-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A8CccCpUZtyX5MqG/ePEmJJfWu5TRvcp5BevfhcN89CuKniKbb5l5RxLMzTKBqln JxHfpr8gu/6jrkQ3VsdX/w== 0001002105-02-000078.txt : 20020515 0001002105-02-000078.hdr.sgml : 20020515 20020515160001 ACCESSION NUMBER: 0001002105-02-000078 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MIDDLEBURG FINANCIAL CORP CENTRAL INDEX KEY: 0000914138 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541696103 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24159 FILM NUMBER: 02652216 BUSINESS ADDRESS: STREET 1: 111 W WASHINGTON ST STREET 2: C/O MIDDLEBURG BANK CITY: MIDDLEBURG STATE: VA ZIP: 22117 BUSINESS PHONE: 5406876377 MAIL ADDRESS: STREET 1: 111 WEST WASHINGTON STREET STREET 2: C/O MIDDLEBURG BANK CITY: MIDDLEBURG STATE: VA ZIP: 22117 FORMER COMPANY: FORMER CONFORMED NAME: INDEPENDENT COMMUNITY BANKSHARES INC DATE OF NAME CHANGE: 19931027 10-Q 1 bjb21.txt 10-Q U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 [ ] Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________ to _____________ Commission file number: 0-24159 MIDDLEBURG FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) Virginia 54-1696103 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 111 West Washington Street Middleburg, Virginia 20117 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (703) 777-6327 INDEPENDENT COMMUNITY BANKSHARES, INC. Former Name, 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 Exchange Act 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 1,812,432 shares of common stock, par value $5.00 per share, outstanding as of May 6, 2002 MIDDLEBURG FINANCIAL CORPORATION INDEX
Part I. Financial Information Page No. Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Changes in Shareholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 Part II. Other Information Item 1. Legal Proceedings 17 Item 2. Change in Securities 17 Item 3. Defaults upon Senior Securities 17 Item 4. Submission of Matters to a Vote of Security Holders 17 Item 5. Other Information 17 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18
2 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS MIDDLEBURG FINANCIAL CORPORATION Consolidated Balance Sheets (In Thousands, Except Share Data)
(Unaudited) March 31, December 31, 2002 2001 ----------- ------------ Assets: Cash and due from banks $ 9,732 $ 10,053 Interest-bearing balances in banks 36 200 Temporary investments: Federal funds sold 1,000 925 Other money market investments 949 1,797 Securities (fair value: March 31, 2002, $125,821 , December 31, 2001, $124,522) 125,642 124,351 Loans held for sale 5,148 6,652 Loans, net 202,396 194,340 Bank premises and equipment, net 8,417 8,069 Other assets 7,720 7,714 --------- --------- Total assets $ 361,040 $ 354,101 ========= ========= Liabilities and Shareholders' Equity Liabilities: Deposits: Non-interest bearing demand deposits $ 68,487 $ 68,771 Savings and interest-bearing demand deposits 117,973 111,148 Time deposits 94,640 91,812 --------- --------- Total deposits $ 281,100 $ 271,731 Securities sold under agreements to repurchase $ 13,542 $ 12,011 Federal Home Loan Bank Advances 2,000 7,000 Long-term debt 20,740 20,805 Trust preferred debt 10,000 10,000 Other liabilities 2,751 2,216 --------- --------- Total liabilities $ 330,133 $ 323,763 --------- --------- Shareholders' Equity: Common stock par value $5.00 per share, authorized 10,000,000 shares; issued and outstanding at March 31, 2002 - 1,752,558 issued and outstanding at December 31, 2001 - 1,752,258 $ 8,763 $ 8,761 Capital surplus 747 741 Retained earnings 22,053 21,084 Accumulated other comprehensive (loss) (656) (248) --------- --------- Total shareholders' equity $ 30,907 $ 30,338 --------- --------- Total liabilities and shareholders' equity $ 361,040 $ 354,101 ========= =========
See Accompanying Notes to Consolidated Financial Statements. 3 MIDDLEBURG FINANCIAL CORPORATION Consolidated Statements of Income (In Thousands, Except Per Share Data) Unaudited -------------------------- For the Three Months Ended March 31, 2002 2001 -------------------------- Interest Income Interest and fees on loans $ 3,979 $ 3,976 Interest on investment securities Taxable 1 6 Exempt from federal income taxes 66 80 Interest on securities available for sale Taxable 1,234 688 Exempt from federal income taxes 399 381 Dividends 71 71 Interest on federal funds sold and other 23 47 ------- ------- Total interest income $ 5,773 $ 5,249 Interest expense Interest on deposits $ 1,100 $ 1,521 Interest on long-term debt 436 244 Interest on short-term borrowings 81 364 ------- ------- Total interest expense $ 1,617 $ 2,129 ------- ------- Net interest income $ 4,156 $ 3,120 Provision for loan losses 75 75 ------- ------- Net interest income after provision for loan losses $ 4,081 $ 3,045 Other Income Trust fee income $ 319 $ 358 Service charges on deposit accounts 351 312 Net gains (losses) on securities available for sale (80) 252 Fees on loans held for resale 343 299 Other operating income 171 199 ------- ------- Total other income $ 1,104 $ 1,420 ------- ------- Other Expense Advertising $ 98 $ 69 Salaries and employee benefits 1,943 1,740 Net occupancy expense of premises 346 273 Other operating expenses 741 659 ------- ------- Total other expense $ 3,128 $ 2,741 ------- ------- Income before income taxes $ 2,057 $ 1,724 Income taxes 543 432 ------- ------- Net income $ 1,514 $ 1,292 ======= ======= Earnings per weighted average share: Net income per share, basic $ 0.86 $ 0.74 Net income per share, diluted $ 0.84 $ 0.73 Dividends per share $ 0.30 $ 0.25 See Accompanying Notes to Consolidated Financial Statements. 4 MIDDLEBURG FINANCIAL CORPORATION Consolidated Statement of Changes in Shareholders' Equity For the Three Months ended March 31, 2002 and 2001 (In Thousands) (Unaudited)
Accumulated Other Common Capital Retained Comprehensive Comprehensive Stock Surplus Earnings Income (Loss) Income Total ----- ------- -------- ------------- ------ ----- Balances - December 31, 2000 $ 8,696 $ 556 $ 17,616 $ 403 $ - $27,271 Comprehensive Income Net income 1,292 1,292 1,292 Other comprehensive income net of tax: Unrealized gain on available for sale securities (net of tax $356) 688 Reclassification adjustment for gains realized in net income (net of tax $86) (166) --------- Other comprehensive income (net of tax $270) 522 522 522 --------- Total comprehensive income $1,814 ========= Cash dividends declared (435) (435) -------- ------ --------- ------ ------- Balances - March 31, 2001 $ 8,696 $ 556 $ 18,473 $ 925 $28,650 ======== ====== ========= ====== ======= Balances - December 31, 2001 $ 8,761 $ 741 $ 21,084 ($248) $30,338 Comprehensive Income Net income 1,514 1,514 1,514 Issuance of common shares in stock option plan (300 shares) 2 6 8 Other comprehensive income net of tax: Unrealized holding losses arising during the period (net of tax $236) (461) Reclassification adjustment for losses realized in net income (net of tax $27) 53 --------- Other comprehensive income (net of tax $209) (408) (408) (408) --------- Total comprehensive income $1,106 ========= Cash dividends declared (545) (545) -------- ------ --------- ------ ------- Balances - March 31, 2002 $ 8,763 $ 747 $ 22,053 (656) $30,907 ======== ====== ========= ====== =======
See Accompanying Notes to Consolidated Financial Statements. 5 MIDDLEBURG FINANCIAL CORPORATION Consolidated Statements of Cash Flows (In Thousands)
Unaudited For the Three Months Ended March 31, March 31, 2002 2001 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,514 $ 1,292 Adjustments to reconcile net income to net cash provided by (used in) operating activities Provision for loan losses 75 75 Depreciation and amortization 222 183 Net (gains) losses on securities available for sale 80 (252) Net (gains) losses on sales of equipment (15) - Discount accretion and premium amortization on securities, net (25) (30) Originations of loans held for sale (22,513) (16,343) Proceeds from sales of loans held for sale 24,017 9,944 Decrease (increase) in other assets 188 (1,360) Increase in other liabilities 428 293 -------- -------- Net cash provided by (used in) operating activities $ 3,971 $ (6,198) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturity, principal paydowns and calls on investment securities $ 591 $ 687 Proceeds from maturity, principal paydowns and calls of securities available for sale 3,262 2,297 Proceeds from sale of securities available for sale 9,328 12,654 Purchase of securities available for sale (15,144) (14,249) Net (increase) in loans (8,131) (912) Proceeds from sale of bank premises and equipment 20 16 Purchases of bank premises and equipment (560) (372) -------- -------- Net cash provided by (used in) investing activities $(10,634) $ 121 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in demand deposits, NOW accounts, and savings accounts $ 6,541 $ 5,209 Net increase in certificates of deposits 2,828 2,800 Proceeds from Federal Home Loan Bank advances 27,000 15,600 Payment on Federal Home Loan Bank advances (32,000) (15,600) Payments on long-term debt (65) (300) Cash dividends paid (438) (365) Issuance of common stock 8 - Increase (decrease) in securities sold under agreement to repurchase 1,531 (1,364) -------- -------- Net cash provided by financing activities $ 5,405 $ 5,980 -------- -------- Decrease in cash and cash equivalents $ (1,258) $ (97) CASH AND CASH EQUIVALENTS Beginning $ 12,975 $ 17,147 ======== ======== Ending $ 11,717 $ 17,050 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash payments for: Interest paid to depositors 1,343 1,652 Income taxes - 85 SUPPLEMENTAL DISCLOSURES FOR NON-CASH INVESTING AND FINANCING ACTIVITIES Unrealized gain on securities available for sale 617 792
See Accompanying Notes to Consolidated Financial Statements. 6 MIDDLEBURG FINANCIAL CORPORATION Notes to Consolidated Financial Statements For the Three Months Ended March 31, 2002 and 2001 (Unaudited) Note 1. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of March 31, 2002 and the results of operations and changes in cash flows for the three months ended March 31, 2002 and 2001. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-KSB for the year ended December 31, 2001. The results of operations for the three-month periods ended March 31, 2002 and 2001 are not necessarily indicative of the results to be expected for the full year. Note 2. Securities Securities being held to maturity as of March 31, 2002 are summarized as follows:
------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Market Cost Gains (Losses) Value ------------------------------------------------------------ (In Thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ - $ - $ - $ - Obligations of states and political subdivisions 4,743 179 - 4,922 Mortgaged backed securities 60 - - 60 ----------------- --------------- ------------ ------------- $ 4,803 $ 179 $ - $ 4,982 ================= =============== ============ =============
7 Securities available for sale as of March 31, 2002 are summarized below:
----------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains (Losses) Value ----------------------------------------------------------------- (In Thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 249 14 $ - $ 263 Corporate securities 2,082 45 (66) 2,061 Obligations of states and political subdivisions 32,199 438 (374) 32,263 Mortgaged backed securities 74,133 275 (1,093) 73,315 Other 13,167 120 (350) 12,937 --------- --------- --------- --------- $ 121,830 $ 892 $ (1,883) $ 120,839 ========= ========= ========= =========
Note 3. The consolidated loan portfolio is composed of the following: ----------------------------- March 31, December 31, 2002 2001 ----------------------------- (In Thousands) Commercial, financial and agricultural $ 23,276 $ 22,993 Real estate construction 26,239 24,174 Real estate mortgage 26,239 24,174 Installment loans to individuals 12,127 11,901 -------- -------- Total loans 204,525 196,400 Less: Allowance for loan losses 2,129 2,060 -------- -------- Loans, net $202,396 $194,340 ======== ======== The Company had $185,535 in non-performing assets at March 31, 2002. 8 Note 4. Reserve for Loan Losses The following is a summary of transactions in the reserve for loan losses:
--------------------------------- March 31, December 31, 2002 2001 --------------------------------- (In Thousands) Balance at January 1 $ 2,060 $ 1,804 Provision charged to operating expense 75 300 Recoveries added to the reserve 4 39 Loan losses charged to the reserve (10) (83) ---------------- ---------------- Balance at the end of the period $ 2,129 $ 2,060 ================ ================
Note 5. Earnings Per Share The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of potential dilutive common stock. Potential dilutive common stock has no effect on income available to common shareholders. There were no anti-dilutive effects from options at March 31, 2002.
March 31, 2002 March 31, 2001 Per share Per share Shares Amount Shares Amount ----------- ----------- ----------- ------------ Basic EPS 1,752,486 $ 0.86 1,739,247 $ 0.74 =========== ============ Effect of dilutive securities: stock options 50,195 28,744 ----------- ----------- Diluted EPS 1,802,681 $ 0.84 1,767,991 $ 0.73 =========== =========== =========== ============
Note 6. Derivative Financial Instruments Interest rate swap agreements: During May 2000, the Company entered into two agreements to assume variable market-indexed interest payments in exchange for fixed-rate interest payments (interest rate swaps). The notional principal amount of interest rate swaps outstanding was $8,525,000 at March 31, 2002. The original term to maturity was 24 months. The weighted-average fixed payment rate was 7.0% at March 31, 2002. Variable interest payments received are based on three-month LIBOR. At March 31, 2002, the weighted average rate of variable market-indexed interest payment obligations to the Company was 1.56%. The effect of these agreements was to transform fixed rate liabilities to variable rate liabilities. The net income from these agreements was $112,779 for the three month period ended March 31, 2002, which is charged to income as it accrues. 9 The Company's current credit exposure on swaps is limited to the value of interest rate swaps that have become assets to the Company. At March 31, 2002, the fair value of interest rate swaps in an asset position was $112,437. Note 7. Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets - that will potentially impact the accounting for goodwill and other intangible assets. Statement 141 eliminates the pooling method of accounting for business combinations and requires that intangible assets that meet certain criteria be reported separately from goodwill. The Statement also requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. Upon adoption of these Statements, an organization is required to re-evaluate goodwill and other intangible assets that arose from business combinations entered into before July 1, 2001. If the recorded other intangible assets do not meet the criteria for recognition, they should be classified as goodwill. Similarly, if there are other intangible assets that meet criteria for recognition but were not separately recorded from goodwill, they should be reclassified from goodwill. An organization also must reassess the useful lives of intangible assets and adjust the remaining amortization periods accordingly. Any negative goodwill must be written-off. The standards generally are required to be implemented by the Company in its 2002 financial statements. The adoption of these standards will not have a material impact on the financial statements. Note 8. Subsequent Event On August 9, 1999, the Company purchased one percent of the issued and outstanding capital stock of Gilkison Patterson Investment Advisors, Inc. ("GPIA"), an investment advisory firm based in Alexandria, Virginia. The Company also acquired the right to purchase all of the remaining authorized, issued and outstanding shares of GPIA capital stock on or after July 1, 2001. This option was extended through June 30, 2002. On April 1, 2002, the Company completed the acquisition of GPIA. The terms of the transaction include a total purchase price of $6 million with 59,874 shares of the Company's common stock issued to the shareholders of GPIA. The Company expects that nearly all of the purchase price will be booked as goodwill or other intangibles. The Company has not determined how much of the purchase price will be classified as goodwill or other identifiable intangibles. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Policies The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements and management's discussion and analysis are, to a large degree, dependent upon Middleburg Financial Corporation (the "Company") accounting policies. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. Presented below is discussion of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of the Company's financial condition and results of operations. These Critical Accounting Policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial Statements. Allowance for Loan Losses The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan and lease portfolio. The Company maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with GAAP; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan and lease portfolio; and the loan grading system. The Company evaluates various loans individually for impairment as required by Statement of Financial Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5, Accounting for Contingencies (SFAS 5), with a group of loans that have similar characteristics. For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by SFAS 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions. 11 The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loans and lease losses. This estimate of losses is compared to the allowance for loan and lease losses of the Company as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements. Valuation of Derivatives The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative financial instruments. The Company has used derivative financial instruments only for asset/liability management through the hedging of a specific transaction or position, and not for trading or speculative purposes. The Company's derivative financial instruments are classified as fair value hedges or cash flow hedges. Fair value hedges recognize currently in earnings both the impact of change in the fair value of the derivative financial instrument and the offsetting impact of the change in fair value of the hedged asset or liability. The change in fair value of cash flow hedges is recognized in other comprehensive income. Management believes that the risk associated with using derivative financial instruments to mitigate interest rate risk sensitivity is minimal and should not have any material unintended impact on the Company's financial condition or results of operations. See further information regarding derivatives in Note 6 (page 9) of the Notes to Consolidated Financial Statements. Financial Summary Net income for the three months ended March 31, 2002 increased 17.2% to $1.5 million or $.84 per diluted share compared to $1.3 million or $.73 per diluted share for the first three months of 2001. Annualized returns on average assets and equity for the three months ended March 31, 2002 were 1.7% and 19.3%, respectively, compared to 1.7% and 17.1% for the same period in 2001. Total assets for the Company increased to $361.0 million at March 31, 2002 compared to $354.1 million at December 31, 2001, representing an increase of $6.9 million or 2.0%. Total loans at March 31, 2002 were $202.4 million, an increase of $8.1 million from the December 31, 2001 balance of $194.3 million. The Company is located in one of the fastest growing counties and metropolitan areas in the United States. In addition, the Company has increased its customer base as a result of increased advertising and consolidation in the banking industry within its local market. These factors have contributed to the solid loan and deposit growth experienced over the past year. Due to the upward swing in the interest rate environment, mortgage refinancings and purchases have declined slightly in the local market and, as a result, loans held for sale decreased to $5.1 million at March 31, 2002 from $6.7 million at December 31, 2001. The investment portfolio increased 1.0% to $125.6 million at March 31, 2002 compared to $124.4 million at December 31, 2001. Deposits increased $9.4 million to $281.1 million at 12 March 31, 2002 from $271.7 million at December 31, 2001. Growth in the transactional accounts and time deposits accounts for $6.5 million and $2.8 million, respectively, of the increase during the first three months of 2002. Securities sold under agreements to repurchase with commercial checking accounts increased $1.5 million from $12.0 million at December 31, 2001 to $13.5 million at March 31, 2002. Shareholders' equity was $30.9 million at March 31, 2002. This amount represents an increase of 1.9% from the December 31, 2001 balance of $30.3 million. The book value per common share was $17.64 at March 31, 2002 and $17.31 at December 31, 2001. Net Interest Income Net interest income is the Company's primary source of earnings and represents the difference between interest and fees earned on earning assets and the interest expense paid on deposits and other interest bearing liabilities. Net interest income totaled $4.1 million for the first three months of 2002 compared to $3.0 million for the same period in 2001. The increase is attributed to both the significant growth in average earning assets as well as the effect that the lower interest rate environment had on the amount of interest expense paid on deposits. Average earning assets increased $66.7 million from $268.8 million at March 31, 2001 to $335.6 million at March 31, 2002. The average cost of interest bearing deposits was 2.10% for the three months ended March 31, 2002, a decrease of 155 basis points from the average cost of interest bearing deposits for the three months ended March 31, 2001. The total cost of funds decreased 133 basis points from 3.24% to 1.91% for the three months ended March 31, 2001 and 2002, respectively. The interest expense related to the trust preferred securities is also included in long-term debt interest expense and amounted to approximately $144,000 at March 31, 2002. Noninterest Income Noninterest income consisting of fees from deposit accounts, fiduciary activities and mortgage banking decreased 22.3% to $1.1 million for the first three months of 2002 compared to $1.4 million for the same period in 2001. Most of the decline is attributed to the lack of obtainable gains from sales of securities available for sale. The Company realized $80,000 in net losses on the investment portfolio for the three months ended March 31, 2002. However, despite the recent upward swing in the interest rate environment, mortgage refinancings and purchases have remained strong in the local market and have provided significant volume increases in mortgage fees on loans held for sale. Service charges on deposit accounts for the first three months of 2002 totaled $351,000 compared to $312,000 for the same period in 2001, an increase of 12.5%. Commissions and fees from fiduciary activities were $319,000 for the three-month period ended March 31, 2001 compared to $358,000 for the same period in 2001. Fees on loans held for sale increased $44,000 or 14.7% to $343,000 at March 31, 2002 from the March 31, 2001 balance of $299,000. Other operating income decreased $28,000 to $171,000 for the three months ended March 31, 2002 compared to $199,000 for the same period in 2001. Noninterest Expense Total noninterest expense includes employee-related costs, occupancy and equipment expense and other overhead. Total noninterest expense was $3.1 million for the first three months of 2002 compared to $2.7 million for the same period in 2001. This is a 14.2% increase from the three months ended March 31, 2001 to the three months ended March 31, 2002. Salary and benefit expense increased 11.7% from $1.7 million for the three months ended March 31, 2001 to $1.9 million for the three months ended March 31, 2002. The Company has increased its staffing in both the business development and operations areas to support the significant asset growth over the past three years. Commissions paid to employees for fee related business, such as mortgage originations and investment sales have increased by $18,000 to $198,000 as a result in the increase in sales volume. Net occupancy expense of premises increased $73,000 14 from $273,000 for the three months ended March 31, 2001 to $346,000 for the three months ended March 31, 2002. Allowance for Loan Losses The allowance for loan losses at March 31, 2002 was $2.1 million compared to $1.9 million at March 31, 2001. The provision for loan losses was unchanged at $75,000 for the three months ended March 31, 2002, and March 31, 2001. The allowance for loan losses was 1.04% of total loans outstanding at March 31, 2002 and 1.04% of total loans outstanding at March 31, 2001. At March 31, 2002, net loan charge offs totaled $6,000. Total loans past due 90 days or more at March 31, 2002 were approximately $117,000. Non-performing loans increased to .09% of total loans outstanding at March 31, 2002 compared to .05% at March 31, 2001. Management believes that the allowance for loan losses is adequate to cover credit losses inherent in the loan portfolio at March 31, 2002. Loans classified as loss, doubtful, substandard or special mention are adequately reserved for and are not expected to have a material impact beyond what has been reserved. Capital Resources Shareholders' equity at March 31, 2002 and March 31, 2001 was $30.9 million and $28.7 million, respectively. Total common shares outstanding at March 31, 2002 were 1,752,558. At March 31, 2002 the Company's tier 1 and total risk-based capital ratios were 16.4% and 17.3%, respectively, compared to 16.4% and 17.3% at December 31, 2001. The Company's leverage ratio was 12.9% at March 31, 2002 compared to 12.5% at December 31, 2001. The Company's capital structure places it above the regulatory guidelines, which affords the Company the opportunity to take advantage of business opportunities while ensuring that it has the resources to protect against risk inherent in its business. Forward-Looking Statements Certain information contained in this discussion may include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as "the Company expects," "the Company believes" or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company. Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. 14 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market and Interest Rate Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company's primary market risk exposure is interest rate risk, though it should be noted that the assets under management by its trust subsidiary, Tredegar Trust Company, are affected by equity price risk. The ongoing monitoring and management of this risk is an important component of the Company's asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (ALCO) of the Company's banking subsidiary, Middleburg Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company's asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company's financial instruments also change, affecting net interest income, the primary component of the Company's earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also employs additional tools to monitor potential longer-term interest rate risk. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company's balance sheet. The simulation model is prepared and updated four times during each year. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given both a 200 basis point (bp) upward and downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed. The following reflects the range of the Company's net interest income sensitivity analysis during the quarter ended March 31, 2002 and the fiscal year of 2001 compared to the 10% Board-approved policy limit. For the quarter Ended March 31, 2002 Rate Change Estimated Net Interest Income Sensitivity ----------- ----------------------------------------- High Low Average ---- --- ------- + 200 bp (2.51%) (2.51%) (2.51%) - 200 bp 2.62% 2.62% 2.62% For the year ended December 31, 2001 Rate Change Estimated Net Interest Income Sensitivity ----------- ----------------------------------------- High Low Average ---- --- ------- + 200 bp (2.21%) (.32%) (1.32%) - 200 bp 3.24% 1.57% 2.44% Since December 31, 2001, the company's balance sheet has grown by nearly $7.0 million. Deposit inflows and the reduction in loans held for sale provided the funding for the growth in the loan 15 and securities portfolios. Overall, the Company continues to have minimal interest rate risks to either falling or rising interest rates. The additions of fixed rate assets during the first quarter of 2002 have made the Company somewhat more liability sensitive in the short term, reducing its exposure to falling rates but slightly increasing the potential exposure to rising rates. Based upon first quarter 2002's simulation, the Company could expect a negative impact to net interest income of $421,000 over the next 12 months if rates rise 200 basis points. If rates decline 200 basis points, the Company could expect a positive impact to net interest income of $440,000 over the next 12 months. During 2001, the Company was able to test the parameters and assumptions of its simulation model in light of the 4.75% decrease in short term rates over 11 months. The simulation model proved to be accurate in its presentation of a company that benefits from falling interest rates. As presented in the table above, the Company has had minimal interest rate risks to either falling or rising interest rates over the past 15 months. The Company could expect a negative impact to net interest income of $364,000 if rates rise 200 basis points over the next 12 months. If rates decline 200 basis points, the Company could expect a positive impact to net interest income of $386,000 over the next 12 months. During May 2000, the Company entered into two interest rate swap agreements to assume variable market-indexed interest payments in exchange for fixed-rate interest payments. The interest rate swap was used to offset the cost of offering a premium market rate on a promotional retail certificate of deposit. The Company raised $8.5 million in new deposits during this three-day promotion. The terms of the certificate of deposit and the fixed portion of the interest rate swap are identical. The notional principal amount of interest rate swaps outstanding was $8.5 million at March 31, 2002. The original term was 24 months. The weighted-average fixed payment rate was 7.0% at March 31, 2002. Variable interest payments received are based on three-month LIBOR. At March 31, 2002, the weighted average rate of variable market-indexed interest payment obligation to the Company was 1.56%. The effect of these agreements was to transform the certificates of deposit (fixed rate liabilities) to variable rate certificates of deposit (liabilities). The net income from these agreements was $112,779 for the three months ended March 31, 2002. The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels such as yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cashflows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to or anticipation of changes in interest rates. 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Change in Securities. 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 and Reports on Form 8-K. a) Exhibits - None b) Reports on Form 8-K - None 17 SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MIDDLEBURG FINANCIAL CORPORATION (Registrant) Date: May 15, 2002 /s/ Joseph L. Boling ------------------------------------------------ Joseph L. Boling Chairman of the Board & CEO Date: May 15, 2002 /s/ Alice P. Frazier ------------------------------------------------ Alice P. Frazier Executive Vice President & CFO (Chief Accounting Officer) 18 -----END PRIVACY-ENHANCED MESSAGE-----