10-Q 1 j0885501e10vq.txt F.N.B. CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 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 001-31940 F.N.B. CORPORATION -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Florida 25-1255406 --------------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) One F.N.B. Boulevard, Hermitage, PA 16148 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (724) 981-6000 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class Outstanding at July 31, 2004 ----- ---------------------------- Common Stock, $0.01 Par Value 46,259,838 Shares
F.N.B. CORPORATION FORM 10-Q June 30, 2004 INDEX
PAGE PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets (unaudited) 2 Consolidated Statements of Income (unaudited) 3 Consolidated Statements of Cash Flows (unaudited) 5 Consolidated Statement of Stockholders' Equity (unaudited) 6 Notes to Consolidated Financial Statements 7 Report of Independent Registered Public Accounting Firm 19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 36 Item 4. Controls and Procedures 36 PART II - OTHER INFORMATION Item 1. Legal Proceedings 37 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 37 Item 3. Defaults Upon Senior Securities 37 Item 4. Submission of Matters to a Vote of Security Holders 37 Item 5. Other Information 38 Item 6. Exhibits and Reports on Form 8-K 38 Signatures 40
1 F.N.B. CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DOLLARS IN THOUSANDS, EXCEPT PAR VALUES
JUNE 30, DECEMBER 31, 2004 2003 ----------- ----------- UNAUDITED ----------- ASSETS Cash and due from banks $ 99,171 $ 105,160 Interest bearing deposits with banks 408 1,152 Securities available for sale 1,101,229 878,667 Securities held to maturity (fair value of $45,206 and $24,823) 45,794 24,030 Mortgage loans held for sale 3,893 1,435 Loans, net of unearned income of $29,750 and $31,646 3,226,889 3,259,197 Allowance for loan losses (46,099) (46,139) ----------- ----------- NET LOANS 3,180,790 3,213,058 ----------- ----------- Premises and equipment 75,671 79,618 Goodwill 28,940 28,710 Other assets 235,199 225,344 Assets of discontinued operations -- 3,751,136 ----------- ----------- TOTAL ASSETS $ 4,771,095 $ 8,308,310 =========== =========== LIABILITIES Deposits: Non-interest bearing demand $ 589,146 $ 592,795 Savings and NOW 1,439,348 1,513,526 Certificates and other time deposits 1,329,298 1,333,189 ----------- ----------- TOTAL DEPOSITS 3,357,792 3,439,510 Other liabilities 62,615 58,096 Short-term borrowings 417,935 232,966 Long-term debt 700,245 584,808 Liabilities of discontinued operations -- 3,386,021 ----------- ----------- TOTAL LIABILITIES 4,538,587 7,701,401 ----------- ----------- STOCKHOLDERS' EQUITY Common stock - $0.01 par value Authorized - 500,000,000 shares Issued - 46,357,995 and 46,354,673 shares 464 464 Additional paid-in capital 222,884 586,009 Retained earnings 19,341 11,532 Accumulated other comprehensive income (7,052) 10,251 Deferred stock compensation (1,858) -- Treasury stock - 61,668 and 40,764 shares at cost (1,271) (1,347) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 232,508 606,909 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,771,095 $ 8,308,310 =========== ===========
See accompanying Notes to Consolidated Financial Statements 2 F.N.B. CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA UNAUDITED
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- -------------------------- 2004 2003 2004 2003 -------- -------- -------- -------- INTEREST INCOME Loans, including fees $ 50,790 $ 54,615 $102,385 $112,395 Securities: Taxable 9,816 8,944 19,311 16,211 Nontaxable 616 1,076 1,186 2,159 Dividends 291 442 605 855 Other 3 19 5 23 -------- -------- -------- -------- TOTAL INTEREST INCOME 61,516 65,096 123,492 131,643 -------- -------- -------- -------- INTEREST EXPENSE Deposits 12,578 14,872 25,005 29,900 Short-term borrowings 1,506 2,022 2,617 3,563 Long-term debt 5,964 6,181 12,197 11,006 -------- -------- -------- -------- TOTAL INTEREST EXPENSE 20,048 23,075 39,819 44,469 -------- -------- -------- -------- NET INTEREST INCOME 41,468 42,021 83,673 87,174 Provision for loan losses 3,620 3,903 8,242 8,030 -------- -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 37,848 38,118 75,431 79,144 -------- -------- -------- -------- NON-INTEREST INCOME Service charges 8,507 8,607 16,563 17,032 Insurance commissions and fees 2,498 2,426 4,904 4,812 Securities commissions and fees 1,191 1,084 2,532 2,125 Trust 1,676 1,994 3,549 3,763 Gain on sale of securities 522 772 967 1,154 Gain on sale of loans 815 818 1,082 1,600 Gain on sale of branches -- -- 4,135 -- Other 2,171 2,136 4,417 4,283 -------- -------- -------- -------- TOTAL NON-INTEREST INCOME 17,380 17,837 38,149 34,769 -------- -------- -------- -------- 55,228 55,955 113,580 113,913 -------- -------- -------- -------- NON-INTEREST EXPENSE Salaries and employee benefits 17,040 18,987 35,294 38,988 Net occupancy 2,692 2,703 5,406 5,612 Equipment 3,268 3,997 6,286 7,624 Other 10,457 10,624 21,082 21,376 -------- -------- -------- -------- TOTAL NON-INTEREST EXPENSE 33,457 36,311 68,068 73,600 -------- -------- -------- -------- INCOME BEFORE INCOME TAXES 21,771 19,644 45,512 40,313 Income taxes 6,706 5,574 14,225 11,634 -------- -------- -------- -------- INCOME FROM CONTINUING OPERATIONS 15,065 14,070 31,287 28,679 Earnings from discontinued operations, net of taxes of $5,404 and $9,792 -- 10,586 -- 19,305 -------- -------- -------- -------- NET INCOME $ 15,065 $ 24,656 $ 31,287 $ 47,984 ======== ======== ======== ========
3 F.N.B. CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA UNAUDITED
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- -------------------- 2004 2003 2004 2003 ----- ----- ----- ----- NET INCOME PER COMMON SHARE: Basic: Continuing operations $ .33 $ .31 $ .68 $ .62 Discontinued operations -- .23 -- .42 ----- ----- ----- ----- $ .33 $ .54 $ .68 $1.04 ===== ===== ===== ===== Diluted: Continuing operations $ .32 $ .30 $ .66 $ .61 Discontinued operations -- .23 -- .41 ----- ----- ----- ----- $ .32 $ .53 $ .66 $1.02 ===== ===== ===== ===== CASH DIVIDENDS PER COMMON SHARE $ .23 $ .24 $ .46 $ .45 ===== ===== ===== =====
See accompanying Notes to Consolidated Financial Statements 4 F.N.B. CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS DOLLARS IN THOUSANDS UNAUDITED
SIX MONTHS ENDED ----------------------------- JUNE 30, ----------------------------- 2004 2003 --------- --------- OPERATING ACTIVITIES Net income from continuing operations $ 31,287 $ 28,679 Net income from discontinued operations -- 19,305 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,997 5,155 Provision for loan losses 8,242 8,030 Deferred taxes 9,962 13,175 Net gain on sale of securities (967) (1,154) Net gain on sale of loans (1,082) (1,600) Proceeds from sale of loans 54,205 74,885 Loans originated for sale (55,581) (75,358) Net change in: Interest receivable (955) 914 Interest payable (5,325) (427) Change in net assets of discontinued operations -- (20,142) Other, net (1,831) (27,836) --------- --------- Net cash flows from operating activities 43,952 23,626 --------- --------- INVESTING ACTIVITIES Net change in: Interest bearing deposits with banks 744 (2,067) Loans 23,547 (9,770) Bank Owned Life Insurance -- 1,505 Securities available for sale: Purchases (399,748) (493,281) Sales 8,346 82,271 Maturities 144,435 164,927 Securities held to maturity: Purchases (24,167) -- Maturities 2,380 1,679 Increase in premises and equipment (859) 564 Cash paid in purchase business combinations, net of cash acquired -- (150,200) --------- --------- Net cash flows from investing activities (245,322) (404,372) --------- --------- FINANCING ACTIVITIES Net change in: Non-interest bearing deposits, savings and NOW (87,279) 180,330 Time deposits 5,561 (110,554) Short-term borrowings 184,969 197,043 Increase in long-term debt 124,834 153,581 Decrease in long-term debt (9,397) (12,809) Purchase of treasury stock (12,936) (20,361) Issuance of treasury stock 10,883 16,364 Cash dividends paid (21,254) (20,743) --------- --------- Net cash flows from financing activities 195,381 382,851 --------- --------- NET (DECREASE) INCREASE IN CASH AND DUE FROM BANKS (5,989) 2,105 Cash and due from banks at beginning of period 105,160 129,443 --------- --------- CASH AND DUE FROM BANKS AT END OF PERIOD $ 99,171 $ 131,548 ========= =========
See accompanying Notes to Consolidated Financial Statements 5 F.N.B. CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY DOLLARS IN THOUSANDS UNAUDITED
Accumulated Other Compre- Additional Compre- Deferred hensive Common Paid-In Retained hensive Stock Treasury Income Stock Capital Earnings Income Compensation Stock Total -------- -------- ---------- -------- ----------- ------------ -------- --------- Balance at December 31, 2003 $ 464 $ 586,009 $ 11,532 $ 10,251 $ (1,347) $ 606,909 Net income $ 31,287 31,287 31,287 Change in other comprehensive income (loss) (15,406) (15,406) (15,406) -------- Comprehensive income $ 15,881 ======== Cash dividends declared - $0.46 per share (21,254) (21,254) Purchase of common stock (12,937) (12,937) Issuance of common stock 93 (2,224) 13,013 10,882 Change in deferred stock compensation $ (1,858) (1,858) Spin-off of Florida operations (363,218) (1,897) (365,115) -------- ---------- -------- ----------- ------------ -------- --------- Balance at June 30, 2004 $ 464 $ 222,884 $ 19,341 $ (7,052) $ (1,858) $ (1,271) $ 232,508 ======== ========== ======== =========== ============ ======== =========
See accompanying Notes to Consolidated Financial Statements 6 F.N.B. CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2004 BUSINESS F.N.B. Corporation (the Corporation) is a diversified financial services company headquartered in Hermitage, Pennsylvania. The Corporation owns and operates First National Bank of Pennsylvania, First National Trust Company, First National Investment Services Company, F.N.B. Investment Advisors, Inc., First National Insurance Agency, Inc. and Regency Finance Company. It has full service banking offices located in Pennsylvania and Ohio and consumer finance operations in Pennsylvania, Ohio and Tennessee. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of the Corporation and its subsidiaries. The Corporation's consolidated financial statements have historically included subsidiaries in which the Corporation has a controlling financial interest. This requirement has been applied to subsidiaries in which the Corporation has a majority voting interest. Investments in companies in which the Corporation controls operating and financing decisions (principally defined as owning a voting or economic interest greater than 50%) are consolidated. In accordance with Financial Accounting Standards Board Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, the Corporation considers a voting rights entity to be a subsidiary and consolidates it if the Corporation has a controlling financial interest in the entity. Variable interest entities are consolidated if the Corporation is exposed to the majority of the variable interest entity's expected losses and/or residual returns (i.e., the Corporation is considered to be the primary beneficiary). All significant intercompany balances and transactions have been eliminated. Certain reclassifications have been made to the prior years' financial statements to conform to the current year's presentation. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. DISCONTINUED OPERATIONS On January 1, 2004, the Corporation completed the spin-off of its Florida operations into a separate, publicly traded company known as First National Bankshares of Florida, Inc. (Bankshares). Effective January 1, 2004, the Corporation transferred all of its Florida operations to Bankshares. At the same time, the Corporation distributed all of the outstanding stock of Bankshares to the Corporation's shareholders of record as of December 26, 2003. Shareholders eligible for the distribution received one share of Bankshares common stock for each outstanding share of the Corporation's common stock held. Immediately following the distribution, the Corporation and its subsidiaries did not own any shares of Bankshares common stock and Bankshares became an independent public company. 7 The Corporation incurred approximately $49.7 million, including $10.5 million incurred by Bankshares, in restructuring expense during 2003 directly attributable to the spin-off of Bankshares. These expenses consisted of a prepayment penalty for refinancing Federal Home Loan Bank (FHLB) debt, early retirement expenses, involuntary separation costs, professional fees and miscellaneous other expenses. As of December 31, 2003, a liability of $12.4 million remained in connection with these expenses. This liability has been reduced during the first six months of 2004 as follows (in thousands): Liability at December 31, 2003 $ 12,436 Liability at Bankshares (5,200) Reduction in liability: Early retirement expenses and involuntary separation costs (2,587) Professional fees (471) Miscellaneous other expenses (316) -------- Liability at June 30, 2004 $ 3,862 ========
This remaining liability of $3.9 million consists of $3.7 million in early retirement expenses and involuntary separation costs, $24,000 in professional fees and $134,000 in miscellaneous other expenses. As a result of the spin-off, the Florida operations' 2003 earnings have been reclassified as discontinued operations on the consolidated statement of income, and assets and liabilities related to these discontinued operations have been disclosed separately on the consolidated balance sheet for 2003. EQUITY METHOD INVESTMENT The Corporation accounts for its 14.1% ownership of the common stock of Sun Bancorp, Inc. under the equity method. The carrying value of the Corporation's investment in Sun Bancorp is adjusted for the Corporation's share of Sun Bancorp's earnings and reduced by dividends received from Sun Bancorp. Sun Bancorp, a bank holding company headquartered in Lewisburg, Pennsylvania, is a publicly traded company under the stock symbol "SUBI" on the Nasdaq Stock Market. The carrying value of the investment included in other assets was $23.3 million at June 30, 2004. On April 20, 2004, Omega Financial Corporation and Sun Bancorp, Inc. jointly announced that Omega Financial Corporation has agreed to acquire Sun Bancorp, Inc. Under the terms of the agreement, Sun Bancorp shareholders will be entitled to receive either 0.664 shares of Omega Financial common stock for each share of Sun Bancorp common stock or $23.25 in cash for each share held, subject to a pro rata allocation such that 20% of Sun Bancorp common stock shall be paid in cash and 80% shall be in the form of Omega Financial common stock. The Corporation currently owns 1,090,122 shares of Sun Bancorp common stock. COMMON STOCK DIVIDEND Prior period per share amounts have been adjusted for common stock dividends, including the 5 percent stock dividend declared on April 28, 2003. 8 MERGERS AND ACQUISITIONS On July 26, 2004, the Corporation announced that it had signed a definitive agreement to acquire the assets of Morrell, Butz and Junker, Inc. (MBJ), a full-service insurance agency based in Pittsburgh, Pennsylvania. MBJ is one of the largest independent insurance agencies in western Pennsylvania with revenues of $4.0 million. MBJ, which offers property and casualty, life and health, and group benefits coverage to both commercial and individual clients, became a part of the Corporation's existing insurance agency, First National Insurance Agency, Inc., doubling the size of the Corporation's insurance division. This transaction closed on July 30, 2004. On May 6, 2004, the Corporation announced that it had signed a definitive merger agreement to acquire Slippery Rock Financial Corporation (Slippery Rock)(OTC BB: SRCK), a bank holding company headquartered in Slippery Rock, Pennsylvania with $335.0 million in assets, in a stock and cash transaction valued at $78.5 million. Under the terms of the merger agreement, shareholders of Slippery Rock may elect to receive $28.00 in cash or 1.41 shares of the Corporation's common stock for each share of Slippery Rock common stock. The merger agreement allocation procedures provide for the exchange of 15 percent of Slippery Rock shares for cash and the remaining Slippery Rock shares exchanged for the Corporation's common stock. This transaction is scheduled to close during the fourth quarter of 2004, pending regulatory and shareholder approval. On April 30, 2004, Regency Finance Company (Regency), a subsidiary of the Corporation, completed its previously announced acquisition of eight consumer finance offices in the greater Columbus, Ohio area from The Modern Finance Company, an affiliate of Thaxton Group, Inc., headquartered in South Carolina. This acquisition added approximately $7.0 million in net loan outstandings to Regency's portfolio. The Corporation regularly evaluates the potential acquisition of, and holds discussions with, various acquisition candidates and, as a general rule, the Corporation publicly announces such acquisitions only after a definitive merger agreement has been reached. DEBENTURES DUE TO A STATUTORY TRUST During the first quarter of 2003, F.N.B. Statutory Trust I (Statutory Trust), an unconsolidated subsidiary trust, issued $125.0 million of Corporation-obligated mandatorily redeemable capital securities (capital securities). The proceeds from the sale of the capital securities were invested in junior subordinated debt securities of the Corporation (debentures). The Statutory Trust was formed for the sole purpose of issuing the capital securities and investing the proceeds from the sale of such capital securities in the debentures. The debentures held by the Statutory Trust are its sole assets. Distributions on the capital securities issued by the Statutory Trust are recorded as interest expense by the Corporation. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. The capital securities bear interest at a floating rate per annum equal to the three-month LIBOR plus 325 basis points. The rate in effect at June 30, 2004 was 4.36%. The Corporation has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees. The debentures held by the Statutory Trust qualify as Tier 1 capital under Federal Reserve Board guidelines and are first redeemable, in whole or in part, by the Corporation on or after March 31, 2008. 9 PREFERRED STOCK REDEMPTION The Corporation completed the planned redemption of its Preferred Stock Series A and Preferred Stock Series B during 2003. In connection with the redemption, the Corporation issued shares of its common stock out of treasury stock in exchange for the remaining outstanding preferred stock. The Corporation issued 15,882 and 264,568 shares of its common stock for the remaining 19,174 and 98,851 shares of Preferred Stock Series A and Preferred Stock Series B, respectively. As a result of the redemption, the Corporation no longer has any shares of Preferred Stock. NEW ACCOUNTING STANDARDS Financial Accounting Standards Statement (FAS) 148, Accounting for Stock-Based Compensation - Transition and Disclosure, was issued in December 2002. It provides alternative methods of accounting for stock-based employee compensation. In addition, it amends disclosure requirements in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The Corporation continues to account for its stock-based compensation under Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees. Therefore, FAS 148 is not expected to have a material impact on the Corporation's financial condition or results of operations. FIN 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, was issued in January 2003 and amended in December 2003. FIN 46 addresses consolidation by business enterprises of variable interest entities which have certain characteristics. FIN 46 applies immediately to variable interest entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that was acquired before February 1, 2003. The Corporation has limited partnership investments in affordable housing projects, for which it provides funding as a limited partner and receives tax credit for any losses incurred by the projects based on its partnership share. The Corporation's interest in these entities were acquired prior to February 1, 2003. At June 30, 2004, the Corporation had recorded investments in other assets on its balance sheet of approximately $2.5 million associated with these investments. The Corporation currently adjusts the carrying value of these investments for any losses incurred by the limited partnership through earnings. The Corporation determined that it is not the primary beneficiary of these partnerships and will not consolidate them. Additionally, the Corporation determined that it is not the primary beneficiary of Statutory Trust and will not consolidate it. FAS 146, Accounting for Costs Associated with Exit or Disposal Activities, was issued in June 2002 and requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. FAS 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of FAS 146 became effective for the Corporation on January 1, 2003. The costs incurred in connection with the spin-off of Bankshares were accounted for in accordance with the provisions of FAS 146. The American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, in December 2003. SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investors initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP 03-3 does not apply to loans originated by the entity. The provisions of SOP 03-3 are effective for loans acquired in fiscal years beginning after December 31, 2004. 10 The Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan Commitments, in March 2004. SAB 105 informs registrants that the fair value of the recorded loan commitments that are required to follow derivative accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of a future loan. The provisions of SAB 105 are required to be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The implementation of SAB 105 did not have a significant impact on the Corporation's financial condition, results of operations or cash flows. SECURITIES Following is a summary of the fair value of securities available for sale (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 ---------- ------------ U.S. Treasury and other U.S. Government agencies and corporations $ 188,621 $ 124,163 Mortgage-backed securities of U.S. Government agencies 801,255 634,669 States of the U.S. and political subdivisions 30,888 42,408 Other debt securities 33,403 32,299 ---------- ---------- Total debt securities 1,054,167 833,539 Equity securities 47,062 45,128 ---------- ---------- $1,101,229 $ 878,667 ========== ==========
Following is a summary of the amortized cost of securities held to maturity (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 ------- ------------ U.S. Treasury and other U.S. Government agencies and corporations $ 2,725 $ 3,761 States of the U.S. and political subdivisions 39,910 17,105 Other debt securities 3,159 3,164 ------- ------- $45,794 $24,030 ======= =======
BORROWINGS Following is a summary of short-term borrowings (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 -------- ------------ Securities sold under repurchase agreements $122,128 $ 81,444 Federal funds purchased 145,865 865 Federal Home Loan Bank advances 6,000 6,000 Subordinated notes 143,689 144,006 Other short-term borrowings 253 651 -------- -------- $417,935 $232,966 ======== ========
11 Following is a summary of long-term debt (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 -------- ------------ Federal Home Loan Bank advances $540,156 $425,141 Debentures due to Statutory Trust 128,866 128,866 Subordinated notes 30,934 30,517 Other long-term debt 289 284 -------- -------- $700,245 $584,808 ======== ========
The Corporation's banking subsidiary has available credit with the FHLB of $1.5 billion, of which $546.2 million was used as of June 30, 2004. These advances are secured by residential real estate loans and FHLB stock and are scheduled to mature in various amounts periodically through the year 2012. EARNINGS PER SHARE Basic earnings per share is calculated by dividing net income, adjusted for declared dividends on preferred stock, by the weighted average number of shares of common stock outstanding. Diluted earnings per common share is calculated by dividing net income by the weighted average number of shares of common stock outstanding, assuming conversion of outstanding convertible preferred stock from the beginning of the year and the exercise of stock options. Such adjustments to net income and the weighted average number of shares of common stock are made only when such adjustments dilute earnings per share. The following tables set forth the computation of basic and diluted earnings per share (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ------------------------------ 2004 2003 2004 2003 ------------ ------------ ------------ ------------ BASIC Net income from continuing operations $ 15,065 $ 14,070 $ 31,287 $ 28,679 Net income from discontinued operations -- 10,586 -- 19,305 Less: Preferred stock dividends declared -- (8) -- (62) ------------ ------------ ------------ ------------ Earnings applicable to basic earnings per share $ 15,065 $ 24,648 $ 31,287 $ 47,922 ============ ============ ============ ============ Average common shares outstanding 46,265,852 46,067,008 46,219,548 46,052,374 ============ ============ ============ ============ Basic earnings per share: From continuing operations $ .33 $ .31 $ .68 $ .62 From discontinued operations -- .23 -- .42 ------------ ------------ ------------ ------------ Net income $ .33 $ .54 $ .68 $ 1.04 ============ ============ ============ ============
12
Three Months Ended Six Months Ended June 30, June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- DILUTED Net income from continuing operations $ 15,065 $ 14,070 $ 31,287 $ 28,679 Net income from discontinued operations -- 10,586 -- 19,305 ----------- ----------- ----------- ----------- Earnings applicable to diluted earnings per share $ 15,065 $ 24,656 $ 31,287 $ 47,984 =========== =========== =========== =========== Average common shares outstanding 46,265,852 46,067,008 46,219,548 46,052,374 Convertible preferred stock -- 17,941 -- 143,360 Net effect of dilutive stock options based on the treasury stock method 777,159 802,811 835,483 692,554 ----------- ----------- ----------- ----------- 47,043,011 46,887,760 47,055,031 46,888,288 =========== =========== =========== =========== Diluted earnings per share: From continuing operations $ .32 $ .30 $ .66 $ .61 From discontinued operations -- .23 -- .41 ----------- ----------- ----------- ----------- Net income $ .32 $ .53 $ .66 $ 1.02 =========== =========== =========== ===========
STOCK-BASED COMPENSATION In accordance with FAS 148, the following table shows pro forma net income and earnings per share assuming stock-based compensation had been expensed based on the fair value of the compensation granted along with significant assumptions used in the Black-Scholes option pricing model (dollars in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- Net income from continuing operations $ 15,065 $ 14,070 $ 31,287 $ 28,679 Stock-based employee compensation cost included in net income from continuing operations, net of tax 34 19 337 37 Stock-based employee compensation cost determined if the fair value method had been applied to all awards, net of tax (593) (741) (1,224) (1,490) ---------- ---------- ---------- ---------- Pro forma net income from continuing operations $ 14,506 $ 13,348 $ 30,400 $ 27,226 ========== ========== ========== ========== Earnings per share from continuing operations: Basic as reported $ .33 $ .31 $ .68 $ .62 Basic pro forma .31 .29 .66 .59 Diluted as reported $ .32 $ .30 $ .66 $ .61 Diluted pro forma .31 .28 .65 .58 Assumptions: Risk-free interest rate 3.86% 2.93% 3.86% 2.93% Dividend yield 4.16% 2.95% 4.16% 2.95% Expected stock price volatility .25% .21% .25% .25% Expected life (years) 5.00 5.00 5.00 5.00 Fair value of options granted $ 11.79 $ 11.79 $ 11.79 $ 11.79
13 As a result of the Corporation's spin-off of its Florida operations, the Corporation developed a methodology designed to adjust the number and exercise price of outstanding F.N.B. Corporation stock options immediately following the completion of the spin-off for the purpose of preserving the equivalent value of these stock options that existed as of the close of business on December 31, 2003. As of June 30, 2004, the Corporation had options outstanding to purchase 2,088,585 shares of common stock at an average price of $11.22 per share. During the first quarter of 2004, the Corporation issued 107,285 restricted shares of common stock to key employees and directors of the Corporation under its 2001 Incentive Plan. Under this program, shares awarded to management are earned, in part, by delivering certain financial performance results when compared to peers. The rewards are earned over three- to five-year periods. The unvested portion of these awards, totaling $1.9 million at June 30, 2004, is reflected as deferred stock compensation in the stockholders' equity section of the Corporation's balance sheet. RETIREMENT AND OTHER POSTRETIREMENT BENEFIT PLANS The net periodic benefit cost for the defined benefit plans includes the following components (in thousands):
Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 2004 2003 2004 2003 ------- ------- ------- ------- Service cost $ 955 $ 888 $ 1,910 $ 1,776 Interest cost 1,560 1,467 3,120 2,934 Expected return on plan assets (1,671) (1,373) (3,342) (2,746) Net amortization 223 232 446 464 ------- ------- ------- ------- Net periodic cost $ 1,067 $ 1,214 $ 2,134 $ 2,428 ======= ======= ======= =======
Net periodic postretirement benefit cost includes the following components (in thousands):
Three Months Ended Six Months Ended June 30, June 30, ----------------- ----------------- 2004 2003 2004 2003 ---- ---- ---- ---- Service cost $ 82 $ 73 $164 $146 Interest cost 99 91 198 182 One time charge for voluntary retirement -- 37 -- 74 Net amortization 34 25 68 50 ---- ---- ---- ---- Net periodic cost $215 $226 $430 $452 ==== ==== ==== ====
The Corporation sponsors retirement plans for the benefit of its employees. In conjunction with the spin-off of its Florida operations, a portion of the obligations associated with these plans was transferred to Bankshares. Of the December 31, 2003 obligations reported in the Retirement Plans footnote in the Corporation's 2003 Annual Report on Form 10-K, $88.1 million of the $98.7 million accumulated benefit obligation and $101.7 of the $114.0 million projected benefit obligation remained with the Corporation after the spin-off. The fair value of plan assets, which was $84.9 million at December 31, 2003, remained entirely with the Corporation. Of the $11.0 million pension expense for the year ended December 31, 2003, $8.0 million was attributable to continuing operations. With respect to the Other Postretirement Benefit Plans footnote in the Corporation's 2003 Annual Report on Form 10-K, these obligations remained entirely with the Corporation after the spin-off and the related postretirement benefit cost was entirely attributable to continuing operations. 14 The Corporation's subsidiaries participate in a qualified 401(k) defined contribution plan under which eligible employees may contribute a percentage of their salary. The Corporation matches 50 percent of an eligible employee's contribution on the first 6 percent that the employee defers. Employees are generally eligible to participate upon completing 90 days of service and having attained age 21. Employer contributions become 20 percent vested when an employee has completed one year of service, and vest at a rate of 20 percent per year thereafter. The Corporation's contribution expense was $621,000 for the six months ended June 30, 2004. CASH FLOW INFORMATION Following is a summary of supplemental cash flow information (in thousands):
Six Months Ended June 30, 2004 2003 -------- -------- Cash paid for: Interest $ 45,144 $ 44,896 Taxes 8,012 8,981 Noncash Investing and Financing Activities: Acquisition of real estate in settlement of loans 1,886 1,136 Loans granted in the sale of other real estate 124 10 Spin-off of Florida operations 365,115 --
COMPREHENSIVE INCOME The components of comprehensive income, net of related tax, are as follows (in thousands):
Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2004 2003 2004 2003 -------- -------- -------- -------- Net income from continuing operations $ 15,065 $ 14,070 $ 31,287 $ 28,679 Net income from discontinued operations -- 10,586 -- 19,305 Other comprehensive income (loss): Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the period (21,941) 11,929 (14,945) 9,785 Less: reclassification adjustment for gains included in net income (339) (502) (629) (750) Minimum pension liability adjustment -- -- 168 -- -------- -------- -------- -------- Other comprehensive income (loss) (22,280) 11,427 (15,406) 9,035 -------- -------- -------- -------- Comprehensive income (loss) $ (7,215) $ 36,083 $ 15,881 $ 57,019 ======== ======== ======== ========
15 BUSINESS SEGMENTS The Corporation operates in four reportable segments: community banking, wealth management, insurance and consumer finance. The Corporation's community banking subsidiary offers services traditionally offered by full-service commercial banks, including commercial and individual demand and time deposit accounts and commercial, mortgage and individual installment loans. Wealth Management provides a broad range of personal and corporate fiduciary services including the administration of decedent and trust estates. In addition, it offers various alternative products, including securities brokerage and investment advisory services, mutual funds, insurance and annuities. The Corporation's insurance business includes a full-service insurance agency offering all lines of commercial and personal insurance through major carriers. It also includes a reinsurer. The Corporation's consumer finance subsidiary is primarily involved in making personal installment loans to individuals. This activity is funded through the sale of the Corporation's subordinated notes at the finance company's branch offices. The all other segment includes the parent company, other non-bank subsidiaries and eliminations, which are necessary for purposes of reconciling to the consolidated amounts. The following tables provide financial information for these segments of the Corporation (in thousands). 16
At or for the three months Community Wealth Consumer All ended June 30, 2004 Banking Management Insurance Finance Other Consolidated ---------- ---------- ---------- ---------- ---------- ------------ Interest income $ 54,249 $ 8 $ 7 $ 7,706 $ (454) $ 61,516 Interest expense 17,220 2 -- 1,169 1,657 20,048 Provision for loan losses 2,010 -- -- 1,610 -- 3,620 Non-interest income 12,376 3,039 1,046 629 290 17,380 Non-interest expense, excluding intangible amortization 25,583 2,349 1,027 3,493 486 32,938 Intangible amortization 492 -- 27 -- -- 519 Income tax expense (benefit) 6,615 262 9 762 (942) 6,706 Net income (loss) 14,705 434 (10) 1,301 (1,365) 15,065 Total assets 4,562,221 5,713 7,627 152,666 42,868 4,771,095 Total intangibles 33,284 1 3,325 1,809 -- 38,419
At or for the three months Community Wealth Consumer All ended June 30, 2003 Banking Management Insurance Finance Other Consolidated ---------- ---------- ---------- ---------- ---------- ------------ Interest income $ 58,594 $ 2 $ 6 $ 7,065 $ (571) $ 65,096 Interest expense 20,626 4 1 1,266 1,178 23,075 Provision for loan losses 2,519 -- -- 1,384 -- 3,903 Non-interest income 9,177 3,162 704 442 4,352 17,837 Non-interest expense, excluding intangible amortization 24,100 2,609 758 3,164 5,137 35,768 Intangible amortization 492 1 28 -- 22 543 Income tax expense (benefit) 5,814 313 (23) 605 (1,135) 5,574 Net income (loss) from continuing operations 14,220 237 (54) 1,088 (1,421) 14,070 Net income from discontinued operations 9,578 1 1,007 -- -- 10,586 Net income (loss) 23,798 238 953 1,088 (1,421) 24,656 Total assets from continuing operations 4,425,154 3,640 7,392 148,408 13,083 4,597,677 Total intangibles from continuing operations 32,764 13 4,889 1,809 -- 39,475
17
At or for the six months Community Wealth Consumer All ended June 30, 2004 Banking Management Insurance Finance Other Consolidated ---------- ---------- ---------- ---------- ---------- ------------ Interest income $ 109,522 $ 10 $ 12 $ 14,791 $ (843) $ 123,492 Interest expense 34,236 5 -- 2,365 3,213 39,819 Provision for loan losses 5,010 -- -- 3,232 -- 8,242 Non-interest income 28,053 6,440 2,373 1,060 223 38,149 Non-interest expense, excluding intangible amortization 52,479 4,806 2,054 6,696 995 67,030 Intangible amortization 984 1 53 -- -- 1,038 Income tax expense (benefit) 14,137 615 131 1,336 (1,994) 14,225 Net income (loss) 30,729 1,023 147 2,222 (2,834) 31,287 Total assets 4,562,221 5,713 7,627 152,666 42,868 4,771,095 Total intangibles 33,284 1 3,325 1,809 -- 38,419
At or for the six months Community Wealth Consumer All ended June 30, 2003 Banking Management Insurance Finance Other Consolidated ------- ---------- --------- ------- ----- ------------ Interest income $ 118,432 $ 2 $ 21 $ 14,136 $ (948) $ 131,643 Interest expense 41,237 4 4 2,709 515 44,469 Provision for loan losses 5,256 -- -- 2,774 -- 8,030 Non-interest income 22,516 6,094 1,760 910 3,489 34,769 Non-interest expense, excluding intangible amortization 52,242 5,221 1,700 6,282 7,069 72,514 Intangible amortization 984 2 57 -- 43 1,086 Income tax expense (benefit) 12,336 313 26 1,188 (2,229) 11,634 Net income (loss) from continuing operations 28,893 556 (6) 2,093 (2,857) 28,679 Net income from discontinued operations 17,634 (96) 1,767 -- -- 19,305 Net income (loss) 46,527 460 1,761 2,093 (2,857) 47,984 Total assets from continuing operations 4,425,154 3,640 7,392 148,408 13,083 4,597,677 Total intangibles from continuing operations 32,764 13 4,889 1,809 -- 39,475
18 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors F.N.B. Corporation We have reviewed the accompanying consolidated balance sheet of F.N.B. Corporation and subsidiaries (F.N.B. Corporation) as of June 30, 2004, and the related consolidated statements of income for the three-month and six-month periods ended June 30, 2004 and 2003, and the consolidated statements of cash flows for the six-month periods ended June 30, 2004 and 2003, and the consolidated statement of stockholders' equity for the six- month period ended June 30, 2004. These financial statements are the responsibility of F.N.B. Corporation's management. We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles. We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of F.N.B. Corporation as of December 31, 2003, and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended (not presented herein) and in our report dated February 24, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ERNST & YOUNG LLP August 9, 2004 19 PART I ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's discussion and analysis represents an overview of the results of operations and financial condition of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes hereto. IMPORTANT NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements in this Form 10-Q are "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995, which statements generally can be identified by the use of forward-looking terminology, such as "may," "will," "expect," "estimate," "anticipate," "believe," "target," "plan," "project" or "continue" or the negatives thereof or other variations thereon or similar terminology, and are made on the basis of management's plans and current analyses of the Corporation, its business and the industry as a whole. These forward-looking statements are subject to risks and uncertainties, including, but not limited to, economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. The above factors in some cases have affected, and in the future could affect, the Corporation's financial performance and could cause actual results to differ materially from those expressed or implied in such forward-looking statements. The Corporation does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized. FINANCIAL INFORMATION SUMMARY On January 1, 2004, the Corporation completed the spin-off of its Florida operations into a separate, publicly traded company. As a result of the spin-off, the Florida operations' 2003 earnings have been reclassified to discontinued operations in the consolidated statement of income, and assets and liabilities related to these discontinued operations have been disclosed separately on the consolidated balance sheet for 2003. Net income was $31.3 million for the first six months of 2004 compared to net income from continuing operations of $28.7 million for the first six months of 2003. Diluted earnings per share were $.66 for the first six months of 2004 compared to diluted earnings from continuing operations of $.61 for the first six months of 2003. Net income for the first six months of 2004 included an after-tax gain on the sale of two branches of $2.7 million. Common ratios for results of operations include the return on average assets and the return on average equity. The Corporation's return on average assets was 1.36% for the first six months of 2004, while its return on average equity was 26.03% for the same period. CRITICAL ACCOUNTING POLICIES The Corporation's significant accounting policies as described in the "Notes to Consolidated Financial Statements" under "Summary of Significant Accounting Policies" in the Corporation's 2003 Annual Report on Form 10-K filed with the Securities and Exchange Commission remain unchanged. 20 FIRST SIX MONTHS OF 2004 AS COMPARED TO FIRST SIX MONTHS OF 2003: The following table provides average balances and yields and rates on interest earning assets and interest bearing liabilities (dollars in thousands):
Six Months Ended June 30 2004 2003 --------------------------------------- -------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ---------- -------- ------ ---------- -------- ------ ASSETS Interest earning assets: Interest bearing deposits with banks $ 1,077 $ 6 1.12% $ 3,635 $ 15 0.83% Federal funds sold 43 -- 0.89 1,635 8 0.99 Securities: Taxable 929,242 19,767 4.28 683,432 15,299 4.51 Non-taxable (1) 73,069 1,970 5.42 138,297 4,686 6.83 Loans (1) (2) 3,247,741 102,943 6.37 3,224,844 113,035 7.07 ---------- -------- ---------- -------- Total interest earning assets 4,251,172 124,686 5.90 4,051,843 133,043 6.62 ---------- -------- ---------- -------- Cash and due from banks 98,483 97,832 Allowance for loan losses (47,263) (47,281) Premises and equipment 77,749 87,402 Assets of discontinued operations -- 3,241,899 Other assets 253,996 235,434 ---------- ---------- $4,634,137 $7,667,129 ========== ========== LIABILITIES Interest bearing liabilities: Deposits: Interest bearing demand $ 811,332 $ 2,812 0.70 $ 734,865 $ 3,033 0.83 Savings 651,353 1,760 0.54 488,430 1,662 0.69 Other time 1,310,850 20,433 3.13 1,527,298 25,205 3.33 Repurchase agreements 122,709 522 0.86 124,265 578 0.94 Other short-term borrowings 250,312 2,095 1.68 188,317 2,985 3.20 Long-term debt 595,718 12,197 4.12 477,229 11,006 4.65 ---------- -------- ---------- -------- Total interest bearing liabilities 3,742,274 39,819 2.14 3,540,404 44,469 2.53 ---------- -------- ---------- -------- Non-interest bearing, demand deposits 581,435 560,406 Liabilities of discontinued operations -- 2,888,080 Other liabilities 68,725 67,912 ---------- ---------- 4,392,434 7,056,802 ---------- ---------- STOCKHOLDERS' EQUITY 241,702 610,327 ---------- ---------- $4,634,136 $7,667,129 ========== ========== Net interest earning assets $ 508,898 $ 511,439 ========== ========== Net interest income $ 84,867 $ 88,574 ======== ======== Net interest spread 3.76% 4.09% ===== ===== Net interest margin (3) 4.01% 4.41% ===== =====
(1) The amounts are reflected on a fully taxable equivalent basis using the federal statutory tax rate of 35% adjusted for certain federal tax preferences. The Corporation believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. (2) Average balance includes non-accrual loans. Loans consist of average total loans less average unearned income. The amount of loan fees included in interest income on loans is immaterial. (3) Net interest margin is calculated by dividing the difference between total interest earned and total interest paid by average interest earning assets. 21 The following table sets forth certain information regarding changes in net interest income attributable to changes in the volumes and rates of interest earning assets and interest bearing liabilities for the six months ended June 30, 2004 as compared to the six months ended June 30, 2003 (in thousands):
Volume Rate Net -------- -------- -------- Interest Income: Interest bearing deposits with banks $ (18) $ 9 $ (9) Federal funds sold (4) (4) (8) Securities (1) 3,317 (1,565) 1,752 Loans (1) 780 (10,872) (10,092) -------- -------- -------- 4,075 (12,432) (8,357) -------- -------- -------- Interest Expense: Deposits: Interest bearing demand 437 (658) (221) Savings 281 (183) 98 Other time (3,351) (1,421) (4,772) Repurchase agreements (7) (49) (56) Other short-term borrowings 2,010 (2,900) (890) Long-term debt 2,202 (1,011) 1,191 -------- -------- -------- 1,572 (6,222) (4,650) -------- -------- -------- Net Change $ 2,503 $ (6,210) $ (3,707) ======== ======== ========
(1) The amounts are reflected on a fully taxable equivalent basis using the federal statutory tax rate of 35% adjusted for certain federal tax preferences. The Corporation believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. (2) The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the net size of the rate and volume changes. During 2003, in order to help revive economic growth, the Federal Reserve Board reduced its target federal funds rate to the lowest level in nearly 45 years. During the first and second quarter of 2003, concerns about continued economic weakness and possible disinflation drove mid-term and long-term treasury yields down significantly. This, in turn, sparked the refinancing of mortgages in the Corporation's loan and mortgage-backed securities portfolios. Thus, the lower interest rate levels experienced during 2003 and 2004 contributed to the decline in net interest margin as the yield on earning assets declined by more than the rate on interest bearing liabilities. The impact of future rate changes on the Corporation's net income is discussed further within the "Liquidity and Interest Rate Sensitivity" section. Net Interest Income Net interest income, the Corporation's primary source of earnings, is the amount by which interest and fees generated by interest earning assets, primarily loans and securities, exceed interest expense on deposits and borrowed funds. Net interest income totaled $83.7 million for the first six months of 2004, as compared to $87.2 million for the first six months of 2003. On a fully taxable equivalent basis, net interest income totaled $84.9 million and $88.6 million for these same periods, respectively. On a fully taxable equivalent basis, net interest income consisted of interest income of $124.7 million and interest expense of $39.8 million for the first six months of 2004 compared to $133.0 million and $44.5 million for each, respectively, for the first six months of 2003. The Corporation's net 22 interest margin decreased 40 basis points to 4.01% for the six months ended June 30, 2004 as compared to 4.41% for the six months ended June 30, 2003. Total interest income, on a fully taxable equivalent basis, decreased $8.4 million or 6.3% for the first six months of 2004, as compared to the first six months of 2003. This decrease was the result of lower yield, partially offset by higher average earning assets. The impact of the lower yield was $12.4 million while the impact of higher average earning assets was $4.1 million. The decrease in yield was caused primarily by loan refinancing activity and scheduled repricing of adjustable rate loans to lower market rates, coupled with accelerated prepayments of mortgage-backed securities. Average earning assets increased by $199.3 million or 4.9% from the first six months of 2003 to the first six months of 2004. This growth was primarily due to an increase of $180.6 million in average investment securities coupled with an increase of $22.9 million in average loan outstandings. Commercial, direct installment and consumer lines of credit increased a combined $262.4 million from the first six months of 2003, while planned reductions in indirect installment, residential mortgages and lease financing combined for a decrease of $229.8 million over this same period. This shift in loan mix is the result of the Corporation's strategic initiatives to improve asset quality and fee income while focusing on more advantageous loan originations consistent with relationship lending. Total interest expense decreased $4.7 million or 10.5% for the first six months of 2004, as compared to the first six months of 2003. This decrease was driven primarily by the lower rate paid on interest bearing liabilities, partially offset by an increase in average interest bearing liabilities to fund the growth in earning assets. The impact of a lower rate paid was $6.2 million while the impact of higher average interest bearing liabilities was $1.6 million. The decrease in rates paid was driven primarily by actions taken by the Corporation to reduce rates paid on deposits and a reduction in the cost of debt, which was the result of the early retirement of FHLB borrowings during the third quarter of 2003. Average balances for total deposits and repurchase agreements, other short-term borrowings and long-term debt increased by $21.4 million, $62.0 million and $118.5 million, respectively, for the six months ended June 30, 2004 as compared to the six months ended June 30, 2003. PROVISION FOR LOAN LOSSES The provision for loan losses was $8.2 million for the first six months of 2004, as compared to $8.0 million for the first six months of 2003. The allowance for loan losses as a percentage of total loans remained constant at 1.43% for both June 30, 2004 and June 30, 2003. NON-INTEREST INCOME Total non-interest income was $38.1 million for the first six months of 2004, as compared to $34.8 million for the same period of 2003. The first six months of 2004 included a gain on the sale of two branches totaling $4.1 million. The Corporation's fee income from insurance and wealth management activities increased 2.7% to $11.0 million for the six months ended June 30, 2004 as compared to the six months ended June 30, 2003. Contingent fee income from insurance operations and increased sales of annuities and mutual funds through the branch network contributed to the higher fee income in 2004. Partially offsetting these increases, gain on the sale of mortgage loans decreased $518,000 due to a lower volume of mortgage loan originations as higher interest rates in 2004 have led to a slowdown in mortgage refinancing activity. 23 NON-INTEREST EXPENSE Total non-interest expense was $68.1 million for the first six months of 2004, as compared to $73.6 million for the first six months of 2003. In concert with the spin-off of its Florida operations, the Corporation initiated a cost reduction initiative in the third quarter of 2003 and completed it by December 31, 2003. As a result of this cost reduction initiative, the Corporation realized an expense reduction of $5.5 million, or 7.5%, for the first six months of 2004, as compared to the first six months of 2003. The resulting efficiency ratio for the first six months of 2004 was 54.49%, which included a benefit of 1.89% from the gain on the sale of branches. INCOME TAXES The Corporation's income tax was $14.2 million for the first six months of 2004 compared to $11.6 million for the same period of 2003. The effective tax rate of 31.3% for the six months ended June 30, 2004 was lower than the 35.0% federal statutory tax rate due to the tax benefits resulting from tax-exempt instruments and excludable dividend income. 24 SECOND QUARTER OF 2004 AS COMPARED TO SECOND QUARTER OF 2003: The following table provides average balances and yields and rates on interest earning assets and interest bearing liabilities (dollars in thousands): Quarter Ended June 30
2004 2003 -------------------------------------- ---------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ASSETS ---------- -------- ------ ---------- -------- ----- Interest earning assets: Interest bearing deposits with banks $ 1,493 $ 3 0.81% $ 5,922 $ 11 0.75% Federal funds sold -- -- -- 3,150 8 1.02 Securities: Taxable 942,152 10,042 4.29 803,992 8,472 4.23 Non-taxable (1) 75,849 1,006 5.33 134,700 2,363 7.04 Loans (1) (2) 3,232,935 51,062 6.35 3,227,472 54,927 6.83 ---------- -------- ---------- -------- Total interest earning assets 4,252,429 62,113 5.87 4,175,236 65,781 6.32 ---------- -------- ---------- -------- Cash and due from banks 99,742 108,969 Allowance for loan losses (47,336) (47,161) Premises and equipment 76,780 97,013 Assets of discontinued operations -- 3,666,530 Other assets 255,615 208,886 ---------- ---------- $4,637,230 $8,209,473 ========== ========== LIABILITIES Interest bearing liabilities: Deposits: Interest bearing demand $ 847,556 $ 1,612 0.76 $ 800,156 $ 1,908 0.96 Savings 604,162 702 0.47 491,377 774 0.63 Other time 1,315,482 10,264 3.14 1,490,213 12,190 3.28 Repurchase agreements 128,337 280 0.88 103,560 294 1.14 Other short-term borrowings 235,144 1,226 2.10 289,649 1,728 2.39 Long-term debt 605,049 5,964 3.96 555,211 6,181 4.47 ---------- -------- ---------- -------- Total interest bearing liabilities 3,735,730 20,048 2.16 3,730,166 23,075 2.48 ---------- -------- ---------- -------- Non-interest bearing, demand deposits 593,299 569,989 Liabilities of discontinued operations -- 3,235,309 Other liabilities 68,534 60,747 ---------- ---------- 4,397,563 7,596,211 ---------- ---------- STOCKHOLDERS' EQUITY 239,667 613,262 ---------- ---------- $4,637,230 $8,209,473 ========== ========== Net interest earning assets $ 516,699 $ 445,070 ========== ========== Net interest income $ 42,065 $ 42,706 ======== ======== Net interest spread 3.72% 3.84% ==== Net interest margin (3) 3.98% 4.10% ====
(1) The amounts are reflected on a fully taxable equivalent basis using the federal statutory tax rate of 35% adjusted for certain federal tax preferences. The Corporation believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. (2) Average balance includes non-accrual loans. Loans consist of average total loans less average unearned income. The amount of loan fees included in interest income on loans is immaterial. (3) Net interest margin is calculated by dividing the difference between total interest earned and total interest paid by average interest earning assets. 25 The following table sets forth certain information regarding changes in net interest income attributable to changes in the volumes and rates of interest earning assets and interest bearing liabilities for the quarter ended June 30, 2004 as compared to the quarter ended June 30, 2003 (in thousands):
Volume Rate Net ------- ------- ------- Interest Income: Interest bearing deposits with banks $ (9) $ 1 $ (8) Federal funds sold (4) (4) (8) Securities (1) 578 (365) 213 Loans (1) 95 (3,960) (3,865) ------- ------- ------- 660 (4,328) (3,668) ------- ------- ------- Interest Expense: Deposits: Interest bearing demand 118 (414) (296) Savings 676 (748) (72) Other time (1,412) (514) (1,926) Repurchase agreements 300 (314) (14) Other short-term borrowings (305) (197) (502) Long-term debt 801 (1,018) (217) ------- ------- ------- 178 (3,205) (3,027) ------- ------- ------- Net Change $ 482 $(1,123) $ (641) ======= ======= =======
(1) The amounts are reflected on a fully taxable equivalent basis using the federal statutory tax rate of 35% adjusted for certain federal tax preferences. The Corporation believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. (2) The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the net size of the rate and volume changes. NET INTEREST INCOME During the second quarter of 2004, net interest income of $41.5 million decreased $553,000 or 1.3% from the same period last year. While the Corporation's net interest margin decreased 12 basis points to 3.98% in the second quarter of 2004, earning assets increased $77.2 million or 1.8% from the same period last year. Total interest income of $61.5 million for the second quarter of 2004 decreased $3.6 million or 5.5% from the same period last year, primarily due to a decrease of 45 basis points in the yield on earning assets to 5.87% in the second quarter of 2004. A lower interest rate environment in 2004 as compared to 2003 led to lower yields earned on loans and investment securities. Partially offsetting the decrease in yield, average earning assets of $4.3 billion for the second quarter of 2004 increased $77.2 million or 1.8% primarily driven by growth in the investment security portfolio. In addition, average loan outstandings increased $5.5 million in the second quarter of 2004 from the same period last year. While commercial and consumer loans grew a combined $241.6 million, indirect loans, mortgage loans and automobile leases decreased a combined $224.4. These strategic changes in the Corporation's loan mix are designed to improve asset quality, generate fee income and focus on more advantageous loan originations consistent with interest rate risk management and relationship lending. 26 Total interest expense of $20.0 million for the second quarter of 2004 decreased $3.0 million or 13.1% from the same period last year, primarily due to a decrease of 32 basis points in the Corporation's cost of funds to 2.16% in the second quarter of this year. This decrease was a direct result of the Corporation's efforts to reduce rates paid on deposits coupled with customers re-investing funds into lower rate certificates of deposit. In addition, the Corporation early retired higher rate FHLB borrowings in the third quarter of 2003. PROVISION FOR LOAN LOSSES The provision for loan losses totaled $3.6 million for the second quarter of 2004, as compared to $3.9 million for the second quarter of 2003, as credit quality improvements during the second quarter of 2004 permitted a reduction in the provision for loan losses for the quarter. These improvements are evidenced by a decrease of 6 basis points in net charge-offs to average loans to .46% for the second quarter of 2004. Additionally, non-performing loans to total loans decreased 5 basis points to .87% for the second quarter of 2004, while non-performing assets to total assets decreased 5 basis points to .66% for this same period. NON-INTEREST INCOME Non-interest income of $17.4 million for the second quarter of 2004 decreased $457,000 or 2.6% from the second quarter of 2003, primarily due to a decrease of $250,000 in gain on sales of securities. Wealth management fees, comprised of trust income and securities commissions and fees, also decreased slightly to $2.9 million in the second quarter of 2004 from $3.1 million in the second quarter of 2003. NON-INTEREST EXPENSE Non-interest expense of $33.5 million in the second quarter of 2004 decreased $2.9 million or 7.9% from the same period last year, driven primarily by the Corporation's cost reduction initiative implemented during the second half of 2003 in anticipation of the spin-off of the Florida operations. More specifically, salaries and employee benefits expense of $17.0 million and occupancy and equipment expense of $6.0 million in the second quarter of 2004 decreased $1.9 million or 10.3% and $740,000 or 11.0%, respectively, from the same period last year. INCOME TAXES The Corporation's income tax expense of $6.7 million for the second quarter of 2004 compared to $5.6 million for the same period of 2003. This increase was driven primarily by an increase in pretax income coupled with an increase in the Corporation's effective tax rate to 30.8% in the second quarter of 2004, compared to 28.4% for the same period last year. This increase in effective tax rate was driven by a decrease in the mix of tax-exempt earning assets this year. 27 LIQUIDITY AND INTEREST RATE SENSITIVITY The Corporation's goal in liquidity management is to meet the cash flow requirements of depositors and borrowers as well as the operating cash needs of the Corporation, with cost-effective funding. Liquidity is centrally managed on a daily basis by treasury personnel. In addition, the Corporate Asset/Liability Committee (ALCO), which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies which affect balance sheet or cash flow positions. The Board of Directors has established an Asset/Liability Policy in order to achieve and maintain earnings performance consistent with long-term goals while maintaining acceptable levels of interest rate risk, a "well-capitalized" balance sheet and adequate levels of liquidity. This policy designates the ALCO as the body responsible for meeting this objective. Liquidity sources from assets include payments from loans and investments as well as the ability to securitize or sell loans and investment securities. The Corporation continues to originate mortgage loans, most of which are resold in the secondary market. Proceeds from the sale of mortgage loans totaled $54.2 million for the first six months of 2004. Liquidity sources from liabilities are generated primarily through deposits. As of June 30, 2004, deposits comprised 70.4% of total liabilities. To a lesser extent, the Corporation also makes use of wholesale sources which include federal funds purchased, repurchase agreements and public deposits. In addition, the banking affiliate has the ability to borrow funds from the FHLB. FHLB advances are a competitively priced and reliable source of funds. The Corporation has made use of FHLB advances and has a large reserve available for contingency funding purposes. As of June 30, 2004, outstanding advances were $546.2 million, or 11.4% of total assets, while FHLB availability was $1.5 billion, or 30.6% of total assets. The Corporation has repurchased shares of its common stock for re-issuance under various employee benefit plans and the Corporation's dividend reinvestment plan since 1991. In addition, the Corporation has repurchased shares for specific re-issuance in connection with certain business combinations accounted for as purchase transactions. During the first six months of 2004 and 2003, the Corporation purchased 633,044 and 713,327 treasury shares totaling $12.9 million and $20.8 million, respectively, and re-issued 612,141 and 755,148 treasury shares totaling $13.0 million and $21.8 million, respectively. The principal source of cash for the parent company is dividends from its subsidiaries. The parent also has approved lines of credit with several major domestic banks totaling $101.0 million, which were unused as of June 30, 2004. The Corporation also issues subordinated debt on a regular basis and its banking affiliate has access to the Federal Reserve Bank as well as access to the capital markets. The ALCO regularly monitors various liquidity ratios and forecasts of cash position. Management believes the Corporation has sufficient liquidity available to meet its normal operating and contingency funding cash needs. 28 The financial performance of the Corporation is at risk from interest rate fluctuations. This interest rate risk arises due to differences between the amount of interest earning assets and interest bearing liabilities subject to repricing over a period of time, the difference between the change in various interest rates and the embedded options in certain financial instruments. The Corporation utilizes an asset/liability model to support its balance sheet strategies. The Corporation uses gap analysis, net interest income simulations and the economic value of equity (EVE) to measure its interest rate risk. Gap and EVE are static measures which do not incorporate assumptions regarding future business. Gap, while a helpful diagnostic tool, displays cash flows for only a single rate environment. EVE's long term horizon helps identify changes in optionality and longer-term positions. However, EVE's liquidation perspective does not translate into the earnings based measures that are the focus of managing and valuing a going concern. Net interest income simulations explicitly measure the exposure to earnings from changes in market rates of interest. The Corporation's current financial position is combined with assumptions regarding future business to calculate net interest income under various hypothetical rate scenarios. The ALCO reviews earnings simulations over multiple years under various interest rate scenarios. The following gap analysis attempts to measure the interest rate risk of the Corporation by comparing the difference between the amount of interest earning assets and interest bearing liabilities subject to repricing over a period of time. The ratio of rate sensitive assets to rate sensitive liabilities maturing within a one year period was .91 at June 30, 2004, as compared to .93 at June 30, 2003. A ratio of less than one indicates a higher level of repricing liabilities over repricing assets over the next twelve months. Following is the gap analysis as of June 30, 2004 (dollars in thousands):
Within 2-3 4-6 7-12 Total 1 Month Months Months Months 1 Year ---------- --------- ---------- ------------ ---------- INTEREST EARNING ASSETS (IEA) Loans $ 716,149 $ 143,497 $226,352 $370,485 $1,456,483 Investments 14,000 27,398 39,226 88,700 1 69,324 ---------- --------- ---------- ------------ ---------- 730,149 170,895 265,578 459,185 1,625,807 INTEREST BEARING LIABILITIES (IBL) Non-maturity deposits $ 538,693 $ 538,693 Time deposits 74,829 $ 136,792 $ 188,138 $376,153 775,912 Borrowings 392,319 27,846 16,832 25,925 462,922 ---------- --------- ---------- ------------ ---------- 1,005,841 164,638 204,970 402,078 1,777,527 GAP: Period $ (275,692) $ 6,257 $ 60,608 $ 57,107 $ (151,720) ========== ========= ========== ============ ========== Cumulative $ (275,692) $(269,435) $ (208,827) $ (151,720) ========== ========= ========== ============ IEA/IBL (CUMULATIVE) .73 .77 .85 .91 ========== ========= ========== ============ CUMULATIVE GAP TO IEA (6.30) (6.15) (4.77) (3.47) ========== ========= ========== ============
29 The allocation of non-maturity deposits to the one-month maturity bucket is based on the estimated sensitivity of each product to changes in market rates. For example, if a product's rate is estimated to increase by 50% as much as the market rates, then 50% of the account balance was placed in this bucket. The following table presents an analysis of the potential sensitivity of the Corporation's annual net interest income and EVE to sudden and parallel changes (shocks) in market rates versus if rates remained unchanged:
JUNE 30, -------------- 2004 2003 ---- ---- Net interest income change (12 months): - 100 basis points (1.5)% (4.6)% + 100 basis points 0.0% 0.2% Economic value of equity: - 100 basis points 9.2% (9.0)% + 100 basis points (9.9)% 0.5%
The Corporation's ALCO is responsible for the identification and management of interest rate risk exposure. As such, the Corporation continuously evaluates strategies to minimize its exposure to interest rate fluctuations. In order to help mitigate the effect of rising interest rates, the ALCO transacted strategies during the second quarter of 2004 including limiting the length of terms of securities acquired, promoting long-term certificates of deposit, locking long-term wholesale funds through the FHLB and selling fixed rate mortgages. The measures identified above are well within the Corporation's Asset/Liability Policy. The change in EVE from the prior period signifies the significant decline in refinancing activity in certain investments and loans due to higher interest rates. The slower cash flows and higher interest rates create a larger decline in the value of these portfolios. As a going concern, with no plans to liquidate these positions, this decrease in value will not be reflected in earnings. Furthermore, EVE is a volatile, static present value over the life of the balance sheet. As such, it does not reflect future business and ALCO strategies designed to mitigate the effect to earnings from these slowly evolving positions. The Corporation recognizes that earnings simulation models are based on methodologies which may have inherent shortcomings. Further, earnings simulations require certain assumptions, such as prepayment rates on earnings assets and pricing impact on non-maturity deposits, be made, which may differ from actual experience. These business assumptions are based upon the Corporation's experience, business plans and published industry experience. While management believes such assumptions to be reasonable, there can be no assurances that modeled results will approximate actual results. 30 DEPOSITS Following is a summary of deposits (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 ---------- ---------- Non-interest bearing $ 589,146 $ 592,795 Savings and NOW 1,439,348 1,513,526 Certificates and other time deposits 1,329,298 1,333,189 ---------- ---------- Total deposits 3,357,792 3,439,510 Securities sold under repurchase agreements 122,128 81,444 ---------- ---------- Total deposits and repurchase agreements $3,479,920 $3,520,954 ========== ==========
Total deposits and repurchase agreements decreased $41.0 million from December 31, 2003 to June 30, 2004. In February 2004, the Corporation sold $39.9 million in deposits associated with the divestiture of two branches in non-strategic locations. The deposits sold were comprised of $6.1 million, $11.4 million and $22.4 million in non-interest bearing, savings and NOW and certificates of deposits, respectively. Excluding this sale, the Corporation grew non-maturity deposits and took advantage of opportunities to shift certain non-maturity deposits to longer maturity certificates of deposits in order to help mitigate the risk of rising interest rates. Repurchase agreements, mostly with the Corporation's commercial customers, increased $40.7 million as the Corporation was successful in attracting new customers and expanding existing relationships at favorable interest rates. This strategy allows for the Corporation to expand commercial relationships by providing additional valuable services and information to its customers. LOANS Following is a summary of loans (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 ---------- ---------- Commercial $1,324,050 $1,297,559 Direct installment 796,730 776,716 Consumer line of credit 234,364 229,005 Residential mortgages 440,344 468,173 Indirect installment 408,796 452,170 Lease financing 9,325 16,594 Other 13,280 18,980 ---------- ---------- $3,226,889 $3,259,197 ========== ==========
The Corporation's loan portfolio consists principally of loans to individuals and small- and medium-sized businesses within the Corporation's primary market area of western and central Pennsylvania and northeastern Ohio. Additionally, the portfolio contains consumer finance loans to individuals in Pennsylvania, Ohio and Tennessee. Total loans decreased $32.3 million from December 31, 2003 to June 30, 2004. This decrease was driven by planned reductions in indirect installment, residential mortgages and lease financing, which decreased $43.4 million, $27.8 million and $7.3 million, respectively, from December 31, 2003. Partially offsetting these tactical reductions were increases in more desirable segments of the loan portfolio. Commercial, direct installment and consumer lines of credit increased by $26.5 million, $20.0 million and 31 $5.4 million, respectively, from December 31, 2003. These strategic initiatives are designed to improve asset quality and fee income while focusing attention on more advantageous loan originations consistent with relationship lending. NON-PERFORMING ASSETS Non-performing assets include non-performing loans and other real estate owned. Non-performing loans include non-accrual loans and restructured loans. Management classifies non-performing commercial loans over $250,000 as impaired. Non-accrual loans represent loans on which interest accruals have been discontinued. It is the Corporation's policy to discontinue interest accruals when principal or interest is due and has remained unpaid for 90 to 180 days or more depending on the loan type unless the loan is both well-secured and in the process of collection. When a loan is placed on non-accrual status, all unpaid interest is reversed. Non-accrual loans may not be restored to accrual status until all delinquent principal and interest has been paid. Consumer installment loans are generally charged off against the allowance for loan losses upon reaching 90 to 180 days past due, depending on the installment loan type. Commercial loan charge-offs, either in whole or in part, are generally made as soon as facts and circumstances raise a serious doubt as to the collectibility of all or a portion of the principal. Restructured loans are loans in which the borrower has been granted a concession on the interest rate or the original repayment terms due to financial distress. Non-performing loans are closely monitored on an ongoing basis as part of the Corporation's loan review and work-out process. The potential risk of loss on these loans is evaluated by comparing the loan balance to the fair value of any underlying collateral or the present value of projected future cash flows. Losses are recognized where appropriate. Following is a summary of non-performing assets (2003 information based on continuing operations)(dollars in thousands):
JUNE 30, DECEMBER 31, 2004 2003 ------- ------- Non-performing assets: Non-accrual loans $22,353 $22,449 Restructured loans 5,753 5,719 ------- ------- Total non-performing loans 28,106 28,168 Other real estate owned 3,399 3,109 ------- ------- Total non-performing assets $31,505 $31,277 ======= ======= Asset quality ratios: Non-performing loans as percent of total loans .87% .86% Non-performing assets as percent of total assets .66% .69%
32 ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio at a specific point in time. This estimate includes losses associated with specifically identified loans, as well as estimated probable credit losses inherent in the remainder of the loan portfolio. Additions are made to the allowance through both periodic provisions charged to income and recoveries of losses previously incurred. Reductions to the allowance occur as loan losses are recognized and loans are charged off. Management evaluates the adequacy of the allowance at least quarterly, and in doing so relies on various factors including, but not limited to, assessment of historical loss experience, delinquency and non-accrual trends, portfolio growth, underlying collateral coverage and current economic conditions. Naturally, this evaluation is subjective and requires material estimates that may change over time. The components of the allowance for loan losses represent estimates based upon FAS 5, Accounting for Contingencies, and FAS 114, Accounting by Creditors for Impairment of a Loan. FAS 5 applies to smaller balance homogeneous loan pools such as consumer installment, residential mortgages and consumer lines of credit, as well as larger balance commercial loans that are not individually evaluated for impairment under FAS 114. FAS 114 is applied to larger balance commercial loans that are considered impaired. Under FAS 114, a loan is impaired when, based upon current information and events, it is probable that the loan will not be repaid according to its contractual terms, including both principal or interest. Management performs individual assessments of impaired loans to determine the existence of loss exposure and, where applicable, the extent of loss exposure based upon the present value of expected future cash flows available to pay the loan, or based upon the estimated realizable collateral where a loan is collateral dependent. Commercial loans excluded from FAS 114 individual impairment analysis are collectively evaluated by management to estimate reserves for loan losses inherent in those loans in accordance with FAS 5. In estimating loan loss contingencies, management applies historical loss rates and also considers how the loss rates may be impacted by changes in current economic conditions, delinquency and non-performing loan trends, changes in loan underwriting guidelines and credit policies, as well as the results of internal loan reviews. Smaller balance homogeneous loan pools are evaluated using similar criteria that are based upon historical loss rates of various loan types. Historical loss rates are adjusted to incorporate changes in existing conditions that may impact, both positively or negatively, the degree to which these loss histories may vary. This determination inherently involves a high degree of uncertainty and considers current risk factors that may not have occurred in the Corporation's historical loss experience. 33 Following is a summary of changes in the allowance for loan losses and selected ratios (dollars in thousands):
Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Balance at beginning of period $ 46,227 $ 46,625 $ 46,139 $ 46,984 Reduction due to loan sale (54) -- (54) -- Charge-offs (4,418) (4,722) (9,499) (9,726) Recoveries 724 524 1,271 1,042 -------- -------- -------- -------- Net charge-offs (3,694) (4,198) (8,228) (8,684) Provision for loan losses 3,620 3,903 8,242 8,030 -------- -------- -------- -------- Balance at end of period $ 46,099 $ 46,330 $ 46,099 $ 46,330 ======== ======== ======== ======== Allowance for loan losses to: Total loans, net of unearned income 1.43% 1.43% Non-performing loans 164.02% 155.97% Annualized net charge-offs to average loans 0.46% 0.52% 0.51% 0.54%
CAPITAL RESOURCES AND REGULATORY MATTERS The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, changing competitive conditions and economic forces. The Corporation seeks to maintain a strong capital base to support its growth and expansion activities, provide stability to current operations and promote public confidence. The Corporation has an existing registration statement for the Corporation's subordinated notes which are issued through its finance company, Regency Finance Company (Regency). The net proceeds from the issuance of the subordinated notes are used to finance Regency's lending and purchasing activities. In addition, the Corporation has an effective $200.0 million shelf registration with the Securities and Exchange Commission. The Corporation may, from time to time, issue any combination of common stock, preferred stock, debt securities or trust preferred securities in one or more offerings. Quantitative measures established by regulators to ensure capital adequacy require the Corporation and its banking subsidiary to maintain minimum amounts and ratios of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of tier 1 capital to average assets (as defined). As of March 31, 2004, the Corporation and its banking subsidiary have been categorized by the various banking regulators as "well capitalized" under the regulatory framework for prompt corrective action. As of June 30, 2004, the Corporation and its banking subsidiary meet all capital adequacy requirements to which they are subject. 34 Following are capital ratios as of June 30, 2004 for the Corporation (dollars in thousands):
Well Capitalized Minimum Capital Actual Requirements Requirements ------------------ ------------------ ----------------- Amount Ratio Amount Ratio Amount Ratio -------- ----- -------- ----- -------- ----- Total Capital $378,515 11.7% $324,637 10.0% $259,710 8.0% (to risk-weighted assets) Tier 1 Capital 281,470 8.7% 194,782 6.0% 129,855 4.0% (to risk-weighted assets) Tier 1 Capital 281,470 6.1% 229,683 5.0% 183,746 4.0% (to average assets)
The Corporation and its banking subsidiary are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect of the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and its banking subsidiary must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's and banking subsidiary's capital amounts and classifications are also subject to qualitative judgements by the regulators about components, risk weightings and other factors. 35 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information called for by this item is provided under the caption "Liquidity and Interest Rate Sensitivity" under Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 4. CONTROLS AND PROCEDURES. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Corporation's Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that the Corporation's disclosure controls and procedures (as defined in Rules 13a - 15(e) and 15d - 15(e) under the Securities and Exchange Act of 1934, as amended), based on their evaluation of these controls and procedures as of the end of the period covered by this Form 10-Q, are effective at the reasonable assurance level as discussed below to ensure that information required to be disclosed by the Corporation in the reports it files under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to the Corporation's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The Corporation's management, including the CEO and CFO, does not expect that the Corporation's disclosure controls and internal controls 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. 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 Corporation have been detected. These inherent limitations include the realities that judgements 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 controls. CHANGES IN INTERNAL CONTROLS. The CEO and CFO have evaluated the changes to the Corporation's internal controls over financial reporting that occurred during the Corporation's fiscal quarter ended June 30, 2004, as required by paragraph (d) of Rules 13a - 15 and 15d - 15 under the Securities Exchange Act of 1934, as amended and have concluded that there were no such changes that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. 36 PART II ITEM 1. LEGAL PROCEEDINGS The Corporation and persons to whom the Corporation may have indemnification obligations, in the normal course of business, are subject to various pending and threatened lawsuits in which claims for monetary damages are asserted. Other real estate owned includes a property that is subject to litigation. Should the outcome of the pending or threatened lawsuits be adverse, the value of the property will be impaired and other costs may be incurred. Management, after consultation with outside legal counsel, does not at the present time anticipate the ultimate liability arising out of such pending and threatened lawsuits will have a material adverse effect on the Corporation's financial position. At the present time, management is not in a position to determine whether any pending or threatened litigation will have a material adverse effect on the Corporation's results of operation in any future reporting period. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of Shares Maximum Number Total Purchased as of Shares that May Number Average Part of Publicly yet be Purchased of Shares Price Paid Announced Plans Under the Month Ending Purchased Per Share or Programs Plans or Programs ----------------- --------- ---------- ---------------- ----------------- April 30, 2004 88,200 $21.56 N/A N/A May 31, 2004 39,000 $19.53 N/A N/A June 30, 2004 63,000 $19.91 N/A N/A
All shares were purchased through the open-market, and are not part of a publicly announced purchase plan. It has been the Corporation's practice to fund the shares required for employee benefit programs through share purchases. This practice may be discontinued at the Corporation's discretion. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Shareholders of F.N.B. Corporation was held May 12,2004. Proxies were solicited pursuant to Section 14(a) of the Securities and Exchange Act of 1934 and there was no solicitation in opposition to the Corporation's solicitations. 37 All of the Corporation's nominees for directors as listed in the proxy statement were elected with the following votes:
Votes Votes "For" Withheld ---------- -------- William B. Campbell 36,990,633 469,921 Henry M. Ekker 35,237,692 2,222,862 Robert B. Goldstein 36,485,273 975,281 Stephen J. Gurgovits 37,019,403 441,152 Harry F. Radcliffe 35,550,698 1,909,856 John W. Rose 36,929,656 530,898
ITEM 5. OTHER INFORMATION The Secretary of the Corporation must receive written notice of any proposal submitted by a shareholder of the Corporation for consideration at the Annual Meeting of Shareholders on or prior to the date which is 120 days prior to the date on which the Corporation first mailed its proxy materials for the prior year's Annual Meeting of Shareholders. Accordingly, any shareholder proposal must be submitted to the Corporation by November 26, 2004 to be considered at the 2005 Annual Meeting of Shareholders. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31.1. Rule 13a-14(a)/15(d) - 14(a) Certification of Chief Executive Officer. (filed herewith). 31.2. Rule 13a-14(a)/15(d) - 14(a) Certification of Chief Financial Officer. (filed herewith). 32.1. Section 1350 Certification of Chief Executive Officer. (filed herewith). 32.2. Section 1350 Certification of Chief Financial Officer. (filed herewith). (b) Reports on Form 8-K The Corporation has filed the following Current Reports on Form 8-K during the quarter ended June 30, 2004: April 19, 2004 - Items 7 and 12. The Corporation reported its issuance of a press release announcing its financial results for the quarter ended March 31, 2004. May 6, 2004 - Items 5 and 7. The Corporation announced that it has signed a definitive merger agreement to acquire all of the outstanding shares of Slippery Rock Financial Corporation. The acquisition, subject to regulatory approval, is expected to close during the fourth quarter of 2004. 38 The Corporation has filed the following Current Reports on Form 8-K after June 30, 2004: July 21, 2004 - Items 7 and 12. The Corporation reported its issuance of a press release announcing its financial results for the quarter ended June 30, 2004. August 2, 2004 - Items 5 and 7. The Corporation announced its definitive agreement to acquire the assets of Morrell, Butz and Junker, Inc. The transaction closed on July 30, 2004. 39 SIGNATURES Pursuant to the requirements 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. F.N.B. Corporation (Registrant) Dated: AUGUST 9, 2004 /s/ STEPHEN J. GURGOVITS ------------------------------------- Stephen J. Gurgovits President and Chief Executive Officer (Principal Executive Officer) Dated: AUGUST 9, 2004 /s/ BRIAN F. LILLY ------------------------------------- Brian F. Lilly Chief Financial Officer (Principal Financial Officer) 40