Merger Prospectus
Table of Contents
Index to Financial Statements

Filed pursuant to Rule 424 (b) (3)
Registration No. 333-126104

LOGO   LOGO

 

MERGER PROPOSED—YOUR VOTE IS IMPORTANT

 

The Boards of Directors of Flag Financial Corporation (“Flag”) and First Capital Bancorp, Inc. (“First Capital”) have each agreed to a merger transaction that will result in First Capital merging with and into Flag. We expect the proposed merger will bring together two complementary institutions to create a company positioned for further growth. Furthermore, we believe the combined company will achieve stronger earnings growth and create more shareholder value than either could separately achieve.

 

Our combined company will provide additional commercial and retail banking services and products through the combination of our two banks, which will operate from 28 offices located in metro Atlanta and central and west Georgia. Based on our June 30, 2005 financial data, we believe the combined company will have assets of approximately $1.6 billion.

 

Pursuant to our merger agreement, First Capital will merge with and into Flag, and Flag will be the surviving corporation. Each share of First Capital will be converted into 1.6 shares of Flag common stock, resulting in an issuance of approximately 6.8 million shares of Flag common stock on a fully diluted basis. Each share of Flag common stock will remain outstanding as a share of common stock of the combined company. Any non-institutional First Capital shareholder that would own more than 384,000 shares of Flag common stock following the merger will receive a cash payment, in lieu of shares of Flag common stock over the 384,000 share threshold, equal to the number of such excess shares multiplied by $14.76 per share, the average closing price of Flag’s common stock for the 20 trading days immediately following the public announcement of the merger.

 

Your vote is important. We cannot complete the merger of Flag and First Capital unless shareholders of both companies approve the merger agreement. Each of Flag and First Capital will hold a special meeting of its shareholders to vote on the merger proposal. Whether or not you plan to attend your shareholders’ meeting, please take the time to vote by completing and mailing the enclosed proxy card to us. If you do not return your proxy card or otherwise vote, or do not instruct your broker how to vote any shares held for you in your broker’s name, the effect will be a vote against the merger.

 

The places, dates and times of the special meetings are as follows:

 

For Flag shareholders:

  For First Capital shareholders:

Flag Financial Corporation

3475 Piedmont Road, N.E., Suite 550

Atlanta, Georgia 30305

September 20, 2005 at 1:00 p.m.

 

Country Club of Roswell

2500 Club Springs Drive

Roswell, Georgia 30076

September 20, 2005 at 10:00 a.m.

 

This joint proxy statement/prospectus provides detailed information about the special meetings and our proposed merger. We urge you to read this joint proxy statement/prospectus and the documents incorporated by reference into this joint proxy statement/prospectus carefully and in their entirety. In particular, see “ Risk Factors Relating to the Merger” on page 11 of this joint proxy statement/prospectus.

 

The common stock of Flag is currently listed on the Nasdaq National Market under the ticker symbol “FLAG.” The common stock of First Capital is quoted on the Over the Counter Bulletin Board under the ticker symbol “FCBX.OB”

 

We enthusiastically support this combination of our two companies and join with the members of our Boards of Directors in recommending that you vote in favor of the merger.

 

LOGO   LOGO

Joseph W. Evans, Chairman, President

and Chief Executive Officer

Flag Financial Corporation

 

 

    David R. Hink, Chairman

    First Capital Bancorp, Inc.

 

Neither the Securities and Exchange Commission nor any state securities regulator has approved or disapproved of the securities to be issued under this document or determined if this joint proxy statement/prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The securities we are offering through this document are not savings or deposit accounts or other obligations of any bank or non-bank subsidiary of either of our companies, and they are not insured by the Federal Deposit Insurance Corporation or any other governmental agency.

 

This joint proxy statement/prospectus is dated August 12, 2005 and is first being mailed to shareholders of Flag and First Capital on or about August 18, 2005.


Table of Contents
Index to Financial Statements

ADDITIONAL INFORMATION

 

This joint proxy statement/prospectus incorporates important business and financial information about Flag and First Capital from other documents that are not included in or delivered with this joint proxy statement/prospectus. See “Where You Can Find More Information” beginning on page 110. This information is available to you without charge upon your written or oral request. You can obtain the documents incorporated by reference in this joint proxy statement/prospectus through the Securities and Exchange Commission (“SEC”) website at www.sec.gov or by requesting them in writing or by telephone at the appropriate address below:

 

If you are a Flag Shareholder:

 

If you are a First Capital Shareholder:

By Mail:

  

Flag Financial Corporation

 

By Mail:

  

First Capital Bancorp, Inc.

    

3475 Piedmont Road, N.E., Suite 550

      

3320 Holcomb Bridge Road, N.W., Suite A

    

Atlanta, Georgia 30305

      

Norcross, Georgia 30092

    

Attention: Lisa G. Lane

      

Attention: H.N. Padget, Jr.

Telephone:

  

(404) 760-7700

 

Telephone:

  

(770) 921-6400

 

In order to receive timely delivery of the documents in advance of the special meetings of shareholders, you must request such information no later than September 15, 2005.


Table of Contents
Index to Financial Statements

FIRST CAPITAL BANCORP, INC.

3320 Holcomb Bridge Road, N.W., Suite A

Norcross, Georgia 30092

(770) 921-6400

 

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS

TO BE HELD SEPTEMBER 20, 2005

 

To the shareholders of First Capital Bancorp, Inc.:

 

A special meeting of shareholders of First Capital Bancorp, Inc. will be held at the Country Club of Roswell located at 2500 Club Springs Drive, Roswell, Georgia 30076 on Tuesday, September 20, 2005, at 10:00 a.m., local time, for the following purposes:

 

1. to approve the Agreement and Plan of Merger, dated as of May 26, 2005, by and between First Capital Bancorp, Inc. and Flag Financial Corporation, a bank holding company based in Atlanta, Georgia, pursuant to which First Capital will merge with and into Flag, as further described in the enclosed joint proxy statement/prospectus; and

 

2. to transact such other business as may properly come before the special meeting or any postponements or adjournments of the special meeting.

 

Only shareholders of record of First Capital common stock at the close of business on August 12, 2005 are entitled to vote at the special meeting or any postponements or adjournments thereof. The approval of the merger agreement requires the affirmative vote of at least a majority of all of the votes entitled to be cast at the special meeting.

 

FIRST CAPITAL’S BOARD OF DIRECTORS RECOMMENDS THAT FIRST CAPITAL SHAREHOLDERS VOTE “FOR” THE PROPOSAL TO APPROVE THE MERGER AGREEMENT.

 

Notice of Right to Dissent. If Proposal 1 above is approved and the merger is consummated, each shareholder of First Capital will have the right to dissent from approval of the merger and will be entitled to the rights and remedies of dissenting shareholders provided in the Georgia Business Corporation Code. The right of any such shareholder to any dissenters’ rights is contingent upon consummation of the merger and upon strict compliance with the requirements of Sections 14-2-1301 through 14-2-1332 of the Georgia Business Corporation Code. The full text of these sections is attached as Appendix D to this proxy statement/prospectus. For a summary of these requirements, see “Terms of the Merger—Dissenters’ Appraisal Rights” in this proxy statement/prospectus.

 

Each shareholder, whether or not he or she plans to attend the special meeting, is requested to sign, date and return the enclosed proxy without delay in the enclosed postage-paid envelope. Any proxy given by a shareholder may be revoked by filing with First Capital’s Secretary a written revocation or a duly executed proxy bearing a later date. Any shareholder present at the special meeting may revoke his or her proxy and vote personally on each matter brought before the special meeting. However, if you are a shareholder whose shares are not registered in your own name, you will need additional documentation from the record holder of such shares to vote personally at the special meeting.

 

By Order of the Board of Directors,

LOGO

H. N. Padget, Jr.

President and Chief Executive Officer

 

August 12, 2005

Norcross, Georgia

 

IMPORTANT: Please read the attached joint proxy statement/prospectus and then promptly complete, execute and return the enclosed proxy card in the accompanying postage-paid envelope. You can save First Capital the expense of further proxy solicitation by returning your proxy card promptly.


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Index to Financial Statements

FLAG FINANCIAL CORPORATION

3475 Piedmont Road, N.E., Suite 550

Atlanta, Georgia 30305

(404) 760-7700

 

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS

TO BE HELD SEPTEMBER 20, 2005

 

To the shareholders of Flag Financial Corporation:

 

A special meeting of shareholders of Flag Financial Corporation will be held at its offices located at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia 30305 on Tuesday, September 20, 2005, at 1:00 p.m., local time, for the following purposes:

 

1. to approve the Agreement and Plan of Merger, dated as of May 26, 2005, by and between Flag Financial Corporation and First Capital Bancorp, Inc., a bank holding company based in Norcross, Georgia, pursuant to which First Capital will merge with and into Flag, as further described in the enclosed joint proxy statement/prospectus; and

 

2. to transact such other business as may properly come before the special meeting or any postponements or adjournments of the special meeting.

 

Only shareholders of record of Flag common stock at the close of business on July 29, 2005 are entitled to vote at the special meeting or any postponements or adjournments thereof. The approval of the merger agreement requires the affirmative vote of at least a majority of all of the votes entitled to be cast at the special meeting.

 

FLAG’S BOARD OF DIRECTORS RECOMMENDS THAT FLAG SHAREHOLDERS VOTE

FORTHE PROPOSAL TO APPROVE THE MERGER AGREEMENT.

 

Each shareholder, whether or not he or she plans to attend the special meeting, is requested to sign, date and return the enclosed proxy without delay in the enclosed postage-paid envelope. Any proxy given by a shareholder may be revoked by filing with Flag’s Secretary a written revocation or a duly executed proxy bearing a later date. Any shareholder present at the special meeting may revoke his or her proxy and vote personally on each matter brought before the special meeting. However, if you are a shareholder whose shares are not registered in your own name, you will need additional documentation from the record holder of such shares to vote personally at the special meeting.

 

By Order of the Board of Directors,

 

LOGO

Joseph W. Evans

Chairman, President and Chief Executive Officer

 

August 12, 2005

Atlanta, Georgia

 

IMPORTANT: Please read the attached joint proxy statement/prospectus and then promptly complete, execute and return the enclosed proxy card in the accompanying postage-paid envelope. You can save Flag the expense of further proxy solicitation by returning your proxy card promptly.


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

QUESTIONS AND ANSWERS ABOUT VOTING PROCEDURES FOR THE SPECIAL MEETINGS

   1

SUMMARY

   2

THE COMPANIES

   2

THE MERGER

   2

REASONS FOR THE MERGER

   3

REGULATORY MATTERS

   3

FLAG SHAREHOLDERS MEETING

   4

FLAGS RECORD DATE AND VOTING

   4

FLAGS BOARD RECOMMENDS SHAREHOLDER APPROVAL

   4

FIRST CAPITAL SHAREHOLDERS MEETING

   4

FIRST CAPITALS RECORD DATE AND VOTING

   4

FIRST CAPITALS BOARD RECOMMENDS SHAREHOLDER APPROVAL

   4

INTERESTS OF DIRECTORS AND OFFICERS OF FLAG AND FIRST CAPITAL THAT DIFFER FROM YOUR INTERESTS

   5

FEDERAL INCOME TAX CONSEQUENCES

   6

COMPARATIVE RIGHTS OF SHAREHOLDERS

   6

CONDITIONS OF THE MERGER

   6

TERMINATION OF THE MERGER AGREEMENT

   7

DISSENTERS’ APPRAISAL RIGHTS

   7

ACCOUNTING TREATMENT

   7

FLAGS DIVIDENDS FOLLOWING THE MERGER

   8

FLAG FINANCIAL CORPORATION SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

   10

RISK FACTORS RELATING TO THE MERGER

   11

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

   14

THE SPECIAL MEETINGS

   15

GENERAL

   15

MEETING DATES, TIMES AND PLACES AND RECORD DATES

   15

MATTERS TO BE CONSIDERED

   15

VOTE REQUIRED

   16

VOTING OF PROXIES

   16

REVOCABILITY OF PROXIES

   17

SOLICITATION OF PROXIES

   17

RECOMMENDATION OF THE BOARDS OF DIRECTORS

   18

BACKGROUND OF AND REASONS FOR THE MERGER

   19

BACKGROUND OF THE MERGER

   19

FIRST CAPITALS REASONS FOR THE MERGER

   21

FLAGS REASONS FOR THE MERGER

   21

OPINION OF FIRST CAPITALS FINANCIAL ADVISOR

   22

OPINION OF FLAGS FINANCIAL ADVISOR

   28

TERMS OF THE MERGER

   38

GENERAL

   38

CONVERSION OF STOCK; TREATMENT OF OPTIONS

   38

RAISING OF ADDITIONAL CAPITAL

   39

 

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Index to Financial Statements

EFFECTIVE TIME OF THE MERGER

   40

EXCHANGE OF CERTIFICATES

   40

IMPORTANT FEDERAL INCOME TAX CONSEQUENCES

   41

MANAGEMENT AND OPERATIONS AFTER THE MERGER

   42

INTERESTS OF EMPLOYEES AND DIRECTORS OF FLAG AND FIRST CAPITAL IN THE MERGER

   43

CONDITIONS TO CONSUMMATION

   46

REGULATORY MATTERS

   47

AMENDMENT, WAIVER AND TERMINATION

   48

CONDUCT OF BUSINESS PENDING THE MERGER

   49

EXPENSES AND FEES

   51

ACCOUNTING TREATMENT

   51

RESALES OF FLAG COMMON STOCK

   52

DISSENTERS’ APPRAISAL RIGHTS

   52

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

   54

NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

   58

INFORMATION ABOUT FLAG

   59

GENERAL

   59

FLAG BANK

   59

INFORMATION ABOUT FIRST CAPITAL

   59

GENERAL

   59

FIRST CAPITAL BANK

   60

EMPLOYEES

   63

MARKET AREA AND COMPETITION

   63

SUPERVISION AND REGULATION

   63

LEGAL PROCEEDINGS

   70

PROPERTIES

   71

MARKET PRICE AND DIVIDENDS

   71

FIRST CAPITAL MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   72

MANAGEMENT OF FIRST CAPITAL

   94

BOARD OF DIRECTORS

   94

OTHER EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES

   95

EXECUTIVE COMPENSATION

   96

OPTION GRANTS IN LAST FISCAL YEAR

   97

EMPLOYMENT AGREEMENTS

   97

SUPPLEMENTAL RETIREMENT PLAN

   99

LIFE INSURANCE BENEFITS

   99

DIRECTOR FEES

   99

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   100

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF FIRST CAPITAL

   101

COMPARATIVE RIGHTS OF FIRST CAPITAL SHAREHOLDERS AND FLAG SHAREHOLDERS

   102

AUTHORIZED CAPITAL STOCK

   102

AMENDMENTS TO ARTICLES OF INCORPORATION AND BYLAWS

   103

 

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Index to Financial Statements

BOARD OF DIRECTORS AND ABSENCE OF CUMULATIVE VOTING

   104

REMOVAL OF DIRECTORS

   104

INDEMNIFICATION OF DIRECTORS AND OFFICERS

   105

SPECIAL MEETINGS OF SHAREHOLDERS

   106

MERGERS, SHARE EXCHANGES AND SALES OF ASSETS

   107

SHAREHOLDER RIGHTS TO EXAMINE BOOKS AND RECORDS

   108

DIVIDENDS

   108

EXPERTS

   109

LEGAL MATTERS

   109

SHAREHOLDER PROPOSALS AND OTHER MATTERS

   109

WHERE YOU CAN FIND MORE INFORMATION

   110

FINANCIAL STATEMENTS OF FIRST CAPITAL BANCORP, INC. AND SUBSIDIARIES

   F-1

MERGER AGREEMENT

   APPENDIX A

OPINION OF BURKE CAPITAL GROUP, L.L.C.

   APPENDIX B

OPINION OF SANDLER O’NEILL & PARTNERS, L.P.

   APPENDIX C

DISSENTERS’ RIGHTS PROVISIONS OF THE GEORGIA BUSINESS CORPORATION CODE

   APPENDIX D

 

No dealer, salesman or other person has been authorized to give any information or to make any representations, other than those contained in this joint proxy statement/prospectus, and, if given or made, such other information or representations must not be relied upon as having been authorized by Flag or First Capital. Neither the delivery of this joint proxy statement/prospectus nor any sale made hereunder shall under any circumstances create any implication that there has been no change in the affairs of Flag or First Capital since the date hereof or that information contained herein is correct as of any time subsequent to any of the dates as of which information is furnished herein or the date hereof.

 

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Index to Financial Statements

QUESTIONS AND ANSWERS ABOUT VOTING PROCEDURES

FOR THE SPECIAL MEETINGS

 

Q: What should I do now?

 

A: After you have carefully read this joint proxy statement/prospectus, indicate on your proxy card how you want to vote, and sign and mail it in the enclosed postage-paid envelope as soon as possible so that your shares will be represented at your special meeting. If you sign and send in a proxy card but do not indicate how you want to vote, your proxy will be voted in favor of the proposal to approve and adopt the merger agreement.

 

Q: Why is my vote important?

 

A: In the case of First Capital, the merger agreement must be approved by the holders of a majority of the outstanding shares entitled to vote at the First Capital special meeting. Accordingly, if a First Capital shareholder fails to vote on the merger, it will have the same effect as a vote against the merger. In the case of Flag, the merger agreement must be approved by a majority of the votes cast at the Flag special meeting, provided that a quorum is present. Unless the holders of more than 50% of the outstanding shares return their proxy cards or appear in person at the Flag special meeting, a quorum will not be present and the merger agreement will not be approved.

 

Q: If my shares are held in “street name” by my broker, will my broker vote my shares for me?

 

A: No. Your broker will vote your shares only if you provide instructions on how to vote. Following the directions your broker provides, you should instruct your broker how to vote your shares. If you do not provide instructions to your broker, your shares will not be voted.

 

Q: Can I change my vote after I have submitted my proxy?

 

A: Yes. There are three ways you can change your vote. First, you may send a written notice to the person to whom you submitted your proxy stating that you would like to revoke your proxy. Second, you may complete and submit a later dated proxy with new voting instructions. The latest vote actually received by your company prior to your shareholders’ meeting will be your vote. Any earlier votes will be revoked. Third, you may attend your shareholders’ meeting and vote in person. Any earlier votes delivered by proxy will be revoked. Simply attending your meeting without voting, however, will not revoke your proxy. If you have instructed a broker to vote your shares, you must follow the directions you will receive from your broker to change or revoke your proxy.

 

Q: Should I send in my stock certificates now?

 

A: No. You should not send in your stock certificates at this time. Flag shareholders will not exchange their certificates in the merger. The certificates currently representing the shares of Flag common stock will represent an equal number of shares of Flag common stock after the merger.

 

  First Capital shareholders will exchange their First Capital common stock certificates for Flag common stock certificates after we complete the merger. Instructions for exchanging First Capital common stock certificates will be sent to you promptly after the merger is completed.

 

Q: Whom should I call with questions about the merger?

 

A: First Capital shareholders should call H.N. Padget, Jr. at (770) 921-6400. Flag shareholders should call J. Daniel Speight at (404) 760-7700.


Table of Contents
Index to Financial Statements

SUMMARY

 

This summary highlights selected information from this joint proxy statement/prospectus. It may not contain all of the information that is important to you. To better understand the merger and its potential impact on you, we urge you to read this entire joint proxy statement/prospectus and the documents incorporated by reference into this joint proxy statement/prospectus carefully. See “Where You Can Find More Information” on page 110. Each item in this summary includes a page reference directing you to a more complete discussion of the item.

 

The Companies (page 59)

 

Flag Financial Corporation

3475 Piedmont Road, N.E., Suite 550

Atlanta, Georgia 30305

(404) 760-7700

 

Flag Financial Corporation was organized in 1993 and is headquartered in Atlanta, Georgia. As of June 30, 2005, Flag had approximately $862.5 million in assets. Its state bank subsidiary, Flag Bank, operates 23 locations in the following cities and counties in Georgia: Atlanta (Fulton County, DeKalb County and Cobb County), Unadilla (Dooly County), Vienna (Dooly County), Montezuma (Macon County), Buena Vista (Marion County), LaGrange (Troup County), Hogansville (Troup County), Jonesboro (Clayton County), Duluth (Gwinnett County), Columbus (Muscogee County), Macon (Bibb County), Newnan (Coweta County) and Warner Robins (Houston County). The bank offers a broad range of banking products and services, including residential mortgage loans, consumer loans, commercial loans, commercial real estate loans, residential construction loans, securities investments and other services.

 

First Capital Bancorp, Inc.

3320 Holcomb Bridge Road, N.W., Suite A

Norcross, Georgia 30092

(770) 921-6400

 

First Capital Bancorp, Inc. was organized in 1997 and is headquartered in Norcross, Georgia. As of June 30, 2005, First Capital had approximately $674.8 million in assets. Its state bank subsidiary, First Capital Bank, operates five locations in Norcross, Alpharetta, Duluth and Cumming, Georgia. The bank is a full service commercial bank that offers a broad range of banking products and services, including commercial, real estate, residential mortgage, SBA and consumer loans, cash management and other services. In addition, First Capital operates Capital Financial Software, LLC, which markets and sells a proprietary software package used by bankruptcy trustees to monitor and track the disposition of Chapter 7 bankruptcy cases.

 

The Merger (page 38)

 

We are proposing a merger between Flag and First Capital whereby First Capital will merge with and into Flag. Flag will be the surviving company after the merger. The merger will combine our businesses under a single holding company named Flag Financial Corporation. As a result of the merger, Flag will acquire ownership of First Capital Bank, and it will be immediately merged with and into Flag Bank, which will continue as Flag’s sole banking subsidiary. First Capital’s other subsidiary, Capital Financial Software, also will become a subsidiary of Flag Bank after the merger. Flag will also assume First Capital’s trust subsidiary, First Capital Statutory Trust I, which was created in connection with First Capital’s issuance of trust preferred securities.

 

After the merger, Flag’s board of directors will have 12 members, nine from Flag and three from First Capital. The directors from Flag will be William H. Anderson, II, H. Speer Burdette, III, Stephen W. Doughty, Joseph W. Evans, Quill O. Healey, John D. Houser, James W. Johnson, J. Daniel Speight, and J. Thomas Wiley, Jr.

 

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Index to Financial Statements

The directors from First Capital will be H.N. Padget, Jr. and two other directors of First Capital in office immediately prior to the effective time of the merger. Mr. Evans will serve as the chairman of the board, president and chief executive officer, and Messrs. Doughty, Speight and Wiley will serve as vice chairmen. Mr. Padget will serve as the executive vice president of Flag and president of Flag Bank.

 

Upon the completion of the merger, each share of First Capital common stock will be converted into 1.6 shares of Flag common stock. The exchange ratio is fixed. Any non-institutional First Capital shareholder that would own more than 384,000 shares of Flag common stock following the merger will receive a cash payment, in lieu of shares of Flag common stock over the 384,000 share threshold, equal to the number of such excess shares multiplied by $14.76 per share, the average closing price of Flag’s common stock for the 20 trading days immediately following the public announcement of the merger. William R. Blanton, the vice chairman, chief financial officer and chief operating officer of First Capital, will be entitled to a cash payment of approximately $19.1 million as a result. See “—Interests of Directors and Officers of Flag and First Capital that Differ from Your Interests” below. After the merger, the market price of the Flag common stock that First Capital shareholders will receive as a result of the merger may be significantly higher or lower than its current value or its value on the date of the special meetings.

 

Cash payments will be made instead of issuing fractional shares. For example, if you hold 11 shares of First Capital common stock, you will receive 17 shares of Flag common stock (11 x 1.6 = 17.6), plus a cash payment equal to the value of 0.60 of a share of Flag common stock at the time of the merger based on the average of the closing price of Flag Common Stock for the 20 trading days immediately prior to the effective date of the merger.

 

After the merger, Flag’s existing shareholders will own approximately 55.6% of the total shares outstanding, and First Capital’s shareholders will own approximately 44.4% of Flag’s outstanding shares.

 

Reasons for the Merger (page 21)

 

We are proposing to merge our two companies because we believe that:

 

    the complementary, rather than competitive, geographical scope of our banks will allow us to continue to increase our banking presence in the metropolitan Atlanta market;

 

    we will be better positioned to compete and grow in a consolidating financial services industry as a result of a larger capital base, additional leadership and greater financial resources;

 

    we should be able to obtain greater efficiencies and attain a higher level of financial performance than our two companies could achieve separately;

 

    the management and core competencies of the two companies are complimentary, as both are focused on banking the real estate sector and owner managed businesses and on various deposit gathering strategies; and

 

    the increase in our shareholder base may, over time, increase the liquidity and marketability of our shares.

 

Regulatory Matters (page 48)

 

We cannot complete our merger unless we obtain the approval of applicable bank regulatory authorities, including the Federal Reserve Bank of Atlanta (the “Federal Reserve”) and the Georgia Department of Banking and Finance (the “Georgia Department”). We are in the process of preparing and filing applications for approval of the merger with the Federal Reserve and the Georgia Department. In connection with the applications, we propose to issue and sell up to $25,000,000 in trust preferred securities through a newly formed trust subsidiary

 

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Index to Financial Statements

of Flag in an offering to accredited investors that is exempt from the registration requirements of the Securities Act of 1933. The offering of the trust preferred securities by Flag will be subject to the prior approval of the Federal Reserve and the Georgia Department. In connection with applications, we also plan to raise at least $5,000,000 in additional capital through the issuance of common stock upon the exercise of existing warrants, some of which are held by certain members of our senior management team. After the consummation of the merger, we propose to merge Flag Bank and First Capital Bank, with Flag Bank remaining as the surviving banking corporation. We cannot complete the proposed bank merger unless we obtain the approval of applicable bank regulatory authorities, including the Federal Deposit Insurance Corporation (the “FDIC”) and the Georgia Department. We are in the process of preparing and filing applications for approval of the bank merger with the FDIC and the Georgia Department.

 

Flag Shareholders Meeting (page 15)

 

Flag will hold its special shareholders meeting on Tuesday, September 20, 2005 at 1:00 p.m. local time at its offices located at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia 30305.

 

Flag’s Record Date and Voting (page 15)

 

If you owned shares of Flag stock at the close of business on July 29, 2005, the record date, you are entitled to vote on the merger agreement, as well as any other matters considered at the meeting. On the record date, there were 8,546,086 shares of Flag stock outstanding. You will have one vote at the meeting for each share of Flag stock you owned on the record date. The affirmative vote of at least a majority of all of the votes cast at the special meeting is required to approve the merger agreement. As of the record date, Flag’s current directors, executive officers and their affiliates beneficially owned approximately 22.8% of the outstanding shares of Flag common stock. Each of Flag’s directors and executive officers has agreed, subject to several conditions, to vote his or her shares of Flag common stock in favor of the merger agreement.

 

Flag’s Board Recommends Shareholder Approval (page 18)

 

Flag’s board of directors believes that the merger is in the best interest of Flag and its shareholders and recommends that the shareholders vote “FOR” approval of the merger agreement.

 

First Capital Shareholders Meeting (page 15)

 

First Capital will hold its special shareholders meeting on Tuesday, September 20, 2005 at 10:00 a.m. local time at the Country Club of Roswell located at 2500 Club Springs Drive, Roswell, Georgia 30076.

 

First Capital’s Record Date and Voting (page 15)

 

If you owned shares of First Capital stock at the close of business on August 12, 2005, the record date, you are entitled to vote on the merger agreement as well as any other matters considered at the meeting. On the record date, there were 5,079,502 shares of First Capital stock outstanding. You will have one vote at the meeting for each share of First Capital stock you owned on the record date. The affirmative vote of at least a majority of all of the votes entitled to be cast at the special meeting is required to approve the merger agreement. As of the record date, First Capital’s directors and executive officers and their affiliates beneficially owned approximately 43% of the outstanding shares of First Capital common stock. Each of First Capital’s directors and executive officers has agreed, subject to several conditions, to vote his or her shares of First Capital common stock in favor of the merger agreement.

 

First Capital’s Board Recommends Shareholder Approval (page 18)

 

First Capital’s board of directors believes that the merger is in the best interest of First Capital and its shareholders and recommends that the shareholders vote “FOR” approval of the merger agreement.

 

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Index to Financial Statements

Interests of Directors and Officers of Flag and First Capital that Differ from Your Interests (page 43)

 

When considering the recommendations of the Flag and First Capital boards of directors, you should be aware that some directors and officers have interests in the merger that differ from the interests of other shareholders, including the following:

 

    in connection with the merger, Flag will pay cash to any non-institutional First Capital shareholder that would own more than 384,000 shares of Flag common stock following the merger will receive a cash payment, in lieu of shares of Flag common stock over the 384,000 share threshold, equal to the number of such excess shares multiplied by $14.76 per share, the average closing price of Flag’s common stock for the 20 trading days immediately following the public announcement of the merger. William R. Blanton, the vice chairman, chief financial officer and chief operating officer of First Capital, will receive a cash payment of approximately $19.1 million as a result of this provision;

 

    William R. Blanton has entered into a non-compete and consulting agreement with Flag pursuant to which he has agreed to be subject to non-compete covenants and to provide consulting services to Flag for a term of 21 months following the merger in exchange for a payment of $900,000, and Flag has agreed to reimburse Mr. Blanton for up to $20,000 in legal expenses incurred by him in connection with the non-compete and consulting agreement;

 

    following the merger, Flag will employ H. N. Padget, Jr. as executive vice president of Flag and president of Flag Bank. We expect Mr. Padget will receive an annual base salary equal to $180,000 and incentive compensation based on factors to be determined by the board of directors. Mr. Padget’s employment agreement will have an initial term of one year, which will automatically renew each day after the effective date such that the term remains a 12-month term until either party gives notice of termination, except in the event of Mr. Padget’s death;

 

    following the merger, Flag will employ Steven G. Deaton as executive vice president of Flag Bank. We expect Mr. Deaton will receive an annual base salary equal to $160,000 and incentive compensation based on factors to be determined by the board of directors. Mr. Deaton’s employment agreement will have an initial term of one year, which will automatically renew each day after the effective date such that the term remains a 12-month term until either party gives notice of termination, except in the event of Mr. Deaton’s death;

 

    the initial board of directors of the combined company will include three current First Capital directors to be selected by the board of directors of First Capital and approved by Flag, one of whom will be H.N. Padget, Jr.;

 

    following the merger, Flag will transfer to William R. Blanton the software development and deposit and loan production program of First Capital called “Good Shepherds,” which is targeted towards churches and other faith-based organizations, and First Capital and Flag have agreed, at Mr. Blanton’s expense, to permit continued development of the software until the completion of the merger. In consideration of the transfer, Mr. Blanton will pay Flag cash equal to an 8% premium on the principal balance of the deposits developed by the Good Shepherds program as of May 26, 2005, and the principal balance of the loans developed by the Good Shepherds program, plus all accrued interest and other charges;

 

    in connection with the merger agreement, Flag has agreed to provide generally to officers and employees of First Capital, who after the merger become employees of Flag or its subsidiaries, employee benefits under employee benefit plans, on terms and conditions substantially similar to those currently provided to similarly situated Flag officers and employees;

 

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Index to Financial Statements
    in the event Messrs. Padget and Deaton or any of the directors of First Capital are terminated, resign or are removed following the merger, they will receive retirement benefits under the supplemental retirement agreements as if they had been continuously employed until age 65 and their beneficiaries will receive the death benefit set forth in the split dollar agreements as if they had died while serving on the board of directors or while employed by First Capital or First Capital Bank, as applicable; and

 

    following the merger, Flag will generally indemnify and provide liability insurance to the current directors and officers of First Capital.

 

The board of directors of each of Flag and First Capital were aware of these and other interests and considered them before approving and adopting the merger agreement.

 

Federal Income Tax Consequences (page 41)

 

First Capital’s shareholders generally will not recognize gain or loss for federal income tax purposes on the receipt of shares of Flag common stock in the merger in exchange for the shares of First Capital stock surrendered. First Capital shareholders will be taxed, however, on any cash that they receive instead of any shares of Flag stock, including cash in lieu of fractional shares of Flag stock. Flag shareholders also generally will have no tax consequences as a result of the merger. However, First Capital and Flag shareholders who properly exercise their rights to dissent from the merger will generally be taxed on all or a portion of the cash they receive. Tax matters are complicated, and the tax consequences of the merger vary among shareholders. We urge you to contact your own tax advisor to fully understand how the merger will affect you.

 

Comparative Rights of Shareholders (page 102)

 

Both Flag and First Capital are incorporated under the laws of the State of Georgia and are subject to the laws set forth in the Georgia Business Corporation Code. Upon consummation of the merger, the shareholders of First Capital will become shareholders of Flag and the articles of incorporation and bylaws of Flag will govern their rights. Flag’s articles of incorporation and bylaws differ somewhat from those of First Capital.

 

Conditions of the Merger (page 46)

 

The completion of the merger depends on the fulfillment of a number of conditions, including the following:

 

    Flag and First Capital shareholders must approve the merger agreement;

 

    we must receive all required regulatory approvals, and any waiting periods required by law must have passed (see “—Regulatory Matters” above);

 

    we must receive a legal opinion from counsel confirming the tax-free nature of the merger;

 

    each party’s representations, warranties, agreements and covenants, which are contained in the merger agreement, must be accurate in all material respects and must have been duly performed and complied with in all material respects;

 

    each party must have delivered officers’ certificates and its counsel’s legal opinions to the other;

 

    H. N. Padget, Jr. must have entered into an employment agreement with Flag, and must have terminated his existing employment agreement with First Capital;

 

    each of the executive officers and directors of Flag and First Capital must have entered into a support agreement pursuant to which they agree to vote their shares in favor of the merger;

 

    Flag must have received from each “affiliate” of First Capital an agreement stating, among other things, that he or she will comply with federal securities laws when transferring any shares of Flag common stock received in the merger (see “Terms of the Merger—Resales of Flag Common Stock”);

 

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Index to Financial Statements
    the registration statement registering the shares of Flag common stock to be received by First Capital shareholders, of which this joint proxy statement/prospectus is a part, must have been declared effective by the Securities and Exchange Commission, and all necessary approvals under federal and state securities laws relating to the issuance or trading of the shares of Flag common stock issuable pursuant to the merger must have been received;

 

    William R. Blanton shall have entered into a non-compete and consulting agreement with Flag pursuant to which he agrees to be subject to non-compete covenants and to provide consulting services to Flag for a term of 21 months. In addition, Mr. Blanton shall have terminated, effective as of and subject to the closing of the merger, any existing employment with First Capital and its subsidiaries;

 

    Flag’s board of directors must have elected the three directors from First Capital as the members of Flag’s board of directors effective as of the effective time of the merger; and

 

    shares of Flag common stock issuable pursuant to the merger must be approved for listing on the Nasdaq National Market or other market on which its common stock is then listed.

 

Unless prohibited by law, either Flag or First Capital can elect to waive a condition that has not been satisfied and complete the merger. We cannot be certain whether or when any of these conditions will be satisfied, or waived where permissible, or that we will complete the merger.

 

Termination of the Merger Agreement (page 48)

 

Notwithstanding the approval of the merger by Flag and First Capital shareholders, we can agree at any time to terminate the merger agreement before completing the merger.

 

Either Flag or First Capital can also terminate the merger agreement:

 

    if the merger is not approved by the other party’s shareholders;

 

    if the other party materially violates any of its representations or warranties under the merger agreement and fails to cure the violation;

 

    if we do not complete the merger by March 31, 2006; or

 

    if any governmental body whose approval is necessary to complete the merger makes a final decision not to approve the merger.

 

Prior to the shareholder approval of the merger, either Flag or First Capital can terminate the merger, subject to a termination fee of $2,000,000, in order to enter into a definitive agreement with respect to a superior acquisition proposal, if such party’s board of directors determines in good faith that to do so would be consistent with its fiduciary duty to the shareholders.

 

Dissenters’ Appraisal Rights (page 52)

 

Georgia law permits First Capital’s shareholders to dissent from approving the merger agreement and to have the fair value of their First Capital shares paid to them in cash. To do this, First Capital’s shareholders must follow specific procedures, including filing a written notice with First Capital prior to First Capital’s shareholder vote on the merger agreement. If you follow the required procedures, your only right will be to receive the fair value of your common stock in cash.

 

Accounting Treatment (page 51)

 

The merger will be accounted for using the purchase method of accounting, with First Capital being treated as the acquired entity for accounting purposes. Under the purchase method of accounting, the assets and liabilities of First Capital as of the effective time will be recorded at their respective fair values and added to those of Flag.

 

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Index to Financial Statements

Flag’s Dividends Following the Merger (page 108)

 

First Capital has never paid a dividend on its common stock. Flag has historically paid quarterly dividends on its common stock. However, Flag’s future dividend policy after the merger will depend on Flag’s earnings, capital requirements, financial condition and other factors considered relevant by the board of directors of Flag.

 

Market Price of Flag and First Capital Common Stock

 

The common stock of Flag is traded on Nasdaq National Market under the symbol “FLAG.” The common stock of First Capital trades on the Over the Counter Bulletin Board under the symbol “FCBX.OB.” The market for First Capital’s common stock must be characterized as a limited market due to its relatively low trading volume and little analyst coverage. Therefore, the closing sales prices provided herein reflect inter-dealer prices without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.

 

The following table sets forth the closing sales prices per share of Flag and First Capital common stock on May 26, 2005, the last trading day prior to the public announcement of the merger agreement, and on August 12, 2005, the latest practicable date prior to the mailing of this joint proxy statement/prospectus, as well the equivalent per share value of First Capital common stock on those dates.

 

     Flag

   First
Capital


   Equivalent Price of
First Capital
Common Stock(1)


May 26, 2005

   $ 15.90    $ 18.00    $ 25.44

August 12, 2005

   $ 15.15    $ 23.60    $ 24.24

(1) The equivalent prices per share of First Capital common stock have been calculated by multiplying the exchange ratio by the closing price of Flag common stock on that date.

 

Flag common stock was held by approximately 781 shareholders of record as of the record date. First Capital common stock was held by approximately 127 shareholders of record as of the record date.

 

Because the exchange ratio is fixed and because the market price of Flag common stock is subject to fluctuation, the market value of the shares of Flag common stock that you may receive in the merger may increase or decrease prior to and following the merger. You are urged to obtain current market quotations for Flag common stock.

 

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Index to Financial Statements

Comparative Unaudited Per Share Data

 

The following unaudited financial information presents certain comparative per share data (i) for Flag and First Capital on a historical basis, (ii) for Flag on a pro forma combined basis assuming the merger has been effective during the periods presented, and (iii) for First Capital on a pro forma equivalent basis. The pro forma combined information has been prepared giving effect to the merger under the purchase method of accounting with Flag treated as the acquirer.

 

The information shown below should be read in conjunction with (i) the consolidated financial statements of Flag and the related notes, incorporated by reference herein, (ii) the consolidated financial statements of First Capital and the related notes, appearing elsewhere in this joint proxy statement/prospectus, and (iii) the unaudited pro forma financial statements appearing elsewhere in this joint proxy statement/prospectus. See “Where You Can Find More Information,” “Uuaudited Pro Forma Condensed Combined Financial Information,” and “Financial Statements of First Capital Bancorp, Inc. and Subsidiaries.” The following information is not necessarily indicative of the results of operations or combined financial position that would have resulted had the merger been consummated at the beginning of the periods presented, nor is it necessary indicative of the result of operations of future periods or future combined financial position.

 

    

Six Months Ended

June 30, 2005


  

Year Ended

December 31, 2004


Net Income Per Share—Fully Diluted:

         

Historical—Flag (1)

   0.45    0.82

Historical—First Capital (2)

   0.50    0.80

Pro Forma Combined

   0.36    0.56

First Capital Pro Forma Equivalent (3)

   0.58    0.90

Cash Dividends Declared Per Share:

         

Historical—Flag (1)

   0.12    0.24

Historical—First Capital (2)

     

Pro Forma Combined

   0.12    0.24

First Capital Pro Forma Equivalent (3)

   0.19    0.38
     At Period Ended

     June 30, 2005

   December 31, 2004

Book Value Per Share

         

Historical—Flag (4)

   8.47    8.14

Historical—First Capital (4)

   11.73    11.30

Pro Forma Combined

   11.62    11.77

First Capital Pro Forma Equivalent (3)

   18.59    18.84

(1) Based on the weighted average shares of common stock outstanding during the indicated periods.
(2) Based on the weighted average shares of common stock and dilutive common stock equivalents outstanding during the indicated periods.
(3) First Capital Pro Forma Equivalent amounts represent pro forma combined information multiplied by the exchange ratio of 1.6 shares of Flag common stock for each share of First Capital common stock.
(4) Based on shares of common stock outstanding at the indicated date.

 

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FLAG FINANCIAL CORPORATION

SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

 

Set forth below are highlights from Flag’s consolidated financial data as of and for the years ended December 31, 2000 through 2004 and Flag’s unaudited consolidated financial data as of and for the six months ended June 30, 2004 and 2005. This information should be read together with Flag’s consolidated financial statements and related notes included in Flag’s Annual Report on Form 10-K for the year ended December 31, 2004, which is incorporated by reference in this document and from which this information is derived.

 

(Dollars in thousands except

per share data)


 

Six Months Ended
June 30,

(Unaudited)


    Year Ended December 31

 
    2005

    2004

    2004

    2003

    2002

    2001

    2000

 

Net interest income

  $ 26,851     19,745     30,564     25,987     24,302     23,980     24,961  

Provision for loan losses

    375     1,095     1,845     1,321     4,549     2,488     3,597  

Non-interest income

    5,194     7,283     11,468     10,365     7,395     10,668     11,962  

Non-interest expense

    16,539     14,721     29,509     26,202     31,005     25,701     27,633  

Earnings (loss) before income taxes

    6,106     5,958     10,678     8,829     (3,857 )   6,459     5,693  

Income taxes

    1,973     1,941     3,310     2,724     (2,028 )   1,753     1,409  

Extraordinary items

                    165     696      

Net earnings (loss) income

    4,133     4,017     7,368     6,105     (1,994 )   4,010     4,284  

PER COMMON SHARE

                                           

Basic earnings per common share

  $ 0.48     0.47     0.88     0.72     (0.24 )   0.51     0.52  

Diluted earnings per common share

    0.45     0.44     0.82     0.67     (0.24 )   0.51     0.52  

Cash dividends declared

    0.12     0.12     0.24     0.24     0.24     0.24     0.24  

Book value

    8.47     7.55     8.14     7.65     7.24     7.33     6.83  

PERIOD END BALANCES

                                           

Loans, net of unearned income

  $ 647,862     530,338     596,101     477,095     374,784     368,967     384,661  

Earning assets

    805,442     693,613     772,387     647,481     569,755     512,942     501,046  

Assets

    862,509     749,371     828,337     703,857     636,131     570,202     559,037  

Deposits

    740,803     610,636     706,847     570,570     509,731     440,582     461,438  

Shareholders’ equity

    72,389     64,392     69,202     65,260     60,749     54,023     55,498  

Common shares outstanding

    8,546     8,333     8,503     8,528     8,394     7,370     8,333  

AVERAGE BALANCES

                                           

Loans, net of unearned income

  $ 611,506     497,017     541,502     417,395     366,571     378,867     405,101  

Earning assets

    780,975     661,420     690,187     587,484     511,737     508,752     510,898  

Assets

    837,974     714,916     743,082     645,430     560,984     560,816     566,355  

Deposits

    719,083     578,219     612,712     516,067     442,645     449,985     455,338  

Shareholders’ equity

    70,424     66,568     65,854     63,299     58,865     56,294     53,853  

Weighted average shares outstanding—diluted

    9,249     9,036     8,396     8,471     8,201     7,808     8,210  

KEY PERFORMANCE RATIOS

                                           

Return on average assets

    0.99 %   1.12 %   0.99 %   0.95 %   (0.36 )%   0.72 %   0.77 %

Return on average shareholders’ equity

    11.74 %   12.07 %   11.19 %   9.64 %   (3.39 )%   7.12 %   7.95 %

Net interest margin

    4.65 %   4.47 %   4.48 %   4.50 %   4.86 %   4.83 %   4.99 %

Dividend payout ratio

    24.56 %   25.27 %   27.38 %   33.35 %   N/A     46.27 %   45.98 %

Average equity to average assets

    8.40 %   9.27 %   8.86 %   9.81 %   10.49 %   10.04 %   9.31 %

 

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Index to Financial Statements

RISK FACTORS RELATING TO THE MERGER

 

If the merger is consummated and you are a First Capital shareholder, you will receive shares of Flag common stock in exchange for your shares of First Capital common stock. An investment in Flag common stock is subject to a number of risks and uncertainties, many of which also apply to your existing investment in First Capital common stock. Risks and uncertainties relating to general economic conditions are not summarized below. Those risks, among others, are highlighted on page 14 under the heading “A Warning About Forward-Looking Statements.”

 

However, there are a number of other risks and uncertainties relating to Flag and your decision on the merger that you should consider in addition to the risks and uncertainties associated with financial institutions generally. Many of these risks and uncertainties could affect Flag’s future financial results and may cause Flag’s future earnings and financial condition to be less favorable than Flag’s expectations. This section summarizes those risks.

 

Your merger consideration is fixed despite any change in Flag’s stock price.

 

Each share of First Capital common stock owned by you will be converted into the right to receive 1.6 shares of Flag common stock. The price of Flag common stock when the merger takes place may vary from its price at the date of this joint proxy statement/prospectus and at the date of First Capital’s special meeting. Because the exchange ratio will not be adjusted to reflect any changes in the market value of Flag or First Capital common stock, the market value of the Flag common stock issued in the merger and the First Capital common stock surrendered in the merger may be higher or lower than the values of such shares on such earlier dates. Such variations in the price of Flag common stock may result from changes in the business, operations or prospects of Flag, regulatory considerations, general market and economic conditions and other factors. At the time of First Capital’s special meeting, you will not know the exact value of the consideration you will receive when the merger is completed.

 

You will experience a reduction in percentage ownership and voting power with respect to your shares as a result of the merger.

 

Flag shareholders and First Capital shareholders will experience a substantial reduction in their respective percentage ownership interests and effective voting power relative to their respective percentage ownership interests in Flag and First Capital prior to the merger. If the merger is consummated, current Flag shareholders will own approximately 55.6% of Flag’s outstanding common stock, on a fully diluted basis, and current First Capital shareholders will own approximately 44.4% of Flag’s outstanding common stock, on a fully diluted basis. Accordingly, current First Capital shareholders will own less than a majority of the outstanding voting stock of the combined company and could, as a result, be outvoted by the current Flag shareholders if such current Flag shareholders voted together as a group. Therefore, neither group of shareholders will have the same control over the combined company as they currently have over their respective companies.

 

In the future, Flag may issue additional shares in public offerings, mergers and acquisitions or otherwise, all of which would further reduce your percentage ownership in Flag.

 

If Flag and First Capital do not successfully integrate, the combined company may not realize the expected benefits from the merger.

 

Flag and First Capital expect that the combined company will be able to maintain most of First Capital’s and Flag’s key customers and personnel and integrate their systems and procedures with a minimal amount of cost and diversion of management time and attention. There is a risk that integrating the two companies may take a greater amount of resources and time than we expect.

 

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Index to Financial Statements

Integrating a merger of similar size companies is difficult. The integration process relies on the combination of the management teams of both Flag and First Capital into an effective unit, and the melding of two bank holding companies that have previously operated independently. Accordingly, we may not be able to integrate the operations of the two companies without encountering difficulties. Such difficulties could include interruptions and dislocations associated with integrating the operating cultures and business strategies of the two companies. Furthermore, one-fourth of Flag’s board of directors after the merger will consist of former First Capital directors. Disagreements among the board members of the combined company may result concerning the allocation of resources to various lines of business, strategic considerations relating to the emphasis or elimination of business groups and other matters. Flag’s board of directors may not be able to work together successfully following the merger. In addition, persuading employees that the business cultures of Flag and First Capital are compatible, maintaining employee morale and retaining key employees are additional challenges involved in integrating the two companies.

 

Upon the completion of the merger, we plan to merge Flag Bank and First Capital Bank, the respective bank subsidiaries of Flag and First Capital, with Flag Bank being the surviving banking corporation. The bank merger will be subject to the approval of regulatory authorities, including the FDIC and the Georgia Department. The failure to receive the required approval for the bank merger may impair our ability to achieve the benefits of the merger and the anticipated cost savings.

 

Flag’s ability to achieve the benefits of the merger depends on successfully integrating the two companies. Accordingly, if we are unable to integrate the merger in a timely manner, fail to realize anticipated cost savings, or disrupt customer relationships, there is a risk that the anticipated benefits may not be realized or that they may be less than we expect.

 

In order to be successful, the combined company must retain the relationships of its directors and retain and motivate its key employees, and the failure to do so could seriously harm the combined company.

 

The combined company’s future success depends, in large part, upon the continuing contributions of the directors of First Capital Bank and Flag Bank as well as their key management personnel. If we lose the services of one or more of these important individuals following the merger, Flag could be adversely affected. Flag’s future success is also dependent upon its continuing ability to attract and retain other highly qualified personnel. Although each of H.N. Padget, Jr., who will serve as executive vice president of Flag and president of Flag Bank after the merger, Steven G. Deaton, who will serve as executive vice president of Flag Bank after the merger, and William R. Blanton, who will serve as a consultant after the merger, will be subject to their respective employment agreements and consulting agreement, we cannot be assured of their continued service. Because we will continue to be customer focused and relationship driven, our directors’ and key employees’ community involvement, diverse backgrounds and extensive local business relationships are important to our future success. The unexpected loss of services of one or more of our key employees or directors could have a material adverse effect on our operations and possibly result in reduced earnings and revenues.

 

The capital we intend to raise prior to completing the merger may not be adequate to support our future growth following the merger.

 

In connection with our applications to the Federal Reserve and the Georgia Department for approval of the merger, we have proposed to raise $25 million in additional capital through the issuance of trust preferred securities and $5 million in additional capital through the issuance of common stock upon the exercise of the existing warrants, some of which are held by members of our senior management team. While we believe that the capital to be raised will be sufficient to meet our immediate capital needs following the merger, such amounts may be inadequate to support our growth or to maintain our minimum capital requirements. Consequently, we may need to seek additional long- and short-term financing, including subsequent sales of our common stock and/or preferred stock, to support any additional needs. Such financing, if needed, may not be available or, if available, may not be on terms acceptable to us. In the event such financing is needed and is not available, we may be limited in our ability to grow in the future and our results of operations and financial condition may be adversely affected.

 

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Index to Financial Statements

Additional issuances of Flag common stock may dilute your ownership, and shareholders do not enjoy preemptive rights.

 

No holder of Flag common stock has preemptive rights with respect to the future issuance of shares of any class of Flag capital stock. We are authorized to issue up to 20,000,000 shares of common stock without the approval of shareholders, of which approximately 7,599,650 shares are expected to be issued upon completion of the merger, and of which approximately 16,145,736 shares are expected to be outstanding upon completion of the merger. Flag’s directors could from time to time decide to issue additional shares of common stock in addition to the shares to be issued in the merger and the shares to be issued in this offering. The sale of additional shares of Flag common stock may be at prices lower than the price at which you purchase shares or on terms better than those of shares you purchase.

 

In addition, if the merger is completed, each existing option to purchase First Capital common stock will be converted into the right to purchase shares of Flag common stock. Holders of these options and Flag’s original directors, officers and employees who hold options to purchase Flag common stock may exercise those options, which would result in the dilution of your proportionate interest in Flag. These individuals will have the opportunity to profit from any rise in the market value of the common stock or any increase in Flag’s net worth. As of June 30, 2005, there were 555,672 options outstanding to purchase First Capital common stock, and as of June 30, 2005 there were 2,004,237 options and warrants outstanding to purchase Flag common stock. Based on the number of outstanding options and warrants as of June 30, 2005, following the completion of the merger, there will be 2,125,263 outstanding options and warrants to purchase Flag common stock, which will represent, post-merger, 11.6% of the outstanding common stock, options and warrants of Flag.

 

The exercise of options for the purchase of our common stock also could adversely affect the terms on which Flag can obtain additional capital. For instance, the holders of options may choose to exercise their options, when the securities underlying those options otherwise could be offered to others on terms and at prices more favorable to us than the terms and exercise prices provided for in the options.

 

Flag may not pay dividends in the future.

 

Flag has historically paid quarterly dividends of $0.06 per share. However, no assurance can be provided that Flag will continue to pay dividends following the merger. After the merger, Flag’s ability to pay dividends will depend largely on the ability of Flag Bank to pay dividends to Flag, which will be based primarily on Flag Banks’ earnings, capital requirements and financial condition, among other factors. Bank holding companies and their bank subsidiaries are both subject to significant regulatory restrictions on the payment of cash dividends. Flag’s dividend policy will depend on its earnings, capital requirements and financial condition, as well as other factors its board of directors considers relevant. See “Comparative Rights of First Capital Shareholders and Flag Shareholders—Dividends.”

 

The merger agreement limits Flag’s and First Capital’s abilities to pursue alternatives to the merger.

 

The merger agreement contains “no-solicitation” provisions that, subject to specific exceptions, limit Flag’s and First Capital’s ability to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of either Flag or First Capital. In addition, Flag or First Capital have agreed that if the merger agreement is terminated under certain circumstances, Flag or First Capital will pay the other a termination fee of $2,000,000. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of Flag or First Capital from considering or proposing an acquisition even if it were prepared to pay consideration with a higher per share price than that proposed in the merger, or might result in a potential competing acquirer proposing to pay a lower per share price to acquire Flag or First Capital than it might otherwise have proposed to pay.

 

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Index to Financial Statements

The merger is subject to certain closing conditions that, if not satisfied or waived, will result in the merger not being completed, which may cause the market price of Flag common stock or First Capital common stock to decline.

 

The merger is subject to customary conditions to closing, including the approval of regulatory authorities, including the Federal Reserve and the Georgia Department, and the receipt of required approvals of the shareholders of Flag and First Capital. If any condition to the merger is not satisfied or, if permissible, waived, the merger will not be consummated. In addition, Flag and First Capital may terminate the merger agreement in certain circumstances. If Flag and First Capital do not complete the merger, the market price of Flag or First Capital common stock may fluctuate to the extent that the current market prices of those shares reflect a market assumption that the mergers will be completed. Flag and First Capital will also be obligated to pay certain investment banking, financing, legal and accounting fees and related expenses in connection with the merger, whether or not the mergers are completed. In addition, Flag and First Capital have and will continue to divert significant management resources in an effort to complete the merger and are each subject to restrictions contained in the merger agreement on the conduct of its business. If the merger is not completed, Flag and First Capital will each have incurred significant costs, including the diversion of management resources, for which it will have received little or no benefit. Further, in specified circumstances, Flag and First Capital may be required to pay to the other a termination fee of $2,000,000 if the merger agreement is terminated. For a detailed description of the circumstances in which such termination fee will be paid, see “Terms of the Merger—Amendment, Waiver and Termination.”

 

Directors and Officers of Flag and First Capital may have potential conflicts of interest in recommending that you vote in favor of the adoption of the merger agreement.

 

A number of directors and officers of Flag and First Capital, who recommend that you vote in favor of the adoption of the merger agreement, have employment, consulting or severance agreements, equity compensation and other benefit arrangements or other interests that provide them with interests in the merger that differ from yours. In addition, certain directors of First Capital will continue as directors of Flag while other directors will not, and in either case, Flag will indemnify and provide insurance for their services as directors of Flag and First Capital prior to the merger. You should be aware of these interests when you consider your board of directors’ recommendation that you vote in favor of the merger. For a detailed description of the interests of Flag and First Capital’s directors and officers in the merger, see “Terms of the Merger—Interests of Employees and Directors of Flag and First Capital.”

 

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

 

We make forward-looking statements in this joint proxy statement/prospectus and the documents or information incorporated by reference in this joint statement/prospectus that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our operations or our performance after the merger. Also, when we use any of the words “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and performance. This could cause our results or performance to differ materially from those expressed in our forward-looking statements. You should consider these important factors when you vote on the merger. Factors that may cause actual results to differ materially from those contemplated by our forward-looking statements include the following:

 

    our operating costs after the merger may be greater than expected, and our cost savings from the merger may be less than expected, or we may be unable to obtain those cost savings as soon as expected;

 

    we may be unable to successfully integrate First Capital or we may have more trouble integrating acquired businesses than we expected;

 

    we could lose our key personnel, including the First Capital personnel we will employ as a result of the merger, or spend a greater amount of resources attracting, retaining and motivating them than we have in the past;

 

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    competition among depository and other financial institutions may increase significantly;

 

    changes in the interest rate environment may reduce operating margins;

 

    general economic or business conditions, including acquisition and growth opportunities, may be worse than expected;

 

    legislative or regulatory changes may adversely affect our businesses; and

 

    the continuing war in Iraq, the military deployment in Afghanistan and the war on terrorism, as well as actions taken or to be taken by the United States and other governments as a result of future acts or threats of terrorism.

 

We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations actually will be achieved. We are under no duty to update any of the forward-looking statements after the date of this joint proxy statement/prospectus to conform those statements to actual results. In evaluating these statements, you should consider various factors, including the risks outlined in the section entitled “Risk Factors Relating to the Merger.” You should also consider the cautionary statements contained in Flag’s and First Capital’s filings with the Securities and Exchange Commission.

 

THE SPECIAL MEETINGS

 

General

 

First Capital. With respect to First Capital shareholders, this document constitutes a proxy statement of First Capital and a prospectus of Flag and is being mailed by First Capital and Flag to First Capital shareholders of record on or about August 18, 2005, together with the notice of the special meeting of shareholders of First Capital and a proxy solicited by First Capital’s board of directors for use at the special meeting and at any adjournments or postponements of the meeting.

 

Flag. With respect to Flag shareholders, this document constitutes a proxy statement of Flag and is being mailed by Flag to Flag shareholders of record on or about August 18, 2005, together with the notice of the special meeting of shareholders of Flag and a proxy solicited by Flag’s board of directors for use at the special meeting and at any adjournments or postponements of the meeting.

 

Meeting Dates, Times and Places and Record Dates

 

First Capital. The First Capital special meeting will be held at the Country Club of Roswell, 2500 Club Springs Drive, Roswell, Georgia, at 10:00 a.m., local time, on Tuesday, September 20, 2005. Only holders of First Capital common stock of record at the close of business on August 12, 2005 will be entitled to receive notice of and to vote at the special meeting. As of the record date, there were 5,097,502 shares of First Capital common stock outstanding and entitled to vote, with each such share entitled to one vote.

 

Flag. The Flag special meeting will be held at its office located at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia, at 1:00 p.m., local time, on Tuesday, September 20, 2005. Only holders of Flag common stock of record at the close of business on July 29, 2005 will be entitled to receive notice of and to vote at the special meeting. As of the record date, there were 8,546,086 shares of Flag common stock outstanding and entitled to vote, with each such share entitled to one vote.

 

Matters to be Considered

 

First Capital. At the First Capital special meeting, First Capital shareholders will be asked to approve the Agreement and Plan of Merger, dated as of May 26, 2005 by and between First Capital and Flag. Under the

 

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merger agreement, First Capital will merge with and into Flag and shares of First Capital common stock will be converted into the right to receive shares of Flag common stock. First Capital shareholders may also be asked to consider any other business that properly comes before the special meeting. Finally, First Capital shareholders may be asked to vote on a proposal to adjourn or postpone the special meeting, which could be used to allow more time for soliciting additional votes to approve the merger agreement. Each copy of this proxy statement/prospectus mailed to First Capital shareholders is accompanied by a proxy card for use at the special meeting.

 

Flag. At the Flag special meeting, Flag shareholders will be asked to approve the merger agreement. Flag shareholders may also be asked to consider any other business that properly comes before the special meeting. Finally, Flag shareholders may be asked to vote on a proposal to adjourn or postpone the special meeting, which could be used to allow more time for soliciting additional votes to approve the merger agreement. Each copy of this proxy statement mailed to Flag shareholders is accompanied by a proxy card for use at the special meeting.

 

Vote Required

 

First Capital. Under Georgia law, approval of the merger agreement requires the affirmative vote of the holders of at least a majority of all of the outstanding shares of First Capital common stock. On the record date, there were approximately 5,079,502 outstanding shares of First Capital common stock, each of which is entitled to one vote at the special meeting. On that date, the directors and executive officers of First Capital and their affiliates beneficially owned a total of approximately 43% of the outstanding shares of First Capital common stock. Each of First Capital’s directors and executive officers has agreed, subject to several conditions, to vote his or her shares of First Capital common stock in favor of the merger agreement. Accordingly, we believe it is highly likely that the merger agreement will be approved by First Capital’s shareholders. As of the date of this joint proxy statement/prospectus, neither Flag nor any of its affiliates owned any outstanding shares of First Capital common stock. The presence, in person or by proxy, of shares of First Capital common stock representing a majority of First Capital’s outstanding shares entitled to vote at the special meeting is necessary in order for there to be a quorum at the special meeting. A quorum must be present in order for the vote on the merger agreement to occur.

 

Flag. Approval of the merger agreement requires the affirmative vote of the holders of at least a majority of the votes cast at the special meeting. On the record date, there were approximately 8,546,086 outstanding shares of Flag common stock, each of which is entitled to one vote at the special meeting. On that date, the directors and officers of Flag and their affiliates beneficially owned a total of approximately 22.8% of the outstanding shares of Flag common stock. Each of Flag’s directors and executive officers has agreed, subject to several conditions, to vote his or her shares of Flag common stock in favor of the merger agreement. As of the date of this joint proxy statement/prospectus, neither First Capital nor any of its affiliates owned any outstanding shares of Flag common stock. The presence, in person or by proxy, of shares of Flag common stock representing a majority of Flag’s outstanding shares entitled to vote at the special meeting is necessary in order for there to be a quorum at the special meeting. A quorum must be present in order for the vote on the merger agreement to occur.

 

Voting of Proxies

 

First Capital. Shares of common stock represented by properly executed proxies received at or prior to the First Capital special meeting will be voted at the special meeting in the manner specified by the holders of such shares. Properly executed proxies that do not contain voting instructions will be voted “FOR” approval of the merger agreement, and as determined by a majority of the proxies, as to any other matter that may come before the special meeting, including, among other things, a motion to adjourn or postpone the special meeting to another time for the purpose of soliciting additional proxies or otherwise. However, no proxy with instructions to vote against the merger will be voted in favor of any adjournment or postponement of the special meeting. Any shareholder present in person or by proxy (including broker non-votes, which generally occur when a broker who holds shares in street name for a customer does not have the authority to vote on certain non-routine matters because its customer has not provided any voting instructions with respect to the matter) at the special meeting who abstains from voting will be counted for purposes of determining whether a quorum exists.

 

Because approval of the merger agreement requires the affirmative vote of at least a majority of all the outstanding shares of First Capital common stock entitled to vote at the special meeting, abstentions

 

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and broker non-votes will have the same effect as negative votes. Accordingly, First Capital’s board of directors urges its shareholders to complete, date and sign the accompanying proxy card and return it promptly in the enclosed, postage-paid envelope.

 

If any other matters are properly presented at the special meeting, the person or persons named in the proxy card enclosed with this joint proxy statement/prospectus and acting thereunder will have discretion to vote on such matters in accordance with their best judgment, unless the proxy indicates otherwise. First Capital has no knowledge of any matters to be presented at the special meeting, other than the matters described in this joint proxy statement/prospectus.

 

Flag. Shares of common stock represented by properly executed proxies received at or prior to the Flag special meeting will be voted at the special meeting in the manner specified by the holders of such shares. Properly executed proxies that do not contain voting instructions will be voted “FOR” approval of the merger agreement, and as determined by a majority of the proxies, as to any other matter that may come before the special meeting, including, among other things, a motion to adjourn or postpone the special meeting to another time for the purpose of soliciting additional proxies or otherwise. However, no proxy with instructions to vote against the merger will be voted in favor of any adjournment or postponement of the special meeting. Any shareholder present in person or by proxy (including broker non-votes) at the special meeting who abstains from voting will be counted for purposes of determining whether a quorum exists.

 

Because approval of the merger agreement requires the affirmative vote of at least a majority of the votes cast at the special meeting, abstentions and broker non-votes will have no effect on the outcome of the Flag shareholder vote. Flag’s board of directors urges its shareholders to complete, date and sign the accompanying proxy card and return it promptly in the enclosed, postage-paid envelope.

 

If any other matters are properly presented at the special meeting, the person or persons named in the proxy card enclosed with this joint proxy statement/prospectus and acting thereunder will have discretion to vote on such matters in accordance with their best judgment, unless the proxy indicates otherwise. Flag has no knowledge of any matters to be presented at the special meeting, other than the matters described in this joint proxy statement/prospectus.

 

Revocability of Proxies

 

First Capital. The grant of a proxy on the enclosed proxy card does not preclude you from voting in person or otherwise revoking a proxy. You may revoke a proxy at any time prior to its exercise by delivering to the secretary of First Capital either a duly executed revocation or a proxy bearing a later date. In addition, you may revoke a proxy prior to its exercise by voting in person at the special meeting. All written notices of revocation and other communications with respect to the revocation of First Capital proxies should be addressed to First Capital Bancorp, Inc., 3320 Holcomb Bridge Road, N.W., Suite A, Norcross, Georgia 30092, Attention: Secretary. Attendance at the special meeting will not in and of itself constitute revocation of a proxy.

 

Flag. The grant of a proxy on the enclosed proxy card does not preclude you from voting in person or otherwise revoking a proxy. You may revoke a proxy at any time prior to its exercise by delivering to the secretary of Flag either a duly executed revocation or a proxy bearing a later date. In addition, you may revoke a proxy prior to its exercise by voting in person at the special meeting. All written notices of revocation and other communications with respect to the revocation of Flag proxies should be addressed to Flag Financial Corporation, 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia 30305, Attention: Secretary. Attendance at the special meeting will not in and of itself constitute revocation of a proxy.

 

Solicitation of Proxies

 

First Capital. First Capital will pay all of the costs of soliciting proxies in connection with its special meeting, except that Flag will pay the costs of filing the registration statement with the SEC, of which this joint

 

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proxy statement/prospectus is a part, and one-half of the costs of printing the registration statement and this joint proxy statement/prospectus. Solicitation of proxies may be made in person or by mail, telephone or facsimile, or other form of communication by directors, officers and employees of First Capital who will not be specially compensated for such solicitation. Nominees, fiduciaries and other custodians will be requested to forward solicitation materials to beneficial owners and to secure their voting instructions, if necessary, and will be reimbursed for the expenses incurred in sending proxy materials to beneficial owners.

 

Flag. Flag will pay all of the costs of soliciting proxies in connection with its special meeting and one-half of the costs of printing the registration statement and this joint proxy statement/prospectus. Solicitation of proxies may be made in person or by mail, telephone or facsimile, or other form of communication by directors, officers and employees of Flag who will not be specially compensated for such solicitation. Nominees, fiduciaries and other custodians will be requested to forward solicitation materials to beneficial owners and to secure their voting instructions, if necessary, and will be reimbursed for the expenses incurred in sending proxy materials to beneficial owners.

 

Recommendations of the Boards of Directors

 

First Capital. First Capital’s board of directors (except for Mr. Blanton who abstained due to a conflict of interest) has approved the merger agreement and the transactions contemplated thereby, believes that the merger is in the best interests of First Capital and its shareholders, and recommends that First Capital shareholders vote FOR approval of the merger agreement.

 

In the course of reaching its decision to approve the merger agreement and the transactions contemplated in the merger agreement, First Capital’s board of directors, among other things, consulted with its legal advisors, Troutman Sanders LLP, regarding the legal terms of the merger agreement and with its financial advisor, Burke Capital Group, L.L.C. (“Burke Capital”), as to the fairness, from a financial point of view, of the consideration to be received by the holders of First Capital common stock in the merger. For a discussion of the factors considered by First Capital’s board of directors in reaching its conclusion, see “Background of and Reasons for the Merger—First Capital’s Reasons for the Merger.”

 

First Capital shareholders should note that First Capital’s directors have certain interests in, and may derive benefits as a result of, the merger that are in addition to their interests as shareholders of First Capital. Specifically, William R. Blanton, First Capital’s vice chairman, chief financial officer and chief operating officer, as a non-institutional shareholder, will be entitled to receive a cash payment of approximately $19.1 million, in lieu of approximately 1,295,602 shares of Flag common stock he would otherwise be entitled to receive as merger consideration. Given that the merger consideration Mr. Blanton will receive is different from other First Capital shareholders, Mr. Blanton abstained from voting to approve the merger and recommending it to shareholders as a result of his conflict of interest. See “Terms of the Merger—Interests of Employees and Directors of Flag and First Capital in the Merger.”

 

Flag. Flag’s board of directors has approved the merger agreement and the transactions contemplated thereby, believes that the merger is in the best interests of Flag and its shareholders, and recommends that Flag shareholders vote “FOR” approval of the merger agreement.

 

In the course of reaching its decision to approve the merger agreement and the transactions contemplated in the merger agreement, Flag’s board of directors, among other things, consulted with its legal advisors, Morris, Manning & Martin, LLP, regarding the legal terms of the merger agreement and with its financial advisor, Sandler O’Neill & Partners, L.P. (“Sandler O’Neill”), as to the fairness, from a financial point of view, of the consideration to be paid by Flag to the holders of First Capital common stock in the merger. For a discussion of the factors considered by Flag’s board of directors in reaching its conclusion, see “Background of and Reasons for the Merger—Flag’s Reasons for the Merger.”

 

Flag shareholders should note that Flag’s directors have certain interests in, and may derive benefits as a result of, the merger that are in addition to their interests as shareholders of Flag. See “Terms of the Merger—Interests of Employees and Directors of Flag and First Capital in the Merger.”

 

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BACKGROUND OF AND REASONS FOR THE MERGER

 

Background of the Merger

 

Over the last five years, a consolidation in the banking industry has occurred. This consolidation has been fueled by, among other things, national and state banking-related legislation that has enabled certain financial institutions to benefit from the economies of scale and greater efficiencies available to combined entities. Financial institutions have increasingly sought suitable combinations as a means of obtaining such benefits.

 

Senior management of both Flag and First Capital have regularly reviewed with their respective boards of directors the possible benefits of strategic business combinations with other financial institutions. In each case, these reviews have been considered in light of each institution’s ongoing evaluation of its available strategies to increase shareholder value and strengthen its franchise in order to better compete in the consolidating market for financial services and products. In addition, both Flag’s and First Capital’s senior management teams reviewed market conditions with their counterparts at other financial institutions.

 

In late November 2004, representatives from Burke Capital met with First Capital’s board of directors and informed the directors that a regional bank holding company had expressed initial interest in acquiring First Capital. After the presentation by Burke Capital, the First Capital board discussed pursing a possible transaction and how that would fit with First Capital’s long-term strategic plans. After discussion, the First Capital board decided to further pursue a potential transaction in order to maximize shareholder value and engaged Burke Capital to assist them in analyzing and evaluating any proposed transaction. Between December 2004 and early February 2005, senior management of First Capital and representatives of Burke Capital had ongoing discussions with the other interested party regarding a proposed transaction.

 

In early February 2005, Joseph W. Evans, chairman, president and chief executive officer of Flag, contacted William R. Blanton, vice chairman, chief financial officer and chief operating officer of First Capital to inquire whether First Capital would consider a potential transaction with Flag. Mr. Blanton suggested that Mr. Evans contact H.N. Padget, Jr., president and chief executive officer of First Capital, to discuss Mr. Evans’ ideas for combining the two companies. On February 14, 2005, Mr. Padget met with Mr. Evans and J. Thomas Wiley, Jr., vice chairman and chief banking officer of Flag, at Flag’s offices to discuss the possibility of a strategic merger. Mr. Padget and Mr. Wiley met again the following day to continue the discussions and to discuss Flag’s long-term strategic plans.

 

Following the meetings with Messrs. Evans and Wiley, on February 16, 2005, Mr. Padget brought the First Capital board up to date on his discussions with Flag and the continued discussions with the other interested party. The executive committee of First Capital authorized continued discussions with both interested parties regarding a proposed transaction. On the same day, representatives from Sandler O’Neill met with Flag’s executives to discuss the structure and pro forma financial impact of a potential transaction between Flag and First Capital.

 

On February 17, 2005, the Flag board of directors met by conference call to receive a report from Mr. Evans regarding the meetings with First Capital’s representatives and to discuss the possibility of a merger with First Capital. During this call, the board authorized Flag’s executive management to enter into a non-binding letter of intent with First Capital regarding a merger with First Capital. From this time until March 16, 2005, Mr. Padget and David R. Hink, chairman of First Capital, had meetings with Mr. Wiley and J. Daniel Speight, vice chairman and chief financial officer of Flag, regarding the structure of any transaction between First Capital and Flag and how such transaction would impact Flag’s long-term strategic plans. During this time, senior management of First Capital and representatives of Burke Capital also continued discussions with representatives of the other party interested in acquiring First Capital. At the March 16, 2005 meeting of the First Capital board of directors, the First Capital directors were informed of the status of the discussions with the interested parties and authorized management of First Capital to continue negotiations with both parties.

 

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On March 24, 2005, Messrs. Padget and Hink and representatives of Burke Capital met with Messrs. Evans and Wiley and representatives of Sandler O’Neill, Flag’s financial advisor, to discuss the proposed transaction. At this meeting, Flag presented its proposed terms for a merger between the two companies. Following this meeting, the terms proposed by Flag were forwarded to Mr. Blanton for his review.

 

On March 25, 2005, Flag’s board of directors conducted another conference call to discuss the status of negotiations with respect to the merger.

 

On March 29, 2005, Messrs. Blanton, Hink and Padget met with representatives of Burke Capital to discuss the terms proposed by Flag. Following these discussions, they requested that Burke Capital, on behalf of First Capital, continue to negotiate with representatives of Flag and Sandler O’Neill on the proposed terms. Thereafter, representatives of Burke Capital and Sandler O’Neill, as well as senior management of both Flag and First Capital, met on a number of occasions to discuss various issues with respect to the proposed merger. These discussions focused on the keys terms of any transaction between the parties, including financial terms, transaction structure, management and succession plans and potential integration, transition and regulatory issues. Based on these discussions, on April 1, 2005, Flag delivered to First Capital a non-binding letter of intent regarding the proposed merger.

 

The executive committee of First Capital’s board of directors met on April 5, 2005 to discuss the letter of intent delivered by Flag. At this meeting, representatives of Burke Capital informed the committee that they had shared Flag’s proposed terms with the other party interested in pursuing a transaction with First Capital and had been informed by that interested party that they would be unable to match the terms proposed by Flag. Following a lengthy discussion on Flag’s proposed terms, the First Capital executive committee authorized Mr. Padget to execute the letter of intent and also authorized management of First Capital to direct Troutman Sanders LLP, as First Capital’s legal counsel, to assist management in preparing a definitive merger agreement between First Capital and Flag and further directed management to conduct a due diligence review of Flag’s operations.

 

Between April 1, 2005 and May 25, 2005, representatives of Flag, First Capital, Troutman Sanders, Morris Manning & Martin, LLP, Flag’s legal counsel, as well as representatives of Burke Capital and Sandler O’Neill, negotiated the terms of the definitive merger agreement between the parties, and Flag and First Capital also conducted due diligence on their respective operations. In addition, during this time, senior management of Flag and First Capital communicated on a regular basis regarding the potential merger, including the post-closing operations of the combined companies.

 

On April 27, 2005, representatives of Sandler O’Neill reviewed the terms and financial impact of the merger with the Flag board of directors. After the presentation, the board of directors engaged in a lengthy discussion of the proposed transaction and determined to continue to pursue the potential transaction. On May 17, 2005, the Flag board met again after the Flag annual meeting of shareholders to discuss the merger with First Capital. At this meeting, representatives from Sandler O’Neill presented its oral opinion that the merger consideration in the contemplated transaction with First Capital was fair to Flag from a financial point of view, as of that date and subject to certain assumptions and limitations. Also during this meeting, a representative from Morris, Manning & Martin, LLP, legal counsel to Flag, led the board of directors through a discussion of the terms of the transaction. Following the presentation and discussion, the Flag board of directors approved the merger agreement and recommended its approval by the shareholders of Flag.

 

On May 25, 2005, the First Capital board of directors met with representatives of Troutman Sanders to discuss the terms of the proposed merger agreement. At this meeting, representatives of Burke Capital provided the board with their analysis of the merger consideration to be paid to the First Capital shareholders. Following a discussion of the terms of the merger agreement, the fairness of the merger consideration to First Capital’s shareholders and the other factors discussed below under the heading “—First Capital’s Reasons for the Merger,” the First Capital board concluded, by majority vote, with the exception of Mr. Blanton who abstained from voting as a result of his conflict of interest in the proposed transaction (see “Terms of the Merger—Interests of Employees and Directors of Flag and First Capital in the Merger”), that the merger was fair to the First Capital shareholders and in the best interest of First Capital, approved the merger agreement and recommended its approval by the shareholders of First Capital.

 

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On May 26, 2005, Flag and First Capital executed the merger agreement and issued a joint press release announcing the proposed merger of the two companies.

 

First Capital’s Reasons for the Merger

 

First Capital’s board of directors believes that the merger is fair to, and in the best interest of, First Capital and its shareholders. In reaching its decision to approve the merger agreement, First Capital’s board of directors consulted with its management, as well as with its financial and legal advisors, and considered a variety of factors, including the following:

 

    an analysis of the business, operations, financial condition, earnings and prospects of Flag, including the information obtained in First Capital’s due diligence review of Flag;

 

    the competitive and regulatory environment for financial institutions generally;

 

    the strategic opportunities presented by a merger between First Capital and Flag based on the belief that the combined organization, with assets greater than $1.6 billion, would be more attractive to potential customers, employees, purchasers and sellers;

 

    the merger will enable First Capital shareholders (other than shares in excess of 384,000 shares held by any non-institutional shareholder) to exchange their shares of First Capital common stock, in a tax-free transaction, for registered shares of common stock of a public company listed on the Nasdaq National Market;

 

    the belief that the merger will provide greater liquidity for First Capital shareholders by providing a larger public market for their stock, a greater number of shareholders and a larger number of outstanding shares;

 

    the belief that the merger between First Capital and Flag would provide shareholders of First Capital greater benefits than could be obtained through internal growth or the acquisition of another bank;

 

    First Capital will have three of its current directors join the board of directors of Flag;

 

    the belief that the combined entity will provide greater diversification of assets and a deeper pool of experienced management; and

 

    the opinion of Burke Capital that the merger consideration provided in the merger agreement was fair to the shareholders of First Capital, from a financial point of view.

 

The discussion of the information and factors considered by First Capital’s board of directors is not intended to be exhaustive but includes all of the material factors the board considered. In reaching its determination to approve and recommend the merger, First Capital’s board of directors did not assign any relative or specific weights to the foregoing factors, and individual directors may have given differing weights to different factors.

 

Flag’s Reasons for the Merger

 

Flag’s board of directors believes that the merger is fair to, and in the best interest of, Flag and its shareholders. In reaching its decision to approve the merger agreement, Flag’s board of directors consulted with its management, as well as with its financial and legal advisors, and considered a variety of factors, including the following:

 

    the analysis of the business, operations, financial condition, earnings and prospects of First Capital, including the information obtained in Flag’s due diligence review of First Capital;

 

    the strategic opportunities presented by a merger between Flag and First Capital;

 

    the complementary nature of Flag’s and First Capital’s businesses, management and employee cultures and the geographic locations of their respective banks;

 

    the expectation that the rate of earnings growth of the combined company would be greater than Flag could achieve separately;

 

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    the belief that Flag and First Capital share a common vision about the importance of delivering financial performance and shareholder value and that the management and employees of Flag and First Capital possess complementary skills and expertise;

 

    the belief that the risk of successfully combining and integrating Flag and First Capital would be less than the execution risks of other possible strategic alternatives that would be expected to provide benefits to Flag shareholders comparable to those we expect our shareholders to derive from a merger with First Capital;

 

    the opinion of Sandler O’Neill that the merger consideration set forth in the merger agreement was fair to Flag from a financial point of view; and

 

    the fact that, after the merger, First Capital Bank and Flag Bank, on a combined basis, would be one of the largest community banks in the metropolitan Atlanta market.

 

The discussion of the information and factors considered by Flag’s board of directors is not intended to be exhaustive but includes all of the material factors the board considered. In reaching the determination to approve and recommend the merger, Flag’s board of directors did not assign any relative or specific weights to the foregoing factors, and individual directors may have given differing weights to different factors.

 

Opinion of First Capital’s Financial Advisor

 

First Capital retained Burke Capital to act as its financial advisor in connection with a possible business combination. Burke Capital is a nationally recognized investment banking firm whose principal business specialty is financial institutions. In the ordinary course of its investment banking business, Burke Capital is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

 

Burke Capital acted as financial advisor to First Capital in connection with the proposed merger with Flag and participated in certain of the negotiations leading to the merger agreement. In connection with Burke Capital’s engagement, First Capital asked Burke Capital to evaluate the fairness of the merger consideration to First Capital’s shareholders from a financial point of view. At the May 25, 2005 meeting of First Capital’s board to evaluate the merger, Burke Capital delivered to the board its written opinion that, based upon and subject to various matters set forth in its opinion, the merger consideration was fair to First Capital’s shareholders from a financial point of view. At this meeting, the First Capital board voted to approve the merger and subsequently executed the merger agreement on May 26, 2005.

 

The full text of Burke Capital’s written opinion is attached as Appendix B to this joint proxy statement/prospectus. The opinion outlines matters considered and qualifications and limitations on the review undertaken by Burke Capital in rendering its opinion. The description of the opinion set forth below is qualified in its entirety by reference to the opinion. We urge you to read the entire opinion carefully in connection with your consideration of the proposed merger.

 

Burke Capital’s opinion speaks only as of the date of the opinion. The opinion was directed to the First Capital Board and is directed only to the fairness of the merger consideration to First Capital shareholders from a financial point of view. It does not address the underlying business decision of First Capital to engage in the merger or any other aspect of the merger and is not a recommendation to any First Capital shareholder as to how such shareholder should vote at the shareholder meeting with respect to the merger, or any other matter.

 

In connection with rendering its May 25, 2005 opinion, Burke Capital reviewed and considered, among other things:

 

    the merger agreement and certain of the schedules thereto;

 

    certain publicly available financial statements and other historical financial information of First Capital that it deemed relevant;

 

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    certain publicly available financial statements and other historical financial information of Flag that it deemed relevant;

 

    projected earnings estimates for First Capital for 2005 prepared by and reviewed with senior management of First Capital and the views of senior management regarding First Capital’s business, financial condition, results of operations and future prospects;

 

    the pro forma financial impact of the merger on Flag’s ability to complete a transaction from a regulatory standpoint, based on assumptions determined by senior management of First Capital and Burke Capital;

 

    the financial terms of other recent business combinations in the commercial banking industry, to the extent publicly available;

 

    the current market environment generally and the banking environment in particular; and

 

    such other information, financial studies, analyses and investigations and financial, economic and market criteria as it considered relevant.

 

First Capital’s board of directors did not limit the investigations made or the procedures followed by Burke Capital in giving its opinion.

 

In performing its reviews and analyses and in rendering its opinion, Burke Capital assumed and relied upon the accuracy and completeness of all the financial information, analyses and other information that was publicly available or otherwise furnished to, reviewed by or discussed with it and further relied on the assurances of management of First Capital and Flag that they were not aware of any facts or circumstances that would make such information inaccurate or misleading. Burke Capital was not asked to and did not independently verify the accuracy or completeness of such information and it did not assume responsibility or liability for the accuracy or completeness of any of such information. Burke Capital did not make an independent evaluation or appraisal of the assets, the collateral securing assets or the liabilities, contingent or otherwise, of First Capital or Flag or any of their respective subsidiaries, or the ability to collect any such assets, nor was it furnished with any such evaluations or appraisals. Burke Capital is not an expert in the evaluation of allowances for loan losses, and it did not make an independent evaluation of the adequacy of the allowance for loan losses of First Capital or Flag, nor did it review any individual credit files relating to First Capital or Flag. Burke Capital assumed that the respective allowances for loan losses for both First Capital and Flag were adequate to cover such losses and will be adequate on a pro forma basis for the combined entity. In addition, Burke Capital did not conduct any physical inspection of the properties or facilities of First Capital or Flag. Burke Capital is not an accounting firm and it relied on the reports of the independent accountants of First Capital and the Directors of Flag for the accuracy and completeness of the financial statements furnished to it.

 

Burke Capital’s opinion was necessarily based upon market, economic and other conditions as they existed on, and could be evaluated as of, the date of its opinion. Burke Capital assumed, in all respects material to its analysis, that all of the representations and warranties contained in the merger agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under such agreements and that the conditions precedent in the merger agreement are not waived. Burke Capital also assumed that there has been no material change in First Capital’s and Flag’s assets, financial condition, results of operations, business or prospects since the date of the last financial statements made available to them, that First Capital and Flag will remain as going concerns for all periods relevant to its analyses.

 

In rendering its May 25, 2005 opinion, Burke Capital performed a variety of financial analyses. The following is a summary of the material analyses performed by Burke Capital, but is not a complete description of all the analyses underlying Burke Capital’s opinion. The summary includes information presented in tabular format. In order to fully understand the financial analyses, these tables must be read together with the accompanying text. The tables alone do not constitute a complete description of the financial analyses. The preparation of a fairness opinion is a complex process involving subjective judgments as to the most appropriate

 

23


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Index to Financial Statements

and relevant methods of financial analysis and the application of those methods to the particular circumstances. The process, therefore, is not necessarily susceptible to a partial analysis or summary description. Burke Capital believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses considered without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors and analyses, could create an incomplete view of the evaluation process underlying its opinion. Also, no company included in Burke Capital’s comparative analyses described below is identical to First Capital or Flag and no transaction is identical to the merger. Accordingly, an analysis of comparable companies or transactions involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that could affect the public trading values or merger transaction values, as the case may be, of First Capital or Flag and the companies to which they are being compared.

 

The earnings projections used and relied upon by Burke Capital in its analyses were based upon internal projections of First Capital. With respect to all such financial projections and estimates, First Capital’s management confirmed to Burke Capital that they reflected the best currently available estimates and judgments of management of the future financial performance of First Capital and Burke Capital assumed for purposes of its analyses that such performance would be achieved. Burke Capital expressed no opinion as to such financial projections or the assumptions on which they were based. The financial projections furnished to Burke Capital by First Capital were prepared for internal purposes only and not with a view towards public disclosure. These projections, as well as the other estimates used by Burke Capital in its analyses, were based on numerous variables and assumptions that are inherently uncertain and, accordingly, actual results could vary materially from those set forth in such projections.

 

In performing its analyses, Burke Capital also made numerous assumptions with respect to industry performance, business and economic conditions and various other matters, many of which cannot be predicted and are beyond the control of First Capital, Flag and Burke Capital. The analyses performed by Burke Capital are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. Burke Capital prepared its analyses solely for purposes of rendering its opinion and provided such analyses to the First Capital board at the May 25, 2005 meeting. Estimates on the values of companies do not purport to be appraisals or necessarily reflect the prices at which companies or their securities may actually be sold. Such estimates are inherently subject to uncertainty, and actual values may be materially different. Accordingly, Burke Capital’s analyses do not necessarily reflect the value of First Capital’s common stock or Flag’s common stock or the prices at which First Capital or Flag’s common stock may be sold at any time.

 

Summary of Proposal. Burke Capital reviewed the financial terms of the proposed transaction whereby the holders of First Capital stock shall be entitled to elect to receive, in exchange for their shares of First Capital common stock, 1.6 shares of Flag common stock. Non-institutional shareholders of First Capital common stock who own more than 384,000 shares will receive cash for those excess shares. Based upon the terms of the merger agreement and Flag’s closing stock price of $15.76 on May 25, 2005, Burke Capital calculated a transaction value of $134,878,343 or $25.22 per share of First Capital common stock. Utilizing First Capital’s publicly available financial statements as of March 31, 2005, Burke Capital calculated the following ratios:

 

Deal Value Considerations:


       

Deal Multiples / Premiums:


      

Offer Price / Common Share

   $ 25.22    Transaction Value / LTM Net Income    34.81 x

Flag Closing Market Price as of May 25, 2005

   $ 15.76    Transaction Value / Book Value    2.34 x

Aggregate Value For Common
Shares

   $ 128,084,697   

Transaction Value / Tangible Book

Value

   2.73 x

Aggregate Value for Outstanding
Options / Warrants

   $ 6,793,646    Core Deposit Premium    23.25 %
    

           

Total Transaction Value

   $ 134,878,343    Premium to Closing Market Price    35.00 %
    

           

* Deal multiples based on March 31, 2005 unaudited financial results.

 

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Index to Financial Statements

Burke Capital calculated 5,348,919 fully diluted shares of First Capital common stock outstanding, which was determined using the treasury stock method at the offer price per share. The fully diluted share count is based upon First Capital’s 5,079,502 outstanding common shares and 555,672 outstanding options to purchase common shares at a weighted average strike price of $12.99.

 

Comparable Company Analysis. Burke Capital used publicly available information to compare selected financial information for First Capital and a group of selected financial institutions. The group consisted of First Capital and 24 financial institutions, which Burke Capital refers to as the “First Capital Peer Group.” The First Capital Peer Group consisted of selected Georgia publicly traded banks with assets between $250 million and $1.5 billion. The First Capital Peer Group was comprised of the following institutions:

 

Bank Holding Company


   City

   Ticker
Symbol


  

Bank Holding Company


   City

   Ticker
Symbol


ABC Bancorp

   Moultrie    ABCB    Habersham Bancorp    Cornelia    HABC

Appalachian Bancshares, Inc.

   Ellijay    APAB    Integrity Bancshares, Inc.    Alpharetta    ITYC

CCF Holding Company

   Jonesboro    CCFH    NSB Holdings, Inc.    Macon    NSBG

Citizens Bancshares Corporation

   Atlanta    CZBS    PAB Bankshares, Inc.    Valdosta    PAB

Colony Bankcorp, Inc.

   Fitzgerald    CBAN    Savannah Bancorp, Inc.    Savannah    SAVB

Crescent Banking Company

   Jasper    CSNT    Security Bank Corporation    Macon    SBKC

Fidelity Southern Corporation

   Atlanta    LION   

SouthCrest Financial Group, Inc.

   Fayetteville    SCSG

FLAG Financial Corporation

   Atlanta    FLAG   

Southeastern Banking Corporation

   Darien    SEBC

GB&T Bancshares, Inc.

   Gainesville    GBTB   

Southern Community Bancshares, Inc.

   Fayetteville    SNCB

Georgia Bancshares, Inc.

   Peachtree City    GABA   

Southwest Georgia Financial Corporation

   Moultrie    SGB

Georgia Bank Financial Corporation

   Augusta    GBFP    Summit Bank Corporation    Atlanta    SBGA

Georgia-Carolina Bancshares, Inc.

   Augusta    GECR    WGNB Corp.    Carrollton    WGNB

 

The analysis calculated the median performance of the First Capital Peer Group, based upon the latest publicly available financial data, to First Capital’s March 31, 2005 financial results. The table below sets forth the comparative data.

 

    Revenues

    Earnings

    Capital
Implications


    Asset Quality

 
    Net
Interest
Margin


    Noninterest
Income/Average
Assets


    Efficiency

    ROAA

    ROAE

    Pre-Provision,
Pre-Tax ROAA


    Equity /
Assets


    Asset
Utilization


    NPAs/
Total
Assets


    Reserves /
Loans


 

Peer Group Median

  4.15 %   0.94 %   62.66 %   0.90 %   11.23 %   1.82 %   8.26 %   93.38 %   0.44 %   1.30 %

First Capital

  3.55 %   0.23 %   66.35 %   0.61 %   7.73 %   1.23 %   8.55 %   95.95 %   0.17 %   1.24 %

 

The analysis showed that First Capital’s performance is within the range of its peer group.

 

Analysis of Selected Merger Transactions. Burke Capital compared selected pricing multiples and ratios implied by the merger consideration to corresponding merger and acquisition pricing multiples and ratios observed in transactions Burke Capital deemed relevant to the merger. Burke Capital reviewed selected Southeastern bank and thrift merger and acquisition transactions since January 1, 2002 and U.S. bank and thrift merger and acquisition transactions since January 1, 2003 in which the seller had assets between $500 million

 

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Index to Financial Statements

and $1 billion. Burke Capital’s review showed that the merger consideration represented per share values within the range of the corresponding mean and median values for the selected Southeastern and U.S. merger and acquisition transactions.

 

Southeastern Merger Transactions. In order to address the specific valuation considerations within the Southeastern markets, Burke Capital selected a group of comparable Southeastern merger and acquisition transactions and compared the pricing multiples to the multiples implied by the merger consideration. Specifically, Burke Capital selected bank and thrift merger and acquisition transactions according to the following criteria:

 

    merger and acquisition transactions announced after January 1, 2002;

 

    all stock and partial cash transactions;

 

    seller located in the Southeast;

 

    seller assets between $500 million and $1 billion;

 

    seller ROAA between 0.40% and 1.00%; and

 

    seller located in an MSA market.

 

Burke Capital selected seven transactions fitting the criteria listed above as being comparable to the proposed merger. The seven comparable transactions selected consisted of the following:

 

Buyer


   State

  

Seller


   State

Peoples Holding Co.

   MS    Heritage Financial Holding Corp.    AL

South Financial Group Inc.

   SC    Florida Banks Inc.    FL

South Financial Group Inc.

   SC    CNB Florida Bancshares Inc.    FL

Colonial BancGroup, Inc.

   AL    P.C.B. Bancorp Inc.    FL

Alabama National BanCorp.

   AL    Indian River Banking Co.    FL

South Financial Group Inc.

   SC    MountainBank Financial Corp.    NC

Synovus Financial Corp.

   GA    Community Financial Group Inc.    TN

 

Burke Capital calculated the multiples of transaction value at announcement to the last 12 months’ earnings, book value, tangible book value and book premium to core deposits for each of the seven selected and acquired institutions. Burke Capital then computed high, low, mean, median and quartile multiples and premiums for the transactions. These multiples and premiums were applied to First Capital’s publicly available financial statements as of and for the period ended March 31, 2005 and were used to impute a transaction price. As illustrated in the following table, Burke Capital derived an imputed range of values per share of First Capital’s common stock of $18.25 to $30.58 based upon the median and mean multiples of the selected Southeastern transactions.

 

   

Median

Multiple


  Implied
Value/Share


  Mean
Multiple


  Implied
Value/Share


  Flag's Offer
Price for
First Capital


Transaction Value / LTM E.P.S.

  24.62x   $ 18.25   25.81x   $ 19.07   34.73x

Transaction Value / Book Value

    2.86x   $ 30.58     2.75x   $ 29.48     2.33x

Transaction Value / Tangible Book Value

    2.91x   $ 26.78     2.96x   $ 27.27     2.73x

Book Premium / Core Deposits

  19.48%   $ 23.04   20.42%   $ 23.60   23.16%
                         
    Median Value   $ 24.91       $ 25.44   $25.22
    Mean Value   $ 24.66       $ 24.85  
                         
    Implied Range   $ 18.25   <=>   $ 30.58    

 

The analysis showed that the merger consideration per share of $25.22 is within the range of values imputed by the mean and median multiples of the comparable transactions.

 

U.S. Merger Transactions. Burke Capital selected a group of comparable U.S. merger and acquisition transactions and compared the pricing multiples to the multiples implied by the merger consideration.

 

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Index to Financial Statements

Specifically, Burke Capital selected bank and thrift merger and acquisition transactions according to the following criteria:

 

    merger and acquisition transactions announced after January 1, 2003;

 

    all stock and partial cash transactions;

 

    seller located in the U.S.;

 

    seller assets between $500 million and $1 billion;

 

    seller ROAA between 0.40% and 1.00%; and

 

    seller located in an MSA market.

 

Burke Capital selected 14 transactions fitting the criteria listed above as being comparable to the proposed merger. The 14 comparable transactions selected consisted of the following:

 

Buyer


   State

  

Seller


   State

Willow Grove Bancorp Inc.

   PA    Chester Valley Bancorp Inc.    PA

Valley National Bancorp

   NJ    NorCrown Bank    NJ

F.N.B. Corp.

   PA    NSD Bancorp Inc.    PA

Wells Fargo & Co.

   CA    First Community Capital Corp.    TX

Peoples Holding Co.

   MS    Heritage Financial Holding Corp.    AL

South Financial Group Inc.

   SC    Florida Banks Inc.    FL

Provident Bancorp Inc.

   NY    Warwick Community Bancorp    NY

South Financial Group Inc.

   SC    CNB Florida Bancshares Inc.    FL

Colonial BancGroup Inc.

   AL    P.C.B. Bancorp Inc.    FL

Fulton Financial Corp.

   PA    Premier Bancorp Inc.    PA

Alabama National BanCorp

   AL    Indian River Banking Co.    FL

KNBT Bancorp Inc.

   PA    First Colonial Group Inc.    PA

Seacoast Financial Services

   MA    Abington Bancorp Inc.    MA

South Financial Group Inc.

   SC    MountainBank Financial Corp.    NC

 

Burke Capital calculated the multiples of transaction value at announcement to the last 12 months’ earnings, book value, tangible book value and book premium to core deposits for each of the 14 selected and acquired institutions. Burke Capital then computed high, low, mean, median and quartile multiples and premiums for the transactions. These multiples and premiums were applied to First Capital’s publicly available financial statements as of and for the period ended March 31, 2005 and were used to impute a transaction price. As illustrated in the following table, Burke Capital derived an imputed range of values per share of First Capital’s common stock of $17.87 to $30.31 based upon the median and mean multiples of the selected U.S. transactions.

 

     Median Multiple

  Implied
Value/Share


   Mean
Multiple


  Implied
Value/
Share


   Flag's Offer
Price for
First Capital


Transaction Value / LTM E.P.S.

   24.07x   $ 17.87    26.03x   $ 19.22    34.73x

Transaction Value / Book Value

     2.83x   $ 30.31      2.79x   $ 29.88      2.33x

Transaction Value / Tangible Book Value

     2.90x   $ 26.76      3.07x   $ 28.24      2.73x

Book Premium / Core Deposits

   19.59%   $ 23.11    20.63%   $ 23.72    23.16%
                            
     Median Value   $ 24.93        $ 25.98    $25.22
     Mean Value   $ 24.51        $ 25.26   
                            
     Implied Range   $ 17.87    <=>   $ 30.31     

 

The analysis showed that the merger consideration per share of $25.22 is within the range of values imputed by the mean and median multiples of the comparable transactions.

 

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Index to Financial Statements

Based upon the forgoing analyses and other investigations and assumptions set forth in its opinion, without giving specific weightings to any one factor or comparison, Burke Capital determined that the transaction consideration was fair from a financial point of view to First Capital shareholders.

 

For its financial advisory services provided to First Capital, Burke Capital has been paid fees of $50,000 to date and will be paid an additional fee that will amount to approximately $1.2 million at the time of the closing of the merger. In addition, First Capital has agreed to indemnify Burke Capital against various liabilities, including any that may arise under the federal securities laws, subject to adjustment based on the actual deal value as of the closing date.

 

Opinion of Flag’s Financial Advisor

 

By letter dated March 22, 2005, Flag retained Sandler O’Neill to act as its financial advisor in connection with a possible business combination with First Capital. Sandler O’Neill is a nationally recognized investment banking firm whose principal business specialty is financial institutions. In the ordinary course of its investment banking business, Sandler O’Neill is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

 

Sandler O’Neill acted as financial advisor to Flag in connection with the proposed transaction and participated in certain of the negotiations leading to the execution of a definitive merger agreement on May 26, 2005. At the May 17, 2005 meeting at which Flag’s board considered and approved the merger agreement, subject to satisfactory resolution of certain outstanding issues, Sandler O’Neill delivered to the board its oral opinion, that, as of such date, the merger consideration was fair to Flag from a financial point of view. The full text of Sandler O’Neill’s opinion is attached as Appendix C to this joint proxy statement/prospectus. The opinion outlines the procedures followed, assumptions made, matters considered and qualifications and limitations on the review undertaken by Sandler O’Neill in rendering its opinion. The description of the opinion set forth below is qualified in its entirety by reference to the opinion. Sandler O’Neill urges Flag shareholders to read the entire opinion carefully in connection with their consideration of the proposed merger.

 

Sandler O’Neill’s opinion speaks only as of the date of the opinion. The opinion was directed to the Flag board and is directed only to the fairness of the merger consideration to Flag from a financial point of view. It does not address the underlying business decision of Flag to engage in the merger or any other aspect of the merger and is not a recommendation to any Flag shareholder as to how such shareholder should vote at the special meeting with respect to the merge or any other matter.

 

In connection with rendering its May 17, 2005 opinion, Sandler O’Neill reviewed and considered, among other things:

 

    the merger agreement;

 

    certain publicly available financial statements and other historical financial information of Flag that Sandler O’Neill deemed relevant;

 

    certain publicly available financial statements and other historical financial information of First Capital that Sandler O’Neill deemed relevant;

 

    an internal budget for Flag for the year ending December 31, 2005 furnished by and reviewed with senior management of Flag and estimates of asset, loan and earnings per share growth for the years thereafter;

 

    internal budgets for First Capital for the years ending December 31, 2005 and 2006 furnished by senior management of First Capital and reviewed with and adjusted downward by senior management of Flag, earnings per share estimates for First Capital for the year ending December 31, 2005 published by I/B/E/S and earnings per share and loan and deposit growth rates, furnished by and reviewed with senior management of Flag;

 

   

the pro forma financial impact of the merger on Flag, based on assumptions relating to transaction expenses, purchase accounting adjustments and cost savings furnished by and reviewed with the senior

 

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Index to Financial Statements
 

managements of Flag and First Capital; and the expected issuance of up to $30 million in trust preferred securities by Flag;

 

    the publicly reported historical price and trading activity for the common stock of both Flag and First Capital, including a comparison of certain financial and stock market information for Flag and First Capital with similar publicly available information for certain other financial institutions the securities of which are publicly traded;

 

    to the extent publicly available, the financial terms of certain recent business combinations in the commercial banking industry;

 

    the current market environment generally and the banking environment in particular; and

 

    such other information, financial studies, analyses and investigations and financial, economic and market criteria as Sandler O’Neill considered relevant.

 

Sandler O’Neill also discussed with certain members of senior management of Flag the business, financial condition, results of operations and prospects of Flag and held similar discussions with the financial advisor of First Capital regarding the business, financial condition, results of operations and prospects of First Capital.

 

In performing its reviews and analyses and in rendering its opinion, Sandler O’Neill relied upon the accuracy and completeness of all the financial and other information that was available to it from public sources, that was provided to Sandler O’Neill by Flag or First Capital or their respective representatives or that was otherwise reviewed by Sandler O’Neill and has assumed such accuracy and completeness for purposes of rendering this opinion. Sandler O’Neill further relied on the assurances of the management of each of Flag and First Capital that they are not aware of any facts or circumstances that would make any of such information inaccurate or misleading. Sandler O’Neill has not been asked to undertake, and has not undertaken, an independent verification of any of such information, and Sandler O’Neill does not assume any responsibility or liability for the accuracy or completeness thereof. Sandler O’Neill did not make an independent evaluation or appraisal of the specific assets, the collateral securing the assets or the liabilities (contingent or otherwise) of Flag or First Capital or any of their subsidiaries, or the collectibility of any such assets, nor has Sandler O’Neill been furnished with any such evaluations or appraisals. Sandler O’Neill did not make an independent evaluation of the adequacy of the allowance for loan losses of Flag or First Capital nor has Sandler O’Neill reviewed any individual credit files relating to Flag or First Capital. Sandler O’Neill assumed, with Flag’s consent, that the respective allowances for loan losses for both Flag and First Capital are adequate to cover such losses.

 

The internal budgets and estimates for growth used and relied upon by Sandler O’Neill in its analyses for Flag were provided by Flag senior management who confirmed to Sandler O’Neill that that those budgets and estimates reflected the best currently available estimates and judgments of the future financial performance of Flag. With respect to the internal budgets and growth estimates for First Capital, with Flag’s consent, Sandler O’Neill used and relied on the budgets provided by the senior management of First Capital as adjusted by Flag’s senior management. All projections of transaction costs, purchase accounting adjustments and expected cost savings related to the merger were provided by or reviewed with the senior managements of Flag and First Capital, and those managements confirmed to Sandler O’Neill that those projections reflected the best currently available estimates and judgments. Sandler O’Neill assumed that the financial performances reflected in all budgets, estimates and projections used in its analyses would be achieved. Sandler O’Neill expressed no opinion as to such budgets, estimates or projections or the assumptions on which they were based. Sandler O’Neill also assumed that there has been no material change in the assets, financial condition, results of operations, business or prospects of Flag or First Capital since the date of the last financial statements made available to it and that Flag and First Capital will remain as going concerns for all periods relevant to the analyses.

 

With respect to the merger agreement, Sandler O’Neill assumed that all of the representations and warranties contained in the merger agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under the agreements, that the conditions precedent in the merger agreement are not waived and that the merger will be a tax-free

 

29


Table of Contents
Index to Financial Statements

reorganization for federal income tax purposes. Finally, with Flag’s consent, Sandler O’Neill relied upon the advice received from Flag’s legal, accounting and tax advisors as to all legal, accounting and tax matters relating to the merger agreement and the other transactions contemplated by the agreement.

 

Sandler O’Neill’s opinion was necessarily based upon market, economic and other conditions as they existed on, and could be evaluated as of, the date of its opinion. Events occurring after the date hereof could materially affect this opinion. Sandler O’Neill has not undertaken to update, revise, reaffirm or withdraw its opinion or otherwise comment upon events occurring after the date hereof. Sandler O’Neill expressed no opinion as to what the value of Flag’s common stock will be when issued to First Capital’s shareholders pursuant to the merger agreement or the prices at which the common stocks of Flag or First Capital may trade at any time.

 

In rendering its May 17, 2005 opinion, Sandler O’Neill performed a variety of financial analyses. The following is a summary of the material analyses performed by Sandler O’Neill, but is not a complete description of all the analyses underlying Sandler O’Neill’s opinion. The summary includes information presented in tabular format. In order to fully understand the financial analyses, these tables must be read together with the accompanying text. The tables alone do not constitute a complete description of the financial analyses. The preparation of a fairness opinion is a complex process involving subjective judgments as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances. The process, therefore, is not necessarily susceptible to a partial analysis or summary description. Sandler O’Neill believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses to be considered without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors and analyses, could create an incomplete view of the evaluation process underlying its opinion. Also, no company included in Sandler O’Neill’s comparative analyses described below is identical to Flag or First Capital, and no transaction is identical to the merger. Accordingly, an analysis of comparable companies or transactions involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that could affect the public trading values or merger transaction values, as the case may be, of Flag and First Capital and the companies to which they are being compared.

 

In performing its analyses, Sandler O’Neill also made numerous assumptions with respect to industry performance, business and economic conditions and various other matters, many of which cannot be predicted and are beyond the control of Flag, First Capital and Sandler O’Neill. The analyses performed by Sandler O’Neill are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. Sandler O’Neill prepared its analyses solely for purposes of rendering its opinion and provided such analyses to the Flag board at the board’s May 17, 2005 meeting. Estimates on the values of companies do not purport to be appraisals or necessarily reflect the prices at which companies or their securities may actually be sold. Such estimates are inherently subject to uncertainty, and actual values may be materially different. Accordingly, Sandler O’Neill’s analyses do not necessarily reflect the value of Flag’s or First Capital’s common stock or the prices at which Flag’s or First Capital’s common stock may be sold at any time.

 

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Index to Financial Statements

Summary of Proposal. Sandler O’Neill reviewed the financial terms of the proposed transaction. Using the fixed exchange ratio of 1.6 shares of Flag common stock for each share of First Capital common stock, and the closing price of Flag common stock of $14.96 on May 13, 2005 for calculating both the stock and cash portion of the consideration, Sandler O’Neill calculated a transaction value of $23.93 per share. Based upon financial information for First Capital as or for the 12-month period ended March 31, 2005, Sandler O’Neill calculated the following transaction ratios:

 

Transaction Multiples

Offer Price Per Share / LTM EPS

   31.1 x

Offer Price Per Share / Book Value

   210.2 %

Offer Price Per Share / Tangible Book Value

   242.6 %

Tangible Book Premium / Core Deposits (1)

   22.3 %

Current Market Premium (2)

   36.7 %

(1) Core deposits exclude time deposits with a balance over $100,000.
(2) Based on First Capital’s closing stock price of $17.50 on May 13, 2005.

 

The aggregate transaction value was approximately $127.5 million, based upon the offer price per share of $23.93, the 5,067,719 First Capital common shares outstanding and the intrinsic value of options to acquire 567,454 shares of First Capital common stock at a weighted-average exercise price of $12.86.

 

Stock Trading History. Sandler O’Neill reviewed the history of the reported trading prices and volume of Flag’s and First Capital’s common stock and the relationship between the movements in the price of Flag’s common stock and First Capital’s common stock to movements in the prices of the Standard & Poor’s 500 Index, the Nasdaq Bank Index, the Standard & Poor’s Bank Index and the median performance of a composite peer group of publicly traded commercial banks selected by Sandler O’Neill for Flag and First Capital, respectively. The composition of the respective peer groups for Flag and First Capital is discussed under the relevant section under “—Comparable Company Analysis” below.

 

Sandler O’Neill analyzed Flag’s common stock for the one-year period ended May 13, 2005. During this period, Flag’s common stock generally outperformed each of the indices and the peer group to which it was compared.

 

Flag’s One Year Stock Performance (May 13, 2004 – May 13, 2005)

     Beginning Index Value
May 13, 2004


    Ending Index Value
May 13, 2005


 

Flag

   100.00 %   120.81 %

Flag Peer Group

   100.00     109.91  

S&P Index

   100.00     105.25  

Nasdaq Bank Index

   100.00     104.56  

S&P Bank Index

   100.00     108.80  

 

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Index to Financial Statements

Sandler O’Neill analyzed First Capital’s common stock for the period May 28, 2004 (the closing date of the merger between First Capital and CNB Holdings, Inc.) through May 13, 2005. During this period, First Capital’s common stock generally outperformed each of indices and the peer group to which it was compared.

 

First Capital’s Stock Performance (May 28, 2004 – May 13, 2005)

     Beginning Index Value
May 28, 2004


    Ending Index Value
May 13, 2005


 

First Capital

   100.00 %   116.67 %

First Capital Peer Group

   100.00     117.00  

S&P Index

   100.00     102.98  

Nasdaq Bank Index

   100.00     101.39  

S&P Bank Index

   100.00     104.18  

 

Comparable Company Analysis. Sandler O’Neill also used publicly available information to perform a comparison of selected financial and market trading information for Flag and First Capital, to two different groups of selected financial institutions for Flag and First Capital, respectively.

 

The Flag peer group consisted of the following publicly traded commercial banks headquartered in Georgia, North Carolina or South Carolina with total assets between $750 million and $2.0 billion:

 

ABC Bancorp    GB&T Bancshares, Inc.
Bank of Granite Corporation    Georgia Bank Financial Corporation
Capital Bank Corporation    LSB Bancshares, Inc.
Colony Bancorp, Inc.    PAB Bankshares, Inc.
Fidelity Southern Corporation    SCBT Financial Corporation
First Bancorp    Security Bank Corporation
First South Bancorp, Inc.    Southern Community Financial Corporation
FNB Corp.    Yadkin Valley Bank and Trust Company
FNB Financial Services Corporation     

 

The analysis compared publicly available financial and market trading information for Flag and the high, low and median data for the Flag peer group as of and for the 12 months ended March 31, 2005 (or in cases where March data was not available, as of or for the 12 months ended December 31, 2004). The table below sets forth the data for Flag and the median, high and low data for the Flag peer group as of and for the 12 months ended March 31, 2005 (or in cases where March data was not available, as of or for the 12 months ended December 31, 2004), with pricing data as of May 13, 2005.

 

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Index to Financial Statements

Comparable Group Analysis

 

     Flag

    Peer Group
Median Result


    Peer Group
High Result


    Peer Group
Low Result


 

Balance Sheet

                                

Total Assets (in thousands)

   $ 840,415     $ 995,826     $ 1,687,160     $ 750,881  

Net Loans / Total Assets

     73.00 %     76.54 %     87.62 %     64.12 %

Gross Loans / Total Deposits

     87.25 %     97.41 %     102.23 %     88.63 %

Total Borrowings / Total Assets

     3.77 %     9.30 %     18.35 %     2.04 %

Asset Quality

                                

Non-performing Assets / Assets

     0.80 %     0.60 %     1.24 %     0.21 %

Loan Loss Reserve / Gross Loans

     1.43 %     1.27 %     1.80 %     1.03 %

Capital Adequacy

                                

Tangible Equity / Tangible Assets

     6.01 %     7.64 %     12.52 %     6.02 %

Tier 1 Leverage Ratio

     7.87 %     9.05 %     13.85 %     7.82 %

Tier 1 Risk Based Capital Ratio

     10.20 %     10.40 %     15.97 %     8.96 %

Total Risk Based Capital Ratio

     11.46 %     11.97 %     17.25 %     9.99 %

Intangible Assets / Total Equity

     29.97 %     8.01 %     38.46 %     0.00 %

Profitability

                                

Net Interest Margin

     4.48 %     4.16 %     4.79 %     3.25 %

Non-interest Income / Average Assets

     1.12 %     1.10 %     1.80 %     0.60 %

Fees / Revenues

     21.32 %     20.74 %     32.26 %     15.78 %

Non-interest Expense / Average Assets

     3.83 %     2.90 %     4.19 %     2.36 %

Efficiency Ratio

     72.85 %     62.96 %     74.75 %     48.46 %

Return on Average Assets

     0.92 %     1.06 %     1.66 %     0.62 %

Return on Average Equity

     10.64 %     11.06 %     20.65 %     5.98 %

Trading Multiples

                                

Price / Book Value

     181.5 %     170.2 %     351.9 %     120.0 %

Price / Tangible Book Value

     259.2 %     200.0 %     379.5 %     161.6 %

Price / LTM Earnings per Share

     18.9 x     17.2 x     24.8 x     14.9 x

Price / 2005 Estimated Earnings per Share (1)

     N/A       15.2 x     17.3 x     13.9 x

Dividend Payout Ratio

     30.38 %     36.23 %     65.66 %     20.81 %

Dividend Yield

     1.60 %     2.15 %     3.82 %     0.90 %

Market Capitalization (in thousands)

   $ 127,590     $ 173,475     $ 304,541     $ 103,334  

(1) Based on I/B/E/S estimates.

 

Sandler O’Neill also used publicly available information to compare selected financial and market trading information for First Capital and a group of financial institutions selected by Sandler O’Neill. The First Capital peer group consisted of the following publicly traded commercial banks headquartered in Georgia, North Carolina or South Carolina with total assets between $500 million and $1 billion:

 

BNC Bancorp    Gateway Financial Holdings, Inc.
Capital Bank Corporation    Georgia Bank Financial Corporation
Colony Bankcorp, Inc.    Integrity Financial Corporation
Community Bankshares, Inc.    LSB Bancshares, Inc.
Community Capital Corporation    PAB Bankshares, Inc.
Cooperative Bankshares, Inc.    Peoples Bancorp of North Carolina, Inc.
ECB Bancorp, Inc.    Savannah Bancorp, Inc.
First South Bancorp, Inc.    Summit Bank Corporation
FNB Corp.    Yadkin Valley Bank and Trust Company
FNB Financial Services Corporation     

 

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Index to Financial Statements

The analysis compared publicly available financial and market trading information for First Capital and the high, low and median data for the First Capital peer group as of and for the 12 months ended March 31, 2005 (or in cases where March data was not available, as of or for the 12 months ended December 31, 2004). The table below sets forth the data for First Capital and the median, high and low data for the First Capital peer group as of and for the 12 months ended March 31, 2005 (or in cases where March data was not available, as of or for the 12 months ended December 31, 2004), with pricing data as of May 13, 2005.

 

Comparable Group Analysis

 

     First Capital

    Peer Group
Median Result


    Peer Group
High Result


    Peer Group
Low Result


 

Balance Sheet

                                

Total Assets (in thousands)

   $ 673,842     $ 690,020     $ 995,826     $ 501,890  

Net Loans / Total Assets

     73.30 %     76.26 %     87.62 %     63.31 %

Gross Loans / Total Deposits

     104.65 %     97.30 %     115.08 %     77.02 %

Total Borrowings / Total Assets

     18.93 %     11.03 %     20.12 %     2.04 %

Asset Quality

                                

Non-performing Assets / Assets

     0.32 %     0.43 %     1.24 %     0.00 %

Loan Loss Reserve / Gross Loans

     1.24 %     1.28 %     1.66 %     0.92 %

Capital Adequacy

                                

Tangible Equity / Tangible Assets

     7.50 %     7.56 %     9.39 %     5.04 %

Tier 1 Leverage Ratio

     8.46 %     8.81 %     13.89 %     7.82 %

Tier 1 Risk Based Capital Ratio

     10.22 %     10.43 %     14.46 %     8.96 %

Total Risk Based Capital Ratio

     11.35 %     11.68 %     15.40 %     9.99 %

Intangible Assets / Total Equity

     13.36 %     7.28 %     34.08 %     0.00 %

Profitability

                                

Net Interest Margin

     3.57 %     3.94 %     4.79 %     3.33 %

Non-interest Income / Average Assets

     0.23 %     0.98 %     1.80 %     0.64 %

Fees / Revenues

     6.24 %     21.04 %     32.26 %     15.78 %

Non-interest Expense / Average Assets

     2.46 %     2.94 %     4.19 %     2.51 %

Efficiency Ratio

     67.31 %     64.16 %     77.92 %     48.46 %

Return on Average Assets

     0.61 %     0.91 %     1.66 %     0.31 %

Return on Average Equity

     7.72 %     10.77 %     20.65 %     3.26 %

Trading Multiples

                                

Price / Book Value

     153.7 %     173.2 %     351.9 %     126.7 %

Price / Tangible Book Value

     177.4 %     195.0 %     379.5 %     126.7 %

Price / LTM Earnings per Share

     22.7 x     17.2 x     24.8 x     14.4 x

Price / 2005 Estimated Earnings per Share (1)

     18.8 x     14.5 x     33.1 x     13.1 x

Dividend Payout Ratio

     0.00 %     35.17 %     65.66 %     9.30 %

Dividend Yield

     0.00 %     2.00 %     3.82 %     0.22 %

Market Capitalization (in thousands)

   $ 88,685     $ 111,131     $ 217,748     $ 60,271  

(1) Based on I/B/E/S estimates.

 

Analysis of Selected Merger Transactions. Sandler O’Neill reviewed 18 nationwide merger transactions announced from January 1, 2004 through May 13, 2005 involving commercial banks with assets between $500 million and $1 billion (based on publicly available information when the transactions were announced) as the acquired institution. Sandler O’Neill also reviewed 44 merger transactions with a transaction value greater than $15 million announced during the same period involving commercial banks in the Southeastern United States as the acquired institution. Sandler O’Neill reviewed the following multiples: transaction price at announcement to last 12 months’ EPS, transaction price to book value per share, transaction price to tangible book value per share,

 

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Index to Financial Statements

and tangible book premium to core deposits and premium to market price and then computed high, low, mean, median multiples and premiums for the transactions. The median multiples were applied to First Capital’s financial information as of and for the 12 months ended March 31, 2005. As illustrated in the following tables, Sandler O’Neill derived an imputed range of values per share for First Capital’s common stock of $17.88 to $30.80 based upon the median multiples for the nationwide transactions and $21.09 to $28.41 based upon the median multiples for the Southeast transactions. The implied per share transaction value of the merger as calculated by Sandler O’Neill was $23.93 per share.

 

Transaction Multiples

     Nationwide Transactions

   Southeast Transactions

     Median
Multiple


    Implied
Value


   Median
Multiple


    Implied
Value


Transaction Price/LTM EPS

   23.23 x   $ 17.88    30.63 x   $ 23.58

Transaction Price/Book Value

   270.56 %   $ 30.80    249.58 %   $ 28.41

Transaction Price/Tangible Book Value

   307.65 %   $ 30.34    263.32 %   $ 25.97

Tangible Book Premium/Core Deposits (1)

   21.05 %   $ 23.18    19.29 %   $ 22.09

Premium to Market (2)

   24.13 %   $ 21.72    20.51 %   $ 21.09

(1) Core deposits are defined as total deposits less time deposits over $100,000. The core deposit premium is calculated by taking transaction value, less tangible book value, divided by core deposits.
(2) Based on First Capital’s May 13, 2005 closing price of $17.50.

 

Discounted Dividend Stream and Terminal Value Analysis. Sandler O’Neill performed an analysis that estimated the future stream of after-tax dividend flows of Flag through December 31, 2009 under various circumstances, assuming Flag’s projected dividend stream and that Flag performed in accordance with the 2005 net income projection and earnings per share growth rate projections for 2006 through 2009 provided by management. To approximate the terminal value of Flag common stock at December 31, 2009, Sandler O’Neill applied price to LTM earnings multiples of 14.0x to 24.0x and multiples of tangible book value ranging from 175% to 325%. The dividend income streams and terminal values were then discounted to present values using different discount rates ranging from 9.0% to 15.0% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Flag common stock. As illustrated in the following tables, this analysis indicated an imputed range of values per share for Flag’s common stock of $10.02 to $21.44 when applying the price/earnings multiples, and $10.17 to $23.26 when applying multiples of tangible book value to the current budget. The closing price for Flag’s common stock on May 13, 2005 was $14.96.

 

Earnings Per Share Multiples

Discount Rate


   14.0x

   16.0x

   18.0x

   20.0x

   22.0x

   24.0x

9.00%

   $ 12.83    $ 14.55    $ 16.27    $ 17.99    $ 19.71    $ 21.44

10.00%

   $ 12.30    $ 13.95    $ 15.60    $ 17.25    $ 18.89    $ 20.54

11.00%

   $ 11.80    $ 13.38    $ 14.96    $ 16.53    $ 18.11    $ 19.69

12.00%

   $ 11.32    $ 12.83    $ 14.35    $ 15.86    $ 17.37    $ 18.88

13.00%

   $ 10.87    $ 12.32    $ 13.77    $ 15.22    $ 16.67    $ 18.11

14.00%

   $ 10.43    $ 11.82    $ 13.21    $ 14.60    $ 16.00    $ 17.39

15.00%

   $ 10.02    $ 11.36    $ 12.69    $ 14.02    $ 15.36    $ 16.69

 

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Index to Financial Statements

Tangible Book Value Per Share Multiples

Discount Rate


   175%

   200%

   225%

   250%

   275%

   300%

   325%

9.00%

   $ 13.01    $ 14.72    $ 16.43    $ 18.13    $ 19.84    $ 21.55    $ 23.26

10.00%

   $ 12.47    $ 14.11    $ 15.75    $ 17.38    $ 19.02    $ 20.65    $ 22.29

11.00%

   $ 11.97    $ 13.53    $ 15.10    $ 16.66    $ 18.23    $ 19.80    $ 21.36

12.00%

   $ 11.48    $ 12.98    $ 14.48    $ 15.99    $ 17.49    $ 18.99    $ 20.49

13.00%

   $ 11.02    $ 12.46    $ 13.90    $ 15.34    $ 16.78    $ 18.22    $ 19.66

14.00%

   $ 10.59    $ 11.97    $ 13.35    $ 14.73    $ 16.11    $ 17.49    $ 18.87

15.00%

   $ 10.17    $ 11.49    $ 12.82    $ 14.14    $ 15.47    $ 16.79    $ 18.11

 

In addition, Sandler O’Neill performed an analysis that estimated the future stream of after-tax dividend flows of First Capital through December 31, 2009 under various circumstances, assuming First Capital performed in accordance with 2005 and 2006 net income projections and earnings per share growth rate projections for 2007 through 2009 provided by Flag’s management. To approximate the terminal value of First Capital common stock at December 31, 2009, Sandler O’Neill applied price/earnings multiples ranging from 14.0x to 24.0x and multiples of tangible book value ranging from 175% to 325%. The income streams and terminal values were then discounted to present values using different discount rates ranging from 9.0% to 15.0% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of First Capital common stock. As illustrated in the following tables, this analysis indicated an imputed range of values per share of First Capital common stock of $13.23 to $29.24 when applying the price/earnings multiples, and $15.57 to $37.29 when applying multiples of tangible book value. The implied per share transaction value of the merger as calculated by Sandler O’Neill was $23.93 per share.

 

Earnings Per Share Multiples

Discount Rate


   14.0x

   16.0x

   18.0x

   20.0x

   22.0x

   24.0x

9.00%

   $ 17.06    $ 19.50    $ 21.93    $ 24.37    $ 26.81    $ 29.24

10.00%

   $ 16.33    $ 18.67    $ 21.00    $ 23.34    $ 25.67    $ 28.00

11.00%

   $ 15.65    $ 17.88    $ 20.12    $ 22.35    $ 24.59    $ 26.82

12.00%

   $ 14.99    $ 17.14    $ 19.28    $ 21.42    $ 23.56    $ 25.71

13.00%

   $ 14.37    $ 16.43    $ 18.48    $ 20.54    $ 22.59    $ 24.64

14.00%

   $ 13.79    $ 15.76    $ 17.72    $ 19.69    $ 21.66    $ 23.63

15.00%

   $ 13.23    $ 15.11    $ 17.00    $ 18.89    $ 20.78    $ 22.67

 

Tangible Book Value Per Share Multiples

Discount Rate


   175%

   200%

   225%

   250%

   275%

   300%

   325%

9.00%

   $ 20.08    $ 22.95    $ 25.82    $ 28.69    $ 31.55    $ 34.42    $ 37.29

10.00%

   $ 19.23    $ 21.97    $ 24.72    $ 27.47    $ 30.22    $ 32.96    $ 35.71

11.00%

   $ 18.42    $ 21.05    $ 23.68    $ 26.31    $ 28.94    $ 31.58    $ 34.21

12.00%

   $ 17.65    $ 20.17    $ 22.69    $ 25.22    $ 27.74    $ 30.26    $ 32.78

13.00%

   $ 16.92    $ 19.34    $ 21.76    $ 24.17    $ 26.59    $ 29.01    $ 31.42

14.00%

   $ 16.23    $ 18.55    $ 20.86    $ 23.18    $ 25.50    $ 27.82    $ 30.14

15.00%

   $ 15.57    $ 17.79    $ 20.02    $ 22.24    $ 24.46    $ 26.69    $ 28.91

 

In connection with its analyses, Sandler O’Neill considered and discussed with the Flag board how the present value analyses would be affected by changes in the underlying assumptions, including variations with respect to net income. Sandler O’Neill noted that the discounted dividend stream and terminal value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

 

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Index to Financial Statements

Pro Forma Merger Analysis. Sandler O’Neill analyzed certain potential pro forma effects of the merger, assuming the following: (1) the merger closes on September 30, 2005; (2) approximately 84.4% of First Capital shares are exchanged for Flag common stock at a fixed exchange ratio of 1.6x; (3) approximately 15.6% of First Capital shares are exchanged for cash at a price of $23.93; (4) First Capital stock options are converted into options to purchase Flag common stock, adjusted for the fixed exchange ratio; (5) First Capital’s 2005 and 2006 net income projections and earnings per share growth rates for 2007 through 2009 provided by and reviewed with Flag’s management; (6) Flag’s 2005 budgeted net income and earnings per share growth rate projections for 2006 through 2009 provided by and review with Flag’s management; (7) purchase accounting adjustments, charges and transaction costs associated with the merger and cost savings determined by the senior managements of Flag and First Capital; (8) Flag issues $30 million of trust preferred at closing at a cost of 5.25% per annum. The analyses indicated that for the year ending December 31, 2006 (the first full year of combined operations), the merger would be accretive to Flag’s projected earnings per share and, at September 30, 2005 (the assumed closing date of the merger) the merger would be dilutive to Flag’s tangible book value per share. The actual results achieved by the combined company may vary from projected results and the variations may be material.

 

In connection with the merger, Sandler O’Neill will receive from Flag a customary transaction fee, of which $50,000 has been paid and the balance of which is contingent, and payable, upon closing of the merger. Sandler O’Neill has also received a fee of $150,000 in connection with rendering its opinion, which fee shall be credited against the fee payable upon closing of the merger. Flag has also agreed to reimburse certain of Sandler O’Neill’s reasonable out-of-pocket expenses up to $15,000 incurred in connection with its engagement and to indemnify Sandler O’Neill and its affiliates and their respective partners, directors, officers, employees, agents and controlling persons against certain expenses and liabilities, including liabilities under securities laws.

 

Sandler O’Neill may provide investment banking services to Flag in the future and may receive compensation for such services. The services may include raising capital in connection with the merger and/or other services to be performed during the period prior to the closing of the merger.

 

In the ordinary course of its business as a broker-dealer, Sandler O’Neill may purchase securities from and sell securities to Flag and First Capital and their respective affiliates. Sandler O’Neill may also actively trade the debt and/or equity securities of Flag or First Capital or their respective affiliates for its own account and for the accounts of its customers and, accordingly, may at any time hold a long or short position in such securities.

 

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Index to Financial Statements

TERMS OF THE MERGER

 

The descriptions of the terms and conditions of the merger, the merger agreement and any related documents in this joint proxy statement/prospectus are qualified in their entirety by reference to the copy of the merger agreement attached as Appendix A to this joint proxy statement/prospectus, to the registration statement, of which this joint proxy statement/prospectus is a part, and to the exhibits to the registration statement.

 

General

 

The merger agreement provides that, if all of the conditions set forth in the merger agreement are satisfied or waived, First Capital will merge with and into Flag, with Flag remaining in existence as the surviving corporation in the merger. First Capital Bank and Capital Financial Software, LLC, each a wholly-owned subsidiary of First Capital, will become wholly-owned subsidiaries of Flag following the merger, and First Capital Bank will be immediately merged with and into Flag Bank. Flag will also assume First Capital’s trust subsidiary, First Capital Statutory Trust I, which was created in connection with First Capital’s issuance of trust preferred securities.

 

Conversion of Stock; Treatment of Options

 

First Capital Common Stock. At the effective time of the merger, each share of First Capital common stock outstanding generally will be converted into and exchanged for the right to receive 1.6 shares of Flag common stock and cash instead of fractional shares. The exchange ratio is subject to customary adjustments to preserve the relative value of the consideration First Capital shareholders are to receive in the event of stock splits, reverse stock splits or the like before the merger is completed, as described below under “—Anti-dilution Adjustments.” Because the exchange ratio is fixed and because the market price of Flag common stock will fluctuate, the value of the shares of Flag common stock that First Capital shareholders will receive at the effective time of the merger may increase or decrease, both before and after the merger.

 

Any non-institutional First Capital shareholder that would own more than 384,000 shares of Flag common stock following the merger will receive a cash payment, in lieu of shares of Flag common stock over the 384,000 share threshold, equal to the number of such excess shares multiplied by $14.76 per share, the average closing price of Flag’s common stock for the 20 trading days immediately following the public announcement of the merger. As discussed below under “—Interests of Employees and Directors of Flag and First Capital in the Merger,” as a result of this provision, William R. Blanton, vice president, chief financial officer and chief operating officer of First Capital, will receive a cash payment of approximately $19.1 million in the merger.

 

Any First Capital shareholder who would otherwise have been entitled to receive a fraction of a share of Flag common stock in the merger will receive, in lieu thereof, cash (without interest) in an amount equal to his or her fractional share multiplied by the average closing price of Flag common stock for the 20 trading days immediately preceding the date of the effective time of the merger as reported in The Wall Street Journal.

 

Some shares of First Capital common stock will not be converted in the merger. These include any shares held by Flag, First Capital and their respective subsidiaries, except for shares held on behalf of third parties. Each outstanding share of First Capital common stock owned by Flag, First Capital and their respective subsidiaries will be canceled at the effective time of the merger and will cease to be outstanding.

 

Stock Options. Each outstanding and unexercised option to acquire First Capital common stock granted under First Capital’s stock incentive plans will be assumed by Flag, and any right to purchase First Capital common stock under the options shall be converted at the effective time of the merger into rights to purchase Flag common stock, with the following adjustments:

 

    the number of shares of Flag common stock subject to the option will be equal to the product of the number of shares of First Capital common stock subject to the option immediately prior to the effective time of the merger and the exchange ratio; and

 

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Index to Financial Statements
    the exercise price per share of Flag common stock subject to the option will be equal to the exercise price under the First Capital option immediately prior to the effective time of the merger divided by the exchange ratio.

 

Shares of Flag common stock to be issued upon the exercise of First Capital stock options will be timely registered under the Securities Act of 1933 on a registration statement on Form S-8.

 

Anti-dilution Adjustments. If, before the effective time of the merger, the outstanding shares of First Capital common stock or Flag common stock are increased, decreased, changed into or exchanged for a different number or kind of shares or securities as a result of a stock split, stock dividend, recapitalization, reclassification, exchange of shares or similar recapitalization transaction, an appropriate and proportionate adjustment will be made to the exchange ratio.

 

Flag Common Stock. All shares of Flag common stock issued and outstanding immediately before the effective time of the merger will remain issued and outstanding immediately after completion of the merger as shares of common stock of the surviving corporation. They will not be affected by the merger.

 

Raising of Additional Capital

 

We cannot complete our merger unless we obtain the approval of applicable bank regulatory authorities, including the Federal Reserve and the Georgia Department. We are in the process of preparing and filing applications for approval of the merger with the Federal Reserve and the Georgia Department. In connection with the application, we propose to issue and sell up to $25,000,000 in trust preferred securities through a trust in an offering to accredited investors that is exempt from the registration requirements of the Securities Act of 1933. The offering of the trust preferred securities by Flag will be subject to the prior approval of the Federal Reserve and the Georgia Department.

 

In connection with the applications, we also propose to raise at least $5,000,000 in new capital through the exercise of outstanding warrants to purchase our common stock. The warrants were issued by Flag in connection with a series of private placements of Flag common stock, primarily in 2002, and have a term of 10 years. The warrants were sold to investors in the private placement transactions at a price of $1.00 per warrant as an inducement for the investors’ purchase of Flag common stock in the transactions. Members of Flag’s senior management hold some of these warrants. In consideration for the warrant holders’ agreement to forfeit the remaining term of the warrants and exercise them in connection with the Merger, we have agreed to adjust the exercise price of the warrants. The following table summarizes the warrants and their year of issuance, original weighted exercise price and adjusted weighted exercise price:

 

Year of Issuance


 

Number of

Warrants


 

Original Weighted
Exercise Price


 

Adjusted Weighted
Exercise Price


2002

  1,236,000   $  9.21   $6.59

2003

     12,000   11.50     8.23

2004

       6,000   13.01     9.31

 

Flag’s board of directors established a special committee, consisting of H. Speer Burdette, Quill O. Healey and John D. Houser, none of whom hold any of the warrants, to evaluate and consider whether the terms of the warrant term forfeiture and price adjustment were in the best interests of Flag and its shareholders. After considering the terms and conditions of the warrant term forfeiture and price adjustment and other information which the special committee felt was relevant and consulting with financial and legal experts, the special committee determined that the warrant term forfeiture and price adjustment was in the best interests of Flag and its shareholders. Flag’s board of directors ratified the special committee’s decision.

 

 

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The estimated pro forma capital ratios of the combined company as of June 30, 2005 after giving effect to the capital raising transactions described above and the merger, are as follows:

 

     Pro Forma for $30 Million
Additional Capital


 

Tier 1 Leverage Ratio

   8.35 %

Tier 1 Risk Based Capital Ratio

   10.34 %

Total Risk Based Capital Ratio

   11.55 %

 

Based on these pro forma capital ratios, the combined company will be “well capitalized” under the Federal Reserve’s capital regulations.

 

Effective Time of the Merger

 

If the merger agreement is approved by the requisite votes of the shareholders of First Capital and Flag and all other required governmental and other consents and approvals are received, and if the other conditions to the obligations of the parties to consummate the merger are satisfied or waived (as permitted), the merger will be consummated and effected on the date and at the time the Articles of Merger reflecting the merger become effective with the Secretary of State of Georgia. Unless otherwise mutually agreed upon in writing by our chief executive officers, we will use our reasonable efforts to cause the effective time of the merger to occur on the last business day of the month in which the last of the following occurs:

 

    the effective date (including expiration of any applicable waiting period) of the last required consent of any regulatory authority having authority over and approving or exempting the merger;

 

    the date on which First Capital shareholders approve the merger agreement;

 

    the date on which Flag shareholders approve the merger agreement; or

 

    a later date if agreed upon in writing by Flag and First Capital.

 

 

Assuming satisfaction of all of the conditions to consummation of the merger, the merger is expected to close by the end of the fourth quarter of 2005. Either Flag or First Capital may terminate the merger agreement prior to the effective time, under several circumstances. See “Terms of the Merger—Conditions to Consummation” and “—Amendment, Waiver and Termination.”

 

Exchange of Certificates

 

Promptly after the effective time of the merger, Flag will cause its exchange agent to mail appropriate transmittal materials to each record holder of First Capital common stock for the exchange for Flag common stock. Risk of loss and title to the certificates will remain with the holder until proper delivery of such certificates to Flag or its exchange agent by former First Capital shareholders. First Capital shareholders should not surrender their certificates for exchange until they receive a letter of transmittal and instructions from Flag or its exchange agent. After the effective time of the merger, each holder of shares of First Capital common stock, except holders exercising dissenters’ rights, issued and outstanding at the effective time must surrender the certificate or certificates representing their shares to Flag or its exchange agent and will, promptly upon such surrender, receive the consideration they are entitled to under the merger agreement, together with all undelivered dividends or distributions in respect of such shares (without interest). As provided in the merger agreement, each record holder of First Capital common stock shall also receive cash in lieu of any fractional share of Flag common stock to which he or she would be otherwise entitled (without interest). Flag will not be obligated to deliver the consideration to which any former holder of First Capital common stock is entitled until the holder surrenders the certificate or certificates representing his or her shares for exchange. The certificate or

 

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certificates so surrendered must be duly endorsed as Flag or its exchange agent may require. Neither Flag nor its exchange agent will be liable to a holder of First Capital common stock for any property delivered in good faith to a public official pursuant to any applicable abandoned property, escheat or other law.

 

After the effective time of the merger (and prior to the surrender of certificates of First Capital common stock to Flag or its exchange agent), record holders of certificates that represented outstanding First Capital common stock immediately prior to the effective time of the merger will have no rights with respect to the certificates other than the right to surrender the certificates and receive in exchange for the certificates a certificate or certificates representing the aggregate number of whole shares of Flag common stock to which the holder is entitled pursuant to the merger agreement, together with a check for the amount (without interest) representing any fractional share.

 

In the event that any dividend or distribution, the record date for which is on or after the effective time of the merger, is declared by Flag on Flag common stock, no such dividend or other distribution will be delivered to the holder of a certificate representing shares of First Capital common stock immediately prior to the effective time of the merger until such holder surrenders such certificate as set forth above.

 

In addition, holders of certificates that represented outstanding First Capital common stock immediately prior to the effective time of the merger will be entitled to vote after the effective time of the merger at any meeting of Flag shareholders the number of whole shares of Flag common stock into which such shares are convertible, even if such holder has not surrendered such certificates for exchange as set forth above.

 

Flag shareholders will not be required to exchange certificates representing their shares of Flag common stock or otherwise take any action after the merger is completed.

 

Important Federal Income Tax Consequences

 

The following summarizes certain material federal income tax consequences of the merger to First Capital shareholders. This summary is based on current laws, regulations, rulings and decisions now in effect, all of which are subject to change at any time, possibly with retroactive effect. This summary is not a complete description of all of the tax consequences of the merger and, in particular, may not address federal income tax consequences applicable to you if you are subject to special treatment under federal income tax law, such as rules relating to shareholders who are not citizens or residents of the United States, who are financial institutions, foreign corporations, tax-exempt organizations, insurance companies or dealers in securities, shareholders who acquired their shares pursuant to the exercise of options or similar derivative securities or otherwise as compensation, and shareholders who hold their shares as part of a straddle or conversion transaction. In addition, this summary does not address the tax consequences of the merger under applicable state, local, foreign or estate tax laws. This discussion assumes you hold your shares of First Capital common stock as a capital asset within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). Each First Capital shareholder should consult with his or her tax advisor about the tax consequences of the merger in light of his or her individual circumstances, including the application of any federal, state, local, foreign or estate tax law.

 

The merger is intended to constitute a “reorganization” under Section 368(a) of the Internal Revenue Code. A condition to completing the merger is that, on the closing date, Flag and First Capital receive an opinion from Morris, Manning & Martin, LLP, counsel to Flag, that the merger will qualify as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code. The closing date opinion will be based on customary assumptions and customary representations made by First Capital and Flag. An opinion of counsel represents the counsel’s best legal judgment and is not binding on the Internal Revenue Service or any court. If, notwithstanding such opinion of counsel, the merger does not qualify as a reorganization, the exchange of First Capital common stock for Flag common stock in the merger will be a taxable transaction.

 

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Neither First Capital nor Flag intends to waive the condition that it receive an opinion that the merger will qualify as a reorganization. If, however, First Capital decides to waive the condition, First Capital will recirculate this document to disclose the waiver and to make all related material disclosures, and will resolicit proxies from the First Capital shareholders.

 

Provided the merger qualifies as a reorganization, neither First Capital nor Flag will recognize any gain or loss for federal income tax purposes, and the federal income tax consequences to First Capital shareholders will be as follows:

 

    you will not recognize any gain or loss on the exchange of your First Capital common stock for Flag common stock, except to the extent you receive cash instead of shares (including the receipt of cash in instead of a fractional share);

 

    if you receive cash instead of a whole or fractional share of Flag common stock, you will recognize gain or loss equal to the difference between the amount of the cash received and your tax basis allocable to the share or fractional share, and this gain or loss generally will be capital gain or loss;

 

    if you exercise your dissenters’ rights under Georgia law and receive payment in cash for the fair value of your shares of First Capital common stock, you will be treated as having exchanged such shares for cash in a redemption subject to Section 302 of the Internal Revenue Code, and you generally will recognize capital gain or loss in such exchange equal to the difference between the cash received and the tax basis of such shares;

 

    your aggregate tax basis for the shares of Flag common stock received for your First Capital common stock will be the same as your aggregate tax basis for the First Capital common stock surrendered in exchange therefor, excluding any basis allocable to a fractional share of Flag common stock for which cash is received;

 

    your holding period for shares of Flag common stock received for your First Capital common stock will include your holding period for the First Capital common stock exchanged for Flag common stock if your shares of First Capital common stock are held as a capital asset within the meaning of Section 1221 of the Internal Revenue Code at the effective time of the merger; and

 

    notwithstanding anything herein to the contrary, you (and any affiliate or person acting on your behalf) may disclose to any and all persons, without limitation of any kind, the transaction’s tax treatment and tax structure and all material of any kind (including opinions or other tax analyses) provided to you relating to such tax treatment and tax structure, except to the extent necessary to comply with any applicable federal or state securities laws.

 

Each First Capital shareholder that receives Flag common stock in the merger will be required to file a statement with his, her or its U.S. federal income tax return setting forth his, her or its basis in the First Capital common stock surrendered and the fair market value of the Flag common stock and cash, if any, received in the merger, and to retain permanent records of these facts relating to the transaction.

 

Each First Capital shareholder is urged to consult his or her personal tax and financial advisor as to his or her specific federal income tax consequences, based on his or her own particular status and circumstances, and also as to any state, local, foreign, estate or other tax consequences arising out of the merger.

 

Management and Operations After the Merger

 

At the effective time of the merger, First Capital will merge with and into Flag. The directors of Flag in office immediately prior to the effective time will continue as the directors of Flag after the merger. In addition, at the effective time of the merger, three directors of First Capital in office immediately prior to the effective

 

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time, one of whom will be H.N. Padget, Jr., will be appointed by First Capital and elected as directors of Flag by the Flag board of directors.

 

The new additional directors from First Capital will be divided among the three classes of Flag’s board of directors. In the event any of the three new directors will not serve his or her full term, the remaining new directors appointed by First Capital, by majority vote, will nominate a replacement director to serve out the remaining portion of the term subject to the approval of Flag.

 

The officers of Flag in office immediately prior to the effective time shall continue to serve as the officers of Flag following the merger. Joseph W. Evans will continue to serve as the chairman, chief executive officer and president of Flag and as the chairman of Flag Bank. J. Thomas Wiley, Jr. will continue to serve as vice chairman and chief banking officer of Flag and as chief executive officer of Flag Bank. Stephen W. Doughty will continue to serve as vice chairman and chief risk management officer of Flag, and J. Daniel Speight will continue to serve as vice chairman, chief financial officer and secretary of Flag.

 

Mr. Padget will serve as a member of the executive committee of the Flag board of directors, executive vice president of Flag and the president and director of Flag Bank. Steven G. Deaton will serve as executive vice president of Flag Bank. The current directors of Flag Bank will continue to serve as directors of Flag Bank.

 

Interests of Employees and Directors of Flag and First Capital in the Merger

 

General. Some of the employees and directors of Flag and First Capital may be deemed to have interests in the merger in addition to their interests as shareholders of Flag or First Capital generally. These interests include, among others, proposed employee benefits for those who become employees of Flag or a Flag subsidiary after the merger, employment agreements with two of First Capital Bank’s current executive officers, the appointment of certain First Capital directors to the board of the combined company, the conversion of outstanding First Capital stock options into rights to purchase Flag common stock and insurance coverage for First Capital’s directors and officers, as described below.

 

Employee Benefits. The merger agreement generally provides that Flag will furnish to those employees of First Capital who become employees of Flag or a Flag subsidiary after the effective time of the merger, benefits under employee benefit plans that, when taken as a whole, are substantially similar to those currently provided by Flag and its subsidiaries to their similarly situated employees. Flag may apply any pre-existing condition exclusion or waiting period under any Flag employee health plan for which any employees and/or officers and dependents are covered by the relevant First Capital benefit plans as of the date of the closing, but that portion of any such existing condition exclusion or waiting period will not be enforced to the extent it exceeds in duration the corresponding provision in effect under the First Capital benefit plans immediately prior to the date of the closing. For purposes of participation, vesting and benefit accrual under Flag’s employee benefit plans, service with First Capital prior to the effective time of the merger will be treated as service with Flag or its subsidiaries. Flag will credit new Flag employees for amounts paid under First Capital benefit plans for the plan year, including the effective time of the merger, for purposes of applying deductibles, co-payments and out of pocket maximums under the Flag benefit plans.

 

Padget Employment Agreement. As a condition to the closing of the merger, First Capital, First Capital Bank and Mr. Padget will terminate the existing employment agreement upon the closing of the merger, and Flag and Flag Bank will enter into a new employment agreement with Mr. Padget. Pursuant to the new employment agreement, Mr. Padget will serve as executive vice president of Flag and the president of Flag Bank.

 

Under the terms of the new employment agreement, Mr. Padget will receive an annual base salary equal to $180,000 and annual performance bonuses based on the degree of achievement of performance goals to be determined by the compensation committee of the Flag board of directors. Flag will assign to Mr. Padget title to the automobile currently used by Mr. Padget in connection with his duties at First Capital. Mr. Padget will also

 

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receive, at the effective time of the merger, payments from Flag in the aggregate of $230,000 as an incentive to enter into this new employment agreement and satisfaction of First Capital’s obligations under the previous employment agreement relating to change in control payments. In addition, on January 1, 2006, Mr. Padget will be eligible, subject to the discretion of Flag’s compensation committee, for a bonus up to $90,000 relating to the success of the merger.

 

This new employment agreement will have an initial term of one year and will automatically renew each day after the effective date of the merger until either party gives notice of termination, in which event the term of employment will expire on the first anniversary of the 30th day following the date such written notice is received.

 

The new employment agreement also contains customary provisions regarding termination, and, upon certain events of termination, severance payments and restrictions on competition.

 

Deaton Employment Agreement. In connection with the merger, First Capital, First Capital Bank and Steven G. Deaton will terminate the existing employment agreement, and Flag and Flag Bank will enter into a new employment agreement with Mr. Deaton. Pursuant to the new employment agreement, Mr. Deaton will serve as executive vice president of Flag Bank.

 

Under the terms of the new employment agreement, Mr. Deaton will receive an annual base salary equal to $160,000 and annual performance bonuses based on the degree of achievement of performance goals to be determined by the compensation committee of the Flag board of directors. Mr. Deaton will also receive, at the effective time of the merger, payments from Flag in the aggregate of $14,400 as an incentive to enter into this new employment agreement and satisfaction of First Capital’s obligations under the previous employment agreement relating to change in control payments. In addition, on January 1, 2006, Mr. Deaton will be eligible, subject to the discretion of Flag’s compensation committee, for a bonus up to $100,000 relating to the success of the merger.

 

This new employment agreement will have an initial term of one year and will automatically renew each day after the effective date of the merger until either party gives notice of termination, in which event the term of employment will expire on the first anniversary of the 30th day following the date such written notice is received.

 

The new employment agreement also contains customary provisions regarding termination, and, upon certain events of termination, severance payments and restrictions on competition.

 

Blanton Non-Compete and Consulting Agreement. As a condition to the closing of the merger, Flag and William R. Blanton, a key executive and the largest shareholder of First Capital, will enter into a non-compete and consulting agreement, pursuant to which Mr. Blanton will agree not to compete with Flag or to solicit the employees or customers of Flag, subject to certain exceptions, and to provide technology consulting services for a term of 21 months commencing at the effective time of the merger. Mr. Blanton will not be required to devote more than 16 hours per month (including travel time) to providing the consulting services under this consulting agreement. In consideration for all services rendered by Mr. Blanton to Flag under this consulting agreement, Flag will pay to Mr. Blanton a fee of $900,000 payable in 21 equal monthly installments of $42,857.15. Flag has also agreed to reimburse Mr. Blanton for up to $20,000 in legal expenses incurred by him in connection with the non-compete and consulting agreement.

 

In addition, upon the effective time of the merger, Flag will assign to Mr. Blanton title to the automobile, office furniture and laptop computer currently used by Mr. Blanton in connection with his duties at First Capital, and will assign to Mr. Blanton any interest in any life insurance policy it holds on the life of Mr. Blanton, net of any cash value of such policy. The non-compete and consulting agreement also includes customary confidentiality provisions.

 

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Good Shepherds Program. Following the merger, Flag will transfer to William R. Blanton, a key executive and the largest shareholder of First Capital, the software development and deposit and loan production program of First Capital called “Good Shepherds.” The Good Shepherds program is targeted towards churches and other faith-based organizations, and allows online donations by members of churches and other faith-based organizations and online cash management for the organizations. In connection with the assignment of the program, Flag will transfer to Mr. Blanton its rights in the name “Good Shepherds,” any deposits developed by the Good Shepherds program outside of metropolitan Atlanta, cash equal to the principal balance of the deposits plus accrued but unpaid interest, and any loans developed by the Good Shepherds program. In consideration of the transfer, Mr. Blanton will pay Flag cash equal to an 8% premium on the principal balance of the deposits developed by the Good Shepherds program as of May 26, 2005, and the principal balance of the loans developed by the Good Shepherds program, plus all accrued interest and other charges.

 

First Capital and Flag have agreed to permit the continued operation of the Good Shepherds program, including the continued development of the software components of the program and the continuation of the program’s marketing initiatives until the completion of the merger, and Mr. Blanton has agreed to reimburse First Capital and Flag for the cost of such operations.

 

Merger Cash Payment. In connection with the merger, Flag will pay cash to any non-institutional First Capital shareholder that would own more than 384,000 shares of Flag common stock following the merger will receive a cash payment, in lieu of shares of Flag common stock over the 384,000 share threshold, equal to the number of such excess shares multiplied by $14.76 per share, the average closing price of Flag’s common stock for the 20 trading days immediately following the public announcement of the merger. William R. Blanton, the vice chairman, chief financial officer and chief operating officer of First Capital, will receive a cash payment of approximately $19.1 million as a result of this provision.

 

Directors. The directors of Flag in office immediately prior to the effective time will continue as the directors of Flag after the merger. At the effective time of the merger, three directors of First Capital in office immediately prior to the effective time, one of whom shall be H.N. Padget, Jr., will be appointed by First Capital, subject to Flag’s approval, and elected as directors of Flag by the Flag board of directors. The additional directors from First Capital will be divided among the three classes of Flag’s board of directors. In the event any of the three new directors will not serve his or her full term prior to the 2006 annual meeting of Flag shareholders, the remaining new directors appointed by First Capital, by majority vote, will nominate a replacement director to serve out the remaining portion of the term subject to the approval of Flag.

 

Stock Options. As described above, each outstanding and unexercised option to acquire First Capital common stock granted under First Capital’s stock option and incentive plans will be converted automatically at the effective time of the merger into rights to purchase Flag common stock, with the following adjustments:

 

    the number of shares of Flag common stock subject to the option will be equal to the product of the number of shares of First Capital common stock subject to the option immediately prior to the effective time of the merger and the exchange ratio; and

 

    the exercise price per share of Flag common stock subject to the option will be equal to the exercise price under the First Capital option immediately prior to the effective time of the merger, divided by the exchange ratio.

 

Shares of Flag common stock to be issued upon the exercise of First Capital stock options will be timely registered under the Securities Act of 1933 on a registration statement on Form S-8.

 

Supplemental Retirement Plan. Ms. Grimes and Messrs. Alford, Deaton, Groce, Hink, Padget and Pond have supplemental retirement agreements with First Capital Bank. Under these agreements, the participants are entitled to receive supplemental retirement benefits from and after their respective retirements at or after age 65

 

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until death. In the event a participant is terminated, resigns or is removed for any reason other than for cause following a change of control in either First Capital or First Capital Bank, he or she is entitled to receive the benefits promised under the agreements as if they had been continuously employed by First Capital or First Capital Bank until age 65. Consequently, in the event Messrs. Padget and Deaton or any of the directors of First Capital are so terminated, resign or are removed following the merger of First Capital with Flag, they will receive the retirement benefits under the agreements as if they had been continuously employed until age 65. See “Management of First Capital—Supplemental Retirement Plan.”

 

Life Insurance Benefits. According to the individual split dollar agreements with First Capital, Ms. Grimes and Messrs. Alford, Deaton, Groce, Hink, Padget and Pond are entitled to share in the death benefit proceeds payable under certain life insurance policies owned by First Capital Bank that were purchased in connection with the supplemental retirement agreements. In the event a participant is terminated, resigns or is removed for any reason other than for cause following a change of control in either First Capital or First Capital Bank, he or she becomes 100% vested in the death benefits promised under the agreement. Consequently, in the event Messrs. Padget and Deaton or any of the directors of First Capital are so terminated, resign or are removed following the merger of First Capital with Flag, their beneficiaries will receive the death benefit set forth in the split dollar agreements as if they had died while serving on the board of directors or while employed by First Capital or First Capital Bank, as applicable. See “Management of First Capital—Life Insurance Benefits.”

 

Insurance. Flag has agreed to provide directors’ and officers’ insurance coverage for directors and officers of First Capital, at Flag’s election, either (1) by purchasing continuation coverage under First Capital’s current policy for directors and officers for a period of not less than three years after the effective time of the merger, or (2) if Flag’s current directors’ and officers’ policy provides substantially similar coverage as First Capital’s current policy, by obtaining coverage under Flag’s current policy for First Capital’s directors and officers on a prior acts basis for a period not less than three years prior to the effective time of the merger.

 

Conditions to Consummation

 

The obligations of First Capital and Flag to consummate the merger are subject to the satisfaction or waiver (to the extent permitted) of several conditions, including:

 

    First Capital and Flag shareholders must have approved the merger agreement and the consummation of the merger as and to the extent required by law, First Capital’s and Flag’s governing corporate instruments and the rules of the National Association of Securities Dealers;

 

    the required regulatory approvals described under “Regulatory Matters” must have been received, generally without any conditions or restrictions that would, in the reasonable judgment of the board of directors of First Capital or Flag, materially adversely affect the economic or business benefits of the transactions contemplated by the merger agreement so as to render inadvisable the consummation of the merger;

 

    each party must have received all consents (other than those described in the preceding paragraph) required for consummation of the merger and for the prevention of a default under any contract of such party that, if not obtained or made, would reasonably likely have, individually or in the aggregate, a material adverse effect on such party, generally without any conditions or restrictions that would, in the reasonable judgment of the board of directors of First Capital or Flag, materially adversely affect the economic or business benefits of the transactions contemplated by the merger agreement so as to render inadvisable the consummation of the merger;

 

    no court or regulatory authority may have taken any action that prohibits, restricts or makes illegal the consummation of the transactions contemplated by the merger agreement;

 

   

the registration statement registering the shares of Flag common stock to be received by First Capital shareholders, of which this joint proxy statement/prospectus is a part, must have been declared effective

 

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by the SEC, no stop order suspending the effectiveness of the registration statement may have been issued, no action, suit, proceeding or investigation by the SEC to suspend the effectiveness of the registration statement may have been initiated and be continuing and all necessary approvals under federal and state securities laws relating to the issuance or trading of the shares of Flag common stock issuable pursuant to the merger must have been received;

 

    each party must have received an opinion of Troutman Sanders LLP or Morris, Manning & Martin, LLP to the matters set forth above under “—Important Federal Income Tax Consequences”;

 

    H. N. Padget, Jr. must have entered into an employment agreement with Flag and must have terminated his existing employment agreement with First Capital;

 

    each of the executive officers and directors of each party must have executed and delivered to the other party a support agreement in substantially the form attached to the merger agreement;

 

    William R. Blanton must have entered into a non-compete and consulting agreement with Flag and must have terminated his existing employment agreement with First Capital;

 

    each party’s representations and warranties must remain accurate, and each party must have performed all of the agreements and covenants to be performed by it pursuant to the merger agreement and must have delivered certificates confirming satisfaction of the foregoing requirements and certain other matters;

 

    each party must have received an opinion of the other party’s counsel, dated the closing date, as to certain matters;

 

    Flag must have received from each “affiliate” of First Capital an agreement stating, among other things, that he or she will comply with federal securities laws when transferring any shares of Flag common stock received in the merger (see “—Resales of Flag Common Stock”); and

 

    Flag’s board of directors must have elected three of the current First Capital directors appointed by First Capital, subject to Flag’s approval, as additional new directors of Flag.

 

No assurances can be provided as to when or if all of the conditions precedent to the merger can or will be satisfied or waived by the appropriate party. As of the date of this joint proxy statement/prospectus, the parties know of no reason to believe that any of the conditions set forth above will not be satisfied. The conditions to consummation of the merger may be waived, in whole or in part, to the extent permissible under applicable law, by the party for whose benefit the condition has been imposed, without the approval of such parties’ shareholders.

 

Regulatory Matters

 

The merger is subject to the prior approval of the Federal Reserve and the Georgia Department. Under these agencies’ regulations, they are required, when approving a transaction such as the merger, to take into consideration the financial and managerial resources (including the competence, experience and integrity of the officers, directors and principal shareholders) and future prospects of the existing and proposed institutions and the convenience and needs of the communities to be served. In considering the financial resources and future prospects of the existing and proposed institutions, the Federal Reserve and the Georgia Department will, among other things, evaluate the adequacy of the capital level of the parties to the proposed transaction.

 

We are in the process of preparing and filing applications for approval of the merger with the Federal Reserve and the Georgia Department. In connection with the applications, we propose to issue and sell up to $25,000,000 in trust preferred securities through a newly formed trust subsidiary of Flag in an offering to accredited investors that is exempt from the registration requirements of the Securities Act of 1933. The offering of the trust preferred securities by Flag will be subject to the prior approval of the Federal Reserve and the Georgia Department.

 

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In connection with the applications, we also propose to raise at least $5,000,000 in new capital through the exercise of outstanding warrants to purchase our common stock. The warrants were issued by Flag in connection with a series of private placements of Flag common stock, primarily in 2002, and have a term of 10 years. The warrants were sold to investors in the private placement transactions at a price of $1.00 per warrant as an inducement for the investors’ purchase of Flag common stock in the transactions. Members of Flag’s senior management hold some of these warrants. In consideration for the warrant holders’ agreement to forfeit the remaining term of the warrants and exercise them in connection with the Merger, we have agreed to adjust the exercise price of the warrants. The following table summarizes the warrants and their year of issuance, original weighted exercise price and adjusted weighted exercise price:

 

Year of

Issuance


 

Number of

Warrants


 

Original Weighted
Exercise Price


 

Adjusted Weighted
Exercise Price


2002

  1,236,000   $  9.21   $6.59

2003

     12,000   11.50     8.23

2004

       6,000   13.01     9.31

 

Flag’s board of directors established a special committee, consisting of H. Speer Burdette, Quill O. Healey and John D. Houser, none of whom hold any of the warrants, to evaluate and consider whether the terms of the warrant term forfeiture and price adjustment were in the best interests of Flag and its shareholders. After considering the terms and conditions of the warrant term forfeiture and price adjustment and other information which the special committee felt was relevant and consulting with financial and legal experts, the special committee determined that the warrant term forfeiture and price adjustment was in the best interests of Flag and its shareholders. Flag’s board of directors ratified the special committee’s decision.

 

The merger generally may not be consummated until 30 days after receipt of the Federal Reserve approval, during which time the United States Department of Justice may challenge the merger on antitrust grounds. The commencement of an antitrust action would stay the effectiveness of the Federal Reserve’s approval unless a court specifically ordered otherwise. Flag and First Capital believe that the merger does not raise any other significant regulatory concerns.

 

After the consummation of the merger, we propose to merge Flag Bank and First Capital Bank with Flag Bank remaining as the surviving banking corporation. We cannot complete the proposed bank merger unless we obtain the approval of applicable bank regulatory authorities, including the Federal Deposit Insurance Corporation and the Georgia Department. We are in the process of preparing and filing applications for approval of the bank merger with the Federal Deposit Insurance Corporation and the Georgia Department.

 

Other than as summarized above, we are not aware of any governmental approvals or actions that may be required for consummation of the merger. Should any other approval or action be required, we currently contemplate that we would seek such approval or action. To the extent that the above summary describes statutes and regulations, it is qualified in its entirety by reference to those particular statutes and regulations. In addition to the approvals and notifications of the regulatory authorities summarized above, we are subject to ongoing supervision, regulation and periodic examination by various federal and state regulatory agencies. Those discussions are qualified in their entirety by the actual language of the laws and regulations, which are subject to change based on possible future legislation and regulatory action.

 

Amendment, Waiver and Termination

 

To the extent permitted by law, First Capital and Flag, with the approval of their respective boards of directors, may amend the merger agreement by written agreement at any time without the approval of First Capital shareholders or Flag shareholders. However, after the approval of the merger by First Capital shareholders, no amendment may decrease the consideration to be received without the further approval of First

 

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Capital shareholders. Similarly, after the approval of the merger by Flag shareholders, no amendment may increase the consideration to be paid by Flag without the further approval of Flag shareholders.

 

Prior to or at the effective time of the merger, either First Capital or Flag may waive any default in the performance of any term of the merger agreement by the other party, may waive or extend the time for the fulfillment by the other party of any of its obligations under the merger agreement, and may waive any of the conditions precedent to the obligations of such party under the merger agreement, except any condition that, if not satisfied, would result in the violation of an applicable law.

 

The merger agreement may be terminated, and the merger abandoned, at any time prior to the effective time of the merger, by mutual consent of the boards of directors of First Capital and Flag. In addition, the merger agreement may be terminated, and the merger abandoned, prior to the effective time of the merger by either First Capital or Flag if:

 

    the other party breaches and does not timely cure any representation or warranty contained in the merger agreement;

 

    any consent of any regulatory authority required for consummation of the merger is denied by final nonappealable action of the regulatory authority or if any action taken by the regulatory authority is not appealed within the time limit for appeal, or First Capital shareholders fail to approve the merger agreement at the special meeting;

 

    the merger has not been consummated by March 31, 2006 and the failure to consummate the merger by that date has not been caused by a breach of the terminating party;

 

    any of the conditions precedent to the obligation of the terminating party to consummate the merger cannot be satisfied by March 31, 2006; or

 

    in order to enter into a definitive agreement with respect to a third-party acquisition proposal, the terminating party’s board of directors determines prior to the shareholder approval in good faith that such acquisition constitutes a superior proposal and that, after consultation with its advisors, to do otherwise would be inconsistent with its fiduciary duty to the shareholders, in which event the terminating party will pay the termination fee of $2,000,000 to the other party within 30 business days after the effective date of such termination.

 

Conduct of Business Pending the Merger

 

Under the merger agreement, each of the parties has agreed, except as otherwise contemplated by the merger agreement or with the prior written consent of the other party, to:

 

    operate its business only in the usual, regular and ordinary course;

 

    preserve intact its business organizations and assets and maintain its rights and franchises;

 

    use its reasonable efforts to cause its representations and warranties to be correct at all times; and

 

    take no action that would (1) adversely affect the ability of any party to obtain any consents required for the transactions contemplated by the merger agreement without imposition of a condition or restriction that, in the reasonable judgment of the board of directors of First Capital or Flag, would so materially adversely impact the economic or business benefits of the transactions contemplated by the merger agreement as to render inadvisable the consummation of the merger, or (2) adversely affect in any material respect the ability of either party to perform its covenants and agreements under the merger agreement.

 

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Furthermore, First Capital has agreed in the merger agreement not to take certain actions relating to the operation of their respective businesses pending consummation of the merger without the prior consent of Flag (which consent will not be unreasonably withheld). Such actions include, without limitation:

 

    amending their articles of incorporation, bylaws or other governing corporate instruments;

 

    becoming responsible for any obligation for borrowed money in excess of an aggregate of $100,000, except in the ordinary course of business consistent with past practices or allowing the imposition of a lien on any stock of their subsidiaries;

 

    acquiring or exchanging (other than exchanges in the ordinary course under employee benefit plans) any shares (or securities convertible into any shares) of capital stock or paying any dividend or making any distribution on any capital stock;

 

    issuing, selling or pledging additional shares of common stock, any stock appreciation rights, any rights to acquire any such stock or any security convertible into such stock;

 

    adjusting or reclassifying any capital stock or issuing or authorizing the issuance of any other securities in respect of, or in substitution for, shares of common stock or their subsidiaries’ common stock, or otherwise disposing of or encumbering any asset(s) having a book value in excess of $100,000, other than in the ordinary course for reasonable and adequate consideration;

 

    acquiring control over any real property, subject to certain exceptions such as foreclosures and acquisitions made in a fiduciary capacity;

 

    purchasing any securities or making any material investments in any person or otherwise acquiring direct or indirect control over any person subject to certain exceptions;

 

    granting any increase in compensation or benefits to employees or officers in excess of 5% on an annual basis (except in accordance with past practice and as previously disclosed, or as required by law), paying any bonus, entering into or amending any severance agreements with officers, or granting any increase in compensation or other benefits to directors (except in accordance with past practice as previously disclosed to the other party);

 

    entering into or amending (unless required by law) any employment contract that does not have the unconditional right to terminate without certain liability;

 

    adopting, subject to certain exceptions, any new employee benefit plan or materially changing any existing plan or program;

 

    making any significant change in tax or accounting methods or systems of internal accounting controls, except for any change required by law or generally accepted accounting principles;

 

    commencing any litigation other than in accordance with past practice or settling any litigation for money damages in excess of $50,000 or which places material restrictions on operations;

 

    except in the ordinary course of business, modifying, amending or terminating any material contracts or waiving, releasing or assigning any material rights or claims;

 

    extending credit to any borrower in excess of an aggregate of $1,000,000;

 

    making any material election with respect to taxes; or

 

    incurring or becoming obligated to incur any expenses exceeding $100,000, whether capitalized, expended or otherwise other than in the ordinary course of business, excluding any expenses or obligations incurred in connection with the merger.

 

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Furthermore, Flag has agreed in the merger agreement not to take certain actions relating to the operation of their respective businesses pending consummation of the merger without the prior consent of First Capital (which consent will not be unreasonably withheld). Such actions include, without limitation:

 

    amending their articles of incorporation, bylaws or other governing corporate instruments;

 

    acquiring or exchanging (other than exchanges in the ordinary course under employee benefit plans) any shares (or securities convertible into any shares) of capital stock or paying any dividend or making any distribution on any capital stock;

 

    issuing, selling or pledging additional shares of common stock, any stock appreciation rights, any rights to acquire any such stock or any security convertible into such stock; and

 

    adjusting or reclassifying any capital stock or issuing or authorizing the issuance of any other securities in respect of, or in substitution for, shares of common stock or their subsidiaries’ common stock, or otherwise disposing of or encumbering any asset(s) having a book value in excess of $100,000, other than in the ordinary course for reasonable and adequate consideration.

 

In addition, each party has agreed that neither it nor any of its affiliates or representatives will: (a) solicit, initiate, or encourage the submission of any acquisition proposal (generally, a tender offer or any proposal for a merger, acquisition, or other business combination), (b) participate in any negotiations regarding, or furnish any information with respect to, an acquisition proposal, (c) withhold, withdraw or modify, in a manner adverse to the party, the approval or recommendation by such party’s board of directors of this merger agreement, or (d) approve, recommend or enter into any agreement with respect to any acquisition proposal. However, prior to the approval of the merger agreement by shareholders, each party may take the above mentioned actions in connection with an unsolicited bona fide acquisition proposal, after giving five business days’ prior written notice to the other party, to the extent that such party’s board of directors determines in good faith (after consultation with its advisors) that such acquisition proposal is a superior proposal with more favorable terms from a financial point of view, and that to do otherwise would be inconsistent with its fiduciary duty to its shareholders. Furthermore, such party’s board of directors may, in the case of (d), terminate the merger agreement; provided, however, that any party shall have caused its financial and legal advisors to negotiate in good faith with the other party during such five business days to adjust the terms of the merger agreement as would enable any party to proceed with the merger on such adjusted terms. In the merger agreement, each party also agreed to immediately cease and terminate any negotiations with any other parties with respect to any ongoing acquisition proposal.

 

Expenses and Fees

 

The merger agreement provides that each party will be responsible for its own direct costs and expenses incurred in connection with the negotiation and consummation of the transactions contemplated by the merger agreement, except that Flag will pay the filing fee in connection with the registration statement and this joint proxy statement/prospectus and one-half of the printing costs incurred in connection with printing the registration statement and this joint proxy statement/prospectus.

 

Accounting Treatment

 

The merger will be accounted for using the purchase method of accounting for financial reporting purposes. Flag and First Capital have determined that the merger will be accounted for as an acquisition by Flag of First Capital. In identifying Flag as the acquiring entity, the companies took into account the relative outstanding share ownership, the composition of the governing body of the combined entity and the designation of certain senior management positions. Under purchase accounting, the assets and liabilities of an acquired company as of the effective time of the acquisition are recorded at their respective fair values and added to those of the acquiring company. Financial statements issued after consummation of an acquisition accounted for as a purchase would reflect such values and would not be restated retroactively to reflect the historical financial position or results of operations of the acquired company.

 

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Resales of Flag Common Stock

 

The shares of Flag common stock to be issued to First Capital shareholders in the merger have been registered under the Securities Act of 1933 (the “Securities Act”). Such shares may be traded freely and without restriction by those shareholders not deemed to be “affiliates” of First Capital or Flag as that term is defined under the Securities Act. Any subsequent transfer of such shares, however, by any person who is an affiliate of First Capital at the time the merger is submitted for a vote or consent of the shareholders of First Capital will, under existing law, require either:

 

    the further registration under the Securities Act of the shares of Flag common stock to be transferred;

 

    compliance with Rule 145 promulgated under the Securities Act (permitting limited sales under certain circumstances); or

 

    the availability of another exemption from registration.

 

An “affiliate” of First Capital, as defined by the rules promulgated pursuant to the Securities Act, is a person who directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with First Capital. First Capital has agreed that it will use its reasonable efforts to cause each person or entity that is an “affiliate” for purposes of complying with Rule 145 to enter into a written agreement relating to such restrictions on sale or other transfer.

 

Dissenters’ Appraisal Rights

 

Any First Capital shareholder who desires to dissent from the merger and receive the “fair value” of his or her common stock in cash may do so upon complying with the provisions of Sections 14-2-1301 through 14-2-1332 of the Georgia Business Corporation Code. As a result of exceptions under the Georgia Business Corporation Code, however, shareholders of Flag are not entitled to the dissenters’ appraisal rights in connection with the merger. The following is a summary of those sections and is qualified in its entirety by the copy of the sections attached to this joint proxy statement/prospectus as Appendix D, which is incorporated by reference herein.

 

Georgia law provides that any dissenting shareholder desiring to object to the merger and receive payment in cash for his or her shares of common stock must deliver, prior to the vote by his or her company’s shareholders on the merger agreement, written notice of his or her intent to demand payment for his or her shares of common stock if the merger is completed. A First Capital shareholder should mail or deliver such notice to First Capital Bancorp, Inc., Attention: Corporate Secretary, 3320 Holcomb Bridge Road, N.W., Suite A, Norcross, Georgia 30092. The demand must be in addition to, and separate from, any proxy or vote against the merger. Any dissenting shareholder must not vote in favor of the merger agreement.

 

If the merger agreement is approved by First Capital and Flag shareholders, within ten days after the vote of First Capital’s shareholders, First Capital will send by mail a written notice, known as a “dissenters’ notice,” to each shareholder who filed a written notice of his or her intent to dissent and who has not voted in favor of the merger agreement. The dissenters’ notice will:

 

    state where demand for payment must be sent, and set a date by which the company must receive the payment demand, which date may not be fewer than 30 nor more than 60 days after the date of the dissenters’ notice;

 

    specify where and when share certificates must be deposited, or, in the case of uncertificated shares, the restrictions on the transfer of the uncertificated shares after the payment demand is received by the company; and

 

    be accompanied by a copy of Sections 14-2-1301 through 14-2-1332 of the Georgia Business Corporation Code.

 

 

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Index to Financial Statements

The dissenters’ notice is to be sent to each dissenting shareholder at his or her address as it appears in First Capital’s stock transfer books or at such address as the dissenting shareholder supplies by notice to First Capital. Any dissenting shareholder who fails to demand payment or deposit share certificates where required by the date set in the dissenters’ notice will no longer be entitled to payment for his or her shares of common stock under Georgia law.

 

Within ten days after the later of (1) the effective time of the merger, or (2) the receipt of a demand for payment from a shareholder, First Capital must make a written offer of payment to each dissenting shareholder who demanded payment and deposited certificates as required, in the amount First Capital estimates to be the fair value of the dissenting shareholder’s shares, plus any accrued interest from the effective time of the merger. Such offer of payment must be accompanied by:

 

    First Capital’s financial statements as of the end of a fiscal year ending not more than 16 months before the date of payment, and the latest available interim financial statements of First Capital;

 

    a statement of First Capital’s estimate of the fair value of its shares;

 

    an explanation of how the interest was calculated;

 

    a statement of the dissenter’s right to demand payment under Section 14-2-1327 of the Georgia Business Corporation Code; and

 

    a copy of Sections 14-2-1301 through 14-2-1332 of the Georgia Business Corporation Code.

 

If the shareholder accepts First Capital’s offer by written notice to First Capital within 30 days after its offer, or is deemed to have accepted such offer by failure to respond within 30 days, payment for his or her shares will be made within 60 days after the making of the offer or the effective time of the merger, whichever is later. If the merger is not completed within 60 days after the date set for demanding payment and depositing share certificates, First Capital shall return the deposited certificates and release the transfer restrictions imposed on uncertificated shares. If the merger is later consummated, First Capital must send a new dissenters’ notice and repeat the payment demand procedure.

 

Within 30 days after First Capital’s offer, any dissenting shareholder who believes that First Capital’s offer is less than the fair value of his or her shares, or who believes the interest due has been incorrectly calculated, may, in writing, notify his or her company of his or her estimate of the fair value of the shares or interest due. If the shareholder’s demand for payment remains unsettled, First Capital must commence a proceeding within 60 days after receiving the payment demand and petition the Superior Court located in the county where First Capital is headquartered to determine the fair value of the shares and the accrued interest. The court may appoint one or more persons as appraisers to receive evidence and recommend a decision on the fair value of the shares. Each dissenting shareholder whose demand remains unsettled will be made a party to the proceeding and will be entitled to judgment for the amount the court finds to be the fair value of the shareholder’s shares, plus interest to the date of judgment.

 

The court shall assess the costs of the appraisal proceeding against First Capital. However the court may assess costs against all or some of the dissenters, in amounts the court finds equitable, to the extent the court finds the dissenters acted arbitrarily, vexatiously, or not in good faith in demanding payment for their shares. The court may also assess fees and attorney’s expenses against any party the court finds to have acted arbitrarily, vexatiously, or not in good faith with respect to the rights provided by Georgia law.

 

No action by any dissenter to enforce dissenters’ rights may be brought more than three years after the effective time of the merger, regardless of whether notice of the merger and the right to dissent was given by the applicable company in accordance with Georgia law.

 

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Index to Financial Statements

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

 

The following unaudited pro forma condensed combined financial information and explanatory notes present how the combined financial statements of Flag and First Capital may have appeared had the businesses actually been combined at the beginning of the period presented. The unaudited pro forma condensed combined financial information shows the impact of the merger of Flag and First Capital on the companies’ respective historical financial positions and results of operations under the purchase method of accounting with Flag treated as the acquirer. Under this method of accounting, the assets and liabilities of First Capital will be recorded by Flag at their estimated fair values as of the date the merger is completed. The unaudited pro forma condensed combined financial information combines the historical financial information of Flag and First Capital as of and for the six months ended June 30, 2005 and for the year ended December 31, 2004. The unaudited pro forma condensed combined balance sheet as of June 30, 2005 assumes the merger was completed on that date. The unaudited pro forma condensed combined statements of income give effect to the merger as if the merger had been completed on January 1, 2004 and January 1, 2005, respectively.

 

The merger agreement was announced on May 26, 2005 and provides for each outstanding share of First Capital common stock to be converted into the right to receive 1.6 shares of Flag common stock other than shares beneficially owned by Flag, First Capital or any non-institutional First Capital shareholder who owns in excess of 384,000 of the issued and outstanding pro forma shares of Flag common stock. The unaudited pro forma condensed combined financial information has been derived from and should be read in conjunction with the historical consolidated financial statements and the related notes of both Flag and First Capital, which are incorporated in this document by reference or appear elsewhere in this document. See “Where You Can Find More Information” on page 110 and “Financial Statements of First Capital Bancorp, Inc. and Subsidiaries” on page F-1.

 

The unaudited pro forma condensed combined financial information is presented for illustrative purposes only and does not indicate the financial results of the combined companies had the companies actually been combined at the beginning of each period presented and had the impact of possible revenue enhancements, expense efficiencies, asset dispositions and share repurchases, among other factors, been considered. In addition, as explained in more detail in the accompanying notes to the unaudited pro forma condensed combined financial information, the allocation of the purchase price reflected in the pro forma condensed combined financial information is subject to adjustment.

 

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Index to Financial Statements

Flag Financial Corporation/First Capital Bancorp, Inc.

 

Pro Forma Condensed Combined Balance Sheet

(Unaudited)

 

The following unaudited pro forma condensed combined balance sheet combines the historical balance sheets of Flag and First Capital assuming the companies had been combined on June 30, 2005, on a purchase accounting basis.

 

     June 30, 2005

 
     Flag
Historical


    First Capital
Historical


    Pro Forma
Adjustments


    Pro Forma
Combined


 
     (Dollars in Thousands, Except Share Data)  

Assets

                                

Cash and due from banks

   $ 13,720     $ 20,826     $ 10,804 (a)   $ 45,350  

Federal funds sold

     6,378       3,422       —         9,800  

Interest-bearing deposits in banks

     18,958       1,278       —         20,236  

Investment securities

     123,138       129,667       46 (b)     252,851  

Restricted equity securities

     —         6,916       —         6,916  

Mortgage loans held for sale

     9,106       —         —         9,106  

Loans, net

     638,947       489,775       —         1,128,722  

Premises and equipment

     13,558       1,144       —         14,702  

Goodwill

     20,324       7,411       71,878 (c)     99,613  

Core deposit intangible

     683       953       6,015 (d)     7,651  

Other assets

     17,697       13,422       322 (e)     31,441  
    


 


 


 


Total Assets

   $ 862,509     $ 674,814     $ 89,065     $ 1,626,388  
    


 


 


 


Liabilities

                                

Deposits:

                                

Non-interest-bearing deposits

   $ 56,859     $ 102,927     $ —       $ 159,786  

Interest-bearing deposits

     683,944       367,320       —         1,051,264  
    


 


 


 


Total deposits

     740,803       470,247       —         1,211,050  

Federal Home Loan Bank advances

     25,000       117,371       263 (f)     142,634  

Federal funds purchased and securities sold under repurchase agreements

     1,156       16,273       —         17,429  

Other borrowings

     1,600       —         —         1,600  

Junior subordinated debentures

     14,433       6,392       24,872 (g)     45,697  

Other liabilities

     7,128       4,955       8,352 (h)     20,435  
    


 


 


 


Total liabilities

     790,120       615,238       33,487       1,438,845  
    


 


 


 


Stockholders’ Equity

                                

Common stock

     10,097       5,228       2,372 (i)     17,697  

Additional paid-in capital

     28,296       36,567       70,987 (i)     135,850  

Retained earnings

     47,751       19,876       (19,876 )(i)     47,751  

Accumulated other comprehensive loss

     (251 )     (612 )     612 (i)     (251 )

Unearned ESOP shares

     —         (240 )     240 (i)     —    

Less treasury stock

     (13,504 )     (1,243 )     1,243 (i)     (13,504 )
    


 


 


 


Total shareholders’ equity

     72,389       59,576       55,578       187,543  
    


 


 


 


Total liabilities and stockholders’ equity

   $ 862,509     $ 674,814     $ 89,065     $ 1,626,388  
    


 


 


 


Shares outstanding

     8,546,086       5,079,502       2,520,148 (i)     16,145,736  

 

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Index to Financial Statements

Flag Financial Corporation/First Capital Bancorp, Inc.

 

Pro Forma Condensed Combined Statement of Income

(Unaudited)

 

The following preliminary unaudited pro forma condensed combined statement of income combines the historical statements of income of Flag and First Capital assuming the companies had been combined on January 1, 2005, on a purchase accounting basis.

 

     For the Six Months Ended June 30, 2005

     Flag Historical

   First Capital
Historical


   Pro Forma
Adjustments


    Pro Forma
Combined


     (Dollars in Thousands, Except Share and Per Share Data)

Interest income

   $ 26,851    $ 19,109    $ 116  (j)   $ 46,076

Interest expense

     9,025      6,409      544  (k)     15,978
    

  

  


 

Net interest income

     17,826      12,700      (428 )     30,098

Provision for loan losses

     375      300              675
    

  

          

Net interest income after provision for loan losses

     17,451      12,400      (428 )     29,423

Non-interest income

     5,194      746              5,940

Non-interest expense

     16,539      9,029      570  (l)     26,138
    

  

  


 

Earnings before provision for income taxes

     6,106      4,117      (998 )     9,225

Provision for income taxes

     1,973      1,526      (379 )(m)     3,120
    

  

  


 

Net earnings

   $ 4,133    $ 2,591    $ (619 )   $ 6,105
    

  

  


 

Basic earning per share

   $ 0.48    $ 0.52            $ 0.38
    

  

          

Diluted earnings per share

   $ 0.45    $ 0.50            $ 0.36
    

  

          

Shares

                            

Basic

     8,526,428      5,026,021      2,573,629  (n)     16,126,078

Diluted

     9,249,683      5,217,473      2,496,881  (o)     16,964,037

 

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Index to Financial Statements

Flag Financial Corporation/First Capital Bancorp, Inc.

 

Pro Forma Condensed Combined Statement of Income

(Unaudited)

 

The following preliminary unaudited pro forma condensed combined statement of income combines the historical statements of income of Flag and First Capital assuming the companies had been combined on January 1, 2004, on a purchase accounting basis.

 

     For the Year Ended December 31, 2004

     Flag
Historical


   First Capital
Historical


   Pro Forma
Adjustment


    Pro Forma
Combined


     (Dollars in Thousands, Except Share and Per Share Data)

Interest income

   $ 42,621    $ 29,624    $ 123 (j)   $ 72,368

Interest expense

     12,057      11,191      954 (k)     24,202
    

  

  


 

Net interest income

     30,564      18,433      (831 )     48,166

Provision for loan losses

     1,845      1,325      —         3,170
    

  

  


 

Net interest income after provision for loan losses

     28,719      17,108      (831 )     44,996

Non-interest income

     11,468      1,094      —         12,562

Non-interest expense

     29,509      13,235      1,269 (l)     44,013
    

  

  


 

Earnings before provision for income taxes

     10,678      4,967      (2,100 )     13,545

Provision for income taxes

     3,310      1,755      (798 )(m)     4,267
    

  

  


 

Net earnings

   $ 7,368    $ 3,212    $ (1,302 )   $ 9,278
    

  

  


 

Basic earning per share

   $ 0.88    $ 0.83            $ 0.58
    

  

          

Diluted earnings per share

   $ 0.82    $ 0.80            $ 0.56
    

  

          

Shares

                            

Basic

     8,396,047      3,868,748      3,730,902 (n)     15,995,697

Diluted

     8,981,620      3,994,990      3,718,018 (o)     16,694,628

 

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Index to Financial Statements

NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED

FINANCIAL INFORMATION

(Unaudited)

 

(a) Represents the net proceeds from the proposed trust preferred offering by Flag of $24.9 million and the proceeds from warrant exercises by Flag warrant holders of 768,049 warrants at a price of $6.51 per warrant (or $5.0 million in the aggregate), less the cash paid to First Capital shareholders of $19.1 million.

 

(b) Represents the fair value adjustment for securities held-to-maturity.

 

(c) Represents the write-off of First Capital goodwill of $7.4 million and the recording of $79.3 million in goodwill as a result of the merger.

 

(d) Represents the write-off of First Capital core deposit intangible of $953,000 and the recording of $7.0 million in core deposit intangible as a result of the merger (the estimated core deposit intangible is based on industry averages for premiums recently paid on deposits).

 

(e) Represents $50,000 in debt issuance costs related to the proposed trust preferred offering by Flag and $272,000 deferred tax asset resulting from change of control provisions of the deferred compensation arrangements for First Capital.

 

(f) Represents the fair value adjustment for Federal Home Loan Bank advances.

 

(g) Represents the fair value adjustment of $128,000 relating to First Capital junior subordinated debentures and assumed the proposed issuance of $25 million of trust preferred securities by Flag to help fund the transaction and increase its regulatory capital.

 

(h) Represents the net deferred income taxes of $2.6 million relating to purchase accounting adjustments, $5.0 million of transaction costs, net of the tax benefit relating to the merger, including $2.4 million of personnel related costs, $1.8 million of professional expenses and $851,000 of conversion costs, and $716,000 to adjust deferred compensation for change of control vesting provisions of the deferred compensation arrangements for First Capital.

 

(i) Represents the elimination of First Capital equity accounts, issuance of 6.8 million of Flag common shares in the merger at an estimated fair value of $103.9 million (based on the average closing price of Flag common stock for the 10 days before and the 10 days after the merger announcement of $15.14, a reasonable estimate of the value of the Flag common stock), the recording of $6.2 million in additional paid-in capital relating to the fair value of First Capital stock options, and the exercise of 768,049 warrants by Flag warrant holders at a price of $6.51 per warrant.

 

(j) Represents the earnings on $10.8 million net cash ($24.9 million trust preferred offering and the proceeds from the issuance of 768,049 shares of common stock upon the exercise of warrants of $5.0 million, less the cash paid to First Capital shareholders of $19.1 million) assuming an investment in overnight federal funds and the amortization of purchase accounting adjustment for held-to-maturity securities (12 year straight line amortization).

 

(k) Represents the amortization of purchase accounting adjustments for Federal Home Loan Bank advances (4 year straight line amortization) and junior subordinated debentures (27 year straight line amortization) as well as interest expense related to the proposed $25 million trust preferred offering by Flag (using 3 month LIBOR rate at period end plus 1.50%).

 

(l) Represents the amortization of purchase accounting adjustments for the core deposit intangible (10 year sum of the years digit amortization) and debt issuance costs of $50,000 related to the proposed $25 million trust preferred offering by Flag (30 year straight line amortization).

 

(m) Represents the net tax effect, at 38%, related to the amortization of purchase accounting adjustments, interest income from overnight investments and interest expense from the proposed trust preferred offering by Flag.

 

(n) Represents issuance of 6.8 million shares of Flag common stock in the merger, the elimination of First Capital weighted average basic shares, and the exercise of 768,049 warrants by Flag warrant holders.

 

(o) Represents issuance of 6.8 million shares of Flag common stock in the merger, conversion of First Capital options to Flag options in the merger, elimination of First Capital weighted average dilutive shares, and the issuance of 768,049 shares of common stock upon the exercise of warrants by Flag warrant holders.

 

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Index to Financial Statements

INFORMATION ABOUT FLAG

 

General

 

Flag is a bank holding company headquartered in Atlanta, Georgia and is registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Flag is the sole shareholder of Flag Bank and was incorporated under the laws of the State of Georgia on February 9, 1993.

 

As a bank holding company, Flag facilitates Flag Bank’s abilities to serve its customers’ requirements for financial services. The holding company structure provides greater financial and operating flexibility than is available to Flag Bank. For example, Flag may assist Flag Bank in maintaining its required capital ratios by borrowing money and contributing the proceeds of the debt to Flag Bank as primary capital. Flag provides several services through divisions of Flag Bank including mortgage services through Flag Mortgage, investment and insurance services through Flag Financial Services and payroll processing through Payroll Solutions.

 

As of June 30, 2005, Flag had total assets of $862.5 million, total deposits of $740.8 million, shareholders’ equity of $72.4 million and net loans of $638.9 million.

 

The principal office of Flag is located at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia 30305, telephone number (404) 760-7700.

 

Flag Bank

 

Flag Bank is a state bank organized under the laws of the State of Georgia with locations in the following cities and counties in Georgia: Atlanta (Fulton County, DeKalb County and Cobb County), Unadilla (Dooly County), Vienna (Dooly County), Montezuma (Macon County), Buena Vista (Marion County), LaGrange (Troup County), Hogansville (Troup County), Jonesboro (Clayton County), Duluth (Gwinnett County), Columbus (Muscogee County), Macon (Bibb County), Newnan (Coweta County) and Warner Robins (Houston County). Flag Bank was originally chartered in 1931 as Citizens Bank and became a wholly owned subsidiary of Flag through a series of acquisitions commencing in 1998.

 

Flag Bank’s business consists primarily of attracting deposits from the general public and, with these and other funds, offering a broad range of banking products and services, including residential mortgage loans, consumer loans, commercial loans, commercial real estate loans, residential construction loans, securities investments and other services. Flag Bank’s principal sources of income are interest and fees collected on loans, including fees received for originating and selling loans and for servicing loans sold to others, and, to a lesser extent, interest and dividends collected on other investments and service charges on deposit accounts.

 

For more information about Flag’s business, reference is made to Flag’s Annual Report on Form 10-K for the year ended December 31, 2004, which is incorporated by reference into this proxy statement/prospectus. See “Where You Can Find More Information.”

 

INFORMATION ABOUT FIRST CAPITAL

 

General

 

First Capital is a bank holding company headquartered in Norcross, Georgia and is registered under the BHC Act. First Capital was incorporated under the laws of the State of Georgia on November 5, 1997, and is the sole shareholder of First Capital Bank and Capital Financial Software, LLC.

 

On May 28, 2004, First Capital, which was then known as CNB Holdings, Inc., acquired the former First Capital Bancorp, Inc. (“Old FCBI”) through the merger (the “May 2004 merger”) of Old FCBI with and into

 

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First Capital. First Capital was the surviving company of the May 2004 merger. On December 31, 2004, First Capital changed its name from CNB Holdings, Inc. to First Capital Bancorp, Inc. First Capital’s stock ticker symbol changed to “FCBX.OB” effective January 18, 2005.

 

As a result of the May 2004 merger, First Capital Bank and Capital Financial Software, LLC, which were wholly owned subsidiaries of Old FCBI, became wholly owned subsidiaries of First Capital. Additionally, as a result of the May 2004 merger, First Capital assumed Old FCBI’s obligations under the First Capital Statutory Trust, I, which was created in connection with Old FCBI’s issuance of trust preferred securities. On November 15, 2004, however, First Capital merged its two wholly owned banking subsidiaries, First Capital Bank and Chattahoochee National Bank, with First Capital Bank surviving the bank merger.

 

In addition, First Capital operates Capital Financial Software, LLC, which markets and sells a proprietary software package used by bankruptcy trustees to monitor and track the disposition of Chapter 7 bankruptcy cases.

 

As of June 30, 2005, First Capital had total assets of $674.8 million, total deposits of $470.2 million, shareholders’ equity of $59.6 million and net loans of $489.8 million.

 

First Capital’s executive office is located at 3320 Holcomb Bridge Road, N.W., Suite A, Norcross, Georgia 30092, and its telephone number at such location is (770) 921-6400.

 

First Capital Bank

 

First Capital Bank is a state-chartered commercial bank located in Norcross, Georgia, with its primary market consisting of the metropolitan Atlanta area. First Capital Bank operates five locations in Norcross, Alpharetta, Duluth and Cumming, Georgia. First Capital Bank is a full service commercial bank that offers a broad range of banking products and services, including commercial, real estate, residential mortgage, SBA loans and consumer loans, cash management and other services.

 

First Capital Bank’s business consists primarily of attracting deposits from the general public and, with these and other funds, offering a brand range of banking products and services, including residential mortgage loans, consumer loans, commercial loans, commercial real estate loans, residential construction loans, securities investments and other services. First Capital Bank’s principal sources of income are interest and fees collected on loans, including fees received for originating and selling loans and for servicing loans sold to others, and, to a lesser extent, interest and dividends collected on other investments and service charges on deposit accounts.

 

Loan Approval and Review. First Capital Bank’s loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds that individual officer’s lending authority, the loan request is considered and approved by an officer with a higher lending limit or the loan committee. First Capital Bank makes loans to directors or executive officers of First Capital Bank after approval by the board of directors of First Capital Bank, on terms not more favorable than would be available to entities otherwise unaffiliated with First Capital Bank.

 

Lending Limits. First Capital Bank’s lending activities are subject to a variety of lending limits imposed by state and federal law. Differing limits apply based on the type of loan and the nature of the borrower, including the borrower’s other loan relationships with First Capital Bank. In general, however, First Capital Bank is able to loan to any one borrower a maximum amount equal to either 15% of First Capital Bank’s capital and surplus or 25% of its capital and surplus if the amount that exceeds 15% is fully secured by good collateral and other ample security.

 

Credit Risks. The principal economic risk associated with each category of loans that First Capital Bank makes is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relevant business market segment.

 

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Real Estate Loans. First Capital Bank makes commercial real estate loans, construction and acquisition and development loans, and residential real estate loans. These loans include commercial loans in which First Capital Bank takes a security interest in real estate out of an abundance of caution and not as the principal collateral for the loan, but exclude home equity loans, which are classified as consumer loans.

 

Commercial Real Estate. First Capital Bank focuses on diversifying its portfolio across different property types. Accordingly, its commercial real estate portfolio includes loans secured by warehouses, office buildings, land, extended stay properties, assisted living properties retail office and service properties, self storage properties, apartments, condominiums, industrial properties, and restaurants. Commercial real estate loan terms generally are limited to five years or less, although payments may be structured on a longer amortization basis. Interest rates may be fixed or adjustable, but generally are not fixed for a period exceeding 60 months. First Capital Bank normally charges an origination fee on these loans. Risks associated with commercial real estate loans include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and the quality of the borrower’s management. First Capital Bank attempts to limit its risk by analyzing borrowers’ cash flow and collateral value on an ongoing basis.

 

Construction and Acquisition and Development Loans. First Capital Bank’s construction and acquisition and development loans are diversified over a mix of commercial, single family and multi-family developments. Construction loans are generally made with a term of approximately 12 months, and interest is paid monthly. Acquisition and development loans are generally made with a term of approximately 24 months, and interest is paid monthly. The ratio of the loan principal to the value of the collateral as established by independent appraisal generally does not exceed 80%. Loans on developments or properties that have not been pre-sold by the builder are also based on the builder/borrower’s financial strength and cash flow position, as well as the financial strength and reputation of the builder in case of an acquisition and development loan. Loan proceeds are disbursed based on the percentage of completion and only after an experienced construction lender or engineer has inspected the project. Risks associated with construction loans include fluctuations in the value of real estate and new job creation trends.

 

Residential Real Estate. First Capital Bank’s residential real estate loans consist of residential first and second mortgage loans. The majority of First Capital Bank’s residential real estate loans are “five-one” adjustable rate mortgages. The interest rate on these loans is fixed for the first five years, then is adjusted on the fifth anniversary of the loan and each anniversary thereafter based on the index specified in the loan documentation. As a result, First Capital Bank limits its exposure to long-term interest rate risks that are typically associated with residential real estate loans. Residential real estate loans are made consistent with First Capital Bank’s loan policy and with the ratio of the loan principal to the value of collateral as established by independent appraisal not to exceed 80%. These loan-to-value ratios are designed to compensate for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market.

 

Commercial Loans. First Capital Bank’s commercial loans include working capital loans, accounts receivable and inventory financing and equipment financing. The terms of these loans vary by purpose and by type of underlying collateral, if any. First Capital Bank typically makes equipment loans for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term. Equipment loans generally are secured by the financed equipment, and the ratio of the loan principal to the value of the financed equipment or other collateral is generally 70% or less. Loans to support working capital typically have terms not exceeding one year and usually are secured by accounts receivable, inventory or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash, and for loans secured with other types of collateral, principal is typically due at maturity. The quality of the commercial borrower’s management and its ability both to evaluate properly changes in the supply and demand characteristics affecting its markets for products and services and to respond effectively to such changes are significant factors in a commercial borrower’s creditworthiness.

 

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Consumer Loans. First Capital Bank also makes, to a lesser extent, a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans, home equity loans and lines of credit. Consumer loan repayments depend upon the borrower’s financial stability and are more likely to be adversely affected by divorce, job loss, illness and personal hardships. Because many consumer loans are secured by depreciable assets such as boats, cars and trailers, these loans are typically amortized over the useful life of the asset.

 

First Capital Bank also originates mortgage loans for sale into the secondary market. First Capital Bank limits interest rate risk and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan.

 

Investments. In addition to loans, First Capital Bank makes other investments primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States, other taxable securities and other obligations of states and municipalities. First Capital Bank also engages in federal funds transactions with its principal correspondent banks and acts as both a buyer and seller of funds depending on the cost of funds.

 

Deposits. First Capital Bank offers certificates of deposit, commercial checking and money market accounts and personal checking and money market accounts. Additionally, First Capital Bank offers cash management services to its commercial customers.

 

Asset and Liability Management. The goal of First Capital Bank’s asset and liability management policy is to effectively utilize all sources of funds, including liabilities, capital and off balance sheet items, to minimize principal risk, interest rate risk and funding risk while providing an optimum and stable net interest margin, a profitable after-tax return on assets and return on equity and adequate liquidity. The asset and liability management committee conducts these management functions within the framework of written loan and investment policies that First Capital Bank has adopted. Wide and frequent fluctuations in market interest rates, coupled with an objective of achieving reasonable net interest margin, make a relatively balanced rate sensitivity position a desirable goal. The committee attempts to achieve this goal by monitoring the rate sensitivity gap position. The “gap” is the difference between rate sensitive assets and rate sensitive liabilities as a percentage of total assets.

 

Capital Financial Software. Capital Financial Software, LLC was formed in 1997 to provide proprietary software to bankruptcy trustees. The software is designed to allow bankruptcy trustees to monitor and track the disposition of Chapter 7 bankruptcy cases while assisting the trustees in processing information that must be periodically submitted to bankruptcy courts. Its software product, ProClaim, is fully developed and is being marketed to both financial institutions and bankruptcy trustees throughout the United States.

 

Other Banking Services. Other bank services include cash management services, travelers checks, direct deposit of payroll and social security checks and automatic drafts for various accounts. First Capital Bank is associated with a shared network of automated teller machines that may be used by First Capital Bank’s customers throughout Georgia and other states. First Capital Bank also offers MasterCard and VISA credit card services through The Banker’s Bank, Atlanta, Georgia, as its agent. In addition, First Capital Bank offers Internet banking and corporate cash management services.

 

First Capital Bank also offers to its targeted commercial customers a courier service that will pick up non-cash deposits and minimal cash deposits of up to $200 from the customer’s place of business and deliver it to First Capital Bank. First Capital Bank believes that this is an important service for its customers because First Capital Bank currently has only two full-service locations. First Capital Bank has contracted with a third-party courier service that has been approved by the Georgia Public Service Commission for bank-related work.

 

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Employees

 

First Capital has 109 full-time equivalent employees. Employees of First Capital enjoy a variety of employee benefit programs, including a 401(k) plan, various comprehensive medical, accident and group life insurance plans and paid vacations. First Capital considers its relations with its employees to be excellent.

 

Market Area and Competition

 

First Capital operates in North Atlanta, and its primary market area is the Atlanta metropolitan statistical area (“Atlanta MSA”). The Atlanta MSA continues to experience significant economic and population growth, providing a market with a vibrant economy that is supported by a well-balanced industrial and manufacturing base.

 

The banking business is highly competitive, and the profitability of First Capital Bank depends principally upon First Capital Bank’s ability to compete in its market area. First Capital Bank competes with other commercial and savings banks, savings and loan associations, credit unions, finance companies, mutual funds, asset-based non-bank lenders and certain other non-financial institutions. First Capital Bank has been able to compete effectively with other financial institutions by establishing long-term customer relationships and building customer loyalty, emphasizing technology and customer service and providing products and services designed to address the specific needs of its customers.

 

Supervision and Regulation

 

Both First Capital and First Capital Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to First Capital and First Capital Bank.

 

First Capital. Because First Capital owns all of the capital stock of First Capital Bank, it is a bank holding company under the BHC Act. As a result, First Capital is primarily subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve. As a bank holding company located in Georgia, the Georgia Department also regulates and monitors all significant aspects of First Capital’s operations.

 

Acquisitions of Banks. The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:

 

    acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

 

    acquiring all or substantially all of the assets of any bank; or

 

    merging or consolidating with any other bank holding company.

 

Additionally, the BHC Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or, substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.

 

Under the BHC Act, if adequately capitalized and adequately managed, First Capital, or any other bank holding company located in Georgia, may purchase a bank located outside of Georgia. Conversely, an adequately

 

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capitalized and adequately managed bank holding company located outside of Georgia may purchase a bank located inside Georgia. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. Currently, Georgia law prohibits acquisitions of banks that have been chartered for less than three years. Because First Capital Bank has been incorporated for more than three years, this limitation does not apply to First Capital.

 

Change in Bank Control. Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require the Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:

 

    the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), or

 

    no other person owns a greater percentage of that class of voting securities immediately after the transaction.

 

First Capital common stock is registered under Section 12 of the Exchange Act. The regulations also provide a procedure for challenging the rebuttable presumption of control.

 

Permitted Activities. A bank holding company is generally permitted under the BHC Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

 

    banking or managing or controlling banks; and

 

    any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

    factoring accounts receivable;

 

    making, acquiring, brokering or servicing loans and usual related activities;

 

    leasing personal or real property;

 

    operating a non-bank depository institution, such as a savings association;

 

    trust company functions;

 

    financial and investment advisory activities;

 

    conducting discount securities brokerage activities;

 

    underwriting and dealing in government obligations and money market instruments;

 

    providing specified management consulting and counseling activities;

 

    performing selected data processing services and support services;

 

    acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

 

    performing selected insurance underwriting activities.

 

Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

 

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In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, permitting the bank holding company to engage in activities that are financial in nature or incidental or complementary to financial activity. The BHC Act expressly lists the following activities as financial in nature:

 

    lending, trust and other banking activities;

 

    insuring, guaranteeing or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent or broker for these purposes in any state;

 

    providing financial, investment or advisory services;

 

    issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;

 

    underwriting, dealing in or making a market in securities;

 

    other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;

 

    foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;

 

    merchant banking through securities or insurance affiliates; and

 

    insurance company portfolio investments.

 

To qualify to become a financial holding company, First Capital Bank and any other depository institution subsidiary of First Capital must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, First Capital must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days’ written notice prior to engaging in a permitted financial activity. While First Capital meets the qualification standards applicable to financial holding companies, First Capital has not elected to become a financial holding company.

 

Support of Subsidiary Institutions. Under Federal Reserve policy, First Capital is expected to act as a source of financial strength for First Capital Bank and to commit resources to support First Capital Bank. This support may be required at times when, without this Federal Reserve policy, First Capital might not be inclined to provide it. In addition, any capital loans made by First Capital to First Capital Bank will be repaid only after First Capital Bank’s deposits and various other obligations are repaid in full. In the unlikely event of First Capital’s bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of First Capital Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

First Capital Bank. First Capital Bank is subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of its operations. These laws are generally intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to First Capital Bank.

 

Because First Capital Bank is a commercial bank chartered under the laws of the State of Georgia, it is primarily subject to the supervision, examination and reporting requirements of the FDIC and the Georgia Department. The FDIC and Georgia Department regularly examine First Capital Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Additionally, First Capital Bank’s deposits are insured by the FDIC to the maximum extent provided by law. First Capital Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations.

 

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Branching. Under current Georgia law, First Capital Bank may open branch offices throughout Georgia with the prior approval of the Georgia Department. In addition, with prior regulatory approval, First Capital Bank may acquire branches of existing banks located in Georgia. First Capital Bank and any other national or state-chartered bank generally may branch across state lines by merging with banks in other states if allowed by the laws of the applicable foreign state. Georgia law, with limited exceptions, currently permits branching across state lines through interstate mergers.

 

Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Currently, Georgia has not opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia. This provides a limited barrier of entry into the Georgia banking market, which protects First Capital Bank from an important segment of potential competition. However, because Georgia has elected not to opt-in, First Capital Bank’s ability to establish a new start-up branch in another state may be limited. Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if its home state has also elected to opt-in. Consequently, until Georgia changes its election, the only way First Capital Bank will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.

 

Prompt Corrective Action. The FDIC Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each of the other categories. At December 31, 2004, First Capital Bank qualified for the well-capitalized category.

 

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

 

An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

 

FDIC Insurance Assessments. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the “undercapitalized” category including institutions that are undercapitalized, significantly undercapitalized and critically undercapitalized for prompt corrective action purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institution’s primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. Assessments range from 0 to 27 cents per $100 of deposits, depending on the institution’s capital group and

 

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supervisory subgroup. In addition, the FDIC imposes assessments to help pay off the $780 million in annual interest payments on the $8 billion financing corporation bonds issued in the late 1980s as part of the government rescue of the thrift industry.

 

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve or the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on First Capital and First Capital Bank. Additionally, First Capital must publicly disclose the terms of various Community Reinvestment Act-related agreements.

 

Other Regulations. Interest and other charges collected or contracted for by First Capital Bank are subject to state usury laws and federal laws concerning interest rates. For example, under the Soldiers’ and Sailors’ Civil Relief Act of 1940, a lender is generally prohibited from charging an annual interest rate in excess of 6% on any obligation for which the borrower is a person on active duty with the United States military.

 

First Capital Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

 

    federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

    Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

    Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

    Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 

    Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

    rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

 

In addition to the federal and state laws noted above, the Georgia Fair Lending Act (“GAFLA”) imposes restrictions and procedural requirements on most mortgage loans made in Georgia, including home equity loans and lines of credit. On August 5, 2003, the Office of the Comptroller of the Currency (the “OCC”) issued a formal opinion stating that the entirety of GAFLA is preempted by federal law for national banks and their operating subsidiaries. GAFLA contains a provision that preempts GAFLA as to state banks in the event that the OCC preempts GAFLA as to national banks. Therefore, First Capital Bank is exempt from the requirements of GAFLA.

 

The deposit operations of First Capital Bank are subject to:

 

    the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

 

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    the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

Capital Adequacy. First Capital and First Capital Bank are required to comply with the capital adequacy standards established by the Federal Reserve (in the case of First Capital) and the FDIC (in the case of First Capital Bank). The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. First Capital Bank is also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.

 

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

 

The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2004 First Capital’s ratio of total capital to risk-weighted assets was 11.29% and its Tier 1 Capital to risk-weighted assets was 10.17%.

 

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2004, First Capital’s leverage ratio was 8.43%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

 

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

 

Payment of Dividends. First Capital is a legal entity separate and distinct from First Capital Bank. The principal sources of the First Capital’s cash flow, including cash flow to pay dividends to its shareholders, are dividends that First Capital Bank pays to its sole shareholder, First Capital. Statutory and regulatory limitations apply to First Capital Bank’s payment of dividends. If, in the opinion of the federal banking regulator, First Capital Bank were engaged in or about to engage in an unsafe or unsound practice, the federal banking regulator could require, after notice and a hearing, that it stop or refrain from engaging in the questioned practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the FDIC Improvement Act of 1991, a

 

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depository institution may not pay any dividends if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

 

The Georgia Department also regulates First Capital Bank’s dividend payments and must approve dividend payments that would exceed 50% of First Capital Bank’s net income for the prior year. First Capital’s payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.

 

Restrictions on Transactions with Affiliates. First Capital and First Capital Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

 

    a bank’s loans or extensions of credit to affiliates;

 

    a bank’s investment in affiliates;

 

    assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;

 

    loans or extensions of credit made by a bank to third parties collateralized by the securities or obligations of affiliates; and

 

    a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

 

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. First Capital Bank must also comply with other provisions designed to avoid the taking of low-quality assets.

 

First Capital and First Capital Bank are also subject to the provisions of Section 23B of the Federal Reserve Act, which, among other things, prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

First Capital Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

 

Privacy. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.

 

Consumer Credit Reporting. On December 4, 2003, President Bush signed the Fair and Accurate Credit Transactions Act, amending the federal Fair Credit Reporting Act (the “FCRA”). These amendments to the FCRA (the “FCRA Amendments”) became effective in 2004.

 

The FCRA Amendments include, among other things:

 

    requirements for financial institutions to develop policies and procedures to identify potential identity theft and, upon the request of a consumer, place a fraud alert in the consumer’s credit file stating that the consumer may be the victim of identity theft or other fraud;

 

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    for entities that furnish information to consumer reporting agencies (which would include First Capital Bank), requirements to implement procedures and policies regarding the accuracy and integrity of the furnished information and regarding the correction of previously furnished information that is later determined to be inaccurate; and

 

    a requirement for mortgage lenders to disclose credit scores to consumers.

 

The FCRA Amendments also prohibit a business that receives consumer information from an affiliate from using that information for marketing purposes unless the consumer is first provided a notice and an opportunity to direct the business not to use the information for such marketing purposes (the “opt-out”), subject to certain exceptions. First Capital does not share consumer information among its affiliated companies for marketing purposes, except as allowed under exceptions to the notice and opt-out requirements. Because no affiliate of First Capital is currently sharing consumer information with any other affiliate of First Capital for marketing purposes, the limitations on sharing of information for marketing purposes do not have a significant impact on First Capital.

 

Anti-Terrorism and Money Laundering Legislation. First Capital Bank is subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the “USA PATRIOT Act”), the Bank Secrecy Act, and rules and regulations of the Office of Foreign Assets Control (the “OFAC”). These statutes and related rules and regulations impose requirements and limitations on specified financial transactions and account relationships, intended to guard against money laundering and terrorism financing. First Capital Bank has established a customer identification program pursuant to Section 326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise has implemented policies and procedures to comply with the foregoing rules.

 

Proposed Legislation and Regulatory Action. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating or doing business in the United States. First Capital cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which its business may be affected by any new regulation or statute.

 

Effect of Governmental Monetary Policies. First Capital’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. First Capital cannot predict the nature or impact of future changes in monetary and fiscal policies.

 

Legal Proceedings

 

There are no material pending legal proceedings to which First Capital or any of its subsidiaries is a party or of which any of their properties are subject; nor are there material proceedings known to First Capital to be contemplated by any governmental authority; nor are there material proceedings known to First Capital, pending or contemplated, in which any director, officer or affiliate or any principal security holder of First Capital, or any associate of any of the foregoing is a party or has an interest adverse to First Capital or its subsidiaries.

 

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Properties

 

First Capital’s principal executive office is located at 3320 Holcomb Bridge Road, N.W., Suite A, Norcross, Georgia 30092. As shown in the table below, First Capital Bank has two full-service banking locations and three loan production offices. First Capital leases all of its office space.

 

Executive office and full-service bank branch

   3320 Holcomb Bridge Road., N.W., Suite A,
Norcross, Georgia 30092

Full-service bank branch

   7855 North Point Pkwy., Alpharetta, Georgia 30022

Loan production office

   3802 Satellite Blvd., Suite 100, Duluth, Georgia 30096

Loan production office

   327 Dahlonega Street, Suite 604A, Cumming, Georgia 30040

Loan production office

   3625 Brookside Pkwy., Alpharetta, Georgia 30022

 

Market Price and Dividends

 

The common stock of First Capital trades on the Over the Counter Bulletin Board (“OTC BB”) under the symbol “FCBX.OB.” The market for First Capital’s common stock is limited due to its relatively low trading volume. The following table sets forth, for the periods indicated, the quarterly high and low bid price of the common stock of First Capital reported by the OTC BB. Prices reflect inter-dealer prices without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.

 

     2005

         High    

       Low    

Third Quarter (through August 11, 2005)

   $ 24.10    $ 22.55

Second Quarter

   $ 24.00    $ 16.65

First Quarter

   $ 22.00    $ 19.90

 

     2004

         High    

       Low    

Fourth Quarter

   $ 20.99    $ 16.35

Third Quarter

   $ 16.85    $ 15.25

Second Quarter

   $ 16.25    $ 13.75

First Quarter

   $ 17.50    $ 15.35

 

     2003

         High    

       Low    

Fourth Quarter

   $ 17.50    $ 14.55

Third Quarter

   $ 14.65    $ 10.50

Second Quarter

   $ 13.00    $ 9.00

First Quarter

   $ 9.55    $ 8.35

 

Historically, First Capital has not paid any dividends. First Capital’s future dividend policy will depend on First Capital’s earnings, capital requirements, financial condition and other factors considered relevant by the First Capital board of directors.

 

The principal source of First Capital’s cash flow, including cash flow to pay dividends to its shareholders, is dividends that First Capital Bank pays to First Capital. Statutory and regulatory limitations apply to First Capital Bank’s payment of dividends to First Capital, as well as to First Capital’s payment of dividends to its shareholders. For a complete discussion of restrictions on dividends, see “—Supervision and Regulation—Payment of Dividends” above.

 

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FIRST CAPITAL MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

The purpose of the following discussion is to address information relating to the financial condition and results of operations of First Capital that may not be readily apparent from a review of the consolidated financial statements and notes thereto, which begins on page F-1 of this joint proxy statement/prospectus. This discussion should be read in conjunction with information provided in First Capital’s consolidated financial statements and accompanying footnotes. Unless otherwise noted, the discussion of net interest income in this financial review is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets.

 

In the May 2004 merger, CNB Holdings, Inc. acquired all of the outstanding common stock of First Capital Bancorp, Inc. (“Old FCBI”). For accounting purposes, the acquisition has been treated as a recapitalization of Old FCBI, with Old FCBI as the acquirer (reverse acquisition). The historical financial statements prior to May 28, 2004 are those of Old FCBI. The discussion of financial condition and results of operations for the year ended December 31, 2004, include seven months of operations of the combined company and five months of operations of the Old FCBI. The results of operations for the quarter and six months ended June 30, 2004 include one month of operations of the combined company and two months, with respect to the quarter ended June 30, 2004, and five months with respect to the six months ended June 30, 2004, of operations of the Old FCBI. The results of operations for the year ended December 31, 2003 include only the operations of Old FCBI.

 

Results of Operations

 

Three-Month Period Ended June 30, 2005

 

Net income for the three months ended June 30, 2005 totaled $1,281,000, or $.25 per basic and $.25 per fully diluted share, compared to net income of $344,000, or $.11 per basic and $.10 per fully diluted share, for the same period in 2004.

 

Net interest income (the difference between the interest earned on interest-earning assets and the interest paid on interest-bearing liabilities) is the single largest component of First Capital’s revenue. First Capital actively manages this revenue source to provide an optimal level of revenue while balancing interest rate, credit and liquidity risks. Since market forces and economic conditions beyond First Capital’s control determine interest rates, the ability to generate net interest income depends upon First Capital’s ability to maintain an adequate spread between the rate paid on interest-bearing liabilities and the rate earned on interest-earning assets. Net interest income totaled $6,371,000 for the three months ended June 30, 2005, an increase of $2.5 million or 65%, over the same period in 2004.

 

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Presented below are various components of assets and liabilities, interest income and expense as well as their yield/cost for the three months ended June 30, 2005 and 2004.

 

     Three-Month Period Ended June 30,

 
     2005

    2004

 
     Average
Balances (1)


    Income/
Expense


   Yields/
Rates


    Average
Balances (1)


    Income/
Expense


   Yields/
Rates


 
     (Dollars in Thousands)  

Federal funds sold and interest-bearing deposits

   $ 4,545     $ 31    2.74 %   $ 5,976     $ 17    1.14 %

Securities (2)

     142,754       1,500    4.21       130,384       1,409    4.33  

Loans, net of deferred fees (3)(4)

     497,243       8,137    6.56       393,964       5,353    5.45  
    


 

        


 

      

Total interest-earning assets

     644,542       9,668    6.02 %     530,324       6,779    5.13 %
            

                

      

Unrealized losses on securities

     (1,147 )                  (841 )             

Allowance for loan losses

     (6,249 )                  (4,104 )             

Cash and due from banks

     17,361                    10,171               

Other assets

     22,637                    9,152               
    


              


            

Total

   $ 677,144                  $ 544,702               
    


              


            

Transaction and money market deposits

   $ 130,673     $ 372    1.14 %   $ 103,302     $ 189    0.73 %

Time deposits

     230,780       1,687    2.93       219,853       1,435    2.62  

Federal funds purchased and securities sold under repurchase agreements

     15,806       119    3.02       4,433       19    1.72  

Other borrowings

     124,021       975    3.15       121,101       1,132    3.75  

Subordinated debentures

     6,392       144    9.04       6,392       144    9.04  
    


 

        


 

      

Total interest-bearing liabilities

     507,672       3,297    2.60 %     455,081       2,919    2.57 %
            

                

      

Non interest-bearing demand deposits

     105,097                    55,486               

Other liabilities

     5,411                    2,652               

Stockholders’ equity

     58,964                    31,483