10-Q 1 sep04-10q.txt PFBI SEPT 30, 2004 10-Q TEXT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [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 0-20908 PREMIER FINANCIAL BANCORP, INC. (Exact name of registrant as specified in its charter) Kentucky 61-1206757 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2883 Fifth Avenue Huntington, West Virginia 25702 (address of principal executive officer) (Zip Code) Registrant's telephone number (304) 525-1600 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 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 Securities Exchange Act of 1934). Yes___ No X . Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common stock, no par value, - 5,232,230 shares outstanding at October 31, 2004. PREMIER FINANCIAL BANCORP, INC. PART I - FINANCIAL INFORMATION Item 1. Financial Statements The accompanying information has not been audited by independent public accountants; however, in the opinion of management such information reflects all adjustments necessary for a fair presentation of the results for the interim period. All such adjustments are of a normal and recurring nature. Premier Financial Bancorp, Inc.'s ("Premier's") accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America. Certain accounting principles used by Premier involve a significant amount of judgment about future events and require the use of estimates in their application. The following policies are particularly sensitive in terms of judgments and the extent to which estimates are used: allowance for loan losses, the identification and evaluation of impaired loans, the impairment of goodwill, the realization of deferred tax assets and stock based compensation disclosures. These estimates are based on assumptions that may involve significant uncertainty at the time of their use. However, the policies, the estimates and the estimation process as well as the resulting disclosures are periodically reviewed by the Audit Committee of the Board of Directors and material estimates are subject to review as part of the external audit by the independent public accountants. The accompanying financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the registrant's annual report on Form 10-K. Accordingly, the reader of the Form 10-Q may wish to refer to the registrant's Form 10-K for the year ended December 31, 2003 for further information in this regard. Index to consolidated financial statements: Consolidated Balance Sheets.................................. 3 Consolidated Statements of Income ........................... 4 Consolidated Statements of Comprehensive Income ............. 6 Consolidated Statements of Cash Flows........................ 7 Notes to Consolidated Financial Statements................... 9
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 (DOLLARS IN THOUSANDS) -------------------------------------------------------------------------------------------------------------------- (UNAUDITED) 2004 2003 -------------- -------------- ASSETS Cash and due from banks $ 14,536 $ 16,422 Federal funds sold 30,104 17,051 Securities available for sale 155,035 147,646 Loans 324,464 331,794 Allowance for loan losses (9,186) (14,300) -------------- -------------- Net loans 315,278 317,494 Federal Home Loan Bank and Federal Reserve Bank stock 2,571 2,490 Premises and equipment, net 7,509 7,956 Real estate and other property acquired through foreclosure 1,431 3,187 Interest receivable 2,939 3,448 Goodwill 15,816 15,816 Current year tax receivable 1,411 3,695 Other assets 4,830 8,024 Assets of discontinued operation - 79,163 ------------- -------------- Total assets $ 551,460 $ 622,392 ============= ============== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest bearing $ 63,260 $ 59,001 Time deposits, $100,000 over 40,052 42,780 Other interest bearing 343,231 353,693 ------------- -------------- Total deposits 446,543 455,474 Securities sold under agreements to repurchase 7,187 - Federal Home Loan Bank advances 9,495 10,705 Other borrowed funds 950 6,200 Notes payable 1,402 1,402 Guaranteed junior subordinated interest debentures 26,546 26,546 Interest payable 6,223 3,902 Other liabilities 1,961 1,227 Liabilities of discontinued operation - 71,396 ------------- -------------- Total liabilities 500,307 576,852 Stockholders' equity Preferred stock, no par value; 1,000,000 shares authorized; none issued or outstanding - - Common stock, no par value; 10,000,000 shares authorized; 5,232,230 shares issued and outstanding 1,103 1,103 Surplus 43,445 43,445 Retained earnings 6,449 311 Accumulated other comprehensive income 156 681 ------------- -------------- Total stockholders' equity 51,153 45,540 ------------- -------------- Total liabilities and stockholders' equity $ 551,460 $ 622,392 ============= ============== -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- (Restated) (Restated) Interest income Loans, including fees $ 5,658 $ 6,522 $ 17,249 $ 20,692 Securities available for sale Taxable 1,134 878 3,250 2,821 Tax-exempt 48 160 182 540 Federal funds sold and other 111 105 251 396 ----------- ----------- ----------- ----------- Total interest income 6,951 7,665 20,932 24,449 Interest expense Deposits 1,554 2,000 4,730 6,702 Other borrowings 225 305 731 956 Debentures 754 689 2,209 2,089 ----------- ----------- ----------- ----------- Total interest expense 2,533 2,994 7,670 9,747 ----------- ----------- ----------- ----------- Net interest income 4,418 4,671 13,262 14,702 Provision for loan losses 162 4,343 671 18,388 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 4,256 328 12,591 (3,686) Non-interest income Service charges 647 628 1,866 1,516 Insurance commissions 9 31 45 102 Securities gains - 2 10 206 Other 228 264 725 855 ----------- ----------- ----------- ----------- 884 925 2,646 2,679 Non-interest expenses Salaries and employee benefits 2,211 2,090 6,604 6,650 Occupancy and equipment expenses 711 571 1,726 1,711 Professional fees 485 318 1,551 776 Taxes, other than payroll, property and income 146 144 436 388 Write-downs, expenses, and (gains) or losses on sales of other real estate owned, net (35) 29 15 287 Supplies 99 102 277 281 Bad check losses 27 206 73 395 Other expenses 839 778 2,516 2,452 ----------- ----------- ----------- ----------- 4,483 4,238 13,198 12,940 ----------- ----------- ----------- ----------- Income (loss) from continuing operations before income taxes 657 (2,985) 2,039 (13,947) Provision (benefit) for income taxes 209 (1,108) 635 (4,926) ----------- ----------- ----------- ----------- Income (loss) from continuing operations 448 (1,877) 1,404 (9,021) ----------- ----------- ----------- ----------- Discontinued operation Income (loss) from operation of discontinued component - 30 4 (130) Gain on sale of discontinued operation 6,664 - 6,664 - Provison (benefit) for income taxes 1,934 9 1,934 (48) ----------- ----------- ----------- ----------- Income (loss) from discontinued operation 4,730 21 4,734 (82) ----------- ----------- ----------- ----------- Net income (loss) $ 5,178 $ (1,856) $ 6,138 $ (9,103) =========== =========== =========== =========== -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (continued) THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- (Restated) (Restated) Weighted average shares outstanding: Basic 5,232 5,232 5,232 5,232 Diluted 5,237 5,232 5,235 5,232 Earnings (loss) per share from continuing operations: Basic $ 0.09 $ (0.36) $ 0.27 $ (1.72) Diluted 0.09 (0.36) 0.27 (1.72) Earnings (loss) per share from discontinued operation: Basic $ 0.90 $ 0.00 $ 0.90 $ (0.02) Diluted 0.90 0.00 0.90 (0.02) Net earnings (loss) per share: Basic $ 0.99 $ (0.36) $ 1.17 $ (1.74) Diluted 0.99 (0.36) 1.17 (1.74) -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ---------- ---------- ---------- --------- (Restated) (Restated) Net income (loss) $ 5,178 $ (1,856) $ 6,138 $ (9,103) Other comprehensive income (loss): Unrealized gains and (losses) arising during the period 2,067 625 (785) 1,329 Reclassification of realized amount - (2) (10) (206) ---------- ---------- ---------- --------- Net change in unrealized gain (loss) on securities 2,067 623 (795) 1,123 Less: Tax impact 703 212 (270) 382 ---------- ---------- ---------- --------- Other comprehensive income (loss) 1,364 411 (525) 741 ---------- ---------- ---------- --------- Comprehensive income (loss) $ 6,542 $ (1,445) $ 5,613 $ (8,362) ========== ========== ========== ========= -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- 2004 2003 ------------- ------------- (Restated) Cash flows from continuing operating activities Income (loss) from continuing operations $ 1,404 $ (9,021) Adjustments to reconcile income (loss) to net cash from continuing operating activities Depreciation and impairment of real estate 846 723 Provision for loan losses 671 18,388 Amortization, net 396 401 FHLB stock dividends (67) (109) Investment securities losses (gains), net (10) (206) OREO (gains on sales) writedowns, net (76) 214 Changes in Interest Receivable 509 1,837 Other assets 3,743 (4,929) Interest Payable 2,321 1,927 Other liabilities 734 106 ------------- ------------- Net cash from continuing operating activities 10,471 9,331 Cash flows from continuing investing activities Purchases of securities available for sale (56,712) (98,833) Proceeds from sales of securities available for sale 414 13,294 Proceeds from maturities and calls of securities available for sale 47,923 92,674 Purchases of FHLB stock, net of redemptions (14) (72) Proceeds from sale of subsidiary 14,311 - Net change in federal funds sold (13,053) (22,073) Net change in loans (790) 22,320 Purchases of premises and equipment, net (399) (346) Proceeds from sale of other real estate acquired through foreclosure 4,167 2,061 ------------- ------------- Net cash from continuing investing activities (4,153) 9,025 Cash flows from continuing financing activities Net change in deposits (8,931) (8,953) Advances from Federal Home Loan Bank - 2,750 Repayment of Federal Home Loan Bank advances (1,210) (7,265) Early redemption of guaranteed debentures - (3,000) Repayment of Other Borrowed Funds (5,250) (1,050) Net change in agreements to repurchase securities 7,187 (255) ------------- -------------- Net cash (used in) continuing financing activities (8,204) (17,773) -------------- -------------- Net change in cash and cash equivalents from continuing activities (1,886) 583 Cash and cash equivalents of continuing operations at beginning of period 16,422 14,334 ------------- ------------- Cash and cash equivalents of continuing operations at end of period $ 14,536 $ 14,917 ============= ============= -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (IN THOUSANDS) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- 2004 2003 ------------- ------------- (Restated) Supplemental disclosures of cash flow information: Cash paid during period for interest $ 5,349 $ 7,820 Loans transferred to real estate acquired through foreclosure 2,335 1,663 Net change in cash and cash equivalents of discontinued operations (5,306) 651 Tax refunds received 3,132 - -------------------------------------------------------------------------------------------------------------------- See Accompanying Notes to Consolidated Financial Statements
PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 1 - BASIS OF PRESENTATION The consolidated financial statements include the accounts of Premier Financial Bancorp, Inc. (the Company) and its wholly owned subsidiaries:
Sept 30, 2004 Net Income Year ------------------ Acquired Assets Qtr Nine Mo. -------- ------ ------ ------- Citizens Deposit Bank & Trust Vanceburg, Kentucky 1991 $ 89,301 $ 316 $ 984 Bank of Germantown Germantown, Kentucky 1992 23,070 60 137 Farmers Deposit Bank Eminence, Kentucky 1996 95,003 (113) (297) Ohio River Bank Ironton, Ohio 1998 84,441 220 679 First Central Bank, Inc. Philippi, West Virginia 1998 86,871 297 842 Boone County Bank, Inc. Madison, West Virginia 1998 167,437 531 1,592 Mt. Vernon Financial Holdings, Inc. Huntington, West Virginia 1999 3,628 23 22
The Company also has a data processing subsidiary, Premier Data Services, Inc., and the PFBI Capital Trust unconsolidated subsidiary as discussed in Note 8. In accordance with FASB Interpretation No. 46, the Trust is no longer consolidated with the Company. All other intercompany transactions and balances have been eliminated. The Company maintains Employee Stock Ownership incentive Plans (the Plans) whereby certain employees of the Company are eligible to receive incentive stock options. The Plans are accounted for in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Pursuant to the Plans, a maximum of 600,000 shares of the Company's common stock may be issued through the exercise of these incentive stock options. The option price is the fair market value of the Company's shares at the date of the grant. The options are exercisable within ten years from the date of grant. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 1 - BASIS OF PRESENTATION - (continued) Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at the date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation. 2004 2003 ------------ ----------- (Restated) Income (loss) from continuing operations $ 1,404 $ (9,021) Deduct: Stock-based compensation expense determined under fair value based method (36) (23) ------------ ------------ Pro forma income (loss) $ 1,368 $ (9,044) Basic earnings (loss) per share from continuing operations $ 0.27 $ (1.72) Pro forma basic earnings (loss) per share 0.26 (1.73) Diluted earnings (loss) per share from continuing operations $ 0.27 $ (1.72) Pro forma diluted earnings (loss) per share 0.26 (1.73) For the period ended September 30, 2003, stock options were not considered in the computation of diluted loss per share because they were antidilutive. On February 18, 2004, 28,200 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $9.30. These options vest in three equal annual installments ending on February 18, 2007. On January 15, 2003, 28,650 incentive stock options were granted out of the 2002 Stock Option Plan at an exercise price of $7.96. These options vest in three equal annual installments ending on January 15, 2006. Proforma stock-compensation expense is being amortized over each of the three-year vesting periods. There were no options granted during 2002. Future pro forma net income will be negatively impacted should the Company choose to grant additional options. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 1 - BASIS OF PRESENTATION - (continued) The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date. 2004 2003 ---- ---- Risk-free interest rate 3.15% 3.10% Expected option life (yrs) 5.00 5.00 Expected stock price volatility 0.34 0.42 Dividend yield 0.00% 0.00% Weighted average fair value of options granted during the year $3.29 $3.30 NOTE 2 - RESTATEMENT On June 16, 2003 Premier announced that as a result of an ongoing internal investigation, it had uncovered a systemic disregard for its loan approval and credit administration policies at its Farmers Deposit Bank subsidiary and had accepted the resignation of the bank's former president. On November 7, 2003 Premier disclosed that the Securities and Exchange Commission had requested information about Premier's internal investigation. As the internal investigation progressed, many loans were charged off and additional provisions for loan losses were recorded. Premier's management, with the assistance of outside independent professionals, has conducted a further review of those loans for which significant charge offs or additional provisions were required in 2003. The purpose of this review was to determine if the facts or circumstances that gave rise to additional charge offs or provisions had been improperly concealed from senior management or improperly considered in applying management's estimates and judgments as to the adequacy of the allowance for loan losses in prior financial statement periods. The review did identify instances in which collateral securing loans had been released without proper support or notation in loan files, instances in which obligors on notes had been released from their repayment obligation without proper support or notation in loan files and instances in which delinquent loan reporting systems had been manipulated to prevent problem loans from being identified on a timely basis. Premier's senior management determined that if these circumstances had been considered in evaluating the adequacy of the allowance for loan losses in prior periods then some of the loan charge offs and additional provisions for loan losses recorded in 2003 should have been reflected in prior periods. Therefore the financial statements for the periods ended September 30, 2003 have been restated to reflect the financial statement effect of the matters that occurred in the prior periods but which were improperly concealed by subsidiary management. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 2 - RESTATEMENT (continued) Effect on operating results for the three and nine months ended (in thousands except per share data): Three Months Nine Months Sept 2003 Sept 2003 Increase Increase Operating statement caption (Decrease) (Decrease) --------------------------- ---------- ---------- Interest income, loans $ 145 $ 96 Provision for loan losses (3,672) (4,170) Net interest income after provision for loan losses 3,817 4,266 Income (loss) from continuing operations before income taxes 3,817 4,266 Provision (benefit) for income taxes 1,298 1,451 Income (loss) from continuing operations 2,519 2,815 Net (loss) income 2,519 2,815 Net (loss) income per share, basic and diluted 0.48 0.54 -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 3 - DISCONTINUED OPERATION In the fourth quarter of 2003, the Company adopted and began to implement a plan to sell its subsidiary Citizens Bank (Kentucky), Inc. ("Citizens Bank") located in Georgetown, Kentucky. On February 13, 2004, the Company announced that it had signed a definitive agreement to sell Citizens Bank in a cash transaction valued at approximately $14,500,000. In accordance with Financial Accounting Standard 144, "Accounting for the Impairment or Disposal of Long-lived Assets", which became effective for the Company on January 1, 2002, the financial position and results of operations of Citizens Bank are removed from the detail line items in the Company's financial statements and presented separately as "discontinued operations." The sale was completed on July 1, 2004. The $6,664,000 gain on the sale and $1,934,000 of income taxes accrued on the gain is reported on the income statement in the section titled discontinued operation for the three months and nine months ended September 30, 2004. A condensed balance sheet and statement of operations for Citizens Bank follows (in thousands): Sold on As of July 1 December 31 2004 2003 ----------- ----------- Assets Cash and federal funds sold $ 8,774 $ 6,473 Securities available for sale 11,600 12,082 Loans, net 49,141 53,886 Premises and equipment, net 3,006 3,026 Other assets 3,352 3,696 ----------- ----------- Total assets $ 75,873 $ 79,163 =========== =========== Liabilities Deposits $ 62,440 $ 65,486 Federal Home Loan Bank advances 5,242 5,255 Other liabilities 543 655 ----------- ----------- Total liabilities 68,225 71,396 Equity 7,648 7,767 ----------- ----------- Total liabilities and equity $ 75,873 $ 79,163 =========== ===========
For the Three For the Nine Months Ended Months Ended Sept 30 Sept 30 Sept 30 Sept 30 2004 2003 2004 2003 --------- --------- --------- --------- Interest income $ - $ 1,135 $ 2,021 $ 3,551 Interest expense - 454 732 1,466 --------- --------- --------- --------- Net interest income - 681 1,289 2,085 Provision for loan losses - - - 240 Non-interest income - 233 434 713 Gain on the sale of discontinued operation 6,664 - 6,664 - Non-interest expense - 884 1,719 2,688 Income tax (benefit) 1,934 9 1,934 (48) --------- --------- --------- ---------- Net income (loss) $ 4,730 $ 21 $ 4,734 $ (82) ========= ========= ========= ==========
-------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 3 - DISCONTINUED OPERATION (continued) The parent company leased a building to Citizens Bank to be used in its operations. The purchaser of the subsidiary chose not to continue the lease. As a result, the building was placed on the market to be sold. The market value was less than the carrying value of the building and therefore, in accordance with FAS 144, Accounting for Long-lived Assets, a $165,000 charge to operating earnings was recorded. This expense is included on the income statement in the caption "Occupancy and equipment expenses" for the three and nine month periods ended September 30, 2004. The building was sold in October 2004. NOTE 4 - REGULATORY MATTERS On September 29, 2000, the Company entered into an agreement with the Federal Reserve Bank (FRB) that prohibits the Company from paying dividends or incurring any additional debt without the prior written approval of the FRB. Additionally, the agreement required the Company to develop and monitor compliance with certain operational policies designed to strengthen Board of Director oversight including credit administration, liquidity, internal audit and loan review. Subsequently, on January 29, 2003, the Company entered into a written agreement with the Federal Reserve Bank of Cleveland (FRB) which supersedes and rescinds all previous agreements between the Company and the FRB. Among the provisions of the agreement were the continuation of the restriction on the Company's payment of dividends on its common stock without the express written consent of the FRB and the continuation of the restriction on the Company's payment of quarterly distributions on its Trust Preferred Securities without the express written consent of the FRB. Among other provisions, the agreement required the Company to retain an independent consultant to review its management, directorate and organizational structure, adopt a management plan responsive to such consultant's report, update its management succession plan in accordance with any recommendations in such consultant's report, monitor its subsidiary banks' compliance with bank policies and loan review programs, conduct formal quarterly reviews of its subsidiary Banks' allowances for loan losses, maintain sufficient capital, submit a plan to the FRB for improving consolidated earnings over a three-year period, and submit to the FRB annual projections of planned sources and uses of the Company's cash, including a plan to service its outstanding debt and trust preferred securities. The Company's compliance with the written agreement is being monitored by a committee which consists of three of its outside directors. As of September 30, 2004, management believes the Company is operating in compliance with the provisions of the written agreement. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 4 - REGULATORY MATTERS (continued) On December 22, 2003, the Company's subsidiary Farmers Deposit Bank - Eminence, Kentucky (the Bank), was issued a Cease and Desist order (Order) by the Federal Deposit Insurance Corporation (FDIC) and the Kentucky Office of Financial Institutions (KOFI) [collectively referred to as "Supervisory Authorities"] related to activities of the bank's former president. The Order, effective January 1, 2004, requires the Bank to cease and desist from the following: (a) Operating with management whose policies and procedures are detrimental to the Bank and jeopardize the safety of its deposits; (b) Operating with an inadequate level of capital protection for the kind and quality of assets held by the Bank; (c) Operating with a large volume of adversely classified loans or assets and/or delinquent loans and/or non-accrual loans; (d) Operating with an inadequate allowance for loan and lease losses for the volume, kind and quality of loans and leases held by the Bank; (e) Engaging in hazardous lending and lax collection practices; (f) Operating with inadequate provisions for liquidity and funds management; (g) Operating with disregard of routine and controls policies; (h) Operating in such a manner as to produce operating losses; and (i) Violating laws and/or regulations cited in the most recent Report of Examination issued by the FDIC ("Report"). The Order also outlined a number of steps to be taken by the Bank which are designed to remedy and/or prevent the reoccurrence of the items listed in the Order. These include 1) retaining qualified management and increasing the involvement of the Bank's Board of Directors ("Board"); 2) developing and submitting to the Supervisory Authorities a capital plan that maintains the Bank's Tier I Leverage Ratio above a minimum 5.0% and increases that ratio to 8.0% by December 31, 2004; 3) restricting the payment of cash dividends; 4) requiring the Board to review the adequacy of the allowance for loan losses at least quarterly; 5) requiring the Bank to charge-off certain loans listed in the Report; 6) reviewing the system of internal loan review and system for assigning loan risk grades as well as revising the Bank's lending policies to address items of criticism contained in the Report; 7) developing written plans for reducing and/or improving the level of adversely classified loans and correcting documentation exceptions on certain loans detailed in the Report; 8) generally prohibiting additional lending to borrowers who currently have uncollected adversely classified loans; 9) submitting an annual budget to the Supervisory Authorities outlining goals and strategies for improving and sustaining the earnings of the Bank; 10) adopting and implementing a policy for operating the Bank with adequate internal controls consistent with safe and sound banking practices and developing an internal audit program to ensure the integrity of these controls; 11) adopting and implementing a liquidity and funds management policy; and 12) providing this notice to shareholders. The Bank is required to provide quarterly progress updates to the Supervisory Authorities. The full text of the Order is available on the FDIC website at www.fdic.gov or by calling the FDIC Public Information Center at (877) 275-3342. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 4 - REGULATORY MATTERS (continued) In accordance with the Order, the Company contributed additional capital to Farmers to ensure a 5.00% leverage ratio at December 31, 2003. The Company also submitted to the Supervisory Authorities a written capital restoration plan that incrementally increases the Bank's Tier I Leverage Ratio to 5.50% at March 31, 2004; 6.00% at June 30, 2004; 7.00% at September 30, 2004 and 8.00% at December 31, 2004. At September 30, 2004, the Bank's Tier I Leverage Ratio was 9.00%. NOTE 5- SECURITIES Amortized cost and fair value of securities available for sale, at September 30, 2004 are summarized as follows:
Amortized Unrealized Unrealized Fair Cost Gains Losses Value U. S. Treasury securities $ 250 $ - $ - $ 250 U. S. agency securities 122,481 252 (434) 122,299 Obligations of states and political subdivisions 4,338 232 - 4,570 Mortgage-backed securities 27,299 259 (83) 27,475 Corporate securities 429 12 - 441 -------------- -------------- -------------- --------------- Total available for sale $ 154,797 $ 755 $ (517) $ 155,035 ============== ============== =============== ===============
Amortized cost and fair value of securities available for sale at December 31, 2003 are summarized as follows:
Amortized Unrealized Unrealized Fair Cost Gains Losses Value U. S. Treasury securities $ 650 $ 2 $ - $ 652 U. S. agency securities 106,413 573 (141) 106,845 Obligations of states and political subdivisions 6,540 328 - 6,868 Mortgage-backed securities 31,766 186 (142) 31,810 Corporate securities 1,439 32 - 1,471 -------------- -------------- -------------- --------------- Total available for sale $ 146,808 $ 1,121 $ (283) $ 147,646 ============== ============== =============== ===============
The investment portfolio is predominately high quality interest-bearing bonds with defined maturity dates backed by the U.S. Government or Government sponsored agencies. The unrealized losses at September 30, 2004 and December 31, 2003 are price changes resulting from changes in the interest rate environment. The unrealized losses as of both periods have occurred within the last twelve months and are not considered to be other than temporary declines in the value of the securities. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 6 - LOANS Major classifications of loans at September 30, 2004 and December 31, 2003 are summarized as follows: 2004 2003 ------------ ------------ Commercial, secured by real estate $ 100,565 $ 101,325 Commercial, other 41,279 38,063 Real estate construction 7,438 5,414 Residential real estate 124,748 126,134 Agricultural 2,950 3,032 Consumer and home equity 46,084 56,216 Other 1,400 1,610 ------------ ------------ $ 324,464 $ 331,794 ============ ============ The following table sets forth information with respect to the Company's impaired loans at September 30, 2004 and December 31, 2003. 2004 2003 ------------ ------------ Impaired loans at period end with an allowance $ 16,541 $ 17,071 Impaired loan at period end with no allowance 268 3,849 Amount of allowance for loan losses allocated 3,328 8,418 The following table sets forth information with respect to the Company's nonperforming loans at September 30, 2004 and December 31, 2003. 2004 2003 ------------ ------------ Non-accrual loans $ 9,467 $ 11,958 Accruing loans which are contractually past due 90 days or more 1,020 4,137 Restructured loans 252 104 ------------ ------------ $ 10,739 $ 16,199 ============ ============ Nonperforming loans include some impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. Loan impairment is reported when full payment under the loan terms is not anticipated, which can include loans that are current or less than 90 days past due. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 7 - ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the three and nine months ended September 30, 2004 and 2003 are as follows: Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 -------- -------- -------- -------- (Restated) (Restated) Balance, beginning of period $ 9,550 $ 16,185 $ 14,300 $ 9,698 Gross charge-offs (791) (7,637) (6,576) (15,455) Recoveries 265 130 791 390 Provision for loan losses 162 4,343 671 18,388 -------- -------- -------- -------- Balance, end of period $ 9,186 $ 13,021 $ 9,186 $ 13,021 ======== ======== ======== ======== NOTE 8 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES On June 9, 1997, PFBI Capital Trust (Trust), a statutory business trust created under Delaware law, issued $28,750,000 of 9.750% Preferred Securities ("Preferred Securities" or "Trust Preferred Securities") with a stated value and liquidation preference of $25 per share. The Trust's obligations under the Preferred Securities issued are fully and unconditionally guaranteed by the Company. The proceeds from the sale of the Preferred Securities of the Trust, as well as the proceeds from the issuance of common securities to the Company, were utilized by the Trust to invest in $29,639,000 of 9.750% Junior Subordinated Deferrable Interest Debentures (the "Debentures") of the Company. The Debentures, which mature on June 30, 2027 are unsecured obligations and rank subordinate and junior to the right of payment to all senior indebtedness, liabilities and obligations of the Company. The Debentures represent the sole assets of the Trust. Distributions on the Preferred Securities are payable at an annual rate of 9.750% of the stated liquidation amount of $25 per Preferred Security, payable quarterly. Cash distributions on the Preferred Securities are made to the extent interest on the Debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Debentures are redeemable in whole. Otherwise, the Debentures are generally redeemable by the Company in whole or in part on or after June 30, 2002 at 100% of the liquidation amount. Proceeds from any redemption of the Debentures would cause a mandatory redemption of the Preferred Securities and the common securities having an aggregate liquidation amount equal to the principal amount of the Debentures redeemed. Debt issuance costs of $1,478,000 have been capitalized by the Trust and are being amortized. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 8 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES (continued) As previously disclosed, pursuant to an agreement entered into with the Federal Reserve Bank (FRB) described in Note 4, the Company is required to request approval for the payment of distributions due on the Debentures and Trust Preferred Securities. As part of a Debt Reduction and Profitability plan presented on January 6, 2003, the Company requested and received approval from the FRB to redeem $3,000,000 of the $28,750,000 outstanding Debentures and Trust Preferred Securities which occurred on March 31, 2003. However, the FRB denied the Company's request to make distributions on the remaining Debentures and Trust Preferred Securities. The Company exercised its right to defer the payment of interest on the 9.75% Trust Preferred Securities for the quarter ending December 31, 2002 and all subsequent quarters through September 30, 2004, and for an indefinite period, which can be no longer than 20 consecutive quarterly periods. These and any future deferred distributions accrue interest at an annual rate of 9.75% which will be paid when the deferred distributions are ultimately paid. Management of Premier does not expect to resume payments on the Debentures or the Trust Preferred Securities until the Federal Reserve Bank of Cleveland determines that Premier has achieved adequate and sustained levels of profitability to support such payments and approves such payments. In a letter dated June 22, 2004, Premier requested permission from the FRB to pay all of the current and accumulated deferred distributions on its Trust Preferred Securities as of and through the quarter ending September 30, 2004. The FRB subsequently asked management to analyze a partial redemption of the $25,750,000 (1,030,000 shares) outstanding. The analysis determined that approximately $4,500,000 of the Trust Preferred Securities could be redeemed using an equivalent total cash outlay quantified in Premier's original June 22nd request. After evaluating both alternatives, the FRB granted Premier permission to redeem $4,500,000 of the outstanding Trust Preferred Securities and denied Premier's original request to pay all of the accumulated deferred distributions through September 30, 2004. A partial early redemption requires Premier to pay all of the current and deferred distributions owed on the amount to be redeemed. Accordingly, Premier will continue to exercise its right to defer distributions on the remaining $21,250,000 Trust Preferred Securities outstanding after the partial redemption. The $4,500,000 early redemption was completed on October 15, 2004. NOTE 9 - STOCKHOLDERS' EQUITY AND REGULATORY MATTERS The Company entered into an agreement with the Federal Reserve Bank of Cleveland (FRB), as discussed in Note 4, restricting the Company from declaring or paying dividends to shareholders without prior approval from the FRB. The Company's principal source of funds for dividend payments to shareholders is dividends received from the subsidiary Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year's net profits, as defined, combined with the retained net profits of the preceding two years, subject to the capital requirements and additional restrictions as discussed below. During 2004, the Banks could, without prior approval, declare dividends of approximately $1.4 million plus any 2004 net profits retained to the date of the dividend declaration. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 9 - STOCKHOLDERS' EQUITY AND REGULATORY MATTERS (continued) The Company and the subsidiary Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. These quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of September 30, 2004, that the Company and the Banks meet all quantitative capital adequacy requirements to which they are subject.
Shown below is a summary of regulatory capital ratios for the Company: Regulatory To Be Considered September 3 December 31, Minimum Well 2004 2003 Requirements Capitalized ---------- ------------ ------------ ---------------- Tier I Capital (to Risk-Weighted Assets) 16.1% 10.6% 4.0% 6.0% Total Capital (to Risk-Weighted Assets) 20.1% 14.8% 8.0% 10.0% Tier I Capital (to Average Assets) 9.5% 6.4% 4.0% 5.0%
The capital amounts and classifications are also subject to qualitative judgments by the regulators. As a result of these qualitative judgments, the Company and one of the Company's subsidiaries have entered into agreements with the applicable regulatory authorities which provide for additional restrictions on their respective capital levels and the payment of dividends. The Company entered into an agreement with the Federal Reserve Bank of Cleveland (FRB), as discussed in Note 4, restricting the Company from declaring or paying dividends without prior approval from the FRB. An additional provision of this agreement requires prior approval from the FRB before the Company increases its borrowings or incurs any debt. This agreement is in effect until terminated by the FRB. -------------------------------------------------------------------------------- CONTINUED PREMIER FINANCIAL BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, IN THOUSANDS) -------------------------------------------------------------------------------- NOTE 9 - STOCKHOLDERS' EQUITY AND REGULATORY MATTERS (continued) Citizens Deposit Bank (Citizens) entered into a Written Agreement with the FRB on September 29, 2000 restricting Citizens from declaring or paying dividends without prior approval. This agreement was in effect until terminated by the FRB. The FRB found that Citizens had met all of the objectives of the agreement and, accordingly, terminated the agreement on October 25, 2004. Bank of Germantown (Germantown) entered into an agreement with the Kentucky Office of Financial Institutions (KOFI) and the Federal Deposit Insurance Corporation (FDIC) on June 13, 2000 restricting Germantown from declaring or paying dividends, without prior approval, if its Tier I capital to average assets falls below 8%. The KOFI and FDIC found that Germantown had met all of the objectives of the agreement and, accordingly, terminated the agreement on August 9, 2004. Effective January 1, 2004, Farmers Deposit Bank (Farmers Deposit) was issued a Cease and Desist order by the FDIC and KOFI restricting Farmers Deposit from declaring or paying dividends, without prior approval, if its Tier I capital to average assets falls below 8.00%. The order also required Farmers Deposit to maintain a minimum 5.0% Tier I capital to average assets ratio and submit a written capital restoration plan to increase the ratio to 8.0% by December 31, 2004. This order is in effect until terminated by the KOFI and FDIC. Farmers Deposit's Tier I capital to average assets was 9.0% at September 30, 2004. As of September 30, 2004, the most recent notification from the FRB categorized the Company and its subsidiary banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the preceding table. There are no conditions or events since that notification that management believes have changed the Company's category. -------------------------------------------------------------------------------- PREMIER FINANCIAL BANCORP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS -------------------------------------------------------------------------------- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS Management's discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties, and there are certain important factors that may cause actual results to differ materially from those anticipated. These important factors include, but are not limited to, economic conditions (both generally and more specifically in the markets in which Premier operates), competition for Premier's customers from other providers of financial services, government legislation and regulation (which changes from time to time), changes in interest rates, Premier's ability to originate quality loans, collect delinquent loans and attract and retain deposits, the impact of Premier's growth, Premier's ability to control costs, and new accounting pronouncements, all of which are difficult to predict and many of which are beyond the control of Premier. A. Results of Operations A financial institution's primary sources of revenue are generated by interest income on loans, investments and other earning assets, while its major expenses are produced by the funding of these assets with interest bearing liabilities. Effective management of these sources and uses of funds is essential in attaining a financial institution's optimal profitability while maintaining a minimum amount of interest rate risk and credit risk. The following narrative discusses the continuing operations of the Company. As more fully explained in Note 3 to the consolidated financial statements above, the narrative excludes the discontinued operations of Premier's subsidiary Citizens Bank (Kentucky), Inc. On February 13, 2004, Premier signed a definitive agreement to sell the subsidiary for $14,500,000 in cash. The transaction, which was completed on July 1, 2004, restored the cash reserves used by Premier in 2003 to recapitalize one of its affiliate banks; strengthened Premier's balance sheet by reducing the company's total assets while increasing its total capital, and generated taxable income to be used as a partial offset to Premier's tax loss carryforward. Furthermore, comparative information for the quarter and nine months ended September 30, 2003 reflect the restatement of charge-offs, provision for loan losses, interest income and income taxes as more fully explained in Note 2 of the consolidated financial statements above. Income from continuing operations for the nine months ended September 30, 2004 was $1,404,000, or 27 cents per share, compared to a loss from continuing operations of ($9,021,000), or ($1.72) per share for the nine months ended September 30, 2003. The profitability recorded in the first nine months of 2004 was largely due to lower provisions for loan losses versus the same period of 2003, partially offset by lower net interest income and slightly higher non-interest expense realized in 2004. For the three months ended September 30, 2004, income from continuing operations was $448,000, or 9 cents per share, compared to a loss from continuing operations of ($1,877,000) or ($0.36) per share for the three months ended September 30, 2003. The profitability recorded in the third quarter of 2004 was largely due to lower provisions for loan losses versus the third quarter of 2003, partially offset by lower net interest income and higher non-interest expenses realized in 2004. Net interest income for the nine months ending September 30, 2004 totaled $13.26 million, down from the $14.7 million of net interest income earned in the first nine months of 2003. Both interest income and interest expense decreased in the comparisons. Interest income declined by $3.5 million due to lower loans outstanding due to the charge-offs at Farmers Deposit Bank and other loan paydowns across the company during 2003 compounded by the higher volume of non-accrual loans at Farmers Deposit Bank during the nine months of 2004. Interest expense declined by $2.0 million largely due to lower interest costs on deposits as interest bearing deposits have declined and maturing certificates of deposit have renewed at significantly lower rates due to the low interest rate environment. Interest expense savings were also realized due to the paydown of other borrowings. These savings have been partially offset by interest expense accrued on the deferred trust preferred distributions (see Note 8 to the consolidated financial statements.) As a result, the net interest margin for the nine months ending September 30, 2004 was approximately 3.55% compared to 3.69% for the same period in 2003. Net interest income for the quarter ending September 30, 2004 totaled $4.42 million, down from the $4.67 million of net interest income earned in the third quarter of 2003. Again, both interest income and interest expense decreased in the comparisons. Interest income declined by $714,000 due to lower loans outstanding due to the charge-offs at Farmers Deposit Bank and other loan paydowns across the company during 2003 and early 2004 compounded by the higher volume of non-accrual loans at Farmers Deposit Bank during the three months of 2004. Interest expense declined by $461,000 largely due to lower interest costs on deposits due to lower interest bearing deposits and as maturing certificates of deposit have renewed at significantly lower rates due to the low interest rate environment. Interest expense savings from the paydown of other borrowings have been offset by interest expense accrued on the deferred trust preferred distributions (see Note 8 to the consolidated financial statements.) Non-interest income remained relatively unchanged at $2,646,000 for the first nine months of 2004 compared to $2,679,000 for the first nine months of 2003, as non-recurring gains on the sales of securities in 2003 have been replaced by recurring revenue from service charges on deposit accounts in 2004. Securities gains totaled $206,000 in the first nine months of 2003 compared to $10,000 in the same period of 2004. Excluding the securities gains, non-interest income increased by $163,000 or 6.6% in the first nine months of 2004. Service charges on deposit accounts increased by $350,000 or 23.1% due to a new fee structure. This increase was partially offset by a $57,000 decrease in insurance commissions and a $130,000 decrease in other types of non-interest income including fees from the origination of secondary market mortgages. For the quarter ending September 30, 2004, non-interest income decreased by $41,000 to $884,000 compared to $925,000 for the third quarter of 2003. Excluding the $2,000 of investment securities gains realized in the third quarter of 2003, non-interest income decreased 4.2% in the third quarter of 2004. The decrease is largely due to decreases in income from insurance commissions and a decrease in other income, partially offset by a 3.0% or $19,000 increase in revenue from service charges on deposit accounts due to a change in fee structure during 2003. Non-interest expenses for the first nine months of 2004 totaled $13,198,000 or 3.2% of average assets of continuing operations on an annualized basis compared to $12,940,000 or 3.0% of average assets of continuing operations for the same period of 2003. The slight increase in non-interest expense is largely due to a $775,000 increase in professional fees related to audit costs and legal fees associated with the SEC investigation disclosed in the Company's annual report on Form 10-K for the year ended December 31, 2003 and a $165,000 impairment writedown on facilities listed for sale included in occupancy expense. These increases are partially offset by lower staff costs due to savings from employee participation in the cost of medical insurance premiums more than offsetting increased salary and wages expense; lower depreciation expense on equipment, lower bad check losses and lower writedowns and expenses on the liquidation of other real estate owned (OREO). Taxes not on income increased by $48,000 in the first nine months of 2004 due to an increase in the expense for equity based taxes. Other expenses increased by $64,000 in total, as lower collection expenses in 2004 and $124,000 of accelerated amortization of issuance costs related to the early redemption of $3.0 million of the Trust Preferred Securities (NASDAQ/NMS-PFBIP) in the first quarter of 2003 have been offset by higher FDIC insurance, communications expenses and corporate insurance costs in 2004. Non-interest expenses for the third quarter of 2004 totaled $4,483,000 or 3.3% of average assets of continuing operations on an annualized basis compared to $4,238,000 or 3.0% of average assets of continuing operations for the same period of 2003. The increase in non-interest expense is largely due to a $165,000 impairment writedown on facilities listed for sale included in occupancy expense, a $167,000 increase in professional fees related to legal fees associated with the SEC investigation, and a $121,000 increase in salary costs and related employment taxes. These increases were partially offset by employee participation in the cost of medical insurance premiums, lower bad check losses, and a net gain on the liquidation of OREO in the third quarter of 2004. Other expenses increased $61,000 largely due to increased FDIC insurance, communications expenses, ATM & credit card processing costs, postage and corporate insurance costs. Income tax expense was $635,000 for the first nine months of 2004 compared to a tax benefit of $4.93 million for the first nine months of 2003. The increase in income tax expense can be primarily attributed to the increase in pre-tax income detailed above. The annualized effective tax rate for the nine months ended September 30, 2004 was 31.2%, compared to the 35.3% effective tax rate for the same period in 2003. The higher benefit rate in 2003 was the result of reduced tax expense resulting from tax exempt income. The income tax expense for the quarter ending June 30, 2004 was $209,000 compared to a tax benefit of $1.1 million during the same period of 2003. The annualized returns from continuing operations on shareholders' equity and on average assets were approximately 3.97% and 0.34% for the nine months ended September 30, 2004 compared to a negative (22.83%) and (2.06%) for the same period in 2003. B. Financial Position Total assets of continuing operations at September 30, 2004 increased $8.2 million or 1.5% to $551.5 million from the $543.2 million at December 31, 2003. This increase was largely due to the proceeds from the sale of one of the Company's subsidiary banks on July 1, 2004. Earning assets of continuing operations increased to $512.5 million at September 30, 2004 from the $499.2 million at December 31, 2003, an increase of $13.3 million, or 2.7%. The increase was largely due to a $13.1 million increase in federal funds sold and a $7.4 million increase in investments. Partially offsetting the increase was the $7.3 million decline in loans outstanding since year-end. Cash and due from banks at September 30, 2004 was $14.5 million, a $1.9 million decrease from $16.4 million on December 31, 2003, as surplus funds were employed in short-term interest-bearing federal funds sold. Federal funds sold increased to $30.1 million from the $17.1 million reported at December 31, 2003. The increase in federal funds sold was the result of retaining liquidity from the sale of the bank subsidiary in July to be used for the early redemption of trust preferred securities on October 15, 2004. Also, as loan principal balances have paid down, Premier has used the funds to satisfy deposit withdrawals and retained the surplus in federal funds sold to maintain its liquidity position and to fund future loan growth. Securities available for sale totaled $155.0 million at September 30, 2004, a $7.4 million increase from the $147.6 million at December 31, 2003. The increase was largely due to the investment of proceeds from income tax refunds and the reinvestment of loan collection proceeds at Farmers Deposit bank, as management continues the process of restoring the financial condition of the bank. Also impacting the investment portfolio was a $600,000 decline in the market value of the investment portfolio since year-end 2003. During the third quarter, market values of the investment portfolio rebounded from the $1.8 million net unrealized loss at June 30, 2004 to a net $238,000 unrealized gain at September 30, 2004. Fluctuations in the market value of the investment portfolio is in response to the changes in the interest rate environment. Since Premier primarily holds interest-bearing bonds with a specific maturity date, changes in interest rates will affect the market value of the bond portfolio. However, as bonds approach maturity, differences in the book and market value of bonds, positive or negative, tend to decrease. At maturity, Premier fully anticipates receiving the face value of the bonds as Premier primarily invests in instruments either backed by the U.S. Government or agencies sponsored by the U.S. Government. Premier holds no equity based investments. Additional details on investment activities can be found in the Consolidated Statements of Cash Flows. Total loans at September 30, 2004 were $324.5 million compared to $331.8 million at December 31, 2003, a decrease of $7.3 million. This decrease can primarily be attributed to net loan pay offs and the $6.6 million in loan charge-offs recorded during the first nine months of 2004. The majority of the loan paydowns and charge-offs occurred at Farmers Deposit Bank as management continues to focus on loan collections or charging off loans that were fully reserved and deemed uncollectible. Most of Premier's other affiliate banks are either experiencing loan growth or are generating new loans at a rate similar to or slightly less than the scheduled principal payments and early payoffs by borrowers. Deposits totaled $446.5 million as of September 30, 2004, an $8.9 million decrease from the $455.5 million in deposits at December 31, 2003. The decrease is largely due to $6.0 million of public deposits withdrawn and placed by the depositor into repurchase agreements. Excluding this transaction, deposits decreased by $2.9 million. Modest deposit growth at most of the company's affiliate banks has been offset by planned declines in deposits at Farmers Deposit Bank. Maturing out of area deposits at that bank have generally not been renewed in an effort to restructure that bank's balance sheet. Outstanding debt, including the Company's outstanding subordinated debentures, has decreased by $6.5 million since December 31, 2003, as increases in short-term FHLB advances earlier in 2004 have been paid off and selected long-term borrowings have been paid off. Federal Home Loan Bank advances have decreased by $1,211,000 due to scheduled and accelerated principal payments at Farmers Deposit bank in an effort to restructure that bank's balance sheet. Other borrowed funds have declined by $5,250,000 due to scheduled principal payments plus the full payoff of one loan in the third quarter of 2004 out of the proceeds from the subsidiary bank sale. See note 9 to the consolidated financial statements for additional information on the outstanding subordinated debentures. The following table sets forth information with respect to the Company's nonperforming assets of continuing operations at September 30, 2004 and December 31, 2003. (In Thousands) 2004 2003 -------------- ------------ Non-accrual loans $ 9,467 $ 11,958 Accruing loans which are contractually past due 90 days or more 1,020 4,137 Restructured 252 104 -------------- ------------ Total non-performing loans 10,739 16,199 Other real estate acquired through foreclosure 1,431 3,187 -------------- ------------ Total non-performing assets $ 12,170 $ 19,386 ============== ============ Non-performing loans as a percentage of total loans 3.31% 4.88% Non-performing assets as a percentage of total assets (of continuing operations) 2.21% 3.57% Total non-performing loans and non-performing assets have declined since year-end due to loan charge-offs and the development and execution of action plans for the troubled loans identified at Farmers Deposit Bank. A significant effort has been placed on reviews of loan files, efforts by lenders to bring borrowers current with the terms of their loan agreements and the sale of OREO properties. However, when plans are executed, Premier may experience increases in non-performing loans and non-performing assets as a result of the normal collection process. Furthermore, any resulting increases in loans placed on non-accrual status will have a negative impact on future loan interest income. Also, as these plans are executed, other loans may be identified that would necessitate additional charge-offs and potentially additional provisions for loan losses. The provision for loan losses was $671,000 for the first nine months of 2004 compared to $18.4 million for the first nine months of 2003. The significant provision for losses in the prior year was primarily the result of loan problems identified at Farmers Deposit Bank as more fully discussed in previous filings. The provision for loan losses is made in accordance with Premier's policies regarding management's estimation of probable incurred losses in the loan portfolio and the adequacy of the allowance for loan losses, which are in accordance with accounting principles generally accepted in the United States of America. The provision in 2004 was the result of loan growth and the estimation of probable losses in the loan portfolio. Gross charge-offs totaled $6.6 million during the first nine months of 2004. Most of these charge-offs were loans identified during the 2003 investigation (see Note 2 to the consolidated financial statements) with an allowance for losses provided for at that time. Collection efforts on these loans are continuing and any collections on these loans would be presented in future financial statements as recoveries of the amounts charged against the allowance. During the first nine months of 2004, $791,000 of recoveries were recorded. For the quarter ended September 30, 2004, the provision for loan losses was $162,000 compared to $4.3 million for the same period of 2003. As a result, the allowance for loan losses at September 30, 2004 was 2.83% of total loans as compared to 4.31% at December 31, 2003. The decrease in the percentage of allowance for loan losses to total loans is largely due to sufficient loan loss reserves allocated to the loans actually charged off during the first nine months of 2004. C. Critical Accounting Policies The Company follows financial accounting and reporting policies that are in accordance with generally accepted accounting principles in the United States of America. These policies are presented in Note 1 to the consolidated audited financial statements in the Company's annual report on Form 10-K for the year ended December 31, 2003. Some of these accounting policies, as discussed below, are considered to be critical accounting policies. Critical accounting policies are those policies that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified three accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the financial statements. These policies relate to determining the adequacy of the allowance for loan losses, the impairment of goodwill, and the valuation of deferred tax assets. A detailed description of these accounting policies is contained in the Company's annual report on Form 10-K for the year ended December 31, 2003. There have been no significant changes in the application of these accounting policies since December 31, 2003. Management believes that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time. D. Liquidity Liquidity objectives for the Company can be expressed in terms of maintaining sufficient cash flows to meet both existing and unplanned obligations in a cost effective manner. Adequate liquidity allows the Company to meet the demands of both the borrower and the depositor on a timely basis, as well as pursuing other business opportunities as they arise. Thus, liquidity management embodies both an asset and liability aspect while attempting to maximize profitability. In order to provide for funds on a current and long-term basis, the Company's subsidiary banks rely primarily on the following sources: 1. Core deposits consisting of both consumer and commercial deposits and certificates of deposit of $100,000 or more. Management believes that the majority of its $100,000 or more certificates of deposit are no more volatile than its other deposits. This is due to the nature of the markets in which the subsidiaries operate. 2. Cash flow generated by repayment of loans and interest. 3. Arrangements with correspondent banks for purchase of unsecured federal funds. 4. The sale of securities under repurchase agreements and borrowing from the Federal Home Loan Bank. 5. Maintenance of an adequate available-for-sale security portfolio. The Company owns $155.0 million of securities at market value as of September 30, 2004. The cash flow statements for the periods presented in the financial statements provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. E. Capital At September 30, 2004, total shareholders' equity of $51.2 million was 9.3% of total assets of continuing operations. This compares to total shareholders' equity of $45.5 million or 8.4% of total assets of continuing operations on December 31, 2003. The increase in total shareholders' equity is primarily the result of operating profits, the net gain on the sale of the bank subsidiary partially offset by declines in the market value of securities available for sale since year-end, net of any tax benefits. See additional discussion on the decline in the market value of securities available for sale above. Tier I capital totaled $50.4 million at September 30, 2004, which represents a Tier I leverage ratio of 9.5%. Book value per share was $9.78 at September 30, 2004, and $8.70 at December 31, 2003. The increase in book value per share was primarily the result of the net gain on the sale of the bank subsidiary. PREMIER FINANCIAL BANCORP, INC. -------------------------------------------------------------------------------- Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company currently does not engage in any derivative or hedging activity. Refer to the Company's 2003 10-K for analysis of the interest rate sensitivity. The Company believes there have been no significant changes in the interest rate sensitivity since previously reported on the Company's 2003 10-K. Item 4. Controls and Procedures Premier management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-15c as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. "Internal controls" are procedures, which are designed with the objective of providing reasonable assurance that (1) transactions are properly authorized; (2) assets are safeguarded against unauthorized or improper use; and (3) transactions are properly recorded and reported, all so as to permit the preparation of reports and financial statements in conformity with generally accepted accounting principles. Premier management uses the financial reports of its subsidiaries to make decisions about the allocation of the Company's resources, to implement strategies to improve the Company's performance, and to prepare the consolidated financial statements of the Company for its shareholders and regulatory authorities. However, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their cost. 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 a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Finally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. It is this "management override of controls" that led to the significant charge-offs and provisions for loan losses at Farmers Deposit Bank in 2003 and the financial statement restatement for years 2002 and 2001. Premier's policies and procedures related to the evaluation of a borrower's creditworthiness prior to making or renewing a loan, the reporting of new loan activity and delinquent loans to the bank's board of directors, and the guidelines for assessing the credit risk of existing loans were overridden by local management. The systematic disregard for these controls was sophisticated enough to avoid detection during routine reviews of that bank's records as directed by the Company and the regulatory authorities of the banking industry. Premier management has implemented or is in the process of implementing additional processes and procedures throughout its network of banking subsidiaries in an effort to minimize the likelihood that improper management overrides go undetected. These include: * hiring a credit analyst at the holding company level to review all loan requests over $400,000, * forming loan approval committees made up of the bank presidents and the President and Director of Risk Management of Premier to review all loan requests over $750,000, * incorporating "whistleblower" provisions into the employee code of ethics and conduct, * dispatching members of the Audit Committee of the Company's board of directors, at their request, to conduct employee meetings emphasizing the importance of each employee's responsibilities in maintaining the financial integrity of the Company's books and records, that overriding of internal controls will not be tolerated, and the employees' obligation to report improprieties to senior management or the Audit Committee in accordance with the employee code of ethics, * hiring an internal auditor at the holding company level to, among other duties assigned, conduct various tests for data integrity and compliance with internal control procedures, and * evaluating the internal audit program to incorporate tests designed to specifically detect the abuses uncovered during the Farmers Deposit investigation. Other than the continuing evaluation of the internal audit program identified above, there were no changes in internal controls over financial reporting during the third fiscal quarter that have materially affected or are reasonably likely to materially affect Premier's internal controls over financial reporting. PREMIER FINANCIAL BANCORP, INC. -------------------------------------------------------------------------------- PART II - OTHER INFORMATION Item 1. Legal Proceedings See information regarding regulatory matters in note 4 and note 9 to the consolidated financial statements Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None ---------------------------------------------------------------------- Item 3. Defaults Upon Senior Securities None ------------------------------------------ Item 4. Submission of Matters to a vote of Security Holders None -------------------------------------------------------------- Item 5. Other Information None ---------------------------- Item 6. Exhibits (a) The following exhibits are furnished in accordance with the provisions of Item 601 of Regulation S-K. 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification Pursuant to 18 U.S.Css.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PREMIER FINANCIAL BANCORP, INC. Date: November 12, 2004 /s/ Robert W. Walker ----------------------------------------- Robert W. Walker President & Chief Executive Officer Date: November 12, 2004 /s/ Brien M. Chase ----------------------------------------- Brien M. Chase Vice President & Chief Financial Officer