FIRST NATIONAL CORPORATION Financial Statements (Form 10-Q) March 31, 1999
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended MARCH 31, 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) (803) 534-2175 Registrant's telephone number, including area code 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 March 31, 1999 Common Stock, $2.50 par value 5,835,750
FIRST NATIONAL CORPORATION INDEX Part I: Financial Information Item 1 - Financial Statements Consolidated Balance Sheet - March 31, 1999 and December 31, 1998 Consolidated Statements of Changes in Shareholders' Equity - Three Months Ended March 31, 1999 and 1998 Consolidated Statement of Income - Three Months Ended March 31, 1999 and 1998 Consolidated Statement of Cash Flows - Three Months Ended March 31, 1999 and 1998 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 on Form 8-K (a) Exhibit 2.1 - Merger Agreement between First National Corporation and FirstBancorporation, Inc. (b) Exhibit 27 - Financial Data Schedule (c) Reports on Form 8-K: None
PART I - FINANCIAL INFORMATION Item l. Financial Statements FIRST NATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) ASSETS 3-31-99 12-31-98 (Dollars in thousands) Cash and due from banks $ 27,132 $ 24,254 Federal funds sold 1,600 0 Investment securities - Note 2 Securities held-to-maturity (fair value of $47,042 in 1999 and $47,456 in 1998) 46,392 46,380 Securities available-for-sale, at fair value 173,271 150,791 Total Investment securities 219,663 197,171 Loans - Note 3 433,473 411,035 Less: Unearned income (2,913) (3,074) Allowance for loan losses - Note 4 (6,237) (6,075) Loans, net 424,323 401,886 Premises and equipment 11,114 10,460 Intangible assets 1,982 2,090 Other real estate - Note 6 269 144 Other assets 7,187 6,678 TOTAL ASSETS $693,270 $642,683
Consolidated Balance Sheets - Continued....... LIABILITIES & STOCKHOLDERS' EQUITY 3-31-99 12-31-98 (Dollars in thousands) LIABILITIES: Deposits in domestic offices: Noninterest-bearing $ 81,722 $ 79,325 Interest-bearing - Note 7 457,730 444,813 Total deposits 539,452 524,138 Federal funds purchased & securities sold under agreement to repurchase 67,006 52,150 Long-term debt 20,000 0 Other liabilities 4,047 4,094 TOTAL LIABILITIES 630,505 580,382 Commitments & contingent liabilities - Note 8 STOCKHOLDERS' EQUITY: Common stock - $2.50 par value; authorized 40,000,000 shares; issued and outstanding 5,835,750 shares in 1999, and 5,821,775 shares in 1998 14,589 14,554 Additional paid-in capital 40,305 40,235 Retained earnings 7,603 6,238 Unrealized gain (loss) on securities available- for-sale, net of applicable deferred income taxes 268 1,274 TOTAL STOCKHOLDERS' EQUITY 62,765 62,301 TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $693,270 $642,683
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, 1997 5,188,097 $ 12,970 $ 23,257 $ 17,197 $ 476 $ 53,900 Comprehensive income: Net income - - - 1,913 - 1,913 Change in net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment and tax effects - - - - (11) (11) Total comprehensive income - - - - - 1,902 Cash dividends - - - (570) - (570) Balance, March 31, 1998 5,188,097 12,970 23,257 18,540 465 55,232 Balance, December 31, 1998 5,821,775 14,554 40,235 6,238 1,274 62,301 Comprehensive income: Net income - - - 2,123 - 2,123 Change in net unrealized gain (loss) on securities avaiable-for-sale, net of reclassification adjustment and tax effects - - - - (1,006) (1,006) Total comprehensive income 1,117 Cash dividends - - - (758) - (758) Common stock issued 13,975 35 70 - - 105 Balance, March 31, 1999 5,835,750 $ 14,589 $ 40,305 $ 7,603 $ 268 $ 62,765 </TABLE>
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENT OF INCOME (Unaudited) 3 Months Ended 03-31-99 03-31-98 (Dollars in thousands, except per share data) Interest income: Interest & fees on loans $9,213 $8,123 Interest & dividends on investment sec.: Taxable income 2,449 2,066 Non-taxable income 445 408 Dividends on stock 12 7 Interest on federal funds sold 122 220 Total interest income 12,241 10,824 Interest expense: Interest on deposits 3,998 3,988 Interest on federal funds purchased & securities sold under agreements to repurchase 689 632 Interest on other borrowings 167 0 Total interest Expense 4,854 4,620 Net Interest Income 7,387 6,204 Provision for loan losses - Note 4 293 222 Net interest income after provision for loan losses 7,094 5,982 Noninterest income: Service charges on deposit accounts 1,225 1,116 Other service charges commissions, fees 793 647 Investment securities, gains (losses) 202 18 Other operating income 26 11 Total noninterest income 2,246 1,792 Noninterest expense: Salaries & employee benefits 3,729 2,837 Occupancy expense of bank premises-net 324 251 Furniture & equipment expense - net 623 388 Amortization expense-Intangible assets 110 152 Other expense 1,436 1,366 Total noninterest expense 6,222 4,994 Income before income taxes 3,118 2,780 Applicable income taxes 995 867 Net income $2,123 $1,913 Net income per common share - Basic $0.36 $0.33 Net income per common share - Diluted $0.36 $0.33 Cash dividends per common share $0.13 $0.11
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 3 Months Ended 3 Months Ended 03-31-99 03-31-98 (Dollars in thousands) Cash flows from operating activities: Net income $ 2,123 $ 1,913 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 355 405 Provision for loan losses 293 222 (Gain) loss on sale of securities-AFS (202) Increase (decrease) in reserve for income taxes - current 782 848 (Gain) loss on sale of premises and equipment 0 (2) (Increase) decrease in interest receivables 297 88 Increase (decrease) in accumulated premium amortization and discount accretion - net 141 (170) Increase (decrease) in interest payable (68) 140 (Increase) decrease in miscellaneous assets (114) (936) (Increase) decrease in prepaid assets (447) (159) Increase (decrease) in other liabilities (543) (379) Total adjustments 494 57 Net cash provided by operating activities 2,617 1,970
Consolidated Statements of Cash Flows - Continued....... 3 Months Ended 3 Months Ended 03-31-99 03-31-98 ( Dollars in thousands) Cash flows from investing activities: Proceeds from maturities of investment securities held-to-maturity 2,256 8,072 Purchase of investment securities held-to-maturity (2,408) (3,894) Proceeds from sale of securities-AFS 309 Proceeds from maturities of investment securities available-for-sale 28,974 18,485 Purchase of investment securities available-for-sale (53,159) (39,886) Net (increase) decrease in customer loans (22,790) 1,115 Additions to premises and equipment 76 Proceeds from sale of premises and equipment (899) 2 Recoveries from loans previously charged off 60 64 (Increase) decrease in funds sold (1,600) (22,200) Net cash used in investing activities (49,257) (38,166) Cash flows from financing activities: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 15,315 35,352 Common stock issuance 105 0 Proceeds from issuance of short term debt 20,000 Net increase (decrease) in federal funds purchased and securities sold under agreement to repurchase 14,856 (4,890) Proceeds from issuance of other borrowings 2,500 Dividends paid (758) (571) Net cash provided by financing activities 49,518 32,391 Net increase (decrease) in cash and cash equivalents 2,878 (3,805) Cash and cash equivalents at beginning of year $24,254 $30,802 Cash and cash equivalents at end of period $27,132 $26,997
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 months ended March 31, 1999 are not necessarily indicative of the results that may be expected for the year ended December 31, 1999. 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, 1998. 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 March 31, 1999 and December 31, 1998: <TABLE> <CAPTION> 03-31-99 12-31-98 Gross Gross Gross Gross Amort Unreal Unreal Fair Amort Unreal Unreal Fair Cost Gains Losses Value Cost Gains Losses Value <S> <C> <C> <C> <C> <C> <C> <C> <C> U S Treasury securities 3,209 18 0 3,227 3,213 31 0 3,244 Obligations of U S government agencies & corps 4,873 46 (4) 4,915 5,029 72 0 5,101 Obligations of state and political subdivisions 38,310 701 (111) 38,900 38,138 1,018 (45) 39,111 Total 46,392 765 (115) 47,042 46,380 1,121 (45) 47,456 </TABLE>
Note 2 - Continued... The following is the amortized cost and fair value of securities available-for-sale at March 31, 1999 and December 31, 1998: <TABLE> <CAPTION> 03-31-99 12-31-98 Gross Gross Gross Gross Amort Unreal Unreal Fair Amort Unreal Unreal Fair Cost Gains Losses Value Cost Gains Losses Value <S> <C> <C> <C> <C> <C> <C> <C> <C> U S Treasury securities 49,699 512 (4) 50,207 45,830 1,023 0 46,853 Obligations of U S government agencies & corps 120,206 505 (617) 120,094 100,285 1,078 (78) 101,285 Other securities 2,970 0 0 2,970 2,653 0 0 2,653 Total 172,875 1,017 (621) 173,271 148,768 2,101 (78) 150,791 </TABLE> Investment securities with an aggregate amortized cost of $79,328 on March 31, 1999 and $105,347 on December 31, 1999, 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: 3-31-99 12-31-98 Commercial, financial & agricultural 81,174 78,077 Real Estate - construction 11,912 10,456 Real estate - mortgage 262,156 243,743 Consumer, net of unearned income 75,318 75,685 Total loans 430,560 407,961 As of March 31, 1999 and December 31, 1998 the aggregate dollar amount of loans to related parties; principally, directors and executive officers, their immediate families and their business interests, was $6,974 and $8,992 respectively. The following is an analysis of the activity with respect to loans to related parties for the three months ended March 31, 1999. Balance, beginning of period 8,992 Add: New loans 826 Deduct: Payments 2,849 Other changes 5 Balance, end of period 6,974
Note 4 - Allowance for Loan Losses: Amount 03-31-99 12-31-98 Balance, beginning of period (year) 6,075 5,518 Add: Recoveries 60 260 Provisions for loan losses charged to income 293 1,013 Total 6,428 6,791 Deduct: Loans charged off 191 716 Balance, end of period (year) 6,237 6,075 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, 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 at 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 loan 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 $67,805 and $67,765 at March 31, 1999 and December 31, 1998 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 March 31, 1999, commitments to extend credit and standby letters of credit aggregated $106,662. The Company does not anticipate any material losses as a result of these transactions. Note 9 - 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. In accordance with SFAS 128, the calculation of basic net income per share and diluted net income per share is presented below: 3 Months 3 Months Ended Ended Net income per share - basic: 03/31/99 03/31/98 Net income $ 2,123 $ 1,913 Income available to common shareholders $ 2,123 $ 1,913 Average common shares outstanding-basic 5,824,881 5,716,775 Net income per share-basic $ .36 $ .33
Note 9 - Continued... Net income per share-diluted: Income available to common shareholders $ 2,123 $ 1,913 Average common shares outstanding-basic 5,824,881 5,716,775 Incremental shares from assumed conversion of stock options 55,255 45,439 Average common shares outstanding-diluted 5,880,136 5,762,214 Net income per share- diluted $ .36 $ .33 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 10 - Comprehensive Income: The following is the related tax effects allocated to other comprehensive income at March 31, 1999: Before Tax Tax (Expense) Net of In thousands of dollars) Amount Benefit Tax Amount Unrealized gain (loss) on securities available-for-sale $ 396 $ (128) $268 The following is the other comprehensive income balance at March 31, 1999: Beginning Current Period Ending Balance Change Balance Accumulated other comprehensive income-Unrealized gain (loss) on securities available-for- sale $1,274 $(1,006) $268
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, 1998. First National Corporation (the "Company" or "Corporation") 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 1932, 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 80% of NewSouth 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 March 4, 1999, the Corporation and FirstBancorporation, Inc.("FirstBanc") announced that a definitive merger agreement was approved by the board of directors of both companies. Under the terms of the agreement, 1.222 shares of First National Corporation common stock would be exchanged for each share of FirstBanc Common stock. The transaction will be accounted for by the pooling of interests method of accounting for business combinations and is expected to be tax-free to FirstBanc's shareholders. The transaction is subject to several conditions, including regulatory approvals, shareholder approvals, and customary closing conditions. The transaction may also be terminated by either party in certain circumstances. On March 23, 1999, First Nation Bank, a subsidiary of First National Corporation, and Carolina First Bank, a subsidiary of Carolina First Corporation, announced the signing of a definitive agreement by which First National Bank will purchase three offices from Carolina First Bank. These offices have total deposits of approximately $45 million. The transaction is expected to be completed during the third quarter of 1999, pending regulatory and certain other conditions of closing. Some of the major services which the Company provided 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.
Management's Discussion Continued... For the first quarter of 1999, First National Corporation (" The Corporation ") had consolidated net income of $2,123,000, an increase of 11.0 percent over the $1,913,000 earned in the first quarter of 1998. Basic earnings per share amounted to $0.36 for the three months ended March 31, 1999, a 9.1 percent increase over the $0.33 per share earned in the first quarter of 1998. NET INTEREST INCOME For the first three months of 1999, net interest income was $7,387,000 compared to $6,204,000 for the same period in 1998. This is an increase of $1,183,000 or 19.1 percent. The increase resulted from a 21.5 percent increase in loans outstanding, net of unearned income, as well as a 19.9 percent increase in investment securities outstanding, when compared to the first three months of 1998. 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 three months of 1998, the year to date taxable equivalent yield on earning assets was 7.97 percent. During the same period in 1999, the yield decreased to 7.58 percent or a decrease of 39 basis points. The cost of the liabilities used to support these earning assets decreased 40 basis points from 4.18 percent in 1998 to 3.78 percent in 1999. Interest rates paid on interest-bearing liabilities decreased more rapidly than yields on earning assets due to the Company's negative asset/liability position. First quarter net interest margin decreased from 4.47 percent in 1998 to 4.46 percent in 1999. The impact of interest-free funds for the same period decreased from .68 percent to .61 percent or a decrease of 7 basis points. The largest category of earning assets is loans. At the end of the first quarter 1999, loans outstanding, less unearned income, were $430,560,000 compared to $407,961,000 at December 31, 1998. This represents an increase of $22,599,000. For the three months ended March 31, 1999 interest and fees on loans was $9,213,000 compared to $8,123,000 for the comparable period in 1998, an increase of $1,090,000 or 13.4 percent. For the three months ended March 31, 1999, loans averaged $418,676,000 and yielded 8.38 percent on a taxable equivalent basis compared to $371,223,000 with a taxable equivalent yield of 8.71 percent or a decrease of 33 basis points for the year ended December 31, 1998. 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 March 31, 1999, investment securities were $219,663,000 compared to $197,171,000 at December 31, 1998. This is an increase of $22,492,000 or 11.4 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 three months ended March 31, 1999, investment income was $2,906,000 compared with $2,481,000 for the comparable period in 1998, a net increase of $425,000 or 17.1 percent. Management attributes this increase in income to higher volume and yields on investment securities. For the first quarter 1999, securities averaged $203,633,000 and yielded 6.00 percent on a taxable equivalent basis, compared to $194,661,000 with a yield of 6.13 percent for the year ended December 31, 1998, resulting in a 13 basis point decrease in yield. As of March 31, 1999 the Company had unrealized gains in the U S Treasury and agency portfolio, denoted as held-to-maturity, of $64,000 and in the municipal portfolio of $701,000. Also at March 31, 1999, the Company had an unrealized loss of $4,000 in the U S Treasury and agency portfolio and an $111,000 unrealized loss in the municipal portfolio. At March 31, 1999, the Company showed a net unrealized gain of approximately $396,000 on the $173,271,000 of securities denoted as available-for-sale. For the three months ended March 31, 1999, the Company had a $202,000 realized gain due to the sale of investment securities. 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 three months of 1999, interest-bearing liabilities averaged $203,122,000 and carried an average rate of 1.80 percent. This compares to an average level of $420,190,000 with an average rate of 4.14 percent at December 31, 1998 or an increase of 4 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. PROVISION FOR LOAN LOSSES The provision for loan losses for the three month period ended March 31, 1999 was $293,000 compared to $222,000 for the same period in 1998 which represents a 32.0 percent increase. The increase in the provision for loan losses was due primarily to the increase in loan growth. The allowance for loan losses was $6,237,000 or 1.45 percent of outstanding loans at March 31, 1999 compared to 1.49 percent of outstanding loans at year-end 1998.
Management's Discussion Continued... To determine the adequacy of the allowance for loan losses, management performs an internal loan analysis which indicates 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. At March 31, 1999, other real estate owned was $269,000 compared to $144,000 at December 31, 1998. This increase resulted from the foreclosure of several real estate properties. Management anticipates that the level of charge-offs for 1999 will be near the levels of 1998. 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 first quarter of 1999 was $2,246,000 compared to $1,792,000 for the same period in 1998, representing an increase of $454,000 or 25.3 percent. During the first quarter of 1999, other service charges, commissions and fees increased $146,000 or 22.6 percent compared to the same period in 1998. This increase can be primarily attributed to the increase in debit card fees as well as fees collected on mutual fund sales. Noninterest expense for the first quarter of 1999 was $6,222,000 compared to $4,994,000, an increase of $1,228,000 or 24.6 percent. Salaries and employee benefits for the three month period ended March 31, 1999, increased $892,000 or 31.4 percent compared to the same period in 1998. These increases can be largely attributed to the opening of Florence County National Bank on April 1, 1998, the opening of a First National Bank branch in Hilton Head in December, 1998, a branch of National Bank of York County in York on January 12, 1999 and the opening of an upscale finance company, NewSouth Financial Services Corporation, Inc in November, 1998. Occupancy expense along with furniture and equipment expense increased $146,000 or 22.6 percent for the three month period ended March 31, 1999 when compared to the same period in 1998. This increase can be primarily attributed to the increase in expenses relating to the expansion of our company in other locations during the past year. NET INCOME Net income was up 11.0 percent for the first three months of 1999 when compared to the same period in 1998. The $1,183,000 or 19.1 percent increase in net interest income and the $1,228,000 or 25.6 percent increase in noninterest income for the first quarter ended March 31, 1999 were the primary factors in the growth in net income.
Management's Discussion Continued... 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 first quarter 1999, stockholders' equity was $62,765,000 compared to $62,301,000 at December 31, 1998. 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 March 31, 1999 was 13.8 percent compared to 14.3 percent at December 31, 1998. The total capital ratio was 15.1 percent at March 31, 1999 compared to 15.56 percent at December 31, 1998. 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 March 31, 1999, First National Corporation's leverage ratio was 9.0 percent, compared to 9.0 percent at December 31, 1998. 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 qualified at the 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, more work remains to be done. The Company's current target is to resolve compliant issues in important business information systems by June 30, 1999. 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 are 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 on Form 8-K: (a) Exhibit 2.1 - Merger agreement between First National Corporation and FirstBancorporation, Inc. (b) Exhibit 27 - Financial Data Schedule (c) Reports on Form 8-K: None
Pursuant to the requirements 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. FIRST NATIONAL CORPORATION Date: May 14, 1999 C. John Hipp, III President and Chief Executive Officer Date: May 14, 1999 W. Louis Griffith Principal Accounting Officer and Chief Financial Officer
EXHIBIT INDEX Exhibit No. Description of Exhibit 2.1 Merger Agreement between First National Corporation and FirstBancorporation, Inc. 27 Financial Data Schedule