Annual Statements Open main menu

FIRST COMMUNITY BANKSHARES INC /VA/ - Quarter Report: 2007 June (Form 10-Q)

FIRST COMMUNITY BANCSHARES, INC. 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2007
Commission file number 000-19297
FIRST COMMUNITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
     
Nevada   55-0694814
     
(State or other jurisdiction of   (IRS Employer Identification No.)
incorporation)    
     
P.O. Box 989    
Bluefield, Virginia   24605-0989
     
(Address of principal executive offices)   (Zip Code)
(276) 326-9000
(Registrant’s telephone number, including area code)
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 the to such filing requirements for the past 90 days.
þ  Yes       o  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   o       Accelerated filer  þ       Non-accelerated filer    o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o  Yes       þ  No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class – Common Stock, $1.00 Par Value; 11,207,262 shares outstanding as of July 31, 2007
 
 

 


 

FIRST COMMUNITY BANCSHARES, INC.
FORM 10-Q
For the quarter ended June 30, 2007
INDEX
         
PART I. FINANCIAL INFORMATION
       
 
       
    3  
    4  
    5  
    6  
    7  
 
    14  
 
    24  
 
    26  
 
       
 
    27  
 
    27  
 
    27  
 
    27  
 
    27  
 
    27  
 
    28  
 
    30  
 
    31  
 EX-31.1
 EX-31.2
 EX-32

- 2 -


Table of Contents

PART I. ITEM 1. Financial Statements
FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
                 
    June 30,     December 31,  
    2007     2006  
(Dollars in Thousands, Except Share and Per Share Data)   (Unaudited)          
Assets
               
Cash and due from banks
  $ 40,879     $ 47,909  
Interest-bearing balances with banks
    33,380       9,850  
 
           
Total cash and cash equivalents
    74,259       57,759  
Securities available-for-sale (amortized cost of $666,701 at June 30, 2007; $508,423 at December 31, 2006)
    658,901       508,370  
Securities held-to-maturity (fair value of $13,389 at June 30, 2007; $20,350 at December 31, 2006)
    13,177       20,019  
Loans held for sale
    1,818       781  
Loans held for investment, net of unearned income
    1,243,076       1,284,863  
Less allowance for loan losses
    13,934       14,549  
 
           
Net loans held for investment
    1,229,142       1,270,314  
Premises and equipment
    42,274       36,889  
Other real estate owned
    593       258  
Interest receivable
    12,892       12,141  
Goodwill and other intangible assets
    62,017       62,196  
Other assets
    73,522       64,971  
 
           
Total Assets
  $ 2,168,595     $ 2,033,698  
 
           
 
               
Liabilities
               
Deposits:
               
Noninterest-bearing
  $ 241,423     $ 244,771  
Interest-bearing
    1,180,537       1,150,000  
 
           
Total Deposits
    1,421,960       1,394,771  
Interest, taxes and other liabilities
    21,000       19,641  
Federal funds purchased
          7,700  
Securities sold under agreements to repurchase
    217,987       201,185  
FHLB borrowings and other indebtedness
    291,387       197,671  
 
           
Total Liabilities
    1,952,334       1,820,968  
 
           
 
               
Stockholders’ Equity
               
Preferred stock, par value undesignated; 1,000,000 shares authorized; none issued
           
Common stock, $1 par value; 25,000,000 shares authorized; 11,499,018 shares issued at June 30, 2007, and December 31, 2006, including 266,552 and 253,276 shares in treasury, respectively
    11,499       11,499  
Additional paid-in capital
    108,633       108,806  
Retained earnings
    108,601       100,117  
Treasury stock, at cost
    (8,341 )     (7,924 )
Accumulated other comprehensive (loss) income
    (4,131 )     232  
 
           
Total Stockholders’ Equity
    216,261       212,730  
 
           
Total Liabilities and Stockholders’ Equity
  $ 2,168,595     $ 2,033,698  
 
           
See Notes to Consolidated Financial Statements.

- 3 -


Table of Contents

FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
(Dollars in Thousands, Except Share and Per Share Data)   2007     2006     2007     2006  
Interest Income
                               
Interest and fees on loans held for investment
  $ 23,404     $ 24,506     $ 46,923     $ 48,431  
Interest on securities-taxable
    6,030       3,224       11,011       6,101  
Interest on securities-nontaxable
    2,150       1,816       4,062       3,642  
Interest on deposits in banks
    395       479       669       774  
 
                       
Total interest income
    31,979       30,025       62,665       58,948  
Interest Expense
                               
Interest on deposits
    9,748       8,326       19,048       15,973  
Interest on borrowings
    5,217       3,526       9,588       6,737  
 
                       
Total interest expense
    14,965       11,852       28,636       22,710  
 
                       
Net interest income
    17,014       18,173       34,029       36,238  
Provision for loan losses
          811             1,219  
 
                       
Net interest income after provision for loan losses
    17,014       17,362       34,029       35,019  
 
                       
Noninterest Income
                               
Wealth management income
    1,005       732       2,023       1,415  
Service charges on deposit accounts
    2,662       2,655       5,071       5,072  
Other service charges, commissions and fees
    837       711       1,707       1,451  
Gain (loss) on sale of securities
    30       (94 )     159       66  
Other operating income
    1,013       1,516       1,802       2,664  
 
                       
Total noninterest income
    5,547       5,520       10,762       10,668  
 
                       
Noninterest Expense
                               
Salaries and employee benefits
    6,165       6,782       12,576       14,683  
Occupancy expense of bank premises
    1,020       1,011       2,077       2,051  
Furniture and equipment expense
    780       858       1,603       1,708  
Intangible amortization
    105       144       208       234  
Other operating expense
    4,005       3,793       7,769       7,245  
 
                       
Total noninterest expense
    12,075       12,588       24,233       25,921  
 
                       
Income before income taxes
    10,486       10,294       20,558       19,766  
Income tax expense
    3,047       3,002       5,995       5,630  
 
                       
Net income
  $ 7,439     $ 7,292     $ 14,563     $ 14,136  
 
                       
 
                               
Basic earnings per common share
  $ 0.66     $ 0.65     $ 1.29     $ 1.26  
 
                       
Diluted earnings per common share
  $ 0.66     $ 0.65     $ 1.28     $ 1.25  
 
                       
 
                               
Dividends declared per common share
  $ 0.27     $ 0.26     $ 0.54     $ 0.52  
 
                       
Weighted average basic shares outstanding
    11,260,868       11,201,052       11,260,126       11,216,940  
Weighted average diluted shares outstanding
    11,320,227       11,258,581       11,334,486       11,277,032  
See Notes to Consolidated Financial Statements.

- 4 -


Table of Contents

FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
                 
    Six Months Ended  
    June 30,  
(In Thousands)   2007     2006  
Operating activities:
               
Net Income
  $ 14,563     $ 14,136  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
          1,219  
Depreciation and amortization of premises and equipment
    1,585       1,709  
Intangible amortization
    208       234  
Net investment amortization and accretion
    282       303  
Net gain on the sale of assets
    (154 )     (785 )
Mortgage loans originated for sale
    (23,737 )     (13,332 )
Proceeds from sales of mortgage loans
    22,831       13,372  
Gain on sales of loans
    (131 )     (59 )
Deferred income tax (benefit) expense
    (164 )     60  
(Increase) decrease in interest receivable
    (751 )     43  
Other operating activities, net
    (3,494 )     1,197  
 
           
Net cash provided by operating activities
    11,038       18,097  
 
           
 
               
Investing activities:
               
Proceeds from sales of securities available-for-sale
    827       1,824  
Proceeds from maturities and calls of securities available-for-sale
    16,784       12,807  
Proceeds from maturities and calls of securities held-to-maturity
    6,809       3,574  
Purchase of securities available-for-sale
    (175,977 )     (20,379 )
Net decrease in loans held for investment
    40,832       9,514  
Purchase of bank-owned life insurance
          (25,000 )
Net cash used in branch divestiture
          (13,721 )
Purchase of premises and equipment
    (6,977 )     (3,237 )
Proceeds from sale of equipment
          298  
 
           
Net cash used in investing activities
    (117,702 )     (34,320 )
 
           
 
               
Financing activities:
               
Net increase in demand and savings deposits
    15,331       13,344  
Net increase in time deposits
    11,858       10,141  
Net decrease in federal funds purchased
    (7,700 )     (82,500 )
Net increase in securities sold under agreement to repurchase
    16,802       25,632  
Net increase in FHLB and other borrowings
    93,716       74,927  
Proceeds from the exercise of stock options
    681       322  
Excess tax benefit from stock-based compensation
    284       105  
Acquisition of treasury stock
    (1,729 )     (4,125 )
Dividends paid
    (6,079 )     (5,828 )
 
           
Net cash provided by financing activities
    123,164       32,018  
 
           
 
               
Increase in cash and cash equivalents
    16,500       15,795  
 
               
Cash and cash equivalents at beginning of period
    57,759       57,539  
 
           
Cash and cash equivalents at end of period
  $ 74,259     $ 73,334  
 
           
 
               
Supplemental information — Noncash items
               
Transfer of loans to other real estate
  $ 853     $ 490  

- 5 -


Table of Contents

FIRST COMMUNITY BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
                                                 
                                    Accumulated        
            Additional                     Other        
    Common     Paid-in     Retained     Treasury     Comprehensive        
    Stock     Capital     Earnings     Stock     Income (Loss)     Total  
(Dollars in Thousands, Except Share Data)  
Balance January 1, 2006
  $ 11,496     $ 108,573     $ 82,828     $ (7,625 )   $ (771 )   $ 194,501  
Comprehensive income:
                                               
Net income
                14,136                   14,136  
Other comprehensive income, net of tax:
                                               
Unrealized loss on securities available for sale
                            (3,352 )     (3,352 )
Less reclassification adjustment for gains realized in net income
                                    (16 )     (16 )
Unrealized gain on derivative security
                            902       902  
 
                                   
Comprehensive income
                14,136             (2,466 )     11,670  
 
                                   
Common dividends declared
                (5,828 )                 (5,828 )
Net acquisition of 130,861 treasury shares
                      (4,125 )           (4,125 )
Acquisition of Stone Capital 2,706 shares issued
    3       85                         88  
Stock awards 5,132 shares issued
          (36 )           160             124  
ESOP allocation 27,733 shares
          16             867             883  
Equity-based compensation expense
          140                         140  
Tax benefit from exercise of stock options
          139                         139  
Option exercise 19,942 shares
          (315 )           626             311  
 
                                   
Balance June 30, 2006
  $ 11,499     $ 108,602     $ 91,136     $ (10,097 )   $ (3,237 )   $ 197,903  
 
                                   
 
                                               
Balance January 1, 2007
  $ 11,499     $ 108,806     $ 100,117     $ (7,924 )   $ 232     $ 212,730  
Comprehensive income:
                                               
Net income
                14,563                   14,563  
Other comprehensive income, net of tax:
                                               
Unrealized loss on securities available-for-sale
                            (4,601 )     (4,601 )
Less reclassification adjustment for gains realized in net income
                            (47 )     (47 )
Unrealized gain on derivative security
                            285       285  
 
                                   
Comprehensive income
                14,563             (4,363 )     10,200  
 
                                   
Common dividends declared
                (6,079 )                 (6,079 )
Acquisition of 55,200 treasury shares
                      (1,729 )           (1,729 )
Equity-based compensation expense
          66             87             153  
Tax benefit from exercise stock options
          328                         328  
Option exercises 39,174 shares
          (567 )           1,225             658  
 
                                   
Balance June 30, 2007
  $ 11,499     $ 108,633     $ 108,601     $ (8,341 )   $ (4,131 )   $ 216,261  
 
                                   
See Notes to Consolidated Financial Statements.

- 6 -


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. General
Unaudited Consolidated Financial Statements
The accompanying unaudited condensed consolidated financial statements of First Community Bancshares, Inc. and subsidiaries (“First Community” or the “Company”) have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments including normal recurring accruals, necessary for a fair presentation, have been made. These results are not necessarily indicative of the results of consolidated operations that might be expected for the full calendar year.
The consolidated balance sheet as of December 31, 2006, has been derived from the audited financial statements included in the Company’s 2006 Annual Report on Form 10-K. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with standards for the preparation of interim consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2006 Annual Report on Form 10-K.
A more complete and detailed description of First Community’s significant accounting policies is included within Footnote 1 to the Company’s Annual Report on Form 10-K for December 31, 2006. Further discussion of the Company’s application of critical accounting policies is included within the “Application of Critical Accounting Policies” section of Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included herein.
The Company operates within one business segment, community banking.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” which seeks to reduce the diversity in practice associated with the accounting and reporting for uncertainty in income tax positions. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The Company adopted FIN 48 on January 1, 2007, and the adoption did not have an effect on its consolidated financial statements. The Company includes interest and penalties related to income tax liabilities in income tax expense. The Company and its subsidiaries’ tax filings for the years ended December 31, 2003 through 2006 are currently open to audit under statutes of limitation by the Internal Revenue Service and various state tax departments.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.” SFAS 156 requires that all separately recognized servicing assets and liabilities be initially measured at fair value and permits (but does not require) subsequent measurement of servicing assets and liabilities at fair value. This statement is effective for fiscal years beginning after September 15, 2006. The adoption of this standard did not have a material effect on the financial condition, the results of operations, or liquidity of the Company.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company must adopt these new requirements no later than the first quarter of 2008. The Company has not yet determined the effect of adopting SFAS 157 on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 123(R).” SFAS 158 requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the

- 7 -


Table of Contents

fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The Company does not expect the full adoption of this standard to have a significant impact on its consolidated financial statements.
In September 2006, the Emerging Issues Task Force reached a consensus regarding EITF 06-4 “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” The scope of EITF 06-4 is limited to the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods. Therefore, this EITF would not apply to a split-dollar life insurance arrangement that provides a specified benefit to an employee that is limited to the employee’s active service period with an employer. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Company does not expect the adoption of this EITF to have a significant impact on its consolidated financial statements.
In September 2006, the Emerging Issues Task Force reached a consensus regarding EITF 06-5 “Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4.” The scope of EITF 06-5 is limited to the determination of net cash surrender value of a life insurance contract in accordance with Technical Bulletin 85-4. This EITF outlines when contractual limitations of the policy should be considered when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted. The adoption of EITF 06-5 did not have a material effect on the condition, results of operations, or liquidity of the Company.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The Statement’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of Statement 157. The Company did not elect early adoption as provided for in the Statement, and is currently evaluating the impact, if any, of adopting this Statement on the consolidated financial statements.
Note 2. Mergers, Acquisitions and Branching Activity
In March 2007, the Company opened two new branch locations in the Winston-Salem, North Carolina, area. The Company currently has plans to open five more branch offices during 2007. In Richmond, Virginia, locations are planned for the Chesterfield Towne Center and on Mechanicsville Turnpike, Route 360. In West Virginia, locations are planned for Daniels, Summersville, and Princeton. These locations are all in various stages of construction, and are anticipated to be open by the third and fourth quarters of 2007.
In December 2006, the Company completed the sale of its Rowlesburg, West Virginia, branch location. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $10.6 million and loans of approximately $2.2 million. The transaction resulted in a pre-tax gain of approximately $333 thousand.
In November 2006, the Company completed the acquisition of Investment Planning Consultants, Inc. (“IPC”), a registered investment advisory firm. In connection with the initial payment of approximately $1.47 million, the Company issued 39,874 shares of common stock. Under the terms of the stock purchase agreement, former shareholders of IPC are entitled to additional consideration aggregating up to $1.43 million in the form of the Company’s common stock, valued at the time of issuance, if certain future operating performance targets are met. If those operating targets are met, the value of the consideration ultimately paid will be added to the cost of the acquisition, which will increase the amount of goodwill related to the acquisition.
In June 2006, the Company sold its Drakes Branch, Virginia, location. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $16.4 million and loans of approximately $1.9 million. The transaction resulted in a pre-tax gain of approximately $702 thousand.

- 8 -


Table of Contents

Note 3. Investment Securities
As of June 30, 2007, and December 31, 2006, the amortized cost and estimated fair value of available-for-sale securities are as follows:
                                 
    June 30, 2007  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
(In Thousands)  
U.S. Government agency securities
  $ 136,784     $     $ (2,885 )   $ 133,899  
States and political subdivisions
    188,303       1,220       (3,909 )     185,614  
Corporate notes
    145,023       393       (430 )     144,986  
Mortgage-backed securities
    188,391       138       (4,129 )     184,400  
Equities
    8,200       1,940       (138 )     10,002  
 
                       
Total
  $ 666,701     $ 3,691     $ (11,491 )   $ 658,901  
 
                       
                                 
    December 31, 2006  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
U.S. Government agency securities
  $ 117,777     $     $ (1,716 )   $ 116,061  
States and political subdivisions
    152,189       2,379       (521 )     154,047  
Corporate notes
    85,080       350       (397 )     85,033  
Mortgage-backed securities
    146,444       206       (1,896 )     144,754  
Equities
    6,933       1,615       (73 )     8,475  
 
                       
Total
  $ 508,423     $ 4,550     $ (4,603 )   $ 508,370  
 
                       
As of June 30, 2007, and December 31, 2006, the amortized cost and estimated fair value of held-to-maturity securities are as follows:
                                 
    June 30, 2007  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
(In Thousands)  
States and political subdivisions
  $ 12,799     $ 219     $ (7 )   $ 13,011  
Mortgage-backed securities
    3                   3  
Other securities
    375                   375  
 
                       
Total
  $ 13,177     $ 219     $ (7 )   $ 13,389  
 
                       
                                 
    December 31, 2006  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
States and political subdivisions
  $ 19,638     $ 334     $ (2 )   $ 19,970  
Mortgage-backed securities
    6                   6  
Other securities
    375             (1 )     374  
 
                       
Total
  $ 20,019     $ 334     $ (3 )   $ 20,350  
 
                       

- 9 -


Table of Contents

The following table reflects those investments in an unrealized loss position at June 30, 2007, and December 31, 2006. There were no securities in a continuous unrealized loss position for 12 or more months which the Company does not have the ability to hold until the security matures or recovers in value.
                                                 
    June 30, 2007  
    Less than 12 Months     12 Months or longer     Total  
Description of Securities   Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
(In Thousands)                                                
U. S. Government agency securities
  $ 79,440     $ (1,493 )   $ 54,459     $ (1,392 )   $ 133,899     $ (2,885 )
States and political subdivisions
    86,000       (2,792 )     33,968       (1,124 )     119,968       (3,916 )
Other securities
    62,662       (430 )                 62,662       (430 )
Mortgage-backed securities
    115,870       (2,359 )     53,028       (1,770 )     168,898       (4,129 )
Equity securities
    1,144       (58 )     1,665       (80 )     2,809       (138 )
 
                                   
Total
  $ 345,116     $ (7,132 )   $ 143,120     $ (4,366 )   $ 488,236     $ (11,498 )
 
                                   
                                                 
    December 31, 2006  
    Less than 12 Months     12 Months or longer     Total  
Description of Securities   Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
U. S. Government agency securities
  $ 60,416     $ (517 )   $ 55,645     $ (1,199 )   $ 116,061     $ (1,716 )
States and political subdivisions
    10,732       (34 )     36,797       (489 )     47,529       (523 )
Other securities
    28,339       (213 )     27,698       (185 )     56,037       (398 )
Mortgage-backed securities
    50,093       (223 )     66,620       (1,673 )     116,713       (1,896 )
Equity securities
    2,186       (70 )     32       (3 )     2,218       (73 )
 
                                   
Total
  $ 151,766     $ (1,057 )   $ 186,792     $ (3,549 )   $ 338,558     $ (4,606 )
 
                                   
At June 30, 2007, the combined depreciation in value of the 351 individual security holdings in an unrealized loss position was 1.71% of the combined reported value of the aggregate securities portfolio. Management does not believe any individual unrealized loss as of June 30, 2007, represents other-than-temporary impairment. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature. Furthermore, the Company believes the declines in value are attributable to changes in market interest rates and not the credit quality of the issuer.
Note 4. Loans
Loans, net of unearned income, consist of the following:
                                 
    June 30, 2007     December 31, 2006  
(Dollars in Thousands)   Amount     Percent     Amount     Percent  
Loans held for investment:
                               
Commercial and agricultural
  $ 96,835       7.79 %   $ 106,645       8.30 %
Commercial real estate
    394,418       31.73 %     421,067       32.77 %
Residential real estate
    498,156       40.07 %     506,370       39.41 %
Construction
    166,010       13.35 %     158,566       12.34 %
Consumer
    83,665       6.73 %     88,666       6.90 %
Other
    3,992       0.33 %     3,549       0.28 %
 
                       
Total
  $ 1,243,076       100.00 %   $ 1,284,863       100.00 %
 
                       
                                 
Loans held for sale
  $ 1,818             $ 781          
 
                           
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the

- 10 -


Table of Contents

amount recognized on the balance sheet. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is not a violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the counterparties. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit and written financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.
Financial instruments whose contract amounts represent credit risk at June 30, 2007, are commitments to extend credit (including availability of lines of credit) of $224.31 million and standby letters of credit and financial guarantees written of $4.70 million.
Note 5. Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provision for loan losses and recoveries of prior loan charge-offs, and decreased by loans charged off. The provision is calculated to bring the allowance to a level which, according to a systematic process of measurement, reflects the amount management estimates is needed to absorb probable losses within the portfolio.
Management performs periodic assessments to determine the appropriate level of allowance. Differences between actual loan loss experience and estimates are reflected through adjustments that are made by either increasing or decreasing the loss provision based upon current measurement criteria. Commercial, consumer and mortgage loan portfolios are evaluated separately for purposes of determining the allowance. The specific components of the allowance include allocations to individual commercial credits and allocations to the remaining non-homogeneous and homogeneous pools of loans. Management’s allocations are based on judgment of qualitative and quantitative factors about both macro and micro economic conditions reflected within the portfolio of loans and the economy as a whole. Factors considered in this evaluation include, but are not necessarily limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and non-accruals. While management has allocated the allowance for loan losses to various portfolio segments, the entire allowance is available for use against any type of loan loss deemed appropriate by management.
The following table details the Company’s allowance for loan loss activity for the three- and six-month periods ended June 30, 2007 and 2006.
                                 
    For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,  
    2007     2006     2007     2006  
(In Thousands)                                
Beginning balance
  $ 14,510     $ 14,797     $ 14,549     $ 14,736  
Provision for loan losses
          811             1,219  
Charge-offs
    (911 )     (1,389 )     (1,804 )     (2,104 )
Recoveries
    335       491       1,189       859  
 
                       
Ending balance
  $ 13,934     $ 14,710     $ 13,934     $ 14,710  
 
                       

- 11 -


Table of Contents

Note 6. Deposits
The following is a summary of interest-bearing deposits by type as of June 30, 2007, and December 31, 2006.
                 
    June 30,     December 31,  
    2007     2006  
(In Thousands)                
Interest-bearing demand deposits
  $ 143,080     $ 140,578  
Savings deposits
    333,855       317,678  
Certificates of deposit
    703,602       691,744  
 
           
Total
  $ 1,180,537     $ 1,150,000  
 
           
Note 7. Borrowings
The following schedule details the Company’s Federal Home Loan Bank (“FHLB”) borrowings and other indebtedness at June 30, 2007, and December 31, 2006.
                 
    June 30,     December 31,  
    2007     2006  
(In thousands)                
FHLB borrowings
  $ 275,923     $ 182,207  
Subordinated debt
    15,464       15,464  
 
           
Total
  $ 291,387     $ 197,671  
 
           
FHLB borrowings include $275.00 million in convertible and callable advances and $923 thousand of noncallable term advances from the FHLB at June 30, 2007. The weighted average interest rates of advances are 4.46% and 4.64% at June 30, 2007, and December 31, 2006, respectively.
The Company has entered into a derivative interest rate swap instrument where it receives LIBOR-based variable interest payments and pays fixed interest payments. The notional amount of the derivative swap is $50 million and effectively fixes a portion of the FHLB borrowings at approximately 4.34%. After considering the effect of the interest rate swap, the effective weighted average interest rate of all FHLB borrowings is 4.35% at June 30, 2007. The fair value of the interest rate swap was $915 thousand at June 30, 2007.
At June 30, 2007, the FHLB advances have maturities between three and fourteen years. The scheduled maturities of the advances are as follows:
         
    Amount  
(In Thousands)        
2007
  $  
2008
     
2009
     
2010
    25,000  
2011
     
2012 and thereafter
    250,923  
 
     
Total
  $ 275,923  
 
     
The callable advances may be redeemed at quarterly intervals after various lockout periods. These call options may substantially shorten the lives of these instruments. If these advances are called, the debt may be paid in full, converted to another FHLB credit product, or converted to a fixed or adjustable rate advance. Prepayment of the advances may result in substantial penalties based upon the differential between contractual note rates and current advance rates for similar maturities. Advances from the FHLB are secured by stock in the FHLB of Atlanta, qualifying first mortgage loans, mortgage-backed securities, and certain other securities.
Also included in borrowings is $15.5 million of junior subordinated debentures (the “Debentures”) issued by the Company in October 2003 to an unconsolidated trust subsidiary, FCBI Capital Trust (the “Trust”) with an interest rate of three-month

- 12 -


Table of Contents

LIBOR plus 2.95%. The Trust was able to purchase the Debentures through the issuance of trust preferred securities which had substantially identical terms as the Debentures. The Debentures mature on October 8, 2033, and are callable beginning October 8, 2008. The net proceeds from the offering were contributed as capital to the Company’s subsidiary bank to support further growth.
The Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that the Trust has not made such payments or distributions: (i) accrued and unpaid distributions, (ii) the redemption price, and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amount and all accrued and unpaid distributions and the amount of assets of the trust remaining available for distribution, in each case to the extent the Trust has funds available.
Note 8. Comprehensive Income
Comprehensive income is the total of net income and other comprehensive income. The following table summarizes the components of comprehensive income.
                                 
    For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,  
    2007     2006     2007     2006  
(In Thousands)                                
Net income
  $ 7,439     $ 7,292     $ 14,563     $ 14,136  
Other comprehensive income
                               
Unrealized loss on securities available-for-sale
    (8,453 )     (3,121 )     (7,668 )     (5,586 )
Reclassification adjustment for losses (gains) realized in net income
    14       133       (79 )     (27 )
Unrealized loss on derivative securities
    727       675       475       1,503  
Income tax effect
    3,086       925       2,909       1,644  
 
                       
Total other comprehensive loss
    (4,626 )     (1,388 )     (4,363 )     (2,466 )
 
                       
Comprehensive income
  $ 2,813     $ 5,904     $ 10,200     $ 11,670  
 
                       
Note 9. Commitments and Contingencies
In the normal course of business, the Company is a defendant in various legal actions and asserted claims. While the Company and its legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

- 13 -


Table of Contents

PART I. ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is provided to address information about First Community Bancshares, Inc.’s (the “Company”) financial condition and results of operations. This discussion and analysis should be read in conjunction with the Company’s 2006 Annual Report on Form 10-K and the other financial information included in this report.
The Company is a multi-state financial holding company headquartered in Bluefield, Virginia, with total assets of $2.17 billion at June 30, 2007. Through its community bank subsidiary, First Community Bank, N. A. (the “Bank”), the Company provides financial, trust and investment advisory services to individuals and commercial customers through fifty-six locations and four wealth management offices located in the four states of Virginia, West Virginia, North Carolina and Tennessee. The Bank is the parent of Investment Planning Consultants, Inc., a SEC-registered investment advisory firm that offers wealth management and investment advice. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol “FCBC”.
FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral “forward-looking statements”, including statements contained in its filings with the SEC (including this Quarterly Report on Form 10-Q and the Exhibits hereto and thereto), in its reports to stockholders and in other communications which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include, among others, statements with respect to the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (many of which are beyond the Company’s control). The words “may”, “could”, “should”, “would”, “believe”, “anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from that expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of competitive new products and services of the Company and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions; the growth and profitability of the Company’s non-interest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.
The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company. These factors are described in greater detail in Item 1A. Risk Factors of the Company’s 2006 Annual Report on Form 10-K.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and consolidated results of operations.
Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third party sources, when available. When third party information

- 14 -


Table of Contents

is not available, valuation adjustments are estimated by management primarily through the use of internal modeling techniques and appraisal estimates.
The Company’s accounting policies are fundamental to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operation. The disclosures presented in the Notes to the Consolidated Financial Statements and in Management’s Discussion and Analysis provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, accounting for acquisitions and intangible assets, and accounting for income taxes as the accounting areas that require the most subjective or complex judgments. The identified critical accounting policies are described in detail in the Company’s 2006 Annual Report on Form 10-K. There have been no material changes in the Company’s critical accounting policies since December 31, 2006.
COMPANY OVERVIEW
The Company is a full service commercial bank holding company which operates within the four-state region of Virginia, West Virginia, North Carolina, and Tennessee. The Company operates through the Bank, and offers a wide range of financial services. The Company reported total assets of $2.17 billion at June 30, 2007, and operates through fifty-six offices and four wealth management offices.
The Company funds its lending activities primarily through the retail deposit operations of its branch banking network. Retail and wholesale repurchase agreements and borrowings from the Federal Home Loan Bank (“FHLB”) provide additional funding as needed. The Company invests its funds primarily in loans to retail and commercial customers. In addition to loans, the Company also invests a portion of its funds in various debt securities, including those of United States agencies, state and political subdivisions, and certain corporate notes and debt instruments. The Company also maintains overnight interest-bearing balances with the FHLB and correspondent banks. The difference between interest earned on assets and interest paid on liabilities is the Company’s primary source of earnings.
The Company also conducts asset management activities through its Trust Division and its registered investment advisory firm, Investment Planning Consultants. These two divisions manage assets with a market value of over $840 million. These assets are not assets of the Company, but are managed under various fee-based arrangements as fiduciary or agent.
MERGERS, ACQUISITIONS AND BRANCHING ACTIVITY
In March 2007, the Company opened two new branch locations in the Winston-Salem, North Carolina, area. The Company currently has plans to open five more branch offices during 2007. In Richmond, Virginia, locations are planned for the Chesterfield Towne Center and on Mechanicsville Turnpike, Route 360. In West Virginia, locations are planned for Daniels, Summersville, and Princeton. These locations are all in various stages of construction, and are anticipated to be open by the third and fourth quarters of 2007.
In December 2006, the Company completed the sale of its Rowlesburg, West Virginia, branch location. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $10.6 million and loans of approximately $2.2 million. The transaction resulted in a pre-tax gain of approximately $333 thousand.
In November 2006, the Company completed the acquisition of Investment Planning Consultants, Inc. (“IPC”), a registered investment advisory firm. In connection with the initial payment of approximately $1.47 million, the Company issued 39,874 shares of common stock. Under the terms of the stock purchase agreement, former shareholders of IPC are entitled to additional consideration aggregating up to $1.43 million in the form of the Company’s common stock, valued at the time of issuance, if certain future operating performance targets are met. If those operating targets are met, the value of the consideration ultimately paid will be added to the cost of the acquisition, which will increase the amount of goodwill related to the acquisition.
In June 2006, the Company sold its Drakes Branch, Virginia, branch office. At the time of the sale, the branch had deposits and repurchase agreements totaling approximately $16.4 million and loans of approximately $1.9 million. The transaction resulted in a gain of approximately $702 thousand. The sale of this and the previously referenced Rowlesburg branch were designed to enhance the efficiency of the Company’s branch network.

- 15 -


Table of Contents

RESULTS OF OPERATIONS
Overview
Net income for the three months ended June 30, 2007, was $7.44 million, or $0.66 per basic and diluted share, compared with $7.29 million or $0.65 per basic and diluted share for the three months ended June 30, 2006, an improvement of $147 thousand, or 2.02%. Return on average equity for the three months ended June 30, 2007, was 13.56% compared with 14.74% for the three months ended June 30, 2006. Return on average assets was 1.40% for the three months ended June 30, 2007, compared with 1.47% for the same period in 2006.
Net income for the six months ended June 30, 2007, was $14.56 million, or $1.29 per basic and $1.28 per diluted share, compared with $14.14 million or $1.26 per basic and $1.25 per diluted share for the six months ended June 30, 2006, an improvement of $427 thousand, or 3.02%. Return on average equity for the six months ended June 30, 2007, was 13.45% compared with 14.42% for the six months ended June 30, 2006. Return on average assets was 1.41% for the six months ended June 30, 2007, compared with 1.45% for the same period in 2006.
Net Interest Income – Quarterly Comparison (See Table I)
Net interest income, the largest contributor to earnings, was $17.01 million for the three months ended June 30, 2007, compared with $18.17 million for the corresponding period in 2006, a decrease of $1.16 million, or 6.38%. Tax-equivalent net interest income totaled $18.19 million for the three months ended June 30, 2007, a decrease of $975 thousand from $19.16 million for the second quarter of 2006. The net decrease was due mostly to increases in rates paid on interest-bearing liabilities which outpaced increases in the rates earned on loans and securities.
Compared with the second quarter of 2006, average earning assets increased $134.03 million while interest-bearing liabilities increased $133.11 million. The yield on average earning assets decreased by three basis points to 6.89% from 6.92%. Total cost of interest-bearing liabilities increased 50 basis points between the second quarter of 2006 and 2007, which resulted in a net interest rate spread that was 53 basis points lower at 3.28% compared with 3.81% for the same period last year. The Company’s tax-equivalent net interest margin of 3.78% for the three months ended June 30, 2007, decreased 50 basis points from 4.28% for the same period of 2006.
The rate earned on loans increased to 7.49% from 7.40%, which is attributable to the general rise in market rates of interest since the beginning of 2006. Declines in the average portfolio balances contributed largely to a net $1.10 million decrease in tax-equivalent loan interest income compared with the second quarter of 2006.
The largest contributors to the increase in the tax-equivalent interest income in 2007 were the increases in both average balance and rate earned on the securities portfolio. During the three months ended June 30, 2007, the tax-equivalent yield on available-for-sale securities increased 23 basis points to 5.75%, while the average balance increased by $223.32 million. The average tax-equivalent yield increased due to the addition of higher rate securities and the reduction of lower rate securities. As net payoffs in the loan portfolio are realized, the Company has been reinvesting those funds in securities. The average balance of the held-to-maturity securities portfolio continued to decline as securities matured and called and were not replaced.
Compared with the second quarter of 2006, average interest-bearing balances with banks decreased to $32.30 million during the second quarter of 2007, as the yield increased 25 basis points to 4.90%. Interest-bearing balances with banks is made up largely of excess liquidity bearing overnight market rates. The rate earned on those balances has risen along with increases in short-term benchmark interest rates. The balance has decreased as the Company has invested in higher yielding securities.
Compared with the same period in 2006, the average balances of interest-bearing demand and savings deposits decreased $932 thousand and $31.07 million, respectively, for the three months ended June 30, 2007. The average rate paid on interest-bearing demand deposits increased by two basis points, while the average rate paid on savings increased 20 basis points. Average time deposits increased $21.39 million while the average rate paid increased 68 basis points from 3.79% in 2006 to 4.47% in 2007. The level of average non-interest-bearing demand deposits decreased $5.76 million to $234.54 million during the quarter ended June 30, 2007, compared with the corresponding period of the prior year.
The changes in average deposits between the two quarters include the effect of the previously disclosed sale of the Company’s Drakes Branch, Virginia, and Rowlesburg, West Virginia, branch offices. The average deposit balances held by those two branches in the second quarter of 2006 totaled $26.07 million.

- 16 -


Table of Contents

Compared with the same period in 2006, average federal funds purchased and repurchase agreements increased $92.33 million to $228.86 million during the second quarter of 2007, while the average rate increased 51 basis points. The Company added approximately $50.00 million of wholesale repurchase agreement funding in the latter part of 2006. The average balance of FHLB borrowings and other long-term debt increased by $51.38 million in 2007 to $255.55 million, while the rate paid on those borrowings increased only five basis points. The Company borrowed an additional $100 million in FHLB advances early in the second quarter that have a weighted-average cost of 4.18%.
Net Interest Income – Year-to-Date Comparison (See Table II)
Net interest income was $34.03 million for the six months ended June 30, 2007, compared with $36.24 million for the corresponding period in 2006, a decrease of $2.21 million, or 6.10%. Tax-equivalent net interest income totaled $36.24 million for the six months ended June 30, 2007, a decrease of $1.98 million from $38.22 million for the first half of 2006. The net decrease was due mostly to increases in rates paid on interest-bearing liabilities which outpaced increases in the rates earned on loans and securities.
Compared with the first half of 2006, average earning assets increased $92.43 million while interest-bearing liabilities increased $95.93 million. The yield on average earning assets increased nine basis points to 6.94% from 6.85%. Total cost of interest-bearing liabilities increased 56 basis points during the first half of 2007, which resulted in a net interest rate spread that was 47 basis points lower at 3.37% compared with 3.84% for the same period last year. The Company’s tax-equivalent net interest margin of 3.87% for the six months ended June 30, 2007, decreased 43 basis points from 4.30% for the same period of 2006.
The rate earned on loans increased to 7.52% from 7.34%, which is attributable to the general rise in market rates of interest since the beginning of 2006. Declines in the average portfolio balances contributed largely to a net $1.51 million decrease in tax-equivalent loan interest income compared with the first half of 2006.
The largest contributors to the increase in the tax-equivalent interest income in 2007 were the increases in both average balance and rate earned on the securities portfolio. During the six months ended June 30, 2007, the tax-equivalent yield on available-for-sale securities increased 35 basis points to 5.74%, while the average balance increased by $176.40 million. The average tax-equivalent yield increased due to the addition of higher rate securities and the reduction of lower rate securities. As net payoffs in the loan portfolio are realized, the Company has been reinvesting those funds in securities. The average balance of the held-to-maturity securities portfolio continued to decline as securities matured and called and were not replaced.
Compared with the first half of 2006, average interest-bearing balances with banks decreased to $27.79 million during the first half of 2007, as the yield increased 41 basis points to 4.85%. Interest-bearing balances with banks is made up largely of excess liquidity bearing overnight market rates. The rate earned on those balances has risen along with increases in short-term benchmark interest rates. The balance has decreased as the Company has invested in higher yielding securities.
Compared with the same period in 2006, the average balances of interest-bearing demand and savings deposits decreased $720 thousand and $35.58 million, respectively, for the six months ended June 30, 2007. The average rate paid on interest-bearing demand deposits increased by one basis point, while the average rate paid on savings increased 25 basis points. Average time deposits increased $21.14 million while the average rate paid increased 75 basis points from 3.67% in 2006 to 4.42% in 2007. The level of average non-interest-bearing demand deposits decreased slightly to $232.07 million during the six months ended June 30, 2007, compared with the corresponding period of the prior year.
The changes in average deposits between the two periods include the effect of the previously disclosed sale of the Company’s Drakes Branch, Virginia, and Rowlesburg, West Virginia, branch offices. The average deposit balances held by those two branches in the first half of 2006 totaled $26.40 million.
Compared with the same period in 2006, average federal funds purchased and repurchase agreements increased $88.13 million to $221.70 million during the first half of 2007, while the average rate increased 68 basis points. The Company added approximately $50.00 million of wholesale repurchase agreement funding in the latter part of 2006. The average balance of FHLB borrowings and other long-term debt increased by $22.96 million in 2007 to $225.08 million, while the rate paid on those borrowings increased 17 basis points. The Company borrowed an additional $100 million in FHLB advances early in the second quarter that have a weighted-average cost of 4.18%.

- 17 -


Table of Contents

Table I
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
                                                 
    Three Months Ended     Three Months Ended  
    June 30, 2007     June 30, 2006  
    Average             Yield/     Average             Yield/  
    Balance     Interest (1)     Rate (1)     Balance     Interest (1)     Rate (1)  
                    (Dollars in Thousands)                  
ASSETS
                                               
Earning Assets:
                                               
Loans: (2)
                                               
Taxable
  $ 1,251,696     $ 23,379       7.49 %   $ 1,327,278     $ 24,487       7.40 %
Tax-exempt
    1,983       38       7.69 %     1,490       30       8.08 %
 
                                   
Total
    1,253,679       23,417       7.49 %     1,328,768       24,517       7.40 %
Securities available for sale:
                                               
Taxable
    439,504       6,024       5.50 %     257,838       3,218       5.01 %
Tax-exempt
    189,526       2,993       6.33 %     147,869       2,367       6.42 %
 
                                   
Total
    629,030       9,017       5.75 %     405,707       5,585       5.52 %
Securities held to maturity:
                                               
Taxable
    378       6       6.37 %     388       5       5.17 %
Tax-exempt
    15,858       316       7.99 %     20,990       427       8.16 %
 
                                   
Total
    16,236       322       7.95 %     21,378       432       8.11 %
Interest-bearing deposits
    32,302       395       4.90 %     41,361       479       4.65 %
 
                                   
Total Earning Assets
    1,931,247       33,151       6.89 %     1,797,214       31,013       6.92 %
Other assets
    203,365                       187,527                  
 
                                           
TOTAL ASSETS
  $ 2,134,612                     $ 1,984,741                  
 
                                           
 
                                               
LIABILITIES
                                               
Interest-bearing liabilities:
                                               
Demand deposits
  $ 147,570     $ 118       0.32 %   $ 148,502     $ 111       0.30 %
Savings deposits
    324,759       1,776       2.19 %     355,826       1,761       1.99 %
Time deposits
    704,611       7,854       4.47 %     683,221       6,454       3.79 %
 
                                   
Total interest-bearing deposits
    1,176,940       9,748       3.32 %     1,187,549       8,326       2.81 %
Federal funds purchased and repurchase agreements
    228,856       2,206       3.87 %     136,522       1,142       3.36 %
FHLB borrowings and other long-term debt
    255,554       3,011       4.73 %     204,172       2,384       4.68 %
 
                                   
Total interest-bearing liabilities
    1,661,350       14,965       3.61 %     1,528,243       11,852       3.11 %
 
                                           
Non-interestbearing demand deposits
    234,536                       240,296                  
Other liabilities
    18,737                       17,762                  
Stockholders’ Equity
    219,989                       198,440                  
 
                                           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 2,134,612                     $ 1,984,741                  
 
                                           
Net Interest Income, Tax Equivalent
          $ 18,186                     $ 19,161          
 
                                           
Net Interest Rate Spread (3)
                    3.28 %                     3.81 %
 
                                           
Net Interest Margin (4)
                    3.78 %                     4.28 %
 
                                           
 
(1)   Fully Taxable Equivalent (“FTE”) at the rate of 35%. The FTE basis adjusts for the tax benefits of income on certain tax-exempt loans and investments using the federal statutory rate of 35% for each period presented. The Company believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts.
 
(2)   Non-accrual loans are included in average balances outstanding but with no related interest income during the period of non-accrual.
 
(3)   Represents the difference between the yield on earning assets and cost of funds.
 
(4)   Represents tax equivalent net interest income divided by average interest-earning assets.

- 18 -


Table of Contents

Table II
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
                                                 
    Six Months Ended     Six Months Ended  
    June 30, 2007     June 30, 2006  
    Average             Yield/     Average             Yield/  
    Balance     Interest (1)     Rate (1)     Balance     Interest (1)     Rate (1)  
                    (Dollars in Thousands)                  
ASSETS
                                               
Earning Assets:
                                               
Loans: (2)
                                               
Taxable
  $ 1,257,722     $ 46,877       7.52 %   $ 1,330,375     $ 48,391       7.34 %
Tax-exempt
    1,898       71       7.54 %     1,531       62       8.17 %
 
                                   
Total
    1,259,620       46,948       7.52 %     1,331,906       48,453       7.34 %
Securities available for sale:
                                               
Taxable
    405,390       10,999       5.47 %     254,702       6,091       4.82 %
Tax-exempt
    175,701       5,553       6.37 %     149,991       4,726       6.35 %
 
                                   
Total
    581,091       16,552       5.74 %     404,693       10,817       5.39 %
Securities held to maturity:
                                               
Taxable
    380       12       6.37 %     389       10       5.18 %
Tax-exempt
    17,611       699       8.00 %     21,938       876       8.05 %
 
                                   
Total
    17,991       711       7.97 %     22,327       886       8.00 %
Interest-bearing deposits
    27,788       669       4.85 %     35,134       774       4.44 %
 
                                   
Total Earning Assets
    1,886,490       64,880       6.94 %     1,794,060       60,930       6.85 %
Other assets
    199,588                       178,179                  
 
                                           
TOTAL ASSETS
  $ 2,086,078                     $ 1,972,239                  
 
                                           
 
                                               
LIABILITIES
                                               
Interest-bearing liabilities:
                                               
Demand deposits
  $ 146,770     $ 229       0.31 %   $ 147,490     $ 217       0.30 %
Savings deposits
    322,223       3,449       2.16 %     357,804       3,393       1.91 %
Time deposits
    700,884       15,370       4.42 %     679,745       12,363       3.67 %
 
                                   
Total interest-bearing deposits
    1,169,877       19,048       3.28 %     1,185,039       15,973       2.72 %
Federal funds purchased and repurchase agreements
    221,695       4,241       3.86 %     133,566       2,103       3.18 %
FHLB borrowings and other long-term debt
    225,082       5,347       4.79 %     202,118       4,634       4.62 %
 
                                   
Total interest-bearing liabilities
    1,616,654       28,636       3.57 %     1,520,723       22,710       3.01 %
 
                                           
Non-interestbearing demand deposits
    232,069                       235,987                  
Other liabilities
    18,949                       17,806                  
Stockholders’ Equity
    218,406                       197,723                  
 
                                           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 2,086,078                     $ 1,972,239                  
 
                                           
Net Interest Income, Tax Equivalent
          $ 36,244                     $ 38,220          
 
                                           
Net Interest Rate Spread (3)
                    3.37 %                     3.84 %
 
                                           
Net Interest Margin (4)
                    3.87 %                     4.30 %
 
                                           
 
(1)   Fully Taxable Equivalent (“FTE”) at the rate of 35%. The FTE basis adjusts for the tax benefits of income on certain tax-exempt loans and investments using the federal statutory rate of 35% for each period presented. The Company believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts.
 
(2)   Non-accrual loans are included in average balances outstanding but with no related interest income during the period of non-accrual.
 
(3)   Represents the difference between the yield on earning assets and cost of funds.
 
(4)   Represents tax equivalent net interest income divided by average interest-earning assets.

- 19 -


Table of Contents

The following table summarizes the changes in tax-equivalent interest earned and paid resulting from changes in the volume of earning assets and paying liabilities and changes in their interest rates. The changes in interest due to both rate and volume have been allocated to the volume and rate columns in proportion to dollar amounts.
                                                 
    Three Months Ended     Six Months Ended  
    June 30, 2007,     June 30, 2007,  
    Compared to 2006     Compared to 2006  
(In Thousands)   $ Increase/(Decrease) due to     $ Increase/(Decrease) due to  
    Volume     Rate     Total     Volume     Rate     Total  
Interest Earned On:
                                               
Loans (1)
  $ (1,384 )   $ 284     $ (1,100 )   $ (2,628 )   $ 1,123     $ (1,505 )
Securities available for sale (1)
    2,934       498       3,432       4,414       1,321       5,735  
Securities held to maturity (1)
    (105 )     (5 )     (110 )     (173 )     (2 )     (175 )
Interest-bearing deposits with other banks
    (105 )     21       (84 )     (162 )     57       (105 )
 
                                   
Total interest-earning assets
    1,340       798       2,138       1,451       2,499       3,950  
 
                                   
 
                                               
Interest Paid On:
                                               
Demand deposits
    (1 )     8       7       (1 )     13       12  
Savings deposits
    (154 )     169       15       (337 )     393       56  
Time deposits
    202       1,198       1,400       384       2,623       3,007  
Fed funds purchased and repurchase agreements
    772       292       1,064       1,388       750       2,138  
FHLB borrowings and other long-term debt
    600       27       627       527       186       713  
 
                                   
Total interest-bearing liabilities
    1,419       1,694       3,113       1,961       3,965       5,926  
 
                                   
 
                                               
Change in net interest income, tax-equivalent
  $ (79 )   $ (896 )   $ (975 )   $ (510 )   $ (1,466 )   $ (1,976 )
 
                                   
 
(1)   Fully taxable equivalent using a rate of 35%.
Provision and Allowance for Loan Losses
The allowance for loan losses was $13.93 million at June 30, 2007, $14.55 million at December 31, 2006 and $14.71 million at June 30, 2006. The Company’s allowance for loan loss activity for the three- and six-month periods ended June 30, 2007 and 2006, is as follows:
                                 
(In Thousands)   For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,  
    2007     2006     2007     2006  
Allowance for loan losses
                               
Beginning balance
  $ 14,510     $ 14,797     $ 14,549     $ 14,736  
Provision for loan losses
          811             1,219  
Charge-offs
    (911 )     (1,389 )     (1,804 )     (2,104 )
Recoveries
    335       491       1,189       859  
 
                       
Net charge-offs
    (576 )     (898 )     (615 )     (1,245 )
 
                       
Ending balance
  $ 13,934     $ 14,710     $ 13,934     $ 14,710  
 
                       
The total allowance for loan losses to loans held for investment ratio was 1.12% at June 30, 2007, compared with 1.13% at December 31, 2006, and 1.12% at June 30, 2006. Management considers the allowance adequate based upon its analysis of the portfolio as of June 30, 2007. However, no assurances can be made that future adjustments to the allowance for loan losses will not be necessary as a result of increases in non-performing loans and other factors.
Throughout the first half of 2007, the Company had excellent experience with charge-offs and recoveries with net charge-offs of $576 thousand and $615 thousand for the second quarter and year-to-date periods, respectively. Net charge-offs for the

- 20 -


Table of Contents

second quarter and the first half of 2007 compare very favorably with the comparable periods in 2006. The lower net charge-offs and improving credit quality metrics led the Company to make no provision for loan losses for the first half of 2007.
Non-interest Income
Non-interest income consists of all revenues which are not included in interest and fee income related to earning assets. Non-interest income for the second quarter of 2007 was $5.55 million compared with $5.52 million in the same period of 2006, an increase of 0.49%. Wealth management revenues increased $273 thousand to $1.01 million, reflective of the additional revenues generated by the IPC acquisition. Service charges on deposit accounts was flat between the comparable quarterly periods, however the Bank had two more branches during the 2006 period. Other service charges, commissions, and fees increased $126 thousand, or 17.72%. Other operating income was $1.01 million, a decrease of $503 thousand compared with 2006. Included in the second quarter 2006 results was the $702 thousand gain on the sale of the Drakes Branch, Virginia, banking office.
Non-interest income for the first half of 2007 was $10.76 million compared with $10.67 million in 2006, an increase of 0.88%. Wealth management revenues increased $608 thousand to $2.02 million, also reflective of the addition of IPC. In the first half of 2007, service charges on deposit accounts were also flat compared to 2006, however the two branches sold were included in the 2006 amount. Other service charges, commissions, and fees increased $256 thousand, or 17.64%. Other operating income was $1.80 million, a decrease of $862 thousand compared with 2006. In addition to the branch sale gain, the first half of 2006 included a $676 thousand partial recovery from a fraud claim that is more than a decade old.
During the second quarter and first half of 2007, securities gains of $30 thousand and $159 thousand, respectively, were realized, compared with a loss of $94 thousand and a gain $66 thousand in the respective comparable periods in 2006.
Non-interest Expense
Non-interest expense totaled $12.08 million for the quarter ended June 30, 2007, decreasing $513 thousand, or 4.08%, from the same period in 2006. Year-to-date non-interest expense totaled $24.23 million compared with $25.92 million for the same period in 2006, a decrease of $1.69 million, or 6.51%. The quarterly and year-to-date decreases are the result of the Company’s continuing efforts to control costs and capture efficiencies available from recent acquisitions and changes in the Company’s organization structure. Those cost control efforts began in earnest in the second quarter of 2006 and focused on consolidation of backroom operations and a reduction of branch staffing levels. The results of those cost control measures are decreases in second quarter and year-to-date salaries and benefits of $617 thousand, or 9.10%, and $2.11 million, or 14.35%, respectively, from the comparable prior year periods. All other operating expenses increased only $104 thousand and $419 thousand between the comparable periods.
Income Tax Expense
Income tax expense is comprised of federal and state current and deferred income taxes on pre-tax earnings of the Company. Income taxes as a percentage of pre-tax income may vary significantly from statutory rates due to items of income and expense which are excluded, by law, from the calculation of taxable income. These items are commonly referred to as permanent differences. The most significant permanent differences for the Company include income on state and municipal securities which are exempt from federal income tax, certain dividend payments which are deductible by the Company, and tax credits generated by investments in low income housing and historic rehabilitations.
For the second quarter of 2007, income taxes were $3.05 million compared with $3.00 million for the second quarter of 2006. For the quarters ended June 30, 2007 and 2006, the effective tax rates were 29.06% and 29.16%, respectively. For the first six months of 2007, income taxes were $6.00 million compared with $5.63 million for the first six months of 2006. For the six-month periods ended June 30, 2007 and 2006, the effective tax rates were 29.16% and 28.48%, respectively. The effective tax rate was higher during the first half 2007 due to slightly lower proportions of tax-free municipal security interest income than in the comparable period of 2006.

- 21 -


Table of Contents

FINANCIAL CONDITION
Total assets at June 30, 2007, increased $134.90 million to $2.17 billion from December 31, 2006, an annualized growth rate of 13.38%. The growth reflects deposit growth, capitalized earnings, and additional borrowings, which were invested in various debt securities.
Securities
Available-for-sale securities were $658.90 million at June 30, 2007, compared with $508.37 million at December 31, 2006, an increase of $150.53 million. The Company has continued to reinvest net paydowns from the loan portfolio through the purchase of state and federal securities, various mortgage-backed securities, and trust-preferred obligations.
Held-to-maturity securities declined to $13.18 million at June 30, 2007, reflective of continuing paydowns, maturities, and calls within the portfolio. The market value of investment securities held-to-maturity was 101.61% and 101.65% of book value at June 30, 2007, and December 31, 2006, respectively.
The Company’s available-for-sale securities portfolio is reported at fair value. The fair value of most securities is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Available-for-sale and held-to-maturity securities are reviewed quarterly for possible other-than-temporary impairment. This review includes an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer and the Company’s intent and ability to hold the security to recovery or maturity. Management does not believe any unrealized loss, individually or in the aggregate, as of June 30, 2007, represents other-than-temporary impairment. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature. Furthermore, the Company believes the decrease in value is attributable to changes in market interest rates and not the credit quality of the issuer.
Loan Portfolio
Loans Held for Sale: The $1.82 million balance of loans held for sale at June 30, 2007, represents mortgage loans that are sold to investors on a best efforts basis. Accordingly, the Company does not retain the interest rate risk involved in the commitment. The gross notional amount of outstanding commitments at June 30, 2007, was $12.44 million on 89 loans.
Loans Held for Investment: Total loans held for investment were $1.24 billion at June 30, 2007, a slight decline from $1.28 billion at December 31, 2006, and $1.32 billion at June 30, 2006. The average loan to deposit ratio decreased to 88.82% for the second quarter of 2007, compared with 92.97% for the fourth quarter of 2006 and 93.06% for the second quarter of 2006. The 2007 year-to-date average loans of $1.26 billion decreased $72.29 million when compared with the average for the first six months of 2006 of $1.33 billion.
The held for investment loan portfolio continues to be diversified among loan types and industry segments. The following table presents the various loan categories and changes in composition as of June 30, 2007, December 31, 2006, and June 30, 2006.
                                                 
    June 30, 2007     December 31, 2006     June 30, 2006  
(Dollars in Thousands)   Amount     Percent     Amount     Percent     Amount     Percent  
Loans Held for Investment
                                               
Commercial and agricultural
  $ 96,835       7.79 %   $ 106,645       8.30 %   $ 108,749       8.25 %
Commercial real estate
    394,418       31.73 %     421,067       32.77 %     434,161       32.92 %
Residential real estate
    498,156       40.07 %     506,370       39.41 %     514,019       38.97 %
Construction
    166,010       13.35 %     158,566       12.34 %     160,685       12.18 %
Consumer
    83,665       6.73 %     88,666       6.90 %     99,018       7.51 %
Other
    3,992       0.33 %     3,549       0.28 %     2,311       0.17 %
 
                                   
Total
  $ 1,243,076       100.00 %   $ 1,284,863       100.00 %   $ 1,318,943       100.00 %
 
                                   
 
                                               
Loans Held for Sale
  $ 1,818             $ 781             $ 1,293          
 
                                         

- 22 -


Table of Contents

Non-Performing Assets
Non-performing assets include loans on non-accrual status, loans contractually past due 90 days or more and still accruing interest, and other real estate owned (“OREO”). Non-performing assets were $3.50 million at June 30, 2007, $4.07 million at December 31, 2006, and $3.91 million at June 30, 2006. The percentage of non-performing assets to total loans, and OREO was 0.28% at June 30, 2007, 0.32% at December 31, 2006, and 0.29% at June 30, 2006.
The following schedule details non-performing assets by category at the close of each of the quarters ended June 30, 2007 and 2006, and December 31, 2006.
                         
(In Thousands)   June 30,     December 31,     June 30,  
    2007     2006     2006  
Non-accrual
  $ 2,910     $ 3,813     $ 2,937  
Ninety days past due and accruing
                 
Other real estate owned
    593       258       910  
 
                 
Total non-performing assets
  $ 3,503     $ 4,071     $ 3,847  
 
                 
 
                       
Restructured loans performing in accordance with modified terms
  $ 256     $ 272     $ 289  
 
                 
At June 30, 2007, non-accrual loans decreased $903 thousand from December 31, 2006, and decreased $27 thousand from June 30, 2006. Ongoing activity within the classification and categories of non-performing loans continues to include collections on delinquencies, foreclosures and movements into or out of the non-performing classification as a result of changing customer business conditions. OREO was $593 thousand at June 30, 2007, and is carried at the lesser of estimated net realizable value or cost.
Deposits and Other Borrowings
Total deposits increased by $27.19 million during the first six months of 2007. Non interest-bearing demand deposits decreased by $3.35 million and interest-bearing demand deposits increased $2.50 million. Savings increased $16.18 million and time deposits increased $11.86 million.
Securities sold under repurchase agreements increased $16.80 million in the first six months of 2007 to $217.99 million. There were no federal funds purchased outstanding at June 30, 2007.
The Company borrowed an additional $100.00 million in FHLB advances during the second quarter. The weighted-average interest rate of the 10-year callable advances is 4.18%. The advances effectively refinanced and lowered the borrowing cost of the federal funds purchased position of $45.00 million at March 31, 2007. The remaining funds were invested in securities and deposited in bank accounts bearing interest rates approximating the target federal funds rate.
Stockholders’ Equity
Total stockholders’ equity increased $3.53 million from December 31, 2006, as the Company continued to balance capital adequacy and returns to stockholders. The increase in equity was due mainly to net earnings of $14.56 million, less dividends paid to stockholders of $6.08 million, net changes of $417 thousand to treasury stock, and other comprehensive loss of $4.36 million.
Risk-based capital guidelines and the leverage ratio measure capital adequacy of banking institutions. Risk-based capital guidelines weight balance sheet assets and off-balance sheet commitments based on inherent risks associated with the respective asset types. At June 30, 2007, the Company’s total capital to risk-weighted assets ratio was 12.81% versus 12.69% at December 31, 2006. The Company’s Tier 1 capital to risk-weighted assets ratio was 11.79% at June 30, 2007, compared with 11.60% at December 31, 2006. The Company’s Tier 1 leverage ratio at June 30, 2007, was 8.36% compared with 8.50% at December 31, 2006. All of the Company’s regulatory capital ratios exceed the current well-capitalized levels prescribed for banks.

- 23 -


Table of Contents

PART I. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Liquidity and Capital Resources
At June 30, 2007, the Company maintained a significant level of liquidity in the form of cash and cash equivalent balances of $74.26 million, investment securities available-for-sale of $658.90 million, and FHLB credit availability of approximately $157.80 million. Cash and cash equivalents as well as advances from the FHLB are immediately available for satisfaction of deposit withdrawals, customer credit needs and operations of the Company. Investment securities available-for-sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. The Company also maintains approved lines of credit with correspondent banks as backup liquidity sources.
The Company maintains a liquidity policy as a means to manage the liquidity risk process and associated risk. The policy includes a Liquidity Contingency Plan (the “Liquidity Plan”) that is designed as a tool for the Company to detect liquidity issues promptly in order to protect depositors, creditors and shareholders. The Liquidity Plan includes monitoring various internal and external indicators such as changes in core deposits and changes in market conditions. It provides for timely responses to a wide variety of funding scenarios ranging from changes in loan demand to a decline in the Company’s quarterly earnings to a decline in the market price of the Company’s stock. The Liquidity Plan calls for specific responses designed to meet a wide range of liquidity needs based upon assessments on a recurring basis by management and the Board of Directors.
Interest Rate Risk and Asset/Liability Management
The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest-earning assets, such as loans and securities, and its interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company, like other financial institutions, is subject to interest rate risk to the degree that interest-earning assets reprice differently than interest-bearing liabilities. The Company manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment.
The Company’s primary component of operational revenue, net interest income, is subject to variation as a result of changes in interest rate environments in conjunction with unbalanced repricing opportunities on earning assets and interest-bearing liabilities. Interest rate risk has four primary components including repricing risk, basis risk, yield curve risk and option risk. Repricing risk occurs when earning assets and paying liabilities reprice at differing times as interest rates change. Basis risk occurs when the underlying rates on the assets and liabilities the institution holds change at different levels or in varying degrees. Yield curve risk is the risk of adverse consequences as a result of unequal changes in the spread between two or more rates for different maturities for the same instrument. Lastly, option risk is due to embedded options, often put or call options, given or sold to holders of financial instruments.
In order to mitigate the effect of changes in the general level of interest rates, the Company manages repricing opportunities and thus, its interest rate sensitivity. The Company seeks to control its interest rate risk exposure to insulate net interest income and net earnings from fluctuations in the general level of interest rates. To measure its exposure to interest rate risk, quarterly simulations of net interest income are performed using financial models that project net interest income through a range of possible interest rate environments including rising, declining, most likely and flat rate scenarios. The simulation model used by the Company captures all earning assets, interest-bearing liabilities and all off-balance sheet financial instruments and combines the various factors affecting rate sensitivity into an earnings outlook. The results of these simulations indicate the existence and severity of interest rate risk in each of those rate environments based upon the current balance sheet position, assumptions as to changes in the volume and mix of interest-earning assets and interest-paying liabilities and management’s estimate of yields to be attained in those future rate environments and rates that will be paid on various deposit instruments and borrowings. These assumptions are inherently uncertain and, as a result, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management’s strategies. However, the earnings simulation model is currently the best tool available to management for managing interest rate risk.
Specific strategies for management of interest rate risk have included shortening the amortized maturity of new fixed-rate loans, increasing the volume of adjustable-rate loans to reduce the average maturity of the Company’s interest-earning assets and monitoring the term structure of liabilities to maintain a balanced mix of maturity and repricing structures to mitigate the potential exposure. Based upon the latest simulation, the Company believes that it has shifted more towards a liability

- 24 -


Table of Contents

sensitive position. Absent adequate management, liability sensitive positions can negatively impact net interest income in a rising rate environment, or alternatively, positively impact net interest income in a declining rate environment.
The Company has established policy limits for tolerance of interest rate risk that allow for no more than a 10% reduction in projected net interest income for the next twelve months based on a comparison of net interest income simulations in various interest rate scenarios. In addition, the policy addresses exposure limits to changes in the economic value of equity according to predefined policy guidelines. The most recent simulation indicates that current exposure to interest rate risk is within the Company’s defined policy limits.
The following table summarizes the projected impact on the next twelve month’s net interest income and the economic value of equity as of June 30, 2007, and December 31, 2006, of immediate and sustained rate shocks in the interest rate environments of plus and minus 100 and 200 basis points from the base simulation, assuming no remedial measures are affected.
Rate Sensitivity Analysis
 
                                 
(Dollars in Thousands)   June 30, 2007  
    Change in             Change in        
Increase (Decrease) in   Net Interest     %     Econcomic Value     %  
Interest Rates (Basis Points)   Income     Change     of Equity     Change  
200
  $ (2,694 )     (3.6 )   $ (45,580 )     (13.7 )
100
    (1,290 )     (1.7 )     (28,510 )     (8.5 )
(100)
    708       1.0       (474 )     (0.1 )
(200)
    86       0.1       (11,332 )     (3.4 )
                                 
    December 31, 2006  
    Change in             Change in        
Increase (Decrease) in   Net Interest     %     Econcomic Value     %  
Interest Rates (Basis Points)   Income     Change     of Equity     Change  
200
  $ (2,006 )     (2.8 )   $ (16,229 )     (5.4 )
100
    (958 )     (1.3 )     (7,453 )     (2.5 )
(100)
    (1,024 )     (1.4 )     (4,301 )     (1.4 )
(200)
    (1,614 )     (2.3 )     (18,278 )     (6.1 )
When comparing the impact of the rate shock analysis between June 30, 2007, and December 31, 2006, the changes in net interest income are minor and reflect management’s trend of positioning the balance sheet more towards a liability sensitive position.
The economic value of equity is a measure which reflects the impact of changing rates of the underlying values of the Company’s assets and liabilities in various rate scenarios. The scenarios illustrate the potential estimated impact of instantaneous rate shocks on the underlying value of equity. The economic value of the equity is based on the present value of all the future cash flows under the different rate scenarios.

- 25 -


Table of Contents

PART I. ITEM 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) along with the Company’s Chief Financial Officer (“CFO”), of the effectiveness of the Company’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (“Exchange Act”) Rule 13a-15(b). Based on that evaluation, the Company’s CEO along with the Company’s CFO concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.
The Company’s management, including the CEO and CFO, does not expect that the Company’s disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.
Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. For management’s assessment over financial reporting, refer to the Company’s Annual Report on Form 10-K, “Management’s Assessment of Internal Control Over Financial Reporting.”

- 26 -


Table of Contents

PART II. OTHER INFORMATION
ITEM 1.   Legal Proceedings
The Company is currently a defendant in various legal actions and asserted claims in the normal course of business. While the Company and legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, they are of the belief that the resolution of these actions should not have a material adverse affect on the financial position, results of operations, or cash flows of the Company.
ITEM 1A.   Risk Factors
There were no material changes to the risk factors as presented in the Company’s annual report on Form 10-K for the year ended December 31, 2006.
ITEM 2.   Unregistered Sales of Equity Securities and Use of Proceeds
  (a)   Not Applicable
 
  (b)   Not Applicable
 
  (c)   Issuer Purchases of Equity Securities
The following table sets forth open market purchases by the Company of its equity securities during the three months ended June 30, 2007.
                                 
                            Maximum  
                    Total Number of     Number of  
    Total # of     Average     Shares Purchased     Shares That May  
    Shares     Price Paid     as Part of Publicly     Yet be Purchased  
    Purchased     per Share     Announced Plan     Under the Plan  
April 1-30, 2007
        $             322,284  
May 1-31, 2007
    37,200       31.63       37,200       301,448  
June 1-30, 2007
    18,000       30.70       18,000       283,448  
 
                         
Total
    55,200     $ 31.33       55,200          
 
                         
The Company’s stock repurchase plan, as amended, allows the purchase and retention of up to 550,000 shares. The plan has no expiration date and remains open. The Company held 266,552 shares in treasury at June 30, 2007.
ITEM 3.   Defaults Upon Senior Securities
Not Applicable
ITEM 4.   Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on April 24, 2007. Three proposals were voted upon at the annual meeting and the results were disclosed in the Quarterly Report on Form 10-Q for the period ended March 31, 2007, filed on May 10, 2007, which is incorporated herein by reference.
ITEM 5.   Other Information
Not Applicable

- 27 -


Table of Contents

Item 6.   Exhibits
     (a) Exhibits
         
Exhibit No.       Exhibit
 
3(i)
    Articles of Incorporation of First Community Bancshares, Inc., as amended. (1)
 
       
3(ii)
    Bylaws of First Community Bancshares, Inc., as amended. (17)
 
       
4.1
    Specimen stock certificate of First Community Bancshares, Inc. (3)
 
       
4.2
    Indenture Agreement dated September 25, 2003. (11)
 
       
4.3
    Amended and Restated Declaration of Trust of FCBI Capital Trust dated September 25, 2003. (11)
 
       
4.4
    Preferred Securities Guarantee Agreement dated September 25, 2003. (11)
 
       
 
       
10.1
    First Community Bancshares, Inc. 1999 Stock Option Contracts (2) and Plan. (4)
 
       
10.1.1
    Amendment to First Community Bancshares, Inc. 1999 Stock Option Plan. (11)
 
       
10.2
    First Community Bancshares, Inc. 2001 Non-Qualified Directors Stock Option Plan. (5)
 
       
10.3
    Employment Agreement dated January 1, 2000 and amended October 17, 2000, between First Community Bancshares, Inc. and John M. Mendez. (2) (6)
 
       
10.4
    First Community Bancshares, Inc. 2000 Executive Retention Plan, as amended. (4)
 
       
10.5
    First Community Bancshares, Inc. Split Dollar Plan and Agreement. (4)
 
       
10.6
    First Community Bancshares, Inc. 2001 Directors Supplemental Retirement Plan. (2)
 
       
10.6.1
    First Community Bancshares, Inc. 2001 Directors Supplemental Retirement Plan. Second Amendment (B.W. Harvey, Sr. – October 19, 2004). (14)
 
       
10.7
    First Community Bancshares, Inc. Wrap Plan. (7)
 
       
10.8
    Employment Agreement between First Community Bancshares, Inc. and J. E. Causey Davis. (8)
 
       
10.9
    Form of Indemnification Agreement between First Community Bancshares, its Directors and Certain Executive Officers. (9)
 
       
10.10
    Form of Indemnification Agreement between First Community Bank, N. A, its Directors and Certain Executive Officers. (9)
 
       
10.11
    Reserved.
 
       
10.12
    First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan (10) and Award Agreement. (13)
 
       
10.13
    Reserved.
 
       
10.14
    First Community Bancshares, Inc. Directors Deferred Compensation Plan. (7)
 
       
10.15
    First Community Bancshares, Inc. Deferred Compensation and Supplemental Bonus Plan For Key Employees. (15)
 
       
31.1
    Rule 13a-14(a)/a5d-14(a) Certification of Chief Executive Officer
 
       
31.2
    Rule 13a-14(a)/a5d-14(a) Certification of Chief Financial Officer
 
       
32
    Certification of Chief Executive Officer and Chief Financial Officer Section 1350.

- 28 -


Table of Contents

 
(1)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended March 31, 2007, filed on May 10, 2007.
 
(2)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002.
 
(3)   Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2002, filed on March 25, 2003, as amended on March 31, 2003.
 
(4)   Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 1999, filed on March 30, 2000, as amended April 13, 2000.
 
(5)   The option agreements entered into pursuant to the 1999 Stock Option Plan and the 2001 Non-Qualified Directors Stock Option Plan are incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002.
 
(6)   First Community Bancshares, Inc. has entered into substantially identical agreements with Robert L. Buzzo and E. Stephen Lilly, with the only differences being with respect to title, salary and the use of a vehicle.
 
(7)   Incorporated by reference from Item 1.01 of the Current Report on Form 8-K dated August 22, 2006, and filed August 23, 2006.
 
(8)   Incorporated by reference from S-4 Registration Statement filed on March 28, 2003. The Company has entered into a substantially identical contract with Phillip R. Carriger dated March 31, 2004.
 
(9)   Form of indemnification agreement entered into by the Corporation and by First Community Bank, N. A. with their respective directors and certain officers of each including, for the Registrant and Bank: John M. Mendez, Robert L. Schumacher, Robert L. Buzzo, E. Stephen Lilly, and David D. Brown. Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2003, filed on March 15, 2004, and amended on May 19, 2004.
 
(10)   Incorporated by reference from the 2004 First Community Bancshares, Inc. Definitive Proxy filed on March 19, 2004.
 
(11)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended September 30, 2003, filed on November 10, 2003.
 
(12)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed on May 7, 2004.
 
(13)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on August 6, 2004.
 
(14)   Incorporated by reference from the Annual Report on Form 10-K for the period ended December 31, 2004, and filed on March 16, 2005. Amendments in substantially similar form were executed for Directors Clark, Kantor, Hamner, Modena, Perkinson, Stafford, and Stafford II.
 
(15)   Incorporated by reference from Item 1.01 of the Current Report on Form 8-K dated October 24, 2006, and filed October 25, 2006.
 
(16)   Reserved.
 
(17)   Incorporated by reference from the Quarterly Report on Form 10-Q for the period ended September 30, 2006, filed on November 8, 2006.
 
(18)   Reserved.

- 29 -


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
First Community Bancshares, Inc.
DATE: August 8, 2007
     
/s/ John M. Mendez
 
   
John M. Mendez
   
President & Chief Executive Officer
   
(Principal Executive Officer)
   
DATE: August 8, 2007
     
/s/ David D. Brown
 
David D. Brown
   
Chief Financial Officer
   
(Principal Accounting Officer)
   

- 30 -


Table of Contents

Index to Exhibits
     
Exhibit No.   Exhibit
 
31.1
  Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
 
   
31.2
  Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
 
   
32
  Certification of Chief Executive and Chief Financial Officer pursuant to 18 USC Section 1350

- 31 -