##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Fiscal Year Ended December 31, 2004
OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to
 Commission File Number: 0-29040 FIDELITY BANKSHARES, INC. 
  Delaware
    
    65-1101656(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification Number)205 Datura Street, West Palm Beach, Florida
    
    33401(Address of Principal Executive Offices)
    
    (Zip Code)
 (561) 803-9900 
 Securities Registered Pursuant to Section 12(b) of the Act: None  Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.10 per share 
  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 twelve months
(or for such shorter period that the Registrant was required to file reports) and (2) has been
subject to such requirements for the past 90 days. YES þ NO o 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 amendments to this Form 10-K. þ Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Securities Exchange Act of 1934). YES þ NO o As of June 30, 2004, there were issued and outstanding 22,695,039 shares of the Registrants
Common Stock. The aggregate value of the voting stock held by non-affiliates of the Registrant,
computed by reference to the average bid and asked prices of the Common Stock as of June 30, 2004
($22.83) was $414,705,512. DOCUMENTS INCORPORATED BY REFERENCE  1.
    Sections of Annual Report to Stockholders for the fiscal year ended December 31, 2004 (Parts
II and IV).2.
    Proxy Statement for the 2005 Annual Meeting of Stockholders (Parts I and III).




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERSITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUALITATIVE AND QUANTITATIVE ANALYSIS OF MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL            DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESITEM 9B. OTHER INFORMATIONPART IIIITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULESSIGNATURESEXHIBIT INDEXEX-13: CONSOLIDATED FINANCIAL STATEMENTSEX-21: SUBSIDIARIESEX-23: CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMEX-31.2: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32: CERTIFICATION    Table of Contents  
 PART I 
 ITEM 1. BUSINESS Fidelity Bankshares, Inc. Fidelity Bankshares, Inc. is a Delaware corporation which, on May 15, 2001, became the holding
company parent of Fidelity Federal Bank & Trust, following the completion of the second step
mutual-to-stock conversion of Fidelity Bankshares, MHC. Prior to completion of the second step
conversion, Fidelity Federal Bank & Trusts mid-tier stock holding company parent was also called
Fidelity Bankshares, Inc. References to Fidelity Bankshares, Inc. includes references before and
after the second step conversion. The conversion was accounted for as a change in corporate form
with no subsequent change in the historical basis of the Companys assets, liabilities and equity.
All references in this filing to share data (including number of shares and per-share amounts) have
been restated giving retroactive recognition to the exchange rate. At December 31, 2004, the only
significant asset or business activity of Fidelity Bankshares, Inc. was its ownership of all of the
outstanding stock of Fidelity Federal Bank & Trust. Our corporate office is located at 205 Datura
Street, West Palm beach, Florida 33401. Our telephone number is (561) 803-9900. On September 22, 2004, we entered into an agreement to acquire First Community Bancorp, Inc.
and its subsidiary, First Community Bank of Palm Beach County, located in Pahokee, Florida. We
agreed to pay $14.75 in cash and 0.3937 of a share of Fidelity Bankshares common stock for each
outstanding share of common stock of First Community Bancorp, Inc., for an aggregate purchase price
of approximately $27.1 million. First Community Bank of Palm Beach County will merge into Fidelity
Federal Bank & Trust at the completion of this acquisition. As of September 30, 2004, First
Community Bancorp, Inc. had total consolidated assets of $157.1 million, deposits of $144.8 million
and shareholders equity of $11.6 million. First Community Bank of Palm Beach County operates five
community banking offices in Palm Beach County. Completion of the First Community Bancorp, Inc.
acquisition is subject to approval by First Community Bancorp, Inc.s shareholders, as well as
applicable regulatory authorities. The Office of Thrift Supervision approved the acquisition on
February 15, 2005. First Community Bancorp, Inc. shareholders approved the acquisition on March 8,
2005. This transaction is expected to be completed in April 2005. In December 2004, we completed the sale of 1,150,000 shares of our common stock in an
underwritten public offering. Net proceeds from the sale of the common stock was $43.8 million. In December 2003, we sold $22.7 million of cumulative trust preferred securities and issued
related junior subordinated debentures. The cumulative trust preferred securities have a floating
rate of 285 basis points above the three-month LIBOR rate. In October 2004, we sold $30.9 million
of floating rate trust preferred securities. The floating rate trust preferred securities have a
floating rate of 197 basis points over the three-month LIBOR rate. The proceeds from this trust
preferred securities offering were used to fund the redemption of $29.6 million higher cost,
fixed-rate trust preferred securities issued in 1998. The net proceeds raised from our 2003 and
2004 trust preferred securities offerings and our common stock offering have provided additional
capital to support the growth of our business. At December 31, 2004, we had consolidated assets and consolidated stockholders equity of $3.5
billion and $251.3 million, respectively. Our deposits totaled $2.8 billion at December 31, 2004.




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Fidelity Federal Bank & Trust Fidelity Federal Bank & Trust was originally chartered as a federal mutual savings and loan
association in 1952. In January 1994, Fidelity Federal Bank & Trust reorganized from a mutual
savings bank to the stock form of ownership as part of its mutual holding company reorganization.
In July 1999, we began offering insurance and investment products through our wholly owned
subsidiary  Florida Consolidated Agency, Inc. In February 2000, we began offering trust services,
and at December 31, 2004, we had $77.9 million of trust assets under administration, including
$63.2 million under trust management. We are primarily engaged in the business of attracting deposits from the general public in our
market area, and investing such deposits, together with other mortgage loans funds, in one- to
four-family residential mortgage loans, commercial real estate loans, commercial business and
consumer loans. Our goal over the next several years is to continue to increase the origination of
commercial real estate, commercial business and consumer loans, consistent with our standards of
safety and soundness. To a lesser extent, we also originate multi-family loans, construction loans
and land loans for single-family properties, and we invest in mortgage-backed securities issued by
government sponsored enterprises. In addition, we invest a portion of our assets in securities
issued by the United States Government, cash and cash equivalents, including deposits in other
financial institutions, corporate securities and Federal Home Loan Bank stock. Our principal
sources of funds are deposits and principal and interest payments on loans. Principal sources of
income are interest received from loans and investment securities. Our principal expense is
interest paid on deposits and employee compensation and benefits. Since 1998, we have expanded our branch network throughout our market area. Since December
1998 we have opened 21 new branches. Market Area We are headquartered in West Palm Beach, Florida, and we conduct our business primarily in
Palm Beach, Martin, and St. Lucie Counties in Florida. To a lesser extent, we conduct business in
Indian River and Broward Counties. At December 31, 2004, we had 43 offices in our market area, of
which 38 were located in Palm Beach County, three were located in Martin County and two were
located in St. Lucie County. Palm Beach, Martin and St. Lucie Counties are located in southeastern
Florida, an area that has experienced considerable growth and development since the 1960s. This
three-county area had a total population of 1.6 million as of December 31, 2004. Our market area includes a mix of rural and urban areas. The strength of the southeast
Florida economy depends significantly upon government, foreign trade, tourism, and its attraction
as a retirement area. Major employers in our market area include Tenet Health Care, Florida Power
and Light, BellSouth and the Palm Beach County School Board. Competition Our market area in southeast Florida has a large number of financial institutions. All of
these financial institutions compete with us to varying degrees, and many of them are significantly
larger and have greater financial resources than we have. As a result, we encounter strong
competition both in attracting deposits and in originating real estate and other loans. Our most
direct competition for deposits historically has come from commercial banks, securities brokerage
firms, other savings associations, and credit unions, and we expect continued strong competition
from these financial institutions in the foreseeable future. Our market area includes branches of
several commercial banks that are substantially 2




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larger than Fidelity Federal Bank & Trust in terms of state-wide deposits. We compete for
deposits by offering customers a high level of personal service and expertise, and a wide range of
financial services. The competition for real estate and other loans comes principally from commercial banks,
mortgage banking companies, credit unions and other savings associations. This competition for
loans has increased substantially in recent years as a result of the number of institutions
competing in our market area, as well as the increased efforts by commercial banks to expand
mortgage loan originations. We compete for loans primarily through the interest rates and loan fees we charge, and the
efficiency and quality of services we provide to borrowers, real estate brokers, and builders.
Factors that also affect competition include general and local economic conditions, current
interest rate levels, and volatility of the mortgage markets. Fidelity Bankshares, Inc. is the sixth largest financial institution holding company
headquartered in Florida, and the largest headquartered in Palm Beach, Martin and St. Lucie
counties based on total assets. Fidelity Federal Bank & Trusts share of deposits in Palm Beach
County increased from 3.1% in 1995 to 8.3% at June 30, 2004. Our 7.6% share of deposits in Palm
Beach, Martin and St. Lucie counties ranked us fourth among financial institutions in the three
county area at June 30, 2004, the most recent date for which market share data are available. Lending Activities General.Historically, our principal lending activity has been the origination of fixed rate
and adjustable rate mortgage loans secured by one- to four-family residential properties located in
our market area. We currently originate both fixed rate mortgage loans and adjustable rate
mortgage (ARM) loans for retention in our loan portfolio. The majority of our mortgage loans are
eligible for sale in the secondary mortgage market. We also originate loans secured by commercial
real estate and multi-family residential real estate, construction loans, commercial business loans
and consumer loans. In recent years, we have increased our commercial real estate, commercial
business and consumer lending. In an effort to manage interest rate risk, we make our interest-earning assets more sensitive
to changes in interest rates by originating adjustable rate mortgage loans, such as ARM loans, and
short- and medium-term consumer loans, including home equity loans. We also purchase both fixed
rate and adjustable rate mortgage-backed securities. At December 31, 2004, approximately $1.7
billion, or 66.5%, of our total loan portfolio, net of loans in process and $92.6 million, or
17.5%, of our mortgage-backed securities portfolio, consisted of loans or securities with
adjustable interest rates. We originate fixed rate mortgage loans generally with 15- to 30-year
terms to maturity, collateralized by one- to four-family residential properties. One- to
four-family fixed rate and adjustable rate residential mortgage loans generally are originated and
underwritten according to standards that allow us to resell such loans in the secondary mortgage
market for the purpose of managing interest rate risk and liquidity. We periodically sell without
recourse to us, a portion of our residential mortgage loans which have terms to maturity of fifteen
years and greater, both on a servicing released and servicing retained basis. Generally, we retain
in our portfolio all consumer, commercial real estate and multi-family residential real estate
loans. 3




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Composition of Loan Portfolio. Set forth below are selected data relating to the composition
of our loan portfolio by type of loan as of the dates indicated. Also set forth below is the
aggregate amount of our investment in mortgage-backed securities at the dates indicated. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Real Estate Loans:One- to four-family
    
    $
    918,142
    
    
    
    67.4
    %
    
    $
    944,046
    
    
    
    59.7
    %
    
    $
    1,062,956
    
    
    
    54.9
    %
    
    $
    1,002,573
    
    
    
    45.7
    %
    
    $
    1,023,520
    
    
    
    40.0
    %Construction loans
    
    
    177,062
    
    
    
    13.1
    
    
    
    284,495
    
    
    
    18.0
    
    
    
    364,346
    
    
    
    18.8
    
    
    
    470,016
    
    
    
    21.5
    
    
    
    634,455
    
    
    
    24.8Land loans
    
    
    14,421
    
    
    
    1.0
    
    
    
    25,627
    
    
    
    1.6
    
    
    
    29,181
    
    
    
    1.5
    
    
    
    36,660
    
    
    
    1.7
    
    
    
    57,661
    
    
    
    2.3Commercial
    
    
    122,733
    
    
    
    9.0
    
    
    
    244,620
    
    
    
    15.5
    
    
    
    413,775
    
    
    
    21.4
    
    
    
    647,848
    
    
    
    29.6
    
    
    
    865,756
    
    
    
    33.9Multi-family
    
    
    21,254
    
    
    
    1.6
    
    
    
    43,701
    
    
    
    2.8
    
    
    
    45,279
    
    
    
    2.3
    
    
    
    106,042
    
    
    
    4.8
    
    
    
    106,790
    
    
    
    4.2Total real estate loans
    
    
    1,253,615
    
    
    
    92.1
    
    
    
    1,542,489
    
    
    
    97.6
    
    
    
    1,915,537
    
    
    
    98.9
    
    
    
    2,263,139
    
    
    
    103.3
    
    
    
    2,688,182
    
    
    
    105.2Other Loans:Consumer (1)
    
    
    85,407
    
    
    
    6.3
    
    
    
    105,077
    
    
    
    6.6
    
    
    
    141,343
    
    
    
    7.3
    
    
    
    185,450
    
    
    
    8.4
    
    
    
    231,333
    
    
    
    9.0Commercial business
    
    
    152,524
    
    
    
    11.2
    
    
    
    132,881
    
    
    
    8.4
    
    
    
    146,205
    
    
    
    7.6
    
    
    
    131,292
    
    
    
    6.0
    
    
    
    125,791
    
    
    
    4.9Total other loans
    
    
    237,931
    
    
    
    17.5
    
    
    
    237,958
    
    
    
    15.0
    
    
    
    287,548
    
    
    
    14.9
    
    
    
    316,742
    
    
    
    14.4
    
    
    
    357,124
    
    
    
    13.9Total loans receivable
    
    
    1,491,546
    
    
    
    109.6
    
    
    
    1,780,447
    
    
    
    112.6
    
    
    
    2,203,085
    
    
    
    113.8
    
    
    
    2,579,881
    
    
    
    117.7
    
    
    
    3,045,306
    
    
    
    119.1Less:Undisbursed loan proceeds
principally residential
and
residential construction
    
    
    128,116
    
    
    
    9.4
    
    
    
    194,662
    
    
    
    12.3
    
    
    
    260,380
    
    
    
    13.5
    
    
    
    374,974
    
    
    
    17.1
    
    
    
    472,324
    
    
    
    18.5Unearned discount and net
deferred fees (costs)
    
    
    (2,707
    )
    
    
    (0.2
    )
    
    
    (2,289
    )
    
    
    (0.1
    )
    
    
    (1,612
    )
    
    
    (0.1
    )
    
    
    2,092
    
    
    
    0.1
    
    
    
    2,654
    
    
    
    0.1Allowance for loan losses
    
    
    4,905
    
    
    
    0.4
    
    
    
    6,847
    
    
    
    0.4
    
    
    
    8,318
    
    
    
    0.4
    
    
    
    11,119
    
    
    
    0.5
    
    
    
    13,628
    
    
    
    0.5Total loans receivable-net
    
    $
    1,361,232
    
    
    
    100.0
    %
    
    $
    1,581,227
    
    
    
    100.0
    %
    
    $
    1,935,999
    
    
    
    100.0
    %
    
    $
    2,191,696
    
    
    
    100.0
    %
    
    $
    2,556,700
    
    
    
    100.0
    %Mortgage-backed securities.
    
    $
    283,993
    
    
    
    
    
    
    $
    201,533
    
    
    
    
    
    
    $
    109,755
    
    
    
    
    
    
    $
    471,228
    
    
    
    
    
    
    $
    529,640
   (1)
    
    Includes primarily home equity lines of credit, second mortgages and automobile
loans. At December 31, 2001, 2002 and 2003, the disbursed portion of equity lines of credit
totaled $23.5 million, $40.2 million, $83.5 million and $136.1 million and $190.9 million,
respectively. Loan and Mortgage-Backed Securities Contractual Terms to Maturity.The following table
sets forth certain information as of December 31, 2004, regarding the dollar amount of loans and
mortgage-backed securities maturing in our portfolio based on their contractual terms to maturity.
The amounts shown represent outstanding principal balances, less loans in process, and are not
adjusted for premiums, discounts, reserves, and unearned fees. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one
year or less. Adjustable and floating rate loans and mortgage-backed securities are included in
the period in which interest rates are next scheduled to adjust rather than in which they
contractually mature, and fixed rate loans and mortgage-backed securities are included in the
period in which the final contractual repayment is due. Fixed rate mortgage-backed securities are
assumed to mature in the period in which the final contractual payment is due. 4




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Over 1
    
    
    Over 3
    
    
    Over 5
    
    
    Over 10
    
    
    BeyondWithin
    
    
    Year to 3
    
    
    Years to 5
    
    
    Years to 10
    
    
    Years to 20
    
    
    201 Year
    
    
    Years
    
    
    Years
    
    
    Years
    
    
    Years
    
    
    Years
    
    
    Total(In Thousands)Real estate loans:One- to four-family residential (1)
    
    $
    189,900
    
    
    $
    77,811
    
    
    $
    94,778
    
    
    $
    582,078
    
    
    $
    224,831
    
    
    $
    161,784
    
    
    $
    1,331,182Commercial, multi-family and
land
    
    
    781,501
    
    
    
    15,438
    
    
    
    21,604
    
    
    
    36,259
    
    
    
    34,009
    
    
    
    
    
    
    
    888,811Consumer and commercial
business loans (2)
    
    
    300,796
    
    
    
    27,561
    
    
    
    17,318
    
    
    
    5,411
    
    
    
    1,761
    
    
    
    142
    
    
    
    352,989Total loans receivable (3)
    
    $
    1,272,197
    
    
    $
    120,810
    
    
    $
    133,700
    
    
    $
    623,748
    
    
    $
    260,601
    
    
    $
    161,926
    
    
    $
    2,572,982Mortgage-backed securities
available for sale(4)
    
    $
    119,512
    
    
    $
    56,511
    
    
    $
    61,546
    
    
    $
    159,790
    
    
    $
    127,432
    
    
    $
    6,772
    
    
    $
    531,563
   (1)
    
    Includes construction loans.(2)
    
    Includes commercial business loans of $125.8 million.(3)
    
    Excludes unearned discount and net deferred fees and allowance for loan losses and
is shown net of undisbursed loan proceeds.(4)
    
    Includes $441.6 million in mortgage-backed securities available for sale and $90.0
million in mortgage-backed securities held to maturity. The following table sets forth at December 31, 2004, the dollar amount of all fixed rate
and adjustable rate loans and mortgage-backed securities due or repricing after December 31, 2005. Fixed
    
    
    Adjustable
    
    
    Total(In Thousands)Real estate loans:One- to four-family residential
    
    $
    652,260
    
    
    $
    489,022
    
    
    $
    1,141,282Commercial, multi-family and land
    
    
    94,848
    
    
    
    12,462
    
    
    
    107,310Consumer and commercial business loans (1)
    
    
    52,193
    
    
    
    
    
    
    
    52,193Total
    
    
    799,301
    
    
    
    501,484
    
    
    
    1,300,785Mortgage-backed securities (2)
    
    
    412,051
    
    
    
    
    
    
    
    412,051
   (1)
    
    Includes commercial business loans of $29.6 million.(2)
    
    Includes $326.3 million in mortgage-backed securities available for sale
and $85.8 million in mortgage-backed securities held to maturity. One- to Four-Family Residential Real Estate Loans. Our primary lending activity consists of
originating one- to four-family, owner-occupied, residential mortgage loans secured by properties
located in our market area. We also originate one- to four-family residential loans secured by
properties outside of our market area. These loans, which are originated through a network of
brokers throughout Florida, are subject to our customary underwriting standards. At December 31,
2004, $1.0 billion, or 40.0%, of our net loans receivable consisted of one- to four-family
residential mortgage loans. Of this amount, $157.3 million are secured by properties located
outside of our market area, all of which are located in Florida. We currently offer one- to four-family residential mortgage loans with terms typically ranging
from 15 to 30 years, and with adjustable or fixed interest rates. Originations of fixed rate
mortgage loans versus ARM loans are monitored on an ongoing basis and are affected significantly by
the level of market interest rates, customer preference, and loan products offered by our
competitors. Therefore, even if managements strategy is to emphasize originating ARM loans,
market conditions may be such that there is greater demand for fixed rate mortgage loans. ARM
loans originated and purchased totaled $370.3 million and $528.4 million during the years ended
December 31, 2003 and 2004, respectively. Our fixed rate loans and adjustable rate loans are generally originated and underwritten
according to standards that permit their sale in the secondary mortgage market. Whether we can or
will sell loans into the secondary market, however, depends on a number of factors, including the
yield and the term of the loan, market conditions, and our current interest rate sensitivity. Our
fixed rate mortgage loans amortize on a monthly basis with principal and interest due each month.
One- to four-family residential real estate loans often remain outstanding for significantly
shorter periods than their contractual terms because borrowers have the right to refinance or
prepay their loans. 5




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We currently offer ARM loans with initial interest rate adjustment periods of one, three,
five, seven and ten years, based on changes in a designated market index. After the initial
interest rate adjustment period, our one-, three-, five-, seven- and ten-year ARM loans give the
borrower the option of converting the ARM loan to a fixed rate mortgage for the remaining term of
the loan at the prevailing interest rate for comparable fixed rate mortgages at the time of the
conversion. The interest rate on one year ARM loans and on the three-, five-, seven and ten-year
ARM loans that are not converted to fixed rate mortgage loans, adjusts annually with an annual
interest rate adjustment limit of 200 basis points and with a maximum lifetime interest rate
adjustment limit of 600 basis points above the initial interest rate. The initial interest rate on
all owner-occupied one- to four-family ARM loans is 275 to 325 basis points above the appropriate
United States Treasury security rates used as the index for ARM originations. We originate ARM
loans with initially discounted rates, which vary depending upon whether the initial interest rate
adjustment period is one, three, five, seven or ten years. We determine whether a borrower
qualifies for an ARM loan based on the fully indexed rate of the ARM loan at the time the loan is
originated. The outstanding principal balance of one- to four-family residential ARM loans,
including construction ARM loans, totaled $654.8 million, or 25.6%, of our net loan portfolio at
December 31, 2004. The primary purpose of offering ARM loans is to make our loan portfolio more sensitive to
changes in market interest rates. However, as the interest income earned on ARM loans varies with
prevailing market interest rates, these loans may not offer cash flows that are as predictable as
cash flows in our long-term, fixed rate mortgage loan portfolio. ARM loans also have the increased
credit risk associated with potentially higher monthly payments for borrowers as market interest
rates increase. It is possible, therefore, that during periods of rising interest rates, the risk
of default on ARM loans may increase due to the upward adjustment of interest costs to borrowers. Our one- to four-family residential first mortgage loans customarily include due-on-sale
clauses, which are provisions giving us the right to declare a loan immediately due and payable in
the event, among other things, that the borrower sells or otherwise disposes of the underlying real
property serving as security for the loan. Due-on-sale clauses are an important means of making
our fixed rate mortgage loan portfolio more interest rate sensitive, and we have generally
exercised our rights under these clauses. Regulations limit the amount that a savings association may lend relative to the appraised
value of the real estate securing the loan, as determined by an appraisal at the time of loan
origination. Appraisals are generally performed by our service corporation subsidiary. Such
regulations permit a maximum loan-to-value ratio of 97% for residential property and 85% for all
other real estate loans. Our lending policies generally limit the maximum loan-to-value ratio on
both fixed rate mortgage loans and ARM loans without private mortgage insurance, to 80% of the
lesser of the appraised value or the purchase price of the property that is collateral for the
loan. For one- to four-family real estate loans with loan-to-value ratios of between 80% and 90%,
we generally require the borrower to obtain private mortgage insurance. We require that the
borrower obtain private mortgage insurance for any mortgage loan with a loan-to-value ratio of more
than 90%. We require fire and casualty insurance, including windstorm insurance, as well as a
title guaranty regarding good title, on all properties securing real estate loans. Construction and Land Loans.At December 31, 2004, $634.5 million, or 24.8% of our net loans
receivable consisted of residential construction loans, of which $311.2 million was disbursed and
outstanding. We currently offer fixed rate and adjustable rate residential construction loans
primarily for the construction of owner-occupied, single-family residences. These loans generally
are offered to builders who have a contract for sale of the property, and to owners who have a
contract for construction of the property. In addition, we make construction loans to builders
where the home is not under contract for sale to a buyer at the time the loan is closed. The gross
amount of loans to these builders where the 6




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home is not under contract for sale totaled $203.0 million, of which $116.5 million was
disbursed and outstanding at December 31, 2004. Construction loans are generally structured to
become permanent mortgage loans once the construction is completed, and are originated with terms
of up to 30 years with an allowance of up to one year for construction. Construction loans require
the payment of interest only during the construction period. Funds are disbursed as construction
is completed. Substantially all of our construction loans are secured by properties located in our
market area. In addition, we originate land loans that are secured by unimproved or improved lots. At
December 31, 2004, $57.7 million, or 2.3% of our net loans receivable, consisted of land loans.
Land loans are currently offered with one-year adjustable rates for terms of up to 15 years. The
maximum loan-to-value ratio for our land loans is 85%. We currently use the applicable United
States Treasury securities rate as our index on newly originated land loans. Initial interest
rates may be below the fully indexed rate. Substantially all of our land loans are secured by
properties located in our market area. Construction loans and land loans generally involve a greater degree of credit risk than one-
to four-family residential mortgage loans. The repayment of the construction loan often depends
upon the successful completion of the construction project. Construction delays or the inability
of the borrower to sell the property once construction is completed may impair the borrowers
ability to repay the loan. Multi-Family Residential Real Estate Loans.At December 31, 2004, $106.8 million, or 4.2% of
our net loans receivable, consisted of multi-family residential real estate loans. At December 31,
2004, we had 84 loans secured by multi-family properties, and substantially all of our multi-family
residential real estate loans are secured by properties located within our market area. At
December 31, 2004, our multi-family residential real estate loans had an average principal balance
of $1.3 million and the largest multi-family residential real estate loan had a principal balance
outstanding of $18.0 million and is located in Martin County, Florida. At December 31, 2004, this
loan was performing in accordance with its terms. Multi-family residential real estate loans
currently are offered with adjustable interest rates, although in the past we originated fixed rate
multi-family real estate loans. The terms of each multi-family residential real estate loan are
negotiated on a case-by-case basis. These loans typically have adjustable interest rates tied to a
market index with a 600 basis point lifetime interest rate cap, and an interest rate floor equal to
the initial rate. Multi-family residential real estate loans generally amortize over 15 to 25
years. We may offer initial discount rates depending on market conditions, but generally the
initial interest rate on multi-family residential real estate loans is tied to an applicable United
States Treasury bill rate. In underwriting our multi-family residential real estate loans, we generally lend up to 80% of
the appraised value of the property securing the loan. The appraised value is determined by
independent appraisers that we designate. We generally obtain either an environmental assessment
from an independent engineering firm of any environmental risks that may be associated with the
property, or we obtain an insurance policy that covers potential environmental risks. When
deciding whether to make a multi-family residential real estate loan we examine the history of the
property to generate cash flow and the experience of the borrower in managing multi-family
residential real estate properties. We also review the operating costs of comparable properties in
the market area. Generally, we require a cash flow to debt service ratio of 125%. In addition,
generally a personal guarantee of the loan is required from the borrower. We require title
insurance, fire and casualty insurance, and flood insurance, if appropriate. Loans secured by multi-family residential real estate generally have more credit risk than
one- to four-family residential mortgage loans and carry larger loan balances. This increased
credit risk is a result of several factors, including the concentration of principal in a limited
number of loans and borrowers, the impact of the local economy on the borrowers ability to repay
the loan, and the increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured 7




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by multi-family properties is typically dependent upon the successful operation of the real
property securing the loan. If the cash flow from the multi-family property is reduced, the
borrowers ability to repay the loan may be impaired. Commercial Real Estate Loans. At December 31, 2004, our loans secured by commercial real
estate totaled $865.8 million, or 33.9% of our net loans receivable. Our commercial real estate
loans are secured by land or improved property such as offices, small business facilities, strip
shopping centers, warehouses and other non-residential buildings. At December 31, 2004,
substantially all of our commercial real estate loans were secured by properties located within our
market area. At December 31, 2004, our commercial real estate loans had an average principal
balance of $1.1 million. At that date, our largest commercial real estate loan outstanding had a
principal balance of $18.9 million and was secured by commercial property located in Palm Beach
County, Florida. At December 31, 2004, this loan was performing in accordance with its terms.
Commercial real estate loans are currently offered with adjustable rates. The terms of each
commercial real estate loan are negotiated on a case-by-case basis. Generally, these loans have
adjustable interest rates tied to a market index. We may choose to offer initial discount rates on
our commercial real estate loans depending on market conditions. We use the applicable United
States Treasury bill rate as our index on newly originated loans. Our commercial real estate loans
generally have terms of 15 to 25 years. In underwriting our commercial real estate loans, we generally lend up to 80% of the appraised
value of the property securing the loan. The appraised value is determined by independent
appraisers that we designate. We generally obtain either an environmental assessment from an
independent engineering firm of any environmental risks that may be associated with the property,
or we obtain an insurance policy that covers potential environmental risks. When deciding whether
to make a commercial real estate loan we examine the history of the property to generate cash flow
and the experience of the borrower in managing commercial real estate properties. We also review
the operating costs of comparable properties in the market area. Generally, we require a cash flow
to debt service ratio of 125%. In addition, generally a personal guarantee of the loan is required
from the borrower. We require title insurance, fire and casualty insurance, and flood insurance,
if appropriate. Loans secured by commercial real estate generally involve a greater degree of risk than one-
to four-family residential mortgage loans and carry larger loan balances. This increased credit
risk is a result of several factors, including the concentration of principal in a limited number
of loans and borrowers, the effects of general economic conditions on income producing properties,
and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the
repayment of loans secured by commercial real estate is typically dependent upon the successful
operation of the property securing the loan. If the cash flow from the property is reduced, the
borrowers ability to repay the loan may be impaired. However, loans secured by commercial real
estate generally have higher interest rates than loans secured by one-to four-family residential
real estate. Consumer Loans. As of December 31, 2004, consumer loans totaled $231.3 million, or 9.0% of
our net loans receivable. The principal types of consumer loans that we offer are home equity
lines of credit, adjustable and fixed rate second mortgage loans and automobile loans. We also
offer boat loans and loans secured by deposit accounts and, to a much lesser extent, unsecured
loans. We do not offer credit card loans. Consumer loans are offered on a fixed rate and
adjustable rate basis with maturities generally of less than fifteen years. Our home equity lines
of credit and second mortgages are secured by the borrowers principal residence with a maximum
loan-to-value ratio, including the principal balances of both the first and second mortgage loans,
of 90%. Such loans are offered on an adjustable-rate or fixed rate basis with terms of up to
twenty years. At December 31, 2004, the disbursed portion of home equity lines of credit totaled
$190.9 million, or 74.3%, of our consumer loans. 8




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##### Table of Contents



Our underwriting standards for consumer loans include a review of the borrowers credit
history and an assessment of the borrowers ability to meet existing obligations and payments on
the proposed loan. The stability of the borrowers monthly income may be determined by
verification of gross monthly income from primary employment, and additionally from any verifiable
secondary income. Creditworthiness of the borrower is of primary consideration; however, the
underwriting process also includes a comparison of the value of the collateral in relation to the
proposed loan amount, and in the case of home equity lines of credit and second mortgage loans, we
obtain a title guarantee or an opinion as to the validity of title. Consumer loans generally have shorter terms and higher interest rates than one-to four-family
residential mortgage loans. However, consumer loans have more credit risk than residential
mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets
that depreciate rapidly, such as automobiles, mobile homes, boats, and recreational vehicles. In
such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source
of repayment for the outstanding loan and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In particular, amounts realizable on the sale
of repossessed automobiles may be significantly reduced based upon the condition of the automobiles
and the lack of demand for used automobiles. We add a general provision on a regular basis to our
consumer loan loss allowance, based on general economic conditions and prior loss experience. See
Delinquent Loans and Classified AssetsNonPerforming Assets for information regarding our loan
loss experience and reserve policy. Commercial Business Loans. We also offer commercial business loans to businesses in our
market area. Our strategy is to substantially increase our loans and services to commercial
business enterprises, and to support this strategy, we have hired additional lenders with
commercial business lending expertise. Our largest commercial business loan at December 31, 2004
had a principal balance outstanding of $6.7 million, and was secured by business assets located in
Palm Beach County, Florida. At December 31, 2004, we had 658 commercial business loans outstanding
with an aggregate balance of $125.8 million, or 4.9% of our net loans receivable. The average
commercial business loan balance was approximately $191,000. Commercial business loans are
generally offered with adjustable interest rates only, which are tied to The Wall Street Journal
prime interest rate, plus up to 300 basis points. The loans are offered with prevailing terms of
five years, but may range up to 15 years. In addition, we offer Small Business Administration
loans. Our underwriting standards for commercial business loans include a review of the borrowers
credit history and an assessment of the borrowers ability to meet existing obligations and
payments on the proposed loan based on cash flows generated by the applicants business. The
financial strength of each applicant also is assessed through a review of financial statements
provided by the applicant. Commercial business loans generally bear higher interest rates and shorter terms than one-to
four-family residential loans, but they also may involve higher average balances, increased
difficulty of loan monitoring and a higher risk of default since their repayment is generally
dependent on the successful operation of the borrowers business. We generally obtain personal
guarantees from the borrower or a third party as a condition to the origination of commercial
business loans. We generally obtain the personal guarantee of all persons with an equity interest
in the business that is obtaining a commercial business loan. Furthermore, in order to reduce the
risks associated with the origination of commercial business loans, a substantial portion of our
commercial business loans are also secured by real estate and business assets owned by the
borrower. Loan Originations, Purchases, Sales, Processing, and Commitments. Our new loan originations
come from a number of sources including real estate broker referrals, existing customers,
borrowers, builders, attorneys, and walk-in customers. Upon receiving a loan application, we
obtain a 9




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##### Table of Contents



credit report and employment verification to verify specific information relating to the
applicants employment, income, and credit standing. In the case of a real estate loan, we obtain
an appraisal of the real estate intended to secure the proposed loan. We check the loan
application file for accuracy and completeness, and we verify the information provided. All loans
of up to $359,650 may be approved by any one of our senior loan underwriters; loans between
$359,651 and $750,000 must be approved by one of our designated senior lending officers; loans
between $750,001 and $2.0 million must be approved by at least two of our designated senior lending
officers; and loans in excess of $2.0 million must be approved by at least three members of the
Board of Directors acting as a loan committee. These limits are reduced for unsecured loans. The
loan committee meets as needed to review and verify that loan approvals by management are within
the scope of managements authority. After the loan is approved, a loan commitment letter is
promptly issued to the borrower. At December 31, 2004, we had commitments to originate and
purchase $239.2 million of loans. If the loan is approved, the commitment letter specifies the terms and conditions of the
proposed loan, including the amount of the loan, interest rate, amortization term, a brief
description of the required collateral, and required insurance coverage. We also require the
borrower to provide proof of fire and casualty insurance and, as required, flood insurance on the
property serving as collateral for which insurance must be maintained during the full term of the
loan. Title insurance or an opinion of title, based on a title search of the property, is required
on all loans secured by real property. Borrowers who refinance an existing loan must satisfy our underwriting criteria at the time
they apply to refinance their loan, and must have been current in their loan payments for a minimum
of one year. Approximately 3.1% of our loan originations during the year ended December 31, 2004,
represented the refinancing of loans that we hold. Refinancings have resulted in a decrease in our
interest rate spread. The Bank also allows borrowers to apply for a modification of their existing loan rate for a
fee. These borrowers must satisfy our underwriting criteria at the time of application and
modification. Modifications do not allow for an increase in the outstanding principal balance of
the loan. The new rate on these loans is normally 1/8 percent higher than the current rate for a
new loan. During the year ended December 31, 2004, we modified approximately $57.6 million in
existing loans. Modifications decreased the yield on our loan portfolio which in turn decrease our
interest rate spread. In connection with local mortgage brokers throughout the state of Florida, we have established
a mortgage loan broker solicitation program to supplement our internal originations of one- to
four-family residential mortgage loans. Under this program, which is limited to the origination of
one- to four-family residential mortgage loans, prospective borrowers complete loan applications
which are provided by mortgage brokers. All loans obtained in this manner are reviewed by our
underwriting department in accordance with our customary underwriting standards. Total
originations from all sources under the mortgage loan broker solicitation program during 2003 and
2004 were $101.9 million and $106.6 million, respectively. We have a correspondent relationship with the wholly owned mortgage subsidiary of a major
South Florida builder-developer, who has substantial operations in our local service area, whereby
the mortgage company originates, processes and closes home mortgages resulting from the sale of the
developers inventory of homes. The mortgage files are sent to our underwriting department and
reviewed in accordance with our customary underwriting standards and, if we approve the loans, we
will issue a commitment to purchase the loan from the mortgage company. We are not obligated to
purchase any loans that are presented for our review. Purchases are accomplished by assignment of
the mortgage from the mortgage company to Fidelity Federal Bank & Trust. We purchased $40.9
million and $38.1 million, respectively, of loans from this provider during the years ended 2003
and 2004. 10




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##### Table of Contents



We also originate one- to four-family residential real estate loans secured by properties
located outside of our market area. These loans, which are originated through a network of brokers
throughout Florida, are subject to our customary underwriting standards. At December 31, 2004,
$1.7 billion, or 64.8%, of our net loans receivable consisted of loans, including residential
construction loans, that were secured by one- to four-family residential real estate loans. Of
this amount, $203.1 million were secured by properties located outside of our market area. We also purchase mortgage loans which are collateralized by residential real estate located
primarily in Florida, although we have in the past purchased loans collateralized by properties
located outside of Florida. Generally, we only purchase residential mortgage loans that are
underwritten to Freddie Mac or Fannie Mae guidelines. At December 31, 2004, $124.9 million, or
4.1% of all loans in our total loan portfolio, consisted of purchased loans. Of this amount, $102.1
million represented our interest in purchased one-to four-family residential real estate loans.
Commercial real estate loans that we may purchase or participate in must satisfy the underwriting
standards of commercial real estate loans we originate. Our largest loan participation was a $9.8
million interest in a loan secured by residential real estate in Palm Beach County, Florida. Prior to 2003 we generally did not originate loans for sale. On occasion, we sold loans where
the borrower was located outside of our market area. Commencing in 2003, we began regular sales of
fixed rate mortgage loans into the secondary markets. Generally, these sales are on a servicing
released basis for loans on properties located outside our market area. The servicing is generally
retained on sold loans where the property is within our market area. Originations, Purchases and Sales of Loans.The table below shows our loan origination,
purchase and sales activity for the periods indicated. This table is presented on a gross loan
receivable basis. Year Ended December 31,2002
    
    
    2003
    
    
    2004(In thousands)Loan receivable-gross, beginning of period
    
    $
    1,780,447
    
    
    $
    2,203,085
    
    
    $
    2,579,881Originations:Real estate:One- to four-family residential (1)
    
    
    535,360
    
    
    
    639,249
    
    
    
    548,828Land loans
    
    
    52,727
    
    
    
    67,670
    
    
    
    134,267Commercial
    
    
    179,333
    
    
    
    198,187
    
    
    
    255,843Multi-family
    
    
    19,538
    
    
    
    78,615
    
    
    
    98,526Other loans:Consumer
    
    
    118,777
    
    
    
    144,760
    
    
    
    177,106Commercial business
    
    
    158,299
    
    
    
    137,805
    
    
    
    116,620Total originations:
    
    
    1,064,034
    
    
    
    1,266,286
    
    
    
    1,331,190Transfer of loans to foreclosed real estate and
repossessed property
    
    
    (680
    )
    
    
    (870
    )
    
    
    (84
    )Loan purchases
    
    
    47,167
    
    
    
    40,854
    
    
    
    38,137Repayments
    
    
    (682,811
    )
    
    
    (734,162
    )
    
    
    (780,693
    )Loan sales
    
    
    (5,072
    )
    
    
    (195,312
    )
    
    
    (33,077
    )Loan securitizations
    
    
    
    
    
    
    
    
    
    
    (90,048
    )Net loan activity
    
    
    422,638
    
    
    
    376,796
    
    
    
    465,425Total loans receivable-gross, end of period
    
    $
    2,203,085
    
    
    $
    2,579,881
    
    
    $
    3,045,306
   (1)
    
    Includes loans to finance the construction of one- to four-family residential
properties, and loans originated for sale in the secondary market. Loan Origination Fees and Costs and Other Income. In addition to interest earned on
loans, we may also charge a fee, often expressed as a percentage of the principal amount of the
loan, at the time the loan is originated. To the extent that loans are originated or acquired for
our portfolio, Statement of Financial Accounting Standards (SFAS) 91 Accounting for
Nonrefundable Fees and Costs Associated 11




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with Originating or Acquiring loans and Initial Direct Costs of Leases requires that we defer
loan origination fees and costs and amortize such fees and accrete such costs as an adjustment of
yield over the life of the loan by use of the level yield method. Fees and costs deferred under
SFAS 91 are recognized into income immediately upon prepayment or the sale of the related loan. At
December 31, 2004, we had $12.8 million of deferred loan origination fees, and $10.1 million of
deferred loan origination costs. Such fees vary with the volume and type of loans originated and
commitments and competitive conditions in the mortgage markets. We also receive other fees and, service charges that consist primarily of deposit transaction
account service charges, late payment charges, credit card fees, fees from the sale of insurance
and annuity products and income from real estate owned operations. We recognized fees and service
charges of $15.7 million, $19.9 million and $22.2 million for the years ended December 31, 2002,
2003 and 2004. Loans-to-One Borrower. Federal savings banks are subject to the same loans-to-one borrower
limits as those applicable to national banks, which under current regulations restrict loans-to-one
borrower to an amount equal to 15% of unimpaired capital and unimpaired surplus on an unsecured
basis, and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the
loan is secured by readily marketable collateral (generally, financial instruments and bullion, but
not real estate). At December 31, 2004, our largest outstanding loan relationship with one
borrower totaled $32.5 million. These loans are secured by various residential and commercial
properties in Palm Beach County, Florida. At that date, our second largest lending relationship
totaled $27.7 million and is secured by various residential properties in Palm Beach County. Our
third largest lending relationship totaled $27.5 million, and is secured by residential property in
Palm Beach County, Florida. Our fourth largest lending relationship totaled $27.4 million and is
secured by residential properties in Palm Beach County, Florida. Our fifth largest lending
relationship totaled $27.3 million and is secured by residential properties in Palm Beach County,
Florida. All of the loans comprising these lending relationships are performing in accordance with
their terms. Our regulatory limit on the maximum total loans to a single or related group of
borrowers was $44.3 million at December 31, 2004. Mortgage-Backed Securities We also invest in mortgage-backed securities issued or guaranteed by the United States
Government or enterprises sponsored by the United States Government. These securities consist
primarily of fixed rate mortgage-backed securities issued or guaranteed by Fannie Mae or Freddie
Mac. At December 31, 2004 our mortgage-backed securities had a market value of $530.5 million of
which $440.5 million was classified as available for sale and $90.0 million was classified as held
to maturity. Our objective in investing in mortgage-backed securities classified as available for
sale varies from time to time depending upon market interest rates, local mortgage loan demand, and
our level of liquidity. Mortgage-backed securities classified as available for sale are more
liquid than whole loans and can be readily sold in response to market conditions and changing
interest rates. Mortgage-backed securities purchased by us also have lower credit risk than
mortgage loans because principal and interest are either insured or guaranteed by the United States
Government or enterprises sponsored by the United States Government. 12




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##### Table of Contents



During 2004, the Bank securitized certain of its one-to-four-family mortgage loans, receiving
mortgage-backed securities secured by these loans. These securities, all classified as held to
maturity, are summarized as follows: Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair Value(Dollars in thousands)December 31, 2004:FHLMC fixed rate
    
    $
    89,167
    
    
    $
    881
    
    
    $
    
    
    
    $
    90,048Total
    
    $
    89,167
    
    
    $
    881
    
    
    $
    
    
    
    $
    90,048Weighted average interest rate
    
    
    4.64
    %
 Since the Bank retained all interest in the loans securitized, no portion of this
securitization was accounted for as a sale. As a result of this transaction, the Bank received
securities representing its interests in the loans transferred and contractual servicing rights
related to these loans. The book value of these loans was allocated to the securities and to the
servicing rights based on relative fair value, as determined by quoted prices for such assets on
the date each transfer was effected. The Bank held no such assets at December 31, 2003. The following table shows our purchases and sales of mortgage-backed securities, which are
classified as available for sale or held to maturity, for the periods indicated. Year Ended December 31,2002
    
    
    2003
    
    
    2004(In Thousands)Mortgage-backed securities at beginning of period
    
    $
    201,533
    
    
    $
    109,755
    
    
    $
    471,228Purchases
    
    
    37,054
    
    
    
    693,042
    
    
    
    355,069Retained securities from loan securitization
    
    
    
    
    
    
    
    
    
    
    89,167Sales
    
    
    (4,392
    )
    
    
    (43,373
    )
    
    
    (221,077
    )Repayments
    
    
    (124,275
    )
    
    
    (281,571
    )
    
    
    (169,982
    )Discount (premium) amortization
    
    
    (739
    )
    
    
    (3,166
    )
    
    
    53Increase (decrease) in market value of securities
held for sale in accordance with SFAS 115
    
    
    574
    
    
    
    (3,459
    )
    
    
    5,182Mortgage-backed securities at end of period
    
    $
    109,755
    
    
    $
    471,228
    
    
    $
    529,640
 13




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##### Table of Contents



The following table sets forth the allocation of fixed and adjustable rate
mortgage-backed securities, classified as available for sale or held to maturity for the periods
indicated. At December 31,2002
    
    
    2003
    
    
    2004$
    
    
    %
    
    
    $
    
    
    %
    
    
    $
    
    
    %(Dollars In Thousands)Mortgage-backed securities available for sale, net:Adjustable:FreddieMac
    
    $
    28,012
    
    
    
    25.42
    %
    
    $
    15,691
    
    
    
    3.32
    %
    
    
    25,265
    
    
    
    4.75
    %FannieMae
    
    
    4,527
    
    
    
    4.11
    
    
    
    115,484
    
    
    
    24.43
    
    
    
    67,314
    
    
    
    12.66GinnieMae
    
    
    5,009
    
    
    
    4.55
    
    
    
    60,458
    
    
    
    12.79
    
    
    
    
    
    
    
    Total adjustable
    
    
    37,548
    
    
    
    34.08
    
    
    
    191,633
    
    
    
    40.54
    
    
    
    92,579
    
    
    
    17.41Fixed:FreddieMac
    
    
    27,568
    
    
    
    25.02
    
    
    
    120,317
    
    
    
    25.45
    
    
    
    116,983
    
    
    
    22.01FannieMae
    
    
    41,640
    
    
    
    37.79
    
    
    
    157,713
    
    
    
    33.36
    
    
    
    201,109
    
    
    
    37.83GinnieMae
    
    
    2,999
    
    
    
    2.72
    
    
    
    1,565
    
    
    
    0.32
    
    
    
    29,802
    
    
    
    5.61Total fixed
    
    
    72,207
    
    
    
    65.53
    
    
    
    279,595
    
    
    
    59.14
    
    
    
    347,894
    
    
    
    65.45Mortgage-backed securities held to maturity, net:Fixed:Freddie Mac
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89,167
    
    
    
    16.77Total fixed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89,167
    
    
    
    16.77Accrued interest
    
    
    428
    
    
    
    0.39
    
    
    
    1,505
    
    
    
    0.32
    
    
    
    1,955
    
    
    
    0.37Total mortgage-backed securities, net
    
    $
    110,183
    
    
    
    100.00
    %
    
    $
    472,733
    
    
    
    100.00
    %
    
    $
    531,595
    
    
    
    100.00
    %
 Delinquent Loans and Classified Assets Delinquencies.Our collection procedures provide that when a loan is 15 days past due, a
computer generated late charge notice is sent to the borrower requesting payment, plus a late
charge. If the delinquency continues for 30 days, a delinquent notice is sent and personal contact
efforts are attempted, either in person or by telephone, to strengthen the collection process and
obtain reasons for the delinquency. Also, plans to arrange a repayment plan are made. If a loan
becomes 60 days past due, a collection letter is sent, personal contact is attempted, and the loan
becomes subject to possible legal action if suitable arrangements to repay have not been made. In
addition, the borrower is given information which provides access to consumer counseling services,
to the extent required by regulations of the Department of Housing and Urban Development. When a
loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been
made or kept by the borrower, generally a notice of intent to foreclose is sent to the borrower,
giving 30 days to cure the delinquency. If not cured, foreclosure proceedings are initiated. Impaired Loans. A loan is impaired when, based on current information and events, it is
probable that we will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Nonperforming Assets.Loans are reviewed on a regular basis and are placed on a non-accrual
status when, in the opinion of management, the collection of additional interest is doubtful.
Residential mortgage loans are placed on non-accrual status when either principal or interest is 90
days or more past due. Consumer and commercial business loans are placed on non-accrual status
when either principal or interest is 60 days or more past due. Interest accrued and unpaid at the
time a loan is placed on a non-accrual status is charged against interest income. Real estate that we acquire as a result of foreclosure or by the deed in lieu of foreclosure
is classified as real estate owned (REO) until such time as it is sold. When real estate is
acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at its fair value,
less estimated costs of disposal. If the value of the property is less than the loan, less any
related specific loan loss provisions, the difference is charged against our earnings. Any
subsequent write-down of REO is also charged against 14




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##### Table of Contents



earnings. At December 31, 2004, we had no property that was acquired as the result of
foreclosure and classified as REO. At December 31, 2004, we had nonperforming assets of $6.4
million, and a ratio of nonperforming assets to total assets of 0.19%. The following table sets forth information regarding our non-accrual mortgage loans delinquent
90 days or more, non-accrual consumer and commercial business loans delinquent 60 days or more, and
real estate acquired or deemed acquired by foreclosure at the dates indicated. When a loan is
delinquent 90 days or more, we fully reserve all accrued interest thereon and cease to accrue
interest thereafter. For all the dates indicated, we did not have any material restructured loans
within the meaning of SFAS 15, Accounting by Debtors and Creditors for Troubled Debt
Restructurings. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(Dollars in Thousands)Delinquent Loans:One- to four-family residential
    
    $
    3,222
    
    
    $
    2,534
    
    
    $
    4,508
    
    
    $
    8,133
    
    
    $
    3,628Commercial and multi-family real
estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer and commercial business
loans(1)
    
    
    1,762
    
    
    
    2,476
    
    
    
    2,082
    
    
    
    3,085
    
    
    
    2,805Total delinquent loans
    
    
    4,984
    
    
    
    5,010
    
    
    
    6,590
    
    
    
    11,218
    
    
    
    6,433Total REO
    
    
    27
    
    
    
    219
    
    
    
    
    
    
    
    
    
    
    
    Total nonperforming assets
    
    $
    5,011
    
    
    $
    5,229
    
    
    $
    6,590
    
    
    $
    11,218
    
    
    $
    6,433Total nonperforming loans
to net loans receivable(1)
    
    
    0.37
    %
    
    
    0.32
    %
    
    
    0.34
    %
    
    
    0.51
    %
    
    
    0.25
    %Total nonperforming loans
to total assets(1)
    
    
    0.26
    %
    
    
    0.23
    %
    
    
    0.27
    %
    
    
    0.37
    %
    
    
    0.19
    %Total nonperforming loans and
REO to total assets
    
    
    0.26
    %
    
    
    0.24
    %
    
    
    0.27
    %
    
    
    0.37
    %
    
    
    0.19
    %
   (1)
    
    Includes consumer and commercial business loans delinquent 60 days or more. During the year ended December 31, 2004, gross interest income of approximately $438,000
would have been recorded on loans accounted for on a non-accrual basis if the loans had been
current throughout the periods. No interest income on non-accrual loans was included in income
during 2004. The following table sets forth information with respect to loans past due 60-89 days in our
portfolio at the dates indicated. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(In Thousands)Loans past due 60-89 days:One- to four-family residential
    
    $
    4,711
    
    
    $
    5,086
    
    
    $
    4,997
    
    
    $
    2,444
    
    
    $
    885Consumer and commercial
business loans
    
    
    84
    
    
    
    1,696
    
    
    
    286
    
    
    
    1,317
    
    
    
    548Land loans
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    Total past due 60-89 days
    
    $
    4,795
    
    
    $
    6,798
    
    
    $
    5,283
    
    
    
    3,761
    
    
    
    1,433
 Classification of Assets.Federal regulations provide that loans and other assets, such
as debt and equity securities, that are of lesser quality, must be classified as substandard,
doubtful, or loss assets. An asset is considered substandard if it is inadequately protected
by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.
Substandard assets include those characterized by the distinct possibility that the savings
institution will sustain some loss if the deficiencies are not corrected. Assets classified as
doubtful have all of the weaknesses inherent in those classified substandard, with the added
characteristic that these weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions, and values, highly questionable and improbable. Assets
classified as loss are those considered uncollectible and of such little value 15




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##### Table of Contents



that their
continuation as assets without the establishment of a specific loss reserve is not warranted.
Assets that do not expose the savings institution to risk sufficient to warrant classification in
one of the aforementioned categories, but which possess some weaknesses, are designated special
mention by management. When we classify problem assets as either substandard or doubtful, we are required to
establish allowances for loan losses in an amount deemed prudent by management. General allowances
represent loss allowances that have been established to recognize the inherent risk associated with
lending activities, but which, unlike specific allowances, have not been allocated to particular
problem assets. When we classify problem assets as loss, we are required either to establish a
specific allowance for losses equal to 100% of the amount of the assets so classified, or to charge
off such amount. Our determination of which assets are classified, and the amount of the valuation
allowances that we establish as a result of asset classification is subject to review by the Office
of Thrift Supervision, which can direct us to increase our general or specific loss allowances. We
regularly review the problem loans in our portfolio to determine whether any loans require
classification in accordance with applicable regulations. The following table sets forth the aggregate amount of our classified assets at the dates
indicated. We had no assets classified as doubtful at the dates indicated. At December 31,2002
    
    
    2003
    
    
    2004(In thousands)Substandard assets(1)
    
    $
    8,150
    
    
    $
    12,605
    
    
    $
    9,786Loss assets
    
    
    171
    
    
    
    65
    
    
    
    36Total classified assets
    
    $
    8,321
    
    
    $
    12,670
    
    
    $
    9,822
   (1)
    
    Includes real estate owned. The following table sets forth information regarding our delinquent loans and real estate
owned, net of specific valuation allowances at December 31, 2004. Balance
    
    
    Number(Dollars In Thousands)Residential real estate loans:Loans 60 to 89 days delinquent
    
    $
    885
    
    
    
    12Loans more than 89 days delinquent
    
    
    3,614
    
    
    
    22Commercial and multi-family real estate loans:Loans 60 to 89 days delinquent
    
    
    
    
    
    
    Loans more than 89 days delinquent
    
    
    
    
    
    
    Land loans:Loans 60 to 89 days delinquent
    
    
    
    
    
    
    Loans more than 89 days delinquent
    
    
    
    
    
    
    Consumer and commercial business loans:60 days or more delinquent
    
    
    2,339
    
    
    
    26Real estate owned
    
    
    
    
    
    
    Total
    
    $
    6,838
    
    
    
    60
 Allowance for Loan Losses.We maintain an allowance for loan losses to absorb losses
inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the
probable estimated losses inherent in the loan portfolio, and to a lesser extent, unused
commitments to provide financing. Our methodology for assessing the appropriateness of the
allowance consists of several key elements, which include a formula allowance and specific
allowances for identified problem loans and portfolio segments. The formula allowance is calculated by applying loss factors to outstanding loans based on an
internal risk grading of such loans or pools of loans. Changes in risk grades of both performing
and 16




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##### Table of Contents



nonperforming loans affect the amount of the formula allowance. Loss factors are based
primarily on our historical loss experience and may be adjusted for other significant conditions
that, in managements judgment, affect the collectibility of the portfolio as of the evaluation
date. During the past five years we have not made any changes to our methodology for calculating
of the allowance for loan losses. The conditions that we evaluate in connection with establishing the allowance for loan losses
include the following:  
    general economic and business conditions affecting our key lending areas;
    credit quality trends (including trends in nonperforming loans expected to
result from existing conditions);
    collateral values;
    loan volumes and concentrations;
    seasoning of the loan portfolio;
    specific industry conditions within portfolio segments;
    recent loss experience in particular segments of the loan portfolio;
    duration of the current business cycle; and
    bank regulatory examination results. Where any of these conditions is not evidenced by a specifically identifiable problem loan or
portfolio segment as of the evaluation date, managements evaluation of the probable loss related
to such condition is reflected in the allowance. The allowance for loan losses is based upon estimates of probable losses inherent in the loan
portfolio. The amount actually reserved for losses can vary significantly from the estimated
amounts. Our methodology includes several features that are intended to reduce the differences
between estimated and actual losses. The historical loss experience model that is used to
establish the loan loss factors for problem graded loans is designed to be self-correcting by
taking into account our recent loss experience. Similarly, by reviewing our historical loss
experience, the methodology is designed to take our recent loss experience into account. Pooled
loan loss factors are adjusted, if necessary, quarterly based upon the level of net charge-offs
expected by management. Furthermore, our methodology permits adjustments to any loss factor used
in the computation of the formula allowance in the event that, in managements judgment,
significant conditions which affect the collectibility of the portfolio as of the evaluation date
are not reflected in the loss factors. By assessing the probable estimated losses inherent in the
loan portfolio on a monthly basis, we are able to adjust specific and inherent loss estimates based
upon any more recent information that becomes available. The allowance also incorporates the results of measuring impaired loans as provided in SFAS
No. 114, Accounting by Creditors for Impairment of a Loan and SFAS No. 118, Accounting by
Creditors for Impairment of a Loan-Income Recognition and Disclosures. These accounting standards
prescribe the measurement methods, income recognition and disclosure related to impaired loans. A
loan is considered impaired when we determine that it is probable that we will be unable to collect
all amounts due according to the original contractual terms of the loan agreement. Impairment is
measured by the difference between the recorded investment in the loan (including accrued interest,
net deferred loan fees or costs and unamortized premium or discount) and the estimated present
value of the collateral, if the loan is collateral dependent. Impairment is recognized by
adjusting an allocation of the existing allowance for loan losses. Additional specific allowances are established in cases where management has identified
significant conditions or circumstances related to a specific loan that management believes
indicate the probability that a loss has been incurred in excess of the amount determined by the
formula allowance. 17




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##### Table of Contents



Pooled loan loss factors (not individually graded loans) are derived from a model that tracks
five years of historical loss experience. Pooled loans are loans that are homogeneous in nature,
such as consumer installment and residential mortgage loans. Management will continue to review the entire loan portfolio to determine the extent, if any,
to which further additional loan loss provisions may be deemed necessary. The allowance for loan
losses is maintained at a level that represents managements best estimate of losses in the loan
portfolio at the balance sheet date that were both probable and reasonably estimable. However,
there can be no assurance that the allowance for loan losses will be adequate to cover all losses
that may in fact be realized in the future or that additional provisions for loan losses will not
be required. Further, as we expand our portfolio of commercial real estate and loans that are not
secured by real estate, which have a higher risk of loss than single family mortgage loans, we
expect to provide greater allowances for loan losses than we have considered necessary in the past. Analysis of the Allowance For Loan Losses.The following table sets forth the analysis of the
allowance for loan losses for the periods indicated. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(Dollars in Thousands)Total net loans receivable
outstanding
    
    $
    1,361,232
    
    
    $
    1,581,227
    
    
    $
    1,935,999
    
    
    $
    2,191,696
    
    
    
    2,556,700Average net loans receivable
outstanding
    
    $
    1,272,362
    
    
    $
    1,561,569
    
    
    $
    1,745,639
    
    
    $
    2,037,993
    
    
    
    2,424,354Allowance balance (at beginning of
period)
    
    $
    3,609
    
    
    $
    4,905
    
    
    $
    6,847
    
    
    $
    8,318
    
    
    
    11,119Provision for losses:Residential real estate
    
    
    (126
    )
    
    
    823
    
    
    
    491
    
    
    
    506
    
    
    
    157Commercial and multi-family
residential real estate
    
    
    138
    
    
    
    521
    
    
    
    1,379
    
    
    
    1,335
    
    
    
    1,527Land loans
    
    
    (146
    )
    
    
    114
    
    
    
    
    
    
    
    126
    
    
    
    124Consumer and commercial business
    
    
    1,462
    
    
    
    596
    
    
    
    116
    
    
    
    1,155
    
    
    
    928Total provisions for losses
    
    
    1,328
    
    
    
    2,054
    
    
    
    1,986
    
    
    
    3,122
    
    
    
    2,736Charge-offs:Residential real estate
    
    
    (90
    )
    
    
    (43
    )
    
    
    (176
    )
    
    
    (51
    )
    
    
    (2
    )Commercial and multi-family
residential real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )
    
    
    Land loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer and commercial business
    
    
    (52
    )
    
    
    (74
    )
    
    
    (399
    )
    
    
    (264
    )
    
    
    (250
    )Total charge-offs
    
    
    (142
    )
    
    
    (117
    )
    
    
    (575
    )
    
    
    (322
    )
    
    
    (252
    )Recoveries:Residential real estate
    
    
    7
    
    
    
    3
    
    
    
    28
    
    
    
    
    
    
    
    Commercial and multi-family
residential real estate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Land loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer and commercial business
    
    
    103
    
    
    
    2
    
    
    
    32
    
    
    
    1
    
    
    
    25Total recoveries
    
    
    110
    
    
    
    5
    
    
    
    60
    
    
    
    1
    
    
    
    25Allowance balance (at end of period)
    
    $
    4,905
    
    
    $
    6,847
    
    
    $
    8,318
    
    
    $
    11,119
    
    
    $
    13,628Allowance for loan losses as a percent
of net loans receivable at end of
period
    
    
    0.36
    %
    
    
    0.43
    %
    
    
    0.43
    %
    
    
    0.51
    %
    
    
    0.53
    %Net loans charged-off as a percent of
average loans outstanding
    
    
    0.01
    %
    
    
    0.01
    %
    
    
    0.03
    %
    
    
    0.02
    %
    
    
    0.01
    %Ratio of allowance for loan losses to
total non-performing loans at end
of period
    
    
    98.41
    %
    
    
    136.67
    %
    
    
    126.21
    %
    
    
    99.12
    %
    
    
    211.85
    %Ratio of allowance for loan losses to
total non-performing loans, REO and
in-substance foreclosures
at end of period
    
    
    97.88
    %
    
    
    130.94
    %
    
    
    126.21
    %
    
    
    99.12
    %
    
    
    211.85
    %
 18




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##### Table of Contents



Allocation of Allowance for Loan Losses.The following table sets forth the allocation
of allowance for loan losses by loan category for the periods indicated. Management believes that
the allowance can be allocated by category only on an approximate basis. The allocation of the
allowance by category is not necessarily indicative of future losses and does not restrict the use
of the allowance to absorb losses in any category. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % ofLoans in
    
    
    
    
    
    
    Loans in
    
    
    
    
    
    
    Loans in
    
    
    
    
    
    
    Loans in
    
    
    
    
    
    
    Loans inEach
    
    
    
    
    
    
    Each
    
    
    
    
    
    
    Each
    
    
    
    
    
    
    Each
    
    
    
    
    
    
    EachCategory
    
    
    
    
    
    
    Category
    
    
    
    
    
    
    Category
    
    
    
    
    
    
    Category
    
    
    
    
    
    
    Categoryto total
    
    
    
    
    
    
    to total
    
    
    
    
    
    
    to total
    
    
    
    
    
    
    to total
    
    
    
    
    
    
    to totalAmount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans
    
    
    Amount
    
    
    Loans(Dollars in thousands)Balance at end of period
applicable to:One- to four-family
residential mortgage
    
    $
    722
    
    
    
    67.60
    %
    
    $
    1,241
    
    
    
    53.02
    %
    
    $
    836
    
    
    
    48.24
    %
    
    $
    809
    
    
    
    38.86
    %
    
    $
    821
    
    
    
    33.61
    %Construction
    
    
    432
    
    
    
    5.83
    
    
    
    696
    
    
    
    15.98
    
    
    
    977
    
    
    
    16.54
    
    
    
    1,680
    
    
    
    18.22
    
    
    
    1,572
    
    
    
    20.83Commercial real estate
    
    
    749
    
    
    
    8.23
    
    
    
    1,226
    
    
    
    11.41
    
    
    
    2,628
    
    
    
    18.78
    
    
    
    3,652
    
    
    
    25.11
    
    
    
    5,078
    
    
    
    28.43Multi-family residential
    
    
    106
    
    
    
    1.42
    
    
    
    149
    
    
    
    1.96
    
    
    
    97
    
    
    
    2.06
    
    
    
    180
    
    
    
    4.11
    
    
    
    532
    
    
    
    3.51Land loans
    
    
    
    
    
    
    0.96
    
    
    
    114
    
    
    
    1.44
    
    
    
    114
    
    
    
    1.32
    
    
    
    240
    
    
    
    1.42
    
    
    
    364
    
    
    
    1.89Consumer
    
    
    700
    
    
    
    5.73
    
    
    
    821
    
    
    
    5.90
    
    
    
    980
    
    
    
    6.42
    
    
    
    1,226
    
    
    
    7.19
    
    
    
    1,379
    
    
    
    7.60Commercial business
    
    
    2,196
    
    
    
    10.23
    
    
    
    2,600
    
    
    
    10.56
    
    
    
    2,686
    
    
    
    6.64
    
    
    
    3,332
    
    
    
    5.09
    
    
    
    3,882
    
    
    
    4.13Total allowance for loan
losses
    
    $
    4,905
    
    
    
    100.00
    %
    
    $
    6,847
    
    
    
    100.00
    %
    
    $
    8,318
    
    
    
    100.00
    %
    
    $
    11,119
    
    
    
    100.00
    %
    
    $
    13,628
    
    
    
    100.00
    %
 Investment Activities We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We
adjust our liquidity levels to fund deposit growth, repay borrowings or to fund our loan
commitments. We also adjust our liquidity levels depending upon the yields available on
alternative investments and upon managements judgment as to the attractiveness of those yields
relative to other opportunities, its expectation of whether more attractive yields will be
available in the future, and its projections of the short term demand for funds to be used for our
loan originations and other activities. In recent years, we increased the percentage of our assets held as investments, rather than as
loans, as part of our strategy of maintaining higher levels of liquidity and improving our interest
rate risk position. Our investment portfolio consists of United States Government and United
States Government-sponsored agency securities, municipal bonds, Federal Home Loan Bank stock and
interest earning deposits. The carrying value of our investment securities totaled $123.6 million
at December 31, 2004, including our interest-earning deposits with other financial institutions
with original maturities of three months or less which totaled $41.1 million at December 31, 2004. 19




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##### Table of Contents



Investment Portfolio.The following tables set forth the carrying value of our investments at
the dates indicated. At December 31, 2004, the market value of our investments was approximately
$123.6 million. As allowed by SFAS 115, Accounting for Certain Investments in Debt and Equity
Securities, we classified our investment in United States Government and United States
Government-sponsored agency obligations as available for sale. As a result, such securities are
now presented at fair value, as determined by market quotations. The market value of investments
includes interest-earning deposits and Federal Home Loan Bank stock at book value, which
approximates market value. At December 31,2002
    
    
    2003
    
    
    2004(In Thousands)U.S. Government and agency obligations
    
    $
    89,210
    
    
    $
    122,209
    
    
    $
    64,792Investment in trust preferred securities
    
    
    35,384
    
    
    
    
    
    
    
    Municipal bonds
    
    
    669
    
    
    
    522
    
    
    
    364Interest-earning deposits
    
    
    63,488
    
    
    
    33,797
    
    
    
    41,082Federal Home Loan Bank stock
    
    
    12,919
    
    
    
    13,322
    
    
    
    17,399Total investments
    
    $
    201,670
    
    
    $
    169,850
    
    
    $
    123,637
 20




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##### Table of Contents



Investment Portfolio Maturities.The following table sets forth the scheduled
maturities, amortized cost, market values and average yields of our investment securities at
December 31, 2004. At December 31, 2004One Year or Less
    
    
    One to Three Years
    
    
    Three to Five Years
    
    
    Over Five Years
    
    
    TotalAnnualized
    
    
    
    
    
    
    Annualized
    
    
    
    
    
    
    Annualized
    
    
    
    
    
    
    Annualized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AnnualizedWeighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    
    
    
    
    Average
    
    
    WeightedAmortized
    
    
    Average
    
    
    Amortized
    
    
    Average
    
    
    Amortized
    
    
    Average
    
    
    Amortized
    
    
    Average
    
    
    Amortized
    
    
    Market
    
    
    Life in
    
    
    AverageCost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Value
    
    
    Years (1)
    
    
    Yield(Dollars in thousands)Investment securities:U.S. Government and
agency securities
    
    $
    10,180
    
    
    
    1.60
    %
    
    $
    25,271
    
    
    
    2.03
    %
    
    $
    30,238
    
    
    
    3.38
    %
    
    $
    
    
    
    
    
    %
    
    $
    65,689
    
    
    $
    64,792
    
    
    
    2.6
    
    
    
    2.58
    %Municipal bonds
    
    
    120
    
    
    
    5.98
    
    
    
    235
    
    
    
    6.06
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    355
    
    
    
    364
    
    
    
    1.4
    
    
    
    6.03Interest-earning deposits.
    
    
    41,082
    
    
    
    2.10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,082
    
    
    
    41,082
    
    
    
    
    
    
    
    2.10Federal Home Loan Bank
stock (2)
    
    
    17,399
    
    
    
    3.75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,399
    
    
    
    17,399
    
    
    
    
    
    
    
    3.75Total
    
    $
    68,781
    
    
    
    2.45
    %
    
    $
    25,506
    
    
    
    2.07
    %
    
    $
    30,238
    
    
    
    3.38
    %
    
    $
    
    
    
    
    
    %
    
    $
    124,525
    
    
    $
    123,637
    
    
    
    2.6
    
    
    
    2.59
    %
   (1)
    
    Total weighted average life in years is calculated only on United States Government
and United States Government-sponsored agency securities, investment in trust preferred
securities and municipal bonds.(2)
    
    Federal Home Loan Bank stock has no stated maturity, and the interest rate is
adjustable. 21




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##### Table of Contents



Sources of Funds General.Deposits are the major source of our funds for lending and other investment
purposes. In addition to deposits, other sources of funds are the amortization, prepayment and
sale of loans and mortgage-backed securities, the maturity of investment securities, our net income
from operations and, if needed, advances from the Federal Home Loan Bank. Scheduled loan principal
repayments are a relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are influenced significantly by market interest rates and other economic conditions.
Borrowings may be used on a short-term basis to meet liquidity needs or on a longer-term basis for
general business purposes. Deposits.We attract consumer and commercial deposits primarily within our market area by
offering a broad selection of deposit instruments, including non-interest bearing demand accounts,
NOW accounts, passbook savings, money market accounts, certificates of deposit and individual
retirement accounts. Deposit account terms vary according to, among other factors, the minimum
balance required, the period of time during which the funds must remain on deposit and the interest
rate. We regularly evaluate our internal cost of funds, survey rates offered by competing
financial institutions, review our cash flow requirements for lending and liquidity, and implement
interest rate changes when considered appropriate. We do not obtain deposits through brokers. As
a part of our strategy of increasing our business customer base, we have expanded our commercial
deposit products and services, particularly variable rate money market accounts, sweep accounts,
and other transaction accounts. Our deposit growth has benefited from the expansion of our branch network to 43 branches at
December 31, 2004. During this time, the growth in our checking accounts and savings accounts
exceeded the growth in our certificates of deposit. Certificates of deposits generally are higher
cost, and more interest rate sensitive than checking and savings accounts. At December 31, 2004,
certificate of deposit accounts comprised 22.5% of our total deposits. Deposit Portfolio.The following table sets forth information regarding interest rates,
terms, minimum amounts and balances of our deposit portfolio as of December 31, 2004 based on
original term to maturity. Weighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    PercentageAverage
    
    Minimum
    
    
    
    Minimum
    
    
    
    
    
    
    of TotalInterest Rate
    
    Term
    
    Checking and Savings Deposits
    
    Amount
    
    
    Balances
    
    
    Deposits(In Thousands)0.00%
    
    None
    
    Non-interest bearing demand
    
    $
    
    
    
    $
    386,790
    
    
    
    13.74
    %1.03
    
    None
    
    Interest bearing checking accounts
    
    
    100
    
    
    
    689,533
    
    
    
    24.501.61
    
    None
    
    Passbooks and statement savings
    
    
    100
    
    
    
    770,124
    
    
    
    27.361.52
    
    None
    
    Money market accounts
    
    
    2,500
    
    
    
    335,573
    
    
    
    11.92Certificates of Deposit0.25
    
    0 - 3 months
    
    Fixed term, fixed rate
    
    
    1,000
    
    
    
    3,839
    
    
    
    0.140.77
    
    3 - 6 months
    
    Fixed term, fixed rate
    
    
    1,000
    
    
    
    28,581
    
    
    
    1.021.44
    
    6 - 12 months
    
    Fixed term, fixed rate
    
    
    1,000
    
    
    
    259,912
    
    
    
    9.232.95
    
    12 - 36 months
    
    Fixed term, fixed rate
    
    
    1,000
    
    
    
    259,275
    
    
    
    9.214.19
    
    36 - 60 months
    
    Fixed term, fixed rate
    
    
    1,000
    
    
    
    81,043
    
    
    
    2.88Total
    
    
    
    
    
    
    
    
    2,814,670
    
    
    
    100.00
    %
 22




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##### Table of Contents



Set forth below is information regarding the average balance, cost and weighted average
interest rate on our deposits for the periods indicated. Year ended December 31,2002
    
    
    2003
    
    
    2004Weighted
    
    
    
    
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    
    
    
    
    WeightedAverage
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    Average
    
    
    Average
    
    
    Interest
    
    
    AverageBalances
    
    
    Expense
    
    
    Interest Rate
    
    
    Balances
    
    
    Expense
    
    
    Interest Rate
    
    
    Balances
    
    
    Expense
    
    
    Interest Rate(Dollars in Thousands)Non-interest bearing demand
    
    $
    188,606
    
    
    $
    
    
    
    
    
    %
    
    $
    246,853
    
    
    $
    
    
    
    
    
    %
    
    $
    350,979
    
    
    $
    
    
    
    
    
    %Interest bearing checking accounts
    
    
    299,223
    
    
    
    4,036
    
    
    
    1.35
    
    
    
    477,055
    
    
    
    5,553
    
    
    
    1.16
    
    
    
    622,843
    
    
    
    6,667
    
    
    
    1.07Passbooks
    
    
    270,999
    
    
    
    4,337
    
    
    
    1.60
    
    
    
    526,512
    
    
    
    9,643
    
    
    
    1.83
    
    
    
    702,607
    
    
    
    11,860
    
    
    
    1.69Money market accounts
    
    
    182,585
    
    
    
    3,176
    
    
    
    1.74
    
    
    
    251,965
    
    
    
    4,006
    
    
    
    1.59
    
    
    
    331,765
    
    
    
    5,176
    
    
    
    1.56Certificates of deposit
    
    
    810,903
    
    
    
    28,804
    
    
    
    3.55
    
    
    
    732,822
    
    
    
    19,403
    
    
    
    2.65
    
    
    
    657,735
    
    
    
    15,973
    
    
    
    2.43Total
    
    $
    1,752,316
    
    
    $
    40,353
    
    
    
    2.30
    %
    
    $
    2,235,207
    
    
    $
    38,605
    
    
    
    1.73
    %
    
    $
    2,665,929
    
    
    $
    39,676
    
    
    
    1.49
    %
 23




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##### Table of Contents



The following table sets forth our certificates of deposit classified by rates as of the
dates indicated. At December 31,2002
    
    
    2003
    
    
    2004(In Thousands)0.00  1.00%
    
    $
    21,078
    
    
    $
    78,324
    
    
    $
    39,5621.01  2.00%
    
    
    126,774
    
    
    
    209,013
    
    
    
    141,2032.01  3.00%
    
    
    310,644
    
    
    
    193,797
    
    
    
    263,8883.01  4.00%
    
    
    97,826
    
    
    
    60,962
    
    
    
    110,8974.01  5.00%
    
    
    173,915
    
    
    
    135,450
    
    
    
    72,4685.01  6.00%
    
    
    19,406
    
    
    
    5,684
    
    
    
    2,1946.01  7.00%
    
    
    15,789
    
    
    
    2,637
    
    
    
    2,4387.01  8.00%
    
    
    2,323
    
    
    
    12
    
    
    
    $
    767,755
    
    
    $
    685,879
    
    
    $
    632,650
 The following table sets forth the amount and maturities of certificates of deposit at
December 31, 2004. Amount DueLess than
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    After 5One Year
    
    
    1-2 Years
    
    
    2-3 Years
    
    
    3-4 Years
    
    
    4-5 Years
    
    
    Years
    
    
    Total(In Thousands)0.00  1.00%
    
    $
    39,489
    
    
    $
    34
    
    
    $
    39
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    39,5621.01  2.00%
    
    
    130,015
    
    
    
    11,061
    
    
    
    117
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    141,2032.01  3.00%
    
    
    200,482
    
    
    
    51,958
    
    
    
    3,032
    
    
    
    6,658
    
    
    
    1,758
    
    
    
    
    
    
    
    263,8883.01  4.00%
    
    
    18,328
    
    
    
    13,152
    
    
    
    64,683
    
    
    
    9,840
    
    
    
    4,894
    
    
    
    
    
    
    
    110,8974.01  5.00%
    
    
    30,516
    
    
    
    20,974
    
    
    
    20,978
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    72,4685.01  6.00%
    
    
    898
    
    
    
    1,296
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,1946.01  7.00%
    
    
    2,431
    
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,438$
    422,159
    
    
    $
    98,482
    
    
    $
    88,849
    
    
    $
    16,498
    
    
    $
    6,662
    
    
    $
    
    
    
    $
    632,650
 The following table indicates the amount of our certificates of deposit of $100,000 or
more by time remaining until maturity as of December 31, 2004. These deposits represented 8.3% of
our total deposits at December 31, 2004. Remaining Maturity
    
    Amount(In Thousands)Three months or less
    
    $
    51,350Three through six months
    
    
    30,039Six through twelve months
    
    
    67,798Over twelve months
    
    
    85,241Total
    
    $
    234,428
 The following table sets forth the net changes in our deposits for the periods indicated. Year Ended December 31,2002
    
    
    2003
    
    
    2004(In Thousands)Deposits
    
    $
    11,214,770
    
    
    $
    13,070,245
    
    
    $
    16,447,838Withdrawals
    
    
    10,909,963
    
    
    
    12,473,767
    
    
    
    16,132,268Net increase before interest credited
    
    
    304,807
    
    
    
    596,478
    
    
    
    315,570Interest credited
    
    
    34,098
    
    
    
    34,718
    
    
    
    38,999Net increase in deposits
    
    $
    338,905
    
    
    $
    561,760
    
    
    $
    354,569
 Borrowings Deposits are the primary source of funds for our lending and investment activities and for
general business purposes. If the need arises, we may borrow from the Federal Home Loan Bank of
Atlanta and from the Federal Reserve Bank discount window to supplement our supply of lendable
funds and to meet deposit withdrawal requirements. Loans from the Federal Home Loan Bank are
typically collateralized by our Federal Home Loan Bank stock and a portion of our first mortgage
loans. At December 31, 2004, we had $250.9 million of Federal Home Loan Bank advances outstanding.
Our borrowings also include $53.6 million of junior subordinated debentures. The debentures were
issued in connection with the issuance $22.7 million of 24




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##### Table of Contents



Cumulative Trust Preferred Securities which pay interest at a floating rate of 285 basis
points above the three month LIBOR rate issued by Fidelity Capital Trust II, and the issuance by
Fidelity Capital Trust III of Cumulative Trust Preferred Securities of $30.9 million, paying
interest at a floating rate of 197 basis points above the three month LIBOR rate. The Federal Home Loan Bank functions as a central reserve bank providing credit to us as well
as other member financial institutions. As a member, we are required to own capital stock in the
Federal Home Loan Bank and are authorized to apply for loans on the security of such stock and
certain of our residential mortgage loans and other assets (principally, securities that are
obligations of, or guaranteed by, the United States), provided certain standards related to
creditworthiness are met. The Federal Home Loan Bank offers several different loan programs and
each loan program has its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based either on a fixed percentage of a member
institutions net worth or on the Federal Home Loan Banks assessment of the institutions
creditworthiness. All Federal Home Loan Bank advances have fixed interest rates and mature between
three months and 10 years. Year Ended December 31,2002
    
    
    2003
    
    
    2004(Dollars in Thousands)Federal Home Loan Bank advances:Maximum month-end balance
    
    $
    315,031
    
    
    $
    277,244
    
    
    $
    387,679Balance at end of period
    
    
    253,371
    
    
    
    264,561
    
    
    
    250,855Average balance
    
    
    303,016
    
    
    
    269,718
    
    
    
    307,735Weighted average interest rate on:Balance at end of period
    
    
    6.01
    %
    
    
    5.81
    %
    
    
    5.91
    %Average balance for period
    
    
    6.08
    %
    
    
    5.85
    %
    
    
    5.86
    %
 Subsidiary Activities Fidelity Federal Bank & Trust has two wholly owned subsidiaries. Fidelity Realty and
Appraisal Service, Inc., a Florida corporation, is primarily engaged in providing appraisal
services for Fidelity Federal Bank & Trust and selling our real estate owned. At December 31, 2004
Fidelity Realty and Appraisal Service, Inc. had total equity capital of $850,000, including
retained earnings of $375,000. Fidelity Realty and Appraisal Service, Inc. had net income of
$149,000 for the year ended December 31, 2003 and net income of $161,000 for the year ended
December 31, 2004 Our other subsidiary, Florida Consolidated Agency, Inc., a Florida corporation doing business
as Fidelity Insurance, was established in 1999. On July 16, 1999, Fidelity Insurance acquired Dunn
and Noel, Inc., a full-service insurance agency based in Juno Beach, Florida. Dunn & Noel was
founded in 1947, originally as Burns & Company. Fidelity Insurance operates as an independent
insurance agency, and licensed agents make insurance products available through Fidelity Federal
Bank & Trusts branch offices. Licensed representatives also sell a variety of investment
products. Fidelity Insurance had net income of $336,000 and $247,000 for the years ended December
31, 2003 and 2004, respectively. Federal savings banks insured by the Savings Association Insurance Fund are required to
provide 30 days advance notice to the Office of Thrift Supervision and the Federal Deposit
Insurance Corporation before establishing or acquiring a subsidiary or conducting a new activity in
a subsidiary. The insured savings bank must also provide the Federal Deposit Insurance Corporation
and the Office of Thrift Supervision such information as may be required by applicable regulations
and must conduct the activity in accordance with the rules and orders of the Office of Thrift
Supervision. In addition to other enforcement and supervisory powers, the Office of Thrift
Supervision may determine after notice and opportunity for a hearing that the continuation of a
savings banks ownership of or relation to a subsidiary (i) constitutes a serious risk to the
safety, soundness or stability of the savings bank, or (ii) is inconsistent with law and
regulation. Upon the making of such a determination, the Office of Thrift Supervision may order
the savings bank to divest the subsidiary or take other actions. 25




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##### Table of Contents



Personnel As of December 31, 2004, we had 705 full-time and 128 part-time employees. None of our
employees is represented by a collective bargaining group. We believe our relationship with our
employees is good. REGULATION Fidelity Federal Bank & Trust is examined and supervised extensively by the Office of Thrift
Supervision and the Federal Deposit Insurance Corporation. This regulation and supervision limits
the activities in which Fidelity Federal Bank & Trust may engage. Under this system of federal
regulation, financial institutions are periodically examined to ensure that they satisfy applicable
standards with respect to their capital adequacy, assets, management, earnings, liquidity and
sensitivity to market interest rates. Fidelity Federal Bank & Trust also is a member of, and owns
stock in, the Federal Home Loan Bank of Atlanta, which is one of the twelve regional banks in the
Federal Home Loan Bank System. Fidelity Federal Bank & Trust also is regulated to a lesser extent
by the Board of Governors of the Federal Reserve System, governing reserves to be maintained
against deposits and other matters. Fidelity Federal Bank & Trusts relationship with its
depositors and borrowers is regulated by both federal and state laws, especially in matters
concerning the ownership of deposit accounts and the form and content of Fidelity Federal Bank &
Trusts mortgage documents. Any change in this regulation, whether by the Federal Deposit
Insurance Corporation, the Office of Thrift Supervision, or the United States Congress, could have
a material adverse impact on the results of the operations of Fidelity Bankshares, Inc. and
Fidelity Federal Bank & Trust. Federal Regulation of Savings Institutions Business Activities.The activities of federal savings banks are subject to extensive
regulation, including restrictions or requirements with respect to loans-to-one borrower, the
percentage of non-mortgage loans or investments to total assets, capital distributions, permissible
investments and lending activities, liquidity, transactions with affiliates and community
reinvestment. In particular, many types of loans, such as commercial real estate, commercial
business and consumer loans, are limited to a specific percentage of our capital or assets. The
description of statutory provisions and regulations applicable to federal savings banks set forth
herein does not purport to be a complete description of these statutes and regulations and their
effect on Fidelity Federal Bank & Trust. Capital Requirements.The Office of Thrift Supervision capital regulations require federal
savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio; a 4% leverage
ratio (3% for institutions receiving the highest rating on the supervisory rating system); and an
8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below
also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for
institutions receiving the highest supervisory rating), and together with the risk-based capital
standard itself, a 4% Tier 1 risk-based capital standard. Institutions must generally deduct from
regulatory capital investments in and loans to subsidiaries engaged in activities as principal that
are not permissible for a national bank. The risk-based capital standards for federal savings banks require the maintenance of Tier 1
(core) and total capital (which is defined as core capital and supplementary capital) to
risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of
risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a
risk-weighted factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation
based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders equity (including retained earnings), certain noncumulative perpetual
preferred stock and related surplus and minority interests in equity accounts of consolidated
subsidiaries, less intangible assets other than certain mortgage servicing rights and credit card
relationships. The components of supplementary capital currently include cumulative preferred
stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and
intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25%
of risk-weighted assets, and up to 45% of unrealized gains on 26




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##### Table of Contents



available-for-sale equity securities with readily determinable fair market values. Overall,
the amount of supplementary capital included as part of total capital may not exceed 100% of core
capital. Loans-to-One-Borrower.Federal savings associations generally may not make a loan or extend
credit to a single or related group of borrowers in excess of 15% of unimpaired capital and
surplus. An additional 10% of unimpaired capital and surplus may be loaned (for a total of 25% of
unpaid capital surplus), if the loan is secured by readily marketable collateral, which is defined
to include certain marketable securities, but generally not real estate. As of December 31, 2004,
Fidelity Federal Bank & Trust was in compliance with its loans-to-one-borrower limitations. Qualified Thrift Lender Test.As a federal savings association, Fidelity Federal Bank & Trust
is required to satisfy a qualified thrift lender test whereby it must maintain at least 65% of its
portfolio assets in qualified thrift investments, which consist primarily of residential
mortgages and related investments, including mortgage-backed and related securities. Portfolio
assets generally means total assets less specified liquid assets up to 20% of total assets,
goodwill and other intangible assets, and the value of property used to conduct business. A
savings association that fails the qualified thrift lender test must either convert to a bank
charter or operate under specified restrictions. As of December 31, 2004, Fidelity Federal Bank &
Trust maintained 77.3% of its portfolio assets in qualified thrift investments and, therefore, met
the qualified thrift lender test. Capital Distributions.Office of Thrift Supervision regulations govern capital distributions
by savings institutions, which include cash dividends, stock repurchases and other transactions
charged to the capital account of a savings institution. A savings institution must file an
application for Office of Thrift Supervision approval of a capital distribution if either (1) the
total capital distributions for the applicable calendar year exceed the sum of the institutions
net income for that year to date plus the institutions retained net income for the preceding two
years, (2) the institution would not be at least adequately capitalized following the distribution,
(3) the distribution would violate any applicable statute, regulation, agreement or OTS-imposed
condition, or (4) the institution is not eligible for expedited treatment of its filings. If an
application is not required to be filed, a savings institution which is a subsidiary of a holding
company, as well as certain other institutions, must still file a notice with the Office of Thrift
Supervision at least 30 days before the board of directors declares a dividend or approves a
capital distribution. Any additional capital distributions would require prior Office of Thrift Supervision
approval. If Fidelity Federal Bank & Trusts capital falls below its required levels or the Office
of Thrift Supervision notifies it that it is in need of more than normal supervision, Fidelity
Federal Bank & Trusts ability to make capital distributions could be restricted. In addition, the
Office of Thrift Supervision may prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by regulation, if the Office of Thrift Supervision determines that the
distribution would constitute an unsafe or unsound practice. Liquidity.Fidelity Federal Bank & Trust is required to maintain liquid assets at levels
considered safe and sound by the Office of Thrift Supervision. Fidelity Federal Bank & Trusts
average liquidity ratio for the quarter ended December 31, 2004 was 8.35%. Community Reinvestment Act and Fair Lending Laws.Federal savings banks have a responsibility
under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to
help meet the credit needs of their communities, including low- and moderate-income neighborhoods.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from
discriminating in their lending practices on the basis of characteristics specified in those
statutes. An institutions failure to comply with the provisions of the Community Reinvestment Act
could, at a minimum, result in regulatory restrictions on its activities, and failure to comply
with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions
by the Office of Thrift Supervision, as well as other federal regulatory agencies and the
Department of Justice. Fidelity Federal Bank & Trust received a satisfactory Community
Reinvestment Act rating under the current Community Reinvestment Act regulations in its most recent
federal examination by the Office of Thrift Supervision. 27




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Transactions with Related Parties.Fidelity Federal Bank & Trusts authority to engage in
transactions with related parties or affiliates or to make loans secured by the securities of any
affiliate is limited by Sections 23A and 23B of the Federal Reserve Act and its implementing
federal regulations. The term affiliates for these purposes generally means any company that
controls or is under common control with an institution, including Fidelity Bankshares, Inc. and
its non-savings institution subsidiaries. Section 23A limits the aggregate amount of certain
covered transactions with any individual affiliate to 10% of the capital and surplus of the
savings institution and also limits the aggregate amount of covered transactions with all
affiliates to 20% of the savings institutions capital and surplus. Covered transactions with
affiliates are required to be secured by collateral in an amount and of a type described in Section
23A and the purchase of low quality assets from affiliates is prohibited. Section 23B provides
that covered transactions with affiliates, including loans and asset purchases, must be on terms
and under circumstances, including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable transactions with
non-affiliated companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank holding companies, and no
savings institution may purchase the securities of any affiliate other than a subsidiary. Fidelity Federal Bank & Trusts authority to extend credit to executive officers, directors
and 10% or more stockholders, as well as entities controlled by these persons, is currently
governed by Sections 22(g) and 22(h) of the Federal Reserve Act, and its implementing federal
regulations. Among other things, these regulations generally require these loans to be made on
terms substantially the same as those offered to unaffiliated individuals and that do involve more
than the normal risk of repayment. Federal regulation also places individual and aggregate limits
on the amount of loans Fidelity Federal Bank & Trust may make to these persons based, in part, on
Fidelity Federal Bank & Trusts capital position, and requires approval procedures to be followed.
At December 31, 2004, Fidelity Federal Bank & Trust was in compliance with these regulations. Enforcement.The Office of Thrift Supervision has primary enforcement responsibility over
savings institutions and has the authority to bring enforcement action against all
institution-related parties, including stockholders, and attorneys, appraisers and accountants
who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a capital directive
or cease and desist order to removal of officers and/or directors of the institutions,
receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a
wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless
disregard is made, in which case penalties may be as high as $1.0 million per day. The Federal
Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of
Thrift Supervision that enforcement action be taken with respect to a particular savings
institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has
authority to take such action under specified circumstances. Standards for Safety and Soundness.Federal law requires each federal banking agency to
prescribe for all insured depository institutions standards relating to, among other things,
internal controls, information systems and audit systems, loan documentation, credit underwriting,
interest rate risk exposure, asset growth, compensation, and such other operational and managerial
standards as the agency deems appropriate. The federal banking agencies adopted Interagency
Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness
standards required under the federal law. The guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. The guidelines address internal controls
and information systems; internal audit systems; credit underwriting; loan documentation; interest
rate risk exposure; asset growth; and compensation, fees and benefits. If the appropriate federal
banking agency determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard. If an institution fails to meet these standards, the
appropriate federal banking agency may require the institution to submit a compliance plan. 28




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Prompt Corrective Regulatory Action Under the Office of Thrift Supervision Prompt Corrective Action regulations, the Office of
Thrift Supervision is required to take supervisory actions against undercapitalized institutions,
the severity of which depends upon the institutions level of capital. Generally, a savings
institution that has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1
core capital ratio that is less than 4.0% is considered to be undercapitalized. A savings
institution that has total risk-based capital less than 6.0%, a Tier 1 core risk-based capital
ratio of less than 3.0% or a leverage ratio that is less than 3.0% is considered to be
significantly undercapitalized, and a savings institution that has a tangible capital to assets
ratio equal to or less than 2.0% is deemed to be critically undercapitalized. Generally, the
applicable banking regulator is required to appoint a receiver or conservator for an institution
that is critically undercapitalized. The regulation also provides that a capital restoration
plan must be filed with the Office of Thrift Supervision within 45 days of the date an institution
receives notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. In addition, numerous mandatory supervisory actions become immediately
applicable to the institution, including, but not limited to, restrictions on growth, investment
activities, capital distributions, and affiliate transactions. The Office of Thrift Supervision
could also take any one of a number of discretionary supervisory actions against undercapitalized
institutions, including the issuance of a capital directive and the replacement of senior executive
officers and directors. Insurance of Deposit Accounts The Federal Deposit Insurance Corporation has adopted a risk-based deposit insurance
assessment system. The Federal Deposit Insurance Corporation assigns an institution to one of
three capital categories, based on the institutions financial information, as of the reporting
period ending seven months before the assessment period, and one of three supervisory subcategories
within each capital group. The three capital categories are well capitalized, adequately
capitalized and undercapitalized. The supervisory subgroup to which an institution is assigned is
based on a supervisory evaluation provided to the Federal Deposit Insurance Corporation by the
institutions primary federal regulator and information which the Federal Deposit Insurance
Corporation determines to be relevant to the institutions financial condition and the risk posed
to the deposit insurance funds. An institutions assessment rate depends on the capital category
and supervisory category to which it is assigned. The Federal Deposit Insurance Corporation is
authorized to raise the assessment rates. The Federal Deposit Insurance Corporation has exercised
this authority several times in the past and may raise insurance premiums in the future. If this
type of action is taken by the Federal Deposit Insurance Corporation, it could have an adverse
effect on the earnings of Fidelity Federal Bank & Trust. Federal Home Loan Bank System The Federal Home Loan Bank System provides a central credit facility primarily for member
institutions. Fidelity Federal Bank & Trust, as a member of the Federal Home Loan Bank of Atlanta,
is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount
at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home
Loan Bank, whichever is greater. As of December 31, 2004, Fidelity Federal Bank & Trust was in
compliance with this requirement. The Federal Home Loan Banks are required to provide funds for
the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their
members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. Federal Reserve System The Federal Reserve Board regulations require savings institutions to maintain
non-interest-earning reserves against their transaction accounts, such as negotiable order of
withdrawal and regular checking accounts. At December 31, 2004, Fidelity Federal Bank & Trust was
in compliance with these reserve 29




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requirements. The balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift
Supervision. Holding Company Regulation Fidelity Bankshares, Inc. is a non-diversified unitary savings and loan holding company,
subject to regulation and supervision by the Office of Thrift Supervision. A non-diversified
unitary savings and loan holding company is a savings and loan holding company which controls only
one subsidiary savings association which, together with all related activities, represents more
than 50% of the holding companys consolidated net worth. The Office of Thrift Supervision has
enforcement authority over Fidelity Bankshares, Inc. and its non-savings institution subsidiaries.
Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit
activities that are determined to be a risk to the subsidiary savings institution. As a non-diversified unitary savings and loan holding company that was formed after May 4,
1999, Fidelity Bankshares, Inc. may only engage in business activities that are permissible for
financial holding companies or for multiple savings and loan holding companies. A financial
holding company may engage in activities that are financial in nature, incidental to financial
activities or complementary to a financial activity. A multiple savings and loan holding company
is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of
the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision,
and certain additional activities authorized by Office of Thrift Supervision regulation. Federal law prohibits a savings and loan holding company, directly or indirectly, or through
one or more subsidiaries, from acquiring control another savings institution or holding company
thereof, without prior written approval of the Office of Thrift Supervision. In evaluating
applications by holding companies to acquire savings institutions, the Office of Thrift Supervision
must consider the financial and managerial resources of the acquiror, the future prospects of the
acquiror and the institution to be acquired, the effect of the acquisition on the risk to the
insurance fund, the convenience and needs of the community, competitive factors, and the
associations compliance with applicable anti-money laundering regulations. The USA PATRIOT Act In response to the terrorist attacks of September 11, 2001, the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or
the USA PATRIOT Act, was enacted in October 2001. The USA PATRIOT Act gives the federal government
new powers to address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing and broadened anti-money laundering
requirements. Financial institutions, such as Fidelity Federal Bank & Trust, have been required by
federal law for years to have an effective anti-money laundering program. As such, the
requirements of the USA PATRIOT Act should not have material impact on its operations. Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) was enacted to implement legislative reforms
to address corporate and accounting fraud. In addition to the establishment of a new accounting
oversight board that will enforce auditing, quality control and independence standards (and will be
funded by fees from all publicly traded companies), Sarbanes-Oxley places certain restrictions on
the scope of services that may be provided by accounting firms to their public company audit
clients. Any non-audit services being provided to a public company audit client will require
preapproval by the companys audit committee. In addition, Sarbanes-Oxley makes certain changes to
the requirements for audit partner rotation after a period of time. Sarbanes-Oxley requires chief
executive officers and chief financial officers, or their equivalent, to certify to the accuracy of
periodic reports filed with the Securities and Exchange Commission, and makes them subject to civil
and criminal penalties if they knowingly or willingly violate this certification requirement. The
Companys Chief Executive Officer and Chief Financial Officer have signed certifications to this
Form 10-K as required by Sarbanes-Oxley. In addition, under Sarbanes-Oxley, counsel will be
required to report evidence of a material 30




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violation of the securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not appropriately respond,
to report such evidence to the audit committee or other similar committee of the board of directors
or the board itself. Under Sarbanes-Oxley, longer prison terms will apply to corporate executives who violate
federal securities laws; the period during which certain types of suits can be brought against a
company or its officers is extended; and bonuses issued to top executives prior to restatement of a
companys financial statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from trading the companys securities during
retirement plan blackout periods, and loans to company executives (other than loans by financial
institutions permitted by federal rules and regulations) are restricted. In addition, a provision
directs that civil penalties levied by the Securities and Exchange Commission as a result of any
judicial or administrative action under Sarbanes-Oxley be deposited to a fund for the benefit of
harmed investors. The Federal Accounts for Investor Restitution provision also requires the
Securities and Exchange Commission to develop methods of improving collection rates. The
legislation accelerates the time frame for disclosures by public companies, as they must
immediately disclose any material changes in their financial condition or operations. Directors
and executive officers must also provide information for most changes in ownership in a companys
securities within two business days of the change. Sarbanes-Oxley also increases the oversight of, and codifies certain requirements relating to
audit committees of public companies and how they interact with the companys registered public
accounting firm. Audit committee members must be independent and are absolutely barred from
accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies
must disclose whether at least one member of the committee is a financial expert (as such term is
defined by the Securities and Exchange Commission) and if not, why not. Under Sarbanes-Oxley, a
companys registered public accounting firm is prohibited from performing statutorily mandated
audit services for a company if such companys chief executive officer, chief financial officer,
comptroller, chief accounting officer or any person serving in equivalent positions had been
employed by such firm and participated in the audit of such company during the one-year period
preceding the audit initiation date. Sarbanes-Oxley also prohibits any officer or director of a
company or any other person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent accountant engaged in the audit of the
companys financial statements for the purpose of rendering the financial statements materially
misleading. Sarbanes-Oxley also requires the Securities and Exchange Commission to prescribe rules
requiring inclusion of any internal control report and assessment by management in the annual
report to shareholders. Sarbanes-Oxley requires the companys registered public accounting firm
that issues the audit report to attest to and report on managements assessment of the companys
internal controls. Compliance with the provisions of the Sarbanes-Oxley Act have not had a material impact on our
results of operations or financial condition. TAXATION Federal Taxation For federal income tax purposes, Fidelity Bankshares, Inc. and its subsidiaries file a
consolidated federal income tax return on a calendar year basis, using the accrual method of
accounting. As a result of the enactment of the Small Business Job Protection Act of 1996, all savings
banks and savings associations may convert to a commercial bank charter, diversify their lending,
or be merged into a commercial bank without having to recapture any of their pre-1988 tax bad debt
reserve accumulations. However, transactions that would require recapture of the pre-1988 tax bad
debt reserve include redemption of Fidelity Federal Bank & Trusts stock, payment of dividends or
distributions in excess of earnings and profits, or failure by the institution to qualify as a bank
for federal income tax purposes. At December 31, 2004, Fidelity Federal Bank & Trust had a balance
of approximately $7.4 million of pre-1988 tax bad debt reserves. A deferred 31




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tax liability has not been provided on this amount as management does not intend to make
distributions, redeem stock or fail certain bank tests that would result in recapture of the
reserve. Deferred income taxes arise from the recognition of items of income and expense for tax
purposes in years different from those in which they are recognized in the consolidated financial
statements. Fidelity Bankshares, Inc. accounts for deferred income taxes by the asset and
liability method, applying the enacted statutory rates in effect at the balance sheet date to
differences between the book basis and the tax basis of assets and liabilities. The resulting
deferred-tax liabilities and assets are adjusted to reflect changes in the tax laws. Fidelity Bankshares, Inc. is subject to the corporate alternative minimum tax to the extent it
exceeds Fidelity Bankshares, Inc.s regular income tax for the year. The alternative minimum tax
will be imposed at the rate of 20% of a specially computed tax base. Included in this base are a
number of preference items, including interest on certain tax-exempt bonds issued after August 7,
1986, and an adjusted current earnings computation which is similar to a tax earnings and profits
computation. In addition, for purposes of the alternative minimum tax, the amount of alternative
minimum taxable income that may be offset by net operating losses may be limited to 90% of
alternative minimum taxable income. State Taxation Florida Taxation.Foreign corporations, like Fidelity Bankshares, Inc., pay a 51/2% tax on the
portion of their net taxable income which is allocable to the State of Florida. Delaware Taxation.As a Delaware holding company not earning income in Delaware, Fidelity
Bankshares, Inc. is exempt from Delaware corporate income tax but is required to file an annual
report with and pay an annual franchise tax to the State of Delaware. Fidelity Bankshares, Inc. has not been audited by the Internal Revenue Service or the State of
Delaware within the past five years. During 2004, the state income tax returns of Fidelity
Bankshares, Inc. were audited by the State of Florida for income tax years 2000 through 2003. See
Notes 1 and 11 to the Financial Statements. AVAILABILITY OF ANNUAL REPORT Our Annual Report on Form 10-K, Code of Ethics required pursuant to the Sarbanes-Oxley Act and
our Nominating and Corporate Governance Committee Charter may be obtained by accessing our website
at www.fidelityfederal.com. 
 ITEM 2. PROPERTIES Property At December 31, 2004, we conducted our business through our administrative office located in
West Palm Beach, Florida, and 43 full service branch offices located in Palm Beach, Martin and St.
Lucie Counties and 4 loan production offices located in Palm Beach, Broward, St. Lucie and Indian
River Counties. The aggregate net book value of our premises and equipment was $83.4 million at
December 31, 2004. 
 ITEM 3. LEGAL PROCEEDINGS There are various claims and lawsuits in which Fidelity Federal Bank & Trust is periodically
involved incident to our business. Other than as set forth below, we believe these legal
proceedings, in the aggregate, are not material to our financial condition or results of
operations. On July 1, 2003, Fidelity Federal Bank & Trust was named as defendant in the lawsuit,
James Kehoe v. Fidelity Federal Bank & Trust, filed in the United States District Court for
the Southern District of Florida. In this action, James Kehoe (Kehoe), on behalf of himself and
other similarly situated persons, has alleged that 32




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Fidelity Federal violated the Driver Privacy Protection Act by obtaining driver registration
information from the State of Florida for use in its marketing efforts. Kehoe sought as damages a
statutory minimum of $2,500.00 per violation on behalf of the class of plaintiffs. On June 14,
2004, the Court granted Fidelity Federals Motion for Summary Judgment and entered a Final Judgment
in favor of the bank against Mr. Kehoe. A Notice of Appeal was filed by Mr. Kehoes lawyers on
June 28, 2004. Fidelity Federal, in consultation with counsel, has concluded that the lawsuit is
without merit and intends to defend against the Plaintiffs Appeal of the Courts Final Judgment in
the banks favor. On February 18, 2004, Fidelity Federal Bank & Trust was named as defendant in a lawsuit
William Adams et al., vs. Thomson Financial, Inc., Fidelity Federal Bank & Trust, N.A.,
Fidelity Investments Services, L.L.C., d/b/a Fidelity Investments, National Financial Services,
L.L.C., f/k/a National Financial Services Corporation, Zoe Marrero,filed in the Fifteenth
Judicial Circuit in and for Palm Beach County, Florida. The plaintiffs in this case have alleged
various causes of action against numerous defendants which arise from plaintiffs investments in
various entities controlled and generated by Thomas Abrams, who was convicted for running a Ponzi
Scheme. Fidelity Federal is a named defendant in one count of the complaint alleging aiding and
abetting breaches of fiduciary duty. The allegations are based upon Fidelity Federal allowing
Abrams to set up accounts with Fidelity Federal, deposit monies in them, issue bank checks based
upon the deposits and instructions from authorized signatures on the accounts and generally offer
banking services to the Abrams entities. There are additional allegations that Fidelity Federal
solicited clients for the Abrams entities and pressured clients to place deposits with the Abrams
entities and Fidelity Federal, which are without basis. There is no specific request for damages,
other than the jurisdictional amount of in excess of $15,000.00. The Plaintiffs allege they lost
in excess of $18,000,000.00 investing with Abrams. The actual amount of losses incurred by the
plaintiffs are undetermined as of this time. We have moved to dismiss the second amended
complaint, and we intend to vigorously defend our position on the basis that we acted solely as a
depository bank in the transactions and allegations of improper conduct by us are factually
inaccurate. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the year ended December 31, 2004 to a
vote of security holders. 
 PART II 
 ITEM 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS Fidelity Bankshares, Inc. common stock, is currently listed on the Nasdaq National Market
under the symbol FFFL, and there is an established market for such common stock. At December 31,
2004, Fidelity Bankshares, Inc. had 21 market makers. The following table sets forth the high and low bid quotations for Fidelity Bankshares, Inc.
common stock and cash dividends per share declared for the periods indicated. These quotations
represent prices between dealers and do not include retail markups, markdowns, or commissions and
do not reflect actual transactions. This information has been obtained from monthly statistical
summaries provided by the Nasdaq Stock Market. All prices and dividend data has been adjusted to
reflect the Companys three for two stock split, in the form of a stock dividend, distributed on
January 14, 2005 to stockholders of record as of December 31, 2004. As of December 31, 2004, there
were 24,425,050 shares of Fidelity Bankshares, Inc. common stock issued and outstanding, net of
shares held in treasury. At December 31, 2004, Fidelity Bankshares, Inc. had approximately 3,256
stockholders of record. All per-share items shown have been retroactively adjusted for the 3-for-2 stock split which
was paid to stockholders on January 14, 2005. 33




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Cash DividendFiscal 2004
    
    High Bid
    
    
    Low Bid
    
    
    DeclaredQuarter Ended December 31, 2004
    
    $
    28.847
    
    
    $
    24.240
    
    
    $
    0.080Quarter Ended September 30, 2004
    
    
    25.867
    
    
    
    22.273
    
    
    
    0.067Quarter Ended June 30, 2004
    
    
    24.733
    
    
    
    20.413
    
    
    
    0.067Quarter Ended March 31, 2004
    
    
    25.633
    
    
    
    20.833
    
    
    
    0.067
 Cash DividendFiscal 2003
    
    High Bid
    
    
    Low Bid
    
    
    DeclaredQuarter Ended December 31, 2003
    
    $
    21.667
    
    
    $
    17.547
    
    
    $
    0.067Quarter Ended September 30, 2003
    
    
    18.480
    
    
    
    14.380
    
    
    
    0.067Quarter Ended June 30, 2003
    
    
    15.733
    
    
    
    12.047
    
    
    
    0.067Quarter Ended March 31, 2003
    
    
    13.167
    
    
    
    11.493
    
    
    
    0.067
 On October 20, 2004, the Company, through Fidelity Capital Trust III issued $30.9 million of
trust preferred securities. These securities bear interest at three month LIBOR plus 1.97% and
mature in 2034. The net proceeds of $29.8 million from this issue were used on November 24, 2004
to redeem the $29.6 million of 8.375%, fixed rate trust preferred securities, issued through
Fidelity Capital Trust I. On December 15, 2004, the Company completed a secondary offering of 1.15 million shares of its
common stock. Of the $43.8 million net proceeds from the issue, the Company invested $35.0 million
in its wholly-owned subsidiary Fidelity Federal Bank & Trust to provide funds for the banks
continued branch expansion. The remaining funds were retained by the Company for general corporate
purposes. Fidelity Bankshares, Inc. did not repurchase any of its shares during 2004. 
 ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
OF FIDELITY BANKSHARES, INC. AND SUBSIDIARY The following tables set forth selected consolidated historical financial and other data of
Fidelity Bankshares, Inc. for the periods and at the dates indicated. The information is derived
in part from, and should be read together with, the audited Consolidated Financial Statements and
Notes thereto of Fidelity Bankshares, Inc. At December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(In thousands, except per share amounts)Selected Financial Condition Data:Total assets
    
    $
    1,932,434
    
    
    $
    2,136,935
    
    
    $
    2,439,397
    
    
    $
    3,048,222
    
    
    $
    3,470,539Loans receivable, net
    
    
    1,361,232
    
    
    
    1,581,227
    
    
    
    1,935,999
    
    
    
    2,191,696
    
    
    
    2,556,700Mortgage-backed securities and
corporate debt securities
    
    
    322,223
    
    
    
    237,671
    
    
    
    145,139
    
    
    
    471,228
    
    
    
    529,640Investment securities(1)
    
    
    105,163
    
    
    
    152,446
    
    
    
    166,286
    
    
    
    169,850
    
    
    
    123,637Deposits
    
    
    1,497,818
    
    
    
    1,559,436
    
    
    
    1,898,341
    
    
    
    2,460,101
    
    
    
    2,814,670Total borrowings(2)
    
    
    310,005
    
    
    
    355,342
    
    
    
    326,537
    
    
    
    358,970
    
    
    
    350,560Stockholders equity
    
    
    91,651
    
    
    
    177,612
    
    
    
    169,087
    
    
    
    184,509
    
    
    
    251,283Book value per common share(3) (5)
    
    $
    8.92
    
    
    $
    7.50
    
    
    $
    7.10
    
    
    $
    8.19
    
    
    $
    10.29Tangible book value per common
share(4) (5)
    
    $
    8.67
    
    
    $
    7.41
    
    
    $
    7.01
    
    
    $
    7.94
    
    
    $
    10.17
   (1)
    
    Includes interest-bearing deposits, United States Government and United States
Government-sponsored agency securities and Federal Home Loan Bank stock.(2)
    
    Includes $29.6 million of junior subordinated debentures issued in connection with
the issuance of 8.375% Cumulative Trust Preferred Securities by Fidelity Capital Trust I, and
$22.7 million of junior subordinated debentures issued in connection with the issuance of
Trust Preferred Securities by Fidelity Capital Trust II with interest at a floating rate of
285 basis points above the three month LIBOR rate, and $30.9 million in connection with the
issuance of Trust Preferred Securities by Fidelity Capital Trust III with interest at a
floating rate of 197 basis points above the three month LIBOR rate. .(3)
    
    Book value per share data is calculated by dividing total Stockholders equity
by total common shares outstanding. 34




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(4)
    
    Tangible book value per share data is calculated by dividing total Stockholders
equity less goodwill by total common shares outstanding.(5)
    
    Per share data has been adjusted to reflect the second step conversion of Fidelity
Bankshares MHC in 2002 and the 3-for-2 stock split, in the form of a stock dividend,
distributed on January 14, 2005, to stockholders of record on December 31, 2004. For the Years Ended December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(In thousands, except per share amounts)Selected Operating Data:Interest income
    
    $
    132,580
    
    
    $
    138,480
    
    
    $
    137,867
    
    
    $
    143,683
    
    
    $
    164,664Interest expense
    
    
    85,671
    
    
    
    81,422
    
    
    
    61,768
    
    
    
    57,164
    
    
    
    59,864Net interest income
    
    
    46,909
    
    
    
    57,058
    
    
    
    76,099
    
    
    
    86,519
    
    
    
    104,800Provision for loan losses
    
    
    1,328
    
    
    
    2,054
    
    
    
    1,986
    
    
    
    3,122
    
    
    
    2,736Net interest income after
provision for loan losses
    
    
    45,581
    
    
    
    55,004
    
    
    
    74,113
    
    
    
    83,397
    
    
    
    102,064Other income
    
    
    13,406
    (1)
    
    
    13,764
    
    
    
    16,991
    
    
    
    22,516
    
    
    
    25,173Non-interest expense
    
    
    45,403
    
    
    
    55,722
    
    
    
    63,569
    
    
    
    76,513
    
    
    
    89,650Income before taxes
    
    
    13,584
    
    
    
    13,046
    
    
    
    27,535
    
    
    
    29,400
    
    
    
    37,587Income tax expense
    
    
    5,063
    
    
    
    5,166
    
    
    
    10,737
    
    
    
    11,479
    
    
    
    14,690Net income
    
    $
    8,521
    
    
    $
    7,880
    
    
    $
    16,798
    
    
    $
    17,921
    
    
    $
    22,897Income per common share:Basic(2)
    
    $
    0.36
    
    
    $
    0.34
    
    
    $
    0.75
    
    
    $
    0.82
    
    
    $
    1.04Diluted(2)
    
    $
    0.36
    
    
    $
    0.34
    
    
    $
    0.74
    
    
    $
    0.81
    
    
    $
    1.01
   (1)
    
    Includes $3.7 million from the receipt and sale of 147,232 shares of John
Hancock Financial common stock provided to policy holders pursuant to John Hancock Financials
conversion from a mutual (or policy owned insurance company) to a stock insurance company.(2)
    
    Per share data has been adjusted to reflect the second step conversion of Fidelity
Bankshares, MHC in 2002 and the 3-for 2 stock split in 2004 . 35




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##### Table of Contents



At and for the Years ended December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Selected Financial Ratios and Other Data:Return on average assets (ratio of net
income to average total assets)
    
    
    0.46
    %
    
    
    0.38
    %
    
    
    0.71
    %
    
    
    0.64
    %
    
    
    0.69
    %Return on average stockholders
equity (ratio of net income to
average stockholders equity)
    
    
    9.97
    %
    
    
    5.46
    %
    
    
    9.49
    %
    
    
    10.15
    %
    
    
    11.49
    %Non-interest income to average assets
    
    
    0.70
    %
    
    
    0.67
    %
    
    
    0.72
    %
    
    
    0.80
    %
    
    
    0.75
    %Non-interest expense to average assets
    
    
    2.43
    %
    
    
    2.71
    %
    
    
    2.71
    %
    
    
    2.73
    %
    
    
    2.69
    %Net interest rate spread during
the period
    
    
    2.77
    %
    
    
    2.55
    %
    
    
    3.45
    %
    
    
    3.29
    %
    
    
    3.53
    %Net interest margin (net interest income
to average interest earning assets)
    
    
    2.72
    %
    
    
    2.85
    %
    
    
    3.51
    %
    
    
    3.31
    %
    
    
    3.36
    %Ratio of average interest-earning assets
to average interest-bearing liabilities
    
    
    99.21
    %
    
    
    107.37
    %
    
    
    102.09
    %
    
    
    101.62
    %
    
    
    101.67
    %Efficiency ratio(1)
    
    
    75.07
    %
    
    
    78.68
    %
    
    
    68.29
    %
    
    
    70.17
    %
    
    
    68.98
    %Dividend payout ratio
    
    
    76.34
    %
    
    
    76.92
    %
    
    
    35.71
    %
    
    
    32.25
    %
    
    
    26.92
    %Asset Quality Ratios:Nonperforming loans to net loans
at end of period
    
    
    0.37
    %
    
    
    0.32
    %
    
    
    0.34
    %
    
    
    0.51
    %
    
    
    0.25
    %Allowance for loan losses to
nonperforming loans at end of period
    
    
    98.41
    %
    
    
    136.67
    %
    
    
    126.21
    %
    
    
    99.12
    %
    
    
    211.85
    %Allowance for loan losses to
total loans at end of period
    
    
    0.36
    %
    
    
    0.43
    %
    
    
    0.43
    %
    
    
    0.51
    %
    
    
    0.53
    %Non-performing assets to total
assets at end of period
    
    
    0.26
    %
    
    
    0.24
    %
    
    
    0.27
    %
    
    
    0.37
    %
    
    
    0.19
    %Ratio of net charge-offs during
the period to average loans
outstanding during the period
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.03
    %
    
    
    0.02
    %
    
    
    0.01
    %Capital Ratios:Stockholders equity to total assets
at end of period
    
    
    4.77
    %
    
    
    8.31
    %
    
    
    6.93
    %
    
    
    6.05
    %
    
    
    7.24
    %Average stockholders equity to
average total assets
    
    
    4.62
    %
    
    
    7.02
    %
    
    
    7.53
    %
    
    
    6.31
    %
    
    
    5.97
    %Tangible capital to tangible assets
at end of period(2)
    
    
    6.32
    %
    
    
    7.97
    %
    
    
    7.68
    %
    
    
    7.10
    %
    
    
    8.14
    %Core capital to adjusted tangible
assets at end of period(2)
    
    
    6.32
    %
    
    
    7.97
    %
    
    
    7.68
    %
    
    
    7.10
    %
    
    
    8.14
    %Risk-based capital to risk-weighted
assets at end of period(2)
    
    
    11.03
    %
    
    
    12.45
    %
    
    
    11.01
    %
    
    
    10.79
    %
    
    
    11.80
    %Other Data:Number of branch offices
at end of period
    
    
    35
    
    
    
    38
    
    
    
    40
    
    
    
    41
    
    
    
    43Number of deposit accounts
at end of period
    
    
    127,467
    
    
    
    133,650
    
    
    
    142,683
    
    
    
    148,023
    
    
    
    151,739
   (1)
    
    The efficiency ratio represents non-interest expense divided by the sum of net
interest income before provision for loan losses and non-interest income.(2)
    
    Represents regulatory capital ratios for Fidelity Federal Bank & Trust only. 
 ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis reflects Fidelity Bankshares, Inc.s consolidated financial
statements and other relevant statistical data and is intended to enhance your understanding of our
financial condition and results of operations. You should read the information in this section in
conjunction with Fidelity Bankshares, Inc.s consolidated financial statements and their notes
beginning on page F-1, and the other statistical data provided in this report. This report
contains certain forward-looking statements which may be identified by the use of such words as
believe, expect, intend, anticipate, should, planned,  estimated and potential.
Examples 36




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of forward-looking statements include, but are not limited to, estimates with respect to our
financial condition, results of operations and business that are subject to various factors which
could cause actual results to differ materially from these estimates and most other statements that
are not historical in nature. These factors include, but are not limited to, general and local
economic conditions; changes in interest rates, deposit flows, demand for mortgage and other loans,
real estate values, and competition; changes in accounting principles policies, or guidelines;
changes in legislation or regulations; and other economic, competitive, governmental, regulatory,
and technological factors affecting our operations, pricing, products and services. We conduct no business other than holding the common stock of Fidelity Federal Bank & Trust.
Consequently, our net income depends on the net income of Fidelity Federal Bank & Trust. The net
income of Fidelity Federal Bank & Trust is derived primarily from its net interest income, which is
the difference between the interest income we receive on loans, mortgage-backed securities and
investments and our cost of funds, consisting of interest paid on deposits and borrowings.
Fidelity Federal Bank & Trusts net income also is affected by its provision for loan losses, as
well as by the amount of other income, including income from fees and service charges, net gains
and losses on sales of investments, and operating expenses such as employee compensation and
benefits, deposit insurance premiums, occupancy and equipment costs, and income taxes. In
addition, earnings are affected significantly by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions of regulatory
authorities, which events are beyond our control. In particular, the general level of market
interest rates tends to be highly cyclical. Pending Acquisition of First Community Bancorp, Inc. On September 22, 2004 we announced that we signed a definitive agreement to acquire First
Community Bancorp, Inc. (First Community) for approximately $14.0 million in cash and
approximately 525,000 shares of our common stock. Regulatory and stockholder approval for this
acquisition is expected in March 2005 and the transaction is expected to close in the second
quarter of 2005. At December 31, 2004, First Community had $155.0 million in assets, $134.8
million in deposits and $11.6 million in stockholders equity. Approximately 15.5% of First
Community Banks deposits consist of certificates of deposit, while 84.5% are core deposits,
consisting of checking, savings and money market accounts. Critical Accounting Policies The Accounting and reporting policies of Fidelity Bankshares, Inc. and its subsidiaries
conform with accounting principles generally accepted in the United States of America and general
practices within the financial services industry. 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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those estimates. A summary of
our significant accounting policies is contained in Note 1 to the consolidated financial
statements. Our critical accounting policies are shown below. Allowance for Loan Losses.The allowance for loan losses represents managements best
estimate of inherent losses in the existing loan portfolio. The allowance for loan losses is
increased by the provision for loan losses charged to expense and reduced by loans charged off, net
of recoveries. The provision for loan losses is determined based on managements assessment of
several factors: reviews and evaluations of specific loans, changes in the nature and volume of the
loan portfolio, current and anticipated economic conditions and the related impact on specific
borrowers and industry groups, historical loan loss experience, the level of classified and
nonperforming loans and the results of regulatory examinations. A periodic review of selected credits (based on loan size and type) is conducted to identify
loans with heightened risk or inherent losses and to assign risk grades. The primary
responsibility for this review rests with the management personnel who are responsible for
overseeing the credit relationship. This review is supplemented with periodic reviews by our
credit review function, as well as periodic examination of both selected credits and the credit
review process by the applicable regulatory agencies. The information from these 37




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reviews assists management in the timely identification of problems and potential problems,
and provides a basis for deciding whether the credit represents a probable loss or risk that should
be recognized. Changes in the financial condition of individual borrowers, in economic conditions, in
historical loss experience and in the conditions of the various markets in which collateral may be
sold may all affect the required level of the allowance for loan losses and the associated
provision for loan losses. Long-Lived Assets.Long-lived assets, such as office, properties and equipment, to be held
and used by the Company are reviewed to determine whether any events or changes in circumstances
indicate that the carrying amount of the asset may not be recoverable. For long-lived assets to be
held and used, we base our evaluation on impairment indicators such as the nature of the assets,
the future economic benefit of the assets, any historical or future profitability measurements, as
well as other external market conditions or factors that may be present. If impairment indicators
are present or other factors exist that indicate the carrying amount of the asset may not be
recoverable, the fair value of the asset is measured using quoted market prices or, in the absence
of quoted fair market prices, fair value is based on the estimate of discounted cash flow analysis
or other available methods. If an impairment has occurred, we recognize a loss for the difference
between the carrying amount and the estimated fair value of the asset. Servicing Assets.Servicing assets are recognized as separate assets when rights are acquired
through sale of financial assets. For sales of mortgage loans, a portion of the cost of
originating the loan is allocated to the servicing right based on relative fair value. Fair valued
is based on market prices for comparable mortgage servicing contracts. Capitalized servicing
rights are reported in other assets and are amortized into non-interest income in proportion to,
and over the period of, the estimated future net servicing income of the underlying financial
assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as
compared to amortized cost. Impairment is determined by stratifying rights into tranches based on
predominant risk characteristics, such as interest rate, loan type and investor type. Impairment
is recognized through a valuation allowance, to the extent that fair value is less than the
capitalized amount of servicing rights. If we later determine that all or a portion of the
impairment no longer exists, a reduction of the allowance may be recorded as an increase to income. Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a
contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as
income when earned. The amortization of mortgage servicing rights is netted against loan servicing
fee income. Determining Fair Value of Financial Instruments.We require to disclose the fair value of
certain of its financial instruments. The following is a summary of how the fair value of these
assets and liabilities is determined. Securities Available for Sale and Held to Maturity The fair value of these securities are
based on quoted market prices. Loans Receivable The fair value of fixed and variable rate loans is estimated by discounting
the future cash flows of the loans using the current rates at which similar loans would be made to
borrowers with similar credit rating for the same remaining maturities. Federal Home Loan Bank Stock The carrying value of Federal Home Loan Bank stock approximates
fair value based on the redemption provisions of the Federal Home Loan Bank. Advances from the Federal Home Loan Bank The fair value of these advances is estimated by
discounting the future cash flows of these advances using the current rates at which similar term
advances could be obtained. 38




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##### Table of Contents



Junior Subordinated Debentures The fair value of these debentures is estimated by
discounting the future cash flows of the debentures using current rates at which similar debentures
could be obtained. Although management uses its best judgment in estimating the fair value of these financial
instruments, there are inherent limitations in any estimation technique. Therefore, the fair value
estimates presented herein are not necessarily indicative of the amounts which the Bank could
realize in a current transaction. Changes in Financial Position Comparison of Financial Position at December 31, 2003 and December 31, 2004 Our assets increased by $422.3 million from $3.0 billion at December 31, 2003 to $3.5 billion
at December 31, 2004. Our net loans receivable increased by $365.0 million. We also securitized
$89.2 million of loans from our loan portfolio and now hold these mortgage-backed securities as
assets held to maturity. This securitization was undertaken to improve our regulatory risk-based
capital levels. Our cash and cash equivalents increased by $39.5 million. Another asset increase
requiring funding included office properties and equipment, which increased by $9.9 million. Our
required investment in FHLB stock also increased by $4.1 million, while all other assets increased
by $3.0 million. Additionally, a reduction in FHLB advances required $13.7 million of funding. Funds were principally provided by cash received from the decrease in assets available for
sale of $88.3 million and an increase in deposits of $354.6 million. Increases in borrowings
provided $14.8 million in funds, while increases in equity provided additional funding of $66.0
million. Of the increases in stockholders equity, $43.8 million was provided by a secondary issue
of 1.15 million shares of our common stock in December 2004. Net income, net of dividends paid
provided an additional $16.6 million increase in equity. Stockholders equity totaled $251.3 million at December 31, 2004, compared to $184.5 at
December 31, 2003. Results of Operations Results of operations for the years ended December 31, 2003 and 2004 General.We split our common stock on a three for two share basis by distributing a stock
dividend to our shareholders of record on December 31, 2004. All per share data retroactively
reflects this stock split. Our net income for the year ended December 31, 2004 was $22.9 million,
or $1.04 basic and $1.01 diluted earnings per share, compared to net income for the year ended
December 31, 2003 of $17.9 million or $.82 basic and $.81 diluted earnings per share. Several
factors contributed to this $5.0 million, or 27.9%, increase in net income. Interest income
increased by $21.0 million from $143.7 million for the year ended December 31, 2003 to $164.7
million for the year ended December 31, 2004. Interest expense, however, increased by only $2.7
million from $57.2 million for 2003 to $59.9 million for the year ended December 31, 2004. As a
result, net interest income increased by $18.3 million, or 21.2%, from $86.5 million for the year
ended December 31, 2003 to $104.8 million in 2004. Our provision for loan losses was $3.1 million
and $2.7 million for the years ended December 31, 2003 and 2004, respectively, a decrease of
$385,000 from year to year. Other income increased $2.7 million from $22.5 million for the year
ended December 31, 2003 to $25.2 million for the year ended December 31, 2004. Operating expense
increased by $13.1 million, or 17.1%, from $76.5 million in 2003 to $89.6 million for the year
ended December 31, 2004. Interest income.Our interest income increased by $21.0 million, or 14.6%, from $143.7
million in 2003 to $164.7 million for the year ended December 31, 2004. Although the average yield
on our interest earning assets declined from 5.50% for the year ended December 31, 2003 to 5.28%
for the year ended December 31, 2004, our average interest earning assets increased by $505.0
million or 19.3%, from $2.6 billion to $3.1 billion. The decline in average yield resulted
primarily from the repayment of assets acquired in a higher interest rate environment being
replaced in a lower interest rate environment. 39




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##### Table of Contents



Interest income on mortgage loans increased by $12.4 million, or 11.3%, from $110.8 million
for the year ended December 31, 2003 to $123.2 million for the year ended December 31, 2004. While
the average balance of these loans increased by $340.7 million, or 19.4%, the average yield on the
loans declined from 6.30% during 2003 to 5.87% during 2004. Interest income on consumer and
commercial business loans increased by 7.0%, or $1.2 million, from $17.5 million for the year ended
December 31, 2003 to $18.7 million during 2004. Although the average balance of these loans
increased by $45.7 million, or 16.4%, this was partially offset by a decrease in average yield on
these loans from 6.25% for the year ended December 31, 2003 to 5.74% for the year ended December
31, 2004. The average balance of our mortgage-backed securities increased by $66.1 million, or
16.5%. Together with an increase in yield from 3.15% in 2003 to 3.89% during 2004, this resulted
in an increase in interest income of $5.5 million, or 43.9%, from $12.6 million in 2003 to $18.1
million for the year ended December 31, 2004. Interest income from investment securities
increased by $2.0 million, or 160.4%, from $1.2 million in 2003 to $3.2 million in 2004, as a
result of a 153.3% increase in the average balances of these assets. The yield on investment
securities for the years ended December 31, 2003 and 2004 was 2.10% and 2.16%, respectively. Our
interest income on other investments declined by $216,000, or 13.2%, from $1.6 million for the year
ended December 31, 2003 to $1.4 million for the year ended December 31, 2004. While the average
yield on these investments increased from 1.41% during 2003 to 1.81% for the year ended December
31, 2004, the average balance of these investments declined by 32.7%, offsetting the benefits from
the increase in yield. Interest expense.Interest expense increased by $2.7 million, or 4.7%, from $57.2 million
for the year ended December 31, 2003 to $59.9 million for the year ended December 31, 2004.
Interest expense on deposits increased by $1.1 million, or 2.8%, from $38.6 million for the year
ended December 31, 2003 to $39.7 million for the year ended December 31, 2004. During 2004, the
average balance of our deposits increased by $430.7 million, or 19.3%. The average cost of our
deposits during 2004 was 1.49%, compared to 1.73% for the year ended December 31, 2003. The
principal reason for the decrease in that the average cost of our deposits was the increase in our
total core deposits, consisting of lower costing checking, savings and money market accounts. At
December 31, 2004, 2003 and 2002 our core deposits comprised 77.5%, 72.1% and 59.6%, respectively,
of our total deposits. Management believes that these core deposits will be less interest rate
sensitive in a rising interest rate environment. The average balance of our borrowings for the
year ended December 31, 2004 increased by $64.7 million, or 19.3%. The average cost of our
borrowings during 2003 was 5.53% and declined to 5.04% for the year ended December 31, 2004.
Accordingly, interest expense on borrowings increased by only $1.6 million, or 8.8%, from $18.6
million for the year ended December 31, 2003 to $20.2 million for the year ended December 31, 2004. Net interest income.Our net interest income increased by $18.3 million, or 21.1%, from $86.5
million for the year ended December 31, 2003 to $104.8 million for the year ended December 31,
2004. Our net interest spread remained relatively constant at 3.28% and 3.33% for the years ended
December 31, 2003 and 2004, respectively. However, our average balance of interest earning assets
increased by $505 million, or 19.3%, resulting in the increase in net interest income. Provision for loan losses. Our provision for loan losses decreased by $386,000 from $3.1
million to $2.7 million for the years ended December 31, 2003 and 2004, respectively. Our financial statements are prepared in accordance with accounting principles generally
accepted in the United States of America. Accordingly, allowances for loan losses are based on
managements estimate of losses inherent in the loan portfolio. We provide both general valuation
allowances (for unspecified, probable losses) and specific valuation allowances (for known losses)
in our portfolio. General valuation allowances are added to our capital for purposes of
calculating our regulatory risk-based capital. We conduct a monthly review of our loan portfolio,
including impaired loans, to determine whether any loans require classification or the
establishment of appropriate valuation allowances. As we continue to increase our originations of
commercial business loans, consumer loans and commercial real estate loans, our provision for loan
losses is likely to increase in future periods, since such loans traditionally have a higher risk
of loss than residential mortgage loans. 40




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##### Table of Contents



Other income. Other income increased by 11.8%, or $2.7 million, from $22.5 million for the
year ended December 31, 2003 to $25.2 million for the year ended December 31, 2004. Income from
service charges on deposit accounts increased by $1.0 million, or 9.6%, from $10.0 million in 2003
to $11.0 million for the year ended December 31, 2004. Fees for other banking services, which
includes premiums on insurance sales, trust fee income, annuity sales and appraisal service income
increased by $1.4 million, or 14.0%, from $9.8 million to $11.2 million for the years ended
December 31, 2003 and 2004, respectively. Net gain on the sale of loans was $4.2 million and
$619,000 for the years ended December 31, 2003 and 2004, respectively, a decline of $3.5 million,
or 85.1%. The year ended December 31, 2003 included a one-time gain of $1.5 million on the sale of
$50.0 million of loans. We have been selling substantially all of the 30 year, fixed rate loans
that we originate. During 2004, our customers have opted for a greater percentage of shorter
duration loans and adjustable rate loans. As a result, we have had fewer loans available for sale. Operating expense.Operating expense increased by $13.1 million, or 17.2%, from $76.5 million
for the year ended December 31, 2003 to $89.6 million for the year ended December 31, 2004.
Employee compensation and benefits expense increased by $5.7 million, or 12.7%, from $44.8 million
during 2003 to $50.5 million for the year ended December 31, 2004. Direct compensation accounted
for $4.4 million of the $5.7 million increase, while benefits cost increases were $1.3 million.
The companys workforce grew by 6.4%, to 769 full time equivalent employees at December 31, 2004
from 723 full time equivalent employees at December 31, 2003. Increases in benefit costs include a
$614,000 increase in medical care costs and a $449,000 increase in ESOP costs which reflects
increases in the market value of our common stock. Occupancy and equipment costs increased by $2.1
million, or 14.8%, from $14.5 million for the year ended December 31, 2003 to $16.6 million for the
year ended December 31, 2004. Of this increase, $853,000 is attributable to increased data
processing costs, while the remainder is largely related to our continued growth. Marketing and
federal deposit insurance costs increased by $164,000 and $53,000, respectively, from 2003 to 2004.
Miscellaneous expense increased by 34.9%, or $5.1 million, from $14.8 million for the year ended
December 31, 2003 to $19.9 million for the year ended December 31, 2004. Of this increase, $1.1
million resulted from the write off of deferred issuance costs on the redemption of trust preferred
securities, $1.4 million relates to the write off of fraudulent checks received, $550,000 resulted
from the write off of misapplied account balances in connection with our check imaging conversion,
$1.1 million reflected increased temporary help costs, $902,000 was for consulting and accounting
cost primarily related to Sarbanes-Oxley compliance, and $250,000 was for the settlement of a
lawsuit. Income taxes.Our provision for income taxes was $14.7 million for the year ended December
31, 2004, compared to $11.5 million for the year ended December 31, 2003. This represents a 28.0%
increase in income taxes, which corresponds to the increase in our income before taxes. Our
effective tax rate was 39.0% in both 2003 and 2004. Results of Operations Results of operations for the years ended December 31, 2002 and 2003 General.Our net income for the year ended December 31, 2003 was $17.9 million. or
$0. 82 basic and $0.81 diluted earnings per share. By comparison, our net income for the
year ended December 31, 2002 was $16.8 million, or $0.75 basic and $0.74 diluted earnings per
share. A number of factors contributed to the $1.1 million increase in net income for the year
ended December 31, 2003. Interest income increased from $137.9 million for the year ended December
31, 2002 to $143.7 million for the year ended December 31, 2003 and was accompanied by a $4.6
million decrease in interest expense from $61.8 million in 2002 to $57.2 million in 2003. This
resulted in an increase of net interest income before loan losses of $10.4 million, or 13.7%, from
$76.1 million in 2002 to $86.5 million in 2003. The provision for loan losses increased for the
year ended December 31, 2003 by $1.1 million from $2.0 million in 2002 to $3.1 million in 2003.
Our portfolio of commercial mortgage loans, consumer loans and commercial business loans increased
as a percentage of our total loan portfolio. Other income increased by $5.5 million, or 32.5%,
from $17.0 million for the year ended December 31, 2002 to $22.5 million for the year ended
December 31, 2003. Our operating expenses for the year 41




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ended December 31, 2003 increased by $12.9 million, or 20.4%, from $63.6 million for the year
ended December 31, 2002 to $76.5 million. Interest income.Interest income increased by $5.8 million, or 4.2%, from $137.9 million for
the year ended December 31, 2002 to $143.7 million for the year ended December 31, 2003. While
average interest earning assets increased by $444.0 million, or 20.5%, the yield on our assets
declined to 5.50% during 2003, compared to 6.36% during 2002. The decline in yield resulted from
originating loans during the years low interest rate environment, borrower prepayment of higher
interest bearing loans and our increased investment in mortgage backed securities bearing lower
interest rates. Interest income from mortgage loans increased by 5.4%, or $5.7 million, from $105.1 million
for the year ended December 31, 2002 to $110.8 million for the year ended December 31, 2003.
Although the average balance of mortgage loans increased by $266.2 million, or 17.8%, it was
accompanied by a decline in average yield on these assets from 7.04% in 2002 to 6.30% in 2003. The
average balance of consumer and commercial business loans increased by $26.1 million, or 10.3%, but
was offset by a decline in average yield from 7.26% in 2002 to 6.25% in 2003. As a result,
interest income on consumer and commercial business loans declined by $949,000, or 5.2%, from $18.4
million for the year ended December 31, 2002 to $17.5 million for the year ended December 31, 2003.
Our average investment in mortgage-backed securities increased by 106.7%, as a result of funds
provided by our strong deposit growth, from $193.5 million for the year ended December 31, 2002 to
$399.9 million for the year ended December 31, 2003. Because the average yield on these
investments declined from 4.14% during 2002 to 3.15% during 2003, income from mortgage-backed
securities increased by only $4.6 million, or 57.2%, from $8.0 million for the year ended December
31, 2002 to $12.6 million for the year ended December 31, 2003. The average balance of our
investment securities declined by $47.4 million, or 44.6%, from $106.3 million during 2002 to $58.9
million during 2003, and the average yield on these investments declined from 3.27% during 2002 to
2.10% during 2003. Accordingly, our interest income from investment securities declined by $2.2
million, or 64.4%, from $3.5 million for the year ended December 31, 2002 to $1.2 million for the
year ended December 31, 2003. Our average balance of other investments declined by $7.4 million,
or 6.0%, from $123.4 million during the year ended December 31, 2002 to $116.0 million during the
year ended December 31, 2003, and the average yield on these investments declined from 2.35% during
2002 to 1.41% during 2003. This resulted in a decrease in interest income from other investments
of $1.3 million, or 43.6%, from $2.9 million for the year ended December 31, 2002 to $1.6 million
for the year ended December 31, 2003. Interest expense.Interest expense decreased by $4.6 million, or 7.5%, from $61.8 million for
the year ended December 31, 2002 to $57.2 million for the year ended December 31, 2003. Interest
expense on deposits decreased by $1.7 million, or 4.3%, from $40.4 million for the year ended
December 31, 2002 to $38.6 million for the year ended December 31, 2003. While average deposits
increased by $482.9 million, or 27.6%, from $1.8 billion to $2.2 billion, the composition of our
average deposit balances included a higher percentage of lower cost transaction and savings
accounts, as well as a decrease of $81.9 million in higher cost certificates of deposit.
Consequently, the average cost of our deposits decreased from 2.30% during 2002 to 1.73% during
2003. The average balance of our borrowings decreased by $36.2 million, or 9.7%, from $372.0
million for the year ended December 31, 2002 to $335.8 million for the year ended December 31,
2003, and the average cost of these borrowings decreased from 5.76% during 2002 to 5.53% during
2003. As a result, interest expense on our borrowings was $18.6 million for the year ended
December 31, 2003, or $2.9 million and 13.3% lower than our interest expense on borrowings of $21.4
million during the year ended December 31, 2002. Net interest income.Our net interest income increased by $10.4 million, or 13.7%, from $76.1
million for 2002 to $86.5 million for 2003. While our net interest rate spread decreased from
3.45% for the year ended December 31, 2002 to 3.28% for the year ended December 31, 2003, the
average balance of our interest earning assets increased by $444.0 million or 20.5%, resulting in
the increase in net interest income. Provision for loan losses. Our provision for loan losses increased by $1.1 million from $2.0
million for the year ended December 31, 2002 to $3.1 million for the year ended December 31, 2003.
During 2003, the percentage of our portfolio comprised of loans other than one- to four-family
mortgage loans, which are deemed to have a greater risk of loss than one-to four-family loans,
increased from 34.5% at December 31, 2002 to 42




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##### Table of Contents



42.6% of total loans. Our total allowance for loan losses as of December 31, 2003 was $11.1
million, and is maintained at a level that represents our best estimate of losses in our loan
portfolio at the balance sheet date which were both probable and reasonably estimable. At December
31, 2003 our ratio of non-performing loans to net loans was 0.51%. Our financial statements are prepared in accordance with accounting principles generally
accepted in the United States of America. Accordingly, allowances for loan losses are based on
managements estimate of losses inherent in the loan portfolio. We provide both general valuation
allowances (for unspecified, probable losses) and specific valuation allowances (for known losses)
in our portfolio. General valuation allowances are added to our capital for purposes of
calculating our regulatory risk-based capital. We conduct a monthly review of our loan portfolio,
including impaired loans, to determine whether any loans require classification or the
establishment of appropriate valuation allowances. As we continue to increase our origination of
commercial business loans, consumer loans and commercial real estate loans, our provision for loan
losses is likely to increase in future periods since such loans traditionally have a higher risk of
loss than residential mortgage loans. Other Income. Other income increased by 32.5%, or $5.5 million, from $17.0 million for the
year ended December 31, 2002 to $22.5 million for the year ended December 31, 2003. Income from
fees on deposit accounts increased by $2.8 million, largely as a result of our increase in
transaction deposit accounts. Fees for other banking services, which is comprised of insurance and
annuity sales, trust fee income and appraisal income, increased by $1.3 million. Gains on the sale
of loans, which included a one-time gain of $1.5 million on the sale of $50.0 million of loans,
increased by $4.1 million, as we began selling loans in the secondary market during 2003.
Offsetting these increases in other income was a $2.4 million loss on the sale of securities as a
result of restructuring our investment portfolio and a decrease in miscellaneous other income of
$230,000. Operating expense.Operating expense increased by $12.9 million, or 20.4%, from $63.6 million
for the year ended December 31, 2002 to $76.5 million for the year ended December 31, 2003. Of
this increase, $7.6 million is attributable to employee compensation and benefits. Employee health
care costs increased by $957,000, pension costs increased by $1.2 million and stock based
compensation increased by $702,000. The remainder of the increase, $4.8 million, was primarily
attributable increased commissions paid to loan personnel due to increased loan production,
increased commissions on increased insurance sales, normal salary increases and compensation paid
to new employees. During the year we hired 48 new employees, bringing the total to 723 full-time
equivalent employees at December 31, 2003. Most of these employees are loan officers and related
support personnel and customer service employees needed for our expanding branch network.
Occupancy and equipment expense increased by $2.8 million as we continue to expand the number of
our branches and improve our technology. Miscellaneous expense increased by $2.2 million.
Included in this increase are additional costs of $224,000 for legal expense, $218,000 for
communications expense, $294,000 in uncollected deposit overdrafts and fees, and $779,000 of
additional loan closing costs absorbed to increase loan production. Income taxes.Our provision for income taxes for the year ended December 31, 2003 was $11.5
million, an increase of $742,000 from $10.7 million for the year ended December 31, 2002. Our
provision reflects our current rate applied to income before taxes. 43




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##### Table of Contents



Average Balances, Net Interest Income and Yields Earned and Rates Paid The following table presents for the periods indicated the total dollar amount of interest
from average interest-earning assets and the resultant yields, as well as the interest expense on
average interest-bearing liabilities, expressed both in dollar and rates, and the net interest
margin. No tax-equivalent adjustments have been made and all average balances are daily average
balances. Non-accruing loans have been included in the yield calculations in this table and
dividends received are included as interest income. For the Years Ended December 31,2002
    
    
    2003
    
    
    2004Average
    
    
    
    
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    
    
    
    
    AverageAverage
    
    
    
    
    
    
    Yield/
    
    
    Average
    
    
    
    
    
    
    Yield/
    
    
    Average
    
    
    
    
    
    
    Yield/Balance
    
    
    Interest
    
    
    Cost
    
    
    Balance
    
    
    Interest
    
    
    Cost
    
    
    Balance
    
    
    Interest
    
    
    Cost(Dollars in Thousands)Interest-earning assets:Mortgage loans
    
    $
    1,492,219
    
    
    $
    105,084
    
    
    
    7.04
    %
    
    $
    1,758,459
    
    
    $
    110,771
    
    
    
    6.30
    %
    
    $
    2,099,127
    
    
    $
    123,235
    
    
    
    5.87
    %Consumer and commercial
business loans
    
    
    253,420
    
    
    
    18,408
    
    
    
    7.26
    
    
    
    279,534
    
    
    
    17,459
    
    
    
    6.25
    
    
    
    325,227
    
    
    
    18,681
    
    
    
    5.74Mortgage-backed securities (1)
    
    
    193,510
    
    
    
    8,006
    
    
    
    4.14
    
    
    
    399,898
    
    
    
    12,585
    
    
    
    3.15
    
    
    
    466,035
    
    
    
    18,113
    
    
    
    3.89Investment securities
    
    
    106,318
    
    
    
    3,474
    
    
    
    3.27
    
    
    
    58,919
    
    
    
    1,236
    
    
    
    2.10
    
    
    
    149,286
    
    
    
    3,219
    
    
    
    2.16Other investments (2)
    
    
    123,342
    
    
    
    2,895
    
    
    
    2.35
    
    
    
    115,977
    
    
    
    1,632
    
    
    
    1.41
    
    
    
    78,042
    
    
    
    1,416
    
    
    
    1.81Total interest-earning assets
    
    
    2,168,809
    
    
    
    137,867
    
    
    
    6.36
    
    
    
    2,612,787
    
    
    
    143,683
    
    
    
    5.50
    
    
    
    3,117,717
    
    
    
    164,664
    
    
    
    5.28Non-interest-earning assets
    
    
    180,715
    
    
    
    
    
    
    
    
    
    
    
    185,591
    
    
    
    
    
    
    
    
    
    
    
    219,080Total assets
    
    $
    2,349,524
    
    
    
    
    
    
    
    
    
    
    $
    2,798,378
    
    
    
    
    
    
    
    
    
    
    $
    3,336,797Interest-bearing liabilities:Deposits
    
    $
    1,752,316
    
    
    $
    40,353
    
    
    
    2.30
    %
    
    $
    2,235,207
    
    
    $
    38,605
    
    
    
    1.73
    %
    
    $
    2,665,929
    
    
    $
    39,676
    
    
    
    1.49
    %Borrowed funds
    
    
    372,000
    
    
    
    21,415
    
    
    
    5.76
    
    
    
    335,832
    
    
    
    18,559
    
    
    
    5.53
    
    
    
    400,498
    
    
    
    20,188
    
    
    
    5.04Total interest-bearing liabilities
    
    
    2,124,316
    
    
    
    61,768
    
    
    
    2.91
    
    
    
    2,571,039
    
    
    
    57,164
    
    
    
    2.22
    
    
    
    3,066,427
    
    
    
    59,864
    
    
    
    1.95Non-interest bearing liabilities
    
    
    48,199
    
    
    
    
    
    
    
    
    
    
    
    50,862
    
    
    
    
    
    
    
    
    
    
    
    71,097Total liabilities
    
    
    2,172,515
    
    
    
    
    
    
    
    
    
    
    
    2,621,901
    
    
    
    
    
    
    
    
    
    
    
    3,137,524Stockholders equity
    
    
    177,009
    
    
    
    
    
    
    
    
    
    
    
    176,477
    
    
    
    
    
    
    
    
    
    
    
    199,273Total liabilities and
stockholders equity
    
    $
    2,349,524
    
    
    
    
    
    
    
    
    
    
    $
    2,798,378
    
    
    
    
    
    
    
    
    
    
    $
    3,336,797Net interest income
    
    
    
    
    
    $
    76,099
    
    
    
    
    
    
    
    
    
    
    $
    86,519
    
    
    
    
    
    
    
    
    
    
    $
    104,800Net interest rate spread (3)
    
    
    
    
    
    
    
    
    
    
    3.45
    %
    
    
    
    
    
    
    
    
    
    
    3.28
    %
    
    
    
    
    
    
    
    
    
    
    3.33
    %Net interest margin (4)
    
    
    
    
    
    
    
    
    
    
    3.51
    %
    
    
    
    
    
    
    
    
    
    
    3.31
    %
    
    
    
    
    
    
    
    
    
    
    3.36
    %Ratio of average interest-earning
assets to average interest-bearing
liabilities
    
    
    
    
    
    
    
    
    
    
    102.09
    %
    
    
    
    
    
    
    
    
    
    
    101.62
    %
    
    
    
    
    
    
    
    
    
    
    101.67
    %
 At December 31, 2004Actual
    
    
    Yield/Balance
    
    
    Cost(Dollars in Thousands)Interest-earning assets:Mortgage loans
    
    $
    2,212,207
    
    
    
    5.71
    %Consumer and commercial business loans
    
    
    344,493
    
    
    
    6.01
    %Mortgage-backed securities (1)
    
    
    529,640
    
    
    
    4.43
    %Investment securities
    
    
    65,156
    
    
    
    2.59
    %Other investments (2)
    
    
    58,481
    
    
    
    2.52
    %Total interest-earning assets
    
    
    3,209,977
    
    
    
    5.41
    %Non-interest-earning assets
    
    
    260,562Total assets
    
    $
    3,470,539Interest-bearing liabilities:Deposits
    
    $
    2,814,670
    
    
    
    1.53
    %Borrowed funds
    
    
    296,952
    
    
    
    5.19
    %Total interest-bearing liabilities
    
    
    3,111,622
    
    
    
    1.88
    %Non-interest bearing liabilities
    
    
    107,634Total liabilities
    
    
    3,219,256Stockholders equity
    
    
    251,283Total liabilities and stockholders equity
    
    $
    3,470,539Net interest rate spread (3)
    
    
    
    
    
    
    3.53
    %Net interest margin (4)
    
    
    
    
    
    
    3.59
    %Ratio of interest-earning assets
to interest-bearing liabilities
    
    
    
    
    
    
    103.16
    %
   (1)
    
    Includes corporate debt securities for the year 2002.(2)
    
    Includes interest-bearing deposits in other financial institutions and Federal Home
Loan Bank stock.(3)
    
    Net interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities.(4)
    
    Net interest margin represents net interest income as a percentage of
interest-earning assets. 44




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##### Table of Contents



Rate/Volume Analysis The table below sets forth certain information regarding changes in our interest income and
interest expense for the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to (i) changes in
average volume (changes in average volume multiplied by old rate); (ii) changes in rate (change in
rate multiplied by old average volume); (iii) the allocation of changes in rate and volume; and
(iv) the net change. Years Ended December 31,2004 vs. 2003
    
    
    
    
    
    
    2003 vs. 2002Increase/(Decrease)
    
    
    
    
    
    
    Increase/(Decrease)Due to
    
    
    Total
    
    
    Due to
    
    
    TotalRate/
    
    
    Increase
    
    
    
    
    
    
    
    
    
    
    Rate/
    
    
    IncreaseVolume
    
    
    Rate
    
    
    Volume
    
    
    (Decrease)
    
    
    Volume
    
    
    Rate
    
    
    Volume
    
    
    (Decrease)(In Thousands)Interest income:Mortgage loans
    
    $
    21,460
    
    
    $
    (7,536
    )
    
    $
    (1,460
    )
    
    $
    12,464
    
    
    $
    18,749
    
    
    $
    (11,084
    )
    
    $
    (1,978
    )
    
    $
    5,687Consumer and commercial
business loans
    
    
    2,854
    
    
    
    (1,403
    )
    
    
    (229
    )
    
    
    1,222
    
    
    
    1,737
    
    
    
    (2,455
    )
    
    
    (231
    )
    
    
    (949
    )Mortgage-backed securities
    
    
    2,081
    
    
    
    2,958
    
    
    
    489
    
    
    
    5,528
    
    
    
    8,539
    
    
    
    (1,916
    )
    
    
    (2,044
    )
    
    
    4,579Investment securities
    
    
    1,896
    
    
    
    34
    
    
    
    53
    
    
    
    1,983
    
    
    
    (1,549
    )
    
    
    (1,244
    )
    
    
    555
    
    
    
    (2,238
    )Other investments
    
    
    (534
    )
    
    
    472
    
    
    
    (154
    )
    
    
    (216
    )
    
    
    (491
    )
    
    
    (929
    )
    
    
    157
    
    
    
    (1,263
    )Total interest-earning assets
    
    
    27,757
    
    
    
    (5,475
    )
    
    
    (1,301
    )
    
    
    20,981
    
    
    
    26,985
    
    
    
    (17,628
    )
    
    
    (3,541
    )
    
    
    5,816Interest expense:Deposits
    
    
    7,439
    
    
    
    (5,339
    )
    
    
    (1,029
    )
    
    
    1,071
    
    
    
    11,120
    
    
    
    (10,088
    )
    
    
    (2,780
    )
    
    
    (1,748
    )Borrowed funds
    
    
    3,574
    
    
    
    (1,631
    )
    
    
    (314
    )
    
    
    1,629
    
    
    
    (2,082
    )
    
    
    (857
    )
    
    
    83
    
    
    
    (2,856
    )Total interest-bearing liabilities
    
    
    11,013
    
    
    
    (6,970
    )
    
    
    (1,343
    )
    
    
    2,700
    
    
    
    9,038
    
    
    
    (10,945
    )
    
    
    (2,697
    )
    
    
    (4,604
    )Change in net interest income
    
    $
    16,744
    
    
    $
    1,495
    
    
    $
    42
    
    
    $
    18,281
    
    
    $
    17,947
    
    
    $
    (6,683
    )
    
    $
    (844
    )
    
    $
    10,420
 Asset and Liability
Management - Interest Rate Sensitivity Analysis The majority of our assets and liabilities are monetary in nature, which subjects us to
significant interest rate risk. As stated above, the majority of our interest-bearing liabilities
and nearly all of our interest-earning assets are held by Fidelity Federal Bank & Trust and,
therefore, nearly all of our interest rate risk is at the Fidelity Federal Bank & Trust level. We monitor interest rate risk by various methods, including gap analysis and analyzing
changes in the net present value of our assets, liabilities and off-balance sheet items (our net
portfolio value or NPV) which analysis, is reviewed with the Board of Directors on a quarterly
basis. We use an internal model that generates estimates of our NPV over a range of interest rate
scenarios. The model calculates NPV essentially by discounting the cash flows from our assets and
liabilities to present value using current market rates, and adjusting those discount rates
accordingly for various interest rate scenarios. The following table sets forth our estimated internal calculations of NPV as of December 31,
2004, for instantaneous and parallel shifts in the yield curve in 100 basis point increments up and
down. Due to the low interest rate environment that existed at December 31, 2004, an analysis of a
200 basis point downward shift in interest rates is not shown. Changes in Rates
    
    
    Net Portfolio Value(Basis Points)
    
    Amount
    
    
    $ Change
    
    
    % Change(Dollars in Thousands)+200bp
    
    $
    434,957
    
    
    $
    (23,671
    )
    
    
    (5.2
    )%+100bp
    
    $
    447,381
    
    
    $
    (11,247
    )
    
    
    (2.5
    )%-0-
    
    $
    458,628
    
    
    $
    
    
    
    
    
    %-100bp
    
    $
    473,737
    
    
    $
    15,109
    
    
    
    3.3
    %
 In preparing the NPV table above, we have estimated prepayment rates for our loans
ranging from 9% to 40%, depending on the interest rate scenario and loan type. These rates are
managements best estimate based on prior repayment experience. 45




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##### Table of Contents



Decay rates for liabilities indicate an assumed annual rate at which an interest-bearing
liability will be withdrawn in favor of an account with a more favorable interest rate. Decay
rates have been assumed for interest bearing checking accounts, passbook and money market deposits.
We have used national decay rates calculated by a leading bank consulting firm and therefore may
be different than the actual decay rates that we may experience. The following decay rates were
used for this analysis and the gap analysis which follows. OverYear
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    Year
    
    
    TenOne
    
    
    Two
    
    
    Three
    
    
    Four
    
    
    Five
    
    
    Six
    
    
    Seven
    
    
    Eight
    
    
    Nine
    
    
    Ten
    
    
    YearsInterest bearing checking accounts
    
    
    7.69
    
    
    
    4.44
    
    
    
    3.83
    
    
    
    3.44
    
    
    
    3.15
    
    
    
    2.94
    
    
    
    2.74
    
    
    
    2.57
    
    
    
    2.42
    
    
    
    2.29
    
    
    
    100.00Passbook, club accounts
    
    
    11.44
    
    
    
    10.08
    
    
    
    10.32
    
    
    
    9.07
    
    
    
    8.68
    
    
    
    7.83
    
    
    
    7.11
    
    
    
    6.43
    
    
    
    6.02
    
    
    
    5.64
    
    
    
    100.00Money market deposit accounts
    
    
    14.90
    
    
    
    10.40
    
    
    
    9.12
    
    
    
    7.97
    
    
    
    6.93
    
    
    
    6.00
    
    
    
    5.16
    
    
    
    100.00
    
    
    
    
    
    
    
    
    
    
    
    
 The above assumptions are estimates of annual percentages based on remaining balances.
Although management believes these deposit decay rates are a reasonable estimate of future deposit
trends based on past performance, they should not be regarded as indicative of the actual
prepayments and withdrawals that may be experienced by us in any given period. Certain
shortcomings are inherent in the methodology used in the above interest rate risk measurements.
Modeling changes in NPV requires the making of certain assumptions that may or may not reflect how
actual yields and costs respond to changes in market rates. For example, although certain assets
and liabilities may have similar maturities or periods to repricing, they may react differently to
changes in market interest rates. Also, the changes in the contractual interest rates of our assets
and liabilities may not occur at the same time as changes in market interest rates. Additionally,
certain assets, such as adjustable rate (ARM) loans, have features that restrict changes in
interest rates on a short-term basis and over the life of the assets. Moreover, in the event of a
change in interest rates, prepayment and early withdrawal levels may deviate significantly from
those assumed in calculating the above table. Management also has made estimates of fair value
discount rates that it believes to be reasonable. However, because there is no quoted market for
many of the assets and liabilities, there can be no assurance that the fair values presented would
be indicative of the value negotiated in an actual sale. While the above table provides an estimate of our interest rate risk exposure at a particular
point in time, it is not intended to provide a precise forecast of the effect of market changes on
our NPV, as actual results may vary. At December 31, 2004, we were not required by the Office of
Thrift Supervision to hold additional risk-based capital for interest rate risk-purposes. We also monitor the matching of its assets and liabilities through gap analysis. Gap
analysis attempts to measure the difference between the amount of interest earning assets expected
to mature or reprice within a specific time period compared to the amount of interest-bearing
liabilities expected to mature or reprice within that period. An interest rate sensitive gap is
considered positive when the amount of interest-earning assets exceeds the amount of
interest-bearing liabilities maturing or repricing within a specified period of time. An interest
rate sensitive gap is considered negative when the amount of interest-bearing liabilities exceeds
the amount of interest-earnings assets maturing or repricing within a specified period of time.
Gap analysis involves the use of numerous assumptions, as does NPV. Generally, companies with a
positive gap can expect net interest income to increase during periods of rising interest rates and
decline in periods of falling interest rates. 46




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##### Table of Contents



The table below provides information about our financial instruments that are sensitive
to changes in interest rates. As shown in the following table, our cumulative one-year interest
rate sensitivity gap at December 31, 2004 was a positive 24.10%. Period to RepricingMore Than
    
    
    More ThanOne Year to
    
    
    Three Years toWithin Three
    
    
    Four to Twelve
    
    
    Three
    
    
    Five
    
    
    Over FiveMonths
    
    
    Months
    
    
    Years
    
    
    Years
    
    
    Years(Dollars in Thousands)Interest-earning assets (1):Residential mortgage loans: (2)Fixed rate
    
    $
    32,594
    
    
    $
    89,325
    
    
    $
    185,849
    
    
    $
    127,165
    
    
    $
    241,171Adjustable rate
    
    
    116,370
    
    
    
    215,511
    
    
    
    152,342
    
    
    
    228,238
    
    
    
    Commercial mortgage loans: (2)Fixed rate
    
    
    6,370
    
    
    
    15,648
    
    
    
    29,964
    
    
    
    19,479
    
    
    
    31,178Adjustable rate
    
    
    190,620
    
    
    
    527,810
    
    
    
    4,676
    
    
    
    5,405
    
    
    
    Other loans (2)Fixed rate
    
    
    16,140
    
    
    
    23,664
    
    
    
    29,237
    
    
    
    11,882
    
    
    
    3,245Adjustable rate
    
    
    253,307
    
    
    
    15,513
    
    
    
    
    
    
    
    
    
    
    
    Mortgage-backed securitiesFixed rate
    
    
    23,449
    
    
    
    63,847
    
    
    
    130,389
    
    
    
    86,893
    
    
    
    128,934Adjustable rate
    
    
    92,705
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Municipal bonds and government and
agency securities  fixed rate
    
    
    
    
    
    
    10,300
    
    
    
    25,507
    
    
    
    30,238
    
    
    
    Other interest earning assets  adjustable
    
    
    58,481
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    790,036
    
    
    $
    961,618
    
    
    $
    557,964
    
    
    $
    509,300
    
    
    $
    404,528Interest-bearing liabilitiesDeposits: (3)Checking and funds transfer accounts
    
    $
    22,419
    
    
    $
    67,256
    
    
    $
    88,338
    
    
    $
    66,334
    
    
    $
    815,344Passbook accounts
    
    
    22,025
    
    
    
    66,076
    
    
    
    132,037
    
    
    
    93,292
    
    
    
    456,688Money market accounts
    
    
    13,075
    
    
    
    39,225
    
    
    
    55,300
    
    
    
    34,789
    
    
    
    207,679Certificate accounts (4)
    
    
    147,776
    
    
    
    274,947
    
    
    
    186,788
    
    
    
    23,138
    
    
    
    Borrowings: (4)
    
    
    127,864
    
    
    
    134,665
    
    
    
    27,209
    
    
    
    60,563
    
    
    
    260Total
    
    $
    333,159
    
    
    $
    582,169
    
    
    $
    489,672
    
    
    $
    278,116
    
    
    $
    1,479,971Excess (deficiency) of interest-earning assets
over interest-bearing liabilities
    
    $
    456,877
    
    
    $
    379,449
    
    
    $
    68,292
    
    
    $
    231,184
    
    
    $
    (1,075,443
    )Cumulative excess of interest-earning assets
over interest-bearing liabilities
    
    $
    456,877
    
    
    $
    835,326
    
    
    $
    904,618
    
    
    $
    1,135,802
    
    
    $
    60,359Cumulative excess of interest-earning assets
over interest-bearing liabilities as a percent
of total assets
    
    
    13.16
    %
    
    
    24.10
    %
    
    
    26.07
    %
    
    
    32.73
    %
    
    
    1.74
    %
   (1)
    
    Adjustable and floating rate assets are included in the period in which interest rates are
next scheduled to adjust rather than in the period in which they are due. Fixed rate assets
are included in the periods in which they are scheduled to be repaid based on scheduled
amortization. In both cases, amounts are adjusted to reflect estimated prepayments. For this
table, all loans and mortgage-backed securities were assigned a 20% prepayment rate.(2)
    
    Balances are shown net of loans in process and are not adjusted for premiums, discounts,
reserves and unearned fees.(3)
    
    All of our deposits, other than certificates of deposit, are generally subject to immediate
withdrawal. However, in preparation of this table we used national decay rates calculated by
a leading bank consulting firm. These national decay rates consider a significant portion of
these accounts to be core deposits having longer effective maturities based on the firms
calculations of national average deposit runoff. These decay rates may be different than the
actual decay rates we experienced.(4)
    
    Certificate accounts and Borrowings are assumed to have no prepayments and are shown in the
period in which they contractually mature. Certain shortcomings are inherent in any methodology used to calculate interest rate
sensitivity. The asset prepayment speed and deposit decay rate assumptions are based on past
experience and should not be regarded as indicative of the actual prepayments and withdrawals that
may be experienced in any given period. In the event of changes in interest rates, prepayment and
early withdrawal would possibly deviate significantly from those assumed in calculating the above
table. Also, although certain assets and liabilities may have similar maturities or periods to
repricing, they may react differently to changes in market interest rates. Certain assets such as
adjustable rate mortgage loans have features that restrict changes in interest rates on a short
term basis and over the life of the asset. 47




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In recent years our policy has been to reduce our exposure to interest rate risk generally by
better matching the maturities of our interest rate sensitive assets and liabilities, and by
originating ARM loans and other adjustable rate or short-term loans, as well as by purchasing
short-term investments. However, particularly in a low-interest-rate environment, borrowers
typically prefer fixed-rate loans to ARM loans. We do not solicit high-rate jumbo certificates or
brokered funds. Liquidity and Capital Resources Fidelity Federal Bank & Trust is required to maintain liquid assets at levels considered safe
and sound by the Office of Thrift Supervision. Our liquidity ratio averaged 6.5%, 11.5% and 7.4%
during the months ended December 31, 2002, 2003 and 2004, respectively. Our liquidity ratio
averaged 11.7%, 11.5% and 10.2% for the years ended December 31, 2002, 2003 and 2004, respectively.
We adjust our liquidity levels to fund deposit outflows, pay real estate taxes on mortgage loans,
repay our borrowings and loan to fund commitments. We also adjust liquidity as appropriate to meet
asset and liability management objectives. Our primary sources of funds are deposits, amortization and prepayment of loans and
mortgage-backed securities, maturities of investment securities and other short-term investments,
and earnings and funds provided from operations. While scheduled principal repayments on loans and
mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan
prepayments are greatly influenced by general interest rates, economic conditions, and competition.
We set the interest rates on our deposits to maintain a desired level of total deposits. In
addition, we invest excess funds in short-term interest-earning and other assets, which provide
liquidity to meet lending requirements. Short-term interest-earning deposits with the Federal Home
Loan Bank of Atlanta amounted to $63.5 million, $33.8 million and $41.1 million at December 31,
2002, 2003 and 2004, respectively. Other assets qualifying for liquidity purposes at December 31,
2002, 2003 and 2004, totaled $67.6 million, $261.9 million and $110.9 million, respectively. For
additional information about cash flows from our operating, financing, and investing activities,
see Consolidated Statements of Cash Flows included in the consolidated financial statements. A major portion of our liquidity consists of cash and cash equivalents, which are a product of
our operating, investing and financing activities. Our primary sources of cash are net income,
principal repayments on loans and mortgage-backed securities, and increases in deposit accounts,
along with advances from the Federal Home Loan Bank of Atlanta. Liquidity management is both a daily and long-term function of business management. If we
require funds beyond our ability to generate them internally, borrowing agreements exist with the
Federal Home Loan Bank of Atlanta which provides an additional source of funds. At December 31,
2004, we had $250.9 million in advances from the Federal Home Loan Bank of Atlanta. We borrow from
the Federal Home Loan Bank of Atlanta in order to reduce interest rate risk, and for liquidity
purposes. At December 31, 2004, we had outstanding loan commitments of $239.2 million to originate
and/or purchase mortgage loans. This amount does not include the unfunded portion of loans in
process. At December 31, 2004, certificates of deposit scheduled to mature in less than one year,
totaled $422.2 million. Based on prior experience, management believes that a significant portion
of such deposits will remain with Fidelity Federal Bank & Trust, although there can be no assurance
that this will be the case or that the cost of such deposits could be significantly higher. Contractual Obligations and Commercial Commitments Our long-term debt, which in the aggregate totals $304.5 million, consists of obligations to
the FHLB totaling $250.9 million and $53.6 million in obligations resulting from the issuance of
trust preferred securities from Fidelity Capital Trust II in December 2003 as well as Fidelity
Capital Trust III in October 2004. The obligations arising from the issuance of trust preferred
securities, presented as Junior Subordinated Debentures on our balance sheet at December 31, 2004
are due in the amount of $22.7 million in January 2034 and $30.9 48




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##### Table of Contents



million in November 2034. In addition, we have leasehold obligations totaling $25.1 million.
These contractual obligations are set forth in the table below as of December 31, 2004. The tables below summarize the Companys contractual obligations, commercial and other
commitments at December 31 2003. Less Than
    
    
    
    
    
    
    
    
    
    
    After 5Total
    
    
    1 year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    Years(In Thousands)Long-term Debt(1)
    
    $
    304,463
    
    
    $
    163,582
    
    
    $
    27,164
    
    
    $
    59,903
    
    
    $
    53,814Capital Lease Obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating Lease Obligations
    
    
    25,116
    
    
    
    1,951
    
    
    
    3,994
    
    
    
    3,694
    
    
    
    15,477Pension Obligations(2)
    
    
    10,815
    
    
    
    3,615
    
    
    
    7,200
    
    
    
    
    
    
    
    Total Contractual Cash Obligations
    
    $
    340,394
    
    
    $
    169,148
    
    
    $
    38,358
    
    
    $
    63,597
    
    
    $
    69,291
   (1)
    
    Includes advances from the Federal Home Loan Bank and Junior Subordinated
Debentures(2)
    
    Refer to section entitled Pension Plans below. Commercial and Other Commitments Less Than
    
    
    
    
    
    
    
    
    
    
    After 5Total
    
    
    1 year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    Years(In Thousands)Lines of Credit
    
    $
    211,616
    
    
    $
    4,533
    
    
    $
    10,859
    
    
    $
    17,200
    
    
    $
    179,024Standby Letters of Credit
    
    
    14,565
    
    
    
    10,318
    
    
    
    242
    
    
    
    
    
    
    
    5Other Commercial Commitments
    
    
    94,540
    
    
    
    94,540
    
    
    
    
    
    
    
    
    
    
    
    Other Commitments
    
    
    132,204
    
    
    
    132,204
    
    
    
    
    
    
    
    
    
    
    
    Total Commitments
    
    $
    452,925
    
    
    $
    241,595.
    
    
    $
    15,101
    
    
    $
    17,200
    
    
    $
    179,029
 Additionally, the Company had a $224.8 million commitment outstanding at December 31,
2004 to securitize one-to four-family mortgage loans where the Company will retain the resulting
mortgage-backed securities. Pension Plans.We maintain a qualified defined benefit plan (the Qualified Plan), which
covers substantially all employees who were hired prior to January 1, 2001 and a supplemental
retirement plan to provide additional benefits to executives selected for the plan that are in
excess of amounts permitted to be paid under the provisions of tax law to participants in the
Qualified Plan. We also sponsor a non-qualified defined benefit plan for its directors. Our pension costs for all pension plans, excluding our 401(k) deferred savings plan,
approximated $5.3 million and $4.6 million for 2004 and 2003 respectively, and is calculated based
on a number of actuarial assumptions, including an expected long-term rate of return on our
Qualified Plan assets of 9%. In developing our expected long-term rate of return assumption, we
evaluated input from our actuaries and our investment advisors, including their review of asset
class return expectations from respected sources and authorities. We also evaluated the long-term
rate of expected inflation. Projected returns by these sources are based on broad equity and bond
indices. We also considered our historical returns in comparison to various market indices. Our
expected long-term rate of return is based on a target asset allocation of 70% in equities and 30%
in fixed income. We adopted this change in target allocation in early 2003. Previously, our target
allocation was 75% equities and 25% in fixed income investments. At the end of 2003, our pension
committee decided to change asset managers for the defined benefit plan from Security Trust
Company, N.A. to Charles Schwab Trust Company. At December 31, 2003, of the $17.2 million in plan
assets, $15.1 million were in cash and cash equivalents awaiting transfer to Charles Schwab Trust
Company while the remaining $2.1 million was in a debt securities mutual fund which transferred to
Charles Schwab in kind. After the transfer of assets was completed, the assets were invested in an
allocation of approximately 70% equity securities and 30% debt securities. We periodically
rebalance the actual asset allocation to match the target asset allocation. We expect a long-term
rate of return on equities of 10% and a long-term rate of return on fixed income investments of 6%.
We believe this is a reasonable long-term rate of return for our Qualified Plan assets. We will
continue to evaluate our actuarial assumptions, including our expected rate of return, at least
annually, and will adjust as necessary. 49




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We base our determination of pension cost on the market value of assets without adjustments or
smoothing to reduce year-to-year volatility. Actuarial gains and losses are recognized into
pension cost, to the extent they exceed the amount allowed in accordance with SFAS No. 87,
Employers Accounting for Pensions, that can be excluded in determining the amount to be
amortized (the corridor). The amount of gain and loss in excess of the corridor is amortized
over the remaining average expected working lifetime of plan participants, which was 10.32 years
for 2004. As of December 31, 2004, we had cumulative actuarial losses of $11.5 million that had
not yet been recognized into pension cost. The discount rate we utilize for determining future pension obligations is based on a review
of long term bond yields. We use Moodys AA bond index and Merrill Lynchs Corporate 10+ years
High Quality bond index as of our measurement date in determining our discount rate each year. The
discount rate determined on this basis has decreased from 6.0% as of December 31, 2003 to 5.75% as
of December 31, 2004. Lowering the expected long-term rate of return on our Qualified Plan assets by 0.5% (from 9.0%
to 8.5%) would have increased our fiscal 2004 pension cost by $86,552. Lowering the discount rate
and salary increase assumptions by 0.5% would have increased our fiscal 2004 pension cost by
$258,190. The value of our Qualified Plan assets increased from $17.2 million at December 31, 2003 to
$17.5 million at December 31, 2004. The investment performance returns and declining discount
rates have decreased the under funding in our Qualified Plan, net of accumulated benefit
obligations from $1.6 million at December 31, 2003 to an underfunding of $680,000 at December 31,
2004. As a result of this decline in funded status of our Qualified Plan, we expect that based on
our actuarial assumptions that we will continue to make cash contributions to the Qualified Plan of
at least $3.6 million for at least the next three years. Impact of Inflation and Changing Prices The consolidated financial statements of Fidelity Bankshares, Inc. and notes thereto,
presented elsewhere herein, have been prepared in accordance with accounting principles generally
accepted in the United States of America, which require the measurement of financial position and
operating results in terms of historical dollars without considering the change in the relative
purchasing power of money over time and due to inflation. The impact of inflation is reflected in
the increased cost of Fidelity Federal Bank & Trusts operations. Unlike most industrial companies,
nearly all the assets and liabilities of Fidelity Federal Bank & Trust are monetary. As a result,
interest rates have a greater impact on Fidelity Federal Bank & Trusts performance than do the
effects of general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as changes in the price of goods and services. Recent Accounting Pronouncements Affecting the Company In November 2002, the FASB Interpretation No. (FIN) 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others
was issued. This interpretation requires elaborating on the disclosures that must be made by a
guarantor in its interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing
the guarantee. The disclosure requirements of this Interpretation are effective for statements
issued after December 15, 2002 and its recognition requirements are applicable for guarantees
issued or modified after December 31, 2002. The adoption of FIN 45 effective as of the first
quarter of 2003 did not have a material effect on our results of operations or financial position. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123 to provide
alternative methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The provisions of Statement 50




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148 are effective for interim periods beginning after December 15, 2002, with early
application encouraged. The Company has adopted the disclosure provisions of SFAS No. 148. In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities which
addresses consolidation of variable interest entities (VIEs) certain of which are also referred
to as special purpose entities (SPEs). The FASB revised FIN 46 in December 2003. VIEs are
entities in which equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. Under the provisions of FIN 46, a
company is to consolidate a VIE if the company has a variable interest (or combination of variable
interests) that will absorb a majority of the VIEs expected losses if they occur, received a
majority of the VIEs expected residual returns if they occur, or both. The implementation of FIN
46 is required for public entities at the end of the first interim period ending after March 15,
2003 if the VIE was created before February 1, 2003, with early adoption allowed, and immediately
for entities created after February 1, 2003. We early adopted FIN 46 and has deconsolidated the
Fidelity Capital Trust I at December 31, 2003 (See Note 11). The deconsolidation of Fidelity
Capital Trust I did not have a material impact on our consolidated financial position or results of
operations. On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity. SFAS No. 150 was effective May 31, 2003 for
all new and modified financial instruments and otherwise was effective at the beginning of the
first interim period beginning after June 15, 2003. SFAS No. 150 changes the accounting for certain
financial instruments that, under previous guidance, issuers could be accounted for as equity. SFAS
No. 150 requires that those instruments be classified as liabilities or in some circumstances
assets. The adoption of this statement did not have a material impact on our results of operations
or financial condition. In November 2003, the EITF reached a consensus on the disclosure provisions of EITF Issue No.
03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.
EITF No. 03-1 requires that certain quantitative and qualitative disclosures be made for certain
debt securities classified as available-for-sale under SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for
which an other-than-temporary impairment has not been recognized. Debt securities within the scope
of EITF Issue No. 99-20, are not subject to these disclosure provisions. The disclosures are
required for fiscal years ending after December 15, 2003, and accordingly we adopted the disclosure
provisions of EITF No. 03-1 for the year ended December 31, 2003. In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employees Disclosures about
Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, to
address the increasing significance of corporate pension plans to company financial statements and
the call for greater transparency in financial reports. The statement requires additional
disclosures, regarding plan assets, investment strategy, measurement date, plan obligations, cash
flows and components of net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. However, it does not change the measurement or recognition of those
plans required by SFAS No. 87, SFAS No. 88 and SFAS No. 106. We adopted the disclosure provisions
of SFAS No. 132 for the year ended December 31, 2003. In December 2004, the FASB issued FAS 123 (revised 2004), Share-Based Payment. Under this
promulgation, companies are required to reflect costs associated with employee stock options in
their income statements at fair value. The statement becomes effective for interim or annual
periods beginning after June 15, 2005. We will begin reflecting stock option costs under the fair
value method commencing in the quarter beginning July 1, 2005 as required. The effect of the
adoption of this accounting principle is still being evaluated. 
 ITEM 7A. QUALITATIVE AND QUANTITATIVE ANALYSIS OF MARKET RISK For information regarding market risk see Item 7- Managements Discussion and Analysis of
Financial Conditions and Results of Operation. 51




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements identified in Item 15(a)(1) hereof are included as Exhibit 13 and are
incorporated hereunder. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE There were no changes in or disagreements with accountants in our accounting and financial
disclosure during 2004. 
 ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
under the Exchange Act) as of the end of the fiscal year (the Evaluation Date). Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the
Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to
the material information relating to us (or our consolidated subsidiaries) required to be included
in our periodic SEC filings. (b) Changes in internal controls. There were no significant changes made in our internal controls during the period covered by
this report or, to our knowledge, in other factors that could significantly affect these controls
subsequent to the date of their evaluation. See the Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 52




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Managements Assessment  To the Stockholders: Financial Statements The management of Fidelity Bankshares, Inc. and subsidiaries (the Company) is responsible for the
preparation, integrity, and fair presentation of its published financial statements and all other
information presented in this annual report. The financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America and, as
such, include amounts based on informed judgments and estimates made by management. Internal Control Management is responsible for establishing and maintaining effective internal control over
financial reporting, including safeguarding of assets, for financial presentations in conformity
with both accounting principles generally accepted in the United States of America and the Office
of Thrift Supervision Instructions for Schedules SC, SO, and Reconciliation of Equity Capital
included on Schedule SI of the Thrift Financial Reports (TFR instructions). The internal control
contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any internal control, including the
possibility of human error and the circumvention or overriding of controls. Accordingly, even
effective internal control can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal
control may vary over time. Management assessed the institutions internal control over financial reporting, including
safeguarding of assets, for financial presentations in conformity with both accounting principles
generally accepted in the United States of America and TFR Instructions for Schedules SC, SO, and
Reconciliation of Equity Capital included on Schedule SI as of December 31, 2004. This assessment
was based on criteria for effective internal control over financial reporting, including
safeguarding of assets, described in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management
believes that the Company maintained effective internal control over financial reporting, including
safeguarding of assets, presented in conformity with both accounting principles generally accepted
in the United States of America and TFR Instructions for Schedules SC, SO, and Reconciliation of
Equity Capital included on Schedule SI, as of December 31, 2004. The Audit Committee of the Board of Directors is comprised entirely of outside directors who are
independent of the Companys management. The Audit Committee is responsible for recommending to
the Board of Directors the selection of independent auditors. It meets periodically with
management, the independent auditors, and the internal auditors to ensure that they are carrying
out their responsibilities. The Committee is also responsible for performing an oversight role by
reviewing and monitoring the financial, accounting and auditing procedures of the Company in
addition to reviewing the Companys financial reports. The independent auditors and the internal
auditors have full and free access to the Audit Committee, with or without the presence of
management, to discuss the adequacy of internal control over financial reporting and any other
matters which they believe should be brought to the attention of the Committee. Compliance with Designated Laws and Regulations Management is also responsible for ensuring compliance with the federal laws and regulations
concerning loans to insiders and the federal and state laws and regulations concerning dividend
restrictions, both of which are designated by the Federal Deposit Insurance Corporation (FDIC) as
safety and soundness laws and regulations. Management assessed its compliance with the designated safety and soundness laws and regulations
and has maintained records of its determinations and assessments as required by the FDIC. Based on
this assessment, management believes that the Company has complied, in all material respects, with
the designated safety and soundness laws and regulations for the year ended December 31, 2004. by:
    
    /s/ Vince A. Elhilow
    
    
    
    by:
    
    /s/ Richard D. AldredPresident and Chief Executive Officer
    
    
    
    Executive Vice President-Chief Financial OfficerMarch 14, 2005
 53




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Report of Independent Registered Public Accounting Firm To the Audit Committee
Fidelity Bankshares, Inc.
West Palm Beach, Florida We have examined managements assessment, included in the accompanying report on Managements
Assessment as to the Effectiveness of its Internal Control Structure over Financial Reporting and
Compliance with Designated Laws and Regulations, that Fidelity Bankshares, Inc. and subsidiaries
(the Company) maintained effective internal control over financial reporting as of December 31,
2004 based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. Because managements assessment
and our audit were conducted to meet the reporting requirements of Section 112 of the Federal
Deposit Insurance Corporation Improvement Act (FDICIA), managements assessment and our audit of
the Companys internal control over financial reporting included controls over the preparation of
the schedules equivalent to the basic financial statements in accordance with the Office of Thrift
Supervision Instructions for Thrift Financial Reports for Schedules SC, SO, and the Reconciliation
of Equity Capital included on Schedule SI. The Companys management is responsible for maintaining
effective internal control over financial reporting and its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness of the Companys internal control over
financials reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing, and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements. 54




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Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on
the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also, in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2004, based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have not examined and, accordingly, we do not express an opinion or any other form of assurance
on managements statement referring to compliance with laws and regulations. We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements as of and for the year ended December
31, 2004 of the Company and our report dated March 14, 2005 expressed an unqualified opinion on
those financial statements. Deloitte & Touche LLP
Certified Public Accountants West Palm Beach, Florida
March 14, 2005 55




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ITEM 9B. OTHER INFORMATION None 
 PART III 
 ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT We have adopted a Code of Ethics that applies to our principal executive officer, principal
financial officer, principal accounting officer or controller or persons performing similar
functions. The Code of Ethics may be accessed on our website at www.fidelityfederal.com. Directors The Board of Directors of Fidelity Bankshares, Inc. is divided into three classes and is
elected by stockholders of Fidelity Bankshares, Inc. for staggered three-year terms, or until their
successors are elected and qualified. The following table sets forth certain information regarding
the composition of the Board of Directors as of December 31, 2004, including their terms of office: Position Held at
    
    
    
    
    
    Current TermName
    
    Age
    
    Fidelity Bankshares, Inc.
    
    Director Since(1)
    
    to ExpireVince A. Elhilow
    
    
    65
    
    
    Chairman of the Board,
    
    
    1984
    
    
    
    2006President and Chief Executive
OfficerKeith D. Beaty
    
    
    54
    
    
    Director
    
    
    1992
    
    
    
    2005Paul C. Bremer
    
    
    61
    
    
    Director
    
    
    2000
    
    
    
    2007F. Ted Brown, Jr.
    
    
    75
    
    
    Director
    
    
    1990
    
    
    
    2005Donald E. Warren, M.D.
    
    
    77
    
    
    Director
    
    
    1979
    
    
    
    2006Karl H. Watson
    
    
    63
    
    
    Director
    
    
    1999
    
    
    
    2007
   (1)
    
    Reflects initial appointment to Fidelity Bankshares, Inc.s predecessor, Fidelity
Federal Savings Bank of Florida. The principal occupations of each director and executive officer of Fidelity Bankshares,
Inc. during at least the past five years is set forth below. Directors Vince A. Elhilowhas been President of Fidelity Federal Bank & Trust since 1987 and Chief
Executive Officer of Fidelity Federal Bank & Trust since 1992. In May 2002, Mr. Elhilow was
appointed Chairman of the Board of Directors. Prior to his appointment as President of Fidelity
Federal Bank & Trust, Mr. Elhilow was manager of the Loan Department from 1973 to 1992 and
Executive Vice President and Chief Operating Officer from 1981 to 1987. Mr. Elhilow joined
Fidelity Federal Bank & Trust in January 1963 and has been a Director since 1984. Keith D. Beatyis the Chief Executive Officer of Implant Innovations, Inc. a distributor of
dental implants, located in Palm Beach Gardens. Mr. Beaty has been a director of Fidelity Federal
Bank & Trust since 1992. Paul C. Bremeris a retired certified public accountant. From 1979 until his retirement in
2000, Mr. Bremer was a partner with the accounting firm of Ernst & Young LLP. Mr. Bremer was
appointed to the Board of Directors in August 2000. 56




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F. Ted Brown, Jr.is the President of Ted Brown Real Estate, Inc., located in North Palm
Beach. Mr. Brown has been a director of Fidelity Federal Bank & Trust since 1990. Donald E. Warren, M.D.is a retired physician who practiced in West Palm Beach for over 36
years. He was associated with Intracoastal Health Systems until his retirement in November 1996.
Dr. Warren has been a director of Fidelity Federal Bank & Trust since 1979. Karl H. Watsonis President and Chief Operating Officer of the Construction Materials Division
of Rinker Materials, a concrete and building materials company based in West Palm Beach. Mr. Watson
has been with Rinker Materials for over 35 years. Mr. Watson was appointed to the Board of
Directors on January 19, 1999. Executive Officers who are not Directors Richard D. Aldredserves as Executive Vice President, Chief Financial Officer and Treasurer.
Mr. Aldred has been employed by Fidelity Federal Bank & Trust for 19 years. Joseph C. Bovaserves as Executive Vice President and Lending Operations Manager. Mr. Bova
has been employed by Fidelity Federal Bank & Trust for 33 years. Robert L. Fugateserves as Executive Vice President and Banking Operations Manager. Mr.
Fugate has been employed by Fidelity Federal Bank & Trust for 32 years. Christopher H. Cookbecame Executive Vice President and Corporate Counsel in 1996. Prior to
that time, Mr. Cook was a partner with the law firm of Brackett, Cook, Sned, Welch, DAngio, Tucker
& Farach, P.A. 
 ITEM 11. EXECUTIVE COMPENSATION Information required by Item 11 is incorporated by reference to our Proxy Statement for the
2005 Annual Meeting of Stockholders. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by Item 12 is incorporated by reference to our Proxy Statement for the
2005 Annual Meeting of Stockholders. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information required by Item 14 is incorporated by reference to our Proxy Statement for the
2005 Annual Meeting of Stockholders. 
 PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The exhibits and financial statement schedules filed as a part of this Form 10-K are as follows: 57




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(a)(1)
    Financial Statements  
    Report of Independent Registered Public Accounting Firm
    Consolidated Statements of Financial Position,
December 31, 2003 and 2004
    Consolidated Statements of Operations,
Years Ended December 31, 2002, 2003 and 2004
    Consolidated Statements of Comprehensive Operations, Years Ended December 31, 2002, 2003 and 2004
    Consolidated Statements of Changes in Stockholders equity,
Years Ended December 31, 2002, 2003 and 2004
    Consolidated Statements of Cash Flows,
Years Ended December 31, 2002, 2003 and 2004
    Notes to Consolidated Financial Statements.(a)(2)
    Financial Statement Schedules No financial statement schedules are filed because the required information is not applicable
or is included in the consolidated financial statements or related notes.  (a)(3)
    Exhibits 3.1
    
    
    Certificate of Incorporation of Fidelity Bankshares, Inc.***3.2
    
    
    Bylaws of Fidelity Bankshares, Inc.***4.1
    
    
    Form of Indenture with respect to Fidelity Bankshares, Inc.s 8.375% Junior Subordinated Deferrable Interest*4.2
    
    
    Form of Indenture with respect to Floating Rate Junior Subordinated Debt Securities due 2034*10.1
    (a)
    
    Employment Agreement between Fidelity Bankshares, Inc. and Vince A. Elhilow*****10.1
    (b)
    
    Employment Agreement between Fidelity Federal Bank & Trust and Vince A. Elhilow*****10.2
    (a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Richard D. Aldred*****10.2
    (b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Richard D. Aldred*****10.3
    (a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Robert Fugate*****10.3
    (b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Robert Fugate*****
 58




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##### Table of Contents



10.4
    (a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Joseph Bova*****10.4
    (b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Joseph Bova*****10.5
    (a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Christopher H. Cook*****10.5
    (b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Christopher H. Cook*****10.6
    
    
    Recognition and Retention Plan for Employees**10.7
    
    
    Recognition Plan for Outside Directors**13
    
    
    Consolidated Financial Statements15
    
    
    Code of Ethics*****21
    
    
    Subsidiaries of the Registrant23
    
    
    Consent of Independent Registered Public Accounting Firm to incorporate financial statements in Form S-831.1
    
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200232
    
    
    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   *
    
    Filed as exhibits to the Companys Registration Statement on
Form S-2 under the Securities Act of 1933, filed with the SEC on December 15,
1997 (Registration No. 333-42227).**
    
    Filed as exhibits to the Companys Registration Statement on
Form S-4 under the Securities Act of 1933, filed with the Securities and
Exchange Commission on December 12, 1996 (Registration No. 333-17737).***
    
    Filed as exhibits to the Companys Registration Statement on
Form S-1 with the Securities and Exchange Commission. (Registration No.
333-53216).****
    
    Filed as an Exhibit to the Company Annual Report on Form 10-K
for the year ended December 31, 2001.*****
    
    Filed as an Exhibit to the Company Annual Report on Form 10-K
for the year ended December 31, 2003.  (b)
    The exhibits listed under (a)(3) above are filed herewith.(c)
    Not applicable. 59




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##### Table of Contents



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. FIDELITY BANKSHARES, INC.Date: March 15, 2005
    By:
    /s/ Vince A. ElhilowVince A. Elhilow, Chairman of the Board,President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated. By:
    
    /s/ Vince A. Elhilow
    
    
    
    By:
    
    /s/ Richard D. AldredVince A. Elhilow, Chairman of the Board,
    
    
    
    
    
    Richard D. Aldred, Executive Vice President,President and Chief Executive Officer
    
    
    
    
    
    Chief Financial Officer and Treasurer(Principal Executive Officer)
    
    
    
    
    
    (Principal Financial and Accounting Officer)Date: March 15, 2005
    
    
    
    Date: March 15, 2005By:
    
    /s/ Paul C. Bremer
    
    
    
    By:
    
    /s/ F. Ted Brown, Jr.Paul C. Bremer, Director
    
    
    
    
    
    F. Ted Brown, Jr., DirectorDate: March 15, 2005
    
    
    
    Date: March 15, 2005By:
    
    /s/ Donald E. Warren , M.D.
    
    
    
    By:
    
    /s/ Karl H. WatsonDonald E. Warren, M.D., Director
    
    
    
    
    
    Karl H. Watson, DirectorDate: March 15, 2005
    
    
    
    Date: March 15, 2005By:
    
    /s/ Keith D. BeatyKeith D. Beaty, DirectorDate: March 15, 2005
 60




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EXHIBIT INDEX 3.1
    
    Certificate of Incorporation of Fidelity Bankshares, Inc.***3.2
    
    Bylaws of Fidelity Bankshares, Inc.***4.1
    
    Form of Indenture with respect to Fidelity Bankshares, Inc.s 8.375% Junior Subordinated Deferrable Interest*4.2
    
    Form of Indenture with respect to Floating Rate Junior Subordinated Debt Securities due 2034*10.1(a)
    
    Employment Agreement between Fidelity Bankshares, Inc. and Vince A. Elhilow*****10.1(b)
    
    Employment Agreement between Fidelity Federal Bank & Trust and Vince A. Elhilow*****10.2(a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Richard D. Aldred*****10.2(b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Richard D. Aldred*****10.3(a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Robert Fugate*****10.3(b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Robert Fugate*****10.4(a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Joseph Bova*****10.4(b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Joseph Bova*****10.5(a)
    
    Change of Control Agreement between Fidelity Bankshares, Inc. and Christopher H. Cook*****10.5(b)
    
    Change of Control Agreement between Fidelity Federal Bank & Trust and Christopher H. Cook*****10.6
    
    Recognition and Retention Plan for Employees**10.7
    
    Recognition Plan for Outside Directors**13
    
    Consolidated Financial Statements15
    
    Code of Ethics*****21
    
    Subsidiaries of the Registrant23
    
    Consent Independent Registered Public Accounting Firm to incorporate financial statements in Form S-8
 61




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31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200232
    
    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   *
    
    Filed as exhibits to the Companys Registration Statement on Form S-2 under the
Securities Act of 1933, filed with the SEC on December 15, 1997 (Registration No.
333-42227).**
    
    Filed as exhibits to the Companys Registration Statement on Form S-4 under the
Securities Act of 1933, filed with the Securities and Exchange Commission on December
12, 1996 (Registration No. 333-17737).***
    
    Filed as exhibits to the Companys Registration Statement on Form S-1 with the
Securities and Exchange Commission. (Registration No. 333-53216).****
    
    Filed as an Exhibit to the Company Annual Report on Form 10-K for the year ended
December 31, 2001.*****
    
    Filed as an Exhibit to the Company Annual Report on Form 10-K for the year ended
December 31, 2003. 62