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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2002
Commission file number 001-12669
FIRST NATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
South Carolina 57-0799315
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
520 Gervais Street
Columbia, South Carolina 29201
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(Address of principal executive offices, including zip code)
(800) 277-2175
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
Common Stock - $2.50 par value American Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None.
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
The aggregate market value of the voting stock of the registrant held by
non-affiliates was $174,657,000 based on the closing sale price of $27.455 per
share on June 30, 2002. For purposes of the foregoing calculation only, all
directors and executive officers of the registrant have been deemed affiliates.
The number of shares of common stock outstanding as of March 11, 2003 was
7,673,339.
Documents Incorporated by Reference
Portions of the Registrant's 2002 Annual Report to Shareholders are incorporated
by reference into Part II. Portions of the Registrant's Proxy Statement for its
2002 Annual Meeting of Shareholders are incorporated by reference into Part III.
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FORM 10-K CROSS-REFERENCE INDEX
Page
PART I
Item 1. Business ........................................................ 1
Item 2. Properties ...................................................... 6
Item 3. Legal Proceedings ............................................... 6
Item 4. Submission of Matters to a Vote of Security Holders ............. 7
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters (1) ....................................... 8
Item 6. Selected Financial Data (1) ..................................... 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 8
Item 7a. Quantitative and Qualitative Disclosure about Market Risk ....... 24
Item 8. Financial Statements and Supplementary Data ..................... 25
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosures .......................... 53
PART III
Item 10. Directors and Executive Officers of the Registrant (2) .......... 53
Item 11. Executive Compensation (2) ...................................... 53
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters(2) ................. 54
Item 13. Certain Relationships and Related Transactions (2) .............. 54
Item 14. Controls and Procedures ......................................... 54
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ................................................... 54
(1) Incorporated by reference to the Registrant's 2002 Annual Report to
Shareholders.
(2) Incorporated by reference to the Registrant's Proxy Statement for its 2003
Annual Meeting of Shareholders.
FORWARD LOOKING STATEMENTS
Statements included in this report, including 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 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 risk factors 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 rate risk involving the effect of a change in interest rates on both
the bank's earnings and the market value of 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
affects earnings or capital arising from negative public opinion.
PART I
ITEM 1. BUSINESS
GENERAL
First National Corporation (the "Company") is a bank holding company
incorporated under the laws of South Carolina in 1985. The Company owns 100% of
four subsidiaries, namely South Carolina Bank and Trust, N.A. (formerly First
National Bank), a national bank which opened for business in 1934; South
Carolina Bank and Trust of the Piedmont, N.A. (formerly National Bank of York
County), a national bank which opened for business in 1996; South Carolina Bank
and Trust of the Pee Dee, N.A. (formerly National Bank of Florence County), a
national bank which opened for business in 1998; and CreditSouth Financial
Services Corporation, a consumer finance company, which opened for business in
1998. As noted above, the names of the Company's banking subsidiaries were
changed in May 2002 in order to bring the group under a common marketing
identity.
On December 1, 2002, South Carolina Bank and Trust, N.A., acquired the
majority of the consumer loan portfolio and related assets of CreditSouth
Financial Services Corporation and assumed the continuing lending activities of
that business. Thereafter, CreditSouth Financial Services Corporation ceased
active lending programs and focused on servicing a retained portfolio of loans
that were delinquent at the time of the acquisition.
Some of the major services which the Company provides through its banking
subsidiaries include checking, NOW accounts, savings and other time deposits of
various types, alternative investment products such as annuities and mutual
funds, loans for businesses, agriculture, real estate, personal use, home
improvement and automobiles, credit cards, letters of credit, home equity lines
of credit, safe deposit boxes, bank money orders, wire transfer services, asset
management services, discount brokerage services, and use of ATM facilities. The
Company has no material concentration of deposits from any single customer or
group of customers, and no significant portion of its loans is concentrated
within a single industry or group of related industries. There are no material
seasonal factors that would have a material adverse effect on the Company. The
Company does not have any foreign loans.
In January 2003, the Company moved its principal executive offices to 520
Gervais Street, Columbia, South Carolina 29201. The Company's mailing address at
its new headquarters is P.O. Box 1030, Columbia, South Carolina 29202, and its
telephone number is (800) 277-2175.
The Company maintains an Internet site at http://www.scbandt.com.. The
information contained in the Company's web site is not incorporated into this
report. During 2002, the Company did not make its annual reports on Form 10-K,
quarterly reports on Form 10-Q, or current reports on Form 8-K, or any
amendments to these reports, available through its web site. However, the
Company is in the process of modifying its web site to permit the public to
obtain these reports through the Company's web site. In addition, these reports
are available to the public through the SEC's web site at http://www.sec.gov.
The Company will also provide shareholders with a copy of any of these reports
free of charge upon request.
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TERRITORY SERVED AND COMPETITION
South Carolina Bank and Trust, N.A. conducts its business from 24 full
service offices in 19 South Carolina towns. South Carolina Bank and Trust of the
Piedmont, N.A. conducts its business from four locations in three South Carolina
towns. South Carolina Bank and Trust of the Pee Dee, N.A. conducts its business
from two locations in two South Carolina towns. In their markets, the three
banks (the "Banks") encounter strong competition from several major banks that
dominate the commercial banking industry in their service areas and in South
Carolina generally. Several competitors have substantially greater resources and
higher lending limits than the Banks and they offer certain services for their
customers that the Banks do not offer. In addition to commercial banks, savings
institutions and credit unions, the Banks compete for deposits and loans with
other financial intermediaries and investment alternatives, including mortgage
companies, credit card issuers, leasing companies, finance companies, money
market mutual funds, brokerage firms, governmental and corporation bonds and
other securities. Various of these nonbank competitors are not subject to the
same regulatory restrictions as the Company and many have substantially greater
resources than the Company.
As a bank holding company, the Company is a legal entity separate and
distinct from its subsidiaries. The Company coordinates the financial resources
of the consolidated enterprise and maintains financial, operational and
administrative systems that allow centralized evaluation of subsidiary
operations and coordination of selected policies and activities. The Company's
operating revenues and net income are derived primarily from its subsidiaries
through dividends.
EMPLOYEES
The Company does not have any salaried employees. As of December 31, 2002,
the Company's subsidiaries had 480 full-time equivalent employees. The Company
considers its relationship with its employees to be excellent. The employee
benefit programs the Company provides include group life, health and dental
insurance, paid vacation, sick leave, educational opportunities, a cash
incentive plan, a stock award program, a stock purchase plan, stock option plans
for officers and key employees, a defined benefit pension plan, and a 401K plan.
SUPERVISION AND REGULATION
GENERAL
The Company is a "bank holding company" registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") and is
subject to the supervision of, and to regular inspection by, the Federal Reserve
Board. Each of the Banks is organized as a national banking association and
subject to regulation, supervision and examination by the Office of the
Comptroller of the Currency (the "OCC"). In addition, the Company and each of
the Banks is subject to regulation (and in certain cases examination) by the
Federal Deposit Insurance Corporation (the "FDIC"), other federal regulatory
agencies and the South Carolina State Board of Financial Institutions (the
"State Board"). The following discussion summarizes certain aspects of banking
and other laws and regulations that affect the Company and its subsidiaries.
Under the Bank Holding Company Act (the "BHC Act"), the Company's
activities and those of its subsidiaries are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiaries, or any other activity which the Federal Reserve Board determines
to be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. The BHC Act requires prior Federal Reserve Board
approval for, among other things, the acquisition by a bank holding company of
direct or indirect ownership or control of more than 5% of the voting shares or
substantially all the assets of any bank, or for a merger or consolidation of a
bank holding company with another bank holding company. The BHC Act also
prohibits a bank holding company from acquiring direct or indirect control of
more than 5% of the outstanding voting stock of any company engaged in a
non-banking business unless such business is determined by the Federal Reserve
Board to be so closely related to banking as to be a proper incident thereto.
Further, under South Carolina law, it is unlawful without the prior approval of
the State Board for any South Carolina bank holding company (i) to acquire
direct or indirect ownership or control of more than 5% of the voting shares of
any bank or any other bank holding company, (ii) to acquire all or substantially
all of the assets of a bank or any other bank holding company, or (iii) to merge
or consolidate with any other bank holding company.
The Graham-Leach-Bliley Act amended a number of federal banking laws
affecting the Company and the Banks. In particular, the Graham-Leach-Bliley Act
permits a bank holding company to elect to become a "financial holding company,"
provided certain conditions are met. A financial holding company, and the
companies it controls, are permitted to engage in activities considered
"financial in nature" as defined by the Graham-Leach-Bliley Act and Federal
Reserve Board interpretations (including, without limitation, insurance and
securities activities), and therefore may engage in a broader range of
activities than permitted by bank holding companies and their subsidiaries. The
Company continues to evaluate whether to seek to become a financial holding
company under the Graham-Leach-Bliley Act.
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INTERSTATE BANKING
In July 1994, South Carolina enacted legislation which effectively provided
that, after June 30, 1996, out-of-state bank holding companies may acquire other
banks or bank holding companies in South Carolina, subject to certain
conditions. Further, pursuant to the Riegel-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act"), a
bank holding company became able to acquire banks in states other than its home
state, beginning in September 1995, without regard to the permissibility of such
acquisition under state law, subject to certain exceptions. The Interstate
Banking and Branching Act also authorized banks to merge across state lines,
thereby creating interstate branches, unless a state, prior to the July 1, 1997
effective date, determined to "opt out" of coverage under this provision. In
addition, the Interstate Banking and Branching Efficiency Act authorized a bank
to open new branches in a state in which it does not already have banking
operations if such state enacted a law permitting such "de novo" branching.
Effective July 1, 1996, South Carolina law was amended to permit interstate
branching but not de novo branching by an out-of-state bank. The Company
believes that the foregoing legislation has increased takeover activity of South
Carolina financial institutions by out-of-state financial institutions.
OBLIGATIONS OF HOLDING COMPANY TO ITS SUBSIDIARY BANKS
Under the policy of the Federal Reserve Board, a bank holding company is
required to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it otherwise might not desire or be able to do. Under the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), to
avoid receivership of its insured depository institution subsidiary, a bank
holding company is required to guarantee the compliance of any insured
depository institution subsidiary that may become "undercapitalized" within the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution became
undercapitalized, or (ii) the amount which is necessary (or would have been
necessary) to bring the institution into compliance with all applicable capital
standards as of the time the institution fails to comply with such capital
restoration plan.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended ("FDIA"), require insured depository institutions
under common control to reimburse the FDIC for any loss suffered or reasonably
anticipated by the FDIC as a result of the default of a commonly controlled
insured depository institution or for any assistance provided by the FDIC to a
commonly controlled insured depository institution in danger of default. The
FDIC's claim for damages is superior to claims of stockholders of the insured
depository institution or its holding company but is subordinate to claims of
depositors, secured creditors and holders of subordinated debt (other than
affiliates) of the commonly controlled insured depository institutions.
The FDIA also provides that amounts received from the liquidation or other
resolution of any insured depository institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit liabilities of
the institution prior to payment of any other general or unsecured senior
liability, subordinated liability, general creditor or stockholder. This
provision would give depositors a preference over general and subordinated
creditors and stockholders in the event a receiver is appointed to distribute
the assets of the Banks.
Any capital loans by a bank holding company to any of its subsidiary banks
are subordinate in right of payment to deposits and to certain other
indebtedness of such subsidiary bank. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and entitled to a priority of payment.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require payment of the
deficiency by assessment upon the bank's shareholders', pro rata, and if any
such assessment is not paid by any shareholder after three months notice, to
sell the stock of such shareholder to make good the deficiency.
CAPITAL ADEQUACY
The various federal bank regulators, including the Federal Reserve Board
and the OCC, have adopted risk-based capital requirements for assessing bank
holding company and bank capital adequacy. These standards define what qualifies
as capital and establish minimum capital standards in relation to assets and
off-balance sheet exposures, as adjusted for credit risks. Capital is classified
into tiers. For bank holding companies, Tier 1 or "core" capital consists
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primarily of common and qualifying preferred shareholders' equity, less certain
intangibles and other adjustments ("Tier 1 Capital"). Tier 2 capital consists
primarily of the allowance for possible loan losses (subject to certain
limitations) and certain subordinated and other qualifying debt ("Tier 2
Capital"). A minimum ratio of total capital to risk-weighted assets of 8.00% is
required and Tier 1 Capital must be at least 50% of total capital. The Federal
Reserve Board also has adopted a minimum leverage ratio of Tier 1 Capital to
adjusted average total assets (not risk-weighted) of 3%. The 3% Tier 1 Capital
to average total assets ratio constitutes the leverage standard for bank holding
companies and national banks, and is used in conjunction with the risk-based
ratio in determining the overall capital adequacy of banking organizations.
The Federal Reserve Board and the OCC have emphasized that the foregoing
standards are supervisory minimums and that an institution would be permitted to
maintain such levels of capital only if it had a composite rating of "1" under
the regulatory rating systems for bank holding companies and banks. All other
bank holding companies are required to maintain a leverage ratio of 3% plus at
least 1% to 2% of additional capital. These rules further provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain capital positions substantially above the minimum
supervisory levels and comparable to peer group averages, without significant
reliance on intangible assets. The Federal Reserve Board continues to consider a
"tangible Tier 1 leverage ratio" in evaluating proposals for expansion or new
activities. The tangible Tier 1 leverage ratio is the ratio of a banking
organization's Tier 1 Capital less all intangibles, to total assets, less all
intangibles. The Federal Reserve Board has not advised the Company of any
specific minimum leverage ratio applicable to it. As of December 31, 2002, the
Company, South Carolina Bank and Trust, N.A., South Carolina Bank and Trust of
the Piedmont, N.A., and South Carolina Bank and Trust of the Pee Dee, N.A. had
leverage ratios of 8.70%, 8.23%, 8.15% and 10.43%, respectively, and total risk
adjusted capital of 12.92%, 12.12%, 12.57%, and 13.85%, respectively.
FDICIA, among other things, identifies five capital categories for insured
depository institutions (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized) and requires the respective Federal regulatory agencies to
implement systems for "prompt corrective action" for insured depository
institutions that do not meet minimum capital requirements within such
categories. FDICIA also imposes progressively more restrictive constraints on
operations, management and capital distributions, depending on the category in
which an institution is classified. Failure to meet the capital guidelines could
also subject a banking institution to capital raising requirements. An
"undercapitalized" bank must develop a capital restoration plan and its parent
holding company must guarantee that bank's compliance with the plan (see
"Obligations of Holding Company to its Subsidiary Banks," above). In addition,
FDICIA requires the various regulatory agencies to prescribe certain non-capital
standards for safety and soundness relating generally to operations and
management, asset quality and executive compensation and permits regulatory
action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar
regulations that define the five capital categories identified by FDICIA, using
the total risk-based capital, Tier 1 risk-based capital and leverage capital
ratios as the relevant capital measures. Such regulations establish various
degrees of corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 capital ratio of at least 6%, a total capital ratio of at least
10% and a leverage ratio of at least 5% and not be subject to a capital
directive order. An "adequately capitalized" institution must have a Tier 1
capital ratio of at least 4%, a total capital ratio of a least 8% and a leverage
ratio of a least 4%, or 3% in some cases. Under these guidelines, each of the
Banks is considered well capitalized.
Banking agencies have also adopted final regulations which mandate that
regulators take into consideration (i) concentration of credit risk, (ii)
interest rate risk (when the interest rate sensitivity of an institution's
assets does not match the sensitivity of its liabilities or its
off-balance-sheet position), and (iii) risks from non-traditional activities, as
well as an institution's ability to manage those risks, when determining the
adequacy of an institution's capital. That evaluation will be made as a part of
the institution's regular safety and soundness examination. In addition, the
banking agencies have amended their regulatory capital guidelines to incorporate
a measure for market risk. In accordance with the amended guidelines, the
Company and the Banks with significant trading activity (as defined in the
amendment) must incorporate a measure for market risk in their respective
regulatory capital calculations effective for reporting periods after January 1,
1998.
PAYMENT OF DIVIDENDS
The Company is a legal entity separate and distinct from its subsidiaries,
and the Company's funds for cash distributions to its shareholders are derived
primarily from dividends received from the Banks. Each of the Banks is subject
to various general regulatory policies and requirements relating to the payment
of dividends. Any restriction on the ability of the Banks to pay dividends will
indirectly restrict the ability of the Company to pay dividends.
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The approval of the OCC is required if the total of all dividends declared
by a national bank in any calendar year will exceed the total of its retained
net profits for that year combined with its retained net profits for the two
preceding years, less any required transfers to surplus. In addition, national
banks can only pay dividends to the extent that retained net profits (including
the portion transferred to surplus) exceed statutory bad debts in excess of the
bank's allowance for loan losses. Further, if in the opinion of the OCC a bank
under its jurisdiction is engaged in or is about to engage in an unsafe or
unsound practice (which, depending on the financial condition of the bank, could
include the payment of dividends), the OCC may require, after notice and a
hearing, that such bank cease and desist from such practice. The OCC has
indicated that paying dividends that deplete a national bank's capital base to
an inadequate level would be an unsafe and unsound banking practice. The Federal
Reserve Board, the OCC and the FDIC have issued policy statements which provide
that bank holding companies and insured banks should generally only pay
dividends out of current operating earnings.
In addition to the foregoing, the ability of the Company and the Banks to
pay dividends may be affected by the various minimum capital requirements and
the capital and non-capital standards established under FDICIA, as described
above. The right of the Company, its shareholders and its creditors to
participate in any distribution of the assets or earnings of its subsidiaries is
further subject to the prior claims of creditors of the Company's subsidiaries.
CERTAIN TRANSACTIONS BY THE COMPANY AND ITS AFFILIATES
Various legal limitations place restrictions on the ability of the Banks to
lend or otherwise supply funds to the Company. The Federal Reserve Act limits a
bank's "covered transactions," which include extensions of credit, with any
affiliate to 10% of such bank's capital and surplus. All covered transactions
with all affiliates cannot in the aggregate exceed 20% of a bank's capital and
surplus. All covered and exempt transactions between a bank and its affiliates
must be on terms and conditions consistent with safe and sound banking
practices, and banks and their subsidiaries are prohibited from purchasing
low-quality assets from the bank's affiliates. Also, the Federal Reserve Act
requires that all of a bank's extensions of credit to an affiliate be
appropriately secured by acceptable collateral, generally United States
government or agency securities. In addition, the Federal Reserve Act limits
covered and other transactions among affiliates to terms and circumstances,
including credit standards, that are substantially the same or at least as
favorable to a bank holding company, a bank or a subsidiary of either as
prevailing at the time for transactions with unaffiliated companies.
INSURANCE OF DEPOSITS
As FDIC-insured institutions, the Banks are subject to insurance
assessments imposed by the FDIC. Under current law, the insurance assessment to
be paid by FDIC-insured institutions is as specified in a schedule required to
be issued by the FDIC that specifies, at semi-annual intervals, target reserve
ratios designed to increase the FDIC insurance fund's reserve ratio to 1.25% of
estimated insured deposits (or such higher ratio as the FDIC may determine in
accordance with the statute) in 15 years. Further, the FDIC is authorized to
impose one or more special assessments in any amount deemed necessary to enable
repayment of amounts borrowed by the FDIC from the United States Department of
the Treasury. The actual assessment to be paid by each FDIC-insured institution
is based on the institution's assessment risk classification, which is
determined based on whether the institution is considered "well capitalized,"
"adequately capitalized" or "undercapitalized", as such terms have been defined
in applicable federal regulations, and whether such institution is considered by
its supervisory agency to be financially sound or to have supervisory concerns
(see "--Capital Adequacy" above). As a result of the current provisions of
federal law, the assessment rates on deposits could increase over present
levels. Based on the current financial condition and capital levels of the
Banks, the Company does not expect that the current FDIC risk-based assessment
schedule will have a material adverse effect on the Banks' earnings in 2003.
INTERNATIONAL MONEY LAUNDERING ABATEMENT AND FINANCIAL ANTI-TERRORISM
ACT OF 2001
On October 26, 2001, the President signed the USA Patriot Act of 2001 into
law. This act contains the international Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (the "IMLAFA"). The IMLAFA contains
anti-money laundering measures affecting insured depository institutions,
broker-dealers and certain other financial institutions. The IMLAFA requires U.
S. financial institutions to adopt new policies and procedures to combat money
laundering and grants the Secretary of the Treasury broad authority to establish
regulations and to impose requirements and restrictions on financial
institution's operations. The Company has adopted policies and procedures to
comply with the provisions of the Act.
OTHER LAWS AND REGULATIONS
Interest and certain other charges collected or contracted for by the Banks
are subject to state usury laws and certain federal laws concerning interest
rates. The Banks' operations are also subject to certain federal laws applicable
to credit
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transactions, such as the federal Truth-In-Lending Act governing disclosures of
credit terms to consumer borrowers, the Community Reinvestment Act requiring
financial institutions to meet their obligations to provide for the total credit
needs of the communities they serve (which includes the investment of assets in
loans to low- and moderate-income borrowers), the Home Mortgage Disclosure Act
of 1975 requiring financial institutions to provide information to enable the
public and public officials to determine whether a financial institution is
fulfilling its obligation to help meet the housing needs of the community it
serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis
of race, creed or other prohibited factors in extending credit, the Fair Credit
Reporting Act of 1978 governing the use and provision of information to credit
reporting agencies, the Fair Debt Collection Act governing the manner in which
consumer debts may be collected by collection agencies, and the rules and
regulations of the various federal agencies charged with the responsibility of
implementing such federal laws. The deposit operations of the Banks also are
subject to the Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes procedures for
complying with administrative subpoenas of financial records, and the Electronic
Funds Transfer Act and Regulation E issued by the Federal Reserve Board to
implement that act, which govern automatic deposits to and withdrawals from
deposit accounts and customers' rights and liabilities arising from the use of
automated teller machines and other electronic banking services.
From time to time, bills are pending before the United States Congress and
in the South Carolina state legislature which in certain cases contain
wide-ranging proposals for altering the structure, regulation and competitive
relationships of financial institutions. Among such bills are proposals to
prohibit banks and bank holding companies from conducting certain types of
activities, to subject banks to increased disclosure and reporting requirements,
to alter the statutory separation of commercial and investment banking, and to
further expand the powers of banks, bank holding companies and competitors of
banks. It cannot be predicted whether or in what form any of these proposals
will be adopted or the extent to which the business of the Company and its
subsidiaries may be affected thereby.
FISCAL AND MONETARY POLICY
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
its other borrowings, and the interest received by a bank on its loans and
securities holdings, constitute the major portion of a bank's earnings. Thus,
the earnings and growth of the Company will be subject to the influence of
economic conditions generally, both domestic and foreign, and also to the
monetary and fiscal policies of the United States and its agencies, particularly
the Federal Reserve Board. The Federal Reserve Board regulates the supply of
money through various means, including open-market dealings in United States
government securities, the discount rate at which banks may borrow from the
Federal Reserve Board, and the reserve requirements on deposits. The nature and
timing of any changes in such policies and their impact on the Company cannot be
predicted.
ITEM 2. PROPERTIES
In January 2003 the Company relocated its executive headquarters to a new
four-story facility at 520 Gervais Street, Columbia, South Carolina. The lead
branch in the Midlands region of South Carolina Bank and Trust, N.A. also moved
into the 57,000 square foot building. The main offices of South Carolina Bank
and Trust, N.A. are located at 950 John C. Calhoun Drive, S.E., Orangeburg,
South Carolina in a four-story facility that affords 48,000 square feet of space
for operating and administrative purposes. Both of these facilities are owned by
South Carolina Bank and Trust, N.A, which also owns 23 other properties and
leases 15 properties, substantially all of which are used as branch locations or
for housing other operational units.
South Carolina Bank and Trust of the Piedmont, N.A. owns a 12,000 square
foot office building that serves as its main office located at 1127 Ebenezer
Road, Rock Hill, South Carolina. The bank also owns one additional property and
leases two others, which are used as branches. South Carolina Bank and Trust of
the Pee Dee, N.A. owns a 9,000 square foot office building that serves as its
main office located at 1600 W. Palmetto Street, Florence, South Carolina, and
leases one property which is used as a branch.
Although the properties leased and owned are generally considered adequate,
there is a continuing program of modernization, expansion, and, as needs
materialize, occasional replacement of facilities.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party to, nor is any
of their property the subject of, any material pending legal proceedings, other
than ordinary routine proceedings incidental to its business.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders in the fourth quarter
of 2002.
EXECUTIVE OFFICERS
C. John Hipp, III (Age 51). Mr. Hipp has served as President and Chief
Executive Officer of the Company and Chief Executive Officer of South Carolina
Bank and Trust, N.A. (formerly known as First National Bank) since April 1994.
He also served as President of South Carolina Bank and Trust, N.A. from April
1994 to May 2000. From 1990 to 1994, Mr. Hipp served as President of Rock Hill
National Bank and Rock Hill National Corporation.
Robert R. Horger (Age 52). Mr. Horger was named Chairman of the Company and
South Carolina Bank and Trust, N.A. in January 1998 and served as Vice Chairman
of the Company and South Carolina Bank and Trust, N.A. from April 1994 to
January 1998. Mr. Horger became a director of the Company in April 1991. Mr.
Horger is an attorney with Horger, Barnwell and Reid in Orangeburg, South
Carolina.
Dwight W. Frierson (Age 46). Mr. Frierson has served as Vice Chairman of
First National Corporation and South Carolina Bank and Trust, N.A. since January
2000 and has been a director of the Company since April 1996. Mr. Frierson is
Vice President and General Manager of Coca-Cola Bottling Company of Orangeburg.
Robert R. Hill, Jr. (Age 36). Mr. Hill has served as President and Chief
Operating Officer of South Carolina Bank and Trust, N.A. since May 2000. He
served as Senior Executive Vice President and Chief Operating Officer of South
Carolina Bank and Trust, N.A. from November 1998 to May 2000. He served as
President and Chief Executive Officer of South Carolina Bank and Trust of the
Piedmont, N.A. (formerly known as National Bank of York County) from July 1996
to November 1998. Mr. Hill was an organizer of the South Carolina Bank and Trust
of the Piedmont, N.A. from October 1995 to July 1996 and team leader for
NationsBank northern region of South Carolina from March 1995 to October 1995.
Richard C. Mathis (Age 52). Mr. Mathis has served as Executive Vice
President and Chief Financial Officer of the Company since May 2000. He was
owner of Carolina MasterCom LLC, an automotive services company, from January
1999 to May 2000. Mr. Mathis served as Executive Vice President and Chief
Financial Officer of M&M Financial Corporation/First National South from January
1998 to January 1999, through that bank's acquisition. Mr. Mathis was Senior
Vice President in the Fixed Income Division of Sterne, Agee & Leach, Inc. in
Atlanta, Georgia, from 1996 through 1997.
John C. Pollok (Age 37). Mr. Pollok was named Senior Executive Vice
President of the Company in February 2003. He has served as Executive Vice
President and Chief Administrative Officer of South Carolina Bank and Trust,
N.A. since May 2000. He served as Executive Vice President of South Carolina
Bank and Trust, N.A. mortgage division from July 1998 until May 2000. Mr. Pollok
served as Senior Vice President of South Carolina Bank and Trust of the
Piedmont, N.A. from January 1996 to July 1998.
Joe E. Burns (Age 48). Mr. Burns has served as Executive Vice President and
Chief Credit Officer of the Company since November 2000. He served as Senior
Vice President and Private Lending Manager for Bank of America from July 1995 to
November 2000.
William D. Kerr (Age 54). Mr. Kerr has served as Executive Vice President
and Chief Technology Officer of the Company and South Carolina Bank and Trust,
N.A., since January 2002. He served as Senior Vice President and Chief
Technology Officer for the Company from April 1999 to January 2002. Mr. Kerr was
a member of the Financial Institutions Services Team at Dixon Odom PLLC in
Sanford, North Carolina from January 1999 to April 1999. He served in various
positions, including Senior Vice President and Chief Information Officer, Chief
Administrative Officer and Chief Auditor, with MainStreet BankGroup, Inc. in
Martinsville, Virginia from 1977 to 1998.
James A. Shuford, III (51). Mr. Shuford has served as Executive Vice
President of South Carolina Bank and Trust, N.A. since August 1999. He served as
President and Chief Executive Officer of FirstBancorporation, Inc. and
FirstBank, N. A. in Beaufort, South Carolina from October 1993 to August 1999,
when they were acquired by the Company.
Thomas S. Camp (Age 51). Mr. Camp has served as President and Chief
Executive Officer of South Carolina Bank and Trust of the Piedmont, N.A. since
November 1998. He served as Principal and Manager of First Union National Bank
of South Carolina for the Private Client Group from August 1997 to November
1998. Mr. Camp was Vice President of Sales and Marketing at Seibels Bruce
Insurance Co. in Columbia from November 1996 to August 1997. He served as Senior
Vice President of First Union National Bank in South Carolina from February 1989
until November 1996.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
Certain information required by this item is incorporated herein by
reference to the information under the caption "Stock Performance and
Statistics" on page 16 of the 2002 Annual Report to Shareholders. As of March
11, 2003, the Company had issued and outstanding 7,673,339 shares of Common
Stock which were held of record by approximately 4,600 persons. The Company's
Common Stock is traded on the American Stock Exchange under the symbol "FNC".
Dividends are paid by the Company from its assets which are provided by
dividends paid to the Company by its subsidiaries. Certain restrictions exist
regarding the ability of the Company's subsidiaries to transfer funds to the
Company in the form of cash dividends, loans or advances. The approval of the
OCC is required to pay dividends in excess of the Banks' respective net profits
for the current year plus retained net profits (net profits less dividends paid)
for the preceding two years, less any required transfers to surplus. As of
December 31, 2002, $20,136,000 of the Banks' retained earnings were available
for distribution to the Company as dividends without prior regulatory approval.
For the year ended December 31, 2002, the Banks paid dividends of approximately
$6,891,000 to the Company. The Company anticipates that it will continue to pay
comparable cash dividends in the future.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated herein by reference
to the information set forth under the captions "Financial Highlights" and
"Selected Consolidated Financial Data" on pages 1 and 17, respectively, of the
Company's 2002 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
This discussion and analysis is intended to assist the reader in
understanding the financial condition and results of operations of First
National Corporation and its subsidiaries, South Carolina Bank and Trust, N.A.,
South Carolina Bank and Trust of the Piedmont, N.A., South Carolina Bank and
Trust of the Pee Dee, N.A., and CreditSouth Financial Services Corporation. The
five year period 1998 through 2002 is discussed with particular emphasis on the
years 2000 through 2002. This commentary should be reviewed in conjunction with
the financial statements and related footnotes and the other statistical
information related to First National Corporation contained elsewhere herein
(see "Consolidated Financial Statements of First National Corporation").
In 1996, the Company sponsored the organization of South Carolina Bank and
Trust of the Piedmont, N.A. (formerly National Bank of York County) in Rock
Hill, South Carolina, and sold shares of the Company's common stock to
capitalize the new bank and pay organizational and pre-opening expenses. South
Carolina Bank and Trust of the Piedmont, N.A. began operations on July 11, 1996,
as a wholly-owned subsidiary of the Company.
In 1998, the Company sponsored the organization of South Carolina Bank and
Trust of the Pee Dee, N.A. (formerly Florence County National Bank) in Florence,
South Carolina, and sold shares of the Company's common stock to capitalize the
new bank and pay organizational and pre-opening expenses. South Carolina Bank
and Trust of the Pee Dee, N.A. began operations on April 1, 1998, as a
wholly-owned subsidiary of the Company.
Also in 1998, the Company sponsored the organization of CreditSouth
Financial Services Corporation, a consumer finance company which began
operations in Orangeburg, South Carolina, on November 1, 1998. Upon
organization, the Company acquired 80 percent of CreditSouth's common stock. The
remaining 20 percent of CreditSouth common stock was issued to minority employee
shareholders pursuant to their employment agreements. All minority shares were
subsequently acquired by the Company. As noted in Part 1, Item 1, on December 1,
2002, South Carolina Bank and Trust, N.A. acquired the majority of CreditSouth's
consumer loan portfolio and related assets.
RECENT ACCOUNTING PRONOUNCEMENTS
See Notes to Consolidated Financial Statements for information relating to
recent accounting pronouncements.
8
SUMMARY OF OPERATIONS
Earnings of First National Corporation were $13,834,000, $12,257,000, and
$10,533,000 in 2002, 2001 and 2000, respectively. Net income increased 12.9
percent in 2002 when compared to 2001 and increased 16.4 percent in 2001
compared with 2000. Basic earnings per share increased to $1.80 in 2002 compared
to $1.59 in 2001 and $1.36 in 2000. Diluted earnings per share increased to
$1.79 in 2002 from $1.59 in 2001 and $1.36 in 2000. All per share data has been
adjusted to give effect to a ten percent stock dividend paid to shareholders on
December 5, 2002.
The book value per share of First National Corporation increased to $13.49
in 2002 compared with $12.15 in 2001, and $10.97 in 2000. The return on average
assets was 1.28 percent in 2002, compared with 1.21 percent in 2001 and 1.11
percent in 2000. The return on average shareholders' equity was 14.09 percent in
2002, 13.64 percent in 2001, and 13.14 percent in 2000. Per share dividends
declared in 2002 were $0.59, compared with $0.57 in 2001 and $0.54 in 2000.
Total earning assets and total deposits increased in 2002 compared to 2001.
At December 31, 2002, total earning assets were $1,067,549,000, an increase of
11.2 percent over $959,846,000 at year-end 2001, which was 5.2 percent greater
than the 2000 balance of $912,415,000. In 2002, average earning assets were
$1,022,339,000, an increase of 8.8 percent over $939,626,000, which was 3.9
percent greater than the 2000 average of $904,403,000. The increases in average
earning assets in 2002 and 2001 were mainly the result of loan growth.
At December 31, 2002, total deposits were $898,163,000, an increase of 10.7
percent from $811,523,000 at the end of 2001. The 2001 balance was 7.1 greater
than $757,576,000 at year-end 2000. Deposits averaged $855,222,000 during 2002,
an increase of 6.3 percent over $804,281,000 in 2001. The 2001 deposits average
was a 9.3 percent increase over $736,093,000 in 2000.
For the year ended December 31, 2002, total interest income was
$67,487,000, a decrease of $6,985,000, or 9.4 percent, from $74,472,000 in 2001.
The decrease was driven mainly by interest rates, as the rate earned on average
earning assets declined 120 basis points from 7.80 percent in 2001 to 6.60
percent in 2002. In 2001, total interest income increased $626,000, or 0.8
percent, compared with $73,846,000 in 2000. This increase was mainly the result
of earning asset growth of $35,223,000, or 3.9 percent, largely offset by a 24
basis point decline in the average yield.
Total interest expense was $18,748,000 for the year 2002, an $11,224,000,
or 37.5 percent, decrease from $29,972,000 in 2001. Also reflecting the lower
rate environment in 2002, the average rate paid on interest-bearing liabilities
decreased by 153 basis points compared with 2001. Total interest expense in 2001
decreased $3,260,000, or 9.8 percent, from $33,232,000 in 2000. This resulted
from a 74 basis point decline in the average rate paid on interestbearing
liabilities, offset in part by an increase in average interest-bearing
liabilities of $60,487,000, or 8.2 percent.
In 2000, the Company's Board of Directors authorized a repurchase program
to acquire up to 160,000 shares of its outstanding common stock. In January
2002, the Board authorized repurchase of up to 200,000 shares. In March 2003,
the repurchase authorization was increased to 250,000 shares. During the years
ended December 31, 2002, 2001 and 2000, the Company repurchased 12,402, 138,253
and 14,200 shares at a cost of $265,000, $2,518,000 and $214,000, respectively.
COMPETITION
First National Corporation competes with a number of financial institutions
and other firms that engage in activities similar to banking. For example, the
Company competes for deposits with savings and loan associations, credit unions,
brokerage firms and other commercial banks. In its lending activities, the
Company competes with the industries mentioned above as well as consumer finance
companies, leasing companies and other lenders. In today's uncertain financial
climate, all lenders are searching for quality borrowers. Acquisition of
acceptable grade loans becomes increasingly challenging.
A number of financial institution mergers were completed in recent years,
continuing the trend toward consolidation. Although these mergers reduced the
number of banks and branches, they intensified competition for quality funds and
loans.
NET INTEREST INCOME
Net interest income is the difference between interest income and interest
expense. In the analysis of net interest income, two significant factors are net
interest spread and net interest margin. Net interest spread is the difference
9
between the yield on average earning assets and the rate on average
interest-bearing liabilities. Net interest margin is the difference between the
yield on average earning assets and the rate on all average liabilities,
interest and noninterest-bearing, utilized to support earning assets. Net
interest margin is distinguished by the inclusion of the impact of interest free
funds.
Net interest income was $48,739,000 in 2002, an increase of $4,239,000, or
9.5 percent over 2001. The increase from 2001 to 2002 reflected a 33 point
decrease in the net interest spread, due to a decrease of 153 basis points in
the average rate paid on total interest-bearing liabilities that was offset in
part by a 120 basis point decrease in the average yield on total earning assets.
In 2001, net interest income was $44,500,000, a $3,886,000, or 9.6 percent
increase over 2000. This was the result of a 36 basis point increase in the net
interest spread, as rates on total interest-bearing liabilities decreased 73
basis points, outpacing the 37 basis point decline in yield on total earning
assets.
The net interest margin increased ten basis points to 4.76 percent in 2002,
compared with 2001. This also reflected the greater decrease in rates paid on
total interest-bearing liabilities compared with the decrease in yields on total
earning assets. Similarly, a declining rate environment in 2001 contributed to a
net interest margin increase of 16 basis points compared with 2000.
Total average earning assets were $1,022,339,000 in 2002, an increase of
$67,184,000, or 7.1 percent, from 2001. This followed an increase of
$50,752,000, or 5.6 percent, to $955,155,000 in 2001, compared to 2000. In 2002,
total interest-bearing liabilities rose $45,187,000, or 5.7 percent, to
$842,219,000, compared with 2001. These liabilities averaged $797,032,000 in
2001, an increase of $57,501,000, or 7.8 percent, over the previous year.
Earning asset increases in 2002 and 2001 were mainly the result of higher levels
of interest-bearing liabilities, with demand deposit growth also a significant
source of funds in 2002.
TABLE 1
VOLUME AND RATE
VARIANCE ANALYSIS
2002 COMPARED TO 2001 2001 COMPARED TO 2000
CHANGES DUE TO CHANGES DUE TO
INCREASE (DECREASE) IN INCREASE (DECREASE) IN
(Dollars in thousands) VOLUME (L) RATE (L) TOTAL VOLUME (L) RATE (L) TOTAL
Interest income on:
Loans (2) $ 5,371 $(10,448) $ (5,077) $ 5,711 $ (3,799) $ 1,912
Investments:
Taxable 709 (2,087) (1,378) 85 (249) (164)
Tax exempt (3) (91) (14) (105) (161) (8) (169)
Funds sold (326) (145) (471) (578) (345) (923)
Interest -bearing deposits with banks 106 (61) 45 (24) (6) (30)
- ------------------------------------------------------------------------------------------------------------------------------
Total interest income 5,769 (12,755) (6,986) 5,033 (4,407) 626
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense on:
Deposits:
Interest-bearing transaction accounts 257 228 485 210 (5) 205
Savings accounts 152 (2,006) (1,854) 347 (1,571) (1,223)
Certificates of deposit (40) (8,633) (8,673) 1,770 (787) 983
Funds purchased 176 (1,740) (1,564) (1,010) (2,475) (3,485)
Notes payable 429 (48) 381 473 (213) 260
- ------------------------------------------------------------------------------------------------------------------------------
Total interest expense 974 (12,199) (11,225) 1,791 (5,051) (3,260)
- ------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 4,795 $ (556) $ 4,239 $ 3,242 $ 644 $ 3,886
==============================================================================================================================
(1) The rate/volume variance for each category has been allocated on an equal
basis between rate and volumes.
(2) Nonaccrual loans are included in the above analysis.
(3) Tax exempt income is not presented on a taxable-equivalent basis in the
above analysis.
10
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES
2002
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Assets
Interest earning assets:
Loans, net of unearned income $ 806,801 $ 58,119 7.20%
Investment securities:
Taxable 171,926 7,711 4.48
Tax exempt 33,504 1,501 4.48
Funds sold 7,162 107 1.49
Interest-earning deposits with banks 2,946 49 1.66
------------ ------------
Total earning assets 1,022,339 67,487 6.60
------------ ------------
Cash and other assets 73,018
Less allowance for loan losses (10,171)
------------
Total assets $ 1,085,186
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 171,052 $ 1,912 1.12%
Savings 167,268 1,979 1.18
Certificates of deposit 378,443 11,491 3.04
Funds purchased 75,956 874 1.15
Notes payable 49,500 2,492 5.03
------------ ------------
Total interest-bearing liabilities 842,219 18,748 2.23
------------ ------------
Demand deposits 138,460
Other liabilities 6,336
Shareholders' equity 98,171
------------
Total liabilities and shareholders' equity $ 1,085,186
============
Net interest spread 4.37
Impact of interest free funds 0.40
------------
Net interest margin 4.77%
============
Net interest income $ 48,739
============
11
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 2001
2001
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Interest earning assets:
Loans, net of unearned income $ 743,602 $ 63,196 8.50%
Investment securities:
Taxable 159,482 9,088 5.70
Tax exempt 35,522 1,606 4.52
Funds sold 16,442 578 3.52
Interest-earning deposits with banks 107 4 3.74
------------ ------------
Total earning assets 955,155 74,472 7.80
------------ ------------
Cash and other assets 65,827
Less allowance for loan losses (9,265)
------------
Total assets $ 1,011,717
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 144,963 $ 1,427 0.98%
Savings 160,890 3,833 2.38
Certificates of deposit 379,193 20,163 5.32
Funds purchased 70,852 2,438 3.44
Notes payable 41,134 2,111 5.13
------------ ------------
Total interest-bearing liabilities 797,032 29,972 3.76
------------ ------------
Demand deposits 118,084
Other liabilities 6,550
Shareholders' equity 90,051
------------
Total liabilities and shareholders' equity $ 1,011,717
============
Net interest spread 4.04
Impact of interest free funds 0.62
------------
Net interest margin 4.66%
============
Net interest income $ 44,500
============
12
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 2000
2000
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Assets
Interest earning assets:
Loans, net of unearned income $ 680,217 $ 61,284 9.01%
Investment securities:
Taxable 158,029 9,252 5.85
Tax exempt 39,072 1,775 4.54
Funds sold 26,734 1,501 6.51
Interest-bearing deposits with banks 351 34 9.69
------------ ------------
Total earning assets 904,403 73,846 8.17
------------ ------------
Cash and other assets 59,309
Less allowance for loan losses (8,324)
------------
Total assets $ 955,388
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 123,695 $ 1,222 0.99%
Savings 150,534 5,056 3.36
Certificates of deposit 347,121 19,180 5.53
Funds purchased 85,422 5,923 6.93
Notes payable 32,759 1,851 5.65
------------ ------------
Total interest-bearing liabilities 739,531 33,232 4.49
------------ ------------
Demand deposits 114,743
Other liabilities 20,939
Shareholders' equity 80,175
------------
Total liabilities and shareholders' equity $ 955,388
============
Net interest spread 3.68
Impact of interest free funds 0.81
------------
Net interest margin 4.49%
============
Net interest income $ 40,614
============
13
INVESTMENT SECURITIES
The second largest category of earning assets is investment securities,
which are used to fund loan growth and deposit liquidations, provide liquidity,
employ excess funds, and pledge as collateral for certain public funds deposits
and purchased funds. At December 31, 2002, investment securities were
$164,951,000, or 15.5 percent of earning assets, as compared with $189,933,000,
or 20.3 percent of earning assets at year-end 2001. As securities are purchased,
they are designated as held-to-maturity or available-for-sale based upon
management's intent, which incorporates liquidity needs, interest rate
expectations, asset/liability management strategies, and capital requirements.
Interest earned on the held-to-maturity portfolio, consisting mainly of tax
exempt state and municipal securities, was $1,501,000 in 2002, a decrease of
$105,000, or 6.5 percent from the $1,606,000 earned in 2001. This decrease was
due mainly to an average portfolio balance that was $2,018,000, or 5.7 percent,
less than the balance in 2001. Contributing to a lesser extent was the four
basis point decline in the average yield from 2001 to 2002. In 2001, this
portfolio segment earned $169,000, or 9.5 percent, less than 2000 interest of
$1,775,000. The decrease was primarily the result of an average taxable
securities portfolio that was $3,550,000, or 9.1 percent, less than the balance
in 2000, aided slightly by a 2 basis point decline in the average yield. The
average maturity of the held-to-maturity portfolio was 3.2 years at December 31,
2002, 3.9 years at December 31, 2001 and 4.6 years at the end of 2000.
Securities available-for-sale consist mainly of U.S. Government agency and
mortgage-backed securities. In 2002, interest earned on this portfolio segment
was $7,711,000, including $404,000 attributable to short-term money market
funds, compared with $9,088,000, including $108,000 earned on money market
investments, in 2001. The overall decrease of $1,377,000, or 15.2 percent, was
the result of the low rate environment throughout 2002, which was reflected in
an average earnings rate that was 131 basis points less than in 2001. This
decrease was partially offset by an available-for-sale portfolio that averaged
$12,444,000, or 7.8 percent, more in 2002 than 2001. In 2001, earnings from this
segment of the investment securities portfolio were $164,000, or 1.8 percent,
less than the $9,252,000 earned in 2000. This decrease was the result of an
average portfolio yield in 2001 that was 15 basis points less than the previous
year, partially offset by a $1,453,000 increase in the average outstanding
available-for-sale balance.
At December 31, 2002, the fair value of the investment securities portfolio
was $166,784,000, or 1.1 percent higher than the carrying value, including the
effect of a $1,833,000 higher market value of held-to-maturity securities,
compared to their amortized cost. The difference between the fair and carrying
values at the December 31, 2001 was a favorable $648,000, or 0.3 percent,
following a negligible difference at the end of 2000. At December 31, 2002,
investment securities with an amortized cost of $128,752,000 and fair value of
$131,740,000 were classified as available-for-sale. The positive adjustment of
$2,988,000 to the carrying value of these securities has been reflected, net of
tax, in the statement of changes in shareholders' equity as a component of other
comprehensive income.
The Company realized no gains or losses on the disposition of investment
securities in 2002, a gain of $570,000 on the disposition of equity securities
in 2001, and no gains or losses in 2000.
TABLE 3
BOOK VALUE OF INVESTMENT SECURITIES
DECEMBER 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY
U. S. Treasury and other Government agencies -- -- -- $ 3,031 $ 6,299
Mortgage-backed $ 51 $ 247 -- 1,304 2,144
State and municipal 33,160 34,767 $ 38,550 42,933 38,138
- -------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity 33,211 35,014 38,550 47,268 46,581
- -------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U. S. Treasury and other Government agencies 45,859 44,265 93,479 93,033 131,465
Mortgage-backed 74,694 101,728 46,726 51,502 24,642
Other investments 11,187 8,926 4,443 3,769 3,449
- -------------------------------------------------------------------------------------------------------------
Total Available-for-Sale 131,740 154,919 144,648 148,304 159,556
- -------------------------------------------------------------------------------------------------------------
Total $164,951 $189,933 $183,198 $195,572 $206,137
=============================================================================================================
14
TABLE 4
MATURITY DISTRIBUTION AND YIELDS OF INVESTMENT SECURITIES
DUE IN DUE AFTER DUE AFTER DUE AFTER
DECEMBER 31, 2002 1 YR. OR LESS 1 THRU 5 YRS. 5 THRU 10 YRS. 10 YRS. TOTAL PAR FAIR
(DOLLARS IN THOUSANDS) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY
Mortgage-backed $ 51 5.36% -- -- -- -- -- -- $ 51 5.36% $ 51 $ 51
State and municipal 3,226 6.80% $22,172 6.58% $ 7,762 6.65% -- -- 33,160 6.62% 32,960 34,993
- ------------------------------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity 3,277 6.78% 22,172 6.58% 7,762 6.65% -- -- 33,211 6.61% 33,011 35,044
- ------------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U.S. Treasury and
Government agencies 39,376 3.14% 6,483 6.25% -- -- -- -- 45,859 3.58% 45,165 45,859
Mortgage-backed 16,899 4.77% 53,888 5.32% 3,905 6.06% -- -- 74,694 5.23% 71,891 74,692
Other investments (1) -- -- -- -- -- -- 11,189 5.30% 11,187 5.30% 11,189 11,189
- ------------------------------------------------------------------------------------------------------------------------------------
Total Available-for-Sale 56,275 3.63% 60,371 5.42% 3,905 6.06% 11,189 5.30% 131,740 4.66% 128,245 131,740
- ------------------------------------------------------------------------------------------------------------------------------------
Total $59,552 3.80% $82,543 5.73% $11,667 6.45% $11,189 5.30% $164,951 5.06% $161,256 $166,784
====================================================================================================================================
Percent of Total 36% 50% 7% 7%
Cumulative % of Total 36% 86% 93% 100%
(1) Federal Reserve Bank and other corporate stocks have no set maturity and
are classified in "Due after 10 years."
LOAN PORTFOLIO
At December 31, 2002, loans, net of unearned discount, the largest category
of earning assets, were $902,563,000, an increase of $133,699,000, or 17.4
percent, compared to $768,864,000 at the end of 2001. Average loans during 2002
were $806,801,000, an increase of $63,199,000, or 8.5 percent, over the 2001
average.
Real estate mortgage loans continue to comprise the largest segment of the
loan portfolio. All loans secured by real estate, except real estate
construction loans, are included in this category. At the end of 2002, real
estate mortgage loans were $601,320,000, including $39,141,000 of residential
mortgage loans held for sale, and comprised 66.6 percent of the total portfolio.
This was an increase of $105,426,000, or 21.3 percent, over year-end 2001.
Commercial, financial, agricultural and other loans were $149,385,000,
representing 16.5 percent of the loan portfolio at December 31, 2002. This loan
category increased $30,566,000, or 25.7 percent, compared to the balance at the
end of 2001. Consumer loans, comprising 12.4 percent of the portfolio at the end
of 2002, were $111,520,000, a decrease of $4,922,000, or 4.2 percent, from the
previous year.
Loan interest and fee income was $58,119,000 in 2002, an decrease of
$5,077,000, or 8.0 percent, from 2001. While year-end and average outstanding
loan balances increased substantially year-to-year, the loan income decrease was
the result of a 130 basis point drop in the average yield earned on these
assets. This reflected the low interest rate environment throughout 2002, set up
by the unprecedented 11 discount rate reductions initiated in the previous year.
In 2001, interest and fee income was $63,196,000, an increase of $1,912,000, or
3.0 percent from 2000. This increase was the result of an increase in average
outstanding loan balances of $63,385,000, or 9.3 percent, offset in part by a 51
basis point decrease in the average yield. Table 6 shows the maturity and
interest rate sensitivity of the loan portfolio at December 31, 2002. Loans that
mature in one year or less were $385,840,000, comprising 42.8 percent of the
total. Of the loans due after one year, $499,633,000, or 96.7 percent, had fixed
interest rates and $17,090,000, or 3.3 percent, were variable rate loans.
The placement of loans on a nonaccrual status is dependent upon the type of
loan, the past due status and the collection activities in progress. Loans which
are well secured and in the process of collection are allowed to remain on an
accrual basis until they become 120 days past due. Unsecured commercial loans
are charged off on or before the date they become 90 days past due and,
therefore, do not reach nonaccrual status. Commercial and real estate loans
which are partially secured are written down to the collateral value and placed
on nonaccrual status on or before becoming 90 days past due. Closed end consumer
loans are charged off on or before becoming 120 days past due and open end
consumer loans are charged off on or before becoming 180 days past due. All
interest accrued in the current year but unpaid at the date a loan is placed on
nonaccrual status is deducted from interest income, while interest accrued from
previous years is charged against the reserve for loan losses. At December 31,
2002, nonaccrual
15
loans were $2,776,000, compared with $3,317,000 at year-end 2001. At December
31, 2002, loans that were 90 days or more past due were $1,729,000 compared to
$1,561,000 at the end of 2001.
Interest income that was foregone was an immaterial amount for each of the
three years ended December 31, 2002. First National Corporation does not have
any loans that have been restructured or any foreign loans.
Concentrations of credit are considered to exist when the amounts loaned to
a multiple number of borrowers engaged in similar business activities which
would cause them to be similarly impacted by economic or other conditions exceed
10 percent of total loans. As of December 31, 2002, no credit concentrations
existed.
The level of risk elements in the loan portfolio for the past five years is
shown in Table 7.
TABLE 5
DISTRIBUTION OF NET LOANS
BY TYPE
DECEMBER 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------
Commercial, financial,
agricultural and other $ 149,385 $ 118,819 $ 103,468 $ 87,098 $ 87,610
Real estate - construction 40,338 37,709 32,256 27,555 19,113
Real estate - mortgage 601,320 495,894 473,131 396,158 303,300
Consumer 111,520 116,442 120,194 99,730 83,121
- ---------------------------------------------------------------------------------------------------------
Total $ 902,563 $ 768,864 $ 729,049 $ 610,541 $ 493,144
=========================================================================================================
Percent of Total
Commercial, financial,
agricultural and other 16.5% 15.5% 14.1% 14.2% 17.7%
Real estate - construction 4.5 4.9 4.4 4.5 3.9
Real estate - mortgage 66.6 64.5 64.6 64.5 61.1
Consumer 12.4 15.1 16.9 16.8 17.3
- ---------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
=========================================================================================================
TABLE 6
MATURITY DISTRIBUTION OF LOANS
MATURITY
DECEMBER 31, 2002 1 YEAR 1 - 5 OVER 5
(DOLLARS IN THOUSANDS) TOTAL OR LESS YEARS YEARS
- ---------------------------------------------------------------------------------------------------------
Commercial, financial
agricultural and other $ 149,385 $ 84,871 $ 62,609 $ 1,905
Real estate - construction 40,338 27,182 11,737 1,419
Real estate - mortgage 601,320 258,953 294,856 47,511
Consumer 111,520 14,834 90,523 6,163
- ---------------------------------------------------------------------------------------------------------
Total $ 902,563 $ 385,840 $ 459,725 $ 56,998
=========================================================================================================
Loans due after one year with:
Predetermined interest rates $ 499,633
Floating or adjustable interest rates $ 17,090
16
ASSET QUALITY
Asset quality is maintained through the management of credit risk. Each
individual earning asset, whether in the investment, loan, or short-term
investment portfolio, is reviewed by management for credit risk. To facilitate
this review, First National Corporation has established credit and investment
policies which include credit limits, documentation, periodic examination and
follow-up. In addition, these portfolios are examined for exposure to
concentration in any one industry, government agency, or geographic location. At
December 31, 2002 and 2001, the Company did not have more than ten percent of
the loan portfolio in any one industry and had no foreign loans.
Each category of earning assets has a degree of credit risk. To measure
credit risk, various techniques are utilized. Credit risk in the investment
portfolio can be measured through bond ratings published by independent
agencies. In the investment portfolio, 99.5 percent of the investments consist
of U.S. Treasury securities, U.S. Agency securities and taxfree securities
having a rating of "A" or better by at least one of the major bond rating
agencies. The credit risk of the loan portfolio can be measured by historical
experience. The Company maintains its loan portfolio in accordance with its
established credit policies. Reflecting a more difficult economic climate, net
loan charge-offs as a percentage of net average loans were .25 percent in 2002,
compared to .19 percent in 2001 and .12 percent in 2000. See "Loans" for a
discussion of the Company's charge-off and nonaccrual policies.
TABLE 7
NONACCRUAL AND PAST DUE LOANS
DECEMBER 31
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Loans past due 90 days or more $ 1,729 $ 1,561 $ 1,838 $ 729 $ 1,426
Loans on a nonaccruing basis 3,010 3,317 1,481 1,537 1,547
- --------------------------------------------------------------------------------------------------------------
Total $ 4,739 $ 4,878 $ 3,319 $ 2,266 $ 2,973
==============================================================================================================
TABLE 8
SUMMARY OF LOAN
LOSS EXPERIENCE
DECEMBER 31
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses - January 1 $ 9,818 $ 8,922 $ 7,886 $ 6,934 $ 6,246
- --------------------------------------------------------------------------------------------------------------
Total charge-offs (2,236) (1,808) (1,004) (826) (785)
Total recoveries 256 400 202 165 260
- --------------------------------------------------------------------------------------------------------------
Net charge-offs (1,980) (1,408) (802) (661) (525)
Provision for loan losses 3,227 2,304 1,838 1,613 1,213
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses - December 31 $ 11,065 $ 9,818 $ 8,922 $ 7,886 $ 6,934
==============================================================================================================
Average loans - net of unearned income $806,801 $743,602 $680,217 $541,434 $452,600
Ratio of net charge-offs to average
loans - net of unearned income .25% .19% .12% .12% .12%
17
LOAN LOSS PROVISION
The Company maintains an allowance for loan losses at a level which
management believes is sufficient to provide for potential losses in the loan
portfolio. Management periodically evaluates the adequacy of the allowance
utilizing its internal risk rating system, credit review and regulatory agency
examinations to assess the quality of the loan portfolio and identify problem
loans. The evaluation process also includes management's analysis of current and
future economic conditions, composition of the loan portfolio, past due and
nonaccrual loans, concentrations of credit, lending policies and procedures and
historical loan loss experience. The provision for loan losses is charged to
expense in an amount necessary to maintain the allowance at the appropriate
level.
The provision for loan losses for the year ended December 31, 2002 was
$3,227,000, compared to $2,304,000 in 2001. The 40.1 percent increase in the
provision was the result of an increase in net charge offs from $1,408,000 in
2001 to $1,980,000 in 2002, as well as strong loan growth year-to-year.
The allowance for loan losses was $11,065,000 at December 31, 2002, or 1.23
percent of outstanding loans. At the end of 2001, the allowance was $9,818,000,
or 1.28 percent of outstanding loans. Total charge offs were $2,236,000 in 2002,
up from $1,808,000 in 2001. Recoveries were $256,000 in 2002, compared with
$400,000 in the previous year. A summary of loan loss experience for the five
years ending December 31, 2002 is provided in Table 8.
Other real estate owned includes certain real estate acquired as a result
of foreclosure and deeds in lieu of foreclosure, as well as amounts reclassified
as in-substance foreclosures. At December 31, 2002 and December 31, 2001, other
real estate owned was $1,051,000 and $798,000, respectively.
The U.S. and South Carolina economies continue to show mixed signs of
strength and weakness. In this continuing period of uncertainty, management
anticipates that the Company will experience loan charge offs in the coming year
at similar levels to those experienced in 2002. The Office of the Comptroller
recommends that banks take a broad view of certain factors in evaluating their
allowance for loan losses. These factors include loan loss experience, specific
allocations and other subjective factors. In its ongoing consideration of such
factors, management considers the allowance for loan losses to be adequate.
LIQUIDITY
Liquidity may be defined as the ability of an entity to generate cash to
meet its financial obligations. For a bank, liquidity primarily means the
consistent ability to meet loan and investments demands and deposit withdrawals.
The Company has employed its funds in a manner to provide liquidity in both
assets and liabilities sufficient to meet its cash needs.
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. As noted in Table 4, 36 percent of the investment portfolio matures
in one year or less. This segment of the investment portfolio consists of U.S.
Treasury securities, U.S. Agency securities and bank qualified municipal
obligations. Loans and other investments are generally held for longer terms and
not utilized for day-to-day operating needs.
Increases in the Company's liabilities provide liquidity on a day-to-day
basis. Daily liquidity needs may be met from deposit growth or from the use of
federal funds purchased, securities sold under agreements to repurchase and
other short-term borrowings.
The Company regularly obtains borrowed funds in the form of cash management
or "sweep" accounts that are accommodations to corporate and governmental
customers pursuant to sale of securities sold under agreement to repurchase
arrangements. During 2002, the Company maintained a satisfactory level of
liquidity through growth in interest-bearing and non-interest-bearing deposits,
cash management accounts, federal funds purchased, and advances from the Federal
Home Loan Bank of Atlanta.
DERIVATIVES AND SECURITIES HELD FOR TRADING
In January 1998, the Securities and Exchange Commission adopted rules that
require more comprehensive disclosure of accounting policies for derivatives as
well as enhanced quantitative and qualitative disclosures of market risk for
derivatives and other financial instruments. The market risk disclosures are
classified into two categories: financial instruments entered into for trading
purposes and all other instruments (non-trading purposes). The Company does not
have financial derivatives, nor does it maintain a trading portfolio.
18
ASSET-LIABILITY MANAGEMENT AND MARKET RISK SENSITIVITY
The Company's earnings or the value of its shareholders' equity may vary in
relation to changes in interest rates and in relation to the accompanying
fluctuations in market prices of certain of its financial instruments. The
Company uses a number of methods to measure interest rate risk, including
simulating the effect on earnings of fluctuations in interest rates, monitoring
the present value of asset and liability portfolios under various interest rate
scenarios, and monitoring the difference, or gap, between rate sensitive assets
and liabilities, as discussed below. The earnings simulation model and gap
analysis take into account the Company's contractual agreements with regard to
investments, loans and deposits. Although the Company's simulation model is
subject to the accuracy of the assumptions that underlie the process, the
Company believes that such modeling provides a better illustration of the
interest sensitivity of earnings than does static interest rate sensitivity gap
analysis. The simulation model assists in measuring and achieving growth in net
interest income while managing interest rate risk. The simulations incorporate
interest rate changes as well as projected changes in the mix and volume of
balance sheet assets and liabilities. Accordingly, the simulations are
considered to provide a good indicator of the degree of earnings risk the
Company has, or may incur in future periods, arising from interest rate changes
or other market risk factors.
The Company's policy is to monitor exposure to interest rate increases and
decreases of as much as 200 basis points ratably over a 12-month period. The
Company's policy limit for the maximum negative impact on net interest income
from a steady ("ramping") change in interest rates of 200 basis points over 12
months is 8 percent. The Company traditionally has maintained a risk position
well within the policy guideline level. As of December 31, 2002, the earnings
simulations indicated that the impact of a 200 basis point decrease in rates
over 12 months would result in an approximate 5.0 percent decrease in net
interest income while a 200 basis point increase in rates over the same period
would result in an approximate 0.4 percent decrease in interest income -- both
as compared with a base case unchanged interest rate environment. These results
indicate that the Company's rate sensitivity is essentially neutral to the
indicated change in interest rates over a one-year horizon. The decrease in net
interest income in the declining rate environment is attributable primarily to
the current (base) extremely low level of interest rates. Certain key interest
rates, such as the federal funds rate, would have to hypothetically move to zero
percent in order to drop 200 basis points from current levels. In such a
hypothetical case, the Company would not be able to lower certain deposit and
liability rates to the same extent. Also, the model assumes that the Company's
residential mortgage loans would quickly prepay in such an extreme rate
environment -- thereby lowering interest income. Actual results may differ from
simulated results due to the timing, magnitude and frequency of interest rate
changes and changes in market conditions or management strategies, among other
factors.
As mentioned above, another (though less useful) indicator of interest rate
risk exposure is the interest rate sensitivity gap and cumulative gap. Interest
rate sensitivity gap analysis is based on the concept of comparing financial
assets that reprice with financial liabilities that reprice within a stated time
period. The time period in which a financial instrument is considered to be rate
sensitive is determined by that instrument's first opportunity to reprice to a
different interest rate. For variable rate products the period in which
repricing occurs is contractually determined. For fixed rate products the
repricing opportunity is deemed to occur at the instrument's maturity or call
date, if applicable. For noninterest- bearing funding products, the "maturity"
is based solely on a scheduled decay, or runoff, rate. When more assets than
liabilities reprice within a given time period, a positive interest rate gap (or
"asset sensitive" position) exists. Asset sensitive institutions may benefit in
generally rising rate environments as assets reprice more quickly than
liabilities. Conversely, when more liabilities than assets reprice within a
given time period, a negative interest rate gap (or "liability sensitive"
position) exists. Liability sensitive institutions may benefit in generally
falling rate environments as funding sources reprice more quickly than earning
assets. However, another shortfall of static gap analysis based solely on the
timing of repricing opportunities is its lack of attention to the degree of
magnitude of rate repricings of the various financial instruments.
As shown in the gap analysis within Table 9 below, the Company has a
greater dollar value of financial liabilities that are subject to repricing
within a 12 month and 24 month time horizon than its financial assets subject to
repricing. Thereafter, within successive 12-month time horizons, there are more
financial assets than financial liabilities with repricing opportunities. The
degree of magnitude of rate repricings of the financial assets and liabilities
is, as mentioned above, not addressed by a static gap analysis as presented in
Table 9.
The Company does not currently use interest rate swaps or other derivatives
to modify the interest rate risk of its financial instruments.
The following table provides information as of December 31, 2002 about the
Company's financial instruments that are sensitive to changes in interest rates.
For fixed rate loans, securities, time deposits, federal funds and repurchase
agreements, and notes payable, the table presents principal cash flows and
related weighted-average interest rates by expected maturity dates, call dates,
or average-life terminal dates. Variable rate instruments are presented
according to their first repricing opportunities. Non-interest bearing deposits
and interest-bearing savings and checking deposits have no contractual maturity
dates. For purposes of Table 9, projected maturity dates for such deposits were
determined based on decay rate assumptions used internally by the Company to
evaluate such deposits. For further information on the fair value of financial
instruments, see Note 23 to the consolidated financial statements.
19
TABLE 9
FINANCIAL INSTRUMENTS THAT ARE SENSITIVE TO CHANGES IN INTEREST RATES
FAIR
THERE VALUE
(DOLLARS IN THOUSANDS) 2003 2004 2005 2006 2007 AFTER TOTAL 12-31-02
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Financial assets:
Loans, net of unearned income:
Fixed Rate:
Book Value $ 158,022 $ 86,534 $ 84,189 $ 76,121 $ 72,582 $ 147,210 $ 624,658 $ 650,519
Average interest rate 7.08% 7.79% 7.61% 7.37% 6.81% 6.40% 7.09%
Variable Rate:
Book Value $ 266,840 $ -- $ -- $ -- $ -- $ -- $ 266,840 $ 267,172
Average interest rate 4.93% 0.00% 0.00% 0.00% 0.00% 0.00% 4.93%
Securities held-to-maturity:
Fixed Rate:
Book Value $ 3,592 $ 4,732 $ 5,774 $ 6,558 $ 3,932 $ 8,623 $ 33,211 $ 35,044
Average interest rate 7.39% 6.84% 7.00% 6.76% 6.76% 7.00% 6.94%
Variable Rate:
Book Value -- -- -- -- -- -- -- --
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% --
Securities available-for-sale:
Fixed Rate:
Book Value $ 77,204 $ 17,811 $ 7,559 $ 5,674 $ 4,679 $ 18,813 $ 131,740 $ 131,740
Average interest rate 4.12% 4.60% 5.37% 5.63% 5.89% 5.67% 4.60%
Variable Rate:
Book Value $ 334 -- -- -- -- $ 334 $ 334
Average interest rate 4.88% 0.00% 0.00% -- -- 4.88%
Other $ 35 -- -- -- -- -- $ 35 $ 35
Average interest rate 1.50% 0.00% 0.00% -- -- -- 1.50%
- -----------------------------------------------------------------------------------------------------------------------------------
Total Financial Assets $ 506,027 $ 109,077 $ 97,522 $ 88,353 $ 81,193 $ 174,646 $1,056,818 $1,084,844
- -----------------------------------------------------------------------------------------------------------------------------------
Financial Liabilities:
Non-interest bearing-deposits $ 23,711 $ 17,950 $ 17,950 $ 17,950 $ 17,950 $ 54,075 $ 149,586 $ 141,123
Average interest rate N/A N/A N/A N/A N/A N/A N/A
Interest-bearing
savings and checking $ 169,924 $ 55,791 $ 55,791 $ 55,791 $ 9,057 $ -- $ 346,354 $ 345,483
Average interest rate 0.76% 0.35% 0.35% 0.35% 0.33% 0.00% 0.55% --
Time deposits $ 334,192 $ 51,306 $ 6,127 $ 787 $ 3,246 $ 3,067 $ 398,725 $ 404,344
Average interest rate 2.78% 3.58% 4.05% 4.95% 4.82% 5.20% 2.94% --
Federal funds purchased
and securities sold under
agreements to repurchase $ 88,616 -- -- -- -- -- $ 88,616 $ 88,616
Average interest rate .87% -- -- -- -- -- .87%
Notes payable -- -- $ 7,000 -- -- $ 42,500 $ 49,500 $ 53,029
Average interest rate -- -- 4.79% -- -- 4.99% 4.96%
- -----------------------------------------------------------------------------------------------------------------------------------
Total Financial Liabilities $ 616,443 $ 125,047 $ 86,868 $ 74,528 $ 30,253 $ 99,642 $1,032,781 $1,032,595
- -----------------------------------------------------------------------------------------------------------------------------------
Interest rate sensitivity gap $ (110,416) $ (15,970) $ 10,654 $ 13,825 $ 50,940 $ 75,004 $ 24,037 --
Cumulative interest rate
sensitivity gap $ (110,416) $ (126,386) $ (115,732) $ (101,907) $ (50,967) $ 24,037
DEPOSITS
Customer deposits provide the Company with its primary source of funds for
the continued growth of its loan and investment portfolios. Total deposits were
$898,163,000 at December 31, 2002, an increase of $86,640,000, or 10.7 percent
from $811,523,000 at the end of 2001. The 2001 balance was $53,947,000, or 7.1
percent, greater than deposits at year-end 2000. Noninterest bearing accounts
grew by $16,406,000, or 12.6 percent, to $146,104,000 at the end of 2002.
Interest-bearing deposits were $752,059,000 at December 31, 2002, an increase of
$70,234,000, or 10.3 percent, over the balance one year earlier.
During 2002 average total deposits increased by $52,093,000, or 6.5
percent, to $855,223,000. Total average interest-bearing deposits grew by
$31,717,000, or 4.6 percent, led by a $26,089,000, or 18.0 percent, increase in
20
average interest-bearing transaction accounts. Noninterest-bearing demand
accounts increased $20,376,000, or 17.3 percent. In 2001, total deposits
averaged $803,130,000, an increase of $67,037,000, or 9.1 percent, compared with
2000. This increase was the result of growth in average interest-bearing
deposits of $63,696,000, or 10.3 percent, accompanied by a $3,341,000, or 2.9
percent, increase in noninterest-bearing deposits.
At December 31, 2002, the ratio of interest-bearing deposits to total
deposits was 83.7 percent, or slightly less than the 84.0 percent ratio at
December 31, 2001 and the 85.2 percent ratio at the end of 2000.
TABLE 10
MATURITY DISTRIBUTION OF CD'S OF $100,000 OR MORE
DECEMBER 31 2002 2001
- --------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Within three months $ 48,982 $ 46,756
After three through six months 35,579 32,263
After six through twelve months 45,581 31,501
After twelve months 19,380 9,518
- --------------------------------------------------------------------------------
Total $149,522 $120,038
================================================================================
SHORT-TERM BORROWED FUNDS
The distribution of First National Corporation's short-term borrowings at
the end of the last three years, the average amounts outstanding during each
such period, the maximum amounts outstanding at any month-end, and the weighted
average interest rates on year-end and average balances in each category are
presented below. Federal funds purchased and securities sold under agreement to
repurchase generally mature within one to three days from the transaction date.
Certain of the borrowings have no defined maturity date.
TABLE 11
DECEMBER 31 2002 2001 2000
(DOLLARS IN THOUSANDS) AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ----------------------------------------------------------------------------------------------
At period-end:
Federal funds purchased
and securities sold under
repurchase agreements $88,616 0.82% $66,617 1.52% $65,948 5.78%
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 5.03% 49,500 5.03% 57,050 5.95%
- ----------------------------------------------------------------------------------------------
Average for the year:
Federal funds purchased
and securities sold under
repurchase agreements and $75,956 1.15% $70,852 3.44% $85,422 6.93%
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 5.03% 41,134 5.13% 32,759 5.65%
- ----------------------------------------------------------------------------------------------
Maximum month-end balance:
Federal funds purchased
and securities sold under
repurchase agreements $88,617 $91,820 $159,503
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 50,500 57,050
- ----------------------------------------------------------------------------------------------
CAPITAL AND DIVIDENDS
A strong shareholders' equity base has provided First National Corporation
with support for its banking operations and opportunities for growth, while
ensuring sufficient resources to absorb the risks inherent in the business. As
of December 31, 2002, shareholders' equity was $103,496,000, or 9.0 percent, of
total assets. At year-end 2001 and 2000, shareholders' equity was $93,065,000,
or 9.1 percent, and $84,936,000, or 8.8 percent, of total assets, respectively.
21
The Company and its banking subsidiaries are subject to certain risk-based
capital guidelines that measure the relationship of capital to both balance
sheet and off-balance sheet risks. Risk values are adjusted to reflect credit
risk. Pursuant to guidelines of the Board of Governors of the Federal Reserve
System, which are substantially similar to those promulgated by the Office of
the Comptroller of the Currency, Tier 1 capital must be at least 50 percent of
total capital and total capital must be eight percent of risk-weighted assets.
The Tier 1 capital ratio for First National Corporation was 11.67 percent at
December 31, 2002, 12.32 percent at December 31, 2001 and 12.15 at the end of
2000. The total capital ratio for the Company was 12.92 percent, 13.57 percent
and 13.40 percent for the years ended December 31, 2002, 2001 and 2000,
respectively.
As an additional measure of capital soundness, the regulatory agencies have
prescribed a leverage ratio of total capital to total assets. The minimum
leverage ratio assigned to banks is between three and five percent and is
dependent on the institution's composite rating as determined by its regulators.
The leverage ratio for First National Corporation was 8.70 percent at December
31, 2002, 8.39 percent at December 31, 2001 and 8.27 percent at yearend 2000.
The Company well exceeded all minimum ratio standards established by the
regulatory agencies.
First National Corporation pays dividends to shareholders from funds
provided mainly by dividends from its subsidiary banks. Such bank dividends are
subject to certain regulatory restrictions and require the approval of the
Office of the Comptroller of the Currency in order to pay dividends in excess of
the banks' net earnings for the current year, plus retained net profits for the
preceding two years, less any required transfers to surplus. As of December 31,
2002, $20,136,000 of the banks' retained earnings were available for
distribution to the Company as dividends without prior regulatory approval.
In 2002, First National Corporation made shareholder dividend payments of
$4,420,000 as compared with $4,000,000 in 2001 and $3,801,000 in 2000. The
dividend pay-out ratios were 31.74 percent, 32.63 percent and 36.09 percent for
the years 2002, 2001 and 2000, respectively. Earnings that are retained continue
to be utilized as a basis for loan and investment portfolio growth and in
support of acquisition or other business expansion opportunities.
NONINTEREST INCOME AND EXPENSE
Noninterest income provides a significant stable source of revenue for the
Company that is especially important during a period of economic challenges, as
has been the experience of the past two years. For the year ended December 31,
2002, noninterest income was $17,681,000, an increase of $4,001,000, or 29.2
percent, from 2001. In 2001, noninterest income was $13,680,000, which was
$2,709,000, or 24.7 percent more than 2000. In 2002, noninterest income
comprised 20.8 percent of total income from both interest and noninterest
sources. For 2001 and 2000, noninterest income was 15.5 percent and 12.9
percent, respectively, of total interest and noninterest income.
Service charges on deposit accounts were $10,899,000 in 2002, comprising
61.6 percent of total noninterest income, and representing a $3,149,000, or 40.6
percent, increase over 2001. This increase was mainly the result of strong
deposit growth and new customer service programs initiated in the fourth quarter
of 2001. For the year ended December 31, 2001, service charges on deposit
accounts were $7,750,000, comprising 56.7 percent of income from all sources.
This represented an increase of $392,000, or 5.3 percent from 2000 and resulted
from deposit growth and pricing modifications.
During 2002, other service charges and fees increased by $1,422,000, or
26.5 percent, to $6,782,000, compared with 2001. For the year 2001, other
service charges and fees were up $1,747,000, or 48.4 percent, to $5,360,000,
compared with 2000. The increases in both 2002 and 2001 were mainly attributable
to higher origination fees earned on originations of fixed rate first mortgage
loans sold into the secondary market. High loan production volumes spurred by
low interest rates and enhancements to the Company's loan processing system were
key drivers of these increases in both years.
Further enhancing noninterest income in 2001, the Company recognized a
$570,000 gain on the sale of equity securities. No gains or losses on
disposition of securities-available-for-sale were recorded in either 2002 or
2000.
Noninterest expense was $42,567,000 in 2002, an increase of $5,434,000, or
14.6 percent, from 2001. In 2001, noninterest expense was $37,133,000, an
increase of $3,037,000, or 8.9 percent, compared with 2000.
Salaries and employee benefits were the largest component of noninterest
expense, comprising 56.7 percent and 53.2 percent of the category totals in 2002
and 2001, respectively. In 2002, salaries and employee benefits were
$24,136,000, an increase of $4,379,000, or 22.2 percent, over 2001. The main
contributors to the increase in 2002 were increased commission payments in
connection with higher mortgage loan origination activity and higher staffing
levels associated with branch additions and new departments. Salaries and
employee benefits were $19,757,000 in 2001, an increase of $2,453,000, or 14.2
percent, from 2000. The higher expense in 2001 resulted again from higher
commissions paid on increased mortgage loan originations compared with the
previous year and management and administrative personnel additions. The Company
employed 480 full-time equivalent employees at December 31, 2002, compared with
442 and 402 at the end of 2001 and 2000, respectively. Payments under a cash
incentive plan covering
22
all employees were $921,000 in 2002, $730,000 in 2001 and $843,000 in 2000.
Net occupancy expense was $2,319,000, $2,053,000 and $1,989,000 for the
years 2002, 2001 and 2000, respectively. The increase was 13.0 percent from 2001
to 2002 and 3.2 percent from 2000 to 2001. The larger increase in 2002 was the
result of increased operating expenses associated with new banking facilities.
Furniture and equipment expense was $3,858,000 in 2002, an increase of
$135,000, or 3.6 percent, from 2001. The increase was mainly due to higher costs
of leasing data processing and other equipment. In 2001, furniture and equipment
expense was $3,723,000, an increase of $154,000, or 4.3 percent, compared with
2000. This increase was the result of higher equipment leasing costs and costs
of equipment service contracts.
For the year ended December 31, 2002, other expense was $12,254,000, an
increase of $654,000, or 5.6 percent, from 2001. Variations in other expenses
year-to-year included an increase of $613,000 in consulting fees, mainly
attributable to new customer service programs; advertising and marketing costs
of $415,000 associated with changing the names of the three banking affiliates
to South Carolina Bank and Trust; an increase of $360,000 in facilities
operating expenses, including communications, printing, supplies, and postage,
in connection with new banking facilities; and a decrease of $495,000 in
amortization of intangible assets. In 2001, other expense was $11,600,000, an
increase of $366,000, or 3.3 percent, from 2000. Active marketing campaigns in
2001 increased advertising expenses by $626,000, while professional fees
decreased by $565,000 from 2000, in which the Company incurred costs associated
with a process reengineering study.
TABLE 12
QUARTERLY RESULTS OF OPERATIONS
(DOLLARS IN THOUSANDS) 2002 QUARTERS 2001 QUARTERS
----------------------------------------- -----------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
-------- -------- -------- -------- -------- -------- -------- --------
Interest income $ 16,611 $ 17,419 $ 16,767 $ 16,690 $ 17,854 $ 18,865 $ 18,735 $ 19,018
Interest expense 4,246 4,871 4,629 5,002 5,896 7,407 7,981 8,688
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income 12,365 12,548 12,138 11,688 11,958 11,458 10,754 10,330
- ---------------------------------------------------------------------------------------------------------------------------
Provision for loan losses 1,208 884 644 491 915 693 404 292
Noninterest income 5,099 4,327 4,104 4,151 3,660 3,173 3,862 2,985
Noninterest expense 10,525 11,276 10,525 10,241 10,144 9,204 9,463 8,322
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 5,731 4,715 5,073 5,107 4,559 4,734 4,749 4,701
- ---------------------------------------------------------------------------------------------------------------------------
Income taxes 1,931 1,460 1,670 1,731 1,568 1,643 1,650 1,625
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 3,800 $ 3,255 $ 3,403 $ 3,376 $ 2,991 $ 3,091 $ 3,099 $ 3,076
===========================================================================================================================
CRITICAL ACCOUNTING POLICIES
First National Corporation has established various accounting policies that
govern the application of accounting principles generally accepted in the United
States of America in the preparation of the Company's financial statements. The
significant accounting policies of the Company are described in Note 1 to the
consolidated financial statements. Certain of these policies involve significant
judgments and estimates by management that have a material impact on the
carrying value of certain assets and liabilities. Different assumptions in the
application of these policies could result in material changes in the Company's
financial position and results of operations.
The allowance for loan losses reflects the estimated losses that will
result from the inability of the banks' borrowers to make required loan
payments. In determining an appropriate level for the allowance, management
identifies portions applicable to specific loans as well as providing amounts
that are not identified with any specific loan but are derived with reference to
actual loss experience, loan types, loan volumes, economic conditions, and
industry standards. Changes in these factors may cause management's estimate of
the allowance to increase or decrease and result in adjustments to the Company's
provision for loan losses. See "Loan Loss Provision" in this Management's
Discussion and Analysis of Financial Condition and Results of Operations and
"Allowance for Loan Losses" in Note 1 to the consolidated financial statements
for further detailed descriptions of the Company's estimation process and
methodology related to the allowance for loan losses.
Intangible assets, included in other assets in the consolidated balance
sheets, consist of goodwill and core deposit premium costs that resulted from
the acquisition of branches from other commercial banks. Core deposit premium
costs represent the estimated value of long-term deposit relationships acquired
in these transactions. These costs are amortized over the estimated useful lives
of the deposit accounts acquired on a method that management believes reasonably
approximates the anticipated benefit stream from the accounts. The estimated
useful lives are periodically reviewed for reasonableness. Goodwill represents
the excess of the purchase price over the sum of the estimated fair values of
the tangible and identifiable intangible assets acquired less the estimated fair
value of the liabilities assumed. Beginning January 1, 2002, goodwill is no
longer amortized.
23
EFFECT OF INFLATION AND CHANGING PRICES
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America which
require the measure of financial position and results of operations in terms of
historical dollars, without consideration of changes in the relative purchasing
power over time due to inflation. Unlike most other industries, the majority of
the assets and liabilities of a financial institution are monetary in nature. As
a result, interest rates generally have a more significant effect on a financial
institution's performance than does the effect of inflation. Interest rates do
not necessarily change in the same magnitude as the prices of goods and
services.
While the effect of inflation on banks is normally not as significant as is
its influence on those businesses which have large investments in plant and
inventories, it does have an effect. During periods of high inflation, there are
normally corresponding increases in money supply, and banks will normally
experience above average growth in assets, loans and deposits. Also, general
increases in the prices of goods and services will result in increased operating
expenses. Inflation also affects the bank's customers which may result in an
indirect effect on the banks' business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See "Derivatives and Securities Held for Trading" and "Asset-Liability
Management and Market Risk Sensitivity" in Management's Discussion and Analysis
of Financial Condition and Results of Operations for quantitative and
qualitative disclosures about market risk.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
The financial statements, accompanying notes, and other financial
information in this Report were prepared by management of First National
Corporation which is responsible for the integrity of the information given. The
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America and include amounts which are based on
management's judgment or best estimates.
The Company maintains a system of internal controls to reasonably assure
the safeguarding of assets and proper execution of transactions according to
management's directives. The control system consists of written policies and
procedures, segregation of duties, and an internal audit program. Management is
cognizant of the limitations of such controls, but feels reasonable assurance of
effectiveness is achieved without extending costs beyond benefits derived.
Internal audit reports are prepared for the Audit Committee of the Board of
Directors and copies are made available to the independent auditors. The Audit
Committee of the Board of Directors consists solely of outside directors who
meet periodically with management, internal auditors, and the independent
auditors. The Audit Committee reviews matters relating to the audit scope,
quality of financial reporting and control, and evaluation of management's
performance of its financial reporting responsibility. Access to the Audit
Committee is available to both internal and independent auditors without
management present.
J. W. Hunt and Company, LLP independent auditors, has audited the financial
statements and notes included in this Annual Report. Their audit was conducted
in accordance with auditing standards generally accepted in the United States of
America, and their opinion presents an objective evaluation of management's
discharge of its responsibility to fairly present the financial statements of
the Company. Their opinion is contained in their report below. All financial
information appearing in this Annual Report is consistent with that in the
audited financial statements.
First National Corporation
Columbia, South Carolina
January 17, 2003
REPORT OF INDEPENDENT AUDITORS
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Shareholders and
the Board of Directors
First National Corporation
We have audited the accompanying consolidated balance sheets of First
National Corporation and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 2002.
These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First
National Corporation and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
J. W. Hunt and Company, LLP
Columbia, South Carolina
January 17, 2003
25
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except par value)
DECEMBER 31,
2002 2001
---- ----
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 40,479 $ 40,126
Interest-bearing deposits with banks 35 49
Federal funds sold -- 1,000
- --------------------------------------------------------------------------------
Total cash and cash equivalents 40,514 41,175
- --------------------------------------------------------------------------------
Investment securities :
Securities held-to-maturity (fair value of
$35,044 in 2002 and $35,662 in 2001) 33,211 35,014
Securities available-for-sale, at fair value 131,740 154,919
- --------------------------------------------------------------------------------
Total investment securities 164,951 189,933
- --------------------------------------------------------------------------------
Loans held for sale 39,141 20,784
- --------------------------------------------------------------------------------
Loans 864,815 750,372
Less unearned income (1,393) (2,292)
Less allowance for loan losses (11,065) (9,818)
- --------------------------------------------------------------------------------
Loans, net 852,357 738,262
- --------------------------------------------------------------------------------
Premises and equipment, net 28,186 19,537
- --------------------------------------------------------------------------------
Other assets 19,799 15,991
- --------------------------------------------------------------------------------
Total assets $1,144,948 $1,025,682
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing $ 146,104 $ 129,698
Interest-bearing 752,059 681,825
- --------------------------------------------------------------------------------
Total deposits 898,163 811,523
Federal funds purchased and securities
sold under agreements to repurchase 88,616 66,617
Notes payable 49,500 49,500
Other liabilities 5,173 4,977
- --------------------------------------------------------------------------------
Total liabilities 1,041,452 932,617
- --------------------------------------------------------------------------------
Shareholders' equity:
Common stock - $2.50 par value, authorized
40,000,000 shares, issued and outstanding
7,673,339 shares in 2002 and 6,964,878
shares in 2001 19,183 17,412
Surplus 62,423 46,016
Retained earnings 20,071 28,485
Accumulated other comprehensive income 1,819 1,152
- --------------------------------------------------------------------------------
Total shareholders' equity 103,496 93,065
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $1,144,948 $1,025,682
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
26
CONSOLIDATED STATEMENTS OF INCOME
(In thousands of dollars, except per share data)
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Interest income:
Loans, including fees $ 58,119 $ 63,196 $ 61,284
Investment securities:
Taxable 7,307 8,980 9,252
Tax-exempt 1,501 1,606 1,775
Money market funds 404 108 --
Federal funds sold 107 578 1,501
Deposits with banks 49 4 34
- --------------------------------------------------------------------------------
Total interest income 67,487 74,472 73,846
- --------------------------------------------------------------------------------
Interest expense:
Deposits 15,382 25,423 25,458
Federal funds purchased and securities
sold under agreements to repurchase 874 2,438 5,923
Notes payable 2,492 2,111 1,851
- --------------------------------------------------------------------------------
Total interest expense 18,748 29,972 33,232
- --------------------------------------------------------------------------------
Net interest income:
Net interest income 48,739 44,500 40,614
Provision for loan losses 3,227 2,304 1,838
- --------------------------------------------------------------------------------
Net interest income after provision
for loan losses 45,512 42,196 38,776
- --------------------------------------------------------------------------------
Noninterest income:
Service charges on deposit accounts 10,899 7,750 7,358
Other service charges and fees 6,782 5,360 3,613
Gain on sale of securities
available-for-sale -- 570 --
- --------------------------------------------------------------------------------
Total noninterest income 17,681 13,680 10,971
- --------------------------------------------------------------------------------
Noninterest expense:
Salaries and employee benefits 24,136 19,757 17,304
Net occupancy expense 2,319 2,053 1,989
Furniture and equipment expense 3,858 3,723 3,569
Other expense 12,254 11,600 11,234
- --------------------------------------------------------------------------------
Total noninterest expense 42,567 37,133 34,096
- --------------------------------------------------------------------------------
Earnings:
Income before provision for income taxes 20,626 18,743 15,651
Provision for income taxes 6,792 6,486 5,118
- --------------------------------------------------------------------------------
Net income $ 13,834 $ 12,257 $ 10,533
================================================================================
Earnings per share
Basic $ 1.80 $ 1.59 $ 1.36
================================================================================
Diluted $ 1.79 $ 1.59 $ 1.36
================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
27
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands of dollars, except per share data)
ACCUMULATED
OTHER
COMMON STOCK RETAINED COMPREHENSIVE
SHARES AMOUNT SURPLUS EARNINGS INCOME (LOSS) TOTAL
------ ------ ------- -------- ------------- -----
Balance, December 31, 1999 7,041,101 $ 17,603 $ 47,666 $ 13,496 $ (2,946) $ 75,819
Comprehensive income:
Net income -- -- -- 10,533 -- 10,533
Change in net unrealized gain on
securities available-for-sale, net of
tax effects -- -- -- -- 2,599 2,599
----------
Total comprehensive income 13,132
----------
Cash dividends declared at $.54 per share -- -- -- (3,801) -- (3,801)
----------
Common stock repurchased (14,200) (36) (178) -- -- (214)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 7,026,901 17,567 47,488 20,228 (347) 84,936
----------
Comprehensive income:
Net income -- -- -- 12,257 -- 12,257
Change in net unrealized gain on
securities available-for-sale, net
of reclassification adjustments and
tax effects -- -- -- -- 1,499 1,499
----------
Total comprehensive income 13,756
----------
Cash dividends declared at $.57 per share -- -- -- (4,000) -- (4,000)
----------
Stock options exercised 76,230 191 700 -- -- 891
----------
Common stock repurchased (138,253) (346) (2,172) -- -- (2,518)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 6,964,878 17,412 46,016 28,485 1,152 93,065
----------
Comprehensive income:
Net income -- -- -- 13,834 -- 13,834
Change in net unrealized gain on
securities available-for-sale, net
of tax effects -- -- -- -- 667 667
----------
Total comprehensive income 14,501
----------
Cash dividends declared at $.59 per share -- -- -- (4,420) -- (4,420)
----------
Stock options exercised 4,300 11 67 -- -- 78
----------
Employee stock purchases 3,776 9 72 -- -- 81
----------
Restricted stock awards 17,000 43 413 -- -- 456
----------
Common stock repurchased (12,402) (31) (234) -- -- (265)
----------
Common stock dividend of 10%, record date,
November 22, 2002 695,787 1,739 16,089 (17,828) -- --
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 7,673,339 $ 19,183 $ 62,423 $ 20,071 $ 1,819 $ 103,496
==========================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
28
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
YEAR ENDED DECEMBER 31,
Cash flows from operating activities: 2002 2001 2000
---- ---- ----
Net income $ 13,834 $ 12,257 $ 10,533
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 2,005 2,439 2,646
Provision for loan losses 3,227 2,304 1,838
Deferred income taxes (109) (465) (344)
Gain on sale of securities
available-for-sale -- (570) --
Loss on sale of premises and equipment 4 17 --
Net amortization (accretion) of
investment securities 962 189 (92)
Originations of loans held for sale (206,919) (194,060) (1,359)
Proceeds from sales of loans held
for sale 188,556 174,635 --
Net change in:
Accrued interest receivable 667 1,569 (1,571)
Prepaid assets (771) 582 (1,087)
Miscellaneous other assets (3,978) (405) (1,079)
Accrued interest payable (687) (1,312) 1,150
Accrued income taxes 95 244 710
Miscellaneous other liabilities 690 772 (754)
- -----------------------------------------------------------------------------------
Net cash provided (used) by
operating activities (2,424) (1,804) 10,591
- -----------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales of investment
securities available-for-sale -- 14,044 12,973
Proceeds from maturities of investment
securities held-to-maturity 2,807 3,459 10,793
Proceeds from maturities of investment
securities available-for-sale 277,106 172,001 24,135
Purchases of investment securities
held-to-maturity (1,073) -- (2,169)
Purchases of investment securities
available-for-sale (253,744) (193,450) (29,141)
Net increase in customer loans (117,537) (22,198) (118,152)
Recoveries on loans previously charged off 256 400 202
Purchases of premises and equipment (10,773) (4,997) (2,331)
Proceeds from sale of premises and equipment 187 280 29
- -----------------------------------------------------------------------------------
Net cash used by investing activities (102,806) (30,461) (103,661)
- -----------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in demand deposits 86,640 53,948 67,911
Net increase (decrease) in federal funds
purchased and securities sold under
agreements to repurchase 21,999 668 (10,452)
Proceeds from issuance of debt -- 54,500 166,000
Repayment of debt -- (62,050) (135,700)
Common stock issuance 537 -- --
Common stock repurchase (265) (2,518) (214)
Dividends paid (4,420) (4,000) (3,801)
Stock options exercised 78 891 --
- -----------------------------------------------------------------------------------
Net cash provided by financing activities 104,569 41,439 83,744
- -----------------------------------------------------------------------------------
29
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands of dollars)
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Net increase (decrease) in cash and
cash equivalents $ (661) $ 9,174 $ (9,326)
Cash and cash equivalents at beginning
of year 41,175 32,001 41,327
- -----------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 40,514 $ 41,175 $ 32,001
===================================================================================
Supplemental Disclosures:
Cash Flow Information:
Cash paid for:
Interest $ 18,282 $ 31,685 $ 32,083
===================================================================================
Income taxes $ 6,705 $ 6,715 $ 4,882
===================================================================================
Schedule of Noncash Investing Transactions:
Real estate acquired in full or partial
settlement of loans $ 1,051 $ 798 $ 848
===================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF OPERATIONS:
First National Corporation (the "Corporation") is a bank holding company whose
principal activity is the ownership and management of its wholly-owned
subsidiaries, South Carolina Bank and Trust, N.A., South Carolina Bank and Trust
of the Piedmont, N.A., South Carolina Bank and Trust of the Pee Dee, N.A. (the
"Banks"), and CreditSouth Financial Services Corporation ("CreditSouth"). The
accounting and reporting policies of the Corporation and its subsidiaries
conform with accounting principles generally accepted in the United States of
America. The Banks provide general banking services while CreditSouth provides
consumer finance services. All services are provided within the State of South
Carolina ("South Carolina").
On December 1, 2002, South Carolina Bank and Trust, N.A. acquired the majority
of the consumer loan portfolio and related assets of CreditSouth and assumed the
continuing lending activities of that entity. Thereafter, CreditSouth ceased
active lending programs and focused on servicing a retained portfolio of loans
that were delinquent at the time of the acquisition.
BASIS OF CONSOLIDATION:
The consolidated financial statements include the accounts of First National
Corporation and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
SEGMENTS:
The Company, through its subsidiaries, provides a broad range of financial
services to individuals and companies in South Carolina. These services include
demand, time and savings deposits; lending and credit card servicing; ATM
processing; and trust services. While the Company's decision-makers monitor the
revenue streams of the various financial products and services, operations are
managed and financial performance is evaluated on an organization-wide basis.
Accordingly, the Company's banking and finance operations are not considered by
management to be more than one reportable operating segment.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the
balance sheet and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan losses, fair value of
financial instruments, and valuation of deferred tax assets. In connection with
the determination of the allowance for loan losses, management has identified
specific loans as well as adopted a policy of providing amounts for loan
valuation purposes which are not identified with any specific loan but are
derived from actual loss experience ratios, loan types, loan volume, economic
conditions and
30
industry standards. Management believes that the allowance for loan losses is
adequate. While management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on changes in
economic conditions. In addition, regulatory agencies, as an integral part of
the examination process, periodically review the banking subsidiaries' allowance
for loan losses. Such agencies may require additions to the allowance based on
their judgments about information available to them at the time of their
examination.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK:
The Company's subsidiaries grant agribusiness, commercial, and residential loans
to customers throughout South Carolina. Although the subsidiaries have a
diversified loan portfolio, a substantial portion of their debtors' ability to
honor their contracts is dependent upon economic conditions within South
Carolina and the surrounding region.
The Company considers concentrations of credit to exist when the amounts loaned
to a multiple number of borrowers engaged in similar business activities which
would cause them to be similarly impacted by general economic conditions
represents 25% of equity.
INVESTMENT SECURITIES:
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held-to-maturity" and carried at amortized cost.
Securities not classified as held-to-maturity, including equity securities with
readily determinable fair values, are classified as "available-for-sale" and
carried at fair value with unrealized gains and losses excluded from earnings
and reported in other comprehensive income (loss).
Purchase premiums and discounts are recognized in interest income using methods
approximating the interest method over the terms of the securities. Declines in
the fair value of held-to-maturity and available-for-sale securities below their
cost that are deemed to be other than temporary are reflected in earnings as
realized losses. Gains and losses realized on sales of securities
available-for-sale are determined using the specific identification method.
LOANS HELD FOR SALE:
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income.
LOANS:
Loans are stated at unpaid principal balances, less unearned discounts and the
allowance for loan losses. Unearned discounts on installment loans are
recognized as income over the terms of the loans by methods which generally
approximate the interest method. Interest on other loans is calculated by using
the simple interest method on daily balances of the principal amount
outstanding. Loans are placed on nonaccrual when a loan is specifically
determined to be impaired or when principal or interest is delinquent for 120
days or more. A nonaccrual loan may not be considered impaired if it is expected
that the delay in payment is minimal. All interest accrued but not collected for
loans that are placed on nonaccrual is reversed against interest income.
Interest income is subsequently recognized only to the extent of interest
payments received.
A loan is considered impaired when, in management's judgement, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Management determines when loans become impaired through its normal loan
administration and review functions. Those loans identified as substandard or
doubtful as a result of the loan review process are potentially impaired loans.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired provided that management expects to
collect all amounts due, including interest accrued at the contractual interest
rate, for the period of delay. Impairment is measured on a loan by loan basis
for commercial and construction loans by either the present value of expected
future cash flows discounted at the loan's effective interest rate, the loan's
obtainable market price, or the fair value of the collateral if the loan is
collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Company does not separately identify individual
credit card, residential mortgage, overdraft protection, home equity lines,
accounts receivable financing, and consumer installment loans for impairment
disclosures.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes that the
collectibility of the principal is unlikely. Subsequent recoveries, if any, are
credited to the allowance. The allowance for loan losses is evaluated on a
regular basis by management and is based upon management's periodic review of
the collectibility of the loans in light of historical experience, the nature
and volume of the loan
31
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component is maintained to cover uncertainties that
could affect management's estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
Although management uses available information to recognize losses on loans,
because of uncertainties associated with local economic conditions, collateral
values, and future cash flows on impaired loans, it is reasonably possible that
a material change could occur in the allowance for loan losses in the near term.
However, the amount of the change that is reasonably possible cannot be
estimated. The allowance is increased by a provision for loan losses, which is
charged to expense and reduced by charge-offs, net of recoveries. Changes in the
allowance relating to impaired loans are charged or credited to the provision
for loan losses.
OTHER REAL ESTATE OWNED (OREO):
Real estate acquired in satisfaction of a loan and in-substance foreclosures are
reported in other assets. In-substance foreclosures are properties in which the
borrower has little or no equity in the collateral. Properties acquired by
foreclosure or deed in lieu of foreclosure and in-substance foreclosures are
transferred to OREO and recorded at the lower of the outstanding loan balance at
the time of acquisition or the estimated market value. Market value is
determined on the basis of the properties being disposed of in the normal course
of business and not on a liquidation or distress basis. Loan losses arising from
the acquisition of such properties are charged against the allowance for loan
losses. Gains or losses arising from the sale of OREO are reflected in current
operations.
TRANSFERS OF FINANCIAL ASSETS:
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
PREMISES AND EQUIPMENT:
Office equipment, furnishings, and buildings are stated at cost less accumulated
depreciation computed principally on the declining-balance and straight-line
methods over the estimated useful lives of the assets. Leasehold improvements
are amortized on the straight-line method over the shorter of the estimated
useful lives of the improvements or the terms of the related leases. Additions
to premises and equipment and major replacements are added to the accounts at
cost. Maintenance and repairs and minor replacements are charged to expense when
incurred. Gains and losses on routine dispositions are reflected in current
operations.
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 deposits premium costs are being amortized over the estimated
useful lives of the deposit accounts acquired on a method which reasonably
approximates the anticipated benefit stream from the accounts. Beginning January
1, 2002, goodwill is no longer amortized (See RECENT ACCOUNTING PRONOUNCEMENTS).
EMPLOYEE BENEFIT PLANS:
A summary of the Company's various employee benefit plans follows:
PENSION PLAN - The Company and its subsidiaries have a non-contributory defined
benefit pension plan covering all employees who have attained age twenty-one and
have completed one year of eligible service. The Company's funding policy is to
contribute annually the amount necessary to satisfy the Internal Revenue
Service's funding standards.
PROFIT-SHARING PLAN - The Company and its subsidiaries have a profit-sharing
plan, including Internal Revenue Code
32
Section 401(k) provisions. Electing employees are eligible to participate after
attaining age twenty-one and completing one year of eligible service. Plan
participants elect to contribute 1% to 4% of annual base compensation as a
before tax contribution. The Company matches 50% of these contributions.
Employer contributions may be made from current or accumulated net profits.
Participants may additionally elect to contribute 1% to 6% of annual base
compensation as a before tax contribution with no employer matching
contribution.
RETIREE MEDICAL PLAN - Post-retirement health and life insurance benefits are
provided to eligible employees which is limited to those employees of the
Company eligible for early retirement under the pension plan on or before
December 31, 1993, and former employees who are currently receiving benefits.
The plan was unfunded at December 31, 2002, and the liability for future
benefits has been recorded in the consolidated financial statements.
EMPLOYEE STOCK PURCHASE PLAN - The Company 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 the 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.
CASH AND CASH EQUIVALENTS:
For the purpose of presentation in the consolidated statements of cash flows,
cash and cash equivalents include cash on hand, cash items in process of
collection, amounts due from banks, interest bearing deposits with banks, and
federal funds sold. Due from bank balances are maintained in other financial
institutions. Federal funds sold are generally purchased and sold for one-day
periods.
INCOME TAXES:
Income taxes are provided for the tax effects of the transactions reported in
the accompanying consolidated financial statements and consist of taxes
currently due plus deferred taxes related primarily to differences between the
basis of available-for-sale securities, allowance for loan losses, accumulated
depreciation, consumer loan income, accretion income, intangible assets, and
pension plan and post-retirement benefits. The deferred tax assets and
liabilities represent the future tax return consequences of those differences,
which will either be taxable or deductible when the assets and liabilities are
recovered or settled. Deferred tax assets and liabilities are reflected at
income tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes. The Company files a consolidated federal income tax
return with its subsidiaries.
ADVERTISING COSTS:
The cost of advertising is expensed as incurred.
STOCK COMPENSATION PLANS:
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for
Stock-Based Compensation, allows all entities to adopt a fair value based method
of accounting for employee stock compensation plans, whereby compensation cost
is measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. However, it also
allows an entity to continue to measure compensation cost for those plans using
the intrinsic value based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees, whereby compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date (or other measurement date) over the amount
an employee must pay to acquire the stock. Stock options issued under the
Company's stock option plans have no intrinsic value at the grant date, and
under APB Opinion No. 25 no compensation cost is recognized for them. The
Company has elected to continue with the accounting methodology in APB Opinion
No. 25 and, as a result, has provided pro forma disclosures of net income and
earnings per share and other disclosures, as if the fair value based method of
accounting had been applied. The pro forma disclosures include the effects of
all awards granted on or after January 1, 1995. (See NOTE 17.)
EARNINGS PER SHARE:
Basic earnings per share represents income available to shareholders divided by
the weighted-average number of shares outstanding during the year. Diluted
earnings per share reflects additional shares that would have been outstanding
if dilutive potential shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential shares that may be
issued by the Company relate solely to outstanding stock options, and are
determined using the treasury stock method. Under the treasury stock method, the
number of incremental shares is determined by assuming the issuance of the
outstanding stock options, reduced by the number of shares assumed to be
repurchased from the issuance proceeds, using the average market price for the
year of the Company's stock.
33
COMPREHENSIVE INCOME (LOSS):
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income. (See NOTE 13.)
RECENT ACCOUNTING PRONOUNCEMENTS:
In June 2001, the Financial Accounting Standards Board ("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 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 in 2002 or 2001.
SFAS No. 142 addresses financial accounting and reporting for acquired goodwill
and other intangible assets and supersedes APB Opinion No. 17, Intangible
Assets. It requires goodwill and other intangible assets that have indefinite
useful lives to no longer be amortized; however, these assets must be tested at
least annually for impairment. SFAS No. 142 also requires an evaluation of
existing acquired goodwill and other intangible assets for proper classification
under the new requirements. In addition, intangible assets (other than goodwill)
that have finite useful lives will continue to be amortized over their useful
lives; however, the amortization period of such intangible assets will no longer
be limited to 40 years. In addition, any intangible asset classified as goodwill
under SFAS No. 142 is subject to a transitional impairment test prior to June
30, 2002. The Company adopted SFAS No. 142 effective January 1, 2002. See NOTE 6
for details regarding the effect of implementation of SFAS No. 142 on the
Company's financial statements.
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 Company 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. 121 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. Implementation of the provisions of this statement did not have a
material effect on the Company's earnings or financial position.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS No. 145 requires the recording of gains and losses from the extinguishment
of debt to be classified as operating income, as opposed to previous
requirements which reflected such gains and losses as extraordinary items. SFAS
No. 145 is effective for fiscal years beginning on or after May 15, 2002. The
provisions of SFAS 145 will be effective for the Company in 2003. The Company
does not believe that SFAS 145 will have a significant impact on its financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). This Statement requires
that a liability for a cost associated with an exit or disposal activity be
recognized at fair value when the liability is incurred. The provisions of SFAS
No. 146 will be effective for exit and disposal activities initiated after
December 31, 2002. The Company does not believe SFAS No. 146 will have a
significant impact on its financial position or results of operations.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions - an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9, effective October 1, 2002. SFAS No. 147 removes
acquisitions of financial institutions from the scope of both SFAS No. 72 and
FASB Interpretation ("FIN") No. 9 and requires that those transactions be
accounted for in accordance with SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in SFAS No.
72 to recognize (and subsequently amortize) any excess of the fair value of
liabilities assumed over the fair value of tangible and identifiable intangible
assets acquired as an unidentifiable intangible asset no longer applies to
business combinations. The Company adopted the provisions of SFAS No. 147 in the
fourth quarter of 2002. The adoption of SFAS No. 147 did not have a significant
impact on the Company's financial position or results of operations.
34
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 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 No. 148 amends the
disclosure requirements of SFAS No. 123 to require more prominent disclosures in
both annual and interim financial statements about the method of accounting for
stockbased compensation and the effect of the method used on reported results.
The transition guidance and annual disclosure provisions of SFAS No. 148 are
effective for fiscal years ending after December 15, 2002. The interim
disclosure provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. The transition
rules of this standard are not applicable since the Company continues to account
for stock-based compensation under the guidance of APB Opinion 25. (See NOTE 17)
In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107
and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements
of SFAS No. 5, Accounting for Contingencies, relating to the guarantor's
accounting for, and disclosure of, the issuance of certain types of guarantees
and requires that a liability be recognized at the inception of certain
guarantees for the fair value of the obligation, including the ongoing
obligation to stand ready to perform over the term of the guarantee. Guarantees,
as defined in FIN 45, include contracts that contingently require the Company to
make payments to a guaranteed party based on changes in an underlying that is
related to an asset, liability or equity security of the guaranteed party,
performance guarantees, indemnification agreements or indirect guarantees of
indebtedness of others. The disclosure provisions of the Interpretation are
effective for financial statements that end after December 15, 2002. However,
the provisions for initial recognition and measurement are effective on a
prospective basis for guarantees that are issued or modified after December 31,
2002, irrespective of a guarantor's year end. The adoption of the disclosure
provisions of FIN No. 45 as of December 31, 2002 had no significant impact on
the Company's financial position or results of operations. Management does not
believe the adoption of the Interpretation's measurement and recognition
provisions will have a significant impact on future operations of the Company.
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51. FIN 46 provides a new framework for
identifying variable interest entities and determining when a company should
include the assets, liabilities, noncontrolling interests and results of
activities of a variable interest entity in its consolidated financial
statements. FIN 46 states that if a business enterprise has a controlling
financial interest in a variable interest entity, the assets, liabilities and
results of the activities of the variable interest entity should be included in
the consolidated financial statements of the business enterprise. This
Interpretation also requires existing unconsolidated variable interest entities
to be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. Variable interest entities
that effectively disperse risks will not be consolidated unless a single party
holds an interest or combination of interests that effectively recombines risks
that were previously dispersed. FIN 46 is effective immediately for variable
interest entities created after January 31, 2003, and to variable interest
entities in which an enterprise obtains an interest after that date. It applies
in the first fiscal year or interim period beginning after June 15, 2003, to
variable interest entities in which an enterprise holds a variable interest that
it acquired before February 1, 2003. This Interpretation does not apply to
securitization structures that are qualified special purpose entities as defined
within SFAS No. 140. Management does not feel that adoption of this
Interpretation will have a significant impact on future operations of the
Company.
OTHER:
Certain amounts previously reported have been restated in order to conform with
current year presentation. Such reclassifications had no effect on net income.
NOTE 2 - RESTRICTION ON CASH AND DUE FROM BANKS:
The Banks are required to maintain a specified average amount of reserve funds
in cash or on deposit with the Federal Reserve Bank. The average amount of such
reserve funds at December 31, 2002, was approximately $9,148,000.
At December 31, 2002, the Company and its subsidiaries had due from bank
balances in excess of federally insured limits of approximately $3,047,000. The
risk associated with this excess is limited due to the soundness of the
financial institutions with which the funds are deposited.
35
NOTE 3 - INVESTMENT SECURITIES:
The following is the amortized cost and fair value of investment securities
held-to-maturity at December 31, 2002 and 2001:
2002
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
(In thousands of dollars)
Securities of U. S. Government
agencies and corporations $ 51 $ -- $ -- $ 51
Obligations of states
and political subdivisions 33,160 1,836 (3) 34,993
- --------------------------------------------------------------------------------
Total $ 33,211 $ 1,836 $ (3) $ 35,044
================================================================================
2001
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
(In thousands of dollars)
Securities of other U. S.
Government agencies and
corporations $ 247 $ 4 $ -- $ 251
Obligations of states and
political subdivisions 34,767 722 (78) 35,411
- --------------------------------------------------------------------------------
Total $ 35,014 $ 726 $ (78) $ 35,662
================================================================================
The fair values of obligations of states and political subdivisions are
established with the assistance of an independent pricing service. The values
are based on data which often reflect transactions of relatively small size and
are not necessarily indicative of the value of the securities when traded in
large volumes.
The following is the amortized cost and fair value of securities
available-for-sale at December 31, 2002 and 2001:
2002
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
(In thousands of dollars)
U. S. Treasury securities $ -- $ -- $ -- $ --
Securities of other
U. S. Government agencies
and corporations 117,656 2,901 (4) $120,553
Other securities 11,096 97 (6) 11,187
- --------------------------------------------------------------------------------
Total $128,752 $ 2,998 $ (10) $131,740
================================================================================
36
2001
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
(In thousands of dollars)
U. S. Treasury securities $ 8,523 $ 121 $ -- $ 8,644
Securities of other
U. S. Government agencies
and corporations 135,639 1,764 (54) 137,349
Other securities 8,899 72 (45) 8,926
- --------------------------------------------------------------------------------
Total $153,061 $ 1,957 $ (99) $154,919
================================================================================
The amortized cost and fair value of debt securities at December 31, 2002 by
contractual maturity are detailed below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
SECURITIES SECURITIES
HELD-TO-MATURITY AVAILABLE-FOR-SALE
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---- ----- ---- -----
(In thousands of dollars)
Due in one year or less $ 3,277 $ 3,310 $ 55,799 $ 56,275
Due after one year through
five years 22,172 23,438 58,136 60,371
Due after five years through
ten years 7,762 8,296 3,721 3,905
Due after ten years -- -- -- --
- --------------------------------------------------------------------------------
Subtotal 33,211 35,044 117,656 120,551
No contractual maturity -- -- 11,189 11,189
- --------------------------------------------------------------------------------
Total $ 33,211 $ 35,044 $128,845 $131,740
================================================================================
Held-to-maturity securities with a carrying value of $3,000,000 were transferred
to the available for sale category in 2000. There were no sales or transfers of
held-to-maturity securities during 2002 or 2001.
The following table summarizes information with respect to sale of
available-for-sale securities:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Sale proceeds $ -- $13,998,000 $12,973,000
================================================================================
Gross realized gains $ -- $ 597,000 $ 20,000
Gross realized losses -- 27,000 20,000
- --------------------------------------------------------------------------------
Net realized gain $ -- $ 570,000 $ --
================================================================================
The Banks, as members of the Federal Home Loan Bank ("FHLB") of Atlanta, are
required to own capital stock in the FHLB of Atlanta based generally upon their
balances of residential mortgage loans and FHLB advances. FHLB capital stock
owned by the Banks is pledged as collateral on FHLB advances. No secondary
market exists for this stock, and it has no quoted market price. However,
redemption through the FHLB of this stock has historically been at par value.
At December 31, 2002 and 2001, investment securities with a carrying value of
$70,045,000 and $57,882,000, respectively, were pledged to secure public
deposits, FHLB advances and for other purposes required and permitted by law. At
December 31, 2002 and 2001, the carrying amount of securities pledged to secure
repurchase agreements was $73,179,000 and $47,877,000, respectively.
37
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES:
The following is a summary of loans by category at December 31, 2002 and 2001:
2002 2001
---- ----
(In thousands of dollars)
Commercial, financial and agricultural $149,385 $118,819
Real estate - construction 40,338 37,709
Real estate - mortgage 562,179 475,110
Consumer 112,913 118,734
- --------------------------------------------------------------------------------
Total loans 864,815 750,372
================================================================================
Less, unearned income 1,393 2,292
Less, allowance for loan losses 11,065 9,818
- --------------------------------------------------------------------------------
Loans, net $852,357 $738,262
================================================================================
Changes in the allowance for loan losses for the three years ended December 31,
2002, were as follows:
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Balance at beginning of year $ 9,818 $ 8,922 $ 7,886
Loans charged-off (2,236) (1,808) (1,004)
Recoveries of loans previously charged-off 256 400 202
- --------------------------------------------------------------------------------
Balance before provision for loan losses 7,838 7,514 7,084
Provision for loan losses 3,227 2,304 1,838
- --------------------------------------------------------------------------------
Balance at end of year $ 11,065 $ 9,818 $ 8,922
================================================================================
The aggregate amount of non-accrual loans at the end of each of the last five
years is as follows: 2002 - $2,776,000; 2001 - $3,317,000; 2000 - $1,481,000;
1999 - $1,537,000; and 1998 - $1,067,000. Interest income which was foregone was
an immaterial amount for each of the three years ended December 31, 2002. There
were no restructured loans at December 31, 2002 and 2001.
Included in the balance sheet under the caption "Other assets" are certain real
properties which were acquired as a result of completed foreclosure proceedings.
Also included in the caption are amounts reclassified as in-substance
foreclosures. Other real estate totaled $1,051,000 and $798,000 at December 31,
2002 and 2001, respectively.
There were no impaired loans at December 31, 2002 and 2001.
NOTE 5 - PREMISES AND EQUIPMENT:
Premises and equipment at December 31, consisted of the following:
USEFUL LIFE 2002 2001
----------- ---- ----
(In thousands of dollars)
Land $ 3,408 $ 2,453
Buildings and leasehold improvements 15-40 years 26,646 19,450
Equipment and furnishings 5-10 years 12,609 10,818
- --------------------------------------------------------------------------------
Total 42,663 32,721
Less, accumulated depreciation 14,477 13,184
- --------------------------------------------------------------------------------
Premises and equipment, net $ 28,186 $ 19,537
================================================================================
Depreciation expense charged to operations was $1,467,000, $1,474,000, and
$1,684,000, in 2002, 2001, and 2000, respectively.
The Company has commitments related to capital projects primarily for the
purpose of constructing new administrative and branch facilities. At December
31, 2002, outstanding commitments on these projects totaled approximately
$2,328,000.
Computer software with an original cost of $2,020,000 is being amortized using
the straight-line method over thirty-six months. Amortization expense totaled
$333,000, $241,000, $173,000 for the years ended December 31, 2002, 2001, and
2000, respectively.
38
NOTE 6 - INTANGIBLE ASSETS:
As a result of the adoption of SFAS 142, the Company ceased amortization of its
$2,363,000 of goodwill as of January 1, 2002. The Company has completed the
required transitional impairment testing required by SFAS No. 142, and has
determined that there is no impairment of goodwill.
The following is a summary of gross carrying amounts and accumulated
amortization of core deposit premium costs at December 31, 2002 and 2001:
2002 2001
---- ----
Gross carrying amount $5,538,000 $5,538,000
Accumulated amortization (4,414,000) (4,195,000)
Estimated amortization expense for core deposit premium costs for each of the
next five years is as follows:
Year ending December 31:
2003 $191,000
2004 173,000
2005 155,000
2006 138,000
2007 120,000
The following table presents actual results for the year ended December 31,
2002, and adjusted net income and adjusted earnings per share for the years
ended December 31, 2001 and 2000, assuming the nonamortization provisions of
SFAS No. 142 were effective January 1, 2000:
2002 2001 2000
---- ---- ----
Reported net income $ 13,834 $ 12,257 $ 10,533
Add back:
Goodwill amortization -- 199 215
- --------------------------------------------------------------------------------
Adjusted net income $ 13,834 $ 12,456 $ 10,748
================================================================================
Basic earnings per share:
Reported net income $ 1.80 $ 1.59 $ 1.36
Add back:
Goodwill amortization -- .02 .03
- --------------------------------------------------------------------------------
Adjusted net income $ 1.80 $ 1.61 $ 1.39
================================================================================
Diluted earnings per share:
Reported net income $ 1.79 $ 1.59 $ 1.36
Add back:
Goodwill amortization -- .02 .02
- --------------------------------------------------------------------------------
Adjusted net income $ 1.79 $ 1.61 $ 1.38
================================================================================
NOTE 7 - DEPOSITS:
The aggregate amount of time deposits in denominations of $100,000 or more at
December 31, 2002 and 2001 was $149,522,000 and $120,038,000, respectively.
At December 31, 2002, the scheduled maturities of time of deposits are as
follows:
(In thousands of dollars)
2003 $335,258
2004 51,305
2005 6,127
2006 786
2007 4,639
Thereafter 1,674
--------
$399,789
========
39
NOTE 8 - FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO
REPURCHASE:
Federal funds purchased and securities sold under agreements to repurchase
generally mature within one to three days from the transaction date but may have
maturities as long as nine months. Certain of the borrowings have no defined
maturity date. Securities sold under agreements to repurchase are reflected at
the amount of cash received in connection with the transaction. The Company
monitors the fair value of the underlying securities on a daily basis. All
securities underlying these agreements are institution-owned securities.
Information concerning federal funds purchased and securities sold under
agreements to repurchase is included in Table 11 of Management's Discussion and
Analysis of Financial Condition and Results of Operations.
NOTE 9 - NOTES PAYABLE:
The Banks have entered into advance (borrowing) agreements with the FHLB of
Atlanta. Advances under these agreements are collateralized by stock in the FHLB
of Atlanta, and qualifying first mortgage loans under a blanket floating lien. A
summary of advances during the years ended December 31, 2002 and 2001, is as
follows (dollars in thousands):
2002 2001
---- ----
Advances outstanding at December 31 $ 49,500 $ 49,500
================================================================================
Maximum amount outstanding at any month-end 49,500 57,050
================================================================================
Average amount outstanding during the year 49,500 41,134
================================================================================
Weighted-average interest rate at December 31 5.03% 5.03%
================================================================================
Weighted-average interest rate during the year 5.03% 5.13%
================================================================================
Principal maturities of FHLB advances are summarized below:
Years 2003 through 2005 $ --
Year 2006 7,000
Thereafter 42,500
--------
$ 49,500
========
NOTE 10 - INCOME TAXES:
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Current:
Federal $ 6,308 $ 6,346 $ 4,961
State 593 605 501
- --------------------------------------------------------------------------------
Total current tax expense 6,901 6,951 5,462
- --------------------------------------------------------------------------------
Deferred:
Federal (67) (419) (313)
State (42) (46) (31)
- --------------------------------------------------------------------------------
Total deferred tax benefit (109) (465) (344)
- --------------------------------------------------------------------------------
Provision for income taxes $ 6,792 $ 6,486 $ 5,118
- --------------------------------------------------------------------------------
40
Temporary differences in the recognition of revenue and expense for tax and
financial reporting purposes resulted in net deferred income tax benefits as
follows:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
- -------------------------
Provision for loan losses $ (611) $ (401) $ (322)
Pension cost and post-retirement benefits 35 44 48
Consumer loan income (33) 26 35
Depreciation 399 (56) (49)
Other 101 (78) (56)
- --------------------------------------------------------------------------------
Total $ (109) $ (465) $ (344)
================================================================================
The provision for income taxes differs from that computed by applying the
federal statutory income tax rate of 35% (34% in 2000) to income before
provision for income taxes, as indicated in the following analysis:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Income taxes at federal statutory rate $ 7,219 $ 6,560 $ 5,321
Increase (reduction) of taxes resulting from:
State income taxes, net of federal
tax benefit 401 393 331
Tax-exempt interest income (589) (608) (642)
Other, net (239) 141 108
- --------------------------------------------------------------------------------
Provision for income taxes $ 6,792 $ 6,486 $ 5,118
================================================================================
The components of the net deferred tax asset, included in other assets, are as
follows:
2002 2001
---- ----
(In thousands of dollars)
Allowance for loan losses $ 3,967 $ 3,355
Post-retirement benefits 113 87
Intangible assets 390 473
Start-up expenses 19 44
State net operating loss carry forward 60 53
- --------------------------------------------------------------------------------
Total deferred tax assets 4,549 4,012
- --------------------------------------------------------------------------------
Depreciation 1,090 692
Unrealized gains on investment securities available-for-sale 1,115 706
Consumer loan income 269 303
Bond discount accretion 19 44
Pension plan 410 331
- --------------------------------------------------------------------------------
Total deferred tax liabilities 2,903 2,076
- --------------------------------------------------------------------------------
Net deferred tax asset before valuation allowance 1,646 1,936
Less valuation allowance (64) (55)
- --------------------------------------------------------------------------------
Net deferred tax asset $ 1,582 $ 1,881
================================================================================
At December 31, 2002, the Company had net operating loss carryforwards for state
income tax purposes of approximately $1,195,000 available to offset future state
taxable income. The carryforwards expire in the years 2010 to 2017. The
valuation allowance is based on management's estimate of the ultimate
realization of the deferred tax asset.
41
NOTE 11 - OTHER EXPENSE:
The following is a summary of the components of other noninterest expense:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Telephone and postage $ 1,389 $ 1,169 $ 1,078
Professional fees 1,727 1,089 1,654
Office supplies 969 807 869
Advertising 1,519 1,464 835
Amortization 562 965 963
Regulatory fees 701 621 556
Insurance 204 178 96
Other 5,183 5,307 5,183
- --------------------------------------------------------------------------------
Total $ 12,254 $ 11,600 $ 11,234
================================================================================
NOTE 12 - EARNINGS PER SHARE:
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Numerator:
Net income - numerator for basic
and diluted earnings per share $ 13,834 $ 12,257 $ 10,533
- --------------------------------------------------------------------------------
Denominator:
Denominator for basic earnings per share -
weighted-average shares outstanding 7,664 7,712 7,742
Effect of dilutive securities:
Employee stock options 59 12 32
- --------------------------------------------------------------------------------
Dilutive potential shares:
Denominator for diluted earnings per
share - adjusted weighted-average
shares and assumed conversions 7,723 7,724 7,774
- --------------------------------------------------------------------------------
Basic earnings per share $ 1.80 $ 1.59 $ 1.36
- --------------------------------------------------------------------------------
Diluted earnings per share $ 1.79 $ 1.59 $ 1.36
- --------------------------------------------------------------------------------
The calculation of diluted earnings per share excludes outstanding stock options
that have exercise prices greater than the average market price of the common
shares for the year as follows:
2002 2001
---- ----
Number of shares 7,000 101,000
- --------------------------------------------------------------------------------
Range of exercise prices $25.45 to $25.91 $18.75 to $28.00
42
NOTE 13 - OTHER COMPREHENSIVE INCOME:
The components of other comprehensive income and related tax effects are as
follows:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Unrealized holding gains on
available-for-sale securities $ 1,130 $ 2,408 $ 4,126
Tax effect (463) (909) (1,527)
- --------------------------------------------------------------------------------
Net-of-tax amount $ 667 $ 1,499 $ 2,599
================================================================================
NOTE 14 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES:
Dividends are paid by the Company from its assets which are mainly provided by
dividends from the banking subsidiaries. However, certain restrictions exist
regarding the ability of the subsidiaries to transfer funds to the Company in
the form of cash dividends, loans or advances. The approval of the Office of the
Comptroller of the Currency (OCC) is required to pay dividends in excess of the
subsidiaries' net profits for the current year plus retained net profits (net
profits less dividends paid) for the preceding two years, less any required
transfers to surplus. As of December 31, 2002, $20,136,000 of the Banks'
retained earnings are available for distribution to the Company as dividends
without prior regulatory approval. In addition, dividends paid by the Banks to
the Company would be prohibited if the effect thereof would cause the Banks'
capital to be reduced below applicable minimum capital requirements.
Under Federal Reserve regulation, the Banks are also limited as to the amount
they may loan to the Company unless such loans are collateralized by specified
obligations. The maximum amount available for transfer from the Banks to the
Company in the form of loans or advances was approximately $19,690,000 at
December 31, 2002.
NOTE 15 - RETIREMENT PLANS:
The following sets forth the pension plan's funded status and amounts recognized
in the Company's accompanying consolidated financial statements at December 31,
2002 and 2001:
2002 2001
---- ----
(In thousands of dollars)
Change in benefit obligation:
Benefit obligation at beginning of year $ 8,172 $ 8,372
Service cost 472 391
Interest cost 579 530
Actuarial (loss) 678 (868)
Benefits paid (273) (253)
- --------------------------------------------------------------------------------
Benefit obligation at end of year 9,628 8,172
- --------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of year 8,011 7,954
Actual return on plan assets (197) (134)
Employer contribution 500 444
Benefits paid (273) (253)
- --------------------------------------------------------------------------------
Fair value of plan assets at end of year 8,041 8,011
- --------------------------------------------------------------------------------
Funded status (1,587) (161)
Unrecognized net actuarial loss 2,696 1,210
Unrecognized prior service cost 5 6
- --------------------------------------------------------------------------------
Prepaid benefit cost $ 1,114 $ 1,055
================================================================================
43
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Weighted-average assumptions as of December 31:
Discount rate 7.25% 7.50% 7.50%
Expected return on plan assets 8.00% 8.00% 8.00%
Rate of compensation increase 5.00% 5.00% 5.00%
(In thousands of dollars)
Service cost $ 472 $ 391 $ 473
Interest cost 579 530 560
Expected return on plan assets (650) (633) (628)
Amortization of prior service cost 1 1 1
Recognized net actuarial gain/loss 39 -- --
Amortization of transition asset -- (28) (33)
- --------------------------------------------------------------------------------
Net periodic benefit cost $ 441 $ 261 $ 373
================================================================================
Expenses incurred and charged against operations with regard to all of the
Company's retirement plans were as follows:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Pension $ 441 $ 261 $ 373
Profit-sharing 265 224 233
- --------------------------------------------------------------------------------
Total $ 706 $ 485 $ 606
================================================================================
NOTE 16 - POST-RETIREMENT BENEFITS:
The following sets forth the plan's funded status and amounts recognized in the
Company's accompanying consolidated financial statements at December 31, 2002
and 2001:
2002 2001
---- ----
(In thousands of dollars)
Change in benefit obligation:
Benefit obligation at beginning of year $ 494 $ 519
Interest cost 38 34
Actuarial gain loss 76 (30)
Benefits paid (48) (29)
- --------------------------------------------------------------------------------
Benefit obligation at end of year 560 494
- --------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of year -- --
Employer contribution 48 29
Benefits paid (48) (29)
- --------------------------------------------------------------------------------
Fair value of plan assets at end of year -- --
- --------------------------------------------------------------------------------
Funded status (560) (494)
Unrecognized net actuarial gain (13) (89)
Unrecognized transition obligation 315 347
- --------------------------------------------------------------------------------
Accrued benefit cost $ (258) $ (236)
================================================================================
44
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Weighted-average assumptions as of December 31:
Discount rate 6.75% 7.50% 7.50%
Expected return on plan assets N/A N/A N/A
For measurement purposes, a 5 percent annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1999 and beyond.
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Components of net periodic benefit cost:
Interest cost $ 38 $ 35 $ 37
Amortization of transition obligation 31 32 32
Recognized net actuarial gain -- (4) (1)
- --------------------------------------------------------------------------------
Net periodic benefit cost $ 69 $ 63 $ 68
================================================================================
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plan. A onepercentage- point change in assumed
health care cost trend rates would have the following effects at the end of
2002:
1-PERCENTAGE- 1-PERCENTAGE-
POINT INCREASE POINT DECREASE
-------------- --------------
Effect on total of service and
interest cost components $ 3,445 $ (3,026)
Effect on post-retirement benefit
obligation 54,536 (47,771)
NOTE 17 - STOCK-BASED COMPENSATION PLANS:
During 1996 and 1999, 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. The options are granted at an exercise
price at least equal to the fair value of the common stock at the date of grant
and have terms ranging from five to ten years. No options were granted under the
1996 plan after December 18, 2000, and the plan has since terminated. No options
may be granted under the 1999 plan after May 31, 2009.
Activity in the Company's stock option plans is summarized in the following
table. All information has been retroactively restated for stock dividends and
stock splits.
45
2002 2001 2000
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Outstanding, January 1 171,820 $ 17.81 213,620 $ 15.74 145,189 $ 13.40
Granted 76,560 $ 21.22 69,080 $ 14.18 79,695 $ 19.42
Exercised (4,730) $ 16.36 (83,853) $ 10.63 -- $ --
Expired (19,745) $ 20.16 (27,027) $ 14.34 (11,264) $ 11.57
-------- -------- --------
Outstanding, December 31 223,905 $ 17.73 171,820 $ 17.81 213,620 $ 15.74
======== ======== ========
Exercisable, December 31 82,498 $ 18.92 147,434 $ 17.58 174,380 $ 14.71
======== ======== ========
Weighted-average fair value of
options granted during the year $ 5.59 $ 4.44 $ 4.32
======== ======== ========
Information pertaining to options outstanding at December 31, 2002, is as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
------ ----------- ---- ----- ----------- -----
$ 12.10 - $ 17.55 138,215 8.2 years $ 15.67 31,864 $ 15.27
$ 19.92 - $ 25.91 85,690 5.4 years $ 21.03 50,634 $ 21.22
-------- --------
223,905 7.1 years 82,498
======== ========
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Dividend yield 2.63% 3.0% 4.1%
Expected life 10 years 10 years 5-10 years
Expected volatility 30.0% 29.0% 26.0%
Risk-free interest rate 3.820% 5.032% 4.972%-5.106%
The Company applies APB Opinion No. 25 and related interpretations in accounting
for its stock-based compensation plans. Accordingly, no compensation cost has
been recognized. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant dates for awards under the plans
consistent with the method prescribed by SFAS No. 123, the Company's net income
and earnings per share would have been adjusted to the pro forma amounts
indicated below:
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars, except per share data)
Net income, as reported $ 13,834 $ 12,257 $ 10,533
Less, total stock-based employee compensation
expense determined under the fair value based
method, net of related tax effects 231 402 441
- --------------------------------------------------------------------------------
Pro forma net income $ 13,603 $ 11,855 $ 10,092
================================================================================
Earnings per share:
Basic - as reported $ 1.80 $ 1.59 $ 1.36
Basic - pro forma $ 1.77 $ 1.54 $ 1.30
Diluted - as reported $ 1.79 $ 1.59 $ 1.36
Dilutged - pro forma $ 1.76 $ 1.53 $ 1.30
46
The Company has entered into Restricted Stock Agreements with several of its
senior executive officers. All agreements are conditioned upon continued
employment. Termination of employment prior to a vesting date, as described
below, would terminate any interest in non-vested shares. Prior to vesting of
the shares, as long as employed by the Company, the officers will have the right
to vote such shares and to receive dividends paid with respect to such shares.
All restricted shares will fully vest in the event of change in control of the
Company or upon the death of the officer. Under these arrangements, the chief
executive officer was granted 13,175 restricted shares in a prior year with a
weighted average fair value of $5.76 per share at the date of grant. The shares
granted vest free of restrictions as follows: 25% in 1999, 25% in 2001 and 50%
in 2003. During 2002, six executive officers were granted 18,700 shares with a
weighted average fair value of $6.84 per share at the date of grant. These
shares vest free of restrictions as follows: 25% in 2005, 25% in 2007 and 50% in
2009. In January 2003, one executive officer received a grant of 2,000 shares
with a weighted average fair value of $6.18 per share. These shares vest free of
restrictions as follows: 25% in 2006, 25% in 2008 and 50% in 2010.
NOTE 18 - STOCK REPURCHASE PROGRAM:
In 2000, the Company's Board of Directors authorized a repurchase program to
acquire up to 160,000 shares of its outstanding common stock. In March 2003, the
repurchase authorization was increased to 250,000 shares. During the years ended
December 31, 2002, 2001 and 2000, the Company repurchased 12,402, 138,253, and
14,200 shares at a cost of $265,000, $2,518,000, and $214,000, respectively.
NOTE 19 - LEASE COMMITMENTS:
The Company's subsidiaries were obligated at December 31, 2002, under certain
noncancelable operating leases extending to the year 2013 pertaining to banking
premises and equipment. Some of the leases provide for the payment of property
taxes and insurance and contain various renewal options. The exercise of renewal
options is, of course, dependent upon future events.
Accordingly, the following summary does not reflect possible additional payments
due if renewal options are exercised. Future minimum lease payments, by year and
in the aggregate, under noncancelable operating leases with initial or remaining
terms in excess of one year are as follows:
(In thousands of dollars) YEAR ENDING DECEMBER 31,
2003 $ 1,156
2004 433
2005 353
2006 268
2007 238
Later years 1,243
--------
Total $ 3,691
========
Total rental expense for the years ended December 31, 2002, 2001, and 2000 was
$2,678,000, $2,344,000, and $2,102,000, respectively.
NOTE 20 - CONTINGENT LIABILITIES:
The Company and its subsidiaries are involved at times in various litigation
arising in the normal course of business. In the opinion of management, there is
no pending or threatened litigation that will have a material effect on the
Company's consolidated financial position or results of operations.
NOTE 21 - RELATED PARTY TRANSACTIONS:
During 2002 and 2001, the Company's banking subsidiaries had loan and deposit
relationships with certain related parties; principally, directors and executive
officers, their immediate families and their business interests. All of these
relationships were in the ordinary course of business. Loans outstanding to this
group (including immediate families and business interests) totaled $25,122,000
and $10,604,000 at December 31, 2002 and 2001, respectively. During 2002,
$19,850,000 of new loans were made to this group while repayments of $11,361,000
were received during the year. Related party deposits totaled approximately
$16,927,000 and $10,581,000 at December 31, 2002 and 2001, respectively.
47
NOTE 22 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK:
The Company's subsidiaries are parties to credit related financial instruments
with off-balance sheet risks in the normal course of business to meet the
financing needs of their customers. These financial instruments include
commitments to extend credit, standby letters of credit and financial
guarantees. Such commitments involve, to varying degrees, elements of credit,
interest rate, or liquidity risk in excess of the amounts recognized in the
consolidated balance sheets. The contract amounts of these instruments express
the extent of involvement the subsidiaries have in particular classes of
financial instruments.
The subsidiaries' exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit and financial guarantees is represented by the
contractual amount of those instruments. The subsidiaries use the same credit
policies in making commitments and conditional obligations as they do for
on-balance sheet instruments. At December 31, 2002 and 2001, the following
financial instruments were outstanding whose contract amounts represent credit
risk:
2002 2001
---- ----
(In thousands of dollars)
Commitments to extend credit $208,193 $167,307
================================================================================
Standby letters of credit and
financial guarantees $ 4,232 $ 1,928
================================================================================
COMMITMENTS TO EXTEND CREDIT:
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future liquidity requirements. The banking subsidiaries evaluate each
customer's credit worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the subsidiaries upon extension of credit, is
based on management's credit evaluation of the customer. Collateral held varies
but may include accounts receivable, inventory, property, plant and equipment,
and personal guarantees. Unfunded commitments under commercial lines-of-credit,
revolving credit lines and overdraft protection agreements are commitments for
possible future extensions of credit to existing customers. These
lines-of-credit are uncollateralized and usually do not contain a specified
maturity date and may not be drawn to the extent to which the banking
subsidiaries are committed.
STANDBY LETTERS OF CREDIT AND FINANCIAL GUARANTEES:
Standby letters of credit and financial guarantees are conditional commitments
issued by the banking subsidiaries to guarantee the performance of a customer to
a third party. Those letters of credit and guarantees are primarily issued to
support public and private borrowing arrangements. Essentially all standby
letters of credit have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The amount of collateral obtained, if
deemed necessary, is based on management's credit evaluation of the customer.
NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Company's various financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument. SFAS
No. 107 excludes certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Company. The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
CASH AND CASH EQUIVALENTS:
The carrying amount is a reasonable estimate of fair value.
48
INVESTMENT SECURITIES:
Securities available-for-sale, excluding Federal Reserve Bank and Federal Home
Loan Bank Stock, are valued at quoted market prices where available. If quoted
market prices are not available, fair values are based on quoted market prices
of comparable securities. Securities held-to-maturity are valued at quoted
market prices or dealer quotes. The carrying value of Federal Reserve Bank and
Federal Home Loan Bank stock approximates fair value based on their redemption
provisions.
LOANS:
For variable-rate loans that reprice frequently and with no significant change
in credit risk, fair values are based on carrying values. Fair values for
certain mortgage loans (e.g., one-to-four family residential), credit card
loans, and other consumer loans are based on quoted market prices of similar
loans sold in conjunction with securitization transactions, adjusted for
differences in loan characteristics. Fair values for other loans (e.g.,
commercial real estate and investment property mortgage loans, commercial and
industrial loans) are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. Fair values for non-performing loans are estimated
using discounted cash flow analyses or underlying collateral values, where
applicable.
DEPOSIT LIABILITIES:
The fair values disclosed for demand deposits (e.g., interest and non-interest
checking, passbook savings, and certain types of money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). The carrying amounts of variable-rate, fixed-term money
market accounts and certificates of deposit approximate their fair values at the
reporting date. Fair values for fixed-rate certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected monthly
maturities on time deposits.
FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
The fair value of federal funds purchased and securities sold under agreements
to repurchase is estimated based on the current rates offered for borrowings of
the same remaining maturities.
NOTES PAYABLE:
The carrying amount of short-term borrowings is a reasonable estimate of fair
value. The fair value of long-term borrowings is estimated using discounted cash
flow analysis and the Company's current incremental borrowing rates for similar
types of instruments.
COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT AND FINANCIAL
GUARANTEES:
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between
current levels of interest rates and the committed rates. The fair value of
guarantees and letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties at the reporting date.
49
The estimated fair values and related carrying amounts of the Company's
financial instruments at December 31, 2002 and 2001, are as follows:
2002 2001
---- ----
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
(In thousands of dollars)
Financial assets:
Cash and cash
equivalents $ 40,514 $ 40,514 $ 41,175 $ 41,175
Investment securities 164,951 166,784 189,933 190,581
Loans:
Loans and loans held for sale 902,563 928,756 768,864 798,729
Less, allowance for loan
losses (11,065) (11,065) ( 9,818) ( 9,818)
Net loans 891,498 917,691 759,046 788,911
Financial liabilities:
Deposits 898,163 890,950 811,523 801,576
Federal funds purchased
and securities sold under
agreements to repurchase 88,616 88,616 66,617 66,617
Notes payable 49,500 53,029 49,500 49,842
Unrecognized financial
instruments:
Commitments to extend credit 208,193 214,235 167,305 170,651
Standby letters of credit 4,232 4,232 1,928 1,928
NOTE 24 - REGULATORY MATTERS:
The Company and its banking subsidiaries are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and its subsidiaries must meet specific capital guidelines that involve
quantitative measures of the assets, liabilities, and certain
off-balance-sheet-items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and its subsidiaries to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, at December 31,
2002 and 2001, that the Company and its subsidiaries met all capital adequacy
requirements to which they are subject.
As of their most recent regulatory examinations, the Company and its
subsidiaries were considered well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, an institution
must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the following tables. There are no conditions or events
since that notification that management believes have changed the institutions'
category.
Actual capital amounts and ratios are also presented in the table.
50
MINIMUM TO BE WELL
CAPITALIZED UNDER
MINIMUM CAPITAL PROMPT CORRECTIVE
(In thousands of dollars) ACTUAL REQUIREMENT ACTION PROVISIONS
---------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
At December 31, 2002:
Total capital (to risk weighted assets):
Consolidated $108,593 12.92% $ 64,843 8.00% $ 84,053 10.00%
South Carolina Bank and Trust, N.A. 82,282 12.12% 57,627 8.00% 72,034 10.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 11,014 12.57% 7,012 8.00% 8,766 10.00%
South Carolina Bank and Trust
of the PeeDee, N.A. 5,669 13.85% 3,275 8.00% 4,094 10.00%
Tier I capital (to risk weighted assets):
Consolidated $ 98,079 11.67% $ 33,621 4.00% $ 50,426 6.00%
South Carolina Bank and Trust, N.A. 78,276 10.87% 28,814 4.00% 42,221 6.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 9,917 11.31% 3,506 4.00% 5,259 6.00%
South Carolina Bank and Trust
of the PeeDee, N.A. 5,157 12.60% 1,620 4.00% 2,429 6.00%
Tier I capital (to average assets):
Consolidated $ 98,079 8.70% $ 45,098 4.00% $ 56,372 5.00%
South Carolina Bank and Trust, N.A. 78,276 8.23% 38,041 4.00% 47,552 5.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 9,917 8.15% 4,866 4.00% 6,082 5.00%
South Carolina Bank and Trust
of the PeeDee, N.A. 5,157 10.43% 1,978 4.00% 2,473 5.00%
At December 31, 2001:
Consolidated $ 96,419 13.57% $ 56,842 8.00% $ 71,053 10.00%
South Carolina Bank and Trust, N.A. 79,544 13.18% 48,282 8.00% 60,352 10.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 9,661 14.45% 5,349 8.00% 6,685 10.00%
South Carolina Bank and Trust
of the PeeDee, N.A 4,277 11.73% 2,917 8.00% 3,646 10.00%
Tier I capital (to risk weighted assets):
Consolidated $ 87,526 12.32% $ 28,418 4.00% $ 42,626 6.00%
South Carolina Bank and Trust, N.A. 71,970 11.92% 24,151 4.00% 36,227 6.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 8,823 13.20% 2,674 4.00% 4,010 6.00%
South Carolina Bank and Trust
of the PeeDee, N.A 3,821 10.48% 1,458 4.00% 2,188 6.00%
Tier I capital (to average assets):
Consolidated $ 87,526 8.39% $ 41,729 4.00% $ 52,160 5.00%
South Carolina Bank and Trust, N.A. 71,970 8.30% 34,684 4.00% 43,355 5.00%
South Carolina Bank and Trust
of the Piedmont, N.A. 8,823 7.49% 4,712 4.00% 5,890 5.00%
South Carolina Bank and Trust
of the PeeDee, N.A 3,821 7.64% 2,001 4.00% 2,501 5.00%
51
NOTE 25 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY:
Financial information pertaining only to First National Corporation is as
follows:
DECEMBER 31,
2002 2001
---- ----
(In thousands of dollars)
Balance Sheets
Assets:
Cash $ 2,686 $ --
Investment securities available-for-sale 414 2,371
Investment in subsidiaries 98,453 89,740
Loans 1,054 50
Premises and equipment 39 356
Other assets 922 806
- --------------------------------------------------------------------------------
Total assets $103,568 $ 93,323
================================================================================
DECEMBER 31,
2002 2001
---- ----
(In thousands of dollars)
Liabilities $ 72 $ 258
Shareholders' equity 103,496 93,065
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $103,568 $ 93,323
================================================================================
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Statements of Income
Income:
Dividends from subsidiaries $ 6,891 $ 4,001 $ 5,801
Gain on sale of securities available-for-sale -- 569 --
Interest and dividends 52 102 197
- --------------------------------------------------------------------------------
Total income 6,943 4,672 5,998
Operating expenses 258 692 292
- --------------------------------------------------------------------------------
Income before income tax benefit and equity in
undistributed earnings of subsidiaries 6,685 3,980 5,706
Applicable income tax benefit 75 8 36
Equity in undistributed earnings of
subsidiaries 7,074 8,269 4,791
- --------------------------------------------------------------------------------
Net income $ 13,834 $ 12,257 $ 10,533
================================================================================
52
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(In thousands of dollars)
Statements of Cash Flows
Cash flows from operating activities:
Net income $ 13,834 $ 12,257 $ 10,533
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 14 14 16
Premium amortization (discount accretion) 39 (72) ( 152)
Gain on sale of securities
available-for-sale -- (569) --
Increase in other assets 56 (3) (231)
Increase in other liabilities (379) 246 --
Undistributed earnings of subsidiaries (7,074) (8,269) (4,791)
- --------------------------------------------------------------------------------
Net cash provided by operating activities 6,490 3,604 5,375
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales of investment
securities available-for-sale -- 583 --
Proceeds from maturities of investment
securities available-for-sale 8,000 7,234 6,265
Purchases of investment securities
available-for-sale (6,034) (6,147) (6,235)
Loan to subsidiary (1,004) -- --
Purchases of premises and equipment -- -- (301)
Proceeds from sale of premises and equipment 304 -- --
Investment in subsidiaries (1,000) -- (2,000)
- --------------------------------------------------------------------------------
Net cash provided (used) by investing
activities 266 1,670 (2,271)
- --------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of debt -- -- --
Cash dividends paid (4,420) (4,000) (3,801)
Common stock issuance 537 -- --
Common stock redeemed (265) (2,518) (214)
Stock options exercised 78 891 --
- --------------------------------------------------------------------------------
Net cash used by financing activities (4,070) (5,627) (4,015)
- --------------------------------------------------------------------------------
Net increase (decrease) in cash and cash
equivalents 2,686 (353) (911)
Cash and cash equivalents at beginning
of year -- 353 1,264
- --------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 2,686 $ -- $ 353
================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable
53
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated herein by reference to the
information under the caption "Election of Directors" on page 4 and "Section 16
(a) Beneficial Ownership Reporting Compliance" on page 15 of the definitive
proxy statement of the Company to be filed in connection with the Company's 2003
Annual Meeting of the Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the
information under the captions "Executive Compensation," "Employment Agreement,"
"Stock Options," "Compensation Committee Interlocks and Insider Participation,"
"Defined Benefit Pension Plan," and "Election of Directors - Compensation of
Directors" on pages 5, 7 through 10, 12, and 15 of the definitive proxy
statement of the Company to be filed in connection with the Company's 2003
Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table contains certain information as of December 31, 2002,
relating to securities authorized for issuance under the Company's equity
compensation plans:
Number of securities
remaining available
for future issuance
Number of securities under equity
to be issued upon Weighted-average compensation plans
exercise of exercise price of (excluding securities
outstanding options, outstanding options, reflected in column
Plan category warrants and rights warrants and rights (a))
- ------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 222,970 $17.72 254,045
security holders
Equity compensation
plans not approved None -- --
by security holders
Other information required by this item is incorporated herein by reference to
the information under the caption "Principal Shareholders" on page 3 of the
definitive proxy statement of the Company to be filed in connection with the
Company's 2003 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
information under the caption "Certain Relationships and Related Transactions"
on page 14 of the definitive proxy statement of the Company to be filed in
connection with the Company's 2003 Annual Meeting of Shareholders.
54
ITEM 14. 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.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements Filed:
First National Corporation and Subsidiaries
Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Financial Schedules Filed: None
3. Exhibits
Exhibit No. Description of Exhibit
3.1 Articles of Incorporation of the Registrant, as amended
(incorporated by reference to Exhibit 3 filed with the
Registrant's Form 10-Q for the quarter ended June 30,
1996 and Exhibits 3.1 and 3.2 filed with the
Registrant's Form 8-K filed on May 23, 1997).
3.2 Bylaws of the Registrant, as amended (incorporated by
reference to Exhibit 3.2 filed with the Registrant's
Form 10-K for the year ended December 31, 1995).
10.1* First National Corporation Executive Incentive
Compensation Plan (incorporated by reference to
exhibits filed with Registration Statement on Form S-4,
Registration No. 33-52052).
10.2 First National Corporation Dividend Reinvestment Plan
(incorporated by reference to exhibits filed with
Registration Statement on Form S-8, Registration No.
33-58692).
10.3* First National Corporation Incentive Stock Option Plan
of 1996 (incorporated by reference to Registrant's
Definitive Proxy Statement filed in connection with its
1996 Annual Meeting of Shareholders).
10.4* Employment Agreement between the Registrant and C. John
Hipp, III, dated May 1, 1994 (incorporated by reference
to Registrant's Form 10-K for the year ended December
31, 1995).
10.5* First National Corporation 1999 Stock Option Plan
(incorporated by reference to Registrant's Registration
Statement From S-8, Registration No. 333-33092)
10.6* 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))
55
10.7* 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))
10.8* Restricted Stock Agreement, effective as of January 17,
2002, between the Registrant and John C. Pollock
(incorporated by reference to Exhibit 4.3 to the
Registration Statement on Form S-8 (File No.
333-86922))
10.9* 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))
10.10* 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))
10.11* Restricted Stock Agreement, effective as of January 17,
2002, between the Registrant and Joseph E. Burns
(incorporated by reference to Exhibit 4.1 to the
Registration Statement on Form S-8 (File No.
333-86922))
10.12* 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. 333-9014))
10.13* Restricted Stock Agreement, effective as of January 2,
2003, between the Registrant and Joseph E. Burns
(incorporated by reference to Exhibit 4.1 to the
Registration Statement on Form S-8 (File No.
333-103707))
13 2002 Annual Report to Shareholders
21 Subsidiaries of the Registrant (incorporated by
reference to exhibits filed with Registration Statement
on Form S-4, Registration No. 33-52052).
23 Consent of J. W. Hunt and Company, LLP.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2000, Signed by Chief Executive Officer.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, Signed by Chief Financial Officer.
* Denotes a management compensatory plan or arrangement.
(b) No reports were filed on Form 8-K during the fourth quarter of 2002.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Columbia
and State of South Carolina, on the 20th day of March, 2003.
FIRST NATIONAL CORPORATION
By /S/ C. John Hipp, III
---------------------------------------
C. John Hipp, III
President and Chief Executive Officer Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, this report has been signed
below by the following persons in the capacities indicated on March 20, 2003.
/S/ C. John Hipp, III
------------------------------------------
C. John Hipp, III
President and Chief Executive Officer
/S/ Richard C. Mathis
------------------------------------------
Richard C. Mathis
Executive Vice President and Chief
Financial Officer
/S/ John L. Phillips
------------------------------------------
John L. Phillips
Senior Vice President and Corporate
Controller
/S/ Robert R. Horger
------------------------------------------
Robert R. Hoger
Chairman of the Board of Directors
/S/ Colden R. Battey, Jr.
------------------------------------------
Colden R. Battey, Jr.
Director
/S/ Luther J. Battiste, III
------------------------------------------
Luther J. Battiste, III
Director
/S/ Charles W. Clark
------------------------------------------
Charles W. Clark
Director
/S/ M. Oswald Fogle
------------------------------------------
M. Oswald Fogle
Director
/S/ Dwight W. Frierson
------------------------------------------
Dwight W. Frierson
Director
57
/S/ John L. Gramling, Jr.
------------------------------------------
John L. Gramling, Jr.
Director
/S/ Richard L. Gray
------------------------------------------
Richard L. Gray
Director
/S/ Robert R. Hill, Jr.
------------------------------------------
Robert R. Hill, Jr.
Director
/S/ Harry M. Mims, Jr.
------------------------------------------
Harry M. Mims, Jr.
Director
/S/ Ralph W. Norman
------------------------------------------
Ralph W. Norman
Director
/S/ Anne H. Oswald
------------------------------------------
Anne H. Oswald
Director
/S/ Samuel A. Rodgers
------------------------------------------
Samuel A. Rodgers
Director
/S/ James W. Roquemore
------------------------------------------
James W. Roquemore
Director
/S/ Thomas E. Suggs
------------------------------------------
Thomas E. Suggs
Director
/S/ A. Dewall Waters
------------------------------------------
A. Dewall Waters
Director
/S/ John W. Williamson, III
------------------------------------------
John W. Williamson, III
Director
/S/ Cathy Cox Yeadon
------------------------------------------
Cathy Cox Yeadon
Director
58
CERTIFICATION
I, C. John Hipp, III, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of First National
Corporation;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and
c) presented in this annual 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 functions):
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
annual report whether 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: March 20, 2003
59
CERTIFICATION
I, Richard C. Mathis, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of First National
Corporation;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date"); and
c) presented in this annual 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 functions):
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
annual report whether 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: March 20, 2003
60
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ----------------------
13 2002 Annual Report to Shareholders
23 Consent of J. W. Hunt and Company, LLP.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As
adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, Signed by Chief Executive Officer.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As
adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, Signed by Chief Financial Officer.
61