesexist,including,withoutlimitation,thefactthatthebankinginstitutionisundercapitalizedandhasnoreasonableprospectofbecomingadequatelycapitalized;failstobecomeadequatelycapitalizedwhenrequiredtodoso;failstosubmitatimelyandacceptablecapitalrestorationplan;ormateriallyfailstoimplementanacceptedcapitalrestorationplan.ConsumerLawsandRegulations.Inadditiontothelawsandregulationsdiscussedherein,theBankisalsosubjecttocertainconsumerlawsandregulationsthataredesignedtoprotectconsumersintransactionswithbanks.Whilethelistsetforthhereinisnotexhaustive,theselawsandregulationsincludetheTruthinLendingAct,theTruthinSavingsAct,theElectronicFundsTransferAct,theExpeditedFundsAvailabilityAct,theEqualCreditOpportunityAct,andtheFairHousingAct,andvariousstatecounterparts.Theselawsandregulationsmandatecertaindisclosurerequirementsandregulatethemannerinwhichfinancialinstitutionsmustdealwithcustomerswhentakingdepositsormakingloanstosuchcustomers.TheBankmustcomplywiththeapplicableprovisionsoftheseconsumerprotectionlawsandregulationsaspartoftheirongoingcustomerrelations.Inaddition,federallawcurrentlycontainsextensivecustomerprivacyprotectionprovisions.Undertheseprovisions,afinancialinstitutionmustprovidetoitscustomers,attheinceptionofthecustomerrelationshipandannuallythereafter,theinstitution’spoliciesandproceduresregardingthehandlingofcustomers’nonpublicpersonalfinancialinformation.Theseprovisionsalsoprovidethat,exceptforcertainlimitedexceptions,afinancialinstitutionmaynotprovidesuchpersonalinformationtounaffiliatedthirdpartiesunlesstheinstitutiondisclosestothecustomerthatsuchinformationmaybesoprovidedandthecustomerisgiventheopportunitytooptoutofsuchdisclosure.USAPATRIOTActof2001.TheUnitingandStrengtheningAmericabyProvidingAppropriateToolsRequiredtoInterceptandObstructTerrorismActof2001(“PatriotAct”)wasenactedinOctober2001.ThePatriotActhasbroadenedexistinganti-moneylaunderinglegislationwhileimposingnewcomplianceandduediligenceobligationsonbanksandotherfinancialinstitutions,withaparticularfocusondetectingandreportingmoney-launderingtransactionsinvolvingdomesticorinternationalcustomers.TheU.S.TreasuryDepartmenthasissuedandwillcontinuetoissueregulationsclarifyingthePatriotAct’srequirements.ThePatriotActrequiresall“financialinstitutions,”asdefined,toestablishcertainanti-moneylaunderingcomplianceandduediligenceprograms.Recently,theregulatoryagencieshaveintensifiedtheirexaminationproceduresinlightofthePatriotAct’santi-moneylaunderingandbanksecrecyactrequirements.TheCompanybelievesthatitscontrolsandproceduresareincompliancewiththePatriotAct.WebsiteAccesstoCompanyReportsTheCompanymakesavailablefreeofchargeonitswebsiteatwww.fcbinc.comitsAnnualReportonForm10-K,QuarterlyReportsonForm10-QandCurrentReportsonForm8-K,andallamendmentsthereto,assoonasreasonablypracticableaftertheCompanyfilessuchreportswith,orfurnishesthemto,theSecuritiesandExchangeCommission.InvestorsareencouragedtoaccessthesereportsandtheotherinformationabouttheCompany’sbusinessonitswebsite.InformationfoundontheCompany’swebsiteisnotpartofthisAnnualReportonForm10-K.TheCompanywillalsoprovidecopiesofitsAnnualReportonForm10-K,freeofcharge,uponwrittenrequestofitsInvestorRelationsdepartmentattheCompany’smainaddress,P.O.Box989,Bluefield,VA24605.Forward-LookingStatementsThisAnnualReportonForm10-Kmayinclude“forward-lookingstatements”,whicharemadeingoodfaithbytheCompanypursuanttothe“safeharbor”provisionsofthePrivateSecuritiesLitigationReformActof1995.Theseforward-lookingstatementsinclude,amongothers,statementswithrespecttotheCompany’sbeliefs,plans,objectives,goals,guidelines,expectations,anticipations,estimatesandintentionsthataresubjecttosignificant8SBM 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17:06:26risksanduncertaintiesandaresubjecttochangebasedonvariousfactors,manyofwhicharebeyondtheCompany’scontrol.Thewords“may”,“could”,“should”,“would”,“believe”,“anticipate”,“estimate”,“expect”,“intend”,“plan”andsimilarexpressionsareintendedtoidentifyforward-lookingstatements.Thefollowingfactors,amongothers,couldcausetheCompany’sfinancialperformancetodiffermateriallyfromthatexpressedinsuchforward-lookingstatements:thestrengthoftheUnitedStateseconomyingeneralandthestrengthofthelocaleconomiesinwhichtheCompanyconductsoperations;theeffectsof,andchangesin,trade,monetaryandfiscalpoliciesandlaws,includinginterestratepoliciesoftheFederalReserveBoard;inflation,interestrate,marketandmonetaryfluctuations;thetimelydevelopmentofcompetitivenewproductsandservicesoftheCompanyandtheacceptanceoftheseproductsandservicesbynewandexistingcustomers;thewillingnessofcustomerstosubstitutecompetitors’productsandservicesfortheCompany’sproductsandservicesandviceversa;theimpactofchangesinfinancialserviceslawsandregulations(includinglawsconcerningtaxes,banking,securitiesandinsurance);technologicalchanges;theeffectofacquisitions,including,withoutlimitation,thefailuretoachievetheexpectedrevenuegrowthand/orexpensesavingsfromsuchacquisitions;thegrowthandprofitabilityoftheCompany’snon-interestorfeeincomebeinglessthanexpected;unanticipatedregulatoryorjudicialproceedings;changesinconsumerspendingandsavinghabits;andthesuccessoftheCompanyatmanagingtherisksinvolvedintheforegoing.TheCompanycautionsthattheforegoinglistofimportantfactorsisnotexclusive.Ifoneormoreofthefactorsaffectingtheseforward-lookingstatementsprovesincorrect,thentheCompany’sactualresults,performance,orachievementscoulddiffermateriallyfromthoseexpressedin,orimpliedby,forward-lookingstatementscontainedinthisAnnualReportonForm10-K.Therefore,theCompanycautionsyounottoplaceunduerelianceontheseforward-lookingstatements.TheCompanydoesnotintendtoupdatetheseforward-lookingstatements,whetherwrittenororal,toreflectchange.Allforward-lookingstatementsattributabletotheCompanyareexpresslyqualifiedbythesecautionarystatements.ITEM1A.RISKFACTORS.TheCompanyanditssubsidiarybusinessaresubjecttointerestrateriskandvariationsininterestratesmaynegativelyaffectitsfinancialperformance.Weareunabletopredictactualfluctuationsofmarketinterestrateswithcompleteaccuracy.Ratefluctuationsareaffectedbymanyfactors,includinginflation,recession,ariseinunemployment,atighteningofthemoneysupplyanddomesticandinternationaldisorderandinstabilityindomesticandforeignfinancialmarkets.Changesintheinterestrateenvironmentmayreduceprofits.WeexpectthattheCompanyandtheBankwillcontinuetorealizeincomefromthedifferentialor“spread”betweentheinterestearnedonloans,securitiesandotherinterest-earningassets,andinterestpaidondeposits,borrowingsandotherinterest-bearingliabilities.Netinterestspreadsareaffectedbythedifferencebetweenthematuritiesandrepricingcharacteristicsofinterest-earningassetsandinterest-bearingliabilities.ChangesinlevelsofmarketinterestratescouldmateriallyandadverselyaffecttheCompany’snetinterestspread,levelsofprepaymentsandcashflows,themarketvalueofitssecuritiesportfolio,andoverallprofitability.TheBank’sabilitytopaydividendsissubjecttoregulatorylimitationswhich,totheextenttheCompanyrequiressuchdividendsinthefuture,mayaffecttheCompany’sabilitytopayitsobligationsandpaydividends.TheCompanyisaseparatelegalentityfromtheBankanditssubsidiariesanddoesnothavesignificantoperationsofitsown.TheCompanycurrentlydependsontheBank’scashandliquidityaswellasdividendstopaytheCompany’soperatingexpensesanddividendstoshareholders.NoassurancecanbemadethatinthefuturetheBankwillhavethecapacitytopaythenecessarydividendsandthattheCompanywillnotrequiredividendsfromtheBanktosatisfytheCompany’sobligations.TheavailabilityofdividendsfromtheBankislimitedbyvariousstatutesandregulations.Itispossible,dependinguponthefinancialconditionoftheBankandotherfactorsthattheOCC,theBank’sprimaryregulator,couldassertthatpaymentofdividendsorotherpaymentsbytheBankareanunsafeorunsoundpractice.IntheeventtheBankisunabletopaydividendssufficienttosatisfytheCompany’s9SBM 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17:06:26obligationsorisotherwiseunabletopaydividendstotheCompany,theCompanymaynotbeabletoserviceitsobligationsastheybecomedue,includingpaymentsrequiredtobemadetotheFCBICapitalTrust,abusinesstrustsubsidiaryoftheCompany,orpaydividendsontheCompany’scommonstock.Consequently,theinabilitytoreceivedividendsfromtheBankcouldadverselyaffecttheCompany’sfinancialcondition,resultsofoperations,cashflowsandprospects.TheBank’sallowanceforloanlossesmaynotbeadequatetocoveractuallosses.Likeallfinancialinstitutions,theBankmaintainsanallowanceforloanlossestoprovideforprobablelosses.TheBank’sallowanceforloanlossesmaynotbeadequatetocoveractualloanlosses,andfutureprovisionsforloanlossescouldmateriallyandadverselyaffecttheBank’soperatingresults.TheBank’sallowanceforloanlossesisdeterminedbyanalyzinghistoricalloanlosses,currenttrendsindelinquenciesandcharge-offs,plansforproblemloanresolution,changesinthesizeandcompositionoftheloanportfolio,andindustryinformation.Alsoincludedinmanagement’sestimatesforloanlossesareconsiderationswithrespecttotheimpactofeconomicevents,theoutcomeofwhichareuncertain.Theamountoffuturelossesissusceptibletochangesineconomic,operatingandotherconditions,includingchangesininterestratesthatmaybebeyondtheBank’scontrol,andtheselossesmayexceedcurrentestimates.Federalregulatoryagencies,asanintegralpartoftheirexaminationprocess,reviewtheBank’sloansandallowanceforloanlosses.WhilewebelievethattheBank’sallowanceforloanlossesisadequatetoprovideforprobablelosses,wecannotassureyouthatwewillnotneedtoincreasetheBank’sallowanceforloanlossesorthatregulatorswillnotrequireustoincreasethisallowance.EitheroftheseoccurrencescouldmateriallyandadverselyaffecttheBank’searningsandprofitability.TheCompany’sbusinessissubjecttovariouslendingandothereconomicrisksthatcouldadverselyimpacttheCompany’sresultsofoperationsandfinancialcondition.Changesineconomicconditions,particularlyaneconomicslowdown,couldhurttheCompany’sbusiness.TheCompany’sbusinessisdirectlyaffectedbypoliticalandmarketconditions,broadtrendsinindustryandfinance,legislativeandregulatorychanges,andchangesingovernmentalmonetaryandfiscalpoliciesandinflation,allofwhicharebeyondtheCompany’scontrol.Adeteriorationineconomicconditions,inparticularaneconomicslowdownwithintheCompany’sgeographicregion,couldresultinthefollowingconsequences,anyofwhichcouldhurttheCompany’sbusinessmaterially:(cid:129)loandelinquenciesmayincrease;(cid:129)problemassetsandforeclosuresmayincrease;(cid:129)demandfortheCompany’sproductsandservicesmaydecline;and(cid:129)collateralforloansmadebytheCompanymaydeclineinvalue,inturnreducingaclient’sborrowingpower,andreducingthevalueofassetsandcollateralassociatedwiththeCompany’sloansheldforinvestment.AdownturnintherealestatemarketcouldhurttheCompany’sbusiness.TheCompany’sbusinessactivitiesandcreditexposureareconcentratedinVirginia,WestVirginia,NorthCarolina,Tennesseeandthesurroundingregion.AdownturninthisregionalrealestatemarketcouldhurttheCompany’sbusinessbecauseofthegeographicconcentrationwithinthisregionalarea.Ifthereisasignificantdeclineinrealestatevalues,thecollateralfortheCompany’sloanswillprovidelesssecurity.Asaresult,theCompany’sabilitytorecoverondefaultedloansbysellingtheunderlyingrealestatewouldbediminished,andwewouldbemorelikelytosufferlossesondefaultedloans.TheCompany’slevelofcreditriskisincreasingduetoitsfocusoncommerciallending,andtheconcen-trationonsmallbusinessesandmiddlemarketcustomerswithheightenedvulnerabilitytoeconomicconditions.Commercialbusinessandcommercialrealestateloansgenerallyareconsideredriskierthansingle-familyresidentialloansbecausetheyhavelargerbalancestoasingleborrowerorgroupofrelatedborrowers.Commercialbusinessandcommercialrealestateloansinvolverisksbecausetheborrower’sabilitytorepaytheloantypically10SBM 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17:06:26dependsprimarilyonthesuccessfuloperationofthebusinessorthepropertysecuringtheloan.Mostofthecommercialbusinessloansaremadetosmallbusinessormiddlemarketcustomerswhomayhaveaheightenedvulnerabilitytoeconomicconditions.Moreover,aportionoftheseloanshavebeenmadeoracquiredbytheCompanyinthelastseveralyearsandtheborrowersmaynothaveexperiencedacompletebusinessoreconomiccycle.TheBankmaysufferlossesinitsloanportfoliodespiteitsunderwritingpractices.TheBankseekstomitigatetherisksinherentintheBank’sloanportfoliobyadheringtospecificunderwritingpractices.Thesepracticesincludeanalysisofaborrower’spriorcredithistory,financialstatements,taxreturnsandcashflowprojections,valuationofcollateralbasedonreportsofindependentappraisersandverificationofliquidassets.AlthoughtheBankbelievesthatitsunderwritingcriteriaareappropriateforthevariouskindsofloansitmakes,theBankmayincurlossesonloansthatmeetitsunderwritingcriteria,andtheselossesmayexceedtheamountssetasideasreservesintheBank’sallowanceforloanlosses.TheCompanyanditssubsidiariesaresubjecttoextensiveregulationwhichcouldadverselyaffectthem.TheCompanyanditssubsidiaries’operationsaresubjecttoextensiveregulationbyfederal,stateandlocalgovernmentalauthoritiesandaresubjecttovariouslawsandjudicialandadministrativedecisionsimposingrequirementsandrestrictionsonpartoralloftheCompany’soperations.TheCompanybelievesthatitisinsubstantialcomplianceinallmaterialrespectswithapplicablefederal,stateandlocallaws,rulesandregulations.BecausetheCompany’sbusinessishighlyregulated,thelaws,rulesandregulationsapplicabletoitaresubjecttoregularmodificationandchange.Therearevariouslaws,rulesandregulationsthatimpacttheCompany’soperations,including,amongotherthings,matterspertainingtocorporategovernance,requirementsforlistingandmaintenanceonnationalsecuritiesexchangesandoverthecountermarkets,SecuritiesandExchangeCommission(“SEC”)rulespertainingtopublicreportingdisclosuresandbankingregulationsgoverningtheamountofloansthatafinancialinstitution,suchastheBank,canacquireforinvestmentfromanaffiliate.Inaddition,theFinancialAccountingStandardsBoard(“FASB”)madechangeswhichrequire,amongotherthings,theexpensingofthefairvalueofstockoptions.Theselaws,rulesandregulations,oranyotherlaws,rulesorregulations,thatmaybeadoptedinthefuture,couldmakecompliancemoredifficultorexpensive,restricttheCompany’sabilitytooriginate,brokerorsellloans,furtherlimitorrestricttheamountofcommissions,interestorotherchargesearnedonloansoriginatedorsoldbytheBankandotherwiseadverselyaffecttheCompany’sbusiness,financialconditionorprospects.TheCompanyfacesstrongcompetitionfromotherfinancialinstitutions,financialservicecompaniesandotherorganizationsofferingservicessimilartothoseofferedbytheCompanyanditssubsidiaries,whichcouldhurttheCompany’sbusiness.TheCompany’sbusinessoperationsarecenteredprimarilyinVirginia,WestVirginia,NorthCarolina,Tennesseeandthesurroundingregion.Increasedcompetitionwithinthisregionmayresultinreducedloanoriginationsanddeposits.Ultimately,wemaynotbeabletocompetesuccessfullyagainstcurrentandfuturecompetitors.Manycompetitorsofferthetypesofloansandbankingservicesthatweoffer.Thesecompetitorsincludeothersavingsassociations,nationalbanks,regionalbanksandothercommunitybanks.TheCompanyalsofacescompetitionfrommanyothertypesoffinancialinstitutions,includingfinancecompanies,brokeragefirms,insurancecompanies,creditunions,mortgagebanksandotherfinancialintermediaries.Inparticular,theBank’scompetitorsincludeotherstateandnationalbanksandmajorfinancialcompanieswhosegreaterresourcesmayaffordthemamarketplaceadvantagebyenablingthemtomaintainnumerousbankinglocationsandmountextensivepromotionalandadvertisingcampaigns.Additionally,banksandotherfinancialinstitutionswithlargercapitalizationandfinancialintermediariesnotsubjecttobankregulatoryrestrictionshavelargerlendinglimitsandaretherebyabletoservethecreditneedsoflargerclients.Theseinstitutions,particularlytotheextenttheyaremorediversifiedthantheCompany,maybeabletoofferthesameloanproductsandservicesthattheCompanyoffersatmorecompetitiveratesandprices.IftheCompanyisunabletoattractandretainbankingclients,theCompanymaybeunabletocontinuetheBank’sloananddepositgrowthandtheCompany’sbusiness,financialconditionandprospectsmaybenegativelyaffected.11SBM 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17:06:26ITEM1B.UNRESOLVEDSTAFFCOMMENTS.TheCompanyhasnounresolvedstaffcommentsasofthefilingdateofthis2006AnnualReportonForm10-K.ITEM2.PROPERTIES.TheCompanygenerallyownsitsoffices,relatedfacilities,andunimprovedrealproperty.TheprincipalofficesoftheCompanyarelocatedatOneCommunityPlace,Bluefield,Virginia,wheretheCompanyownsandoccupiesapproximately36,000squarefeetofofficespace.TheBankoperatesforty-eightfull-servicebranchesandeightloanproductionofficesthroughoutthefour-stateregionofVirginia,WestVirginia,NorthCarolinaandTennessee.TheBankalsoprovideswealthmanagementservicesthroughtwotrustandinvestmentmanagementoffices,aswellasInvestmentPlanningConsultants,aninvestmentadvisoryfirm,whichhastwooffices.TheCompany’sbankingsubsidiaryownsfortyofitsbankingofficeswhileothersareleasedorarelocatedonleasedland.TherearenomortgagesorliensagainstanypropertyoftheBankortheCompany.InVirginia,theBankoperatesofficesinBlacksburg,Bluefield,Clintwood,Emporia,MaxMeadows,Pound,Richlands,Richmond,Tazewell,andWytheville.InWestVirginia,theBankoperatesofficesinAthens,Beckley,Bluefield,Bridgeport,Buckhannon,Cowen,Craigsville,Grafton,Hinton,Lindside,Man,Mullens,Oceana,Pineville,Princeton,Richwood,Summersville,andTeaysValley.InNorthCarolina,theBankoperatesofficesinCharlotte,Elkin,Hays,MountAiry,Sparta,Taylorsville,andWinston-Salem.InTennessee,theBankoperatesofficesinBoonesCreek,FallBranch,JohnsonCity,Kingsport,andPineyFlats.AcompletelistingofallbranchesandATMsitescanbefoundontheInternetatwww.fcbresource.com.InformationonsuchwebsiteisnotpartofthisAnnualReportonForm10-K.ITEM3.LEGALPROCEEDINGS.TheCompanyiscurrentlyadefendantinvariouslegalactionsandassertedclaimsinvolvinglendingandcollectionactivitiesandothermattersinthenormalcourseofbusiness.WhiletheCompanyandlegalcounselareunabletoassesstheultimateoutcomeofeachofthesematterswithcertainty,theyareofthebeliefthattheresolutionoftheseactionsshouldnothaveamaterialadverseaffectonthefinancialpositionoftheCompany.ITEM4.SUBMISSIONOFMATTERSTOAVOTEOFSECURITYHOLDERS.Nomattersweresubmittedtoavoteofsecurityholdersduringthefourthquarterof2006.PARTIIITEM5.MARKETFORREGISTRANT’SCOMMONEQUITY,RELATEDSTOCKHOLDERMATTERSANDISSUERPURCHASESOFEQUITYSECURITIES.ThenumberofcommonstockholdersofrecordonDecember31,2006,was2,548andoutstandingsharestotaled11,245,742.Thenumberofcommonstockholdersismeasuredbythenumberofrecordholders.TheCompany’scommonstocktradesontheNASDAQGlobalSelectmarketunderthesymbolFCBC.OnDecember31,2006,theCompany’syear-endcommonstockpricewas$39.56,a27.0%increasefromthe$31.16closingpriceonDecember31,2005.Bookvaluepercommonsharewas$18.92atDecember31,2006,comparedwith$17.29atDecember31,2005,and$16.29atthecloseof2004.Theyear-endmarketpricefortheCompany’scommonstockof$39.56represents209.1%oftheCompany’sbookvalueasofthecloseoftheyearandreflectstotalmarketcapitalizationof$444.9million.Utilizingtheyear-endmarketpriceand2006dilutedearningspershare,theCompany’scommonstockclosedtheyeartradingataprice/earningsmultipleof15.4timesdilutedearningspershare.Cashdividendsfor2006totaled$1.04pershare,up$0.02or2.0%fromthe$1.02paidin2005.The2006dividendsresultedinacashyieldontheyear-endmarketvalueof2.63%.Totaldividendspaidforthecurrentandprioryearstotaled$11.7millionand$11.5million,respectively.12SBM 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17:06:26Thefollowingtablesetsforththehighandlowstockprices,bookvaluepershare,anddividendspaidpershareontheCompany’scommonstockduringtheperiodsindicated.HighLowBookValuePerShare(EndofPeriod)CashDividendsPerShare2006FirstQuarter.................................$35.27$30.16$17.49$0.26SecondQuarter...............................33.0029.5017.710.26ThirdQuarter................................34.4430.0418.400.26FourthQuarter...............................41.1731.6718.920.26$1.042005FirstQuarter.................................$36.21$27.39$16.35$0.255SecondQuarter...............................33.2026.2516.830.255ThirdQuarter................................34.2528.0217.150.255FourthQuarter...............................33.7127.1417.290.255$1.02TheCompany’sstockrepurchaseplan,asamended,allowsthepurchaseandretentionofupto550,000shares.Theplanhasnoexpirationdate,remainsopenandnoplanshaveexpiredduringthereportingperiod.Nodeterminationhasbeenmadetoterminatetheplanortostopmakingpurchases.ThefollowingtablesetsforthopenmarketpurchasesbytheCompanyofitsequitysecuritiesduring2006.TherepurchaseofCompanystockhastheeffectofincreasingearningspershare.During2006,theweighted-averageincreaseinthenumberoftreasuryshareshadaninsignificantimpactonearningspershare.TotalNumberofSharesPurchasedAveragePricePaidperShareTotalNumberofSharesPurchasedasPartofPubliclyAnnouncedPlanMaximumNumberofSharesThatMayYetBePurchasedUnderthePlanJanuary1-31,2006..................23,161$32.1023,161284,455February1-29,2006.................32,90032.1432,900287,234March1-31,2006...................25,00031.8125,000265,566April1-30,2006....................10,00030.3810,000255,566May1-31,2006....................14,30030.6814,300248,337June1-30,2006....................25,50030.8525,500227,437July1-31,2006.....................14,30030.8414,300215,756August1-31,2006..................———234,650September1-30,2006................———234,650October1-31,2006..................———242,871November1-30,2006................———296,224December1-31,2006................———296,724Total............................145,161$31.46145,161InNovember2006,theCompanycompletedtheacquisitionofInvestmentPlanningConsultants,Inc.(“IPC”),aregisteredinvestmentadvisoryfirm.Inconnectionwiththeinitialpaymentofapproximately$1.47million,theCompanyissued39,874sharesofcommonstock.Underthetermsofthestockpurchaseagreement,formershareholdersofIPCareentitledtoadditionalconsiderationof$1.43millionintheformoftheCompany’scommonstockifcertainfutureoperatingperformancetargetsaremet.13SBM BOOKPROOF -- l24096-i000_a.pdf Page 13 of Imposition -- Mon Mar 12 2007-- 17:06:26TotalReturnAnalysisThefollowingchartwascompiledbySNLSecurities,LC,andcomparescumulativetotalshareholderreturnoftheCompany’sCommonStockforthefive-yearperiodendedDecember31,2006,withthecumulativetotalreturnoftheNASDAQCompositeindexandtheAssetSize&RegionalPeerGroup.TheAssetSize&RegionalPeerGroupconsistsof42bankholdingcompaniesthataretradedontheNASDAQ,OTCBulletinBoard,andpinksheetswithtotalassetsbetween$1billionand$5billionandarelocatedinthesoutheastregionoftheUnitedStates.ThecumulativereturnsincludepaymentofdividendsbytheCompany.TotalReturnPerformance05010015020025030012/31/0612/30/0512/31/0412/31/0312/31/0212/31/01Index ValueFirst Community Bancshares, Inc.NASDAQ CompositeAsset Size & Regional Peer GroupIndex12/31/0112/31/0212/31/0312/31/0412/30/0512/31/06PeriodEndingFirstCommunityBancshares,Inc.100.00118.64144.89162.66145.22190.26NASDAQComposite100.0068.76103.67113.16115.57127.58AssetSize&RegionalPeerGroup100.00128.61174.02208.63212.50238.4714SBM BOOKPROOF -- l24096-i000_a.pdf Page 14 of Imposition -- Mon Mar 12 2007-- 17:06:26ITEM6.SELECTEDFINANCIALDATA.Five-YearSelectedFinancialData20062005200420032002AtorfortheYearEndedDecember31,(Amountsinthousands)BalanceSheetSummary(atendofperiod)Securities(a).........................$528,389$428,554$410,218$473,177$334,018Loansheldforsale....................7811,2741,194424865Loans,netofunearnedincome............1,284,8631,331,0391,238,7561,026,191927,621Allowanceforloanlosses...............14,54914,73616,33914,62414,410Assetsrelatedtodiscontinuedoperations....———22,37271,631Totalassets..........................2,033,6981,952,4831,830,8221,672,7271,524,363Deposits............................1,394,7711,403,2201,356,7191,223,3761,137,816Borrowings..........................406,556335,885274,212242,267156,823Liabilitiesrelatedtodiscontinuedoperations..———17,99265,519Totalliabilities........................1,820,9681,757,9821,647,5891,497,6921,371,901Stockholders’equity....................212,730194,501183,233175,035152,462SummaryofEarningsTotalinterestincome...................$120,026$109,508$96,136$90,641$92,580Totalinterestexpense...................48,38135,88026,95326,39732,299Provisionforloanlosses................2,7063,7062,6713,4194,208Non-interestincome....................21,32322,30517,32914,54210,617Non-interestexpense...................49,83755,59148,03537,59032,720Incomefromcontinuingoperationsbeforeincometaxes.......................40,42536,63635,80637,77733,970Incometaxexpense....................11,47710,1919,78611,0589,740Incomefromcontinuingoperations.........28,94826,44526,02026,71924,230(Loss)incomefromdiscontinuedoperationsbeforeincometaxes..................—(233)(5,746)(2,174)798Incometax(benefit)expense.............—(91)(2,090)(693)309(Loss)incomefromdiscontinuedoperations..—(142)(3,656)(1,481)489Netincome..........................28,94826,30322,36425,23824,719(a)Reflectsthereclassificationduringthe2002-2004periodsofFederalReserveBankandFederalHomeLoanBankstockfromSecuritiesAvailableforSaletoOtherAssets,consistentwiththe2005and2006presentation.15SBM 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17:06:26Five-YearSelectedFinancialData20062005200420032002AtorfortheYearEndedDecember31,PerShareDataBasicearningspershare...........................$2.58$2.33$1.99$2.27$2.26Basicearningspercommonshare—continuingoperations....................................2.582.352.322.412.22Basic(loss)earningspercommonshare—discontinuedoperations....................................—(0.02)(0.33)(0.14)0.04Dilutedearningspercommonshare...................$2.57$2.32$1.97$2.25$2.25Dilutedearningspercommonshare—continuingoperations....................................2.572.332.292.392.21Diluted(loss)earningspercommonshare—discontinuedoperations....................................—(0.01)(0.32)(0.14)0.04Cashdividends..................................$1.04$1.02$1.00$0.98$0.91Bookvalueatyear-end............................$18.92$17.29$16.29$15.57$14.02SelectedRatiosReturnonaverageassets...........................1.46%1.37%1.24%1.56%1.68%Returnonaverageassets-continuing..................1.46%1.38%1.45%1.70%1.72%Returnonaverageequity...........................14.32%13.79%12.53%15.13%17.16%Returnonaverageequity-continuing..................14.32%13.87%14.58%16.02%16.82%Averageequitytoaverageassets.....................10.21%9.91%9.88%10.32%9.79%Averageequitytoaverageassets-continuing............10.21%9.91%9.96%10.64%10.22%Dividendpayout.................................40.31%43.78%50.25%43.17%40.16%Riskbasedcapitaltoriskadjustedassets...............12.69%11.65%12.09%14.55%13.33%Leverageratio..................................8.50%7.77%7.62%8.83%8.10%ITEM7.MANAGEMENT’SDISCUSSIONANDANALYSISOFFINANCIALCONDITIONANDRESULTSOFOPERATION.Thisdiscussionshouldbereadinconjunctionwiththeconsolidatedfinancialstatements,notesandtablesincludedthroughoutthisreport.Allstatementsotherthanstatementsofhistoricalfactincludedinthisreport,includingstatementsinthisManagement’sDiscussionandAnalysisofFinancialConditionandResultsofOperationsare,ormaybedeemedtobe,forward-lookingstatementswithinthemeaningofSection27AoftheSecuritiesActof1933andSection21EoftheExchangeAct.Asdiscussedbelow,thefinancialstatements,footnotes,schedulesanddiscussionwithinthisreporthavebeenreformattedtoconformtothepresentationrequiredfor“discontinuedoperations”pursuanttotheCompany’ssaleofitsmortgagebankingsubsidiary.ExecutiveOverviewFirstCommunityBancshares,Inc.isabankholdingcompanywhichprovidescommercialbankingservicesandhaspositioneditselfasaregionalcommunitybankandafinancialservicesalternativetolargerbankswhichoftenprovidelessemphasisonpersonalrelationships,andsmallercommunitybankswhichlackthecapitalandresourcestoefficientlyservecustomerneeds.TheCompanyhasfocuseditsgrowtheffortsonbuildingfinancialpartnershipsandmoreenduringandcompleterelationshipswithbusinessesandindividualsthroughaverypersonalapproachtobankingandfinancialservices.TheCompanyanditsoperationsareguidedbyastrategicplanwhichincludesgrowththroughacquisitionsandthroughofficeexpansioninnewmarketareasincludingstrategicallyidentifiedmetromarketsinVirginia,WestVirginia,NorthCarolinaandTennessee.WhiletheCompany’smissionremainsthatofacommunitybank,managementbelievesthatentryintonewmarketswillacceleratetheCompany’sgrowthratebydiversifyingthedemographicsofitscustomerbaseandcustomerprospectsandbygenerallyincreasingitssalesandservicenetwork.16SBM 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17:06:26EconomyThroughout2006,short-termmarketinterestratesincreased,whilelong-termmarketratesremainedlargelyunchanged.Thosechangeshaveresultedinaninvertedinterestratecurve,anenvironmentthathasledtoincreasedcompressionofnetinterestmargins.ThelocaleconomiesinwhichtheCompanyoperatesarediverseandcoverthemajorityportionofafourstateregion.WestVirginiaandSouthwestVirginiacontinuetobenefitfromincreasingcrudeoilprices.Theseeconomieshavesignificantexposuretoextractiveindustries,suchascoalandnaturalgas,whichbecomemoreactiveandlucrativewhenoilpricesrise.ThelocaleconomiesinthecentralportionofNorthCarolinahavesufferedinrecentyearsduetoforeigncompetitioninbothfurnitureandtextilesaswellasconsolidationinthefinancialservicesindustry.Despitethesedetractions,theeconomiesinthisregioncontinuetobenefitfromstrongrealestatedevelopment,goodcommercialoccupancyratesandnationalcompaniesrelocatingandexpandingintheTriadandCentralPiedmontareas.TheEasternVirginialocaleconomiesareexperiencingstronggrowthinresidentialandcommercialdevelopmentasthoseareascontinuetobenefitfromawidearrayofcorporateactivitiesandrelocations.CompetitiveFocusAstheCompanycompetesforincreasedmarketshareandgrowthinbothloansanddepositsitcontinuestoencounterstrongcompetitionfrommanysources.Bankexpansionthroughdenovobranchesandloanproductionofficeshasgrowninpopularityasameansofreachingouttonewmarkets.ManyofthemarketstargetedbytheCompanyarealsobeingenteredbyotherbanksinnearbymarketsand,insomecases,frommoredistantmarkets.Despitestrongcompetitionfromotherbanks,creditunionsandmortgagecompanies,theCompanyhasseensuccessinnewlyestablishedofficesinWinston-SalemaswellasothermarketsinbothVirginiaandNorthCarolina.TheCompanyattributesthismeasureofsuccesstoitsrecruitmentoflocal,establishedbankersandloanpersonnelinthosetargetedmarkets.CompetitiveforcesdoimpacttheCompanythroughpressureoninterestyields,productfeesandloanstructureandterms;however,theCompanyhascounteredthesepressureswithitsrelationshipstyleandpricingandadisciplinedapproachtoloanunderwriting.ApplicationofCriticalAccountingPoliciesTheCompany’sconsolidatedfinancialstatementsarepreparedinaccordancewithU.S.generallyacceptedaccountingprinciples(“GAAP”)andconformtogeneralpracticeswithinthebankingindustry.TheCompany’sfinancialpositionandresultsofoperationsareaffectedbymanagement’sapplicationofaccountingpolicies,includingjudgmentsmadetoarriveatthecarryingvalueofassetsandliabilitiesandamountsreportedforrevenues,expensesandrelateddisclosures.DifferentassumptionsintheapplicationofthesepoliciescouldresultinmaterialchangesintheCompany’sconsolidatedfinancialpositionandconsolidatedresultsofoperations.Estimates,assumptions,andjudgmentsarenecessaryprincipallywhenassetsandliabilitiesarerequiredtoberecordedatestimatedfairvalue,whenadeclineinthevalueofanassetcarriedonthefinancialstatementsatfairvaluewarrantsanimpairmentwrite-downorvaluationreservetobeestablished,orwhenanassetorliabilityneedstoberecordedbasedupontheprobabilityofoccurrenceofafutureevent.Carryingassetsandliabilitiesatfairvalueinherentlyresultsinmorefinancialstatementvolatility.Thefairvaluesandtheinformationusedtorecordvaluationadjustmentsforcertainassetsandliabilitiesarebasedeitheronquotedmarketpricesorareprovidedbythirdpartysources,whenavailable.Whenthirdpartyinformationisnotavailable,valuationadjustmentsareestimatedbymanagementprimarilythroughtheuseofinternalmodelingtechniquesandappraisalestimates.TheCompany’saccountingpoliciesarefundamentaltounderstandingManagement’sDiscussionandAnalysisofFinancialConditionandResultsofOperation.ThefollowingisasummaryoftheCompany’smoresubjectiveandcomplex“criticalaccountingpolicies.”Inaddition,thedisclosurespresentedintheNotestotheConsolidatedFinancialStatementsandinManagement’sDiscussionandAnalysisprovideinformationonhowsignificantassetsandliabilitiesarevaluedinthefinancialstatementsandhowthosevaluesaredetermined.Basedonthevaluationtechniquesusedandthesensitivityoffinancialstatementamountstothemethods,assumptions,andestimatesunderlyingthoseamounts,managementhasidentifiedthedeterminationoftheallowanceforloanlosses,accountingforacquisitionsandintangibleassets,andaccountingforincometaxesastheaccountingareasthatrequirethemostsubjectiveorcomplexjudgments.17SBM 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17:06:26AllowanceforLoanLossesTheallowanceforloanlossesismaintainedatlevelsmanagementdeemsadequatetoabsorbprobablelossesinherentintheportfolio,andisbasedonmanagement’sevaluationoftherisksintheloanportfolioandchangesinthenatureandvolumeofloanactivity.TheCompanyconsistentlyappliesareviewprocesstoperiodicallyevaluateloansandcommitmentsforchangesincreditrisk.ThisprocessservesastheprimarymeansbywhichtheCompanyevaluatestheadequacyoftheallowanceforloanlosses.TheCompanydeterminestheallowanceforloanlossesbymakingspecificallocationstoimpairedloansthatexhibitinherentweaknessesandvariouscreditriskfactors.Generalallocationstocommercial,residentialrealestate,andconsumerloanpoolsaredevelopedgivingweighttoriskratings,historicallosstrendsandmanagement’sjudgmentconcerningthosetrendsandotherrelevantfactors.Thesefactorsmayinclude,amongothers,actualversusestimatedlosses,regionalandnationaleconomicconditions,businesssegmentandportfolioconcentrations,industrycompetitionandconsolidation,andtheimpactofgovernmentregulations.Theforegoinganalysisisperformedbymanagementtoevaluatetheportfolioandcalculateanestimatedvaluationallowancethroughaquantitativeandqualitativeanalysisthatappliesriskfactorstothoseidentifiedriskareas.Thisriskmanagementevaluationisappliedatboththeportfoliolevelandtheindividualloanlevelforcommercialloansandcreditrelationshipswhilethelevelofconsumerandresidentialmortgageloanallowanceisdeterminedprimarilyonatotalportfoliolevelbasedonareviewofhistoricallosspercentagesandotherqualitativefactorsincludingconcentrations,industryspecificfactorsandeconomicconditions.Thecommercialportfoliorequiresmorespecificanalysisofindividuallysignificantloansandtheborrower’sunderlyingcashflow,businessconditions,capacityfordebtrepaymentandthevaluationofsecondarysourcesofpayment,suchascollateral.Thisanalysismayresultinspecificallyidentifiedweaknessesandcorrespondingspecificimpairmentallowances.Whileallocationsaremadetospecificloansandclassificationswithinthevariouscategoriesofloans,theallowanceforloanlossesisavailableforallloanlosses.TheuseofvariousestimatesandjudgmentsintheCompany’songoingevaluationoftherequiredlevelofallowancecansignificantlyimpacttheCompany’sresultsofoperationsandfinancialconditionandmayresultineithergreaterprovisionsagainstearningstoincreasetheallowanceorreducedprovisionsbaseduponmanagement’scurrentviewofportfolioandeconomicconditionsandtheapplicationofrevisedestimatesandassumptions.Differencesbetweenactualloanlossexperienceandestimatesarereflectedthroughadjustmentseitherincreasingordecreasingtheloanlossprovisionbaseduponcurrentmeasurementcriteria.AcquisitionsandIntangibleAssetsTheCompanymay,fromtimetotime,engageinbusinesscombinationswithothercompanies.TheacquisitionofabusinessisgenerallyaccountedforunderpurchaseaccountingrulespromulgatedbytheFASB.Purchaseaccountingrequirestherecordingofunderlyingassetsandliabilitiesoftheentityacquiredattheirfairmarketvalue.Anyexcessofthepurchasepriceofthebusinessoverthenetassetsacquiredandanyidentifiedintangiblesisrecordedasgoodwill.Fairvaluesareassignedbasedonquotedpricesforsimilarassets,ifreadilyavailable,orappraisalbyqualifiedindependentpartiesforrelevantassetandliabilitycategories.Financialassetsandliabilitiesaretypicallyvaluedusingdiscountmodelswhichapplycurrentdiscountratestostreamsofcashflow.Allofthesevaluationmethodsrequiretheuseofassumptionswhichcanresultinalternatevaluationsandvaryinglevelsofgoodwilland,insomecases,amortizationexpenseoraccretionincome.Managementmustalsomakeestimatesofusefuloreconomiclivesofcertainacquiredassetsandliabilities.Theselivesareusedinestablishingamortizationandaccretionofsomeintangibleassetsandliabilities,suchastheintangibleassociatedwithcoredepositsacquiredintheacquisitionofacommercialbank.Goodwillisrecordedastheexcessofthepurchaseprice,ifany,overthefairvalueoftherevaluednetassets.GoodwillistestedannuallyinthemonthofNovemberforpossibleimpairmentbycomparingthefairvalueoftheunitwithitsbookvalue,includinggoodwill.IfthefairvalueoftheCompanyisgreaterthanitsbookvalue,nogoodwillimpairmentexists.However,ifthebookvalueoftheCompanyisgreaterthanitsdeterminedfairvalue,goodwillimpairmentmayexistandfurthertestingisrequiredtodeterminetheamount,ifany,oftheactualimpairmentloss.Furthertestingwoulduseadiscountedcashflowmodelappliedtotheanticipatedstreamofcash18SBM 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17:06:26flowsfromoperationsofthebusinessorsegmentbeingtested.Impairmenttestingnecessarilyusesestimatesintheformofgrowthandattritionrates,anticipatedratesofreturn,anddiscountrates.Theseestimateshaveadirectbearingontheresultsoftheimpairmenttestingandserveasthebasisformanagement’sconclusionsastoimpairment.IncomeTaxesTheestablishmentofprovisionsforfederalandstateincometaxesisacomplexareaofaccountingwhichalsoinvolvestheuseofjudgmentsandestimatesinapplyingrelevanttaxstatutes.TheCompanyoperatesinmultiplestatetaxjurisdictionsandthisrequirestheappropriateallocationofincomeandexpensetoeachstatebasedonavarietyofapportionmentorallocationbases.Managementstrivestokeepabreastofchangesintaxlawandtheissuanceofregulationswhichmayimpacttaxreportingandprovisionsforincometaxexpense.TheCompanyisalsosubjecttoauditbyfederalandstatetaxauthorities.ResultsoftheseauditsmayproduceindicatedliabilitieswhichdifferfromCompanyestimatesandprovisions.TheCompanycontinuallyevaluatesitsexposuretopossibletaxassessmentsarisingfromauditsandrecordsitsestimateofpossibleexposurebasedoncurrentfactsandcircumstances.RecentAcquisitionsandBranchingActivityInDecember2006,theCompanycompletedthesaleofitsRowlesburg,WestVirginia,branchlocation.Atthetimeofthesale,thebranchhaddepositsandrepurchaseagreementstotalingapproximately$10.6millionandloansofapproximately$2.2million.Thetransactionresultedinapre-taxgainofapproximately$333thousand.InNovember2006,theCompanycompletedtheacquisitionofInvestmentPlanningConsultants,Inc.(“IPC”),aregisteredinvestmentadvisoryfirm.Inconnectionwiththeinitialpaymentofapproximately$1.47million,theCompanyissued39,874sharesofcommonstock.Underthetermsofthestockpurchaseagreement,formershareholdersofIPCareentitledtoadditionalconsiderationof$1.43millionintheformoftheCompany’scommonstockifcertainfutureoperatingperformancetargetsaremet.Ifthoseoperatingtargetsaremet,thevalueoftheconsiderationultimatelypaidwillbeaddedtothecostoftheacquisition,whichwillincreasetheamountofgoodwillrelatedtotheacquisition.InJune2006,theCompanycompletedthesaleofitsDrakesBranch,Virginia,branchlocation.Atthetimeofthesale,thebranchhaddepositsandrepurchaseagreementstotalingapproximately$16.4millionandloansofapproximately$1.9million.Thetransactionresultedinapre-taxgainofapproximately$702thousand.InDecember2005,theCompanycompletedthesaleofitsCliftonForge,Virginia,branchlocation.Thesaleincludeddepositsandrepurchaseagreementstotalingapproximately$45.3millionandloansofapproximately$7.1million.Thetransactionresultedinanapproximate$4.4millionpre-taxgainonsale.TheCompanyhasplanstoopentwonewbranchesinWinston-Salem,NorthCarolina,duringthefirstquarterof2007.ConstructionisalsounderwayonbranchesinMechanicsville,Virginia,andDanielsandSummersville,WestVirginia.Thosethreebranchesareexpectedtobeopenbythefourthquarterof2007.RESULTSOFOPERATIONS2006COMPAREDTO2005Netincomefor2006was$28.9million,up$2.6millionfrom$26.3millionin2005.Basicanddilutedearningspersharefor2006were$2.58and$2.57,respectively,comparedtobasicanddilutedearningspershareof$2.33and$2.32,respectively,in2005.TheCompany’skeyprofitabilityratiosarereturnonaverageassetsandreturnonaverageequity.Returnsonaverageassetsfor2006and2005were1.46%and1.37%,respectively.Thereturnsonaverageequityfor2006and2005were14.32%and13.79%,respectively.TheCompanycontinuestocomparefavorablytonationalpeerreturnsof1.13%and13.20%,respectively,basedontheSeptember2006BankHoldingCompanyPerformanceReport,preparedbytheFederalReserve.19SBM 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17:06:26NetInterestIncomeTheprimarysourceoftheCompany’searningsisnetinterestincome,thedifferencebetweenincomeonearningassetsandthecostoffundssupportingthoseassets.Significantcategoriesofearningassetsareloansandsecuritieswhiledepositsandborrowingsrepresentthemajorportionofinterest-bearingliabilities.Forpurposesofthefollowingdiscussion,comparisonofnetinterestincomeisperformedonataxequivalentbasis,whichprovidesacommonbasisforcomparingyieldsonearningassetsexemptfromfederalincometaxestothoseassetswhicharefullytaxable(seethetabletitledAverageBalanceSheetsandNetInterestIncomeAnalysis).Netinterestincomewas$71.6millionfor2006,comparedto$73.6millionfor2005.Tax-equivalentnetinterestincometotaled$75.7millionfor2006,adecreaseof$2.0millionfromthe$77.7millionreportedfor2005.Thedecreaseisattributabletoa$651thousanddecreaseduetovolumeanda$1.4milliondecreaseduetoratechangesontheunderlyingassetsandliabilities.During2006,averageearningassetsincreased$23.8millionwhileaverageinterest-bearingliabilitiesincreased$35.9million,ineachcaseoverthecomparableperiod.Theyieldonaverageearningassetsincreased50basispointsto6.92%from6.42%for2005.Therateearnedonassetswaspositivelyimpactedbythecontinuedincreasesinshort-termmarketinterestratesthroughout2006.Totalcostofaverageinterest-bearingliabilitiesincreased76basispointsto3.17%during2006,asliabilitieswerealsoaffectedbyincreasesinshort-termmarketinterestrates.Thenetresultwasadecreaseof26basispointstonetinterestratespread,orthedifferencebetweeninterestincomeonearningassetsandexpenseoninterest-bearingliabilities.Spreadfor2006was3.75%comparedto4.01%for2005.TheCompany’stax-equivalentnetinterestmarginof4.22%for2006wasadecreaseof17basispointsfrom4.39%in2005.Thelargestcontributortotheincreaseintheyieldonaverageearningassetsin2006,onavolume-weightedbasis,wasa50basispointincreaseintherateearnedonloansheldforinvestment.Theincreaseinratecontributedapproximately$6.5milliontothe$7.5millionchangeininterestincomefromtheportfolio.Theyieldonvariable-rateloanstiedtoprimeandotherindicesincreasedinresponsetotherecentincreasesinshort-terminterestrates.During2006,thetax-equivalentyieldonavailable—for-salesecuritiesincreased52basispointsto5.50%whiletheaveragebalanceincreasedby$21.6million.Theaveragetax-equivalentyieldincreasedduetotheadditionofhigher-ratesecuritiesandthesales,maturities,andcallsoflower-ratesecurities.Averageinterest-bearingbalanceswithbanksdeclined$4.8millionduring2006to$27.3million,whiletheyieldincreased120basispointsto4.56%.Theyieldonthosebalancesisdirectlycorrelatedtotheincreasesinthetargetfederalfundsratewhichoccurredthroughouttheyear.TheCompanyattemptstocontrolthecostofdepositedfundsinrelationtotheprevailingeconomicclimateandcompetitiveforces.TheCompanydeterminesitsoverallbalancesheetmanagementgoalsthroughitsAsset/LiabilityManagementCommittee.Throughout2006,thepressuresofincreasingshort-terminterestratesresultedinanincreaseof86basispointsintheaveragecostofinterest-bearingdeposits.Theaverageratepaidoninterest-bearingdemanddepositsincreased6basispoints,whiletheaverageratepaidonsavings,whichincludesmoneymarketandpassbookaccounts,increased82basispoints.TheCompanywassuccessfulinkeepingratespaidoninterest-bearingcheckingaccountsrelativelystableandincreasedmoneymarketaccountratestoremaincom-petitiveandretaindepositfunding.Averagetimedepositsincreased$21.9millionwhiletheaverageratepaidincreased96basispointsto3.88%.Thelevelofaveragenon-interest-bearingdemanddepositsincreased$8.9millionto$237.7millioncomparedtotheprioryear.Averagefederalfundspurchasedandrepurchaseagreementsincreased$22.3million,duemostlytoincreasesinthebalancesofrepurchaseagreements.Theaverageratepaidonthosefundsalsoincreased,astheyarecloselytiedtothetargetfederalfundsrate.AverageFederalHomeLoanBank(“FHLB”)advancesincreased$22.7millionwhileinterestpaidonthoseborrowingsdecreased56basispointsastheCompanyrepositioneditsFHLBborrowings,andtookadvantageoflowerinterestrateborrowingproducts.InJanuaryof2006,theCompanyborrowed$75millionfromtheFHLB.Atthesametime,theCompanyenteredintoa$50millionpayfixed,receivevariableinterestrateswap,effectivelyfixingtheborrowingrateatapproximately4.34%.Otherborrowings20SBM 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17:06:26remainedsteady,buttheratepaidincreased176basispointsbecausethemajorityofsuchborrowingsconsistoftheCompany’strustpreferredborrowing,whichistiedtoLIBOR.AverageBalanceSheetsandNetInterestIncomeAnalysisAverageBalanceInterest(1)Yield/Rate(1)AverageBalanceInterest(1)Yield/Rate(1)AverageBalanceInterest(1)Yield/Rate(1)200620052004(Dollarsinthousands)EarningAssets:LoansHeldforInvestment:(2)Taxable...............$1,314,976$97,3867.41%$1,299,328$89,7886.91%$1,154,166$76,5196.63%Tax-exempt............1,4991147.61%2,6921776.58%4,9652975.98%Total.................1,316,47597,5007.41%1,302,02089,9656.91%1,159,13176,8166.63%Available-for-SaleSecurities:Taxable...............276,14213,9295.04%262,71511,0624.21%313,03312,0943.86%Tax-exempt............152,4379,6556.33%144,2429,1936.37%110,9047,4746.74%Total.................428,57923,5845.50%406,95720,2554.98%423,93719,5684.62%Held-to-MaturitySecurities:Taxable...............386225.70%399153.76%419255.97%Tax-exempt............20,9121,6868.06%28,3362,2698.01%35,5352,8538.03%Total.................21,2981,7088.02%28,7352,2847.95%35,9542,8788.00%Interest-bearingdepositswithbanks................27,2891,2444.56%32,1001,0773.36%32,4305911.82%Federalfundssold.........————6011.67%Totalearningassets.....1,793,641$124,0366.92%1,769,812$113,5816.42%1,651,512$99,8546.05%Otherassets..............186,639153,410140,379Assetsrelatedtodiscontinuedoperations.............——14,950Total...............$1,980,280$1,923,222$1,806,841Interest-bearingLiabilities:Demanddeposits..........$146,248$4620.32%$152,774$4010.26%$149,502$3660.24%Savingsdeposits..........343,8546,8571.99%368,3394,3091.17%366,0743,1120.85%Timedeposits............683,41826,5493.88%661,49819,3212.92%615,34615,0012.44%Federalfundspurchasedandrepurchaseagreements....150,8395,0793.37%128,5512,7822.16%109,2231,4051.29%FHLBborrowingsandotherlong-termdebt..........200,5709,4344.70%177,8329,0685.10%148,3847,0704.76%TotalInterest-bearingLiabilities..........1,524,92948,3813.17%1,488,99435,8812.41%1,388,52926,9541.94%Demanddeposits..........237,714228,781212,777Otherliabilities...........15,51314,77213,980Liabilitiesrelatedtodiscontinuedoperations....——13,113Stockholders’equity........202,124190,675178,442Total...............$1,980,280$1,923,222$1,806,841NetInterestIncome........$75,655$77,700$72,900NetInterestRateSpread(3)...3.75%4.01%4.11%NetInterestMargin(4)......4.22%4.39%4.41%(1)Fullytaxableequivalentattherateof35%.(2)Non-accrualloansareincludedinaveragebalancesoutstandingbutwithnorelatedinterestincomeduringtheperiodofnon-accrual.(3)Representsthedifferencebetweentheyieldonearningassetsandcostoffunds.(4)Representstaxequivalentnetinterestincomedividedbyaverageinterest-earningassets.21SBM 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17:06:26RateandVolumeAnalysisofInterestThefollowingtablesummarizesthechangesininterestearnedandpaidresultingfromchangesinvolumeofearningassetsandpayingliabilitiesandchangesintheirinterestrates.Inthisanalysis,thechangeininterestduetobothrateandvolumehasbeenallocatedtothevolumeandratecolumnsinproportiontoabsolutedollaramounts.Thetableshows(i)theoveralldecreaseinnetinterestincomeduring2006wasduetoincreasesininterestexpensewhichoutpacedincreasesininterestincome;and(ii)increasesinratesearnedonassetsandpaidonliabilitiescontinuedtoincreasein2006,dueprimarilytocontinuingincreasesinbenchmarkshort-terminterestrates.Whencomparing2005to2004,thetableshows(i)theincreaseinnetinterestincomein2005wasduelargelytoincreasesinearningassetsresultingfromgrowthseeninboththeconsumerandcommercialloanportfolios;(ii)increasesinbothratesearnedonassetsandpaidonliabilitiesduetoincreasesinbenchmarkshort-terminterestrates;and(iii)in2005,margincompressedslightlyasincreasestotheratespaidonmoneymarketaccountsandcertificatesofdepositoutpacedincreasesintheratesreceivedonloans.VolumeRateTotalVolumeRateTotal$Increase/(Decrease)dueto$Increase/(Decrease)dueto2006Comparedto20052005Comparedto2004(Amountsinthousands)InterestEarnedOn(1):Loans............................$1,005$6,530$7,535$9,782$3,367$13,149Securitiesavailableforsale............1,1082,2213,32987600687Securitiesheldtomaturity.............(599)23(576)(578)(16)(594)Interest-bearingdepositswithotherbanks..........................(178)345167(6)492486Federalfundssold...................———(1)—(1)Totalinterest-earningassets.............1,3369,11910,4559,2844,44313,727InterestPaidOn:Demanddeposits....................(18)796182735Savingsdeposits....................(304)2,8522,548191,1781,197Timedeposits......................6606,5687,2281,1863,1344,320Federalfundspurchasedandrepurchaseagreements......................5461,7512,2972841,0931,377FHLBborrowingsandotherlong-termdebt...........................1,103(737)3661,4435551,998Totalinterest-bearingliabilities...........1,98710,51312,5002,9405,9878,927Changeinnetinterestincome............$(651)$(1,394)$(2,045)$6,344$(1,544)$4,800(1)Fullytaxableequivalentusingarateof35%.ProvisionforLoanLossesTheprovisionforloanlossesfor2006was$2.7million,adecreaseof$1.0millionwhencomparedto2005.Thedecreaseinloanlossprovisionbetweentheperiodsisprimarilyattributabletochangesinspecificallocations,decreasesincommercialandconsumerinstallmentloanvolume,reductionsinnetcharge-offs,overallimprovedassetquality,andchangesinvariousqualitativeriskfactors.Netcharge-offsfor2006and2005were$2.9millionand$4.9million,respectively.Expressedasapercentageofaverageloans,netcharge-offsdecreasedfrom0.38%for2005to0.22%for2006.During2005,theCompanyexperiencedalossfromacredittoahospitalityconcern,whichlargelyaccountedforthehighernetcharge-offsin2005.The$4.4millionloanwaschargeddowntoitsnetrealizablevalueof$2.2million,andthenotewassoldtoathirdpartyandthefinalnetlosstotheCompanywas$1.5million.22SBM 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17:06:26Non-interestIncomeDetailsofnon-interestincomearesummarizedinthefollowingtable:200620052004YearsEndedDecember31,(Amountsinthousands)Wealthmanagementincome..............................$2,811$2,956$2,489Servicechargesondepositaccounts........................10,24210,0959,122Otherservicecharges,commissionsandfees.................2,9922,7852,239Otheroperatingincome.................................5,2035,7161,875Netgainsonsaleofsecurities............................757531,604Total.............................................$21,323$22,305$17,329Non-interestincomeconsistsofallrevenueswhicharenotincludedininterestandfeeincomerelatedtoearningassets.Non-interestincomefor2006was$21.3millioncomparedto$22.3millionin2005.Wealthmanagementincome,whichincludesfeesfortrustservicesandcommissionandfeeincomegeneratedbyIPC(post-acquisition)andtheCompany’spriorinvestmentadvisorysubsidiary,whosecustomerbasemigratedtoIPCin2006,decreased$145thousandin2006,or4.9%,comparedto2005.Servicechargesondepositaccountsincreased$147thousand,or1.5%,whileotherservicecharges,com-missionsandfeesreflectedgainsof$207thousand,or7.4%.Otheroperatingincomeincludes$1.0millionand$4.4millioningainsfromthesaleofbranchlocationsin2006and2005,respectively.Theremainingcomponentsofotheroperatingincomeincreased$2.8millioncomparedto2005.Thelargestsingleiteminthatincreaseisthe$976thousandearnedontheCompany’s$25millioninvestmentinlifeinsurancemadeinApril2006.Alsoincludedinotherincomefor2006isa$676thousandrecoveryrelatingtoa1997paymentsystemfraudloss.During2006,theCompanyalsorecognizedsecuritiesgainsof$75thousand,whichwere$678thousandlessthanthoserecognizedin2005.Non-interestExpenseTotalnon-interestexpensewas$49.8millionfor2006,adecreaseof$5.8millionover2005.Salariesandbenefitsdecreasedapproximately$2.6millionduetotheCompany’srefocusedeffortsonexpensecontrolandefficiency.During2006,totalfull-timeequivalentemployeesdecreasedto602from716atDecember31,2005.Alsocontributingtothedecreasefromyeartoyearwasthe$3.8millionprepaymentpenaltyincurredinconnectionwiththeearlyterminationof$77.0millionofFHLBadvancesin2005.Occupancyandfurnitureandequipmentexpensesincreased$165thousandand$147thousand,respectively,comparedto2005.Thegenerallevelofoccupancyandfurnitureandequipmentcostsin2006grewlargelyasaresultofincreasesindepreciationassociatedwithcontinuedinvestmentinfacilities,operatingequipment,andtechnologyinfrastructure.Allotheroperatingexpenseaccountsincreased$367thousand,orlessthan3%,in2006comparedto2005.TheCompanyusesanefficiencyratiothatisanon-GAAPfinancialmeasureofoperatingexpensecontrolandefficiencyofoperations.ManagementbelievesthisratiobetterfocusesattentiononthecoreoperatingperformanceoftheCompanyovertimethandoesaGAAP-basedratio,andishighlyusefulincomparingperiod-to-periodoperatingperformanceoftheCompany’scorebusinessoperations.Itisusedbymanagementaspartofitsassessmentofitsperformanceinmanagingnon-interestexpenses.However,thismeasureissupplementalandisnotasubstituteforananalysisofperformancebasedonGAAPmeasures.ThereaderiscautionedthattheefficiencyratiousedbytheCompanymaynotbecomparabletoefficiencyratiosreportedbyotherfinancialinstitutions.Ingeneral,theefficiencyratiousedbytheCompanyisnon-interestexpensesasapercentageofnetinterestincomeplusnon-interestincome.Non-interestexpensesusedinthecalculationexcludeamortizationofgoodwillandintangiblesandnon-recurringexpenses.Incomefortheratioisincreasedforthefavorableeffectoftax-exemptincome(seeAverageBalanceSheetsandNetInterestIncomeAnalysis),andexcludessecuritiesgainsandlosses,23SBM 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17:06:26whichvarywidelyfromperiodtoperiodwithoutappreciablyaffectingoperatingexpenses,andnon-recurringgains.ThemeasureisdifferentfromtheGAAP-basedefficiencyratio,whichalsoispresentedinthisreport,whichiscalculatedusingnon-interestexpenseandincomeamountsasshownonthefaceoftheConsolidatedStatementsofIncome.Bothtypesofefficiencyratiocalculationsaresetforthandarereconciledinthetablebelow.Our(non-GAAP)efficiencyratiosforcontinuingoperationsfor2006,2005,and2004were51.1%,53.8%,and53.2%,respectively.Thefollowingtabledetailsthecomponentsusedincalculationoftheefficiencyratios.GAAP-basedandOurEfficiencyRatios200620052004(Dollarsinthousands)GAAP-basedefficiencyratioNon-interestexpenses..................................$49,837$55,591$48,035Netinterestincomeplusnon-interestincome.................92,96895,93386,512Efficiencyratio—GAAP-based..........................53.61%57.95%55.52%OurefficiencyratioNon-interestexpenses—GAAP-based......................$49,837$55,591$48,035Lessnon-GAAPadjustments:Foreclosedpropertyexpense..........................(248)(288)(500)Amortizationofintangibles...........................(410)(435)(399)PrepaymentpenaltiesonFHLBadvances................—(3,794)—Othernon-core,non-recurringexpenseitems..............(581)——Adjustednon-interestexpenses......................48,59851,07447,136Netinterestincomeplusnon-interestincome—GAAP-based.....92,96895,93386,512Plusnon-GAAPadjustment:Tax-equivalency...................................4,0104,0723,719Lessnon-GAAPadjustments:Securitygains....................................(75)(753)(1,604)Branchsalegains..................................(1,035)(4,366)—Othernon-core,non-recurringincomeitems..............(676)——Adjustednetinterestincomeplusnon-interestincome.....95,19294,88688,627Ourefficiencyratio...................................51.05%53.83%53.18%Equity-basedCompensationOnJanuary1,2006,theCompanyadoptedtheequity-basedcompensationaccountingprovisionsofStatementofFinancialAccountingStandards(“SFAS”)123R.ThroughDecember31,2005,theCompanyaccountedforequity-basedcompensationunderAPBOpinionNo.25,usingtheintrinsicvaluemodel.UnderOpinionNo.25,theCompanyrecognizednocompensationexpenserelatedtostockoptionsgranted,andprovidedpro-formadisclo-suresoftheeffectsofaccountingforstockoptionsunderthefairvaluemodel.TheCompanyselectedthemodifiedprospectivemethodoftransition.Theadoptionofthenewequity-basedcompensationaccountingstandardresultedinincreasedcompensationexpense.Thetotalcompensationcostrelatedtostockoptionawardsvestingin2006wasapproximately$208thousandafter-tax.IncomeTaxExpenseIncometaxexpenseiscomprisedoffederalandstatecurrentanddeferredincometaxesonpre-taxearningsoftheCompany.Incometaxesasapercentageofpre-taxincomemayvarysignificantlyfromstatutoryratesduetoitemsofincomeandexpensewhichareexcluded,bylaw,fromthecalculationoftaxableincome.Theseitemsare24SBM 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17:06:26commonlyreferredtoaspermanentdifferences.ThemostsignificantpermanentdifferencesfortheCompanyincludeincomeonstateandmunicipalsecuritieswhichareexemptfromfederalincometax,certaindividendpaymentswhicharedeductiblebytheCompany,taxcreditsgeneratedbyinvestmentsinlowincomehousingandhistoricalbuildingrehabilitation.Consolidatedincometaxesfor2006were$11.5million,a28.4%effectivetaxrate,comparedto$10.1million,aneffectivetaxrateof27.7%,for2005.Theeffectivetaxratefor2006wasgreaterthan2005duetoalowerproportionoftax-freemunicipalinterestincome.Asdisclosedinpreviousfilings,thestatetaxauditofstateincome,franchise,andsalestaxinoneoftheCompany’staxjurisdictionswasconcludedduringthefourthquarterof2005.TheoutcomeofthisauditwasfavorabletotheCompanyandresultedintotalstateincomeandfranchisetaxrefundsofapproximately$473thousand,whichwasreflectedinthe2005provisionforincometaxexpense.2005COMPAREDTO2004Netincomefor2005was$26.3million,up$3.9millionfrom$22.4millionin2004.Basicanddilutedearningspersharefor2005were$2.33and$2.32,respectively,comparedtobasicanddilutedearningspershareof$1.99and$1.97,respectively,for2004.Returnonaverageassetsfor2005and2004were1.37%and1.24%,respectively.Thereturnonaverageequityfor2005and2004were13.79%and12.53%,respectively.TheCompanycomparedfavorablytonationalpeerreturnsof1.16%and13.51%,respectively,basedontheSeptember2005BankHoldingCompanyPerformanceReport.NetInterestIncomeTheprimarysourceoftheCompany’searningsisnetinterestincome,thedifferencebetweenincomeonearningassetsandthecostoffundssupportingthoseassets.Significantcategoriesofearningassetsareloansandsecuritieswhiledepositsandborrowingsrepresentthemajorportionofinterest-bearingliabilities.Forpurposesofthefollowingdiscussion,comparisonofnetinterestincomeisdoneonataxequivalentbasis,whichprovidesacommonbasisforcomparingyieldsonearningassetsexemptfromfederalincometaxestothoseassetswhicharefullytaxable(seethetabletitledAverageBalanceSheetsandNetInterestIncomeAnalysis).Netinterestincomewas$73.6millionfor2005,comparedto$69.2millionfor2004.Tax-equivalentnetinterestincometotaled$77.7millionfor2005,anincreaseof$4.8millionfromthe$72.9millionreportedfor2004.Theincreasereflectsa$6.3millionincreaseduetoincreasedvolume,whichwaspartiallyoffsetbya$1.5milliondecreaseduetoratechangesontheunderlyingassetsandliabilities.During2005,averageearningassetsincreased$118.3millionwhileaverageinterest-bearingliabilitiesincreased$100.5millionoverthecomparableperiod.Theyieldonaverageearningassetsincreased37basispointsto6.42%from6.05%for2004.Therateearnedonassetswaspositivelyimpactedbythecontinuedincreasesinshort-termmarketinterestratesthroughout2005.Totalcostofaverageinterest-bearingliabilitiesincreased47basispointsduring2005,assuchliabilitieswerealsoaffectedbyincreasesinshort-termmarketinterestrates.Thenetresultwasadecreaseof10basispointstonetinterestratespread,orthedifferencebetweeninterestincomeonearningassetsandexpenseoninterest-bearingliabilities.2005spreadwas4.01%comparedto4.11%for2004.TheCompany’stax-equivalentnetinterestmarginof4.39%for2005wasessentiallyunchangedwithasmalldecreaseof2basispointsfrom4.41%in2004.Thelargestcontributortotheincreaseintheyieldonaverageearningassetsin2005,onavolume-weightedbasis,wasthe$142.9millionincreaseinloansheldforinvestment.Theloanportfoliocontributedapproximately$13.1milliontothechangeininterestincome,whiletheportfolio’saverageyieldincreased28basispointsfromtheprioryearto6.91%.Theyieldonvariable-rateloanstiedtoprimeandotherindicesincreasedinresponsetotherecentincreasesinshort-terminterestrates.During2005,thetax-equivalentyieldonavailable-for-salesecuritiesincreased36basispointsto4.98%whiletheaveragebalancedecreasedby$17.0million.Althoughthetotalportfoliodecreasedthroughtheperiod,theaveragetax-equivalentyieldincreasedduetotheadditionofhigher-ratesecuritiesandthesaleoflower-rate25SBM 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17:06:26securities.Fundsreceivedfromthepaydowns,maturities,calls,andsalesofinvestmentsecuritieshelpedfundloangrowth.Averageinterest-bearingbalanceswithbanksremainedsteadyduring2005,whiletheyieldincreased154basispointsto3.36%.Theyieldonthosebalancesisdirectlycorrelatedtotheincreasesinthetargetfederalfundsratewhichoccurredthroughouttheyear.TheCompanyattemptstocontrolthecostofdepositedfundsinrelationtotheprevailingeconomicclimateandcompetitiveforces.TheCompanydeterminesitsbalancesheetmanagementgoalsthroughitsAsset/LiabilityManagementCommittee.Throughout2005,thepressuresofincreasingshort-terminterestratesresultedinanincreaseof40basispointsintheaveragecostofinterest-bearingdeposits.Theaverageratepaidoninterest-bearingdemanddepositsremainedconsistent,whiletheaverageratepaidonsavings,whichincludesmoneymarketandpassbookaccounts,increased32basispoints.TheCompanywassuccessfulinkeepingratespaidoninterest-bearingcheckingaccountsrelativelystableandincreasedmoneymarketaccountratestoremaincompetitive.Averagetimedepositsincreased$46.2millionwhiletheaverageratepaidincreased48basispointsto2.92%.Thelevelofaveragenon-interest-bearingdemanddepositsincreased$16.0millionto$228.8millioncomparedtotheprioryear.Averagefederalfundspurchasedandrepurchaseagreementsincreased$19.3millionduemostlytoincreasesinthebalancesofcustomerrepurchaseagreements.Theaverageratepaidonthosefundsalsoincreased,astheyarecloselytiedtothetargetfederalfundsrate.AverageFederalHomeLoanBank(“FHLB”)advancesincreased$29.5millionastheCompanyborrowed$75millionthroughtheyear.Interestpaidonthoseborrowingsincreased19basispointsasinterestrateswereincreasingonadjustable-rateborrowings.Otherborrowingsremainedsteady,buttheratepaidincreased198pointsbecausethemajorityofsuchborrowingsconsistoftheCompany’strustpreferredborrowing,whichistiedtoLIBOR.Non-interestIncomeNon-interestincomeconsistsofallrevenueswhicharenotincludedininterestandfeeincomerelatedtoearningassets.Non-interestincomefromcontinuingoperationsfor2005was$22.3millioncomparedto$17.3million2004.Wealthmanagementincome,whichincludesfeesfortrustservicesandcommissionandfeeincomegeneratedbyStoneCapital,theCompany’spriorinvestmentadvisorysubsidiary,increased$467thousandin2005,or18.8%,comparedto2004asaresultoftheCompany’scontinuedfocusongrowth.StoneCapitalexpandeditsretailassetmanagementservicesthroughtheadditionoftwoinvestmentadvisorsandthelicensingofanumberofinvestmentassociateswithinthebankbranches.Servicechargesondepositaccountsincreased$973thousand,or10.7%,whileotherservicecharges,commissionsandfeesreflectedgainsof$546thousand,or24.4%.Otherservicecharges,commissionsandfeesincreasedlargelybecauseofATMusagefeesonforeigncardswhichtotaled$1.4millionandofficialcheckcommissionswhichreached$256thousand.Otheroperatingincomeincludes$4.4millioningainfromthesaleoftheCliftonForge,Virginia,branchlocationinDecember2005.Theremainingcomponentsofotheroperatingincomedecreased$525thousandcomparedto2004.During2005,otheroperatingincomeincludedsecuritiesgainsof$753thousand,whichwere$851thousandlessthanthoserecognizedin2004.Non-interestExpenseTotalnon-interestexpensefromcontinuingoperationswas$55.6million,anincreaseof$7.6millionfor2005over2004.Thesinglelargestitemcontributingtotheincreasewasa$3.8millionprepaymentpenaltyincurredinconnectionwiththeearlyterminationof$77.0millionofFHLBadvancesinlateDecember2005.Salariesandbenefitsincreasedapproximately$2.8millionduetoincreasesinstaffingtosupportaddedcorporateservices,continuedbranchandloanproductionofficegrowth,andincreasedhealthbenefitscosts.Occupancyandfurnitureandequipmentexpensesincreased$344thousandand$447thousandin2005,respectively,comparedto2004.Thegenerallevelofoccupancyandfurnitureandequipmentcostsin2005grew26SBM 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17:06:26largelyasaresultofincreasesindepreciationandinsurancecostsassociatedwithdenovobranchesanddepreciationassociatedwithcontinuedinvestmentinoperatingequipmentandtechnologyinfrastructure.Allotheroperatingexpenseaccountsincreased$100thousandin2005comparedto2004.Themostsignificantitemwithintheincreaseinotheroperatingexpensewastheincreaseinauditfees,whichincreasedover$335thousandyear-over-year.IncomeTaxExpenseIncometaxexpenseiscomprisedoffederalandstatecurrentanddeferredincometaxesonpre-taxearningsoftheCompany.Incometaxesasapercentageofpre-taxincomemayvarysignificantlyfromstatutoryratesduetoitemsofincomeandexpensewhichareexcluded,bylaw,fromthecalculationoftaxableincome.Theseitemsarecommonlyreferredtoaspermanentdifferences.ThemostsignificantpermanentdifferencesfortheCompanyincludei)incomeonstateandmunicipalsecuritieswhichareexemptfromfederalincometax,ii)certaindividendpaymentswhicharedeductiblebytheCompany,iii)taxcreditsgeneratedbyinvestmentsinlowincomehousingandiv)for2004,goodwillimpairmentexpensewhichisnotdeductible.Consolidatedincometaxesfor2005were$10.1million,a27.7%effectivetaxrate,comparedto$7.7million,aneffectivetaxrateof25.6%,for2004.Theeffectivetaxratefor2004waslessthan2005duetothetaxbenefitsrealizedfromthedivestitureoftheCompany’smortgagebankingsubsidiary.Specifically,thenon-deductibleimpairmentchargesrecognizedin2003andthefirsttwoquartersof2004reducedthebookcarryingbasisoftheinvestmentinthemortgagesubsidiaryandresultedinapermanentdifferenceduringthethirdquarterof2004uponsaleoftheentity.Thisdifferencereducedthe2004effectivetaxrateto25.6%andistheprimarycauseoftheincreaseintheeffectivetaxratewhencomparing2004to2005.FINANCIALPOSITIONAvailable-for-SaleSecuritiesAvailable-for-salesecuritieswere$508.4millionatDecember31,2006,comparedto$404.4millionatDecember31,2005,anincreaseof$104.0million.TheCompanypurchasedsecuritiesthroughouttheyearwithliquidityprovidedbynetloanportfoliopayoffs,andexecutedtwoleveragetransactionstotaling$50millionduring2006.TheCompanyattemptstomaintainanacceptablelevelofinterestrateriskwithinitssecuritiesportfolio.AtDecember31,2006,theaveragelifeanddurationoftheportfoliowere7.1yearsand5.4,respectively.AveragelifeanddurationremainedrelativelyunchangedfromDecember31,2005,at7.0yearsand5.4,respectively.Available-for-saleandheld-to-maturitysecuritiesarereviewedquarterlyforpossibleother-than-temporaryimpairment.Thisreviewincludesananalysisofthefactsandcircumstancesofeachindividualinvestmentsuchasthelengthoftimethefairvaluehasbeenbelowcost,theexpectationforthatsecurity’sperformance,thecreditworthinessoftheissuerandtheCompany’sintentandabilitytoholdthesecuritytorecoveryormaturity.Adeclineinvaluethatisconsideredtobeother-than-temporarywouldberecordedasalosswithinnon-interestincomeintheConsolidatedStatementsofIncome.TheCompanydoesnotbelieveanyunrealizedloss,individuallyorintheaggregate,asofDecember31,2006,representsother-than-temporaryimpairment.TheCompanyhastheintentandabilitytoholdthesesecuritiesuntilsuchtimeasthevaluerecoversorthesecuritiesmature.Furthermore,theCompanybelievesthedeclineinvalueisattributabletochangesinmarketinterestratesandnotthecreditqualityoftheissuer.27SBM 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17:06:26Thefollowingtabledetailsamortizedcostandfairvalueofavailable-for-salesecuritiesasofDecember31,2006,2005,and2004.AmortizedCostFairValueAmortizedCostFairValueAmortizedCostFairValue200620052004December31,(Amountsinthousands)U.S.Governmentagencysecurities...........$117,777$116,061$92,739$91,424$46,541$45,946Statesandpoliticalsubdivisions........152,189154,047151,118152,168142,882145,146CorporateNotes.......85,08085,03361,46661,27437,58938,129355,046355,141305,323304,866227,012229,221Mortgage-backedsecurities...........146,444144,75494,95492,994142,427142,979Equities.............6,9338,4755,3906,5212,6263,797Total..............$508,423$508,370$405,667$404,381$372,065$375,997Held-to-MaturitySecuritiesInvestmentsecuritiesclassifiedasheld-to-maturityarecomprisedprimarilyofhigh-gradestateandmunicipalbonds.ThesesecuritiesgenerallycarryAAAbondratings,mostofwhichalsocarrycreditenhancementinsurancebymajorinsurersofdebtinstruments.Theportfoliototaled$20.0millionatDecember31,2006,comparedto$24.2millionatDecember31,2005.Thisdecreaseisreflectiveofcontinuingpaydowns,maturitiesandcallswithintheportfolio.Themarketvalueofheld-to-maturityinvestmentsecuritieswas101.7%and102.9%ofbookvalueatDecember31,2006and2005,respectively.RecenttrendsininterestrateshavehadlittleeffectontheportfoliomarketvaluesinceDecember31,2005,duetoitslargerpercentageofmunicipalsecuritieswhichdisplaylesspricesensitivitytoratechanges.Theaveragefinalmaturityoftheheld-to-maturityinvestmentportfoliodecreasedfrom6.6yearsatDecem-ber31,2005,to6.1yearsatDecember31,2006,withthetax-equivalentyieldincreasingfrom7.95%atyear-end2005to8.02%atthecloseof2006.Theweighted-averageexpectedmaturityoftheinvestmentportfolio,basedonmarketassumptionsforprepayment,istenmonthsand1.6yearsatDecember2006and2005,respectively.Theaveragematuritydatadiffersfromfinalmaturitydatabecauseoftheuseofassumptionsastoanticipatedprepayments,andisgenerallyamoreaccurateindicatoroftrueaveragelifeoftheinvestment.Thefollowingtabledetailsamortizedcostandfairvalueofheld-to-maturitysecuritiesforthethreeyearsendedDecember31,2006.AmortizedCostFairValueAmortizedCostFairValueAmortizedCostFairValue200620052004December31,(Amountsinthousands)Statesandpoliticalsubdivisions............$19,638$19,970$23,781$24,486$33,814$35,202CorporateNotes..........37537437537437537520,01320,34424,15624,86034,18935,577Mortgage-backedsecurities..6617173233Total.................$20,019$20,350$24,173$24,877$34,221$35,61028SBM 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17:06:26LoansHeldforSaleTomitigateinterestraterisk,theCompanysellsmostofthelong-term,fixed-ratemortgageloansitoriginatesinthesecondarymarket.AtDecember31,2006,theCompanyheld$781thousandofloansforsaletothesecondarymarket,downfrom$1.3millionatDecember31,2005.ThegrossnotionalamountofoutstandingcommitmentstooriginatemortgageloansforcustomersatDecember31,2006,was$6.6millionon49loans.LoansHeldforInvestmentTotalloansheldforinvestmentdecreased$46.2millionto$1.28billionatDecember31,2006,from$1.33billionatDecember31,2005,asaresultofdecreasedloanproductionandlargepayoffsoccurringthroughout2006.Theaverageloantodepositratioincreasedto93.3%for2006,comparedwith92.3%for2005.Averageloansheldforinvestmentfor2006of$1.32billionincreased$14.5millionwhencomparedtotheaveragefor2005of$1.30billion.Theheldforinvestmentloanportfoliocontinuestobediversifiedamongloantypesandindustrysegments.Thefollowingtablepresentsthevariousloancategoriesandchangesincompositionatyear-end2002through2006.LoanPortfolioSummary20062005200420032002December31,(Amountsinthousands)Commercial,financialandagricultural.............$106,645$110,211$99,302$69,395$74,186Realestate—commercial....421,067464,510453,899317,421285,847Realestate—construction...158,566143,976112,70598,51072,275Realestate—residential.....506,370504,387457,417421,299364,087Consumer................88,679106,206113,639119,195131,385Other...................3,5491,8082,012992726Total..................1,284,8761,331,0981,238,9741,026,812928,506Lessunearnedincome.......13592186218851,284,8631,331,0391,238,7561,026,191927,621Lessallowanceforloanlosses.................14,54914,73616,33914,62414,410Netloans..............$1,270,314$1,316,303$1,222,417$1,011,567$913,211TheCompanymaintainednoforeignloansintheperiodspresented.AlthoughtheCompany’sloansaremadeprimarilyinthefour-stateregioninwhichitoperates,theCompanyhadnoconcentrationsofloanstooneborrowerorindustryrepresenting10%ormoreofoutstandingloansatDecember31,2006.29SBM 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17:06:26ThefollowingtabledetailsthematuritiesandratesensitivityoftheCompany’sloanportfolioatDecember31,2006.OneYearandLessOverOnetoFiveYearsOverFiveYearsTotalPercentRemainingMaturities(Amountsinthousands)Commercial,financialandagricultural...................$53,476$49,592$3,577$106,6458.30%Realestate—commercial..........82,588253,90284,577421,06732.77%Realestate—construction.........113,21940,2585,089158,56612.34%Realestate—mortgage...........44,107161,437300,826506,37039.41%Consumer......................15,98666,9675,72688,6796.90%Other.........................1,2512,1111873,5490.28%$310,627$574,267$399,982$1,284,876100.00%RateSensitivity:Pre-determinedrate...............$125,257$456,522$81,833$663,61251.65%Floating-oradjustable-rate.........185,370117,745318,149621,26448.35%$310,627$574,267$399,982$1,284,876100.00%AllowanceforLoanLossesTheallowanceisincreasedbychargestoearningsintheformofprovisionsandbyrecoveriesofpriorcharge-offs,anddecreasedbycharge-offs.Theprovisionsarecalculatedtobringtheallowancetoalevel,which,accordingtoasystematicprocessofmeasurement,isreflectiveoftherequiredamountneededtoabsorbprobablelosses.Theallowanceforloanlosseswas$14.5millionatDecember31,2006,comparedto$14.7millionatDecember31,2005.ManagementconsiderstheallowanceadequatebaseduponitsanalysisoftheportfolioasofDecember31,2006,however,noassurancecanbemadethatadditionstotheallowanceforloanlosseswillnotberequiredinfutureperiods.30SBM 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17:06:26Thefollowingtabledetailsloancharge-offsandrecoveriesbyloantypeforthefiveyearsendedDecember31,2002through2006.20062005200420032002YearsEndedDecember31,(Amountsinthousands)Allowanceforloanlossesatbeginningofperiod...........................$14,736$16,339$14,624$14,410$13,952Acquisitionbalances..................——1,7861,583395Charge-offs:Commercial,financial,agriculturalandcommercialrealestate.............1,9535,0171,9253,3022,162Realestate-residential...............1,234385723686464Installment.......................1,3561,5341,5262,1332,243Totalcharge-offs.................4,5436,9364,1746,1214,869Recoveries:Commercial,financialandagricultural...1,0321,413727711167Realestate-residential...............1251889058129Installment.......................493418615564428Totalrecoveries..................1,6502,0191,4321,333724Netcharge-offs......................2,8934,9172,7424,7884,145Provisionchargedtooperations..........2,7063,7062,6713,4194,208Reclassificationofallowanceforlending-relatedcommitments(1)..............—(392)———Allowanceforloanlossesatendofperiod..$14,549$14,736$16,339$14,624$14,410Ratioofnetcharge-offstoaverageloansoutstanding.......................0.22%0.38%0.24%0.49%0.45%Ratioofallowanceforloanlossestototalloansoutstanding...................1.13%1.11%1.32%1.43%1.55%(1)AtJune30,2005,theCompanyreclassified$392thousandofitsallowanceforloanlossestoaseparateallowanceforlending-relatedliabilities.Netincomeandpriorperiodbalanceswerenotaffectedbythisreclassification.Theallowanceforlending-relatedliabilitiesisincludedinotherliabilities.ThefollowingtabledetailstheallocationoftheallowanceforloanlossesandthepercentofloansineachcategorytototalloansforthefiveyearsendedDecember31,2006.20062005200420032002December31,(Dollarsinthousands)Commercial,financialandagricultural..........$8,41853%$9,99358%$11,70057%$9,41447%$8,90547%Realestate—mortgage...3,85839%2,46234%2,08434%2,20741%1,68439%Consumer.............2,2738%2,2818%2,5559%3,00312%3,82114%Unallocated...........—0%—0%—0%—0%—0%Total..............$14,549100%$14,736100%$16,339100%$14,624100%$14,410100%31SBM 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17:06:26RiskElementsNon-performingassetsincludeloansonnon-accrualstatus,loanscontractuallypastdue90daysormoreandstillaccruinginterest,andotherrealestateowned.Thelevelsofnon-performingassetsforthelastfiveyearsarepresentedinthefollowingtable.20062005200420032002December31,(Dollarsinthousands)Non-accrualloans........................$3,813$3,383$5,168$2,993$3,075Loans90daysormorepastdueandstillaccruinginterest...............................—11——91Totalnon-performingloans..................3,8133,3945,1682,9933,166Otherrealestateowned....................2581,4001,4192,0912,855Totalnon-performingassets.................$4,071$4,794$6,587$5,084$6,021Non-performingloansasapercentageoftotalloans................................0.30%0.25%0.42%0.29%0.34%Non-performingassetsasapercentageoftotalloansandotherrealestateowned...........0.32%0.36%0.53%0.49%0.65%Allowanceforloanlossesasapercentageofnon-performingloans.......................381.6%434.2%316.2%488.6%455.1%Allowanceforloanlossesasapercentageofnon-performingassets.......................357.4%307.4%248.0%287.6%239.3%Totalnon-performingassetswere$4.1millionatDecember31,2006,comparedto$4.8millionatDecember31,2005,adecreaseof$723thousand.Non-accrualloansincreasedby$430thousandto$3.8millionatDecember31,2006.Ongoingactivitywithintheclassificationandcategoriesofnon-performingloanscontinuestoincludecollectionsondelinquentloans,foreclosures,andmovementsintooroutofthenon-performingclassificationasaresultofchangingcustomerbusinessconditions.Therewerenoloans90dayspastdueandstillaccruingatDecember31,2006,and$11thousandatDecember31,2005.Otherrealestateowneddecreased$1.1millionto$258thousandin2006andiscarriedatthelesserofestimatednetrealizablevalueorcost.Certainloansincludedinthenon-accrualcategoryhavebeenwrittendowntotheestimatedrealizablevalueorhavebeenassignedspecificreserveswithintheallowanceforloanlossesbaseduponmanagement’sestimateoflossuponultimateresolution.During2006,2005and2004,$1.3million,$1.3million,and$2.1million,respectively,ofassetswereacquiredthroughforeclosureandtransferredtootherrealestateowned.TheCompanyhasconsideredallimpairedloansintheevaluationoftheadequacyoftheallowanceforloanlossesatDecember31,2006.Thefollowingtablepresentsadditionaldetailofnon-performingandrestructured32SBM 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17:06:26loansforthefiveyearsendedDecember31,2006.AdditionalinformationregardingnonperformingloanscanbefoundinNote5oftheNotestoConsolidatedFinancialStatements,includedinItem8hereof.Non-PerformingLoans20062005200420032002December31,(Amountsinthousands)Non-accruingloans.......................$3,813$3,383$5,168$2,993$3,075Loanspastdueover90daysandstillaccruinginterest...............................—11——91Restructuredloansperforminginaccordancewithmodifiedterms.........................272302354356345Grossinterestincomewhichwouldhavebeenrecordedunderoriginaltermsofnon-accruingandrestructuredloans....................397380439282222Actualinterestincomeduringtheperiod........286161293194108Therearenooutstandingcommitmentstolendadditionalfundstoborrowersrelatedtorestructuredloans.AtDecember31,2006,therewerenosignificantpotentialproblemloansrequiringdisclosurebeyondthoseaddressedintheprecedingtables.DepositsTotaldepositsdecreasedby$8.5million,or0.6%,during2006.Noninterest-bearingdemanddepositsincreasedduring2006by$14.2million,or6.2%,whileinterest-bearingdemanddepositsdecreased$3.7million,or2.6%.Savingsdeposits,whichconsistofmoneymarketaccountsandpassbooksavings,decreased$37.5millionduring2006,or10.6%,whiletimedepositsincreased$18.6million,or2.8%.Averagetotaldepositsremainedsteadyat$1.41billionfor2006.Averagenon-interestbearingdemanddepositsandtimedepositsincreased$8.9millionand$21.9millionduring2006,respectively.Averageinterest-bearingdemanddepositsandsavingsdepositsdecreased$6.5and$24.5millionduring2006,respectively.In2006,theaverageratepaidoninterestbearingdepositswas2.89%,upsignificantlyfrom2.03%in2005.Theattritionfrominterest-bearingdemandandsavingsdepositsandthecontinuedincreaseintimedepositsreflectsthemigrationofnewandcurrentcustomerfundsinresponsetotheupwardmovementintimedepositinterestrates.AverageDepositsandAverageRatesAverageBalanceInterestRateAverageBalanceInterestRateAverageBalanceInterestRate200620052004(Dollarsinthousands)Interest-bearingliabilities:Demanddeposits........$146,248$4620.32%$152,774$4010.26%$149,502$3660.24%Savingsdeposits.........343,8546,8571.99%368,3394,3091.17%366,0743,1120.85%Timedeposits...........683,41826,5493.88%661,49819,3212.92%615,34615,0012.44%Totalinterest-bearingdeposits...........$1,173,520$33,8682.89%$1,182,611$24,0312.03%$1,130,922$18,4791.63%Non-interestbearingdemanddeposits.............$237,714$228,781$212,77733SBM 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17:06:26BorrowingsTheCompany’sborrowingsconsistprimarilyofovernightfederalfundspurchasedfromtheFHLBandothersources,securitiessoldunderagreementstorepurchase,andtermFHLBborrowings.ThiscategoryofliabilitiesrepresentswholesalesourcesoffundingandliquidityfortheCompany.Short-termborrowingsincreasedonaverageapproximately$22.3millioncomparedtotheprioryearasaresultofcontinuedincreasesinportfolioassets.FundingcostismanagedbytheCompany’sAsset/LiabilityManagementCommittee,whichmonitors,amongotherthings,productandpricing,overallcostoffunds,andmaintenanceofanacceptablenetinterestmargin.Federalfundspurchasedwere$7.7millionand$82.5million,atDecember31,2006and2005,respectively.Repurchaseagreementswere$201.2millionand$124.2millionatDecember31,2006and2005,respectively.Retailrepurchaseagreementsaresoldtocustomersasanalternativetoavailabledepositproducts.AtDecember31,2006,totalrepurchaseagreementsincluded$50millionofwholesaleinstruments.TheCompanyadded$50millionofwholesalerepurchaseagreementfundingduring2006.Theweighted-averagerateofthoserepurchaseagree-mentswas4.30%atDecember31,2006.Therewerenowholesalerepurchaseagreementsattheendof2005.TheunderlyingsecuritiesincludedinrepurchaseagreementsremainundertheCompany’scontrolduringtheeffectiveperiodoftheagreements.Short-termborrowingsincludeovernightfederalfunds,andrepurchaseagreements.Balancesandratespaidonshort-termborrowingsforcontinuingoperationsaresummarizedasfollows:AmountRateAmountRateAmountRate200620052004(Dollarsinthousands)Atyear-end.....................$208,8853.70%$206,6542.79%$142,3571.55%Averageduringtheyear............150,8393.37%128,5512.16%109,2231.29%Maximummonth-endbalance........208,885206,654142,357InJanuary2006,theCompanyborrowed$75millioninnewadjustable-rateadvancesfromtheFHLB.$50millionoftheadvanceswerehedgedbyaninterestrateswaptoapproximateafixedrateof4.34%.Theremaining$25millionfloatsataninterestrateequalto3-monthLIBORless45basispoints.AtDecember31,2006,FHLBborrowingsincluded$175.0millioninconvertibleandcallableadvancesand$7.2millionofnoncallableadvancesforatotalof$182.2million.Theweighted-averageinterestratesofalladvanceswere4.64%and4.17%atDecember31,2006and2005,respectively.Afterconsideringtheeffectoftheinterestrateswap,theweighted-averageinterestrateofalladvanceswas4.26%atDecember31,2006.AtDecember31,2006,theFHLBadvanceshadmaturitiesbetweenonemonthand14years.ThescheduledmaturitiesoftheFHLBadvancesareasfollows:(Amountsinthousands)2007.......................................................$6,2502008.......................................................—2009.......................................................—2010.......................................................25,0002011.......................................................—2012andthereafter............................................150,957$182,207Alsoincludedinotherindebtednessis$15.5millionofjuniorsubordinateddebenturesissuedbytheCompanyinOctober2003throughFCBICapitalTrust,anunconsolidatedtrustsubsidiary.34SBM BOOKPROOF -- l24096-i000_a.pdf Page 34 of Imposition -- Mon Mar 12 2007-- 17:06:26LiquidityandCapitalResourcesLiquidityrepresentstheCompany’sabilitytorespondtodemandsforfundsandisprimarilyderivedfrommaturinginvestmentsecurities,overnightinvestments,periodicrepaymentofloanprincipal,andtheCompany’sabilitytogeneratenewdeposits.TheCompanyalsohastheabilitytoattractshort-termsourcesoffundsanddrawoncreditlinesthathavebeenestablishedatfinancialinstitutionstomeetcashneeds.Totalliquidityof$789.4millionatDecember31,2006,iscomprisedofthefollowing:cashonhandanddepositswithotherfinancialinstitutionsof$57.8million;available-for-salesecuritiesof$508.4million;held-to-maturitysecuritiesduewithinoneyearof$125thousand;andFHLBcreditavailabilityof$223.1million.Liquiditymanagementisbothadailyandlong-termfunctionofbusinessmanagement.Excessliquidityisgenerallyusedtopaydownshort-termborrowings.Onalonger-termbasis,theCompanymaintainsastrategyofinvestinginsecurities,mortgage-backedobligationsandloanswithvaryingmaturities.TheCompanyusessourcesoffundsprimarilytomeetongoingcommitments,topaymaturingsavingscertificatesandsavingswithdrawals,fundloancommitmentsandmaintainaportfolioofsecurities.AtDecember31,2006,approvedloancommitmentsoutstandingamountedto$213.4million.Certificatesofdepositscheduledtomatureinoneyearorlesstotaled$529.9million.ManagementbelievesthattheCompanyhasadequateresourcestofundoutstandingcommitmentsandcouldeitheradjustratesoncertificatesofdepositinordertoretainorattractdepositsinchanginginterestrateenvironmentsorreplacesuchdepositswithadvancesfromtheFHLBorotherfundsprovidersifitprovedtobecosteffectivetodoso.ThefollowingtablepresentscontractualcashobligationsasofDecember31,2006.TotalLessThan1YearTwotoThreeYearsFourtoFiveYearsAfter5YearsDecember31,2006TotalPaymentsDuebyPeriod(Amountsinthousands)Depositswithoutastatedmaturity(1)...................$703,024$703,024$—$—$—Federalfundsborrowedandovernightsecurityrepurchaseagreements....103,191103,191———CertificatesofDeposit(2)(3)........720,284529,908127,72361,841812Termsecurityrepurchaseagreements...................129,02257,9425,2624,91860,900FHLBadvances(2)(3).............262,86914,10715,66239,253193,847Trustpreferredindebtedness........50,2031,2872,5732,57343,770Leases........................2,7797001,044462573Total.........................$1,971,372$1,410,159$152,264$109,047$299,902(1)Excludesinterest.(2)Includesinterestonbothfixedandvariable-rateobligations.Theinterestassociatedwithvariable-rateobligationsisbaseduponinterestratesineffectatDecember31,2006.Theinteresttobepaidonvariable-rateobligationsisaffectedbychangesinmarketinterestrates,whichmateriallyaffectthecontractualobligationamountstobepaid.(3)Excludescarryingvalueadjustmentssuchasunamortizedpremiumsordiscounts.35SBM 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17:06:26ThefollowingtablepresentsdetailedinformationregardingtheCompany’soff-balancesheetarrangementsatDecember31,2006.TotalLessthanOneYearTwotoThreeYearsFourtoFiveYearsAfterFiveYearsDecember31,2006AmountofCommitmentExpirationPerPeriod(Amountsinthousands)CommitmentstoextendcreditCommercial,financialandagricultural...$34,842$32,475$664$74$1,629Realestate—commercial...........24,60918,7182,6902,411790Realestate—residential............61,74215,9531,8172,93441,038Realestate—construction..........68,89960,0852,2923,1593,363Consumerlinesofcredit............23,30323,01726521—Totalunusedcommitments........$213,395$150,248$7,728$8,599$46,820Financiallettersofcredit.............$1,593$1,539$37$7$10Performancelettersofcredit...........5,3893,2001,99213364Totallettersofcredit..............$6,982$4,739$2,029$140$74InJanuary2006,theCompanyenteredintoapayfixedandreceivevariableinterestrateswap.Theswapeffectivelyfixes$50millionofFHLBborrowingsat4.34%foraperiodoffiveyears.Managementdoesnotanticipatethisderivativetransactionwillhaveasignificantimpactonreportedearningsorcashflows.Stockholders’EquityTotalstockholders’equityincreased$18.2millionto$212.7millionatDecember31,2006,astheCompanycontinuedtobalancecapitaladequacyandreturnstostockholders.Theincreaseinequitywasduemainlytonetearningsof$28.9millionlessdividendspaidtostockholdersof$11.7million.Risk-basedcapitalguidelinesandtheleverageratiomeasurecapitaladequacyofbankinginstitutions.AtDecember31,2006,theCompany’sTierIcapitalratiowas11.60%comparedwith10.54%in2005.TheCompany’stotalrisk-basedcapital-to-assetratiowas12.69%atthecloseof2006comparedwith11.65%in2005.Bothoftheseratiosarewellabovethecurrentminimumlevelof8%prescribedforbankholdingcompanies.Theleverageratioisthemeasurementoftotaltangibleequitytototalassets.TheCompany’sleverageratioatDecember31,2006,was8.50%versus7.77%atDecember31,2005,bothofwhicharewellabovetheminimumlevelsprescribedbytheFederalReserve.SeeNote14oftheNotestoConsolidatedFinancialStatementsinItem8hereof.TrustandInvestmentManagementServicesAspartofitscommunitybankingservices,theCompanyofferstrustmanagementandestateadministrationservicesthroughitsTrustandFinancialServicesDivision(TrustDivision).TheTrustDivisionreportedmarketvalueofassetsundermanagementof$507millionand$487millionatDecember31,2006and2005,respectively.TheTrustDivisionmanagesintervivostrustsandtrustsunderwill,developsandadministersemployeebenefitplansandindividualretirementplansandmanagesandsettlesestates.Fiduciaryfeesfortheseservicesarechargedonaschedulerelatedtothesize,natureandcomplexityoftheaccount.TheTrustDivisionemploys16professionalsandfulltimeequivalentsupportstaffwithawidevarietyofestateandfinancialplanning,investingandplanadministrationskills.TheTrustDivisionislocatedwithintheCompany’sbankingofficesinBluefield,WestVirginia.ServicesandtrustdevelopmentactivitiesareofferedtootherbranchlocationsandprimarymarketsthroughtheBluefield-baseddivision.36SBM 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17:06:26ITEM7A.QUANTITATIVEANDQUALITATIVEDISCLOSURESABOUTMARKETRISK.TheCompany’sprofitabilityisdependenttoalargeextentuponitsnetinterestincome,whichisthedifferencebetweenitsinterestincomeoninterest-earningassets,suchasloansandsecurities,anditsinterestexpenseoninterest-bearingliabilities,suchasdepositsandborrowings.TheCompany,likeotherfinancialinstitutions,issubjecttointerestraterisktothedegreethatitsinterest-earningassetsrepricedifferentlythanitsinterest-bearingliabilities.TheCompanymanagesitsmixofassetsandliabilitieswiththegoalsoflimitingitsexposuretointerestraterisk,ensuringadequateliquidity,andcoordinatingitssourcesandusesoffundswhilemaintaininganacceptablelevelofnetinterestincomegiventhecurrentinterestrateenvironment.TheCompany’sprimarycomponentofoperationalrevenue,netinterestincome,issubjecttovariationasaresultofchangesininterestrateenvironmentsinconjunctionwithunbalancedrepricingopportunitiesonearningassetsandinterest-bearingliabilities.Interestrateriskhasfourprimarycomponentsincludingrepricingrisk,basisrisk,yieldcurveriskandoptionrisk.Repricingriskoccurswhenearningassetsandpayingliabilitiesrepriceatdifferingtimesasinterestrateschange.Basisriskoccurswhentheunderlyingratesontheassetsandliabilitiestheinstitutionholdschangeatdifferentlevelsorinvaryingdegrees.Yieldcurveriskistheriskofadverseconsequencesasaresultofunequalchangesinthespreadbetweentwoormoreratesfordifferentmaturitiesforthesameinstrument.Lastly,optionriskisdueto“embeddedoptions”,oftencalledputorcalloptions,givenorsoldtoholdersoffinancialinstruments.Inordertomitigatetheeffectofchangesinthegenerallevelofinterestrates,theCompanymanagesrepricingopportunitiesandthus,itsinterestratesensitivity.TheCompanyseekstocontrolitsinterestraterisk(“IRR”)exposuretoinsulatenetinterestincomeandnetearningsfromfluctuationsinthegenerallevelofinterestrates.TomeasureitsexposuretoIRR,quarterlysimulationsofnetinterestincomeareperformedusingfinancialmodelsthatprojectnetinterestincomethrougharangeofpossibleinterestrateenvironmentsincludingrising,declining,mostlikelyandflatratescenarios.TheresultsofthesesimulationsindicatetheexistenceandseverityofIRRineachofthoserateenvironmentsbaseduponthecurrentbalancesheetposition,assumptionsastochangesinthevolumeandmixofinterest-earningassetsandinterest-payingliabilities,management’sestimateofyieldstobeattainedinthosefuturerateenvironments,andratesthatwillbepaidonvariousdepositinstrumentsandborrowings.SpecificstrategiesformanagementofIRRhaveincludedshorteningtheamortizedmaturityofnewfixed-rateloans,increasingthevolumeofadjustable-rateloanstoreducetherepricingtermoftheBank’sinterest-earningassets,andmonitoringthetermstructureofliabilitiestomaintainabalancedmixofmaturityandrepricingtomitigatethepotentialexposure.ThesimulationmodelusedbytheCompanycapturesallearningassets,interest-bearingliabilitiesandalloff-balancesheetfinancialinstrumentsandcombinesthevariousfactorsaffectingratesensitivityintoanearningsoutlook.Baseduponthelatestsimulation,theCompanybelievesthatitisbiasedslightlytowardaliabilitysensitiveposition.Absentadequatemanagement,liabilitysensitivepositionscannegativelyimpactnetinterestincomeinarisingrateenvironmentor,alternatively,positivelyimpactnetinterestincomeinafallingrateenvironment.TheCompanyhasestablishedpolicylimitsfortoleranceofinterestrateriskthatallowfornomorethana10%reductioninthenexttwelvemonthsprojectednetinterestincomebasedontheincomesimulationcomparedtoforecastedresults.Inaddition,thepolicyaddressesexposurelimitstochangesintheeconomicvalueofequityaccordingtopredefinedpolicyguidelines.ThemostrecentsimulationindicatesthatcurrentexposuretointerestrateriskiswithintheCompany’sdefinedpolicylimits.37SBM 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17:06:26ThefollowingtablesummarizestheimpactofimmediateandsustainedrateshocksintheinterestrateenvironmentonnetinterestincomeandtheeconomicvalueofequityasofDecember31,2006and2005.Themodelsimulatesplusandminus200basispointsfromthebasecaseratesimulationatDecember31,2006.Thistable,whichillustratestheprospectiveeffectsofhypotheticalinterestratechanges,isbaseduponnumerousassumptionsincludingrelativeandestimatedlevelsofkeyinterestratesoveratwelve-monthtimeperiod.Thismodelingtechnique,althoughuseful,doesnottakeintoaccountallstrategiesthatmanagementmightundertakeinresponsetoasuddenandsustainedrateshockasdepicted.Also,asmarketconditionsvaryfromthoseassumedinthesensitivityanalysis,actualresultswillalsodifferduetoprepaymentandrefinancinglevelslikelydeviatingfromthoseassumed,thevaryingimpactofinterestratechangecapsorfloorsonadjustablerateassets,thepotentialeffectofchangingdebtservicelevelsoncustomerswithadjustablerateloans,depositorearlywithdrawalsandproductpreferencechanges,andotherinternalandexternalvariables.RateSensitivityAnalysisIncrease(Decrease)inInterestRates(BasisPoints)ChangeinNetInterestIncome%ChangeChangeinMarketValueofEquity%Change2006(Dollarsinthousands)200.....................................$(2,006)(2.8)$(16,229)(5.4)100.....................................(958)(1.3)(7,453)(2.5)(100)....................................(1,024)(1.4)(4,301)(1.4)(200)....................................(1,614)(2.3)(18,278)(6.1)Increase(Decrease)inInterestRates(BasisPoints)ChangeinNetInterestIncome%ChangeChangeinMarketValueofEquity%Change2005200.....................................$(764)(1.0)$(13,392)(4.6)100.....................................(403)(0.5)(6,211)(2.2)(100)....................................(950)(1.3)(4,376)(1.5)(200)....................................(4,299)(5.8)(15,755)(5.5)38SBM BOOKPROOF -- l24096-i000_a.pdf Page 38 of Imposition -- Mon Mar 12 2007-- 17:06:26ITEM8.FINANCIALSTATEMENTSANDSUPPLEMENTARYDATA.ConsolidatedFinancialStatementsConsolidatedBalanceSheets..........................................................40ConsolidatedStatementsofIncome.....................................................41ConsolidatedStatementsofCashFlow...................................................42ConsolidatedStatementsofChangesinStockholders’Equity..................................43NotestoConsolidatedFinancialStatements...............................................44ReportsofIndependentRegisteredPublicAccountingFirmsonConsolidatedFinancialStatements......80Management’sAssessmentofInternalControlOverFinancialReporting.........................82ReportofIndependentRegisteredPublicAccountingFirmonManagement’sAssessmentofInternalControlOverFinancialReporting....................................................8339SBM BOOKPROOF -- l24096-i000_a.pdf Page 39 of Imposition -- Mon Mar 12 2007-- 17:06:26FIRSTCOMMUNITYBANCSHARES,INC.CONSOLIDATEDBALANCESHEETS20062005December31,(Amountsinthousands,exceptshareandpersharedata)ASSETSCashandduefrombanks............................................$47,909$46,872Interest-bearingbalanceswithbanks....................................9,85010,667Totalcashandcashequivalents......................................57,75957,539Securitiesavailableforsale(amortizedcostof$508,423,2006;$405,667,2005)...508,370404,381Securitiesheldtomaturity(fairvalueof$20,350,2006;$24,877,2005).........20,01924,173Loansheldforsale.................................................7811,274Loansheldforinvestment,netofunearnedincome.........................1,284,8631,331,039Lessallowanceforloanlosses......................................14,54914,736Netloansheldforinvestment.........................................1,270,3141,316,303Premisesandequipment,net..........................................36,88934,993Otherrealestateowned.............................................2581,400Interestreceivable.................................................12,14110,232Goodwill........................................................60,13559,182Otherintangibleassets..............................................2,0611,937Otherassets......................................................64,97141,069TotalAssets..................................................$2,033,698$1,952,483LIABILITIESDeposits:Noninterest-bearing..............................................$244,771$230,542Interest-bearing.................................................1,150,0001,172,678TotalDeposits.................................................1,394,7711,403,220Interest,taxesandotherliabilities......................................19,64118,877Federalfundspurchased.............................................7,70082,500Securitiessoldunderagreementstorepurchase............................201,185124,154FHLBborrowingsandotherindebtedness................................197,671129,231TotalLiabilities...............................................1,820,9681,757,982Stockholders’EquityPreferredstock,parvalueundesignated;1,000,000sharesauthorized;nosharesissuedandoutstandingin2006and2005...............................——Commonstock,$1parvalue;sharesauthorized:25,000,000;sharesissued:11,499,018in2006and11,496,312in2005;sharesoutstanding:11,245,742in2006and11,251,803in2005.......................................11,49911,496Additionalpaid-incapital............................................108,806108,573Retainedearnings..................................................100,11782,828Treasurystock,atcost..............................................(7,924)(7,625)Accumulatedothercomprehensiveincome...............................232(771)TotalStockholders’Equity.......................................212,730194,501TotalLiabilitiesandStockholders’Equity............................$2,033,698$1,952,483SeeNotestoConsolidatedFinancialStatements.40SBM 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17:06:26FIRSTCOMMUNITYBANCSHARES,INC.CONSOLIDATEDSTATEMENTSOFINCOME200620052004YearsEndedDecember31,(Amountsinthousands,exceptshareandpersharedata)InterestIncome:Interestandfeesonloans.......................................$97,460$89,903$76,713Interestonsecurities-taxable.....................................13,95111,07712,119Interestonsecurities-nontaxable..................................7,3717,4516,712Interestonfederalfundssoldanddepositsinbanks.....................1,2441,077592Totalinterestincome........................................120,026109,50896,136InterestExpense:Interestondeposits...........................................33,86824,03018,478Interestonshort-termborrowings.................................6,9779,7217,585Interestonlong-termdebt.......................................7,5362,129890Totalinterestexpense........................................48,38135,88026,953Netinterestincome.............................................71,64573,62869,183Provisionforloanlosses.........................................2,7063,7062,671Netinterestincomeafterprovisionforloanlosses.......................68,93969,92266,512NoninterestIncome:Wealthmanagementincome.....................................2,8112,9562,489Servicechargesondepositaccounts................................10,24210,0959,122Otherservicecharges,commissionsandfees.........................2,9922,7852,239Netgainsonsaleofsecurities....................................757531,604Otheroperatingincome........................................5,2035,7161,875Totalnoninterestincome......................................21,32322,30517,329NoninterestExpense:Salariesandemployeebenefits...................................26,86729,48126,646Occupancyexpenseofbankpremises...............................4,0683,9033,559Furnitureandequipmentexpense..................................3,4663,3192,872Coredepositamortization.......................................410435399PrepaymentpenaltiesonFHLBadvances............................—3,794—Otheroperatingexpense........................................15,02614,65914,559Totalnoninterestexpense.....................................49,83755,59148,035Incomefromcontinuingoperationsbeforeincometaxes...................40,42536,63635,806Incometaxexpense.............................................11,47710,1919,786Incomefromcontinuingoperations................................28,94826,44526,020Lossfromdiscontinuedoperationsbeforeincometax.....................—(233)(5,746)Incometaxbenefit.............................................—(91)(2,090)Lossfromdiscontinuedoperations.................................—(142)(3,656)Netincome..................................................$28,948$26,303$22,364Basicearningspercommonshare...................................$2.58$2.33$1.99Dilutedearningspercommonshare..................................$2.57$2.32$1.97Basicearningspercommonsharefromcontinuingoperations...............$2.58$2.35$2.32Dilutedearningspercommonsharefromcontinuingoperations..............$2.57$2.33$2.29Dividendsdeclaredpercommonshare................................$1.04$1.02$1.00Weightedaveragebasicsharesoutstanding.............................11,204,87511,269,25811,238,648Weightedaveragedilutedsharesoutstanding...........................11,279,48011,341,80411,337,606SeeNotestoConsolidatedFinancialStatements.41SBM 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17:06:26FIRSTCOMMUNITYBANCSHARES,INC.CONSOLIDATEDSTATEMENTSOFCASHFLOWS200620052004YearsEndedDecember31,(Amountsinthousands)Cashflowsfromoperatingactivities—continuingoperations:Incomefromcontinuingoperations............................................$28,948$26,445$26,020Adjustmentstoreconcilenetincometonetcashprovidedbyoperatingactivities:Provisionforloanlosses.................................................2,7063,7062,671Depreciationandamortizationofpremisesandequipment...........................3,3663,3392,938Intangibleamortization..................................................410436399Netinvestmentamortizationandaccretion.....................................6991,0492,203Gainsonthesaleofassets................................................(1,329)(4,845)(1,786)Mortgageloansoriginatedforsale...........................................(33,565)(37,593)(26,751)Proceedsfromsaleofmortgageloans........................................34,05837,51325,981Equity-basedcompensationexpense..........................................427——Deferredincometaxexpense..............................................4651,864147(Increase)decreaseininterestreceivable.......................................(1,928)(1,707)705Excesstaxbenefitfromstock-basedcompensation................................(201)——Decrease(increase)inotherassets...........................................215(6,549)(2,660)Increaseinotherliabilities................................................7691,5161,495Netcashprovidedbyoperatingactivities—continuingoperations35,04025,17431,362Cashflowsfrominvestingactivities—continuingoperations:Proceedsfromsalesofsecuritiesavailableforsale................................14,18533,15945,391Proceedsfrommaturitiesandcallsofsecuritiesavailableforsale......................23,51544,115144,573Proceedsfrommaturitiesandcallsofheldtomaturitysecurities.......................4,22110,0974,374Purchaseofsecuritiesavailableforsale.......................................(139,624)(111,223)(108,726)Purchaseofbank-ownedlifeinsurance........................................(25,000)——Netdecrease(increase)inloansmadetocustomers................................40,610(104,307)(84,580)Cashusedindivestituresandacquisitions,net...................................(22,046)(32,630)(26,340)Purchaseofpremisesandequipment.........................................(5,709)(3,215)(7,336)Proceedsfromsaleofequipment............................................4021,018334Netcashusedininvestingactivities—continuingoperations..........................(109,446)(162,986)(32,310)Cashflowsfromfinancingactivities—continuingoperations:Net(decrease)increaseindemandandsavingsdeposits.............................(17,215)(6,362)13,902Netincrease(decrease)intimedeposits.......................................35,55195,751(29,216)Netincrease(decrease)inFHLBandotherborrowings.............................68,440(3,088)(19,914)Net(decrease)increaseinfederalfundspurchased................................(74,800)50,00032,500Netincreaseinsecuritiessoldunderagreementtorepurchase.........................77,36916,72111,044Proceedsfromtheexerciseofstockoptions.....................................1,305522504Excesstaxbenefitfromstock-basedcompensation................................201——Acquisitionoftreasurystock..............................................(4,566)(1,303)(1,196)Dividendspaid.......................................................(11,659)(11,494)(11,239)Netcashprovidedby(usedin)financingactivities—continuingoperations.................74,626140,747(3,615)Netincrease(decrease)incashandcashequivalents—continuingoperations................$220$2,935$(4,563)Cashflowsfromdiscontinuedoperations:(Revised-SeeNote18)Netcash(usedin)providedbyoperatingactivities................................$—$(142)$15,149Netcashprovidedbyinvestingactivities.......................................——460Netcashusedinfinancingactivities.........................................——(17,852)Netcashusedindiscontinuedoperations........................................$—$(142)$(2,243)Cashandcashequivalentsatbeginningofyear—continuingoperations...................$57,539$54,746$59,309Cashandcashequivalentsatbeginningofyear—discontinuedoperations..................——2,243Cashandcashequivalentsatbeginningofyear....................................$57,539$54,746$61,552Cashandcashequivalentsatendofyear—continuingoperations........................$57,759$57,539$54,746Cashandcashequivalentsatendofyear—discontinuedoperations......................———Cashandcashequivalentsatendofyear........................................$57,759$57,539$54,746Supplementalinformation—NoncashitemsTransfersofloanstootherrealestate.........................................$1,281$1,263$2,070(SeeNote1fordetailofincometaxesandinterestpaidandNote2forsupplementalinformationregardingdetailofcashpaidinacquisitions.)SeeNotestoConsolidatedFinancialStatements42SBM 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17:06:26FIRSTCOMMUNITYBANCSHARES,INC.CONSOLIDATEDSTATEMENTSOFCHANGESINSTOCKHOLDERS’EQUITYCommonStockAdditionalPaid-inCapitalRetainedEarningsTreasuryStockAccumulatedOtherComprehensiveIncomeTotal(Amountsinthousands,exceptshareandpershareinformation)BalanceDecember31,2003....................11,442108,12856,894(6,407)4,978175,035Comprehensiveincome:Netincome..............................——22,364——$22,364OthercomprehensiveincomeUnrealizedlossonsecuritiesavailableforsaleof$5,413,netof$2,165taxbenefit.............————(3,248)(3,248)Lessreclassificationadjustmentforgainsrealizedinnetincomeof$1,050,netof$420taxexpense....————630630Comprehensiveincome(loss)...............——22,364—(2,618)19,746Commondividendsdeclared($1.00pershare).........——(11,239)——(11,239)Purchaseof44,467treasurysharesat$26.89pershare...———(1,196)—(1,196)AcquisitionofStoneCapitalManagement—2,541sharesissued.................................385———88Taxbenefitfromexerciseofnon-qualifiedstockoptions..—164———164Equity-basedcompensation.....................—131———131Exerciseof54,873optionsunderstockoptionplans.....27(245)—722—504BalanceDecember31,2004....................11,472108,26368,019(6,881)2,360183,233Comprehensiveincome:Netincome...............................——26,303——26,303OthercomprehensiveincomeUnrealizedlossonsecuritiesavailableforsaleof$5,647,netof$2,259taxbenefit.............————(3,388)(3,388)Lessreclassificationadjustmentforgainsrealizedinnetincomeof$428,netof$171taxbenefit......————257257Comprehensiveincome(loss)...............——26,303—(3,131)23,172Commondividendsdeclared($1.02pershare).........——(11,494)——(11,494)Purchaseof41,534treasurysharesat$31.38pershare...———(1,303)—(1,303)AcquisitionofStoneCapitalManagement—2,541sharesissued.................................285———87Taxbenefitfromexerciseofnon-qualifiedstockoptions..—102———102Equity-basedcompensation.....................217—8—27Exerciseof38,146optionsunderstockoptionplans.....20106—551—677BalanceDecember31,2005....................11,496108,57382,828(7,625)(771)194,501Comprehensiveincome:Netincome...............................——28,948——28,948OthercomprehensiveincomeUnrealizedgainonsecuritiesavailableforsaleof$1,242,netof$497taxexpense...........————745745Lessreclassificationadjustmentforlossesrealizedinnetincomeof$10,netof$4taxbenefit........————(6)(6)Unrealizedgainonderivativesecuritiesof$441,netof$177taxexpense.............————264264Comprehensiveincome...................——28,948—1,00329,951Commondividendsdeclared($1.04pershare).........——(11,659)——(11,659)Purchaseof145,161treasurysharesat$31.46pershare..———(4,566)—(4,566)AcquisitionofStoneCapitalManagement—2,706sharesissued.................................385———88AcquisitionofInvestmentPlanningConsultants—39,874sharesissued........................—217—1,248—1,465ESOPallocation27,733shares...................—16—867—883Equity-basedcompensation.....................—267—160—427Taxbenefitfromexerciseofstockoptions...........—335———335Exerciseof63,655optionsunderstockoptionplans.....—(687)—1,992—1,305BalanceDecember31,2006....................$11,499$108,806$100,117$(7,924)$232$212,730SeeNotestoConsolidatedFinancialStatements43SBM 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17:06:26FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTSNote1.SummaryofSignificantAccountingPoliciesBasisofPresentationTheaccountingandreportingpoliciesofFirstCommunityBancshares,Inc.andsubsidiaries(“FirstCom-munity”orthe“Company”)conformtoaccountingprinciplesgenerallyacceptedintheUnitedStatesandtopredominantpracticeswithinthebankingindustry.Inpreparingfinancialstatements,managementisrequiredtomakeestimatesandassumptionsthataffectthereportedamountsofassetsandliabilitiesasofthedateofthebalancesheetandrevenuesandexpensesfortheperiod.Actualresultscoulddifferfromthoseestimates.AssetsheldinanagencyorfiduciarycapacityarenotassetsoftheCompanyandarenotincludedintheaccompanyingconsolidatedbalancesheets.PrinciplesofConsolidationTheconsolidatedfinancialstatementsofFirstCommunityincludetheaccountsofallwholly-ownedsub-sidiaries.Allsignificantintercompanybalancesandtransactionshavebeeneliminatedinconsolidation.FirstCommunityoperatesinthecommunitybankingsegmentandoperatedasecondsegmentrelatedtomortgagebankinguntilthedispositionofUnitedFirstMortgage,Inc.in2004.ThefinancialstatementsandfootnoteswithinthisreporthavebeenreformattedtoconformtothepresentationrequiredinStatementofFinancialAccountingStandards(“SFAS”)144for“discontinuedoperations”pursuanttotheCompany’ssaleofitsformermortgagebankingsubsidiaryinAugust2004.Incomestatementitemsforthediscontinuedsubsidiary,includingcontractualobligations,arepresentedindiscontinuedoperationswithoutelimination.Interestexpenseaccruedandpaidbythediscontinuedoperationisbaseduponthecontractualtermsoftheobligationsenteredintobytheformermortgagesubsidiaryincludinglinesofcreditextendedbyitsparentcompany.UseofEstimatesInpreparingconsolidatedfinancialstatementsinconformitywithgenerallyacceptedaccountingprinciples,managementisrequiredtomakeestimatesandassumptionsthataffectthereportedamountsofassetsandliabilitiesasofthedateofthebalancesheetandreportedamountsofrevenuesandexpensesduringthereportingperiod.Actualresultscoulddifferfromthoseestimates.CashandCashEquivalentsCashandcashequivalentsincludecashandduefrombanks,timedepositswithotherbanks,federalfundssold,andinterest-bearingbalancesondepositwiththeFHLBthatareavailableforimmediatewithdrawal.Interestandincometaxespaidwereasfollows:200620052004(Amountsinthousands)Interest.............................................$48,382$35,880$26,952IncomeTaxes........................................9,7178,9627,616PursuanttoagreementswiththeFederalReserveBank,theCompanymaintainsacashbalanceofapprox-imately$1.0millioninlieuofchargesforcheckclearingandotherservices.TradingSecuritiesAtDecember31,2006and2005,nosecuritieswereheldfortradingpurposesandnotradingaccountwasmaintained.44SBM 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17:06:26Available-for-SaleSecuritiesSecuritiestobeheldforindefiniteperiodsoftime,includingsecuritiesthatmanagementintendstouseaspartofitsasset/liabilitymanagementstrategyandthatmaybesoldinresponsetochangesininterestrates,changesinprepaymentrisk,orothersimilarfactors,areclassifiedasavailable-for-saleandarerecordedatestimatedfairvalue.Unrealizedappreciationordepreciationinfairvalueaboveorbelowamortizedcostisincludedinstockholders’equity,netofincometaxes,andisentitled“OtherComprehensiveIncome.”Premiumsanddiscountsareamortizedtoexpenseoraccretedtoincomeoverthelifeofthesecurity.Gainorlossonsaleisbasedonthespecificidentificationmethod.Otherthantemporarylosses,ifany,onavailable-for-salesecuritiesareincludedinnetsecuritieslossesandgains.Allsecurities,includingheld-to-maturitysecurities,areevaluatedforindicationsofother-than-temporaryimpairment.Foravailable-for-saledebtsecuritieswithunrealizedlosses,managementhastheintentandabilitytoholdthesesecuritiesuntilsuchtimeasthevaluerecoversorthesecuritiesmature.Held-to-MaturitySecuritiesInvestmentsindebtsecuritiesthatmanagementhastheabilityandintenttoholdtomaturityarecarriedatamortizedcost.Premiumsanddiscountsareamortizedtoexpenseandaccretedtoincomeoverthelivesofthesecurities.Gainorlossonthecallormaturityofinvestmentsecurities,ifany,isrecordedbasedonthespecificidentificationmethod.LoansHeldforSaleLoansheldforsaleprimarilyconsistofone-to-fourfamilyresidentialloansoriginatedforsaleinthesecondarymarketandarecarriedatthelowerofcostorestimatedfairvaluedeterminedonanaggregatebasis.Thelong-term,fixed-rateloansaresoldtoinvestorsonabesteffortsbasissuchthattheCompanydoesnotabsorbtheinterestrateriskinvolvedintheloan.Thefairvalueofloansheldforsaleisdeterminedbyreferencetoquotedpricesforloanswithsimilarcouponratesandterms.TheCompanyentersintorate-lockcommitmentsitmakestocustomerswiththeintentiontoselltheloaninthesecondarymarket.Thederivativesarisingfromtherate-lockcommitmentsarerecordedatfairvalueinotherassetsandliabilitiesandchangesinthatfairvalueareincludedinotherincome.Thefairvalueoftherate-lockcommitmentderivativesaredeterminedbyreferencetoquotedpricesforloanswithsimilarcouponratesandterms.TheCompanyalsoentersintoforwardsalescommitmentswithinstitutionalinvestorsforthesaleofthoseloans,whichhavebeendeterminednottoqualifyasderivatives.Gainsandlossesonthesaleofthoseloansareincludedinotherincome.LoansHeldforInvestmentLoansheldforinvestmentarecarriedattheprincipalamountoutstandinglessanywrite-downswhichmaybenecessarytoreduceindividualloanstonetrealizablevalue.Individuallysignificantcommercialloansareevaluatedforimpairmentwhenevidenceofimpairmentexists.Impairmentallowancesarerecordedthroughspecificadditionstotheallowanceforloanlosses.Loansareconsideredpastduewhenprincipalorinterestbecomesdelinquentby30daysormore.Consumerloansarechargedoffwhentheloanbecomes120dayspastdue(180daysifsecuredbyresidentialrealestate).Otherloansarechargedoffagainsttheallowanceforloanlossesaftercollectionattemptshavebeenexhausted,whichgenerallyiswithin120days.Recoveriesofloanschargedoffarecreditedtotheallowanceforloanlossesintheperiodreceived.AllowanceforLoanLossesTheallowanceforloanlossesismaintainedatlevelsmanagementdeemsadequatetoabsorbprobablelossesinherentintheportfolio,andisbasedonmanagement’sevaluationoftherisksintheloanportfolioandchangesinthenatureandvolumeofloanactivity.TheCompanyconsistentlyappliesareviewprocesstoperiodicallyevaluate45FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26loansandcommitmentsforchangesincreditrisk.ThisprocessservesastheprimarymeansbywhichtheCompanyevaluatestheadequacyoftheallowanceforloanlosses.TheCompanydeterminestheallowanceforloanlossesbymakingspecificallocationstoimpairedloansthatexhibitinherentweaknessesandvariouscreditriskfactors.Generalallocationstocommercial,residentialrealestate,andconsumerloanpoolsaredevelopedgivingweighttoriskratings,historicallosstrendsandmanagement’sjudgmentconcerningthosetrendsandotherrelevantfactors.Thesefactorsmayinclude,amongothers,actualversusestimatedlosses,regionalandnationaleconomicconditions,businesssegmentandportfolioconcentrations,industrycompetitionandconsolidation,andtheimpactofgovernmentregulations.Theforegoinganalysisisperformedbymanagementtoevaluatetheportfolioandcalculateanestimatedvaluationallowancethroughaquantitativeandqualitativeanalysisthatappliesriskfactorstothoseidentifiedriskareas.Thisriskmanagementevaluationisappliedatboththeportfoliolevelandtheindividualloanlevelforcommercialloansandcreditrelationshipswhilethelevelofconsumerandresidentialmortgageloanallowanceisdeterminedprimarilyonatotalportfoliolevelbasedonareviewofhistoricallosspercentagesandotherqualitativefactorsincludingconcentrations,industryspecificfactorsandeconomicconditions.Thecommercialportfoliorequiresmorespecificanalysisofindividuallysignificantloansandtheborrower’sunderlyingcashflow,businessconditions,capacityfordebtrepaymentandthevaluationofsecondarysourcesofpayment,suchascollateral.Thisanalysismayresultinspecificallyidentifiedweaknessesandcorrespondingspecificimpairmentallowances.Whileallocationsaremadetospecificloansandclassificationswithinthevariouscategoriesofloans,theallowanceforloanlossesisavailableforallloanlosses.TheuseofvariousestimatesandjudgmentsintheCompany’songoingevaluationoftherequiredlevelofallowancecansignificantlyimpacttheCompany’sresultsofoperationsandfinancialconditionandmayresultineithergreaterprovisionsagainstearningstoincreasetheallowanceorreducedprovisionsbaseduponmanagement’scurrentviewofportfolioandeconomicconditionsandtheapplicationofrevisedestimatesandassumptions.Differencesbetweenactualloanlossexperienceandestimatesarereflectedthroughadjustmentseitherincreasingordecreasingtheloanlossprovisionbaseduponcurrentmeasurementcriteria.Long-termInvestmentsCertainlong-termequityinvestmentsrepresentinglessthan20%ownershiparecarriedatcostandareincludedinotherassets.Theseinvestmentsinoperatingcompaniesrepresentrequiredlong-terminvestmentsininsurance,investmentandservicecompanyaffiliatesorconsortiumswhichserveasvehiclesforthedeliveryofvarioussupportservices.Onthecostbasis,dividendsreceivedarerecordedascurrentperiodrevenuesandthereisnorecognitionoftheCompany’sproportionateshareofnetoperatingincomeorloss.TheCompanyhasdeterminedthatfairvaluemeasurementisnotpractical,andfurther,nothinghascometotheattentionoftheCompanythatwouldindicateimpairmentofanyoftheseinvestments.PremisesandEquipmentPremisesandequipmentarestatedatcostlessaccumulateddepreciation.Depreciationandamortizationarecomputedonthestraight-linemethodoverestimatedusefullives.Usefullivesrangefrom5to10yearsforfurniture,fixtures,andequipment;threetofiveyearsforsoftware,hardware,anddatahandlingequipment;and10to40yearsforbuildingsandbuildingimprovements.Landimprovementsareamortizedoveraperiodof20years,andleaseholdimprovementsareamortizedoverthelesseroftheusefullifeorthetermoftheleaseplusthefirstoptionalrenewalperiod,whenrenewalisreasonablyassured.Maintenanceandrepairsarechargedtocurrentoperationswhileimprovementsthatextendtheeconomicusefullifeoftheunderlyingassetarecapitalized.Dispositiongainsandlossesarereflectedincurrentoperations.46FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26TheCompanyleasesvariouspropertieswithinitsbranchnetwork.Leasesgenerallyhaveinitialtermsofupto20yearsandmostcontainoptionstorenewwithreasonableincreasesinrent.Allleasesareaccountedforasoperatingleases.OtherRealEstateOwnedOtherrealestateownedandacquiredthroughforeclosureisstatedatthelowerofcostorfairvaluelessestimatedcoststosell.Loanlossesarisingfromtheacquisitionofsuchpropertiesarechargedagainsttheallowanceforloanlosses.Expensesincurredinconnectionwithoperatingtheproperties,subsequentwrite-downsandgainsorlossesuponsaleareincludedinothernon-interestexpense.GoodwillandOtherIntangibleAssetsTheexcessofthecostofanacquiredcompanyoverthefairvalueofthenetassetsandidentifiedintangiblesacquiredisrecordedasgoodwill.Thenetcarryingamountofgoodwillfromcontinuingoperationswas$60.1millionand$59.2millionatDecember31,2006and2005,respectively.Aportionofthepurchasepriceincertaintransactionshasbeenallocatedtovaluesassociatedwiththefutureearningspotentialofacquireddepositsandisbeingamortizedovertheestimatedlivesofthedeposits,rangingfromseventotenyearswhiletheweightedaverageremaininglifeofthesecoredepositsisapproximately4.8years.AsofDecember31,2006and2005,thebalanceofcoredepositintangibleswas$4.4millionand$4.5million,respectively,whilethecorrespondingaccumulatedamortizationwas$2.9millionand$2.5million,respectively.Thenetunamortizedbalanceofidentifiedintangiblesassociatedwithacquireddepositswas$1.5millionand$1.9millionatDecember31,2006and2005,respectively.TheacquisitionofInvestmentPlanningConsultants,Inc.added$1.0millionofgoodwilland$534thousandinotherintangibleassets.Annualamortizationexpenseofallintangiblesisapprox-imately$420thousandforthenexttwoyears,then$380thousand,$289thousand,and$284thousandforthefollowingtwoyears,respectively.TheCompanyreviewsandtestsgoodwillforpotentialimpairmentonanannualbasis.Goodwillistestedforimpairmentbycomparingthefairvalueoftheunitwithitsbookvalue,includinggoodwill.IfthefairvalueoftheCompanyisgreaterthanitsbookvalue,nogoodwillimpairmentexists.However,ifthebookvalueoftheCompanyisgreaterthanitsdeterminedfairvalue,goodwillimpairmentmayexistandfurthertestingisrequiredtodeterminetheamount,ifany,oftheactualimpairmentloss.Throughtheresultsofimpairmenttests,andthesaleofthediscontinuedoperatingsubsidiary,agoodwillimpairmentchargeof$1.4millionwasappropriateforthediscon-tinuedmortgagebankingsegmentin2004,andisincludedin“lossfromdiscontinuedoperations”intheconsolidatedstatementsofincome.47FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26TheprogressionoftheCompany’sgoodwillandintangibleassetsforcontinuingoperationsforthethreeyearsendedDecember31,2006,isdetailedinthefollowingtable:GoodwillOtherIntangibles(Amountsinthousands)BalanceatDecember31,2003...................................$37,978$1,363Acquisitions.................................................21,2311,518TaxBenefits,ExerciseofStockOptionsandOtherAdjustments...........(381)—Amortization................................................—(399)BalanceatDecember31,2004...................................58,8282,482Acquisitions(Dispositions)......................................—(109)TaxBenefits,ExerciseofStockOptionsandOtherAdjustments...........354—Amortization................................................—(436)BalanceatDecember31,2005...................................59,1821,937Acquisitionsanddispositions,net.................................953472TaxBenefits,ExerciseofStockOptionsandOtherAdjustments...........——Amortization................................................—(348)BalanceatDecember31,2006...................................$60,135$2,061SecuritiesSoldUnderAgreementstoRepurchaseSecuritiessoldunderagreementstorepurchasearegenerallyaccountedforascollateralizedfinancingtransactions.Securities,generallyU.S.governmentandFederalagencysecurities,pledgedascollateralunderthesearrangementscannotbesoldorrepledgedbythesecuredparty.Thefairvalueofthecollateralprovidedtoathirdpartyiscontinuallymonitored,andadditionalcollateralisprovidedasappropriate.LoanInterestIncomeRecognitionAccrualofinterestonloansisbasedgenerallyonthedailyamountofprincipaloutstanding.Loansareconsideredpastduewheneitherprincipalorinterestpaymentsaredelinquentby30ormoredays.ItistheCompany’spolicytodiscontinuetheaccrualofinterestonloansbasedonthepaymentstatusandevaluationoftherelatedcollateralandthefinancialstrengthoftheborrower.Theaccrualofinterestincomeisnormallydiscontinuedwhenaloanbecomes90dayspastdueastoprincipalorinterest.Managementmayelecttocontinuetheaccrualofinterestwhentheloaniswellsecuredandinprocessofcollection.Wheninterestaccrualsarediscontinued,interestaccruedandnotcollectedinthecurrentyearisreversedfromincomeandinterestaccruedandnotcollectedfromprioryearsischargedtotheallowanceforloanlosses.Interestincomerealizedonimpairedloansisrecognizeduponreceiptiftheimpairedloanisonanon-accrualbasis.Accrualofinterestonnon-accrualloansmayberesumediftheloanisbroughtcurrentandfollowsaperiodofsubstantialperformance,includingsixmonthsofregularprincipalandinterestpayments.Accrualofinterestonimpairedloansisgenerallycontinuedunlesstheloanbecomesdelinquent90daysormore.Cashreceiptsarecreditedfirsttointerestunlesstheloanhasbeenconvertedtonon-accrual,inwhichcasethereceiptsareappliedtoprincipal.LoanFeeIncomeLoanoriginationandunderwritingfeesarereducedbydirectandindirectcostsassociatedwithloanprocessing,includingsalaries,reviewoflegaldocumentsandobtainmentofappraisals.Netoriginationfeesandcostsaredeferredandamortizedoverthelifeoftherelatedloan.Loancommitmentfeesaredeferredand48FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26amortizedovertherelatedcommitmentperiod.Netdeferredloancostswere$57thousandatDecember31,2006,andnetdeferredloanfeeswere$1.35millionatDecember31,2005.AdvertisingExpensesAdvertisingcostsaregenerallyexpensedasincurred.AmountsrecognizedforthethreeyearsendedDecember31,2006,aredetailedinNote15—OtherOperatingExpenses.Equity-BasedCompensationTheCompanyhasstockoptionplansforcertainexecutivesanddirectors.TheFinancialAccountingStandardsBoard(“FASB”)issuedSFAS123R,“Share-BasedPayment,”whichisanamendmentofSFAS123.Forpubliccompanies,thecostofemployeeservicesreceivedinexchangeforequityinstrumentsincludingoptionsandrestrictedstockawardsgenerallywillbemeasuredatfairvalueatthegrantdate.TheCompanyadoptedthestandard’sfair-valuemethodofaccountingforshare-basedpaymentstoemployeesonJanuary1,2006,usingthe“modifiedprospective”method.UnderthemodifiedprospectivemethodtheCompanyrecognizedcompensationcostbeginningJanuary1,2006,forallshare-basedpaymentsgrantedafterDecember31,2005,andforallunvestedawardsgrantedpriortoJanuary1,2006.Theeffectofoptionsharesonearningspersharerelatestothedilutiveeffectoftheunderlyingoptionsoutstanding.Totheextentthegrantedexercisesharepriceislessthanthecurrentmarketprice,or“inthemoney”,thereisaneconomicincentivefortheoptionstobeexercisedandanincreaseinthedilutiveeffectonearningspershare.IncomeTaxesIncometaxexpenseiscomprisedoffederalandstatecurrentanddeferredincometaxesonpre-taxearningsoftheCompany.Incometaxesasapercentageofpre-taxincomemayvarysignificantlyfromstatutoryratesduetoitemsofincomeandexpensewhichareexcluded,bylaw,fromthecalculationoftaxableincome.Theseitemsarecommonlyreferredtoaspermanentdifferences.ThemostsignificantpermanentdifferencesfortheCompanyincludeincomeonstateandmunicipalsecuritieswhichareexemptfromfederalincometax,certaindividendpaymentswhicharedeductiblebytheCompany,for2004,goodwillimpairmentexpensewhichisnotdeductible,forthethirdquarterof2004,thelossonthesaleofthemortgagesubsidiarywhichhadasignificanttaxbasisoverandaboveitsbookcarryingvalue,andtaxcreditsgeneratedbyinvestmentsinlowincomehousingandrehabilitationofhistoricstructures.Stateandmunicipalincomeandthedomesticcorporationdividenddeductionarepermanentdifferencesthatoccuronaregularbasis.Goodwillimpairmentexpenseisinfrequentandhashistoricallybeenrelatedtothemortgagesubsidiary,whichhasbeensold.Thedifferencerelatedtotheexcesstaxoverbookbasisofthemortgagesubsidiarywasaone-timeeventlinkedtothesaleofthemortgagesubsidiary.Thisitemreducedthecarryingbasisofthemortgagesubsidiaryand,uponthesaleoftheentity,resultedinapermanentdifferenceofapproximately$950thousandin2004,whichreducedthecombinedeffectivetaxratein2004to25.6%.Incometaxexpenseisclassifiedaccordingtocontinuingoperationsanddiscontinuedoperations.The$950thousandtaxbenefitassociatedwiththelossonthesaleofthemortgagesubsidiaryin2004isincludedinIncomeTaxBenefit—DiscontinuedOperationsintheconsolidatedstatementsofincome.Duringboth2005and2006theCompanyinvestedinlimitedpartnershipsformedtoperformtherehabilitationofpropertiescertifiedashistoricstructuresbytheNationalParkService.TheCompany’sinvestmentinthesepartnershipsgeneratesfederalandstatehistorictaxcredits.Theassociatedcreditsarerealizedandthebalanceoftheinvestmentiswrittenoffatthetimethebuildingsareplacedinservice.AsofDecember31,2006,allbuildingsassociatedwiththepartnershipinvestmentswereinservice.49FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26Deferredtaxassetsandliabilitiesarerecognizedfortheestimatedfuturetaxconsequencesattributabletodifferencesbetweenthetaxbasesofassetsandliabilitiesandtheircarryingamountsforfinancialreportingpurposes.Deferredtaxassetsandliabilitiesaremeasuredusingenactedtaxratesineffectfortheyearinwhichthetemporarydifferencesareexpectedtoberecoveredorsettled.Deferredtaxassetsarereducedbyavaluationallowanceifitismorelikelythannotthatthetaxbenefitswillnotberealized.EarningsPerShareBasicearningspershareisdeterminedbydividingnetincomebytheweightedaveragenumberofsharesoutstanding.Dilutedearningspershareisdeterminedbydividingnetincomebytheweightedaveragesharesoutstandingincreasedbythedilutiveeffectofstockoptions.Basicanddilutednetincomepercommonsharecalculationsfollow:200620052004FortheYearEndedDecember31,(Amountsinthousands,exceptshareandpersharedata)Basic:Incomefromcontinuingoperations...............$28,948$26,445$26,020Lossfromdiscontinuedoperations...............—(142)(3,656)Netincome................................$28,948$26,303$22,364Weightedaveragesharesoutstanding..............11,204,87511,269,25811,238,648Dilutivesharesforstockoptions.................74,60572,54698,958Weightedaveragedilutivesharesoutstanding........11,279,48011,341,80411,337,606Basic:Earningspersharecontinuingoperations...........2.582.35$2.32Losspersharediscontinuedoperations............—(0.02)(0.33)Earningspershare...........................2.582.331.99Diluted:Dilutedearningspersharecontinuingoperations.....$2.57$2.33$2.29Dilutedlosspersharediscontinuedoperations.......—(0.01)(0.32)Dilutedearningspershare.....................2.572.321.97VariableInterestEntitiesTheCompanymaintainsownershippositionsinvariousentitieswhichitdeemsvariableinterestentities(“VIE’s”)asdefinedinFIN46R.TheseVIE’sincludecertaintaxcreditlimitedpartnershipsandotherlimitedliabilitycompanieswhichprovideaviationservices,insurancebrokerage,investmentbrokerage,titleinsuranceandotherfinancialandrelatedservices.BasedontheCompany’sanalysis,itisanon-primarybeneficiary;accordingly,theseentitiesdonotmeetthecriteriaforconsolidationunderFIN46R.ThecarryingvalueofVIE’swas$3.2millionatbothDecember31,2006and2005,andtheCompany’smaximumpossiblelossexposurewas$3.2millionand$3.3million,respectively,atDecember31,2006and2005.Managementdoesnotbelievelossesresultingfromitsinvolvementwiththeentitiesdiscussedabovewillbematerial.DerivativeInstrumentsTheCompanyentersintoderivativetransactionsprincipallytoprotectagainsttheriskofadversepriceorinterestratemovementsonthevalueofcertainassetsandliabilitiesandonfuturecashflows.Inaddition,certaincontractsandcommitmentsaredefinedasderivativesundergenerallyacceptedaccountingprinciples.50FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26UndertherequirementsofSFAS133,“AccountingforDerivativeInstrumentsandHedgingActivities,”asamended,allderivativeinstrumentsarecarriedatfairvalueonthebalancesheet.SFAS133providesspecialhedgeaccountingprovisions,whichpermitthechangeinthefairvalueofthehedgeditemrelatedtotheriskbeinghedgedtoberecognizedinearningsinthesameperiodandinthesameincomestatementlineasthechangeinthefairvalueofthederivative.Derivativeinstrumentsdesignatedinahedgerelationshiptomitigateexposuretochangesinthefairvalueofanasset,liability,orfirmcommitmentattributabletoaparticularrisk,suchasinterestraterisk,areconsideredfairvaluehedgesunderSFAS133.Derivativeinstrumentsdesignatedinahedgerelationshiptomitigateexposuretovariabilityinexpectedfuturecashflows,orothertypesofforecastedtransactions,areconsideredcashflowhedges.TheCompanyformallydocumentsallrelationshipsbetweenhedginginstrumentsandhedgeditems,aswellasitsriskmanagementobjectiveandstrategyforundertakingeachhedgetransaction.ReclassificationsTheCompanyhasmadecertainreclassificationsof2005and2004amountsnecessarytoconformwiththecurrentyearpresentation.ThesereclassificationshadnoeffectontheCompany’sfinancialposition,shareholders’equity,orresultsofoperations.OtherRecentAccountingDevelopmentsInSeptember2006,theFASBissuedSFASNo.158,“Employers’AccountingforDefinedBenefitPensionandOtherPostretirementPlans—anamendmentofFASBStatementsNo.87,88,106,and132(R).”SFAS158requiresanemployerto:(a)recognizeinitsstatementoffinancialpositionanassetforaplan’soverfundedstatusoraliabilityforaplan’sunderfundedstatus;(b)measureaplan’sassetsanditsobligationsthatdetermineitsfundedstatusasoftheendoftheemployer’sfiscalyear(withlimitedexceptions);and(c)recognizechangesinthefundedstatusofadefinedbenefitpostretirementplanintheyearinwhichthechangesoccur.Thosechangeswillbereportedincomprehensiveincome.TherequirementtorecognizethefundedstatusofabenefitplanandthedisclosurerequirementsareeffectiveasoftheendofthefiscalyearendingafterDecember15,2006.Therequirementtomeasureplanassetsandbenefitobligationsasofthedateoftheemployer’sfiscalyear-endstatementoffinancialpositioniseffectiveforfiscalyearsendingafterDecember15,2008.TheCompanydoesnotexpecttheadoptionofthisstandardtoasignificantimpactonitsconsolidatedfinancialstatements.InSeptember2006,theFASBissuedSFAS157,“FairValueMeasurements,”whichdefinesfairvalue,establishesaframeworkformeasuringfairvalueinGAAP,andexpandsdisclosuresaboutfairvaluemeasurements.SFAS157iseffectiveforfinancialstatementsissuedforfiscalyearsbeginningafterNovember15,2007,andinterimperiodswithinthosefiscalyears,withearlyadoptionpermitted.TheCompanymustadoptthesenewrequirementsnolaterthanthefirstquarterof2008.TheCompanyhasnotyetdeterminedtheeffectofadoptingSFAS157onitsconsolidatedfinancialstatements.InSeptember2006,theFASBissuedSFASNo.156,“AccountingforServicingofFinancialAssets—anamendmentofFASBStatementNo.140.”SFAS156requiresthatallseparatelyrecognizedservicingassetsandliabilitiesbeinitiallymeasuredatfairvalueandpermits(butdoesnotrequire)subsequentmeasurementofservicingassetsandliabilitiesatfairvalue.ThisstatementiseffectiveforfiscalyearsbeginningafterSeptember15,2006.Theadoptionofthisstandarddidnothaveamaterialeffectonthecondition,theresultsofoperations,orliquidityoftheCompany.InSeptember2006,theSecuritiesandExchangeCommission(“SEC”)issuedStaffAccountingBulle-tinNo.108,“ConsideringtheEffectsofPriorYearMisstatementswhenQuantifyingMisstatementsinCurrentYearFinancialStatements”(“SAB108”).SAB108providesinterpretiveguidanceonhowtheeffectsofthecarryoverorreversalofprioryearmisstatementsshouldbeconsideredinquantifyingacurrentyearmisstatement.TheSECstaffbelievesthatregistrantsshouldquantifyerrorsusingbothabalancesheetandanincomestatementapproachand51FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26evaluatewhethereitherapproachresultsinquantifyingamisstatementthat,whenallrelevantquantitativeandqualitativefactorsareconsidered,ismaterial.TheguidanceinSAB108mustbeappliedtoannualfinancialstatementsforfiscalyearsendingafterNovember15,2006.Accordingly,theCompanyhasadoptedSAB108effectivewiththeyearendedDecember31,2006.TheadoptionofSAB108didnothaveaneffectontheCompany’sfinancialpositionorresultsofoperations.InSeptember2006,theEmergingIssuesTaskForcereachedaconsensusregardingEITF06-4“AccountingforDeferredCompensationandPostretirementBenefitAspectsofEndorsementSplit-DollarLifeInsuranceArrange-ments.”ThescopeofEITF06-4islimitedtotherecognitionofaliabilityandrelatedcompensationcostsforendorsementsplit-dollarlifeinsurancepoliciesthatprovideabenefittoanemployeethatextendstopostretirementperiods.Therefore,thisEITFwouldnotapplytoasplit-dollarlifeinsurancearrangementthatprovidesaspecifiedbenefittoanemployeethatislimitedtotheemployee’sactiveserviceperiodwithanemployer.EITFiseffectiveforfiscalyearsbeginningafterDecember15,2007,withearlierapplicationpermitted.TheCompanyhasnotyetdeterminedtheimpact,ifany,ofadoptingEITF06-4onitsconsolidatedfinancialstatements.InSeptember2006,theEmergingIssuesTaskForcereachedaconsensusregardingEITF06-5“AccountingforPurchasesofLifeInsurance-DeterminingtheAmountThatCouldBeRealizedinAccordancewithFASBTechnicalBulletinNo.85-4.”ThescopeofEITF06-5islimitedtothedeterminationofnetcashsurrendervalueofalifeinsurancecontractinaccordancewithTechnicalBulletin85-4.ThisEITFoutlineswhencontractuallimitationsofthepolicyshouldbeconsideredwhendeterminingthenetrealizablevalueofthecontract.EITF06-5iseffectiveforfiscalyearsbeginningafterDecember15,2006,withearlierapplicationpermitted.TheCompanyhasdeterminedthatitwilllikelyreducethecarryingamountofcertainofitsbank-ownedlifeinsurancebyapproximately$200thousanduponadoptionofEITF06-5.InJuly2006,theFASBissuedInterpretationNo.48(“FIN48”),“AccountingforUncertaintyinIncomeTaxes,aninterpretationofFASBStatementNo.109,”whichseekstoreducethediversityinpracticeassociatedwiththeaccountingandreportingforuncertaintyinincometaxpositions.ThisInterpretationprescribesacomprehensivemodelforthefinancialstatementrecognition,measurement,presentationanddisclosureofuncertaintaxpositionstakenorexpectedtobetakeninincometaxreturns.FIN48iseffectiveforfiscalyearsbeginningafterDecember15,2006andtheCompanywilladoptthenewrequirementsinthefirstquarterof2007.Thecumulativeeffects,ifany,ofadoptingFIN48willberecordedasanadjustmenttoretainedearningsasofthebeginningoftheperiodofadoption.TheCompanyhasnotyetdeterminedtheimpact,ifany,ofadoptingFIN48onitsconsolidatedfinancialstatements.InFebruary2006,theFASBissuedSFASNo.155,“AccountingforCertainHybridFinancialInstruments—anamendmentofFASBStatementsNo.133and140.”SFAS155providesentitiesrelieffromtherequirementtoseparatelydeterminethefairvalueofanembeddedderivativethatwouldotherwisebebifurcatedfromthehostcontractunderSFAS133.Thisstatementallowsanirrevocableelectiononaninstrument-by-instrumentbasistomeasuresuchahybridfinancialinstrumentatfairvalue.ThisstatementiseffectiveforallfinancialinstrumentsacquiredorissuedafterthebeginningofthefiscalyearsbeginningafterSeptember15,2006.Theadoptionofthisstandarddidnothaveamaterialeffectonthecondition,theresultsofoperations,orliquidityoftheCompany.Note2.Merger,AcquisitionsandBranchingActivityInDecember2006,theCompanycompletedthesaleofitsRowlesburg,WestVirginia,branchlocation.Atthetimeofthesale,thebranchhaddepositsandrepurchaseagreementstotalingapproximately$10.6millionandloansofapproximately$2.2million.Thetransactionresultedinapre-taxgainofapproximately$333thousand.InNovember2006,theCompanycompletedtheacquisitionofInvestmentPlanningConsultants,Inc.(“IPC”),aregisteredinvestmentadvisoryfirm.Inconnectionwiththeinitialpaymentofapproximately$1.47million,theCompanyissued39,874sharesofcommonstock.Underthetermsofthestockpurchaseagreement,formershareholdersofIPCareentitledtoadditionalconsiderationofupto$1.43millionintheformoftheCompany’scommonstockifcertainfutureoperatingperformancetargetsaremet.Ifthoseoperatingtargetsaremet,thevalueof52FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26theconsiderationultimatelypaidwillbeaddedtothecostoftheacquisition,whichwillincreasetheamountofgoodwillarisingintheacquisition.InJune2006,theCompanycompletedthesaleofitsDrakesBranch,Virginia,branchlocation.Atthetimeofthesale,thebranchhaddepositsandrepurchaseagreementstotalingapproximately$16.4millionandloansofapproximately$1.9million.Thetransactionresultedinapre-taxgainofapproximately$702thousand.InDecember2005,theCompanycompletedthesaleofitsCliftonForge,Virginia,branchlocation.Atthetimeofthesale,thebranchhaddepositsandrepurchaseagreementsofapproximately$45.3millionandloansofapproximately$7.1million.Thetransactionresultedinanapproximate$4.4millionpre-taxgainonsale.AfterthecloseofbusinessonMarch31,2004,PCBBancorp,Inc.,aTennessee-charteredbankholdingcompany(“PCB”)headquarteredinJohnsonCity,Tennessee,wasacquiredbytheCompany.PCBhadfivefullservicebranchofficeslocatedinJohnsonCity,KingsportandsurroundingareasinWashingtonandSullivanCountiesinEastTennessee.Atacquisition,PCBhadtotalassetsof$171.0million,totalnetloansof$128.0millionandtotaldepositsof$150.0million.TheseresourceswereincludedintheCompany’sfinancialstatementsbeginningwiththesecondquarterof2004.Underthetermsofthemergeragreement,sharesofPCBcommonstockwerepurchasedfor$40.00pershareincash.Thetotaldealvalue,includingthecash-outofoutstandingstockoptions,wasapproximately$36.0million.ConcurrentwiththePCBacquisition,PeoplesCommunityBank,thewholly-ownedsubsidiaryofPCB,wasmergedintoFirstCommunityBank,N.A.(the“Bank”).Asaresultoftheacquisitionandpreliminarypurchasepriceallocation,approximately$21.3millioningoodwillwasrecordedwhichrepresentstheexcessofthepurchasepriceoverthefairmarketvalueofthenetassetsacquiredandidentifiedintangibles.InJanuary2003,theBankcompletedtheacquisitionofStoneCapitalManagement(“StoneCapital”),basedinBeckley,WestVirginia.ThisacquisitionexpandedtheBank’soperationstoincludeabroaderrangeoffinancialservices,includingwealthmanagement,assetallocation,financialplanningandinvestmentadvice.StoneCapitalwasacquiredthroughtheissuanceof8,409sharesofCompanycommonstock,whichrepresented50%ofthetotalconsideration.In2003,2004and2005,StoneCapitalexceededtheannualrevenuerequirementoutlinedintheacquisitionagreementandadditionalshareswerepaidtotheoriginalshareholders.ThebalanceoftheremainingconsiderationwaspaidinJanuary2006intheformof2,706sharesofCompanycommonstock.Asaresultofthepurchasepriceallocation,approximately$360thousandofgoodwillwasrecorded.53FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:26ThefollowingtablesummarizesthenetcashprovidedbyorusedinacquisitionsanddivestituresduringthethreeyearsendedDecember31,2006.200620052004(Amountsinthousands)Fairvalueofassetsacquired............................$232$—$172,375Fairvalueofliabilitiesassumed.........................(17)—(158,906)Purchasepriceinexcessofnetassetsacquired..............1,488—22,750Totalpurchaseprice..................................1,703—36,219Lessnon-cashpurchaseprice...........................1,465——Lesscashacquired...................................18—9,879Netcashpaidforacquisition............................$220$—$26,340Fairvalueofassetssold...............................$(4,678)$(7,803)$—Fairvalueofliabilitiessold.............................27,16445,363—Salespriceinexcessofnetliabilitiesassumed...............(1,035)(4,570)—Totalsalesprice.....................................21,45132,990—Addcashonhandsold................................395166—Lessamountdueremainingonbooks.....................20526—Netcashpaidfordivestiture............................$21,826$32,630$—Note3.InvestmentSecuritiesTheamortizedcostandestimatedfairvalueofsecurities,withgrossunrealizedgainsandlosses,classifiedasavailable-for-saleareasfollows:AmortizedCostUnrealizedGainsUnrealizedLossesFairValueDecember31,2006(Amountsinthousands)U.S.Governmentagencysecurities............$117,777$—$(1,716)$116,061Statesandpoliticalsubdivisions...............152,1892,379(521)154,047CorporateNotes..........................85,080350(397)85,033355,0462,729(2,634)355,141Mortgage-backedsecurities..................146,444206(1,896)144,754Equities................................6,9331,615(73)8,475Total.................................$508,423$4,550$(4,603)$508,370AmortizedCostUnrealizedGainsUnrealizedLossesFairValueDecember31,2005(Amountsinthousands)U.S.Governmentagencysecurities............$92,739$—$(1,315)$91,424Statesandpoliticalsubdivisions...............151,1182,426(1,376)152,168CorporateNotes..........................61,466125(317)61,274305,3232,551(3,008)304,866Mortgage-backedsecurities..................94,954155(2,115)92,994Equities................................5,3901,282(151)6,521Total.................................$405,667$3,988$(5,274)$404,38154FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Theamortizedcostandestimatedfairvalueofavailable-for-salesecuritiesbycontractualmaturity,atDecember31,2006,areshownbelow.Expectedmaturitiesmaydifferfromcontractualmaturitiesbecauseissuersmayhavetherighttocallorprepayobligationswithorwithoutcallorprepaymentpenalties.AvailableForSaleU.S.GovernmentAgencies&CorporationsStatesandPoliticalSubdivisionsCorporateNotesTotalTaxEquivalentPurchaseYield(Dollarsinthousands)AmortizedCostMaturity:Withinoneyear.............$—$2,037$—$2,0377.88%Afteroneyearthroughfiveyears...................34,4355,547—39,9825.01%Afterfiveyearsthroughtenyears...................42,35965,56443,534151,4575.82%Aftertenyears..............40,98379,04141,546161,5706.46%Amortizedcost............$117,777$152,189$85,080355,046Mortgage-backedsecurities......146,4444.20%Equitysecurities..............6,9332.92%TotalAmortizedcost.........$508,423Taxequivalentpurchaseyield.....5.24%6.49%6.29%6.03%Averagecontractualmaturity(inyears)....................8.5010.5813.9710.70FairValueMaturity:Withinoneyear.............$—$2,046$—$2,046Afteroneyearthroughfiveyears...................33,9445,603—39,547Afterfiveyearsthroughtenyears...................41,77965,53443,614150,927Aftertenyears..............40,33880,86441,419162,621FairValue...............$116,061$154,047$85,033355,141Mortgage-backedsecurities......144,754Equitysecurities..............8,475TotalFairValue.............$508,370AsaconditiontomembershipintheFHLBsystem,theBankisrequiredtosubscribetoaminimumlevelofstockintheFHLB.AtDecember31,2006,theBankownedapproximately$12.7millioninstockwhichisclassifiedasotherassets.BecauseoftheredemptionprovisionsoftheFHLBstock,weestimatethatfairvalueapproximatescostresultinginnoimpairmentatDecember31,2006.55FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Theamortizedcostandestimatedfairvalueofsecurities,withgrossunrealizedgainsandlosses,classifiedasheld-to-maturityareasfollows:AmortizedCostUnrealizedGainsUnrealizedLossesFairValueDecember31,2006(Amountsinthousands)Statesandpoliticalsubdivisions................$19,638$334$(2)$19,970Othersecurities............................375—(1)37420,013334(3)20,344Mortgage-backedsecurities...................6——6Total..................................$20,019$334$(3)$20,350AmortizedCostUnrealizedGainsUnrealizedLossesFairValueDecember31,2005(Amountsinthousands)Statesandpoliticalsubdivisions................$23,781$706$(1)$24,486Othersecurities............................375—(1)37424,156706(2)24,860Mortgage-backedsecurities...................17——17Total..................................$24,173$706$(2)$24,877Theamortizedcostandestimatedfairvalueofsecuritiesbycontractualmaturity,atDecember31,2006,areshownbelow.Expectedmaturitiesmaydifferfromcontractualmaturitiesbecauseissuersmayhavetherighttocallorprepayobligationswithorwithoutcallorprepaymentpenalties.Held-to-MaturityStatesandPoliticalSubdivisionsOtherSecuritiesTotalTaxEquivalentPurchaseYield(Dollarsinthousands)AmortizedCostMaturity:Withinoneyear.........................$125$—$1258.88%Afteroneyearthroughfiveyears............5,5013755,8767.50%Afterfiveyearsthroughtenyears............13,874—13,8747.99%Aftertenyears..........................138—1388.82%Amortizedcost........................$19,638$37520,013Mortgage-backedsecurities...................66.57%TotalAmortizedcost......................$20,019Taxequivalentpurchaseyield.................7.90%6.00%7.86%Averagecontractualmaturity(inyears)..........6.151.756.07FairValueMaturity:Withinoneyear.........................$126$—$126Afteroneyearthroughfiveyears............5,5583745,932Afterfiveyearsthroughtenyears............14,146—14,146Aftertenyears..........................140—140FairValue............................$19,970$37420,344Mortgage-backedsecurities...................6TotalFairValue.........................$20,35056FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Thecarryingvalueofsecuritiespledgedtosecurepublicdepositsandforotherpurposesrequiredbylawwere$341.8millionand$254.8millionatDecember31,2006and2005,respectively.AtDecember31,2006,therewerenosecuritiesofasingleissuer,otherthanU.S.federalagencydebenturesandotherU.S.government-sponsoredagencysecurities,whichexceeded10%ofstockholders’equity.In2006,netgainsonthesaleofsecuritieswere$75thousand.Grossgainswere$240thousandwhilegrosslosseswere$165thousand.Grossproceedsfromsalesofsecuritieswere$14.2million,whilegrossproceedsfromthematurityandcallofsecuritieswereapproximately$27.7million.Totalpurchasesofsecuritiesapproximated$139.6million.In2005,netgainsonthesaleofsecuritieswere$753thousand.Grossgainswere$799thousandwhilegrosslosseswere$46thousandduring2005.Grossproceedsfromsalesofsecuritieswere$33.2million,whilegrossproceedsfromthematurityandcallofsecuritieswereapproximately$54.2million.Totalpurchasesofsecuritiesapproximated$111.2million.Thefollowingtablesreflectthoseinvestments,bothavailable-for-saleandheld-to-maturity,inacontinuousunrealizedlosspositionforlessthan12monthsandfor12monthsorlongerfortheyearsendedDecember31,2006and2005.Therewerenosecuritiesforeitherperiodinacontinuousunrealizedlosspositionfor12ormoremonthsforwhichtheCompanydoesnothavetheabilitytoholduntilthesecuritymaturesorrecoversinvalue.DescriptionofSecuritiesFairValueUnrealizedLossesFairValueUnrealizedLossesFairValueUnrealizedLossesLessthan12Months12MonthsorLongerTotalDecember31,2006(Amountsinthousands)U.S.Governmentagencysecurities..................$60,416$(517)$55,645$(1,199)$116,061$(1,716)Statesandpoliticalsubdivisions...10,732(34)36,797(489)47,529(523)OtherSecurities...............28,339(213)27,698(185)56,037(398)Subtotal,debtsecurities.......$99,487$(764)$120,140$(1,873)$219,627$(2,637)Mortgage-backedsecurities......50,093(223)66,620(1,673)116,713(1,896)Equitysecurities..............2,186(70)32(3)2,218(73)Total.....................$151,766$(1,057)$186,792$(3,549)$338,558$(4,606)DescriptionofSecuritiesFairValueUnrealizedLossesFairValueUnrealizedLossesFairValueUnrealizedLossesLessthan12Months12MonthsorLongerTotalDecember31,2005(Amountsinthousands)U.S.Governmentagencysecurities...................$61,469$(722)$29,851$(593)$91,320$(1,315)Statesandpoliticalsubdivisions....47,706(830)18,583(547)$66,289(1,377)OtherSecurities................41,523(318)——41,523(318)Subtotal,debtsecurities........$150,698$(1,870)$48,434$(1,140)$199,132$(3,010)Mortgage-backedsecurities.......40,651(952)45,607(1,163)86,258(2,115)Equitysecurities...............1,786(129)99(22)1,885(151)Total......................$193,135$(2,951)$94,140$(2,325)$287,275$(5,276)AtDecember31,2006,thecombineddepreciationinvalueofthe191individualsecuritiesinanunrealizedlosspositionwaslessthan1.00%ofthecombinedreportedvalueoftheaggregatesecuritiesportfolio.AtDecember31,2005,thecombineddepreciationinvalueofthe263individualsecuritiesinanunrealizedloss57FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27positionwaslessthan1.25%ofthecombinedreportedvalueoftheaggregatesecuritiesportfolio.ManagementdoesnotbelieveanyindividualunrealizedlossasofDecember31,2006,representsanother-than-temporaryimpair-ment.TheCompanyhastheintentandabilitytoholdthesesecuritiesuntilsuchtimeasthevaluerecoversorthesecuritiesmature.Furthermore,theCompanybelievesthevalueisattributabletochangesinmarketinterestratesandnotthecreditqualityoftheissuer.Note4.LoansLoansheldforinvestment,netofunearnedincome,consistofthefollowingatDecember31:20062005(Amountsinthousands)Realestate-commercial.....................................$421,067$464,510Realestate-construction.....................................158,566143,976Realestate-residential......................................506,370504,386Commercial,financialandagricultural..........................106,645110,211Loanstoindividualsforhouseholdandotherconsumerexpenditures....88,666106,148Allotherloans............................................3,5491,808$1,284,863$1,331,039Inthenormalcourseofbusiness,theCompany’ssubsidiarybankhasmadeloanstodirectorsandexecutiveofficersoftheCompanyanditssubsidiary.Allloansandcommitmentsmadetosuchofficersanddirectorsandtocompaniesinwhichtheyareofficers,orhavesignificantownershipinterest,havebeenmadeonsubstantiallythesameterms,includinginterestratesandcollateral,asthoseprevailingatthetimeforcomparabletransactionswithotherpersons.Theaggregatedollaramountofsuchloanswas$5.0millionand$5.5millionatDecember31,2006and2005,respectively.During2006,approximately$793thousandinnewloansandincreasesweremade,repaymentstotaled$1.2million,andotherincreasesduetothechangeincompositionoftheBank’sboardmembersandexecutiveofficersapproximated$49thousand.AtDecember31,2006and2005,customeroverdraftstotaling$1.1millionand$895thousand,respectively,werereclassifiedasloans.Note5.AllowanceforLoanLossesActivityintheallowanceforloanlosseswasasfollows:200620052004(Amountsinthousands)BalanceatJanuary1...................................$14,736$16,339$14,624Provisionforloanlosses................................2,7063,7062,671Acquisitionbalance....................................——1,786Loanschargedoff.....................................(4,543)(6,936)(4,174)Recoveriescreditedtoallowance..........................1,6502,0191,432Netcharge-offs.....................................(2,893)(4,917)(2,742)Reclassificationofallowanceforlending-relatedcommitments(1)..—(392)—BalanceatDecember31................................$14,549$14,736$16,339(1)AtJune30,2005,theCompanyreclassified$392thousandofitsallowanceforloanlossestoaseparateallowanceforlending-relatedliabilities.Netincomeandpriorperiodbalanceswerenotaffectedbythisreclassification.Theallowanceforlending-relatedliabilitiesisincludedinotherliabilities.58FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27During2006,2005and2004,assetsintheamountsof$1.3million,$1.3millionand$2.1million,respectively,wereacquiredthroughforeclosureandtransferredtootherrealestateowned.Managementanalyzestheloanportfolioregularlyforconcentrationsofcreditrisk,includingconcentrationsinspecificindustriesandgeographiclocation.AtDecember31,2006,commercialrealestateloanscomprised32.7%ofthetotalloanportfolio.Commercialloansincludeloanstosmalltomid-sizeindustrial,commercialandservicecompaniesthatincludebutarenotlimitedtocoalminingcompanies,manufacturers,automobiledealers,andretailandwholesalemerchants.Commercialrealestateprojectsrepresentseveraldifferentsectorsofthecommercialrealestatemarket,includingresidentiallanddevelopment,singlefamilyandapartmentbuildingoperators,commercialrealestatelessors,andhotel/moteldevelopers.Underwritingstandardsrequirethatcomprehensivereviewsandindependentevaluationsbeperformedoncreditsexceedingpredefinedmarketlimitsoncommercialloans.Updatestotheseloanreviewsaredoneperiodicallyoronanannualbasisdependingonthesizeoftheloanrelationship.ThemajorityoftheloansinthecurrentportfolioweremadeandcollateralizedinVirginia,WestVirginia,NorthCarolina,Tennesseeandthesurroundingregion.AlthoughsectionsoftheWestVirginiaandSouthwesternVirginiaeconomiesarecloselyrelatedtonaturalresources,theyaresupplementedbyserviceindustries.TheCompany’spresenceinfourstates,Virginia,WestVirginia,NorthCarolinaandTennessee,providesadditionaldiversificationagainstgeographicconcentrationsofcreditrisk.ThefollowingtablepresentstheCompany’sinvestmentinloansconsideredtobeimpairedandrelatedinformationonthoseimpairedloans:200620052004(Amountsinthousands)Recordedinvestmentinloansconsideredtobeimpaired............$5,786$4,645$8,319Loansconsideredtobeimpairedthatwereonanon-accrualbasis....3,8133,3832,096Recordedinvestmentinimpairedloanswithrelatedallowance.......4,0703,5558,319Allowanceforloanlossesrelatedtoloansconsideredtobeimpaired..1,5311,5282,647Averagerecordedinvestmentinimpairedloans..................6,4105,6878,483Totalinterestincomerecognizedonimpairedloans...............390338389Recordedinvestmentinimpairedloanswithnorelatedallowance.....1,7161,090—Note6.PremisesandEquipmentPremisesandequipmentarecomprisedofthefollowingasofDecember31:20062005(Amountsinthousands)Land.......................................................$13,131$11,001Bankpremises................................................33,02231,631Equipment...................................................24,95624,11371,10966,745Less:accumulateddepreciationandamortization.......................34,22031,752Total......................................................$36,889$34,993TotaldepreciationandamortizationexpenseforyearsendedDecember31,2006,2005,and2004,was$3.4million,$3.3million,and$2.9million,respectively.In2004,theCompanyconstructednewofficesinoneofitsexistinglocationsfortheconsolidationofloanoperationsandpaidtheremainingcostsfortheconstructionofanewbranchthatwasopenedin2004.Theprime59FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27contractorforthisconstructionwasafirmwhichhasapreferredshareholderwhoisanimmediatefamilymemberoftwodirectorsoftheCompany.Allbranchconstructioncontractsinvolvingtherelatedpartywereletpursuanttoacompetitivebiddingprocess.Totalpaymentstotherelatedpartywere$247thousandand$880thousand2005and2004,respectively.Therewerenopaymentstotherelatedpartyin2006.TheCompanyalsoentersintolandandbuildingleasesfortheoperationofbankingandloanproductionoffices,operationscentersandfortheoperationofautomatedtellermachines.Allsuchleasesqualifyasoperatingleases.Followingisaschedulebyyearoffutureminimumleasepaymentsrequiredunderoperatingleasesthathaveinitialorremainingnon-cancelableleasetermsinexcessofoneyearasofDecember31,2006:YearEndedDecember31:(Amountsinthousands)2007.......................................................$7002008.......................................................6822009.......................................................3622010.......................................................2592011.......................................................203Lateryears..................................................573Total.....................................................$2,779TotalleaseexpensefortheyearsendedDecember31,2006,2005,and2004,was$1.0million,$777thousandand$692thousand,respectively.CertainportionsoftheabovelistedleaseshavebeensublettothirdpartiesforpropertiesnotcurrentlybeingusedbytheCompany.Theimpactofthefutureleasepaymentstobereceivedandthenon-cancelablesubleasesareasfollows:YearEndedDecember31:(Amountsinthousands)2007.......................................................$192008.......................................................192009.......................................................192010.......................................................192011.......................................................20Lateryears..................................................315Total.....................................................$411Note7.DepositsThefollowingisasummaryofinterest-bearingdepositsbytypeasofDecember31:20062005(Amountsinthousands)Interest-bearingdemanddeposits..............................$140,578$144,314Moneymarketaccounts.....................................146,052161,958Savingsdeposits..........................................171,626193,226Certificatesofdeposit......................................614,126595,204IndividualRetirementAccounts...............................77,61877,976Total.................................................$1,150,000$1,172,67860FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27AtDecember31,2006,thescheduledmaturitiesofcertificatesofdepositareasfollows:(Amountsinthousands)2007.......................................................$512,9402008.......................................................79,7252009.......................................................38,8582010.......................................................38,1942011.......................................................21,4812012andthereafter............................................546$691,744Timedepositsof$100thousandormorewere$262.3millionand$247.5millionatDecember31,2006and2005,respectively.Interestexpenseonthesedepositswas$10.0million,$7.4million,and$5.5millionfor2006,2005,and2004,respectively.AtDecember31,2006,thescheduledmaturitiesofcertificatesofdepositof$100thousandormoreareasfollows:(Amountsinthousands)ThreeMonthsorLess..........................................$66,165OverThreetoSixMonths.......................................62,276OverSixtoTwelveMonths......................................68,316OverTwelveMonths...........................................65,564Total.....................................................$262,321Includedintotaldepositsaredepositsbyrelatedpartiesinthetotalamountof$27.8millionand$23.4millionatDecember31,2006and2005,respectively.Note8.BorrowingsThefollowingtabledetailsborrowingsasofDecember31:20062005(Amountsinthousands)Federalfundspurchased.......................................$7,700$82,500Securitiessoldunderagreementstorepurchase......................201,185124,154FHLBborrowings............................................182,207113,767Subordinateddebt............................................15,46415,464Securitiessoldunderagreementstorepurchaseinclude$151.2millionofretailovernightandtermrepurchaseagreementsand$50millionofwholesalerepurchaseagreementsatDecember31,2006.TheBankisamemberoftheFHLBwhichprovidescreditintheformofshort-termandlong-termadvancescollateralizedbyvariousmortgageassets.AtDecember31,2006,creditavailabilitywiththeFHLBtotaledapproximately$223.1million.AdvancesfromtheFHLBaresecuredbystockintheFHLBofAtlanta,qualifyingfirstmortgageloansof$423.3million,mortgage-backedsecurities,andcertainotherinvestmentsecurities.TheFHLBadvancesaresubjecttorestrictionsorpenaltiesintheeventofprepayment.FHLBborrowingsinclude$175.0millionand$106.1millioninconvertibleandcallableadvancesatDecember31,2006and2005,respectively.Thecallableadvancesmaybecalled,orredeemedatquarterlyintervalsaftervariouslockoutperiods.Thesecalloptionsmaysubstantiallyshortenthelivesoftheseinstruments.If61FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27theseadvancesarecalled,thedebtmaybepaidinfull,convertedtoanotherFHLBcreditproduct,orconvertedtoanadjustablerateadvance.AtDecember31,2006and2005,theCompanyalsoheldnon-callabletermadvancesof$7.2millionand$7.7million,respectively.Theweighted-averagecontractualrateoftheFHLBadvanceswas4.64%atDecember31,2006.AtDecember31,2006,theFHLBadvanceshavematuritiesbetweenonemonthand14years.Thescheduledmaturitiesoftheadvancesareasfollows:(Amountsinthousands)2007.......................................................$6,2502008.......................................................—2009.......................................................—2010.......................................................25,0002011.......................................................—2012andthereafter............................................150,957$182,207InJanuary2006,theCompanyenteredintoaderivativeswapinstrumentwhereitreceivesLIBOR-basedvariableinterestpaymentsandpaysfixedinterestpayments.Thenotionalamountofthederivativeswapis$50millionandeffectivelyfixesaportionoftheFHLBborrowingsatapproximately4.34%.Afterconsideringtheeffectoftheinterestrateswap,theeffectiveweightedaverageinterestrateoftheFHLBborrowingswas4.26%atDecember31,2006.Thefairvalueoftheinterestrateswapwas$441thousandatDecember31,2006.Alsoincludedinborrowingsis$15.5millionofjuniorsubordinateddebentures(the“Debentures”)issuedbytheCompanyinOctober2003toanunconsolidatedtrustsubsidiary,FCBICapitalTrust(the“Trust”)withaninterestrateofthree-monthLIBORplus2.95%.TheTrustwasabletopurchasetheDebenturesthroughtheissuanceoftrustpreferredsecuritieswhichhadsubstantiallyidenticaltermsastheDebentures.TheDebenturesmatureonOctober8,2033,andarecallablebeginningOctober8,2008.ThenetproceedsfromtheofferingwerecontributedascapitaltotheCompany’ssubsidiarybanktosupportfurthergrowth.TheCompanyhascommittedtoirrevocablyandunconditionallyguaranteethefollowingpaymentsordistributionswithrespecttothetrustpreferredsecuritiestotheholdersthereoftotheextentthattheTrusthasnotmadesuchpaymentsordistributions:(i)accruedandunpaiddistributions,(ii)theredemptionprice,and(iii)uponadissolutionorterminationoftheTrust,thelesseroftheliquidationamountandallaccruedandunpaiddistributionsandtheamountofassetsoftheTrustremainingavailablefordistribution,ineachcasetotheextenttheTrusthasfundsavailable.62FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Note9.IncomeTaxes,ContinuingOperationsThecomponentsofincometaxexpensefromcontinuingoperationsconsistofthefollowing:200620052004YearsEndedDecember31,(Amountsinthousands)CurrenttaxexpenseFederal............................................$9,883$7,673$8,977State..............................................1,12965466211,0128,3279,639DeferredtaxexpenseFederal............................................4181,673137State..............................................47191104651,864147Totalincometaxexpense.................................$11,477$10,191$9,786Deferredincometaxesrelatedtocontinuingoperationsreflecttheneteffectsoftemporarydifferencesbetweenthecarryingamountsofassetsandliabilitiesforfinancialreportingversustaxpurposes.ThetaxeffectsofsignificantitemscomprisingtheCompany’snetdeferredtaxassetsasofDecember31,2006and2005areasfollows:20062005(Amountsinthousands)Deferredtaxassets:Allowanceforloanlosses.........................................$5,940$6,043Unrealizedlossesonassets........................................465362Deferredcompensation...........................................2,5542,164Deferredloanfees..............................................—526Lowincomeinvestments,basisdifference.............................341338Unrealizedlossonsecuritiesavailableforsale..........................21515Unrealizedcapitalloss...........................................302229Other........................................................186126Totaldeferredtaxassets........................................$9,809$10,303Deferredtaxliabilities:Intangibleassets................................................$3,214$3,091Odddaysinterestdeferral.........................................2,5482,206Fixedassets...................................................1,3361,289Accrueddiscounts..............................................755736Deferredgainoninvoluntaryconversion..............................365365Deferredgainonsaleofassets.....................................344383Other........................................................20355Totaldeferredtaxliabilities......................................8,7658,125Netdeferredtaxassets........................................$1,044$2,17863FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Incometaxesasapercentageofpre-taxincomemayvarysignificantlyfromstatutoryratesduetoitemsofincomeandexpensewhichareexcluded,bylaw,fromthecalculationoftaxableincome.Stateandmunicipalbondincomerepresentthemostsignificantpermanenttaxdifference.Theseadditionalpermanentdifferencesresultedinaconsolidatedeffectivetaxrateof28.4%in2006,comparedto27.7%in2005,and25.6%in2004.ThereconciliationofthestatutoryfederaltaxrateandtheeffectivetaxratesfromcontinuingoperationsfortheyearsendedDecember31,2006,2005and2004isas:200620052004YearsEndedDecember31,Taxatstatutoryrate.........................................35.00%35.00%35.00%(Reduction)increaseresultingfrom:Tax-exemptinterest,netofnondeductibleexpense.................(5.79)%(6.70)%(6.36)%Stateincometaxes,netoffederalbenefit........................1.89%2.19%1.22%Other,net...............................................(2.71)%(2.67)%(2.53)%Effectivetaxrate...........................................28.39%27.82%27.33%Note10.EmployeeBenefitsEmployeeStockOwnershipandSavingsPlanTheCompanymaintainsanEmployeeStockOwnershipandSavingsPlan(“KSOP”).Coverageundertheplanisprovidedtoallemployeesmeetingminimumeligibilityrequirements.EmployerStockFund:AnnualcontributionstothestockportionoftheplanaremadeatthediscretionoftheBoardofDirectors,andareallocatedtoplanparticipantsonthebasisofrelativecompensation.SubstantiallyallplanassetsareinvestedincommonstockoftheCompany.TotalexpenserecognizedbytheCompanyrelatedtotheEmployerStockFundwithintheKSOPwas$254thousand,$891thousandand$913thousandin2006,2005and2004,respectively.TheCompanyreportsthecontributionstotheplanasacomponentofemployeecompensationandbenefits.The2006contributionratewas3.0%ofeligibleemployeecompensation,butthetotalexpensewasoffsetbytheavailabilityofforfeitedshares.TheEmployerStockFundheld495,725and519,255sharesoftheCompany’sstockatDecember31,2006and2005,respectively.EmployeeSavingsPlan:TheCompanyprovidesa401(k)SavingsfeaturewithintheKSOPthatisavailabletosubstantiallyallemployeesmeetingminimumeligibilityrequirements.ThecostofCompanycontributionsundertheSavingsPlancomponentoftheKSOPwas$902thousand,$967thousand,and$870thousandin2006,2005and2004,respectively.TheCompany’smatchingcontributionsareatthediscretionoftheBoardupto100%ofelectivedeferralsofnomorethan6%ofcompensation.TheCompanymatchingratewas100%for2006,2005,and2004.Theemployeeparticipantshavevariousinvestmentalternativesavailableinthe401(k)Savingsfeature,butCompanysecuritiesarenotpermittedasaninvestmentalternative.EmployeeWelfarePlanTheCompanyprovidesvariousmedical,dental,vision,life,accidentaldeathanddismembermentandlong-termdisabilityinsurancebenefitstoallfull-timeemployeeswhoelectcoverageunderthisprogram(basiclife,accidentaldeathanddismemberment,andlong-termdisabilitycoverageareautomatic).Thehealthplanismanagedbyathirdpartyadministrator.Monthlyemployerandemployeecontributionsaremadetoatax-exemptemployerbenefitstrustagainstwhichthethirdpartyadministratorprocessesandpaysclaims.StoplossinsurancecoveragelimitstheCompany’sfundingrequirementsandriskoflossto$85thousandand$2.7millionforindividualandaggregateclaims,respectively.TotalCompanyexpensesundertheplanwere$1.6million,$2.7million,and$2.2millionin2006,2005and2004,respectively.64FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27DeferredCompensationPlanTheCompanyhasdeferredcompensationagreementswithcertaincurrentandformerofficersprovidingforbenefitpaymentsovervariousperiodscommencingatretirementordeath.TheliabilityatDecember31,2006and2005,wasapproximately$504thousandand$511thousand,respectively.Theannualexpensesassociatedwiththeseagreementswere$64thousand,$41thousandand$10thousandfor2006,2005and2004,respectively.Theobligationisbaseduponthepresentvalueoftheexpectedpaymentsandestimatedlifeexpectanciesoftheindividuals.TheCompanymaintainsalifeinsurancecontractonthelifeofoneoftheparticipantscoveredundertheseagreements.Proceedsderivedfromdeathbenefitsareintendedtoprovidereimbursementofplanbenefitspaidoverthepostemploymentlivesoftheparticipants.Premiumsontheinsurancecontractarecurrentlypaidthroughpolicydividendsonthecashsurrendervaluesof$946thousandand$865thousandatDecember31,2006and2005,respectively.ExecutiveRetentionPlanTheCompanymaintainsanExecutiveRetentionPlanforkeymembersofseniormanagement.TheExecutiveRetentionPlanprovidesforabenefitatnormalretirement(age62)targetedat35%offinalcompensationprojectedatanassumed3%salaryprogressionrate.BenefitsundertheExecutiveRetentionPlanbecomepayableatage62.ActualbenefitspayableundertheExecutiveRetentionPlanaredependentonanindexedretirementbenefitformulawhichaccruesbenefitsequaltotheaggregateafter-taxincomeofassociatedlifeinsurancecontractslesstheCompany’stax-effectedcostoffundsforthatplanyear.BenefitsundertheExecutiveRetentionPlanaredependentontheperformanceoftheinsurancecontractsandarenotguaranteedbytheCompany.Inconnectionwiththecontracts,theCompanypurchasedbank-ownedlifeinsurance(“BOLI”),whichisanticipatedtofullyfundtheprojectedbenefitpayoutafterretirement.ThecashsurrendervalueoftheBOLIfortheExecutiveRetentionPlanatDecember31,2006and2005,was$7.0millionand$6.8million,respectively.Theassociatedbenefitaccruedasofyear-end2006and2005was$2.9millionand$2.5million,respectively,whiletheassociatedexpenseincurredinconnectionwiththeExecutiveRetentionPlanwas$131thousand,$247thousandand$307thousandfor2006,2005and2004,respectively.Theincomederivedfrompolicyappreciationwas$255thousand,$230thousandand$248thousandin2006,2005and2004,respectively.InconnectionwiththeExecutiveRetentionPlan,theCompanyhasalsoenteredintoLifeInsuranceEndorsementMethodSplitDollarAgreementswiththeindividualscoveredundertheExecutiveRetentionPlan.UnderSplitDollarAgreements,theCompanyshares80%ofdeathbenefits(afterrecoveryofcashsurrendervalue)withthedesignatedbeneficiariesoftheplanparticipantsunderlifeinsurancecontractsreferencedinthePlan.TheCompanyasownerofthepoliciesretainsa20%interestinlifeproceedsanda100%interestinthecashsurrendervalueofthepolicies.TheExecutiveRetentionPlanalsocontainsprovisionsforchangeofcontrol,asdefined,whichallowtheparticipantstoretainbenefits,subjecttocertainconditions,intheeventofachangeincontrol.BenefitsundertheExecutiveRetentionPlan,whichbegintoaccruewithrespecttoyearsofservice,vest25%afterfiveyears,50%aftertenyears,75%after15yearsand5%peryearthereafter,withvestingacceleratedto100%uponattainmentofage62.DirectorsSupplementalRetirementPlanTheCompanymaintainsaDirectorsSupplementalRetirementPlan(the“DirectorsPlan”)foritsnon-employeedirectors.TheDirectorsPlanprovidesforabenefituponretirementfromserviceontheBoardatspecifiedagesdependinguponlengthofserviceordeath.BenefitsundertheDirectorsPlanbecomepayableatage70,75,and78dependingupontheindividualdirector’sageandoriginaldateofelectiontotheBoard.ActualbenefitspayableundertheDirectorsPlanaredependentonanindexedretirementbenefitformulathataccruesbenefitsequaltothe65FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27aggregateafter-taxincomeofassociatedlifeinsurancecontractslesstheCompany’stax-effectedcostoffundsforthatplanyear.BenefitsundertheDirectorsPlanaredependentontheperformanceoftheinsurancecontractsandarenotguaranteedbytheCompany.ParticipantsintheDirectorsPlanvestintheindexedbenefitbalanceasitaccrues.InconnectionwiththeDirectorsPlan,theCompanyhasalsoenteredintoLifeInsuranceEndorsementMethodSplitDollarAgreements(the“Agreements”)withcertaindirectorscoveredundertheDirectorsPlan.UndertheAgreements,theCompanyshares80%ofdeathbenefits,afterrecoveryofcashsurrendervalue,withthedesignatedbeneficiariesoftheexecutivesunderlifeinsurancecontractsreferencedintheRetentionPlan.TheCompany,asownerofthepolicies,retainsa20%interestinlifeproceedsanda100%interestinthecashsurrendervalueofthepolicies.TheDirectorsPlanalsocontainsprovisionsforchangeofcontrol,asdefined,whichallowthedirectorstoretainbenefitsundertheDirectorsPlanintheeventofaterminationofservice,otherthanforcause,duringthe12monthspriortoachangeincontroloranytimethereafter,unlessthedirectorvoluntarilyterminateshisservicewithin90daysfollowingthechangeincontrol.TheexpensesassociatedwiththeDirectorsPlanfor2006,2005and2004were$366thousand,$322thousandand$202thousand,respectively.Note11.Equity-BasedCompensationStockOptionsTheCompanymaintainsshare-basedcompensationplanstoencourageandfacilitateinvestmentinthecommonstockoftheCompanybykeyexecutivesandtoassistinthelong-termretentionofservicebythoseexecutives.TheCompanyhasmadestockoptionawardstoofficersanddirectorsunderatotaloffourstock-basedcompensationplans.In1999,theCompanyinstitutedaStockOptionPlantoencourageandfacilitateinvestmentinthecommonstockoftheCompanybykeyexecutivesandtoassistinthelong-termretentionofservicebythoseexecutives.ThePlancoverskeyexecutivesasdeterminedbytheCompany’sBoardofDirectorsfromtimetotime.OptionsunderthePlanweregrantedintheformofnon-statutorystockoptionswiththeaggregatenumberofsharesofcommonstockavailableforgrantunderthePlansetat332,750(adjustedfor10%stockdividendspaidin2002andagainin2003).TheoptionsgrantedunderthePlanrepresenttherightstoacquiretheoptionshareswithdeemedgrantdatesofJanuary1stforeachyearbeginningwiththeinitialyeargrantedandthefollowingfouranniversaries.AllstockoptionsgrantedpursuanttothePlanvestratablyonthefirstthroughtheseventhanniversarydatesofthedeemedgrantdate.Theoptionpriceofeachstockoptionisequaltothefairmarketvalue(asdefinedbythePlan)oftheCompany’scommonstockonthedateofeachdeemedgrantduringthefive-yeargrantperiod.VestedstockoptionsgrantedpursuanttothePlanareexercisableduringemploymentandforaperiodoffiveyearsafterthedateofthegrantee’sretirement,providedretirementoccursatorafterage62.Ifemploymentisterminatedotherthanbyearlyretirement,disability,ordeath,vestedoptionsmustbeexercisedwithin90daysaftertheeffectivedateoftermination.Anyoptionnotexercisedwithinsuchperiodwillbedeemedcancelled.In2001,theCompanyalsoinstitutedaplantograntstockoptionstonon-employeedirectors.TheDirectorOptionPlanwasimplementedtofacilitateandencourageinvestmentinthecommonstockoftheCompanybynon-employeedirectorswhoseefforts,solelyasdirectors,areexpectedtocontributetotheCompany’sfuturegrowthandcontinuedsuccess.TheoptionsgrantedpursuanttothePlanexpireattheearlierof10yearsfromthedateofgrantortwoyearsaftertheoptioneeceasestoserveasadirectoroftheCompany.Optionsnotexercisedwithintheappropriatetimeshallexpireandbedeemedcancelled.ThePlancoversnon-employeedirectorsasdeterminedbytheCompany’sBoardofDirectors.OptionsunderthePlanweregrantedintheformofnon-statutorystockoptionswiththeaggregatenumberofsharesofcommonstockavailableforgrantunderthePlansetat108,900shares(adjustedforthe10%stockdividendspaidin2002and2003).66FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27In2003,withtheacquisitionofCommonWealth,theCompanyacquiredadditionalstockoptionson120,155shares(adjustedbythemergerconversionfactorof.9015andthe10%stockdividendin2003).TheseoptionswereissuedbyCommonWealthin12grantsbeginningin1994andendingin2002and,followingthemerger,reflectadjustedexercisepricesrangingfrom$4.75to$17.40.Theseoptionswerefullyvestedatthepointofgrantandareexercisableforuptotenyearsfollowingtheoriginalgrantdate.Atthe2004AnnualMeeting,shareholdersratifiedapprovalofthe2004OmnibusStockOptionPlan(“2004Plan”)whichmadeavailableupto200,000sharesforpotentialgrantsofincentivestockoptions,non-qualifiedstockoptions,restrictedstockawardsorperformanceawards.Thepurposesofthe2004Planweretopromotethelong-termsuccessoftheCompanybyencouragingofficers,employees,directorsandindividualsperformingservicesfortheCompanytofocusoncriticallong-rangeobjectives.Non-qualifiedandincentivestockoptions,aswellasrestrictedandunrestrictedstockmaycontinuetobeawardedunderthe2004OmnibusStockOptionPlan.Vestingunderthe2004planisgenerallyoverathree-yearperiod.TheCompanyadoptedFASBStatementNo.123R,“Share-BasedPayment”(“SFAS123R”),onJanuary1,2006,usingthe“modifiedprospective”method.Underthismethod,awardsthataregranted,modified,orsettledafterDecember31,2005,aremeasuredandaccountedforinaccordancewithSFAS123R.Alsounderthismethod,expenseisrecognizedforunvestedawardsthatweregrantedpriortoJanuary1,2006,baseduponthefairvaluedeterminedatthegrantdateunderFASBStatementNo.123,“AccountingforStock-BasedCompensation”(SFAS123).PriortotheadoptionofSFAS123R,theCompanyaccountedforstockcompensationundertheintrinsicvaluemethodpermittedbyAccountingPrinciplesBoardOpinionNo.25,“AccountingforStockIssuedtoEmployees”andrelatedinterpretations.Accordingly,theCompanypreviouslyrecognizednocompensationcostforemployeestockoptionsthatweregrantedwithanexercisepriceequaltothemarketvalueoftheunderlyingcommonstockonthedateofgrant.ThefollowingtableillustratestheeffectonnetincomeandearningspershareiftheCompanyhadappliedthefairvaluerecognitionprovisionsofSFAS123in2005and2004.20052004(Dollarsinthousands,exceptpersharedata)Netincomeasreported..........................................$26,303$22,364Less:Totalstock-basedemployeecompensationexpensedeterminedunderfairvaluebasedmethodforallawards,netofrelatedtaxeffects.............(258)(205)Proformanetincome...........................................$26,045$22,159Earningspershare:Basicasreported..............................................$2.33$1.99Basicproforma...............................................$2.31$1.97Dilutedasreported.............................................$2.32$1.97Dilutedproforma..............................................$2.30$1.95PriortotheadoptionofSFAS123R,theCompanypresentedalltaxbenefitsofdeductionsresultingfromtheexerciseofstockoptionsandthevestingofrestrictedstockasoperatingcashflowsintheconsolidatedstatementsofcashflows.SFAS123Rrequiresthecashflowsfromthetaxbenefitsresultingfromtaxdeductionsinexcessofthecompensationexpenserecognizedforthoseoptionsandrestrictedstock(“excesstaxbenefits”)tobeclassifiedasfinancingcashflows.Anexcesstaxbenefittotaling$201thousandisclassifiedasafinancingcashinflowfortheyearendedDecember31,2006.AsaresultofadoptingSFAS123R,pre-taxincomeandnetincomefortheyearendedDecember31,2006,areapproximately$287thousandand$208thousandlower,respectively,thanaccountingforstockoptionsunderthe67FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27intrinsicvaluemethod.TheincreasedcompensationexpensedecreasedbasicanddilutedearningspershareapproximatelytwocentsfortheyearendedDecember31,2006.DuringtheyearendedDecember31,2006,theCompanyrecognizedpre-taxcompensationexpenserelatedtototalequity-basedcompensationofapproximately$427thousand.TheCompanyrecognizesequity-basedcom-pensationonastraight-linepro-ratabasis,sothatthepercentageofthetotalexpenserecognizedforanawardisneverlessthanthepercentageoftheawardthathasvested.AsofDecember31,2006,therewasapproximately$639thousandofunrecognizedcompensationcostrelatedtounvestedstockoptions.Thatcostisexpectedtoberecognizedoveraweightedaverageperiodof1.2years.Theactualcompensationcostrecognizedwilldifferfromthisestimateduetoanumberofitems,includingnewawardsgrantedandchangesinestimatedforfeitures.AsummaryoftheCompany’sstockoptionactivity,andrelatedinformationforthethreeyearsendedDecember31,2006,isasfollows:OptionSharesWeightedAverageExercisePriceWeightedAverageRemainingContractualTerm(Years)AggregateIntrinsicValue(Inthousands)OutstandingatJanuary1,2004.............414,809$19.01Granted...............................42,00026.24Exercised.............................54,87311.58Forfeited..............................61—OutstandingatDecember31,2004..........401,875$20.7913.2$8,353ExercisableatDecember31,2004...........225,549$18.6212.0$4,200OutstandingatJanuary1,2005.............401,875$20.79Granted...............................31,67529.78Exercised.............................38,14613.69Forfeited..............................11,84225.72OutstandingatDecember31,2005..........383,562$22.0812.2$3,492ExercisableatDecember31,2005...........256,327$20.7811.5$2,663OutstandingatJanuary1,2006.............383,562$22.08Granted...............................11,00034.64Exercised.............................63,65520.55Forfeited..............................4,26728.24OutstandingatDecember31,2006..........326,640$22.7211.3$5,500ExercisableatDecember31,2006...........240,681$21.2510.8$4,407ThefairvalueofoptionswasestimatedatthedateofgrantusingtheBlack-Scholesoptionpricingmodelandcertainassumptions.Expectedvolatilityisbasedontheweeklyhistoricalvolatilityofourstockpriceovertheexpectedtermoftheoption.ExpecteddividendyieldisbasedontheratioofthemostrecentdividendratepaidpershareoftheCompany’scommonstocktorecenttradingpriceoftheCompany’scommonstock.TheexpectedtermiscalculatedusingtheSEC’s“shortcutmethod”describedinStaffAccountingBulletin107.Therisk-freeinterest68FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27rateisbasedontheU.S.Treasuryyieldcurveatthetimeofgrantfortheperiodequaltotheexpectedtermoftheoption.ThefairvaluesofgrantsmadeduringthethreeyearsendedDecember31,2006,wereestimatedusingthefollowingweighted-averageassumptions:200620052004Volatility.................................................28.95%28.26%30.10%Expecteddividendyield......................................3.00%3.54%3.10%Expectedterm(inyears)......................................6.235.536.60Risk-freerate..............................................4.80%4.10%3.99%Theweightedaveragegrant-datefairvalueofoptionsgrantedduringthethreeyearsendedDecember31,2006,were$9.16,$6.53,and$6.79,respectively.TheaggregateintrinsicvalueofoptionsexercisedduringthethreeyearsendedDecember31,2006,wereapproximately$830thousand,$650thousand,and$386thousand,respectively.StockAwardsThe2004OmnibusStockOptionPlanpermitsthegrantingofrestrictedandunrestrictedstockgrantseitheralone,inadditionto,orintandemwithotherawardsmadebytheCompany.StockgrantsaregenerallymeasuredatfairvalueonthedateofgrantbasedonthenumberofsharesgrantedandthequotedpriceoftheCompany’sstock.Suchvalueisrecognizedasexpenseoverthecorrespondingserviceperiod.Compensationcostsrelatedtothesetypesofawardsareconsistentlyreportedforallperiodspresented.ThefollowingtablesummarizesthestatusoftheCompany’snonvestedsharesasofthethreeyearsendedDecember31,2006,andchangesduringthoseyears.SharesWeightedAverageGrant-DateFairValueSharesWeightedAverageGrant-DateFairValueSharesWeightedAverageGrant-DateFairValue200620052004NonvestedatJanuary1.........4,000$26.245,000$26.24—$—Granted....................6,03232.2975030.985,00026.24Vested.....................5,13229.671,75028.27——Forfeited...................10032.62————NonvestedatDecember31......4,800$30.044,000$26.245,000$26.24Note12.Litigation,CommitmentsandContingenciesInthenormalcourseofbusiness,theCompanyisadefendantinvariouslegalactionsandassertedclaims,mostofwhichinvolvelending,collectionandemploymentmatters.WhiletheCompanyandlegalcounselareunabletoassesstheultimateoutcomeofeachofthesematterswithcertainty,theyareofthebeliefthattheresolutionoftheseactions,singlyorintheaggregate,shouldnothaveamaterialadverseaffectonthefinancialcondition,resultsofoperationsorcashflowsoftheCompany.TheBankisapartytofinancialinstrumentswithoff-balancesheetriskinthenormalcourseofbusinesstomeetthefinancingneedsofitscustomers.Thesefinancialinstrumentsincludecommitmentstoextendcredit,standbylettersofcreditandfinancialguarantees.Theseinstrumentsinvolve,tovaryingdegrees,elementsofcreditandinterestrateriskbeyondtheamountsrecognizedonthebalancesheet.ThecontractualamountsofthoseinstrumentsreflecttheextentofinvolvementtheCompanyhasinparticularclassesoffinancialinstruments.TheCompany’s69FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27exposuretocreditlossintheeventofnon-performancebytheotherpartytothefinancialinstrumentforcommitmentstoextendcreditandstandbylettersofcreditandfinancialguaranteeswrittenisrepresentedbythecontractualamountofthoseinstruments.TheCompanyusesthesamecreditpoliciesinmakingcommitmentsandconditionalobligationsasitdoesforon-balancesheetinstruments.Commitmentstoextendcreditareagreementstolendtoacustomeraslongasthereisnotaviolationofanyconditionestablishedinthecontract.Commitmentsgenerallyhavefixedexpirationdatesorotherterminationclausesandmayrequirepaymentofafee.Sincemanyofthecommitmentsareexpectedtoexpirewithoutbeingdrawnupon,thetotalcommitmentamountsdonotnecessarilyrepresentfuturecashrequirements.TheCompanyevaluateseachcustomer’screditworthinessonacase-by-casebasis.Theamountofcollateralobtained,ifdeemednecessarybytheCompany,uponextensionofcreditisbasedonmanagement’screditevaluationofthecounter-parties.Collateralheldvariesbutmayincludeaccountsreceivable,inventory,property,plantandequipment,andincome-producingcommercialproperties.StandbylettersofcreditandwrittenfinancialguaranteesareconditionalcommitmentsissuedbytheCompanytoguaranteetheperformanceofacustomertoathirdparty.Thecreditriskinvolvedinissuinglettersofcreditisessentiallythesameasthatinvolvedinextendingloanfacilitiestocustomers.Totheextentdeemednecessary,collateralofvaryingtypesandamountsisheldtosecurecustomerperformanceundercertainofthoselettersofcreditoutstanding.FinancialinstrumentswhosecontractamountsrepresentcreditriskatDecember31,2006and2005,arecommitmentstoextendcredit(includingavailabilityoflinesofcredit)of$213.4millionand$232.9million,respectively,andstandbylettersofcreditandfinancialguaranteeswrittenof$7.0millionand$8.7million,respectively.TheCompanyhasissued,throughFCBICapitalTrust(the“Trust”),$15.0millionoftrustpreferredsecuritiesinaprivateplacement.Inconnectionwiththeissuanceofthetrustpreferredsecurities,theCompanyhascommittedtoirrevocablyandunconditionallyguaranteethefollowingpaymentsordistributionswithrespecttothetrustpreferredsecuritiestotheholdersthereoftotheextentthattheTrusthasnotmadesuchpaymentsordistributionsandhasthefundstherefor:(i)accruedandunpaiddistributions,(ii)theredemptionprice,and(iii)uponadissolutionorterminationoftheTrust,thelesseroftheliquidationamountandallaccruedandunpaiddistributionsandtheamountofassetsoftheTrustremainingavailablefordistribution.Note13.DerivativeInstrumentsandHedgingActivitiesTheCompanyusesderivativeinstrumentsprimarilytoprotectagainsttheriskofadversepriceorinterestratemovementsonthevalueofcertainassetsandliabilitiesandonfuturecashflows.Thesederivativesmayconsistofinterestrateswaps,floors,caps,collars,futures,forwardcontracts,andwrittenandpurchasedoptions.Derivativeinstrumentsrepresentcontractsbetweenpartiesthatusuallyrequirelittleornoinitialnetinvestmentandresultinonepartydeliveringcashoranothertypeofassettotheotherpartybasedonanotionalamountandanunderlyingasspecifiedinthecontract.TheCompanyenteredintoaninterestrateswapderivativeaccountedforasacashflowhedgeinJanuary2006.The$50millionnotionalamountpayfixed,receivevariableinterestrateswapwasanassetwithanestimatedfairvalueof$441thousandatDecember31,2006.TheCompanypaysafixedrateof4.34%andreceivesaLIBOR-basedfloatingratefromthecounterparty.ThecashflowhedgeisaccountedforundertheshortcutmethodprovidedforinSFAS133.Undertheshortcutmethod,thegainsandlossesassociatedwiththemarketvaluefluctuationsoftheinterestrateswapareincludedinothercomprehensiveincome.Othercomprehensiveincomeincluded$264thousandofunrealizedgainontheinterestrateswap,netofincometaxes,fortheyearendedDecember31,2006.TheCompanyheldnointerestratederivativesatDecember31,2005.70FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Note14.RegulatoryCapitalRequirementsandRestrictionsTheprimarysourceoffundsfordividendspaidbytheCompanyisdividendsreceivedfromitssubsidiarybank.DividendspaidbytheCompany’ssubsidiarybankaresubjecttorestrictionsbybankingregulations.ThemostrestrictiveprovisionoftheregulationsrequiresapprovalbytheOfficeoftheComptrolleroftheCurrencyifdividendsdeclaredinanyyearexceedtheyear’snetincome,asdefined,plusretainednetprofitofthetwoprecedingyears.During2007,subsidiaryaccumulatedearningsavailablefordistributionasdividendstotheCompanywithoutpriorapprovalare$38.8millionplusnetincomefortheinterimperiodthroughthedateofdividenddeclaration.TheCompanyanditssubsidiarybankaresubjecttovariousregulatorycapitalrequirementsadministeredbythefederalbankingagencies.Failuretomeetminimumcapitalrequirementscaninitiatecertainmandatoryandpossiblyadditionaldiscretionaryactionsbyregulatorsthat,ifundertaken,couldhaveadirectmaterialeffectontheCompany’sfinancialstatements.Underthecapitaladequacyguidelinesandtheregulatoryframeworkforpromptcorrectiveaction,whichappliesonlytotheCompany’ssubsidiarybank,thebankingsubsidiarymustmeetspecificcapitalguidelinesthatinvolvequantitativemeasuresoftheentity’sassets,liabilities,andcertainoff-balancesheetitemsascalculatedunderregulatoryaccountingpractices.Theentity’scapitalamountsandclassificationsarealsosubjecttoqualitativejudgmentsbytheregulatorsaboutcomponents,riskweightings,andotherfactors.Quan-titativemeasuresestablishedbyregulationtoensurecapitaladequacyrequiretheCompanyanditssubsidiarybanktomaintainminimumamountsandratiosfortotalandTier1capital(asdefinedintheregulations)torisk-weightedassets(asdefined),andofTier1capital(asdefined)toaverageassets(asdefined).AsofDecember31,2006,theCompanyandbankingsubsidiarymetallcapitaladequacyrequirementstowhichtheyaresubject.AsofDecember31,2006and2005,themostrecentnotificationsfromtheFederalReserveBoardcategorizedtheCompany’ssubsidiarybankaswellcapitalizedundertheregulatoryframeworkforpromptcorrectiveaction.Tobecategorizedaswellcapitalized,theCompany’ssubsidiarybankmustmaintainminimumTotalrisk-based,Tier1risk-based,andTier1leverageratiosassetforthinthetablebelow.Therearenoconditionsoreventssincethosenotificationsthatmanagementbelieveshavechangedtheinstitution’scategory.TheCompany’sandtheBank’scapitalratiosasofDecember31,2006and2005,arepresentedinthefollowingtable.AmountRatioAmountRatioAmountRatioActualForCapitalAdequacyPurposesToBeWellCapitalizedUnderPromptCorrectiveActionProvisionsDecember31,2006(Dollarsinthousands)TotalCapitaltoRisk-WeightedAssetsFirstCommunityBancshares,Inc...........$180,75812.69%$113,9618.00%N/AN/AFirstCommunityBank,N.A..............166,80211.77%113,3288.00%$141,66010.00%Tier1CapitaltoRisk-WeightedAssetsFirstCommunityBancshares,Inc...........$165,30211.60%$56,9814.00%N/AN/AFirstCommunityBank,N.A..............152,04010.73%56,6644.00%$84,9966.00%Tier1CapitaltoAverageAssets(Leverage)FirstCommunityBancshares,Inc...........$165,3028.50%$77,7634.00%N/AN/AFirstCommunityBank,N.A..............152,0407.85%77,4244.00%$96,7805.00%71FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27AmountRatioAmountRatioAmountRatioActualForCapitalAdequacyPurposesToBeWellCapitalizedUnderPromptCorrectiveActionProvisionsDecember31,2005(Dollarsinthousands)TotalCapitaltoRisk-WeightedAssetsFirstCommunityBancshares,Inc...........$164,86411.65%$113,2188.00%N/AN/AFirstCommunityBank,N.A..............154,70910.99%112,6398.00%$140,79910.00%Tier1CapitaltoRisk-WeightedAssetsFirstCommunityBancshares,Inc...........$149,15410.54%$56,6094.00%N/AN/AFirstCommunityBank,N.A..............139,5089.91%56,3194.00%$84,4796.00%Tier1CapitaltoAverageAssets(Leverage)FirstCommunityBancshares,Inc...........$149,1547.77%$76,7724.00%N/AN/AFirstCommunityBank,N.A..............139,5087.30%76,4184.00%$95,5225.00%AtDecember31,2006and2005,$15.5millioninsubordinateddebtistreatedasTier1capitalforbankregulatorypurposes.Note15.OtherOperatingExpensesIncludedinotheroperatingexpensesarecertaincosts,thetotalofwhichexceedsonepercentofcombinedinterestincomeandnon-interestincome.Followingaresuchcostsfortheyearsindicated:200620052004YearsEndedDecember31,(Amountsinthousands)Advertisingandpublicrelations..............................$1,265$1,158$1,323Telephoneanddatacommunications..........................1,4031,4881,561Note16.FairValueofFinancialInstrumentsFairvalueinformationaboutfinancialinstruments,whetherornotrecognizedinthebalancesheet,forwhichitispracticaltoestimatethevalueisbaseduponthecharacteristicsoftheinstrumentsandrelevantmarketinformation.Financialinstrumentsincludecash,evidenceofownershipinanentity,orcontractsthatconveyorimposeonanentitythatcontractualrightorobligationtoeitherreceiveordelivercashforanotherfinancialinstrument.Fairvalueistheamountatwhichafinancialinstrumentcouldbeexchangedinacurrenttransactionbetweenwillingparties,otherthaninaforcedsaleorliquidation,andisbestevidencedbyaquotedmarketpriceifoneexists.ThefollowingsummarypresentsthemethodologiesandassumptionsusedtoestimatethefairvalueoftheCompany’sfinancialinstrumentspresentedbelow.Theinformationusedtodeterminefairvalueishighlysubjectiveandjudgmentalinnatureand,therefore,theresultsmaynotbeprecise.Subjectivefactorsinclude,amongotherthings,estimatesofcashflows,riskcharacteristics,creditquality,andinterestrates,allofwhicharesubjecttochange.Sincethefairvalueisestimatedasofthebalancesheetdate,theamountsthatwillactuallyberealizedorpaiduponsettlementormaturityonthesevariousinstrumentscouldbesignificantlydifferent.72FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27CarryingAmountFairValueCarryingAmountFairValueDecember31,2006December31,2005(Amountsinthousands)AssetsCashandcashequivalents.............$57,759$57,759$57,539$57,539Securitiesavailableforsale............508,370508,370404,381404,381Securitiesheldtomaturity.............20,01920,35024,17324,877Loansheldforsale...................7817871,2741,278Loansheldforinvestment.............1,270,3141,248,9601,316,3031,304,804LiabilitiesDemanddeposits....................244,771244,771230,542230,542Interest-bearingdemanddeposits........140,578140,578144,314144,314Savingsdeposits.....................317,678317,678355,184355,184Timedeposits.......................691,744688,178673,180666,439Federalfundspurchased...............7,7007,70082,50082,500Securitiessoldunderagreementstorepurchase.......................201,185201,185124,154124,154FHLBandotherindebtedness...........197,671196,233129,231128,951FinancialInstrumentswithBookValueEqualtoFairValueThebookvaluesofcashandduefrombanksandfederalfundssoldandpurchasedareconsideredtobeequaltofairvalueasaresultoftheshort-termnatureoftheseitems.Available-for-SaleSecuritiesForavailable-for-salesecurities,fairvalueisbasedoncurrentmarketquotations,whereavailable.Ifquotedmarketpricesarenotavailable,fairvaluehasbeenbasedonthequotedpriceofsimilarinstruments.Held-to-MaturitySecuritiesForinvestmentsecurities,fairvaluehasbeenbasedoncurrentmarketquotations,whereavailable.Ifquotedmarketpricesarenotavailable,fairvaluehasbeenbasedonthequotedpriceofsimilarinstruments.LoansTheestimatedvalueofloansheldforinvestmentismeasuredbasedupondiscountedfuturecashflowsandusingthecurrentratesforsimilarloans.Loansheldforsalearerecordedatlowerofcostorestimatedfairvalue.Thefairvalueofloansheldforsaleisdeterminedbaseduponthemarketsalespriceofsimilarloans.DepositsandSecuritiesSoldUnderAgreementstoRepurchaseDepositswithoutastatedmaturity,includingdemand,interest-bearingdemand,andsavingsaccounts,arereportedattheircarryingvalueinaccordancewithSFAS107.Novaluehasbeenassignedtothefranchisevalueofthesedeposits.Forothertypesofdepositswithfixedmaturities,fairvaluehasbeenestimatedbydiscountingfuturecashflowsbasedoninterestratescurrentlybeingofferedondepositswithsimilarcharacteristicsandmaturities.Securitiessoldunderagreementstorepurchasearereportedattheircarryingvalue.73FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27OtherIndebtednessFairvaluehasbeenestimatedbasedoninterestratescurrentlyavailabletotheCompanyforborrowingswithsimilarcharacteristicsandmaturities.CommitmentstoExtendCredit,StandbyLettersofCredit,andFinancialGuaranteesTheamountofoff-balancesheetcommitmentstoextendcredit,standbylettersofcredit,andfinancialguaranteesisconsideredequaltofairvalue.Becauseoftheuncertaintyinvolvedinattemptingtoassessthelikelihoodandtimingofcommitmentsbeingdrawnupon,coupledwiththelackofanestablishedmarketandthewidediversityoffeestructures,theCompanydoesnotbelieveitismeaningfultoprovideanestimateoffairvaluethatdiffersfromthegivenvalueofthecommitment.Note17.ParentCompanyFinancialInformationCondensedfinancialinformationrelatedtoFirstCommunityBancshares,Inc.asofDecember31,2006and2005,andforeachoftheyearsendedDecember31,2006,2005,and2004,isasfollows:CondensedBalanceSheets20062005December31,(Amountsinthousands)AssetsCash......................................................$4,511$1,344Securitiesavailableforsale.....................................9,0668,874Investmentinsubsidiary.......................................214,030199,109Otherassets................................................1,328651Totalassets...............................................$228,935$209,978LiabilitiesOtherliabilities..............................................$741$13Long-termdebt..............................................15,46415,464Totalliabilities............................................16,20515,477Stockholders’EquityCommonstock..............................................11,49911,496Additionalpaid-incapital......................................108,806108,573Retainedearnings............................................100,11782,828Treasurystock...............................................(7,924)(7,625)Accumulatedothercomprehensiveincome..........................232(771)Totalstockholders’equity....................................212,730194,501Totalliabilitiesandstockholders’equity..........................$228,935$209,97874FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM BOOKPROOF -- l24096-i000_a.pdf Page 74 of Imposition -- Mon Mar 12 2007-- 17:06:27CondensedStatementsofIncome200620052004YearsEndedDecember31,(Amountsinthousands,exceptpersharedata)Cashdividendsreceivedfromsubsidiarybank................$15,775$11,600$12,600Otherincome........................................354823339Operatingexpense.....................................(2,049)(1,808)(1,361)14,08010,61511,578Incometaxbenefit.....................................1,237662606Equityinundistributedearningsofsubsidiary—continuingoperations.........................................13,63115,02610,180Netincome..........................................$28,948$26,303$22,36475FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM BOOKPROOF -- l24096-i000_a.pdf Page 75 of Imposition -- Mon Mar 12 2007-- 17:06:27CondensedStatementsofCashFlows200620052004YearsEndedDecember31,(Amountsinthousands)CashflowsfromoperatingactivitiesNetincome........................................$28,948$26,303$22,364Adjustmentstoreconcilenetincometonetcashprovidedbyoperatingactivities:Equityinundistributedearningsofsubsidiary—continuingoperations.............................(13,631)(15,026)(10,180)Gainonsaleofsecurities............................(62)(513)(94)Decreaseinotherassets.............................63312527Increase(decrease)inotherliabilities...................455(666)93Other,net........................................(3)3793Netcashprovidedbyoperatingactivities..................15,77010,78912,713CashflowsfrominvestingactivitiesPurchaseofsecuritiesavailableforsale...................(1,881)(3,819)(526)Proceedsfromsaleofsecuritiesavailableforsale............2,2101,568430Other,net.........................................3——Netcashprovidedby(usedin)investingactivities...........332(2,251)(96)CashflowsfromfinancingactivitiesIssuanceofcommonstock.............................1,518522504Acquisitionoftreasurystock...........................(4,566)(1,303)(1,196)Dividendspaid......................................(11,659)(11,494)(11,239)Other,net.........................................1,772——Netcashusedinbyfinancingactivities...................(12,935)(12,275)(11,931)Netincrease(decrease)incashandcashequivalents..........3,167(3,737)686Cashandcashequivalentsatbeginningofyear..............1,3445,0814,395Cashandcashequivalentsatendofyear..................$4,511$1,344$5,081Note18.DiscontinuedOperationsOnAugust18,2004,theCompanysoldUnitedFirstMortgage,Inc.,itsmortgagebankingsubsidiaryheadquarteredinRichmond,Virginia.Thetransactionresultedinthesaleof100%ofthestockofthemortgagebankingsubsidiaryforcashconsiderationofapproximately$250thousand.Thetransactionproducedanafter-taxgainofapproximately$387thousand.ThissalecompletedtheCompany’sexitfromitsmortgagebankingoperations.ThebusinessrelatedtotheformermortgagebankingsubsidiaryisaccountedforasdiscontinuedoperationsinaccordancewithSFAS144forallperiodspresentedinthisreport.Theresultsoftheformermortgagebankingsubsidiaryarepresentedasdiscontinuedoperationsinaseparatecategoryontheincomestatementfollowingresultsfromcontinuingoperations.76FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27TheresultsofdiscontinuedoperationsforthemostrecentthreeyearsendedDecember31areasfollows:200620052004YearEndedDecember31,(Amountsinthousands)InterestIncomeInterest&feesonloansheldforsale............................$—$—$681Incomeoninvestmentstaxable.................................——6Interestonfedfundsandtimedeposits...........................——3Totalinterestincome......................................——690InterestExpenseInterestonshorttermborrowings...............................——505Interestonotherborrowings...................................——2Totalinterestexpense......................................——507Netinterestincome.....................................——183OtherIncomeGain(loss)onsecurities......................................——13Mortgagebankingincome....................................——943Totalotherincome........................................——956OtherExpensesSalariesandbenefits........................................—252,990Occupancyexpense.........................................——229Furnitureandequipmentexpense...............................—35106Otheroperatingexpense.....................................—1733,560Totalotherexpenses.......................................—2336,885Lossbeforeincometaxes(2004includesa$570thousandlossonthedispositionofUFM).......................................—(233)(5,746)Applicableincometaxbenefit(2004includesataxbenefitof$957thousandrelatedtothedispositionofUFM).....................—(91)(2,090)Netloss.................................................$—$(142)$(3,656)TherewerenodiscontinuedassetsandliabilitiesfromtheformermortgagebankingsubsidiaryfortheperiodsendedDecember31,2006and2005.Thediscontinuedcashflowsfor2004havebeenrevisedtoconformwiththecurrentyears’presentation,whichdetailscashflowsfromoperating,investing,andfinancingactivities.77FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27Note19.SupplementalFinancialData(Unaudited)QuarterlyearningsfortheyearsendedDecember31,2006and2005,areasfollows:March31June30Sept30Dec312006QuarterEnded(Amountsinthousands,exceptpersharedata)Interestincome..............................$28,923$30,025$30,240$30,838Interestexpense..............................10,85811,85212,48413,187Netinterestincome...........................18,06518,17317,75617,651Provisionforloanlosses.......................408811579908Netinterestincomeafterprovisionforloanlosses....17,65717,36217,17716,743Otherincome................................4,9895,6145,1045,542Netsecuritiesgains...........................159(94)(6)15Otherexpenses..............................13,33312,58812,21311,703Incomebeforeincometaxes.....................9,47210,29410,06210,597Incometaxes................................2,6283,0022,8772,970Netincome.................................$6,844$7,292$7,185$7,627Pershare:Basicearnings.............................$0.61$0.65$0.64$0.68Dilutedearnings............................$0.61$0.65$0.64$0.68Dividends................................$0.26$0.26$0.26$0.26Weightedaveragebasicsharesoutstanding..........11,23311,20111,17411,212Weightedaveragedilutedsharesoutstanding.........11,31211,25911,24511,29878FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27March31June30Sept30Dec312005QuarterEnded(Amountsinthousands,exceptpersharedata)Interestincome..............................$25,188$26,790$28,293$29,237Interestexpense..............................7,4358,2689,57210,605Netinterestincome...........................17,75318,52218,72118,632Provisionforloanlosses.......................6911,0731,060882Netinterestincomeafterprovisionforloanlosses....17,06217,44917,66117,750Otherincome................................3,7004,4494,4968,907Netsecuritiesgains...........................2212153674Otherexpenses..............................12,49613,30113,11816,676Incomebeforeincometaxes.....................8,2888,7189,57510,055Incometaxes................................2,2372,4942,6412,819Netincomefromcontinuingoperations............6,0516,2246,9347,236Lossfromdiscontinuedoperationsbeforeincometax..(131)(39)(36)(27)Incometaxbenefit............................(51)(15)(14)(11)Lossfromdiscontinuedoperations................(80)(24)(22)(16)Netincome.................................$5,971$6,200$6,912$7,220Pershare:Basicearnings.............................$0.53$0.55$0.61$0.64Basicearningscontinuing.....................$0.54$0.55$0.61$0.64Dilutedearnings............................$0.53$0.55$0.61$0.64Dilutedearningscontinuing...................$0.53$0.55$0.61$0.64Dividends................................$0.255$0.255$0.255$0.255Weightedaveragebasicsharesoutstanding..........11,25911,27411,27511,268Weightedaveragedilutedsharesoutstanding.........11,33911,34411,34311,34179FIRSTCOMMUNITYBANCSHARES,INC.NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)SBM 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17:06:27REPORTOFINDEPENDENTREGISTEREDPUBLICACCOUNTINGFIRMTotheAuditCommitteeoftheBoardofDirectorsandtheStockholdersFirstCommunityBancshares,Inc.WehaveauditedtheaccompanyingconsolidatedbalancesheetofFirstCommunityBancshares,Inc.andSubsidiary(the“Company”)asofDecember31,2006,andtherelatedstatementsofincome,changesinstockholders’equityandcashflowsfortheyearended2006.TheseconsolidatedfinancialstatementsaretheresponsibilityoftheCompany’smanagement.Ourresponsibilityistoexpressanopiniononthesefinancialstatementsbasedonouraudit.WeconductedourauditinaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates).Thosestandardsrequirethatweplanandperformtheaudittoobtainreasonableassuranceaboutwhetherthefinancialstatementsarefreeofmaterialmisstatement.Anauditincludesexamining,onatestbasis,evidencesupportingtheamountsanddisclosuresinthefinancialstatements.Anauditalsoincludesassessingtheaccountingprinciplesusedandsignificantestimatesmadebymanagement,aswellasevaluatingtheoverallfinancialstatementpresentation.Webelievethatourauditprovidesareasonablebasisforouropinion.Inouropinion,theconsolidatedfinancialstatementsreferredtoabovepresentfairly,inallmaterialrespects,thefinancialpositionofFirstCommunityBancshares,Inc.andSubsidiaryasofDecember31,2006,andtheresultsoftheiroperationsandtheircashflowsfortheyearended2006inconformitywithaccountingprinciplesgenerallyacceptedintheUnitedStatesofAmerica.Wealsohaveaudited,inaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates),theeffectivenessoftheCompany’sinternalcontroloverfinancialreportingasofDecember31,2006,basedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission(COSO),andourreportdatedMarch12,2007expressedanunqualifiedopiniononmanagement’sassessmentofinternalcontroloverfinancialreportingandanunqualifiedopinionontheeffectivenessofinternalcontroloverfinancialreporting.Asheville,NorthCarolinaMarch12,200780SBM 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17:06:27REPORTOFINDEPENDENTREGISTEREDPUBLICACCOUNTINGFIRMTheAuditCommitteeoftheBoardofDirectorsandStockholdersofFirstCommunityBancshares,Inc.WehaveauditedtheaccompanyingconsolidatedbalancesheetofFirstCommunityBancshares,Inc.andsubsidiariesasofDecember31,2005,andtherelatedconsolidatedstatementsofincome,stockholders’equity,andcashflowsforeachofthetwoyearsintheperiodendedDecember31,2005.ThesefinancialstatementsaretheresponsibilityoftheCompany’smanagement.Ourresponsibilityistoexpressanopiniononthesefinancialstatementsbasedonouraudits.WeconductedourauditsinaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates).Thosestandardsrequirethatweplanandperformtheaudittoobtainreasonableassuranceaboutwhetherthefinancialstatementsarefreeofmaterialmisstatement.Anauditincludesexamining,onatestbasis,evidencesupportingtheamountsanddisclosuresinthefinancialstatements.Anauditalsoincludesassessingtheaccountingprinciplesusedandsignificantestimatesmadebymanagement,aswellasevaluatingtheoverallfinancialstatementpresentation.Webelievethatourauditsprovideareasonablebasisforouropinion.Inouropinion,thefinancialstatementsreferredtoabovepresentfairly,inallmaterialrespects,theconsolidatedfinancialpositionofFirstCommunityBancshares,Inc.andsubsidiariesatDecember31,2005,andtheconsolidatedresultsoftheiroperationsandtheircashflowsforeachofthetwoyearsintheperiodendedDecember31,2005,inconformitywithU.S.generallyacceptedaccountingprinciples.Charleston,WestVirginiaMarch3,200681SBM 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17:06:27MANAGEMENT’SASSESSMENTOFINTERNALCONTROLOVERFINANCIALREPORTINGFirstCommunityBancshares,Inc.(the“Company”)isresponsibleforthepreparation,integrity,andfairpresentationoftheconsolidatedfinancialstatementsincludedinthisAnnualReportonForm10-K.Theconsol-idatedfinancialstatementsandnotesincludedinthisAnnualReportonForm10-KhavebeenpreparedinconformitywithU.S.generallyacceptedaccountingprinciplesandnecessarilyincludesomeamountsthatarebasedonmanagement’sbestestimatesandjudgments.We,asmanagementoftheCompany,areresponsibleforestablishingandmaintainingeffectiveinternalcontroloverfinancialreportingthatisdesignedtoproducereliablefinancialstatementsinconformitywithU.S.generallyacceptedaccountingprinciples.Thesystemofinternalcontroloverfinancialreportingasitrelatestothefinancialstatementsisevaluatedforeffectivenessbymanagementandtestedforreliability.Anysystemofinternalcontrol,nomatterhowwelldesigned,hasinherentlimitations,includingthepossibilitythatacontrolcanbecircumventedoroverriddenandmisstatementsduetoerrororfraudmayoccurandnotbedetected.Also,becauseofchangesinconditions,internalcontroleffectivenessmayvaryovertime.Accordingly,evenaneffectivesystemofinternalcontrolwillprovideonlyreasonableassurancewithrespecttofinancialstatementpreparation.ManagementconductedanassessmentoftheeffectivenessoftheCompany’sinternalcontroloverfinancialreportingbasedontheframeworkinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission.Basedonthisassessment,managementconcludedthatitssystemofinternalcontroloverfinancialreportingwaseffectiveasofDecember31,2006.DixonHughesPLLC,independentregisteredpublicaccountingfirm,hasissuedanattestationreportonmanagement’sassessmentoftheCompany’sinternalcontroloverfinancialreporting.TheReportofIndependentRegisteredAccountingFirmonManagement’sReportonInternalControlOverFinancialReportingappearshereafterinItem8ofthisAnnualReportonForm10-K.82SBM 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17:06:27REPORTOFINDEPENDENTREGISTEREDPUBLICACCOUNTINGFIRMTotheBoardofDirectorsandStockholdersFirstCommunityBancshares,Inc.Wehaveauditedmanagement’sassessment,includedintheaccompanyingReportonManagement’sAssess-mentofInternalControlOverFinancialReporting,thatFirstCommunityBancshares,Inc.andSubsidiary(the“Company”)maintainedeffectiveinternalcontroloverfinancialreportingasofDecember31,2006,basedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrgani-zationsoftheTreadwayCommission.TheCompany’smanagementisresponsibleformaintainingeffectiveinternalcontroloverfinancialreportingandforitsassessmentoftheeffectivenessofinternalcontroloverfinancialreporting.Ourresponsibilityistoexpressanopiniononmanagement’sassessmentandanopinionontheeffectivenessoftheCompany’sinternalcontroloverfinancialreportingbasedonouraudit.WeconductedourauditinaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates).Thosestandardsrequirethatweplanandperformtheaudittoobtainreasonableassuranceaboutwhethereffectiveinternalcontroloverfinancialreportingwasmaintainedinallmaterialrespects.Ourauditincludedobtaininganunderstandingofinternalcontroloverfinancialreporting,evaluatingmanagement’sassessment,testingandevaluatingthedesignandoperatingeffectivenessofinternalcontrol,andperformingsuchotherproceduresasweconsiderednecessaryinthecircumstances.Webelievethatourauditprovidesareasonablebasisforouropinion.Acompany’sinternalcontroloverfinancialreportingisaprocessdesignedtoprovidereasonableassuranceregardingthereliabilityoffinancialreportingandthepreparationoffinancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples.Acompany’sinternalcontroloverfinancialreportingincludesthosepoliciesandproceduresthat(1)pertaintothemaintenanceofrecordsthat,inreasonabledetail,accuratelyandfairlyreflectthetransactionsanddispositionsoftheassetsofthecompany;(2)providereasonableassurancethattransactionsarerecordedasnecessarytopermitpreparationoffinancialstatementsinaccordancewithgenerallyacceptedaccountingprinciples,andthatreceiptsandexpendituresofthecompanyarebeingmadeonlyinaccordancewithauthorizationsofmanagementanddirectorsofthecompany;and(3)providereasonableassuranceregardingpreventionortimelydetectionofunauthorizedacquisition,use,ordispositionofthecompany’sassetsthatcouldhaveamaterialeffectonthefinancialstatements.Becauseofitsinherentlimitations,internalcontroloverfinancialreportingmaynotpreventordetectmisstatements.Also,projectionsofanyevaluationofeffectivenesstofutureperiodsaresubjecttotheriskthatcontrolsmaybecomeinadequatebecauseofchangesinconditions,orthatthedegreeofcompliancewiththepoliciesorproceduresmaydeteriorate.Inouropinion,management’sassessmentthatFirstCommunityBancshares,Inc.andSubsidiarymaintainedeffectiveinternalcontroloverfinancialreportingasofDecember31,2006,isfairlystated,inallmaterialrespects,basedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission.Alsoinouropinion,FirstCommunityBancshares,Inc.andSubsidiarymaintained,inallmaterialrespects,effectiveinternalcontroloverfinancialreportingasofDecember31,2006,basedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission.Wehavealsoaudited,inaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates),theconsolidatedfinancialstatementsofFirstCommunityBancshares,Inc.andSubsidiaryasofandfortheyearendedDecember31,2006,andourreportdatedMarch12,2007,expressedanunqualifiedopiniononthoseconsolidatedfinancialstatements.Asheville,NorthCarolinaMarch12,200783SBM 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17:06:27ITEM9.CHANGESINANDDISAGREEMENTSWITHACCOUNTANTSONACCOUNTINGANDFINANCIALDISCLOSURE.OnMay10,2006,theAuditCommitteeoftheBoardofFirstCommunityBancshares,Inc.(the“Registrant”)approvedthedismissalofErnst&YoungLLP(“E&Y”)astheindependentregisteredpublicaccountingfirmfortheRegistrant.Further,onMay10,2006,theAuditCommitteeoftheBoardselectedDixonHughesPLLCastheRegistrant’snewindependentregisteredpublicaccountingfirmfortheyearendedDecember31,2006.ThereportofE&YontheconsolidatedfinancialstatementsoftheRegistrantfortheyearsendedDecember31,2005and2004,containednoadverseopinionordisclaimerofopinion,andsuchreportwasnotqualifiedormodifiedastouncertainty,auditscope,oraccountingprinciples.DuringtheyearsendedDecember31,2005and2004,andthroughMay10,2006,therewerenodisagreementswithE&Yonanyaccountingprinciplesorpractices,financialstatementdisclosure,orauditingscopeorprocedure,whichdisagreementsifnotresolvedtothesatisfactionofE&YwouldhavecausedittomakeareferencetothesubjectmatterofthedisagreementsinconnectionwithitsreportontheRegistrant’sfinancialstatementsforsuchyears.Noreportableeventasdescribedinparagraph(a)(1)(v)ofItem304ofRegulationS-KhasoccurredduringtheyearsendedDecember31,2005and2004,andthroughMay10,2006.TheRegistrantprovidedacopyoftheforegoingdisclosurestoE&YpriortothedateofthefilingofthisreportandrequestedthatE&YfurnishitwithaletteraddressedtotheUnitedStatesSecuritiesandExchangeCommissionstatingwhetherornotitagreeswiththeabovedisclosures.EffectiveonMay10,2006,theAuditCommitteeselectedDixonHughesPLLCasitsnewindependentregisteredpublicaccountingfirm.Duringthetwomostrecentfiscalyearsandsubsequentinterimperiodpriortoitsselectionasindependentaccountants,DixonHughesPLLChadnotbeenconsultedbytheRegistrantonanyofthemattersreferencedinRegulationS-KItem304(a)(2)(i)or(ii).ITEM9A.CONTROLSANDPROCEDURES.Asoftheendoftheperiodcoveredbythisreport,theCompanycarriedoutanevaluation,underthesupervisionandwiththeparticipationoftheCompany’smanagement,includingtheCompany’sChiefExecutiveOfficeralongwiththeCompany’sChiefFinancialOfficer,oftheeffectivenessofthedesignandoperationoftheCompany’sdisclosurecontrolsandprocedurespursuanttotheExchangeActRule13a-15(b).Baseduponthatevaluation,theCompany’sChiefExecutiveOfficeralongwiththeCompany’sChiefFinancialOfficerconcludedthattheCompany’sdisclosurecontrolsandproceduresareeffectiveintimelyalertingthemtomaterialinformationrelatingtotheCompany(includingitsconsolidatedsubsidiaries)requiredtobeincludedintheCompany’speriodicSECfilings.TherehavenotbeenanychangesintheCompany’sinternalcontrolsoverfinancialreportingduringthemostrecentfiscalquarterthathavemateriallyaffected,orarereasonablylikelytomateriallyaffecttheCompany’sinternalcontrolsoverfinancialreporting.DisclosurecontrolsandproceduresareCompanycontrolsandotherproceduresthataredesignedtoensurethatinformationrequiredtobedisclosedbytheCompanyinthereportsthatitfilesorsubmitsundertheExchangeActisrecorded,processed,summarizedandreportedwithinthetimeperiodsspecifiedintheSEC’srulesandforms.Disclosurecontrolsandproceduresinclude,withoutlimitation,controlsandproceduresdesignedtoensurethatinformationrequiredtobedisclosedbytheCompanyinthereportsthatitfilesorsubmitsundertheExchangeActisaccumulatedandcommunicatedtotheCompany’smanagement,includingtheChiefExecutiveOfficerandChiefFinancialOfficer,asappropriate,toallowtimelydecisionsregardingrequireddisclosure.OurManagement’sReportonInternalControlOverFinancialReportingandtheReportofIndependentRegisteredPublicAccountingFirmonManagement’sAssessmentofInternalControlOverFinancialReportingareeachherebyincorporatedbyreferencefromItem8ofthisAnnualReportonForm10-K.ITEM9B.OTHERINFORMATION.None.84SBM 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17:06:27PARTIIIITEM10.DIRECTORS,EXECUTIVEOFFICERSANDCORPORATEGOVERNANCE.TherequiredinformationconcerningdirectorsandexecutiveofficershasbeenomittedinaccordancewithGeneralInstructionG.Suchinformationregardingdirectorsandexecutiveofficerswillbesetforthundertheheadingsof“ElectionofDirectors”,“ContinuingDirectors”,and“ExecutiveOfficerswhoarenotDirectors”oftheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.AportionoftheinformationrelatingtocompliancewithSection16(a)oftheExchangeActhasbeenomittedinaccordancewithGeneralInstructionG.Suchinformationwillbesetforthundertheheadingof“Section16(a)BeneficialOwnershipReportingCompliance”oftheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.TheCompanyhasadoptedaCodeofEthicsthatappliestoitsprincipalexecutiveofficer,principalfinancialofficer,principalaccountingofficerorcontrollerorpersonsperformingsimilarfunctions,aswellasallemployeesoftheCompany.AcopyoftheCompany’sCodeofEthicsisavailableontheCompany’swebsiteatwww.fcbinc.-com.Sinceitsadoption,therehavebeennowaiversofthecodeofethicsrelatedtoanyoftheaboveofficers.AportionoftheinformationrelatingtotheAuditCommitteeandtheAuditCommitteeFinancialExperthasbeenomittedinaccordancewithGeneralInstructionG.SuchinformationregardingtheAuditCommitteeandtheAuditCommitteeFinancialExpertwillbesetforthundertheheading“ReportoftheAuditCommittee”oftheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.TheCompanyhasnotmadeanymaterialchangestotheproceduresbywhichstockholdersmayrecommendnomineestotheCompany’sboardofdirectors.BOARDOFDIRECTORS,FIRSTCOMMUNITYBANCSHARES,INC.HaroldV.Groome,Jr.Chairman,GroomeTransportation,Inc.;Chairman,GroomeTransportationofGeorgia,Inc.;Chairman,CompensationCommitteeA.A.ModenaPastExecutiveVicePresidentandSecretary,FirstCommunityBancshares,Inc.;PastPresident&ChiefExecutiveOfficer,TheFlatTopNationalBankofBluefield;MemberExecutiveandCompensationCommittees;Chairman,GovernanceandNominatingCommitteeAllenT.HamnerProfessorofChemistry,WestVirginiaWesleyanCollege;MemberExecutive,Audit,Compensation,andGovernanceandNominatingCommitteesRobertE.Perkinson,Jr.PastVicePresident-Operations,MAPCOCoal,Inc.—VirginiaRegion;Chairman,AuditCommitteeB.W.HarveyRetired—FormerPresident,HighlandsRealEstateManagement,Inc.;MemberExecutive,Audit,andGovernanceandNominatingCommitteesWilliamP.StaffordPresident,PrincetonMachineryService,Inc.;Chairman,FirstCommunityBancshares,Inc.;Chairman,ExecutiveCommitteeI.NorrisKantorOfCounsel,Katz,Kantor&Perkins,Attorneys-at-Law;MemberGovernanceandNominatingCommitteeWilliamP.Stafford,IIAttorney-at-Law,Brewster,Morhous,Cameron,Mullins,Caruth,Moore,Kersey&Stafford,PLLC;MemberExecutiveandCompensationCommittesJohnM.MendezPresidentandChiefExecutiveOfficer,FirstCommunityBancshares,Inc.;ExecutiveVicePresident,FirstCommunityBank,N.A.;MemberExecutiveCommittee85SBM 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17:06:27EXECUTIVEOFFICERS,FIRSTCOMMUNITYBANCSHARES,INC.JohnM.MendezPresidentandChiefExecutiveOfficerDavidD.BrownChiefFinancialOfficerRobertL.BuzzoVicePresidentandSecretaryE.StephenLillyChiefOperatingOfficerBOARDOFDIRECTORS,FIRSTCOMMUNITYBANK,N.A.W.C.Blankenship,Jr.Agent,StateFarmInsuranceI.NorrisKantorOfCounsel,Katz,Kantor&Perkins,Attorneys-at-LawD.L.Bowling,Jr.President,TrueEnergy,Inc.JohnM.MendezPresidentandChiefExecutiveOfficer,FirstCommunityBancshares,Inc.;ExecutiveVicePresident,FirstCommunityBank,N.A.JuanitaG.BryanHomemakerA.A.ModenaPastExecutiveVicePresidentandSecretary,FirstCommunityBancshares,Inc.;PastPresidentandChiefExecutiveOfficer,TheFlatTopNationalBankofBluefieldRobertL.BuzzoVicePresidentandSecretary,FirstCommunityBancshares,Inc.;President,FirstCommunityBank,N.A.RobertE.Perkinson,Jr.PastVicePresident-Operations,MAPCOCoal,Inc.—VirginiaRegionC.WilliamDavisAttorney-at-Law,Richardson&DavisClydeB.RatliffPresident,GascoDrilling,Inc.HaroldV.Groome,Jr.Chairman,GroomeTransportation,Inc.;Chairman,GroomeTransportationofGeorgia,Inc.WilliamP.StaffordPresident,PrincetonMachineryService,Inc.FranklinP.HallBusinessman;SeniorPartner,Hall&FamilyLawFirmWilliamP.Stafford,IIAttorneyatLaw,Brewster,Morhous,Cameron,Mullins,Caruth,Moore,Kersey&Stafford,PLLCAllenT.Hamner,Ph.D.ProfessorofChemistry,WestVirginiaWesleyanCollegeFrankC.TinderPresident,TinderEnterprises,Inc.andTincoLeasingCorporationB.W.HarveyRetired—FormerPresident,HighlandsRealEstateManagement,Inc.;Chairman,FirstCommunityBank,N.A.DaleF.WoodyPresident,WoodyLumberCompany86SBM 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17:06:27ITEM11.EXECUTIVECOMPENSATION.TheinformationcalledforbyItem11hasbeenomittedinaccordancewithGeneralInstructionG.SuchinformationwillbesetforthintheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.ITEM12.SECURITYOWNERSHIPOFCERTAINBENEFICIALOWNERSANDMANAGEMENTANDRELATEDSTOCKHOLDERMATTERS.TherequiredinformationconcerningsecurityownershipofcertainbeneficialownersandmanagementhasbeenomittedinaccordancewithGeneralInstructionG.Suchinformationappearsundertheheadingof“BeneficialOwnershipofCommonStockbyCertainBeneficialOwnersandManagement”oftheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.Thefollowingtablepresentsinformationforallequitycompensationplanswithindividualcompensationarrangements,whetherwithemployeesornon-employeessuchasdirectors,ineffectasofDecember31,2006.PlanCategoryNumberofSecuritiestobeIssuedUponExerciseofOutstandingOptions,WarrantsandRightsWeighted-AverageExercisePriceofOutstandingOptions,WarrantsandRightsNumberofSecuritiesRemainingAvailableforFutureIssuanceUnderEquityCompensationPlans(ExcludingSecuritiesReflectedinColumn(a))(a)(b)(c)Equitycompensationplansapprovedbysecurityholders.............61,800$26.60103,543Equitycompensationplansnotapprovedbysecurityholders......269,64021.4377,851Total..........................331,440181,394ITEM13.CERTAINRELATIONSHIPSANDRELATEDTRANSACTIONS,ANDDIRECTORINDEPENDENCE.TheinformationcalledforbyItem13hasbeenomittedinaccordancewithGeneralInstructionG.SuchinformationshallbesetforthintheProxyStatementrelatingtothe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.ITEM14.PRINCIPALACCOUNTANTFEESANDSERVICES.TheinformationcalledforbyItem14hasbeenomittedinaccordancewithGeneralInstructionG.Suchinformationshallbesetforththe2007AnnualMeetingofStockholdersandisincorporatedhereinbyreference.87SBM 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17:06:27PARTIVITEM15.EXHIBITS,FINANCIALSTATEMENTSCHEDULES.(a)DocumentsFiledasPartofthisReport(1)FinancialStatementsTheConsolidatedFinancialStatementsofFirstCommunityBancshares,Inc.andsubsidiariestogetherwiththeIndependentRegisteredPublicAccountingFirm’sReportdatedMarch12,2007,areincorporatedbyreferencetoItem8hereof.(2)FinancialStatementSchedulesNofinancialstatementschedulesarebeingfiledsincetherequiredinformationisinapplicableorispresentedintheconsolidatingfinancialstatementsorrelatednotes.(b)ExhibitsExhibitNo.Exhibit2.1—AgreementandPlanofMergerdatedasofDecember31,2003amongFirstCommunityBancshares,Inc.,FirstCommunityBank,NationalAssociation,andPCBBancorp.(18)3(i)—ArticlesofIncorporationofFirstCommunityBancshares,Inc.,asamended.(1)3(ii)—BylawsofFirstCommunityBancshares,Inc.,asamended.(17)4.1—SpecimenstockcertificateofFirstCommunityBancshares,Inc.(3)4.2—IndentureAgreementdatedSeptember25,2003.(11)4.3—AmendedandRestatedDeclarationofTrustofFCBICapitalTrustdatedSeptember25,2003.(11)4.4—PreferredSecuritiesGuaranteeAgreementdatedSeptember25,2003.(11)10.1—FirstCommunityBancshares,Inc.1999StockOptionContracts(2)andPlan.(4)10.1.1—AmendmenttoFirstCommunityBancshares,Inc.1999StockOptionPlan.(11)10.2—FirstCommunityBancshares,Inc.2001Non-QualifiedDirectorsStockOptionPlan.(5)10.3—EmploymentAgreementdatedJanuary1,2000andamendedOctober17,2000,betweenFirstCommunityBancshares,Inc.andJohnM.Mendez.(2)(6)10.4—FirstCommunityBancshares,Inc.2000ExecutiveRetentionPlan,asamended.(4)10.5—FirstCommunityBancshares,Inc.SplitDollarPlanandAgreement.(4)10.6—FirstCommunityBancshares,Inc.2001DirectorsSupplementalRetirementPlan.(2)10.6.1—FirstCommunityBancshares,Inc.2001DirectorsSupplementalRetirementPlan.SecondAmendment(B.W.Harvey,Sr.—October19,2004).(14)10.7—FirstCommunityBancshares,Inc.WrapPlan.(7)10.8—EmploymentAgreementbetweenFirstCommunityBancshares,Inc.andJ.E.CauseyDavis.(8)10.9—FormofIndemnificationAgreementbetweenFirstCommunityBancshares,itsDirectorsandCertainExecutiveOfficers.(9)10.10—FormofIndemnificationAgreementbetweenFirstCommunityBank,N.A,itsDirectorsandCertainExecutiveOfficers.(9)10.11—Reserved.10.12—FirstCommunityBancshares,Inc.2004OmnibusStockOptionPlan(10)andAwardAgreement.(13)10.13—Reserved.10.14—FirstCommunityBancshares,Inc.DirectorsDeferredCompensationPlan.(7)10.15—FirstCommunityBancshares,Inc.DeferredCompensationandSupplementalBonusPlanForKeyEmployees.(15)11—Statementregardingcomputationofearningspershare.(16)12*—ComputationofRatios.21—SubsidiariesofRegistrant—Referenceismadeto‘Item1.Business‘fortherequiredinformation.23.1*—ConsentofDixonHughesPLLC,IndependentRegisteredPublicAccountingFirmforFirstCommunityBancshares,Inc.88SBM 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17:06:27ExhibitNo.Exhibit23.2*—ConsentofErnst&Young,LLP,formerIndependentRegisteredPublicAccountingFirmforFirstCommunityBancshares,Inc.31.1*—Rule13a-14(a)/a5d-14(a)CertificationofChiefExecutiveOfficer31.2*—Rule13a-14(a)/a5d-14(a)CertificationofChiefFinancialOfficer32*—CertificationofChiefExecutiveOfficerandChiefFinancialOfficerSection1350.*Furnishedherewith.(1)IncorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedJune30,2005,filedonAugust5,2005.(2)IncorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedJune30,2002,filedonAugust14,2002.(3)IncorporatedbyreferencefromtheAnnualReportonForm10-KfortheperiodendedDecember31,2002,filedonMarch25,2003,asamendedonMarch31,2003.(4)IncorporatedbyreferencefromtheAnnualReportonForm10-KfortheperiodendedDecember31,1999,filedonMarch30,2000,asamendedApril13,2000.(5)Theoptionagreementsenteredintopursuanttothe1999StockOptionPlanandthe2001Non-QualifiedDirectorsStockOptionPlanareincorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedJune30,2002,filedonAugust14,2002.(6)FirstCommunityBancshares,Inc.hasenteredintosubstantiallyidenticalagreementswithRobertL.BuzzoandE.StephenLilly,withtheonlydifferencesbeingwithrespecttotitle,salaryandtheuseofavehicle.(7)IncorporatedbyreferencefromItem1.01oftheCurrentReportonForm8-KdatedAugust22,2006,andfiledAugust23,2006.(8)IncorporatedbyreferencefromS-4RegistrationStatementfiledonMarch28,2003.TheCompanyhasenteredintoasubstantiallyidenticalcontractwithPhillipR.CarrigerdatedMarch31,2004.(9)FormofindemnificationagreemententeredintobytheCorporationandbyFirstCommunityBank,N.A.withtheirrespectivedirectorsandcertainofficersofeachincluding,fortheRegistrantandBank:JohnM.Mendez,RobertL.Schumacher,RobertL.Buzzo,E.StephenLilly,DavidD.BrownandattheBanklevel:SamuelL.Elmore.IncorporatedbyreferencefromtheAnnualReportonForm10-KfortheperiodendedDecember31,2003,filedonMarch15,2004,andamendedonMay19,2004.(10)Incorporatedbyreferencefromthe2004FirstCommunityBancshares,Inc.DefinitiveProxyfiledonMarch19,2004.(11)IncorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedSeptember30,2003,filedonNovember10,2003.(12)IncorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedMarch31,2004,filedonMay7,2004.(13)IncorporatedbyreferencefromtheQuarterlyReportonForm10-QfortheperiodendedJune30,2004,filedonAugust6,2004.(14)IncorporatedbyreferencefromtheAnnualReportonForm10-KfortheperiodendedDecember31,2004,andfiledonMarch16,2005.AmendmentsinsubstantiallysimilarformwereexecutedforDirectorsClark,Kantor,Hamner,Modena,Perkinson,Stafford,andStaffordII.(15)IncorporatedbyreferencefromItem1.01oftheCurrentReportonForm8-KdatedOctober24,2006,andfiledOctober25,2006.(16)IncorporatedbyreferencefromFootnote1oftheNotestoConsolidatedFinancialStatementsincludedherein.(17)IncorporatedbyreferencefromtheQuarterlyReportonFrom10-QfortheperiodendedSeptember30,2006,filedonNovember8,2006.(18)IncorporatedbyreferencetothecorrespondingexhibitpreviouslyfiledasanexhibittotheForm8-KfiledonDecember31,2003.89SBM 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17:06:27SIGNATURESPursuanttotherequirementsofSection13or15(d)oftheSecuritiesExchangeActof1934,theRegistranthasdulycausedthisreporttobesignedonitsbehalfbytheundersigned,thereuntodulyauthorizedonthe12thdayofMarch2007.FirstCommunityBancshares,Inc.(Registrant)By:/s/JohnM.MendezJohnM.MendezPresidentandChiefExecutiveOfficerBy:/s/DavidD.BrownDavidD.BrownChiefFinancialOfficerPursuanttotherequirementsoftheSecuritiesExchangeActof1934,thisreporthasbeensignedbelowbythefollowingpersonsonbehalfoftheRegistrantandinthecapacitiesandonthedatesindicated.SignatureTitleDate/s/JohnM.MendezJohnM.MendezDirector,PresidentandChiefExecutiveOfficerMarch12,2007/s/DavidD.BrownDavidD.BrownChiefFinancialOfficerMarch12,2007/s/HaroldV.Groome,Jr.HaroldV.Groome,Jr.DirectorMarch12,2007/s/AllenT.HamnerAllenT.HamnerDirectorMarch12,2007/s/B.W.HarveyB.W.HarveyDirectorMarch12,2007/s/I.NorrisKantorI.NorrisKantorDirectorMarch12,2007/s/A.A.ModenaA.A.ModenaDirectorMarch12,2007/s/RobertE.Perkinson,Jr.RobertE.Perkinson,Jr.DirectorMarch12,2007/s/WilliamP.StaffordWilliamP.StaffordChairmanoftheBoardofDirectorsMarch12,2007/s/WilliamP.Stafford,IIWilliamP.Stafford,IIDirectorMarch12,200790SBM 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17:06:27Exhibit12ComputationofRatiosBasicEarningsPerShare=NetIncome/AverageCommonSharesOutstandingDilutedEarningsPerShare=NetIncome/AverageDilutedSharesOutstandingCashDividendsPerShare=DividendsPaid/AverageCommonSharesOutstandingBookValuePerShare=TotalShareholders’Equity/AverageCommonSharesOutstandingReturnonAverageAssets=NetIncome/AverageAssetsReturnonAverageAssets—Continuing=NetIncomefromContinuingOperations/AverageAssetsReturnonAverageShareholders’Equity=NetIncome/AverageShareholders’EquityReturnonAverageShareholders’Equity—Continuing=IncomefromContinuingOperations/AverageShareholders’EquityEfficiencyRatio=NoninterestExpense/(NetInterestIncomePlusNoninterestIncome)LoanstoDeposits=AverageNetLoans/AverageDepositsOutstandingDividendPayout=DividendsDeclared/NetIncomeAverageShareholders’EquitytoAverageAssets=AverageShareholders’Equity/AverageAssetsTierICapitalRatio=Shareholders’Equity—IntangibleAssets—SecuritiesMark-to-marketCapitalReserve(TierICapital)/RiskAdjustedAssetsTotalCapitalRatio=TierICapitalPlusAllowanceforLoanLosses/RiskAdjustedAssetsTierILeverageRatio=TierICapital/AverageAssetsNetCharge-offstoAverageLoans=(GrossCharge-offsLessRecoveries)/AverageNetLoansNon-performingLoanstoTotalLoans=(NonaccrualLoansPlusLoansPastDue90DaysorGreater)/GrossLoansNetofUnearnedInterest)Non-performingAssetstoTotalLoansPlusOREO=(NonaccrualLoansPlusLoansPastDue90DaysorGreaterPlusOREO)/TotalLoans+OREOAllowanceforLoanLossestoTotalLoans=AllowanceforLoanLosses/(GrossLoansNetofUnearnedInterest)AllowanceforLoanLossestoNon-performingAssets=AllowanceforLoanLosses/(NonaccrualLoansPlusLoansPastDue90daysorGreaterPlusOREO)AllowanceforLoanLossestoNon-performingLoans=AllowanceforLoanLosses/(NonaccrualLoansPerformingLoans)NetInterestMargin=TaxEquivalentNetInterestIncome/AverageEarningAssetsBasicEarningsPerShare—Continuing=IncomefromContinuingOperations/AverageCommonSharesDilutedEarningsPerShare—Continuing=IncomefromContinuingOperations/AverageDilutedSharesSBM BOOKPROOF -- l24096-i000_a.pdf Page 91 of Imposition -- Mon Mar 12 2007-- 17:06:27Exhibit23.1ConsentofIndependentRegisteredPublicAccountingFirmTheBoardofDirectorsandStockholdersFirstCommunityBancshares,Inc.Weconsenttotheincorporationbyreferenceintheregistrationstatementspertainingtothe2004OmnibusStockOptionPlan(FormS-8,No.333-120376),the2001DirectorsStockOptionPlan(FormS-8,No.333-75222),the1999StockOptionPlan(FormS-8,333-31338)andtheEmployeeStockOwnershipandSavingsPlan(FormS-8,No.333-63865)ofFirstCommunityBancshares,Inc.andSubsidiary(the“Company”)ofourreportsdatedMarch12,2007,withrespecttothe2006consolidatedfinancialstatementsoftheCompany,aswellastheCompany’sassessmentoftheeffectivenessofinternalcontroloverfinancialreportingandtheeffectivenessofinternalcontroloverfinancialreportingoftheCompanyincludedinthisAnnualReport(Form10-K)fortheyearendedDecember31,2006.Asheville,NorthCarolinaMarch12,2007SBM BOOKPROOF -- l24096-i000_a.pdf Page 92 of Imposition -- Mon Mar 12 2007-- 17:06:27Exhibit23.2ConsentofIndependentRegisteredPublicAccountingFirmWeconsenttotheincorporationbyreferenceintheRegistrationStatementspertainingtothe2004OmnibusStockOptionPlan(FormS-8,No.333-120376),the2001DirectorsStockOptionPlan(FormS-8,No.333-75222),the1999StockOptionPlan(FormS-8,No.333-31338)andtheEmployeeStockOwnershipandSavingsPlan(FormS-8,No.333-63865)ofFirstCommunityBancshares,Inc.ofourreportdatedMarch3,2006,withrespecttotheconsolidatedfinancialstatementsofFirstCommunityBancshares,Inc.andsubsidiariesincludedinthisAnnualReport(Form10-K)fortheyearendedDecember31,2006.Charleston,WestVirginiaMarch7,2007SBM BOOKPROOF -- l24096-i000_a.pdf Page 93 of Imposition -- Mon Mar 12 2007-- 17:06:27Exhibit31.1CERTIFICATIONI,JohnM.Mendez,certifythat:1.IhavereviewedthisAnnualReportonForm10-KofFirstCommunityBancshares,Inc.;2.Basedonmyknowledge,thisreportdoesnotcontainanyuntruestatementofamaterialfactoromittostateamaterialfactnecessarytomakethestatementsmade,inlightofthecircumstancesunderwhichsuchstatementsweremade,notmisleadingwithrespecttotheperiodcoveredbythisreport;3.Basedonmyknowledge,thefinancialstatements,andotherfinancialinformationincludedinthisreport,fairlypresentinallmaterialrespectsthefinancialcondition,resultsofoperationsandcashflowsoftheregistrantasof,andfor,theperiodspresentedinthisreport;4.Theregistrant’sothercertifyingofficerandIareresponsibleforestablishingandmaintainingdisclosurecontrolsandprocedures(asdefinedinExchangeActRules13a-15(e)and15d-15(e))andinternalcontroloverfinancialreporting(asdefinedinExchangeActRules13a-15(f)and15d-15(f))fortheregistrantandhave:a)Designedsuchdisclosurecontrolsandprocedures,orcausedsuchdisclosurecontrolsandprocedurestobedesignedunderoursupervision,toensurethatmaterialinformationrelatingtotheregistrant,includingitsconsolidatedsubsidiaries,ismadeknowntousbyotherswithinthoseentities,particularlyduringtheperiodinwhichthisreportisbeingprepared;b)Designedsuchinternalcontroloverfinancialreportingorcausedsuchinternalcontroloverfinancialreportingtobedesignedunderoursupervision,toprovidereasonableassuranceregardingthereliabilityoffinancialreportingandthepreparationoffinancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples;c)Evaluatedtheeffectivenessoftheregistrant’sdisclosurecontrolsandproceduresandpresentedinthisreportourconclusionsabouttheeffectivenessofthedisclosurecontrolsandprocedures,asoftheendoftheperiodcoveredbythisreportbasedonsuchevaluation;andd)Disclosedinthisreportanychangeintheregistrant’sinternalcontroloverfinancialreportingthatoccurredduringtheregistrant’sfourthfiscalquarterthathasmateriallyaffected,orisreasonablylikelytomateriallyaffect,theregistrant’sinternalcontroloverfinancialreporting;and5.Theregistrant’sothercertifyingofficerandIhavedisclosed,basedonourmostrecentevaluationofinternalcontroloverfinancialreporting,totheregistrant’sauditorsandtheauditcommitteeoftheregistrant’sboardofdirectors:a)Allsignificantdeficienciesandmaterialweaknessesinthedesignoroperationofinternalcontroloverfinancialreportingwhicharereasonablylikelytoadverselyaffecttheregistrant’sabilitytorecord,process,summarizeandreportfinancialinformation;andb)Anyfraud,whetherornotmaterial,thatinvolvesmanagementorotheremployeeswhohaveasignificantroleintheregistrant’sinternalcontroloverfinancialreporting./s/JohnM.MendezJohnM.MendezChiefExecutiveOfficerDate:March12,2007SBM 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17:06:27Exhibit31.2CERTIFICATIONI,DavidD.Brown,certifythat:1.IhavereviewedthisAnnualReportonForm10-KofFirstCommunityBancshares,Inc.;2.Basedonmyknowledge,thisreportdoesnotcontainanyuntruestatementofamaterialfactoromittostateamaterialfactnecessarytomakethestatementsmade,inlightofthecircumstancesunderwhichsuchstatementsweremade,notmisleadingwithrespecttotheperiodcoveredbythisreport;3.Basedonmyknowledge,thefinancialstatements,andotherfinancialinformationincludedinthisreport,fairlypresentinallmaterialrespectsthefinancialcondition,resultsofoperationsandcashflowsoftheregistrantasof,andfor,theperiodspresentedinthisreport;4.Theregistrant’sothercertifyingofficerandIareresponsibleforestablishingandmaintainingdisclosurecontrolsandprocedures(asdefinedinExchangeActRules13a-15(e)and15d-15(e))andinternalcontroloverfinancialreporting(asdefinedinExchangeActRules13a-15(f)and15d-15(f))fortheregistrantandhave:a)Designedsuchdisclosurecontrolsandprocedures,orcausedsuchdisclosurecontrolsandprocedurestobedesignedunderoursupervision,toensurethatmaterialinformationrelatingtotheregistrant,includingitsconsolidatedsubsidiaries,ismadeknowntousbyotherswithinthoseentities,particularlyduringtheperiodinwhichthisreportisbeingprepared;b)Designedsuchinternalcontroloverfinancialreportingorcausedsuchinternalcontroloverfinancialreportingtobedesignedunderoursupervision,toprovidereasonableassuranceregardingthereliabilityoffinancialreportingandthepreparationoffinancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples;c)Evaluatedtheeffectivenessoftheregistrant’sdisclosurecontrolsandproceduresandpresentedinthisreportourconclusionsabouttheeffectivenessofthedisclosurecontrolsandprocedures,asoftheendoftheperiodcoveredbythisreportbasedonsuchevaluation;andd)Disclosedinthisreportanychangeintheregistrant’sinternalcontroloverfinancialreportingthatoccurredduringtheregistrant’sfourthfiscalquarterthathasmateriallyaffected,orisreasonablylikelytomateriallyaffect,theregistrant’sinternalcontroloverfinancialreporting;and5.Theregistrant’sothercertifyingofficerandIhavedisclosed,basedonourmostrecentevaluationofinternalcontroloverfinancialreporting,totheregistrant’sauditorsandtheauditcommitteeoftheregistrant’sboardofdirectors:a)Allsignificantdeficienciesandmaterialweaknessesinthedesignoroperationofinternalcontroloverfinancialreportingwhicharereasonablylikelytoadverselyaffecttheregistrant’sabilitytorecord,process,summarizeandreportfinancialinformation;andb)Anyfraud,whetherornotmaterial,thatinvolvesmanagementorotheremployeeswhohaveasignificantroleintheregistrant’sinternalcontroloverfinancialreporting./s/DavidD.BrownDavidD.BrownChiefFinancialOfficerDate:March12,2007SBM BOOKPROOF -- l24096-i000_a.pdf Page 95 of Imposition -- Mon Mar 12 2007-- 17:06:27Exhibit32CERTIFICATIONPURSUANTTO18U.S.C.SECTION1350ASADOPTEDPURSUANTTOSECTION906OFTHESARBANES-OXLEYACTOF2002InconnectionwiththeAnnualReportofFirstCommunityBancshares,Inc.(the“Company”)onForm10-KfortheperiodendedDecember31,2006,asfiledwiththeSecuritiesandExchangeCommissiononthedatehereof(the“Report”),theundersignedherebycertify,totheofficers’bestknowledgeandbelief,pursuantto18U.S.C.Section1350,asadoptedpursuanttoSection906oftheSarbanes-OxleyActof2002,that:(a)theReportfullycomplieswiththerequirementsofSection13(a)or15(d)oftheSecuritiesExchangeActof1934,asamended;and(b)theinformationcontainedintheReportfairlypresents,inallmaterialrespects,thefinancialconditionandresultsofoperationsoftheCompany.Datedthis12thdayofMarch,2007.FirstCommunityBancshares,Inc./s/JohnM.MendezJohnM.MendezChiefExecutiveOfficer/s/DavidD.BrownDavidD.BrownChiefFinancialOfficerSBM BOOKPROOF -- l24096-i000_a.pdf Page 96 of Imposition -- Mon Mar 12 2007-- 17:06:27

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