-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F8mbylJC38shIynH1jJ13XDVzFv5KoyYPlgmT1fgeGl1l6LCseaLlnhgCVOylhnS K2rkUvpGJpb/9yHF+Wf0zQ== 0000036029-04-000025.txt : 20040308 0000036029-04-000025.hdr.sgml : 20040308 20040308171349 ACCESSION NUMBER: 0000036029-04-000025 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040308 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST FINANCIAL BANKSHARES INC CENTRAL INDEX KEY: 0000036029 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 750944023 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-07674 FILM NUMBER: 04655385 BUSINESS ADDRESS: STREET 1: 400 PINE STREET STREET 2: P.O. BOX 701 CITY: ABILENE STATE: TX ZIP: 79601 BUSINESS PHONE: 325.627.7167 MAIL ADDRESS: STREET 1: P.O. BOX 701 CITY: ABILENE STATE: TX ZIP: 79604 10-K 1 ffin10k2003.txt FIRST FINANCIAL BANKSHARES, INC. - 12-31-03 10K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to ________ Commission file number 0-7674 First Financial Bankshares, Inc. (Exact Name of Registrant as Specified in Its Charter) Texas 75-0944023 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 400 Pine Street Abilene, Texas 79601 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (325) 627-7155 Securities registered pursuant to Section 12(b) of the Act: Title of Class Name of Exchange on Which Registered -------------- ------------------------------------ None N/A Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $10.00 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No As of June 30, 2003, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of voting stock held by non-affiliates was $459,223,000. As of March 1, 2004, there were 15,483,840 shares of Common Stock outstanding. Documents Incorporated by Reference Certain information called for by Part III is incorporated by reference to the Proxy Statement for the 2004 Annual Meeting of our shareholders, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2003. TABLE OF CONTENTS Page ---- CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS....................1 PART I ITEM 1. Business.................................................1 ITEM 2. Properties..............................................11 ITEM 3. Legal Proceedings.......................................12 ITEM 4. Submission of Matters to a Vote of Security Holders.....12 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters................................12 ITEM 6. Selected Financial Data.................................14 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................15 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk........................................30 ITEM 8. Financial Statements and Supplementary Data.............31 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................32 ITEM 9A. Controls and Procedures.................................33 PART III ITEM 10. Directors and Executive Officers of the Registrant......33 ITEM 11. Executive Compensation..................................33 ITEM 12. Security Ownership of Certain Beneficial Owners and Management ........................................33 ITEM 13. Certain Relationships and Related Transactions..........34 ITEM 14. Principal Accounting Fees and Services..................34 PART IV ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................................34 SIGNATURES..................................................................35 EXHIBIT INDEX...............................................................37 i CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. When used in this Form 10-K, words such as "anticipate," "believe," "estimate," "expect," "intend," "predict," "project," and similar expressions, as they relate to us or our management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including but not limited to: o general economic conditions; o legislative and regulatory actions and reforms; o competition from other financial institutions and financial holding companies; o the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; o changes in the demand for loans; o fluctuations in value of collateral and loan reserves; o inflation, interest rate, market and monetary fluctuations; o changes in consumer spending, borrowing and savings habits; o our ability to attract deposits; o consequences of continued bank mergers and acquisitions in our market area, resulting in fewer but much larger and stronger competitors; o acquisitions and integration of acquired businesses; and o other factors described in "PART II, Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations." Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise. PART I ITEM 1. BUSINESS General First Financial Bankshares, Inc., a Texas corporation, is a financial holding company registered under the Bank Holding Company Act of 1956, or BHCA. As such, we are supervised by the Board of Governors of the Federal Reserve System, or Federal Reserve Board, as well as several other state and federal regulators. We were formed as a bank holding company in 1956 under the original name F & M Operating Company, but our banking operations date back to 1890, when Farmers and Merchants National Bank opened for business in Abilene, Texas. By 1 virtue of a series of reorganizations, mergers, and acquisitions since 1956, we now own, through our wholly-owned Delaware subsidiary, First Financial Bankshares of Delaware, Inc., ten banks, a trust company and a technology operating company, all organized and located in Texas. These subsidiaries are: o First National Bank of Abilene, Abilene, Texas; o First Technology Services, Inc., Abilene, Texas; o First Financial Trust & Asset Management Company, National Association, Abilene, Texas; o Hereford State Bank, Hereford, Texas; o First National Bank, Sweetwater, Texas; o Eastland National Bank, Eastland, Texas; o First Financial Bank, National Association, Cleburne, Texas; o Stephenville Bank and Trust Co., Stephenville,Texas; o San Angelo National Bank, San Angelo, Texas; o Weatherford National Bank, Weatherford, Texas; o First Financial Bank, National Association, Southlake, Texas; and o City National Bank, Mineral Wells, Texas. As described in more detail below, we elected to be treated as a financial holding company in September 2001. Our service centers are located primarily in North-Central and West Texas. Considering the branches and locations of all our subsidiaries, as of December 31, 2003, we had 28 financial centers across Texas, with seven locations in Abilene, two locations in Cleburne, two locations in Stephenville, two locations in San Angelo, three locations in Weatherford, and one location each in Mineral Wells, Hereford, Sweetwater, Eastland, Southlake, Aledo, Alvarado, Burleson, Keller, Trophy Club, Roby, and Trent. Information on our revenues, profits and losses and total assets appears in the discussion of our Results of Operations contained in Item 7 hereof. First Financial Bankshares, Inc. We provide management and technical resources and policy direction to our subsidiaries, which enables them to improve or expand their banking services while continuing their local activity and identity. Each of our subsidiaries operates under the day-to-day management of its own board of directors and officers, with substantial authority in making decisions concerning their own investments, loan policies, interest rates, and service charges. We provide resources and policy direction in, among other things, the following areas: o asset and liability management; o accounting, budgeting, planning and insurance; o capitalization; and o regulatory compliance. In particular, we assist our subsidiaries with, among other things, decisions concerning major capital expenditures, employee fringe benefits, including pension plans and group medical, dividend policies, and appointment of officers and directors and their compensation. We also perform, through corporate staff groups or by outsourcing to third parties, internal audits and loan reviews of our subsidiaries. We provide advice and specialized services for our banks related to lending, investing, purchasing, advertising, public relations, and computer services. We evaluate various potential financial institution acquisition opportunities and evaluate potential locations for new branch offices. We anticipate that funding for any acquisitions or expansions would be provided from our existing cash balances, available dividends from subsidiary banks, utilization of available lines of credit and future debt or equity offerings. 2 Services Offered by Our Subsidiary Banks Each of our subsidiary banks is a separate legal entity that operates under the day-to-day management of its own board of directors and officers. Each of our subsidiary banks provides general commercial banking services, which include accepting and holding checking, savings and time deposits, making loans, automated teller machines, drive-in and night deposit services, safe deposit facilities, transmitting funds, and performing other customary commercial banking services. Effective January 1, 2004, the activities of trust departments of First National Bank of Abilene, First National Bank, Sweetwater, Stephenville Bank and Trust Co., and San Angelo National Bank were transferred to our new trust company, First Financial Trust & Asset Management Company, National Association. Through this new company, we administer pension plans, profit sharing plans and other employee benefit plans as well as administering estates, testamentary trusts, various types of living trusts, and agency accounts. We believe that the structure of our new trust company will result in a more effectively managed trust department and provide trust services to customers of our banks that do not currently have trust departments. In addition, First National Bank of Abilene, First Financial Bank, National Association, Cleburne, San Angelo National Bank and First Financial Bank, National Association, Southlake, Texas provide securities brokerage services through arrangements with various third parties. Competition Commercial banking in Texas is highly competitive, and because we hold less than 1% of the state's deposits, we represent only a minor segment of the industry. To succeed in this industry, our management believes that our banks must have the capability to compete in the areas of (1) interest rates paid or charged; (2) scope of services offered; and (3) prices charged for such services. Our subsidiary banks compete in their respective service areas against highly competitive banks, thrifts, savings and loan associations, small loan companies, credit unions, mortgage companies, and brokerage firms, all of which are engaged in providing financial products and services and some of which are larger than our subsidiary banks in terms of capital, resources and personnel. Our business does not depend on any single customer or any few customers, the loss of any one of which would have a materially adverse effect upon our business. Although we have a broad base of customers that are not related to us, our customers also occasionally include our officers and directors, as well as other entities with which we are affiliated. With our subsidiary banks we may make loans to officers and directors, and entities with which we are affiliated, in the ordinary course of business. We make these loans on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Loans to directors, officers and their affiliates are also subject to numerous restrictions under federal and state banking laws which we describe in greater detail below. Employees With our subsidiary banks we employed approximately 780 full-time equivalent employees at March 1, 2004. Our management believes that our employee relations have been and will continue to be good. Supervision and Regulation Both federal and state laws extensively regulate bank holding companies, financial holding companies and banks. These laws (and the regulations promulgated thereunder) are primarily intended to protect depositors and the deposit insurance fund of the Federal Deposit Insurance Corporation, or FDIC, although shareholders may also benefit. The following information describes particular laws and regulatory provisions relating to financial holding companies and banks. This discussion is qualified in its entirety by reference to the particular laws and regulatory provisions. A change in any of these laws or regulations may have a material effect on our business and the business of our subsidiary banks. Bank Holding Companies and Financial Holding Companies Traditionally, the activities of bank holding companies were limited to the business of banking and activities closely related or incidental to banking. Bank holding companies were generally prohibited from acquiring control of any 3 company which was not a bank and from engaging in any business other than the business of banking or managing and controlling banks. The Gramm-Leach-Bliley Act, which took effect on March 12, 2000, dismantled many Depression-era restrictions against affiliation between banking, securities and insurance firms by permitting bank holding companies to engage in a broader range of financial activities, so long as certain safeguards are observed. Specifically, bank holding companies may elect to become "financial holding companies" that may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental to a financial activity. Thus, with the enactment of the Gramm-Leach-Bliley Act, banks, securities firms and insurance companies find it easier to acquire or affiliate with each other and cross-sell financial products. The act permits a single financial services organization to offer a more complete array of financial products and services than historically was permitted. A financial holding company is essentially a bank holding company with significantly expanded powers. Under the Gramm-Leach-Bliley Act, among the activities that will be deemed "financial in nature" for financial holding companies are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, activities which the Federal Reserve Board determines to be closely related to banking, and certain merchant banking activities. The Federal Reserve Board has proposed permitting a number of additional financial activities, but we cannot predict whether any of these additional proposals will be adopted or the form any final rule will take. We elected to become a financial holding company in September 2001. As a financial holding company, we have very broad discretion to affiliate with securities firms and insurance companies, make merchant banking investments, and engage in other activities that the Federal Reserve Board has deemed financial in nature. In order to continue as a financial holding company, we must continue to be well-capitalized, well-managed and maintain compliance with the Community Reinvestment Act. Depending on the types of financial activities that we may engage in in the future, under Gramm-Leach-Bliley's fractional regulation principles, we may become subject to supervision by additional government agencies. The election to be treated as a financial holding company increases our ability to offer financial products and services that historically we were either unable to provide or were only able to provide on a limited basis. As a result, we will face increased competition in the markets for any new financial products and services that we may offer. Likewise, an increased amount of consolidation among banks and securities firms or banks and insurance firms could result in a growing number of large financial institutions that could compete aggressively with us. Mergers and Acquisitions We generally must obtain approval from the banking regulators before we can acquire other financial institutions. We must not engage in certain acquisitions if we are undercapitalized. Furthermore, the BHCA provides that the Federal Reserve Board cannot approve any acquisition, merger or consolidation that may substantially lessen competition in the banking industry, create a monopoly in any section of the country, or be a restraint of trade. However, the Federal Reserve Board may approve such a transaction if the convenience and needs of the community clearly outweigh any anti-competitive effects. Specifically, the Federal Reserve Board would consider, among other factors, the expected benefits to the public (greater convenience, increased competition, greater efficiency, etc.) against the risks of possible adverse effects (undue concentration of resources, decreased or unfair competition, conflicts of interest, unsound banking practices, etc.). Banks Federal and state laws and regulations that govern banks have the effect of, among other things, regulating the scope of business, investments, cash reserves, the purpose and nature of loans, the maximum interest rate chargeable on loans, the amount of dividends declared, and required capitalization ratios. National Banking Associations. Banks that are organized as national banking associations under the National Bank Act are subject to regulation and examination by the Office of the Comptroller of the Currency, or OCC. The OCC supervises, regulates and regularly examines the First National Bank of Abilene, First National Bank, Sweetwater, First Financial Bank, National Association, Cleburne, Eastland National Bank, San Angelo National Bank, Weatherford National Bank, First Financial Bank, National Association, Southlake and City National Bank, Mineral Wells, as well as our new trust company, First Financial Trust & 4 Asset Management Company, National Association. The OCC's supervision and regulation of banks is primarily intended to protect the interests of depositors. The National Bank Act: o requires each national banking association to maintain reserves against deposits, o restricts the nature and amount of loans that may be made and the interest that may be charged, and o restricts investments and other activities. State Banks. Banks that are organized as state banks under Texas law are subject to regulation and examination by the Banking Commissioner of the State of Texas. The Commissioner regulates and supervises, and the Texas Banking Department regularly examines, Hereford State Bank and Stephenville Bank and Trust Co. The Commissioner's supervision and regulation of banks is primarily designed to protect the interests of depositors. Texas law o requires each state bank to maintain reserves against deposits, o restricts the nature and amount of loans that may be made and the interest that may be charged, and o restricts investments and other activities. Because our Texas-chartered banks are members of the FDIC, they are also subject to regulation at the federal level by the FDIC, and are subject to most of the federal laws described below. Deposit Insurance Each of our subsidiary banks is a member of the FDIC. The FDIC provides deposit insurance protection that covers all deposit accounts in FDIC-insured depository institutions and generally does not exceed $100,000 per depositor. Our subsidiary banks must pay assessments to the FDIC under a risk-based assessment system for federal deposit insurance protection. FDIC-insured depository institutions that are members of the Bank Insurance Fund pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (i.e., institutions that pose a greater risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to bank regulators. In addition, the FDIC can impose special assessments to cover the costs of borrowings from the U.S. Treasury, the Federal Financing Bank and the Bank Insurance Fund member banks. As of December 31, 2003, the assessment rate for each of our subsidiary banks is at the lowest level risk-based premium available. Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, or FIRREA, an FDIC-insured depository institution can be held liable for any losses incurred by the FDIC in connection with (1) the "default" of one of its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one of its FDIC-insured subsidiaries "in danger of default." "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The Federal Deposit Insurance Act, or FDIA requires that the FDIC review (1) any merger or consolidation by or with an insured bank, or (2) any establishment of branches by an insured bank. The FDIC is also empowered to regulate interest rates paid by insured banks. Approval of the FDIC is also required before an insured bank retires any part of its common or preferred stock, or any capital notes or debentures. Insured banks that are also members of the Federal Reserve System, however, are regulated with respect to the foregoing matters by the Federal Reserve System. 5 Payment of Dividends We are a legal entity separate and distinct from our banking and other subsidiaries. We receive most of our revenue from dividends paid to us by our Delaware holding company subsidiary. Similarly, the Delaware holding company subsidiary receives dividends from our bank subsidiaries. Described below are some of the laws and regulations that apply when either we or our subsidiary banks pay dividends. Each state bank that is a member of the Federal Reserve System and each national banking association is required by federal law to obtain the prior approval of the Federal Reserve Board and the OCC, respectively, to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank's net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). Our subsidiary banks paid aggregate dividends of approximately $34.6 million in 2003 and approximately $26.6 million in 2002. Under the dividend restrictions discussed above, as of December 31, 2003, our subsidiary banks, without obtaining governmental approvals, could have declared in the aggregate additional dividends of approximately $14.5 million from retained net profits. To pay dividends, we and our subsidiary banks must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve Board and the OCC have each indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends to the extent that net income is sufficient to cover both cash dividends and rate of earnings retention consistent with capital needs, asset quality and overall financial condition. No undercapitalized institution may pay a dividend. Affiliate Transactions The Federal Reserve Act, the FDIA and the rules adopted under these statutes restrict the extent to which we can borrow or otherwise obtain credit from, or engage in certain other transactions with, our depository subsidiaries. These laws regulate "covered transactions" between insured depository institutions and their subsidiaries, on the one hand, and their nondepository affiliates, on the other hand. "Covered transactions" include a loan or extension of credit to a nondepository affiliate, a purchase of securities issued by such an affiliate, a purchase of assets from such an affiliate (unless otherwise exempted by the Federal Reserve Board), an acceptance of securities issued by such an affiliate as collateral for a loan, and an issuance of a guarantee, acceptance, or letter of credit for the benefit of such an affiliate. The "covered transactions" that an insured depository institution and its subsidiaries are permitted to engage in with their nondepository affiliates are limited to the following amounts: (1) in the case of any one such affiliate, the aggregate amount of "covered transactions" cannot exceed ten percent of the capital stock and the surplus of the insured depository institution; and (2) in the case of all affiliates, the aggregate amount of "covered transactions" cannot exceed twenty percent of the capital stock and surplus of the insured depository institution. In addition, extensions of credit that constitute "covered transactions" must be collateralized in prescribed amounts. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Finally, when we and our subsidiary banks conduct transactions internally among us, we are required to do so at arm's length. Loans to Directors, Executive Officers and Principal Shareholders The authority of our subsidiary banks to extend credit to our directors, executive officers and principal shareholders, including their immediate family members and corporations and other entities that they control, is subject to substantial restrictions and requirements under Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder, as well as the Sarbanes-Oxley Act of 2002. These statutes and regulations impose specific 6 limits on the amount of loans our subsidiary banks may make to directors and other insiders, and specified approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans our subsidiary banks make to directors and other insiders must satisfy the following requirements: o The loans must be made on substantially the same terms, including interest rates and collateral, as prevailing at the time for comparable transactions with persons not affiliated with us or the subsidiary banks; o The subsidiary banks must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with persons who are not affiliated with us or the subsidiary banks; and o The loans must not involve a greater than normal risk of repayment or other unfavorable features. Furthermore, each subsidiary bank must periodically report all loans made to directors and other insiders to the bank regulators, and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O. Capital Bank Holding Companies and Financial Holding Companies. The Federal Reserve Board has adopted risk-based capital guidelines for bank holding companies and financial holding companies. The ratio of total capital to risk weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) must be a minimum of eight percent. At least half of the total capital is to be composed of common shareholders' equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less goodwill, which is collectively referred to as Tier 1 Capital. The remainder of total capital may consist of subordinated debt, other preferred stock and a limited amount of loan loss reserves. In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies and financial holding companies. Bank holding companies and financial holding companies that meet certain specified criteria, including having the highest regulatory rating, must maintain a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to average assets for the current quarter, less goodwill) of three percent. Bank holding companies and financial holding companies that do not have the highest regulatory rating will generally be required to maintain a higher Tier 1 Capital leverage ratio of three percent plus an additional cushion of 100 to 200 basis points. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us. The guidelines also provide that bank holding companies and financial holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions. Such strong capital positions must be kept substantially above the minimum supervisory levels without significant reliance on intangible assets (e.g., goodwill, core deposit intangibles and purchased mortgage servicing rights). As of December 31, 2003, our capital ratios were as follows: (1) Tier 1 Capital to Risk-Weighted Assets Ratio, 18.83%; (2) Total Capital to Risk-Weighted Assets Ratio, 19.83%; and (3) Tier 1 Capital Leverage Ratio, 10.6%. Banks. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA established five capital tiers with respect to depository institutions: "well-capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." A depository institution's capital tier will depend upon where its capital levels are in relation to various relevant capital measures, including (1) risk-based capital measures, (2) a leverage ratio capital measure and (3) certain other factors. Regulations establishing the specific capital tiers provide that a "well-capitalized" institution will have a total risk-based capital ratio of ten percent or greater, a Tier 1 risk-based capital ratio of six percent or greater, and a Tier 1 leverage ratio of five percent or greater, and not be subject to any written regulatory enforcement agreement, order, capital directive or prompt corrective action derivative. For an institution to be "adequately capitalized," it will have a total risk-based capital ratio of eight percent or greater, a Tier 1 risk-based capital ratio of four percent or greater, and a Tier 1 leverage ratio of four percent or greater (in some cases three percent). For an institution to be "undercapitalized," it will have a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio less than four percent or a Tier 1 leverage ratio less than four percent (or a leverage ratio less than three percent if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). For an institution to be "significantly undercapitalized," it will have a total risk-based capital ratio less than six percent, a Tier 1 7 risk-based capital ratio less than three percent, or a Tier 1 leverage ratio less than three percent. For an institution to be "critically undercapitalized," it will have a ratio of tangible equity to total assets equal to or less than two percent. FDICIA requires federal banking agencies to take "prompt corrective action" against depository institutions that do not meet minimum capital requirements. Under current regulations, we were "well capitalized" as of December 31, 2003. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be "undercapitalized." An "undercapitalized" institution must develop a capital restoration plan and its parent holding company must guarantee that institution's compliance with such plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the institution's assets at the time it became "undercapitalized" or the amount needed to bring the institution into compliance with all capital standards. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. If a depository institution fails to submit an acceptable capital restoration plan, it shall be treated as if it is "significantly undercapitalized." "Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator. Finally, FDICIA requires the various regulatory agencies to set forth certain standards that do not relate to capital. Such standards relate to the safety and soundness of operations and management and to asset quality and executive compensation, and permit regulatory action against a financial institution that does not meet such standards. If an insured bank fails to meet its capital guidelines, it may be subject to a variety of other enforcement remedies, including a prohibition on the taking of brokered deposits and the termination of deposit insurance by the FDIC. Bank regulators continue to indicate their desire to raise capital requirements beyond their current levels. In addition to FDICIA capital standards, Texas-chartered banks must also comply with the capital requirements imposed by the Texas Banking Department. Neither the Texas Finance Code nor its regulations specify any minimum capital-to-assets ratio that must be maintained by a Texas-chartered bank. Instead, the Texas Banking Department determines the appropriate ratio on a bank by bank basis, considering factors such as the nature of a bank's business, its total revenue, and the bank's total assets. As of December 31, 2003, all of our Texas-chartered banks exceeded the minimum ratios applied to them. Our Support of Our Subsidiary Banks Under Federal Reserve Board policy, we are expected to commit resources to act as a source of strength to support each of our subsidiary banks. This support may be required at times when, absent such Federal Reserve Board policy, we would not otherwise be required to provide it. In addition, any loans we make to our subsidiary banks would be subordinate in right of payment to deposits and to other indebtedness of our banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be subject to a priority of payment. Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the OCC is authorized to require the bank's shareholders to pay the deficiency on a pro-rata basis. If any shareholder refuses to pay the pro-rata assessment after three months notice, then the bank's board of directors must sell an appropriate amount of the shareholder's stock at a public auction to make up the deficiency. To the extent necessary, if a deficiency in capital still exists and the bank refuses to go into liquidation, then a receiver may be appointed to wind up the bank's affairs. Additionally, under the Federal Deposit Insurance Act, in the event of a loss suffered or anticipated by the FDIC (either as a result of the default of a banking subsidiary or related to FDIC assistance provided to a subsidiary in danger of default) our other banking subsidiaries may be assessed for the FDIC's loss. 8 Interstate Banking and Branching Act Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or Riegle-Neal Act, a bank holding company or financial holding company is able to acquire banks in states other than its home state. The Riegle-Neal Act also authorized banks to merge across state lines, thereby creating interstate branches, beginning June 1, 1997. Furthermore, under this act, a bank is now able to open new branches in a state in which it does not already have banking operations, if the laws of such state permit it to do so. Accordingly, both the OCC and the Texas Banking Department accept applications for interstate merger and branching transactions, subject to certain limitations on ages of the banks to be acquired and the total amount of deposits within the state a bank or financial holding company may control. Since our primary service area is Texas, we do not expect that the ability to operate in other states will have any material impact on our growth strategy. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets in Texas. Community Reinvestment Act of 1977 The Community Reinvestment Act of 1977, or CRA subjects a bank to regulatory assessment to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the bank, and to take that determination into account in its evaluation of any application made by such bank for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. We believe our subsidiary banks have taken significant actions to comply with the CRA, and each has received at least a "satisfactory" commendation in its most recent review by federal regulators with respect to its compliance with the CRA. Monitoring and Reporting Suspicious Activity Under the Bank Secrecy Act, IRS rules and other regulations, we are required to monitor and report unusual or suspicious account activity as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism, or USA PATRIOT Act, of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and "know your customer" standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps: o to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction; o to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions; o to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and o to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information. Under the USA PATRIOT Act, financial institutions are also required to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including: 9 o the development of internal policies, procedures, and controls; o the designation of a compliance officer; o an ongoing employee training program; and o an independent audit function to test the programs. In addition, the USA PATRIOT Act also requires the Secretary of the Treasury to adopt rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to violate the privacy provisions of the Gramm-Leach-Bliley Act that are discussed below. Finally, under the regulations of the Office of Foreign Asset Control, we are required to monitor and block transactions with certain "specially designated nationals" who OFAC has determined pose a risk to U.S. national security. Consumer Laws and Regulations We are also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the following list is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others. These laws and regulations among other things prohibit discrimination on the basis of race, gender or other designated characteristics and mandate various disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. These and other laws also limit finance charges or other fees or charges earned in our activities. We must comply with the applicable provisions of these consumer protection laws and regulations as part of our ongoing customer relations. Technology Risk Management and Consumer Privacy State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes expose a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology-related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology. Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information. Under the Gramm-Leach-Bliley Act, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a consumer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution's ability to disclose nonpublic personal information about consumers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices which describe in general terms the bank's information sharing practices. Banks that share nonpublic personal information about customers with nonaffiliated third 10 parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit, or transaction accounts to any nonaffiliated third party for use in marketing. Monetary Policy Banks are affected by the credit policies of other monetary authorities, including the Federal Reserve Board, that affect the national supply of credit. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. Pending and Proposed Legislation New regulations and statutes are regularly proposed containing wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute. Enforcement Powers of Federal Banking Agencies The Federal Reserve and other state and federal banking agencies and regulators have broad enforcement powers, including the power to terminate deposit insurance, issue cease-and-desist orders, impose substantial fees and other civil and criminal penalties and appoint a conservator or receiver. Our failure to comply with applicable laws, regulations and other regulatory pronouncements could subject us, as well as our officers and directors, to administrative sanctions and potentially substantial civil penalties. Available Information We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document we file at the Securities and Exchange Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public at the Securities and Exchange Commission's web site at http://www.sec.gov. Our web site is http://www.ffin.com. You may also obtain copies of our annual, quarterly and special reports, proxy statements and certain other information filed with the SEC, as well as amendments thereto, free of charge from our web site. These documents are posted to our web site as soon as reasonably practicable after we have filed them with the SEC. Our corporate governance guidelines, including our code of conduct applicable to all our employees, officers and directors, as well as the charters of our audit and nominating committees, are available at www.ffin.com. The foregoing information is also available in print to any shareholder who requests it. No information on any web site is incorporated into this Form 10-K or our other securities filings and is not a part of them. ITEM 2. PROPERTIES Our principal office is located in the First National Bank Building at 400 Pine Street in downtown Abilene, Texas. We lease two spaces in a building owned by First National Bank of Abilene. The lease for approximately 3,300 square feet of space expires December 31, 2010. The lease for approximately 1,100 square feet of space expires May 31, 2006. Our subsidiary banks collectively own 22 banking facilities, some of which are detached drive-ins, and they also lease five banking facilities and two ATM locations. Our management considers all of our existing locations to be well-suited for conducting the business of banking. We believe that our existing facilities are adequate to meet our requirements and our subsidiary banks' requirements for the foreseeable future. 11 ITEM 3. LEGAL PROCEEDINGS From time to time we and our subsidiary banks are parties to lawsuits arising in the ordinary course of our banking business. However, there are no material pending legal proceedings to which we, our subsidiary banks or our other direct and indirect subsidiaries, or any of their properties, are currently subject. Other than regular, routine examinations by state and federal banking authorities, there are no proceedings pending or known to be contemplated by any governmental authorities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our security holders during the fourth quarter of our fiscal year ended December 31, 2003. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information Our common stock, par value $10.00 per share, is traded on the Nasdaq Stock Market under the trading symbol FFIN. See "Item 8--Financial Statements and Supplementary Data--Quarterly Financial Data" for the high, low and closing sales prices as reported by the Nasdaq National Market for our common stock for the periods indicated. Holders As of February 1, 2004, we had approximately 1,600 shareholders of record. Dividends See "Item 8--Financial Statements and Supplementary Data--Quarterly Results of Operations" for the frequency and amount of cash dividends paid by us. Also, see "Item 1 - Business - Supervision and Regulation - Payment of Dividends" and "Item 7 - Management's Discussion and Analysis of the Financial Condition and Results of Operations - Liquidity - Dividends" for restrictions on our present or future ability to pay dividends, particularly those restrictions arising under federal and state banking laws. 12 Recent Sales of Unregistered Securities During the year ended December 31, 2003, the following sales of unregistered shares of common stock were made to employees in connection with their exercise of stock options: Number of Aggregate Sales Date Common Shares Price Per Share Price ---- ------------- --------------- ----- 02-11-03 551 $ 11.92 $ 6,571 03-05-03 250 11.92 2,980 03-05-03 125 11.92 1,490 03-06-03 94 16.64 1,560 03-07-03 3,018 11.92 35,969 04-03-03 187 16.64 3,120 04-03-03 1,609 11.92 19,176 04-21-03 94 16.64 1,560 04-29-03 137 23.42 3,220 04-29-03 1,250 11.92 14,900 04-29-03 1,688 11.92 20,115 04-29-03 250 11.92 2,980 04-29-03 94 16.64 1,560 05-02-03 125 11.92 1,490 05-07-03 1,071 18.15 19,468 05-07-03 313 11.92 3,725 05-08-03 94 11.92 1,118 05-08-03 250 11.92 2,980 05-14-03 1,072 18.15 19,468 05-14-03 278 23.42 6,498 05-14-03 250 16.64 4,160 05-14-03 464 11.92 5,528 05-14-03 257 23.42 6,029 06-06-03 801 11.92 9,548 06-06-03 500 11.92 5,960 06-10-03 103 23.42 2,412 06-13-03 2,012 11.92 23,983 07-08-03 549 23.42 12,858 07-21-03 2,165 16.30 35,283 07-29-03 300 23.42 7,026 07-29-03 824 23.42 19,298 09-18-03 500 23.42 11,710 11-07-03 808 11.92 9,631 11-07-03 150 23.42 3,513 12-02-03 500 11.92 5,960 12-08-03 800 18.15 14,520 12-09-03 686 23.42 16,066 12-09-03 412 23.42 9,649 12-10-03 756 23.42 17,705 12-11-03 600 11.92 7,152 12-18-03 200 11.92 2,384 ------ --------- Totals 26,187 $ 400,323 ====== ========= Each of the foregoing sales were made in reliance upon the exemption provided by Section 4(2)and Section 3(a)(10) of the Securities Act of 1933, as amended. 13 ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below as of and for the years ended December 31, 2003, 2002, 2001, 2000, and 1999, have been derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with "Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements. The results of operations presented below are not necessarily indicative of the results of operations that may be achieved in the future. The amounts related to shares of our common stock have been adjusted to give effect to all stock dividends and stock splits. Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated information required to be disclosed by the Securities and Exchange Commissions' Industry Guide 3, "Statistical Disclosure by Bank Holding Companies."
Year Ended December 31, --------------------------------------------------------------------- 2003 2002 2001 2000 1999 ------------ ---------- ---------- ---------- ---------- (dollars in thousands, except per share data) Summary Income Statement Information: Interest income $ 95,285 $ 104,286 $ 115,874 $ 117,951 $ 110,013 Interest expense 17,131 24,380 44,834 48,829 43,338 ------------ ---------- ---------- ---------- ---------- Net interest income 78,154 79,906 71,040 69,122 66,675 Provision for loan losses 1,178 2,370 1,964 2,398 2,031 Noninterest income 34,109 30,129 28,177 25,947 24,484 Noninterest expense 61,154 59,082 55,071 51,692 51,934 ------------ ---------- ---------- ---------- ---------- Earnings before income taxes 49,931 48,583 42,182 40,979 37,194 Income tax expense 14,626 14,630 12,827 12,663 11,504 ------------ ---------- ---------- ---------- ---------- Net earnings $ 35,305 $ 33,953 $ 29,355 $ 28,316 $ 25,690 ============ ========== ========== ========== ========== Per Share Data: Net earnings per share, basic $ 2.28 $ 2.20 $ 1.91 $ 1.82 $ 1.65 Net earnings per share, assuming dilution 2.27 2.19 1.90 1.82 1.64 Cash dividends declared 1.21 1.08 0.93 0.82 0.72 Book value at period-end 16.25 15.45 13.86 12.74 11.46 Earnings performance ratios: Return on average assets 1.75% 1.78% 1.62% 1.67% 1.53% Return on average equity 14.40 14.97 14.35 15.39 14.84 Summary Balance Sheet Data (Period-end): Investment securities $ 910,302 $ 772,256 $ 721,694 $ 654,253 $ 656,218 Loans 987,523 964,040 940,131 859,271 797,275 Total assets 2,092,571 1,993,183 1,929,694 1,753,814 1,723,369 Deposits 1,796,271 1,711,562 1,685,163 1,519,874 1,524,704 Total liabilities 1,841,085 1,754,415 1,716,040 1,557,693 1,544,706 Total shareholders' equity 251,487 238,768 213,654 196,121 178,663 Asset quality ratios: Allowance for loan losses/period-end loans 1.17% 1.16% 1.13% 1.15% 1.12% Nonperforming assets/period-end loans plus foreclosed assets 0.32 0.44 0.51 0.48 0.26 Net charge offs/average loans 0.09 0.19 0.18 0.18 0.27 Capital ratios: Average shareholders' equity/average assets 12.13% 11.89% 11.29% 10.86% 10.30% Leverage ratio (1) 10.60 10.51 9.92 10.40 9.62 Tier 1 risk-based capital (2) 18.83 18.42 17.10 17.75 17.19 Total risk-based capital (3) 19.83 19.47 18.08 18.74 18.13 Dividend payout ratio 53.10 49.13 48.94 45.23 43.64
- -------------------------------------------------------------------------------- (1) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available-for-sale) less intangible assets by fourth quarter average assets less intangible assets. (2) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available-for-sale) less intangible assets by risk-adjusted assets. (3) Calculated by dividing, at period-end, shareholders' equity (before unrealized gain/loss on securities available for sale) less intangible assets plus allowance for loan losses to the extent allowed under regulatory guidelines by risk-adjusted assets. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction As a multi-bank financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans are deposits we hold in our subsidiary banks. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing non interest expense by the sum of net interest income on a tax equivalent basis and non interest income. You should read the following discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2003 and 2002, and consolidated statements of earnings for the years 2001 through 2003 in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K. All prices and per share data related to our common stock have been adjusted to give effect to all stock splits and stock dividends, including the five-for-four stock split in the form of a 25% stock dividend effective June 2, 2003 for shareholders of record on May 16, 2003. Critical Accounting Policies We prepare consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions. We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements. The following discussion addresses our allowance for loan loss and its provision for loan losses, which we deem to be our most critical accounting policy. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe that these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely that they would have a material impact on our reported results for a given period. The allowance for loan losses is an amount that we believe will be adequate to absorb inherent estimated losses on existing loans in which full collectibility is unlikely based upon our review and evaluation of the loan portfolio, including letters of credit, lines of credit and unused commitments to provide financing. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Our periodic evaluation of the adequacy of the allowance is based on general economic conditions, the financial condition of the borrower, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners. We have developed a consistent, well-documented loan review methodology that includes allowances assigned to specific loans and nonspecific allowances, which are based on the factors noted in the prior sentence. While each subsidiary bank is responsible for the adequacy of its allowance, our independent loan review department is responsible for reviewing this evaluation for all of our subsidiary banks to ensure consistent methodology and overall adequacy for us. Although we believe that we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory 15 agencies periodically review our allowance for loan losses. The bank regulatory agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Our policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan's observable market price. Results of Operations Performance Summary. Net earnings for 2003 were $35.3 million, an increase of $1.4 million, or 3.98% over net earnings for 2002 of $34.0 million. Net earnings for 2001 were $29.4 million. The increase in net earnings for 2003 over 2002 was primarily attributable to growth in noninterest income and a decline in the provision for loan losses. The increase in net earnings for 2002 over 2001 was primarily attributable to an increase in net interest income resulting primarily from the growth in average earning assets and an overall improved net interest margin. The improvement in loan loss provision experienced in 2003 over 2002 was due to decreases in net charge-offs and nonperforming loans. On a basic net earnings per share basis, net earnings were $2.28 for 2003 as compared to $2.20 for 2002 and $1.91 for 2001. Return on average assets was 1.75% for 2003 as compared to 1.78% for 2002 and 1.62% for 2001. Return on average equity was 14.40% for 2003 as compared to 14.97% for 2002 and 14.35% for 2001. The implementation of Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") affect our 2003 and 2002 net earnings and basic and diluted earnings per share as compared to 2001 amounts. SFAS No. 141 required that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addressed the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 also addressed the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provided that intangible assets with finite useful lives continue to be amortized and that goodwill and intangible assets with indefinite lives no longer be amortized, but rather be tested annually for impairment. SFAS No. 142 was effective January 1, 2002; however, acquired goodwill and intangible assets recorded in the acquisition of City Bancshares, Inc. were subject immediately to its provisions. On January 1, 2002, goodwill amounting to $23,765,896 was not subject to further amortization as a result of SFAS No. 142. We conducted our required goodwill impairment test in 2003 and 2002, with no reduction of recorded goodwill resulting from the test. A reconciliation adjusting comparative net earnings and earnings per share for the year ended December 31, 2001, to show the effect of no longer amortizing our goodwill, follows: 16 Reported net earnings $ 29,354,505 Add back: goodwill amortization Goodwill amortization, before income tax 1,641,367 Income tax benefit (420,000) ------------ Adjusted net earnings $ 30,575,872 ============ Basic earnings per share: Reported net earnings $ 1.91 Goodwill amortization, net of income tax benefit 0.08 ------------ Adjusted net earnings $ 1.99 ============ Earnings per share, assuming dilution: Reported net earnings $ 1.90 Goodwill amortization, net of income tax benefit 0.08 ------------ Adjusted net earnings $ 1.98 ============ On July 3, 2001, we acquired City Bancshares, Inc. and its subsidiary City National Bank, Mineral Wells, Texas for $16.5 million in cash. The results of City National Bank are included in our consolidated financial statements beginning July 1, 2001 and may to some extent affect the comparisons to the prior period amounts and 2003 and 2002 operating results which include full years of City National Bank's operations. Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest income was $82.3 million in 2003 as compared to $83.6 million in 2002 and $74.2 million in 2001. The decrease in 2003 compared to 2002 was the result of declining net interest spreads offset by increases in volume of earning assets. In 2002, the increase over 2001 was primarily due to the growth in the volume of earning assets and an improved net interest spread. Average earning assets were $1.856 billion in 2003, as compared to $1.748 billion in 2002 and $1.653 billion in 2001. The 2003 increase in average earning assets is attributable to a larger volume of investment securities we held, which increased $118.1 million, and a larger volume of loans we made, which increased $4.1 million. These increases were partially offset by a $14.4 million decrease in the 2003 average of short-term investments, which consist primarily of federal funds sold. The 2002 increase in average earning assets was attributable to higher average investment securities we held, which increased $72.3 million, and higher average loans we made, which increased $44.5 million. Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and rate. Table 1 -- Changes in Interest Income and Interest Expense (in thousands):
2003 Compared to 2002 2002 Compared to 2001 ------------------------------------ ------------------------------------ Change Attributable to Change Attributable to --------------------- Total ----------------------- Total Volume Rate Change Volume Rate Change -------- -------- ---------- ----------- -------- -------- Short-term investments................. $ (239) $ (241) $ (480) $ (905) $ (1,359) $ (2,264) Taxable investment securities.......... 4,907 (8,234) (3,327) 3,394 (3,094) 300 Tax-exempt investment securities (1)... 1,925 (325) 1,600 1,032 241 1,273 Loans (1).............................. 277 (6,599) (6,322) 3,690 (14,065) (10,375) -------- -------- ---------- ----------- -------- -------- Interest income.................... 6,870 (15,399) (8,529) 7,211 (18,277) (11,066) Interest-bearing deposits.............. 943 (8,063) (7,120) 1,169 (21,052) (19,883) Short-term borrowings.................. (59) (70) (129) (26) (545) (571) -------- -------- ---------- ----------- -------- -------- Interest expense................... 884 (8,133) (7,249) 1,143 (21,597) (20,454) -------- -------- ---------- ----------- -------- -------- Net interest income (expense) $ 5,986 $ (7,266) $ (1,280) $ 6,068 $ 3,320 $ 9,388 ======== ======== ========== =========== ======== ========
- ------------------ (1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%. The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2 for the years 2001 through 2003. As the prime rate declined from 4.75% to 4.00% in 2003, 17 we repriced our earning assets correspondingly as the market required but were unable to reduce interest bearing deposits by the same amounts as some deposits had previously been reduced to the lowest rates we believed the market could bear. This change resulted in a lower net interest margin. In 2002, we repriced our interest bearing deposits more than our earning assets as we had repriced earning assets in 2001 in advance of changes to rates of interest bearing deposits. This repricing improved our net margin in 2002 over 2001. Table 2 -- Average Balances and Average Yields and Rates (in thousands, except percentages):
2003 2002 2001 ------------------------- ------------------------- ------------------------- Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate ---------- -------- ---- ---------- -------- ---- ---------- -------- ---- Assets Short-term investments..... $ 42,643 $ 467 1.10% $ 57,030 $ 947 1.66% $ 79,424 $ 3,211 4.04% Taxable investment securities 688,178 29,143 4.23 597,830 32,470 5.43 540,771 32,170 5.95 Tax-exempt investment securities (1)............ 178,541 12,075 6.76 150,824 10,475 6.95 135,620 9,202 6.79 Loans (1)(2)............... 946,173 57,768 6.11 942,101 64,090 6.80 897,616 74,465 8.30 ---------- -------- ---------- -------- ---------- -------- Total earning assets...... 1,855,535 99,453 5.36 1,747,785 107,982 6.18 1,653,431 119,048 7.20 Cash and due from banks.... 88,518 81,016 80,032 Bank premises and equipment 41,866 41,195 40,903 Other assets............... 21,825 24,458 17,693 Goodwill, net.............. 23,866 24,644 29,178 Allowance for loan losses.. (11,425) (11,099) (10,107) ---------- ---------- ---------- Total assets.............. $2,020,185 $1,907,999 $1,811,130 ========== ========== ========== Liabilities and Shareholders' Equity Interest-bearing deposits.. $1,308,485 $ 16,968 1.30% $1,259,158 $ 24,088 1.91% $1,226,560 $ 43,971 3.58% Short-term borrowings...... 19,615 163 0.83 24,628 292 1.19 25,392 863 3.40 ---------- -------- ---------- -------- ---------- -------- Total interest-bearing liabilities............... 1,328,100 17,131 1.29 1,283,786 24,380 1.90 1,251,952 44,834 3.58 -------- -------- -------- Noninterest-bearing deposits 430,747 385,012 339,800 Other liabilities.......... 16,210 12,433 14,861 ---------- ---------- ---------- Total liabilities......... 1,775,057 1,681,231 1,606,613 Shareholders' equity......... 245,128 226,768 204,517 ---------- ---------- ---------- Total liabilities and shareholders' equity...... $2,020,185 $1,907,999 $1,811,130 ========== ========== ========== Net interest income.......... $ 82,322 $ 83,602 $ 74,214 ======== ======== ======== Rate Analysis: Interest income/earning assets..................... 5.36% 6.18% 7.20% Interest expense/earning assets..................... 0.92 1.40 2.71 ---- ---- ---- Net yield on earning assets 4.44% 4.78% 4.49% ==== ==== ====
- --------------- (1) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%. (2) Nonaccrual loans are included in loans. Noninterest Income. Noninterest income for 2003 was $34.1 million, an increase of $4.0 million, or 13.2%, as compared to 2002. The increase resulted primarily from (1) an increase in real estate mortgage fees of $1.1 million from a continued high volume of mortgage originations and refinancing transactions generated by low mortgage rates; (2) an increase in the gain from sale of student loans of $1.1 million resulting from increased fees received from the sale, (3) an increase in the gain on sale of other real estate of $736 thousand, primarily from the sale of two properties, (4) an increase of $415 thousand in ATM transaction fees which reflects our effort to increase the cardholder base and the usage of check cards; and (5) an increase of $176 thousand in check printing fees. Noninterest income for 2002 was $30.1 million, an increase of $2.0 million, or 6.9%, as compared to 2001. The increase resulted primarily from (1) an increase in service fees on deposit accounts of $692 thousand which reflects growth in number of accounts and transactions processed; (2) an increase in real estate mortgage fees of $248 thousand which reflects a continued high volume of mortgage originations and refinancing transactions generated by low mortgage rates; (3) an increase of $429 thousand in ATM transaction fees which reflects our effort to increase the cardholder base and the usage of check cards; and (4) $735 thousand in check printing fees that, in periods prior to 2002, were recorded as a reduction in printing and supplies expense. The change in classification for check printing fees was made in response to a change in bank regulatory financial reporting guidelines. Table 3 provides comparisons for other categories of noninterest income. 18 Table 3 -- Noninterest Income (in thousands):
Increase Increase 2003 (Decrease) 2002 (Decrease) 2001 ------- -------- -------- -------- -------- Trust department income ............. $ 6,018 $ 182 $ 5,836 $ (55) $ 5,891 Service fees on deposit accounts .... 15,747 312 15,435 692 14,743 Real estate mortgage fees ........... 2,923 1,065 1,858 248 1,610 Net gain on sale of student loans ... 1,896 1,113 783 185 598 Net gain on sale of other real estate 743 736 7 1 6 Net gain on securities transactions . 25 9 16 (52) 68 ATM fees ............................ 2,785 415 2,370 429 1,941 Other: Mastercard fees ................... 751 (229) 980 26 954 Check printing fees ............... 911 176 735 735 - Miscellaneous income .............. 871 376 495 (303) 798 Safe deposit rental fees .......... 396 (7) 403 9 394 Exchange fees ..................... 184 (12) 196 11 185 Credit life fees .................. 130 (70) 200 (16) 216 Data processing fees .............. 249 4 245 (16) 261 Brokerage commissions ............. 311 (29) 340 46 294 Interest on loan recoveries ....... 169 (61) 230 12 218 ------- -------- -------- -------- -------- Total other .................... 3,972 148 3,824 504 3,320 ------- -------- -------- -------- -------- Total Noninterest Income .......... $34,109 $ 3,980 $ 30,129 $ 1,952 $ 28,177 ======= ======== ======== ======== ========
Noninterest Expense. Total noninterest expense for 2003 was $61.2 million, an increase of $2.1 million, or 3.5%, as compared to 2002. Noninterest expense for 2002 amounted to $59.1 million, an increase of $4.0 million or 7.3% as compared to 2001. An important measure in determining whether a banking company effectively managed noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Our efficiency ratio for 2003 was 52.52% compared to 51.96% for 2002, and 53.82% for 2001. Salaries and employee benefits for 2003 totaled $33.3 million, an increase of $1.4 million, or 4.2%, as compared to 2002. Salaries for 2003 were up $1.5 million with the increase attributable to normal pay increases and a higher number of full time equivalent employees. Medical and other benefits increased $688 thousand in 2003 over 2002 due primarily to adverse claims experience in the Company's self insured health plan. Profit sharing expense for 2003 decreased $1.2 million, as compared to the prior year due to the decreased percentage increase in net income for 2003 over 2002. Pension expense for 2003 increased $196 thousand or 16.7% over 2002 due primarily from the increased amortization of unrecognized net loss on return on plan assets. In 2002, we lowered the expected long-term rate of return on pension plan assets from 8.5% to 6.5%, but reinstated the long-term rate to 8.5% during 2003 to the level we believe is representative of expected long-term rates for the assets in our portfolio. Effective January 1, 2004, we froze our pension plan whereby no additional service costs will accrue in the future (unless the pension plan is reinstated). Under current generally accepted accounting principles and utilizing current assumptions, we do not expect any significant pension costs in 2004 and beyond as a result of this action. We replaced the costs of our frozen pension plan with a matching of employee salary deferrals into the 401(k) plan. Effective January 1, 2004, we will match a maximum of 4% on employee deferrals of 5% of their respective employee compensation. Net occupancy expense and equipment expense for 2003 was virtually unchanged from the prior year. Intangible asset amortization resulting from the core deposit intangible from the Mineral Wells acquisition was the same for 2003 and 2002. Other professional and service fees increased by $340 thousand in 2003 as compared to 2002 primarily as a result of a consulting agreement with Mr. Ken Murphy, the chairman of our board of directors and fees paid for information technology consulting. Salaries and employee benefits for 2002 totaled $32.0 million, an increase of $3.3 million, or 11.5%, as compared to 2001. Salaries for 2002 were up $1.6 million with the increase attributable to normal pay increases, a higher number of full time equivalent employees and higher performance incentive payments. Profit sharing and pension expenses for 2002 increased $823 thousand and $549 thousand, respectively, as compared to the prior year. The higher profit sharing 19 expense related to our 2002 increase in net earnings. Net occupancy expense for 2002 was virtually unchanged from the prior year and equipment expense was up $343 thousand over the 2001 amount. The higher equipment expense resulted primarily from higher depreciation and higher repairs and maintenance expense as compared to 2001. Intangible asset amortization for 2002 decreased $1.5 million and resulted primarily from the change in accounting principle that became effective January 1, 2002 and which eliminated the amortization of goodwill. Printing, stationery and supplies expense for 2002 increased $391 thousand over the prior year amount. The increase for 2002 was due to $735 thousand in check printing fees being included in noninterest income for 2002 versus a reduction in printing expense in prior years. ATM expense for 2002 was $266 thousand higher than the 2001 amount and reflects increased customer usage in 2002. Table 4 -- Noninterest Expense (in thousands):
Increase Increase 2003 (Decrease) 2002 (Decrease) 2001 ------------ -------- ---------- ---------- ---------- Salaries..................................... $ 25,472 $ 1,488 $ 23,984 $ 1,604 $ 22,380 Medical and other benefits................... 2,985 688 2,297 180 2,117 Profit sharing............................... 1,473 (1,208) 2,681 823 1,858 Pension...................................... 1,369 196 1,173 549 624 Payroll taxes................................ 2,050 192 1,858 152 1,706 ------------ -------- ---------- ---------- ---------- Total salaries and employee benefits....... 33,349 1,356 31,993 3,308 28,685 Net occupancy expense........................ 3,941 32 3,909 (87) 3,996 Equipment expense............................ 4,869 68 4,801 343 4,458 Intangible amortization...................... 135 - 135 (1,506) 1,641 Other: Data processing and operation fees......... 1,040 (38) 1,078 (38) 1,116 Postage.................................... 1,118 24 1,094 (80) 1,174 Printing, stationery and supplies.......... 1,431 (44) 1,475 391 1,084 Advertising................................ 1,186 17 1,169 64 1,105 Correspondent bank service charges......... 1,501 10 1,491 162 1,329 ATM expense................................ 1,515 154 1,361 266 1,095 Credit card fees........................... 506 (190) 696 27 669 Telephone.................................. 883 13 870 (8) 878 Public relations and business development.. 792 34 758 43 715 Directors' fees............................ 596 80 516 30 486 Audit and accounting fees.................. 890 105 785 39 746 Legal fees................................. 426 43 383 50 333 Other professional and service fees........ 1,136 340 796 (37) 833 Regulatory exam fees....................... 535 9 526 83 443 Travel..................................... 298 (13) 311 7 304 Courier expense............................ 803 127 676 127 549 Operational and other losses............... 542 (201) 743 203 540 Other miscellaneous expense................ 3,662 146 3,516 623 2,893 ------------ -------- ---------- ---------- ---------- Total other............................. 18,860 616 18,244 1,952 16,292 ------------ -------- ---------- ---------- ---------- Total Noninterest Expense.................... $ 61,154 $ 2,072 $ 59,082 $ 4,010 $ 55,072 ============ ======== ========== ========== ==========
Income Taxes. Income tax expense was $14.6 million for 2003 as compared to $14.6 million for 2002 and $12.8 million for 2001. Our effective tax rates on pretax income were 29.3%, 30.1% and 30.4%, respectively, for the years 2003, 2002 and 2001. The slight decrease in the effective rate in 2003 was due to deductibility of dividends paid to our employee stock ownership plan that was implemented effective July 1, 2003. Balance Sheet Review Loans. Our portfolio is comprised of loans made to businesses, individuals, and farm and ranch operations located in the primary trade areas served by our subsidiary banks. Real estate loans represent loans primarily for new home construction and owner-occupied real estate. The structure of loans in the real estate mortgage classification generally provides repricing intervals to minimize the interest rate risk inherent in long-term fixed rate mortgage loans. 20 As of December 31, 2003, total loans were $987.5 million, an increase of $23.5 million, as compared to December 31, 2002. As compared to year-end 2002, real estate loans increased $37.4 million and commercial, financial and agriculture loans increased $22.1 million. Consumer loans as of year-end 2003 decreased $36.0 million as compared to 2002 due primarily to increased competition from zero/low interest rates on automobile loans. Loans averaged $946.2 million during 2003, an increase of $4.1 million over the prior year average. Table 5 -- Composition of Loans (in thousands):
December 31, ------------------------------------------------------------------ 2003 2002 2001 2000 1999 ---------- ---------- --------- --------- --------- Commercial, financial and agricultural..... $ 333,840 $ 311,743 $ 312,053 $ 295,032 $ 297,966 Real estate-- construction................. 77,834 50,911 47,173 40,610 43,039 Real estate-- mortgage..................... 385,770 375,256 350,382 290,920 208,895 Consumer, net of unearned income........... 190,079 226,130 230,523 232,709 247,375 ---------- ---------- --------- --------- --------- $ 987,523 $ 964,040 $ 940,131 $ 859,271 $ 797,275 ========== ========== ========= ========= =========
Table 6 -- Maturity Distribution and Interest Sensitivity of Loans at December 31, 2003 (in thousands): The following tables summarize maturity and yield information for the commercial, financial, and agricultural and the real estate-construction portion of our loan portfolio as of December 31, 2003:
After One Year One Year Through After Five or less Five Years Years Total ------------- ------------- ----------- --------- Commercial, financial, and agricultural $ 228,307 $ 84,600 $ 20,933 $ 333,840 Real estate-- construction........... 60,234 14,524 3,076 77,834 ------------- ------------- ----------- --------- $ 288,541 $ 99,124 $ 24,009 $ 411,674 ============= ============= =========== =========
Maturities After One Year --------- Loans with fixed interest rates.................... $ 62,754 Loans with floating or adjustable interest rates... 60,379 --------- $ 123,133 Asset Quality. Loan portfolios of each of our subsidiary banks are subject to periodic reviews by our centralized independent loan review group as well as periodic examinations by state and federal bank regulatory agencies. Loans are placed on nonaccrual status when, in the judgment of management, the collectibility of principal or interest under the original terms becomes doubtful. Nonperforming assets, which consist of nonperforming loans and foreclosed assets, were $3.2 million at December 31, 2003, as compared to $4.3 million at December 31, 2002 and $4.8 million at December 31, 2001. As a percent of loans and foreclosed assets, nonperforming assets were 0.32% at December 31, 2003, as compared to 0.44% at December 31, 2002 and 0.51% at December 31, 2001. We consider the level of nonperforming assets to be manageable and are not aware of any material classified credit not properly disclosed as nonperforming at December 31, 2003. 21 Table 7 -- Nonperforming Assets (in thousands, except percentages):
At December 31, -------------------------------------------------------------- 2003 2002 2001 2000 1999 -------- ---------- ---------- ---------- --------- Nonaccrual loans............................. $ 1,690 $ 3,716 $ 3,727 $ 3,512 $ 1,389 Loans still accruing and past due 90 days or more......................................... 61 14 66 34 63 Restructured loans........................... - - - - - -------- ---------- ---------- ---------- --------- Nonperforming loans..................... 1,751 3,730 3,793 3,546 1,452 Foreclosed assets............................ 1,420 536 1,031 546 637 -------- ---------- ---------- ---------- --------- Total nonperforming assets.............. $ 3,171 $ 4,266 $ 4,824 $ 4,092 $ 2,089 ======== ========== ========== ========== ========= As a % of loans and foreclosed assets........ 0.32% 0.44% 0.51% 0.48% 0.26%
We record interest payments received on impaired loans as interest income unless collections of the remaining recorded investment are doubtful, at which time we record payments received as reductions of principal. We recognized interest income on impaired loans of approximately $46,000, $111,000 and $136,000 during the years ended December 31, 2003, 2002, and 2001, respectively, of which approximately $4,000, $2,000 and $9,000 represented cash interest payments received and recorded as interest income. If interest on impaired loans had been recognized on a full accrual basis during the years ended December 31, 2003, 2002, and 2001, respectively, such income would have approximated $207,000, $317,000 and $399,000. Provision and Allowance for Loan Losses. The allowance for loan losses is the amount we determine as of a specific date to be adequate to provide for losses on loans that we deem are uncollectible. We determine the allowance and the required provision expense by reviewing general loss experiences and the performances of specific credits. The provision for loan losses was $1.2 million for 2003 as compared to $2.4 million for 2002 and $2.0 million for 2001. As a percent of average loans, net loan charge-offs were 0.09% during 2003, 0.19% during 2002 and 0.18% during 2001. The allowance for loan losses as a percent of loans was 1.17% as of December 31, 2003, as compared to 1.16% as of December 31, 2002. A key indicator of the adequacy of the allowance for loan losses is the ratio of the allowance to nonperforming loans, which consist of nonaccrual loans, loans past due 90 days, and restructured loans. This ratio for the past five years is disclosed in Table 7. Table 9 provides an allocation of the allowance for loan losses based on loan type and the percent of total loans that each major loan type represents. Other than the loan types presented in Table 9, we had no loan concentration at December 31, 2003 that represented more than 10% of total loans. Although we believe that we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. 22 Table 8 -- Loan Loss Experience and Allowance for Loan Losses (in thousands, except percentages):
2003 2002 2001 2000 1999 --------- --------- --------- --------- --------- Balance at January 1,.............................. $ 11,219 $ 10,602 $ 9,888 $ 8,938 $ 8,988 Allowance established from purchase acquisitions... - - 407 - - --------- --------- --------- --------- --------- 11,219 10,602 10,295 8,938 8,988 Charge-offs: Commercial, financial and agricultural........... 990 1,116 1,094 950 1,038 Consumer......................................... 1,186 1,471 1,498 1,998 2,747 All other........................................ 1 - 33 45 36 --------- --------- --------- --------- --------- Total charge-offs.................................. 2,177 2,587 2,625 2,993 3,821 Recoveries: Commercial, financial and agricultural........... 867 288 269 391 632 Consumer......................................... 482 535 688 855 936 All other........................................ 7 11 11 299 172 --------- --------- --------- --------- --------- Total recoveries................................... 1,356 834 968 1,545 1,740 --------- --------- --------- --------- --------- Net charge-offs.................................... 821 1,753 1,657 1,448 2,081 Provision for loan losses.......................... 1,178 2,370 1,964 2,398 2,031 --------- --------- --------- --------- --------- Balance at December 31,............................ $ 11,576 $ 11,219 $ 10,602 $ 9,888 $ 8,938 ========= ========= ========= ========= ========= Loans at year-end.................................. $ 987,523 $ 964,040 $ 940,131 $ 859,271 $ 797,275 Average loans...................................... 946,173 942,101 897,616 817,603 779,283 Net charge-offs/average loans...................... 0.09% 0.19% 0.18% 0.18% 0.27% Allowance for loan losses/year-end loans........... 1.17 1.16 1.13 1.15 1.12 Allowance for loan losses/nonperforming loans...... 661.10 300.78 279.51 278.85 615.55
Table 9 -- Allocation of Allowance for Loan Losses (in thousands):
2003 2002 2001 2000 1999 ----------- --------- --------- --------- ---------- Allocation Allocation Allocation Allocation Allocation Amount Amount Amount Amount Amount ----------- --------- --------- --------- ---------- Commercial, financial and agricultural........ $ 5,293 $ 3,628 $ 4,966 $ 3,394 $ 3,340 Real estate-- construction.................... 669 592 415 468 483 Real estate-- mortgage........................ 3,754 4,368 2,710 3,348 2,342 Consumer...................................... 1,860 2,631 2,511 2,678 2,773 ----------- --------- --------- --------- ---------- Total..................................... $ 11,576 $ 11,219 $ 10,602 $ 9,888 $ 8,938 =========== ========= ========= ========= ==========
Percent of Total Loans: 2003 2002 2001 2000 1999 ----- ----- ----- ----- ----- Commercial, financial and agricultural................ 33.81% 32.34% 33.19% 34.33% 37.37% Real estate-- construction............................ 7.88 5.28 5.02 4.73 5.40 Real estate-- mortgage................................ 39.06 38.93 37.27 33.86 26.20 Consumer, net of unearned income...................... 19.25 23.45 24.52 27.08 31.03
Certain loans classified for regulatory purposes as doubtful, substandard, or special mention are included in the nonperforming asset table. Also included in classified loans are certain other loans that are deemed to be potential problems. Potential problem loans are those loans that are currently performing but where known information about trends or uncertainties or possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present repayment terms, possibly resulting in the transfer of such loans to nonperforming status. These potential problem loans totaled $1.7 million as of December 31, 2003. Investment Securities. Investment securities totaled $910.3 million as of December 31, 2003, as compared to $772.3 million at December 31, 2002 and $721.7 million at December 31, 2001. At December 31, 2003, securities with an amortized cost of $131.3 million were classified as securities held-to-maturity and securities with a market value of $779.0 million were classified as securities available-for-sale. As compared to December 31, 2002, the overall portfolio at 23 December 31, 2003, reflected (1) an increase of $54.7 million in U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies; (2) an increase of $55.7 million in tax-exempt obligations of states and political subdivisions; (3) a $12.7 million decrease in corporate bonds and other securities; and (4) a $40.5 million increase in mortgage-backed securities. As compared to December 31, 2001, the portfolio at December 31, 2002 reflected (1) an increase of $14.8 million in U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies; (2) an increase of $12.8 million in tax-exempt obligations of states and political subdivisions; (3) a $4.2 million decrease in corporate bonds and other securities; and (4) a $27.2 million increase in mortgage-backed securities. The overall portfolio yield of 4.9% at the end of 2003 was down from the prior year-end yield of 5.6% due to lower average interest rates. We did not hold any high risk collateralized mortgage obligations or structured notes as of December 31, 2003. See Note 2 to the Consolidated Financial Statements for additional disclosures relating to the maturities and fair values of the investment portfolio at December 31, 2003 and 2002. Table 10 -- Composition of Investment Securities (dollars in thousands):
At December 31, ----------------------------------------------------------------------------------- 2003 2002 2001 ----------------------- ------------------------ ------------------------ Amortized Amortized Amortized Held-to-Maturity: Cost Fair Value Cost Fair Value Cost Fair Value ---------------- -------- -------- --------- --------- --------- --------- U.S. Treasury securities and obligations of U.S. government sponsored- enterprises and agencies $ 78,224 $ 82,405 $ 110,939 $ 117,808 $ 172,880 $ 177,872 Obligations of states and political subdivisions.. 43,325 45,885 60,836 64,050 75,959 77,495 Corporate bonds........... 503 545 499 540 498 512 Mortgage-backed securities 9,274 9,759 28,176 29,464 41,333 42,687 Other securities.......... - - - - 4 4 -------- -------- --------- --------- --------- --------- $131,326 $138,594 $ 200,450 $ 211,862 $ 290,674 $ 298,570
At December 31, ------------------------------------------------------------------------------------- 2003 2002 2001 ------------------------- ------------------------ ------------------------ Amortized Amortized Amortized Available-for-Sale: Cost Fair Value Cost Fair Value Cost Fair Value ------------------ ---------- ---------- --------- --------- --------- --------- U.S. Treasury securities and obligations of U.S. government sponsored- enterprises and agencies $ 253,515 $ 259,000 $ 164,090 $ 171,619 $ 93,151 $ 94,919 Obligations of states and political subdivisions. 178,287 183,904 104,800 110,741 82,546 82,851 Corporate bonds........... 36,103 37,798 49,234 51,812 56,553 58,522 Mortgage-backed securities 291,809 291,481 228,490 232,106 189,421 191,720 Other securities.......... 6,720 6,793 5,453 5,529 3,007 3,007 ---------- ---------- --------- --------- --------- --------- 766,434 778,976 552,067 571,807 424,678 431,019 ---------- ---------- --------- --------- --------- --------- $ 897,760 $ 917,570 $ 752,517 $ 783,669 $ 715,352 $ 729,589 ========== ========== ========= ========= ========= =========
24 Table 11 -- Maturities and Yields of Investment Securities Held at December 31, 2003 (in thousands, except percentages):
Maturing ------------------------------------------------------------------------------------ After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- -------------- -------------- ------------- -------------- Held-to-Maturity: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield - ---------------- ------- ---- ------- ---- ------- ---- ------ ---- -------- ---- U.S. Treasury obligations.. $ - -% $ - -% $ - -% $ - -% $ - -% Obligations of U.S. government sponsored-enterprises and agencies.............. 25,760 5.73 52,464 5.67 - - - - 78,224 5.69 Obligations of states and political subdivisions.. 10,483 6.40 11,049 6.11 21,458 7.41 335 8.44 43,325 6.84 Corporate bonds and other securities.............. - - 499 6.17 - - 4 - 503 6.12 Mortgage-backed securities. 999 5.69 7,054 6.36 1,221 5.38 - - 9,274 6.16 ------- ---- ------- ---- ------- ---- ------ ---- -------- ---- Total................... $37,242 5.92% $71,066 5.81 $22,679 7.30% $ 339 8.44% $131,326 6.10% ======= ==== ======= ==== ======= ==== ====== ==== ======== ====
Maturing ------------------------------------------------------------------------------------ After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- -------------- -------------- -------------- -------------- Available-for-Sale: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield - ------------------ ------- ---- -------- ---- -------- ---- ------- ----- -------- ---- U.S. Treasury obligations.. $ 1,007 1.89% $ 100 1.62% $ - -% $ - -% $ 1,107 1.87% Obligations of U.S. government sponsored-enterprises and agencies.............. 24,095 4.52 233,798 3.70 - - - - 257,893 3.78 Obligations of states and political subdivisions.. 3,123 6.42 34,847 6.64 88,675 6.89 57,259 5.70 183,904 6.46 Corporate bonds and other securities.............. 14,669 6.23 25,353 5.65 - - 4,569 5.09 44,591 5.79 Mortgage-backed securities............ 17,998 3.59 161,209 4.07 112,195 4.37 79 4.25 291,481 4.16 ------- ---- -------- ---- -------- ---- ------- ---- -------- ---- Total................... $60,892 4.71% $455,307 4.17% $200,870 5.48% $61,907 5.65% $778,976 4.67% ======= ==== ======== ==== ======== ==== ======= ==== ======== ====
Maturing ------------------------------------------------------------------------------------ After One Year After Five Years One Year Through Through After or Less Five Years Ten Years Ten Years Total -------------- -------------- -------------- ------------- -------------- Total Investment Securities: Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield - --------------------------- ------- ---- -------- ---- -------- ---- ------ ---- -------- ---- U.S. Treasury obligations.. $ 1,007 1.89% $ 100 1.62% $ - -% $ - -% $ 1,107 1.87% Obligations of U.S. government sponsored-enterprises and agencies.............. 49,855 5.15 286,262 4.06 - - - - 336,117 4.22 Obligations of states and political subdivisions.. 13,606 6.40 45,896 6.51 110,133 6.99 57,594 5.72 227,229 6.54 Corporate bonds and other securities.. 14,669 6.23 25,852 5.66 - - 4,573 5.09 45,094 5.79 Mortgage-backed securities............ 18,997 3.70 168,263 4.17 113,416 4.38 79 4.25 300,755 4.22 ------- ---- -------- ---- -------- ---- ------- ---- -------- ---- Total................... $98,134 5.17% $526,373 4.39% $223,549 5.67% $62,246 5.67% $910,302 4.88% ======= ==== ======== ==== ======== ==== ======= ==== ======== ====
All yields are computed on a tax-equivalent basis assuming a marginal tax rate of 35%. Maturities of mortgage-backed securities are based on contractual maturities and could differ due to prepayments of underlying mortgages. Table 12 -- Disclosure of Investment Securities with Continuous Unrealized Loss The following table discloses, as of December 31, 2003, our investment securities that have been in a continuous unrealized-loss position for less than 12 months and those that have been in a continuous unrealized-loss position for 12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total --------------------- -------------------- ------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss --------- ------- -------- ------ -------- ------- U. S. Treasury securities and obligations of U.S. government sponsored- enterprises and agencies $ 45,904 $ 640 $ - $ - $ 45,904 $ 640 Obligations of state and political subdivisions 51,027 1,537 - - 51,027 1,537 Mortgage-backed securities 145,394 2,166 - - 145,394 2,166
25 We believe the investment securities in the table above are within ranges customary for the banking industry. The number of investment positions in this unrealized loss position totals 278. We do not believe these unrealized losses are "other than temporary" as (1) the Company has the ability and intent to hold the investments to maturity, or a period of time sufficient to allow for a recovery in market value, (2) it is not probable that the Company will be unable to collect the amounts contractually due and (3) no decision to dispose of the investments were made prior to the balance sheet date. The unrealized losses noted are interest rate related due to rising rates at December 31, 2003, in relation to previous rates in mid-2003. The duration of these investments is less than 5 years for all securities other than the municipal bonds, which is less than 15 years. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Deposits. Deposits held by subsidiary banks represent our primary source of funding. Total deposits were $1.796 billion as of December 31, 2003, as compared to $1.712 billion as of December 31, 2002 and $1.685 billion as of December 31, 2001. Table 13 provides a breakdown of average deposits and rates paid over the past three years and the remaining maturity of time deposits of $100,000 or more. Table 13 -- Composition of Average Deposits and Remaining Maturity of Time Deposits of $100,000 or More (in thousands, except percentages):
2003 2002 2001 ----------------------- ----------------------- ---------------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate ----------- ---- ---------- ---- ---------- ---- Noninterest-bearing deposits.... $ 430,747 - $ 385,012 - $ 339,800 - Interest-bearing deposits Interest-bearing checking.... 306,259 0.38 315,688 0.71% 279,585 1.43% Savings and money market accounts................... 434,574 0.79 389,337 1.18 366,412 2.58 Time deposits under $100,000. 340,384 2.20 371,970 3.11 384,576 5.30 Time deposits of $100,000 or more....................... 227,268 2.15 182,163 3.13 195,987 5.19 ----------- ---- ---------- ---- ---------- ---- Total interest-bearing deposits 1,308,485 1.30% 1,259,158 1.91% 1,226,560 3.58% ----------- ---------- ---------- Total average deposits.......... $ 1,739,232 $1,644,170 $1,566,360 =========== ========== ==========
December 31, 2003 ----------------- Three months or less............................... $ 83,583 Over three through six months...................... 57,033 Over six through twelve months..................... 53,328 Over twelve months................................. 26,123 ----------- Total time deposits of $100,000 or more.......... $ 220,067 =========== Capital Resources We calculate capital resources by our ability to maintain adequate regulatory capital ratios to do business in the banking industry. Issues related to capital resources arise primarily when we are growing at an accelerated rate but not retaining a significant amount of our profits or when we experience significant asset quality deterioration. By way of background, total shareholders' equity was $251.5 million, or 12.02% of total assets, at December 31, 2003, as compared to $238.8 million, or 11.98% of total assets, at December 31, 2002. During 2003, total shareholders' equity averaged $245.1 million, or 12.13% of average assets, as compared to $224.4 million, or 11.76% of average assets, during 2002. Banking regulators measure capital adequacy by means of the risk-based capital ratio and leverage ratio. The risk-based capital rules provide for the weighting of assets and off-balance-sheet commitments and contingencies according to prescribed risk categories ranging from 0% to 100%. Regulatory capital is then divided by risk-weighted assets to determine the risk-adjusted capital ratios. The leverage ratio is computed by dividing shareholders' equity less intangible assets by quarter-to-date average assets less intangible assets. Regulatory minimums for risk-based and leverage ratios are 8.00% and 3.00%, respectively. As of December 31, 2003, our total risk-based and leverage ratios were 19.83% and 10.60%, respectively, as compared to total risk-based and 26 leverage ratios of 19.47% and 10.51% as of December 31, 2002. We believe by all measurements our capital ratios remain well above regulatory minimums. Interest Rate Risk. Interest rate risk results when the maturity or repricing intervals of interest-earning assets and interest-bearing liabilities are different. Our exposure to interest rate risk is managed primarily through our strategy of selecting the types and terms of interest-earning assets and interest-bearing liabilities that generate favorable earnings while limiting the potential negative effects of changes in market interest rates. We use no off-balance-sheet financial instruments to manage interest rate risk. Each of our subsidiary banks has an asset liability committee that monitors interest rate risk and compliance with investment policies as well as a holding company-wide committee that monitors the aggregate companies' interest rate risk and compliance with investment policies. Each subsidiary bank tracks interest rate risk by, among other things, interest-sensitivity gap and simulation analysis. Table 14 sets forth the interest rate sensitivity of our consolidated assets and liabilities as of December 31, 2003, and sets forth the repricing dates of our consolidated interest-earning assets and interest-bearing liabilities as of that date, as well as our projected consolidated interest rate sensitivity gap percentages for the periods presented. The table is based upon our estimates and assumptions as to when assets and liabilities will reprice in a changing interest rate environment. Assets and liabilities indicated as maturing or otherwise repricing within a stated period may, in fact, mature or reprice at different times and at different volumes than those estimated. Also, the renewal or repricing of certain assets and liabilities can be discretionary and subject to competitive and other pressures. Therefore, the following table does not and cannot necessarily indicate the actual future impact of general interest rate movements on our consolidated net interest income. Should we be unable to maintain a reasonable balance of maturities and repricing of our interest-earning assets and our interest-bearing liabilities, we could be required to dispose of our assets in an unfavorable manner or pay a higher than market rate to fund our activities. Our asset liability committees oversee and monitor this risk. 27 Table 14 -- Interest Sensitivity Analysis (in thousands, except percentages):
December 31, 2003 Estimated 2004 2005 2006 2007 2008 Beyond Total Fair Value ---------- -------- -------- -------- -------- -------- ---------- --------- Loans: Fixed rate loans...... $ 100,542 $ 58,555 $ 70,124 $ 73,124 $ 78,421 $ 65,756 $446,522 $453,513 Average interest rate 6.60% 7.87% 7.22% 6.89% 6.57% 7.33% 7.01% Adjustable rate loans 505,511 4,095 9,473 9,308 11,653 961 541,001 541,001 Average interest rate 4.57 6.18 5.96 6.44 5.94 5.49 4.67 Investment securities: Fixed rate securities 95,403 160,909 192,410 85,207 87,847 285,795 907,571 914,839 Average interest rate 5.24 4.68 4.52 3.84 4.10 5.63 4.87 Adjustable rate securities............ 2,731 - - - - - 2,731 2,731 Average interest rate 2.68 - - - - - 2.68 Other earning assets: Adjustable rate other 2,678 99 - - - - 2,777 2,777 Average interest rate 0.95 0.22 - - - - 0.92 ---------- -------- -------- -------- -------- -------- ---------- --------- Total interest sensitive assets................ 706,865 223,658 272,007 167,639 177,921 352,512 1,900,602 1,914,861 Average interest rate 4.97% 5.54% 5.27% 5.32% 5.31% 5.95% 5.32% Interest-bearing Deposits: Fixed rate deposits. 475,531 32,013 7,667 11,341 6,786 309 533,647 536,208 Average interest rate 1.71 3.18 3.14 4.23 3.25 2.66 1.89 Adjustable rate deposits.............. 790,050 - - - - - 790,050 790,050 Average interest rate 0.58 - - - - - 0.59 Other interest-bearing liabilities: Adjustable rate other 28,975 - - - - - 28,975 28,975 Average interest rate 1.12 - - - - - 1.12 ---------- -------- -------- -------- -------- -------- ---------- --------- Total interest sensitive liabilities......... 1,294,556 32,013 7,667 11,341 6,786 309 1,352,672 1,355,233 Average interest rate 1.01% 3.07% 3.14% 4.23% 3.25% 2.66% 1.11% Interest sensitivity gap $(587,691) $191,645 $264,340 $156,298 $171,135 $352,203 $547,930 $559,628 Cumulative interest sensitivity gap..... (587,691) (396,046) (131,706) 24,592 195,727 547,930 Ratio of interest sensitive assets to interest sensitive liabilities......... 54.69% Cumulative ratio of interest sensitive assets to interest sensitive liabilities 54.69% 70.14% 90.11% 101.82% 114.46% 140.51% Cumulative interest sensitivity gap as a percent of earning assets.............. (30.81)% (20.84)% (6.94)% 1.29% 10.29% 28.83%
As of December 31, 2002, our 2003 interest-sensitivity gap was $(516.1) million and our 2003 ratio of interest sensitive assets to interest sensitive liabilities was 58.48%. We estimate that, as of December 31, 2003, an upward shift of interest rates by 150 basis points would result in a 1.8% increase in projected net interest income over the next twelve months, and a downward shift of interest rates by 100 basis points would result in a 3.7% reduction in projected net interest income over the next twelve months. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe, these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. We also believe that it is unlikely that such changes would occur in a short time period. As interest-bearing assets and liabilities reprice at different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material. 28 Liquidity Liquidity is our ability to meet cash demands as they arise. Such needs can develop from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The potential need for liquidity arising from these types of financial instruments is represented by the contractual notional amount of the instrument, as detailed in Tables 15 and 16. Asset liquidity is provided by cash and assets, which are readily marketable or which will mature in the near future. Liquid assets include cash, federal funds sold, and short-term investments in time deposits in banks. Liquidity is also provided by access to funding sources, which include core depositors and correspondent banks that maintain accounts with and sell federal funds to our subsidiary banks. Other sources of funds include our ability to sell securities under agreement to repurchase, which amounted to $29.0 million at December 31, 2003, and an unfunded $20.0 million line of credit established with a nonaffiliated bank which matures on June 30, 2004. We believe the line of credit will be renewed upon maturity. Given the strong core deposit base and relatively low loan to deposit ratios maintained at our subsidiary banks, we consider our current liquidity position to be adequate to meet our short- and long-term liquidity needs. In addition, we anticipate that any future acquisition of financial institutions and expansion of branch locations could also place a demand on our cash resources. Available cash at our parent company which totaled $34.2 million at December 31, 2003, available dividends from subsidiary banks which totaled $14.5 million at December 31, 2003, utilization of available lines of credit, and future debt or equity offerings are expected to be the source of funding for these potential acquisitions or expansions. Table 15-- Contractual Obligations As of December 31, 2003 (in thousands):
Payment Due by Period -------------------------------------------------------------------- Less than 1 Over 5 Total Amounts year 1-3 years 4-5 years years ---------- ---------- ------- -------- ---------- Deposits.............................. $1,796,271 $1,735,953 $41,882 $ 18,127 $ 309 Capital Leases........................ - - - - - Operating Leases...................... 1,499 468 821 207 3 Outsourcing Service Contracts......... 462 462 - - - Long Term Debt........................ - - - - - Contributions to Pension Plan......... 250 50 100 100 - ---------- ---------- ------- -------- ---------- Total Contractual Obligations..... $1,798,482 $1,736,933 $42,803 $ 18,434 $ 312 ========== ========== ======= ======== ==========
Off-Balance Sheet Arrangements. We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include unfunded lines of credit commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheets. Our exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We generally use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments. Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, as we deem necessary upon extension of credit, is based on our credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plan, and equipment and income-producing commercial properties. 29 Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount. Table 16 - Commitments As of December 31, 2003 (in thousands):
Total Notional Amounts Less than 1 Over 5 Committed year 1-3 years 4-5 years years -------- -------- ------- ------- ------- Unfunded lines of credit.............. $123,803 $120,445 $ 3,358 $ - $ - Unfunded commitments to extend credit. 62,092 56,313 1,421 2,491 1,867 Standby letters of credit............. 6,068 5,252 807 9 - -------- -------- ------- ------- ------- Total Commercial Commitments....... $191,963 $182,010 $ 5,586 $ 2,500 $ 1,867 ======== ======== ======= ======= =======
We believe we have no other off-balance sheet arrangements or transactions with unconsolidated, special purpose entities that would expose us to liability that is not reflected on the face of the financial statements. Parent Company Funding. Our ability to fund various operating expenses, dividends, and cash acquisitions is generally dependent solely on our own earnings (without giving effect to our subsidiaries), cash reserves and funds derived from our subsidiary banks. These funds historically have been produced by intercompany dividends and management fees that are limited to reimbursement of actual expenses. We anticipate that our recurring cash sources will continue to include dividends and management fees from our subsidiary banks. At December 31, 2003, approximately $14.5 million was available for the payment of intercompany dividends by the subsidiary banks without the prior approval of regulatory agencies. Our subsidiary banks paid aggregate dividends of $34.6 million in 2003 and $26.6 million in 2002. Also at December 31, 2003, we had $20.0 million available under a line of credit with an unaffiliated financial institution. Dividends. Our long-term dividend policy is to pay cash dividends to our shareholders of between 40% and 50% of net earnings while maintaining adequate capital to support growth. The cash dividend payout ratios have amounted to 53.1%, 49.1% and 48.9% of net earnings, respectively, in 2003, 2002 and 2001. Given our current strong capital position and projected earnings and asset growth rates, we do not anticipate any significant change in our current dividend policy. Each state bank that is a member of the Federal Reserve System and each national banking association is required by federal law to obtain the prior approval of the Federal Reserve Board and the OCC, respectively, to declare and pay dividends if the total of all dividends declared in any calendar year would exceed the total of (1) such bank's net profits (as defined and interpreted by regulation) for that year plus (2) its retained net profits (as defined and interpreted by regulation) for the preceding two calendar years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). To pay dividends, we and our subsidiary banks must maintain adequate capital above regulatory guidelines. In addition, if the applicable regulatory authority believes that a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the authority may require, after notice and hearing, that such bank cease and desist from the unsafe practice. The Federal Reserve Board and the OCC have each indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC and the FDIC have issued policy statements that recommend that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our management considers interest rate risk to be a significant market risk for us. See "Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations--Balance Sheet Review--Interest Rate Risk" for disclosure regarding this market risk. 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements begin on page F-1. Quarterly Results of Operations (in thousands, except per share and common stock data): The following tables set forth certain unaudited historical quarterly financial data for each of the eight consecutive quarters in fiscal 2003 and 2002. This information is derived from unaudited consolidated financial statements that include, in our opinion, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation when read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K. All prices and per share data related to our common stock have been adjusted to give effect to all stock splits and stock dividends, including the five-for-four stock split in the form of a 25% stock dividend effective June 2, 2003 for shareholders of record on May 16, 2003.
2003 ---------------------------------------------------- 4th 3rd 2nd 1st ---------- ---------- ---------- ---------- Summary Income Statement Information: Interest income $ 23,730 $ 23,209 $ 23,990 $ 24,356 Interest expense 3,830 4,097 4,482 4,722 ---------- ---------- ---------- ---------- Net interest income 19,900 19,112 19,508 19,634 Provision for loan losses 208 233 226 511 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 19,692 18,879 19,282 19,123 Noninterest income 7,669 8,836 9,513 8,066 Net gain (loss) on securities transactions 9 20 (4) - Noninterest expense 15,622 14,905 15,521 15,106 ---------- ---------- ---------- ---------- Earnings before income taxes 11,748 12,830 13,270 12,083 Income tax expense 3,228 3,716 4,049 3,633 ---------- ---------- ---------- ---------- Net earnings $ 8,520 $ 9,114 $ 9,221 $ 8,450 ========== ========== ========== ========== Per Share Data: Net earnings per share, basic $ 0.55 $ 0.59 $ 0.60 $ 0.55 Net earnings per share, assuming dilution 0.55 0.59 0.59 0.54 Cash dividends declared 0.31 0.31 0.31 0.28 Book value at period-end 16.25 16.10 16.24 15.54 Common stock sales price: (1) High $ 43.89 $ 41.02 $ 33.28 $ 32.34 Low 37.12 32.38 30.50 27.27 Close 41.12 36.96 33.46 28.40
31
2002 --------------------------------------------------- 4th 3rd 2nd 1st ---------- --------- --------- --------- Summary Income Statement Information: Interest income $ 25,591 $ 26,052 $ 26,346 $ 26,445 Interest expense 5,244 5,818 6,246 7,072 ---------- --------- ---------- --------- Net interest income 20,347 20,234 20,100 19,373 Provision for loan losses 809 652 510 399 ---------- --------- ---------- --------- Net interest income after provision for loan losses 19,538 19,582 19,590 18,974 Noninterest income 7,954 7,792 7,245 6,975 Net gain (loss) on securities transactions - (3) 19 - Noninterest expense 15,247 14,903 14,677 14,256 ---------- --------- ---------- --------- Earnings before income taxes 12,245 12,468 12,177 11,693 Income tax expense 3,694 3,768 3,655 3,513 ---------- --------- ---------- --------- Net earnings $ 8,551 $ 8,700 $ 8,522 $ 8,180 ========== ========= ========== ========= Per Share Data: Net earnings per share, basic $ 0.55 $ 0.56 $ 0.55 $ 0.53 Net earnings per share, assuming dilution 0.55 0.56 0.55 0.53 Cash dividends declared 0.28 0.28 0.28 0.24 Book value at period-end 15.45 15.40 14.75 14.08 Common stock sales price: (1) High $ 33.60 $ 33.38 $ 34.40 $ 27.44 Low 27.72 27.88 26.40 23.44 Close 30.40 29.15 33.47 26.57 (1) These quotations reflect inter-dealer prices without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On March 25, 2002, we determined not to renew the engagement of our independent accountants, Arthur Andersen LLP. Arthur Andersen had served as our independent auditors since 1990. The decision not to renew the engagement of Arthur Andersen was made by the executive committee of our board of directors following the recommendation of our audit committee. Arthur Andersen's report on our 2001 financial statements was filed with the Securities and Exchange Commission on March 20, 2002 in conjunction with the filing of our Annual Report on Form 10-K for the year ended December 31, 2001. During the two fiscal years ended December 31, 2001, and through the subsequent interim period through March 25, 2002, there were no disagreements between Arthur Andersen and us on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to Arthur Andersen's satisfaction would have caused them to make reference to the subject matter of the disagreement in connection with their reports. None of the reportable events defined under Item 304(a)(1)(v) of Regulation S-K occurred within our two fiscal years ended December 31, 2001 and through the subsequent interim period through March 25, 2002. The audit reports of Arthur Andersen on our consolidated financial statements as of and for the fiscal years ended December 31, 2001 and 2000 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. We provided Arthur Andersen with a copy of the foregoing disclosure, and a copy of its letter stating its agreement with these statements was filed as an exhibit to our Form 8-K dated March 25, 2002. The executive committee of our board of directors, upon the recommendation of our audit committee, elected to appoint Ernst & Young LLP as our independent auditors, effective May 16, 2002. Prior to engaging the new independent auditors, we did not consult with Ernst & Young regarding any of the matters or events set forth in Items 304(a)(2)(i) and (ii) of Regulation S-K. 32 ITEM 9A. CONTROLS AND PROCEDURES As of December 31, 2003, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rule 15d-15. Our management, including the principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our principal executive officer and principal financial officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures under Rule 13a-14 (c) and Rule 15d-14 (c) of the Securities Exchange Act of 1934 are effective. Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect these internal controls. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 is hereby incorporated by reference from our proxy statement for our 2004 annual meeting of shareholders. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is hereby incorporated by reference from our 2004 proxy statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by Item 12 related to security ownership of certain beneficial owners and management is hereby incorporated by reference from our 2004 proxy statement. The following chart gives aggregate information under our equity compensation plans as of December 31, 2003. 33
Number of Securities Remaining Available For Future Issuance Number of Securities Under Equity To be Issued Upon Weighted Average Compensation Plans Exercise of Exercise Price of (Excluding Securities Outstanding Options, Outstanding Options, Reflected in Warrants and Rights Warrants and Rights Far Left Column) ------- ------ ------- Equity compensation plans approved by security holders 181,100 $23.43 553,687 Equity compensation plans not approved by security holders - - - ------- ------- Total 181,100 $23.43 553,687 ======= =======
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is hereby incorporated by reference from our 2004 proxy statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 is hereby incorporated by reference from our 2004 proxy statement. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) Financial Statements - Report of Independent Auditors Report of Independent Public Accountants Management's Report on Responsibility for the Financial Statements Consolidated Balance Sheets as of December 31, 2003 and 2002 Consolidated Statements of Earnings for the years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Comprehensive Earnings for the years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 Notes to the Consolidated Financial Statements (2) Financial Statement Schedules - These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements. (3) Exhibits - The information required by this Item 15(a)(3) is set forth in the Exhibit Index immediately following our signature pages. The exhibits listed herein will be furnished upon written request to J. Bruce Hildebrand, Executive Vice President, First Financial Bankshares, Inc., 400 Pine Street, Abilene, Texas 79601, and payment of a reasonable fee that will be limited to our reasonable expense in furnishing such exhibits. (b) Reports on Form 8-K. On January 16, 2004, we furnished on Form 8-K our earnings release for the quarter and year ended December 31, 2003. 34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST FINANCIAL BANKSHARES, INC. Date: March 5, 2004 By: /s/ F. SCOTT DUESER ----------------------------------------------- F. SCOTT DUESER President, Chief Executive Officer and Director The undersigned directors and officers of First Financial Bankshares, Inc. hereby constitute and appoint J. Bruce Hildebrand, with full power to act and with full power of substitution and resubstitution, our true and lawful attorney-in-fact with full power to execute in our name and behalf in the capacities indicated below any and all amendments to this report and to file the same, with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission and hereby ratify and confirm all that such attorney-in-fact or his substitute shall lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /s/ KENNETH T. MURPHY Chairman of the Board and Director March 5, 2004 - ----------------------------------------------- Kenneth T. Murphy /s/ F. SCOTT DUESER President, Chief Executive Officer March 5, 2004 - ----------------------------------------------- and Director F. Scott Dueser (Principal Executive Officer) /s/ J. BRUCE HILDEBRAND Executive Vice President and Chief March 5, 2004 - ----------------------------------------------- Financial Officer J. Bruce Hildebrand (Principal Financial Officer and Principal Accounting Officer) /s/ JOSEPH E. CANON Director March 5, 2004 - ----------------------------------------------- Joseph E. Canon /s/ MAC A. COALSON Director March 5, 2004 - ----------------------------------------------- Mac A. Coalson /s/ DAVID COPELAND Director March 5, 2004 - ----------------------------------------------- David Copeland 35 Name Title Date ---- ----- ---- /s/ DERRELL E. JOHNSON Director March 5, 2004 - ----------------------------------------------- Derrell E. Johnson /s/ KADE L. MATTHEWS Director March 5, 2004 - ----------------------------------------------- Kade L. Matthews /s/ RAYMOND A. MCDANIEL, JR. Director March 5, 2004 - ----------------------------------------------- Raymond A. McDaniel, Jr. /s/ BYNUM MIERS Director March 5, 2004 - ----------------------------------------------- Bynum Miers /s/ JAMES M. PARKER Director March 5, 2004 - ----------------------------------------------- James M. Parker /s/ JACK D. RAMSEY Director March 5, 2004 - ----------------------------------------------- Jack D. Ramsey /s/ DIAN GRAVES STAI Director March 5, 2004 - ----------------------------------------------- Dian Graves Stai /s/ F. L. STEPHENS Director March 5, 2004 - ----------------------------------------------- F. L. Stephens /s/ JOHNNY TROTTER Director March 5, 2004 - ----------------------------------------------- Johnny Trotter
36 EXHIBIT INDEX
Item 601 Regulation S-K Exhibit Reference Number Exhibits ------ -------- 3.1 -- Articles of Incorporation, and all amendments thereto, of the Registrant (incorporated by reference from Exhibit 1 of the Registrant's Amendment No. 2 to Form 8-A filed on Form 8-A/A No. 2 on November 21, 1995). 3.2 -- Amended and Restated Bylaws, and all amendments thereto, of the Registrant (incorporated by reference from Exhibit 2 of the Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994). 4.1 -- Specimen certificate of First Financial Common Stock (incorporated by reference from Exhibit 3 of the Registrant's Amendment No. 1 to Form 8-A filed on Form 8-A/A No. 1 on January 7, 1994). 10.1 -- Deferred Compensation Agreement, dated October 28, 1992, between the Registrant and Kenneth T. Murphy (incorporated by reference from Exhibit 10.1 of the Registrant's Form 10-K Annual Report for the year ended December 31, 2002). 10.2 -- Revised Deferred Compensation Agreement, dated December 28, 1995, between the Registrant and Kenneth T. Murphy (incorporated by reference from Exhbiit 10.2 of the Registrant's Form 10-K Annual Report for the year ended December 31, 2002). 10.3 -- Executive Recognition Plan (incorporated by reference from Exhibit 10.3 of the Registrant's Form 10-K Annual Report for year ended December 31, 2002). 10.4 -- Form of Executive Recognition Agreement (incorporated by reference from Exhbiit 10.4 of the Registrant's Form 10-K Annual Report for the year ended December 31, 2002). 10.5 -- 1992 Incentive Stock Option Plan (incorporated by reference from Exhibit 10.5 of the Registrant's Form 10-K Annual Report for the fiscal year ended December 31, 1998). 10.6 -- 2002 Incentive Stock Option Plan (incorporated by reference from Appendix A of the Registrant's Schedule 14a Definitive Proxy Statement for the 2002 Annual Meeting of Shareholders) *10.7 -- Revised Consulting Agreement dated January 1, 2004 between the Registrant and Kenneth T. Murphy. 16.1 -- Letter regarding Change in Certifying Accountant (incorporated by reference from Exhibit 16.1 of the Registrant's Form 8-K filed on March 25, 2002). *21.1 -- Subsidiaries of the Registrant. 24.1 -- Power of Attorney (included on signature page of this Form 10-K). *31.1 -- Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Executive Officer of First Financial Bankshares, Inc. *31.2 -- Rule 13a-14(a) / 15(d)-14(a) Certification of Chief Financial Officer of First Financial Bankshares, Inc. *32.1 -- Section 1350 Certification of Chief Executive Officer of First Financial Bankshares, Inc. *32.2 -- Section 1350 Certification of Chief Financial Officer of First Financial Bankshares, Inc. - --------------- *Filed herewith
37 Exhibit 10.7 ------------ CONSULTING AGREEMENT This Consulting Agreement (the "Agreement") is made and entered into as of the 1st day of January, 2004 (the "Effective Date"), by and between FIRST FINANCIAL BANKSHARES, INC. (the "Company"), and KENNETH T. MURPHY ("Murphy"). WITNESSETH: WHEREAS, following December 31, 2002, Murphy retired as an officer of the Company, and served in a Consulting capacity during the calendar year 2003; and WHEREAS, the Company recognizes the experience, leadership, knowledge and relationships of Murphy continue to be of great value to the Company and its Shareholders; and WHEREAS, the Company desires to retain Murphy's services as a consultant to: (i) participate in the identification and evaluation of prospects for acquisition or merger with the Company or a subsidiary of the Company; (ii) negotiate with potential sellers and recommend terms and conditions of such transaction(s); (iii) be accessible to the executive management of the Company for advice as to opportunities for growth and expansion, to review planning decisions, to build relationships and develop strategies which are intended to enhance the business interests of the Company for the benefit of its Shareholders (the "Services"); and WHEREAS, Murphy is willing to provide the Services to the Company; and WHEREAS, the parties desire to enter into this Agreement in a spirit of mutual respect, congeniality, and a desire to work together in harmony for the continued success of the Company; NOW, THEREFORE, for and in consideration of the premises and of the mutual representation, warranties, covenants and agreements contained herein, and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and upon the terms and subject to the conditions hereinafter set forth, the parties, intending to be legally bound, hereby agree as follows: 1. Duties and Term of Consultancy. The Company hereby engages Murphy, and Murphy hereby accepts engagement, as a consultant to provide the Services as reasonably requested by the Company. The term of this Agreement shall commence on the Effective Date and continue for a period of twelve (12) months ending on December 31, 2004. 2. Commitment of Time. No specific time requirement shall be a part of this Agreement. Rather, Murphy shall be reasonably available during the term of this Agreement, whether it be in his office or by telephone conference, to provide the Services as requested by the Company. 3. Means to Perform Services. Murphy shall be provided the necessary means for the performance of the Services, including an office and secretarial support, use of the Company's aircraft for travel related to the provision of the Services, use of membership in Abilene Country Club, and membership(s) in appropriate state and national banking organizations as determined by the Company. 4. Compensation for Services. As compensation for the Services rendered under this Agreement, the Company shall pay Murphy a fee of $8,333.33 per month, shall reimburse Murphy for his reasonable business expenses incurred in the provision of the Services, and shall convey the title of the 1998 Cadillac VIN #1G6KD54Y6WU734561 to Murphy as of February 1, 2004. 5. Termination. Either party hereto may terminate this Agreement without cause upon thirty (30) days written notice to the other party. In the event of termination of this Agreement prior to December 31, 2004, the Company shall pay Murphy the amount earned through the date of termination. This Agreement and the obligations of the Company shall terminate in the event of the death of Murphy as of the date of death. IN WITNESS WHEREOF, the parties hereto have signed this Agreement to take effect as of January 1, 2004. FIRST FINANCIAL BANKSHARES, INC. By: /s/ F. Scott Dueser ------------------- Name: F. Scott Dueser Title: President and Chief Executive Officer "Company" /s/ Kenneth T. Murphy --------------------- KENNETH T. MURPHY "Murphy" Exhibit 21.1 ------------ SUBSIDIARIES OF REGISTRANT
Percentage of Voting Names of Subsidiary Place of Organization Securities Owned ------------------- --------------------- ---------------- First Financial Bankshares of Delaware, Inc. Delaware 100% First Financial Investments, Inc. Texas 100% First Technology Services, Inc. Texas 100%** Abilene, Texas First Financial Trust & Asset Management Texas 100%** Company, National Association* Abilene, Texas First National Bank of Abilene* Texas 100%** Abilene, Texas Hereford State Bank Texas 100%** Hereford, Texas First National Bank, Sweetwater* Texas 100%** Sweetwater, Texas Eastland National Bank* Texas 100%** Eastland, Texas First Financial Bank, National Association* Texas 100%** Cleburne, Texas Stephenville Bank & Trust Co. Texas 100%** Stephenville, Texas San Angelo National Bank* Texas 100%** San Angelo, Texas Weatherford National Bank* Texas 100%** Weatherford, Texas First Financial Bank, National Association* Texas 100%** Southlake, Texas City National Bank* Texas 100%** Mineral Wells, Texas *Federal charter. **By First Financial Bankshares of Delaware, Inc.
All subsidiaries (other than First Financial Investments, Inc. which, as of December 31, 2003, had not yet begun operations) are included in the consolidated financial statements. Exhibit 31.1 ------------ Certification of Chief Executive Officer of First Financial Bankshares, Inc. I, F. Scott Dueser, President and Chief Executive Officer of First Financial Bankshares, Inc., certify that: 1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. [Intentionally omitted]; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectives of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting; and Date: March 5, 2004 By: /s/ F. SCOTT DUESER -------------------------------------------- F. Scott Dueser President and Chief Executive Officer Exhibit 31.2 ------------ Certification of Chief Financial Officer of First Financial Bankshares, Inc. I, J. Bruce Hildebrand, Executive Vice President and Chief Financial Officer of First Financial Bankshares, Inc., certify that: 1. I have reviewed this Form 10-K of First Financial Bankshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. [Intentionally omitted]; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectives of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting; and Date: March 5, 2004 By: /s/ J. Bruce Hildebrand ----------------------------------- J. Bruce Hildebrand Executive Vice President and Chief Financial Officer Exhibit 32.1 ------------ Certification of Chief Executive Officer of First Financial Bankshares, Inc. This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States code) and accompanies the annual report on Form 10-K (the "Form 10-K") for the year ended December 31, 2003 of First Financial Bankshares, Inc. I, F. Scott Dueser, the President and Chief Executive Officer of the Issuer certify that: 1. the Form 10-K fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and 2. the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 5, 2004 By: /s/ F. SCOTT DUESER --------------------------- F. Scott Dueser Chief Executive Officer Subscribed and sworn to before me this 5th of March 2004. /s/ Gaila N. Kilpatrick - ----------------------- Gaila N. Kilpatrick Notary Public My commission expires: April 15, 2005 Exhibit 32.2 ------------ Certification of Chief Financial Officer of First Financial Bankshares, Inc. This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States code) and accompanies the annual report on Form 10-K (the "Form 10-K") for the year ended December 31, 2003 of First Financial Bankshares, Inc. I, J. Bruce Hildebrand, the Executive Vice President and Chief Financial Officer of the Issuer certify that: 1. the Form 10-K fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and 2. the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 5, 2004 By: /s/ J. Bruce Hildebrand --------------------------- J. Bruce Hildebrand Chief Financial Officer Subscribed and sworn to before me this 5th of March 2004. /s/ Gaila N. Kilpatrick - ----------------------- Gaila N. Kilpatrick Notary Public My commission expires: April 15, 2005 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of First Financial Bankshares, Inc. We have audited the accompanying consolidated balance sheets of First Financial Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements of First Financial Bankshares, Inc. and subsidiaries for the year ended December 31, 2001, were audited by other auditors who have ceased operations and whose report dated January 11, 2002, expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Financial Bankshares, Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. As discussed above, the financial statements of First Financial Bankshares, Inc. and subsidiaries for the year ended December 31, 2001 were audited by other auditors who have ceased operations. As described in Note 1, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 1 with respect to 2001 amounts included (a) agreeing the previously reported net income to the previously issued financial statements and the proforma adjustments to reported net income representing amortization expense including related tax effects recognized in those periods related to goodwill to the Company's underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliation of proforma adjusted net income to reported net income, and the related earnings per share amounts. In our opinion, the disclosures for 2001 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole. Ernst & Young LLP Dallas, Texas January 16, 2004 F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of First Financial Bankshares, Inc. We have audited the accompanying consolidated balance sheets of First Financial Bankshares, Inc. (a Texas corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Financial Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Dallas, Texas, January 11, 2002 NOTE: THIS IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP, WHICH CEASED OPERATIONS. THIS REPORT ADDRESSES CERTAIN FINANCIAL STATEMENTS FOR PERIODS THAT ARE NOT OTHERWISE REQUIRED TO BE INCLUDED IN THIS FORM 10-K. F-2 MANAGEMENT'S REPORT ON RESPONSIBILITY FOR THE FINANCIAL STATEMENTS The Management of First Financial Bankshares, Inc. and subsidiaries is responsible for the preparation, integrity, and fair presentation of its annual consolidated financial statements as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and, as such, include amounts based on judgments and estimates made by Management. Management has also prepared the other information included in this Annual Report and is responsible for its accuracy and consistency with the consolidated financial statements. The annual consolidated financial statements as of and for the years ended December 31, 2003 and 2002 have been audited by Ernst & Young LLP, who have been given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders and the Board of Directors. Management believes that all representations made to Ernst & Young LLP during the audit were valid and appropriate. The annual consolidated financial statements for the year ended December 31, 2001, were audited by Arthur Andersen LLP, who were given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders and the Board of Directors. Management believes that all representations made to Arthur Andersen LLP during the audits were valid and appropriate. Arthur Andersen LLP subsequently ceased operations. F. Scott Dueser J. Bruce Hildebrand President and Chief Executive Officer Executive Vice President and Chief Financial Officer F-3 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2003 and 2002
ASSETS 2003 2002 ------ -------------- -------------- CASH AND DUE FROM BANKS $ 111,940,573 $ 108,436,645 FEDERAL FUNDS SOLD 1,900,000 70,000,000 -------------- -------------- Total cash and cash equivalents 113,840,573 178,436,645 INTEREST-BEARING DEPOSITS IN BANKS 876,839 2,324,425 INVESTMENT SECURITIES: Securities held-to-maturity (fair value of $138,594,081 in 2003 and $211,862,151 in 2002) 131,326,111 200,449,784 Securities available-for-sale, at fair value 778,976,003 571,806,629 -------------- -------------- Total investment securities 910,302,114 772,256,413 LOANS 987,523,103 964,039,773 Less- allowance for loan losses 11,576,299 11,218,729 -------------- -------------- Net loans 975,946,804 952,821,044 BANK PREMISES AND EQUIPMENT, net 43,902,112 40,605,401 INTANGIBLE ASSETS 24,717,671 24,870,788 OTHER ASSETS 22,985,321 21,868,220 -------------- -------------- Total assets $2,092,571,434 $1,993,182,936 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ NONINTEREST-BEARING DEPOSITS $ 472,574,590 $ 425,473,353 INTEREST-BEARING DEPOSITS 1,323,696,580 1,286,088,863 -------------- -------------- Total deposits 1,796,271,170 1,711,562,216 DIVIDENDS PAYABLE 4,798,948 4,327,374 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 28,975,167 26,708,994 OTHER LIABILITIES 11,039,392 11,816,707 -------------- -------------- Total liabilities 1,841,084,677 1,754,415,291 -------------- -------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $10 par value; authorized 20,000,000 shares; 15,480,679 and 12,364,201 issued and outstanding at December 31, 2003 and 2002, respectively 154,806,790 123,642,010 Capital surplus 58,253,180 58,087,687 Retained earnings 31,276,464 45,647,522 Accumulated other comprehensive earnings 7,150,323 11,390,426 -------------- -------------- Total shareholders' equity 251,486,757 238,767,645 -------------- -------------- Total liabilities and shareholders' equity $2,092,571,434 $1,993,182,936 ============== ==============
The accompanying notes are an integral part of these consolidated financial statements. F-4 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Earnings December 31, 2003, 2002 and 2001
2003 2002 2001 ------------- ------------- ------------ INTEREST INCOME: Interest and fees on loans $ 57,531,240 $ 63,826,534 $ 74,213,243 Interest on investment securities: Taxable 29,142,980 32,469,972 32,169,874 Exempt from federal income tax 8,143,832 7,042,102 6,279,973 Interest on federal funds sold and interest-bearing deposits in banks 466,615 946,861 3,211,316 ------------- ------------- ------------ Total interest income 95,284,667 104,285,469 115,874,406 ------------- ------------- ------------ INTEREST EXPENSE: Interest on deposits 16,968,469 24,087,911 43,970,532 Other 162,402 291,793 863,480 ------------- ------------- ------------ Total interest expense 17,130,871 24,379,704 44,834,012 ------------- ------------- ------------ Net interest income 78,153,796 79,905,765 71,040,394 PROVISION FOR LOAN LOSSES 1,177,868 2,369,634 1,964,050 ------------- ------------- ------------ Net interest income after provision for loan losses 76,975,928 77,536,131 69,076,344 ------------- ------------- ------------ NONINTEREST INCOME: Trust department income 6,017,962 5,835,909 5,890,600 Service fees on deposit accounts 15,747,288 15,435,137 14,743,217 ATM fees 2,784,537 2,370,313 1,941,508 Real estate mortgage fees 2,923,360 1,858,378 1,609,518 Net gain on securities transactions 24,984 16,373 67,789 Net gain on sale of student loans 1,895,977 782,655 598,439 Net gain on sale of other real estate 743,180 6,593 6,175 Other 3,971,333 3,823,564 3,319,683 ------------- ------------- ------------ Total noninterest income 34,108,621 30,128,922 28,176,929 ------------- ------------- ------------ NONINTEREST EXPENSE: Salaries and employee benefits 33,349,068 31,992,733 28,685,294 Net occupancy expense 3,941,428 3,908,856 3,995,597 Equipment expense 4,868,583 4,800,768 4,457,909 Printing, stationary and supplies 1,431,031 1,474,683 1,084,134 Correspondent bank service charges 1,501,142 1,491,132 1,329,134 Amortization of intangible assets 135,156 135,156 1,641,367 Other expenses 15,927,292 15,278,722 13,878,262 ------------- ------------- ------------ Total noninterest expense 61,153,700 59,082,050 55,071,697 ------------- ------------- ------------ EARNINGS BEFORE INCOME TAXES 49,930,849 48,583,003 42,181,576 INCOME TAX EXPENSE 14,626,049 14,630,453 12,827,071 ------------- ------------- ------------ NET EARNINGS $ 35,304,800 $ 33,952,550 $ 29,354,505 ============= ============= ============ NET EARNINGS PER SHARE, BASIC $ 2.28 $ 2.20 $ 1.91 ============= ============= ============ NET EARNINGS PER SHARE, ASSUMING DILUTION $ 2.27 $ 2.19 $ 1.90 ============= ============= ============
The accompanying notes are an integral part of these consolidated financial statements. F-5 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Earnings December 31, 2003, 2002 and 2001
2003 2002 2001 ------------- ------------ ------------ NET EARNINGS $ 35,304,800 $ 33,952,550 $ 29,354,505 OTHER ITEMS OF COMPREHENSIVE EARNINGS: Change in unrealized gain on investment securities available-for-sale, before income tax (7,172,878) 13,414,265 3,916,477 Reclassification adjustment for realized gains on investment securities included in net earnings, before income tax (24,984) (16,373) (67,789) Minimum liability pension adjustment, before income tax 674,626 (2,215,820) - ------------- ------------ ------------ Total other items of comprehensive earnings (6,523,236) 11,182,072 3,848,688 Income tax expense related to other items of comprehensive earnings 2,283,133 (3,913,725) (1,347,041) ------------- ------------ ------------ COMPREHENSIVE EARNINGS $ 31,064,697 $ 41,220,897 $ 31,856,152 ============= ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-6 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity December 31, 2003, 2002 and 2001
Accumulated Other Common Stock Treasury Comprehensive Total ----------------------- Capital Retained Stock, Earnings Shareholders' Shares Amount Surplus Earnings at cost (Losses) Equity ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2000 9,983,002 $99,830,020 $60,592,310 $38,003,195 $(3,925,069)$ 1,620,432 $196,120,888 Net earnings - - - 29,354,505 - - 29,354,505 Five for four stock split, effected in the form of a 25% stock dividend 2,461,770 24,617,700 - (24,617,700) - - - Cash dividends declared, $0.93 per share - - - (14,364,647) - - (14,364,647) Acquisition of treasury stock - - - - (315,050) - (315,050) Retirement of treasury stock (136,000) (1,360,000) (2,880,119) - 4,240,119 - - Stock issuances 24,480 244,800 111,870 - - - 356,670 Change in unrealized gain on investment in securities available-for-sale, net of related income taxes - - - - - 2,501,647 2,501,647 ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2001 12,333,252 $123,332,520 $57,824,061 $28,375,353 $ - $ 4,122,079 $213,654,013 Net earnings - - - 33,952,550 - - 33,952,550 Cash dividends declared, $1.08 per share - - - (16,680,381) - - (16,680,381) Stock issuances 30,949 309,490 263,626 - - - 573,116 Minimum liability pension adjustment, net of related income taxes - - - - - (1,440,283) (1,440,283) Change in unrealized gain on investment in securities available-for-sale, net of related income taxes - - - - - 8,708,630 8,708,630 ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2002 12,364,201 $123,642,010 $58,087,687 $45,647,522 $ - $11,390,426 $238,767,645 Net earnings - - - 35,304,800 - - 35,304,800 Five for four stock split, effected in the form of a 25% stock dividend 3,092,995 30,929,950 - (30,929,950) - - - Cash dividends declared, $1.21 per share - - - (18,745,908) - - (18,745,908) Stock issuances 23,483 234,830 165,493 - - - 400,323 Minimum liability pension adjustment, net of related income taxes - - - - - 438,507 438,507 Change in unrealized gain on investment in securities available-for-sale, net of related taxes - - - - - (4,678,610) (4,678,610) ---------- ------------ ----------- ----------- ----------- ----------- ------------ BALANCE, December 31, 2003 15,480,679 $154,806,790 $58,253,180 $31,276,464 $ - $7,150,323 $251,486,757 ========== ============ =========== =========== =========== =========== ============ The accompanying notes are an integral part of these consolidated financial statements.
F-7 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows December 31, 2003, 2002 and 2001
2003 2002 2001 -------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 35,304,800 $ 33,952,550 $ 29,354,505 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 4,303,567 4,125,655 5,679,082 Provision for loan losses 1,177,868 2,369,634 1,964,050 Premium amortization, net of discount accretion 5,162,940 2,077,358 1,662,108 Gain on sale of assets (2,664,141) (739,765) (651,254) Deferred federal income tax expense (benefit) (90,828) 350,415 (188,982) (Increase) decrease in other assets (158,175) (1,508,089) 3,565,172 Increase (decrease) in other liabilities 2,289,231 2,695,532 (1,778,326) -------------- ------------- ------------- Total adjustments 10,020,462 9,370,740 10,251,850 ------------- ----------- ------------- Net cash provided by operating activities 45,325,262 43,323,290 39,606,355 -------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease (increase) in interest-bearing deposits in banks 1,447,587 (950,140) (1,269,947) Payment for stock of City Bancshares, Inc., net of cash acquired - - (6,848,231) Activity in available-for-sale securities: Sales 50,617,175 30,077,478 57,925,815 Maturities 875,368,243 814,880,024 660,484,725 Purchases (1,148,629,137) (972,026,050) (854,748,980) Activity in held-to-maturity securities: Maturities 74,627,202 90,203,464 176,972,321 Purchases (2,365,000) (2,360,727) (76,102,656) Net increase in loans (23,046,251) (25,229,765) (31,041,094) Purchases of bank premises and equipment (7,108,990) (2,913,886) (5,151,260) Proceeds from sale of other assets 66,722 526,065 200,461 -------------- ------------- ------------- Net cash used in investing activities (179,022,449) (67,793,537) (79,578,846) -------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in noninterest-bearing deposits 47,101,236 36,066,687 41,179,967 Net increase (decrease) in interest-bearing deposits 37,607,717 (9,667,069) 41,583,909 Net increase (decrease) in securities sold under agreements to repurchase 2,266,173 6,861,927 (6,317,292) Common stock transactions: Acquisition of treasury stock - - (315,050) Proceeds of stock issuances 400,323 573,116 356,670 Dividends paid (18,274,334) (16,052,983) (13,921,211) -------------- ------------- ------------- Net cash provided by financing activities 69,101,115 17,781,678 62,566,993 -------------- ------------- ------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (64,596,072) (6,688,569) 22,594,502 CASH AND CASH EQUIVALENTS, beginning of year 178,436,645 185,125,214 162,530,712 -------------- ------------- ------------- CASH AND CASH EQUIVALENTS, end of year $ 113,840,573 $ 178,436,645 $ 185,125,214 ============== ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-8 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ------------------------------------------- Nature of Operations - -------------------- First Financial Bankshares, Inc. (a Texas corporation) ("Bankshares") is a financial holding company which owns (through its wholly-owned Delaware subsidiary) all of the capital stock of ten banks located in Texas as of December 31, 2003. Those subsidiary banks are First National Bank of Abilene; Hereford State Bank; First National Bank, Sweetwater; Eastland National Bank; First Financial Bank, National Association, Cleburne; Stephenville Bank & Trust Co.; San Angelo National Bank; Weatherford National Bank; First Financial Bank, National Association, Southlake and City National Bank, Mineral Wells. Each subsidiary bank's primary source of revenue is providing loans and banking services to consumers and commercial customers in the market area in which the subsidiary is located. In addition, the Company owns First Financial Trust & Asset Management Company, National Association and First Technology Services, Inc., an information technology subsidiary. A summary of significant accounting policies of Bankshares and subsidiaries (collectively, the "Company") applied in the preparation of the accompanying consolidated financial statements follows. The accounting principles followed by the Company and the methods of applying them are in conformity with both accounting principles generally accepted in the United States and prevailing practices of the banking industry. Stock Split - ----------- All prices and per share data related to our common stock have been adjusted to give effect to all stock splits and stock dividends, including the five-for-four stock split in the form of a 25% stock dividend effective June 2, 2003 for shareholders of record on May 16, 2003. Use of Estimates in Preparation of Financial Statements - ------------------------------------------------------- The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuations of foreclosed real estate, deferred income tax assets, and the fair value of financial instruments. Consolidation - ------------- The accompanying consolidated financial statements include the accounts of Bankshares and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated. Investment Securities - --------------------- Management classifies debt and equity securities as held-to-maturity, available-for-sale, or trading based on its intent. Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income using the interest method. Securities not classified as held-to-maturity or trading are classified as available-for-sale and recorded at estimated fair value, with unrealized gains and losses, net of deferred income taxes, excluded from earnings and reported in a separate component of shareholders' equity. Securities classified as trading are recorded at estimated fair value, with unrealized gains and losses included in earnings. The Company had no trading securities at December 31, 2003, 2002, or 2001. F-9 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 Loans and Allowance for Loan Losses - ----------------------------------- Loans are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amounts outstanding. The Company expenses its net loan origination costs, a method which does not materially differ from deferring and amortizing such amounts as an adjustment to yield. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb estimated inherent losses on existing loans that are deemed uncollectible based upon management's review and evaluation of the loan portfolio. The allowance is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specific loans. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on general economic conditions, the financial condition of the borrower, the value and liquidity of collateral, delinquency, prior loan loss experience, and the results of periodic reviews of the portfolio. For purposes of determining our general allocations, all loans, other than consumer, are segregated by credit grades which are assigned an allocation percentage. Our methodology is constructed so that specific allocations are increased in accordance with deterioration in credit quality and a corresponding increase in risk and loss. In addition, we adjust our allowance for qualitative factors such as national, state and local economic conditions, changes in trends in delinquencies or non-accruals, deterioration in concentration of credit and results of independent and regulatory loan review. This additional allocation based on qualitative factors serves to compensate for additional areas of uncertainty inherent in our portfolio. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. Generally all loans past due greater than 90 days are placed on non-accrual. The Company's policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan's observable market price. At December 31, 2003 and 2002, all significant impaired loans have been determined to be collateral dependent and the allowance for loss has been measured utilizing the estimated fair value of the collateral. Other Real Estate - ----------------- Other real estate is foreclosed property held pending disposition and is valued at the lower of its fair value, less estimated costs to sell or the recorded investment in the related loan. At foreclosure, if the fair value, less estimated costs to sell, of the real estate acquired is less than the Company's recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Any subsequent reduction in value is recognized by a charge to income. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in noninterest expense. Bank Premises and Equipment - --------------------------- Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the life of the respective lease or the estimated useful lives of the improvements, whichever is shorter. Business Combinations, Goodwill and Other Intangible Assets - ----------------------------------------------------------- Goodwill, relating to acquisitions of certain subsidiary banks, was amortized by the straight-line method over periods of 15 and 40 years during the year ended December 31, 2001. F-10 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 In June 2001, Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") were issued. SFAS No. 141 required that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addressed the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 also addressed the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provided that intangible assets with finite useful lives continue to be amortized and that goodwill and intangible assets with indefinite lives no longer be amortized, but rather be tested annually for impairment. SFAS No. 142 was effective January 1, 2002; however, acquired goodwill or intangible assets recorded in our acquisition of City Bancshares, Inc. were subject immediately to its provisions. On January 1, 2002, goodwill amounting to $23,765,896 was not subject to further amortization as a result of SFAS No. 142. The Company conducted its required goodwill impairment test in 2003 and 2002, with no reduction of recorded goodwill resulting from the test. A reconciliation adjusting comparative net earnings and earnings per share for the year ended December 31, 2001, to show the effect of no longer amortizing the Company's goodwill, follows: Reported net earnings $29,354,505 Add back: goodwill amortization Goodwill amortization, before income tax 1,641,367 Income tax benefit (420,000) ----------- Adjusted net earnings $30,575,872 =========== Basic earnings per share: Reported net earnings $ 1.91 Goodwill amortization, net of income tax benefit 0.08 ----------- Adjusted net earnings $ 1.99 =========== Earnings per share, assuming dilution: Reported net earnings $ 1.90 Goodwill amortization, net of income tax benefit 0.08 ----------- Adjusted net earnings $ 1.98 =========== Goodwill arising from acquisitions of assets and liabilities, rather than acquisitions of stock, amounting to $13,000,000, is deductible for federal income tax purposes. Other identifiable intangible assets recorded by the Company represent the future benefit associated with the acquisition of the core deposits of City Bancshares, Inc. (Note 17) and is being amortized over seven years utilizing a method that approximates the expected attrition of the deposits. Securities Sold Under Agreements To Repurchase - ---------------------------------------------- Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of the cash received in connection with the transaction. The Company may be required to provide additional collateral based on the estimated fair value of the underlying securities. Segment Reporting - ----------------- The Company has determined that it operates one line of business (community banking) located in a single geographic area (Texas). F-11 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 Statements of Cash Flows - ------------------------ For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Accounting for Income Taxes - --------------------------- The Company's provision for income taxes is based on income before income taxes adjusted for permanent differences between financial reporting and taxable income. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Stock Based Compensation - ------------------------ The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Had compensation cost for the plan been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the Company's net earnings and earnings per share would have been reduced by insignificant amounts on a pro forma basis for the years ended December 31, 2003, 2002 and 2001. Note 15 provides additional information on the Company's stock option plan. Stock Repurchase - ---------------- On July 25, 2000, the Company approved a stock repurchase plan, authorizing the repurchase of shares of the Company's common stock. During the year ended December 31, 2001, the Company repurchased 12,375 shares. The treasury shares were purchased for $315,050, representing an average purchase price of $25.46 per share and were retired in 2001. The 2000 stock repurchase plan expired in 2002. Additionally, on April 22, 2003, the Company's Board of Directors authorized the repurchase of up to 500,000 shares of common stock over the next three years. The plan authorizes management to repurchase the stock at such time as repurchases are considered beneficial to stockholders. Any repurchases of the stock will be through the open market or in privately negotiated transactions in accordance with applicable laws and regulations. No stock has been repurchased under this plan as of December 31, 2003. Per Share Data - -------------- Net earnings per share ("EPS") are computed by dividing net earnings by the weighted average number of shares of common stock outstanding during the period. The Company calculates dilutive EPS assuming all outstanding options to purchase common stock have been exercised at the beginning of the year (or the time of issuance, if later.) The dilutive effect of the outstanding options is reflected by application of the treasury stock method, whereby the proceeds from the exercised options are assumed to be used to purchase common stock at the average market price during the period. The following table reconciles the computation of basic EPS to dilutive EPS:
Weighted Net Average Per Share Earnings Shares Amount ----------- ---------- --------- For the year ended December 31, 2003: Net earnings per share, basic $35,304,800 15,468,752 $ 2.28 ========= Effect of stock options - 63,633 ----------- ---------- Net earnings per share, assuming dilution $35,304,800 15,532,385 $ 2.27 =========== ========== ========= F-12 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 For the year ended December 31, 2002: Net earnings per share, basic $33,952,550 15,439,205 $ 2.20 ========= Effect of stock options - 59,404 ----------- ---------- Net earnings per share, assuming dilution $33,952,550 15,498,609 $ 2.19 =========== ========== ========= For the year ended December 31, 2001: Net earnings per share, basic $29,354,505 15,397,933 $ 1.91 ========= Effect of stock options - 56,654 ----------- ---------- Net earnings per share, assuming dilution $29,354,505 15,454,587 $ 1.90 =========== ========== =========
Reclassifications - ----------------- Certain 2002 and 2001 amounts have been reclassified to conform to the 2003 presentation. 2. CASH AND INVESTMENT SECURITIES: ------------------------------- The amortized cost, estimated fair values, and gross unrealized gains and losses of the Company's investment securities as of December 31, 2003 and 2002, are as follows:
December 31, 2003 ------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Estimated Cost Basis Holding Gains Holding Losses Fair Value ------------ ----------- ---------- ------------ Securities held-to-maturity: U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies $ 78,223,829 $ 4,181,765 $ - $ 82,405,594 Obligations of state and political subdivisions 43,324,769 2,592,521 (32,564) 45,884,726 Corporate bonds and other 503,243 41,391 - 544,634 Mortgage-backed securities 9,274,270 485,902 (1,045) 9,759,127 ------------ ----------- ---------- ------------ Total debt securities held-to-maturity $131,326,111 $ 7,301,579 ($33,609) $138,594,081 ============ =========== ========== ============ Securities available-for-sale: U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies $253,515,211 $6,125,162 ($640,484) $258,999,889 Obligations of state and political subdivisions 178,287,396 7,120,946 (1,504,035) 183,904,307 Corporate bonds and other 42,822,744 1,767,885 - 44,590,629 Mortgage-backed securities 291,808,871 1,836,831 (2,164,524) 291,481,178 ------------ ----------- ---------- ------------ Total securities available-for-sale $766,434,222 $16,850,824 ($4,309,043) $778,976,003 ============ =========== ========== ============
F-13 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001
December 31, 2003 ------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Estimated Cost Basis Holding Gains Holding Losses Fair Value ------------ ----------- ---------- ------------ Securities held-to-maturity: U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies $110,939,173 $ 6,868,716 $ - $117,807,889 Obligations of state and political subdivisions 60,835,676 3,214,571 - 64,050,247 Corporate bonds and other 498,936 41,064 - 540,000 Mortgage-backed securities 28,175,999 1,288,594 (578) 29,464,015 ------------ ----------- ---------- ------------ Total debt securities held-to-maturity $200,449,784 $11,412,945 $ (578) $211,862,151 ============ =========== ========== ============ Securities available-for-sale: U.S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies $164,090,045 $ 7,545,917 $ (16,670) $171,619,292 Obligations of state and political subdivisions 104,800,319 5,952,505 (12,189) 110,740,635 Corporate bonds and other 54,687,216 2,653,387 - 57,340,603 Mortgage-backed securities 228,489,406 4,066,253 (449,560) 232,106,099 ------------ ----------- ---------- ------------ Total securities available-for-sale $552,066,986 $20,218,062 $(478,419) $571,806,629 ============ =========== ========== ============
The Company invests in mortgage-backed securities that have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty. These securities include collateralized mortgage obligations (CMOs) and other asset backed securities. The expected maturities of these securities at December 31, 2003 and 2002, were computed by using scheduled amortization of balances and historical prepayment rates. At December 31, 2003 and 2002, the Company did not hold any CMOs that entail higher risks than standard mortgage-backed securities. F-14 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 The amortized cost and estimated fair value of debt securities at December 31, 2003, by contractual and expected maturity, are shown below.
Held-to-Maturity Available-for-Sale ---------------- ---------------------- Amortized Estimated Amortized Estimated Cost Basis Fair Value Cost Basis Fair Value ------------ ------------ ------------ ------------ Due within one year $ 36,242,878 $ 37,083,292 $ 42,073,996 $ 42,894,034 Due after one year through five years 64,012,353 68,091,801 285,706,445 294,098,528 Due after five years through ten years 21,457,610 23,300,435 83,755,802 88,675,093 Due after ten years 339,000 359,426 63,089,108 61,827,170 ------------ ------------ ------------ ------------ 122,051,841 128,834,954 474,625,351 487,494,825 ------------ ------------ ------------ ------------ Mortgage-back securities 9,274,270 9,759,127 291,808,871 291,481,178 ------------ ------------ ------------ ------------ Total $131,326,111 $138,594,081 $766,434,222 $778,976,003 ============ ============ ============ ============
The following table discloses, as of December 31, 2003, the Company's investment securities that have been in a continuous unrealized-loss position for less than 12 months and those that have been in a continuous unrealized-loss position for 12 or more months (in thousands):
Less than 12 Months 12 Months or Longer Total --------------------- ------------------- -------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss --------- ------- -------- -------- -------- ------ U. S. Treasury securities and obligations of U.S. government sponsored-enterprises and agencies $ 45,904 $ 640 - - $ 45,904 $ 640 Obligations of state and political subdivisions 51,027 1,537 - - 51,027 1,537 Mortgage-backed securities 145,394 2,166 - - 145,394 2,166
We believe the investment securities in the table above are within ranges customary for the banking industry. The number of investment positions in this unrealized loss position totals 278. We do not believe these unrealized losses are "other than temporary" as (1) the Company has the ability and intent to hold the investments to maturity, or a period of time sufficient to allow for a recovery in market value, (2) it is not probable that the Company will be unable to collect the amounts contractually due and (3) no decision to dispose of the investment were made prior to the balance sheet date. The unrealized losses noted are interest rate related due to rising rates at December 31, 2003, in relation to previous rates in mid-2003. The duration of these investments is less than 5 years for all securities other than the municipal bonds, which is less than 15 years. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities. Securities, carried at approximately $275,342,000 and $239,971,000 at December 31, 2003 and 2002, respectively, were pledged as collateral for public or trust fund deposits and for other purposes required or permitted by law. During 2003, 2002, and 2001 sales of investment securities that were classified as available-for-sale totaled approximately $50,617,000, $30,077,000, and $57,926,000 respectively. Gross realized gains and losses from sales in 2003 were approximately $296,000 and $271,000, respectively. Gross realized gains and losses from 2002 sales were approximately $24,000 and $7,000, respectively. Gross realized gains and losses from 2001 sales were approximately $105,000 and $37,000, respectively. The specific identification method was used to determine cost in computing the realized gains and losses. F-15 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 Certain subsidiary banks are required to maintain reserve balances with the Federal Reserve Bank. During 2003 and 2002, such average balances totaled approximately $15,727,000 and $12,776,000, respectively. 3. LOANS AND ALLOWANCE FOR LOAN LOSSES: ------------------------------------ Major classifications of loans are as follows: December 31, ------------------------------ 2003 2002 ------------ ------------ Commercial, financial, and agricultural $333,840,269 $311,743,212 Real estate - construction 77,833,890 50,911,156 Real estate - mortgage 385,770,437 375,255,678 Consumer 190,081,323 226,140,626 ------------ ------------ 987,525,919 964,050,672 Unearned income (2,816) (10,899) ------------ ------------ Total loans $987,523,103 $964,039,773 ============ ============ Included in real estate-mortgage and consumer loans above are $2.6 million and $53.6 million in loans held for sale at December 31, 2003 in which the carrying amount approximates market. The Company's recorded investment in impaired loans and the related valuation allowance are as follows: December 31, 2003 December 31, 2002 -------------------------- ------------------------- Recorded Valuation Recorded Valuation Investment Allowance Investment Allowance ---------- ---------- ---------- ---------- $1,741,278 $ 332,927 $3,734,261 $ 752,385 ========== ========== ========== ========== F-16 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 The average recorded investment in impaired loans for the years ended December 31, 2003 and 2002, was approximately $2,738,000 and $3,776,000, respectively. The Company had approximately $3,171,000 and $4,266,000 in nonperforming assets at December 31, 2003 and 2002, respectively. No additional funds are committed to be advanced in connection with impaired loans. Interest payments received on impaired loans are recorded as interest income unless collections of the remaining recorded investment are doubtful, at which time payments received are recorded as reductions of principal. The Company recognized interest income on impaired loans of approximately $46,000, $111,000 and $136,000 during the years ended December 31, 2003, 2002, and 2001, respectively, of which approximately $4,000, $2,000 and $9,000 represented cash interest payments received and recorded as interest income. If interest on impaired loans had been recognized on a full accrual basis during the years ended December 31, 2003, 2002, and 2001, respectively, such income would have approximated $207,000, $317,000 and $399,000. The allowance for loan losses as of December 31, 2003 and 2002, is presented below. Management has evaluated the adequacy of the allowance for loan losses by estimating the losses in various categories of the loan portfolio which are identified below:
2003 2002 ----------- ------------ Allowance for loan losses provided for: Loans specifically evaluated as impaired $ 332,927 $ 752,385 Remaining portfolio 11,243,372 10,466,344 ----------- ------------ Total allowance for loan losses $11,576,299 $11,218,729 =========== ============
Changes in the allowance for loan losses are summarized as follows:
December 31, ----------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Balance at beginning of year $11,218,729 $10,602,419 $ 9,887,646 Add: Provision for loan losses 1,177,868 2,369,634 1,964,050 Loan recoveries 1,356,625 834,150 968,535 Allowance established at acquisition - - 407,129 Deduct: Loan charge-offs (2,176,923) (2,587,474) (2,624,941) ----------- ----------- ----------- Balance at end of year $11,576,299 $11,218,729 $10,602,419 =========== =========== ===========
An analysis of the changes in loans to officers, directors, principal shareholders, or associates of such persons for the years ended December 31, 2003 and 2002 (determined as of each respective year-end) follows:
Beginning Additional Ending Balance Loans Payments Balance ----------- ----------- ----------- ----------- Year ended December 31, 2003 $27,731,290 $39,953,042 $22,917,464 $44,766,868 =========== =========== =========== =========== Year ended December 31, 2002 $44,426,313 $27,349,995 $44,235,855 $27,540,453 =========== =========== =========== ===========
In the opinion of management, those loans are on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with unaffiliated persons. F-17 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 4. BANK PREMISES AND EQUIPMENT: ---------------------------- The following is a summary of bank premises and equipment:
Useful Life December 31, ----------------------------------- ----------------------------- 2003 2002 ----------- ----------- Land - $ 8,620,686 $ 7,362,814 Buildings 20 to 40 years 53,526,533 50,560,723 Furniture and equipment 3 to 10 years 28,602,702 26,347,819 Leasehold improvements Lesser of lease term or 5 to 15 years 4,544,393 4,385,288 ----------- ----------- 95,294,314 88,656,644 Less- accumulated depreciation and amortization (51,392,202) (48,051,243) ----------- ----------- $43,902,112 $40,605,401 =========== ===========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001 amounted to $4,168,411, $4,284,473, and $3,755,878, respectively and is included in the captions net occupancy expense and equipment expense in the accompanying consolidated statements of earnings. The Company is lessor for portions of its banking premises. Total rental income for all leases included in net occupancy expense is approximately $1,821,000, $1,578,000 and $1,432,000, for the years ended December 31, 2003, 2002, and 2001, respectively. 5. TIME DEPOSITS ------------- Time deposits of $100,000 or more totaled approximately $220,067,000 and $195,754,000 at December 31, 2003 and 2002, respectively. Interest expense on these deposits was approximately $4,885,000, $5,694,000, and $10,163,000 during 2003, 2002, and 2001, respectively. At December 31, 2003, the scheduled maturities of time deposits (in thousands) were, as follows: Year ending December 31, ------------------------ 2004 $475,531 2005 32,013 2006 7,667 2007 11,341 2008 6,786 Thereafter 309 -------- $533,647 ======== 6. LINE OF CREDIT -------------- The Company has a line of credit with a nonaffiliated bank under which it could borrow up to $20,000,000. The line of credit is unsecured and matures on June 30, 2004. The Company paid no fee to secure the unused line of credit and, accordingly, did not estimate a fair value of the unused line of credit at December 31, 2003 or 2002. The line of credit carries an interest rate of the London Interbank Offering Rate plus 1.0%. There was no outstanding balance under the line of credit as of December 31, 2003 or 2002. F-18 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 7. INCOME TAXES: ------------- The Company files a consolidated federal income tax return. Income tax expense is comprised of the following:
Year Ended December 31, ----------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Current federal income tax $14,716,877 $14,280,038 $13,016,053 Deferred federal income tax expense (benefit) (90,828) 350,415 (188,982) ----------- ----------- ----------- Income tax expense $14,626,049 $14,630,453 $12,827,071 =========== =========== ===========
Income tax expense, as a percentage of pretax earnings, differs from the statutory federal income tax rate as follows:
As a Percent of Pretax Earnings ------------------------------------------------- 2003 2002 2001 --------------- -------------- -------------- Statutory federal income tax rate 35.0% 35.0 % 35.0 % Reductions in tax rate resulting from interest income exempt from federal income tax (5.9)% (5.6)% (5.2)% ESOP tax credit (0.2)% - - Other 0.4 % 0.7 % 0.6 % ---- ---- ---- Effective income tax rate 29.3% 30.1 % 30.4 % ==== ==== ====
F-19 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 The approximate effects of each type of difference that gave rise to the Company's deferred tax assets and liabilities at December 31, 2003 and 2002 are as follows:
2003 2002 ----------- ----------- Deferred tax assets- Tax basis of loans in excess of financial statement basis $ 4,082,056 $ 3,940,576 Minimum liability in defined benefit plan 539,418 775,537 Recognized for financial reporting purposes but not for tax purposes- Deferred compensation 705,217 686,098 Write-downs and adjustments to other real estate owned and repossessed assets 24,039 133,000 Other deferred tax assets 358,194 343,527 ----------- ----------- Total deferred tax assets 5,708,924 5,878,738 ----------- ----------- Deferred tax liabilities- Financial statement basis of fixed assets in excess of tax basis 1,567,661 1,442,962 Intangible asset amortization deductible for tax purposes, but not for financial reporting purposes 831,314 832,527 Recognized for financial reporting purposes but not for tax purposes: Accretion on investment securities 481,930 437,660 Pension plan contributions 297,379 497,869 Net unrealized gain on investment securities available-for-sale 4,389,625 6,908,875 Other deferred tax liabilities 79,545 71,334 ----------- ----------- Total deferred tax liabilities 7,647,454 10,191,227 ----------- ----------- Net deferred tax liability $(1,938,530) $(4,312,489) =========== ===========
8. FAIR VALUE OF FINANCIAL INSTRUMENTS: ------------------------------------ The Company is required to disclose the estimated fair value of its financial instrument assets and liabilities. For the Company, as for most financial institutions, substantially all of its assets and liabilities are considered financial instruments as defined. Many of the Company's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Estimated fair values have been determined by the Company using the best available data, as generally provided in the Company's regulatory reports, and an estimation methodology suitable for each category of financial instruments. For those loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the carrying value. F-20 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 The estimated fair values, and carrying values at December 31, 2003 and 2002, were as follows:
2003 2002 ------------------------------ ------------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ------------- -------------- ------------- ------------- Cash and due from banks $111,940,573 $111,940,573 $108,436,645 $108,436,645 Federal funds sold 1,900,000 1,900,000 70,000,000 70,000,000 Interest-bearing deposits in banks 876,839 876,839 2,324,425 2,324,425 Investment securities 910,302,114 917,570,084 772,256,413 783,668,780 Net loans 975,946,804 982,937,785 952,821,044 964,782,729 Accrued interest receivable 14,901,681 14,901,681 15,360,833 15,360,833 Deposits with stated maturities 533,647,010 536,207,802 541,031,072 544,575,352 Deposits with no stated maturities 1,262,624,160 1,262,624,160 1,170,531,144 1,170,531,144 Securities sold under agreements to repurchase 28,975,167 28,975,167 26,708,994 26,708,994 Accrued interest payable 1,723,217 1,723,217 2,150,309 2,150,309
Financial instruments actively traded in a secondary market have been valued using quoted available market prices. Financial instruments with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. Financial instrument assets with variable rates and financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the carrying value. Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values. The Company's remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than customary with historical cost accounting. There is no material difference between the carrying value and the estimated fair value of the Company's contractual off-balance-sheet unfunded lines of credit, loan commitments and letters of credit which are generally priced at market at the time of funding. Reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. 9. COMMITMENTS AND CONTINGENCIES: ------------------------------ The Company is engaged in legal actions arising from the normal course of business. In management's opinion, the Company has adequate legal defenses with respect to these actions, and the resolution of these matters will have no material adverse effects upon the results of operations or financial condition of the Company. The Company leases a portion of its bank premises and equipment under operating leases. At December 31, 2003, future minimum lease commitments were: 2004 - $468,000; 2005 - $437,000; 2006 - $384,000; 2007 - $189,000; 2008 - $18,000; and thereafter - $3,000. F-21 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: -------------------------------------------------- The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include unfunded lines of credit, commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded lines of credit, commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. The Company generally uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Contract or Notional Amount at December 31, 2003 ----------------- Financial instruments whose contract amounts represent credit risk: Unfunded lines of credit $123,803,128 Unfunded commitments to extend credit 62,092,132 Standby letters of credit 6,067,787 Unfunded lines of credit and commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment, livestock, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The average collateral value held on letters of credit usually exceeds the contract amount. The Company has no other off-balance sheet arrangements or transactions that would expose the Company to liability that is not reflected on the face of the financial statements. 11. CONCENTRATION OF CREDIT RISK: ----------------------------- The Company grants commercial, retail, agriculture, and residential loans to customers primarily in North Central and West Texas. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon this local economic sector. 12. PENSION AND PROFIT SHARING PLANS: --------------------------------- The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and a percentage of the employee's qualifying compensation during the final years of employment. The Company's funding policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding standards. Contributions to the pension plan through December 31, 2003 were intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Effective January 1, 2004, the pension plan was frozen whereby no additional years of service will accrue to F-22 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 participants, unless the pension plan is reinstated. Under current generally accepted accounting principles and utilizing current assumptions, we do not expect any significant pension costs in 2004 and beyond as a result of this action. Using an actuarial measurement date of September 30, benefit obligation activity and fair value of plan assets for the years ended December 31, 2003 and 2002, and a statement of the funded status as of December 31, 2003 and 2002 are as follows:
2003 2002 ----------- ------------ Reconciliation of benefit obligations: Benefit obligation at January 1 $15,540,397 $ 14,183,582 Service cost - benefits earned during the period 1,118,607 994,630 Interest cost on projected benefit obligation 1,078,485 983,977 Actuarial loss 1,027,430 45,731 Benefits paid (737,859) (667,523) ----------- ------------ Benefit obligation at December 31 18,027,060 15,540,397 ----------- ------------ Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 11,659,711 12,631,250 Actual return on plan assets 1,535,499 (1,031,005) Employer contributions 1,038,301 726,989 Benefits paid (737,859) (667,523) ----------- ------------ Fair value of plan assets at December 31 13,495,652 11,659,711 ----------- ------------ Funded status $(4,531,408) $ (3,880,686) =========== ============ Reconciliation of funded status to accrued pension liability: Funded status at December 31 $(4,531,408) $ (3,880,686) Unrecognized loss from past experience different than that assumed and effects of changes in assumptions 5,447,571 5,109,193 Additional minimum liability recorded (1,717,208) (2,409,795) Unrecognized prior-service cost 176,014 193,975 Other (66,509) (36,644) ----------- ------------ Accrued pension liability $ (691,540) $ (1,023,957) =========== ============
The Company recorded an additional minimum liability in the year ended December 31, 2003 and 2002 to reflect the underfunded status of the plan. The accrued pension liability at December 31, 2003 and 2002 represents the difference between the fair value of plan assets and the accumulated benefit obligation. The accumulated benefit obligation is the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to that date and based on current and past compensation levels. The accumulated benefit obligation differs from the projected benefit obligation in that it assumes no increase in future compensation. The following table details the financial statement captions affected by recording the minimum liability: F-23 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001
2003 2002 ----------- ----------- Prepaid pension asset before adjustment $ 1,025,668 $ 1,385,838 Intangible asset recorded (included in other assets) (176,014) (193,975) Minimum liability adjustment (1,541,194) (2,215,820) ----------- ----------- Accrued pension liability $ (691,540) $(1,023,957) =========== ===========
Net periodic pension cost for the years ended December 31, 2003, 2002, and 2001, included:
Year Ended December 31, ---------------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Service cost - benefits earned during the period $1,118,607 $ 994,630 $ 847,620 Interest cost on projected benefit obligation 1,078,485 983,977 970,710 Expected return on plan assets (1,072,853) (880,562) (1,153,733) Amortization of unrecognized net loss 226,405 116,722 - Amortization of prior-service cost 17,961 17,960 17,961 Other - (59,405) (58,954) ---------- ---------- ---------- Net periodic pension cost $1,368,605 $1,173,322 $ 623,604 ========== ========== ==========
The following table sets forth the rates used in the actuarial calculations of the present value of benefit obligations and net periodic pension cost and the rate of return on plan assets:
2003 2002 2001 ---- ---- ---- Weighted average discount rate 6.5% 6.9% 6.9% Rate of increase in future compensation levels 4% 4% 4% Expected long-term rate of return on assets 8.5% 6.5% 8.5%
The expected long-term rate of return on plan assets is based on historical returns and expectations of future returns based on asset mix, after consultation with our investment advisors and actuaries. In 2002, the expected long-term rate of return was downwardly adjusted to 6.5% to reflect the declining equity markets. In 2003, the expected long-term rate of return was returned to 8.5% based on our estimate of changes to the markets in which our investments reside after consultation with our investment advisors and actuaries. The major type of plan assets in the pension plan and the targeted allocation percentage as of December 31, 2003 and 2002 is as follows:
December 31, 2003 December 31, 2002 Targeted Allocation Allocation Allocation ---------- ---------- ---------- Equity securities 56% 57% 60% Debt securities 35% 38% 40% Other 9% 5% -
The range and weighted average maturities of debt securities held in the pension plan as of December 31, 2003 are one to 15 years and approximately 6.4 years, respectively. The Trust Department of the First National Bank of Abilene, a wholly owned subsidiary bank of the Company, manages the pension plan assets as well as the profit sharing plan assets (see below). The investment strategy and targeted allocations is based on similar strategies the Trust Department employs for most of its managed accounts whereby appropriate diversification is achieved. The Trust Department is prohibited from high risk investments including the use of derivatives. F-24 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 An estimate of the undiscounted projected future payments to eligible participants for the next five years and the following five years in the aggregate is as follows (dollars in thousands): Year Ending December 31, ------------------------ 2004 $ 831 2005 930 2006 1,019 2007 1,153 2008 1,248 2009-2013 8,371 The Company expects to make a contribution to the pension plan during 2004 in a range of zero to $50,000 as required by the regulations. No discretionary or non-cash contributions are expected. As of December 31, 2003 and 2002, the fair value of the pension plan's assets included Company common stock valued at approximately $634,000 and $468,000, respectively. The Company also provides a profit sharing plan, which covers substantially all full-time employees. The profit sharing plan is a defined contribution plan and allows employees to contribute up to 5% of their base annual salary. Employees are fully vested to the extent of their contributions and become fully vested in the Company's contributions over a seven-year vesting period. Costs related to the Company's defined contribution plan totaled approximately $1,473,000, $2,681,000 and $1,858,000 in 2003, 2002 and 2001, respectively, and are included in salaries and employee benefits in the accompanying consolidated statements of earnings. As of December 31, 2003 and 2002, the fair value of the profit sharing plan's assets included Company common stock valued at approximately $18,348,000 and $14,323,000, respectively. We replaced the costs of our frozen pension plan with a matching of employee salary deferrals into the 401(k) plan. Effective January 1, 2004, we will match a maximum of 4% on employee deferrals of 5% of their respective employee compensation. 13. DIVIDENDS FROM SUBSIDIARIES: ---------------------------- At December 31, 2003, approximately $14.5 million was available for the declaration of dividends by the Company's subsidiary banks without the prior approval of regulatory agencies. 14. REGULATORY MATTERS: ------------------- The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, each of Bankshares' subsidiaries must meet specific capital guidelines that involve quantitative measures of the subsidiaries' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The subsidiaries' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require Bankshares and each of its subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined), to average assets (as defined). Management believes as of December 31, 2003 and 2002, that Bankshares and each of its subsidiaries meet all capital adequacy requirements to which they are subject. F-25 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 As of December 31, 2003 and 2002, the most recent notification from each respective subsidiaries' primary regulator categorized each of Bankshares' subsidiaries as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institutions' categories. Bankshares' and its significant subsidiaries' actual capital amounts and ratios are presented in the table below:
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes: Action Provisions: --------------------- ---------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ------------- --- -------------- ----- -------------- ------ As of December 31, 2003: - ------------------------ Total Capital (to Risk-Weighted Assets): Consolidated $ 230,226,000 20% =>$ 92,890,000 => 8% N/A N/A First National Bank of Abilene $ 69,175,000 16% =>$ 34,109,000 => 8% =>$ 42,637,000 => 10% San Angelo National Bank $ 30,793,000 20% =>$ 12,214,000 => 8% =>$ 15,267,000 => 10% Weatherford National Bank $ 20,025,000 17% =>$ 9,462,000 => 8% =>$ 11,828,000 => 10% Tier I Capital (to Risk-Weighted Assets): Consolidated $ 218,617,000 19% =>$ 46,445,000 => 4% N/A N/A First National Bank of Abilene $ 65,436,000 15% =>$ 17,055,000 => 4% =>$ 25,582,000 => 6% San Angelo National Bank $ 29,494,000 19% =>$ 6,107,000 => 4% =>$ 9,160,000 => 6% Weatherford National Bank $ 18,890,000 16% =>$ 4,731,000 => 4% =>$ 7,097,000 => 6% Tier I Capital (to Average Assets): Consolidated $ 218,617,000 11% =>$ 61,933,000 => 3% N/A N/A First National Bank of Abilene $ 65,436,000 9% =>$ 22,244,000 => 3% =>$ 37,074,000 => 5% San Angelo National Bank $ 29,494,000 10% =>$ 9,286,000 => 3% =>$ 15,476,000 => 5% Weatherford National Bank $ 18,890,000 9% =>$ 6,216,000 => 3% =>$ 10,361,000 => 5%
F-26 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes: Action Provisions: --------------------- ---------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ------------- --- -------------- ----- -------------- ------ As of December 31, 2002: - ------------------------ Total Capital (to Risk-Weighted Assets): Consolidated $ 213,725,000 20% =>$ 87,579,000 => 8% N/A N/A First National Bank of Abilene $ 68,874,000 17% =>$ 32,153,000 => 8% =>$ 40,191,000 => 10% San Angelo National Bank $ 30,716,000 22% =>$ 10,816,000 => 8% =>$ 13,520,000 => 10% Weatherford National Bank $ 19,758,000 18% =>$ 8,802,000 => 8% =>$ 11,002,000 => 10% Tier I Capital (to Risk-Weighted Assets): Consolidated $ 202,507,000 18% =>$ 43,790,000 => 4% N/A N/A First National Bank of Abilene $ 64,971,000 16% =>$ 16,077,000 => 4% =>$ 24,115,000 => 6% San Angelo National Bank $ 29,374,000 21% =>$ 5,408,000 => 4% =>$ 8,112,000 => 6% Weatherford National Bank $ 18,757,000 17% =>$ 4,401,000 => 4% =>$ 6,601,000 => 6% Tier I Capital (to Average Assets): Consolidated $ 202,507,000 11% =>$ 57,856,000 => 3% N/A N/A First National Bank of Abilene $ 64,971,000 9% =>$ 20,626,000 => 3% =>$ 34,377,000 => 5% San Angelo National Bank $ 29,374,000 10% =>$ 8,410,000 => 3% =>$ 14,016,000 => 5% Weatherford National Bank $ 18,757,000 10% =>$ 5,884,000 => 3% =>$ 9,807,000 => 5%
15. STOCK OPTION PLAN: ------------------ The Company has an incentive stock plan to provide for the granting of options to senior management of the Company at prices not less than market at the date of grant. At December 31, 2003, the Company had allocated 734,787 shares of stock for issuance under the plan. The plan provides that options granted are exercisable after two years from date of grant at a rate of 20% each year cumulatively during the 10-year term of the option. An analysis of stock option activity for the years ended December 31, 2003, 2002, and 2001, is presented in the table and narrative below:
2003 2002 2001 ------------------- ------------------- ------------------- Wtd. Avg. Wtd. Avg. Wtd. Avg. Shares Ex. Price Shares Ex. Price Shares Ex. Price ------- ------- ------- ------ ------- ------ Outstanding, beginning of year 142,850 $ 17.98 187,571 $17.28 218,699 $16.41 Granted 71,560 30.80 2,500 24.40 4,625 23.86 Exercised (26,187) 15.29 (38,686) 14.82 (30,600) 11.66 Canceled (7,123) 18.08 (8,535) 18.78 (5,153) 19.96 ------- ------- ------- Outstanding, end of year 181,100 $ 23.43 142,850 $17.98 187,571 $17.28 ======= ======= ======= ====== ======= ====== Exercisable at end of year 66,008 $ 18.52 72,281 $16.92 82,763 $15.15 ======= ======= ======= ====== ======= ====== Weighted average fair value of options granted at date of issue $6.54 $4.85 $4.90 ===== ===== =====
F-27 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 The options outstanding at December 31, 2003, have exercise prices between $11.92 and $30.80 with a weighted average remaining contractual life of 5.74 years. Stock options have been adjusted retroactively for the effects of stock dividends and splits. The Company accounts for this plan under APB 25 under which no compensation cost has been recognized for options granted. The fair value of the options granted in 2003, 2002 and 2001, was estimated using the Black-Scholes options pricing model with the following weighted-average assumptions: risk-free interest rate of 3.22%, 4.75% and 5.23% respectively; expected dividend yield of 3.94%, 4.43% and 3.89% respectively; expected life of 6.0, 6.0 and 6.0 years, respectively; and expected volatility of 28.18%, 26.9% and 26.5%, respectively. F-28 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 16. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY: ------------------------------------------------- Condensed Balance Sheets-December 31, 2003 and 2002
ASSETS 2003 2002 ------ ------------ ------------ Cash in subsidiary bank $ 1,316,462 $ 903,319 Interest-bearing deposits in subsidiary banks 32,908,291 22,212,064 ------------ ------------ Total cash and cash equivalents 34,224,753 23,115,383 Investment in and advances to subsidiaries, at equity 223,037,332 220,150,157 Intangible assets 899,390 917,350 Other assets 1,262,681 748,101 ------------ ------------ Total assets $259,424,156 $244,930,991 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Total liabilities $ 7,937,399 $ 6,163,346 Shareholders' equity: Common stock 154,806,790 123,642,010 Capital surplus 58,253,180 58,087,687 Retained earnings 31,276,464 45,647,522 Accumulated other comprehensive earnings 7,150,323 11,390,426 ------------ ------------ Total shareholders' equity 251,486,757 238,767,645 ------------ ------------ Total liabilities and shareholders' equity $259,424,156 $244,930,991 ============ ============
Condensed Statements of Earnings- For the Years Ended December 31, 2003, 2002, and 2001 ----------------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Income: Cash dividends from subsidiary banks $34,625,000 $26,550,000 $25,500,000 Excess of earnings over dividends of subsidiary banks 1,713,407 8,479,939 4,582,993 Other income 1,065,245 944,911 1,092,375 ----------- ----------- ----------- 37,403,652 35,974,850 31,175,368 ----------- ----------- ----------- Expenses: Salaries and employee benefits 1,191,453 1,451,136 1,160,903 Other operating expenses 1,602,354 1,142,832 1,015,184 ----------- ----------- ----------- 2,793,807 2,593,968 2,176,087 ----------- ----------- ----------- Earnings before income taxes 34,609,845 33,380,882 28,999,281 Income tax benefit 694,955 571,668 355,224 ----------- ----------- ----------- Net earnings $35,304,800 $33,952,550 $29,354,505 =========== =========== ===========
F-29 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001
Condensed Statements of Cash Flows- For the Years Ended December 31, 2003, 2002, and 2001 ----------------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Cash flows from operating activities: Net earnings $35,304,800 $33,952,550 $29,354,505 Adjustments to reconcile net earnings to net cash provided by operating activities: Excess of earnings over dividends of subsidiary banks (1,713,407) (8,479,939) (4,582,993) Depreciation 53,778 54,219 32,658 Discount accretion, net of premium amortization - - (4,667) Amortization of excess of cost over fair value of assets acquired - - 55,576 (Increase) decrease in other assets (491,762) (215,435) 559,515 (Decrease) increase in liabilities 1,758,948 (1,041,688) 186,391 ----------- ----------- ----------- Net cash provided by operating activities 34,912,357 24,269,707 25,600,985 ----------- ----------- ----------- Cash flows from investing activities: Purchases of bank premises and equipment (76,598) (50,481) (157,291) Maturities of available-for-sale securities - - 10,000,000 Cash payment for stock acquisition - - (16,500,000) Investment in and advances to subsidiaries (5,852,378) - - ----------- ----------- ----------- Net cash used in investing activities (5,928,976) (50,481) (6,657,291) ----------- ----------- ----------- Cash flows from financing activities: Proceeds of stock issuances 400,323 573,116 356,670 Acquisition of treasury stock - - (315,050) Cash dividends paid (18,274,334) (16,052,983) (13,921,211) ----------- ----------- ----------- Net cash used in financing activities (17,874,011) (15,479,867) (13,879,591) ----------- ----------- ----------- Net increase in cash and cash equivalents 11,109,370 8,739,359 5,064,103 Cash and cash equivalents, beginning of year 23,115,383 14,376,024 9,311,921 ----------- ----------- ----------- Cash and cash equivalents, end of year $34,224,753 $23,115,383 $14,376,024 =========== =========== ===========
F-30 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 17. BUSINESS COMBINATION: --------------------- In July 2001, the Company purchased all of the outstanding stock of City Bancshares, Inc. ("City") and its subsidiary, City National Bank for $16,500,000 in cash. The total purchase price exceeded the estimated fair market value of net assets acquired by approximately $7,800,000, of which approximately $950,000 was assigned to an identifiable intangible asset with the balance recorded by the Company as goodwill. The identifiable intangible asset represents the future benefit associated with the acquisition of the core deposits of City and is being amortized over seven years utilizing a method that approximates the expected attrition of the deposits. The primary purpose of the acquisition was to expand the Company's market share in areas with close proximity to Dallas/Ft. Worth, Texas. Factors that contributed to a purchase price resulting in goodwill include City's historically stable record of earnings, capable management and its geographic location, which complements the Company's existing service locations. Subsequent to the acquisition, the Company liquidated the stock of City and City National Bank is operating as a subsidiary of the Company. The results of operations of City National Bank are included in the consolidated earnings of the Company commencing July 1, 2001. The following is a condensed consolidated balance sheet disclosing the preliminary estimated fair value amounts assigned to the major asset and liability captions at the acquisition date. ASSETS Cash and cash equivalents $ 9,651,769 Investment securities 29,717,834 Loans, net 51,061,735 Goodwill 6,891,959 Identifiable intangible asset 946,073 Other assets 1,465,727 ------------ Total assets $ 99,735,097 ============ LIABILITIES AND SHAREHOLDER'S EQUITY Noninterest-bearing deposits $ 11,949,766 Interest-bearing deposits 70,575,256 Other liabilities 710,075 Shareholders' equity 16,500,000 ------------ Total liabilities and shareholder's equity $ 99,735,097 ============ Goodwill recorded in the acquisition of City has been accounted for in accordance with SFAS No. 142. Accordingly, goodwill has not been amortized, rather it has been tested for impairment. The goodwill and identifiable intangible asset recorded are not deductible for federal income tax purposes. The proforma impact of City is insignificant to the Company's financial statements. Cash flow information relative to the acquisition of City is, as follows: Fair value of assets acquired $ 99,735,097 Cash paid for the capital stock of City 16,500,000 ------------ Liabilities assumed $ 83,235,097 ============ F-31 FIRST FINANCIAL BANKSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2003, 2002 and 2001 18. CASH FLOW INFORMATION: ---------------------- Supplemental information on cash flows and noncash transactions is as follows:
Year Ended December 31, --------------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Supplemental cash flow information: Interest paid $17,572,092 $25,704,950 $46,243,602 Federal income taxes paid 14,063,418 14,682,343 13,227,101 Schedule of noncash investing and financing activities: Assets acquired through foreclosure 1,117,256 553,840 628,797 Loans to finance the sale of other real estate 19,400 - - Retirement of treasury stock - - 4,240,119
F-32 -----END PRIVACY-ENHANCED MESSAGE-----