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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, 2001
COMMISSION FILE NUMBER 001-12669
FIRST NATIONAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
SOUTH CAROLINA 57-0799315
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
950 JOHN C. CALHOUN DRIVE, S.E.
ORANGEBURG, SOUTH CAROLINA 29115
(Address of principal executive offices, including zip code)
(803) 534-2175
(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. [ ]
The aggregate market value of the voting stock of the registrant held by
non-affiliates at March 12, 2002 was $144,196,000 based on the closing sale
price of $22.75 per share on that date. 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 12, 2002 was 6,952,976.
Documents Incorporated by Reference
Portions of the Registrant's 2001 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.
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 . . . . . . . . . . . . . . . . . . . 23
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . .24
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures . . . . . .51
PART III
Item 10. Directors and Executive Officers of the Registrant (2) . . . . . . . . . . . . . . . . . . . . .51
Item 11. Executive Compensation (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51
Item 12. Security Ownership of Certain Beneficial Owners and Management (2) . . . . . . . . . . . . . . .51
Item 13. Certain Relationships and Related Transactions (2) . . . . . . . . . . . . . . . . . . . . . . .51
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . .51
(1) Incorporated by reference to the Registrant's 2001 Annual Report to Shareholders.
(2) Incorporated by reference to the Registrant's Proxy Statement for its 2002 Annual Meeting of Shareholders.
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 First National Bank, a national bank which opened for
business in 1934, National Bank of York County, a national bank which opened for
business in 1996, Florence County National Bank, a national bank which opened
for business in 1998, and CreditSouth Financial Services Corporation, an upscale
finance company which opened for business in 1998. The Company engages in no
significant operations other than the ownership of its subsidiaries.
On July 31, 1999, the Company and FirstBancorporation, Inc. ("FirstBanc")
consummated the merger of FirstBanc into the Company. Under the terms of the
merger, 1.222 shares of First National Corporation common stock were exchanged
for each share of FirstBanc common stock. The transaction was accounted for by
the pooling of interests method of accounting for business combinations.
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.
FORWARD LOOKING STATEMENTS
Statements included in Management's discussion and Analysis of financial
condition and Results of Operations which are not historical in nature are
intended to be, and are hereby identified as, forward looking statements for
purposes of the sale 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 effects earnings or capital
arising from negative public opinion.
TERRITORY SERVED AND COMPETITION
First National Bank conducts its business from 24 locations in 18 South
Carolina towns. National Bank of York County conducts its business from three
locations in three South Carolina towns. Florence County National Bank conducts
its business from two locations in two South Carolina towns, while CreditSouth
Financial Services Corporation conducts its business from four locations in
three South Carolina towns. In their markets, First National Bank, National Bank
of York County, and Florence County National Bank (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.
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As a bank holding company, the Company is a legal entity separate and
distinct from its bank and non-bank 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, fees for services performed and interest on
advances and loans.
EMPLOYEES
The Company does not have any salaried employees. As of December 31, 2001,
the Company's subsidiaries had 442 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, 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 attempt to become a financial holding
company under the Graham-Leach-Bliley Act.
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
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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
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.
3
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, 2001, the
Company, First National Bank, National Bank of York County and Florence County
National Bank had leverage ratios of 8.39%, 8.30%, 7.49% and 7.64%,
respectively, and total risk adjusted capital ratios of 13.57%, 13.18%, 14.45%
and 11.73%, 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.
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 bad debts. 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.
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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 2002.
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. As of the date of this filing, the Company has not
determined the impact that IMLAFA will have on its operations, but the impact is
not expected to be material.
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 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
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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
First National Bank's main office and the Company's executive offices are
located at 950 John C. Calhoun Drive, S.E., Orangeburg, South Carolina. These
facilities are owned by First National Bank and afford approximately 48,000
square feet of space for operating and administrative purposes. First National
Bank owns 27 other properties and leases 16 properties, substantially all of
which are used for branch locations or housing other operational units of First
National Bank.
National Bank of York County owns the property located at 1127 Ebenezer
Road, Rock Hill, South Carolina. National Bank of York County also leases two
properties, which are used as branches. Florence County National Bank owns the
property located at 1600 W. Palmetto Street, Florence, South Carolina, and
leases one property which is used as a branch. CreditSouth Financial Services
Corporation leases four offices, one in Orangeburg, South Carolina used for
finance company operations, two in Florence, South Carolina used as a mortgage
loan production office and finance company operations, and one in Socastee,
South Carolina used for finance company operations.
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. The Company has announced its
intention to relocate its headquarters to a new four-story facility that is
being constructed on previously acquired property in the Columbia Vista section
of South Carolina's capital city. The 48,000 square foot building is expected to
be completed by the end of 2002 and will house corporate offices, the Columbia
division of first National Bank, and leased office space.
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 2001.
EXECUTIVE OFFICERS
C. John Hipp, III (Age 50). Mr. Hipp has served as President and Chief Executive
Officer of the Company and First National Bank since April 1994. He also served
as President of First National Bank 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 51). Mr. Horger was named Chairman of the Company and
First National Bank in January 1998 and served as Vice Chairman of the Company
and First National Bank 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 45). Mr. Frierson has served as Vice Chairman of First
National Corporation and First National Bank 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 35). Mr. Hill has served as President and Chief
Operating Officer of First National Bank since May 2000. He served as Senior
Executive Vice President and Chief Operating Officer of First National Bank from
November 1998 to May 2000. He served as President and Chief Executive Officer of
National Bank of York County from July 1996 to November 1998. Mr. Hill was an
organizer of the National Bank of York County 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 51). 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, GA during
1996 through 1997.
John C. Pollok (Age 36). Mr. Pollok has served as Executive Vice President and
Chief Administrative Officer of First National Bank since May 2000. He served as
Executive Vice President of First National Bank mortgage division from July 1998
until May 2000. Mr. Pollok served as Senior Vice President of National Bank of
York County from January 1996 to July 1998.
Joe E. Burns (Age 47). 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 53). Mr. Kerr was named Executive Vice President and Chief
Technology Officer of the Company in February 2002. He served as Senior Vice
President and Chief Technology Officer for the Company from April 1999 to
February 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 (50). Mr. Shuford has served as Executive Vice President
of First National Bank 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.
Thomas S. Camp (Age 50). Mr. Camp has served as President and Chief Executive
Officer of National Bank of York County 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.
Jeffery E. Fulp (Age 34). Mr. Fulp was named President and Chief Executive
Officer of Florence County National Bank in September 2001. He served First
National Bank in several positions, including Regional President from January
2000 to
7
September 2001, Senior Vice President and County Executive from August 1999 to
January 2000, Senior Vice President from January 1998 to August 1999, and Vice
President and City Executive from November 1995 to January 1998.
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 14 of the 2001 Annual Report to Shareholders. As of March
12, 2002, the Company had issued and outstanding 6,952,976 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
primarily by dividends paid to the Company by First National Bank. 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, 2001, $16,530,000 of the banking
subsidiaries' retained earnings were available for distribution to First
National Corporation as dividends without prior regulatory approval. For the
year ended December 31, 2001, the banking subsidiaries paid dividends of
approximately $4,000,000 to the Company.
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 the inside front cover and page 15,
respectively, of the Company's 2001 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, First National Bank, National Bank of
York County, Florence County National Bank and CreditSouth Financial Services
Corporation. The five year period 1997 through 2001 is discussed with particular
emphasis on the years 1999 through 2001. 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 Corporation sponsored the organization of National Bank of
York County in Rock Hill, South Carolina, and sold shares of the Corporation's
common stock to capitalize the new bank and pay organizational and pre-opening
expenses. National Bank of York County began operations on July 11, 1996, as a
wholly-owned subsidiary of the Corporation.
In 1998, the Corporation sponsored the organization of Florence County
National Bank in Florence, South Carolina, and sold shares of the Corporation's
common stock to capitalize the new bank and pay organizational and pre-opening
expenses. Florence County National Bank began operations on April 1, 1998, as a
wholly-owned subsidiary of the Corporation.
Also in 1998, the Corporation sponsored the organization of CreditSouth
Financial Services Corporation, an upscale finance company which began
operations in Orangeburg, South Carolina, on November 1, 1998. Upon
organization, the Corporation 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 have since been acquired by the Corporation.
8
On July 31, 1999, the Corporation completed the merger with
FirstBancorporation, Inc. ("FirstBanc") through the issuance of 1.222 shares of
First National Corporation common stock for each share of outstanding common
stock of FirstBanc. The transaction was accounted for by the pooling of
interests method of accounting for business combinations.
RECENT ACCOUNTING PRONOUNCEMENTS
See Notes to Consolidated Financial Statements for information relating to
recent accounting pronouncements.
SUMMARY OF OPERATIONS
Earnings of First National Corporation were $12,257,000, $10,533,000 and
$7,940,000 in 2001, 2000 and 1999, respectively. Net income increased 16.4
percent in 2001 when compared to 2000 and increased 32.7 percent in 2000 when
compared to 1999. Basic earnings per share increased to $1.75 in 2001 compared
to $1.50 in 2000 and $1.14 in 1999. Diluted earnings per share increased to
$1.75 in 2001 compared to $1.49 in 2000 and $1.13 in 1999. The earnings
increases in 2001 compared with 2000 and in 2000 compared with 1999 resulted
primarily from increases in net interest income.
The book value per share of First National Corporation increased 10.5
percent to $13.36 in 2001 from $12.09 in 2000, following an increase of 12.3
percent in 2000 from $10.77 in 1999. The return on average assets was 1.21
percent in 2001, compared with 1.11 percent in 2000 and .98 percent in 1999. The
return on average shareholders' equity was 13.64 percent for 2001, 13.14 percent
in 2000 and 10.58 percent for 1999. The per share cash dividends declared in
2001 were $0.57, compared to $0.54 in 2000 and $0.54 in 1999.
Total earning assets and total deposits increased in 2001 compared to 2000.
At December 31, 2001, total earning assets were $959,846,000, an increase of 5.2
percent over $912,415,000 at year-end 2000, which was 12.9 percent greater than
the 1999 balance of $807,961,000. Average earning assets were $939,626,000 in
2001, an increase of 3.9 percent over $904,403,000 in 2000, which was 16.2
percent greater than the 1999 average of $778,598,000. The increases in average
earning assets in 2001 and 2000 were mainly the result of loan growth.
Total deposits were $811,523,000 at December 31, 2001, up 7.1 percent from
$757,576,000 at the end of 2000. The 2000 balance was an increase of 9.9 percent
from $689,665,000 at year-end 1999. Deposits averaged $804,281,000 in 2001, an
increase of 9.3 percent over $736,093,000 in 2000. The 2000 average was a 15.4
percent increase over $637,682,000 in 1999.
Interest income increased $626,000, or 0.8 percent, to $74,472,000 for the
year ended December 31, 2001, compared to $73,846,000 in 2000. This modest
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. In
2000, interest income increased $13,277,000, or 21.9 percent, compared to
$60,569,000 earned in 1999. The 2000 increase was mainly attributable to the
$104,444,000, or 12.9 percent, increase in earning assets.
Interest expense was $29,972,000 for the year 2001, a $3,260,000, or 9.8
percent, decrease from 2000. The decrease in 2001 was the result of a 74 basis
point decline in the average rate paid on interest-bearing liabilities, offset
in part by an increase in average interest-bearing liabilities of $60,487,000,
or 8.2 percent. For 2000 compared to 1999, interest expense increased
$9,316,000, or 39.0 percent, to $33,232,000, mainly due to an $112,716,000, or
18.0 percent, increase in average interest-bearing liabilities.
In 2000, the Corporation's Board of Directors authorized a repurchase
program to acquire up to 160,000 shares of its outstanding common stock. During
the years ended December 31, 2001 and 2000, the Corporation repurchased 138,253
and 14,200 shares at a cost of $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
Corporation competes for deposits with savings and loan associations, credit
unions, brokerage firms and other commercial banks. In its lending activities,
the Corporation 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.
9
NET INTEREST INCOME
Net interest income is the difference between interest income and interest
expense. Two significant elements in analyzing a bank's net interest income are
net interest spread and net interest margin. Net interest spread is the
difference 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 non-interest- bearing, utilized to support earning assets. A
significant distinction between net interest spread and net interest margin is
that net interest margin reflects the impact of interest free funds supporting
earning assets. First National Corporation's net interest margin expanded
considerably in 2001, as the Company was able to bring its funding rates down to
a greater extent than its earning assets' yields decreased in a generally
declining interest rate environment. The net interest margin expanded by 25
basis points to an average of 4.74 percent from 4.49 percent in 2000. The net
interest margin in 1999 was 4.71 percent.
Net interest income was $44,500,000 in 2001, an increase of $3,886,000, or
9.6 percent, over 2000. The increase was mainly due to a 48 basis point increase
in net interest spread, as the average rate paid on total interest-bearing
liabilities decreased by 72 basis points and the average yield on total earning
assets was down by 24 basis points. In 2000, net interest income was
$40,614,000, a $3,961,000, or 10.8 percent, increase over 1999. This increase
was primarily the result of growth in average earning assets, particularly the
loan portfolio, which increased by an average $138,783,000, or 25.6 percent, to
$680,217,000 in 2000.
Total average earning assets increased $35,223,000, or 3.9 percent, to
$939,626,000 in 2001. This followed an increase of $125,805,000, or 16.2
percent, to $904,403,000 in 2000, compared with 1999. Total average
interest-bearing liabilities were $794,798,000 in 2001, an increase of
$55,267,000, or 7.5 percent, compared with 2000. These liabilities averaged
$739,531,000 in 2000, an increase of $112,716,000, or 18.0 percent, from the
previous year.
Earning asset increases in 2001 and 2000 were funded by higher levels on
interest-bearing liabilities, mainly the result of deposit growth.
TABLE 1
VOLUME AND RATE
VARIANCE ANALYSIS
2001 COMPARED TO 2000 2000 COMPARED TO 1999
CHANGES DUE TO CHANGES DUE TO
INCREASE (DECREASE) IN INCREASE (DECREASE) IN
(Dollars in thousands) VOLUME(I) RATE(I) TOTAL VOLUME(I) RATE(I) TOTAL
Interest income on:
Loans (2) $5,617 (3,705) $1,912 $12,227 $1,356 $13,583
Investments:
Taxable (716) 552 (164) (1,583) 536 (1,047)
Tax exempt(3) (161) (8) (169) (23) (49) (72)
Funds sold (654) (269) (923) 1,410 (365) 1,045
Interest -bearing deposits with banks 29 (59) (30) (244) 12 (232)
- --------------------------------------------------------------------------------------------------------
Total interest income 4,115 (3,489) 626 11,787 1,490 13,277
========================================================================================================
Interest expense on:
Deposits:
Interest-bearing transaction accounts 210 (5) 205 116 92 208
Savings accounts 311 (1,534) (1,223) 213 753 966
Certificates of deposit 1,840 (857) 983 2,896 1,744 4,640
Funds purchased (1,174) (2,311) (3,485) 1,213 1,892 3,105
Notes payable 473 (213) 260 564 (167) 397
- --------------------------------------------------------------------------------------------------------
Total interest expense 2,023 (5,283) (3,260) 5,002 4,314 9,316
- --------------------------------------------------------------------------------------------------------
Net interest income $2,092 $1,794 $3,886 $6,785 $(2,824) $3,961
========================================================================================================
(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 2001
AVERAGE INTEREST AVERAGE
(Dollars in thousands) BALANCE EARNED/PAID YIELD/RATE
Assets
Interest earning assets:
Loans, net of unearned income $ 742,558 $63,196 8.51%
Investment securities:
Taxable 145,804 9,088 6.23
Tax exempt 35,522 1,606 4.52
Funds sold 15,088 578 3.83
Interest-earning deposits with banks 654 4 0.61
---------- ------- ------
Total earning assets 939,626 74,472 7.93
------- ------
Cash and other assets 85,850
Less allowance for loan losses (9,265)
----------
Total assets $1,016,211
==========
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 144,963 $ 1,427 0.98%
Savings 159,785 3,833 2.40
Certificates of deposit 380,426 20,163 5.30
Funds purchased 68,490 2,438 3.56
Notes payable 41,134 2,111 5.13
---------- ------- ------
Total interest-bearing liabilities 794,798 29,972 3.77
Demand deposits 119,107
Other liabilities 12,732
Shareholders' equity 89,574
----------
Total liabilities and shareholders' equity $1,016,211
==========
Net interest spread 4.16
Impact of interest free funds 0.58
-------
Net interest margin 4.74%
=======
Net interest income $44,500
=======
11
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 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
=======
12
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 1999
AVERAGE INTEREST AVERAGE
(Dollars in thousands) BALANCE EARNED/PAID YIELD/RATE
Assets
Interest earning assets:
Loans, net of unearned income $541,434 $47,701 8.81%
Investment securities:
Taxable 186,763 10,299 5.51
Tax exempt 39,566 1,847 4.67
Funds sold 6,529 456 6.98
Interest-bearing deposits with banks 4,306 266 6.18
-------- ------ -----
Total earning assets 778,598 60,569 7.78
------
Cash and other assets 35,996
Less allowance for loan losses (7,295)
--------
Total assets $807,299
========
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $110,967 $ 1,014 0.91%
Savings 143,087 4,090 2.86
Certificates of deposit 289,431 14,540 5.02
Funds purchased 59,724 2,818 4.72
Notes payable 23,606 1,454 6.16
-------- ------ -----
Total interest-bearing liabilities 626,815 23,916 3.82
------ -----
Demand deposits 94,197
Other liabilities 12,714
Shareholders' equity 73,573
--------
Total liabilities and shareholders' equity $807,299
========
Net interest spread 3.96
Impact of interest free funds 0.75
-----
Net interest margin 4.71%
=====
Net interest income $36,653
=======
13
INVESTMENT SECURITIES
Investment securities, the second largest category of earning assets, are
utilized 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, 2001, investment securities were $189,933,000,
or 20.0 percent, of earning assets, as compared with $183,198,000, or 20.3
percent, of earning assets at year-end 2000. 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 $1,606,000 in 2001, a decrease of
$169,000, or 9.5 percent, from the $1,775,000 earned in 2000. This decrease was
mainly due to to an average portfolio balance that was $3,550,000, or 9.1
percent, less than the balance in 2000. A slight 2 basis point decline in
average yield also contributed to the decrease. In 2000, this segment of the
securities portfolio earned $92,000, or 3.9 percent, less than 1999 interest of
$1,847,000. This decrease was result of an average yield that was 13 basis
points lower in 2000 and a modest 1.3 percent decline in the average
held-to-maturity portfolio balance. The average maturity of this portfolio
segment was 3.9 years at December 31, 2001, 4.6 years at December 31, 2000, and
5.2 years at December 31, 1999.
Interest from securities available-for-sale, primarily taxable U.S.
Government agency and mortgage-backed securities, was $9,088,000 in 2001, a
decrease of $164,000, or 1.8 percent, from the 9,252,000 earned in 2000. This
decrease was the result of an average taxable securities portfolio that was
$12,225,000, or 7.8 percent, less than the average balance in 2000, partially
offset by an increase in average yield of 38 basis points. Earning's from this
portfolio segment were $1,047,000, or 10.2 percent, less in 2000 than in 1999.
This decrease was the result of an average volume decline of 15.4 percent,
partially offset by a 34 basis point increase in average yield. The average
maturity of this segment of the securities portfolio was 2.8 years at December
31, 2001, 3.2 years at December 31, 2000, and 3.8 years at the end of 1999.
At December 31, the fair value of the investment securities portfolio was
$190,581,000, or .3 percent higher than the portfolio's carrying value, when the
effect of a $684,000 higher market value of held-to-maturity securities, as
compared to their amortized cost, is considered. The difference between fair and
carrying values at the end of 2000 was negligible, following a discount to
market of .4 percent at year-end 1999. At December 31, 2001, investment
securities with an amortized cost of $153,061,000 and fair value of $154,919,000
were classified as available-for-sale. The resultant $1,858,000 increase in the
carrying value of these securities has been reflected, net of tax, in the
statement of changes in shareholders' equity as a component of comprehensive
income.
The Corporation realized a gain on the disposition of equity securities of
$570,000 in 2001, realized no gains or losses in 2000 and gains of $214,000 in
1999.
TABLE 3
BOOK VALUE OF INVESTMENT SECURITIES
DECEMBER 31,
(Dollars in thousands) 2001 2000 1999 1998 1997
HELD-TO-MATURITY
U.S. Treasury and other Government agencies - - $ 3,031 $ 6,299 $ 12,232
Mortgage-backed $ 247 - 1,304 2,144 3,320
State and municipal 34,767 $ 38,550 42,933 38,138 34,851
- --------------------------------------------------------------------------------------------------
Total Held to Maturity 35,014 38,550 47,268 46,581 50,403
- --------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U.S. Treasury and other Government agencies 44,265 93,479 93,033 131,465 113,973
Mortgage-backed 101,728 46,726 51,502 24,642 2,696
State and municipal 8,926 4,443 3,769 3,449 1,306
- --------------------------------------------------------------------------------------------------
Total Available-for-Sale 154,919 144,648 148,304 159,556 117,975
- --------------------------------------------------------------------------------------------------
Total $189,933 $183,198 $195,572 $206,137 $168,378
==================================================================================================
14
TABLE 4
MATURITY DISTRIBUTION AND YIELDS OF INVESTMENT SECURITIES
DUE IN DUE AFTER DUE AFTER DUE AFTER
DECEMBER 31, 2001 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 $ 247 5.69 - - - - - - $ 247 5.69% $ 247 $ 251
State and municipal 2,412 6.42% $21,203 6.45% $10,696 6.37% $455 7.56% 34,767 6.44% 34,510 35,410
- ------------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity 2,659 6.35% 21,203 6.45% 10,696 6.37% 455 7.56% 35,014 6.43% 34,757 35,662
- ------------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U.S. Treasury and U.S.
Government agencies 26,977 4.34% 13,605 5.75% 3,683 7.46% - - 44,265 5.03% 42,979 44,265
Mortgage-backed 11,765 5.46% 81,311 5.96% 8,652 6.07% - - 101,728 5.91% 100,883 101,728
Other investments(1) - - - - - - 8,926 7.08% 8,926 7.08% $8,882 8,926
- ------------------------------------------------------------------------------------------------------------------------------------
Total available-
for-sale 38,742 4.68% 94,915 5.93% 12,336 6.49% 8,926 7.08% 154,919 5.73% 152,744 154,919
- ------------------------------------------------------------------------------------------------------------------------------------
Total $41,401 4.79% $116,118 6.02% $22,032 6.43% $9,381 7.10% $189,933 5.86% $187,501 $190,581
====================================================================================================================================
Percent of total 22% 61% 12% 5%
Cumulative % of total 22% 83% 95% 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, 2001, loans, net of unearned discount, were $768,864,000,
an increase of $39,815,000, or 5.5 percent compared to year-end 2000. Average
loans during 2001 were $742,558,000, an increase of $62,341,000, or 9.2 percent,
over the 2000 average.
Real estate mortgage loans continue to be the largest segment of the loan
portfolio. All loans secured by real estate, except real estate construction
loans, are included in this category. Real estate mortgage loans were
$495,894,000 at the end of 2001 and represented 64.3 percent of the total
portfolio. This was an increase of $22,763,000, or 4.8 percent, over the
year-end 2000. Commercial, financial and agricultural loans were $118,819,000,
representing 15.4 percent of the loan portfolio, at December 31, 2001. This was
an increase of $15,351,000, or 14.8 percent, compared to the balance at the end
of 2000. Consumer loans, also representing 15.4 percent of the portfolio at the
end of 2001, were $118,734,000, a decrease of $4,707,000, or 3.8 percent from
the previous year.
Interest and fee income was $63,196,000 in 2001, an increase of $1,912,000,
or 3.0 percent, from 2000. Loan growth contributed to this increase, offsetting
the impact of an unprecedented 11 discount rate reductrions totaling 4.75
percent, as the Federal Reserve sought to provide monetary stimulus to a
weakened economy. The average yield on the loan portfolio was 7.93 percent in
2001, compared with 8.17 percent in 2000. Table 6 shows the maturity and
interest rate sensitivity of the loan portfolio at December 31, 2001. Loans that
mature in one year or less were $148,524,000, comprising 19.3 percent of the
total. Of the loans due after one year, $592,962,000, or 95.2 percent, had fixed
interest rates and $29,670,000, or 4.8 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 a 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,
2001, nonaccrual loans were $3,317,000 compared with $1,481,000 at year-end
2000. At December 31, 2001, loans which were 90 days or more past due were
$1,561,000 compared to $1,838,000 at year-end 2000.
15
Interest income which was foregone was an immaterial amount for each of the
three years ended December 31, 2001. First National Corporation does not have
any loans which 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% of total loans. As of December 31, 2001, no credit concentrations existed.
Table 7 provides the level of risk elements in the loan portfolio for the
past five years.
TABLE 5
DISTRIBUTION OF LOANS
BY TYPE
DECEMBER 31,
(Dollars in thousands) 2001 2000 1999 1998 1997
Commercial, financial,
agricultural and other $118,819 $ 103,468 $ 87,098 $ 72,312 $ 72,312
Real estate - construction 37,709 32,256 27,555 72,312 18,378
Real estate - mortgage 495,894 473,131 396,158 303,300 268,153
Consumer 118,734 123,441 103,150 86,195 78,139
- -------------------------------------------------------------------------------------------
Total $771,156 $ 732,266 $613,961 $496,218 $436,982
===========================================================================================
Percent of Total
Commercial, financial,
agricultural and other 15.4% 14.1% 14.2% 17.7% 16.5%
Real estate - construction 4.9 4.4 4.5 3.9 4.2
Real estate - mortgage 64.3 64.6 64.5 61.1 61.4
Consumer 15.4 16.9 16.8 17.3 17.9
- -------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
===========================================================================================
TABLE 6
MATURITY DISTRIBUTION OF LOANS
MATURITY
DECEMBER 31, 2001 1 YEAR 1 - 5 OVER 5
(Dollars in thousands) TOTAL OR LESS YEARS YEARS
Commercial, financial
agricultural and other $118,819 $ 55,166 $ 58,135 $ 5,518
Real estate - construction 37,709 14,665 19,203 3,841
Real estate - mortgage 495,894 60,689 274,981 160,224
Consumer 118,734 18,004 94,154 6,576
- -------------------------------------------------------------------------------------------
Total $771,156 $148,524 $446,473 $176,159
===========================================================================================
Loans due after one year with:
Predetermined interest rates $592,962
Floating or adjustable interest
rates $ 29,670
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, 2001 and 2000, the Corporation 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 tax-free 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 Corporation maintains its loan portfolio in accordance with its
established credit policies. Reflecting a more difficult economic climate in
2001, net loan charge-offs as a percentage of net average loans were .19 percent
compared to .12 percent in 2000. See "Loans" for a discussion of the
Corporation's charge-off and nonaccrual policies.
TABLE 7
NONACCRUAL AND PAST DUE LOANS
DECEMBER 31
(Dollars in thousands) 2001 2000 1998 1998 1997
Loans past due 90 days or more $1,561 $1,838 $ 729 $1,426 $ 488
Loans on a nonaccruing basis 3,317 1,481 1,537 1,547 1,445
- -------------------------------------------------------------------------------------------
Total $4,878 $3,319 $2,266 $2,973 $1,933
===========================================================================================
TABLE 8
SUMMARY OF LOAN
LOSS EXPERIENCE
DECEMBER 31
(Dollars in thousands) 2001 2000 1999 1998 1997
Allowance for loan losses
- January 1 $ 8,922 $ 7,886 $ 6,934 $ 6,246 $ 5,336
Total charge-offs (1,807) (1,008) (826) (785) (829)
Total recoveries 399 206 165 260 323
- -------------------------------------------------------------------------------------------
Net charge-offs (1,408) (802) (661) (525) (506)
Provision for loan losses 2,304 1,838 1,613 1,213 1,416
- -------------------------------------------------------------------------------------------
Allowance for loan losses
- December 31 $ 9,818 $ 8,922 $ 7,886 $ 6,934 $ 6,246
===========================================================================================
Average loans - net of
unearned income $742,558 $679,379 $541,434 $452,600 $404,641
Ratio of net charge-offs
to average loans - net
of unearned income .19% .12% .12% .12% .13%
17
LOAN LOSS PROVISION
First National Corporation 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 allowance is established on an overall portfolio basis, and management
does not subsequently allocate the allowance by geographic area or loan
category.
The provision for loan losses for the year ended December 31, 2001 was
$2,304,000, compared to $1,838,000 in 2000. The 25.4 percent increase in the
provision for loan losses was in response to increased net charge off activity
as well as overall growth of the loan portfolio.
The allowance for loan losses was $9,818,000, or 1.28 percent of
outstanding loans at December 31, 2001, as compared with $8,922,000, or 1.22
percent at the end of 2000. Total charge-offs were $1,807,000 in 2001 and
$1,008,000 in 2000. Recoveries were $399,000 in 2000 and $206,000 in the prior
year. Net charge-offs were $1,408,000 in 2001 and $802,000 in 2000. The ratio of
net charge-offs to average loans was .19 percent in 2001 and .12 percent in
2000. A summary of loan loss experience for the five years ending December 31,
2001 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, 2001, and December 31, 2000, other
real estate owned was $798,000 and $848,000 respectively.
While the economic outlook is more favorable in the coming months,
management anticipates that the level of charge offs for 2002 will be similar to
the level experienced the past year due to planned expansion into and further
growth in major South Carolina markets. The OCC handbook recommends that banks
take a broad look at certain factors in considering allowance for loan loss.
These factors include loan loss experience, specific allocations and other
subjective factors. First National Corporation continues to consider such
factors as these and 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 Corporation 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, 17 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 Corporation's
liabilities provide liquidity on a day-to-day basis. Daily liquidity needs may
be met from deposit growth or from the Corporation's use of federal funds
purchased, securities sold under agreements to repurchase and other short-term
borrowings.
The Corporation 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 2001, the Corporation 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.
18
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 Corporation does
not have financial derivatives, nor does it maintain a trading portfolio.
ASSET-LIABILITY MANAGEMENT AND MARKET RISK SENSITIVITY
The Corporation'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 Corporation 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 Corporation's
contractual agreements with regard to investments, loans and deposits. Although
the Corporation's simulation model is subject to the accuracy of the assumptions
that underlie the process, the Corporation 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 Corporation'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
Corporation'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 Corporation traditionally has maintained a risk
position well within the policy guideline level. As of December 31, 2001, the
earnings simulations indicated that the impact of a 200 basis point decrease in
rates over 12 months would result in an approximate 1.2 percent decrease in net
interest income while a 200 basis point increase in rates over the same period
would result in an approximate 0.5 percent decrease in interest income -- both
as compared with a base case unchanged interest rate environment. These results
indicate that the Corporation'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) 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 non-interest- 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, 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.
19
The Company does not currently use interest rate swaps or other derivatives
to modify the interest rate risk of its financial instruments.
Table 9 below provides information as of December 31, 2001 about the
Corporation'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.
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 Corporation to evaluate such deposits. For
further information on the fair value of financial instruments, see Note 23 to
the consolidated financial statements.
TABLE 9
FINANCIAL INSTRUMENTS THAT ARE SENSITIVE TO CHANGES IN INTEREST RATES
FAIR
THERE VALUE
(Dollars in thousands) 2002 2003 2004 2005 2006 AFTER TOTAL 12-31-01
Financial assets:
Loans, net of unearned income:
Fixed Rate:
Book value $ 120,468 $ 69,989 $ 68,114 $ 63,936 $ 63,047 $159,898 $545,453 $574,640
Average interest
rate 7.90% 8.93% 8.61% 8.69% 8.10% 7.76% 8.20%
Variable rate:
Book value $ 223,411 - - - - - $223,411 $228,858
Average interest rate 5.70% - - - - - 5.70%
Securities held-to-maturity:
Fixed rate:
Book value $ 3,262 $ 3,468 $ 4,735 $ 5,676 $ 5,338 $ 12,535 $ 35,014 $ 35,662
Average interest rate 7.13% 7.18% 6.73% 6.90% 6.44% 6.83% 6.83%
Variable rate:
Book value - - - - - - - -
Average interest rate - - - - - - - -
Securities
available-for-sale:
Fixed rate:
Book value $ 52,896 $ 25,401 $ 16,096 $ 11,322 $ 10,158 $ 38,559 $154,432 $154,432
Average interest rate 5.26% 5.81% 5.81% 5.87% 5.88% 5.97% 5.67% -
Variable rate:
Book value $ 487 - - - - - $ 487 $ 487
Average interest rate 5.47% - - - - - 5.47% -
Federal funds sold $1,000 - - - - - $ 1,000 $ 1,000
Average interest rate 1.75% - - - - - 1.75% -
- ------------------------------------------------------------------------------------------------------------------------------------
Total financial assets $401,524 $ 98,858 $88,945 $ 80,934 $ 78,543 $210,992 $959,797 $995,079
- ------------------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Noninterest
bearing-deposits $ 21,857 $ 15,536 $ 15,536 $ 15,536 $ 15,536 $ 45,697 $129,698 $120,830
Average interest rate N/A N/A N/A N/A N/A N/A N/A N/A
Interest-bearing
savings and checking $169,918 $ 48,836 $ 48,836 $ 48,836 $ 7,937 - $324,363 $320,891
Average interest rate 1.90% 0.90% 0.90% 0.90% 0.92% - 1.43% -
Time deposits $307,753 $ 41,611 $ 6,864 $ 1,075 $ 159 $ - $357,462 $360,089
Average interest rate 4.64% 4.76% 6.13% 5.63% 5.15% - 4.68% -
Federal funds purchased
and securities sold
under agreements to
repurchase $ 66,617 - - - - - $ 66,617 $ 66,617
Average interest rate 2.41% - - - - - 2.41% -
Notes payable - - - - $ 7,000 $ 42,500 $ 49,500 $ 49,842
Average interest rate - - - - 4.79% 5.00% 4.97% -
- ------------------------------------------------------------------------------------------------------------------------------------
Total financial
liabilities $566,145 $ 105,983 $ 71,236 $ 65,447 $ 30,632 $ 88,197 $927,640 $918,269
- ------------------------------------------------------------------------------------------------------------------------------------
Interest rate sensitivity
gap $(164,621) $ (7,125) $ 17,709 $ 15,487 $ 47,911 $ 122,795 $ 32,157 -
Cumulative interest rate
sensitivity gap $(164,621) $(171,745) $(154,036) $(138,549) $(90,638) $ 32,157 - -
20
DEPOSITS
Customer deposits provide First National Corporation with its primary
source of funds for the continued growth of its loan and investment portfolios.
Total deposits were $811,523,000 at December 31, 2001, an increase of
$53,947,000, or 7.1 percent, from year-end 2000. Noninterest bearing accounts
grew by 17,701,000 or 15.8 percent to $129,698,000 at the end of 2001.
Interest-bearing deposits were $681,825,000 at December 31, 2001, an increase of
$36,246,000, or 5.6 percent, over the balance one year earlier.
During 2001 average total deposits increased by $68,188,000, or 9.3
percent, to $804,281,000. Every major deposit category experienced growth, with
total average interest-bearing deposits increasing $63,824,000 or 10.3 percent,
and noninterest-bearing demand accounts increasing $4,364,000, or 3.8 percent.
In 2000, total deposits averaged $736,093,000, an increase of $98,411,000, or
15.4 percent, compared with 1999. This increase was the result of growth in
average interest-bearing deposits of $77,865,000, or 14.3 percent, accompanied
by a $20,546,000, or 21.8 percent, increase in noninterest-bearing deposits.
At December 31, 2001, the ratio of interest-bearing deposits to total
deposits was 84.0 percent, or slightly less than the 85.2 percent ratio at
December 31, 2000 and the 84.8 percent ratio at the end of 1999.
TABLE 10
MATURITY DISTRIBUTION OF
CD'S OF $100,000 OR MORE
DECEMBER 31 2001 2000
(Dollars in thousands)
Within three months $46,756 $34,860
After three through six months 32,263 39,830
After six through twelve months 31,501 28,353
After twelve months 9,499 16,622
- ---------------------------------------------------------------------
Total $120,019 $119,665
=====================================================================
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
(Dollars in thousands) 2001 2000 1999
AMOUNT RATE AMOUNT RATE AMOUNT RATE
At period-end:
Federal funds purchased
and securities sold under
repurchase agreements $66,617 1.52% $65,948 5.78% $76,400 5.75%
- ----------------------------------------------------------------------------------------
Other borrowings - - 44,050 5.95% 7,700 5.92
- ----------------------------------------------------------------------------------------
Average for the year:
Federal funds purchased
and securities sold under
repurchase agreements and $68,490 3.56% $85,422 5.13% $59,724 4.72%
- ----------------------------------------------------------------------------------------
Other borrowings - - 32,759 5.70% 23,606 6.16%
- ----------------------------------------------------------------------------------------
Maximum month-end balance:
Federal funds purchased
and securities sold under
repurchase agreements $91,820 - $159,503 - $76,400 -
- ----------------------------------------------------------------------------------------
Other borrowings - 57,050 26,750
- ----------------------------------------------------------------------------------------
21
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, 2001, shareholders' equity was $93,065,000, or 9.1 percent, of
total assets. At year-end 2000 and 1999, shareholders' equity was $84,936,000,
or 8.8 percent, and $75,819,000, or 8.7 percent, of total assets, respectively.
The Corporation 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 12.32 percent at December 31, 2001, 12.15 percent at December 31, 2000 and
12.70 at the end of 1999. The total capital ratio for the Corporation was 13.57
percent, 13.40 percent and 13.95 percent for the years ended December 31, 2001,
2000 and 1999, 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 8.39 percent at December
31, 2001, 8.27 percent at December 31, 2000 and 8.64 percent at year-end 1999.
The Corporation 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,
2001, $16,530,000 of the banks' retained earnings were available for
distribution to the Corporation as dividends without prior regulatory approval.
In 2001, First National Corporation made shareholder dividend payments of
$4,000,000 as compared with $3,801,000 in 2000 and $3,187,000 in 1999. The
dividend pay-out ratios were 32.63 percent, 36.09 percent and 40.14 percent for
the years 2001, 2000 and 1999, 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
With strong competition for loans and deposits and continued pressure on
the interest margin - especially during an economic downturn as experienced in
the past year - noninterest income provides a significant stable source of
revenue for the Corporation. For the year ended December 31, 2001, noninterest
income was $13,680.000, an increase of 24.7 percent from 2000. Noninterest
income was $10,971,000 in 2000, which was 11.3 percent more than 1999. In 2001,
noninterest income comprised 15.5 percent of total income from both interest and
noninterest sources. For 2000 and 1999, noninterest income was 12.9 percent and
13.8 percent, respectively, of total interest and noninterest income.
Service charges on deposit accounts were $7,750,000, comprising 56.7
percent of noninterest income in 2001, and representing a $392,000, or 5.3
percent, increase over 2000. For the year ended December 31, 2000, service
charges on deposit accounts were $7,358,000, a $1,520,000, or 26.0 percent,
increase compared with 1999. These increases resulted from customer deposit
growth and pricing modifications to reflect new services and their related
costs.
During 2001, other service charges and fees increased by $1,815,000, or
51.2 percent, to $5,360,000, compared with 2000. This followed a decline of 2.4
percent from $3,632,000 in 1999 to $3,545,000 in 2000. The sharply higher
results in 2001 were primarily attributable to origination fee income from
secondary market mortgage loans. Longer-term, fixed rate mortgage loans, which
the Company normally sells in the secondary market, were strong as a result of
refinance activity driven by declining interest rates throughout the year and a
strong housing market. Also contributing to higher fee income in 2001 were
growing Asset Management (Trust) revenues.
Noninterest income in 2001 was further enhanced by a previously announced
$570,000 gain on the sale of equity securities.
Noninterest expense was $37,133,000 in 2001, an increase of $3,037,000, or
8.9 percent, from 2000. In 2000, noninterest expenses were $34,096,000, rising
$294,000, or .9 percent from 1999.
22
The largest component of noninterest expense was salaries and employee
benefits, which were $19,757,000 in 2001, an increase of $2,453,000, or 14.2
percent, compared with the previous year. In 2000, salaries and employee
benefits were $17,304,000, higher than 1999, by 463,000, or 2.8 percent. The
main contributors to the increase in 2001 included increased incentive payments
commensurate with strong mortgage origination activity and asset management
production and higher salary and benefit expenses reflecting added management
and administrative staffing. The Corporation employed 442 full-time equivalent
employees at December 31, 2001, compared with 402 and 426 at the end of 2000 and
1999, respectively. Payments under a cash incentive program covering all
employees were $730,000 in 2001, $843,000 in 2000 and $829,000 in 1999.
Net occupancy expense was $2,053,000, $1,989,000 and $1,773,000 for the
years ended December 31, 2001, 2000 and 1999, respectively. The increase from
2000 to 2001 was 3.2, compared to a 12.8 percent rise from 1999 to 2000. This
was due to facilities operating expenses increasing at a lesser rate in 2001 as
compared to the previous year.
Furniture and equipment expense was $3,732,000 in 2001, an increase of
$163,000, or 4.6 percent, compared with 2000. The increase was the result of
higher equipment leasing costs and equipment service contracts. These costs also
contributed to an increase of $527,000, or 17.3 percent, comparing the year 2000
with 1999.
For the year ended December 31, 2001, other expense was $11,600,000, an
increase of $366,000, or 3.3 percent over the previous year, In 2000, other
expense was $11,234,000, a $912,000, or 7.5 percent, decline compared with 1999.
Active marketing campaigns in 2001 increased advertising expenses by $626,000 to
$1,464,000, as compared with 2000. Professional fees were $1,089,000 in 2001, a
decrease of $565,000 from the previous year in which the Corporation incurred
costs associated with a process reengineering project. In 1999, other expenses
of $12,146,000 included nonrecurring charges of approximately $2,381,000 in
connection with completion of the merger with FirstBancorporation.
TABLE 12
QUARTERLY RESULTS OF OPERATIONS
(Dollars in thousands) 2001 QUARTERS 2000 QUARTERS
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
Interest income $17,854 $18,865 $18,735 $19,018 $18,710 $19,173 $19,013 $16,950
Interest expense 5,896 7,407 7,981 8,688 8,366 8,937 8,800 7,129
- ---------------------------------------------------------------------------------------------------------
Net interest income 11,958 11,458 10,754 10,330 10,344 10,236 10,213 9,821
- ---------------------------------------------------------------------------------------------------------
Provision for loan losses 915 693 404 292 624 456 440 318
Noninterest income 3,660 3,173 3,862 2,985 2,592 2,783 2,995 2,601
Noninterest expense 10,144 9,204 9,463 8,322 8,755 8,356 8,656 8,329
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 4,559 4,734 4,749 4,701 3,557 4,207 4,112 3,775
Income taxes 1,568 1,643 1,650 1,625 1,132 1,400 1,361 1,225
- ---------------------------------------------------------------------------------------------------------
Net income $2,991 $3,091 $3,099 $3,076 $ 2,425 $ 2,807 $ 2,751 $ 2,550
=========================================================================================================
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 "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.
23
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 Corporation 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 Corporation. 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
Orangeburg, South Carolina
January 25, 2002
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, 2001 and 2000, 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, 2001.
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, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America.
J. W. Hunt and Company, LLP
Columbia, South Carolina
January 25, 2002
24
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except par value)
December 31,
2001 2000
---- ----
ASSETS
Cash and cas