UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20529 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2003 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.) 520 GERVAIS STREET, COLUMBIA, SOUTH CAROLINA 29201 (Address of principal executive offices) (Zip code) (803) 277-2175 (Registrant's telephone number, including area code) 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 reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) Yes [ X ] No [ ] Indicate the number of shares outstanding of each of issuer's classes of common stock: Class Outstanding as of September 30, 2003 Common Stock, $2.50 par value 7,686,107
FIRST NATIONAL CORPORATION INDEX Part I: Financial Information Item 1 - Financial Statements Condensed Consolidated Balance Sheets - September 30, 2003 and December 31, 2002 Condensed Consolidated Statements of Changes In Shareholders' Equity - Nine Months Ended September 30, 2003 and 2002 Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2003 and 2002 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2003 and 2002 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, 2002 Item 4 - Controls and Procedures Part II: Other Information Item 1 - Legal Proceedings Item 4 - Submission of Matters to a Vote of Security Holders Item 6 - Exhibits and Reports on Form 8-K
<TABLE> <CAPTION> PART I - FINANCIAL INFORMATION Item 1. Financial Statements FIRST NATIONAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands of dollars, except par value) 9/30/03 12/31/2002 (Unaudited) (Note 1) --------------------------------------- ASSETS <S> <C> <C> Cash and cash equivalents: Cash and due from banks $ 37,587 $ 40,479 Interest-bearing deposits with banks 27 35 Federal funds sold and securities purchased under agreements to resell - - --------------------------------------- Total cash and cash equivalents 37,614 40,514 --------------------------------------- Investment securities: Held-to-maturity (fair value of $31,573 in 2003 and $34,857 in 2002) 29,973 33,211 Available-for-sale 132,219 131,740 --------------------------------------- Total investment securities 162,192 164,951 --------------------------------------- Loans held for sale 35,924 39,141 --------------------------------------- Loans 914,295 864,815 Less, unearned income (914) (1,393) Less, allowance for loan losses (11,473) (11,065) --------------------------------------- Loans, net 901,908 852,357 --------------------------------------- Premises and equipment, net 32,010 28,186 --------------------------------------- Other assets 24,673 19,799 --------------------------------------- Total assets $ 1,194,321 $ 1,144,948 ======================================= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing $ 184,760 $ 146,104 Interest-bearing 748,752 752,059 --------------------------------------- Total deposits 933,512 898,163 Federal funds purchased and securities sold under agreements to repurchase 95,916 88,616 Notes payable 49,500 49,500 Other liabilities 5,545 5,173 --------------------------------------- Total liabilities 1,084,473 1,041,452 --------------------------------------- Shareholders' equity: Common stock - $2.50 par value; authorized 40,000,000 shares; issued and outstanding 7,686,107 and 7,673,339 shares 19,215 19,183 Surplus 62,639 62,423 Retained earnings 27,426 20,071 Accumulated other comprehensive income 568 1,819 --------------------------------------- Total shareholders' equity 109,848 103,496 --------------------------------------- Total liabilities and shareholders' equity $ 1,194,321 $ 1,144,948 ======================================= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS </TABLE>
<TABLE> <CAPTION> FIRST NATIONAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (Unaudited) (Dollars in thousands) ACCUMULATED COMMON STOCK RETAINED OTHER ------------- RETAINED COMPREHENSIVE SHARES AMOUNT SURPLUS EARNINGS INCOME (LOSS) TOTAL ------ ------ ------- -------- ------------- ----- <S> <C> <C> <C> <C> <C> <C> 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 ========================================================================================= BALANCE, DECEMBER 31, 2002 7,673,339 $ 19,183 $ 62,423 $ 20,071 $ 1,819 $ 103,496 --------------- Comprehensive income: Net income - - - 11,118 - 11,118 Change in net unrealized gain (loss) on securities available-for-sale, net of tax effects - - - - (1,251) (1,251) --------------- Total comprehensive income 9,867 --------------- Cash dividends declared at $.49 per share - - - (3,763) - (3,763) --------------- Exercise stock options 5,173 13 78 - - 91 --------------- Employee stock purchases 7,695 19 142 - - 161 --------------- Restricted stock awards 2,000 5 44 - - 49 --------------- Repurchase of common stock (2,100) (5) (48) - - (53) ----------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 2003 7,686,107 $ 19,215 $ 62,639 $ 27,426 $ 568 $ 109,848 ========================================================================================= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS </TABLE>
<TABLE> <CAPTION> FIRST NATIONAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands of dollars, except per share data) Three Months Ended Nine Months Ended --------------------- -------------------- 9/30/2003 9/30/2002 9/30/2003 9/30/2002 --------- --------- --------- --------- <S> <C> <C> <C> <C> Interest income: Loans, including fees $ 14,867 $ 14,721 $ 44,342 $ 43,083 Investment securities: Taxable 1,189 1,895 3,784 5,786 Tax-exempt 335 414 1,054 1,249 Money market funds - 81 58 333 Federal funds sold and securities purchased under agreements to resell 15 73 88 98 Deposits with banks 5 11 41 43 --------------------------------------------------------- Total interest income 16,411 17,195 49,367 50,592 --------------------------------------------------------- Interest expense: Deposits 2,703 3,670 9,215 11,782 Federal funds purchased and securities sold under agreements to repurchase 155 272 466 695 Notes payable 653 750 1,889 1,863 --------------------------------------------------------- Total interest expense 3,511 4,692 11,570 14,340 --------------------------------------------------------- Net interest income: Net interest income 12,900 12,503 37,797 36,252 Provision for loan losses 831 884 1,900 2,019 --------------------------------------------------------- Net interest income after provision for loan losses 12,069 11,619 35,897 34,233 --------------------------------------------------------- Noninterest income: Service charges on deposit accounts 2,974 2,827 8,653 7,973 Other service charges and fees 3,458 1,545 8,752 4,731 --------------------------------------------------------- Total noninterest income 6,432 4,372 17,405 12,704 --------------------------------------------------------- Noninterest expense: Salaries and employee benefits 7,428 6,203 21,282 17,750 Net occupancy expense 764 616 2,111 1,761 Furniture and equipment expense 1,188 1,057 3,302 3,001 Other expense 3,448 3,400 9,958 9,530 --------------------------------------------------------- Total noninterest expense 12,828 11,276 36,653 32,042 --------------------------------------------------------- Earnings: Income before provision for income taxes 5,673 4,715 16,649 14,895 Provision for income taxes 1,787 1,460 5,531 4,861 --------------------------------------------------------- Net income $ 3,886 $ 3,255 $ 11,118 $ 10,034 ========================================================= Comprehensive income $ 3,010 $ 3,453 $ 9,867 $ 10,780 ========================================================= Earnings per share: Basic $ 0.506 $ 0.424 $ 1.448 $ 1.310 ========================================================= Diluted $ 0.500 $ 0.421 $ 1.435 $ 1.301 ========================================================= Cash dividends per common share $ 0.17 $ 0.16 $ 0.49 $ 0.47 ========================================================= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS </TABLE>
<TABLE> <CAPTION> FIRST NATIONAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands of dollars) Nine Months Ended 9/30/2003 9/30/2002 ---------- ---------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 11,118 $ 10,034 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 1,888 1,085 Provision for loan losses 1,900 2,019 Gain on sale of premises and equipment (5) - Net amortization of investment securities 931 582 Originations of loans held for sale (408,141) (102,365) Proceeds from sale of loans held for sale 411,359 104,369 Net change in: Miscellaneous other assets (4,543) (2,193) Miscellaneous other liabilities 372 1,405 ----------------------------- Net cash provided by operating activities 14,879 14,936 ----------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of investment securities available-for-sale - - Proceeds from maturities of investment securities held to maturity 3,671 2,619 Proceeds from maturities of investment securities available-for-sale 91,661 176,240 Purchases of investment securities available-for-sale (95,047) (158,928) Purchases of investment securities held-to maturity (475) (1,072) Net increase in customer loans (51,989) (93,583) Recoveries of loans previously charged off 539 223 Purchases of premises and equipment (5,293) (8,314) Proceeds from sale of premises and equipment 21 - ----------------------------- Net cash used by investing activities (56,912) (82,815) ----------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 35,349 79,174 Net increase in federal funds purchased and securities sold under agreements to repurchase 7,299 12,009 Federal Home Loan Bank advances 44,000 - Repayment of Federal Home Loan Bank advances (44,000) - Common stock issuance 210 490 Common stock repurchase (53) (265) Dividends paid (3,763) (3,275) Stock options exercised 91 78 ----------------------------- Net cash provided by financing activities 39,133 88,211 ----------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,900) 20,332 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 40,514 41,175 ----------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 37,614 $ 61,507 ============================= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS </TABLE>
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 six months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. The condensed consolidated balance sheet at December 31, 2002, 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 Company's annual report on Form 10-K for the year ended December 31, 2002 should be referenced when reading these unaudited condensed consolidated financial statements. Note 2 - Recent Accounting Pronouncements: In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 148, Accounting for Stock-Based Compensation -- Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The Company continues to account for stock-based compensation under the guidance of Accounting Principles Board ("APB") Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. (See NOTE 5) In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS 149 amends SFAS 133 for certain decisions made by the FASB as part of the Derivatives Implementation Group process. SFAS 149 also amends SFAS 133 to incorporate clarifications of the definition of a derivative. The amendments set forth in SFAS 149 require that contracts with comparable characteristics be accounted for similarly. SFAS also amends certain other existing pronouncements. SFAS 149 is effective for contracts entered into or modified after June 30, 2003, except as stated below, and for hedging
relationships designated after June 30, 2003. In addition, except as stated below, all provisions of SFAS 149 should be applied prospectively. The provisions of SFAS 149 that relate to SFAS 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003. SFAS 149 is not expected to have a material impact on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 is not expected to have a material impact on the Company's consolidated financial statements. 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 ended September 30, 2003 and 2002 are as follows: 3 Months Ended 9 Months Ended 9/30/03 9/30/02 9/30/03 9/30/02 -------- ------- -------- ------- Basic 7,682,611 7,670,216 7,678,418 7,661,533 Diluted 7,764,910 7,739,106 7,750,205 7,715,323 Dividends per share are calculated using the current equivalent number of common shares outstanding at the time of the dividend based on the Company's shares outstanding. Note 4 - Commitments and Contingent Liabilities: In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities, which are not reflected in the accompanying financial statements. The commitments and contingent liabilities include guarantees, commitments to extend credit and standby letters of credit. At September 30, 2003, commitments to extend credit and standby
letters of credit totaled $247,206,000. The Company does not anticipate any material losses as a result of these transactions. Note 5 - Stock-Based Compensation: During 1999 and 1996, the Company adopted stock option plans under which incentive and nonqualified stock options may be granted periodically to key employees and non-employee directors. With the exception of options granted to directors under the 1999 plan, which may be exercised at any time prior to expiration, options granted under the plans may not be exercised in whole or in part within one year following the date of the grant, and thereafter become exercisable in 25% increments over the next four years. No stock-based employee compensation cost is, or is expected to be, reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Had stock-based employee compensation costs of the Company's stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed by SFAS 123, as amended by SFAS 148, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (per share data has been restated to reflect all stock dividends as of September 30, 2003): <TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands of dollars, except per share data) 9/30/2003 9/30/2002 9/30/2003 9/30/2002 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net income, as reported $ 3,886 $ 3,255 $ 11,118 $ 10,034 Less, total stock-based employee compensation expense determined under fair value based method, net of related tax effects 56 18 168 87 ----------------------------- ----------------------------- Pro forma net income $ 3,830 $ 3,237 $ 10,950 $ 9,947 ============================= ============================= Earnings per share: Basic - as reported $ 0.51 $ 0.42 $ 1.45 $ 1.31 ============================= ============================= Basic - pro forma $ 0.50 $ 0.42 $ 1.43 $ 1.30 ============================= ============================= Diluted - as reported $ 0.50 $ 0.42 $ 1.43 $ 1.30 ============================= ============================= Diluted - pro forma $ 0.49 $ 0.42 $ 1.41 $ 1.29 ============================= ============================= </TABLE> The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
Nine Months Ended ------------------- 9/30/2003 9/30/2002 --------- --------- Dividend yield 2.55% 2.63% Expected life 10 years 10 years Expected volatility 30.0% 30.0% Risk-free interest rate 3.35% to 3.82% 3.82%
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 First National Corporation's Annual Report on Form 10-K for the year ended December 31, 2002. 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 (the "Company") cautions readers that forward-looking statements are estimates reflecting the best judgement of the Company's senior management or directors based on current information, and 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. First National Corporation is a bank holding company incorporated under the laws of South Carolina in 1985. The Company owns 100 percent of South Carolina Bank and Trust, National Association, a national bank which opened for business in 1932, and 100 percent of South Carolina Bank and Trust of the Piedmont, National Association, a national bank which opened for business in 1996. In July 2003, the Company completed the merger of South Carolina Bank and Trust of the Pee Dee, National Association, with its lead bank, South Carolina Bank and Trust, National Association. In October 2003, the Company announced a preliminary agreement to acquire another institution's bank branch in Denmark, South Carolina. Pending regulatory approvals, the purchase is expected to occur in the first quarter of 2004 and provide South Carolina Bank and Trust, N.A. with an enhanced presence in that market. The Company engages in no significant operations other than the ownership of its subsidiaries. Some of the major services which the Company provides 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 Company 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 Company. The Company does not have foreign loans or deposits. For the third quarter of 2003, the Company had consolidated net income of $3,886,000, an increase of 19.4 percent over the $3,255,000 earned in the third quarter of 2002. Diluted earnings per share were $0.50 for the three months ended September 30, 2003, a 19.1 percent increase over the $0.42 per share earned in the third quarter of 2002. Net income for the first nine months of 2003 was $11,118,000, an increase of 10.8 percent over the $10,034,000 earned for the same period in 2002. Diluted earnings per share were $1.43 for the nine months ended September 30, 2003, a 10.0 percent increase over the $1.30 per share earned during the first nine months of 2002. NET INTEREST INCOME For the third quarter of 2003, net interest income was $12,900,000, an increase of $397,000, or 3.2 percent, over $12,503,000 for the same period in 2002. For the first nine months of 2003, net interest income was $37,797,000, an increase of $1,545,000, or 4.3 percent, compared with $36,252,000 for the same period a year earlier. This increase was largely the result of significantly lower rates paid on higher average levels of interest-bearing liabilities in the first nine months of 2003, as compared with the same period in 2002. The yield on a major portion of the Company's earning assets adjusts simultaneously, but to varying degrees of magnitude, with changes in the general level of interest rates. The prolonged low interest rate environment has continued to pressure the net interest margins of depository institutions. For the first nine months of 2003, the Company's non-taxable equivalent yield on interest earning assets was 5.86 percent, as compared with 6.71 percent during the same period in 2002, a decrease of 85 basis points. The cost of interest-bearing liabilities used to fund most of these assets decreased 62 basis points from 2.31 percent in 2002 to 1.69 percent in 2003. Thus, comparing the first nine months of 2003 and 2002, the yield on interest earning assets declined more rapidly than interest rates paid on interest-bearing liabilities. Consequently, during the first nine-month periods of 2003 and 2002, the net interest margin, on a taxable equivalent basis, decreased from 4.90 percent to 4.57 percent. Loans comprise the largest category of earning assets. As of September 30, 2003, loans, net of unearned income and excluding mortgage loans held for sale, were $913,381,000, compared with $863,422,000 at December 31, 2002. This increase of $49,959,000, or 5.8 percent, was most noticeable in the commercial real estate and residential mortgage loan categories. Mortgage loans held for sale decreased by $3,217,000, or 8.2 percent, from $39,141,000 at December 31, 2002 to $35,924,000 at September 30, 2003, reflecting some upward long-term rate movement during the second and third quarters of 2003. For the third quarter of 2003, interest and fees on portfolio loans and interest on mortgage loans held for sale, were $14,867,000, compared with $14,721,000 for the comparable period in 2002, an increase of $146,000, or 1.0 percent. For the first nine months of the year, interest and fees on portfolio loans and interest on mortgage loans held for sale were $44,342,000, compared with $43,083,000 for the same period in 2002, an increase of $1,259,000, or 2.9 percent. Higher loan volumes offset the effects of declining interest rates during the first three quarters of 2003. During this period, loans, including mortgage loans held for sale, averaged $943,204,000 and decreased in yield by 93 basis points to 6.27 percent on a non-taxable equivalent basis, compared to $806,801,000 and a yield of 7.20 percent for the year ended December 31, 2002.
Investment securities, the second largest category of earning assets, 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 deposits and purchased funds. At September 30, 2003, investment securities were $162,192,000, compared to $164,951,000 at December 31, 2002. The composition of the portfolio remained relatively consistent during the first nine months of 2003, with a bias toward shorter maturities in the continuing low rate environment. At the end of the third quarter of 2003, the portfolio included $20,060,000 of short-term government agency securities, a decrease of $1,881,000, or 8.6 percent, from $21,941,000 invested at December 31, 2002. For the quarter ended September 30, 2003, interest earned on investment securities was $1,524,000, compared with $2,309,000 for the comparable period in 2002, a decrease of $785,000, or 34.0 percent. For the nine months ended September 30, 2003, interest income was $4,838,000, compared with $7,035,000 for the same period in 2002. This decrease of $2,197,000, or 31.2 percent, was the result of significantly lower yields in 2003 and a cautious bias toward shorter-term securities. For the first nine months of 2003, investment securities averaged $170,220,000 with a non-taxable equivalent yield of 3.91 percent, compared to an average of $205,430,000 and yield of 4.48 percent for the year ended December 31, 2002. There were no gains or losses on sales of securities during the first nine months of 2003 or 2002. As of September 30, 2003, the Company had unrealized gains of $1,600,000 and $460,000, 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 Company 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 The Company has from time to time invested on a short-term basis in government agency-backed money market funds. There were no such investments outstanding at either December 31, 2002 or September 30, 2003. For the first nine months of 2003, interest income of $58,000 was earned on average money market fund balances of $6,526,000. For the same period in 2002, interest income of $333,000 was earned on average balances of $25,181,000. During the first nine months of 2003, the average balance of interest-bearing liabilities was $917,877,000, a $75,658,000, or 9.0 percent, increase over the twelve-month average of $842,219,000 in 2002. Interest expense of $11,570,000 was incurred on an average rate of 1.69 percent for the first nine months of 2003, compared with expense of $18,748,000 and an average rate of 2.23 percent for the full year 2002. At September 30, 2003, approximately 48 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, 2003 was $831,000, compared with $884,000 for the same period in 2002, a decrease of 6.0 percent. For the nine months ended September 30, 2003, the provision was $1,900,000, compared to $2,019,000 for the
same period in 2002, a decrease of 5.9 percent. The provision is intended to accommodate loan growth and the level of charge-offs. The allowance for loan losses was $11,473,000, or 1.26 percent, of outstanding loans at September 30, 2003 and $11,065,000, or 1.28 percent, of outstanding loans at December 31, 2002. The allowance at September 30, 2003 provided 2.0 times coverage of nonperforming loans, which totaled $5,724,000, or 0.63 percent, of period end loans. The allowance for loan losses also provides approximately 6.2 times coverage of third quarter annualized net charge-offs. In 2003, net charge-offs for the third quarter and year-to-date were $470,000 and $1,492,000, respectively. This represents an annualized 0.21 percent of average loans, net of unearned income, for the quarter and 0.22 percent for the first nine months. In the prior year, net charge offs were $424,000, or 0.21 percent, of average loans for the third quarter and $1,227,000, or 0.21 percent, of average loans for the first nine months. While some recent statistics have been encouraging, there remains much uncertainty as to the timing or strength of an economic upturn. In this climate, management anticipates that charge offs in the near term will continue at percentage of loan levels reasonably similar to the experience thus far in 2003. 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 real estate acquired as a result of foreclosure. The balance in other real estate owned was $1,540,000 at September 30, 2003 and $1,051,000 at the December 31, 2002. NONINTEREST INCOME AND EXPENSE Noninterest income for the third quarter of 2003 was $6,432,000, compared with $4,372,000 for the same period in 2002, an increase of $2,060,000, or 47.1 percent. For the first nine months of 2003, noninterest income was $17,405,000, compared with $12,704,000 for the same period in 2002, an increase of $4,701,000, or 37.0 percent. In the nine-month comparisons, these increases have been mainly attributable to increases in secondary market mortgage fee income and in service charges on deposit accounts. Secondary market mortgage fees increased by $3,360,000, or 156.4 percent, reflecting strong residential loan production. Service charges on deposit accounts increased by $800,000, or 10.2 percent, in line with the 11.1 percent increase in average total deposits in the comparative nine-month periods. Noninterest expense for the third quarter of 2003 was $12,828,000, an increase of $1,552,000, or 13.8 percent, from $11,276,000 for the same period in 2002. For the nine months ended September 30, 2003, noninterest expense increased $4,611,000, or 14.4 percent, to $36,653,000 from $32,042,000 in the first nine months of 2002. Salaries and employee benefits increased $1,225,000, or 19.8 percent, to $7,428,000 from the third quarter of 2002 to the same period in 2003. Comparing nine-month periods, salaries and employee benefits increased $3,532,000, or 19.9 percent, to $21,282,000 in 2003. Other expense was $3,448,000 in the third quarter of 2003, an increase of $48,000, or 1.4 percent, from the third quarter of 2002. For the first nine months of 2003, other expense was $9,958,000, an increase of $428,000, or 4.5 percent, from the same period a year earlier. Expense increases during the first nine months of 2003 were attributable to higher staffing levels in support of the Company's continued growth and entry into new markets; planned salary and incentive increases; higher benefit costs associated with additional employees and increases
in group insurance premiums and pension plan costs; and increased commissions paid to loan originators, based on sharply higher loan production levels. Additional expenses were incurred in early 2003 with the completion of the Company's headquarters facility in Columbia, South Carolina, and the relocation of both the corporate offices and the main branch of the Midlands Region of South Carolina Bank and Trust, N.A. Also during the first half of 2003, South Carolina Bank and Trust of the Piedmont, N.A., opened a new full-service banking facility on East Main Street in Rock Hill, South Carolina. NET INCOME Net income was $3,886,000 for the third quarter of 2003, an increase of $631,000, or 19.4 percent, compared with $3,255,000 in the third quarter of 2002. For the first three quarters of 2003, net income was $11,118,000, an increase of $1,084,000, or 10.8 percent, compared with $10,034,000 in the previous year. In nine-month comparisons, the $4,823,000, or 38.3 percent, increase in noninterest income was the main driver of earnings growth. Net interest income contributed with an increase of $1,423,000, or 3.9 percent. CAPITAL RESOURCES AND LIQUIDITY The ongoing capital requirements of the Company have been met through retained earnings, less the payment of cash dividends. As of September 30, 2003, shareholders' equity was $109,848,000, an increase of $6,352,000, or 6.1 percent, over $103,496,000 at December 31, 2002. The Company 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 Company's Tier 1 risk-weighted asset capital ratios at September 30, 2003 and December 31, 2002 were 11.68 and 11.67, respectively. The total risk-weighted asset capital ratios were 12.94 at the end of the third quarter of 2003 and 12.92 at December 31, 2002. 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, 2003, the Company's leverage ratio was 8.59 percent, compared to 8.70 percent at December 31, 2002. The Company's capital ratios currently well exceed the minimum standards. Liquidity is the ability of the Company 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 Company's liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from the use of federal funds purchased and securities sold under
agreements to repurchase. Additional liquidity can be secured from lines of credit extended to the Company from its correspondent banks. Management believes that its liquidity position is adequate. Item 4. CONTROLS AND PROCEDURES 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 as of the end of the period covered by this report. 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 were effective as of the end of the period covered by this report. There were no changes in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's control over financial reporting.
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). 31 Rule 13a-14(a)/15d-14(a) Certifications 32 Section 1350 Certifications (b) Reports on Form 8-K: Current Report on Form 8-K, Item 12, dated July 17, 2003 and furnished to the Securities and Exchange Commission on July 17, 2003. Current Report on Form 8-K, Item 9, dated August 6. 2003 and furnished to the Securities and Exchange Commission on August 6, 2003. Current Report on Form 8-K, Item 9, dated August 7, 2003 and furnished to the Securities and Exchange Commission on August 7, 2003. Current Report on Form 8-K, Item 9, dated August 21, 2003 and furnished to the Securities and Exchange Commission on August 21, 2003.
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, 2003 /s/ C. John Hipp, III --------------------- President and Chief Executive Officer Date: November 13, 2003 /s/ Richard C. Mathis --------------------- Executive Vice President and Chief Financial Officer Exhibit Index Exhibit No. Description of Exhibit - ----------- ---------------------- 31 Rule 13a-14(a)/15d-14(a) Certifications. 32 Section 1350 Certifications.