SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2002 Commission File Number 1-15773 NBC Capital Corporation (Exact name of registrant as specified in its charter) Mississippi 64-0694775 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) NBC Plaza, Starkville, Mississippi 39759 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (662) 323-1341 Securities registered pursuant to Section 12(b) of the Act: Title of each class: Common stock, $1 par value Name of each exchange on which registered: American Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. ( ) Aggregate market value of the voting stock held by nonaffiliates as of February 14, 2003, was approximately: $157,964,207 ___________________________ (based on most recent sale) Indicate the number of shares outstanding of each of the issuers' classes of common stock as of the latest practicable date: Common Stock, $1 par value - 8,182,878 shares outstanding as of February 14, 2003. Documents incorporated by reference - Portions of the Proxy Statement dated April 10, 2003 are incorporated by reference into Part III. FORM 10-K INDEX Part I ______ Item 1. Business Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders Part II _______ Item 5. Market for the Company's Common Stock and Related Shareholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7.A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Matters Part III ________ Item 10. Directors and Executive Officers of the Company Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions Part IV _______ Item 14. Controls and Procedures Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K PART I ______ ITEM 1 - BUSINESS Forward Looking Statements From time to time, NBC Capital Corporation (the Company) may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performances, development and results of the Company's business include, but are not limited to, the following: risks from changes in economic and industry conditions; changes in interest rates; risks inherent in making loans including repayment risks and value of collateral; dependence on senior management; and recently-enacted or proposed legislation. Statements contained in this filing regarding the demand for the Company and its subsidiaries' products and services, changing economic conditions, interest rates, and numerous other factors, may be forward-looking statements and are subject to uncertainties and risks. The Corporation undertakes no obligation to update or revise any forward-looking statements, whether as a result of changes in actual results, changes in assumptions or other factors affecting such statements. NBC Capital Corporation The Company is a financial holding company which was organized under the laws of the State of Mississippi. On July 2, 1984, the Company acquired all of the outstanding common stock of the National Bank of Commerce (NBC), a national banking corporation. For the year ended December 31, 2002, the Company's subsidiaries accounted for approximately 99% of the Company's consolidated income and consolidated expenses. National Bank of Commerce NBC was originally formed through a series of mergers which began in 1972 and concluded on October 1, 1974. In March, 1991, NBC acquired the assets and assumed the liabilities of the Bank of Philadelphia. In 1994, the Company acquired NBC of Tuscaloosa (formerly First State Bank of Tuscaloosa). On December 31, 1998, the Company acquired all the outstanding common stock of First National Corporation of West Point ("FNC") in exchange for 864,736 shares of the Company's common stock. The acquisition was accounted for as a pooling of interest. FNC was merged into the Company and FNC's wholly-owned subsidiary banks, First National Bank of West Point and National Bank of the South, were merged into NBC. Concurrently, the Company's subsidiary, NBC of Tuscaloosa, was merged into NBC (formerly NBC of Mississippi). As a result of the acquisition and reorganization, NBC was the resulting financial institution. Also, First National Finance Company, a wholly-owned finance company subsidiary of FNC became a wholly-owned subsidiary of the Company. On August 31, 1999, the Company acquired all the outstanding stock of FFBS Bancorp, Inc. (FFBS). FFBS was the holding company of its wholly-owned savings bank, First Federal Bank for Savings (First Federal), Columbus, Mississippi. The Company exchanged 1,396,162 shares of its common stock and a nominal amount of cash in lieu of fractional shares for each common share of FFBS. First Federal was merged into NBC with NBC as the surviving institution. The transaction was accounted for as a pooling of interests and historical financial statements of the Company were restated to give effect of the acquisition. On September 30, 1999, NBC acquired the insurance agencies of Galloway-Wiggers Insurance Agency, Inc., Kyle Chandler Insurance Agency, Inc., Galloway-Chandler-McKinney, Inc., and Napier Insurance Agency, Inc. NBC exchanged 173,184 of the Company's common stock for all of the issued and outstanding stock of the insurance agencies. The insurance agencies were combined into a wholly-owned subsidiary of NBC, Galloway-Chandler-McKinney Insurance Agency, Inc. (GCM). The acquisition was accounted for as a pooling of interests. The historical financial statements of the Company were not restated as the changes would have been immaterial. On April 28, 2000, GCM acquired Heritage Insurance Agency, Ltd., an independent insurance agency located in Starkville, Mississippi, for $47,025 in cash and 14,028 shares of the Company's common stock. The acquisition was accounted for as a purchase. NBC is the largest commercial bank domiciled in the north central area of the state known as the Golden Triangle. A total of twenty-seven banking facilities and an operation/administration center serves the communities of Aberdeen, Amory, Brooksville, Caledonia, Columbus, Hamilton, Maben, New Hope, Philadelphia, West Point and Starkville. This area extends into six Mississippi counties with a radius of approximately 65 miles from the home office in Starkville. The Bank also serves the Tuscaloosa, Alabama, area with a main office and four branch locations. NBC is engaged in the general banking business and activities closely related to banking as authorized by the banking laws and regulations of the United States. There were no significant changes in the business activities of NBC during 2002. NBC provides a complete line of wholesale and retail services including mortgage loans and trusts. The customer base is well diversified and consists of business, industry, agriculture, government, education and individual accounts. Profitability and growth have been consistent throughout the history of the bank. NBC utilizes a written Asset/Liability Management Policy which calls for a static gap position of no more than a plus or minus 10% of aggregate assets over a 24-month period. There has been no disposition of any material amounts of assets nor has there been a material change in the mode of conducting business. No major changes in operations are planned for the near future. NBC Service Corporation NBC Service Corporation (Service) is a wholly-owned subsidiary of NBC and was formed to provide additional financial services that otherwise might not be provided by NBC. For the years 2002 and 2001, its primary activity was limited to its investment in Commerce National Insurance Company (CNIC) of which Service owns 79%. Commerce National Insurance Company is a credit life insurance company whose primary source of income is from premiums on credit life insurance on loans issued by NBC. For the year 2002, NBC discontinued credit life insurance on loans. As a result, plans are for CNIC to be dissolved and liquidated in 2003. Galloway-Chandler-McKinney Insurance Agency, Inc. Galloway-Chandler-McKinney Insurance Agency, Inc. (GCM) is a wholly-owned subsidiary of NBC. GCM operates as an independent insurance agency with its primary source of revenue coming from commissions and premiums on the sale of property and casualty insurance, title insurance, life insurance, annuities, and other commercial lines. GCM is the result of the insurance agencies acquired on September 30, 1999, and April 28, 2000, as previously described. GCM has locations in Columbus, West Point, Amory, Starkville, and Aberdeen, Mississippi. At December 31, 2002, GCM had total assets of approximately $3.0 million, and for the year ended December 31, 2002, reported gross revenues of approximately $4.1 million. NBC Insurance Services of Alabama, Inc. NBC Insurance Services of Alabama is a wholly-owned subsidiary of NBC and was formed in 1999 for the purpose of selling annuity products in the State of Alabama. For the years ended December 31, 2002 and 2001, its activities were not significant. First National Finance First National Finance (Finance), a wholly-owned subsidiary of the Company, is a finance company that provides lending and financing services to consumers. It engages in consumer financing, and its loans are of a smaller amount and a higher interest rate than those of NBC. Its loan portfolio totaled approximately $640,000 at December 31, 2002. Finance is located in West Point, Mississippi. Finance was acquired as part of the FNC acquisition previously mentioned. Competition NBC and its subsidiaries currently serve six counties and eleven municipalities in North Central Mississippi. Over this same area, the bank competes directly with numerous competing banking institutions, credit unions, finance companies, brokerage firms, mortgage companies and insurance companies. The competing banking institutions range in asset size from approximately $270 million to in excess of $40 billion. NBC is the largest bank domiciled in its immediate service area. Asset size of competitive banks is that of the parent bank and not the branch. Several other competitors are branches or divisions of nationwide and regional companies with more resources than the Company and its subsidiaries. NBC also serves the City of Tuscaloosa, Alabama, with a main office and four branch locations. The bank competes with approximately eight other financial institutions, most of which are larger. The other institutions range in size from approximately $90 million to $45 billion. Asset size of the competitive banks is that of the parent bank and not of the branch. In Tuscaloosa, NBC also competes with numerous credit unions, finance companies, etc., many of which are branches of nationwide companies. Supervision and Regulation The Company and its subsidiary bank are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. These laws and regulations are generally intended to protect depositors, not shareholders. To the extent that the following summary describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company. Beginning with the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and following with Federal Deposit Insurance Corporation Improvement Act (FDICIA), which was enacted in 1991, numerous additional regulatory requirements have been placed on the banking industry, and additional changes have been proposed. The operations of the Company and its subsidiaries may be affected by legislative changes and the policies of various regulatory authorities. The Company is unable to predict the nature or the extent of the effect on its business and earnings that fiscal or monetary policies, economic control, or new federal or state legislation may have in the future. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the Act) and a financial holding company under the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB Act") and is registered as such with the Board of Governors of the Federal Reserve System (the Federal Reserve Board). As a financial holding company, the Company is required to file with the Federal Reserve Board an annual report and such other information as may be required. The Federal Reserve Board also performs examinations of the Company. In addition, the Federal Reserve Board has the authority to regulate provisions of certain holding company debt. The Act restricts the Company's nonbanking activities to those which are determined by the Federal Reserve Board to be financial in nature, incidental to such financial activity, or complementary to a financial activity. The Act does not place territorial restrictions on the activities of nonbank subsidiaries of holding companies. The Company's banking subsidiaries are subject to limitations with respect to transactions with affiliates. The Act requires every holding company to obtain the prior approval of the Federal Reserve Board before acquiring substantially all the assets of or direct or indirect ownership or control of more than 5% of the voting shares of any bank which is not already majority-owned. The Act also prohibits a holding company, with certain exceptions, from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities. One of the principal exceptions to these prohibitions is for engaging in or acquiring shares of a company engaged in activities found by the Federal Reserve Board by order or regulation to be so closely related to banking or managing banks as to be a proper incident thereto. The Act permits the acquisition by a holding company of more than 5% of the outstanding voting shares of a bank located outside the state in which the operations of its banking subsidiaries are principally conducted, subject to certain state laws, including the establishment by states of a minimum age of their local banks before such banks can be acquired by an out-of-state institution. The Act and regulations of the Federal Reserve Board also prohibit a holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit or provision of any property or services. In addition, and subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act require Federal Reserve approval prior to any person or company acquiring "control" of a holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns a greater percentage of that class of voting securities immediately after the transaction. In accordance with Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the subsidiaries. The Federal Reserve Board may require a holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve Board's determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the holding company. Further, federal bank regulatory authorities have additional discretion to require a holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution's financial condition. Dividends paid by the Company are substantially provided from dividends from NBC. Generally, the approval of the OCC is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. In March, 2001, NBC obtained approval to pay a dividend of $24.2 million to the Company which was used to acquire 976,676 shares of the Company's common stock from its largest stockholder and related parties. For the year 2003, NBC has available approximately $7.1 million plus its net income for that year to pay as dividends. The Federal Reserve Board, FDIC and OCC have established risk-based capital guidelines for holding companies, such as the Company, and its subsidiary bank. The capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." The Company's strategy related to risk-based capital is to maintain capital levels which will be sufficient to qualify the Company's bank subsidiary for the "well capitalized" category under the guidelines set forth by the FDICIA. Maintaining capital ratios at the "well capitalized" level avoids certain restrictions which, for example, could impact the Company's bank subsidiary's FDIC assessment, trust services and asset/liability management. At December 31, 2002, the Tier 1 and total capital ratios, respectively, of the Company (consolidated) and NBC (individually) were well above the minimum 6% and 10% levels required to be categorized as a "well capitalized" insured depository institution. The FDIC, OCC and Federal Reserve Board have historically had common capital adequacy guidelines involving minimum (a) leverage capital and (b) risk-based capital requirements: (a) The first requirement establishes a minimum ratio of capital as a percentage of total assets. The FDIC, OCC and Federal Reserve Board require institutions to maintain a minimum leverage ratio of Tier 1 capital (as defined) to total average assets based on the institution's rating under the regulatory CAMELS rating system. Institutions with CAMELS ratings of one that are not anticipating or experiencing significant growth and have well-diversified risk are required to maintain a minimum leverage ratio of 3 percent. An additional 100 to 200 basis points are required for all but these most highly rated institutions. At December 31, 2002, the Company's leverage capital ratio was 9.9%. (b) The second requirement also establishes a minimum ratio of capital as a percentage of total assets, but gives weight to the relative risk of each asset. The FDIC, OCC and Federal Reserve Bank require institutions to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 3.0 percent. Banks must also maintain a minimum ratio of total capital to risk-weighted assets of 8.0 percent. At December 31, 2002, the Company's Tier 1 and total capital ratios were 16.5% and 17.4%, respectively. The primary supervisory authority of NBC is the OCC. The OCC regulates or monitors virtually all areas of operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The OCC also imposes limitations on the aggregate investment in real estate, bank premises, and furniture and fixtures. In addition to regular examinations, the institution must furnish to its regulator quarterly reports containing a full and accurate statement of its affairs. Banks are subject to the provisions of Section 23A of the Federal Reserve Act, which place limits on the amount of loans or extensions of credit to, or investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the bank's capital and surplus and, as to all affiliates combined, to 20% of the bank's capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. Compliance is also required with certain provisions designed to avoid the taking of low quality assets. Banks are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with non-affiliated companies. The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The GLB Act was signed into law in November, 1999, and allows banks to engage in a wider range of nonbanking activities, including greater authority to engage in securities and insurance activities through the use of "financial holding companies." The expanded powers, which became effective March 11, 2000, generally are available to banks only if the bank and its bank subsidiaries remain well-capitalized and well-managed, and have a satisfactory CRA rating. Under the GLB Act, a national bank may engage in expanded financial activities through a "financial subsidiary," provided the aggregate assets of all of its financial subsidiaries do not exceed the lesser of 45 percent of the bank's assets or $50 billion. A financial subsidiary may underwrite any financial product other than insurance and may sell any financial product, including title insurance. A national bank itself may not sell title insurance, however, unless the state in which the bank is located permits state banks to sell title insurance. National banks are required by the National Bank Act to adhere to branch office banking law. NBC may open branches throughout Mississippi or Alabama with the prior approval of the OCC. In addition, with prior regulatory approval, the subsidiary bank is able to acquire existing banking operations in Mississippi and Alabama. Furthermore, federal legislation permits interstate branching. The law also permits out of state acquisitions by bank holding companies (subject to veto by new state law), interstate branching by banks if allowed by state law, interstate merging by banks, and de novo branching by national banks if allowed by state law. Effective June 1, 1997, the Interstate Banking Act allows banks with different home states to merge, unless a particular state opts out of the statute. In addition, beginning June 1, 1997, the Interstate Banking Act permitted national and state banks to establish de novo branches in another state if there is a law in that state which applies equally to all banks and expressly permits all out-of-state banks to establish such branches. The Community Reinvestment Act (CRA) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC, or the OCC shall evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Interest and certain other charges collected or contracted by Banks are often subject to state usuary laws and certain federal laws concerning interest rates. The loan operations are also subject to certain federal laws applicable to credit transactions. These include but are not limited to the federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution will be fulfilling its obligation to help meet the housing needs of the community it serves; the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations also are subject to certain laws and regulations, included but not limited to, the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, and the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that act, which governs automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services. A subsidiary bank of a holding company is subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the holding company or its subsidiary, on investments in stock or other securities thereof and on the taking of such stock or securities as collateral for loans to any borrower. NBC is a member of the FDIC and its deposits are insured as provided by law. CNIC, GCM, and NBC Insurance Services of Alabama, Inc. are subject to regulation by the applicable state agencies. These agencies set reserve requirements, reporting standards, and establish regulations, all of which affect business operations. On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act"). The USA Patriot Act broadened anti-money laundering requirements on financial institutions, including national banks such as NBC. Among its provisions, the USA Patriot Act requires a financial institution: (i) to establish an anti-money laundering program, (ii) to establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks and (iii) to avoid establishing, maintaining, administering or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the USA Patriot Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. The federal banking agencies have begun proposing and implementing regulations interpreting the USA Patriot Act. It is not anticipated that the USA Patriot Act will have a significant impact on the financial condition or results of operations of NBC. The Company's common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently, the Company is subject to the information, proxy solicitation, insider trading, and other restrictions and requirements of the SEC under the Exchange Act. On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), which attempts to strengthen the independence of public company auditors by, among other things, (i) prohibiting public company auditors from providing certain non-audit services to their audit clients, (ii) requiring a company's audit committee to preapprove all audit and non-audit services being provided by its independent auditor, (iii) requiring the rotation of audit partners and (iv) prohibiting an auditor from auditing a client that has as its chief executive officer, chief financial officer, chief accounting officer or controller a person that was employed by the auditor during the previous year. The Sarbanes-Oxley Act also seeks to enhance the responsibility of corporate management by, among other things, (i) requiring the chief executive officer and chief financial officer of public companies to provide certain certifications in their periodic reports regarding the accuracy of the periodic reports filed with the Securities and Exchange Commission, (ii) prohibiting officers and directors of public companies from fraudulently influencing an accountant engaged in the audit of the company's financial statements, (iii) requiring chief executive officers and chief financial officers to forfeit certain bonuses in the event of a misstatement of financial results, (iv) prohibiting officers and directors found to be unfit from serving in a similar capacity with other public companies, and (v) prohibiting officers and directors from trading in the company's equity securities during pension blackout periods. In addition, public companies with securities listed on a national securities exchange or association must satisfy the following additional requirements: (i) the company's audit committee must appoint and oversee the company's auditors; (ii) each member of the company's audit committee must be independent; (iii) the company's audit committee must establish procedures for receiving complaints regarding accounting, internal accounting controls and audit-related matters; (iv) the company's audit committee must have the authority to engage independent advisors; and (v) the company must provide appropriate funding to its audit committee, as determined by the audit committee. The Sarbanes-Oxley Act contains several provisions intended to enhance the quality of financial disclosures of public companies, including provisions that (i) require that financial disclosures reflect all material correcting adjustments identified by the company's auditors, (ii) require the disclosure of all material off-balance sheet transactions, (iii) require the Securities and Exchange Commission to issue rules regarding the use by public companies of pro forma financial information, (iv) with certain limited exceptions, including an exception for financial institutions making loans in compliance with federal banking regulations, prohibit public companies from making personal loans to its officers and directors, (v) with certain limited exceptions, require directors, officers and principal shareholders of public companies to report changes in their ownership in the company's securities within two business days of the change, (vi) require a company's management to provide a report of its assessment of the internal controls of the company in its annual report, (vii) require public companies to adopt codes of conduct for senior financial officers and (viii) require companies to disclose whether the company's audit committee has a financial expert as a member. The Sarbanes-Oxley Act imposes criminal liability for certain acts, including altering documents involving federal investigations, bankruptcy proceedings, corporate audits and increases the penalties for certain offenses, including mail and wire fraud. In addition, the Sarbanes-Oxley Act gives added protection to corporate whistle-blowers. While certain provisions of the Sarbanes-Oxley Act have already become effective, many provisions in the Sarbanes-Oxley Act will become effective over the course of 2003. Although the Company anticipates that it will incur additional expense in complying with the provisions of the Sarbanes- Oxley Act and the regulations promulgated by the Securities and Exchange Commission thereunder, the Company does not expect that such compliance will have a material impact on the Company's financial condition or results of operations. Governmental Monetary Policies As a bank chartered under the laws of the United States, NBC is a member of the Federal Reserve System. Its earnings are affected by the fiscal and monetary policies of the Federal Reserve System which regulates the national money supply in order to mitigate recessionary and inflationary pressures. The techniques used by the Federal Reserve System include setting the reserve requirements of depository institutions and establishing the discount rate on member bank borrowings. The Federal Reserve System also conducts open market operations in United States Government securities. The policies of the Federal Reserve System and other regulatory agencies have a direct effect on the amount of bank loans and deposits, and the interest rates charged and paid thereon. While the impact these policies may have upon the future business and earnings of the financial institutions cannot be accurately predicted, such policies can materially affect the earnings of commercial banks. Critical Accounting Policies The most significant accounting policies followed by the Company are presented in Note A to the consolidated financial statements. The allowance for loan losses is based upon management's assessment of the probable loan losses inherent in the loan portfolio and, as such, is considered a critical accounting policy. The determination of the allowance requires significant judgment and is based upon various factors, many of which are subjective. Note A to the consolidated financial statements discloses the methodology used by management to determine the allowance. Sources and Availability of Funds The materials essential to the business of the Company and its subsidiaries consist primarily of funds derived from deposits and other borrowings in the financial markets. The availability of funds is primarily dependent upon the economic policies of the government, the economy in general and the institution's ability to compete in the market place. Seasonability Neither the Company nor any of its subsidiaries are dependent upon any seasons. Dependence Upon A Single Customer Neither the Company nor any of its subsidiaries are dependent upon a single customer or any small group of customers. Executive Officers The executive officers of the Company and its bank subsidiary, NBC, are listed below. The title indicates a position held in the Company and the bank. Name and Title Age Five Year Experience _____________________________ ___ ____________________________________ L. F. Mallory, Jr. 60 Chairman and Chief Executive Officer, Chairman and Chief Executive NBC Capital Corporation and NBC Officer, NBC Capital Corporation and NBC Mark A. Abernathy 46 President and Chief Operating Officer, President and Chief NBC Capital Corporation and NBC Operating Officer, NBC Capital Corporation and NBC Hunter M. Gholson 70 Secretary of NBC Capital Corporation Secretary and NBC Richard T. Haston 56 Executive Vice President, Chief Executive Vice President, Financial Officer, and Treasurer, CFO, and Treasurer, NBC NBC Capital Corporation, and Capital Corporation and Executive Vice President and Executive Vice President Chief Financial Officer, NBC and CFO, NBC Bobby L. Harper 61 Chairman of Executive Committee, NBC Chairman of the Executive Capital Corporation and NBC. Committee, NBC Capital Columbus Regional Bank President, Corporation and NBC and NBC since September, 2002; Columbus Regional Bank Executive Vice President, Banking President, NBC Center Administration, NBC January, 1999 - September, 2002; President of NBC Columbus Banking Center from January, 1981 - January, 1999 Tommy M. Tomlinson 49 Vice President, NBC Capital Vice President, NBC Capital Corporation since January, 1999. Corporation and Starkville Starkville Regional Bank Regional Bank President, NBC President, NBC, since September, 2002; Executive Vice President, Credit Administration, NBC, from January, 1999 - September, 2002; Executive Vice President and Senior Credit Officer of the Starkville Banking Center, NBC from January, 1996 - December, 1998 Thomas J. Prince, Jr. 61 Vice President, NBC Capital Vice President, NBC Capital Corporation and Executive Vice Corporation and Executive President, Division Manager of Vice President, Division Consumer Financial Service, NBC, Manager of Consumer Financial since April, 1998; President, Services NBC NBC Aberdeen Banking Center from January, 1985 - April, 1998 Donald J. Bugea, Jr. 49 Vice President, NBC Capital Vice President, NBC Capital Corporation and Executive Vice Corporation and Executive President and Investment Vice President and Investment Officer, NBC Officer, NBC John R. Davis 47 Vice President, NBC Capital Vice President, NBC Capital Corporation and Senior Vice Corporation and Senior Vice President and Trust Officer, President and Trust Officer, NBC since January, 1999, Vice NBC President and Trust Officer of NBC from January, 1991 - December, 1998 Clifton B. Fowler 54 Vice President, NBC Capital Vice President, NBC Capital Corporation, Executive Vice Corporation and Executive President, Commercial Banking Vice President, Commercial of NBC in 2002; previously Banking, NBC President, NBC Starkville Banking Center Marcus Mallory 35 Vice President, NBC Capital Vice President, NBC Capital Corporation and Executive Vice Corporation and Executive President, Credit Administration, Vice President, Credit NBC since August, 2002; Senior Administration, NBC Vice President, Senior Credit Officer, NBC Columbus Banking Center from June, 1997 - September, 2002 Terry Jones 57 Vice President, NBC Capital Vice President, NBC Capital Corporation, Chief Information Corporation, Chief Officer, NBC since December, Information Officer, NBC 2001, Senior Vice President, Chief Information Officer, NBC, from January, 2000 - August, 2002; Senior Vice President, Director of Information Systems, NBC, from June, 1997 - January, 2000 Personnel At December 31, 2002, NBC had approximately 430 full-time employees, Finance had 3 full-time employees and GCM had approximately 44 full-time employees. The Company, Service, and CNIC had no employees at December 31, 2002. ITEM 2 - PROPERTIES The Company, Service and CNIC owned no properties at December 31, 2002. GCM and Finance operate out of leased office buildings. The following listing describes the locations and general character of the Bank-owned properties: Approximate Office Space Type Location (Square Feet) ______________________________ _________________________ _____________ NBC: Main Office Starkville, Mississippi 35,000 University Branch Starkville, Mississippi 1,485 Motor Branch Starkville, Mississippi 2,000 Operations Center Starkville, Mississippi 26,000 Starkville Crossing Starkville, Mississippi 2,000 Main Office Columbus, Mississippi 36,000 Mortgage Loan Center Columbus, Mississippi 14,000 North Columbus Branch Columbus, Mississippi 1,440 Fairlane Branch Columbus, Mississippi 2,400 Bluecutt Road Branch Columbus, Mississippi 3,200 New Hope Branch New Hope, Mississippi 1,500 Caledonia Branch Caledonia, Mississippi 1,000 Main Office Aberdeen, Mississippi 11,026 Maple Street Branch Aberdeen, Mississippi 998 Highway 45 North Branch Aberdeen, Mississippi 1,205 Main Office Amory, Mississippi 8,550 Medical and Industrial Center Branch Amory, Mississippi 950 Main Office Brooksville, Mississippi 3,000 Main Office Hamilton, Mississippi 1,800 Main Office Maben, Mississippi 4,000 Main Office Philadelphia, Mississippi 6,000 Northside Branch Philadelphia, Mississippi 300 Southside Branch Philadelphia, Mississippi 450 Westside Branch Philadelphia, Mississippi 3,250 Main Office Tuscaloosa, Alabama 30,000 Northport Branch Tuscaloosa, Alabama 3,018 University Branch Tuscaloosa, Alabama 2,480 North Tuscaloosa Branch Tuscaloosa, Alabama 3,250 Highway 69 South Branch Tuscaloosa, Alabama 2,000 Main Office West Point, Mississippi 18,000 East Main Branch West Point, Mississippi 1,900 Highway 45 South Branch West Point, Mississippi 1,520 Highway 45 North Branch West Point, Mississippi 825 In the opinion of management, all properties are in good condition and are adequate to meet the needs of the communities they serve. ITEM 3 - LEGAL PROCEEDINGS There are no pending proceedings of a material nature to which the Company, or its subsidiaries, are a party. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II _______ ITEM 5 - MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS (a) Reference is made to Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, under the caption, "Market Information." (b) At December 31, 2002, the Company had 2,627 security holders. (c) Dividends on common stock were declared quarterly in 2002 and 2001 and totaled as follows: (In thousands) December 31, ______________ 2002 2001 ______ ______ Dividends declared, $.87 per share $7,123 $ - Dividends declared, $.82 per share - 6,998 ______ ______ $7,123 $6,998 ====== ====== Also, in the year 2002, the Company declared a 4-for-3 stock split accounted for as a stock dividend. All per share information has been restated to reflect the stock split. ITEM 6 - SELECTED FINANCIAL DATA Years Ended December 31, 2002 2001 2000 1999 1998 __________ __________ __________ ________ ________ (In thousands, except per share data) INCOME DATA Interest and fees on loans $ 40,022 $ 51,852 $ 57,535 $ 52,219 $ 52,955 Interest and dividends on securities 19,814 17,968 14,052 12,430 13,416 Other interest income 215 950 1,148 2,440 1,953 __________ __________ __________ ________ ________ Total interest income 60,051 70,770 72,735 67,089 68,324 Interest expense 22,876 36,001 34,978 30,998 32,744 __________ __________ __________ ________ ________ Net interest income 37,175 34,769 37,757 36,091 35,580 Provision for loan losses 2,790 1,720 1,280 1,769 3,187 __________ __________ __________ ________ ________ Net interest income after provision for loan losses 34,385 33,049 36,477 34,322 32,393 __________ __________ __________ ________ ________ Service charges on deposit accounts 7,110 5,942 5,306 5,230 4,720 Other income 10,936 10,524 8,456 7,824 4,871 __________ __________ __________ ________ ________ Total noninterest income 18,046 16,466 13,762 13,054 9,591 __________ __________ __________ ________ ________ Salaries and employee benefits 19,827 18,156 17,260 17,545 16,024 Occupancy and equipment expense 4,728 4,616 4,539 4,213 3,778 Other expenses 8,863 9,344 9,118 12,211 9,299 __________ __________ __________ ________ ________ Total noninterest expenses 33,418 32,116 30,917 33,969 29,101 __________ __________ __________ ________ ________ Income before income taxes 19,013 17,399 19,322 13,407 12,883 Income taxes 4,792 4,261 5,277 2,899 2,881 __________ __________ __________ ________ ________ Net income $ 14,221 $ 13,138 $ 14,045 $ 10,508 $ 10,002 ========== ========== ========== ======== ======== PER SHARE DATA (1) Net income - basic $ 1.73 $ 1.54 $ 1.47 $ 1.10 $ 1.07 Net income - diluted 1.73 1.54 1.47 1.10 1.06 Dividends .87 .82 .73 .65 .55 FINANCIAL DATA Total assets $1,077,456 $1,050,802 $1,009,515 $973,570 $937,147 Net loans 578,678 616,187 637,800 613,557 576,731 Total deposits 817,447 810,703 804,804 752,810 776,955 Total shareholders' equity 111,107 102,927 120,123 111,251 111,868 (1) Restated for 4-for-3 stock split. (2) Financial data includes accounts of significant pooled acquisitions for all years presented. (3) Merger-related expenses amounted to $2.5 million after tax in 1999 and $1.8 million after tax in 1998. SUPPLEMENTAL STATISTICAL INFORMATION I. DISTRIBUTION OF ASSETS, LIABILITIES, AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL A. Average balance sheets (consolidated): The following table presents, for the years indicated, condensed daily average balance sheet information. (In Thousands) Assets 2002 2001 2000 __________ __________ ________ Cash and due from banks $ 25,711 $ 26,462 $ 28,968 Securities: Taxable 250,970 185,076 133,497 Non-taxable 123,380 132,200 118,341 __________ __________ ________ Total securities 374,350 317,276 251,838 Federal funds sold and other interest-bearing assets 12,986 22,816 17,962 Loans 591,297 629,248 630,851 Less allowance for loan losses 7,122 8,507 10,093 __________ __________ ________ Net loans 584,175 620,741 620,758 Other assets 61,060 54,571 44,728 __________ __________ ________ Total Assets $1,058,282 $1,041,866 $964,254 ========== ========== ======== (In Thousands) Liabilities and 2002 2001 2000 Stockholders' Equity __________ __________ ________ Deposits: Noninterest-bearing $ 99,199 $ 96,249 $ 94,038 Interest-bearing 701,654 714,491 685,287 __________ __________ ________ Total deposits 800,853 810,740 779,325 Federal funds purchased and securities sold under agreements to repurchase 19,430 19,159 18,734 Borrowed funds 115,209 96,605 39,781 Other liabilities 15,528 13,167 10,806 __________ __________ ________ Total liabilities 951,020 939,671 848,646 Stockholders' equity 107,262 102,195 115,608 __________ __________ ________ Total Liabilities and Stockholders' Equity $1,058,282 $1,041,866 $964,254 ========== ========== ======== B. Analysis of Net Interest Earnings The table below shows, for the periods indicated, an analysis of net interest earnings, including the average amount of interest- earning assets and interest-bearing liabilities outstanding during the period, the interest earned or paid on such amounts, the average yields/rates paid and the net yield on interest-earning assets: ($ In Thousands) Average Balance ____________________________ 2002 2001 2000 ________ ________ ________ EARNING ASSETS Loans $591,297 $629,248 $630,851 Federal funds sold and other interest-bearing assets 12,986 22,816 17,962 Securities: Taxable 250,970 185,076 133,497 Nontaxable 123,380 132,200 118,341 ________ ________ ________ Totals 978,633 969,340 900,651 ________ ________ ________ INTEREST-BEARING LIABILITIES Interest-bearing deposits 701,654 714,491 685,287 Borrowed funds, federal funds purchased and securities sold under agreements to repurchase 134,639 115,764 58,515 ________ ________ ________ Totals 836,293 830,255 743,802 ________ ________ ________ Net Amounts $142,340 $139,085 $156,849 ======== ======== ======== ($ In Thousands) Yields Earned Interest for the Year And Ended December 31, Rates Paid (%) _______________________ ______________ 2002 2001 2000 2002 2001 2000 _______ _______ _______ ____ ____ ____ EARNING ASSETS Loans $40,022 $51,852 $57,535 6.77 8.24 9.12 Federal funds sold and other interest-bearing assets 215 950 1,148 1.66 4.16 6.39 Securities: Taxable 13,675 11,165 7,966 5.45 6.03 5.97 Nontaxable 6,139 6,803 6,086 4.98 5.15 5.14 _______ _______ _______ ____ ____ ____ Totals $60,051 $70,770 $72,735 6.14 7.30 8.08 ======= ======= ======= ==== ==== ==== ($ In Thousands) Yields Earned Interest for the Year And Ended December 31, Rates Paid (%) _______________________ ______________ 2002 2001 2000 2002 2001 2000 _______ _______ _______ ____ ____ ____ INTEREST-BEARING LIABILITIES Interest-bearing deposits $17,171 $29,866 $31,559 2.45 4.18 4.61 Borrowed funds, federal funds purchased and securities sold under agreements to repurchase 5,705 6,135 3,419 4.24 5.30 5.84 _______ _______ _______ ____ ____ ____ Totals 22,876 36,001 34,978 2.74 4.34 4.70 _______ _______ _______ ==== ==== ==== Net interest income $37,175 $34,769 $37,757 ======= ======= ======= Net yield on earning assets 3.80 3.59 4.19 ==== ==== ==== (1) Interest and yields on tax-exempt obligations are not on a fully taxable equivalent basis. (2) For the purpose of these computations, nonaccruing loans are included in the average loan balances outstanding. (3) Interest income on loans includes related fees. C. Increase (Decrease) in Interest Income and Interest Expense The following table analyzes the changes in both the rate and volume components of net interest revenue: (In Thousands) (In Thousands) 2002 Over 2001 2001 Over 2000 ___________________________ _________________________ Change Due To: Change Due To: ___________________________ _________________________ Total Rate Volume Total Rate Volume ________ ________ _______ _______ _______ _______ EARNING ASSETS Loans $(11,830) $ (8,841) $(2,989) $(5,683) $(5,540) $ (143) Federal funds sold and other interest-bearing assets (735) (428) (307) (198) (881) 683 Securities: Taxable 2,510 (929) 3,439 3,199 88 3,111 Nontaxable (664) (219) (445) 717 4 713 ________ ________ _______ _______ _______ _______ Totals $(10,719) $(10,417) $ (302) $(1,965) $(6,329) $ 4,364 ======== ======== ======= ======= ======= ======= (In Thousands) (In Thousands) 2002 Over 2001 2001 Over 2000 __________________________ ________________________ Change Due To: Change Due To: __________________________ ________________________ Total Rate Volume Total Rate Volume ________ ________ ______ _______ _______ ______ INTEREST-BEARING LIABILITIES Interest-bearing deposits $(12,695) $(12,167) $ (528) $(1,693) $(4,004) $2,311 Interest on borrowed funds and federal funds purchased and securities sold under agreements to repurchase (430) (1,327) 897 2,717 (396) 3,113 ________ ________ ______ _______ _______ ______ Totals $(13,125) $(13,494) $ 369 $ 1,024 $(4,400) $5,424 ======== ======== ====== ======= ======= ====== NOTE: (1) Change in volume is the change in volume times the previous year's rate. (2) Change in rate is the change in rate times the previous year's balance. (3) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change to each. II. INVESTMENT PORTFOLIO A. The following tables present the book values of securities as of the dates indicated: (In Thousands) December 31, ____________________________ 2002 2001 2000 ________ ________ ________ U. S. Treasury $ 302 $ 306 $ 4,544 U. S. Government agencies and mortgage-backed securities 259,548 185,751 137,684 States and political subdivisions 106,212 113,871 124,011 Other 27,721 40,798 15,551 ________ ________ ________ Total book value $393,783 $340,726 $281,790 ======== ======== ======== B. The following table sets forth the maturities of investment and mortgage-backed securities (carrying values) at December 31, 2002, and the weighted average yield of such securities: ($ In Thousands) Weighted Average Yield _______________________________________________ 0 - 1 Yield 1 - 5 Yield 5 - 10 Yield Year (%) Years (%) Years (%) _______ _____ ________ _____ _______ _____ Securities: U. S. Treasury $ 100 2.75% $ 202 2.25% $ - - U. S. Govern- ment agencies 402 5.80% 774 3.36% 273 5.04% Nontaxable municipals 12,720 7.65% 59,321 7.60% 10,496 8.84% Taxable municipals - - 1,192 6.66% 128 7.18% Other 2,252 6.86% 2,102 5.91% 1,466 5.81% _______ _______ _______ Total $15,474 $63,591 $12,363 ======= ======= ======= 10+ Yield Years (%) _______ _____ Nontaxable municipals $22,201 9.15% Taxable municipals 154 7.37% Equities 21,569 4.87% Other 332 6.45% _______ Total $44,256 ======= Book Yield Value (%) ________ _____ Mortgage- backed securities $258,099 5.49% ======== NOTE: Interest and yields on tax-exempt obligations are on a taxable equivalent basis. Average yield on floating rate securities was determined using the current yield. Table includes securities classified as available-for- sale and held-to-maturity at carrying values. The majority of mortgage-backed securities are backed by U. S. Government agencies. C. Investment securities in excess of 10% of stockholders' equity. At December 31, 2002, there were no securities from any issuers in excess of 10% of stockholders' equity that were not securities of the U. S. Government or U. S. Government agencies or corporations. III. LOAN PORTFOLIO A. Type of loans The amount of loans outstanding by type at the indicated dates are shown in the following table: (In Thousands) December 31, ________________________________________________ Type 2002 2001 2000 1999 1998 ______________ ________ ________ ________ ________ ________ Commercial, financial and agriculture $103,327 $101,630 $103,045 $101,503 $ 81,365 Real estate - construction 30,028 31,461 33,638 26,185 27,253 Real estate - mortgage 364,875 387,667 402,987 390,205 366,219 Installment loans to individuals 77,692 94,424 105,564 101,624 104,470 Other 8,785 7,758 2,255 4,234 7,526 ________ ________ ________ ________ ________ Total loans $584,707 $622,940 $647,489 $623,751 $586,833 ======== ======== ======== ======== ======== B. Maturities and sensitivities of loans to changes in interest rates: (In Thousands) December 31, 2002 ____________________________ Maturing or Repricing ____________________________ After 1 Year Within Through Over Type 1 Year 5 Years 5 Years Total _______________________ ________ ________ ________ ________ Commercial, financial and agricultural $ 78,834 $ 22,646 $ 1,847 $103,327 Real estate - construction 26,859 3,019 150 30,028 ________ ________ ________ ________ $105,693 $ 25,665 $ 1,997 $133,355 ======== ======== ======== ======== (In Thousands) December 31, 2002 ____________________________ Maturing or Repricing ____________________________ After 1 Year Within Through Over Type 1 Year 5 Years 5 Years Total ________________________ ________ ________ ________ ________ Loans with: Predetermined interest rates $ 25,393 $ 25,665 $ 1,997 $ 53,055 Floating interest rates 80,300 - - 80,300 ________ ________ ________ ________ $105,693 $ 25,665 $ 1,997 $133,355 ======== ======== ======== ======== C. Nonperforming loans 1. The following table states the aggregate amount of loans which were nonperforming in nature: (In Thousands) December 31, ______________________________________ Type 2002 2001 2000 1999 1998 __________________ ______ ______ ______ ______ ______ Loans accounted for on a nonaccrual basis $1,274 $2,050 $1,384 $ 270 $ 927 ====== ====== ====== ====== ====== Accruing loans past due 90 days or more $2,700 $1,850 $2,356 $2,975 $2,902 ====== ====== ====== ====== ====== Renegotiated "troubled" debt $ 304 $ 665 $ 294 $ 132 $ 337 ====== ====== ====== ====== ====== 2. There were no loan concentrations in excess of 10% of total loans at December 31, 2002. However, lending activities are affected by the economic trends within the areas served by the Company and its subsidiaries. This, in turn, can be influenced by the areas' larger employers, such as Mississippi State University, University of Alabama, Bryan Foods, Columbus Air Force Base, and the Mercedes-Benz Automotive Plant. 3. There were no outstanding foreign loans at December 31, 2002. 4. Loans classified for regulatory purposes or for internal credit review purposes that have not been disclosed in the above table do not represent or result from trends or uncertainties that management expects will materially impact the financial condition of the Company or its subsidiary banks, or their future operating results, liquidity, or capital resources. 5. If all nonaccrual loans had been current throughout their terms, interest income would have not been significantly different for the years ended 2002, 2001 and 2000. 6. Management stringently monitors loans that are classified as nonperforming. Nonperforming loans include nonaccrual loans, loans past due 90 days or more, and loans renegotiated or restructured because of a debtor's financial difficulties. Loans are generally placed on nonaccrual status if any of the following events occur: 1) the classification of a loan as nonaccrual internally or by regulatory examiners, 2) delinquency on principal for 90 days or more unless management is in the process of collection, 3) a balance remains after repossession of collateral, 4) notification of bankruptcy, or 5) management's judgment that nonaccrual is appropriate. 7. At December 31, 2002, the recorded investment in loans identified as impaired totaled approximately $1.2 million. The allowance for loan losses related to these loans approxi- mated $596,000. The average recorded investment in impaired loans during the year ended December 31, 2002, was $1.8 million. Total interest recognized on impaired loans and the amount recognized on a cash basis were not significant. D. Other interest-bearing assets There were no other interest-bearing non-performing assets at December 31, 2002. IV. SUMMARY OF LOAN LOSS EXPERIENCE A. An analysis of the loan loss experience for the periods indicated is as follows: ($ In Thousands) December 31, ___________________________________________ 2002 2001 2000 1999 1998 _______ _______ _______ _______ _______ Beginning balance $ 6,753 $ 9,689 $10,194 $10,102 $ 8,528 _______ _______ _______ _______ _______ Charge-offs: Domestic: Commercial, financial and agricultural (708) (2,840) (499) (566) (575) Real estate (1,240) (780) (206) (444) (451) Installment loans and other (2,226) (1,580) (1,497) (1,047) (960) _______ _______ _______ _______ _______ Total charge-offs (4,174) (5,200) (2,202) (2,057) (1,986) _______ _______ _______ _______ _______ Recoveries: Domestic: Commercial, financial and agricultural 39 119 55 89 124 Real estate 64 61 17 25 76 Installment loans and other 557 364 345 266 173 _______ _______ _______ _______ _______ Total recoveries 660 544 417 380 373 _______ _______ _______ _______ _______ Net charge-offs (3,514) (4,656) (1,785) (1,677) (1,613) _______ _______ _______ _______ _______ Provision charged to operations 2,790 1,720 1,280 1,769 3,187 _______ _______ _______ _______ _______ Ending balance $ 6,029 $ 6,753 $ 9,689 $10,194 $10,102 ======= ======= ======= ======= ======= Ratio of net charge-offs to average loans outstanding .59 .74 .29 .28 .28 Ratio of allowance for loan losses to loans outstanding at year end 1.03 1.08 1.50 1.63 1.72 B. Determination of Allowance for Loan Losses The determination of the allowance for loan losses requires significant judgment. The balance of the allowance for loan losses reflects management's best estimate of probable loan losses related to specifically identified loans, as well as probable incurred loan losses in the remaining portfolio. Reference should be made to Note A-6 to the consolidated financial statements included herein as Item 8 and to Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations. The following schedule sets forth the components of the allowance for loan losses at December 31, 2002 and 2001. This allocation is based upon the consistent, quarterly evaluation of the adequacy of the allowance for loan losses. The entire allowance for loan losses is available to absorb loan losses in any category. 2002 2001 __________________ __________________ Allowance Allowance Loan For Loan Loan For Loan Balance Losses Balance Losses (In thousands) ________ ________ ________ ________ Allocated component: Impaired loans $ 1,230 $ 596 $ 2,471 $ 1,353 Graded loans 24,867 2,302 33,221 2,674 Homogeneous pools 156,837 980 187,751 1,071 Other loans 401,773 1,683 399,497 1,271 Unallocated component - 468 - 384 ________ ________ ________ ________ $584,707 $ 6,029 $622,940 $ 6,753 ======== ======== ======== ======== The allowance allocated to impaired loans for the years 2002 and 2001 was based upon the estimated fair value of the underlying collateral. Graded loans are those loans that exhibit some form of weakness. Allocations to this group are based upon the historical loan loss experience of the grades assigned and upon specific allocations to specific loans. An allowance is allocated to the various pools of loans considered to be homogenous based upon the historical loan losses of each pool. Other loans consist of those loans not graded or impaired or considered homogenous. These loans are grouped by risk assignments which are based upon consideration of collateral values, borrower financial condition and performance, debt service capacity, cash flows, market share, and other indicators. Allocations of the allowance to these loans are based upon historical loan loss experience of the risk assignment. C. Loans and Risk Descriptions Real Estate Loans NBC originates loans secured by commercial real estate, one- to-four family residential properties, and multi-family dwelling units (5 or more units). At December 31, 2002, these loans totaled $395 million or approximately 68% of the loan portfolio. NBC originates commercial real estate loans up to 80% of the appraised value. Currently, it is the philosophy to originate these loans only to selected known borrowers and on properties in the market area. Of primary concern in commercial real estate lending is the borrower's credit worthiness and the feasibility and cash flow potential of the project. To monitor cash flows of borrowers, annual financial statements are obtained from the borrower and loan guarantors, if any. Although many banks have had significant losses in commercial real estate lending, NBC, historically, has sustained few losses, and those losses were not significant relative to the size of the entire commercial real estate loan portfolio at the time. NBC originates loans secured by first and junior liens on one-to-four family residences in their lending areas. Typically, such loans are single family homes that serve as the primary residence of the borrower. Generally, these loans are originated in amounts up to 80% of the appraised value or selling price of the property. In the past, very few losses from these types of loans have been experienced. Loans for multi-family (5 or more) residential properties are generally secured by apartment buildings. Loans secured by income properties are generally larger and involve greater risk than residential loans because payments are often dependent on the successful operation or management of the properties. As a result, these types of loans may be more sensitive to adverse conditions in the real estate market or the economy. Cash flow and financial statements are obtained from the borrowers and any guarantors. Also, rent rolls are often obtained. Consumer and Other Loans NBC offers consumer loans in the form of home improvement loans, mobile home loans, automobile loans and unsecured personal loans. These loans totaled $78 million or 13% of total loans at December 31, 2002. Consumer loans are originated in order to provide a wide range of financial services to customers and because the terms and normally higher interest rates on such loans help maintain a profitable spread between the average loan yield and the cost of funds. In connection with consumer loan applications, the borrower's income statement and credit bureau report are reviewed. In addition, the relationship of the loan to the value of the collateral is considered. All automobile loan applications are reviewed, as well as the value of the unit which secured the loan. NBC intends to continue to emphasize the origination of consumer loans. Management believes that its loan loss experience in connection with its consumer loan portfolio is favorable in comparison to industry averages. NBC makes commercial business loans on both a secured and unsecured basis with terms which generally do not exceed five years. Non-real estate commercial loans primarily consist of short-term loans for working capital purposes, inventories, seasonal loans, lines of credit and equipment loans. A personal guaranty of payment by the principals of any borrowing entity is often required and the financial statements and income tax returns of the entity and its guarantors are reviewed. At December 31, 2002, NBC's commercial business loans represented approximately 16% of its total loan portfolio. D. In the year 2001, NBC experienced an unusual and unexpected loan loss of $2 million (reference should be made to Item 7 - Manage- ment's Discussion and Analysis of Financial Condition and Results of Operations), which is included in the commercial, financial and agricultural category in Table IV.A. Loan losses in 2003 for all loan categories, as a percentage of average loans, are expected to approximate that of 2002. V. DEPOSITS ($ In Thousands) 2002 2001 2000 ______________ ______________ ______________ Amount Rate Amount Rate Amount Rate ________ ____ ________ ____ ________ ____ A. Average deposits: Domestic: Noninterest- bearing $ 99,199 - $ 96,249 - $ 94,038 - Interest- bearing demand (1) 296,313 1.5% 296,160 2.9% 254,458 3.6% Savings 40,996 .8% 39,196 1.5% 48,414 2.1% Time 364,345 3.5% 379,135 5.4% 382,415 5.6% Foreign N/A N/A N/A ________ ________ ________ Total $800,853 $810,740 $779,325 ======== ======== ======== (1) Includes Money Market accounts B. Other categories None C. Foreign deposits Not material D. Time certificates of deposit of $100,000 or more and maturities at December 31, 2002 (In Thousands) 3 6 Months Months 3 Through Through Over Months 6 12 12 Total Or Less Months Months Months ________ _______ _______ _______ _______ Time certificates of deposit of $100,000 or more $164,625 $51,413 $28,262 $23,868 $61,082 ======== ======= ======= ======= ======= E. Foreign office time deposits of $100,000 or more Not applicable VI. RETURN ON EQUITY AND ASSETS The following financial ratios are presented for analytical purposes: December 31, ______________________ 2002 2001 2000 ______ ______ ______ Return on assets (net income divided by total average assets) 1.3 1.3 1.4 Return on equity (net income divided by average equity) 13.3 12.5 12.2 Dividend payout ratio (dividends per share divided by basic net income per share) 50.3 53.2 49.5 Equity to asset ratio (average equity divided by average total assets) 10.1 9.8 12.0 VII. SHORT-TERM BORROWINGS 2002 2001 2000 ____________ ____________ ____________ ($ In Thousands) Securities Securities Securities Sold Under Sold Under Sold Under Agreement to Agreement to Agreement to Repurchase Repurchase Repurchase ____________ ____________ ____________ Balance at year end $25,599 $16,625 $16,326 Weighted average interest rate at year end 1.10% 2.23% 4.15% Maximum amount outstanding at any month end for the year $26,328 $21,765 $17,831 Average amount outstanding during the year 19,430 18,922 17,049 Weighted average interest rate during the year 1.61% 3.45% 4.16% VIII. CAPITAL ADEQUACY DATA Total consolidated capital of the Company was as follows: ($ In Thousands) December 31, __________________ 2002 2001 ________ ________ Total stockholders' equity (excluding unrealized gain/loss) $106,985 $101,277 Allowance for loan losses, as allowed 6,029 6,753 ________ ________ Total primary capital 113,014 108,030 Other secondary capital - - ________ ________ Total capital 113,014 108,030 Less intangible assets and other adjustments, net (2,273) (1,415) ________ ________ Total capital, as defined for regulatory purposes $110,741 $106,615 ======== ======== Tier 1 and total capital as a percentage of "risk-weighted" assets at December 31, 2002 and 2001, are as follows: December 31, ______________ 2002 2001 ______ ______ Tier 1 capital percentage 16.5% 15.0% Total capital percentage 17.4% 16.0% The Company's capital ratios exceed the minimum capital requirements at December 31, 2002, and management expects this to continue. ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations The following provides a narrative discussion and analysis of significant changes in the Corporation's results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, and the supplemental financial data included elsewhere in this report, including the five-year summary of Selected Financial Data and management's letter to shareholders at the beginning of this Annual Report. Certain information included in this discussion contains forward-looking statements and information that are based on management's conclusions, drawn from certain assumptions and information currently available. The Private Securities Litigation Act of 1995 encourages the disclosure of forward-looking information by management by providing a safe harbor for such information. This discussion includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although the Corporation believes that the expectations reflected in such forward-looking statements are reasonable, such forward-looking statements are based on numerous assumptions (some of which may prove to be incorrect) and are subject to risks and uncertainties that could cause the actual results to differ materially from the Corporation's expectations. The forward-looking statements made in this document are based on management's beliefs, as well as assumptions made by and information currently available to management. When used in the Corporation's documents, the words "anticipate," "estimate," "expect," "objective," "projection," "forecast," "goal" and similar expressions are intended to identify forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with forward-looking statements, factors that could cause the Corporation's actual results to differ materially from those contemplated in any forward-looking statements include, among others, increased competition, regulatory factors, economic conditions, changing interest rates, changing market conditions, availability or cost of capital, employee workforce factors, cost and other effects of legal and administrative proceedings, and changes in federal, state or local laws and regulations. The Corporation undertakes no obligation to update or revise any forward-looking statements, whether as a result of changes in actual results, changes in assumptions or other factors affecting such statements. The two major trends that can have a material impact on the Corporation's financial condition and results of operations are the trend in interest rates and the overall trend in the economy. Currently, management expects, based on the available information, that interest rates will remain at their current levels during the first half of 2003 and trend upward slightly during the latter half of the year, and the overall economy in its market will remain relatively flat throughout the year. The Corporation's 2003 projections, budgets and goals are based on these expectations. If these trends move differently than expected in either direction or speed, it could have a material impact on the Corporation's financial condition and results of operations. The areas of the Corporation's operations most directly impacted would be the net interest margin, loan and deposit growth and the provision for loan losses. ACCOUNTING ISSUES Note A of the Notes to Consolidated Financial Statements contains a summary of the Corporation's accounting policies. Management is of the opinion that Note A, read in conjunction with all other information in the annual report, including management's letter to shareholders and management's discussion and analysis, is sufficient to provide the reader with the information needed to understand the Corporation's financial condition and results of operations and to identify the areas in which management is required to make the most difficult, subjective and /or complex judgments. In the normal course of business, the Corporation's wholly-owned subsidiary, National Bank of Commerce, makes loans to related parties, including directors and executive officers of the Corporation and their relatives and affiliates. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other parties. Also, they are consistent with sound banking practices and within the applicable regulatory and lending limitations. See Note O in the Notes to Consolidated Financial Statement and the Corporation's Proxy Statement for additional details concerning related party transactions. Under Section 402 of the Sarbanes-Oxley Act of 2002, loans to executive officers are generally prohibited. However, the rule does not apply to any loan made or maintained by an insured depository institution if the loan is subject to the insider lending restrictions of section 22(h) of the Federal Reserve Act. All loans to executive officers made by the Corporation's bank subsidiary are subject to the above referenced section of the Federal Reserve Act. Note A of the Notes to Consolidated Financial Statements contains a listing of all the Corporation's affiliated companies. The Corporation does not have investments in any unconsolidated entities over which it exercises management or control. The Corporation does not have relationships with limited or special purpose entities that it relies on to provide financing, liquidity or market and credit risk support. Effective January 1, 2002, the Corporation adopted Financial Accounting Standards Board Statement No. 142, "Goodwill and Other Intangible Assets". This Statement eliminated the requirement to amortize goodwill; however, it does require periodic testing for impairment. As a result of the adoption of the Statement, the Corporation did not amortize goodwill during 2002. The Corporation completed its transitional impairment test in accordance with Statement No. 142 in January 2002. No significant impairment write down was recorded as a result of that test. Additionally, the Corporation adopted FASB Statement No. 147, "Acquisition of Certain Financial Institutions" which became effective October 1, 2002. This Statement applies to unidentified intangible assets resulting from the acquisition of less-than-whole financial institutions. The Corporation's unidentified intangible asset resulted from such an acquisition. Management determined that the acquisition met the requirements of a business combination and, in accordance with FASB Statement No. 147, the related unidentified intangible asset was reclassified as goodwill and accounted for in accordance with FASB Statement No. 142. As a result, the Corporation reversed all related amortization expense recognized after FASB Statement No. 142 was applied. This reversal required the Corporation to restate each of the first three quarters of 2002, by reversing the previously recorded amortization. This reversal reduced each quarter's other operating expense by $28,000 and caused net income in each quarter to increase by approximately $18,500. This change did not cause the Earnings Per Share to change in any quarter. At December 31, 2002, the Corporation had approximately $2.8 million of goodwill on its Balance Sheet, including approximately $800,000 of unidentified intangible assets reclassified as goodwill, which will remain at that level unless it becomes impaired under the definition of impairment in FAS 142. The amortization of goodwill during 2001 and 2000 was approximately $333,000 or $.04 per share and $327,000 or $.03 per share, respectively. In June 2002, the FASB issued Statement No. 146, "Accounting for the Cost Associated with Exit or Disposal Activities". The adoption of the Statement is not expected to have a material impact on the Corporation's consolidated financial statements. FINANCIAL CONDITION AND RESULTS OF OPERATIONS Since 1998, the total assets of the Corporation have increased 15.0%. During this same period, loans have increased .3%, while deposits grew by 5.2%. During 1999, net loans grew by $36.8 million, while deposits declined by approximately $24.1 million. Approximately 79% of this decline in deposits occurred during the last sixty days of 1999. This situation required the Corporation to look to other funding sources such as reallocating funds from lower yielding assets and additional borrowings from the Federal Home Loan Bank. During 2000, this trend reversed as the equity markets turned down and cash began flowing back into the banking system. As a result, the Corporation was able to fund its net loan growth of approximately $24.2 million with a growth in deposits of approximately $52 million. During 2001, net loans declined by $21.6 million, mostly as a result of a decline in the Adjustable Rate Mortgage ("ARM") loans that the Corporation carried in its loan portfolio. The reason for the decline was the interest rate environment. During that period the Federal Reserve lowered rates eleven times, totaling 4.75%. Because of these lower rates, many homeowners refinanced their existing ARM loans to fixed rate loans. Due to the interest rate risk, the Corporation does not normally carry fixed rate mortgage loans on its books. As a result of this decline in loans and an overall soft loan demand, the Corporation did not need to aggressively price deposits, and therefore, had a modest $5.9 million growth in deposits during the year. This interest rate environment continued into 2002, as the rates remained at historically low levels, actually declining an additional 50 basis points in November. The mortgage-refinancing trend continued throughout 2002, and as a result, the Corporation's mortgage loan portfolio declined further. Also, the softness in the economy and the very low, or in the case of the auto industry, zero rate loans resulted in an overall decline in the Corporation's consumer loan portfolio. Even though other parts of the loan portfolio actually increased during the year, the increase was not enough to offset the decline in the mortgage and consumer portfolios. As a result, the Corporation experienced its second consecutive year of a declining loan portfolio, as loans decreased by 6.1%. With this continued decline in loans, the Corporation continued its position of not aggressively pricing deposits. As a result, deposits grew by .8% for the year. See the section entitled "Liquidity, Asset / Liability Management" for additional comments on sources and uses of cash during 2002. Shareholders' Equity has represented a consistent strength of the Corporation throughout the years, as noted in the summary of Selected Financial Data. Shareholders' equity has decreased slightly (0.7%) since 1998. During 1999 and 2000, Shareholder's Equity increased from $111.9 million to $120.1 million, or 7.4%. The decline in 2001 resulted primarily from the purchase of approximately $25 million of outstanding shares owned beneficially by two long time shareholders at $18.83 per share (post split price). This purchase was partially offset by income, net of dividend, and an increase in the market value of "Available-for-Sale Securities", the cumulative effect of which caused Accumulated Other Comprehensive Income to increase by approximately $1.7 million. In 2002, Shareholders' Equity increased by $8.2 million, or 7.9% from $102.9 million to $111.1 million. This increase came from income, net of dividends, and a $2.5 million increase in Accumulated Other Comprehensive Income. Accumulated Other Comprehensive Income is composed of unrealized gains (losses), net of taxes on "Available-for-Sale Securities" ($1,650,000 and $4,122,000 at December 31, 2001 and 2002, respectively) and is reported as part of Shareholders' Equity, as required under FASB 115. In 1999, net income increased by $506,000, even though the Corporation incurred approximately $2.5 million of merger related expenses (net of taxes) associated with the acquisitions of FFBS Bancorp, Inc., ("FFBS") and Galloway- Chandler-McKinney Insurance Agency, Inc. ("GCM"). In 1998 and 1999, fully diluted earnings per share were $1.06 and $1.10, respectively, after being impacted by approximately $.20 in 1998 and $.27 in 1999, of non-recurring merger costs. In 2000, fully diluted earnings per share increased by 33.6% to $1.47 per share, as net income increased from $10.5 million in 1999 to $14.0 million in 2000. In 2001, net income declined to $13.1 million; however, fully diluted earnings per share increased to $1.54, a 4.8% increase, due to 10.8% fewer weighted average shares outstanding as a result of the previously mentioned repurchase of the Corporation's stock. In 2001, net income was negatively impacted by an additional $1 million provision made to the Corporation's allowance for loan losses to replenish the allowance for a large commercial loan charge-off. This charge-off will discussed in more detail later in this analysis. The following paragraphs discuss the increase in net income in 2002, compared to 2001. The 1998 earnings per share amounts have been restated to reflect the 1999 merger with FFBS. All earnings per share amounts have been restated to reflect the four for three stock split, accounted for as a stock dividend, that occurred during the third quarter of 2002. Regular cash dividends have increased in each of the years outlined in the summary of Selected Financial Data. The 1998 dividends per share amount has been restated to reflect the 1999 merger with FFBS and all dividends per share have been restated to reflect the four for three stock split, accounted for as a stock dividend, that occurred during the third quarter of 2002. Net interest income ("NII"), the primary source of earnings for the Corporation, represents income generated from earning assets, less the interest expense of funding those assets. NII declined by 7.9% in 2001 and increased by 6.9% in 2002. Changes in NII may be divided into two components; first, the change in average earning assets (volume component) and second, the change in the net interest spread (rate component). Net interest spread represents the difference between yields on earning assets and rates paid on interest-bearing liabilities. The year 2001 was a unique year for the banking industry. During the year, the Federal Reserve reduced interest rates eleven times, for a total of 475 basis points. Even though most thought rates would decline during 2001, few, if any, expected rates to decline that far, that fast. This rate decline did not stop the general state of the economy from continuing to slow throughout the year. With this slow down in the economy, the Corporation experienced a substantial decline in loan demand, as businesses went into a defensive position. In this environment, the competition for quality credits increased. This situation caused many of the fixed rate loans that were in the portfolio to be refinanced at lower rates during the year. Also, at the beginning of the year, approximately 45 percent of the loan portfolio was composed of variable rate loans. These two factors caused an overall decline in loan yields during 2001. As mentioned later in this discussion, the Corporation's policy is to maintain a basically neutral gap position for its balance sheet. The Corporation began 2001 with a twelve-month liability sensitive position of $57.7 million or 5.7% of assets, well within its policy of plus or minus 10%. Even though a liability sensitive position was appropriate for this declining rate environment, the speed and amount of the declines caused the variable loans to reprice more quickly than the cost of liabilities could be reduced, putting a great deal of downward pressure on the Corporation's margin during the year. Even though management began repricing deposits downward during January, it was the third and fourth quarters before the rates stabilized enough for the reduction in rates paid on deposit to catch up with the decline in yields and for the margin to stabilize and begin to increase. In 2001, NII declined 7.9% as the net interest spread declined from 3.38% in 2000 to 2.96%. The primary reason for this decline was a decrease in average loan yields of approximately 88 basis points. This decrease in loan yields was partially offset by a decrease in the average cost of deposits of 43 basis points and a decrease in the cost of other borrowed funds of 54 basis points. The volume component of NII also helped offset this decline in loan yields, as average-earning assets grew $68.7 million, or 7.6%. In 2002, NII increased by 6.9% from $34.8 million to $37.2 million. This increase resulted from improvement in both the rate and volume components of NII. During the year the margin increased from 3.59% in 2001 to 3.80% in 2002. Even though yields on earning assets continued to decline during the year, the Corporation was able to more than offset the decline by continuing to decease the cost of funds during the stable rate, low loan demand environment of 2002. As can be seen in following table, yields on earning assets declined by 116 basis points from 7.30% to 6.14%. This loss was more that offset by a decline of 160 basis points in cost of funds from 4.34% in 2001 to 2.74% in 2002. Also, the Corporation was able to grow earning assets by $9.3 million or 1.3% during 2002. All of this growth came in the area of investment securities. If rates were to continue downward, it will become very difficult for the Corporation to continue to lower deposit rates much below their current level. As a result, if multiple rate reductions occur, the margin will again come under extreme pressure because asset yields will be decreasing and the Corporation's ability to reduce its deposit cost will be limited. The table below shows, for the periods indicated, an analysis of NII, including the average amount of interest-earning assets and interest- bearing liabilities outstanding during the period, the interest earned or paid on such amounts, the average yields/rates paid and the net yield on interest-earning assets on both a book and tax equivalent basis: ($ In Thousands) Average Balance ________ ________ Year Year Ended Ended 12/31/02 12/31/01 ________ ________ EARNING ASSETS: Loans $591,297 $629,248 Federal funds sold and other interest-bearing assets 12,986 22,816 Securities: Taxable 250,970 185,076 Nontaxable 123,380 132,200 ________ ________ Totals $978,633 $969,340 ======== ======== INTEREST-BEARING LIABILITIES: Interest-bearing deposits $701,654 $714,491 Borrowed funds, federal funds purchased and securities sold under agreements to repurchase and other 134,639 115,764 ________ ________ Totals $836,293 $830,255 ======== ======== ($ In Thousands) Interest Yields Earned For and Rates Paid (%) Year Year Year Year Ended Ended Ended Ended 12/31/02 12/31/01 12/31/02 12/31/01 ________ ________ ________ ________ EARNING ASSETS: Loans $ 40,022 $ 51,852 6.77 8.24 Federal funds sold and other interest-bearing assets 215 950 1.66 4.16 Securities: Taxable 13,675 11,165 5.45 6.03 Nontaxable 6,139 6,803 4.98 5.15 ________ ________ ________ ________ Totals $ 60,051 $ 70,770 6.14 7.30 ======== ======== ======== ======== INTEREST-BEARING LIABILITIES: Interest-bearing deposits $ 17,171 $ 29,866 2.45 4.18 Borrowed funds, federal funds sold, securities sold under agreements to repurchase and other 5,705 6,135 4.24 5.30 ________ ________ ________ ________ Totals 22,876 36,001 2.74 4.34 ________ ________ ________ ________ Net interest income $ 37,175 $ 34,769 ======== ======== Net yield on earning assets 3.80 3.59 ________ ________ Note: Yields on a tax equivalent basis would be: Nontaxable securities 7.66 7.92 ________ ________ Total earning assets 6.47 7.68 ________ ________ Net yield on earning assets 4.14 3.96 ________ ________ The Corporation's Provision for Loan Losses is utilized to replenish the Reserve for Loan Losses on its balance sheet. The reserve is maintained at a level deemed adequate by the Board of Directors, after its evaluation of the risk exposure contained in the Corporation's loan portfolio. The methodology used to make this determination is performed on a quarterly basis by the senior credit officers and the loan review staff. As a part of this evaluation, certain loans are individually reviewed to determine if there is an impairment of the bank's ability to collect the loan and the related interest. This determination is generally made based on collateral value. If it is determined that an impairment exists, a specific portion of the reserve is allocated to these individual loans. All other loans are grouped into homogeneous pools, and risk exposure is determined by considering the following list of factors (this list is not all-inclusive and the factors reviewed may change as circumstances change): historical loss experiences; trends in delinquencies and non-accruals; and national, regional and local economic conditions. (These economic conditions would include, but not be limited to, general real estate conditions, the current interest rate environment and trends, unemployment levels and other information, as deemed appropriate.) Even though there has been increased competition for good quality credits in the Corporation's market, the quality of our portfolio remains strong. Net charge-offs for 2000, 2001 and 2002 were .28%, .74% and .59% of average net loans outstanding for each year, respectively. See Note D in the Notes to Consolidated Financial Statements for additional information concerning the transactions in the Reserve for Loan Losses for the three-year period ended December 31, 2002. Had it not been for a single $2 million loan charged off in June of 2001 (this loan will be discussed in more detail in the following paragraph), the ratio for 2001 would have been .42% of average net loans. The ratio of classified loans to capital has decreased from 18.1% at December 31, 2001 to 13.2% at December 31, 2002. The Reserve for Loan Losses as a percentage of total loans has declined from 1.08% of total loans at the end of 2001 to 1.03% at the end of 2002. Based on these evaluations, the reserve amounts maintained at the end of 2001 and 2000 were deemed adequate to cover exposure within the Corporation's loan portfolio. The Provision for Loan Losses increased from $1,280,000 in 2000 to $1,720,000 in 2001 and to $2,790,000 in 2002. In 2001, the provision was increased to $1,720,000, as net charge-offs increased from $1.9 million in 2000 to $4.7 million in 2001. The primary reason for the increased charge-offs in 2001 was that in June, the Corporation charged-off a $2 million commercial loan that defaulted. This loan had previously not been classified as a problem loan and there were special circumstances surrounding the default. The Corporation has filed a claim with its bonding company to recover the entire $2 million; however, it can not predict whether there will be a recovery. In 2002, the provision was increased to $2,790,000. In total, the net charge-offs decreased to $3.5 million in 2002. However, when compared to 2001, exclusive of the special charge-off, the level of charge-offs actually increased in 2002. This increase can be attributed to the overall condition of the economy and the continued softening in the market, especially in the consumer sector. Due to this continued softness in the economy and the forecast of a long, slow recovery, management intends to again increase the provision for loan losses in 2003 to a level that we anticipate will protect the Corporation from any unforeseen deterioration in the quality of the loan portfolio. Non-interest income includes various service charges, fees and commissions collected by the Corporation, including insurance commissions earned by GCM, the wholly owned insurance agency subsidiary of National Bank of Commerce. During 2002, non-interest income grew 9.6% from $16.5 million to $18.0 million. This increase resulted from the Corporation's continued focus on diversifying its income sources so that it can be less dependent on net interest income. Approximately 74% of the total increase came from a $1.2 million or a 19.7% increase in service charges on deposit accounts. This increase resulted primarily from an upgrade in the technology platform that includes more sophisticated account modeling. This gave management the tools needed to better monitor and more uniformly apply the account- based fees across all deposit accounts on a consistent basis. Insurance commissions, fees and premiums increased by $234,000, or 6.1%. This change in insurance commissions, fees and premiums relates directly to the volume of insurance product sold during these periods. Other service charges and fees also increased by $157,000, or 5.3%. This increase came from three areas. First, mortgage loan fee income increased by $37,000 to a level of $1,501,000. Mortgage activity benefited from the continued demand for loans in this low interest rate environment. Also the demand for mortgage refinancing, which had moderated during the first half of the year, began to increase once again during the last half of the year as interest rates fell. Also, during the year, the demand for new loans was strong. With this high level of activity at year-end, the pipeline for both new and refinanced mortgage loans remains strong going into 2003. The other two areas that caused the increase in other service charges and fees were ATM Income, which increased by 27.1%, and Check Card Income, which increased by 20.6%. Trust Department income increased by 3.2% to $1.8 million. Even though the Trust Department was able to continue to grow its assets under management during the year, its income is generated based on the market value of these assets. Therefore, its growth in income was limited by the overall conditions in the equity markets as they continued to decline throughout 2002. During 2001, non-interest income grew 19.6% to $16.5 million. Several different sources contributed to this increase. Service charges on deposit accounts increased by 12% to $5.9 million as a result of an on-going effort by management to better bill and collect fees. The Corporation's Trust Department income increased by 6.3% to $1.7 million. This increase was smaller than the prior year's increase. The activities in this area grew steadily during 2001; however, as mentioned, the amount of income collected from management fees is directly related to the market value of the account assets, which in many cases was negatively impacted by the decline in the equity markets during 2001. Additionally, other non-interest income increased by $1.8 million, or 69%. This increase came primarily from two sources. First, the fees from mortgage- related activities increased 205.7%, or $984,000, as a result of an interest rate environment that produced heavy refinancing activity throughout the year. Second, earnings from a $10 million purchase of Bank Owned Life Insurance ("BOLI") caused this category of other non-interest income to increase by $621,000. This purchase of BOLI was executed to help cover the increasing cost of employee benefits. These increases were partially offset by a decline of 8.3%, or $347,000, in Insurance Commissions, Fees and Premiums. This decline in Insurance Commissions, Fees and Premiums relates directly to the volume of insurance products sold. During the first quarter of 2001, a great deal of time and effort was spent handling claims that resulted from a major storm that hit the service area. This took away from time that would have been spent developing new business. Also, GCM experienced a reduction in incentive rebates from its insurance carriers because of underwriting losses that resulted from the storm. The Corporation recognized $457,000 in securities gains during 2002, compared to $459,000 in 2001 and a loss of $22,000 for 2000. Approximately 80% of the 2002 gain came in the second half of the year. With approximately 74% of available-for-sale securities portfolio composed of mortgage backed securities, a unique situation developed during the second half of 2002. As mortgage rates continued to stay low during most of 2002 and then drop again with the Fed rate cut in November, the prepayment speed on the mortgages behind these securities increased. This caused the average lives on these securities to shorten from the 5 to 7 year ranges they were in when purchased, to ranges of 2 to 3 years. With the low interest rate environment there was a high demand for securities with 2 to 3 year estimated average life. This gave the Corporation the opportunity to sell these securities at a profit and replace them with securities with the same 5 to 7 year average life that were originally purchased. Not only did these transactions create a gain; they also allowed the Corporation to improve the yields on the particular securities sold by approximately 70 basis points. This environment continued into 2003, and the Corporation intends to take advantage of this situation for as long as it exists. The gain in 2001 resulted primarily from several securities that had been purchased at a discount being called, at par value, because of the low interest rate environment. Non-interest expense represents ordinary overhead expenses, including salaries, bonuses and benefits. The Corporation maintains a formal salary administration program that considers extensive comparative salary data and other indices supplied by a leading outside consulting firm. This data is utilized to assure that salaries are in line and competitive with comparable jobs in the marketplace. Incentive bonuses that were expensed in 2002 and 2000 were paid to employees based on the attainment of predetermined profit goals. The predetermined profit goals were not reached in 2001; therefore, no significant bonuses were accrued. Overall, non-interest expense increased by approximately $1.3 million or, 4.1%, during 2002. This entire increase can be attributed to increases in salaries and benefits. Salaries increased by 7.3%, or $1.1 million. Approximately 86% of this increase came from bonuses and related expenses that were accrued in 2002. As stated above, no bonuses were accrued in 2001. The remaining portion of the salary increase is due to normal salary increases for the year. Employee benefits increased by 18.1%, or $568,000 in 2002. Like most companies, NBC experienced an increase in medical insurance premiums during the year. Also, the benefit cost increased due the effects on the Defined Benefit Plan of the lower rate environment on the present value calculations and low returns in the plan's investment portfolio due to the weak equity markets. Additionally, net occupancy expense and furniture and equipment expense increased by $112,000 or 2.4%. This small increase came primarily from higher maintenance and repair cost during the year. These increases were partially offset by a $481,000, or 5.1%, decrease in other expenses. During 2001, non-interest expense increased by approximately $1.2 million or, 3.9%. This increase resulted primarily from a $896,000, or 5.2%, increase in Salaries and Employee Benefits and a $226,000, or 2.5%, increase in Other Operating Expenses. Salaries and Employee Benefits increased as the result of an increase in employee benefit cost and a reduction in the FASB 91 deferral because of the reduction in loan volume. Salaries were basically unchanged during the year. The Corporation made significant changes in its employee benefits that became effective at the beginning of 2001. Management knew that these changes would increase the cost of benefits in the early years, but would eventually allow management to better control and possibly reduce the cost of benefits in future years. To offset these increases, the Corporation purchased the Bank-Owned Life Insurance. The increase in Other Operating Expenses resulted from increases in several expense categories, none of which were individually considered to be material. Changes in the Corporation's income tax expense have generally paralleled changes in pre-tax income. The Corporation's effective tax rates were 27.3% in 2000, 24.5% in 2001 and 25.2% in 2002. The small increase in the effective tax rate in 2002 resulted from a $8.8 million dollar decrease in the average balance of assets that provide either tax-free or tax advantaged earnings. The decrease in the effective rate in 2001 resulted from a $14 million increase in the average balance of assets that provide either tax-free or tax advantaged earnings. The Corporation's ability to reduce income tax expense by acquiring additional tax-free investments is limited by the Alternative Minimum Tax Provision, the market supply of acceptable municipal securities, the level of tax exempt yields and the Corporation's normal liquidity and balance sheet structure requirements. LIQUIDITY, ASSET/LIABILITY MANAGEMENT Liquidity may be defined as the ability of the Corporation to meet cash flow requirements created by decreases in deposits and/or other sources of funds or increases in loan demand. The Corporation has not experienced any problems with liquidity over any of the years noted, and anticipates that all liquidity requirements will be met comfortably in the future. The Corporation's traditional sources of funds from deposit increases, maturing loans and investments and earnings have generally allowed it to consistently generate sufficient funds for liquidity needs. As the result of a $38.2 million decrease in loans and a $6.7 million increase in deposits, the Corporation's loan/deposit ratio has decreased from 76.8% in 2001 to 71.5% in 2002. In addition, the Corporation increased its borrowing from the Federal Home Loan Bank during 2002 by approximately $2.0 million and other borrowed funds by $9.0 million. With the very soft loan demand, this positive flow of funds was used primarily to purchase additional investment securities. During 2002, the investment security portfolio increased from $340.7 million to $393.8 million, representing a $53.1 million, or 15.6%, increase. An additional $15.0 million was placed in Federal Funds Sold. All the remaining liquidity needs for the year were provided from normal operating activities. The Corporation offers repurchase agreements to accommodate excess funds of some of its larger depositors. Management believes that these repurchase agreements stabilize traditional deposit sources as opposed to risking the potential loss of these funds to alternative investment arrangements. Repurchase Agreements, which are viewed as a source of funds to the Corporation, totaled $25.6 million and $16.6 million at December 31, 2002 and 2001, respectively. The level of repurchase agreement activity is limited by the availability of investment portfolio securities to be pledged against the accounts. Due to the limited amount of repurchase agreements and the fact that the underlying securities remain under the control of National Bank of Commerce, the exposure of the Corporation for this service is not considered material. The following table shows the contractual obligations for the Corporation as of December 31, 2002: Obligations Due in ___________ less Due in Due in Due than 1 1-3 3-5 after 5 (In Thousands) Total year years years years ____________ ________ _______ _______ _______ _______ Long-term debt $111,906 $25,757 $51,846 $25,039 $ 9,264 Operating leases 2,852 279 720 236 1,617 Securities sold under repurchase agreements 25,599 25,599 Other borrowings 1,035 1,035 ________ _______ _______ _______ _______ Total cash obligations $141,392 $52,670 $52,566 $25,275 $10,881 ======== ======= ======= ======= ======= The following table shows the other commercial commitments for the Corporation as of December 31, 2002: Commercial Commitments Expires ______________________ in less Expires Expires Expires than 1 in 1-3 in 3-5 after 5 (In Thousands) Total year years years years ____________ ________ _______ _______ _______ _______ Lines of Credit (unfunded commitments) $76,217 $59,380 $ 5,510 $ 1,967 $ 9,360 Commercial and similar letters of credit $6,018 $2,041 $1,363 $2,614 ____________________________________________ The Corporation believes that normal earnings and other traditional sources of cash flow, along with additional borrowings from the Federal Home Loan Bank, if necessary, will provide the cash to allow it to meet these obligations with no adverse effect on liquidity. At December 31, 2002, the Corporation had the ability to borrow approximately $48 million from the Federal Home Loan Bank and had other short-term borrowing lines (Federal Funds Purchased Lines) of approximately $75 million from upstream correspondent banks. The Corporation has no plans for the refinancing or redemption of any liabilities other than normal maturities and payments relating to the borrowings from the Federal Home Loan Bank. The Corporation does not have plans at this time for any discretionary spending that would have a material impact on liquidity other than its announced stock repurchase program. At December 31, 2002, the Corporation had the authority, at its discretion, to purchase 330,583 additional shares of its common stock. If purchased at the year-end closing price of $25.20, this purchase would require approximately $8.3 million. Any purchases under this program will be made over an unknown period of time, and the necessary funds will be provided from normal sources. Under regulations controlling financial holding companies and national banks, the bank is limited in the amount it can lend to the Corporation and such loans are required to be on a fully secured basis. At December 31, 2002, there were no borrowings between the Corporation and its subsidiary bank. The Corporation has maintained a consistent and disciplined asset/ liability management policy during each of the years noted in the summary. This policy focuses on interest rate risk and sensitivity. During 2002, the Corporation did not engage in any non-exchange-traded contracts such as currency or interest rate swaps, nor did it purchase or hold any derivative securities. The primary objective of rate sensitivity management is to maintain net interest income growth while reducing exposure to adverse fluctuations in rates. The Corporation utilizes an Asset/Liability Management Committee that evaluates and analyzes the Corporation's pricing, asset/liability maturities and growth, and balance sheet mix strategies in an effort to make informed decisions that will increase income and limit interest rate risk. The committee uses simulation modeling as a guide for its decision making. Modeling techniques are also utilized to forecast changes in net income and the economic value of equity under assumed fluctuations in interest rate levels. Due to the potential volatility of interest rates, the Corporation's goal is to stabilize the net interest margin by maintaining a neutral rate sensitive position. At year-end 2002, the Corporation's balance sheet reflected approximately $51.6 million more in rate sensitive assets than liabilities that were scheduled to reprice within one year. This represents 4.8% of total assets and would indicate that the Corporation is slightly asset sensitive. This computation results from a static gap analysis that weights assets and liabilities equally. It is the Corporation's policy to maintain a static gap position of no more than a plus or minus 10% of aggregate assets over a moving twenty-four month period. The Corporation's position is considered essentially neutral when using simulation modeling that provides different weighting for assets and liabilities. Management believes that interest rates will increase slightly during the second half of 2003. As a result, it is felt that the Corporation's current position places it in the correct interest rate risk posture for a rising rate environment. Management does not believe that it is in the Corporation's best interest to speculate on changes in interest rate levels. Although earnings could be enhanced if predictions were correct, they could also be put at significant risk if interest rates move against predictions. CAPITAL Retained earnings have served as the Corporation's exclusive source of capital growth over the five years noted in the summary of Selected Financial Data. In 1999, total Stockholders' Equity showed a decline of approximately $600,000. The reason for this decline was that Accumulated Other Comprehensive Income, which is composed primarily of unrealized gains (losses) on available-for-sale securities, moved from a gain of $1.4 million in 1998 to a loss of $2.6 million in 1999. This movement resulted from an increasing rate environment during 1999, which caused a decline in market value of these investment securities. The interest rate trend reversed in 2000, and as a result, the Accumulated Other Comprehensive Income improved from a loss of $2.6 million to a loss of only $68,000. This, along with net income, net of dividends, resulted in Stockholder's Equity increasing from $111.3 million at the end of 1999 to $120.1 million at the end of 2000. In 2001, Shareholder's Equity decreased by $17.2 million or 14.3%. This decrease resulted from a large repurchase of stock during the first quarter and the normal payment of dividends. These decreases were partially offset by the net income for the year and a continued downward trend in interest rates, which caused the Accumulated Other Comprehensive Income to increase from a loss of $68,000 at December 31 2000, to a gain of $1,650,000 at December 31, 2001. In 2002, Shareholders' Equity increased by $8.2 million from $102.9 million to $111.1 million. This represented an increase of 7.9%. This increase came primarily from two sources. First, the Corporation generated net income of $14.2 million, from which it paid approximately $7.1 million in dividends. The second primary cause of this increase was that the interest rate climate continued downward during 2002, causing the market value of the available-for-sale securities to increase. As a result, Accumulated Other Comprehensive Income increased from $1,650,000 at December 31, 2001 to $4,122,000 at December 31, 2002. Offsetting these increases was the purchase of approximately $1.3 million in Treasury Stock. Common Stock also shows an increase of approximately $2.4 million. However, this was the result of a four-for-three stock split, accounted for as a stock dividend, during the third quarter of 2002. This increase in Common Stock was offset by a charge to Retained Earnings and had no impact on Total Shareholders' Equity. During 2002, the amount of Treasury Stock increased from $25,997,000 to $27,341,000 as the number of shares held in the treasury increased from 1,029,702 to 1,428,352. This increase in the shares held in treasury stock came from stock purchased through the Repurchase Program first announced in July of 2001 and extended in July of 2002. The initial plan approved the repurchase of 310,000 shares or up to 5% of the common stock. This total increased to 413,333 as the result of the four for three stock split that occurred during the third quarter of 2002. During 2002, 27,300 shares were purchased under this program prior to the above referenced stock split for approximately $855,000 or an average of $31.31 per share on a pre-split basis. As a result of the split, 352,000 of additional shares were placed in treasury stock at no additional cost. Following the split, an additional 20,350 shares were purchased under the repurchase plan for approximately $517,000, or an average price of $25.39. On a post-split basis, the average purchase price of stock purchased during 2002 was $24.16 per share. During fourth quarter, 11,800 shares were purchased at an average price of $25.45 per share. Also during 2002, the Corporation issued 1,000 shares upon the exercise of stock options granted under a plan carried over from FFBS. At December 31, 2002, the Corporation could purchase an additional 330,583 shares under its Stock Repurchase Program. During the year ended December 31, 2002, the Corporation used Sterne, Agee & Leach, Inc. and FTN Financial Securities Corp. to purchase these shares under the Stock Repurchase Plan in the open market in accordance with Securities and Exchange Commission Rule 10b-18. Current regulatory requirements call for a basic leverage ratio of 5.0% for an institution to be considered "well-capitalized." At the end of 2002, NBC maintained a 9.9% leverage ratio, which means it significantly exceeded the ratio required for a "well-capitalized" institution. Regulatory authorities also evaluate a financial institution's capital under certain risk-weighted formulas (high-risk assets would require a higher capital allotment, lower risk assets a lower capital allotment). In this context, a "well-capitalized" bank is required to have a Tier 1 risk-based capital ratio (excludes reserve for loan losses) of 6.0% and a total risk-based capital ratio (includes reserve for loan losses) of 10.0%. At the end of 2002, the Corporation had a Tier 1 ratio of 16.5% and a total risk-based capital ratio of 17.4%, again placing the Corporation well above the level required for a "well-capitalized" institution. The Corporation's capital position obviously exceeds regulatory requirements, even for "well-capitalized" institutions. Even though capital has decreased 0.7% since 1998 and assets grew by 15.0%; the capital to asset ratio remained high at 10.3%, as of December 31, 2002. Management still considers this level of capital to be excessive in relation to the amount needed to support the assets of the Corporation. As a result, management is continuing to consider alternatives to safely leverage the remaining excess capital in an effort to increase the earnings of the Corporation and improve Return on Average Equity. Some of the items under consideration are the additional purchase of the Corporation's stock, acquisitions and additional arbitrage transactions. There are no material commitments for the use of capital resources that cannot be funded through currently available liquidity sources. MARKET INFORMATION The Corporation's stock is listed on the American Stock Exchange ("AMEX") and is traded under the symbol NBY. SunTrust Bank, Atlanta acts as Transfer Agent for the Corporation. The following table sets forth, for the periods indicated, the range of sales prices of the Corporation's common stock as reported on AMEX for 2001 and 2002 and the dividends declared for each period. Please note that all per share amounts have been restated for the 4-for-3 stock split, accounted for as a stock dividend, that occurred during the third quarter of 2002. CASH DIVIDEND DECLARED PER YEAR QUARTER HIGH LOW QUARTER _______________________________________________________ 2001 First $16.880 $14.160 $0.19 Second 22.090 16.090 0.21 Third 25.310 20.440 0.21 Fourth 24.380 22.430 0.21 2002 First $23.480 $21.490 $0.21 Second 28.500 22.610 0.22 Third 28.200 24.280 0.22 Fourth 26.700 24.800 0.22 ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed only to U.S. dollar interest rate changes and, accordingly, the Company manages exposure by considering the possible changes in the net interest margin. The Company does not have any trading instruments nor does it classify any portion of the investment portfolio as held for trading. The Company does not engage in any hedging activities or enter into any derivative instruments with a higher degree of risk than collateralized mortgage obligations which are commonly held securities generally collateralized by pools of GNMA, FNMA, or FHLMC pass- through securities. Finally, the Company has no exposure to foreign currency exchange rate risk, commodity price risk, and other market risks. The following table reflects the year-end position of the Company's interest-earning assets and interest-bearing liabilities which can either reprice or mature within the designated time period. The interest rate sensitivity gaps can vary from day-to-day and are not necessarily a reflection of the future. In addition, certain assets and liabilities within the same designated time period may nonetheless reprice at different times and at different levels. ($ In Thousands) December 31, 2002 ________________________________________ Interest Sensitive Within (Cumulative) ________________________________________ Total of Within Within Within Interest- 3 12 5 Earning Months Months Years Assets ________ ________ ________ __________ Interest-earning assets: Loans $258,310 $393,865 $524,792 $ 584,707 Investment and mortgage-backed securities 52,266 229,324 329,572 393,783 Federal funds sold and other 29,053 29,053 29,053 29,053 ________ ________ ________ __________ Totals 339,629 652,242 883,417 1,007,543 ________ ________ ________ __________ Interest-bearing liabilities: Deposits 368,907 548,226 708,393 713,945 Borrowed funds 33,073 52,391 129,296 138,540 ________ ________ ________ __________ 401,980 600,617 837,669 882,485 ________ ________ ________ __________ Sensitivity gap: Dollar amount (62,351) 51,625 45,748 125,058 Percent of total interest-earning assets (6.19%) 5.12% 4.54% 12.4% The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap". An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within that time period. A gap is considered positive when the amount of interest rate sensitive assets maturing within a specific time frame exceeds the amount of interest rate sensitive liabilities maturing within that same time frame. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. In a rising interest rate environment, an institution with a positive gap would generally be expected, absent the effects of other factors, to experience a greater increase in the yield of its assets relative to the costs of its liabilities and thus an increase in the institution's net interest income would result whereas an institution with a negative gap could experience the opposite results. At December 31, 2002, total interest-earning assets maturing or repricing within one year were more than interest-bearing liabilities maturing or repricing within the same time period by approximately $51.6 million (cumulative), representing a positive cumulative one year gap of 5.12% of earning assets. Management of the Company believes this position to be acceptable in the current interest rate environment. Banking regulators have issued advisories concerning the management of interest rate risk (IRR). The regulators consider that effective interest rate management is an essential component of safe and sound banking practices. To monitor its IRR, the Company's risk management practices include (a) Risk Management, (b) Risk Monitoring and (c) Risk Control. Risk Management consists of a system in which a measurement is taken of the amount of earnings at risk when interest rates change. The Company does this by first preparing a "base strategy" which is the position of the bank and its forecasted earnings based upon the current interest rate environment or, most likely, interest rate environment. The IRR is then measured based upon hypothetical changes in interest rates by measuring the impact such a change will have on the "base strategy." Risk monitoring consists of evaluating the "base strategy" and the assumptions used in its development based upon the current interest rate environment. This evaluation is performed quarterly by management or more often in a rapidly changing interest rate situation and monitored by an Asset/Liability Management Committee. Risk control is utilized based upon the setting of guidelines as to the tolerance for interest rate exposure. These guidelines are set by senior management and approved by the board of directors. Assuming a 300 basis points increase over the next twelve months, the December, 2002, model reflects net income declining by .6%. A 300 basis points decline would result in an 11.6% decrease in net income. Utilizing a rate shock model, a 200 basis point increase in interest rates results in a 14.8% decrease in market value equity, and a 200 basis point decrease results in a 3.9% increase in market value equity. The guidelines allow for no more than a + - 10% change in income, and no more than a + - 25% change in market value equity. However, at December 31, 2002, management believes the changes in income and market value equity as reflected in the models are acceptable in the current rate environment. ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NBC CAPITAL CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT DECEMBER 31, 2002 AND 2001 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders NBC Capital Corporation We have audited the accompanying consolidated balance sheets of NBC Capital Corporation ("the Corporation") and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above, present fairly, in all material respects, the consolidated financial position of NBC Capital Corporation and subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in the notes to the consolidated financial statements, the Corporation and its subsidiaries adopted Financial Accounting Standards Board Statement No. 142, "Goodwill and Other Intangibles," effective January 1, 2002. /S/ T. E. LOTT & COMPANY Starkville, Mississippi January 17, 2003 NBC CAPITAL CORPORATION CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 AND 2001 2002 2001 __________ __________ ASSETS (In thousands) Cash and due from banks $ 27,865 $ 28,752 Interest-bearing deposits with banks 567 1,263 Federal funds sold 28,486 13,510 __________ __________ Total cash and cash equivalents 56,918 43,525 __________ __________ Securities available-for-sale 349,991 293,043 Securities held-to-maturity (estimated fair value of $46,975 in 2002 and $50,623 in 2001) 43,792 47,683 __________ __________ Total securities 393,783 340,726 __________ __________ Loans 584,707 622,940 Less allowance for loan losses (6,029) (6,753) __________ __________ Net loans 578,678 616,187 __________ __________ Interest receivable 7,605 8,352 Premises and equipment 14,816 15,377 Goodwill 2,853 2,857 Other assets 22,803 23,778 __________ __________ Total Assets $1,077,456 $1,050,802 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Noninterest-bearing deposits $ 103,502 $ 101,569 Interest-bearing deposits 713,945 709,134 __________ __________ Total deposits 817,447 810,703 __________ __________ Interest payable 1,626 2,284 Securities sold under agreements to repurchase 25,599 16,625 Other borrowed funds 112,941 110,594 Other liabilities 8,736 7,669 __________ __________ Total liabilities 966,349 947,875 __________ __________ Shareholders' equity: Common stock - $1 par value, authorized 10,000,000 shares in 2002 and 2001; issued 9,615,806 shares in 2002 and 7,212,662 in 2001 9,616 7,213 Surplus 51,413 51,429 Retained earnings 73,297 68,632 Accumulated other comprehensive income 4,122 1,650 Treasury stock, at cost (27,341) (25,997) __________ __________ Total shareholders' equity 111,107 102,927 __________ __________ Total Liabilities and Shareholders' Equity $1,077,456 $1,050,802 ========== ========== The accompanying notes are an integral part of these statements. NBC CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 2002 2001 2000 ________ ________ ________ (In thousands, except per share data) INTEREST INCOME Interest and fees on loans $ 40,022 $ 51,852 $ 57,535 Interest and dividends on securities: Taxable 13,971 11,165 7,966 Tax-exempt 5,843 6,803 6,086 Other 215 950 1,148 ________ ________ ________ Total interest income 60,051 70,770 72,735 ________ ________ ________ INTEREST EXPENSE Interest on time deposits of $100,000 or more 5,086 7,788 7,692 Interest on other deposits 12,085 22,078 23,867 Interest on borrowed funds 5,705 6,135 3,419 ________ ________ ________ Total interest expense 22,876 36,001 34,978 ________ ________ ________ Net interest income 37,175 34,769 37,757 Provision for loan losses 2,790 1,720 1,280 ________ ________ ________ Net interest income after provision for loan losses 34,385 33,049 36,477 ________ ________ ________ OTHER INCOME Service charges on deposit accounts 7,110 5,942 5,306 Insurance commissions, fees, and premiums 4,091 3,857 4,204 Other service charges and fees 3,092 2,935 1,938 Trust Department income 1,772 1,717 1,616 Securities gains (losses), net 457 459 (22) Other 1,524 1,556 720 ________ ________ ________ Total other income 18,046 16,466 13,762 ________ ________ ________ OTHER EXPENSE Salaries 16,129 15,026 14,976 Employee benefits 3,698 3,130 2,284 Net occupancy expense 2,412 2,311 2,161 Furniture and equipment expense 2,316 2,305 2,378 Other 8,863 9,344 9,118 ________ ________ ________ Total other expense 33,418 32,116 30,917 ________ ________ ________ Income before income taxes 19,013 17,399 19,322 Income taxes 4,792 4,261 5,277 ________ ________ ________ Net income $ 14,221 $ 13,138 $ 14,045 ======== ======== ======== Net income per share: Basic $ 1.73 $ 1.54 $ 1.47 Diluted 1.73 1.54 1.47 The accompanying notes are an integral part of these statements. NBC CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 Accumu- lated Other Compre- Compre- hensive Common Retained Treasury hensive Income Stock Surplus Earnings Stock Income Total _______ ______ _______ ________ ________ ________ ________ (In thousands) Balance, January 1, 2000 $7,213 $51,845 $ 55,410 $ (579) $(2,638) $111,251 Comprehensive income: Net income for 2000 $14,045 - - 14,045 - - 14,045 Net change in unrealized gains on securities available-for-sale, net of tax 2,570 - - - - 2,570 2,570 _______ Comprehensive income $16,615 ======= Cash dividends declared, $.73 per share - - (6,963) - - (6,963) Purchase of treasury stock - - - (1,164) - (1,164) Treasury shares issued for acquisition - (184) - 479 - 295 Exercise of stock options - (132) - 221 - 89 ______ _______ ________ ________ ________ ________ Balance, December 31, 2000 7,213 51,529 62,492 (1,043) (68) 120,123 Comprehensive income: Net income for 2001 $13,138 - - 13,138 - - 13,138 Net change in unrealized gains on securities available-for-sale, net of tax 1,718 - - - - 1,718 1,718 _______ Comprehensive income $14,856 ======= Cash dividend declared, $.82 per share - - (6,998) - - (6,998) Purchase of treasury stock - - - (25,122) - (25,122) Exercise of stock options - (100) - 168 - 68 ______ _______ ________ ________ ________ ________ Balance, December 31, 2001 7,213 51,429 68,632 (25,997) 1,650 102,927 Comprehensive income: Net income for 2002 $14,221 - - 14,221 - - 14,221 Net change in unrealized gains on securities available-for-sale, net of tax 2,472 - - - - 2,472 2,472 _______ Comprehensive income $16,693 ======= 4 for 3 stock split 2,403 - (2,403) - - - Cash dividends declared, $.87 per share - - (7,123) - - (7,123) Purchase of treasury stock - - - (1,372) - (1,372) Exercise of stock options - (16) - 28 - 12 Purchase of fractional shares - - (30) - - (30) ______ _______ ________ ________ ________ ________ Balance, December 31, 2002 $9,616 $51,413 $ 73,297 $(27,341) $ 4,122 $111,107 ====== ======= ======== ======== ======== ======== The accompanying notes are an integral part of these statements. NBC CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 2002 2001 2000 ________ ________ ________ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 14,221 $ 13,138 $ 14,045 Adjustments to reconcile net income to net cash: Depreciation and amortization 2,031 2,558 2,458 Deferred income taxes 719 701 103 Provision for loan losses 2,790 1,720 1,280 Securities amortization and accretion, net 1,447 515 558 FHLB stock dividend (173) (201) (278) (Gains) losses on sale of securities (457) (459) 22 Deferred credits 143 (63) (397) Changes in: Interest receivable 747 2,169 (1,674) Other assets (1,627) 13,080) 992 Interest payable (658) 1,136) 607 Other liabilities 385 (99) (167) ________ ________ ________ Net cash provided by operating activities 19,568 5,763 17,549 ________ ________ ________ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of securities available-for-sale (182,876) (159,165) (46,745) Proceeds from sales of securities available-for-sale 40,591 33,056 1,883 Proceeds from maturities and calls of securities available-for-sale 88,229 67,859 16,930 Purchases of securities held-to-maturity - - (22,866) Proceeds from maturities and calls of securities held-to-maturity 3,891 2,113 2,894 (Increase) decrease in loans 35,651 22,225 (23,993) Additions to premises and equipment (1,313) (1,125) (1,450) Cash paid in business acquisition - - (47) ________ ________ ________ Net cash used in investing activities (15,827) (35,037) (73,394) ________ ________ ________ CASH FLOWS FROM FINANCING ACTIVITIES Increase in deposits 6,744 5,899 51,994 Dividends paid on common stock (7,053) (7,062) (10,138) Net change in securities sold under agreement to repurchase 8,974 299 (12,340) Proceeds from issuance of long-term debt 44,500 75,200 50,000 Repayment of long-term debt (42,153) (21,633) (59,830) Exercise of stock options 12 68 89 Acquisition of stock (1,372) (25,122) (1,164) ________ ________ ________ Net cash provided by financing activities 9,652 27,649 18,611 ________ ________ ________ Net increase (decrease) in cash and cash equivalents 13,393 (1,625) (37,234) Cash and cash equivalents at beginning of year 43,525 45,150 82,384 ________ ________ ________ Cash and cash equivalents at end of year $ 56,918 $ 43,525 $ 45,150 ======== ======== ======== The accompanying notes are an integral part of these statements NBC CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 AND 2001 NOTE A - SUMMARY OF ACCOUNTING POLICIES NBC Capital Corporation (the "Corporation"), and its subsidiaries, follow accounting principles generally accepted in the United States of America, including, where applicable, general practices within the banking industry. 1. Basis of Presentation The consolidated financial statements include the accounts of the Corporation and National Bank of Commerce ("NBC"), a wholly-owned subsidiary of the Corporation, First National Finance Company, a wholly-owned subsidiary of the Corporation, Galloway-Chandler-McKinney Insurance Agency, Inc., a wholly-owned subsidiary of NBC, NBC Insurance Services of Alabama, Inc., a wholly-owned subsidiary of NBC, NBC Service Corporation, a wholly-owned subsidiary of NBC, and Commerce National Insurance Company, a 79%-owned subsidiary of NBC Service Corporation. Significant intercompany accounts and transactions have been eliminated. 2. Nature of Operations The Corporation is a financial holding company. Its primary asset is its investment in its subsidiary bank. NBC provides full banking services, including trust services. The bank operates under a national bank charter and is subject to regulation of the Office of the Comptroller of the Currency. The area served by NBC is the North Central region of Mississippi with locations in ten communities and the Tuscaloosa, Alabama area. Galloway-Chandler-McKinney Insurance Agency, Inc., operates insurance agencies in the NBC servicing area. NBC Insurance Services of Alabama, Inc., sells annuity contracts in the State of Alabama. The primary asset of NBC Service Corporation is its investment in Commerce National Insurance Company, a life insurance company. First National Finance Company is a finance company located in West Point, Mississippi. 3. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 4. Securities Investments in securities are classified into three categories and are accounted for as follows: Securities Available-for-Sale Securities classified as available-for-sale are those securities that are intended to be held for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including movements in interest rates, liquidity needs, security risk assessments, changes in the mix of assets and liabilities and other similar factors. These securities are carried at their estimated fair value, and the net unrealized gain or loss is reported as accumulated other comprehensive income, net of tax, until realized. Premiums and discounts are recognized in interest income using the interest method. Gains and losses on the sale of securities available-for-sale are determined using the adjusted cost of the specific security sold. Securities Held-to-Maturity Securities classified as held-to-maturity are those securities for which there is a positive intent and ability to hold to maturity. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method. Trading Account Securities Trading account securities are those securities which are held for the purpose of selling them at a profit. There were no trading account securities on hand at December 31, 2002 and 2001. 5. Loans Loans are carried at the principal amount outstanding. Interest income on loans is recognized based on the principal balance outstanding and the stated rate of the loan. A loan is considered to be impaired when it appears probable that the entire amount contractually due will not be collected. Factors considered in determining impairment include payment status, collateral values, and the probability of collecting scheduled payments of principal and interest when due. Generally, impairment is measured on a loan by loan basis using the fair value of the supporting collateral. Loans are generally placed on a nonaccrual status when principal or interest is past due ninety days or when specifically determined to be impaired. When a loan is placed on nonaccrual status, interest accrued but not received is generally reversed against interest income. If collectability is in doubt, cash receipts on nonaccrual loans are used to reduce principal rather than recorded as interest income. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. 6. Allowance for Loan Losses The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual and anticipated loss experience, current economic events, including unemployment levels, and other pertinent factors, including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the evaluation of collateral supporting impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. The allowance for loan losses consists of an allocated component and an unallocated component. The components of the allowance for loan losses represent an estimation done pursuant to either Financial Accounting Standards Board (FASB) Statement No. 5, "Accounting for Contingencies," or FASB Statement No. 114, "Accounting by Creditors for Impairment of a Loan." The allocated component of the allowance for loan losses reflects expected losses resulting from an analysis developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific allocations are based on a regular review of all loans over a fixed- dollar amount and where the internal credit rating is at or below a predetermined classification. The historical loan loss element is determined statistically using loss experience and the related internal gradings of loans charged off. The analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for loan losses also includes consideration of the amounts necessary for any concentrations and changes in portfolio mix and volume. The unallocated portion of the allowance reflects management's estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, changes in collateral values, unfavorable information about a borrower's financial condition, and other risk factors that have not yet manifested themselves. In addition, the unallocated allowance includes a component that explicitly accounts for the inherent imprecision in the loan loss analysis. The historical loan loss experiences used in the analysis may not be representative of actual losses inherent in the portfolio that have not yet been realized. 7. Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are determined using the straight-line method at rates calculated to depreciate or amortize the cost of assets over their estimated useful lives. Maintenance and repairs of property and equipment are charged to operations, and major improvements are capitalized. Upon retirement, sale, or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts, and any gains or losses are included in operations. 8. Other Real Estate Other real estate consists of properties acquired through foreclosure and as held for sale property is recorded at the lower of the outstanding loan balance or current appraisal less estimated costs to sell. Any write-down to fair value required at the time of foreclosure is charged to the allowance for loan losses. Subsequent gains or losses on other real estate are reported in other operating income or expenses. 9. Goodwill and Other Intangible Assets Goodwill represents the cost of acquired institutions in excess of the fair value of the net assets acquired. Effective January 1, 2002, the Corporation and its subsidiaries adopted FASB Statement No. 142, "Goodwill and Other Intangible Assets," which eliminated the requirement to amortize goodwill but instead requires periodic testing of goodwill for impairment. The Corporation and its subsidiaries adopted FASB Statement No. 147, "Acquisition of Certain Financial Institutions" which was effective October 1, 2002. The statement applies to unidentified intangible assets resulting from the acquisition of less-than-whole financial institutions. NBC's unidentified intangible asset resulted from such an acquisition. Upon evaluation, NBC determined the acquisition met the requirements of a business combination and, in accordance with FASB Statement No. 147, the related unidentified intangible asset was reclassified as goodwill and accounted for in accordance with FASB Statement No. 142. As a result, NBC reversed all related amortization expense recognized after FASB Statement No. 142 was applied. Goodwill and any other intangible assets are reviewed annually for possible impairment. If impaired, the asset is written down to its estimated fair value. Prior to adopting Statements No. 142 and 147, the Corporation and its subsidiaries amortized goodwill and other intangible assets using the straight-line method over the estimated benefit period. 10. Income Taxes Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes related primarily to differences between the bases of assets and liabilities as measured by income tax laws and their bases as reported in the financial statements. The deferred tax assets and liabilities represent the future tax consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The Corporation and its subsidiaries (except for Commerce National Insurance Company) file consolidated income tax returns. The subsidiaries provide for income taxes on a separate return basis and remit to the Corporation amounts determined to be payable. 11. Trust Assets Except for amounts included in deposits, assets of the Trust Department are not included in the accompanying balance sheets. 12. Advertising Costs Advertising costs are expensed in the period in which they are incurred. Advertising expense for the years ended December 31, 2002, 2001, and 2000, was approximately $601,000, $544,000, and $668,000, respectively. 13. Employee Benefits Employees hired prior to January 1, 2001, participate in a noncontributory defined benefit pension plan. The plan calls for benefits to be paid to eligible employees at retirement based primarily upon years of service and compensation. Contributions to the plan reflect benefits attributed to employees' services to date, as well as services expected to be earned in the future. The annual pension cost charged to expense is actuarially determined in accordance with the provisions of FASB Statement No. 87, "Employers' Accounting for Pensions." The plan was amended effective January 1, 2001, to close participation in the plan. Employees hired subsequent to December 31, 2000, are not eligible to participate. Current participants continue to accrue benefits, but benefits accrued are offset by contributions to the profit sharing plan. On January 1, 2001, the Corporation and its subsidiaries adopted a defined contribution profit sharing plan. Employer contributions are made annually equal to 3% of each participant's base pay. Participant accounts will be 100% vested upon completion of five years of service. The Corporation and its subsidiaries provide a deferred compensation arrangement [401(k)] plan whereby employees contribute a percentage of their compensation. NBC makes matching contributions of fifty percent of employee contributions of six percent or less for employees with less than twenty years of service. For employees with service of twenty years or more, the matching contribution is seventy-five percent of employee contributions of six percent or less. Employees participate in a nonleveraged Employee Stock Ownership Plan (ESOP) through which common stock of the Corporation is purchased at its market price for the benefit of employees. Effective January 1, 2001, the ESOP plan was amended to freeze the plan and to allow no new entrants into the ESOP. All participants at December 31, 2000, became 100% vested in their accounts. The ESOP is accounted for in accordance with Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans." The Corporation and its subsidiary bank have various deferred income and supplemental retirement plans for certain key executive and senior officers. Life insurance contracts have been purchased which may be used to fund payments under the plans. The estimated present value of the projected payments under the deferred income plans is being accrued to expense over the remaining expected term of each participant's active employment. Accruals for the supplemental retirement plans are based upon a predetermined rate or upon the earnings of the related life insurance contracts. The Corporation provides an employee stock benefit plan whereby 11,245 shares of the Corporation's stock have been assigned for the benefit of certain key employees. Under the terms of the plan, retirement or similar payments will be equal to the fair market value of the stock plus all cash dividends paid since the adoption of the agreement. An expense was recorded at the establishment date based on the market value of the stock. The difference between any increase or decrease in the value of the stock is recorded as an adjustment to employee benefits expense. 14. Stock Options Stock option grants are accounted for in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, no compensation expense is recognized for stock options granted. 15. Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks, interest-bearing deposits with banks, and federal funds sold. Generally, federal funds are sold for one to seven day periods. 16. Net Income Per Share Basic net income per share computations are based upon the weighted average number of common shares outstanding during the periods. Diluted net income per share computations are based upon the weighted average number of common shares outstanding during the periods plus the dilutive effect of outstanding stock options. Presented below is a summary of the components used to calculate basic and diluted net income per share for the years ended December 31, 2002, 2001, and 2000 (as restated for stock split): Years Ended December 31, ___________________________ 2002 2001 2000 _______ _______ _______ (In thousands, except per share data) Basic Net Income Per Share Weighted average common shares outstanding 8,213 8,548 9,573 ======= ======= ======= Net income $14,221 $13,138 $14,045 ======= ======= ======= Basic net income per share $ 1.73 $ 1.54 $ 1.47 ======= ======= ======= Diluted Net Income Per Share Weighted average common shares outstanding 8,213 8,548 9,573 Net effect of the assumed exercise of stock options based on the treasury stock method 15 - 7 _______ _______ _______ Total weighted average common shares and common stock equivalents outstanding 8,228 8,548 9,580 ======= ======= ======= Net income $14,221 $13,138 $14,045 ======= ======= ======= Diluted net income per share $ 1.73 $ 1.54 $ 1.47 ======= ======= ======= 17. Stock Split On July 30, 2002, the Corporation announced a four-for-three stock split that was effected in the form of a 33-1/3% stock dividend on September 9, 2002. Shareholders' equity, as presented in the consolidated financial statements, reflects the issuance of 2,403,144 shares of the Corporation's common stock. Per share and related information for all periods has been restated to reflect the stock split. 18. Off-Balance Sheet Financial Instruments In the ordinary course of business, NBC enters into off-balance sheet financial instruments consisting of commitments to extend credit, credit card lines, commercial and similar letters of credit and commitments to purchase securities. Such financial instruments are recorded in the financial statements when they are exercised. 19. Business Segments FASB Statement No. 131, "Disclosures About Segments of an Enterprise and Related Information," requires public companies to report (i) certain financial and descriptive information about their reportable operating segments (as defined) and (ii) certain enterprise-wide financial information about products and services, geographic areas, and major customers. Management believes the Corporation's principal activity is community banking and that any other activities are not considered significant segments. 20. Reclassifications Certain amounts reported in prior years have been reclassified to conform with the 2002 presentation. These reclassifications did not impact the Corporation's consolidated financial condition or results of operations. 21. Accounting Pronouncements In June, 2002, the FASB issued Statement No. 146, "Accounting for the Costs Associated with Exit or Disposal Activities." Statement No. 146 addresses the financial accounting and reporting for costs associated with exit or disposal activities and requires that a liability for a cost associated with an exit or disposal activity can be recognized when it is incurred and measured initially at fair value. This new guidance will impact the timing of recognition and the initial measurement of the amount of liabilities the Corporation and its subsidiaries recognize in connection with exit or disposal activities initiated after December 31, 2002, the effective date of the statement. The adoption of this statement is not expected to have a material impact on the Corporation's consolidated financial statements. In October, 2002, the FASB issued Statement No. 147, "Acquisition of Certain Financial Institutions." Except for transactions between mutual enterprises, this statement removes acquisitions of financial institutions from the scope of both FASB Statement No. 72 and FASB Interpretation No. 9 and requires that these transactions be accounted for in accordance with FASB Statements No. 141, "Business Combinations" and FASB Statement No. 142, "Goodwill and Other Intangible Assets." Further, the statement amends FASB Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to include in its scope long-term customer relationship intangible assets of financial institutions. Consequently, such assets are subject to the same impairment loss recognition and measurement provisions that FASB Statement No. 144 requires for other long-lived assets. As previously mentioned, the Corporation adopted this statement in 2002. NOTE B - ACQUISITIONS On April 28, 2000, NBC acquired Heritage Insurance Agency, Ltd. (Heritage), an independent insurance agency located in Starkville, Mississippi, for $47,025 in cash, and 14,028 shares of the Corporation's common stock issued from treasury. Simultaneously with the acquisition, Heritage was merged into Galloway-Chandler-McKinney Insurance Agency, Inc. The acquisition of Heritage was accounted for as a purchase business combination, and the results of operations of Heritage, which are not material, have been included in the consolidated financial statements from the acquisition date. NOTE C - SECURITIES A summary of amortized cost and estimated fair value of securities available-for-sale and securities held-to-maturity at December 31, 2002 and 2001, follows: December 31, 2002 ____________________________________________ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value _________ __________ __________ _________ (In thousands) Securities available- for-sale: U. S. Treasury securities $ 300 $ 2 $ - $ 302 Obligations of other U. S. Government agencies 1,402 47 - 1,449 Obligations of states and municipal subdivisions 59,989 2,432 1 62,420 Mortgage-backed securities 252,827 5,315 43 258,099 Equity securities 23,219 - 1,650 21,569 Other securities 5,980 178 6 6,152 _________ __________ __________ _________ $ 343,717 $ 7,974 $ 1,700 $ 349,991 ========= ========== ========== ========= Securities held-to- maturity: Obligations of states and municipal subdivisions $ 43,792 $ 3,218 $ 35 $ 46,975 ========= ========== ========== ========= December 31, 2001 ____________________________________________ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value _________ __________ __________ _________ (In thousands) Securities available- for-sale: U. S. Treasury securities $ 300 $ 6 $ - $ 306 Obligations of other U. S. Government agencies 4,354 185 - 4,539 Obligations of states and municipal subdivisions 64,588 1,604 4 66,188 Mortgage-backed securities 180,484 1,485 757 181,212 Equity securities 27,511 - 140 27,371 Other securities 13,285 142 - 13,427 _________ __________ __________ _________ $ 290,522 $ 3,422 $ 901 $ 293,043 ========= ========== ========== ========= Securities held-to- maturity: Obligations of states and municipal subdivisions $ 47,683 $ 2,983 $ 43 $ 50,623 ========= ========== ========== ========= The scheduled maturities of securities available-for-sale and securities held-to-maturity at December 31, 2002, are as follows: Available-for-Sale Held-to-Maturity ____________________ _____________________ Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value _________ __________ __________ _________ (In thousands) Due in one year or less $ 10,284 $ 10,439 $ 781 $ 801 Due after one year through five years 45,134 47,287 6,280 6,665 Due after five years through ten years 3,492 3,599 13,458 14,430 Due after ten years 2,781 2,847 23,273 25,079 Mortgage-backed securities and other securities 282,026 285,819 - - _________ __________ __________ _________ $ 343,717 $ 349,991 $ 43,792 $ 46,975 ========= ========== ========== ========= Equity securities consist of investments in FNMA preferred stock and stock of the Federal Reserve Bank and the Federal Home Loan Bank (FHLB). The transferability of the Federal Reserve Bank and FHLB stock is restricted. Gross gains of $534,000, $480,000, and $ -0-, and gross losses of $77,000, $21,000, and $22,000 were realized on securities available- for-sale in 2002, 2001, and 2000, respectively. Securities with a carrying value of $161,435,000 and $193,986,000 at December 31, 2002 and 2001, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law. NOTE D - LOANS Loans outstanding include the following types: December 31, ___________________ 2002 2001 ________ ________ (In thousands) Commercial, financial and agricultural $103,327 $101,630 Real estate - construction 30,028 31,461 Real estate - mortgage 364,875 387,667 Installment loans to individuals 77,692 94,424 Overdrafts 1,194 789 Net deferred costs and fees 631 775 Other 6,960 6,194 ________ ________ 584,707 622,940 Allowance for loan losses (6,029) (6,753) ________ ________ $578,678 $616,187 ======== ======== Transactions in the allowance for loan losses are summarized as follows: Years Ended December 31, ______________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Balance at beginning of year $ 6,753 $ 9,689 $ 10,194 Additions: Provision for loan losses charged to operating expense 2,790 1,720 1,280 Recoveries of loans previously charged off 660 544 417 ________ ________ ________ 10,203 11,953 11,891 Deductions: Loans charged off 4,174 5,200 2,202 ________ ________ ________ Balance at end of year $ 6,029 $ 6,753 $ 9,689 ======== ======== ======== At December 31, 2002 and 2001, the recorded investment in loans considered to be impaired totaled approximately $1,230,000 and $2,471,000, respectively. The allowance for loan losses related to these loans approximated $596,000 and $1,353,000 at December 31, 2002 and 2001, respectively. The average recorded investment in impaired loans during the years ended December 31, 2002 and 2001, was approximately $1.8 million and $4.1 million, respectively. For the years ended December 31, 2002 and 2001, the amount of income recognized on impaired loans was immaterial. At December 31, 2002 and 2001, nonaccrual loans amounted to approximately $1,274,000 and $2,050,000, respectively, and loans past due ninety days or more and still accruing interest amounted to approximately $2,700,000 and $1,900,000, respectively. NOTE E - PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation and amortization as follows: Estimated December 31, Useful Lives __________________ In Years 2002 2001 ____________ ________ ________ (In thousands) Premises: Land - $ 3,404 $ 3,404 Buildings, construction and improvements 10 - 50 16,535 16,308 ________ ________ 19,939 19,712 Equipment 3 - 10 8,548 11,688 ________ ________ 28,487 31,400 Less accumulated depreciation and amortization (13,671) (16,023) ________ ________ $ 14,816 $ 15,377 ======== ======== The amount charged to operating expenses for depreciation was $1,875,000 for 2002, $2,032,000 for 2001, and $1,922,000 for 2000. During the year 2002, the Corporation and its subsidiaries retired fully depreciated equipment with an original cost of approximately $4 million. NOTE F - DEPOSITS The aggregate amount of time deposits in denominations of $100,000 or more for 2002 and 2001 was $164,625,000 and $147,885,000, respectively. At December 31, 2002, the scheduled maturities of time deposits included in interest-bearing deposits are as follows (in thousands): 2003 $ 227,620 2004 62,412 2005 49,861 2006 36,326 2007 6,016 Thereafter 5,552 _________ $ 387,787 ========= NOTE G - BORROWED FUNDS Securities sold under agreements to repurchase generally mature within one to seven days from the transaction date. Information concerning securities sold under agreements to repurchase is summarized as follows: 2002 2001 ________ ________ ($ In thousands) Balance at year end $ 25,599 $ 16,625 Average balance during the year 19,430 18,922 Average interest rate during the year 1.61% 3.45% Maximum month-end balance during the year 26,328 21,765 Securities underlying the repurchase agreements remain under the control of NBC. Other borrowed funds consisted of the following at December 31: 2002 2001 ________ ________ (In thousands) FHLB advances $111,906 $109,911 Treasury tax and loan note 1,035 683 ________ ________ $112,941 $110,594 ======== ======== Advances from the FHLB consist of monthly amortizing borrowings with maturity dates ranging from June, 2004, through August, 2012. Interest is payable monthly at rates ranging from 3.53% to 7.29%. Advances due to the FHLB are collateralized by a blanket lien on the bank's first mortgage loans. FHLB advances available and unused at December 31, 2002, totaled $47.8 million. The treasury tax and loan note generally matures within one to sixty days from the transaction date. Interest is paid at an adjustable rate as set by the U. S. Government. Annual principal repayment requirements on FHLB borrowings at December 31, 2002, are as follows: Year Amount ____ ______ (In thousands) 2003 $25,757 2004 26,398 2005 25,448 2006 20,275 2007 4,764 Thereafter 9,264 NOTE H - OTHER ASSETS AND OTHER LIABILITIES Other assets and other liabilities at December 31, 2002 and 2001, consisted of the following: December 31, ___________________ 2002 2001 ________ ________ (In thousands) Other assets: Cash surrender value of life insurance $ 15,121 $ 14,316 Deferred income tax benefits - 1,373 Prepaid pension 1,782 1,279 Other real estate 1,512 2,531 Prepaid expenses and other 4,388 4,279 ________ ________ $ 22,803 $ 23,778 ======== ======== Other liabilities: Dividends payable $ 1,801 $ 1,731 Deferred income tax liability 611 - Accrued expenses 4,416 3,745 Minority interest in subsidiary 1,663 1,606 Other 245 587 ________ ________ $ 8,736 $ 7,669 ======== ======== NOTE I - COMPREHENSIVE INCOME In the calculation of comprehensive income, certain reclassification adjustments are made to avoid double counting amounts that are displayed as part of net income for a period that also had been displayed as part of other comprehensive income. The disclosures of the reclassification amounts are as follows: Years Ended December 31, ______________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Net change in unrealized gains: Net unrealized gains on securities available-for-sale $ 4,216 $ 3,113 $ 3,887 Reclassification adjustment for (gains) losses on securities available-for-sale (457) (459) 22 ________ ________ ________ Net change in unrealized gains on securities available-for-sale before tax 3,759 2,654 3,909 ________ ________ ________ Income tax expense: Net unrealized gains on securities available-for-sale $ (1,436) $ (1,080) $ (1,323) Reclassification adjustment for gains (losses) on securities available-for-sale 171 171 (8) ________ ________ ________ Total income tax expense (1,265) (909) (1,331) ________ ________ ________ Net change in unrealized gains on securities available-for-sale, net of tax before minority interest 2,494 1,745 2,578 Minority interest in net change (22) (27) (8) ________ ________ ________ $ 2,472 $ 1,718 $ 2,570 ======== ======== ======== NOTE J - INCOME TAXES The provision for income taxes including the tax effects of securities transactions [2002 - $171,375; 2001 - $171,247; 2000 - $(8,254)] is as follows: Years Ended December 31, ______________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Current tax expense $ 4,073 $ 3,560 $ 5,174 Deferred tax expense 719 701 103 ________ ________ ________ $ 4,792 $ 4,261 $ 5,277 ======== ======== ======== The difference between the total expected tax expense at the federal tax rate of 34% and the reported income tax expense is as follows: Years Ended December 31, ______________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Tax on income before income taxes $ 6,464 $ 5,916 $ 6,569 Increase (decrease) resulting from: Tax-exempt income (2,349) (2,597) (2,231) Nondeductible expenses 251 442 442 State income taxes, net of federal benefit 530 462 540 Tax credits (72) - - Other, net (32) 38 (43) ________ ________ ________ $ 4,792 $ 4,261 $ 5,277 ======== ======== ======== The components of the net deferred tax included in the consolidated balance sheets as of December 31, 2002 and 2001, are as follows: December 31, _________________ 2002 2001 _______ _______ (In thousands) Deferred tax assets: Allowance for loan losses $ 2,261 $ 2,532 Employee benefits 731 676 Other 933 1,049 _______ _______ Total deferred tax assets 3,925 4,257 _______ _______ Deferred tax liabilities: Premises and equipment (1,185) (818) Unrealized gain on securities available-for-sale (2,125) (860) Other (1,226) (1,206) _______ _______ Total deferred tax liabilities (4,536) (2,884) _______ _______ Net deferred tax asset (liability) $ (611) $ 1,373 ======= ======= NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS The Corporation and its subsidiaries adopted FASB Statements No. 142, "Goodwill and Other Intangible Assets" and No. 147, "Acquisitions of Certain Financial Institutions" effective January 1, 2002. Had the statements been adopted effective January 1, 2000, the consolidated net income and the basic and diluted net income per share would have been as follows: Years Ended December 31, ___________________________ 2002 2001 2000 _______ _______ _______ (In thousands, except per share amounts) Reported net income $14,221 $13,138 $14,045 Add back goodwill amortization - 262 256 Add back amortization of unidentified intangible asset - 71 71 _______ _______ _______ Adjusted net income $14,221 $13,471 $14,372 ======= ======= ======= Basic net income per share: Reported net income $ 1.73 $ 1.54 $ 1.47 Amortization - .04 .03 _______ _______ _______ $ 1.73 $ 1.58 $ 1.50 ======= ======= ======= Diluted net income per share: Reported net income $ 1.73 $ 1.54 $ 1.47 Amortization - .04 .03 _______ _______ _______ Adjusted net income $ 1.73 $ 1.58 $ 1.50 ======= ======= ======= Upon adoption of FASB Statements No. 142 and 147, the carrying value of goodwill associated with business acquisitions was approximately $2 million and the carrying value of the unidentified intangible asset reclassified as goodwill was $841,050. The Corporation completed its transitional impairment test in accordance with Statement No. 142 in January, 2002, with no significant impairment identified. NOTE L - STOCK OPTIONS In connection with a business combination in 1999, the Corporation assumed stock options which were previously granted and converted those options, based upon the appropriate exchange ratio, into options to acquire the Corporation's common stock. All options were granted with an exercise price of $8.57 per share (as adjusted by the exchange ratio). In June, 2001, the Corporation established the 2001 Long-Term Compensation Plan that is administered by a committee appointed by the Corporation's Board of Directors. Employees eligible to receive incentives under the plan are those designated, individually or by groups or categories, by the committee. The plan is a nonqualified stock option plan. The number of shares of Corporation common stock that may be issued under the plan cannot exceed 313,333 (stock split adjusted). The committee may grant options to designated employees at an exercise price not less than the fair market value of the common stock at the date of the grant and the number of shares subject to the option must be designated at the grant date. The option term is determined by the committee, but cannot exceed ten years. Vesting is in equal amounts over a four year period. In June, 2001, grants for 112,000 shares were issued at an option price of $20.75 per share, and in June, 2002, grants for 117,868 shares were issued at an option price of $24.11. A summary of the status of the Corporation's stock option plans for the three years ended December 31, 2002, follows: 2002 2001 2000 __________________ _________________ _________________ Weighted Weighted Weighted Number Average Number Average Number Average Of Exercise Of Exercise Of Exercise Options Price Options Price Options Price ________ ________ _______ ________ _______ ________ Options outstanding, beginning of year 114,357 $ 20.50 10,372 $ 8.57 20,729 $ 8.57 Options granted 117,868 24.11 112,000 20.75 - - Options exercised (1,333) 8.57 (8,015) 8.57 (10,357) 8.57 Options cancelled - - - ________ _______ _______ Options outstanding, end of year 230,892 22.41 114,357 20.50 10,372 8.57 ======== ======= ======= Options exercisable at end of year 29,019 20.32 2,357 8.57 10,372 8.57 ======== ======= ======= Weighted average fair value of options granted during year $ 4.64 $ 4.30 - ======== ======= ======= The following table summarizes information about stock options outstanding at December 31, 2002: Remaining Contractual Exercise Price Number Outstanding Life In Years Number Exercisable ______________ __________________ _____________ __________________ $8.57 1,024 .5 1,024 20.75 112,000 8.5 28,000 24.11 117,868 9.4 - Had compensation cost for the stock option plans been determined based on the fair value of the options at the grant dates consistent with FASB Statement No. 123, "Accounting for Stock-Based Compensation," the Corporation's net income and income per share would have been reduced to the pro forma amounts indicated below: Years Ended December 31, _________________________ 2002 2001 2000 _______ _______ _______ (In thousands, except per share data) Net income - as reported $14,221 $13,138 $14,045 Net income - pro forma 14,007 13,051 14,045 Primary net income per share - as reported 1.73 1.54 1.47 Primary net income per share - pro forma 1.71 1.53 1.47 Fully diluted net income per share - as reported 1.73 1.54 1.47 Fully diluted net income per share - pro forma 1.70 1.53 1.47 The fair value of each option granted is estimated on the date of grant using the Black-Scholes options pricing model with the following weighted average assumptions in 2002 and 2001, respectively: dividend yield of 3.62% for each year; expected volatility of 22% and 21%; risk-free interest rates of 4.5% and 5.1%; and expected lives of 6.75 and 7.07 years. Pro forma amounts for the year ended December 31, 2000, were not different than the reported amounts. NOTE M - EMPLOYEE BENEFITS The following table sets forth the defined benefit plan's funded status and amounts recognized in the Corporation's consolidated financial statements at December 31, 2002 and 2001: December 31, ________________ 2002 2001 _______ _______ ($ In thousands) Change in benefit obligation: Benefit obligation at beginning of year $ 9,536 $ 7,747 Service cost 454 390 Interest cost 652 622 Actuarial loss 269 498 Beginning of year measurement loss 102 837 Administrative expenses paid (62) (68) Benefits paid (364) (490) _______ _______ Benefit obligation at end of year 10,587 9,536 _______ _______ Change in plan assets: Fair value of plan assets at beginning of year 8,220 8,853 Return on plan assets (758) (422) Employer contributions 864 346 Administrative expenses paid (63) (68) Benefits paid (364) (490) _______ _______ Fair value of plan assets at end of year 7,899 8,219 _______ _______ Funded status (2,688) (1,317) Unrecognized net actuarial loss 5,778 4,044 Unrecognized prior service cost (1,308) (1,448) _______ _______ Prepaid benefit cost $ 1,782 $ 1,279 ======= ======= Weighted average assumptions: Discount rate 6.75% 7.00% Expected return on plan assets 8.50% 8.50% Rate of compensation increase 5.00% 5.00% Components of net periodic benefit cost: Service cost 454 390 Interest cost 652 622 Expected return on plan assets (767) (764) Amortization of prior service costs (140) (140) Recognized net actuarial loss 162 87 _______ _______ Net periodic benefit cost $ 361 $ 195 ======= ======= No contributions were made to the Corporation's nonleveraged ESOP in each of the three years ended December 31, 2002. At December 31, 2002 the plan held 406,093 shares of the Corporation's common stock. Contributions to the 401(k) plan amounted to $417,475 in 2002, $401,175 in 2001, and $278,534 in 2000. Expense for the defined contribution plan totaled $451,439 in 2002 and $303,000 in 2001. Expenses under the deferred income and supplemental retirement plans, net of increases in the cash surrender value of life insurance contracts, were not material in each of the three years ended December 31, 2002. NOTE N - TREASURY STOCK Shares held in treasury totaled 1,428,352 at December 31, 2002, and 1,029,702 at December 31, 2001. Upon the exercise of stock options, 1,333, 6,011, and 7,768 treasury shares were issued in 2002, 2001, and 2000, respectively, and an additional 14,028 treasury shares were issued in 2000 in connection with the acquisition of Heritage. On June 28, 2001, the Corporation announced a one-year stock repurchase program of up to 5%, or 413,333 (stock split adjusted) shares of the Corporation's common stock. Stock repurchases were carried out through open market purchases, block trades, and in negotiated private purchases. After one year, the Board of Directors approved the continuation of the program and at December 31, 2002, 330,583 shares remained to be purchased. In March, 2001, the Corporation repurchased 976,676 shares of its common stock from parties representing the largest block of stock controlled by related shareholders. The purchase price of $24.5 million was financed by borrowings from the FHLB. NOTE O - RELATED PARTY TRANSACTIONS In the normal course of business, loans are made to directors and executive officers and to companies in which they have a significant ownership interest. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other parties, and are consistent with sound banking practices and are within applicable regulatory and lending limitations. The activity in loans to current directors, executive officers, and their affiliates during 2002 is summarized as follows: December 31, ________________ 2002 2001 _______ _______ (In thousands) Loans outstanding at beginning of year $23,211 $11,634 New loans 26,367 14,498 Repayments (10,433) (2,921) _______ _______ Loans outstanding at end of year $39,145 $23,211 ======= ======= Also, in the normal course of business, the Corporation and its subsidiaries enter into transactions for services with companies and firms whose principals are directors and shareholders. NOTE P - REGULATORY MATTERS Any dividends paid by the Corporation are provided from dividends received from its subsidiary bank. Under regulations controlling national banks, the payment of any dividends by a bank without prior approval of the Comptroller of the Currency is limited to the current year's net profits (as defined by the Comptroller of the Currency) and retained net profits of the two preceding years. The Corporation and its subsidiary bank are subject to regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and its subsidiary bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgment by regulators about components, risk weightings, and other related factors. To ensure capital adequacy, quantitative measures have been established by regulators and these require the Corporation and its bank subsidiary to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined) to risk- weighted assets (as defined), and of Tier I capital to adjusted average total assets (leverage). Management believes, as of December 31, 2002, that the Corporation and its subsidiary bank exceed all capital adequacy requirements. At December 31, 2002, NBC was categorized by regulators as well- capitalized under the regulatory framework for prompt corrective action. A financial institution is considered to be well-capitalized if it has a total risk-based capital ratio of 10% or more, has a Tier I risk-based capital ratio of 6% or more, and has a Tier I leverage capital ratio of 5% or more. There are no conditions or anticipated events that, in the opinion of management, would change the categorization. The actual capital amounts and ratios at December 31, 2002 and 2001, are presented in the following table. No amount was deducted from capital for interest-rate risk exposure. NBC Capital Corporation (Consolidated) NBC _______________ _______________ Amount Ratio Amount Ratio ________ _____ ________ _____ ($ In thousands) December 31, 2002: Total risk-based $110,741 17.4% $108,521 17.1% Tier I risk-based 104,712 16.5% 102,562 16.1% Tier I leverage 104,712 9.9% 102,562 9.7% December 31, 2001: Total risk-based $106,615 16.0% $103,763 15.7% Tier I risk-based 99,862 15.0% 97,040 14.6% Tier I leverage 99,862 9.7% 97,040 9.4% The minimum amounts of capital and ratios as established by banking regulators at December 31, 2002 and 2001, were as follows: NBC Capital Corporation (Consolidated) NBC _______________ _______________ Amount Ratio Amount Ratio ________ _____ ________ _____ ($ In thousands) December 31, 2002: Total risk-based $ 50,958 8.0% $ 50,829 8.0% Tier I risk-based 25,454 4.0% 25,414 4.0% Tier I leverage 31,838 3.0% 31,793 3.0% December 31, 2001: Total risk-based $ 53,174 8.0% $ 53,001 8.0% Tier I risk-based 26,595 4.0% 26,500 4.0% Tier I leverage 30,946 3.0% 30,890 3.0% NBC is required to maintain average reserve balances in the form of cash or deposits with the Federal Reserve Bank. The reserve balance varies depending upon the types and amounts of deposits. At December 31, 2002 and 2001, the required reserve balance on deposit with the Federal Reserve Bank was approximately $600,000 and $500,000, respectively. NOTE Q - COMMITMENTS AND CONTINGENT LIABILITIES The consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of banking business and which involve elements of credit risk, interest rate risk, and liquidity risk. The commitments and contingent liabilities are commitments to extend credit, credit card lines, and commercial and similar letters of credit. A summary of commitments and contingent liabilities at December 31, 2002 and 2001, is as follows: Contractual Amount _______________ December 31, ________________ 2002 2001 _______ _______ (In thousands) Commitments to extend credit $70,833 $89,460 Credit card lines 5,384 5,416 Commercial and similar letters of credit 6,018 4,880 Commitments to extend credit, credit card lines, and commercial and similar letters of credit include some exposure to credit loss in the event of nonperformance of the customer. The credit policies and procedures for such commitments are the same as those used for lending activities. Because these instruments have fixed maturity dates and because a number expire without being drawn upon, they generally do not present any significant liquidity risk. No significant losses on commitments were incurred during the three years ended December 31, 2002, nor are any significant losses as a result of these transactions anticipated. NBC leases various banking premises and equipment under operating leases with minimum lease payments of approximately $250,000 for each of the next five years and a total of approximately $1.6 million due after five years. NBC is a defendant in various pending and threatened legal actions arising in the normal course of business. In the opinion of management, based upon the advice of legal counsel, the ultimate disposition of these matters will not have a material effect on the Corporation's consolidated financial statements. NOTE R - CONCENTRATIONS OF CREDIT Most of the loans, commitments and letters of credit of NBC have been granted to customers in its market areas. Generally, such customers are also depositors. Investments in state and municipal securities also involve governmental entities within the bank's market areas. The concentrations of credit by type of loan are set forth in Note D. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Letters of credit were granted primarily to commercial borrowers. NOTE S - SUPPLEMENTAL CASH FLOW INFORMATION Years Ended December 31, ____________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Cash paid during the year for: Interest $ 23,534 $ 37,138 $ 34,376 Income taxes, net of refunds 4,612 2,895 4,924 Non-cash activities: Transfers of loans to other real estate 1,075 2,269 1,113 NOTE T - DISCLOSURE ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments." The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and Cash Equivalents - For such short-term instruments, the carrying amount is a reasonable estimate of fair value. Securities - For securities held as investments, fair value equals market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Deposits - The fair values of demand deposits are, as required by Statement No. 107, equal to the carrying value of such deposits. Demand deposits include noninterest-bearing demand deposits, savings accounts, NOW accounts, and money market demand accounts. The fair value of variable rate term deposits, those repricing within six months or less, approximates the carrying value of these deposits. Discounted cash flows have been used to value fixed rate term deposits and variable rate term deposits repricing after six months. The discount rate used is based on interest rates currently being offered on comparable deposits as to amount and term. Short-Term Borrowings - The carrying value of any federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings approximates their carrying values. FHLB and Other Borrowings - The fair value of the fixed rate borrowings are estimated using discounted cash flows, based on current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of any variable rate borrowings approximates their fair values. Off-Balance Sheet Instruments - Fair values of off-balance sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit do not represent a significant value until such commitments are funded or closed. Management has determined that these instruments do not have a distinguishable fair value and no fair value has been assigned. December 31, 2002 December 31, 2001 ___________________ ___________________ Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ________ _________ ________ _________ Financial Instruments: (In thousands) Assets: Cash and cash equivalents $ 56,918 $ 56,918 $ 43,525 $ 43,525 Securities available- for-sale 349,991 349,991 293,043 293,043 Securities held-to- maturity 43,792 46,975 47,683 50,623 Loans 578,678 579,209 616,187 617,419 Liabilities: Noninterest-bearing deposits 103,502 103,502 101,569 101,569 Interest-bearing deposits 713,945 715,910 709,134 709,772 Securities sold under agreements to repurchase 25,599 25,599 16,625 16,625 FHLB and other borrowings 112,941 112,767 110,594 110,229 NOTE U - CONDENSED PARENT COMPANY STATEMENTS Balance sheets as of December 31, 2002 and 2001, and statements of income and cash flows for the years ended December 31, 2002, 2001 and 2000, of NBC Capital Corporation (parent company only) are presented below: BALANCE SHEETS December 31, __________________ 2002 2001 ________ ________ (In thousands) Assets Cash and cash equivalents $ 734 $ 1,385 Investment in subsidiaries 109,713 100,898 Other assets 2,842 2,703 ________ ________ $113,289 $104,986 ======== ======== Liabilities and Shareholders' Equity Dividends payable and other liabilities $ 2,182 $ 2,059 Shareholders' equity 111,107 102,927 ________ ________ $113,289 $104,986 ======== ======== STATEMENTS OF INCOME Years Ended December 31, ____________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Income Dividends from subsidiaries $ 8,123 $ 31,199 $ 8,136 Other 14 73 130 ________ ________ ________ 8,137 31,272 8,266 Expense 407 459 127 ________ ________ ________ Income before income taxes and equity in undistributed earnings of subsidiaries 7,730 30,813 8,139 Income tax benefit 147 122 4 ________ ________ ________ Income before equity in undistributed earnings of subsidiaries 7,877 30,935 8,143 Equity in undistributed earnings of subsidiaries in excess of (less than) dividends 6,344 (17,797) 5,902 ________ ________ ________ Net income $ 14,221 $ 13,138 $ 14,045 ======== ======== ======== STATEMENTS OF CASH FLOWS Years Ended December 31, ____________________________ 2002 2001 2000 ________ ________ ________ (In thousands) Cash Flows From Operating Activities Net income $ 14,221 $ 13,138 $ 14,045 Equity in subsidiaries' earnings in excess of (less than) dividends (6,344) 17,797 (5,902) Other, net (174) 97 2,981 ________ ________ ________ Net cash provided by operating activities 7,703 31,032 11,124 ________ ________ ________ Cash Flows From Investing Activities - - (47) ________ ________ ________ Cash Flows From Financing Activities Dividends paid on common stock (7,053) (7,062) (10,138) Acquisition of stock (1,372) (25,122) (1,164) Other, net 71 68 89 ________ ________ ________ Net cash used in financing activities (8,354) (32,116) (11,213) ________ ________ ________ Net decrease in cash and cash equivalents (651) (1,084) (136) Cash and cash equivalents at beginning of year 1,385 2,469 2,605 ________ ________ ________ Cash and cash equivalents at end of year $ 734 $ 1,385 $ 2,469 ======== ======== ======== NOTE V - SUMMARY OF QUARTERLY RESULTS OF OPERATIONS AND PER SHARE AMOUNTS (UNAUDITED) Three Months Ended ______________________________________ Mar. 31 June 30 Sept. 30 Dec. 31 ________ ________ ________ ________ (In thousands, except per share data) 2002 ____ Total interest income $ 15,480 $ 15,171 $ 15,092 $ 14,308 Total interest expense 6,156 5,666 5,669 5,385 ________ ________ ________ ________ Net interest income 9,324 9,505 9,423 8,923 Provision for loan losses 630 630 755 775 ________ ________ ________ ________ Net interest income after provision for loan losses 8,694 8,875 8,668 8,148 Total noninterest income, excluding securities gains 4,078 4,313 4,415 4,783 Securities gains 91 - 188 178 Total noninterest expenses 8,029 8,178 8,401 8,810 Income taxes 1,288 1,313 1,254 937 ________ ________ ________ ________ Net income $ 3,546 $ 3,697 $ 3,616 $ 3,362 ======== ======== ======== ======== Per share: Net income $ .43 $ .45 $ .44 $ .41 Net income, diluted .43 .45 .44 .41 Cash dividends declared .21 .22 .22 .22 2001 ____ Total interest income $ 18,975 $ 18,331 $ 17,456 $ 16,008 Total interest expense 9,929 9,841 8,802 7,429 ________ ________ ________ ________ Net interest income 9,046 8,490 8,654 8,579 Provision for loan losses 180 1,180 180 180 ________ ________ ________ ________ Net interest income after provision for loan losses 8,866 7,310 8,474 8,399 Total noninterest income, excluding securities gains 3,566 3,974 3,963 4,504 Securities gains 49 163 109 138 Total noninterest expenses 7,981 8,179 7,780 8,176 Income taxes 1,152 595 1,313 1,201 ________ ________ ________ ________ Net income $ 3,348 $ 2,673 $ 3,453 $ 3,664 ======== ======== ======== ======== Per share: Net income $ .35 $ .32 $ .42 $ .44 Net income, diluted .35 .32 .42 .44 Cash dividends declared .19 .21 .21 .21 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE MATTERS Not applicable. PART III ________ ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Reference is made to the material under the captions, "Election of Directors" of the Company's proxy statement, dated April 10, 2003, which is incorporated herein by reference, and to "Executive Officers" included in Part I, Item 1, of this report. ITEM 11 - EXECUTIVE COMPENSATION Reference is made to the caption, "Executive Compensation" of the Company's proxy statement, dated April 10, 2003, which is incorporated herein by reference. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reference is made to the caption, "Stock Ownership of Directors, Officers, and Principal Shareholders," of the Company's proxy statement, dated April 10, 2003, which is incorporated herein by reference. Equity Compensation Plan Information: (a) Number of Securities Number of Remaining Securities to Available for Be Issued Upon Weighted- Future Issuance Exercise of Average Price Under Equity Outstanding Of Outstanding Compensation Plan Category Options Options Plans ___________________ ______________ ______________ ______________ (a) (b) (c) Equity compensation plans approved by security holders 1,024 $ 8.57 - Equity compensation plans not approved by security holders 229,868 $22.47 83,465 (b) Note L - Stock Options of the notes to the consolidated financial statements and the information contained under the caption, "Stock Option Plan" of the Company's proxy statement, dated April 10, 2003, should also be read in connection with this item. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to, "Certain Relationships, Related Transactions and Indebtedness" of the Company's proxy statement, dated April 10, 2003, which is incorporated herein by reference. ITEM 14 - DISCLOSURES AND CONTROLS It is the responsibility of the Chief Executive Officer and the Chief Financial Officer to establish and maintain the disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for NBC Capital Corporation. These disclosure controls and procedures have been designed to ensure that material information relating to NBC Capital Corporation, including its consolidated subsidiaries, is made known to these officers by others within those entities, during the period covered by this filing and up to and including the filing date of this report. In accordance with Item 307a of Regulation S-K, these disclosure controls and procedures were evaluated on February 18, 2003 (a date within 90 days of the filing of this report). It is the conclusion of the Chief Executive and the Chief Financial Officer that, as of the date of the evaluation, the disclosure controls and procedures of NBC Capital Corporation are functioning effectively to make known all material information that requires disclosure in this filing. In response to Item 307b of Regulation S-K, there have been no significant changes in the Corporation's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation. Therefore, no corrective actions were necessary with regard to significant deficiencies and material weaknesses. PART IV _______ ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of this report: 1. Financial Statements The following consolidated financial statements and report of independent auditors of NBC Capital Corporation and subsidiaries are included in this Form 10-K (Item 8) of the registrant for the year ended December 31, 2002. Report of Independent Auditors Consolidated Balance Sheets--December 31, 2002 and 2001 Consolidated Statements of Income--Years Ended December 31, 2002, 2001, and 2000 Consolidated Statements of Shareholders' Equity--Years Ended December 31, 2002, 2001, and 2000 Consolidated Statements of Cash Flows--Years Ended December 31, 2002, 2001, and 2000 Notes to Consolidated Financial Statements 2. Financial Statement Schedules Schedules not included have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3(a)&(c). Exhibits: 1. - 2. None 3.1 Articles of Incorporation of NBC Capital Corporation (included as Exhibit B to NBC Capital Corporation's Definitive Proxy Statement dated March 20, 1998, and filed with the Commission on March 18, 1998, Commission File No. 0-12885, which Exhibit B is incorporated herein by reference). 3.2 By-laws of NBC Capital Corporation (included as Exhibit 3(b) to NBC Capital Corporation's Registration Statement on Form S-4A, filed with the Commission on November 4, 1998, Commission File No. 333-65545, which Exhibit 3(b) is incorporated herein by reference. 4. - 9. None 10.1 Employment Agreement dated January 31, 1991, between National Bank of Commerce and L. F. Mallory, Jr., as previously filed. 10.2 Agreement and Plan of Merger by and between NBC Capital Corporation and FFBS Bancorp, Inc., dated February 3, 1999 (included as Appendix A to the Proxy Statement-Prospectus dated May 7, 1999, forming part of the Company's Registration Statement on Form S-4 filed with the Commission on March 30, 1999, Commission File No. 333-75293) and incorporated herein by reference. 10.3 Plan of Reorganization and Merger by and between National Bank of Commerce and First Federal Bank for Savings dated February 3, 1999 (included as Appendix A to the Proxy Statement-Prospectus dated May 7, 1999, forming part of the Company's Registration Statement on Form S-4 filed with the Commission on March 30, 1999, Commission File No. 333-75293) and incorporated herein by reference. 10.4 Merger Agreement by and between NBC Capital Corporation and National Bank of Commerce and Galloway-Wiggers Insurance Agency, Inc., Galloway-Chandler-McKinney Insurance, Inc., Galloway-Chandler-McKinney Insurance Agency of Amory, Inc., Kyle Chandler Insurance Agency, Inc., and Napier Insurance Agency, Inc. (included as Exhibit 99.2 on Form 10Q filed with the Commission on August 10, 1999, Commission File No. 0-12885) and incorporated herein by reference. 10.5 1993 Incentive Stock Option Plan and 1993 Stock Option Plan for Outside Directors of FFBS Bancorp, Inc., assumed by NBC Capital Corporation (incorporated by reference to Exhibit A of Form S-8 filed September 20, 1999) and incorporated herein by reference. 10.6 Employment Agreement Dated January 2, 2001, by and Between National Bank of Commerce and Richard T. Haston (incorporated by reference to Exhibit 10.7 of Form 10-K filed March 30, 2001). 10.7 Employment Agreement Dated January 2, 2001, by and Between National Bank of Commerce and Mark A. Abernathy (incorporated by reference to Exhibit 10.8 of Form 10-K filed March 30, 2001). 10.8 2001 Long-Term Incentive Compensation Plan (incorporated by reference to Exhibit 4 of Form S-8 filed August 8, 2001) and incorporated herein by reference. 10.9 Salary Reduction Thrift Plan (incorporated by reference to Exhibit 4.3 of Form S-8 filed December 13, 2001) and incorporated herein by reference. 11. - 20. None 21. Subsidiaries of Company 22. None 23. Consent of Independent Auditors 99. Section 906 Certifications (b) No reports on Form 8-K were filed during the quarter ended December 31, 2002. (d) Financial statement schedules - None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NBC CAPITAL CORPORATION (Registrant) /s/ L. F. MALLORY, JR. By _______________________________________ L. F. Mallory, Jr. Chairman of Board and Chief Executive Officer /s/ RICHARD T. HASTON By _______________________________________ Richard T. Haston Executive Vice President, CFO, and Treasurer (Chief Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated. /S/ RALPH E. POGUE /S/ J. NUTIE DOWDLE _________________________________ _______________________________ (Director) (Director) /S/ ROBERT L. CALVERT, III /S/ SAMMY J. SMITH _________________________________ _______________________________ (Director) (Director) /S/ HARRY STOKES SMITH /S/ ROBERT S. JONES _________________________________ _______________________________ (Director) (Director) /S/ JAMES D. GRAHAM /S/ R. S. CALDWELL, JR. _________________________________ _______________________________ (Director) (Director) /S/ JAMES C. GALLOWAY, JR. /S/ R. D. MILLER _________________________________ _______________________________ (Director) (Director) /S/ HENRY WEISS _________________________________ (Director) Date: March 19, 2003 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES/OXLEY ACT OF 2002 _________________________________ I, L. F. Mallory, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of NBC Capital Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ L. F. MALLORY, JR. By _____________________________ L. F. Mallory, Jr. Chairman of Board and Chief Executive Officer Date: March 18, 2003 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES/OXLEY ACT OF 2002 _________________________________ I, Richard T. Haston, CFO, certify that: 1. I have reviewed this annual report on Form 10-K of NBC Capital Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /S/ RICHARD T. HASTON By _____________________________ Richard T. Haston Executive Vice President, CFO, and Treasurer Date: March 18, 2003