================================================================================ UNITED STATES OF AMERICA 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, 2002 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 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, 2002 Common Stock, $2.50 par value 6,975,254 ================================================================================
FIRST NATIONAL CORPORATION INDEX PART I: FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 Condensed Consolidated Statements of Changes In Shareholders' Equity - Nine Months Ended September 30, 2002 and 2001 Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2002 and 2001 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001 Notes to Consolidated Financial Statements Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3 - Quantitative and Qualitative Disclosures About Market Risk - Reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2001 Item 4 - Controls and Procedures PART II: OTHER INFORMATION Item 1 - Legal Proceedings Item 6 - Exhibits and Reports on Form 8-K
PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ------------------------------------- (In thousands of dollars, except par value) <TABLE><CAPTION> 9/30/2002 12/31/2001 ASSETS (Unaudited) (Note 1) ------ ------------ ------------ <S> <C> <C> Cash and cash equivalents: Cash and due from banks $ 44,025 $ 40,126 Interest-bearing deposits 82 49 Federal funds sold and securities purchased under agreements to resell 6,400 1,000 Money market funds 11,000 -- ------------ ------------ Total cash and cash equivalents 61,507 41,175 ------------ ------------ Investment securities: Held-to-maturity (fair value of $36,845 in 2002 and $35,662 in 2001) 33,416 35,014 Available-for-sale 138,139 154,919 ------------ ------------ Total investment securities 171,555 189,933 ------------ ------------ Loans held for sale 18,774 20,784 ------------ ------------ Loans 841,863 750,372 Less, unearned income (1,628) (2,292) Less, allowance for loan losses (10,626) (9,818) ------------ ------------ Loans, net 829,609 738,262 ------------ ------------ Premises and equipment, net 26,766 19,537 ------------ ------------ Other assets 16,909 15,056 ------------ ------------ Total assets $ 1,125,120 $ 1,024,747 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Deposits: Noninterest-bearing $ 147,544 $ 129,698 Interest-bearing 743,155 681,825 ------------ ------------ Total deposits 890,699 811,523 Federal funds purchased and securities sold under agreements to repurchase 78,625 66,617 Notes payable 49,500 49,500 Other liabilities 5,424 4,042 ------------ ------------ Total liabilities 1,024,248 931,682 ------------ ------------ Shareholders' equity: Common stock - $2.50 par value; authorized 40,000,000 shares; issued and outstanding 6,975,254 and 6,964,878 shares 17,438 17,412 Surplus 46,293 46,016 Retained earnings 35,243 28,485 Accumulated other comprehensive income 1,898 1,152 ------------ ------------ Total shareholders' equity 100,872 93,065 ------------ ------------ Total liabilities and shareholders' equity $ 1,125,120 $ 1,024,747 ============ ============ </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -----------------------------------------------------------------------
FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 --------------------------------------------- (Unaudited) (Dollars in thousands) <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, 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) Exercise stock options 76,230 191 700 -- -- 891 Repurchase of common stock (93,800) (235) (1,433) -- -- (1,668) ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, SEPTEMBER 30, 2001 7,009,331 17,523 46,755 26,544 1,797 92,619 ========== ========== ========== ========== ========== ========== BALANCE, DECEMBER 31, 2001 6,964,878 $ 17,412 $ 46,016 $ 28,485 $ 1,152 $ 93,065 ---------- Comprehensive income: Net income -- -- -- 10,034 -- 10,034 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects -- -- -- -- 746 746 ---------- Total comprehensive income 10,780 ---------- Cash dividends declared at $.47 per share -- -- -- (3,276) -- (3,276) Exercise stock options 4,300 11 67 -- -- 78 Employee stock purchases 1,478 4 31 35 Restricted stock awards 17,000 42 413 -- -- 455 Repurchase of common stock (12,402) (31) (234) -- -- (265) ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, SEPTEMBER 30, 2002 6,975,254 17,438 46,293 35,243 1,898 100,872 ========== ========== ========== ========== ========== ========== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -----------------------------------------------------------------------
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 ------------------------- ------------------------- 9/30/2002 9/30/2001 9/30/2002 9/30/2001 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Interest income: Loans, including fees $ 14,965 $ 15,846 $ 43,204 $ 48,182 Investment securities: Taxable 1,895 2,305 5,786 6,731 Tax-exempt 414 392 1,249 1,213 Money market funds 81 11 333 11 Federal funds sold and securities purchased under agreements to resell 53 306 94 476 Interest-bearing deposits 11 5 43 5 ---------- ---------- ---------- ---------- Total interest income 17,419 18,865 50,709 56,618 ---------- ---------- ---------- ---------- Interest expense: Deposits 3,849 6,207 11,777 20,460 Federal funds purchased and securities sold under agreements to repurchase 272 561 695 2,135 Long-term debt 750 638 1,863 1,480 ---------- ---------- ---------- ---------- Total interest expense 4,871 7,406 14,335 24,075 ---------- ---------- ---------- ---------- Net interest income: Net interest income 12,548 11,459 36,373 32,543 Provision for loan losses 884 693 2,019 1,389 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 11,664 10,766 34,355 31,154 ---------- ---------- ---------- ---------- Noninterest income: Service charges on deposit accounts 2,827 1,802 7,851 5,407 Other service charges and fees 1,500 1,370 4,731 4,042 Gain on sale of securities available-for-sale -- -- -- 570 ---------- ---------- ---------- ---------- Total noninterest income 4,327 3,172 12,582 10,019 ---------- ---------- ---------- ---------- Noninterest expense: Salaries and employee benefits 6,203 5,119 17,750 14,518 Net occupancy expense 616 529 1,761 1,518 Furniture and equipment expense 1,057 911 3,001 2,720 Amortization of intangibles 57 597 172 597 Other expense 3,343 2,048 9,358 7,636 ---------- ---------- ---------- ---------- Total noninterest expense 11,276 9,204 32,042 26,989 ---------- ---------- ---------- ---------- Earnings: Income before provision for income taxes 4,715 4,734 14,895 14,184 Provision for income taxes 1,460 1,643 4,861 4,918 ---------- ---------- ---------- ---------- Net income $ 3,255 $ 3,091 $ 10,034 $ 9,266 ========== ========== ========== ========== Comprehensive income $ 3,453 $ 4,153 $ 10,780 $ 11,410 ========== ========== ========== ========== Earnings per share: Basic $ 0.47 $ 0.44 $ 1.44 $ 1.32 ========== ========== ========== ========== Diluted $ 0.46 $ 0.44 $ 1.43 $ 1.32 ========== ========== ========== ========== Cash dividends per common share $ 0.16 $ 0.14 $ 0.47 $ 0.42 ========== ========== ========== ========== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -----------------------------------------------------------------------
FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ----------------------------------------------- (Unaudited) (In thousands of dollars) <TABLE><CAPTION> NINE MONTHS ENDED -------------------------- 9/30/02 9/30/01 ---------- ---------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 10,034 $ 9,266 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,085 1,078 Provision for loan losses 2,019 1,389 Deferred income taxes (316) (1,310) Gain on sale of securities available-for-sale -- (570) Net amortization of investment securities 582 41 Originations of loans held for sale (102,365) (150,363) Proceeds from sale of loans held for sale 104,369 146,103 Net change in: Miscellaneous other assets (1,877) (3,940) Miscellaneous other liabilities 1,405 3,006 ---------- ---------- Net cash provided by operating activities 14,936 4,700 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investment securities available-for-sale 47,000 15,189 Proceeds from maturities of investment securities held-to-maturity 2,619 3,300 Proceeds from maturities of investment securities available-for-sale 129,240 112,462 Purchases of securities held-to-maturity (1,072) 100 Purchases of investment securities available-for-sale (158,928) (161,097) Net increase in customer loans (93,583) (14,238) Recoveries of loans previously charged off 223 197 Purchases of premises and equipment (8,314) (2,621) ---------- ---------- Net cash used by investing activities (82,815) (46,708) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand deposits, NOW accounts, savings accounts and certificates of deposit 79,174 71,485 Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase 12,009 10,618 Proceeds from issuance of debt -- 29,500 Repayment of debt -- (36,050) Common stock issued 490 -- Repurchase of common stock (265) (1,667) Dividends paid (3,275) (2,950) Stock options exercised 78 891 ---------- ---------- Net cash provided by financing activities 88,211 71,827 ---------- ---------- NET INCREASE IN CASH AND CASH EQUIVALENTS 20,332 29,819 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 41,175 32,001 ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 61,507 $ 61,820 ========== ========== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS -----------------------------------------------------------------------
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 nine months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. The condensed consolidated balance sheet at December 31, 2001, 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, 2001 should be referenced when reading these unaudited condensed consolidated financial statements. Note 2 - Recent Accounting Pronouncements: In June 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. Although, SFAS No. 141 will impact the accounting for any future business combinations, it had no effect on the Corporation's financial position or results of operations for the nine months ended September 30, 2002. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB 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
Note 2 - Recent Accounting Pronouncements (Continued): 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 Corporation has determined that as a result of the adoption of SFAS 142 on January 1, 2002, it had $2,363,000 of goodwill that will no longer be amortized. Based on its transitional impairment tests, management does not anticipate that any material impairment losses will be recorded in 2002. Due to the adoption of SFAS No. 142, the amortization of intangible assets is expected to be reduced by approximately $221,000 for 2002. In June 2001, the FASB issued SFAS No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. SFAS No. 143 requires that an entity recognize the fair value of a liability for an asset retirement obligation in the period in which a reasonable estimate of fair value can be made. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002, with early adoption permitted. The Corporation does not expect the adoption of this standard to have a significant impact on its financial statements. In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. This Statement replaces SFAS No. 141 and provisions of APB Opinion No. 30 for the disposal of segments of a business. SFAS No. 144 requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. The Corporation adopted SFAS No. 144 effective January 1, 2002. Adoption of this Statement did not have a significant impact on the financial position or results of operations of the Corporation. 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 six months ended September 30, 2002 and 2001 are as follows: 3 MONTHS ENDED 9 MONTHS ENDED ------------------------ ------------------------ 9/30/02 09/30/01 9/30/02 9/30/01 --------- --------- --------- --------- Basic 6,972,924 7,024,392 6,965,030 7,015,485 Diluted 7,035,551 7,039,536 7,013,930 7,026,165
Note 3 - Earnings Per Share (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 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, 2002, commitments to extend credit and standby letters of credit totaled $214,159,000. The Corporation does not anticipate any material losses as a result of these transactions. Note 5 - Intangible Assets: Intangible assets consist primarily of goodwill and core deposit premium costs which resulted from the acquisition of branches from other commercial banks. Core deposit premium costs represent the value of long-term deposit relationships acquired in these transactions. Goodwill represents the excess of the purchase price over the sum of the fair values of the tangible and identifiable intangible assets acquired less the fair value of the liabilities assumed. Core deposit premium costs are being amortized over an estimated useful life of fifteen years. The gross carrying amounts and accumulated amortization of core deposit premium costs are as follows: 9/30/02 12/31/01 ----------- ----------- Gross carrying amount $ 5,538,000 $ 5,538,000 Accumulated amortization (3,365,000) (3,200,000) Estimated amortization expense for core deposit premium costs for each of the next five years is as follows: Year ending December 31: 2002 $ 400,000 2003 353,000 2004 317,000 2005 281,000 2006 245,000
Note 5 - Intangible Assets (Continued): The following table presents actual results for the nine months ended September 30, 2002, and adjusted net income and adjusted earnings per share for the nine months ended September 30, 2001, assuming the nonamortization provisions of SFAS No. 142 were effective January 1, 2001: (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA) Three Months Ended Nine Months Ended --------------------- --------------------- 9/30/02 9/30/01 9/30/02 9/30/01 -------- -------- -------- -------- Reported net income $ 3,255 $ 3,091 $ 10,034 $ 9,266 Add back: Goodwill amortization -- 60 -- 180 -------- -------- -------- -------- Adjusted net income $ 3,255 $ 3,151 $ 10,034 $ 9,446 ======== ======== ======== ======== Basic earnings per share: Reported net income $ 0.47 $ 0.44 $ 1.44 $ 1.32 Add back: Goodwill amortization -- 0.01 -- 0.02 -------- -------- -------- -------- Adjusted net income $ 0.47 $ 0.45 $ 1.44 $ 1.34 ======== ======== ======== ======== Diluted earnings per share: Reported net income $ 0.46 $ 0.44 $ 1.43 $ 1.32 Add back: Goodwill amortization -- 0.01 -- 0.02 -------- -------- -------- -------- Adjusted net income $ 0.46 $ 0.45 $ 1.43 $ 1.34 ======== ======== ======== ======== Note 6 - Employee Benefit Plans: During the second quarter of 2002, the Corporation entered into Restricted Stock Agreements with six of its executive officers. The agreements grant to the officers 17,000 total shares of restricted common stock conditioned upon continued employment . The shares vest free of restrictions as follows: 25% in 2005, 25% in 2007 and 50% in 2009. Termination of employment prior to a vesting date would terminate any interest in non-vested shares. Prior to vesting of the shares, the officers have the right to vote such shares and to receive dividends paid with respect to such shares. All restricted shares will vest in the event of a change in control of the Corporation or upon the death of an officer. The fair value of the shares granted under these agreements was $27.79 per share at the date of grant. The Corporation has registered 300,000 shares of common stock in connection with the establishment of an Employee Stock Purchase Plan. The Plan, which is effective for the seven year period commencing July 1, 2002, is available to all employees who have attained age 21 and completed one year of service. The price at which common stock may be purchased for each quarterly option period is the lessor of 85 percent of the fair market value of the common stock on the date of grant of the option period, or 85 percent of the fair market value of the common stock on the exercise date of the option period.
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, 2001. 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 South Carolina Bank and Trust, National Association, a national bank which opened for business in 1932, 100 percent of South Carolina Bank and Trust of the Piedmont, National Association, a national bank which opened for business in 1996, 100 percent of South Carolina Bank and Trust, National Association, a national bank which opened for business in 1998, and 100 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. Statements included in Management's Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature are intended to be, and are hereby identified as, forward looking statements for purposes of the safe harbor provided by Section 21E of the Securities and Exchange Act of 1934, as amended. First National Corporation cautions readers that forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from forecasted results. Such risks and uncertainties, include, among others, the following possibilities: (1) Credit risk associated with an obligor's failure to meet the terms of any contract with the bank or otherwise fail to perform as agreed; (2) Interest risk involving the effect of a change in interest rates on both the bank's earnings and the market value of the portfolio equity; (3) Liquidity risk affecting the bank's ability to meet its obligations when they come due; (4) Price risk focusing on changes in market factors that may affect the value of traded instruments in mark-to-market portfolios; (5) Transaction risk arising from problems with service or product delivery; (6) Compliance risk involving risk to earnings or capital resulting from violations of or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards; (7) Strategic risk resulting from adverse business decisions or improper implementation of business decisions; and (8) Reputation risk that adversely effects earnings or capital arising from negative public opinion. Some of the major services which the Corporation provided through its banking subsidiaries include checking, NOW accounts, savings and other deposits of various types, 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 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 2002, the Corporation had consolidated net income of $3,255,000, an increase of 5.3 percent over the $3,091,000 earned in the third quarter of 2001. Diluted earnings per share were $0.46 for the nine months ended September 30, 2002, a 4.5 percent increase over the $0.44 per share earned in the third quarter of 2001. Net income for the first nine months of 2002 was $10,034,000, an increase of 8.3 percent over the $9,266,000 earned for the same period in 2001. Diluted earnings per share amounted to $1.43 for the nine months ended September 30, 2002, a 8.3 percent increase over the $1.32 per share earned in the first nine months of 2001.
NET INTEREST INCOME For the third quarter of 2002, net interest income was $12,548,000, an increase of $1,089,000, or 9.5 percent, over $11,459,000 for the same period in 2001. Net interest income for the first nine months of 2001 was $36,374,000, an increase of $3,831,000, or 11.8 percent, compared with $32,543,000 for the same period a year earlier. This increase was largely the result of significantly lower rates paid on interest-bearing liabilities in the first nine months of 2002, as compared with the similar period of 2001. 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 2002, the taxable equivalent yield on earning assets was 6.71 percent, as compared with 7.45 percent during the same period in 2001, a decrease of 74 basis points. The cost of interest-bearing liabilities used to fund most of these assets decreased 173 basis points from 4.03 percent in 2001 to 2.30 percent in 2002. Thus, comparing the first nine months of 2002 and 2001, interest rates paid on interest-bearing liabilities decreased more rapidly than yields on earning assets. Consequently, for the first nine months of 2001 and 2002, the net interest margin increased from 4.60 percent to 4.81 percent. In the same nine-month comparisons, the positive impact of interest-free funds decreased from 0.59 percent to 0.40 percent. Loans comprise the largest category of earning assets. As of September 30, 2002, loans outstanding, net of unearned income, were $859,009,000, compared with $768,864,000 at December 31, 2001. This represents an increase of $90,145,000 or 11.7 percent, with the most noticeable growth in the commercial, residential mortgage and consumer installment loan categories. For the third quarter ended September 30, 2002, interest and fees on loans were $14,965,000, compared with $15,846,000 for the comparable period in 2001, a decrease of $881,000, or 5.6 percent. Further reflecting the lower interest rate environment in the current year, for the nine months ended September 30, 2002, interest and fees on loans were $43,205,000, compared with $48,182,000 for the same period in the previous year, a decrease of $4,977,000, or 10.3 percent. For the nine months ended September 30, 2002, loans averaged $783,995,000 and decreased in yield by 116 basis points to 7.35 percent on a taxable equivalent basis, compared to $742,558,000 with a taxable equivalent yield of 8.51 for the year ended December 31, 2001. 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, 2002, investment securities were $171,555,000, compared to $189,933,000 at December 31, 2001. The composition of the portfolio remained relatively consistent during the first nine months of 2002, with a bias toward shorter maturities in the continuing low rate environment. The portfolio at the end of the third quarter of 2002 included $32,129,000 of short-term investments in government agency securities.
For the quarter ended September 30, 2002, interest earned on investment securities was $2,309,000, compared with $2,697,000 for the comparable period in 2001, a decrease of $388,000, or 14.4 percent. For the nine-month period ended September 30, 2002, income was $7,035,000, compared with $7,944,000 for the same period in 2001. This decrease of $909,000, or 11.4 percent, was the result of significantly lower yields in 2002 and a cautious bias toward shorter-term securities. For the first nine months of 2002, investment securities averaged $186,796,000 and yielded 5.21 percent on a taxable equivalent basis, compared to an average of $181,326,000 and yield of 5.90 percent for the year ended December 31, 2001. There were no gains or losses on sale of securities during the third quarter of 2002 and none in the third quarter of the previous year. The first nine months of 2001 reflect a $546,000 gain realized on the sale of equity shares of an ATM network exchange company during the second quarter. There were no gains or losses recognized in the first nine months of 2002. As of September 30, 2002, the Corporation had unrealized gains of $2,095,000 and $3,672,000, respectively, in the held-to-maturity and available-for-sale securities portfolio segments. 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. While management has the ability and generally holds these assets on a long-term basis or until maturity, the short-term investments noted above may be converted at an earlier point, depending on changes in interest rates and alternative investment options As of September 30, 2002, the Corporation held $11,000,000 in money market funds. These short-term investments averaged $25,181,000 for the first nine months of 2002 and earned $333,000. During the first nine months of 2001, money market funds averaged $476,000 and earned $11,000. During the first nine months of 2002, the balance in interest-bearing liabilities averaged $830,784,000 with an average rate of 2.30 percent. This compares to an average balance of $794,798,000 and rate of 3.77 percent for the year ended December 31, 2001, a decrease of 147 basis points. At September 30, 2002, approximately 43 percent of interest-bearing liabilities had fixed rates and were expected to renew at prevailing market rates as they mature. PROVISION FOR LOAN LOSSES The provision for loan losses for the three months ended September 30, 2002 was $884,000, compared with $693,000 for the same period in 2001, an increase of 27.6 percent. For the nine months ended September 30, 2002, the provision was $2,019,000, compared to $1,389,000 for the year-earlier period, an increase of 45.4 percent. The provision has been increased in 2002 to accommodate loan growth and the level of charge-offs. The allowance for loan losses was $10,626,000, or 1.24 percent, of outstanding loans, at September 30, 2002 and $9,818,000, or 1.31 percent, of outstanding loans at December 31, 2001. The current allowance provides 2.51 times coverage of period end nonperforming loans, which totaled $4,230,000, or 0.49 percent, of period end loans. The allowance for loan losses also provides approximately six times coverage of third quarter annualized net charge-offs. Net charge-offs for the third quarter and year-to-date in 2002 totaled $423,000 and $1,210,000, or an annualized 0.21 percent of average loans, net of unearned income, for both the quarter and first nine months. In the prior year, net charge offs were $555,000, or 0.30 percent, of average loans for the third quarter and $840,000, or 0.15 percent, of average loans for the first three quarters.
With continued economic uncertainty, management anticipates that charge offs in the near term will continue at percentage of loan levels reasonably similar to the 2002 experience. 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 $1,225,000 at September 30, 2002 and $798,000 at the end of 2001. NONINTEREST INCOME AND EXPENSE Noninterest income for the third quarter of 2002 was $4,327,000, compared with $3,172,000 for the same period in 2001, an increase of $1,155,000, or 36.4 percent. For the first nine months of 2002, noninterest income was $12,582,000, compared with $10,019,000 for the same period in 2001, an increase of $2,563,000, or 25.6 percent. The increases in 2002 were primarily attributable to increases in secondary market mortgage fee income of 21 percent, or $366,000, and deposit account service charge increases of 45 percent, or $2,444,000. Noninterest expense for the third quarter of 2002 was $11,276,000, an increase of $2,072,000, or 22.5 percent, from $9,204,000 for the same period in the previous year. For the nine months ended September 30, 2002, noninterest expense increased $5,053,000, or 18.7 percent, to $32,042,000 from $26,989,000 in the year-earlier period. Salaries and employee benefits increased $1,084,000, or 21.2 percent, to $6,203,000 from the third quarter of 2001 to the third quarter of 2002. Comparing the nine month periods, salaries and employee benefits increased $3,232,000, or 22.3 percent, to $17,750,000 in 2002. Other expense was $3,343,000 in the third quarter of 2002, an increase of $1,295,000, or 63.2 percent, from the third quarter of 2001. For the first nine months of 2002, other expense was $9,358,000, an increase of $1,722,000, or 22.6 percent, from the same period a year earlier. Contributing to expense increases during the first three quarters of 2002 were a number of corporate initiatives, including entry into the Greenville, South Carolina market with a new branch opening in June; the opening of two permanent branch facilities, replacing older or temporary facilities; creation of a correspondent banking unit headquartered in Columbia; and a corporate branding campaign associated with the previously announced name changes of the Corporation's subsidiary banks. The latter endeavor was effective in May as each bank adopted "South Carolina Bank and Trust" as part of its title. Salaries and employee benefits increased as both management and staff level positions were added to complement and support these initiatives and as a result of increased commissions paid on higher mortgage loan originations. NET INCOME Net income was $3,255,000 for the third quarter of 2002, an increase of $164,000, or 5.3 percent, compared with $3,091,000 in the third quarter of 2001. For the nine months ended September 30, 2002, net income was up $768,000, or 8.3 percent, to $10,034,000, compared with $9,266,000 in the first nine months of 2001. Comparing the first three quarters of 2001 and 2002, the $3,832,000, or 11.8 percent, increase in net interest income and the $2,563,000, or 25.6 percent, increase in noninterest income were the main contributors to the growth in net income.
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, 2002, shareholders' equity was $100,872,000, an increase of $7,807,000, or 8.4 percent, over $93,065,000 at December 31, 2001. The Corporation and its subsidiaries are subject to certain risk-based capital guidelines. Certain 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, 2002 was 11.73 percent, compared to 12.32 percent at December 31, 2001. The total risk-weighted asset capital ratio was 12.98 at the end of the third quarter of 2002, compared with 13.57 at the end of 2001. 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, 2002, the Corporation's leverage ratio was 8.69 percent, compared to 8.39 percent at December 31, 2001. 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. Management believes that its liquidity position is adequate. Item 4. CONTROLS AND PROCEDURES Within ninety days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President and Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Management necessarily applied its judgment in the process of reviewing these controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. Based upon this evaluation, the Company's President and Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them as to material information relating to the Company, including its consolidated subsidiaries, required to be included in the Company's Exchange Act filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation.
PART II - OTHER INFORMATION Item 1. Legal Proceedings: Neither First National Corporation nor its subsidiaries is a 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. Change 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) The following is a list of exhibits to this report: Exhibit No. Description of Exhibit - ----------- ---------------------- 3.1 Articles of Incorporation of the Registrant, as amended (incorporated by reference to Exhibit 3 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and Exhibits 3.1 and 3.2 to the Current Report on Form 8-K filed on May 23, 1997.) 3.2 Bylaws of the Registrant, as amended (incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1995). 10.1 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Robert R. Hill, Jr. (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.2 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Thomas S. Camp (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.3 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and John C. Pollok (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.4 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Richard C. Mathis (incorporated by reference to Exhibit 4.4 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.5 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and A. Loran Adams (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.6 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Joseph A. Burns (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.7 First National Corporation 2002 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (File No. 333-90014)). 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Executive Officer of the Registrant. 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Financial Officer of the Registrant. (b) No reports on Form 8-K were filed during the quarter.
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST NATIONAL CORPORATION Date: November 13, 2002 /s/ C. JOHN HIPP, III ------------------------------------- PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: November 13, 2002 /s/ RICHARD C. MATHIS ------------------------------------- EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
CERTIFICATION I, C. John Hipp, III certify that: 1. I have reviewed this quarterly report on Form 10-Q of First National Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ C. John Hipp, III - ----------------------- Chief Executive Officer Date: November 13, 2002
CERTIFICATION I, Richard C. Mathis, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First National Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Richard C. Mathis - ------------------------ Chief Financial Officer Date: November 13, 2002
Exhibit Index Exhibit No. Description of Exhibit - ----------- ---------------------- 3.1 Articles of Incorporation of the Registrant, as amended (incorporated by reference to Exhibit 3 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and Exhibits 3.1 and 3.2 to the Current Report on Form 8-K filed on May 23, 1997.) 3.2 Bylaws of the Registrant, as amended (incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1995). 10.1 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Robert R. Hill, Jr. (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.2 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Thomas S. Camp (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.3 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and John C. Pollok (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.4 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Richard C. Mathis (incorporated by reference to Exhibit 4.4 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.5 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and A. Loran Adams (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.6 Restricted Stock Agreement, effective as of January 17, 2002, between the Registrant and Joseph A. Burns (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-8 (File No. 333-86922)). 10.7 First National Corporation 2002 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (File No. 333-90014)). 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Executive Officer of the Registrant. 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by the Chief Financial Officer of the Registrant.