1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 COMMISSION FILE NUMBER 001-12669 FIRST NATIONAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) SOUTH CAROLINA 57-0799315 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 950 JOHN C. CALHOUN DRIVE, S.E. ORANGEBURG, SOUTH CAROLINA 29115 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (803) 534-2175 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK - $2.50 PAR VALUE AMERICAN STOCK EXCHANGE SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: NONE. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock of the registrant held by non-affiliates at March 23, 2001 was $104,825,365 based on the closing sale price of $16.30 per share on that date. For purposes of the foregoing calculation only, all directors and executive officers of the registrant have been deemed affiliates. The number of shares of common stock outstanding as of March 23, 2001 was 7,011,201. Documents Incorporated by Reference Portions of the Registrant's 2000 Annual Report to Shareholders are incorporated by reference into Part II. Portions of the Registrant's Proxy Statement for its 2001 Annual Meeting of Shareholders are incorporated by reference into Part III.
2 Form 10-K Cross-Reference Index <TABLE> <CAPTION> Page <S> <C> <C> PART I Item 1. Business ..................................................................................................... 1 Item 2. Properties.................................................................................................... 6 Item 3. Legal Proceedings ............................................................................................ 6 Item 4. Submission of Matters to a Vote of Security Holders........................................................... 6 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters (1)................................. 7 Item 6. Selected Financial Data (1)................................................................................... 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 8 Item 7a. Quantitative and Qualitative Disclosure about Market Risk .................................................... 23 Item 8. Financial Statements and Supplementary Data................................................................... 24 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures......................... 49 PART III Item 10. Directors and Executive Officers of the Registrant (2) ....................................................... 49 Item 11. Executive Compensation (2) ................................................................................... 50 Item 12. Security Ownership of Certain Beneficial Owners and Management (2) ........................................... 50 Item 13. Certain Relationships and Related Transactions (2) ........................................................... 50 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................................. 50 </TABLE> (1) Incorporated by reference to the Registrant's 2000 Annual Report to Shareholders. (2) Incorporated by reference to the Registrant's Proxy Statement for its 2001 Annual Meeting of Shareholders.
3 PART I ITEM 1. BUSINESS GENERAL First National Corporation (the "Company") is a bank holding company incorporated under the laws of South Carolina in 1985. The Company owns 100% of First National Bank, a national bank which opened for business in 1934, 100% of National Bank of York County, a national bank which opened for business in 1996, 100% of Florence County National Bank, a national bank which opened for business in 1998, and 90% of CreditSouth Financial Services Corporation, an upscale finance company which opened for business in 1998. The Company engages in no significant operations other than the ownership of its subsidiaries. On July 31, 1999, the Company and FirstBancorporation, Inc. ("FirstBanc") consummated the merger of FirstBanc into the Company. Under the terms of the merger, 1.222 shares of First National Corporation common stock were exchanged for each share of FirstBanc common stock. The transaction was accounted for by the pooling of interests method of accounting for business combinations. Some of the major services which the Company provides through its banking subsidiaries include checking, NOW accounts, savings and other time deposits of various types, alternative investment products such as annuities and mutual funds, loans for businesses, agriculture, real estate, personal use, home improvement and automobiles, credit cards, letters of credit, home equity lines of credit, safe deposit boxes, bank money orders, wire transfer services, trust services, discount brokerage services, and use of ATM facilities. The Company has no material concentration of deposits from any single customer or group of customers, and no significant portion of its loans is concentrated within a single industry or group of related industries. There are no material seasonal factors that would have a material adverse effect on the Company. The Company does not have foreign loans. TERRITORY SERVED AND COMPETITION First National Bank conducts its business from thirty-two locations in twenty South Carolina towns. National Bank of York County conducts its business from three locations in three South Carolina towns. Florence County National Bank conducts its business from two locations in two South Carolina towns, while CreditSouth Financial Services Corporation conducts its business from four locations in three South Carolina towns. In their markets, First National Bank, National Bank of York County, and Florence County National Bank (the "Banks") encounter strong competition from several major banks that dominate the commercial banking industry in their service areas and in South Carolina generally. Several competitors have substantially greater resources and higher lending limits than the Banks and they offer certain services for their customers that the Banks do not offer. In addition to commercial banks, savings institutions and credit unions, the Banks compete for deposits and loans with other financial intermediaries and investment alternatives, including but not limited to mortgage companies, captive finance companies, money market mutual funds, brokerage firms, governmental and corporation bonds and other securities. Various of these nonbank competitors are not subject to the same regulatory restrictions as the Company and many have substantially greater resources than the Company. As a bank holding company, the Company is a legal entity separate and distinct from its bank and non-bank subsidiaries. The Company coordinates the financial resources of the consolidated enterprise and maintains financial, operational and administrative systems that allow centralized evaluation of subsidiary operations and coordination of selected policies and activities. The Company's operating revenues and net income are derived primarily from its subsidiaries through dividends, fees for services performed and interest on advances and loans. EMPLOYEES The Company does not have any salaried employees. As of December 31, 2000, the Company's subsidiaries had 402 full-time equivalent employees. The Company considers its relationship with its employees to be excellent. The employee benefit programs the Company provides include group life, health and dental insurance, paid vacation, sick leave, educational opportunities, stock option plans for officers and key employees, a defined benefit pension plan, and a 401K plan for employees. 1
4 SUPERVISION AND REGULATION GENERAL The Company is a registered "bank holding company" with the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and is subject to the supervision of, and to regular inspection by, the Federal Reserve Board. Each of the Banks is organized as a national banking association and subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (the "OCC"). In addition, the Company and each of the Banks is subject to regulation (and in certain cases examination) by the Federal Deposit Insurance Corporation (the "FDIC"), other federal regulatory agencies and the South Carolina State Board of Financial Institutions (the "State Board"). The following discussion summarizes certain aspects of banking and other laws and regulations that affect the Company and its subsidiaries. Under the Bank Holding Company Act (the "BHC Act"), the Company's activities and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries, or any other activity which the Federal Reserve Board determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The BHC Act requires prior Federal Reserve Board approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. The BHC Act also prohibits a bank holding company from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless such business is determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto. Further, under South Carolina law, it is unlawful without the prior approval of the State Board for any South Carolina bank holding company (i) to acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank or any other bank holding company, (ii) to acquire all or substantially all of the assets of a bank or any other bank holding company, or (iii) to merge or consolidate with any other bank holding company. The Graham-Leach-Bliley Act amended a number of federal banking laws affecting the Company and the Banks. In particular, the Graham-Leach-Bliley Act permits a bank holding company to elect to become a "financial holding company," provided certain conditions are met. A financial holding company, and the companies it controls, are permitted to engage in activities considered "financial in nature" as defined by the Graham-Leach-Bliley Act and Federal Reserve Board interpretations (including, without limitation, insurance and securities activities), and therefore may engage in a broader range of activities than permitted by bank holding companies and their subsidiaries. The Company is evaluating whether to elect to become a financial holding company under the Graham-Leach-Bliley Act. INTERSTATE BANKING In July 1994, South Carolina enacted legislation which effectively provided that, after June 30, 1996, out-of-state bank holding companies may acquire other banks or bank holding companies in South Carolina, subject to certain conditions. Further, pursuant to the Riegel-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act"), a bank holding company became able to acquire banks in states other than its home state, beginning in September 1995, without regard to the permissibility of such acquisition under state law, subject to certain exceptions. The Interstate Banking and Branching Act also authorized banks to merge across state lines, thereby creating interstate branches, unless a state, prior to the July 1, 1997 effective date, determined to "opt out" of coverage under this provision. In addition, the Interstate Banking and Branching Efficiency Act authorized a bank to open new branches in a state in which it does not already have banking operations if such state enacted a law permitting such "de novo" branching. Effective July 1, 1996, South Carolina law was amended to permit interstate branching but not de novo branching by an out-of-state bank. The Company believes that the foregoing legislation has increased takeover activity of South Carolina financial institutions by out-of-state financial institutions. OBLIGATIONS OF HOLDING COMPANY TO ITS SUBSIDIARY BANKS Under the policy of the Federal Reserve Board, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it otherwise might not desire or be able to do. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become 2
5 "undercapitalized" within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. In addition, the "cross-guarantee" provisions of the Federal Deposit Insurance Act, as amended ("FDIA"), require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC's claim for damages is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions. The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder. This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the assets of the Banks. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the OCC is authorized to require payment of the deficiency by assessment upon the bank's shareholders', pro rata, and if any such assessment is not paid by any shareholder after three months notice, to sell the stock of such shareholder to make good the deficiency. CAPITAL ADEQUACY The various federal bank regulators, including the Federal Reserve Board and the OCC, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define what qualifies as capital and establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risks. Capital is classified into tiers. For bank holding companies, Tier 1 or "core" capital consists primarily of common and qualifying preferred shareholders' equity, less certain intangibles and other adjustments ("Tier 1 Capital"). Tier 2 capital consists primarily of the allowance for possible loan losses (subject to certain limitations) and certain subordinated and other qualifying debt ("Tier 2 Capital"). A minimum ratio of total capital to risk-weighted assets of 8.00% is required and Tier 1 Capital must be at least 50% of total capital. The Federal Reserve Board also has adopted a minimum leverage ratio of Tier 1 Capital to adjusted average total assets (not risk-weighted) of 3%. The 3% Tier 1 Capital to total assets ratio constitutes the leverage standard for bank holding companies and national banks, and will be used in conjunction with the risk-based ratio in determining the overall capital adequacy of banking organizations. The Federal Reserve Board and the OCC have emphasized that the foregoing standards are supervisory minimums and that an institution would be permitted to maintain such levels of capital only if it had a composite rating of "1" under the regulatory rating systems for bank holding companies and banks. All other bank holding companies are required to maintain a leverage ratio of 3% plus at least 1% to 2% of additional capital. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The Federal Reserve Board continues to consider a "tangible Tier 1 leverage ratio" in evaluating proposals for expansion or new activities. The tangible Tier 1 leverage ratio is the ratio of a banking organization's Tier 1 Capital less all intangibles, to total assets, less all intangibles. The Federal Reserve Board has not advised the Company of any specific minimum leverage ratio applicable to it. As of December 31, 2000, the Company, First National Bank, National Bank of York County and Florence County National Bank had leverage ratios of 8.27%, 7.74%, 8.72% and 8.30%, respectively, and total risk adjusted capital ratios of 12.15%, 11.24%, 13.22% and 11.18%, respectively. 3
6 FDICIA, among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective Federal relatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA also imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan (see "Obligations of Holding Company to its Subsidiary Banks," above). In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards. The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a "well capitalized" institution must have a Tier 1 capital ratio of at least 6%, a total capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order. An "adequately capitalized" institution must have a Tier 1 capital ratio of at least 4%, a total capital ratio of a least 8% and a leverage ratio of a least 4%, or 3% in some cases. Under these guidelines, each of the Banks is considered well capitalized. Banking agencies have also adopted final regulations which mandate that regulators take into consideration (i) concentration of credit risk, (ii) interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position), and (iii) risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. That evaluation will be made as a part of the institution's regular safety and soundness examination. In addition, the banking agencies have amended their regulatory capital guidelines to incorporate a measure for market risk. In accordance with the amended guidelines, the Company and the Banks with significant trading activity (as defined in the amendment) must incorporate a measure for market risk in their respective regulatory capital calculations effective for reporting periods after January 1, 1998. The revised guidelines are not expected to have a material impact on the Company or the Banks' regulatory capital ratios or their well capitalized status. PAYMENT OF DIVIDENDS The Company is a legal entity separate and distinct from its subsidiaries, and the Company's funds for cash distributions to its shareholders are derived primarily from dividends received from the Banks. Each of the Banks is subject to various general regulatory policies and requirements relating to the payment of dividends. Any restriction on the ability of the Banks to pay dividends will indirectly restrict the ability of the Company to pay dividends. The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year will exceed the total of its retained net profits for that year combined with its retained net profits for the two preceding years, less any required transfers to surplus. In addition, national banks can only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts. Further, if in the opinion of the OCC a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the OCC may require, after notice and a hearing, that such bank cease and desist from such practice. The OCC has indicated that paying dividends that deplete a national bank's capital base to an inadequate level would be an unsafe and unsound banking practice. The Federal Reserve Board, the OCC and the FDIC have issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. In addition to the foregoing, the ability of the Company and the Banks to pay dividends may be affected by the various minimum capital requirements and the capital and non-capital standards established under FDICIA, as described above. The right of the Company, its shareholders and its creditors to participate in any distribution of the assets or earnings of its subsidiaries is further subject to the prior claims of creditors. 4
7 CERTAIN TRANSACTIONS BY THE COMPANY AND ITS AFFILIATES Various legal limitations place restrictions on the ability of the Banks to lend or otherwise supply funds to the Company. The Federal Reserve Act limits a bank's "covered transactions," which include extensions of credit, with any affiliate to 10% of such bank's capital and surplus. All covered transactions with all affiliates cannot in the aggregate exceed 20% of a bank's capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank's affiliates. Also, the Federal Reserve Act requires that all of a bank's extensions of credit to an affiliate be appropriately secured by acceptable collateral, generally United States government or agency securities. In addition, the Federal Reserve Act limits covered and other transactions among affiliates to terms and circumstances, including credit standards, that are substantially the same or at least as favorable to a bank holding company, a bank or a subsidiary of either as prevailing at the time for transactions with unaffiliated companies. INSURANCE OF DEPOSITS As FDIC-insured institutions, First National Bank, National Bank of York County, and Florence County National Bank are subject to insurance assessments imposed by the FDIC. Under current law, the insurance assessment to be paid by FDIC-insured institutions is as specified in a schedule required to be issued by the FDIC that specifies, at semi-annual intervals, target reserve ratios designed to increase the FDIC insurance fund's reserve ratio to 1.25% of estimated insured deposits (or such higher ratio as the FDIC may determine in accordance with the statute) in 15 years. Further, the FDIC is authorized to impose one or more special assessments in any amount deemed necessary to enable repayment of amounts borrowed by the FDIC from the United States Department of the Treasury. The FDIC has implemented a risk-based assessment schedule that provides for assessments ranging from 0.00% to 0.27% of an institution's average assessment base. The actual assessment to be paid by each FDIC-insured institution is based on the institution's assessment risk classification, which is determined based on whether the institution is considered "well capitalized," "adequately capitalized" or "undercapitalized", as such terms have been defined in applicable federal regulations, and whether such institution is considered by its supervisory agency to be financially sound or to have supervisory concerns (see "--Capital Adequacy" above). As a result of the current provisions of federal law, the assessment rates on deposits could increase over present levels. Based on the current financial condition and capital levels of the Banks, the Company does not expect that the current FDIC risk-based assessment schedule will have a material adverse effect on the Banks' earnings in 2000. OTHER LAWS AND REGULATIONS Interest and certain other charges collected or contracted for by the Banks are subject to state usury laws and certain federal laws concerning interest rates. The Banks' operations are also subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers, the Community Reinvestment Act requiring financial institutions to meet their obligations to provide for the total credit needs of the communities they serve (which includes the investment of assets in loans to low- and moderate-income borrowers), the Home Mortgage Disclosure Act of 1975 requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit, the Fair Credit Reporting Act of 1978 governing the use and provision of information to credit reporting agencies, the Fair Debt Collection Act governing the manner in which consumer debts may be collected by collection agencies, and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The deposit operations of the Banks also 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 the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board 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. From time to time, bills are pending before the United States Congress and in the South Carolina state legislature which in certain cases contain wide-ranging proposals for altering the structure, regulation and competitive relationships of financial institutions. Among such bills are proposals to prohibit banks and bank holding companies from conducting 5
8 certain types of activities, to subject banks to increased disclosure and reporting requirements, to alter the statutory separation of commercial and investment banking, and to further expand the powers of banks, bank holding companies and competitors of banks. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Company and its subsidiaries may be affected thereby. FISCAL AND MONETARY POLICY Banking is a business which depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitute the major portion of a bank's earnings. Thus, the earnings and growth of the Company will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve Board. The Federal Reserve Board regulates the supply of money through various means, including open-market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve Board, and the reserve requirements on deposits. The nature and timing of any changes in such policies and their impact on the Company cannot be predicted. ITEM 2. PROPERTIES First National Bank's main office and the Company's executive offices are located at 950 John C. Calhoun Drive, S.E., Orangeburg, South Carolina. These facilities are owned by First National Bank and afford approximately 48,000 square feet of space for operating and administrative purposes. First National Bank owns twenty-seven other properties and leases twelve properties, substantially all of which are used for branch locations or housing other operational units of First National Bank. National Bank of York County owns the property located at 1127 Ebenezer Road, Rock Hill, South Carolina. National Bank of York County also leases two properties, which are used as branches. Florence County National Bank owns the property located at 1600 W. Palmetto Street, Florence, South Carolina, and leases one property which is used as a branch. CreditSouth Financial Services Corporation leases four offices, one in Orangeburg, South Carolina used for finance company operations, two in Florence, South Carolina used as a mortgage loan production office and finance company operations, and one in Socastee, South Carolina used for finance company operations. Although the properties leased and owned are generally considered adequate, there is a continuing program of modernization, expansion, and, as needs materialize, occasional replacement of facilities. ITEM 3. LEGAL PROCEEDINGS Neither the Company nor any of its subsidiaries is a party to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to their business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of shareholders in the fourth quarter of 2000. 6
9 EXECUTIVE OFFICERS C. John Hipp, III (Age 49). Mr. Hipp has served as President and Chief Executive Officer of the Company and First National Bank since April 1994. He also served as President of First National Bank from April 1994 to May 2000. From 1990 to 1994, Mr. Hipp served as President of Rock Hill National Bank and Rock Hill National Corporation. Robert R. Horger (Age 50). Mr. Horger was named Chairman of the Company and First National Bank in January 1998 and served as Vice Chairman of the Company and First National Bank from April 1994 to January 1998. Mr. Horger became a director of the Company in April 1991. Mr. Horger is an attorney with Horger, Barnwell and Reid in Orangeburg, South Carolina. Dwight W. Frierson (Age 44). Mr. Frierson has served as Vice Chairman of First National Corporation and First National Bank since January 2000 and has been a director of the Company since April 1996. Mr. Frierson is Vice President and General Manager of Coca-Cola Bottling Company of Orangeburg. Robert R. Hill, Jr. (Age 34). Mr. Hill has served as President and Chief Operating Officer of First National Bank since May 2000. He served as Senior Executive Vice President and Chief Operating Officer of First National Bank from November 1998 to May 2000. He served as President and Chief Executive Officer of National Bank of York County from July 1996 to November 1998. Mr. Hill was an organizer of the National Bank of York County from October 1995 to July 1996 and team leader for NationsBank northern region of South Carolina from March 1995 to October 1995. Richard C. Mathis (Age 50). Mr. Mathis has served as Executive Vice President and Chief Financial Officer of the Company since May 2000. He was owner of Carolina MasterCom LLC, an automotive services company, from January 1999 to May 2000. Mr. Mathis served as Executive Vice President and Chief Financial Officer of M&M Financial Corporation/First National South from January 1998 to January 1999, through that bank's acquisition. Mr. Mathis was Senior Vice President in the Fixed Income Division of Sterne, Agee & Leach, Inc. in Atlanta, GA during 1996 through 1997. Prior to that he served 13 years from 1983 through 1995 with Wachovia Bank primarily as a Senior Funds Management Administrator. John C. Pollok (Age 35). Mr. Pollok has served as Executive Vice President and Chief Administrative Officer of First National Bank since May 2000. He served as Executive Vice President of First National Bank mortgage division from July 1998 until May 2000. Mr. Pollok served as Senior Vice President of National Bank of York County from January 1996 to July 1998. Joe E. Burns (Age 46). Mr. Burns has served as Executive Vice President and Chief Credit Officer of the Company since November 2000. He served as Senior Vice President and Private Lending Manager for Bank of America from July 1995 to November 2000. Thomas S. Camp (Age 49). Mr. Camp has served as President and Chief Executive Officer of National Bank of York County since November 1998. He served as Principal and Manager of First Union National Bank of South Carolina for the Private Client Group from August 1997 to November 1998. Mr. Camp was Vice President of Sales and Marketing at Seibels Bruce Insurance Co. in Columbia from November 1996 to August 1997. He served as Senior Vice President of First Union National Bank in South Carolina from February 1989 until November 1996. William W. Coleman, Jr. (Age 51). Mr. Coleman has served as President and Chief Executive Officer of Florence County National Bank since April 1998. He was an organizer of Florence County National Bank from July 1997 to April 1998. Mr. Coleman served as Florence County Executive Vice President of National Bank of South Carolina from January 1992 to July 1997. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Certain information required by this item is incorporated herein by reference to the information under the caption "Stock Price Ranges" on page 14 of the 2000 Annual Report to Shareholders. As of March 23, 2001, the Company had issued and outstanding 7,011,201 shares of Common Stock which were held of record by approximately 4,100 persons. The Company's Common Stock is traded on the American Stock Exchange under the symbol "FNC". 7
10 Dividends are paid by the Company from its assets which are provided primarily by dividends paid to the Company by First National Bank. Certain restrictions exist regarding the ability of the Company's subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the OCC is required to pay dividends in excess of the Banks' respective net profits for the current year plus retained net profits (net profits less dividends paid) for the preceding two years, less any required transfers to surplus. As of December 31, 2000, $11,726,000 of the banking subsidiaries' retained earnings were available for distribution to First National Corporation as dividends without prior regulatory approval. For the year ended December 31, 2000, the banking subsidiaries paid dividends to the Company of approximately $5,801,000. ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated herein by reference to the information set forth under the caption "Selected Consolidated Financial Data" on page 15 of the Company's 2000 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW This discussion and analysis is intended to assist the reader in understanding the financial condition and results of operations of First National Corporation and its subsidiaries, First National Bank, National Bank of York County, Florence County National Bank and CreditSouth Financial Services Corporation. The five year period 1996 through 2000 is discussed with particular emphasis on the years 1998 through 2000. This commentary should be reviewed in conjunction with the financial statements and related footnotes and the other statistical information related to First National Corporation contained elsewhere herein (see "Consolidated Financial Statements of First National Corporation"). In 1996, the Corporation sponsored the organization of National Bank of York County in Rock Hill, South Carolina, and sold shares of the Corporation's common stock to capitalize the new bank and pay organizational and pre-opening expenses. National Bank of York County began operations on July 11, 1996, as a wholly-owned subsidiary of the Corporation. In 1998, the Corporation sponsored the organization of Florence County National Bank in Florence, South Carolina, and sold shares of the Corporation's common stock to capitalize the new bank and pay organizational and pre-opening expenses. Florence County National Bank began operations on April 1, 1998, as a wholly-owned subsidiary of the Corporation. Also in 1998, the Corporation sponsored the organization of CreditSouth Financial Services Corporation, an upscale finance company which began operations in Orangeburg, South Carolina, on November 1, 1998. Upon organization, the Corporation acquired 80 percent of CreditSouth's common stock. The remaining 20 percent of CreditSouth common stock was issued to minority employee shareholders pursuant to their employment agreements. The minority shares are subject to vesting and forfeiture in accordance with the terms of the agreements. On July 31, 1999, the Corporation completed the merger with FirstBancorporation, Inc. ("FirstBanc") through the issuance of 1.222 shares of First National Corporation common stock for each share of outstanding common stock of FirstBanc. The transaction was accounted for by the pooling of interests method of accounting for business combinations. Forward Looking Statements Statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature are intended to be, and are hereby identified as, forward looking statements for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. First National Corporation cautions readers that forward looking statements, including without limitation, those relating to First National Corporation's future business prospects, revenues, working capital, liquidity, capital needs, interest costs, and income, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward looking statements, due to several important factors herein identified, among others, and other risks and factors identified from time to time in First National Corporation's reports filed with the Securities and Exchange Commission. 8
11 Recent Accounting Pronouncements See Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements. SUMMARY OF OPERATIONS Earnings of First National Corporation were $10,533,000, $7,940,000, and $8,271,000 in 2000, 1999 and 1998, respectively. Net income increased 32.7 percent in 2000 when compared to 1999 and decreased 4.0 percent in 1999 when compared to 1998. Basic earnings per share increased to $1.50 in 2000 compared to $1.14 in 1999. Per share earnings in 1998 were $1.24. Diluted earnings per share increased to $1.49 in 2000 compared to $1.13 in 1999 and $1.21 in 1998. The increase in net income in 2000 resulted primarily from an increase in interest income. The decrease in net income in 1999 compared to 1998 resulted primarily from the acquisitions of FirstBanc and two Carolina First branches. The per share cash dividend declared in 2000 was $0.54 compared to $0.52 in 1999 and $0.48 in 1998. The book value per share of First National Corporation increased 12.3 percent to $12.09 in 2000 from $10.77 in 1999, and remained the same in 1999 as in 1998. The return on average assets was 1.11 percent in 2000, .98 percent in 1999 and 1.18 percent in 1998. The return on average shareholders' equity was 13.14 percent for 2000, 10.58 percent for 1999 and 12.14 percent in 1998. Earning assets and deposits increased in 2000 compared to 1999. At December 31, 2000, earning assets were $912,405,000, and increase of 12.9 percent over $807,961,000 at year-end 1999, which was 14.4 percent greater than the 1998 balance of $706,045,000. Average earning assets were $904,403,000 in 2000, an increase of 16.2 percent over $778,598,000 in 1999, which was 14.7 percent greater than the $678,683,000 average of 1998. The increases in average earning assets in each year was mainly the result of loan growth. Deposits were $757,576,000 at year-end 2000, up 9.9 percent from $689,665,000 at year-end 1999. The 1999 balance was an increase of 12.7 percent, compared to deposits of $611,891,000 at the end of 1998. Deposits averaged $621,350,000 during 2000, up 14.3 percent from $543,485,000 in 1999. The 1999 average was an increase of 8.5 percent over $500,772,000 in 1998. Interest income increased by $13,277,000, or 21.9 percent, to $73,846,000 for the year ended December 31, 2000, when compared to $60,569,000 earned in 1999. This increase was largely the result of the $104,444,000, or 12.9 percent, increase in earning assets. For the year ended December 31, 1999, interest income was up $6,082,000, or 11.2 percent, compared to the prior year. The increase was mainly the result of a $101,916,000, or 14.4 percent increase in earning assets during 1999. Interest expense was $33,232,000 for the year ended December 31, 2000, a $9,316,000, or 39.0 percent, increase over the $23,916,000 incurred in 1999. The increase in 2000 was mainly due to an $112,716,000, or 18.0 percent, increase in average interest-bearing liabilities. For 1999, interest expense was up $794,000, or 3.4 percent, as compared to $23,122,000 in 1998. The 1999 increase was mainly due to an increase in average interest-bearing liabilities of $69,667,000, or 12.5 percent from the prior year. COMPETITION First National Corporation competes with a number of financial institutions and other firms that engage in activities similar to banking. For example, the Corporation competes for deposits with savings and loan associations, credit unions, brokerage firms and other commercial banks. In its lending activities, the Corporation competes with the industries mentioned above as well as consumer finance companies, leasing companies and other lenders. In today's uncertain financial climate, all lenders are searching for quality borrowers. Acquisition of acceptable grade loans becomes increasingly challenging. A number of financial institution mergers were completed in recent years, continuing the trend toward consolidation. Although these mergers reduced the number of banks and branches, they intensified competition for quality funds and loans. 9
12 NET INTEREST INCOME Net interest income is the difference between interest income and interest expense. Two significant elements in analyzing a bank's net interest income are net interest spread and net interest margin. Net interest spread is the difference between the yield on average earning assets and the rate on average interest-bearing liabilities. Net interest margin is the difference between the yield on average earning assets and the rate on all average liabilities, interest and non-interest- bearing, utilized to support earning assets. The significant distinction between net interest spread and net interest margin is that net interest margin reflects the volume of interest free funds supporting earning assets. Net interest income in 2000 was $40,614,000, an increase of $3,961,000, or 10.8 percent, over 1999. During 1999, net interest income was $36,653,000, which was $5,288,000, or 16.9 percent greater than 1998. In both years the increases were primarily the result of volume growth in interest-earning assets, particularly in the loan portfolio. The average yield on earning assets was 8.17 percent in 2000, as compared with 7.78 percent in 1999 and 8.03 percent in 1998. Total average earning assets increased $125,805,000, or 16.2 percent, from $778,598,000 in 1999 to $904,403,000 in 2000. This followed an increase of $99,915,000, or 14.7 percent, in 1999 compared with 1998. Total average interest-bearing liabilities were $739,531,000 during 2000, an increase of $112,716,000, or 18.0 percent, over $626,815,000 in 1999. Growth in these liabilities during 1999 was $69,667,000, or 12.5 percent, higher than in the previous year. Earning asset increases in 2000 and 1999 were funded by higher levels of interest-bearing liabilities, mainly the result of deposit growth. Net total volume growth in 2000 had a positive impact of $6,785,000 on net interest income. This was partially offset by a $2,824,000 decrease resulting from rates paid on interest-bearing liabilities increasing more than yields on earning assets. In 1999 compared to 1998, net volume growth contributed $5,383,000 to net interest income, while the rate differential between assets and liabilities resulted in a decline of $95,000. As a result of these volume and rate variances year to year, the net interest margin decreased to 4.49 percent in 2000 from 4.71 percent in 1999, mainly on the basis of a 28 basis point decline in net interest spread. From 1998 to 1999, the net interest margin rose from 4.62 percent to 4.71 percent, as the net interest spread increased by eight basis points. TABLE 1 VOLUME AND RATE VARIANCE ANALYSIS <TABLE> <CAPTION> 2000 COMPARED TO 1999 1999 COMPARED TO 1998 CHANGES DUE TO CHANGES DUE TO INCREASE (DECREASE) IN INCREASE (DECREASE) IN (Dollars in thousands) VOLUME (L) RATE (L) TOTAL VOLUME (L) RATE (L) TOTAL <S> <C> <C> <C> <C> <C> <C> Interest income on: Loans (2) $ 12,227 $ 1,356 $ 13,583 $ 8,208 $ (2,306) $ 5,902 Investments: Taxable (1,583) 536 (1,047) 1,358 (1,025) 333 Tax exempt (3) (23) (49) (72) 244 (69) 175 Funds sold 1,410 (365) 1,045 (375) 252 (123) Interest-bearing deposits with banks (244) 12 (232) (239) 34 (205) - ---------------------------------------------------------------------------------------------------------------------------- Total interest income 11,787 1,490 13,277 9,196 (3,114) 6,082 - ---------------------------------------------------------------------------------------------------------------------------- Interest expense on: Deposits: Interest-bearing transaction accounts 116 92 208 (268) (1,155) (1,423) Savings accounts 213 753 966 1,150 (306) 844 Certificates of deposit 2,896 1,744 4,640 1,035 (1,265) (230) Funds purchased 1,213 1,892 3,105 202 191 393 Notes payable 564 (167) 397 1,694 (484) 1,210 - ---------------------------------------------------------------------------------------------------------------------------- Total interest expense 5,002 4,314 9,316 3,813 (3,019) 794 - ---------------------------------------------------------------------------------------------------------------------------- Net interest income $ 6,785 $ (2,824) $ 3,961 $ 5,383 $ (95) $ 5,288 ============================================================================================================================ </TABLE> (1) The rate/volume variance for each category has been allocated on an equal basis between rate and volumes. (2) Nonaccrual loans are included in the above analysis. (3) Tax exempt income is not presented on a taxable-equivalent basis in the above analysis. 10
13 TABLE 2 <TABLE> <CAPTION> YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES 2000 AVERAGE INTEREST AVERAGE (Dollars in thousands) BALANCE EARNED/PAID YIELD/RATE <S> <C> <C> <C> Assets Interest earning assets: Loans, net of unearned income $ 680,217 $ 61,284 9.01% Investment securities: Taxable 158,029 9,252 5.85 Tax exempt 39,072 1,775 4.54 Funds sold 26,734 1,501 5.61 Interest-earning deposits with banks 351 34 9.69 ---------- --------- Total earning assets 904,403 73,846 8.17 --------- ---- Cash and other assets 59,309 Less allowance for loan losses (8,324) ---------- Total assets $ 955,388 ========== Liabilities Interest-bearing liabilities: Deposits: Interest-bearing transaction accounts $ 123,695 $ 1,222 0.99% Savings 150,534 5,056 3.36 Certificates of deposit 347,121 19,180 5.53 Funds purchased 85,422 5,923 6.93 Notes payable 32,759 1,851 5.65 ---------- --------- Total interest-bearing liabilities 739,531 33,232 4.49 --------- ---- Demand deposits 114,743 Other liabilities 20,939 Shareholders' equity 80,175 ---------- Total liabilities and shareholders' equity $ 955,388 ========== Net interest spread 3.68 Impact of interest free funds 0.81 ---- Net interest margin 4.49% ==== Net interest income $ 40,614 ========= </TABLE> 11
14 TABLE 2 <TABLE> <CAPTION> YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES 1999 AVERAGE INTEREST AVERAGE (Dollars in thousands) BALANCE EARNED/PAID YIELD/RATE <S> <C> <C> <C> Assets Interest earning assets: Loans, net of unearned income $ 541,434 $ 47,701 8.81% Investment securities: Taxable 186,763 10,299 5.51 Tax exempt 39,566 1,847 4.67 Funds sold 6,529 456 6.98 Interest-bearing deposits with banks 4,306 266 6.18 ---------- --------- Total earning assets 778,598 60,569 7.78 --------- ---- Cash and other assets 35,996 Less allowance for loan losses (7,295) ---------- Total assets $ 807,299 ========== Liabilities Interest-bearing liabilities: Deposits: Interest-bearing transaction accounts $ 110,967 $ 1,014 0.91% Savings 143,087 4,090 2.86 Certificates of deposit 289,431 14,540 5.02 Funds purchased 59,724 2,818 4.72 Notes payable 23,606 1,454 6.16 ---------- --------- Total interest-bearing liabilities 626,815 23,916 3.82 --------- ---- Demand deposits 94,197 Other liabilities 12,714 Shareholders' equity 73,573 --------- Total liabilities and shareholders' equity $ 807,299 ========= Net interest spread 3.96 Impact of interest free funds 0.75 ---- Net interest margin 4.71% ==== Net interest income $ 36,653 ========= </TABLE> 12
15 TABLE 2 <TABLE> <CAPTION> YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES 1998 AVERAGE INTEREST AVERAGE (Dollars in thousands) BALANCE EARNED/PAID YIELD/RATE <S> <C> <C> <C> Assets Interest earning assets: Loans, net of unearned income $ 452,600 $ 41,799 9.24% Investment securities: Taxable 164,359 9,966 6.06 Tax exempt 34,516 1,672 4.84 Funds sold 18,456 579 3.14 Interest-bearing deposits with banks 8,752 471 5.38 --------- --------- Total earning assets 678,683 54,487 8.03 --------- ---- Cash and other assets 43,856 Less allowance for loan losses (5,795) --------- Total assets $ 716,744 ========= Liabilities Interest-bearing liabilities: Deposits: Interest-bearing transaction accounts $ 124,663 $ 2,437 1.95% Savings 105,635 3,246 3.07 Certificates of deposit 270,474 14,770 5.46 Funds purchased 50,676 2,425 4.79 Notes payable 5,700 244 4.28 --------- --------- Total interest-bearing liabilities 557,148 23,122 4.15 --------- ---- Demand deposits 83,179 Other liabilities 8,572 Shareholders' equity 67,845 --------- Total liabilities and shareholders' equity $ 716,744 ========= Net interest spread 3.88 Impact of interest free funds 0.74 ---- Net interest margin 4.62% ==== Net interest income $ 31,365 ========= </TABLE> 13
16 INVESTMENT SECURITIES Investment securities, the Corporation's second largest category of earning assets, are utilized to fund loan growth and deposit liquidations, provide liquidity, employ excess funds, and pledge as collateral for certain deposits and purchased funds. At December 31, 2000, investment securities were $183,198,000, or 20.3 percent, of earning assets, as compared with $195,572,000, or 24.4 percent, of earning assets at year-end 1999. As securities are purchased, they are designated as available for sale or held to maturity based upon management's intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. Interest earned on the taxable securities portfolio was $9,252,000 in 2000, a decrease of $1,047,000, or 10.2 percent, from the $10,299,000 earned in 1999. This decrease was the result of an average taxable securities volume decline of 15.4 percent, partially offset by the impact of a 34 basis point rise in average yield, from 5.51 percent in 1999 to 5.85 percent in 2000. Taxable income in 1999 was $333,000, or 3.3 percent, higher than 1998. This increase was based upon 13.6 percent higher average volumes in 1999 compared with 1998, while offset in large part by a 55 basis point decline in the average yield. The average maturity for the taxable investment portfolio was 3.2 years at December 31, 2000, 3.8 years at December 31, 1999 and 2.6 years at year-end 1998. Non-taxable investments have remained at relatively constant levels, with similar earnings results year to year. In 2000, this segment of the portfolio earned $1,775,000, or 3.9 percent less compared with $1,847,000 in 1999. Contributing to the decrease was a modest decline of 1.3 percent in the average non-taxable securities balance and a 13 basis point decrease in the average yield. From 1998 to 1999 non-taxable income rose $175,000 as a result of an increase in the average volume from $34,516,000 to $39,566,000, or 14.6 percent. This positive influence was offset in part by a 17 basis point decrease in average yield during the period. The average maturity of the non-taxable investment portfolio was 4.6 years at December 31, 2000, 5.2 years at December 31, 1999 and 4.0 years at the end of 1998. At December 31, 2000, the fair value of the investment securities portfolio was $183,178,000, a negligible discount from the carrying value. The market discount was .4 percent at December 31, 1999, following a .5 premium valuation at the end of 1998. At December 31, 2000, investment securities with an amortized cost of $145,198,000 and fair value of $144,648,000 were classified as available-for-sale. The resultant $550,000 decrease in the carrying value of the securities has been reflected, net of tax effect, in the statement of changes in shareholders' equity as a component of comprehensive income. Disposition of investment securities involved no realized gain or loss in 2000 and realized gains of $214,000 in 1999 and $95,000 in 1998. TABLE 3 BOOK VALUE OF INVESTMENT SECURITIES December 31, <TABLE> <CAPTION> (Dollars in thousands) 2000 1999 1998 1997 1996 <S> <C> <C> <C> <C> <C> U. S. Treasury Securities $ 24,519 $ 28,946 $ 50,066 $ 33,791 $ 37,853 U. S. Government Agencies and Corporations 115,686 119,924 114,484 98,430 89,747 Other Securities 4,443 3,769 3,449 1,171 1,188 - ----------------------------------------------------------------------------------------------------------------------------- Total Taxable 144,648 152,639 167,999 133,392 128,788 - ----------------------------------------------------------------------------------------------------------------------------- State, County and Municipal Obligations 38,550 42,933 38,138 34,851 34,578 - ----------------------------------------------------------------------------------------------------------------------------- Total Tax-exempt 38,550 42,933 38,138 34,851 34,578 - ----------------------------------------------------------------------------------------------------------------------------- Total Investment Securities $ 183,198 $ 195,572 $ 206,137 $ 168,243 $ 163,366 ============================================================================================================================= </TABLE> 14
17 TABLE 4 MATURITY DISTRIBUTION AND YIELDS OF INVESTMENT SECURITIES <TABLE> <CAPTION> DUE IN DUE AFTER DUE AFTER DUE AFTER DECEMBER 31, 2000 1 YR. OR LESS 1 THRU 5 YRS. 5 THRU 10 YRS. 10 YRS. (Dollars in thousands) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury Securities $ 2,764 5.25% $ 21,755 5.43% U.S. Government Agencies and Corporations 16,605 6.47 61,456 6.01 $37,625 6.19% Other Securities (1) $ 4,443 6.91% - ----------------------------------------------------------------------------------------------------------------------- Total Taxable 19,369 6.30 83,211 5.86 37,625 6.19 4,443 6.91 - ----------------------------------------------------------------------------------------------------------------------- State, County and Municipal Obligations 3,200 7.32 17,040 6.51 16,378 6.20 1,932 7.55 - ----------------------------------------------------------------------------------------------------------------------- Total $22,569 6.45% $100,251 5.97% $54,003 6.19% $ 6,375 7.11% ======================================================================================================================= Percent of Total 12% 55% 29% 4% Cumulative % of Total 12% 67% 96% 100% <CAPTION> DECEMBER 31, 2000 TOTAL PAR FAIR (Dollars in thousands) AMOUNT YIELD VALUE VALUE <S> <C> <C> <C> <C> U. S. Treasury Securities $ 24,519 5.40% $ 24,400 $ 24,558 U.S. Government Agencies and Corporations 115,686 6.15 116,200 115,647 Other Securities (1) 4,443 6.91 4,443 4,443 - ------------------------------------------------------------------------------- Total Taxable 144,648 6.05 145,043 144,648 - ------------------------------------------------------------------------------- State, County and Municipal Obligations 38,550 6.43 37,000 38,530 - ------------------------------------------------------------------------------- Total $183,198 6.14% $182,043 $183,178 =============================================================================== Percent of Total Cumulative % of Total </TABLE> (1) Federal Reserve Bank and other corporate stocks have no set maturity and are classified in "Due after 10 years." LOAN PORTFOLIO At December 31, 2000, loans, net of unearned discount, were $732,266,000, an increase of $118,305,000, or 19.3 percent, compared to year-end 1999. Average loans during 2000 were $680,217,000, an increase of 25.6 percent over the $541,434,000 average for 1999. Real estate mortgage loans continue to comprise the largest portion of the loan portfolio. All loans secured by real estate, except real estate construction loans, are placed in this category. Real estate mortgage loans were $473,131,000 at the end of 2000, representing 64.6 percent of the total portfolio. This was an increase of $76,973,000, or 19.4 percent over year-end 1999. Consumer loans, the next largest lending segment at $123,411,000, represented 16.9 percent of the loan portfolio at December 31, 2000. This was $20,261,000, or 19.6 percent, more than the $103,150,000 loan balance at the prior year end. At December 31, 2000, commercial, financial and agricultural loans represented 14.1 percent of the portfolio at $103,468,000, an increase of $16,370,000, or 18.8 percent, over the previous year. Interest and fee income increased $13,583,000 to $61,284,000 in 2000, as compared with 1999. The growth of the loan portfolio was the main contributor to this 28.4 percent increase. While Federal monetary activity included three interest rate hikes totaling 1.00 percent during 2000, the average yield on the loan portfolio was 9.0 percent for the year, up from 8.8 percent in 1999. Table 6 shows the maturity and interest rate sensitivity of the loan portfolio as of December 31, 2000. At that date, loans that mature in one year or less totaled $165,741,000. Of the loans due after one year, $532,462,000, or 94.0 percent, had fixed interest rates and $34,063,000, or 6.0 percent, were variable rate loans. The placement of loans on a nonaccrual status is dependent upon the type of loan, the past due status and the collection activities in progress. Loans which are well secured and in the process of collection are allowed to remain on an accrual basis until they become 120 days past due. Unsecured commercial loans are charged off on or before the date they become 90 days past due and, therefore, do not reach a nonaccrual status. Commercial and real estate loans which are partially secured are written down to the collateral value and placed on nonaccrual status on or before becoming 90 days past due. Closed end consumer loans are charged off on or before becoming 120 days past due and open end consumer loans are charged off on or before becoming 180 days past due. All interest accrued in the current year but unpaid at the date a loan goes on nonaccrual status is deducted from interest income, while interest accrued from previous years is charged against the reserve for loan losses. At December 31, 2000, nonaccrual loans were $1,481,000 compared with $1,537,000 at year-end 1999. At December 31, 2000, loans which were 90 days or more past due were $1,838,000 compared to $729,000 at year-end 1999. Interest income which was foregone was an immaterial amount for each of the three years ended December 31, 2000. First National Corporation does not have any loans which have been restructured or any foreign loans. 15
18 Concentrations of credit are considered to exist when the amounts loaned to a multiple number of borrowers engaged in similar business activities which would cause them to be similarly impacted by general economic conditions represents 25% of equity. As of December 31, 2000, no credit concentrations existed. Table 7 provides the level of risk elements in the loan portfolio for the past five years. TABLE 5 DISTRIBUTION OF NET LOANS BY TYPE <TABLE> <CAPTION> December 31, (Dollars in thousands) 2000 1999 1998 1997 1996 <S> <C> <C> <C> <C> <C> Commercial, financial, agricultural and other $ 103,468 $ 87,098 $ 87,610 $ 72,312 $ 49,380 Real estate - construction 32,256 27,555 19,113 18,378 18,971 Real estate - mortgage 473,131 396,158 303,300 268,153 239,779 Consumer 123,441 103,150 86,195 78,139 64,932 - ----------------------------------------------------------------------------------------------------------------------- Total $ 732,266 $ 613,961 $ 496,218 $ 436,982 $ 373,062 ======================================================================================================================= Percent of Total Commercial, financial, agricultural and other 14.1% 14.2% 17.7% 16.5% 13.2% Real estate - construction 4.4 4.5 3.9 4.2 5.1 Real estate - mortgage 64.6 64.5 61.1 61.4 64.3 Consumer 16.9 16.8 17.3 17.9 17.4 - ----------------------------------------------------------------------------------------------------------------------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ======================================================================================================================= </TABLE> TABLE 6 MATURITY DISTRIBUTION OF LOANS <TABLE> <CAPTION> MATURITY December 31, 2000 1 YEAR 1 - 5 OVER 5 (Dollars in thousands) TOTAL OR LESS YEARS YEARS <S> <C> <C> <C> <C> Commercial, financial agricultural and other $103,468 $ 51,450 $ 45,419 $ 6,599 Real estate - construction 32,256 15,229 11,597 5,430 Real estate - mortgage 473,131 79,812 226,593 166,725 Consumer 123,411 19,250 93,266 16,896 - ----------------------------------------------------------------------------------------------- Total $732,266 $165,741 $376,875 $189,650 =============================================================================================== Loans due after one year with: Predetermined interest rates $532,462 Floating or adjustable interest rates $ 34,063 </TABLE> ASSET QUALITY Asset quality is maintained through the management of credit risk. Each individual earning asset, whether in the investment, loan, or short-term investment portfolio, is reviewed by management for credit risk. To facilitate this review, First National Corporation has established credit policies which include credit limits, documentation, periodic 16
19 examination and follow-up. In addition, these portfolios are examined for exposure to concentration in any one industry, government agency, or geographic location. At December 31, 2000 and 1999, the Corporation did not have more than ten percent of the loan portfolio in any one industry and had no foreign loans. Each category of earning assets has a degree of credit risk. To measure credit risk, various techniques are utilized. Credit risk in the investment portfolio can be measured through bond ratings published by independent agencies. In the investment portfolio, 99.2 percent of the investments consist of U.S. Treasury securities, U.S. Agency securities and tax-free securities having a rating of "A" or better by at least one of the major bond rating agencies. The credit risk of the loan portfolio can be measured by historical experience. The Corporation maintains its loan portfolio in accordance with its established credit policies. Net loan charge-offs over the past five years have not exceeded .13 percent of net average loans. In 2000 net loan charge-offs as a percentage of net average loans were .12 percent compared to .12 percent in 1999. See "Loans" for a discussion of the Corporation's charge-off and nonaccrual policies. TABLE 7 NONACCRUAL AND PAST DUE LOANS <TABLE> <CAPTION> December 31 (Dollars in thousands) 2000 1999 1998 1997 1996 <S> <C> <C> <C> <C> <C> Loans past due 90 days or more $ 1,838 $ 729 $ 1,426 $ 488 $ 412 Loans on a nonaccruing basis 1,481 1,537 1,547 1,445 1,423 - -------------------------------------------------------------------------------------------------------------- Total $ 3,319 $ 2,266 $ 2,973 $ 1,933 $ 1,835 ============================================================================================================== </TABLE> TABLE 8 SUMMARY OF LOAN LOSS EXPERIENCE <TABLE> <CAPTION> December 31 (Dollars in thousands) 2000 1999 1998 1997 1996 <S> <C> <C> <C> <C> <C> Allowance for loan losses - January 1 $ 7,886 $ 6,934 $ 6,246 $ 5,336 $ 4,173 - ------------------------------------------------------------------------------------------------------------- Total charge-offs (1,008) (826) (785) (829) (720) - ------------------------------------------------------------------------------------------------------------- Total recoveries 206 165 260 323 401 - ------------------------------------------------------------------------------------------------------------- Net charge-offs (802) (661) (525) (506) (319) Provisions for loan losses 1,838 1,613 1,213 1,416 1,481 - ------------------------------------------------------------------------------------------------------------- Allowance for loan losses - December 31 $ 8,922 $ 7,886 $ 6,934 $ 6,246 $ 5,335 ============================================================================================================= Average loans - net of unearned income $679,379 $541,434 $452,600 $404,641 $342,311 Ratio of net charge-offs to average loans - net of unearned income .12% .12% .12% .13% .09% </TABLE> LOAN LOSS PROVISION First National Corporation maintains an allowance for loan losses at a level which management believes is sufficient to provide for potential losses in the loan portfolio. Management periodically evaluates the adequacy of the allowance utilizing its internal risk rating system, credit review and regulatory agency examinations to assess the quality of the loan 17
20 portfolio and identify problem loans. The evaluation process also includes management's analysis of current and future economic conditions, composition of the loan portfolio, past due and nonaccrual loans, concentrations of credit, lending policies and procedures and historical loan loss experience. The provision for loan losses is charged to expense in an amount necessary to maintain the allowance at the appropriate level. The allowance is established on an overall portfolio basis, and management does not subsequently allocate the allowance by geographic area or loan category. The provision for loan losses for the year ended December 31, 2000, was $1,838,000, compared to $1,613,000 in 1999. The 14.0 percent increase in the provision for loan losses was due mainly to the overall growth of the loan portfolio. The allowance for loan losses was $8,922,000, or 1.22 percent of outstanding loans at December 31, 2000, as compared with $7,886,000, or 1.28 percent at the end of 1999. Total charge-offs were $1,008,000 in 2000 and $826,000 in 1999. Recoveries were $206,000 in 2000 and $165,000 in the prior year. Net charge-offs were $802,000 in 2000 and $661,000 in 1999. The ratio of net charge-offs to average loans was .12 percent in both 2000 and 1999. A summary of loan loss experience for the five years ending December 31, 2000 is provided in Table 8. Other real estate owned includes certain real estate acquired as a result of foreclosure and deeds in lieu of foreclosure, as well as amounts reclassified as in-substance foreclosures. At December 31, 2000, and December 31, 1999, other real estate owned was $848,000 and $227,000 respectively. This increase year-to-year resulted from foreclosure activities. Although management anticipates that the level of charge-offs for 2001 will be somewhat higher than the level experienced in 2000 due to more difficult business conditions caused by the slowing of the economy, the allowance is currently considered to be adequate. The OCC handbook recommends that banks take a broad look at certain factors in considering allowance for loan loss. These factors include loan loss experience, specific allocations and other subjective factors. First National Corporation continues to consider such factors recognized in the handbook to evaluate the allowance for loan losses. LIQUIDITY Liquidity may be defined as the ability of an entity to generate cash to meet its financial obligations. For a bank, liquidity means the consistent ability to meet loan demand and deposit withdrawals. The Corporation has employed its funds in a manner to provide liquidity in both assets and liabilities. Asset liquidity is maintained by the maturity structure of loans, investment securities and other short-term investments. Management has policies and procedures governing the length of time to maturity on loans and investments. As noted in Table 4, 12 percent of the investment portfolio matures in one year or less. This segment of the investment portfolio consists of U.S. Treasury securities, U.S. Agency securities and bank qualified municipal obligations. Loans and other investments are generally held for longer terms and not utilized for day-to-day operating needs. Increases in the Corporation's liabilities provide liquidity on a day-to-day basis. Daily liquidity needs may be met from deposit growth or from the Corporation's use of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowing. The Corporation regularly obtains borrowed funds in the form of cash management or "sweep" accounts that are accommodations to corporate and governmental customers pursuant to sale of securities sold under agreement to repurchase arrangements. During 2000, the Corporation maintained a satisfactory level of liquidity through growth in interest-bearing and non-interest-bearing deposits, cash management accounts, federal funds purchased, and advances from the Federal Home Loan Bank of Atlanta. DERIVATIVES AND SECURITIES HELD FOR TRADING In January 1998, the Securities and Exchange Commission adopted rules that require more comprehensive disclosure of accounting policies for derivatives as well as enhanced quantitative and qualitative disclosures of market risk for derivatives and other financial instruments. The market risk disclosures are classified into two categories: financial instruments entered into for trading purposes and all other instruments (non-trading purposes). The Corporation does not have financial derivatives, nor does it maintain a trading portfolio. 18
21 TABLE 9 FINANCIAL INSTRUMENTS <TABLE> <CAPTION> FAIR THERE VALUE (DOLLARS IN THOUSANDS) 2001 2002 2003 2004 2005 AFTER TOTAL 12-31-00 <S> <C> <C> <C> <C> <C> <C> <C> <C> Financial Assets: Loans, net of unearned income: Fixed Rate: Book Value $ 99,629 $ 48,647 $ 84,262 $ 76,533 $ 79,876 $134,517 $523,464 $520,198 Average interest rate 8.64% 8.74% 8.57% 8.31% 8.80% 7.82% 8.58% Variable Rate: Book Value $ 205,585 -- -- -- -- $205,585 $204,302 Average interest rate 9.04% -- -- -- -- 9.04% Securities held to maturity: Fixed Rate: Book Value $ 3,374 $ 2,958 $ 3,941 $ 4,413 $ 6,750 $ 17,114 $ 38,550 $ 38,530 Average interest rate 7.87% 6.91% 6.89% 6.43% 6.61% 6.42% 6.63% Variable Rate: Book Value -- -- -- -- -- -- -- -- Average interest rate -- -- -- -- -- -- -- Securities available for sale: Fixed Rate: Book Value $ 56,994 $ 27,958 $ 21,156 $ 12,705 $ 4,783 $ 20,364 $143,960 $143,960 Average interest rate 6.17% 5.88% 5.78% 5.76% 6.01% 6.03% 6.10% Variable Rate: Book Value $ 688 -- -- -- -- $ 688 $ 688 Average interest rate 6.57% -- -- -- -- 6.57% Federal funds sold $ 7,584 -- -- -- -- -- $ 7,584 $ 7,584 Average interest rate 6.50% -- -- -- -- -- 6.50% - ----------------------------------------------------------------------------------------------------------------------------------- Total financial assets $ 373,854 $ 79,563 $ 109,359 $ 93,651 $ 91,409 $171,995 $919,831 $915,262 - ----------------------------------------------------------------------------------------------------------------------------------- Financial liabilities: Non-interest bearing deposits $ 12,705 $ 13,540 $ 13,540 $ 13,540 $ 13,540 $ 45,132 $111,997 $107,402 Average interest rate N/A N/A N/A N/A N/A N/A N/A Interest-bearing savings and checking $ 146,311 $ 42,422 $ 42,422 $ 42,422 $ 7,072 -- $280,649 $269,134 Average interest rate 2.35% 1.17% 1.17% 1.17% 1.17% -- 2.35% Time deposits $ 295,163 $ 57,477 $ 6,386 $ 4,836 $ 519 $ 549 $364,930 $349,958 Average interest rate 5.73% 6.26% 5.77% 6.50% 6.82% 3.72% 5.91% Federal funds purchased and securities sold under agreements to repurchase $ 65,948 -- -- -- -- -- $ 65,948 $ 65,948 Average interest rate 5.78% -- -- -- -- -- 5.78% Notes payable $ 57,050 -- -- -- -- -- $ 57,050 $ 57,323 Average interest rate 5.70% -- -- -- -- -- 5.70% - ----------------------------------------------------------------------------------------------------------------------------------- Total financial liabilities $ 577,177 $ 113,439 $ 62,348 $ 60,798 $ 21,131 $ 45,681 $880,574 $849,765 - ----------------------------------------------------------------------------------------------------------------------------------- Interest rate sensitivity gap $(203,323) $ (33,876) $ 47,011 $ 32,853 $ 70,278 $126,314 $ 39,257 Cumulative interest rate sensitivity gap $(203,323) $(237,199) $(190,188) $(157,335) $(87,057) $ 39,257 Cumulative interest rate sensitivity gap as percent of total financial assets -22.11% -25.79% -20.68% -17.10% -9.46% 4.27% </TABLE> Table 9 provides information as of December 31, 2000 about the Corporation's financial instruments that are sensitive to changes in interest rates. For fixed rate loans, securities, time deposits, federal funds and repurchase agreements, and notes payable, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Variable rate instruments are presented according to their first repricing opportunities. Non-interest bearing deposits and interest-bearing savings and checking deposits have no contractual maturity dates. For purposes of Table 9, projected maturity dates for such deposits were determined based on decay rate assumptions used internally by the Corporation to evaluate such deposits. For further information on the fair value of financial instruments, see Note 24 to the consolidated financial statements. 19
22 ASSET-LIABILITY MANAGEMENT AND MARKET RISK SENSITIVITY The Corporation's earnings may vary in relation to changes in interest rates and in relation to the accompanying fluctuations in market prices of certain of its financial instruments. The Corporation uses a number of methods to measure interest rate risk, including simulating the effect on earnings of fluctuations in interest rates, monitoring the present value of asset and liability portfolios under various interest rate scenarios and monitoring the difference, or gap, between rate sensitive assets and liabilities, as discussed below. The earnings simulation model and gap analysis take into account the Corporation's contractual agreements with regard to investments, loans and deposits. Although the Corporation's simulation model is subject to the accuracy of the assumptions that underlie the process, the Corporation believes that such modeling provides a better illustration of the interest sensitivity of earnings than does static sensitivity gap analysis. The simulation model assists in measuring and achieving growth in net interest income while managing interest rate risk. The simulations incorporate interest rate changes as well as projected changes in the mix and volume of balance sheet assets and liabilities. Accordingly, the simulations present a good indicator of the degree of earnings risk the Company has, or may incur in future periods, arising from interest rate changes or other market risk factors. The Corporation's policy is to monitor exposure to interest rate increases and decreases of as much as 200 basis points over a 12-month period. The Corporation's policy limit for the maximum negative impact on net interest income from a steady ("ramping") change in interest rates of 200 basis points over 12 months is 8 percent. The Corporation traditionally has maintained a risk position well within the policy guideline level. As of December 31, 2000, the earnings simulations indicated that the impact of a 200 basis point decrease in rates over 12 months would result in an approximate 2.6 percent increase in net interest income while a 200 basis point increase in rates over the same period would result in an approximate 3.0 percent decrease in interest income -- both as compared with a base case unchanged interest rate environment. Actual results may differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions or management strategies, among other factors. As mentioned above, another (though less useful) indicator of interest rate risk exposure is the interest rate sensitivity gap and cumulative gap. Interest rate sensitivity gap analysis is based on the concept of comparing financial assets which reprice with financial liabilities which reprice within a stated time period. The time period in which a financial instrument is considered to be rate sensitive is determined by that instrument's first opportunity to reprice to a different interest rate. For variable rate products the period in which repricing occurs is contractually determined. For fixed rate products the repricing opportunity is deemed to occur at the instrument's maturity or call date, if applicable. For non-interest-bearing funding products, the "maturity" is based solely on a scheduled decay, or runoff, rate. When more assets than liabilities reprice within a given time period, a positive interest rate gap (or "asset sensitive" position) exists. Asset sensitive institutions may benefit in generally rising rate environments as assets reprice more quickly than liabilities. Conversely, when more liabilities than assets reprice within a given time period, a negative interest rate gap (or "liability sensitive" position) exists. Liability sensitive institutions may benefit in generally falling rate environments as funding sources reprice more quickly than earning assets. However, another shortfall of static gap analysis based solely on the timing of repricing opportunities is its lack of attention to the degree of magnitude of rate repricings of the various financial instruments. As shown in the gap analysis within Table 9, the Company's financial liabilities will generally reprice more quickly than its financial assets. In this respect, the gap analysis ties together with the simulation analysis in indicating that the Company was somewhat liability sensitive at December 31, 2000. The Company does not currently use interest rate swaps or other derivatives to modify the interest rate risk of its financial instruments. DEPOSITS Customer deposits provide First National Corporation with its primary source of funds for the continued growth of the loan and investment portfolios. Total deposits grew to $757,576,000 at December 31, 2000, an increase of $67,911,000, or 9.9 percent from year-end 1999. This growth was provided largely from a 10.4 percent increase in interest-bearing accounts from $584,647,000 at December 31, 1999 to $645,579,000 at the end of 2000. Also contributing to the increase was 6.7 percent growth in non-interest-bearing deposits, which grew from $105,018,000 to $111,997,000 year-to-year. Average total deposits increased 15.4 percent to $736,093,000 in 2000 from $637,682,000 the previous year. This increase was comprised of a $77,865,000, or 14.3 percent, rise in average interest-bearing deposits and an increase in non-interest-bearing deposits of $20,546,000, or 21.8 percent. The growth in average interest-bearing deposits from 1999 to 2000 was the result of a $57,690,000, or 19.9 percent increase in certificates of deposit; a $12,728,000, or 11.5 percent increase in interest-bearing transaction accounts; and a $7,447,000, or 5.2 percent rise in savings deposits. 20
23 At December 31, 2000, the ratio of interest-bearing deposits to total deposits was 85.2 percent as compared with 84.8 percent at December 31, 1999 and 85.9 percent at the end of 1998. The average rate paid on interest-bearing deposit accounts was 4.5 percent during 2000 and 3.8 percent and 4.2 percent during 1999 and 1998, respectively. TABLE 10 MATURITY DISTRIBUTION OF CD'S OF $100,000 OR MORE <TABLE> <CAPTION> DECEMBER 31 2000 1999 (Dollars in thousands) <S> <C> <C> Within three months $ 34,860 $ 47,044 After three through six months 39,830 15,977 After six through twelve months 28,353 15,090 After twelve months 16,622 10,651 - -------------------------------------------------------------------------- Total $119,665 $ 88,762 ========================================================================== </TABLE> SHORT-TERM BORROWED FUNDS The distribution of First National Corporation's short-term borrowings at the end of the last three years, the average amounts outstanding during each such period, the maximum amounts outstanding at any month-end, and the weighted average interest rates on year-end and average balances in each category are presented below. Federal funds purchased and securities sold under agreement to repurchase generally mature within one to three days from the transaction date. Certain of the borrowings have no defined maturity date. TABLE 11 <TABLE> <CAPTION> DECEMBER 31 (Dollars in thousands) 2000 1999 1998 AMOUNT RATE AMOUNT RATE AMOUNT RATE <S> <C> <C> <C> <C> <C> <C> At period-end: Federal funds purchased and securities sold under repurchase agreements $ 65,948 5.78% $ 76,400 5.75% $ 52,150 3.75% - -------------------------------------------------------------------------------------------------------------- Other borrowings 57,050 5.95% 26,750 5.92 100 6.35 - -------------------------------------------------------------------------------------------------------------- Average for the year: Federal funds purchased and securities sold under repurchase agreements and $ 85,422 5.13% $ 59,724 4.72% $ 50,676 4.68% - -------------------------------------------------------------------------------------------------------------- Other borrowings 32,759 5.70% 23,606 6.16 5,700 7.48 - -------------------------------------------------------------------------------------------------------------- Maximum month-end balance: Federal funds purchased and securities sold under repurchase agreements $159,503 $ 76,400 $ 66,618 - -------------------------------------------------------------------------------------------------------------- Other borrowings 57,050 26,750 2,100 - -------------------------------------------------------------------------------------------------------------- </TABLE> CAPITAL AND DIVIDENDS A strong shareholders' equity base has provided First National Corporation with support for its banking operations and opportunities for growth, while ensuring sufficient resources to absorb the risks inherent in the business. As of December 31, 2000, shareholders' equity was $84,936,000, or 8.8 percent, of total assets. At year-end 1999 and 1998, shareholders' equity was $75,819,000, or 8.7 percent, of total assets and $74,325,000, or 9.9 percent, of total assets, respectively. 21
24 The Corporation and its banking subsidiaries are subject to certain risk-based capital guidelines that measure the relationship of capital to both balance sheet and off-balance sheet risks. Risk values are adjusted to reflect credit risk. Pursuant to guidelines of the Board of Governors of the Federal Reserve System, which are substantially similar to those promulgated by the Office of the Comptroller of the Currency, Tier 1 capital must be at least 50 percent of total capital and total capital must be eight percent of risk-weighed assets. The Tier 1 capital ratio for First National Corporation was 12.15 percent at December 31, 2000, 12.70 percent percent at December 31, 1999 and 14.78 at the end of 1998. The total capital ratio for the Corporation was 13.40 percent, 13.95 percent and 16.02 percent for the years ended December 31, 2000, 1999 and 1998, respectively. As an additional measure of capital soundness, the regulatory agencies have prescribed a leverage ratio of total capital to total assets. The minimum leverage ratio assigned to banks is between three and five percent and is dependent on the institution's composite rating as determined by its regulators. The leverage ratio for First National Corporation was 8.27 percent at December 31, 2000, 8.64 percent at December 31, 1999 and 9.37 percent at year-end 1998. The Corporation well exceeded all minimum ratio standards established by the regulatory agencies. First National Corporation pays dividends from funds provided mainly by dividends from its subsidiary banks. Such bank dividends are subject to certain regulatory restrictions and require the approval of the Office of the Comptroller of the Currency in order to pay dividends in excess of the banks' net earnings for the current year, plus retained net profits for the preceding two years, less any required transfers to surplus. As of December 31, 2000, $11,726,000 of the banks' retained earnings were available for distribution to the Corporation as dividends without prior regulatory approval. In 2000, First National Corporation made shareholder dividend payments of $3,801,000 as compared with $3,187,000 in 1999 and $2,538,000 in 1998. The dividend pay-out ratios were 36.09 percent, 40.14 percent and 30.69 percent for the years 2000, 1999 and 1998, respectively. Earnings retained continue to be utilized as a basis for loan and investment growth and in support of acquisition opportunities. NON-INTEREST INCOME AND EXPENSE As interest rates fluctuate and banks continue to encounter strong competition for deposits, non-interest income provides an important stable source of revenue for the Corporation. For the year ended December 31, 2000, non-interest income was $10,971,000, an increase of $1,244,000, or 12.8 percent, when compared with 1999. Income from non-interest sources was $9,727,000 for 1999, $871,000, or 9.8 percent, greater than 1998. Service charges on deposit accounts were $7,358,000, comprising 67.1 percent of non-interest income in 2000, and representing a $1,520,000, or 26.0 percent increase over 1999. For the year ended December 31, 1999, service charges on deposit accounts were $5,838,000, a $219,000, or 3.9 percent, increase compared with 1998. These increases were attributed to increased account activity and pricing modifications to reflect new services and related costs. Other service charges and fees declined $87,000, or .2 percent to $3,545,000 in 2000, as compared with the previous year. This followed a $536,000, or 17.3 percent increase for the year ended December 31, 1999, compared to 1998. The marginal decrease in 2000 revenues was the result of higher gain on sale of loans in 1999, partially offset by growth in trust asset management income. Non-interest expense was $34,096,000 for the year ended December 31, 2000, an increase of .9 percent compared with $33,802,000 in 1999. The 1999 result was $6,936,000, or 25.8 percent higher than 1998. The largest component of non-interest expense has been salaries and employee benefits, which were $17,304,000 in 2000, an increase of $463,000, or 2.8 percent, compared with the previous year. In 1999, salaries and employee benefits were $16,841,000, higher than 1998 by $2,474,000, or 17.2 percent. The Corporation employed 402 full-time equivalent employees at December 31, 2000, compared with 426 at December 31, 1999, and 353 at year-end 1998. The increase from 1998 to 1999 was primarily related to the acquisitions of FirstBanc and two Carolina First branches. Payments under a cash incentive program covering all employees were $843,000 in 2000 and $829,000 in 1999. Net occupancy expense was $1,989,000, $1,773,000, and $1,417,000 for the years ended December 31, 2000, 1999, 1998, respectively. The 12.2 percent increase in 2000 as compared to 1999 and the 25.1 percent rise from 1998 to 1999 were due to increased facilities operating expenses. 22
25 Furniture and equipment expense was $3,569,000 in 2000, an increase of 17.3 percent over 1999. This was a result of a rise in equipment leasing costs and equipment service contracts. An increase in the latter expense also contributed to an increase of 57.1 percent in 1999, as compared to 1998. For the year ended December 31, 2000, other expense decreased by $912,000, or 7.5 percent, to $11,234,000, compared with 1999. Acquisition expenses of $2,255,000 were incurred in 1999, while in 2000, consulting expenses increased $597,000, mainly due to a process reengineering project, and amortization of expenses associated with acquisition intangibles increased by $303,000. Compared with 1998, other expense in 1999 rose $3,001,000, or 32.8 percent, primarily due to the aforementioned acquisition expenses and increases in other areas, including advertising, insurance, office supplies, postage, telephone, and other expenses. TABLE 12 QUARTERLY RESULTS OF OPERATIONS <TABLE> <CAPTION> (Dollars in thousands) 2000 QUARTERS 1999 QUARTERS FOURTH THIRD SECOND FIRST FOURTH THIRD(1) SECOND FIRST <S> <C> <C> <C> <C> <C> <C> <C> <C> Interest income $18,710 $19,173 $19,013 $16,950 $16,204 $15,263 $14,840 $14,262 Interest expense 8,366 8,937 8,800 7,129 6,386 5,974 5,839 5,717 - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income 10,344 10,236 10,213 9,821 9,818 9,289 9,001 8,545 - ----------------------------------------------------------------------------------------------------------------------------------- Provision for loan losses 624 456 440 318 503 366 397 347 Non-interest income 2,592 2,783 2,995 2,601 2,198 2,462 2,537 2,530 Non-interest expense 8,755 8,356 8,656 8,329 8,413 10,217 7,732 7,440 - ----------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 3,557 4,207 4,112 3,775 3,100 1,168 3,409 3,288 Income taxes 1,132 1,400 1,361 1,225 860 182 918 1,065 - ----------------------------------------------------------------------------------------------------------------------------------- Net income $ 2,425 $ 2,807 $ 2,751 $ 2,550 $ 2,240 $ 986 $ 2,491 $ 2,223 =================================================================================================================================== </TABLE> (1) As previously reported in the Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, certain errors resulting in a $486,000 overstatement of the reported net income for the quarter ended September 30, 1999 in the Corporation's previously filed Form 10-Q for that period were corrected in the 2000 3rd quarter report. The errors had no effect on the previously reported 1999 year to date earnings or retained earnings. However, basic and diluted earnings per share for the quarter were reduced from $.22 to $.14. EFFECT OF INFLATION AND CHANGING PRICES The consolidated financial statements have been prepared in accordance with generally accepted accounting principles which require the measure of financial position and results of operations in terms of historical dollars, without consideration of changes in the relative purchasing power over time due to inflation. Unlike most other industries, the majority of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on a financial institution's performance than does the effect of inflation. Interest rates do not necessarily change in the same magnitude as the prices of goods and services. While the effect of inflation on banks is normally not as significant as is its influence on those businesses which have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in money supply, and banks will normally experience above average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expenses. Inflation also affects the bank's customers which may result in an indirect effect on the banks' business. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK See "Asset-Liability Management and Market Risk Sensitivity" in Management's Discussion and Analysis of Financial Condition and Results of Operations for quantitative and qualitative disclosures about market risk. 23
26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF MANAGEMENT The financial statements, accompanying notes, and other financial information in this Report were prepared by management of First National Corporation which is responsible for the integrity of the information given. The statements have been prepared in conformity with generally accepted accounting principles and include amounts which are based on management's judgment or best estimates. The Corporation maintains a system of internal controls to reasonably assure the safeguarding of assets and proper execution of transactions according to management's directives. The control system consists of written policies and procedures, segregation of duties, and an internal audit program. Management is cognizant of the limitations of such controls, but feels reasonable assurance of effectiveness is achieved without extending costs beyond benefits derived. Internal audit reports are prepared for the Audit Committee of the Board of Directors and copies are made available to the independent auditors. The Audit Committee of the Board of Directors consists solely of outside directors who meet periodically with management, internal auditors, and the independent auditors. The Audit Committee reviews matters relating to the audit scope, quality of financial reporting and control, and evaluation of management's performance of its financial reporting responsibility. Access to the Audit Committee is available to both internal and independent auditors without management present. J. W. Hunt and Company, LLP independent auditors, has audited the financial statements and notes included in this Annual Report. Their audit was conducted in accordance with generally accepted auditing standards and their opinion presents an objective evaluation of management's discharge of its responsibility to fairly present the financial statements of the Corporation. Their opinion is contained in their report on the facing page. All financial information appearing in this Annual Report is consistent with that in the audited financial statements. First National Corporation Orangeburg, South Carolina January 26, 2001 REPORT OF INDEPENDENT AUDITORS INDEPENDENT AUDITORS' REPORT To the Shareholders and the Board of Directors First National Corporation We have audited the accompanying consolidated balance sheets of First National Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First National Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. J. W. Hunt and Company, LLP Columbia, South Carolina January 26, 2001 24
27 CONSOLIDATED BALANCE SHEETS (In thousands of dollars, except par value) <TABLE> <CAPTION> December 31, 2000 1999 ---------- ---------- <S> <C> <C> ASSETS Cash and cash equivalents: Cash and due from banks (Note 3) $ 31,843 $ 39,479 Interest-bearing deposits with banks 158 1,848 - ------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 32,001 41,327 - ------------------------------------------------------------------------------------------------------------------------- Investment securities (Note 4): Securities held-to-maturity: Taxable 615 4,335 Tax-exempt 37,935 42,933 - ------------------------------------------------------------------------------------------------------------------------- Total (fair value of $38,530 in 2000 and $47,456 in 1999) 38,550 47,268 Securities available-for-sale, at fair value 144,648 148,304 - ------------------------------------------------------------------------------------------------------------------------- Total investment securities 183,198 195,572 - ------------------------------------------------------------------------------------------------------------------------- Loans (Note 5) 732,266 613,961 Less, unearned income (3,217) (3,420) Less, allowance for loan losses (8,922) (7,886) - ------------------------------------------------------------------------------------------------------------------------- Loans, net 720,127 602,655 - ------------------------------------------------------------------------------------------------------------------------- Premises and equipment, net (Note 6) 16,311 15,693 - ------------------------------------------------------------------------------------------------------------------------- Other assets (Note 7) 18,211 16,620 - ------------------------------------------------------------------------------------------------------------------------- Total assets $ 969,848 $ 871,867 ========================================================================================================================= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand $ 111,997 $ 105,018 Interest-bearing transaction accounts 128,196 123,597 Savings 152,453 134,203 CDs of $100,000 and over 116,663 88,762 Other time 248,267 238,085 - ------------------------------------------------------------------------------------------------------------------------- Total deposits 757,576 689,665 Federal funds purchased and securities sold under agreements to repurchase (Note 9) 65,948 76,400 Notes payable (Note 10) 57,050 26,750 Other liabilities 4,338 3,233 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities 884,912 796,048 - ------------------------------------------------------------------------------------------------------------------------- Shareholders' equity: Common stock - $2.50 par value, authorized 40,000,000 shares, issued and outstanding 7,026,901 shares in 2000 and 7,041,101 shares in 1999 17,567 17,603 Surplus 47,488 47,666 Retained earnings 20,228 13,496 Accumulated other comprehensive income (loss) (Note 14) (347) (2,946) - ------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 84,936 75,819 - ------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 969,848 $ 871,867 ========================================================================================================================= </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS 25
28 CONSOLIDATED STATEMENTS OF INCOME (In thousands of dollars, except per share data) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 --------- --------- --------- <S> <C> <C> <C> Interest Income: Loans, including fees $ 61,284 $ 47,701 $ 41,799 Investment securities: Taxable: Held-to-maturity 67 400 676 Available-for-sale 9,185 9,899 9,290 Tax-exempt - held-to-maturity 1,775 1,847 1,672 Federal funds sold 1,501 456 579 Deposits with banks 34 266 471 - ------------------------------------------------------------------------------------------------------------------------------- Total interest income 73,846 60,569 54,487 - ------------------------------------------------------------------------------------------------------------------------------- Interest Expense: Interest-bearing transaction accounts 1,222 1,014 2,437 Savings 5,056 4,090 3,246 Certificates of deposit 19,180 14,540 14,770 Federal funds purchased and securities sold under agreements to repurchase 5,923 2,818 2,425 Notes payable 1,851 1,454 244 - ------------------------------------------------------------------------------------------------------------------------------- Total interest expense 33,232 23,916 23,122 - ------------------------------------------------------------------------------------------------------------------------------- Net Interest Income: Net interest income 40,614 36,653 31,365 Provision for loan losses (Note 5) 1,838 1,613 1,213 - ------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 38,776 35,040 30,152 - ------------------------------------------------------------------------------------------------------------------------------- Non-interest- Income: Service charges on deposit accounts 7,358 5,838 5,619 Other service charges and fees 3,545 3,632 3,096 Gain on sale of securities available-for-sale -- 214 95 Other income 68 43 46 - ------------------------------------------------------------------------------------------------------------------------------- Total non-interest- income 10,971 9,727 8,856 - ------------------------------------------------------------------------------------------------------------------------------- Non-interest- Expenses: Salaries and employee benefits (Note 15) 17,304 16,841 14,367 Net occupancy expense 1,989 1,773 1,417 Furniture and equipment expense 3,569 3,042 1,937 Other expense (Note 12) 11,234 12,146 9,145 - ------------------------------------------------------------------------------------------------------------------------------- Total non-interest- expense 34,096 33,802 26,866 - ------------------------------------------------------------------------------------------------------------------------------- Earnings: Income before provision for income taxes 15,651 10,965 12,142 Provision for income taxes (Note 11) 5,118 3,025 3,871 - ------------------------------------------------------------------------------------------------------------------------------- Net income $ 10,533 $ 7,940 $ 8,271 =============================================================================================================================== Earnings per share (Note 13): Basic $ 1.50 $ 1.14 $ 1.24 =============================================================================================================================== Diluted $ 1.49 $ 1.13 $ 1.21 =============================================================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS 26
29 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands of dollars, except per share data) <TABLE> <CAPTION> ACCUMULATED OTHER COMMON STOCK RETAINED COMPREHENSIVE SHARES AMOUNT SURPLUS EARNINGS INCOME (LOSS) TOTAL --------- -------- -------- --------- ------------- -------- <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 1997 6,031,672 $ 15,079 $ 27,404 $ 18,937 $ 461 $ 61,881 -------- Comprehensive income: Net income -- -- -- 8,271 -- 8,271 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- 800 800 -------- Total comprehensive income 9,071 -------- Cash dividends declared at $.48 per share -- -- -- (2,538) -- (2,538) -------- Common stock dividend of 10%, date of record, November 2, 1998 528,678 1,322 14,605 (15,927) -- -- -------- Common stock issued 339,329 848 5,063 -- -- 5,911 - ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1998 6,899,679 17,249 47,072 8,743 1,261 74,325 Comprehensive income: Net income -- -- -- 7,940 -- 7,940 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- (4,207) (4,207) -------- Total comprehensive income 3,733 -------- Cash dividends declared at $.52 per share -- -- -- (3,187) -- (3,187) Common stock issued 141,422 354 594 -- -- 948 Balance, December 31, 1999 7,041,101 17,603 47,666 13,496 (2,946) 75,819 Comprehensive income: Net income -- -- -- 10,533 -- 10,533 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- 2,599 2,599 -------- Total comprehensive income 13,132 -------- Cash dividends declared at $.54 per share -- -- -- (3,801) -- (3,801) -------- Common stock repurchased (14,200) (36) (178) -- -- (214) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2000 7,026,901 $ 17,567 $ 47,488 $ 20,228 $ (347) $ 84,936 ================================================================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS 27
30 CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of dollars) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 --------- --------- --------- <S> <C> <C> <C> Cash flows from operating activities: Net income $ 10,533 $ 7,940 $ 8,271 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,646 1,926 2,402 Provision for loan losses 1,838 1,613 1,213 Deferred income taxes (344) (399) (337) Gain on sale of securities available-for-sale -- (214) (95) Loss on sale of premises and equipment -- 26 74 Gain on sale of other real estate -- -- (7) Net amortization (accretion) of investment securities (92) 212 (23) Net change in: Accrued interest receivable (1,571) 147 (422) Prepaid assets (1,087) (581) (446) Miscellaneous other assets (1,079) (3,670) (1,510) Accrued interest payable 1,150 446 488 Accrued income taxes 710 (756) 80 Miscellaneous other liabilities (754) (1,818) 460 - ------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 11,950 4,872 10,148 - ------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Proceeds from sales of investment securities available-for-sale 12,973 36,520 36,499 Proceeds from maturities of investment securities held-to-maturity 10,793 8,149 18,132 Proceeds from maturities of investment securities available-for-sale 24,135 52,528 36,900 Purchases of investment securities held-to-maturity (2,169) (9,149) (14,101) Purchases of investment securities available-for-sale (29,141) (84,157) (111,854) Net increase in customer loans (119,511) (118,223) (57,927) Recoveries on loans previously charged off 202 165 260 Proceeds from sale of other real estate -- -- 162 Purchases of premises and equipment (2,331) (4,945) (2,692) Proceeds from sale of premises and equipment 29 276 2 - ------------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (105,020) (118,836) (94,619) - ------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 67,911 77,773 80,084 Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase (10,452) 24,250 (2,162) Proceeds from issuance of debt 166,000 22,600 9,600 Repayment of debt (135,700) (2,200) (8,300) Common stock issuance -- 635 5,873 Common stock repurchase (214) -- -- Dividends paid (3,801) (3,187) (2,538) Stock options exercised -- 313 38 - ------------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 83,744 120,184 82,595 - ------------------------------------------------------------------------------------------------------------------------------- </TABLE> 28
31 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (In thousands of dollars) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 --------- --------- --------- <S> <C> <C> <C> Net increase (decrease) in cash and cash equivalents $ (9,326) $ 6,220 $ (1,876) Cash and cash equivalents at beginning of year 41,327 35,107 36,983 - ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 32,001 $ 41,327 $ 35,107 =============================================================================================================================== Supplemental Disclosures: Cash Flow Information: Cash paid for: Interest $ 32,083 $ 23,606 $ 22,756 =============================================================================================================================== Income taxes $ 4,882 $ 4,416 $ 4,231 =============================================================================================================================== Schedule of Noncash Investing Transactions: Real estate acquired in full or partial settlement of loans $ 848 $ 227 $ 202 =============================================================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF OPERATIONS: First National Corporation (the "Corporation") is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiaries, First National Bank, National Bank of York County, and Florence County National Bank (the "Banks"), and its 90%-owned subsidiary, CreditSouth Financial Services Corporation ("CreditSouth"). The accounting and reporting policies of the Corporation and its subsidiaries conform with generally accepted accounting principles. The Banks provide general banking services while CreditSouth provides consumer finance services. All services are provided within the State of South Carolina ("South Carolina"). On August 1, 1999, First National Corporation merged with FirstBancorporation, Inc. ("FirstBanc"). The surviving entity was First National Corporation. The transaction was accounted for as a pooling-of-interests. The consolidated financial statements have been restated to present combined financial information of the Corporation as if the merger had been in effect for all periods presented. All expenses relating to effecting the pooling-of-interests were deducted in determining the net income of the Corporation for 1999. BASIS OF CONSOLIDATION: The consolidated financial statements include the accounts of First National Corporation and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. SEGMENTS: The Corporation, through its subsidiaries, provides a broad range of financial services to individuals and companies in South Carolina. These services include demand, time and savings deposits; lending and credit card servicing; ATM processing; and trust services. While the Corporation's decision-makers monitor the revenue streams of the various financial products and services, operations are managed and financial performance is evaluated on an organization-wide basis. Accordingly, the Corporation's banking and finance operations are not considered by management to be more than one reportable operating segment. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reporting period. Actual 29
32 results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of deferred tax assets. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK: The Corporation's subsidiaries grant agribusiness, commercial, and residential loans to customers throughout South Carolina. Although the subsidiaries have a diversified loan portfolio, a substantial portion of their debtors' ability to honor their contracts is dependent upon economic conditions within South Carolina and the surrounding region. The Corporation considers concentrations of credit to exist when the amounts loaned to a multiple number of borrowers engaged in similar business activities which would cause them to be similarly impacted by general economic conditions represents 25% of equity. INVESTMENT SECURITIES: Debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" and carried at amortized cost. Securities not classified as held-to-maturity are classified as "available-for-sale" and carried at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss). Purchase premiums and discounts are recognized in interest income using methods approximating the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Realized gains (losses) on the sale of securities available-for-sale are included in other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Gains and losses on sales of securities are determined using the specific identification method. LOANS: Loans are stated at unpaid principal balances, less unearned discounts and the allowance for loan losses. Unearned discounts on installment loans are recognized as income over the terms of the loans by methods which generally approximate the interest method. Interest on other loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Loans are placed on nonaccrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 120 days or more. A nonaccrual loan may not be considered impaired if it is expected that the delay in payment is minimal. All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income. Interest income is subsequently recognized only to the extent of interest payments received. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management determines when loans become impaired through its normal loan administration and review functions. Those loans identified as substandard or doubtful as a result of the loan review process are potentially impaired loans. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired provided that management expects to collect all amounts due, including interest accrued at the contractual interest rate, for the period of delay. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual credit card, residential mortgage, overdraft protection, home equity lines, accounts receivable financing, and consumer installment loans for impairment disclosures. ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes that the collectibility of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with 30
33 local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. OTHER REAL ESTATE OWNED (OREO): Real estate acquired in satisfaction of a loan and in-substance foreclosures are reported in other assets. In-substance foreclosures are properties in which the borrower has little or no equity in the collateral. Properties acquired by foreclosure or deed in lieu of foreclosure and in-substance foreclosures are transferred to OREO and recorded at the lower of the outstanding loan balance at the time of acquisition or the estimated market value. Market value is determined on the basis of the properties being disposed of in the normal course of business and not on a liquidation or distress basis. Loan losses arising from the acquisition of such properties are charged against the allowance for loan losses. Gains or losses arising from the sale of OREO are reflected in current operations. PREMISES AND EQUIPMENT: Office equipment, furnishings, and buildings are stated at cost less accumulated depreciation computed principally on the declining-balance method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line method over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Additions to premises and equipment and major replacements are added to the accounts at cost. Maintenance and repairs and minor replacements are charged to expense when incurred. Gains and losses on routine dispositions are reflected in current operations. INTANGIBLE ASSETS: Intangible assets consist primarily of core deposit premium costs which resulted from the acquisition of branches from other commercial banks. The excess of the purchase price over the fair value of the net tangible assets acquired in the transactions is included in other assets and is being amortized over the estimated useful lives of the deposit accounts acquired on a method which reasonably approximates the anticipated benefit stream from the accounts. (See NOTE 7.) EMPLOYEE BENEFIT PLANS: A summary of the Corporation's various employee benefit plans follows: Pension Plan - The Corporation and its subsidiaries have a non-contributory defined benefit pension plan covering all employees who have attained age twenty-one and have completed one year of eligible service. The Corporation's funding policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding standards. Profit-Sharing Plan - The Corporation and its subsidiaries have a profit-sharing plan, including Internal Revenue Code Section 401(k) provisions. Electing employees are eligible to participate after attaining age twenty-one and completing one year of eligible service. Plan participants elect to contribute 1% to 4% of annual base compensation as a before tax contribution. The Corporation matches 50% of these contributions. Employer contributions may be made from current or accumulated net profits. Participants may additionally elect to contribute 1% to 6% of annual base compensation as a before tax contribution with no employer matching contribution. Retiree Medical Plan - Post-retirement health and life insurance benefits are provided to eligible employees which is limited to those employees of the Corporation eligible for early retirement under the pension plan on or before December 31, 1993, and former employees who are currently receiving benefits. The plan was unfunded at December 31, 2000, and the liability for future benefits has been recorded in the consolidated financial statements. CASH AND CASH EQUIVALENTS: For the purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash on hand, cash items in process of collection, amounts due from banks, and time deposits. Due from bank balances are maintained in other financial institutions. 31
34 INCOME TAXES: Income taxes are provided for the tax effects of the transactions reported in the accompanying consolidated financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of available-for-sale securities, allowance for loan losses, accumulated depreciation, consumer loan income, accretion income, intangible assets, and pension plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Corporation files a consolidated federal income tax return with its subsidiaries. ADVERTISING COSTS: The cost of advertising is expensed as incurred. STOCK COMPENSATION PLANS: Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, allows all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Corporation's stock option plans have no intrinsic value at the grant date, and under APB Opinion No. 25 no compensation cost is recognized for them. The Corporation has elected to continue with the accounting methodology in APB Opinion No. 25 and, as a result, has provided pro forma disclosures of net income and earnings per share and other disclosures, as if the fair value based method of accounting has been applied. The pro forma disclosures include the effects of all awards granted on or after January 1, 1995. (See NOTE 18.) EARNINGS PER SHARE: Basic earnings per share represents income available to shareholders divided by the weighted-average number of shares outstanding during the year. Diluted earnings per share reflects additional shares that would have been outstanding if dilutive potential shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method, if dilutive. Under the treasury stock method, the number of incremental shares is determined by assuming the issuance of the outstanding stock options, reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price for the year of the Corporation's stock. COMPREHENSIVE INCOME (LOSS): Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. (See NOTE 14.) RECENT ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, effective for fiscal years beginning June 15, 2000. This statement establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other contracts and requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them at fair value. If certain conditions are met, an entity may elect to designate a derivative as follows: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the 32
35 foreign currency exposure of an unrecognized firm commitment, an available-for-sale security, a foreign currency denominated forecasted transaction, or a net investment in a foreign operation. The Statement generally provides for matching the timing of the recognition of the gain or loss on derivatives designated as hedging instruments with the recognition of the changes in the fair value of the item being hedged. Depending on the type of hedge, such recognition will be either in net income or other comprehensive income. For a derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in the period of change. The adoption of SFAS No. 133 is not expected to have a material effect on the Corporation's consolidated financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 140 replaces and carries over most of the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and it revises those standards for accounting for securitizations and other transfers of assets and collateral and requires additional disclosures. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers occurring after March 31, 2001. However, the recognition and reclassification of collateral and disclosures relating to securitization transactions and collateral is effective for fiscal years ending after December 15, 2000. The Corporation adopted the disclosure provisions related to the securitization of financial assets on December 31, 2000. The Corporation does not anticipate the implementation of the remaining provisions of the Statement, which are effective subsequent to March 31, 2001, will have a material effect on its earnings or financial condition. OTHER: Certain amounts previously reported have been restated in order to conform with current year presentation. Such reclassifications had no effect on net income. NOTE 2 - MERGER On July 31, 1999, the Corporation completed the merger with FirstBanc through the issuance of 1.222 shares of the Corporation's common stock for each share of outstanding common stock of FirstBanc, or 976,666 shares. At December 31, 1998, the Corporation owned 5,555 shares of FirstBanc common stock (6,788 after applying the exchange ratio) with a recorded value of $100,000. This pre-merger intercompany balance was eliminated. NOTE 3 - RESTRICTION ON CASH AND DUE FROM BANKS: The Banks are required to maintain average reserve funds in cash or on deposit with the Federal Reserve Bank. The average amount of such reserve funds at December 31, 2000, was approximately $6,471,000. At December 31, 2000, the Corporation and its subsidiaries had due from bank balances in excess of federally insured limits of approximately $2,587,000. The risk associated with this excess is limited due to the soundness of the financial institutions with which the funds are deposited. NOTE 4 - INVESTMENT SECURITIES: The following is the amortized cost and fair value of investment securities held-to-maturity at December 31, 2000 and 1999: <TABLE> <CAPTION> 2000 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- <S> <C> <C> <C> <C> (In thousands of dollars) Securities of U. S. Government agencies and corporations $ 615 $ 3 $ (3) $ 615 Obligations of states and political subdivisions 37,935 280 (300) 37,915 - --------------------------------------------------------------------------------- Total $ 38,550 $ 283 $ (303) $ 38,530 ================================================================================= </TABLE> 33
36 <TABLE> <CAPTION> 1999 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- <S> <C> <C> <C> <C> (In thousands of dollars) Securities of other U. S. Government agencies and corporations $ 4,335 $ 7 $ (34) $ 4,308 Obligations of states and political subdivisions 42,933 82 (794) 42,221 - ---------------------------------------------------------------------------------- Total $ 47,268 $ 89 $ (828) $ 46,529 ================================================================================== </TABLE> The fair values of obligations of states and political subdivisions are established with the assistance of an independent pricing service. The values are based on data which often reflect transactions of relatively small size and are not necessarily indicative of the value of the securities when traded in large volumes. The following is the amortized cost and fair value of securities available-for-sale at December 31, 2000 and 1999: <TABLE> <CAPTION> 2000 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- <S> <C> <C> <C> <C> (In thousands of dollars) U. S. Treasury securities $ 24,485 $ 43 $ (9) $ 24,519 Securities of other U. S. Government agencies and corporations 116,285 306 (905) 115,686 Other securities 4,428 15 -- 4,443 - ---------------------------------------------------------------------------------- Total $145,198 $ 364 $ (914) $144,648 ================================================================================== <CAPTION> 1999 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- <S> <C> <C> <C> <C> (In thousands of dollars) U. S. Treasury securities $ 32,446 $ 19 $ (508) $ 31,957 Securities of other U. S. Government agencies and corporations 116,780 17 (4,218) 112,579 Other securities 3,754 14 -- 3,768 - ---------------------------------------------------------------------------------- Total $152,980 $ 50 $(4,726) $148,304 ================================================================================== </TABLE> 34
37 The amortized cost and fair value of debt securities at December 31, 2000 by contractual maturity are detailed below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. <TABLE> <CAPTION> SECURITIES SECURITIES HELD-TO-MATURITY AVAILABLE-FOR-SALE AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---- ----- ---- ----- <S> <C> <C> <C> <C> (In thousands of dollars) Due in one year or less $ 3,265 $ 3,280 $20,401 $ 20,412 Due after one year through five years 16,973 17,025 82,402 82,168 Due after five years through ten years 16,378 16,205 37,967 37,625 Due after ten years 1,934 2,020 -- -- - --------------------------------------------------------------------------------- Subtotal 38,550 38,530 140,770 140,205 No contractual maturity -- -- 4,428 4,443 - --------------------------------------------------------------------------------- Total $ 38,550 $38,530 $145,198 $144,648 ================================================================================= </TABLE> Held-to-maturity securities with a carrying value of $3,000,000 were transferred to available for sale category in 2000. There were no sales or transfers of held-to-maturity securities during 1999 or 1998. The following table summarizes information with respect to sale of available-for-sale securities: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Sale proceeds $ 12,973,000 $ 36,520,000 $ 36,499,000 ==================================================================================== Gross realized gains $ 20,000 $ 246,000 $ 95,000 Gross realized losses 20,000 32,000 -- - ------------------------------------------------------------------------------------ Net realized gain $ -- $ 214,000 $ 95,000 ==================================================================================== </TABLE> The Banks, as members of the Federal Home Loan Bank ("FHLB") of Atlanta, are required to own capital stock in the FHLB of Atlanta based generally upon their balances of residential mortgage loans and FHLB advances. FHLB capital stock owned by the Banks is pledged as collateral on FHLB advances. No ready market exists for this stock, and it has no quoted market price. However, redemption of this stock has historically been at par value. At December 31, 2000 and 1999, investment securities with a carrying value of $57,600,000 and $58,974,000, respectively, were pledged to secure public deposits, FHLB advances and for other purposes required and permitted by law. At December 31, 2000 and 1999, the carrying amount of securities pledged to secure repurchase agreements was $40,282,000 and $36,111,000, respectively. NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES: The following is a summary of loans by category at December 31, 2000 and 1999: <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> (In thousands of dollars) Commercial, financial and agricultural $ 103,468 $ 87,098 Real estate - construction 32,256 27,555 Real estate - mortgage 473,131 396,158 Consumer 123,411 103,150 - ---------------------------------------------------------------------------------- Total loans 732,266 613,961 Less, unearned income (3,217) (3,420) Less, allowance for loan losses (8,922) (7,886) - ---------------------------------------------------------------------------------- Loans, net $ 720,127 $ 602,655 ================================================================================== </TABLE> 35
38 Changes in the allowance for loan losses for the three years ended December 31, 2000, were as follows: <TABLE> <CAPTION> 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> (In thousands of dollars) Balance at beginning of year $ 7,886 $ 6,934 $ 6,246 Loans charged-off (1,004) (826) (785) Recoveries of loans previously charged-off 202 165 260 - ------------------------------------------------------------------------------------------ Balance before provision for loan losses 7,084 6,273 5,721 Provision for loan losses 1,838 1,613 1,213 - ------------------------------------------------------------------------------------------ Balance at end of year $ 8,922 $ 7,886 $ 6,934 ========================================================================================== </TABLE> At December 31, 2000 and 1999, the aggregate amount of loans for which the accrual of interest had been discontinued was $1,481,000 and $1,537,000, respectively. Interest income which was foregone was an immaterial amount for each of the three years ended December 31, 2000. There were no restructured loans at December 31, 2000 and 1999. Included in the balance sheet under the caption "Other assets" are certain real properties which were acquired as a result of completed foreclosure proceedings. Also included in the caption are amounts reclassified as in-substance foreclosures. Other real estate totaled $848,000 and $227,000 at December 31, 2000 and 1999, respectively. There were no impaired loans at December 31, 2000 and 1999. NOTE 6 - PREMISES AND EQUIPMENT: Premises and equipment at December 31, consisted of the following: <TABLE> USEFUL LIFE 2000 1999 ----------- ---- ---- <S> <C> <C> <C> (In thousands of dollars) Land $ 2,453 $ 2,406 Buildings and leasehold improvements 15-40 years 15,514 14,270 Equipment and furnishings 5-10 years 10,080 9,096 - ------------------------------------------------------------------------------------- Total 28,047 25,772 Less, accumulated depreciation 11,736 10,079 - ------------------------------------------------------------------------------------- Premises and equipment, net $ 16,311 $ 15,693 ===================================================================================== </TABLE> Depreciation expense charged to operations was $1,684,000, $1,342,000, and $1,432,000, in 2000, 1999, and 1998, respectively. NOTE 7 - INTANGIBLE ASSETS: CORE DEPOSIT PREMIUM COST: Purchases in prior years of branches of other commercial banks resulted in core deposit premium cost of $9,723,000. Amortization expense, which is included in other non-interest expense, for the years ended December 31, 2000, 1999 and 1998 was $786,000, $483,000, and $414,000 respectively. COMPUTER SOFTWARE: Computer software with an original cost of $1,622,000 is being amortized using the straight-line method over thirty-six months. Amortization expense totaled $173,000, $79,000 and $329,000 for the years ended December 31, 2000, 1999 and 1998, respectively. 36
39 NOTE 8 - DEPOSITS: At December 31, 2000, the scheduled maturities of certificates of deposit are as follows: <TABLE> <CAPTION> (In thousands of dollars) <S> <C> 2001 $294,714 2002 57,928 2003 6,385 2004 4,836 2005 519 Thereafter 548 -------- $364,930 ======== </TABLE> NOTE 9 - FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: Federal funds purchased and securities sold under agreements to repurchase generally mature within one to three days from the transaction date. Certain of the borrowings have no defined maturity date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Corporation monitors the fair value of the underlying securities on a daily basis. All securities underlying these agreements are institution-owned securities. Information concerning federal funds purchased and securities sold under agreements to repurchase is included in Table 11 of Management's Discussion and Analysis of Financial Condition and Results of Operations. NOTE 10 - NOTES PAYABLE: The Banks have entered into advance agreements with the FHLB of Atlanta. Advances under these agreements are collateralized by stock in the FHLB of Atlanta, and qualifying first mortgage loans under a blanket floating lien. A summary of advances during the years ended December 31, 2000 and 1999, is as follows: <TABLE> <CAPTION> 2000 1999 ---- ---- <S> <C> <C> Advances outstanding at December 31 $ 57,050,000 $ 26,750,000 ========================================================================================== Maximum amount outstanding at any month-end 57,050,000 26,800,000 ========================================================================================== Average amount outstanding during the year 32,759,000 23,606,000 ========================================================================================== Weighted-average interest rate at December 31 5.95% 5.20% ========================================================================================== Weighted-average interest rate during the year 5.70% 5.14% ========================================================================================== </TABLE> Principal maturities of FHLB advances are summarized below: <TABLE> <CAPTION> YEAR ENDING DECEMBER 31: <S> <C> 2001 $ 44,050,000 2002 -- 2003 -- 2004 -- 2005 and thereafter 13,000,000 ------------ Total $ 57,050,000 ============ </TABLE> 37
40 NOTE 11 - INCOME TAXES: The provision for income taxes consists of the following: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Current: Federal $ 4,961 $ 3,043 $ 3,777 State 501 381 431 - ---------------------------------------------------------------------------------------- Total current tax expense 5,462 3,424 4,208 - ---------------------------------------------------------------------------------------- Deferred: Federal (313) (281) (286) State (31) (118) (51) - ---------------------------------------------------------------------------------------- Total deferred tax benefit (344) (399) (337) - ---------------------------------------------------------------------------------------- Provision for income taxes $ 5,118 $ 3,025 $ 3,871 - ---------------------------------------------------------------------------------------- </TABLE> Temporary differences in the recognition of revenue and expense for tax and financial reporting purposes resulted in net deferred income tax benefits as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 - ------------------------- ---- ---- ---- <S> <C> <C> <C> Provision for loan losses $ (322) $ (397) $ (251) Pension cost and post-retirement benefits 48 64 47 Consumer loan income 35 41 21 Depreciation (49) 9 (25) Other (56) (116) (129) - ------------------------------------------------------------------------------- Total $ (344) $ (399) $ (337) =============================================================================== </TABLE> The provision for income taxes differs from that computed by applying Federal statutory income tax rates to income before provision for income taxes, as indicated in the following analysis: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 - ------------------------- ---- ---- ---- <S> <C> <C> <C> Income taxes at Federal statutory rate of 34% $ 5,321 $ 3,728 $ 4,128 Increase (reduction) of taxes resulting from: State income taxes, net of federal tax benefit 331 248 356 Tax-exempt interest income (642) (663) (614) Other, net 108 (288) 1 - -------------------------------------------------------------------------------------------- Total $ 5,118 $ 3,025 $ 3,871 ============================================================================================ </TABLE> 38
41 The components of the net deferred tax asset, included in other assets, are as follows: <TABLE> <CAPTION> (In thousands of dollars) 2000 1999 ---- ---- <S> <C> <C> Allowance for loan losses $ 2,990 $ 2,628 Unrealized losses on investment securities available-for-sale 204 1,730 Post-retirement benefits 93 83 Intangible assets 381 281 Start-up expenses 76 115 State net operating less carry forward 98 62 Other -- 5 - ------------------------------------------------------------------------------------------------- Total deferred tax assets 3,842 4,904 - ------------------------------------------------------------------------------------------------- Depreciation 748 (797) Consumer loan income 274 (240) Bond discount accretion 62 (61) Pension plan 293 (235) - ------------------------------------------------------------------------------------------------- Total deferred tax liabilities 1,377 (1,333) - ------------------------------------------------------------------------------------------------- Net deferred tax asset before valuation allowance 2,465 3,571 Less, valuation allowance (138) (62) - ------------------------------------------------------------------------------------------------- Net deferred tax asset $ 2,327 $ 3,509 ================================================================================================= </TABLE> At December 31, 2000, the Corporation had net operating loss carryforwards for state income tax purposes of approximately $2,000,000 available to offset future state taxable income. The carryforwards expire in the years 2010 to 2015. The valuation allowance is based on management's estimate of the ultimate realization of the deferred tax asset. NOTE 12 - OTHER EXPENSE: The following is a summary of the components of other non-interest expense: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Telephone and postage $ 1,078 $ 1,062 $ 927 Professional fees 1,654 864 441 Office supplies 869 804 932 Advertising 835 780 807 Amortization of intangible assets 963 594 750 Regulatory fees 556 525 436 Insurance 96 235 344 Other(1) 5,183 7,282 4,508 - ---------------------------------------------------------------------------- Total $ 11,234 $ 12,146 $ 9,145 ============================================================================ </TABLE> (1) Other expenses for the year ended December 31, 1999, include nonrecurring charges of approximately $2,381,000 related to the costs associated with completing the merger as disclosed in NOTE 2. 39
42 NOTE 13 - EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts): <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 --------- --------- --------- <S> <C> <C> <C> Numerator: Net income - numerator for basic and diluted earnings per share $ 10,533 $ 7,940 $ 8,271 - ------------------------------------------------------------------------------------------------------------------------------- Denominator: Denominator for basic earnings per share - weighted-average shares outstanding 7,039 6,996 6,693 Effect of dilutive securities: Employee stock options 29 57 156 - ------------------------------------------------------------------------------------------------------------------------------- Dilutive potential shares: Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 7,068 7,053 6,849 - ------------------------------------------------------------------------------------------------------------------------------- Basic earnings per share $ 1.50 $ 1.14 $ 1.24 - ------------------------------------------------------------------------------------------------------------------------------- Diluted earnings per share $ 1.49 $ 1.13 $ 1.21 - ------------------------------------------------------------------------------------------------------------------------------- </TABLE> Options to purchase 96,000 shares of common stock at a range of $16.88 to $28.00 were outstanding during 2000 but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares for the year. NOTE 14 - OTHER COMPREHENSIVE INCOME (LOSS): The components of other comprehensive income (loss) and related tax effects are as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 --------- --------- -------- <S> <C> <C> <C> Unrealized holding gains (losses) on available-for-sale securities $ (4,126) $ (6,678) $ 1,270 Tax effect (1,527) 2,471 (470) - ------------------------------------------------------------------------------------------------------------------------------ Net-of-tax amount $ 2,599 $ (4,207) $ 800 ============================================================================================================================== </TABLE> NOTE 15 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES: Dividends are paid by the Corporation from its assets which are mainly provided by dividends from the banking subsidiaries. However, certain restrictions exist regarding the ability of the subsidiaries to transfer funds to the Corporation in the form of cash dividends, loans or advances. The approval of the Office of the Comptroller of the Currency (OCC) is required to pay dividends in excess of the subsidiaries' net profits for the current year plus retained net profits (net profits less dividends paid) for the preceding two years, less any required transfers to surplus. As of December 31, 2000, $11,726,000 of the Banks' retained earnings are available for distribution to the Corporation as dividends without prior regulatory approval. Under Federal Reserve regulation, the Banks are also limited as to the amount they may loan to the Corporation unless such loans are collateralized by specified obligations. The maximum amount available for transfer from the Banks to the Corporation in the form of loans or advances was approximately $16,157,000 at December 31, 2000. 40
43 NOTE 16 - RETIREMENT PLANS: The following sets forth the pension plan's funded status and amounts recognized in the Corporation's accompanying consolidated financial statements at December 31, 2000 and 1999: <TABLE> <CAPTION> (In thousands of dollars) 2000 1999 -------- -------- <S> <C> <C> Change in Benefit Obligation: Benefit obligation at beginning of year $ 7,619 $ 6,660 Service cost 473 416 Interest cost 560 492 Actuarial loss (23) 267 Benefits paid (257) (216) - ------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year 8,372 7,619 - ------------------------------------------------------------------------------------------------------------------------- Change in Plan Assets: Fair value of plan assets at beginning of year 7,751 6,718 Actual return on plan assets (29) 781 Employer contribution 489 468 Benefits paid (257) (216) - ------------------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year 7,954 7,751 - ------------------------------------------------------------------------------------------------------------------------- Funded status (418) 131 Unrecognized net actuarial loss 1,311 678 Unrecognized prior service cost 7 8 Unrecognized transition asset (28) (61) - ------------------------------------------------------------------------------------------------------------------------- Prepaid benefit cost $ 872 $ 756 ========================================================================================================================= </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 ------- ------- ------- <S> <C> <C> <C> Weighted-Average Assumptions as of December 31: Discount rate 7.50% 7.50% 7.50% Expected return on plan assets 8.00% 8.00% 8.00% Rate of compensation increase 5.00% 5.00% 5.00% (In thousands of dollars) Service cost $ 473 $ 416 $ 333 Interest cost 560 492 436 Expected return on plan assets (628) (542) (459) Amortization of prior service cost 1 1 1 Amortization of transition asset (33) (33) (33) Recognized net actuarial loss -- -- 14 - ------------------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 373 $ 334 $ 292 =============================================================================================================================== </TABLE> Expenses incurred and charged against operations with regard to all of the Corporation's retirement plans were as follows: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 ------ ------ ------ <S> <C> <C> <C> Pension $ 373 $ 334 $ 292 Profit-sharing 233 174 191 - ------------------------------------------------------------------------------------------------------------------------------- Total $ 606 $ 508 $ 483 =============================================================================================================================== </TABLE> 41
44 NOTE 17 - POST-RETIREMENT BENEFITS: The following sets forth the plan's funded status and amounts recognized in the Corporation's accompanying consolidated financial statements at December 31, 2000 and 1999: <TABLE> <CAPTION> (In thousands of dollars) 2000 1999 ------- ------- <S> <C> <C> Change in Benefit Obligation: Benefit obligation at beginning of year $ 516 $ 481 Interest cost 38 34 Actuarial loss (1) 31 Benefits paid (34) (30) - -------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year 519 516 - -------------------------------------------------------------------------------------------------------------------------- Change in Plan Assets: Fair value of plan assets at beginning of year -- -- Employer contribution 34 30 Benefits paid (34) (30) - -------------------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year -- -- - -------------------------------------------------------------------------------------------------------------------------- Funded status (519) (516) Unrecognized net actuarial gain (62) (63) Unrecognized transition obligation 378 410 - -------------------------------------------------------------------------------------------------------------------------- Accrued benefit cost $ (203) $ (169) ========================================================================================================================== </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Weighted-Average Assumptions as of December 31: Discount rate 7.50% 7.50% 7.50% Expected return on plan assets N/A N/A N/A </TABLE> For measurement purposes, a 13 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 1993. The rate was assumed to decrease gradually to 5 percent for 1999 and remain at that level thereafter. <TABLE> <CAPTION> (In thousands of dollars) <S> <C> <C> <C> Components of Net Periodic Benefit Cost: Interest cost 37 $ 34 $ 35 Amortization of transition obligation 32 32 31 Recognized net actuarial gain (1) (31) (33) - ------------------------------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 68 $ 35 $ 33 =============================================================================================================================== </TABLE> Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one-percentage-point change in assumed health care cost trend rates would have the following effects at the end of 2000: <TABLE> <CAPTION> 1-PERCENTAGE- 1-PERCENTAGE- POINT INCREASE POINT DECREASE -------------- -------------- <S> <C> <C> Effect on total of service and interest cost components $ 4,000 $ (3,000) Effect on post-retirement benefit obligation 53,000 (46,000) </TABLE> 42
45 NOTE 18 - STOCK-BASED COMPENSATION PLANS: During 1992 and 1996, the Corporation adopted stock options plans covering certain of its officers and key employees. Options under both plans may not be exercised in whole or in part within one year following the date of the grant of the options, and thereafter become exercisable in 25% increments over the next four years. The exercise price of the options may not be less than fair market value of the common stock on the date of the grant. No options may be exercised after five years from the date of the grant. No options were granted under the 1992 plan after March 12, 1997, at which time the plan terminated. The final options outstanding under the 1992 plan were exercised in 1999. FirstBanc adopted stock option plans in 1987 and 1996 covering certain of its officers and non-employee directors. A committee of its Board of Directors determined the periods of vesting and exercise. However, vesting was accelerated with the change in control of the company. The Corporation has also adopted the First National Corporation 1999 Stock Option Plan, under which incentive and nonqualified stock options may be granted periodically to key employees and non-employee directors. The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant, they have a term of no more than ten years, and they may be exercised at any time prior to expiration. No options may be granted under this plan after May 31, 2009. Activity in the Corporation's stock option plans is summarized below. All information has been retroactively restated to reflect stock dividends and stock splits. <TABLE> <CAPTION> 2000 1999 1998 -------------------- ---------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE <S> <C> <C> <C> <C> <C> <C> Outstanding, January 1 131,990 $ 14.74 269,840 $ 10.06 255,005 $ 9.23 Granted 72,450 $ 21.36 9,400 $ 26.25 19,727 $ 22.15 Exercised -- -- (141,801) $ 6.96 (4,756) $ 11.03 Expired (10,240) $ 12.73 (5,449) $ 5.51 (136) $ 8.43 -------- --------- -------- Outstanding, December 31 194,200 $ 17.32 131,990 $ 14.74 269,840 $ 10.06 ======== ========= ======== Exercisable, December 31 158,527 $ 16.18 82,852 $ 12.70 160,841 $ 8.16 Weighted-average fair value of options granted during the year $ 4.75 $ 6.65 $ 5.76 </TABLE> Information pertaining to options outstanding at December 31, 2000, is as follows: <TABLE> <CAPTION> OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- ----------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE <S> <C> <C> <C> <C> <C> $ 11.69 - $ 16.88 103,200 1.2 years $ 12.10 97,400 $ 11.95 $ 22.38 - $ 28.00 91,000 5.9 years $ 23.24 61,127 $ 22.91 ------- ------- 194,200 3.4 years 158,527 ======= ======= </TABLE> The Corporation has entered into a Restricted Stock Agreement with its chief executive officer. The agreement grants to the officer 11,977 shares of restricted common stock conditioned upon continued employment. The options vest free of restrictions as follows: 25% in 1999, 25% in 2001, and 50% in 2003. Termination of employment prior to a vesting date would terminate any interest in non-vested shares. Prior to vesting of the shares, as long as employed as chief executive officer, the officer will have the right to vote such shares and to receive dividends paid with respect to such shares. All restricted shares will fully vest in the event of change of control of the Corporation or upon the death of 43
46 the officer. The weighted average fair value of the shares granted under this agreement was $6.34 at the date of the grant. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, 2000 1999 1998 ------------ ------- ------- <S> <C> <C> <C> Dividend yield 4.1% 2.3% 1.7% Expected life 5-10 YEARS 5 years 5 years Expected volatility 26.0% 24.0% 21.0% Risk-free interest rate 4.972%-5.106% 5.875% 4.700% </TABLE> The Corporation applies APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized. Had compensation cost for the Corporation's stock option plans been determined based on the fair value at the grant dates for awards under the plans consistent with the method prescribed by SFAS 123, the Corporation's net income and earnings per share would have been adjusted to the pro forma amounts indicated below: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars, except per share data) 2000 1999 1998 --------- -------- -------- <S> <C> <C> <C> Net income As reported $ 10,533 $ 7,940 $ 8,271 Pro forma $ 10,092 $ 7,765 $ 8,115 Earnings per share As reported $ 1.50 $ 1.14 $ 1.24 Pro forma $ 1.43 $ 1.11 $ 1.21 Earnings per share - As reported $ 1.49 $ 1.13 $ 1.21 assuming dilution Pro forma $ 1.43 $ 1.10 $ 1.18 </TABLE> NOTE 19 - STOCK REPURCHASE PROGRAM: During the current year, the Corporation's Board of Directors authorized a repurchase program to acquire up to 160,000 shares of its outstanding common stock. As of December 31, 2000, the Corporation had repurchased 14,200 shares at a cost of $214,000. NOTE 20 - LEASE COMMITMENTS: The Corporation's subsidiaries were obligated at December 31, 2000, under certain noncancelable operating leases extending to the year 2013 pertaining to banking premises and equipment. Some of the leases provide for the payment of property taxes and insurance and contain various renewal options. The exercise of renewal options is, of course, dependent upon future events. Accordingly, the following summary does not reflect possible additional payments due if renewal options are exercised. Future minimum lease payments, by year and in the aggregate, under noncancelable operating leases with initial or remaining terms in excess of one year are as follows: <TABLE> <CAPTION> (In thousands of dollars) YEAR ENDING DECEMBER 31, <S> <C> <C> 2001 $ 1,200 2002 1,148 2003 1,024 2004 345 2005 261 Later years 1,539 -------- Total $ 5,517 ======== </TABLE> Total rental expense for the years ended December 31, 2000, 1999, and 1998 was $2,102,000, $1,881,000, and $352,000 respectively. 44
47 NOTE 21 - CONTINGENT LIABILITIES: The Corporation and its subsidiaries are involved at times in various litigation arising in the normal course of business. In the opinion of management, there is no pending or threatened litigation that will have a material effect on the Corporation's consolidated financial position or results of operations. NOTE 22 - RELATED PARTY TRANSACTIONS: During 2000 and 1999, the Corporation's banking subsidiaries had loan and deposit relationships with certain related parties; principally, directors and executive officers, their immediate families and their business interests. All of these relationships were in the ordinary course of business. Loans outstanding to this group (including immediate families and business interests) totaled $10,362,000 and $10,429,000 at December 31, 2000 and 1999, respectively. During 2000, $8,386,000 of new loans were made to this group while repayments of $6,875,000 were received during the year. Other changes, which included loans outstanding to new or former officers and directors, resulted in a decrease of $1,578,000. Related party deposits totaled approximately $13,810,000 and $10,113,000 at December 31, 2000 and 1999, respectively. NOTE 23 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: The Corporation's subsidiaries are parties to credit related financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Such commitments involve, to varying degrees, elements of credit, interest rate, or liquidity risk in excess of the amounts recognized in the consolidated balance sheets. The contract amounts of these instruments express the extent of involvement the subsidiaries have in particular classes of financial instruments. The subsidiaries' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and financial guarantees is represented by the contractual amount of those instruments. The subsidiaries use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. At December 31, 2000 and 1999, the following financial instruments were outstanding whose contract amounts represent credit risk: <TABLE> <CAPTION> (In thousands of dollars) 2000 1999 ---------- ---------- <S> <C> <C> Commitments to extend credit $ 114,771 $ 126,333 ====================================================================================================== Standby letters of credit and financial guarantees $ 1,003 $ 1,983 ====================================================================================================== </TABLE> COMMITMENTS TO EXTEND CREDIT: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The banking subsidiaries evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the subsidiaries upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and personal guarantees. STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES: Standby letters of credit and financial guarantees are conditional commitments issued by the banking subsidiaries to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Essentially all standby letters of credit have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the customer. NOTE 24 - FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: 45
48 CASH AND CASH EQUIVALENTS: The carrying amount is a reasonable estimate of fair value. INVESTMENT SECURITIES: Securities available-for-sale are valued at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Securities held-to-maturity are valued at quoted market prices or dealer quotes. LOANS: The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. DEPOSIT LIABILITIES: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE: The fair value of federal funds purchased and securities sold under agreements to repurchase is estimated based on the current rates offered for borrowings of the same remaining maturities. NOTES PAYABLE: The carrying amount of short-term borrowings is a reasonable estimate of fair value. The fair value of long-term borrowings is estimated using discounted cash flow analysis and the Corporation's current incremental borrowing rates for similar types of instruments. COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The estimated fair value of the Corporation's financial instruments at December 31, 2000 and 1999, are as follows: <TABLE> <CAPTION> 2000 1999 ------------------------------- ------------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- (In thousands of dollars) Financial assets: <S> <C> <C> <C> <C> Cash and cash equivalents $ 32,001 $ 32,001 $ 41,327 $ 41,327 Investment securities 183,198 183,178 195,572 194,833 Loans: Loans 729,049 724,500 610,541 599,042 Less, allowance for loan losses (8,922) (8,922) (7,886) (7,886) ---------- ---------- ---------- ---------- Net loans 720,227 715,578 602,655 591,156 Financial liabilities: Deposits 757,576 726,494 689,665 688,683 Federal funds purchased and securities sold under agreements to repurchase 65,948 65,948 76,400 76,400 Notes payable 57,050 57,323 26,750 27,053 Unrecognized financial instruments: Commitments to extend credit 114,771 114,055 126,333 123,954 Standby letters of credit 1,003 1,003 1,983 1,983 </TABLE> 46
49 NOTE 25 - REGULATORY MATTERS: The Corporation and its banking subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and its subsidiaries must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet-items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and its subsidiaries to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, at December 31, 2000 and 1999, that the Corporation and its subsidiaries met all capital adequacy requirements to which they are subject. As of their most recent regulatory examinations, the Corporation and its subsidiaries were considered well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the institutions' category. Actual capital amounts and ratios are also presented in the table. <TABLE> <CAPTION> MINIMUM TO BE WELL CAPITALIZED UNDER MINIMUM CAPITAL PROMPT CORRECTIVE (In Thousands of Dollars) ACTUAL REQUIREMENT ACTION PROVISIONS ---------------------------------------------------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> At December 31, 2000: Total capital (to risk weighted assets): Consolidated $88,814 13.40% $53,021 8.00% $66,276 10.00% First National Bank 71,219 12.49% 45,616 8.00% 57,020 10.00% National Bank of York County 8,757 14.47% 4,841 8.00% 6,051 10.00% Florence County National Bank 4,169 12.42% 2,685 8.00% 3,356 10.00% Tier I Capital (to risk weighted assets): Consolidated $80,514 12.15% $26,510 4.00% $39,766 6.00% First National Bank 64,086 11.24% 22,808 4.00% 34,212 6.00% National Bank of York County 8,000 13.22% 2,420 4.00% 3,630 6.00% Florence County National Bank 3,751 11.18% 1,342 4.00% 2,014 6.00% Tier I Capital (to average assets): Consolidated $80,514 8.27% $38,925 4.00% $48,656 5.00% First National Bank 64,086 7.74% 33,101 4.00% 41,377 5.00% National Bank of York County 8,000 8.72% 3,671 4.00% 4,589 5.00% Florence County National Bank 3,751 8.30% 1,808 4.00% 2,260 5.00% At December 31, 1999: Total capital (to risk weighted assets): Consolidated $80,560 13.95% $46,199 8.00% $57,749 10.00% First National Bank 65,577 13.10% 40,041 8.00% 50,052 10.00% National Bank of York County 6,043 11.87% 4,072 8.00% 5,091 10.00% Florence County National Bank 4,149 14.95% 2,220 8.00% 2,775 10.00% Tier I Capital (to risk weighted assets): Consolidated $73,333 12.70% $23,100 4.00% $34,649 6.00% First National Bank 59,313 11.85% 20,021 4.00% 30,031 6.00% National Bank of York County 5,406 10.62% 2,036 4.00% 3,054 6.00% Florence County National Bank 3,873 13.96% 1,110 4.00% 1,665 6.00% Tier I Capital (to average assets): Consolidated $73,333 8.64% 33,934 4.00% $42,418 5.00% First National Bank 59,313 8.04% 29,501 4.00% 36,877 5.00% National Bank of York County 5,406 7.63% 2,836 4.00% 3,545 5.00% Florence County National Bank 3,873 10.94% 1,416 4.00% 1,771 5.00% </TABLE> 47
50 NOTE 26 - FIRST NATIONAL CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION: First National Corporation's condensed balance sheets at December 31, 2000 and 1999, and condensed statements of income and cash flows for each of the three years in the period ended December 31, 2000, are presented below. The condensed financial statements have been restated for all periods presented to reflect the merger with FirstBanc, which was accounted for as a pooling-of-interests. <TABLE> <CAPTION> DECEMBER 31, (In thousands of dollars) 2000 1999 ---- ---- <S> <C> <C> Balance Sheets - Parent only: Assets: Cash $ 353 $ 1,264 Investment securities available-for-sale 3,425 3,303 Investment in subsidiaries 79,958 70,569 Premises and equipment 370 85 Other assets 830 598 - ------------------------------------------------------------------------------------- Total assets $84,936 $75,819 ===================================================================================== Shareholders' equity 84,936 75,819 - ------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $84,936 $75,819 ===================================================================================== </TABLE> <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Statements of Income: Income: Dividends from subsidiaries $ 5,801 $ 5,227 $ 5,378 Gain on sale of securities available-for-sale -- 204 -- Interest and dividends 197 145 114 Other income -- 18 26 - ------------------------------------------------------------------------------------------------ Total income 5,998 5,594 5,518 - ------------------------------------------------------------------------------------------------ Expenses: Interest -- 51 54 Other general 292 592 278 - ------------------------------------------------------------------------------------------------ Total expenses 292 643 332 - ------------------------------------------------------------------------------------------------ Income before income tax benefit and equity in undistributed earnings of subsidiaries 5,706 4,951 5,186 Applicable income tax benefit 36 137 63 Equity in undistributed earnings of subsidiaries 4,791 2,852 3,022 - ------------------------------------------------------------------------------------------------ Net income $ 10,533 $ 7,940 $ 8,271 ================================================================================================ Statements of Cash Flows - Parent only: Cash flows from operating activities: Net income $ 10,533 $ 7,940 $ 8,271 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 16 19 40 Discount accretion (152) (126) (161) </TABLE> 48
51 <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (In thousands of dollars) 2000 1999 1998 ---- ---- ---- <S> <C> <C> <C> Gain on sale of securities available-for-sale -- (204) -- Increase in other assets (231) (387) (89) Increase in other liabilities -- 244 28 Undistributed earnings of subsidiaries (4,791) (2,852) (3,022) - --------------------------------------------------------------------------------------------------- Net cash provided by operating activities 5,375 4,634 5,067 - --------------------------------------------------------------------------------------------------- Cash flows from investing activities: Proceeds from sales of investment securities available-for-sale -- 309 6,537 Proceeds from maturities of investment securities available-for-sale 6,265 5,430 2,328 Purchases of investment securities available-for-sale (6,235) (6,302) (7,680) Purchases of premises and equipment (301) (3) (29) Investment in subsidiaries (2,000) (1,000) (9,633) - --------------------------------------------------------------------------------------------------- Net cash used by investing activities (2,271) (1,566) (8,477) - --------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of debt -- -- 2,100 Repayment of debt -- (2,100) -- Cash dividends paid (3,801) (3,187) (2,538) Common stock issuance -- 635 5,873 Common stock redeemed (214) -- -- Stock options exercised -- 313 38 - --------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities (4,015) (4,339) 5,473 - --------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (911) (1,271) 2,063 Cash and cash equivalents at beginning of year 1,264 2,535 472 - --------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 353 $ 1,264 $ 2,535 =================================================================================================== </TABLE> Supplementary financial information regarding the Company is incorporated herein by reference to the information in Table 11 of Item 7 above. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated herein by reference to the information under the caption "Election of Directors" on pages 4 and 5 of the definitive proxy statement of the Company to be filed in connection with the Company's 2001 Annual Meeting of the Shareholders. 49
52 ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the information under the captions "Executive Compensation," "Employment Agreement," "Stock Options," "Defined Benefit Pension Plan" and "Election of Directors - Compensation of Directors" on pages 6 through 9, and 11 of the definitive proxy statement of the Company to be filed in connection with the Company's 2001 Annual Meeting of Shareholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated herein by reference to the information under the caption "Principal Shareholders" on page 3 of the definitive proxy statement of the Company to be filed in connection with the Company's 2001 Annual Meeting of Shareholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the information under the caption "Certain Relationships and Related Transactions" on page 13 of the definitive proxy statement of the Company to be filed in connection with the Company's 2001 Annual Meeting of Shareholders. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements Filed: First National Corporation and Subsidiaries Independent Auditors' Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Changes in Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 2. Financial Schedules Filed: None 3. Exhibits <TABLE> <CAPTION> Exhibit No. Description of Exhibit <S> <C> 2.1 Merger Agreement, dated March 4, 1999, between First National Corporation and FirstBancorporation, Inc. (incorporated by reference to the Registrant's Registration Statement on Form S-4, Registration No. 333-80047). 3.1 Articles of Incorporation of the Registrant, as amended (incorporated by reference to exhibits filed with the Registrant's Form 10-Q for the quarter ended June 30, 1996). 3.2 Bylaws of the Registrant, as amended (incorporated by reference to exhibits filed with the Registrant's Form 10-K for the year ended December 31, 1995). 10.1(*) First National Corporation Incentive Stock Option Plan of 1992 (incorporated by reference to exhibits filed with Registration Statement on Form S-4, Registration No. 33-52052). 10.2(*) First National Corporation Executive Incentive Compensation Plan (incorporated by reference to exhibits filed with Registration Statement on Form S-4, Registration No. 33-52052). </TABLE> 50
53 <TABLE> <S> <C> 10.3 First National Corporation Dividend Reinvestment Plan (incorporated by reference to exhibits filed with Registration Statement on Form S-8, Registration No. 33-58692). 10.4(*) First National Corporation Incentive Stock Option Plan of 1996 (incorporated by reference to Registrant's Definitive Proxy Statement filed in connection with its 1996 Annual Meeting of Shareholders). 10.5(*) Employment Agreement between the Registrant and C. John Hipp, III, dated May 1, 1994 (incorporated by reference to Registrant's Form 10-K for the year ended December 31, 1995). 10.6(*) First National Corporation 1999 Stock Option Plan (incorporated by reference to Registrant's Registration Statement From S-8, Registration No. 333-33092) 13 2000 Annual Report to Shareholders 21 Subsidiaries of the Registrant (incorporated by reference to exhibits filed with Registration Statement on Form S-4, Registration No. 33-52052). 23 Consent of J. W. Hunt and Company, LLP. </TABLE> (*) Denotes a management compensatory plan or arrangement. (b) No reports were filed on Form 8-K during the fourth quarter of 2000. 51
54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Orangeburg and State of South Carolina, on the 30th day of March, 2001. First National Corporation By /S/ C. John Hipp, III ----------------------------------------- C. John Hipp, III President and Chief Executive Officer Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on March 30, 2001. /S/ C. John Hipp, III ----------------------------------------- C. John Hipp, III President and Chief Executive Officer /S/ Richard C. Mathis ----------------------------------------- Richard C. Mathis Executive Vice-President and Chief Financial Officer /S/ Colden R. Battey, Jr. ----------------------------------------- Colden R. Battey, Jr. Director /S/ Charles W. Clark ----------------------------------------- Charles W. Clark Director /S/ William W. Coleman, Jr. ----------------------------------------- William W. Coleman, Jr. Director /S/ Dwight W. Frierson ----------------------------------------- Dwight W. Frierson Director /S/ John L. Gramling, Jr. ----------------------------------------- John L. Gramling, Jr. Director /S/ Richard L. Gray ----------------------------------------- Richard L. Gray Director /S/ Robert R. Hill, Jr. ----------------------------------------- Robert R. Hill, Jr. 52
55 Director /s/ Robert R. Horger ----------------------------------------- Robert R. Horger Director /s/ Harry M. Mims, Jr. ----------------------------------------- Harry M. Mims, Jr. Director /s/ Ralph W. Norman ----------------------------------------- Ralph W. Norman Director /s/ Anne H. Oswald ----------------------------------------- Anne H. Oswald Director /s/ Samuel A. Rodgers ----------------------------------------- Samuel A. Rodgers Director /s/ James W. Roquemore ----------------------------------------- James W. Roquemore Director /s/ Walter L. Tobin ----------------------------------------- Walter L. Tobin Director /s/ Johnny E. Ward ----------------------------------------- Johnny E. Ward Director /s/ A. Dewall Waters ----------------------------------------- A. Dewall Waters Director /s/ Cathy Cox Yeadon ----------------------------------------- Cathy Cox Yeadon Director 53
56 EXHIBIT INDEX <TABLE> <CAPTION> Exhibit No. Description of Exhibit <S> <C> 13 2000 Annual Report to Shareholders 23 Consent of J. W. Hunt and Company, LLP. </TABLE> 54