FIRST NATIONAL CORPORATION Financial Statements (Form 10-Q) September 30, 1998
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-Q QUARTERLY REPORT UNDER SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended SEPTEMBER 30, 1998 Commission File Number 0-13663 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, SE, ORANGEBURG, SC 29115 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (803) 534-2175 NOT APPLICABLE Former name, former address and former fiscal year, if changed since last report. 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 report) and (2) has been subject to such filing requirements for the past 90 days. YES "X" NO Indicate the number of shares outstanding of each of issuer's class of securities. CLASS OUTSTANDING as of September 30, 1998 Common Stock, $2.50 par value 5,293,097
FIRST NATIONAL CORPORATION INDEX Part I: Financial Information Item 1 - Financial Statements Consolidated Balance Sheet - September 30, 1998 and December 31, 1997 Consolidated Statements of Changes In Shareholders' Equity - Nine Months Ended September 30, 1998 and 1997 Consolidated Statement of Income - Three and Nine Months Ended September 30, 1998 and 1997 Consolidated Statement of Cash Flows - Nine Months Ended September 30, 1998 and 1997 Notes to Consolidated Financial Statements Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Part II: Other Information Item 1 - Legal Proceedings Item 6 - Exhibits and Reports of Form 8-K (A) Exhibit 27 - Financial Data Schedule (B) Reports on Form 8-K: None
PART I - FINANCIAL INFORMATION Item l. FINANCIAL STATEMENTS FIRST NATIONAL CORPORATION CONSOLIDATED BALANCE SHEET (Unaudited) ASSETS 9-30-98 12-31-97 (In Thousands) (In Thousands) Cash and due from banks $31,431 $30,802 Federal funds sold 0 0 Investment securities - Note 2 Securities held-to-maturity (fair value of $44,012 in 1998 and $51,026 in 1997) 43,049 50,403 Securities available-for-sale, at fair value 168,160 115,658 Total investment securities 211,209 166,061 Loans - Note 3 387,373 359,167 Less: Unearned income 3,273 3,654 Allowance for loan losses-Note 4 5,905 5,518 Loans, net 378,195 349,995 Premises and equipment 9,858 9,946 Intangible assets 2,162 2,732 Other real estate - Note 6 142 61 Other assets 7,307 5,974 TOTAL ASSETS $640,304 $565,571
Consolidated Balance Sheet - Continued....... LIABILITIES & STOCKHOLDERS' EQUITY 9-30-98 12-31-97 (In Thousands) (In Thousands) Liabilities: Deposits in domestic offices: Noninterest bearing $77,048 $70,052 Interest-bearing - Note 7 437,302 384,323 TOTAL DEPOSITS 514,350 454,375 Federal funds purchased & securities sold under agreement to repurchase 54,273 54,312 Other liabilities 10,089 2,984 TOTAL LIABILITIES 578,712 511,671 Commitments & Contingent liabilities - Note 8 Stockholders' equity: Common stock - $2.50 par value; authorized 40,000,000 shares; issued and outstanding 5,293,097 shares in 1998 and 5,188,097 shares in 1997 - Note 9 13,233 12,970 Additional paid-in capital 25,669 23,257 Retained earnings 21,242 17,197 Unrealized gain (loss) on securities available-for-sale, net of applicable deferred income taxes 1,448 476 TOTAL SHAREHOLDERS' EQUITY 61,592 53,900 TOTAL LIABILITIES & SHAREHOLDER'S EQUITY $640,304 $565,571
FIRST NATIONAL CORPORATION AND SUBSIDIARIES 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, 1996 5,100,048 $ 12,750 $ 22,856 $ 12,790 $ (50) $ 48,346 Comprehensive income: Net income - - - 4,953 - 4,953 Other comprehensive income (loss) net of tax - - - - 465 465 Comprehensive income - - - - - 5,418 Common stock issued 88,049 220 401 - - 621 Cash dividends - - - (1,488) - (1,488) Balance, September 30, 1997 5,188,097 12,970 23,257 16,255 415 52,897 Balance, December 31, 1997 5,188,097 12,970 23,257 17,197 476 53,900 Comprehensive income: Net income - - - 5,874 - 5,874 Other comprehensive income (loss) net of tax - - - - 972 972 Comprehensive income - - - - - 6,846 Common stock issued 105,000 263 2,412 - - 2,675 Cash dividends - - - (1,829) - (1,829) Balance, September 30, 1998 5,293,097 $ 13,233 $ 25,669 $ 21,242 $ 1,448 $ 61,592 </TABLE>
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) 3 Months Ended 9 Months Ended 09-30-98 09-30-97 09-30-98 09-30-97 (In Thousands) (In Thousands) Interest income: Interest and fees on loans $8,755 $7,929 $25,244 $22,252 Interest & dividends on investment sec.: Taxable income 2,514 2,238 7,105 6,488 Non-taxable income 406 396 1,251 1,184 Dividends on stock 30 6 50 34 Interest on federal funds sold 159 76 553 468 Total Interest income 11,864 10,645 34,203 30,426 Interest expense: Interest on deposits 4,515 3,972 12,860 11,317 Interest on federal funds purchased & securities sold under agreement to repurchase 621 548 1,865 1,526 Other interest expense 0 0 19 0 Total interest expense 5,136 4,520 14,744 12,843 Net Interest Income 6,728 6,125 19,459 17,583 Provisions for loan losses - Note 4 216 275 604 873 Net interest income after provisions for loan losses 6,512 5,850 18,855 16,710 Noninterest income: Service charges on deposit accounts 1,310 1,056 3,614 3,106 Other service charges commissions, fees 758 518 2,097 1,441 Gains (losses) on investment securities 6 0 44 2 Other operating income 22 15 57 37 Total noninterest income 2,096 1,589 5,812 4,586 Noninterest expense: Salaries & employee benefits 3,136 2,708 9,007 7,685 Occupancy expense of bank premises - net 291 329 788 954 Furniture & equipment expense - net 424 375 1,189 1,109 Amortization expense-Intangible assets 212 171 572 482 Other expense 1,592 1,380 4,524 3,882 Total noninterest expense 5,655 4,963 16,080 14,112 Income before income taxes 2,953 2,476 8,587 7,184 Applicable income taxes 945 770 2,713 2,231 Net Income $2,008 $1,706 $5,874 $4,953 Net income per common share - Basic $0.38 $0.33 $1.12 $0.96 Net income per common share - Diluted $0.38 $0.33 $1.11 $0.95 Cash dividends per common share $0.13 $0.10 $0.35 $0.29
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 9 Months Ended 9 Months Ended 09-30-98 09-30-97 (In Thousands) (In Thousands) Cash flows from operating activities: Net income $ 5,874 $ 4,953 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,419 1,341 Provision for loan losses 604 873 Increase (decrease) in reserve for income taxes-current 20 75 (Gain)loss on sale of premises and equipment 2 0 (Increase) decrease in interest receivables (475) (697) Increase (decrease) in accumulated premium amortization and discount accretion - net 138 8 Increase (decrease) in interest payable 447 277 (Increase) decrease in miscellaneous assets (418) (23) (Increase) decrease in prepaid assets (192) (146) Increase (decrease) in other liabilities 195 332 Total adjustments 1,740 2,040 Net cash provided by operating activities $ 7,614 $ 6,993
Consolidated Statement of Cash Flows - Continued....... 9 Months Ended 9 Months Ended 09-30-98 09-30-97 (In Thousands) (In Thousands) Cash flows from investing activities: Proceeds from maturities of investment securities held-to-maturity $15,934 $17,716 Purchase of investment securities held-to-maturity (8,349) (5,533) Proceeds from maturities of investment securities available-for-sale 54,168 19,965 Purchase of investment securities available-for-sale (101,258) (43,935) Net (increase) decrease in customer loans (29,212) (48,809) Additions to premises and equipment 758 (569) Proceeds from sale of premises and equipment 2 0 Recoveries from loans previously charged off 191 294 (Increase) decrease in funds sold 0 (1,975) Net cash used in investing activities (67,766) (62,846) Cash flows from financing activities: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 59,975 38,654 Sale of common stock 2,674 622 Net increase (decrease) in federal funds purchased and securities sold under agreement to repurchase (38) 18,401 Proceeds from issuance of other borrowings 2,500 0 Repayment of other borrowings (2,500) 0 Dividends paid (1,830) (1,488) Net cash provided by financing activities 60,781 56,189 Net increase (decrease) in cash and cash equivalents 629 336 Cash and cash equivalents at beginning of year 30,802 28,824 Cash and cash equivalents at end of reporting period $ 31,431 $ 29,160
FIRST NATIONAL CORPORATION NOTE 1 - Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. All dollar amounts are stated in thousands, except per share data. NOTE 2 - Investment Securities: The following is the amortized cost and fair value of investment securities held-to-maturity at September 30, 1998 and December 31, 1997: 09-30-98 12-31-97 Gross Gross Gross Gross Amort Unreal Unreal Fair Amort Unreal Unreal Fair Cost Gains Losses Value Cost Gains Losses Value U S Treasury securities 3,218 34 0 3,252 3,231 28 0 3,259 Obligations of U S government agencies & corps 5,417 73 (2) 5,488 12,321 39 (18) 12,342 Obligations of state and political subdivisions 34,414 858 0 35,272 34,851 581 (7) 35,425 Total 43,049 965 (2) 44,012 50,403 648 (25) 51,026
NOTE 2 - Continued... The following is the amortized cost and fair value of securities available-for-sale at September 30, 1998 and December 31, 1997: 09-30-98 12-31-97 Gross Gross Gross Gross Amort Unreal Unreal Fair Amort Unreal Unreal Fair Cost Gains Losses Value Cost Gains Losses Value U S Treasury securities 46,852 1,025 0 47,877 30,320 240 0 30,560 Obligations of U S government agencies & corps 116,356 1,315 (41) 117,630 83,990 538 (23) 84,505 Other securities 2,653 0 0 2,653 593 0 0 593 Total 165,861 2,340 (41) 168,160 114,903 778 (23) 115,658 Investment securities with an aggregate amortized cost of $106,961 on September 30, 1998, and $88,276 on December 31, 1997, were pledged to secure public deposits and for other purposes as required and permitted by law. NOTE 3 - Loans: The following is a summary of loans at: 9-30-98 12-31-97 Commercial, financial & agricultural 70,804 67,519 Real Estate - construction 11,804 12,429 Real estate - mortgage 226,775 207,630 Consumer 74,717 67,935 Total loans 384,100 355,513 As of September 30, 1998 and December 31, 1997 the aggregate dollar amount of loans to related parties; principally, directors and executive officers, their immediate families and their business interests, was $5,946 and $8,025 respectively. The following is an analysis of the activity with respect to loans to related parties for the nine months ended September 30, 1998: Balance, beginning of period 8,025 Add: New loans 5,817 Deduct: Payments 7,819 Other changes (77) Balance, end of period 5,946
NOTE 4 - Allowance for Loan Losses: Amount 09-30-98 12-31-97 Balance, beginning of period (year) 5,518 4,705 Add: Recoveries 191 323 Provisions for loan losses charged to income 604 1,251 Total 6,313 6,279 Deduct: Loans charged off 408 761 Balance, end of period (year) 5,905 5,518 The allowance for loan losses is maintained at a level which, in management's judgement 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, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. For impairment recognized in accordance with Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan", the entire change in present value of expected cash flows is reported as bad debt expense in the same manner in which impairment initially was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported. NOTE 5 - Adoption of Statement of Financial Accounting Standards No. 114 and No. 118: Effective January 1, 1995, the bank adopted Statement of Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan", and Statement of Financial Accounting Standards No. 118 (SFAS 118), "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures". These statements require creditors to account for impaired loans, except for those loans that are accounted for at fair value or at the lower of cost or fair value, at the present value of the expected future cash flows discounted to the loan's effective interest rate.
NOTE 5 - continued... The Company 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. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued at the contractual interest rate, for the period of delay. In accordance with these standards, the Company does not apply SFAS 114 and SFAS 118 to large groups of smaller balance homogeneous loans that are collectively evaluated for impairment. These groups include the Company's credit card, residential mortgage, overdraft protection, home equity lines, accounts receivable financing, and consumer installment loans. The Company's adoption of these accounting standards did not have a material effect on the financial condition and results of operations of the Company. In accordance with SFAS 114, historical information has not been restated to reflect the application of this standard. NOTE 6 - Other Real Estate: Real estate acquired in satisfaction of a loan is reported in other assets. Properties acquired by foreclosure or deed in lieu of foreclosure are transferred to Other Real Estate Owned ("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 losses. Gains or losses arising from the sale of OREO are reflected in current operations.
NOTE 7 - Interest Bearing Deposits: Certificates of deposit in excess of $100,000 totaled $64,541 and $40,794 at September 30, 1998 and December 31, 1997 respectively. Note 8 - Commitments and Contingent Liabilities: In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities, which are not reflected in the accompanying financial statements. The commitments and contingent liabilities include guarantees, commitments to extend credit and standby letters of credit. At September 30, 1998, commitments to extend credit and standby letters of credit aggregated $97,775. The Company does not anticipate any material losses as a result of these transactions. Note 9 - Common Stock: As of December 31, 1997, the common stock outstanding was 5,188,097. The board of directors of the Company approved a 2 for 1 stock split payable May 30, 1997. As a result of a stock offering, the Company sold and issued 105,000 shares of First National Corporation stock during the second quarter of 1998. The proceeds from this offering are to be used to purchase all the common stock of the newly formed Florence County National Bank. As of September 30, 1998, the common stock outstanding was 5,293,097 shares. Note 10 - Earnings Per Share: Earnings per share are calculated on the weighted-average of number of shares of common stock outstanding, giving retroactive effect to stock dividends and stock splits. In 1997, the Financial Accounting Standards Board "FASB" issued SFAS No. 128, "Earnings Per Share", which establishes standards for computing and presenting earnings per share ("EPS") by replacing the presentation of primary EPS with a presentation of basic EPS. In addition, SFAS No. 128 requires dual presentation of basic and diluted EPS on the face of the income statement and requires a reconciliation of the numerator and denominator of the diluted EPS calculation.
Note 10 - Continued... In accordance with SFAS 128, the calculation of basic net income per share and diluted net income per share is presented below: <TABLE> <CAPTION> 3 Months 3 Months 6 Months 6 Months Ended Ended Ended Ended Net income per share - basic: 09/30/98 09/30/97 09/30/98 09/30/97 <S> <C> <C> <C> <C> Net income $2,008 $1,706 $5,874 $4,953 Income available to common shareholders $2,008 $1,706 $5,874 $4,953 Average common shares outstanding-basic 5,234,822 5,132,748 5,234,822 5,132,748 Net income per share-basic $ .38 $ .33 $ 1.12 $ .96 Net income per share-diluted: Income available to common shareholders $2,008 $1,706 $5,874 $4,953 Average common shares outstanding-basic 5,234,822 5,132,748 5,234,822 5,132,748 Incremental shares from assumed conversion of stock options 62,695 57,896 62,695 57,896 Average common shares outstanding-diluted 5,297,517 5,190,644 5,297,517 5,190,644 Net income per share- diluted $ .38 $ .33 $ 1.11 $ .95 </TABLE> Dividends per share are calculated using the current equivalent of number of common shares outstanding at the time of the dividend based on the Company's shares outstanding.
Note 11 - Comprehensive Income: The following is the related tax effects allocated to other comprehensive income at September 30, 1998: Before Tax Tax (Expense) Net of (In thousands of dollars) Amount Benefit Tax Amount Unrealized gain (loss) on securities available-for-sale $2,298 $(850) $1,448 The following is the other comprehensive income balance at September 30, 1998: Beginning Current Period Ending Balance Change Balance Accumulated other comprehensive income-Unrealized gain (loss) on securities available-for- sale $ 476 $ 972 $1,448
FIRST NATIONAL CORPORATION Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion relates to financial statements contained in this report. For further information refer to the Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. The National Bank of York County commenced business operations as a national bank in Rock Hill, South Carolina, on July 11, 1996. The National Bank of York County is also a full service commercial bank and its deposits are insured to applicable limits by the Federal Deposit Insurance Corporation (FDIC). Upon completion of its organization, 100% of the common stock of the National Bank of York County was acquired by First National Corporation, and the bank operates as a wholly owned subsidiary of the Corporation with its own Board of Directors and operating policies. The Florence County National Bank commenced business operations as a national bank in Florence, South Carolina, on April 1, 1998. Florence County National Bank is also a full service commercial bank and its deposits are insured to applicable limits by the Federal Deposit Insurance Corporation (FDIC). Upon completion of its organization, 100% of the common stock of the Florence County National Bank was acquired by First National Corporation, and the bank operates as a wholly owned subsidiary of the Corporation with its own Board of Directors and operating policies. The Corporation is sponsoring the organization of a nonbank subsidiary. The organizers have filed an application with the Board of Governors of the Federal Reserve System to establish NewSouth Financial Service Corporation, Orangeburg, South Carolina and would acquire certain fixed assets of Superior Mortgage Corporation of Florence, South Carolina. NewSouth Financial Service Corporation would engage denovo in lending activities and credit-related insurance sales. First National Corporation would own 80 percent of the common stock of NewSouth and the manager of NewSouth would own the remaining 20 percent. Having received Federal Reserve approval on September 22, 1998, operations will commence on or about November 1, 1998. For the third quarter of 1998, First National Corporation ("the Corporation") had consolidated net income of $2,008,000, an increase of 17.7 percent over the $1,706,000 earned in the third quarter of 1997. Earnings per share amounted to $0.38 for the three months ended September 30, 1998, a 15.2 percent increase over the $0.33 per share earned in the third quarter of 1997. Net income for the first nine months of 1998 was $5,874,000, an increase of 18.6 percent over the $4,953,000 earned for the same period in 1997. Earnings per share amounted to $1.12 for the nine months ended September 30, 1998, a 16.7 percent increase over the $0.96 per share earned in the first nine months of 1997.
Management's Discussion Continued... NET INTEREST INCOME For the third quarter of 1998, net interest income was $6,728,000 compared to $6,125,000 for the same period in 1997. This is an increase of $603,000 or 9.8 percent. Net interest income for the first nine months of 1998 was $19,459,000 compared to $17,583,000 for the same period in 1997. This represents an increase of $1,876,000 or 10.7 percent. This increase resulted from a 12.3 percent increase in loan outstandings, net of unearned income as well as a 21.8 percent increase in investment security outstandings, when compared to the first nine months of 1997. The yield on a major portion of the Company's earning assets adjusts simultaneously with changes in the general level of interest rates. In the first nine months of 1997, the year to date taxable equivalent yield on earning assets was 7.99 percent. During the same period of 1998, the yield decreased to 7.81 percent, or a decrease of 18 basis points. The cost of the liabilities used to support these earning assets increased 4 basis points from 4.12 percent in 1997 to 4.16 percent in 1998. Interest rates paid on interest-bearing liabilities increased more rapidly than yields on earning assets due to the Company's negative asset/liability position. For the first nine months net interest margins decreased from 4.52 percent in 1997 to 4.34 percent in 1998. The impact of interest-free funds for the same period increased from .65 percent to .69 percent or an increase of 4 basis points. The largest category of earning assets is loans. At the end of the third quarter 1998, loans outstanding, less unearned income, were $384,100,000 compared to $355,513,000 at December 31, 1997. This represents an increase of $28,587,000 or 8.0 percent. For the third quarter ended September 30, 1998, interest and fees on loans were $8,755,000 compared to $7,929,000 for the comparable period in 1997, an increase of $826,000 or 10.4 percent. For the nine months ended September 30, 1998, interest and fees on loans were $25,244,000 compared with $22,252,000 for the same period in 1997. This represents an increase of $2,992,000 or 13.4 percent. For the nine months ended September 30, 1998, loans averaged $364,673,000 and yielded 8.76 percent on a taxable equivalent basis compared to $323,420,000 with a taxable equivalent yield of 8.93 percent or a decrease of 17 basis points for the year ended December 31, 1997. Investment securities are the second largest category of earning assets. Investment securities are utilized by the Company as a vehicle for the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral for certain deposit and purchased funds.
Management's Discussion Continued... At September 30, 1998, investment securities were $211,209,000 compared to $166,061,000 at December 31, 1997. This is an increase of $45,148,000 or 27.2 percent. This increase is the result of management's decision to utilize excess funds in the investment function in an attempt to increase yields and profitability. For the third quarter ended September 30, 1998, investment income was $2,950,000 compared with $2,640,000 for the comparable period in 1997, a net increase of $310,000 or 11.7 percent. For the nine month period ended September 30, 1998, investment income was $8,406,000 compared with $7,706,000 for the same period in 1997, a net increase of $700,000 or 9.1 percent. Management attributes this increase in income to higher yields on investment securities. At the end of the third quarter 1998, securities averaged $190,525,000 and yielded 6.17 percent on a taxable equivalent basis, compared to $167,895,000 with a yield of 6.36 percent for the year ended December 31, 1997, resulting in a 19 basis point decrease in yield. As of September 30, 1998, the Company had unrealized gains in the U.S. Treasury and agency portfolio denoted as held-to-maturity, of $107,000 and in the municipal portfolio $858,000. Also at September 30, 1998, the Company had an unrealized loss of $2,000 in the U. S. Treasury and agency portfolio and no unrealized loss in the municipal portfolio. At year end 1993, the Company adopted Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debit and Equity Securities" for the investment portfolio, and showed a net unrealized gain at September 30, 1998 of approximately $2,299,000 on the $168,160,000 of securities denoted as available-for-sale. For the first nine months ended September 30, 1998, the Company had a $44,000 realized gain due to called agency bonds. Although securities classified as available-for-sale may be sold from time to time to meet liquidity or other needs, it is not the normal activity of the Company to trade the investment portfolio. Management has the intent and the ability to hold securities on a long-term basis or until maturity. During the first nine months of 1998, interest-bearing liabilities averaged $475,679,000 and carried an average rate of 4.16 percent. This compares to an average level of $420,190,000 with a rate of 4.14 percent at December 31, 1997 or an increase of 2 basis points. Approximately half of these interest-bearing liabilities have fixed rates. They are expected to be renewed at prevailing market rates as they mature.
Management's Discussion Continued... PROVISION FOR LOAN LOSSES The provision for loan losses for the three month period ended September 30, 1998 was $216,000 compared to $275,000 for the same period in 1997 which represents a 21.5 percent decrease. For the nine month period ended September 30, 1998, the provision for loan loss was $604,000 compared to $873,000 for the same period in 1997 which represents a 30.8 percent decrease. The decrease in the provision for loan losses was due to a weakening loan demand. The allowance for loan losses was $5,905,000 or 1.54 percent of outstanding loans at September 30, 1998 compared to 1.55 percent of outstanding loans at year-end 1997. To determine the adequacy of the allowance for loan losses, management performs an internal loan analysis which indicated the estimated loan losses. Management feels that the allowance for loan losses is adequately funded. Other real estate owned includes certain real estate acquired as a result of foreclosure. For the period ended September 30, 1998, other real estate owned was $142,000 compared to $61,000 at December 31, 1997. This increase resulted from the foreclosure of real estate properties. Management anticipates that the level of charge-offs for 1998 will be near the levels of 1997. The loan loss allowance is considered adequate by management. However, changes in economic conditions in the Company's market area could affect these levels. NONINTEREST INCOME AND EXPENSE Noninterest income for the third quarter of 1998 was $2,096,000 compared to $1,589,000 for the same period in 1997, representing an increase of $507,000 or 31.9 percent. For the first nine months of 1998 noninterest income was $5,812,000 compared to $4,586,000 for the same period in 1997, representing an increase of $1,226,000 or 26.7 percent. During the first nine months of 1998, other service charges, commissions, and fees increased $656,000 or 45.5 percent compared to the same period in 1997. This increase can be primarily attributed to the increase in secondary market origination fees and debit card fees as well as fees collected on mutual fund sales.
Management's Discussion continued... Noninterest expense for the third quarter of 1998 was $5,655,000 compared to $4,963,000 for the same period in 1997, representing an increase of $692,000 or 13.9 percent. For the nine months ended September 30, 1998, noninterest expense was $16,080,000 compared to $14,112,000, an increase of $1,968,000 or 13.9 percent. Salaries and employee benefits for the third quarter ended September 30, 1998 increased $428,000 or 15.8 percent compared to the same period in 1997. For the first nine months of 1998 salaries and employee benefits increased $1,322,000 or 17.2 percent compared to the same period in 1997. These increases can be largely attributed to the opening of the Florence County National Bank on April 1, 1998. Occupancy and furniture and equipment expense increased $11,000 or 1.6 percent for the third quarter of 1998 compared to the same period in 1997. For the nine months ended September 30, 1998 occupancy and furniture and equipment expense decreased $86,000 or 4.2 percent compared to the same period in 1997. These decreases can be largely attributed to a decrease in both building and furniture and equipment depreciation expense, reductions in maintenance and repairs on buildings as well as a decrease in equipment service contract costs. Other expenses increased $212,000 or 15.4 percent for the third quarter of 1998 compared to the same period in 1997. For the nine months ended September 30, 1998, other expenses increased $642,000 or 16.5 percent compared to the same period in 1997. This increase in other expenses is distributed among the following expense categories: advertising, insurance, office and printing supplies, postage, telephone and line charges, and other expenses. NET INCOME Net income was up 17.7 percent for the third quarter of 1998 when compared to the same period in 1997. For the nine months ended September 30, 1998, net income was up 18.6 percent compared to the same period in 1997. The $2,145,000 or 12.8 percent increase in net interest income and the $1,226,000 or 26.7 percent increase in noninterest income for the nine months ended September 30, 1998 as compared to the same period in 1997 were the primary factors in the growth in net income. CAPITAL RESOURCES AND LIQUIDITY To date, the capital needs of the Company have been met through the retention of earnings less cash dividends. At the end of the third quarter, 1998, stockholder's equity was $61,592,000 compared to $53,900,000 at December 31, 1997.
Management's Discussion Continued... The Corporation and subsidiaries are subject to certain risk-based capital guidelines. These ratios measure the relationship of capital to a combination of balance sheet and off balance sheet risks. The values of both balance sheet and off balance sheet items will be adjusted to reflect credit risk. Under the guidelines of the Board of Governors of the Federal Reserve System, which are substantially similar to the Office of the Comptroller of the Currency guidelines, as of December 31, 1995, Tier 1 capital must be at least 4 percent of risk-weighted assets, while total capital must be 8 percent of risk-weighted assets. The Tier 1 capital ratio at September 30, 1998 was 14.9 percent compared to 13.5 percent at December 31, 1997. The total capital ratio was 16.1 percent at September 30, 1998 compared to 14.7 percent at December 31, 1997. In conjunction with the risk-based capital ratio, applicable regulatory agencies have also prescribed a leverage capital ratio in evaluating capital strength and adequacy. The minimum leverage ratio required for banks is between 3 percent and 5 percent, depending on the institution's composite rating as determined by its regulators. At September 30, 1998, First National Corporation's leverage ratio was 9.4 percent, compared to 9.5 percent at December 31, 1997. First National Corporation's ratio exceeds the minimum standards by substantial margins. Liquidity is the ability of the Company to meet its cash flow requirements which arise primarily from withdrawal of deposits, extension of credit and payment of operating expenses. 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. Normally changes in the earning asset mix are of a longer term nature and are not utilized for day-to-day Corporation liquidity needs. The Company's liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from the Company's use of federal funds purchased and securities sold under agreement to repurchase. Additional liquidity can be secured from lines of credit extended to the Company from its correspondent banks. Management feels that its liquidity position is adequate.
Management's Discussion Continued... YEAR 2000 The year 2000 issue is the result of computer programs using two digits rather than four to define the applicable year. Such software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations leading to disruptions in the Company's activities and operations. If the Company, its significant customers, or suppliers fail to make necessary modifications and conversions on a timely basis, the year 2000 issue could have a material adverse effect on Company operations. However, the impact cannot be quantified at this time. The Company believes that its competitors face a similar risk. In August 1997, the Company established a corporate-wide project team to identify non-compliant software and complete the corrections required by the year 2000 issue. The Company intends to fix or replace non-compliant internal software with code or software that is year 2000 compliant. While a plan is in place, minor work remains to be done. The Company's current target is to resolve compliance issues in important business information systems by December 31, 1998. Remediation and testing activities are underway on the Company's core business applications. The Company is also focusing on major customers and suppliers to assess their compliance. Nevertheless, there can be no absolute assurance that there will not be a material adverse effect on the Company if third party governmental or business entities do not convert or replace their systems in a timely manner and in a way that is compatible with the Company's systems. Costs related to the year 2000 issue are funded through operating cash flows. Through fiscal 1998, the Company expended approximately $575,000 in remediation efforts, including the cost of new software and modifying the applicable code of existing software. The Company estimates remaining costs to be negligible. The Company presently believes that the total cost of achieving year 2000 compliant systems is not expected to be material to First National Corporation's financial condition, liquidity, or results of operations. Time and cost estimates are based on currently available information. Developments that could affect estimates include, but are not limited to, the availability and cost of trained personnel; the ability to locate and correct all relevant computer code and systems; and remediation success of the Company's customers and suppliers.
PART II - OTHER INFORMATION Item l. Legal Proceedings: Neither First National Corporation nor its subsidiaries, First National Bank, National Bank of York County, and Florence County National Bank is a party to nor is any of their property the subject of any material or other pending legal proceedings, other than ordinary routine proceedings incidental to their business. Item 2. Changes in Securities: Not Applicable Item 3. Defaults Upon Senior Securities: Not Applicable Item 4. Submission of Matters to a Vote of Security Holders: Not Applicable Item 5. Other Information: Not Applicable Item 6. Exhibits and Reports of Form 8-K (A) Exhibit 27 - Financial Data Schedule (B) Reports on Form 8-K: None
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST NATIONAL CORPORATION Date: November 13, 1998 C. JOHN HIPP, III PRESIDENT & CHIEF EXECUTIVE OFFICER Date: November 13, 1998 W. LOUIS GRIFFITH PRINCIPAL ACCOUNTING OFFICER AND CHIEF FINANCIAL OFFICER
EXHIBIT INDEX EXHIBIT NO. DESCRIPTION OF EXHIBIT 27 Financial Data Schedule Attached