================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20529 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 2001 Commission File Number 9-13663 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.) 905 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, 2001 Common Stock, $2.50 par value 7,009,331 ================================================================================
FIRST NATIONAL CORPORATION INDEX PART I: FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheets - September 30, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Changes In Shareholders' Equity - Nine Months Ended September 30, 2001 and 2000 4 Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2001 and 2000 5 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2001 and 2000 6 Notes to Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II: OTHER INFORMATION Item 1 - Legal Proceedings 14 Signatures 15 -2-
PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ------------------------------------- (In thousands of dollars, except par value) <TABLE><CAPTION> 9/30/2001 12/31/2000 ASSETS (Unaudited) (Note 1) ------ ------------ ------------ <S> <C> <C> Cash and cash equivalents: Cash and due from banks $ 39,101 $ 31,843 Interest-bearing deposits with banks 19 158 ------------------------------ Total cash and cash equivalents 39,120 32,001 ------------------------------ Federal funds sold 21,400 -- Other short-term investments 38,788 -- Investment securities: Held-to-maturity (fair value of $36,167 in 2001 and $38,530 in 2000) 35,115 38,550 Available-for-sale 143,264 136,339 ------------------------------ Total investment securities 178,379 174,889 ------------------------------ Loans 748,983 732,266 Less, unearned income (2,524) (3,217) Less, allowance for loan losses (9,471) (8,922) ------------------------------ Loans, net 736,988 720,127 ------------------------------ Premises and equipment, net 17,853 16,311 ------------------------------ Other assets 20,384 26,520 ------------------------------ Total assets $ 1,052,912 $ 969,848 ============================== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Deposits: Noninterest-bearing $ 130,210 $ 111,997 Interest-bearing transaction accounts 698,851 645,579 ------------------------------ Total deposits 829,061 757,576 Federal funds purchased and securities sold under agreements to repurchase 75,266 65,948 Notes payable 50,500 57,050 Other liabilities 5,465 4,338 ------------------------------ Total liabilities 960,292 884,912 ------------------------------ Shareholders' equity: Common stock - $2.50 par value; authorized 40,000,000 shares; issued and outstanding 7,009,331 and 7,026,901 shares 17,523 17,567 Surplus 46,756 47,488 Retained earnings 26,544 20,228 Accumulated other comprehensive income (loss) 1,797 (347) ------------------------------ Total shareholders' equity 92,620 84,936 ------------------------------ Total liabilities and shareholders' equity $ 1,052,912 $ 969,848 ============================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -3-
FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY -------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (Unaudited) (In thousands of dollars) <TABLE><CAPTION> ACCUMULATED COMMON STOCK OTHER ------------------------- RETAINED COMPREHENSIVE SHARES AMOUNT SURPLUS EARNINGS INCOME (LOSS) TOTAL ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> BALANCE, DECEMBER 31, 1999 7,041,101 $ 17,603 $ 47,666 $ 13,496 $ (2,946) $ 75,819 ---------- Comprehensive income: Net income -- -- -- 8,108 -- 8,108 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- 981 981 ---------- Total comprehensive income 9,089 ---------- Cash dividends declared at $.40 per share -- -- -- (2,816) -- (2,816) Repurchase of common stock (5,900) (15) (78) -- -- (93) ------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 2000 7,035,201 17,588 47,588 18,788 (1,965) 81,999 ===================================================================================== BALANCE, DECEMBER 31, 2000 7,026,901 $ 17,567 $ 47,488 $ 20,228 $ (347) $ 84,936 ---------- Comprehensive income: Net income -- -- -- 9,266 -- 9,266 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- 2,144 2,144 ---------- Total comprehensive income 11,410 ---------- Cash dividends declared at $.42 per share -- -- -- (2,950) -- (2,950) Repurchase of common stock (93,800) (235) (1,432) -- -- (1,667) Stock options exercised 76,230 191 700 -- -- 891 ------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 2001 7,009,331 $ 17,523 $ 46,756 $ 26,544 $ 1,797 $ 92,620 ===================================================================================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -4-
FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME ------------------------------------------- (Unaudited) (In thousands of dollars, except per share data) <TABLE><CAPTION> Three Months Ended Nine Months Ended --------------------- --------------------- 9/30/2001 9/30/2000 9/30/2001 9/30/2000 -------- -------- -------- -------- <S> <C> <C> <C> <C> Interest income: Loans, including fees $ 15,846 $ 15,857 $ 48,182 $ 44,955 Investment securities: Taxable 2,239 2,307 6,662 6,969 Nontaxable 394 438 1,215 1,342 Federal funds sold 306 498 476 1,687 Other 80 73 83 183 --------------------- --------------------- Total interest income 18,865 19,173 56,618 55,136 --------------------- --------------------- Interest expense: Interest on deposits 6,208 6,711 20,461 18,788 Federal funds purchased and securities sold under agreements to repurchase 561 1,730 2,135 4,706 Notes payable 638 496 1,480 1,372 --------------------- --------------------- Total interest expense 7,407 8,937 24,076 24,866 --------------------- --------------------- Net interest income: Net interest income 11,458 10,236 32,542 30,270 Provision for loan losses 693 456 1,389 1,214 --------------------- --------------------- Net interest income after provision for loan losses 10,765 9,780 31,153 29,056 --------------------- --------------------- Noninterest income: Service charges on deposit accounts 1,802 1,826 5,407 5,564 Other service charges and fees 1,371 951 4,043 2,796 Gain (loss) on sale of securities available-for-sale -- 6 570 (6) --------------------- --------------------- Total noninterest income 3,173 2,783 10,020 8,354 --------------------- --------------------- Noninterest expense: Salaries and employee benefits 5,119 4,211 14,518 13,133 Net occupancy expense 529 475 1,518 1,407 Furniture and equipment expense 911 944 2,720 2,651 Other expense 2,645 2,726 8,233 8,125 --------------------- --------------------- Total noninterest expense 9,204 8,356 26,989 25,316 --------------------- --------------------- Earnings: Income before provision for income taxes 4,734 4,207 14,184 12,094 Provision for income taxes 1,643 1,400 4,918 3,986 --------------------- --------------------- Net income $ 3,091 $ 2,807 $ 9,266 $ 8,108 ===================== ===================== Comprehensive income $ 4,153 $ 4,100 $ 11,410 $ 9,089 ===================== ===================== Earnings per share: Basic $ 0.44 $ 0.40 $ 1.32 $ 1.15 ===================== ===================== Diluted $ 0.44 $ 0.40 $ 1.32 $ 1.15 ===================== ===================== Cash dividends per common share $ 0.14 $ 0.14 $ 0.42 $ 0.40 ===================== ===================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -5-
FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ----------------------------------------------- (Unaudited) (In thousands of dollars) <TABLE><CAPTION> Nine Months Ended -------------------------- 9/30/2001 9/30/2000 ---------- ---------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,266 $ 8,108 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,078 1,141 Provision for loan losses 1,389 1,214 Deferred income taxes (1,310) (576) Gain (loss) on sale of securities available-for-sale (570) 6 Net amortization of investment securities 41 10 Net change in: Miscellaneous other assets (3,940) (2,217) Miscellaneous other liabilities 3,006 1,869 -------------------------- Net cash provided by operating activities 8,960 9,555 -------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investment securities available-for-sale 15,189 10,281 Proceeds from maturities of investment securities held-to-maturity 3,300 10,452 Proceeds from maturities of investment securities available-for-sale 112,462 17,843 Purchases of investment securities held-to maturity 100 (2,174) Purchases of investment securities available-for-sale (161,097) (26,129) Net increase in customer loans (18,498) (97,649) Recoveries of loans previously charged off 197 -- Purchases of premises and equipment (2,621) (2,061) Net increase in federal funds sold (22,700) (1,150) -------------------------- Net cash provided (used) by investing activities (73,668) (90,587) -------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 71,485 40,758 Net decrease in federal funds purchased and securities sold under agreements to repurchase 10,618 11,855 Proceeds from issuance of debt 29,500 25,800 Repayment of debt (36,050) (3,650) Repurchase of common stock (1,667) (93) Dividends paid (2,950) (2,816) Stock options exercised 891 -- -------------------------- Net cash provided by financing activities 71,827 71,854 -------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 7,119 $ (9,178) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 32,001 41,327 -------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 39,120 $ 32,149 ========================== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -6-
FIRST NATIONAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 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. Certain prior period information has been reclassified to conform to the current period presentation. Operating results for the three and nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. The condensed consolidated balance sheet at December 31, 2000, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The information contained in the consolidated financial statements and accompanying footnotes included in the Corporation's annual report on Form 10-K for the year ended December 31, 2000 should be referenced when reading these unaudited condensed consolidated financial statements. Note 2 - Recent Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, effective for fiscal years beginning after June 15, 2000. This statement establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other contracts and requires that an entity recognize all derivatives as assets or liabilities in the balance sheet and measure them at fair value. If certain conditions are met, an entity may elect to designate a derivative as follows: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of an unrecognized firm commitment, an available-for-sale security, a foreign currency denominated forecasted transaction, or a net investment in a foreign operation. The Statement generally provides for matching the timing of the recognition of the gain or loss on derivatives designated as hedging instruments with the recognition of the changes in fair value of the item being hedged. Depending on the type of hedge, such recognition will be either in net income or other comprehensive income. For a derivative not designated as a hedging instrument, changes in fair value will be recognized in net income in the period of change. The Company adopted SFAS No. 133 in the first quarter of 2001. The adoption of SFAS No. 133 did not have a material effect on the Corporation's consolidated financial statements. -7-
Note 2 - Recent Accounting Pronouncements (Continued): In September 2000, the FASB issued SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS No. 140 replaces and carries over most of the provisions of SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES, and it revises those standards for accounting for securitizations and other transfers of assets and collateral and requires additional disclosures. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Corporation does not anticipate the implementation of the provisions of SFAS No. 140 will have a material effect on its earnings or financial condition. In July 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141 addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board ("APB") Opinion No. 16, BUSINESS COMBINATIONS, and SFAS No. 38, ACCOUNTING FOR PREACQUISITION CONTINGENCIES OF PURCHASED ENTERPRISES. This Statement eliminates the use of the pooling-of-interest method of accounting for business combinations, requiring future business combinations to be accounted for using the purchase method of accounting. This Statement also requires that intangible assets that meet certain criteria be recognized as assets apart from goodwill. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. Adoption of this Statement is not expected to have a significant impact on the financial position or results of operations of the Corporation. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, INTANGIBLE ASSETS. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. With the adoption of this Statement, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill will be subject to at least an annual assessment for impairment by applying a fair value based test. The provisions of this Statement are required to be applied starting with fiscal years beginning after December 15, 2001. The Corporation is currently evaluating the effect of adopting these pronouncements. In July 2001, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 102 ("SAB 102") which expresses certain of the staff's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. In particular, the guidance focuses on the documentation the staff normally would expect registrants to prepare and maintain in support of their allowances for loan losses. Management believes that the Corporation complies with the views included in SAB 102. -8-
Note 3 - Earnings Per Share: Basic earnings per share is calculated by dividing net income by the weighted-average shares of common stock outstanding during each period. Diluted earnings per share is based on the weighted-average shares of common stock outstanding during each period plus the maximum dilutive effect of common stock issuable upon exercise of stock options. The weighted average number of shares and equivalents are determined after giving retroactive effect to stock dividends and stock splits. Weighted-average shares outstanding used in calculating earnings per share for the three and nine months September 30, 2001 and 2000 are as follows: 3 Months Ended 9 Months Ended ----------------------- ----------------------- 9/30/01 9/30/00 9/30/01 9/30/00 --------- --------- --------- --------- Basic 7,024,392 7,039,621 7,015,485 7,040,604 Diluted 7,039,536 7,064,071 7,026,165 7,072,853 Dividends per share are calculated using the current equivalent of number of common shares outstanding at the time of the dividend based on the Corporation's shares outstanding. Note 4 - Commitments and Contingent Liabilities: In the normal course of business, the Corporation 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, 2001, commitments to extend credit and standby letters of credit totaled $155,596,000. The Corporation does not anticipate any material losses as a result of these transactions. -9-
FIRST NATIONAL CORPORATION Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion relates to the 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, 2000. First National Corporation (the "Corporation") is a bank holding company incorporated under the laws of South Carolina in 1985. The Corporation owns 100 percent of First National Bank, a national bank which opened for business in 1932, 100 percent of National Bank of York County, a national bank which opened for business in 1996, 100 percent of Florence County National Bank, a national bank which opened for business in 1998, and 90 percent of CreditSouth Financial Services Corporation, an upscale financial services company which opened for business in 1998. The Corporation engages in no significant operations other than the ownership of its subsidiaries. Some of the major services which the Corporation provided through its banking subsidiaries include checking, NOW accounts, savings and other 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 the use of ATM facilities. The Corporation has no material concentration of deposits from any single customer or group of customers, and no significant portion of its loan portfolio 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 Corporation. The Corporation does not have foreign loans or deposits. For the third quarter of 2001, the Corporation had consolidated net income of $3,091,000, an increase of 10.1 percent over the $2,807,000 earned in the third quarter of 2000. Diluted earnings per share were $0.44 for the three months ended September 30, 2001, a 10.0 percent increase over the $0.40 per share earned in the third quarter of 2000. Net income for the first nine months of 2001 was $9,266,000, an increase of 14.3 percent over the $8,108,000 earned for the same period in 2000. Diluted earnings per share amounted to $1.32 for the nine months ended September 30, 2001, an increase of 14.8 percent over the $1.15 per share earned in the first nine months of 2000. NET INTEREST INCOME For the third quarter of 2001, net interest income was $11,458,000, an increase of $1,222,000, or 11.9 percent, over $10,236,000 for the same period in 2000. Net interest income for the first nine months of 2001 was $32,542,000, an increase of $2,272,000, or 7.5 percent, compared with $30,270,000 for the same period a year earlier. The yield on a major portion of the Corporation's earning assets adjusts simultaneously, but to varying degrees of magnitude, with changes in the general level of interest rates. For the first nine months of 2001, the taxable equivalent yield on earning assets was 7.45 percent, as compared with 7.93 percent during the same period in 2000, a decrease of 48 basis points. The cost of the interest-bearing liabilities used to fund most of these assets decreased 33 basis points from 4.36 percent in 2000 to 4.03 percent in 2001. Comparing the first nine months of 2000 to -10-
the same period in 2001, interest rates paid on interest-bearing liabilities decreased more rapidly than yields on earning assets. For the first nine months of 2001 and 2000, the net interest margin increased from 4.23 percent to 4.60 percent, respectively. The positive impact of interest-free funds decreased from 0.66 percent to 0.59 percent during the same comparative periods. The largest category of earning assets is loans. As of September 30, 2001, loans outstanding, net of unearned income, were $746,459,000, compared with $729,049,000 at December 31, 2000. This represents an increase of $17,410,000, or 2.4 percent. For the third quarter ended September 30, 2001, interest and fees on loans were $15,846,000, compared to $15,857,000 for the comparable period in 2000, a decrease of $11,000, or 0.1 percent. For the nine months ended September 30, 2001, interest and fees on loans were $48,182,000, compared with $44,955,000 for the same period in the previous year, an increase of $3,227,000, or 7.2 percent. For the nine months ended September 30, 2001, loans averaged $739,401,000 and decreased in yield by 32 basis points to 8.69 percent on a taxable equivalent basis, compared to $680,217,000 with a taxable equivalent yield of 9.01 for the year ended December 31, 2000. Investment securities are the second largest category of earning assets. Investment securities are utilized by the Corporation 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 deposits and purchased funds. At September 30, 2001, investment securities were $182,901,000, compared to $174,889,000 at December 31, 2000. The composition of the portfolio remained relatively consistent during the first nine months of 2001. For the third quarter ended September 30, 2001, investment and money market income was $3,019,000, compared with $3,316,000 for the comparable period in 2000, a decrease of $297,000, or 9.0 percent. For the nine month period ended September 30, 2001, investment income was $8,436,000, compared with $10,181,000 for the same period in 2000, a decrease of $1,745,000, or 17.1 percent. The decrease was primarily attributable to the declining interest rate environment through the first nine months of 2001. For the third quarter of 2001, investment securities averaged $186,725,000 with a taxable equivalent yield of 5.64 percent, compared to $197,101,000 and a yield of approximately 5.59 for the year ended December 31, 2000. In the third quarter of 2001, there were no gains on sale of securities, as compared with $6,000 of gains for the same period a year earlier. For the first nine months of 2001, $570,000 of gains on sale of securities were realized, compared with a loss of $6,000 during the first nine months of the prior year. Most of the 2001 result was attributable to a $546,000 gain realized on the sale of equity shares of an ATM network exchange company. As of September 30, 2001, the Corporation had unrealized gains of $1,052,000 and $2,908,000 in the held-to-maturity and available-for-sale portfolio segments, respectively. 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 Corporation to trade the investment securities portfolio. Management has the intent and ability to hold these assets on a long-term basis or until maturity. -11-
During the first nine months of 2001, interest-bearing liabilities averaged $795,589,000 and carried an average rate of 4.03 percent. This compares to an average level of $739,531,000 with a rate of 4.49 percent for the year ended December 31, 2000, a decrease of 46 basis points. PROVISION FOR LOAN LOSSES The provision for loan losses for the third quarter of 2001 was $693,000, compared with $456,000 for the same period in 2000, an increase of 52.0 percent. For the nine months ended September 30, 2001, the provision was $1,389,000, compared to $1,214,000 for the same period in 2000, or an increase of 14.4 percent. The allowance for loan losses was $9,471,000, or 1.27 percent of outstanding loans, at September 30, 2001 and $8,922,000, or 1.22 percent of outstanding loans at December 31, 2000. Charge off levels have been higher through the first nine months of 2001 as compared with the same period of 2000, as the economy has weakened year to year. Management determines the adequacy of the allowance for loan losses by utilizing its internal risk rating system, credit reviews and regulatory agency examinations to assess the quality of the loan portfolio and identify problem loans. The allowance is currently considered to be adequate. Other real estate owned includes certain real estate acquired as a result of foreclosure. The balances in other real estate owned were $785,000 at September 30, 2001 and $848,000 at the end of 2000. NONINTEREST INCOME AND EXPENSE Noninterest income for the third quarter of 2001 was $3,173,000, compared with $2,783,000 for the same period in 2000, representing an increase of $390,000, or 14.0 percent. For the first nine months of 2001, noninterest income was $10,020,000 compared with $8,354,000 for the same period in 2000, an increase of $1,666,000, or 19.9 percent. The increase was primarily related to increases in other service charges and fees, including secondary market origination fees, and in Asset Management income. Noninterest expense for the third quarter of 2001 was $9,204,000, an increase of $848,000, or 10.1 percent, from $8,356,000 for the same period in the previous year. For the nine months ended September 30, 2001, noninterest expense increased $1,673,000 or 6.6 percent, to $26,989,000 from $25,316,000 in the same period in 2000. Salaries and employee benefits increased $908,000 or 21.6 percent, to $5,119,000 from the third quarter of 2000 to the third quarter of 2001. Comparing the nine month periods, salaries and employee benefits increased $1,385,000, or 10.5 percent, to $14,518,000 in 2001. Other expense was $2,645,000 in the third quarter of 2001, a decrease of $81,000, or 3.0 percent, compared with $2,726,000 for the third quarter of 2000. For the first nine months of 2001, other expense was $8,233,000, an increase of $108,000, or 1.3 percent, from the same period a year earlier. NET INCOME Net income was $3,091,000 for the third quarter of 2001, an increase of $284,000, or 10.1 percent, when compared with $2,807,000 in the third quarter of 2000. For the nine months ended September 30, 2001, net income was $9,266,000, up $1,158,000, or 14.3 percent, compared with $8,108,000 in the first nine months of 2000. Comparing the first three quarters of 2000 and 2001, the $2,272,000, or 7.5 percent, increase in net interest income and the $1,666,000, or 19.9 percent, increase in noninterest income were the main contributors to net earnings growth. -12-
CAPITAL RESOURCES AND LIQUIDITY The ongoing capital requirements of the Corporation have been met through retained earnings, less the payment of cash dividends. As of September 30, 2001, shareholders' equity was $92,620,000, an increase of $7,684,000, or 9.0 percent, over $84,936,000 at December 31, 2000. The Corporation and its subsidiaries are subject to certain risk-base 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 are adjusted to reflect credit risk. Under the guidelines promulgated by the Board of Governors of the Federal Reserve System, which are substantially similar to those of the Comptroller of the Currency, Tier 1 capital must be at least 4 percent of risk-weighted assets, while total capital must be at least 8 percent of risk-weighted assets. The Corporation's Tier 1 risk-weighted asset capital ratio at September 30, 2001 was 12.37 percent, compared to 12.15 percent at December 31, 2000. The total risk-weighted asset capital ratio was 13.62 at the end of the third quarter of 2001, compared with 13.40 at the end of 2000. In conjunction with the risk-based ratios, the regulatory agencies have also prescribed a leverage capital ratio for assessing capital adequacy. The minimum leverage ratio required for banks is between 3 and 5 percent, depending on the institution's composite rating as determined by its regulators. As of September 30, 2001, the Corporation's leverage ratio was 8.34 percent, compared to 8.27 percent at December 31, 2000. The Corporation's capital ratios currently well exceed the minimum standards. Liquidity is the ability of the Corporation to generate sufficient cash to meet its financial obligations which arise primarily from the 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 corporate liquidity needs. The Corporation's liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from the Corporation's use of federal funds purchased and securities sold under agreements to repurchase. Additional liquidity can be secured from lines of credit extended to the Corporation from its correspondent banks. Manangement believes that its liquidity position is adequate. -13-
PART II - OTHER INFORMATION Item 1. Legal Proceedings: Neither First National Corporation nor its subsidiaries are party to nor is any of their property subject to any material or other pending legal proceedings, other than in the ordinary routine proceedings incident 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: Not applicable. -14-
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 14, 2001 /s/ C. JOHN HIPP, III ------------------------------------- PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: November 14, 2001 /s/ RICHARD C. MATHIS ------------------------------------- EXECUTIVE VICE PRESIDENT AND CHIEF FINACIAL OFFICER -15-