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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2002
Commission file number 001-12669
FIRST NATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
South Carolina 57-0799315
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
520 Gervais Street
Columbia, South Carolina 29201
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(Address of principal executive offices, including zip code)
(800) 277-2175
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
Common Stock - $2.50 par value American Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
The aggregate market value of the voting stock of the registrant held by
non-affiliates was $174,657,000 based on the closing sale price of $27.455 per
share on June 30, 2002. For purposes of the foregoing calculation only, all
directors and executive officers of the registrant have been deemed affiliates.
The number of shares of common stock outstanding as of March 11, 2003 was
7,673,339.
Documents Incorporated by Reference
Portions of the Registrant's 2002 Annual Report to Shareholders are incorporated
by reference into Part II. Portions of the Registrant's Proxy Statement for its
2002 Annual Meeting of Shareholders are incorporated by reference into Part III.
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FORM 10-K CROSS-REFERENCE INDEX
Page
PART I
Item 1. Business ........................................................ 1
Item 2. Properties ...................................................... 6
Item 3. Legal Proceedings ............................................... 6
Item 4. Submission of Matters to a Vote of Security Holders ............. 7
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters (1) ....................................... 8
Item 6. Selected Financial Data (1) ..................................... 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 8
Item 7a. Quantitative and Qualitative Disclosure about Market Risk ....... 24
Item 8. Financial Statements and Supplementary Data ..................... 25
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosures .......................... 53
PART III
Item 10. Directors and Executive Officers of the Registrant (2) .......... 53
Item 11. Executive Compensation (2) ...................................... 53
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters(2) ................. 54
Item 13. Certain Relationships and Related Transactions (2) .............. 54
Item 14. Controls and Procedures ......................................... 54
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ................................................... 54
(1) Incorporated by reference to the Registrant's 2002 Annual Report to
Shareholders.
(2) Incorporated by reference to the Registrant's Proxy Statement for its 2003
Annual Meeting of Shareholders.
FORWARD LOOKING STATEMENTS
Statements included in this report, including in Management's Discussion
and Analysis of Financial Condition and Results of Operations, which are not
historical in nature are intended to be, and are hereby identified as, forward
looking statements for purposes of the safe harbor provided by Section 21E of
the Securities Exchange Act of 1934, as amended. First National Corporation
cautions readers that forward looking statements are subject to certain risks
and uncertainties that could cause actual results to differ materially from
forecasted results. Such risk factors include, among others, the following
possibilities: (1) Credit risk associated with an obligor's failure to meet the
terms of any contract with the bank or otherwise fail to perform as agreed; (2)
Interest rate risk involving the effect of a change in interest rates on both
the bank's earnings and the market value of portfolio equity; (3) Liquidity risk
affecting the bank's ability to meet its obligations when they come due; (4)
Price risk focusing on changes in market factors that may affect the value of
traded instruments in mark-to-market portfolios; (5) Transaction risk arising
from problems with service or product delivery; (6) Compliance risk involving
risk to earnings or capital resulting from violations of or nonconformance with
laws, rules, regulations, prescribed practices, or ethical standards; (7)
Strategic risk resulting from adverse business decisions or improper
implementation of business decisions; and (8) Reputation risk that adversely
affects earnings or capital arising from negative public opinion.
PART I
ITEM 1. BUSINESS
GENERAL
First National Corporation (the "Company") is a bank holding company
incorporated under the laws of South Carolina in 1985. The Company owns 100% of
four subsidiaries, namely South Carolina Bank and Trust, N.A. (formerly First
National Bank), a national bank which opened for business in 1934; South
Carolina Bank and Trust of the Piedmont, N.A. (formerly National Bank of York
County), a national bank which opened for business in 1996; South Carolina Bank
and Trust of the Pee Dee, N.A. (formerly National Bank of Florence County), a
national bank which opened for business in 1998; and CreditSouth Financial
Services Corporation, a consumer finance company, which opened for business in
1998. As noted above, the names of the Company's banking subsidiaries were
changed in May 2002 in order to bring the group under a common marketing
identity.
On December 1, 2002, South Carolina Bank and Trust, N.A., acquired the
majority of the consumer loan portfolio and related assets of CreditSouth
Financial Services Corporation and assumed the continuing lending activities of
that business. Thereafter, CreditSouth Financial Services Corporation ceased
active lending programs and focused on servicing a retained portfolio of loans
that were delinquent at the time of the acquisition.
Some of the major services which the Company provides through its banking
subsidiaries include checking, NOW accounts, savings and other time deposits of
various types, alternative investment products such as annuities and mutual
funds, loans for businesses, agriculture, real estate, personal use, home
improvement and automobiles, credit cards, letters of credit, home equity lines
of credit, safe deposit boxes, bank money orders, wire transfer services, asset
management services, discount brokerage services, and use of ATM facilities. The
Company has no material concentration of deposits from any single customer or
group of customers, and no significant portion of its loans is concentrated
within a single industry or group of related industries. There are no material
seasonal factors that would have a material adverse effect on the Company. The
Company does not have any foreign loans.
In January 2003, the Company moved its principal executive offices to 520
Gervais Street, Columbia, South Carolina 29201. The Company's mailing address at
its new headquarters is P.O. Box 1030, Columbia, South Carolina 29202, and its
telephone number is (800) 277-2175.
The Company maintains an Internet site at http://www.scbandt.com.. The
information contained in the Company's web site is not incorporated into this
report. During 2002, the Company did not make its annual reports on Form 10-K,
quarterly reports on Form 10-Q, or current reports on Form 8-K, or any
amendments to these reports, available through its web site. However, the
Company is in the process of modifying its web site to permit the public to
obtain these reports through the Company's web site. In addition, these reports
are available to the public through the SEC's web site at http://www.sec.gov.
The Company will also provide shareholders with a copy of any of these reports
free of charge upon request.
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TERRITORY SERVED AND COMPETITION
South Carolina Bank and Trust, N.A. conducts its business from 24 full
service offices in 19 South Carolina towns. South Carolina Bank and Trust of the
Piedmont, N.A. conducts its business from four locations in three South Carolina
towns. South Carolina Bank and Trust of the Pee Dee, N.A. conducts its business
from two locations in two South Carolina towns. In their markets, the three
banks (the "Banks") encounter strong competition from several major banks that
dominate the commercial banking industry in their service areas and in South
Carolina generally. Several competitors have substantially greater resources and
higher lending limits than the Banks and they offer certain services for their
customers that the Banks do not offer. In addition to commercial banks, savings
institutions and credit unions, the Banks compete for deposits and loans with
other financial intermediaries and investment alternatives, including mortgage
companies, credit card issuers, leasing companies, finance companies, money
market mutual funds, brokerage firms, governmental and corporation bonds and
other securities. Various of these nonbank competitors are not subject to the
same regulatory restrictions as the Company and many have substantially greater
resources than the Company.
As a bank holding company, the Company is a legal entity separate and
distinct from its subsidiaries. The Company coordinates the financial resources
of the consolidated enterprise and maintains financial, operational and
administrative systems that allow centralized evaluation of subsidiary
operations and coordination of selected policies and activities. The Company's
operating revenues and net income are derived primarily from its subsidiaries
through dividends.
EMPLOYEES
The Company does not have any salaried employees. As of December 31, 2002,
the Company's subsidiaries had 480 full-time equivalent employees. The Company
considers its relationship with its employees to be excellent. The employee
benefit programs the Company provides include group life, health and dental
insurance, paid vacation, sick leave, educational opportunities, a cash
incentive plan, a stock award program, a stock purchase plan, stock option plans
for officers and key employees, a defined benefit pension plan, and a 401K plan.
SUPERVISION AND REGULATION
GENERAL
The Company is a "bank holding company" registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") and is
subject to the supervision of, and to regular inspection by, the Federal Reserve
Board. Each of the Banks is organized as a national banking association and
subject to regulation, supervision and examination by the Office of the
Comptroller of the Currency (the "OCC"). In addition, the Company and each of
the Banks is subject to regulation (and in certain cases examination) by the
Federal Deposit Insurance Corporation (the "FDIC"), other federal regulatory
agencies and the South Carolina State Board of Financial Institutions (the
"State Board"). The following discussion summarizes certain aspects of banking
and other laws and regulations that affect the Company and its subsidiaries.
Under the Bank Holding Company Act (the "BHC Act"), the Company's
activities and those of its subsidiaries are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiaries, or any other activity which the Federal Reserve Board determines
to be so closely related to banking or managing or controlling banks as to be a
proper incident thereto. The BHC Act requires prior Federal Reserve Board
approval for, among other things, the acquisition by a bank holding company of
direct or indirect ownership or control of more than 5% of the voting shares or
substantially all the assets of any bank, or for a merger or consolidation of a
bank holding company with another bank holding company. The BHC Act also
prohibits a bank holding company from acquiring direct or indirect control of
more than 5% of the outstanding voting stock of any company engaged in a
non-banking business unless such business is determined by the Federal Reserve
Board to be so closely related to banking as to be a proper incident thereto.
Further, under South Carolina law, it is unlawful without the prior approval of
the State Board for any South Carolina bank holding company (i) to acquire
direct or indirect ownership or control of more than 5% of the voting shares of
any bank or any other bank holding company, (ii) to acquire all or substantially
all of the assets of a bank or any other bank holding company, or (iii) to merge
or consolidate with any other bank holding company.
The Graham-Leach-Bliley Act amended a number of federal banking laws
affecting the Company and the Banks. In particular, the Graham-Leach-Bliley Act
permits a bank holding company to elect to become a "financial holding company,"
provided certain conditions are met. A financial holding company, and the
companies it controls, are permitted to engage in activities considered
"financial in nature" as defined by the Graham-Leach-Bliley Act and Federal
Reserve Board interpretations (including, without limitation, insurance and
securities activities), and therefore may engage in a broader range of
activities than permitted by bank holding companies and their subsidiaries. The
Company continues to evaluate whether to seek to become a financial holding
company under the Graham-Leach-Bliley Act.
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INTERSTATE BANKING
In July 1994, South Carolina enacted legislation which effectively provided
that, after June 30, 1996, out-of-state bank holding companies may acquire other
banks or bank holding companies in South Carolina, subject to certain
conditions. Further, pursuant to the Riegel-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Banking and Branching Act"), a
bank holding company became able to acquire banks in states other than its home
state, beginning in September 1995, without regard to the permissibility of such
acquisition under state law, subject to certain exceptions. The Interstate
Banking and Branching Act also authorized banks to merge across state lines,
thereby creating interstate branches, unless a state, prior to the July 1, 1997
effective date, determined to "opt out" of coverage under this provision. In
addition, the Interstate Banking and Branching Efficiency Act authorized a bank
to open new branches in a state in which it does not already have banking
operations if such state enacted a law permitting such "de novo" branching.
Effective July 1, 1996, South Carolina law was amended to permit interstate
branching but not de novo branching by an out-of-state bank. The Company
believes that the foregoing legislation has increased takeover activity of South
Carolina financial institutions by out-of-state financial institutions.
OBLIGATIONS OF HOLDING COMPANY TO ITS SUBSIDIARY BANKS
Under the policy of the Federal Reserve Board, a bank holding company is
required to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it otherwise might not desire or be able to do. Under the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), to
avoid receivership of its insured depository institution subsidiary, a bank
holding company is required to guarantee the compliance of any insured
depository institution subsidiary that may become "undercapitalized" within the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution became
undercapitalized, or (ii) the amount which is necessary (or would have been
necessary) to bring the institution into compliance with all applicable capital
standards as of the time the institution fails to comply with such capital
restoration plan.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended ("FDIA"), require insured depository institutions
under common control to reimburse the FDIC for any loss suffered or reasonably
anticipated by the FDIC as a result of the default of a commonly controlled
insured depository institution or for any assistance provided by the FDIC to a
commonly controlled insured depository institution in danger of default. The
FDIC's claim for damages is superior to claims of stockholders of the insured
depository institution or its holding company but is subordinate to claims of
depositors, secured creditors and holders of subordinated debt (other than
affiliates) of the commonly controlled insured depository institutions.
The FDIA also provides that amounts received from the liquidation or other
resolution of any insured depository institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit liabilities of
the institution prior to payment of any other general or unsecured senior
liability, subordinated liability, general creditor or stockholder. This
provision would give depositors a preference over general and subordinated
creditors and stockholders in the event a receiver is appointed to distribute
the assets of the Banks.
Any capital loans by a bank holding company to any of its subsidiary banks
are subordinate in right of payment to deposits and to certain other
indebtedness of such subsidiary bank. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and entitled to a priority of payment.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require payment of the
deficiency by assessment upon the bank's shareholders', pro rata, and if any
such assessment is not paid by any shareholder after three months notice, to
sell the stock of such shareholder to make good the deficiency.
CAPITAL ADEQUACY
The various federal bank regulators, including the Federal Reserve Board
and the OCC, have adopted risk-based capital requirements for assessing bank
holding company and bank capital adequacy. These standards define what qualifies
as capital and establish minimum capital standards in relation to assets and
off-balance sheet exposures, as adjusted for credit risks. Capital is classified
into tiers. For bank holding companies, Tier 1 or "core" capital consists
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primarily of common and qualifying preferred shareholders' equity, less certain
intangibles and other adjustments ("Tier 1 Capital"). Tier 2 capital consists
primarily of the allowance for possible loan losses (subject to certain
limitations) and certain subordinated and other qualifying debt ("Tier 2
Capital"). A minimum ratio of total capital to risk-weighted assets of 8.00% is
required and Tier 1 Capital must be at least 50% of total capital. The Federal
Reserve Board also has adopted a minimum leverage ratio of Tier 1 Capital to
adjusted average total assets (not risk-weighted) of 3%. The 3% Tier 1 Capital
to average total assets ratio constitutes the leverage standard for bank holding
companies and national banks, and is used in conjunction with the risk-based
ratio in determining the overall capital adequacy of banking organizations.
The Federal Reserve Board and the OCC have emphasized that the foregoing
standards are supervisory minimums and that an institution would be permitted to
maintain such levels of capital only if it had a composite rating of "1" under
the regulatory rating systems for bank holding companies and banks. All other
bank holding companies are required to maintain a leverage ratio of 3% plus at
least 1% to 2% of additional capital. These rules further provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain capital positions substantially above the minimum
supervisory levels and comparable to peer group averages, without significant
reliance on intangible assets. The Federal Reserve Board continues to consider a
"tangible Tier 1 leverage ratio" in evaluating proposals for expansion or new
activities. The tangible Tier 1 leverage ratio is the ratio of a banking
organization's Tier 1 Capital less all intangibles, to total assets, less all
intangibles. The Federal Reserve Board has not advised the Company of any
specific minimum leverage ratio applicable to it. As of December 31, 2002, the
Company, South Carolina Bank and Trust, N.A., South Carolina Bank and Trust of
the Piedmont, N.A., and South Carolina Bank and Trust of the Pee Dee, N.A. had
leverage ratios of 8.70%, 8.23%, 8.15% and 10.43%, respectively, and total risk
adjusted capital of 12.92%, 12.12%, 12.57%, and 13.85%, respectively.
FDICIA, among other things, identifies five capital categories for insured
depository institutions (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized) and requires the respective Federal regulatory agencies to
implement systems for "prompt corrective action" for insured depository
institutions that do not meet minimum capital requirements within such
categories. FDICIA also imposes progressively more restrictive constraints on
operations, management and capital distributions, depending on the category in
which an institution is classified. Failure to meet the capital guidelines could
also subject a banking institution to capital raising requirements. An
"undercapitalized" bank must develop a capital restoration plan and its parent
holding company must guarantee that bank's compliance with the plan (see
"Obligations of Holding Company to its Subsidiary Banks," above). In addition,
FDICIA requires the various regulatory agencies to prescribe certain non-capital
standards for safety and soundness relating generally to operations and
management, asset quality and executive compensation and permits regulatory
action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar
regulations that define the five capital categories identified by FDICIA, using
the total risk-based capital, Tier 1 risk-based capital and leverage capital
ratios as the relevant capital measures. Such regulations establish various
degrees of corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 capital ratio of at least 6%, a total capital ratio of at least
10% and a leverage ratio of at least 5% and not be subject to a capital
directive order. An "adequately capitalized" institution must have a Tier 1
capital ratio of at least 4%, a total capital ratio of a least 8% and a leverage
ratio of a least 4%, or 3% in some cases. Under these guidelines, each of the
Banks is considered well capitalized.
Banking agencies have also adopted final regulations which mandate that
regulators take into consideration (i) concentration of credit risk, (ii)
interest rate risk (when the interest rate sensitivity of an institution's
assets does not match the sensitivity of its liabilities or its
off-balance-sheet position), and (iii) risks from non-traditional activities, as
well as an institution's ability to manage those risks, when determining the
adequacy of an institution's capital. That evaluation will be made as a part of
the institution's regular safety and soundness examination. In addition, the
banking agencies have amended their regulatory capital guidelines to incorporate
a measure for market risk. In accordance with the amended guidelines, the
Company and the Banks with significant trading activity (as defined in the
amendment) must incorporate a measure for market risk in their respective
regulatory capital calculations effective for reporting periods after January 1,
1998.
PAYMENT OF DIVIDENDS
The Company is a legal entity separate and distinct from its subsidiaries,
and the Company's funds for cash distributions to its shareholders are derived
primarily from dividends received from the Banks. Each of the Banks is subject
to various general regulatory policies and requirements relating to the payment
of dividends. Any restriction on the ability of the Banks to pay dividends will
indirectly restrict the ability of the Company to pay dividends.
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The approval of the OCC is required if the total of all dividends declared
by a national bank in any calendar year will exceed the total of its retained
net profits for that year combined with its retained net profits for the two
preceding years, less any required transfers to surplus. In addition, national
banks can only pay dividends to the extent that retained net profits (including
the portion transferred to surplus) exceed statutory bad debts in excess of the
bank's allowance for loan losses. Further, if in the opinion of the OCC a bank
under its jurisdiction is engaged in or is about to engage in an unsafe or
unsound practice (which, depending on the financial condition of the bank, could
include the payment of dividends), the OCC may require, after notice and a
hearing, that such bank cease and desist from such practice. The OCC has
indicated that paying dividends that deplete a national bank's capital base to
an inadequate level would be an unsafe and unsound banking practice. The Federal
Reserve Board, the OCC and the FDIC have issued policy statements which provide
that bank holding companies and insured banks should generally only pay
dividends out of current operating earnings.
In addition to the foregoing, the ability of the Company and the Banks to
pay dividends may be affected by the various minimum capital requirements and
the capital and non-capital standards established under FDICIA, as described
above. The right of the Company, its shareholders and its creditors to
participate in any distribution of the assets or earnings of its subsidiaries is
further subject to the prior claims of creditors of the Company's subsidiaries.
CERTAIN TRANSACTIONS BY THE COMPANY AND ITS AFFILIATES
Various legal limitations place restrictions on the ability of the Banks to
lend or otherwise supply funds to the Company. The Federal Reserve Act limits a
bank's "covered transactions," which include extensions of credit, with any
affiliate to 10% of such bank's capital and surplus. All covered transactions
with all affiliates cannot in the aggregate exceed 20% of a bank's capital and
surplus. All covered and exempt transactions between a bank and its affiliates
must be on terms and conditions consistent with safe and sound banking
practices, and banks and their subsidiaries are prohibited from purchasing
low-quality assets from the bank's affiliates. Also, the Federal Reserve Act
requires that all of a bank's extensions of credit to an affiliate be
appropriately secured by acceptable collateral, generally United States
government or agency securities. In addition, the Federal Reserve Act limits
covered and other transactions among affiliates to terms and circumstances,
including credit standards, that are substantially the same or at least as
favorable to a bank holding company, a bank or a subsidiary of either as
prevailing at the time for transactions with unaffiliated companies.
INSURANCE OF DEPOSITS
As FDIC-insured institutions, the Banks are subject to insurance
assessments imposed by the FDIC. Under current law, the insurance assessment to
be paid by FDIC-insured institutions is as specified in a schedule required to
be issued by the FDIC that specifies, at semi-annual intervals, target reserve
ratios designed to increase the FDIC insurance fund's reserve ratio to 1.25% of
estimated insured deposits (or such higher ratio as the FDIC may determine in
accordance with the statute) in 15 years. Further, the FDIC is authorized to
impose one or more special assessments in any amount deemed necessary to enable
repayment of amounts borrowed by the FDIC from the United States Department of
the Treasury. The actual assessment to be paid by each FDIC-insured institution
is based on the institution's assessment risk classification, which is
determined based on whether the institution is considered "well capitalized,"
"adequately capitalized" or "undercapitalized", as such terms have been defined
in applicable federal regulations, and whether such institution is considered by
its supervisory agency to be financially sound or to have supervisory concerns
(see "--Capital Adequacy" above). As a result of the current provisions of
federal law, the assessment rates on deposits could increase over present
levels. Based on the current financial condition and capital levels of the
Banks, the Company does not expect that the current FDIC risk-based assessment
schedule will have a material adverse effect on the Banks' earnings in 2003.
INTERNATIONAL MONEY LAUNDERING ABATEMENT AND FINANCIAL ANTI-TERRORISM
ACT OF 2001
On October 26, 2001, the President signed the USA Patriot Act of 2001 into
law. This act contains the international Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (the "IMLAFA"). The IMLAFA contains
anti-money laundering measures affecting insured depository institutions,
broker-dealers and certain other financial institutions. The IMLAFA requires U.
S. financial institutions to adopt new policies and procedures to combat money
laundering and grants the Secretary of the Treasury broad authority to establish
regulations and to impose requirements and restrictions on financial
institution's operations. The Company has adopted policies and procedures to
comply with the provisions of the Act.
OTHER LAWS AND REGULATIONS
Interest and certain other charges collected or contracted for by the Banks
are subject to state usury laws and certain federal laws concerning interest
rates. The Banks' operations are also subject to certain federal laws applicable
to credit
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transactions, such as the federal Truth-In-Lending Act governing disclosures of
credit terms to consumer borrowers, the Community Reinvestment Act requiring
financial institutions to meet their obligations to provide for the total credit
needs of the communities they serve (which includes the investment of assets in
loans to low- and moderate-income borrowers), the Home Mortgage Disclosure Act
of 1975 requiring financial institutions to provide information to enable the
public and public officials to determine whether a financial institution is
fulfilling its obligation to help meet the housing needs of the community it
serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis
of race, creed or other prohibited factors in extending credit, the Fair Credit
Reporting Act of 1978 governing the use and provision of information to credit
reporting agencies, the Fair Debt Collection Act governing the manner in which
consumer debts may be collected by collection agencies, and the rules and
regulations of the various federal agencies charged with the responsibility of
implementing such federal laws. The deposit operations of the Banks also are
subject to the Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes procedures for
complying with administrative subpoenas of financial records, and the Electronic
Funds Transfer Act and Regulation E issued by the Federal Reserve Board to
implement that act, which govern automatic deposits to and withdrawals from
deposit accounts and customers' rights and liabilities arising from the use of
automated teller machines and other electronic banking services.
From time to time, bills are pending before the United States Congress and
in the South Carolina state legislature which in certain cases contain
wide-ranging proposals for altering the structure, regulation and competitive
relationships of financial institutions. Among such bills are proposals to
prohibit banks and bank holding companies from conducting certain types of
activities, to subject banks to increased disclosure and reporting requirements,
to alter the statutory separation of commercial and investment banking, and to
further expand the powers of banks, bank holding companies and competitors of
banks. It cannot be predicted whether or in what form any of these proposals
will be adopted or the extent to which the business of the Company and its
subsidiaries may be affected thereby.
FISCAL AND MONETARY POLICY
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
its other borrowings, and the interest received by a bank on its loans and
securities holdings, constitute the major portion of a bank's earnings. Thus,
the earnings and growth of the Company will be subject to the influence of
economic conditions generally, both domestic and foreign, and also to the
monetary and fiscal policies of the United States and its agencies, particularly
the Federal Reserve Board. The Federal Reserve Board regulates the supply of
money through various means, including open-market dealings in United States
government securities, the discount rate at which banks may borrow from the
Federal Reserve Board, and the reserve requirements on deposits. The nature and
timing of any changes in such policies and their impact on the Company cannot be
predicted.
ITEM 2. PROPERTIES
In January 2003 the Company relocated its executive headquarters to a new
four-story facility at 520 Gervais Street, Columbia, South Carolina. The lead
branch in the Midlands region of South Carolina Bank and Trust, N.A. also moved
into the 57,000 square foot building. The main offices of South Carolina Bank
and Trust, N.A. are located at 950 John C. Calhoun Drive, S.E., Orangeburg,
South Carolina in a four-story facility that affords 48,000 square feet of space
for operating and administrative purposes. Both of these facilities are owned by
South Carolina Bank and Trust, N.A, which also owns 23 other properties and
leases 15 properties, substantially all of which are used as branch locations or
for housing other operational units.
South Carolina Bank and Trust of the Piedmont, N.A. owns a 12,000 square
foot office building that serves as its main office located at 1127 Ebenezer
Road, Rock Hill, South Carolina. The bank also owns one additional property and
leases two others, which are used as branches. South Carolina Bank and Trust of
the Pee Dee, N.A. owns a 9,000 square foot office building that serves as its
main office located at 1600 W. Palmetto Street, Florence, South Carolina, and
leases one property which is used as a branch.
Although the properties leased and owned are generally considered adequate,
there is a continuing program of modernization, expansion, and, as needs
materialize, occasional replacement of facilities.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its subsidiaries is a party to, nor is any
of their property the subject of, any material pending legal proceedings, other
than ordinary routine proceedings incidental to its business.
6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders in the fourth quarter
of 2002.
EXECUTIVE OFFICERS
C. John Hipp, III (Age 51). Mr. Hipp has served as President and Chief
Executive Officer of the Company and Chief Executive Officer of South Carolina
Bank and Trust, N.A. (formerly known as First National Bank) since April 1994.
He also served as President of South Carolina Bank and Trust, N.A. from April
1994 to May 2000. From 1990 to 1994, Mr. Hipp served as President of Rock Hill
National Bank and Rock Hill National Corporation.
Robert R. Horger (Age 52). Mr. Horger was named Chairman of the Company and
South Carolina Bank and Trust, N.A. in January 1998 and served as Vice Chairman
of the Company and South Carolina Bank and Trust, N.A. from April 1994 to
January 1998. Mr. Horger became a director of the Company in April 1991. Mr.
Horger is an attorney with Horger, Barnwell and Reid in Orangeburg, South
Carolina.
Dwight W. Frierson (Age 46). Mr. Frierson has served as Vice Chairman of
First National Corporation and South Carolina Bank and Trust, N.A. since January
2000 and has been a director of the Company since April 1996. Mr. Frierson is
Vice President and General Manager of Coca-Cola Bottling Company of Orangeburg.
Robert R. Hill, Jr. (Age 36). Mr. Hill has served as President and Chief
Operating Officer of South Carolina Bank and Trust, N.A. since May 2000. He
served as Senior Executive Vice President and Chief Operating Officer of South
Carolina Bank and Trust, N.A. from November 1998 to May 2000. He served as
President and Chief Executive Officer of South Carolina Bank and Trust of the
Piedmont, N.A. (formerly known as National Bank of York County) from July 1996
to November 1998. Mr. Hill was an organizer of the South Carolina Bank and Trust
of the Piedmont, N.A. from October 1995 to July 1996 and team leader for
NationsBank northern region of South Carolina from March 1995 to October 1995.
Richard C. Mathis (Age 52). Mr. Mathis has served as Executive Vice
President and Chief Financial Officer of the Company since May 2000. He was
owner of Carolina MasterCom LLC, an automotive services company, from January
1999 to May 2000. Mr. Mathis served as Executive Vice President and Chief
Financial Officer of M&M Financial Corporation/First National South from January
1998 to January 1999, through that bank's acquisition. Mr. Mathis was Senior
Vice President in the Fixed Income Division of Sterne, Agee & Leach, Inc. in
Atlanta, Georgia, from 1996 through 1997.
John C. Pollok (Age 37). Mr. Pollok was named Senior Executive Vice
President of the Company in February 2003. He has served as Executive Vice
President and Chief Administrative Officer of South Carolina Bank and Trust,
N.A. since May 2000. He served as Executive Vice President of South Carolina
Bank and Trust, N.A. mortgage division from July 1998 until May 2000. Mr. Pollok
served as Senior Vice President of South Carolina Bank and Trust of the
Piedmont, N.A. from January 1996 to July 1998.
Joe E. Burns (Age 48). Mr. Burns has served as Executive Vice President and
Chief Credit Officer of the Company since November 2000. He served as Senior
Vice President and Private Lending Manager for Bank of America from July 1995 to
November 2000.
William D. Kerr (Age 54). Mr. Kerr has served as Executive Vice President
and Chief Technology Officer of the Company and South Carolina Bank and Trust,
N.A., since January 2002. He served as Senior Vice President and Chief
Technology Officer for the Company from April 1999 to January 2002. Mr. Kerr was
a member of the Financial Institutions Services Team at Dixon Odom PLLC in
Sanford, North Carolina from January 1999 to April 1999. He served in various
positions, including Senior Vice President and Chief Information Officer, Chief
Administrative Officer and Chief Auditor, with MainStreet BankGroup, Inc. in
Martinsville, Virginia from 1977 to 1998.
James A. Shuford, III (51). Mr. Shuford has served as Executive Vice
President of South Carolina Bank and Trust, N.A. since August 1999. He served as
President and Chief Executive Officer of FirstBancorporation, Inc. and
FirstBank, N. A. in Beaufort, South Carolina from October 1993 to August 1999,
when they were acquired by the Company.
Thomas S. Camp (Age 51). Mr. Camp has served as President and Chief
Executive Officer of South Carolina Bank and Trust of the Piedmont, N.A. since
November 1998. He served as Principal and Manager of First Union National Bank
of South Carolina for the Private Client Group from August 1997 to November
1998. Mr. Camp was Vice President of Sales and Marketing at Seibels Bruce
Insurance Co. in Columbia from November 1996 to August 1997. He served as Senior
Vice President of First Union National Bank in South Carolina from February 1989
until November 1996.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
Certain information required by this item is incorporated herein by
reference to the information under the caption "Stock Performance and
Statistics" on page 16 of the 2002 Annual Report to Shareholders. As of March
11, 2003, the Company had issued and outstanding 7,673,339 shares of Common
Stock which were held of record by approximately 4,600 persons. The Company's
Common Stock is traded on the American Stock Exchange under the symbol "FNC".
Dividends are paid by the Company from its assets which are provided by
dividends paid to the Company by its subsidiaries. Certain restrictions exist
regarding the ability of the Company's subsidiaries to transfer funds to the
Company in the form of cash dividends, loans or advances. The approval of the
OCC is required to pay dividends in excess of the Banks' respective net profits
for the current year plus retained net profits (net profits less dividends paid)
for the preceding two years, less any required transfers to surplus. As of
December 31, 2002, $20,136,000 of the Banks' retained earnings were available
for distribution to the Company as dividends without prior regulatory approval.
For the year ended December 31, 2002, the Banks paid dividends of approximately
$6,891,000 to the Company. The Company anticipates that it will continue to pay
comparable cash dividends in the future.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated herein by reference
to the information set forth under the captions "Financial Highlights" and
"Selected Consolidated Financial Data" on pages 1 and 17, respectively, of the
Company's 2002 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
This discussion and analysis is intended to assist the reader in
understanding the financial condition and results of operations of First
National Corporation and its subsidiaries, South Carolina Bank and Trust, N.A.,
South Carolina Bank and Trust of the Piedmont, N.A., South Carolina Bank and
Trust of the Pee Dee, N.A., and CreditSouth Financial Services Corporation. The
five year period 1998 through 2002 is discussed with particular emphasis on the
years 2000 through 2002. This commentary should be reviewed in conjunction with
the financial statements and related footnotes and the other statistical
information related to First National Corporation contained elsewhere herein
(see "Consolidated Financial Statements of First National Corporation").
In 1996, the Company sponsored the organization of South Carolina Bank and
Trust of the Piedmont, N.A. (formerly National Bank of York County) in Rock
Hill, South Carolina, and sold shares of the Company's common stock to
capitalize the new bank and pay organizational and pre-opening expenses. South
Carolina Bank and Trust of the Piedmont, N.A. began operations on July 11, 1996,
as a wholly-owned subsidiary of the Company.
In 1998, the Company sponsored the organization of South Carolina Bank and
Trust of the Pee Dee, N.A. (formerly Florence County National Bank) in Florence,
South Carolina, and sold shares of the Company's common stock to capitalize the
new bank and pay organizational and pre-opening expenses. South Carolina Bank
and Trust of the Pee Dee, N.A. began operations on April 1, 1998, as a
wholly-owned subsidiary of the Company.
Also in 1998, the Company sponsored the organization of CreditSouth
Financial Services Corporation, a consumer finance company which began
operations in Orangeburg, South Carolina, on November 1, 1998. Upon
organization, the Company acquired 80 percent of CreditSouth's common stock. The
remaining 20 percent of CreditSouth common stock was issued to minority employee
shareholders pursuant to their employment agreements. All minority shares were
subsequently acquired by the Company. As noted in Part 1, Item 1, on December 1,
2002, South Carolina Bank and Trust, N.A. acquired the majority of CreditSouth's
consumer loan portfolio and related assets.
RECENT ACCOUNTING PRONOUNCEMENTS
See Notes to Consolidated Financial Statements for information relating to
recent accounting pronouncements.
8
SUMMARY OF OPERATIONS
Earnings of First National Corporation were $13,834,000, $12,257,000, and
$10,533,000 in 2002, 2001 and 2000, respectively. Net income increased 12.9
percent in 2002 when compared to 2001 and increased 16.4 percent in 2001
compared with 2000. Basic earnings per share increased to $1.80 in 2002 compared
to $1.59 in 2001 and $1.36 in 2000. Diluted earnings per share increased to
$1.79 in 2002 from $1.59 in 2001 and $1.36 in 2000. All per share data has been
adjusted to give effect to a ten percent stock dividend paid to shareholders on
December 5, 2002.
The book value per share of First National Corporation increased to $13.49
in 2002 compared with $12.15 in 2001, and $10.97 in 2000. The return on average
assets was 1.28 percent in 2002, compared with 1.21 percent in 2001 and 1.11
percent in 2000. The return on average shareholders' equity was 14.09 percent in
2002, 13.64 percent in 2001, and 13.14 percent in 2000. Per share dividends
declared in 2002 were $0.59, compared with $0.57 in 2001 and $0.54 in 2000.
Total earning assets and total deposits increased in 2002 compared to 2001.
At December 31, 2002, total earning assets were $1,067,549,000, an increase of
11.2 percent over $959,846,000 at year-end 2001, which was 5.2 percent greater
than the 2000 balance of $912,415,000. In 2002, average earning assets were
$1,022,339,000, an increase of 8.8 percent over $939,626,000, which was 3.9
percent greater than the 2000 average of $904,403,000. The increases in average
earning assets in 2002 and 2001 were mainly the result of loan growth.
At December 31, 2002, total deposits were $898,163,000, an increase of 10.7
percent from $811,523,000 at the end of 2001. The 2001 balance was 7.1 greater
than $757,576,000 at year-end 2000. Deposits averaged $855,222,000 during 2002,
an increase of 6.3 percent over $804,281,000 in 2001. The 2001 deposits average
was a 9.3 percent increase over $736,093,000 in 2000.
For the year ended December 31, 2002, total interest income was
$67,487,000, a decrease of $6,985,000, or 9.4 percent, from $74,472,000 in 2001.
The decrease was driven mainly by interest rates, as the rate earned on average
earning assets declined 120 basis points from 7.80 percent in 2001 to 6.60
percent in 2002. In 2001, total interest income increased $626,000, or 0.8
percent, compared with $73,846,000 in 2000. This increase was mainly the result
of earning asset growth of $35,223,000, or 3.9 percent, largely offset by a 24
basis point decline in the average yield.
Total interest expense was $18,748,000 for the year 2002, an $11,224,000,
or 37.5 percent, decrease from $29,972,000 in 2001. Also reflecting the lower
rate environment in 2002, the average rate paid on interest-bearing liabilities
decreased by 153 basis points compared with 2001. Total interest expense in 2001
decreased $3,260,000, or 9.8 percent, from $33,232,000 in 2000. This resulted
from a 74 basis point decline in the average rate paid on interestbearing
liabilities, offset in part by an increase in average interest-bearing
liabilities of $60,487,000, or 8.2 percent.
In 2000, the Company's Board of Directors authorized a repurchase program
to acquire up to 160,000 shares of its outstanding common stock. In January
2002, the Board authorized repurchase of up to 200,000 shares. In March 2003,
the repurchase authorization was increased to 250,000 shares. During the years
ended December 31, 2002, 2001 and 2000, the Company repurchased 12,402, 138,253
and 14,200 shares at a cost of $265,000, $2,518,000 and $214,000, respectively.
COMPETITION
First National Corporation competes with a number of financial institutions
and other firms that engage in activities similar to banking. For example, the
Company competes for deposits with savings and loan associations, credit unions,
brokerage firms and other commercial banks. In its lending activities, the
Company competes with the industries mentioned above as well as consumer finance
companies, leasing companies and other lenders. In today's uncertain financial
climate, all lenders are searching for quality borrowers. Acquisition of
acceptable grade loans becomes increasingly challenging.
A number of financial institution mergers were completed in recent years,
continuing the trend toward consolidation. Although these mergers reduced the
number of banks and branches, they intensified competition for quality funds and
loans.
NET INTEREST INCOME
Net interest income is the difference between interest income and interest
expense. In the analysis of net interest income, two significant factors are net
interest spread and net interest margin. Net interest spread is the difference
9
between the yield on average earning assets and the rate on average
interest-bearing liabilities. Net interest margin is the difference between the
yield on average earning assets and the rate on all average liabilities,
interest and noninterest-bearing, utilized to support earning assets. Net
interest margin is distinguished by the inclusion of the impact of interest free
funds.
Net interest income was $48,739,000 in 2002, an increase of $4,239,000, or
9.5 percent over 2001. The increase from 2001 to 2002 reflected a 33 point
decrease in the net interest spread, due to a decrease of 153 basis points in
the average rate paid on total interest-bearing liabilities that was offset in
part by a 120 basis point decrease in the average yield on total earning assets.
In 2001, net interest income was $44,500,000, a $3,886,000, or 9.6 percent
increase over 2000. This was the result of a 36 basis point increase in the net
interest spread, as rates on total interest-bearing liabilities decreased 73
basis points, outpacing the 37 basis point decline in yield on total earning
assets.
The net interest margin increased ten basis points to 4.76 percent in 2002,
compared with 2001. This also reflected the greater decrease in rates paid on
total interest-bearing liabilities compared with the decrease in yields on total
earning assets. Similarly, a declining rate environment in 2001 contributed to a
net interest margin increase of 16 basis points compared with 2000.
Total average earning assets were $1,022,339,000 in 2002, an increase of
$67,184,000, or 7.1 percent, from 2001. This followed an increase of
$50,752,000, or 5.6 percent, to $955,155,000 in 2001, compared to 2000. In 2002,
total interest-bearing liabilities rose $45,187,000, or 5.7 percent, to
$842,219,000, compared with 2001. These liabilities averaged $797,032,000 in
2001, an increase of $57,501,000, or 7.8 percent, over the previous year.
Earning asset increases in 2002 and 2001 were mainly the result of higher levels
of interest-bearing liabilities, with demand deposit growth also a significant
source of funds in 2002.
TABLE 1
VOLUME AND RATE
VARIANCE ANALYSIS
2002 COMPARED TO 2001 2001 COMPARED TO 2000
CHANGES DUE TO CHANGES DUE TO
INCREASE (DECREASE) IN INCREASE (DECREASE) IN
(Dollars in thousands) VOLUME (L) RATE (L) TOTAL VOLUME (L) RATE (L) TOTAL
Interest income on:
Loans (2) $ 5,371 $(10,448) $ (5,077) $ 5,711 $ (3,799) $ 1,912
Investments:
Taxable 709 (2,087) (1,378) 85 (249) (164)
Tax exempt (3) (91) (14) (105) (161) (8) (169)
Funds sold (326) (145) (471) (578) (345) (923)
Interest -bearing deposits with banks 106 (61) 45 (24) (6) (30)
- ------------------------------------------------------------------------------------------------------------------------------
Total interest income 5,769 (12,755) (6,986) 5,033 (4,407) 626
- ------------------------------------------------------------------------------------------------------------------------------
Interest expense on:
Deposits:
Interest-bearing transaction accounts 257 228 485 210 (5) 205
Savings accounts 152 (2,006) (1,854) 347 (1,571) (1,223)
Certificates of deposit (40) (8,633) (8,673) 1,770 (787) 983
Funds purchased 176 (1,740) (1,564) (1,010) (2,475) (3,485)
Notes payable 429 (48) 381 473 (213) 260
- ------------------------------------------------------------------------------------------------------------------------------
Total interest expense 974 (12,199) (11,225) 1,791 (5,051) (3,260)
- ------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 4,795 $ (556) $ 4,239 $ 3,242 $ 644 $ 3,886
==============================================================================================================================
(1) The rate/volume variance for each category has been allocated on an equal
basis between rate and volumes.
(2) Nonaccrual loans are included in the above analysis.
(3) Tax exempt income is not presented on a taxable-equivalent basis in the
above analysis.
10
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES
2002
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Assets
Interest earning assets:
Loans, net of unearned income $ 806,801 $ 58,119 7.20%
Investment securities:
Taxable 171,926 7,711 4.48
Tax exempt 33,504 1,501 4.48
Funds sold 7,162 107 1.49
Interest-earning deposits with banks 2,946 49 1.66
------------ ------------
Total earning assets 1,022,339 67,487 6.60
------------ ------------
Cash and other assets 73,018
Less allowance for loan losses (10,171)
------------
Total assets $ 1,085,186
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 171,052 $ 1,912 1.12%
Savings 167,268 1,979 1.18
Certificates of deposit 378,443 11,491 3.04
Funds purchased 75,956 874 1.15
Notes payable 49,500 2,492 5.03
------------ ------------
Total interest-bearing liabilities 842,219 18,748 2.23
------------ ------------
Demand deposits 138,460
Other liabilities 6,336
Shareholders' equity 98,171
------------
Total liabilities and shareholders' equity $ 1,085,186
============
Net interest spread 4.37
Impact of interest free funds 0.40
------------
Net interest margin 4.77%
============
Net interest income $ 48,739
============
11
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 2001
2001
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Interest earning assets:
Loans, net of unearned income $ 743,602 $ 63,196 8.50%
Investment securities:
Taxable 159,482 9,088 5.70
Tax exempt 35,522 1,606 4.52
Funds sold 16,442 578 3.52
Interest-earning deposits with banks 107 4 3.74
------------ ------------
Total earning assets 955,155 74,472 7.80
------------ ------------
Cash and other assets 65,827
Less allowance for loan losses (9,265)
------------
Total assets $ 1,011,717
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 144,963 $ 1,427 0.98%
Savings 160,890 3,833 2.38
Certificates of deposit 379,193 20,163 5.32
Funds purchased 70,852 2,438 3.44
Notes payable 41,134 2,111 5.13
------------ ------------
Total interest-bearing liabilities 797,032 29,972 3.76
------------ ------------
Demand deposits 118,084
Other liabilities 6,550
Shareholders' equity 90,051
------------
Total liabilities and shareholders' equity $ 1,011,717
============
Net interest spread 4.04
Impact of interest free funds 0.62
------------
Net interest margin 4.66%
============
Net interest income $ 44,500
============
12
TABLE 2
YIELDS ON AVERAGE EARNING ASSETS AND
RATES ON AVERAGE INTEREST-BEARING LIABILITIES 2000
2000
AVERAGE INTEREST AVERAGE
(DOLLARS IN THOUSANDS) BALANCE EARNED/PAID YIELD/RATE
------------ ------------ ------------
Assets
Interest earning assets:
Loans, net of unearned income $ 680,217 $ 61,284 9.01%
Investment securities:
Taxable 158,029 9,252 5.85
Tax exempt 39,072 1,775 4.54
Funds sold 26,734 1,501 6.51
Interest-bearing deposits with banks 351 34 9.69
------------ ------------
Total earning assets 904,403 73,846 8.17
------------ ------------
Cash and other assets 59,309
Less allowance for loan losses (8,324)
------------
Total assets $ 955,388
============
Liabilities
Interest-bearing liabilities:
Deposits:
Interest-bearing transaction accounts $ 123,695 $ 1,222 0.99%
Savings 150,534 5,056 3.36
Certificates of deposit 347,121 19,180 5.53
Funds purchased 85,422 5,923 6.93
Notes payable 32,759 1,851 5.65
------------ ------------
Total interest-bearing liabilities 739,531 33,232 4.49
------------ ------------
Demand deposits 114,743
Other liabilities 20,939
Shareholders' equity 80,175
------------
Total liabilities and shareholders' equity $ 955,388
============
Net interest spread 3.68
Impact of interest free funds 0.81
------------
Net interest margin 4.49%
============
Net interest income $ 40,614
============
13
INVESTMENT SECURITIES
The second largest category of earning assets is investment securities,
which are used to fund loan growth and deposit liquidations, provide liquidity,
employ excess funds, and pledge as collateral for certain public funds deposits
and purchased funds. At December 31, 2002, investment securities were
$164,951,000, or 15.5 percent of earning assets, as compared with $189,933,000,
or 20.3 percent of earning assets at year-end 2001. As securities are purchased,
they are designated as held-to-maturity or available-for-sale based upon
management's intent, which incorporates liquidity needs, interest rate
expectations, asset/liability management strategies, and capital requirements.
Interest earned on the held-to-maturity portfolio, consisting mainly of tax
exempt state and municipal securities, was $1,501,000 in 2002, a decrease of
$105,000, or 6.5 percent from the $1,606,000 earned in 2001. This decrease was
due mainly to an average portfolio balance that was $2,018,000, or 5.7 percent,
less than the balance in 2001. Contributing to a lesser extent was the four
basis point decline in the average yield from 2001 to 2002. In 2001, this
portfolio segment earned $169,000, or 9.5 percent, less than 2000 interest of
$1,775,000. The decrease was primarily the result of an average taxable
securities portfolio that was $3,550,000, or 9.1 percent, less than the balance
in 2000, aided slightly by a 2 basis point decline in the average yield. The
average maturity of the held-to-maturity portfolio was 3.2 years at December 31,
2002, 3.9 years at December 31, 2001 and 4.6 years at the end of 2000.
Securities available-for-sale consist mainly of U.S. Government agency and
mortgage-backed securities. In 2002, interest earned on this portfolio segment
was $7,711,000, including $404,000 attributable to short-term money market
funds, compared with $9,088,000, including $108,000 earned on money market
investments, in 2001. The overall decrease of $1,377,000, or 15.2 percent, was
the result of the low rate environment throughout 2002, which was reflected in
an average earnings rate that was 131 basis points less than in 2001. This
decrease was partially offset by an available-for-sale portfolio that averaged
$12,444,000, or 7.8 percent, more in 2002 than 2001. In 2001, earnings from this
segment of the investment securities portfolio were $164,000, or 1.8 percent,
less than the $9,252,000 earned in 2000. This decrease was the result of an
average portfolio yield in 2001 that was 15 basis points less than the previous
year, partially offset by a $1,453,000 increase in the average outstanding
available-for-sale balance.
At December 31, 2002, the fair value of the investment securities portfolio
was $166,784,000, or 1.1 percent higher than the carrying value, including the
effect of a $1,833,000 higher market value of held-to-maturity securities,
compared to their amortized cost. The difference between the fair and carrying
values at the December 31, 2001 was a favorable $648,000, or 0.3 percent,
following a negligible difference at the end of 2000. At December 31, 2002,
investment securities with an amortized cost of $128,752,000 and fair value of
$131,740,000 were classified as available-for-sale. The positive adjustment of
$2,988,000 to the carrying value of these securities has been reflected, net of
tax, in the statement of changes in shareholders' equity as a component of other
comprehensive income.
The Company realized no gains or losses on the disposition of investment
securities in 2002, a gain of $570,000 on the disposition of equity securities
in 2001, and no gains or losses in 2000.
TABLE 3
BOOK VALUE OF INVESTMENT SECURITIES
DECEMBER 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY
U. S. Treasury and other Government agencies -- -- -- $ 3,031 $ 6,299
Mortgage-backed $ 51 $ 247 -- 1,304 2,144
State and municipal 33,160 34,767 $ 38,550 42,933 38,138
- -------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity 33,211 35,014 38,550 47,268 46,581
- -------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U. S. Treasury and other Government agencies 45,859 44,265 93,479 93,033 131,465
Mortgage-backed 74,694 101,728 46,726 51,502 24,642
Other investments 11,187 8,926 4,443 3,769 3,449
- -------------------------------------------------------------------------------------------------------------
Total Available-for-Sale 131,740 154,919 144,648 148,304 159,556
- -------------------------------------------------------------------------------------------------------------
Total $164,951 $189,933 $183,198 $195,572 $206,137
=============================================================================================================
14
TABLE 4
MATURITY DISTRIBUTION AND YIELDS OF INVESTMENT SECURITIES
DUE IN DUE AFTER DUE AFTER DUE AFTER
DECEMBER 31, 2002 1 YR. OR LESS 1 THRU 5 YRS. 5 THRU 10 YRS. 10 YRS. TOTAL PAR FAIR
(DOLLARS IN THOUSANDS) AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
HELD-TO-MATURITY
Mortgage-backed $ 51 5.36% -- -- -- -- -- -- $ 51 5.36% $ 51 $ 51
State and municipal 3,226 6.80% $22,172 6.58% $ 7,762 6.65% -- -- 33,160 6.62% 32,960 34,993
- ------------------------------------------------------------------------------------------------------------------------------------
Total Held-to-Maturity 3,277 6.78% 22,172 6.58% 7,762 6.65% -- -- 33,211 6.61% 33,011 35,044
- ------------------------------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE
U.S. Treasury and
Government agencies 39,376 3.14% 6,483 6.25% -- -- -- -- 45,859 3.58% 45,165 45,859
Mortgage-backed 16,899 4.77% 53,888 5.32% 3,905 6.06% -- -- 74,694 5.23% 71,891 74,692
Other investments (1) -- -- -- -- -- -- 11,189 5.30% 11,187 5.30% 11,189 11,189
- ------------------------------------------------------------------------------------------------------------------------------------
Total Available-for-Sale 56,275 3.63% 60,371 5.42% 3,905 6.06% 11,189 5.30% 131,740 4.66% 128,245 131,740
- ------------------------------------------------------------------------------------------------------------------------------------
Total $59,552 3.80% $82,543 5.73% $11,667 6.45% $11,189 5.30% $164,951 5.06% $161,256 $166,784
====================================================================================================================================
Percent of Total 36% 50% 7% 7%
Cumulative % of Total 36% 86% 93% 100%
(1) Federal Reserve Bank and other corporate stocks have no set maturity and
are classified in "Due after 10 years."
LOAN PORTFOLIO
At December 31, 2002, loans, net of unearned discount, the largest category
of earning assets, were $902,563,000, an increase of $133,699,000, or 17.4
percent, compared to $768,864,000 at the end of 2001. Average loans during 2002
were $806,801,000, an increase of $63,199,000, or 8.5 percent, over the 2001
average.
Real estate mortgage loans continue to comprise the largest segment of the
loan portfolio. All loans secured by real estate, except real estate
construction loans, are included in this category. At the end of 2002, real
estate mortgage loans were $601,320,000, including $39,141,000 of residential
mortgage loans held for sale, and comprised 66.6 percent of the total portfolio.
This was an increase of $105,426,000, or 21.3 percent, over year-end 2001.
Commercial, financial, agricultural and other loans were $149,385,000,
representing 16.5 percent of the loan portfolio at December 31, 2002. This loan
category increased $30,566,000, or 25.7 percent, compared to the balance at the
end of 2001. Consumer loans, comprising 12.4 percent of the portfolio at the end
of 2002, were $111,520,000, a decrease of $4,922,000, or 4.2 percent, from the
previous year.
Loan interest and fee income was $58,119,000 in 2002, an decrease of
$5,077,000, or 8.0 percent, from 2001. While year-end and average outstanding
loan balances increased substantially year-to-year, the loan income decrease was
the result of a 130 basis point drop in the average yield earned on these
assets. This reflected the low interest rate environment throughout 2002, set up
by the unprecedented 11 discount rate reductions initiated in the previous year.
In 2001, interest and fee income was $63,196,000, an increase of $1,912,000, or
3.0 percent from 2000. This increase was the result of an increase in average
outstanding loan balances of $63,385,000, or 9.3 percent, offset in part by a 51
basis point decrease in the average yield. Table 6 shows the maturity and
interest rate sensitivity of the loan portfolio at December 31, 2002. Loans that
mature in one year or less were $385,840,000, comprising 42.8 percent of the
total. Of the loans due after one year, $499,633,000, or 96.7 percent, had fixed
interest rates and $17,090,000, or 3.3 percent, were variable rate loans.
The placement of loans on a nonaccrual status is dependent upon the type of
loan, the past due status and the collection activities in progress. Loans which
are well secured and in the process of collection are allowed to remain on an
accrual basis until they become 120 days past due. Unsecured commercial loans
are charged off on or before the date they become 90 days past due and,
therefore, do not reach nonaccrual status. Commercial and real estate loans
which are partially secured are written down to the collateral value and placed
on nonaccrual status on or before becoming 90 days past due. Closed end consumer
loans are charged off on or before becoming 120 days past due and open end
consumer loans are charged off on or before becoming 180 days past due. All
interest accrued in the current year but unpaid at the date a loan is placed on
nonaccrual status is deducted from interest income, while interest accrued from
previous years is charged against the reserve for loan losses. At December 31,
2002, nonaccrual
15
loans were $2,776,000, compared with $3,317,000 at year-end 2001. At December
31, 2002, loans that were 90 days or more past due were $1,729,000 compared to
$1,561,000 at the end of 2001.
Interest income that was foregone was an immaterial amount for each of the
three years ended December 31, 2002. First National Corporation does not have
any loans that have been restructured or any foreign loans.
Concentrations of credit are considered to exist when the amounts loaned to
a multiple number of borrowers engaged in similar business activities which
would cause them to be similarly impacted by economic or other conditions exceed
10 percent of total loans. As of December 31, 2002, no credit concentrations
existed.
The level of risk elements in the loan portfolio for the past five years is
shown in Table 7.
TABLE 5
DISTRIBUTION OF NET LOANS
BY TYPE
DECEMBER 31,
(Dollars in thousands) 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------
Commercial, financial,
agricultural and other $ 149,385 $ 118,819 $ 103,468 $ 87,098 $ 87,610
Real estate - construction 40,338 37,709 32,256 27,555 19,113
Real estate - mortgage 601,320 495,894 473,131 396,158 303,300
Consumer 111,520 116,442 120,194 99,730 83,121
- ---------------------------------------------------------------------------------------------------------
Total $ 902,563 $ 768,864 $ 729,049 $ 610,541 $ 493,144
=========================================================================================================
Percent of Total
Commercial, financial,
agricultural and other 16.5% 15.5% 14.1% 14.2% 17.7%
Real estate - construction 4.5 4.9 4.4 4.5 3.9
Real estate - mortgage 66.6 64.5 64.6 64.5 61.1
Consumer 12.4 15.1 16.9 16.8 17.3
- ---------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
=========================================================================================================
TABLE 6
MATURITY DISTRIBUTION OF LOANS
MATURITY
DECEMBER 31, 2002 1 YEAR 1 - 5 OVER 5
(DOLLARS IN THOUSANDS) TOTAL OR LESS YEARS YEARS
- ---------------------------------------------------------------------------------------------------------
Commercial, financial
agricultural and other $ 149,385 $ 84,871 $ 62,609 $ 1,905
Real estate - construction 40,338 27,182 11,737 1,419
Real estate - mortgage 601,320 258,953 294,856 47,511
Consumer 111,520 14,834 90,523 6,163
- ---------------------------------------------------------------------------------------------------------
Total $ 902,563 $ 385,840 $ 459,725 $ 56,998
=========================================================================================================
Loans due after one year with:
Predetermined interest rates $ 499,633
Floating or adjustable interest rates $ 17,090
16
ASSET QUALITY
Asset quality is maintained through the management of credit risk. Each
individual earning asset, whether in the investment, loan, or short-term
investment portfolio, is reviewed by management for credit risk. To facilitate
this review, First National Corporation has established credit and investment
policies which include credit limits, documentation, periodic examination and
follow-up. In addition, these portfolios are examined for exposure to
concentration in any one industry, government agency, or geographic location. At
December 31, 2002 and 2001, the Company did not have more than ten percent of
the loan portfolio in any one industry and had no foreign loans.
Each category of earning assets has a degree of credit risk. To measure
credit risk, various techniques are utilized. Credit risk in the investment
portfolio can be measured through bond ratings published by independent
agencies. In the investment portfolio, 99.5 percent of the investments consist
of U.S. Treasury securities, U.S. Agency securities and taxfree securities
having a rating of "A" or better by at least one of the major bond rating
agencies. The credit risk of the loan portfolio can be measured by historical
experience. The Company maintains its loan portfolio in accordance with its
established credit policies. Reflecting a more difficult economic climate, net
loan charge-offs as a percentage of net average loans were .25 percent in 2002,
compared to .19 percent in 2001 and .12 percent in 2000. See "Loans" for a
discussion of the Company's charge-off and nonaccrual policies.
TABLE 7
NONACCRUAL AND PAST DUE LOANS
DECEMBER 31
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Loans past due 90 days or more $ 1,729 $ 1,561 $ 1,838 $ 729 $ 1,426
Loans on a nonaccruing basis 3,010 3,317 1,481 1,537 1,547
- --------------------------------------------------------------------------------------------------------------
Total $ 4,739 $ 4,878 $ 3,319 $ 2,266 $ 2,973
==============================================================================================================
TABLE 8
SUMMARY OF LOAN
LOSS EXPERIENCE
DECEMBER 31
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses - January 1 $ 9,818 $ 8,922 $ 7,886 $ 6,934 $ 6,246
- --------------------------------------------------------------------------------------------------------------
Total charge-offs (2,236) (1,808) (1,004) (826) (785)
Total recoveries 256 400 202 165 260
- --------------------------------------------------------------------------------------------------------------
Net charge-offs (1,980) (1,408) (802) (661) (525)
Provision for loan losses 3,227 2,304 1,838 1,613 1,213
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses - December 31 $ 11,065 $ 9,818 $ 8,922 $ 7,886 $ 6,934
==============================================================================================================
Average loans - net of unearned income $806,801 $743,602 $680,217 $541,434 $452,600
Ratio of net charge-offs to average
loans - net of unearned income .25% .19% .12% .12% .12%
17
LOAN LOSS PROVISION
The Company maintains an allowance for loan losses at a level which
management believes is sufficient to provide for potential losses in the loan
portfolio. Management periodically evaluates the adequacy of the allowance
utilizing its internal risk rating system, credit review and regulatory agency
examinations to assess the quality of the loan portfolio and identify problem
loans. The evaluation process also includes management's analysis of current and
future economic conditions, composition of the loan portfolio, past due and
nonaccrual loans, concentrations of credit, lending policies and procedures and
historical loan loss experience. The provision for loan losses is charged to
expense in an amount necessary to maintain the allowance at the appropriate
level.
The provision for loan losses for the year ended December 31, 2002 was
$3,227,000, compared to $2,304,000 in 2001. The 40.1 percent increase in the
provision was the result of an increase in net charge offs from $1,408,000 in
2001 to $1,980,000 in 2002, as well as strong loan growth year-to-year.
The allowance for loan losses was $11,065,000 at December 31, 2002, or 1.23
percent of outstanding loans. At the end of 2001, the allowance was $9,818,000,
or 1.28 percent of outstanding loans. Total charge offs were $2,236,000 in 2002,
up from $1,808,000 in 2001. Recoveries were $256,000 in 2002, compared with
$400,000 in the previous year. A summary of loan loss experience for the five
years ending December 31, 2002 is provided in Table 8.
Other real estate owned includes certain real estate acquired as a result
of foreclosure and deeds in lieu of foreclosure, as well as amounts reclassified
as in-substance foreclosures. At December 31, 2002 and December 31, 2001, other
real estate owned was $1,051,000 and $798,000, respectively.
The U.S. and South Carolina economies continue to show mixed signs of
strength and weakness. In this continuing period of uncertainty, management
anticipates that the Company will experience loan charge offs in the coming year
at similar levels to those experienced in 2002. The Office of the Comptroller
recommends that banks take a broad view of certain factors in evaluating their
allowance for loan losses. These factors include loan loss experience, specific
allocations and other subjective factors. In its ongoing consideration of such
factors, management considers the allowance for loan losses to be adequate.
LIQUIDITY
Liquidity may be defined as the ability of an entity to generate cash to
meet its financial obligations. For a bank, liquidity primarily means the
consistent ability to meet loan and investments demands and deposit withdrawals.
The Company has employed its funds in a manner to provide liquidity in both
assets and liabilities sufficient to meet its cash needs.
Asset liquidity is maintained by the maturity structure of loans,
investment securities and other short-term investments. Management has policies
and procedures governing the length of time to maturity on loans and
investments. As noted in Table 4, 36 percent of the investment portfolio matures
in one year or less. This segment of the investment portfolio consists of U.S.
Treasury securities, U.S. Agency securities and bank qualified municipal
obligations. Loans and other investments are generally held for longer terms and
not utilized for day-to-day operating needs.
Increases in the Company's liabilities provide liquidity on a day-to-day
basis. Daily liquidity needs may be met from deposit growth or from the use of
federal funds purchased, securities sold under agreements to repurchase and
other short-term borrowings.
The Company regularly obtains borrowed funds in the form of cash management
or "sweep" accounts that are accommodations to corporate and governmental
customers pursuant to sale of securities sold under agreement to repurchase
arrangements. During 2002, the Company maintained a satisfactory level of
liquidity through growth in interest-bearing and non-interest-bearing deposits,
cash management accounts, federal funds purchased, and advances from the Federal
Home Loan Bank of Atlanta.
DERIVATIVES AND SECURITIES HELD FOR TRADING
In January 1998, the Securities and Exchange Commission adopted rules that
require more comprehensive disclosure of accounting policies for derivatives as
well as enhanced quantitative and qualitative disclosures of market risk for
derivatives and other financial instruments. The market risk disclosures are
classified into two categories: financial instruments entered into for trading
purposes and all other instruments (non-trading purposes). The Company does not
have financial derivatives, nor does it maintain a trading portfolio.
18
ASSET-LIABILITY MANAGEMENT AND MARKET RISK SENSITIVITY
The Company's earnings or the value of its shareholders' equity may vary in
relation to changes in interest rates and in relation to the accompanying
fluctuations in market prices of certain of its financial instruments. The
Company uses a number of methods to measure interest rate risk, including
simulating the effect on earnings of fluctuations in interest rates, monitoring
the present value of asset and liability portfolios under various interest rate
scenarios, and monitoring the difference, or gap, between rate sensitive assets
and liabilities, as discussed below. The earnings simulation model and gap
analysis take into account the Company's contractual agreements with regard to
investments, loans and deposits. Although the Company's simulation model is
subject to the accuracy of the assumptions that underlie the process, the
Company believes that such modeling provides a better illustration of the
interest sensitivity of earnings than does static interest rate sensitivity gap
analysis. The simulation model assists in measuring and achieving growth in net
interest income while managing interest rate risk. The simulations incorporate
interest rate changes as well as projected changes in the mix and volume of
balance sheet assets and liabilities. Accordingly, the simulations are
considered to provide a good indicator of the degree of earnings risk the
Company has, or may incur in future periods, arising from interest rate changes
or other market risk factors.
The Company's policy is to monitor exposure to interest rate increases and
decreases of as much as 200 basis points ratably over a 12-month period. The
Company's policy limit for the maximum negative impact on net interest income
from a steady ("ramping") change in interest rates of 200 basis points over 12
months is 8 percent. The Company traditionally has maintained a risk position
well within the policy guideline level. As of December 31, 2002, the earnings
simulations indicated that the impact of a 200 basis point decrease in rates
over 12 months would result in an approximate 5.0 percent decrease in net
interest income while a 200 basis point increase in rates over the same period
would result in an approximate 0.4 percent decrease in interest income -- both
as compared with a base case unchanged interest rate environment. These results
indicate that the Company's rate sensitivity is essentially neutral to the
indicated change in interest rates over a one-year horizon. The decrease in net
interest income in the declining rate environment is attributable primarily to
the current (base) extremely low level of interest rates. Certain key interest
rates, such as the federal funds rate, would have to hypothetically move to zero
percent in order to drop 200 basis points from current levels. In such a
hypothetical case, the Company would not be able to lower certain deposit and
liability rates to the same extent. Also, the model assumes that the Company's
residential mortgage loans would quickly prepay in such an extreme rate
environment -- thereby lowering interest income. Actual results may differ from
simulated results due to the timing, magnitude and frequency of interest rate
changes and changes in market conditions or management strategies, among other
factors.
As mentioned above, another (though less useful) indicator of interest rate
risk exposure is the interest rate sensitivity gap and cumulative gap. Interest
rate sensitivity gap analysis is based on the concept of comparing financial
assets that reprice with financial liabilities that reprice within a stated time
period. The time period in which a financial instrument is considered to be rate
sensitive is determined by that instrument's first opportunity to reprice to a
different interest rate. For variable rate products the period in which
repricing occurs is contractually determined. For fixed rate products the
repricing opportunity is deemed to occur at the instrument's maturity or call
date, if applicable. For noninterest- bearing funding products, the "maturity"
is based solely on a scheduled decay, or runoff, rate. When more assets than
liabilities reprice within a given time period, a positive interest rate gap (or
"asset sensitive" position) exists. Asset sensitive institutions may benefit in
generally rising rate environments as assets reprice more quickly than
liabilities. Conversely, when more liabilities than assets reprice within a
given time period, a negative interest rate gap (or "liability sensitive"
position) exists. Liability sensitive institutions may benefit in generally
falling rate environments as funding sources reprice more quickly than earning
assets. However, another shortfall of static gap analysis based solely on the
timing of repricing opportunities is its lack of attention to the degree of
magnitude of rate repricings of the various financial instruments.
As shown in the gap analysis within Table 9 below, the Company has a
greater dollar value of financial liabilities that are subject to repricing
within a 12 month and 24 month time horizon than its financial assets subject to
repricing. Thereafter, within successive 12-month time horizons, there are more
financial assets than financial liabilities with repricing opportunities. The
degree of magnitude of rate repricings of the financial assets and liabilities
is, as mentioned above, not addressed by a static gap analysis as presented in
Table 9.
The Company does not currently use interest rate swaps or other derivatives
to modify the interest rate risk of its financial instruments.
The following table provides information as of December 31, 2002 about the
Company's financial instruments that are sensitive to changes in interest rates.
For fixed rate loans, securities, time deposits, federal funds and repurchase
agreements, and notes payable, the table presents principal cash flows and
related weighted-average interest rates by expected maturity dates, call dates,
or average-life terminal dates. Variable rate instruments are presented
according to their first repricing opportunities. Non-interest bearing deposits
and interest-bearing savings and checking deposits have no contractual maturity
dates. For purposes of Table 9, projected maturity dates for such deposits were
determined based on decay rate assumptions used internally by the Company to
evaluate such deposits. For further information on the fair value of financial
instruments, see Note 23 to the consolidated financial statements.
19
TABLE 9
FINANCIAL INSTRUMENTS THAT ARE SENSITIVE TO CHANGES IN INTEREST RATES
FAIR
THERE VALUE
(DOLLARS IN THOUSANDS) 2003 2004 2005 2006 2007 AFTER TOTAL 12-31-02
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Financial assets:
Loans, net of unearned income:
Fixed Rate:
Book Value $ 158,022 $ 86,534 $ 84,189 $ 76,121 $ 72,582 $ 147,210 $ 624,658 $ 650,519
Average interest rate 7.08% 7.79% 7.61% 7.37% 6.81% 6.40% 7.09%
Variable Rate:
Book Value $ 266,840 $ -- $ -- $ -- $ -- $ -- $ 266,840 $ 267,172
Average interest rate 4.93% 0.00% 0.00% 0.00% 0.00% 0.00% 4.93%
Securities held-to-maturity:
Fixed Rate:
Book Value $ 3,592 $ 4,732 $ 5,774 $ 6,558 $ 3,932 $ 8,623 $ 33,211 $ 35,044
Average interest rate 7.39% 6.84% 7.00% 6.76% 6.76% 7.00% 6.94%
Variable Rate:
Book Value -- -- -- -- -- -- -- --
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% --
Securities available-for-sale:
Fixed Rate:
Book Value $ 77,204 $ 17,811 $ 7,559 $ 5,674 $ 4,679 $ 18,813 $ 131,740 $ 131,740
Average interest rate 4.12% 4.60% 5.37% 5.63% 5.89% 5.67% 4.60%
Variable Rate:
Book Value $ 334 -- -- -- -- $ 334 $ 334
Average interest rate 4.88% 0.00% 0.00% -- -- 4.88%
Other $ 35 -- -- -- -- -- $ 35 $ 35
Average interest rate 1.50% 0.00% 0.00% -- -- -- 1.50%
- -----------------------------------------------------------------------------------------------------------------------------------
Total Financial Assets $ 506,027 $ 109,077 $ 97,522 $ 88,353 $ 81,193 $ 174,646 $1,056,818 $1,084,844
- -----------------------------------------------------------------------------------------------------------------------------------
Financial Liabilities:
Non-interest bearing-deposits $ 23,711 $ 17,950 $ 17,950 $ 17,950 $ 17,950 $ 54,075 $ 149,586 $ 141,123
Average interest rate N/A N/A N/A N/A N/A N/A N/A
Interest-bearing
savings and checking $ 169,924 $ 55,791 $ 55,791 $ 55,791 $ 9,057 $ -- $ 346,354 $ 345,483
Average interest rate 0.76% 0.35% 0.35% 0.35% 0.33% 0.00% 0.55% --
Time deposits $ 334,192 $ 51,306 $ 6,127 $ 787 $ 3,246 $ 3,067 $ 398,725 $ 404,344
Average interest rate 2.78% 3.58% 4.05% 4.95% 4.82% 5.20% 2.94% --
Federal funds purchased
and securities sold under
agreements to repurchase $ 88,616 -- -- -- -- -- $ 88,616 $ 88,616
Average interest rate .87% -- -- -- -- -- .87%
Notes payable -- -- $ 7,000 -- -- $ 42,500 $ 49,500 $ 53,029
Average interest rate -- -- 4.79% -- -- 4.99% 4.96%
- -----------------------------------------------------------------------------------------------------------------------------------
Total Financial Liabilities $ 616,443 $ 125,047 $ 86,868 $ 74,528 $ 30,253 $ 99,642 $1,032,781 $1,032,595
- -----------------------------------------------------------------------------------------------------------------------------------
Interest rate sensitivity gap $ (110,416) $ (15,970) $ 10,654 $ 13,825 $ 50,940 $ 75,004 $ 24,037 --
Cumulative interest rate
sensitivity gap $ (110,416) $ (126,386) $ (115,732) $ (101,907) $ (50,967) $ 24,037
DEPOSITS
Customer deposits provide the Company with its primary source of funds for
the continued growth of its loan and investment portfolios. Total deposits were
$898,163,000 at December 31, 2002, an increase of $86,640,000, or 10.7 percent
from $811,523,000 at the end of 2001. The 2001 balance was $53,947,000, or 7.1
percent, greater than deposits at year-end 2000. Noninterest bearing accounts
grew by $16,406,000, or 12.6 percent, to $146,104,000 at the end of 2002.
Interest-bearing deposits were $752,059,000 at December 31, 2002, an increase of
$70,234,000, or 10.3 percent, over the balance one year earlier.
During 2002 average total deposits increased by $52,093,000, or 6.5
percent, to $855,223,000. Total average interest-bearing deposits grew by
$31,717,000, or 4.6 percent, led by a $26,089,000, or 18.0 percent, increase in
20
average interest-bearing transaction accounts. Noninterest-bearing demand
accounts increased $20,376,000, or 17.3 percent. In 2001, total deposits
averaged $803,130,000, an increase of $67,037,000, or 9.1 percent, compared with
2000. This increase was the result of growth in average interest-bearing
deposits of $63,696,000, or 10.3 percent, accompanied by a $3,341,000, or 2.9
percent, increase in noninterest-bearing deposits.
At December 31, 2002, the ratio of interest-bearing deposits to total
deposits was 83.7 percent, or slightly less than the 84.0 percent ratio at
December 31, 2001 and the 85.2 percent ratio at the end of 2000.
TABLE 10
MATURITY DISTRIBUTION OF CD'S OF $100,000 OR MORE
DECEMBER 31 2002 2001
- --------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
Within three months $ 48,982 $ 46,756
After three through six months 35,579 32,263
After six through twelve months 45,581 31,501
After twelve months 19,380 9,518
- --------------------------------------------------------------------------------
Total $149,522 $120,038
================================================================================
SHORT-TERM BORROWED FUNDS
The distribution of First National Corporation's short-term borrowings at
the end of the last three years, the average amounts outstanding during each
such period, the maximum amounts outstanding at any month-end, and the weighted
average interest rates on year-end and average balances in each category are
presented below. Federal funds purchased and securities sold under agreement to
repurchase generally mature within one to three days from the transaction date.
Certain of the borrowings have no defined maturity date.
TABLE 11
DECEMBER 31 2002 2001 2000
(DOLLARS IN THOUSANDS) AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ----------------------------------------------------------------------------------------------
At period-end:
Federal funds purchased
and securities sold under
repurchase agreements $88,616 0.82% $66,617 1.52% $65,948 5.78%
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 5.03% 49,500 5.03% 57,050 5.95%
- ----------------------------------------------------------------------------------------------
Average for the year:
Federal funds purchased
and securities sold under
repurchase agreements and $75,956 1.15% $70,852 3.44% $85,422 6.93%
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 5.03% 41,134 5.13% 32,759 5.65%
- ----------------------------------------------------------------------------------------------
Maximum month-end balance:
Federal funds purchased
and securities sold under
repurchase agreements $88,617 $91,820 $159,503
- ----------------------------------------------------------------------------------------------
Other borrowings 49,500 50,500 57,050
- ----------------------------------------------------------------------------------------------
CAPITAL AND DIVIDENDS
A strong shareholders' equity base has provided First National Corporation
with support for its banking operations and opportunities for growth, while
ensuring sufficient resources to absorb the risks inherent in the business. As
of December 31, 2002, shareholders' equity was $103,496,000, or 9.0 percent, of
total assets. At year-end 2001 and 2000, shareholders' equity was $93,065,000,
or 9.1 percent, and $84,936,000, or 8.8 percent, of total assets, respectively.
21
The Company and its banking subsidiaries are subject to certain risk-based
capital guidelines that measure the relationship of capital to both balance
sheet and off-balance sheet risks. Risk values are adjusted to reflect credit
risk. Pursuant to guidelines of the Board of Governors of the Federal Reserve
System, which are substantially similar to those promulgated by the Office of
the Comptroller of the Currency, Tier 1 capital must be at least 50 percent of
total capital and total capital must be eight percent of risk-weighted assets.
The Tier 1 capital ratio for First National Corporation was 11.67 percent at
December 31, 2002, 12.32 percent at December 31, 2001 and 12.15 at the end of
2000. The total capital ratio for the Company was 12.92 percent, 13.57 percent
and 13.40 percent for the years ended December 31, 2002, 2001 and 2000,
respectively.
As an additional measure of capital soundness, the regulatory agencies have
prescribed a leverage ratio of total capital to total assets. The minimum
leverage ratio assigned to banks is between three and five percent and is
dependent on the institution's composite rating as determined by its regulators.
The leverage ratio for First National Corporation was 8.70 percent at December
31, 2002, 8.39 percent at December 31, 2001 and 8.27 percent at yearend 2000.
The Company well exceeded all minimum ratio standards established by the
regulatory agencies.
First National Corporation pays dividends to shareholders from funds
provided mainly by dividends from its subsidiary banks. Such bank dividends are
subject to certain regulatory restrictions and require the approval of the
Office of the Comptroller of the Currency in order to pay dividends in excess of
the banks' net earnings for the current year, plus retained net profits for the
preceding two years, less any required transfers to surplus. As of December 31,
2002, $20,136,000 of the banks' retained earnings were available for
distribution to the Company as dividends without prior regulatory approval.
In 2002, First National Corporation made shareholder dividend payments of
$4,420,000 as compared with $4,000,000 in 2001 and $3,801,000 in 2000. The
dividend pay-out ratios were 31.74 percent, 32.63 percent and 36.09 percent for
the years 2002, 2001 and 2000, respectively. Earnings that are retained continue
to be utilized as a basis for loan and investment portfolio growth and in
support of acquisition or other business expansion opportunities.
NONINTEREST INCOME AND EXPENSE
Noninterest income provides a significant stable source of revenue for the
Company that is especially important during a period of economic challenges, as
has been the experience of the past two years. For the year ended December 31,
2002, noninterest income was $17,681,000, an increase of $4,001,000, or 29.2
percent, from 2001. In 2001, noninterest income was $13,680,000, which was
$2,709,000, or 24.7 percent more than 2000. In 2002, noninterest income
comprised 20.8 percent of total income from both interest and noninterest
sources. For 2001 and 2000, noninterest income was 15.5 percent and 12.9
percent, respectively, of total interest and noninterest income.
Service charges on deposit accounts were $10,899,000 in 2002, comprising
61.6 percent of total noninterest income, and representing a $3,149,000, or 40.6
percent, increase over 2001. This increase was mainly the result of strong
deposit growth and new customer service programs initiated in the fourth quarter
of 2001. For the year ended December 31, 2001, service charges on deposit
accounts were $7,750,000, comprising 56.7 percent of income from all sources.
This represented an increase of $392,000, or 5.3 percent from 2000 and resulted
from deposit growth and pricing modifications.
During 2002, other service charges and fees increased by $1,422,000, or
26.5 percent, to $6,782,000, compared with 2001. For the year 2001, other
service charges and fees were up $1,747,000, or 48.4 percent, to $5,360,000,
compared with 2000. The increases in both 2002 and 2001 were mainly attributable
to higher origination fees earned on originations of fixed rate first mortgage
loans sold into the secondary market. High loan production volumes spurred by
low interest rates and enhancements to the Company's loan processing system were
key drivers of these increases in both years.
Further enhancing noninterest income in 2001, the Company recognized a
$570,000 gain on the sale of equity securities. No gains or losses on
disposition of securities-available-for-sale were recorded in either 2002 or
2000.
Noninterest expense was $42,567,000 in 2002, an increase of $5,434,000, or
14.6 percent, from 2001. In 2001, noninterest expense was $37,133,000, an
increase of $3,037,000, or 8.9 percent, compared with 2000.
Salaries and employee benefits were the largest component of noninterest
expense, comprising 56.7 percent and 53.2 percent of the category totals in 2002
and 2001, respectively. In 2002, salaries and employee benefits were
$24,136,000, an increase of $4,379,000, or 22.2 percent, over 2001. The main
contributors to the increase in 2002 were increased commission payments in
connection with higher mortgage loan origination activity and higher staffing
levels associated with branch additions and new departments. Salaries and
employee benefits were $19,757,000 in 2001, an increase of $2,453,000, or 14.2
percent, from 2000. The higher expense in 2001 resulted again from higher
commissions paid on increased mortgage loan originations compared with the
previous year and management and administrative personnel additions. The Company
employed 480 full-time equivalent employees at December 31, 2002, compared with
442 and 402 at the end of 2001 and 2000, respectively. Payments under a cash
incentive plan covering
22
all employees were $921,000 in 2002, $730,000 in 2001 and $843,000 in 2000.
Net occupancy expense was $2,319,000, $2,053,000 and $1,989,000 for the
years 2002, 2001 and 2000, respectively. The increase was 13.0 percent from 2001
to 2002 and 3.2 percent from 2000 to 2001. The larger increase in 2002 was the
result of increased operating expenses associated with new banking facilities.
Furniture and equipment expense was $3,858,000 in 2002, an increase of
$135,000, or 3.6 percent, from 2001. The increase was mainly due to higher costs
of leasing data processing and other equipment. In 2001, furniture and equipment
expense was $3,723,000, an increase of $154,000, or 4.3 percent, compared with
2000. This increase was the result of higher equipment leasing costs and costs
of equipment service contracts.
For the year ended December 31, 2002, other expense was $12,254,000, an
increase of $654,000, or 5.6 percent, from 2001. Variations in other expenses
year-to-year included an increase of $613,000 in consulting fees, mainly
attributable to new customer service programs; advertising and marketing costs
of $415,000 associated with changing the names of the three banking affiliates
to South Carolina Bank and Trust; an increase of $360,000 in facilities
operating expenses, including communications, printing, supplies, and postage,
in connection with new banking facilities; and a decrease of $495,000 in
amortization of intangible assets. In 2001, other expense was $11,600,000, an
increase of $366,000, or 3.3 percent, from 2000. Active marketing campaigns in
2001 increased advertising expenses by $626,000, while professional fees
decreased by $565,000 from 2000, in which the Company incurred costs associated
with a process reengineering study.
TABLE 12
QUARTERLY RESULTS OF OPERATIONS
(DOLLARS IN THOUSANDS) 2002 QUARTERS 2001 QUARTERS
----------------------------------------- -----------------------------------------
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
-------- -------- -------- -------- -------- -------- -------- --------
Interest income $