FIRST NATIONAL CORPORATION Financial Statements (Form 10-Q) June 30, 1999
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 JUNE 30, 1999 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 June 30, 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 - June 30, 1999 and December 31, 1998 Consolidated Statements of Changes In Shareholders' Equity - Six Months Ended June 30, 1999 and 1998 Consolidated Statement of Income - Three and Six Months Ended June 30, 1999 and 1998 Consolidated Statement of Cash Flows - Six Months Ended June 30, 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 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 6-30-99 12-31-98 (In Thousands) (In Thousands) Cash and due from banks $ 32,032 $ 24,254 Federal funds sold 0 0 Investment securities - Note 2 Securities held-to-maturity (fair value of $46,665 in 1999 and $47,456 in 1998) 46,938 46,380 Securities available-for-sale, at fair value 166,101 150,791 Total investment securities 213,039 197,171 Loans - Note 3 448,337 411,035 Less: Unearned income (3,252) (3,074) Allowance for loan losses-Note 4 (6,492) (6,075) Loans, net 438,593 401,886 Premises and equipment 12,090 10,460 Intangible assets 1,935 2,090 Other real estate - Note 6 913 144 Other assets 8,337 6,678 TOTAL ASSETS $706,939 $642,683
Consolidated Balance Sheet - Continued....... LIABILITIES & STOCKHOLDERS' EQUITY 6-30-99 12-31-98 (In Thousands) (In Thousands) Liabilities: Deposits in domestic offices: Noninterest bearing $90,577 $79,325 Interest-bearing - Note 7 458,964 444,813 TOTAL DEPOSITS 549,541 524,138 Federal funds purchased & securities sold under agreement to repurchase 71,067 52,150 Long-Term debt 20,000 0 Other liabilities 4,068 4,094 TOTAL LIABILITIES 644,676 580,382 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 - Note 9 14,589 14,554 Additional paid-in capital 40,305 40,235 Retained earnings 8,947 6,238 Unrealized gain (loss) on securities available-for-sale, net of applicable deferred income taxes (1,578) 1,274 TOTAL SHAREHOLDERS' EQUITY 62,263 62,301 TOTAL LIABILITIES & SHAREHOLDER'S EQUITY $706,939 $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> <C> BALANCE, DECEMBER 31, 1997 5,188,097 $ 12,970 $ 23,257 $ 17,197 $ 476 $ 53,900 Comprehensive income: Net income - - - 3,866 - 3,866 Change in net unrealized gain (loss) on securities available- for-sale, net of reclassification adjustment and tax effects - - - - (51) (51) Total Comprehensive income - - - - - 3,815 Cash dividends - - - (1,141) - (1,141) Common stock issued 105,000 263 2,412 - - 2,675 BALANCE, JUNE 30, 1998 5,293,097 $ 13,233 $ 25,669 $ 19,922 $ 425 $ 59,249 BALANCE, DECEMBER 31, 1998 5,821,775 $ 14,554 $ 40,235 $ 6,238 $ 1,274 $ 62,301 Comprehensive income: Net income - - - 4,225 - 4,225 Change in net unrealized gain (loss) on securities available- for-sale, net of reclassification adjustment and tax effects - - - - (2,852) (2,852) Total comprehensive income - - - - - 1,373 Cash dividends - - - (1,516) - (1,516) Common stock issued 13,975 35 70 - - 105 BALANCE, JUNE 30, 1999 5,835,750 $ 14,589 $ 40,305 $ 8,947 $ (1,578) $62,263 </TABLE>
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) 3 Months Ended 6 Months Ended 06-30-99 06-30-98 06-30-99 06-30-98 (In Thousands) (In Thousands) Interest income: Interest and fees on loans $9,659 $8,366 $18,872 $16,489 Interest & dividends on investment sec.: Taxable income 2,583 2,525 5,032 4,591 Non-taxable income 452 437 897 845 Dividends on stock 10 13 22 20 Interest on federal funds sold 52 174 174 394 Total Interest income 12,756 11,515 24,997 22,339 Interest expense: Interest on deposits 4,067 4,357 8,065 8,345 Interest on federal funds purchased & securities sold under agreement to repurchase 669 612 1,358 1,244 Other interest expense 251 19 418 19 Total interest expense 4,987 4,988 9,841 9,608 Net Interest Income 7,769 6,527 15,156 12,731 Provisions for loan losses - Note 4 345 166 638 388 Net interest income after provisions for loan losses 7,424 6,361 14,518 12,343 Noninterest income: Service charges on deposit accounts 1,270 1,188 2,495 2,304 Other service charges commissions, fees 807 692 1,600 1,339 Gains (losses) on investment securities 43 20 245 38 Other operating income 14 24 40 35 Total noninterest income 2,134 1,924 4,380 3,716 Noninterest expense: Salaries & employee benefits 3,543 3,034 7,272 5,871 Occupancy expense of bank premises - net 353 246 677 497 Furniture & equipment expense - net 703 377 1,326 765 Amortization expense-Intangible assets 112 208 222 360 Other expense 1,815 1,566 3,251 2,932 Total noninterest expense 6,526 5,431 12,748 10,425 Income before income taxes 3,032 2,854 6,150 5,634 Applicable income taxes 930 901 1,925 1,768 Net Income $2,102 $1,953 $4,225 $3,866 Net income per common share - Basic $0.36 $0.34 $ .72 $0.67 Net income per common share - Diluted $0.36 $0.34 $ .72 $0.67 Cash dividends per common share $0.13 $0.11 $0.26 $0.22
FIRST NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 6 Months Ended 6 Months Ended 06-30-99 06-30-98 (In Thousands) (In Thousands) Cash flows from operating activities: Net income $ 4,225 $ 3,866 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 726 896 Provision for loan losses 638 388 Increase (decrease) in reserve for income taxes-current 283 42 (Gain)loss on sale of premises and equipment (20) (2) (Increase) decrease in interest receivables 308 (224) Increase (decrease) in accumulated premium amortization and discount accretion - net 152 (228) Increase (decrease) in interest payable 37 289 (Increase) decrease in miscellaneous assets (2,257) (596) (Increase) decrease in prepaid assets (477) (83) Increase (decrease) in other liabilities 495 1,927 Total adjustments (115) 2,409 Net cash provided by operating activities $ 4,110 $ 6,275
Consolidated Statement of Cash Flows - Continued....... 6 Months Ended 6 Months Ended 06-30-99 06-30-98 (In Thousands) (In Thousands) Cash flows from investing activities: Proceeds from maturities of investment securities held-to-maturity $ 4,733 $10,479 Purchase of investment securities held-to-maturity (5,091) (6,702) Proceeds from maturities of investment securities available-for-sale 48,766 47,901 Purchase of investment securities available-for-sale (72,505) (86,882) Net (increase) decrease in customer loans (37,414) (13,230) Additions to premises and equipment 2,149 415 Proceeds from sale of premises and equipment 20 2 Recoveries from loans previously charged off 91 108 (Increase) decrease in funds sold 0 (9,200) Net cash used in investing activities (59,251) (57,109) Cash flows from financing activities: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 25,412 49,017 Sale of common stock 105 2,674 Net increase (decrease) in federal funds purchased and securities sold under agreement to repurchase 18,917 (4,455) Proceeds from issuance of other borrowings 20,000 0 Dividends paid (1,515) (1,141) Net cash provided by financing activities 62,919 46,095 Net increase (decrease) in cash and cash equivalents 7,778 (4,739) Cash and cash equivalents at beginning of year 24,254 30,802 Cash and cash equivalents at end of reporting period $ 32,032 $ 26,063
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 six months ended June 30, 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 June 30, 1999 and December 31, 1998: <TABLE> <CAPTION> 06-30-99 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 2,005 7 0 2,012 3,213 31 0 3,244 Obligations of U S government agencies & corps 4,724 28 (37) 4,715 5,029 72 0 5,101 Obligations of state and political subdivisions 40,209 225 (496) 39,938 38,138 1,018 (45) 39,111 Total 46,938 260 (533) 46,665 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 June 30, 1999 and December 31, 1998: <TABLE> <CAPTION> 06-30-99 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 46,801 137 (257) 46,681 45,830 1,023 0 46,853 Obligations of U S government agencies & corps 118,888 181 (2,619) 116,450 100,285 1,078 (78) 101,285 Other securities 2,970 0 0 2,970 2,653 0 0 2,653 Total 168,659 318 (2,876) 166,101 148,768 2,101 (78) 150,791 </TABLE> Investment securities with an aggregate amortized cost of $129,407 on June 30, 1999, and 108,878 on December 31, 1998, 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: 6-30-99 12-31-98 Commercial, financial & agricultural 74,092 78,077 Real Estate - construction 10,950 10,456 Real estate - mortgage 283,291 243,743 Consumer 76,752 75,685 Total loans 445,085 407,961 As of June 30, 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 $8,553 and $8,992 respectively. The following is an analysis of the activity with respect to loans to related parties for the six months ended June 30, 1999: Balance, beginning of period 8,992 Add: New loans 1,927 Deduct: Payments 2,367 Other changes 1 Balance, end of period 8,553
NOTE 4 - Allowance for Loan Losses: Amount 06-30-99 12-31-98 Balance, beginning of period (year) 6,075 5,518 Add: Recoveries 91 260 Provisions for loan losses charged to income 638 1,013 Total 6,804 6,791 Deduct: Loans charged off 312 716 Balance, end of period (year) 6,492 6,075 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 $66,804 and $67,765 at June 30, 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 June 30, 1999, commitments to extend credit and standby letters of credit aggregated $110,599. 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: <TABLE> <CAPTION> 3 Months Ended 6 Months Ended 6/30/99 6/30/98 6/30/99 6/30/98 <S> <C> <C> <C> <C> Numerator: Net income for the period $ 2,102 $ 1,953 $ 4,225 $ 3,866 Denominator: Denominator for basic EPS: Weighted-average shares outstanding for the period 5,830,345 5,733,880 5,830,345 5,733,880 Effect of dilutive securities: Incremental shares-stock option plans 54,331 46,826 54,331 46,826 Denominator for diluted EPS 5,884,676 5,780,706 5,884,676 5,780,706 Basic EPS $ 0.36 $ 0.34 $ 0.72 $ 0.67 Diluted EPS $ 0.36 $ 0.34 $ 0.72 $ 0.67 </TABLE>
NOTE 9 - Continued... 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 June 30, 1999: Before Tax Tax (Expense) Net of (In thousands of dollars) Amount Benefit Tax Amount Unrealized gain (loss) on securities available-for-sale $(2,558) $ 980 $ (1,578) The following is the other comprehensive income balance at June 30, 1999: Beginning Current Period Ending Balance Change Balance Accumulated other comprehensive income-Unrealized gain (loss) on securities available-for- sale $ 1,274 $(2,852) $ (1,578)
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 opended for business in 1996, 100% of Florence County National Bank, a national bank which opened for business in 1998, and 80% 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 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 National 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.
Management' Discussion Continued... 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 servicse, 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. For the second quarter of 1999, First National Corporation ("the Corporation") had consolidated net income of $2,102,000, an increase of 7.6 percent over the $1,953,000 earned in the second quarter of 1998. Earnings per share amounted to $0.36 for the three months ended June 30, 1999, a 5.9 percent increase over the $0.34 per share earned in the second quarter of 1998. Net income for the first six months of 1999 was $4,225,000, an increase of 9.3 percent over the $3,866,000 earned for the same period in 1998. Earnings per share amounted to $0.72 for the six months ended June 30, 1999, a 7.5 percent increase over the $0.67 per share earned in the first six months of 1998. NET INTEREST INCOME For the second quarter of 1999, net interest income was $7,769,000 compared to $6,527,000 for the same period in 1998. This is an increase of $1,242,000 or 19.0 percent. Net interest income for the first six months of 1999 was $15,156,000 compared to $12,731,000 for the same period in 1998. This represents an increase of $2,425,000 or 19.1 percent. This increase resulted from a 9.1 percent increase in loan outstandings, net of unearned income as well as a 8.1 percent increase in investment security outstandings, when compared to the first six 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 six months of 1998, the year to date taxable equivalent yield on earning assets was 7.83 percent. During the same period of 1999, the yield decreased to 7.52 percent, or a decrease of 31 basis points. The cost of the liabilities used to support these earning assets decreased 50 basis points from 4.16 percent in 1998 to 3,66 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.
Management's Discussion Continued... For the first six months net interest margins increased from 4.36 percent in 1998 to 4.44 percent in 1999. The impact of interest-free funds for the same period decreased from .69 percent to .58 percent or an decrease of 11 basis points. The largest category of earning assets is loans. At the end of the second quarter 1999, loans outstanding, less unearned income, were $445,085,000 compared to $407,961,000 at December 31, 1998. This represents an increase of $37,124,000 or 9.1 percent. For the second quarter ended June 30, 1999, interest and fees on loans were $9,659,000 compared to $8,366,000 for the comparable period in 1998, an increase of $1,293,000 or 15.5 percent. For the six months ended June 30, 1999, interest and fees on loans were $18,872,000 compared with $16,489,000 for the same period in 1998. This represents an increase of $2,383,000 or 14.5 percent. For the six months ended June 30, 1999, loans averaged $429,140,000 and yielded 8.30 percent on a taxable equivalent basis compared to $371,223,000 with a taxable equivalent yield of 8.71 percent or a decrease of 41 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. At June 30, 1999, investment securities were $213,039,000 compared to $197,171,000 at December 31, 1998. This is an increase of $15,868,000 or 8.1 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 second quarter ended June 30, 1999, investment income was $3,045,000 compared with $2,975,000 for the comparable period in 1998, a net increase of $70,000 or 2.4 percent. For the six month period ended June 30, 1999, investment income was $5,951,000 compared with $5,456,000 for the same period in 1998, a net increase of $495,000 or 9.1 percent. Management attributes this increase in income to higher yields on investment securities. At the end of the second quarter 1999, securities averaged $209,035,000 and yielded 5.95 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 18 basis point decrease in yield.
Management's Discussion Continued... As of June 30, 1999, the Company had unrealized gains in the U.S. Treasury and agency portfolio denoted as held-to-maturity, of $35,000 and in the municipal portfolio $225,000. Also at June 30, 1999, the Company had an unrealized loss of $37,000 in the U. S. Treasury and agency portfolio and an $496,000 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 loss at June 30, 1999 of approximately $2,558,000 on the $166,101,000 of securities denoted as available-for-sale. For the first six months ended June 30, 1999, the Company had a $245,000 realized gain due to called agency bonds and 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 six months of 1999, interest-bearing liabilities averaged $544,355,000 and carried an average rate of 3.66 percent. This compares to an average level of $420,190,000 with a rate of 4.14 percent at December 31, 1998 or a decrease of 48 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 June 30, 1999 was $345,000 compared to $166,000 for the same period in 1998 which represents a 107.8 percent increase. For the six month period ended June 30, 1999, the provision for loan loss was $638,000 compared to $388,000 for the same period in 1998 which represents a 64.0 percent increase. The increase in the provision for loan losses was due to an increasing loan demand. The allowance for loan losses was $6,492,000 or 1.46 percent of outstanding loans at June 30, 1999 compared to 1.49 percent of outstanding loans at year-end 1998. 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.
Management's Discussion Continued... Other real estate owned includes certain real estate acquired as a result of foreclosure. For the period ended June 30, 1999, other real estate owned was $913,000 compared to $144,000 at December 31, 1998. This increase resulted from the foreclosure of 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 second quarter of 1999 was $2,134,000 compared to $1,924,000 for the same period in 1998, representing an increase of $210,000 or 10.9 percent. For the first six months of 1999 noninterest income was $4,380,000 compared to $3,716,000 for the same period in 1998, representing an increase of $664,000 or 17.9 percent. During the first six months of 1999, other service charges, commissions, and fees increased $261,000 or 19.5 percent compared to the same period in 1998. This increase can be primarily attributed to the increase in debit card fees, mortgage loan origination fees for secondary market loans, as well as fees collected on mutual fund sales. Noninterest expense for the second quarter of 1999 was $6,526,000 compared to $5,431,000 for the same period in 1998, representing an increase of $1,095,000 or 20.2 percent. For the six months ended June 30, 1999, noninterest expense was $12,748,000 compared to $10,425,000, an increase of $2,323,000 or 22.3 percent. Salaries and employee benefits for the second quarter ended June 30, 1999 increased $509,000 or 16.8 percent compared to the same period in 1998. For the first six months of 1999 salaries and employee benefits increased $1,401,000 or 23.9 percent compared to the same period in 1998. These increases can be largely attributed to the opening of the Florence County National Bank on April 1, 1998, a branch of National Bank of York County in York on January 12, 1999 and the opening of an upscale finance company, CreditSouth Financial Services Corporation Inc in November, 1998. Occupancy expense along with furniture and equipment expense increased $433,000 or 69.5 percent for the second quarter of 1999 compared to the same period in 1998. For the six months ended June 30, 1999 occupancy together with furniture and equipment expense increased $741,000 or 59.7 percent compared to the same period in 1998. These increases can be largely attributed to an increase in both building and furniture and equipment depreciation expense, maintenance and repairs on buildings as well as an increase in equipment rental/lease expense. Rental/lease expense increases resulted from the investment in a new computer system for First National Corporation. Other expenses increased $249,000 or 15.9 percent for the second quarter of 1999 compared to the same period in 1998. For the six months ended June 30, 1999, other expenses increased $319,000 or 10.9 percent compared to the same period in 1998. 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.
Management's Discussion Continued... NET INCOME Net income was up 7.6 percent for the second quarter of 1999 when compared to the same period in 1998. For the six months ended June 30, 1999, net income was up 9.3 percent compared to the same period in 1998. The $2,425,000 or 19.1 percent increase in net interest income and the $664,000 or 17.9 percent increase in noninterest income for the six months ended June 30, 1999 as compared to the same period in 1998 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 second quarter, 1999, stockholder's equity was $62,263,000 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 June 30, 1999 was 13.75 percent compared to 14.3 percent at December 31, 1998. The total capital ratio was 15.0 percent at June 30, 1999 compared to 15.6 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 June 30, 1999, First National Corporation's leverage ratio was 8.1 percent, compared to 9.0 percent at December 31, 1998. First National Corporation's ratio exceeds the minimum standards by substantial margins.
Management's Discussion Continued... 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. 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 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, minor work remains to be done. The Company's current target is to resolve compliance 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.
Management's Discussion Continued... 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 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: August 16, 1999 C. JOHN HIPP, III PRESIDENT & CHIEF EXECUTIVE OFFICER Date: August 16, 1999 W. LOUIS GRIFFITH PRINCIPAL ACCOUNTING OFFICER AND CHIEF FINANCIAL OFFICER
EXHIBIT INDEX EXHIBIT NO. DESCRIPTION OF EXHIBIT 27 Financial Data Schedule Attached