SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file number 0-23976
FIRST NATIONAL CORPORATION
(Name of Small Business Issuer in its Charter)
Virginia 54-1232965
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
112 West King Street,
Strasburg, Virginia 22657
(Address of Principal Executive Offices) (Zip Code)
(540) 465-9121
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
None n/a
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $5.00 per share
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.
Yes X No
----- -----
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [X]
The issuer's gross income for its most recent fiscal year was
$19,602,734.
The aggregate market value of the voting stock held by non-affiliates
computed by reference to the closing sales price of such stock on February 28,
2003 was approximately $32,165,364. (The exclusion from such amount of the
market value of the shares owned by any person shall not be deemed an admission
by the registrant that such person is an affiliate of the registrant.)
The number of outstanding shares of Common Stock as of February 28,
2003 was 731,031.
DOCUMENTS INCORPORATED BY REFERENCE
2002 Annual Report to Shareholders - Part II
Proxy Statement for the 2003 Annual Meeting of Shareholders - Part III
TABLE OF CONTENTS
PART I
Page
ITEM 1. DESCRIPTION OF BUSINESS............................................. 3
ITEM 2. DESCRIPTION OF PROPERTY............................................ 11
ITEM 3. LEGAL PROCEEDINGS.................................................. 11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS................................... 11
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.................................. 12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................... 12
ITEM 7. FINANCIAL STATEMENTS............................................... 28
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE................ 28
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND
CONTROL PERSONS; COMPLIANCE WITH SECTION
16(a) OF THE EXCHANGE ACT............................. 29
ITEM 10. EXECUTIVE COMPENSATION............................................. 29
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS................................... 29
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................... 29
ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K..............................29
ITEM 14. CONTROLS AND PROCEDURES.............................................30
2
Part I
Item 1. Description of Business
The Corporation
First National Corporation (the "Corporation") was organized on
September 7, 1983 as a Virginia corporation for the purpose of acquiring all of
the outstanding common stock of the First National Bank of Strasburg (effective
June 1, 1994, name changed to First Bank) (the "Bank") in connection with the
reorganization of the Bank into a one bank holding company structure. At the
effective date of the reorganization, the Bank merged into a newly-formed state
bank organized as a wholly-owned subsidiary of the Corporation, with each
outstanding share of common stock of the Bank being converted into one share of
common stock of the Corporation. The primary activity of the Corporation is the
ownership and operation of the Bank.
The Bank
The bank is currently organized as a state chartered bank under the
laws of the Commonwealth of Virginia. It commenced operations on July 1, 1907 as
The Peoples National Bank of Strasburg. On January 10, 1928 the Bank changed its
name to the First National Bank of Strasburg and moved into its current
headquarters location in Strasburg.
On July 8, 1985, the Bank's first branch was opened in the town of
Front Royal, Virginia. The second branch was opened on July 26, 1985 in the City
of Winchester, Virginia. The Bank purchased a branch in Frederick County,
Virginia from First Union National Bank of Virginia on March 31, 1994. The Bank
opened this former First Union branch as a full service office on July 1, 1994.
A fourth branch was constructed in the town of Woodstock, Virginia and opened
for business on May 30, 1995. During 1998, two additional office locations were
opened. The Bank leased office space for a Loan Production Office in downtown
Winchester, Virginia, which opened on March 18, 1998. Additionally, a new
full-service branch facility was purchased on the north side of Winchester,
Virginia. This location was opened for business on December 19, 1998. The Bank
opened a sixth branch on June 28, 1999 with the lease of a former Regional Bank
branch office in Woodstock, Virginia. In June of 2002, the bank opened a branch
on Shenandoah Avenue in Front Royal, Virginia.
On April 12, 1994, the Bank received approval from the Federal Reserve
Bank of Richmond (the "Federal Reserve") and the Virginia State Corporation
Commission's Bureau of Financial Institutions (the "SCC") to convert to a state
chartered bank with membership in the Federal Reserve System. The Bank was given
one year from approval to convert. On June 1, 1994, the Bank consummated such
conversion and changed its name to First Bank.
In April 1994, the Bank formed a subsidiary, First Bank Financial
Services, Inc. ("Financial Services"), for the purpose of investing in Bankers
Title of Fredericksburg, LLC, a title insurance company formed by a group of
community banks in Virginia. This company underwrites title insurance which is
sold through the banks which own the company.
Banking Services
As a full-service commercial bank, the Bank provides a wide range of
deposit, loan and other general banking services to individuals, businesses,
institutions and government entities. The Bank's deposit services for
individuals include checking, statement savings, NOW accounts, money market
accounts, IRA deposits, certificates of deposit, Christmas club accounts, direct
deposit programs, a club account, life-line checking accounts and investment
savings accounts. Loan services to individuals include personal and installment
loans (including automobile and property improvement loans), residential
mortgages, adjustable rate mortgages, bi-weekly mortgages, home equity loans,
and MasterCard and Visa credit cards. The Bank also offers consumers other
general banking services, such as safe deposit facilities, travelers checks and
collections, and acts as agent for the purchase and redemption of United States
Savings Bonds. In addition, the Bank offers corporate and business services,
including regular business checking, corporate savings, certificates of deposit,
commercial and small business loans, and on-line wire transfer services. The
Bank also offers Commercial mortgages. During 1999 the bank began to
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offer equipment leasing services and a wider array of mortgage products. In 2000
the bank introduced an on-line banking package including bill-payer to be fully
integrated with our enhanced website (www.firstbank-va.com). During 2002, the
bank introduced "free community checking" and "premium interest checking". These
accounts have been some of our most successful checking account programs and
have generated a large part of the $9.7 million increase in noninterest-bearing
demand deposits and $26.7 million increase in savings and interest-bearing
demand deposits.
Location and Service
The Bank serves the areas of Shenandoah, Frederick, Warren and Clarke
Counties and the City of Winchester in Virginia. The Bank solicits business from
individuals and small to medium-sized businesses, including retail shops and
professional service businesses, residing in this service area.
The Bank has offices at the following locations:
Main Office - 112 W. King St., Strasburg, Virginia
Front Royal Express Office - 508 N. Commerce Ave., Front Royal,
Virginia
Winchester Office - 2210 Valley Ave., Winchester, Virginia
Kernstown Office - 3143 Valley Pike, Winchester, Virginia
Remote ATM site at Strasburg Square Shopping Center, Strasburg,
Virginia
Woodstock South Office - 860 South Main Street, Woodstock, Virginia
Remote ATM site at Judd's Inc., Strasburg, Virginia
N. Loudoun Street Office - 661 N. Loudoun Street, Winchester, Virginia
Winchester LPO - 9 W. Piccadilly Street, Winchester, Virginia
Remote ATM site at Apple Mountain Chevron, Linden, Virginia
Woodstock North Office - 496 N. Main Street, Woodstock, Virginia
Four remote ATM sites at Handy-Marts, Winchester, Virginia
Two remote ATM sites at Handy-Marts, Woodstock, Virginia
Front Royal Office - 1717 Shenandoah Avenue, Front Royal, Virginia
Remote ATM site at Bryce Resort, Basye, Virginia
Remote ATM site at Short Stop Chevron, New Market, Virginia
Competition
The Bank is subject to intense competition from various financial
institutions and other companies or firms that offer financial services. In its
market area, the Corporation is and will be competing with several state-wide
and regional banking institutions. The Bank competes for deposits with other
commercial banks, savings and loan associations, credit unions and with issuers
of commercial paper and securities, such as money market and mutual funds. In
making loans, the Bank competes with other commercial banks, savings and loan
associations, consumer finance companies, credit unions, leasing companies and
other lenders.
Federal and state legislative changes since 1982 have significantly
increased competition among financial institutions, and current trends toward
further deregulation may be expected to increase such competition even further.
Many of the financial organizations in competition with the Corporation have
greater financial resources than the Corporation and are able to offer similar
services at varying costs with greater loan capacities. Of all the banks in our
marketplace, the Bank is one of a few that serves the area exclusively as an
independent, community bank. This enables it to identify and meet customer needs
efficiently and enhance its competitiveness in the marketplace. The Bank's
history, dating back to 1907, also allows it to compete from a position of
strength and stability.
Asset and Liability Management
Assets of the Bank consist primarily of loans and its investment
portfolio. Deposit accounts, including checking accounts and interest-bearing
accounts, time deposits and certificates of deposit, represent the majority of
the liabilities of the Bank. In an effort to maintain adequate levels of
liquidity and minimize fluctuations in the net
4
interest margin (net interest earnings divided by total interest-earning
assets), the rate sensitivity of the loan and investment portfolios are similar
to the rate sensitivity of the Bank's liabilities.
The Bank invests the majority of its investment portfolio in highly
marketable short-term assets, such as federal funds and issues of the United
States government and its agencies. By pricing loans on a variable rate
structure, or by keeping the maturity of the investment and loan portfolios
relatively short- term, the Bank is able to maintain loan interest or to
reinvest securities proceeds at prevailing market rates, thereby helping to
maintain a generally consistent spread over the interest rates paid by the Bank
on the deposits which are used to fund the investment and loan portfolios.
Lending Activities
The Bank is an active lender with a loan portfolio that includes
commercial and residential mortgages, real estate construction loans, commercial
loans, and consumer loans. The Corporation's lending activity extends to
individuals and small and medium-sized businesses within its primary service
area. Consistent with its focus on providing community-based financial services,
the Bank does not attempt to diversify its loan portfolio geographically by
making significant amounts of loans to borrowers outside of its primary service
area.
The principal economic risk associated with each of the categories of
loans in the portfolio is the credit worthiness of its borrowers. Within each
category, such risk is increased or decreased depending on prevailing economic
conditions. In an effort to manage this risk, it is the Bank's policy to give
loan amount approval limits to individual loan officers based on their level of
experience. The risk associated with the real estate mortgage loans and
installment loans to individuals varies based upon employment levels, consumer
confidence, fluctuations in the value of residential real estate and other
conditions that affect the ability of consumers to repay indebtedness. The risk
associated with commercial, financial and agricultural loans varies based upon
the strength and activity of the local economies of the Bank's market area. The
risk associated with real estate construction loans varies based upon the supply
and demand for the type of real estate under construction. Most of the Bank's
real estate construction loans are for pre-sold or contract homes.
Residential Mortgage Lending. Residential mortgage loans are made in
amounts up to 80% (95% with Mortgage Guaranty Insurance) of the appraised value
of the security property. Residential mortgage loans are underwritten using
qualification guidelines. The Bank requires that the borrower obtain title, fire
and casualty coverage in an amount equal to the loan amount and in a form
acceptable to the Bank.
The Bank charges origination fees on its residential mortgage loans.
These fees vary among loan products and with market conditions. Generally such
fees amount to 1.0% to 2.125% of the loan principal amount. In addition, the
Bank charges fees to its borrowers to cover the cost of appraisals, credit
reports and certain expenses related to the documentation and closing of loans.
Real Estate Construction Loans. The Bank does originate construction
loans on income-producing properties such as apartments, shopping centers,
hotels and office buildings. These loans are carefully underwritten with
emphasis placed on the project income, as well as, the borrowers and guarantors
ability to repay from outside sources. The Bank also makes construction loans
for residential purposes. These loans are primarily used for construction of
owner-occupied residential homes and are considered an attractive type of
lending due to their short-term maturities and high yields. The Bank does not
participate in any "speculative lending" which relies on market demand after
construction.
Construction lending entails significant additional risk as compared
with commercial and residential mortgage lending. Construction loans typically
involve larger loan balances concentrated with single borrowers or groups of
related borrowers. Construction loans involve additional risks attributable to
the fact that loan funds are advanced upon the security of the home under
construction, which is of uncertain value prior to the completion of
construction. Thus, it is more difficult to evaluate accurately the total loan
funds required to complete a project and related loan-to-value ratios. To
minimize risks associated with construction lending, the Bank limits loan
amounts to 80% of appraised value on pre-sold homes in addition to its usual
credit analysis of its borrowers. The Bank also obtains a first lien on the
security property as security for its construction loans.
5
Commercial Real Estate Lending. The Bank provides permanent mortgage
financing for a variety of commercial projects. These loans are written with
maturities generally within one and five years and are made predominantly on an
adjustable rate basis. The Bank attempts to concentrate its commercial real
estate lending efforts into owner-occupied projects. However, from time to time,
in the normal course of business, the Bank will provide a limited amount of
financing for income producing, non-owner occupied projects which meet all of
the guidelines established by loan policy.
Commercial Loans. As a full-service community bank, the Bank makes
loans to qualified small businesses in its service area. Commercial business
loans generally have a higher degree of risk than commercial and residential
mortgage loans but have commensurately higher yields. To manage these risks, the
Bank secures appropriate collateral and carefully monitors the financial
condition of its business borrowers. Commercial business loans typically are
made on the basis of the borrower's ability to make repayment from the cash flow
of its business and are either unsecured or secured by business assets, such as
accounts receivable, equipment and inventory. As a result, the availability of
funds for the repayment of commercial business loans may be substantially
dependent on the success of the business itself. Further, the collateral for
secured commercial business loans may depreciate over time and cannot be
appraised with as much precision as real estate.
Consumer Loans. The Bank currently offers most types of consumer
demand, time and installment loans including automobile loans and home equity
lines of credit. The risk associated with installment loans to individuals
varies based upon employment levels, consumer confidence, and other conditions
that affect the ability of consumers to repay indebtedness.
Employees
At December 31, 2002, a total of 93 persons were employed by the
Corporation and the Bank in both full and part time positions. None are
represented by any collective bargaining unit. The Corporation considers
relations with its employees to be good.
Supervision and Regulation
General. As a bank holding company registered under the Bank Holding
Company Act of 1956 (the "BHCA"), the Corporation is subject to the supervision
and examination of the Board of Governors of the Federal Reserve System and is
required to file with the Federal Reserve such reports and other information as
the Federal Reserve may require. The Bank was supervised and regularly examined
by the Office of the Comptroller of the Currency, but upon its conversion to a
state chartered bank on June 1, 1994, became subject to the oversight of the
Federal Reserve and the Bureau of Financial Institutions of the Virginia State
Corporation Commission (the "SCC"). The various laws and regulations
administered by the regulatory agencies affect corporate practices, such as
dividend payments, incurring debt, acquisition of financial institutions and
other companies, and types of business conducted.
Bank Holding Company Regulation. Under Federal Reserve policy, a bank
holding company is expected to act as a source of financial strength to each of
its subsidiary banks and to commit resources to support such banks in
circumstances where it might not do so absent such policy. The BHCA requires a
bank holding company to obtain Federal Reserve approval before it acquires,
directly or indirectly, ownership or control of any voting shares of a bank or
bank holding company if, after such acquisition, it would own or control more
than 5% of such shares (unless it already owns or controls a majority of such
voting shares). Federal Reserve approval also must be obtained before a bank
holding company acquires all or substantially all of the assets of another bank
or bank holding company or merges or consolidates with another bank holding
company. In addition to the approval of the Federal Reserve, before any bank
acquisition can be completed, prior approval thereof must be obtained from each
other banking agency which has supervisory jurisdiction over the bank to be
acquired.
The BHCA also prohibits a bank holding company, with certain limited
exceptions, from acquiring or retaining direct or indirect ownership or control
of more than 5% of the voting shares of any company which is not a bank, or from
engaging in any activities other than those of banking or of managing or
controlling banks or furnishing services to or performing services for its
subsidiaries. The principal exceptions to these prohibitions
6
permit a bank holding company to engage in, or acquire an interest in a company
that engages in activities which, after due notice and opportunity for hearing,
the Federal Reserve by regulation or order has determined are so closely related
to banking or of managing or controlling banks as to be a proper incident
thereto.
The subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act on any extensions of credit to
the bank holding company or any of its subsidiaries, or investments in the stock
or other securities thereof, and on the taking of such stocks or securities as
collateral for loans. The Federal Reserve possesses cease and desist powers over
bank holding companies if their actions represent unsafe or unsound practices or
violations of law.
A bank holding company may not, without providing prior notice to the
Federal Reserve, purchase or redeem its own stock if after the transaction the
company is no longer classified as "well-capitalized."
The Corporation is also subject to certain provisions of Virginia law
that affect the ability of a bank holding company to acquire another financial
institution based in Virginia. Under certain amendments to the Virginia
Financial Institutions Holding Company Act that became effective July 1, 1983,
no corporation, partnership or other business entity may acquire, or make any
public offer to acquire, more than 5% of the stock of any Virginia financial
institution or any Virginia financial institution holding company, unless it
shall first file an application with the SCC. The SCC is directed by the statute
to solicit the views of the affected financial institution, or financial
institution holding company, with respect to such stock acquisition, and is
empowered to conduct an investigation during the 60 days following receipt of
such an application. If the SCC takes no action within the prescribed period, or
if during the prescribed period it issues notice of its intent not to disapprove
an application, the acquisition may be completed. The SCC may disapprove an
application subject to such conditions as it may deem advisable.
The Bank. As stated earlier in this item under "The Bank," the Bank
received approval from the Federal Reserve and the SCC and converted to a state
chartered bank, organized under the laws of the Commonwealth of Virginia, with
membership in the Federal Reserve System. The Bank is now supervised and
regularly examined by the Federal Reserve and the SCC and is subject to the laws
and regulations administered by those regulatory authorities.
Limits on Dividends and Other Payments. The Corporation is a legal
entity separate and distinct from the Bank. Most of the Corporation's revenues
result from dividends paid to the Corporation by the Bank. The right of the
Corporation, and consequently the right of creditors and shareholders of the
Corporation, to participate in any distribution of the assets or earnings of the
Bank through the payment of such dividends or otherwise is necessarily subject
to the prior claims of creditors of the Bank, except to the extent that claims
of the Corporation in its capacity as a creditor may be recognized.
The amount of dividends payable by the Bank to the Corporation depends
upon the Bank's earnings and capital position, and is limited by federal and
state law, regulations and policies.
As a state member bank subject to the regulations of the Federal
Reserve Board, the Bank has to obtain the approval of the Federal Reserve Board
for any dividend if the total of all dividends declared in any calendar year
would exceed the total of its net profits, as defined by the Federal Reserve
Board, for that year, combined with its retained net profits for the preceding
two years. In addition, the Bank may not pay a dividend in an amount greater
than its undivided profits then on hand after deducting its losses and bad
debts. For this purpose, bad debts are generally defined to include the
principal amount of loans which are in arrears with respect to interest by six
months or more unless such loans are fully secured and in the process of
collection. Moreover, for purposes of this limitation, the Bank is not permitted
to add the balance in its allowance for loan losses account to its undivided
profits then on hand; however, it may net the sum of its bad debts as so defined
in excess of that account. At December 31, 2002, the Bank had $4.6 million of
retained earnings legally available for the payment of dividends.
In addition, the Federal Reserve is authorized to determine under
certain circumstances relating to the financial condition of a national bank, a
state member bank or a bank holding company that the payment of dividends would
be an unsafe or unsound practice and to prohibit payment thereof. The payment of
dividends that deplete a
7
bank's capital base could be deemed to constitute such an unsafe or unsound
practice. The Federal Reserve has indicated that banking organizations should
generally pay dividends only out of current operating earnings.
Borrowings by the Corporation. There are various legal restrictions on
the extent to which the Corporation can Borrow or otherwise obtain credit from
the Bank. In general, these restrictions require that any such extensions of
credit must be secured by designated amounts of specified collateral and are
limited, as to the Corporation, to 10 percent of the Bank's capital stock and
surplus, and as to the Corporation and any nonbanking subsidiaries in the
aggregate, to 20 percent of the Bank's capital stock and surplus. Federal law
also requires that transactions between the Bank and the Corporation or any
nonbanking subsidiaries, including extensions of credit, sales of securities or
assets and the provision of services, be conducted on terms at least as
favorable to the bank as those that apply or would apply to comparable
transactions with unaffiliated parties.
Capital Requirements
Year Ended
December 31,
2002
Required Capital Ratios:
Leverage Ratio 4.00%
Tier 1 risk-based capital ratio 4.00
Total risk-based capital ratio 8.00
The Corporation Capital Ratios:
Leverage Ratio 7.88%
Tier 1 risk-based capital ratio 10.43%
Total risk-based capital ratio 11.42%
In January 1989, the Federal Reserve Board published risk-based capital
guidelines in final form which are applicable to bank holding companies. The
Federal Reserve Board guidelines redefine the components of capital, categorize
assets into different risk classes and include certain off-balance sheet items
in the calculation of risk-weighted assets. These guidelines became effective on
March 15, 1989. The minimum ratio of qualified total capital to risk-weighted
assets (including certain off balance sheet items, such as standby letters of
credit) is 8.00%. At least half of the total capital must be comprised of common
equity, retained earnings and a limited amount of permanent preferred stock,
less goodwill ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist
of a limited amount of subordinated debt, other preferred stock, certain other
instruments and a limited amount of loan and lease losses reserves. The
Corporation's Tier 1 and Total Capital ratios as of December 31, 2002 were
10.43% and 11.42%, respectively.
In addition, the Federal Reserve Board has established minimum Leverage
ratio (Tier 1 capital to quarterly average assets less goodwill) guidelines for
bank holding companies. These guidelines provide for a minimum ratio of 3.00%
for bank holding companies that meet certain specific criteria, including that
they have the highest regulatory rating. All other bank holding companies will
be required to maintain a Leverage ratio of 3.00% plus an additional cushion of
at least 100 to 200 basis points. The Corporation's Leverage ratio as of
December 31, 2002 was 7.88%. The guidelines also provide that a banking
organization experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Under Federal Reserve Board policy, a bank holding company is required
to serve as a source of financial and managerial strength to its subsidiary
banks and may not conduct its operations in an unsafe or unsound manner. In
addition, it is the Federal Reserve Board's policy that, in serving as a source
of strength to its subsidiary banks, a bank holding company should stand ready
to use available resources to provide adequate capital funds to its subsidiary
banks. This support may be required during periods of financial stress or
adversity or in circumstances
8
where the financial flexibility and capital-raising capacity of the bank holding
company would be called upon to obtain additional resources for assisting its
subsidiary banks. The failure of a bank holding company to serve as a source of
strength to its subsidiary banks would generally be considered by the Federal
Reserve Board to be an unsafe and unsound banking practice, a violation of
Federal Reserve regulations, or both.
FIRREA. In August 1989, Congress enacted the Financial Institutions
Reform, Recovery, and Enforcement Act ("FIRREA"). Among other things, FIRREA
abolished the Federal Savings and Loan Insurance Corporation and established two
new insurance funds under the jurisdiction of the FDIC -- the Savings
Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF"). The
FDIC will set assessments for deposit insurance annually. The act requires that
the FDIC reach an insurance fund reserve ratio for the BIF of $1.25 for every
$100 of insured deposits within fifteen years. Assessments for the BIF and SAIF
are set independently.
FIRREA also imposes, with certain exceptions, a "cross-guarantee" on
the part of commonly controlled depository institutions. Under this provision,
if one depository institution subsidiary of a multi- unit holding company fails
or requires FDIC assistance, the FDIC may assess a commonly controlled
depository institution for the estimated losses suffered by the FDIC. While the
FDIC's claim is junior to the claims of non-affiliated depositors, holders of
secured liabilities, general creditors, and subordinated creditors, it is
superior to the claims of shareholders.
In addition, FIRREA grants numerous new or enhanced enforcement powers
over financial institutions and individuals associated with them. Its criminal
and civil liability provisions apply equally to banks and savings and loan
associations and provide for stiffer civil fines and criminal penalties for any
depository institution or any institution affiliated party who engages in or
tolerates bank fraud or other wrongdoing.
FDICIA. The Federal Deposit Insurance Corporation Improvement Act
("FDICIA") was signed into law on December 19, 1991. Section 131 of FDICIA
requires the federal banking agencies to develop a mechanism to take prompt and
corrective action ("PCA") to resolve the problems of insured depository
institutions ("IDI's"). Capital levels and supervisory concern determine a
bank's PCA capital category.
Section 302 requires the FDIC to establish a risk-based assessment
system. The system is designed as a matrix where each IDI will pay an assessment
rate based on the combination of its capital and supervisory condition.
Section 305 of FDICIA requires incorporating interest rate risk ("IRR")
into the risk-based standard and a measurement system that would identify
institutions with high levels of IRR and ensure that they have sufficient
capital to cover their exposure. The measurement system will quantify IRR
exposure through weighting and risk factors.
Depository institutions are required to establish non-capital standards
for bank safety and soundness. These standards fall into three broad categories:
operations and management standards for internal controls, loan documentation,
and credit underwriting; asset quality, earnings and stock valuation standards;
and executive compensation standards. The failure of a depository institution to
meet these standards will trigger regulatory actions. Section 112 establishes
guidelines for annual independent audit, annual report filings with regulatory
agencies, independent audit reports and procedures, and independent audit
committees.
Section 301 addresses brokered deposits with no restrictions on "well
capitalized" institutions and restrictions based upon the capital threshold of
remaining institutions. Truth in Savings ("TISA") or Regulation DD is intended
to assist consumers in comparing deposit accounts principally through
disclosures of fees, annual percentage yields, interest rates and other terms
associated with interest-bearing deposit accounts. Compliance was mandatory on
June 21, 1993. Section 304 requires a uniform standard for real estate lending
establishing loan-to value ("LTV") ratio guidelines for real estate secured
loans.
FDICIA contains a provision for IDI's to provide supplemental
disclosure of the estimated fair value of assets and liabilities in reports
required to be filed with federal banking agencies.
9
FDICIA establishes various limitations on loans to bank insiders and
prescribes standards that effectively limit the risks posed by an insured bank's
exposure to other insured depository institutions ("Interbank Liabilities").
FDICIA also requires advance notice of a branch closure, the establishment of
incentives to provide life-line accounts to low-income customers and addresses
the frequency and scope of supervisory examinations. Clearly, the ultimate
impact of FDICIA will be profound.
The Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999
(the "GLB Act" or the "Act"), signed into law on November 12, 1999, amended a
number of Federal banking laws that affect the Corporation and the Bank, and the
provisions of the Act that are believed to be of most significance to the
Corporation are discussed below. In particular, the GLB Act permits a bank
holding company to elect to become a financial holding company. In order to
become and maintain its status as a financial holding company, the bank holding
company and all of its affiliated depository institutions must be
well-capitalized, well-managed, and have at least a satisfactory Community
Reinvestment Act rating. The Corporation filed an election and on April 3, 2001,
became a financial holding company.
Under the BHCA, a bank holding company, including a financial holding
company, may not directly or indirectly acquire ownership or control of more
than 5% of the voting shares or substantially all of the assets of any bank or
merge or consolidate with another bank holding company without the prior
approval of the Federal Reserve Board. The BHCA, as amended by the GLB Act, now
generally limits the activities of a bank holding company that is a financial
holding company to that of banking, managing or controlling banks; performing
certain servicing activities for subsidiaries; and engaging in any activity, or
acquiring and retaining the shares of any company engaged in any activity, that
is either (1) financial in nature or incidental to such financial activity, as
determined by the Federal Reserve Board in consultation with the Secretary of
the Treasury; or (2) complementary to a financial activity and does not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally, as determined by the Federal Reserve Board, by order
or regulation in effect prior to enactment of the GLB Act, to be closely related
to banking or managing or controlling banks as to be a proper incident thereto.
The GLB Act covers a broad range of issues, including a repeal of most
of the restrictions on affiliations among depository institutions, securities
firms and insurance companies. In particular, the GLB Act repeals sections 20
and 32 of the Glass-Stegall Act, thus permitting unrestricted affiliations
between banks and securities firms. The Act also provides that, while the states
continue to have the authority to regulate insurance activities, in most
instances they are prohibited from preventing or significantly interfering with
the ability of a bank, directly or through an affiliate, to engage in insurance
sales, solicitations or cross-marketing activities. A financial holding company,
therefore, may engage in or acquire companies that engage in a broad range of
financial services, including securities activities such as underwriting,
dealing, brokerage, investment and merchant banking; and insurance underwriting,
sales and brokerage activities. Although the states generally must regulate bank
insurance activities in a nondiscriminatory manner, the states may continue to
adopt and enforce rules that specifically regulate bank insurance activities in
certain areas identified in the Act. The Act directs the Federal bank regulatory
agencies to adopt insurance consumer protection regulations that apply to sales
practices, solicitations, advertising and disclosures, and such regulations have
been adopted and became effective April 1, 2001.
The GLB Act includes a system of functional regulation under which the
Federal Reserve Board is confirmed as the umbrella regulator for bank holding
companies, but bank holding company affiliates are to be principally regulated
by functional regulators such as the FDIC for state nonmember bank affiliates,
the Securities and Exchange Commission for securities affiliates and state
insurance regulators for insurance affiliates. The Act repealed the broad
exemption of banks from the definitions of "broker" and "dealer" for purposes of
the Securities Exchange Act of 1934, but identifies a set of specific
activities, including traditional bank trust and fiduciary activities, in which
a bank may engage without being deemed a "broker" and a set of activities in
which a bank may engage without being deemed a "dealer". The Act also makes
conforming changes in the definitions of "broker" and "dealer" for purposes of
the Investment Company Act of 1940 and the Investment Advisers Act of 1940.
The GLB Act contains extensive customer privacy protection provisions.
Under these provisions, a financial institution must provide to its customers,
at the inception of the customer relationship and annually thereafter, the
institution's policies and procedures regarding the handling of customers'
nonpublic personal financial
10
information. The Act provides that, except for certain limited exceptions, an
institution may not provide such personal information to unaffiliated third
parties unless the institution discloses to the customer that such information
may be so provided and the customer is given the opportunity to opt out of such
disclosure. An institution may not disclose to an unaffiliated party, other than
to a consumer reporting agency, customer account numbers or other similar
account identifiers for marketing purposes. The Act also provides that the
states may adopt customer privacy protections that are more strict than those
contained in the Act. The Act also makes it a criminal offense, except in
limited circumstances, to obtain or attempt to obtain customer information of a
financial nature by fraudulent or deceptive means. The Act also contains
requirements for the posting of notices by operators of automated teller
machines regarding fees charged for the use of such machines.
Government Policies and Legislation. The policies of regulatory
authorities, including the Federal Reserve Board and the FDIC, have had a
significant effect on the operating results of commercial banks in the past and
are expected to do so in the future. An important function of the Federal
Reserve is to regulate aggregate bank credit and money through such means as
open market dealings in securities, establishment of the discount rate on member
banks, borrowings, and changes in reserve requirements against member deposits.
Policies at these agencies may be influenced by many factors, including
inflation, unemployment, short-term and long-term changes in the international
trade balance, and fiscal policies of the United States government.
Congress has periodically considered and adopted legislation which has
resulted in, and could result in further, deregulation of both banks and
financial institutions. Such legislation could modify or eliminate geographic
restrictions on banks and bank holding companies and could modify or eliminate
current prohibitions against the Corporation engaging in one or more non-banking
activities. Such legislative changes also could place the Corporation in more
direct competition with other financial institutions. No assurance can be given
as to whether any additional legislation will be adopted and as to the effect of
such legislation on the business of the Corporation.
Item 2. Description of Property
The principal executive offices of First National Corporation are
located at 112 West King Street, Strasburg, Virginia, which is owned free of
encumbrances. In addition to operating a full service banking facility at this
Strasburg location, the Corporation operates seven additional branches and a
loan production office. The Corporation owns five of these facilities without
encumbrances and leases three of the facilities. The leases on these facilities
including renewal options, expire in 2007. See Note 13 to the Consolidated
Financial Statements of the Corporation's 2002 Annual Report to Shareholders for
additional information concerning these lease commitments.
Item 3. Legal Proceedings
In the ordinary course of its operations, the Corporation is party to
various legal proceedings. Based on information presently available, and after
consultation with legal counsel, management believes that the ultimate outcome
in such proceedings, in the aggregate, will not have a material adverse effect
on the business or the financial condition or results of operations of the
Corporation.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to security holders for a vote in the fourth
quarter of 2002.
11
Part II
Item 5. Market for Common Equity and Related Stockholder Matters
Shares of the common stock of the Corporation are traded on the
over-the-counter (OTC) market and quoted in the OTC Bulletin Board under the
symbol "FXNC." However, similar to the trading of the Bank's common stock prior
to its reorganization, trading of the Corporation's common stock is generally
the result of private negotiation. Increasingly, a broker or dealer may be
involved.
The Corporation has a limited record of trades involving its common
stock in the sense of "bid" and "asked" prices or in highs and lows. The effort
to accurately disclose trading prices is made more difficult due to the fact
that price per share information is not required to be disclosed to the
Corporation when shares of its stock have been sold by holders and purchased by
others. The following table summarizes the high and low sales prices of shares
of the Corporation's common stock on the basis of trades known to the
Corporation. The Corporation may not be aware of the per share price of all
trades made.
Market Price and Dividends
Sales Price ($) Dividends ($) (1)
--------------- -----------------
High Low
---- ---
2001:
1st quarter................................... 24.75 23.25 .32
2nd quarter................................... 33.00 24.75 .32
3rd quarter................................... 34.00 30.25 .32
4th quarter................................... 33.75 31.50 .34
2002:
1st quarter................................... 35.75 32.25 .34
2nd quarter................................... 41.00 36.50 .34
3rd quarter................................... 40.40 37.25 .34
4th quarter................................... 40.25 37.25 .36
---------
(1) The Corporation increased its dividend to $1.38 per share in 2002,
which represented a payout ratio of 36.60%. The dividend per share and
payout ratios in 2001 were $1.30 and 39.57%, respectively.
The Corporation had 695 shareholders of record as of February 28, 2003.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
First National Corporation (the "Corporation") is the holding company
for First Bank (the "Bank") and First Bank owns First Bank Financial Services
Inc. ("Financial Services"). The following discussion and analysis of the
financial condition and results of operations of the Corporation for the years
ended December 31, 2002, 2001 and 2000 should be read in conjunction with the
consolidated financial statements and related notes.
Overview
Earnings and assets continued to grow in 2002. Net income for 2002 was
$2,979,214 compared to $2,595,334 in 2001 and $2,136,787 in 2000. Net income per
share increased $0.48 per share, both basic and diluted in 2002 from 2001 ($3.77
per share basic and diluted in 2002 versus $3.29 per share basic and diluted in
2001). The increase in earnings resulted primarily from a continuing increase in
the Bank's net interest income. Return on average assets was 1.09% in 2002,
1.10% in 2001 and .98% in 2000. Return on average equity was 12.99% in 2002,
12.57% in 2001 and 11.90% in 2000.
12
Assets grew 18.7% in 2002. In 2001, assets grew 8.8%. Growth occurred
primarily in the loan portfolio where loans, net of unearned income and
allowance for loan losses, increased $25.7 million to $210.4 million. The
securities portfolio also increased to $54.5 million in 2002 from $43.4 million
in 2001.
Critical Accounting Policies
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any,
are credited to the allowance.
The Corporation performs an analysis of the allowance for loan losses
throughout the year, with the objective of quantifying portfolio risk into a
dollar figure of inherent losses. In addition, internal loan reviews are
performed on a regular basis. The determination of the allowance for loan losses
is based on applying qualitative and quantitative factors to each category of
loans along with any specific allowance for impaired and adversely classified
loans within the particular category. The resulting sum is then combined to
arrive at a total allowance for all categories. The Corporation assigns factors
that include historical loss experience, delinquency rates and economic trends
to each loan category for consideration of the qualitative factors. The total
allowance required will fluctuate as a result of changes in the various types
and categories of loans, specific allowances required due to impaired and
adversely classified loans, the historical loss experience, delinquency rates
and economic conditions.
A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan basis for
commercial and construction loans by either the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
obtainable market price, or the fair value of the collateral if the loan is
collateral dependent.
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Corporation does not separately
identify individual consumer and residential loans for impairment disclosures.
During the year ended December 31, 2002 there were no changes in
critical accounting policies as reflected in the last report.
Results of Operations
Net interest income represents the primary source of earnings for the
Corporation. Net interest income equals the amount by which interest income on
earning assets, predominately loans and securities, exceeds interest expense on
interest bearing liabilities, predominately deposits, short-term and long-term
borrowings. The provision for loan losses and the amount of noninterest income
and expense also have an effect on net income. Noninterest income and expense
consists of income from service charges on deposit accounts; fees charged for
various services; gains and losses from the sale of assets, both fixed assets
and securities; and various administrative, operating and income tax expenses.
Changes in the volume and mix of interest-earning assets and
interest-bearing liabilities, as well as their respective yields and rates, have
a significant impact on the level of net interest income. Net interest margin is
calculated by dividing tax equivalent net interest income by average earning
assets and reflects the Company's net yield on its earning assets.
13
General. Net income has increased in each of the last three years. The
increase in income in 2002 was caused by growth in earning assets and by the
funding of higher yielding assets, in part, from lower priced deposits. In 2001
and 2000 net interest income increased as the Corporation continued to
experience favorable asset growth.
Net Interest Income. Net interest income was $9.41 million for the year
ended December 31, 2002, up $754 thousand or 8.72% over the $8.65 million
reported for the same period in 2001. This increase in net interest income
resulted from an increase in interest-earning assets and a decrease in the rates
paid on deposit accounts during the year. In 2001, net interest income increased
13.55% or $1.03 million from $7.62 million in 2000.
Interest income as a percent of average earning assets has decreased in
each of the last three years from 8.29% in 2000, 7.78% in 2001 and 6.74% in
2002. Interest expense as a percent of average interest-bearing liabilities has
also decreased from 5.26% in 2000, 4.58% in 2001 and 3.55% in 2002. Net interest
margin was 3.75% in 2002, 3.93% in 2001, and 3.77% in 1999. Interest rate spread
was 3.19% in 2002, 3.20% in 2001 and 3.03% in 2000. The yield on earning assets
continued to decline during 2002 as earning assets repriced at lower interest
rates.
Provision for Loan Losses. The provision for 2002 was $405,000 compared
to $420,000 in 2001 and $369,000 in 2000. The amount allocated during the year
to the provision for loan losses represents management's analysis of the
existing loan portfolio and related credit risks.
Non-Interest Income. Non-interest income increased $977 thousand or
62.3% for 2002 over 2001 compared to an increase of $166 thousand or 11.8% for
2001 over 2000. The increase in non-interest income is primarily attributed to
service charges, which increased $391 thousand in 2002 and to an increase of
$178 thousand in fees for other customer services. Gains on securities available
for sale totaled $172 thousand during 2002 and losses totaled $4 thousand during
2001. There were no sales of securities available for sale in 2000. Increased
mortgage loan activity contributed to gains on sale of loans totaling $198
thousand in 2002, $71 thousand in 2001 and $7 thousand in 2000.
Non-Interest Expense. In 2002, non-interest expenses increased $1.2
million or 19.0% over 2001. In 2001, non-interest expenses increased $453
thousand or 8.1% over 2000. The increase in 2002 was primarily the result of the
increase in salaries and benefits and other operating expenses.
Income Taxes. The Corporation has adopted FASB Statement No. 109,
"Accounting for Income Taxes". A more detailed discussion of the Corporation's
tax calculation is contained in the notes to the consolidated financial
statements.
14
Table 1 - Selected Consolidated Financial Data
Years Ended December 31,
(in thousands except ratios and per share amounts)
2002 2001 2000 1999 1998
Income Statement Data:
Interest Income $17,058 $17,326 $16,951 $15,217 $13,993
Interest Expense 7,653 8,675 9,332 7,683 7,110
Net Interest Income 9,405 8,651 7,619 7,534 6,883
Provision For Loan Losses 405 420 369 495 330
Net Interest Income After
Provision For Loan Losses 9,000 8,231 7,250 7,039 6,553
Noninterest Income 2,373 1,572 1,402 1,118 1,052
Securities Gains (Losses) 172 (4) 0 1 198
Noninterest Expense 7,219 6,064 5,611 5,271 5,106
Income Before Income Taxes 4,326 3,735 3,041 2,887 2,697
Income Taxes 1,347 1,140 904 853 792
Net Income $2,979 $2,595 $2,137 $2,034 $1,905
Per Share Data:
Net Income, Basic $3.77 $3.29 $2.69 $2.57 $2.43
Net Income, Diluted 3.77 3.29 2.69 2.57 2.42
Cash Dividends 1.38 1.30 1.20 1.15 1.00
Book Value At Period End 30.70 27.34 24.47 21.63 22.31
Balance Sheet Data:
Assets $295,936 $249,354 $229,329 $206,618 $191,136
Loans, Net 210,441 184,765 164,603 149,313 128,371
Securities 54,485 43,355 44,831 45,129 48,263
Deposits 243,012 197,479 175,194 153,422 155,008
Stockholders' Equity 24,254 21,600 19,329 17,176 17,601
Average Shares Outstanding, Diluted 790 790 794 792 787
Performance Ratios:
Return On Average Assets 1.09% 1.10% 0.98% 1.00% 1.05%
Return On Average Equity 12.99% 12.57% 11.90% 11.63% 11.31%
Dividend Payout 36.60% 39.57% 44.56% 44.72% 41.21%
Capital And Liquidity Ratios:
Leverage 7.88% 8.97% 8.67% 8.91% 9.02%
Risk-Based Capital Ratios:
Tier 1 Capital 10.43% 10.34% 11.28% 12.74% 13.78%
Total Capital 11.42% 11.31% 12.26% 13.73% 14.76%
15
Table 2 - Average Balances, Income and Expense, Yields and Rates
Years Ended December 31,
2002 2001 2000
Annual Annual Annual
ASSETS Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
Balances at correspondent banks
- interest bearing $1,214,110 $44,902 3.70% $1,397,710 $73,164 5.23% $508,853 $59,191 11.63%
Securities:
Taxable 45,142,996 2,216,450 4.91% 34,600,602 2,005,522 5.80% 37,411,972 2,365,251 6.32%
Tax-exempt (1) 6,236,303 459,364 7.29% 6,801,538 497,774 7.32% 6,824,295 496,970 7.28%
--------- ------- --------- ------- --------- -------
Total Securities 51,379,299 2,675,814 5.21% 41,402,140 2,503,296 6.05% 44,236,267 2,862,221 6.47%
Loans (net of earned income): (2)
Taxable 197,542,256 14,342,918 7.26% 177,125,433 14,681,390 8.29% 158,582,976 13,956,636 8.80%
Tax-exempt (1) 1,375,620 110,155 8.01% 1,037,843 88,342 8.51% 582,072 66,310 11.39%
--------- ------- --------- ------ ------- ------
Total Loans 198,917,876 14,453,073 7.27% 178,163,276 14,769,732 8.29% 159,165,048 14,022,946 8.81%
Federal funds sold and repurchase
agreements 4,609,904 76,890 1.67% 4,230,045 178,754 4.23% 2,717,194 175,993 6.48%
--------- ------ --------- ------- --------- -------
Total earning assets 256,121,189 17,250,679 6.74% 225,193,171 17,524,946 7.78% 206,627,362 17,120,351 8.29%
Less: allowance for Loan Losses (2,072,676) (1,817,252) (1,618,154)
Total nonearning assets 18,099,672 12,568,264 12,393,531
---------- ---------- ----------
Total Assets $272,148,185 $235,944,183 $217,402,739
============ ============ ============
LIABILITIES AND SHAREHOLDER EQUITY
Interest bearing deposits:
Checking $35,598,074 $678,507 1.91% $12,614,190 $156,986 1.24% $12,083,034 $158,442 1.31%
Money market savings 7,735,680 113,731 1.47% 6,588,356 159,561 2.42% 5,983,995 188,153 3.14%
Regular savings 52,670,319 889,609 1.69% 61,210,167 2,041,066 3.33% 58,761,111 3,107,260 5.29%
Certificates of deposit:
Less than $100,000 63,170,927 3,016,202 4.77% 56,582,840 3,205,785 5.67% 49,448,164 2,729,657 5.52%
$100,000 and more 29,117,733 1,275,892 4.38% 22,437,125 1,243,602 5.54% 15,889,137 947,505 5.96%
---------- --------- ---------- --------- ---------- -------
Total interest bearing deposits 188,292,733 5,973,941 3.17% 159,432,678 6,807,000 4.27% 142,165,441 7,131,017 5.02%
Fed funds purchased 302,573 6,455 2.13% 90,708 3,981 4.39% 969,544 62,648 6.46%
FHLB borrowings 26,988,457 1,672,341 6.20% 29,839,142 1,863,552 6.25% 34,564,638 2,138,546 6.19%
---------- --------- ---------- --------- ---------- ---------
Total interest bearing liabilities 215,583,763 7,652,737 3.55% 189,362,528 8,674,533 4.58% 177,699,623 9,332,211 5.26%
Noninterest bearing liabilities
Demand deposits 31,397,327 23,980,571 20,236,880
Other liabilities 2,228,001 1,954,027 1,510,331
--------- --------- ---------
Total liabilities 249,209,091 215,297,126 199,446,834
Stockholders' equity 22,939,094 20,647,057 17,955,905
---------- ---------- ----------
Total liabilities and
stockholders' equity $272,148,185 $235,944,183 $217,402,739
============ ============ ============
Net Interest income $9,597,942 $8,850,413 $7,788,140
========== ========== ==========
Interest rate spread 3.19% 3.20% 3.03%
Interest expense as a percent of average
earning assets 2.99% 3.85% 4.52%
Net interest margin 3.75% 3.93% 3.77%
---------
(1) Income and yields are reported on a taxable-equivalent basis assuming a
federal tax rate of 34%.
(2) Loans placed on a nonaccrual status are reflected in the balances.
16
Table 3 - Volume and Rate Analysis
2002 2001
Change in Change in
Volume Rate Income/ Volume Rate Income/
Effect Effect Expense Effect Effect Expense
Earning Assets:
Due From Banks $(8,758) $(19,504) $(28,262) $20,400 $(6,427) $13,973
Taxable Securities 424,936 (214,008) 210,928 (171,716) (188,013) (359,729)
Tax-Exempt Securities (36,605) (1,805) (38,410) (1,241) 2,045 804
Taxable Loans 4,345,373 (4,683,845) (338,472) 1,383,685 (658,931) 724,754
Tax-Exempt Loans 26,618 (4,805) 21,813 32,540 (10,508) 22,032
Federal Funds Sold and
Repurchase Agreements 17,748 (119,612) (101,864) 7,336 (4,575) 2,761
------ --------- --------- ----- ------- -----
Total Earning Assets $4,769,312 $(5,043,579) $(274,267) $1,271,004 $(866,409) $404,595
---------- ------------ ---------- ---------- ---------- --------
Interest Bearing Liabilities:
Interest Checking $402,239 $119,282 $521,521 $6,754 $(8,210) $(1,456)
Savings Deposits-
Regular (254,186) (897,271) (1,151,457) 135,136 (1,201,330) (1,066,194)
Money Market 36,540 (82,370) (45,830) 22,507 (51,099) (28,592)
CD's and Other Time Deposits
$100,000 and More 108,806 (76,516) (189,583) 357,174 (61,077) 296,097
Less Than $100,000 521,866 (711,449) 32,290 400,669 75,459 476,128
------- --------- ------ ------- ------ -------
Total Interest-
Bearing Deposits $815,265 $(1,648,324) $(833,059) $922,240 $(1,246,257) $(324,017)
Fed Funds Purchased 3,173 (699) 2,474 (43,344) (15,323) (58,667)
FHLB Borrowings (176,436) (14,775) (191,211) (295,979) 20,985 (274,994)
--------- -------- --------- --------- ------ ---------
Total Interest-
Bearing Liabilities $642,002 $(1,663,798) $(1,021,796) $ 582,917 $(1,240,595) $(657,678)
-------- ------------ ------------ --------- ------------ ----------
Change in
Net Interest Income $4,127,310 $(3,379,781) $747,529 $688,087 $ 374,186 $1,062,273
========== ============ ======== ======== ========= ==========
17
Financial Condition
General. Management continued to increase the size of the loan
portfolio in 2002. Loans, net of unearned discounts and allowance for loan
losses, increased $25.7 million or 13.9% from $184.7 million in 2001 to $210.4
million in 2002. This growth in loans was reflected in an 18.7% increase in
assets during the year. Assets began the year at $249.4 million and grew $46.5
million to $295.9 million by year-end.
Loans. The Bank is an active lender with a loan portfolio which
includes commercial and residential mortgages, commercial loans, consumer loans,
both installment and credit card loans, real estate construction loans and home
equity loans. The Bank's lending activity is concentrated on individuals and
small to medium sized businesses in its primary trade area of the Virginia
counties of Shenandoah, Warren, Clarke, Frederick and the City of Winchester. As
a provider of community oriented financial services, the Bank does not attempt
to geographically diversify its loan portfolio by undertaking significant
lending activity outside its primary trade area.
The Bank's loan portfolio is summarized in table 4 for the periods
indicated.
Table 4 - Loan Portfolio
Loans at December 31, by year are summarized as follows:
2002 2001 2000 1999 1998
(dollars in thousands)
Commercial, Financial, and Agricultural $29,458 $42,101 $36,500 $26,907 $26,217
Real Estate Construction 12,172 9,648 8,836 10,205 5,415
Real Estate-Mortgage:
Residential (1-4 Family) 58,705 35,999 37,046 58,712 47,965
Non-Farm, Non-Residential 67,680 57,761 46,124 20,971 21,381
Secured by Farmland 2,112 2,094 1,791 1,489 851
Consumer 36,828 35,248 34,024 31,829 27,376
All Other Loans 5,648 3,893 1,990 670 513
Total Loans $212,603 $186,744 $166,311 $150,783 $129,718
Less Unearned Income --- 3 5 23 121
Less Allowance for Loan Losses 2,162 1,976 1,703 1,447 1,226
Loans-Net of Unearned Income and $210,441 $184,765 $164,603 $149,313 $128,371
Allowance for Loan Losses
As shown in Table 4 above, the total amount of commercial, financial
and agricultural loans decreased $12.6 million in 2002. Residential real estate
mortgage loans increased $22.7 million in 2002 after decreasing $0.7 million in
2001. Non-farm, non residential mortgage loans increased in 2002 by $9.9 million
and increased in 2001 by $11.6 million. The growth in the consumer loan area
continued in 2002 with an increase of $1.6 million compared to an increase of
$1.2 million in 2001.
There was no category of loans that exceeded 10% of outstanding loans
at December 31, 2002 which were not disclosed in Table 4.
18
Table 5 - Remaining Maturities of Selected Loans
At December 31, 2002
Commercial
Financial, and Real Estate
Agricultural Construction
------------ ------------
(dollars in thousands)
Within 1 Year: $15,966 $7,972
-------- ------
Variable Rate:
1 to 5 Years $2,585 $3,198
After 5 Years 1,650 - -
------- ------
Total $ 4,235 $3,198
------- ------
Fixed Rate:
1 to 5 Years $ 8,932 $1,002
After 5 Years 325 - -
------- -------
Total $ 9,257 $ 1,002
------- -------
Total Maturities $ 29,458 $ 12,172
======== ========
Asset Quality. The Allowance for Loan Losses ("ALL") balance was
$2,161,622 and $1,975,916 at December 31, 2002 and 2001, representing 1.02% and
1.06% of total loans, respectively. Non-performing assets totaled $191,854 and
$118,113 at December 31, 2002 and 2001, representing 8.88% and 5.98% of the
Allowance for Loan Losses, respectively.
Total losses charged against the ALL in 2002 were $249,987 compared to
$181,623 in 2001, and $165,135 in 2000. Recoveries, consisting of the recovery
of principal on loans previously charged against the allowance, totaled $30,693
in 2002, $34,683 in 2001, and $51,980 in 2000.
Management believes, based upon its review and analysis, that the Bank
has sufficient reserves to cover any projected losses within the total loan
portfolio.
19
Allowance for Loan Losses. Changes in the allowance for loan losses are
detailed in Table 6.
Table 6 - Allowance For Loan Losses
At December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Balance, Beginning of Period $1,976 $1,703 $1,447 $1,226 $1,112
Loans Charged-Off
Commercial, Financial and Agricultural -- -- 10 193 65
Real Estate-Construction -- -- -- -- --
Real Estate-Mortgage -- -- -- -- --
Residential (1-4 Family) -- 37 -- -- 30
Non-Farm, Non Residential -- -- -- -- --
Secured by Farmland -- -- -- -- --
Consumer 250 145 146 146 138
All Other Loans -- -- 9 -- --
Total Loans Charged Off 250 182 165 339 233
Recoveries
Commercial, Financial and Agricultural -- -- 4 30 --
Real Estate-Construction -- -- -- -- --
Real Estate-Mortgage -- -- -- -- --
Residential (1-4 Family) -- -- -- -- --
Non-Farm, Non-Residential -- -- -- -- --
Secured by Farmland -- -- -- -- --
Consumer -- 35 48 35 17
All Other Loans 31 -- -- -- --
Total Recoveries 31 35 52 65 17
Net Charge-Offs 219 147 113 274 216
Provision For Loan Losses 405 420 369 495 330
Balance, End of Period $2,162 $1,976 $1,703 $1,447 $1,226
Ratio of net charge-offs during the period
to average loans outstanding during the period 0.11% 0.08% 0.07% 0.20% 0.18%
For each period presented, the provision for loan losses charged to
operating expense was based on management's judgement after taking into
consideration all factors connected with the collectability of the existing
portfolio. Management considers economic conditions, changes in the nature and
value of the portfolio, industry standards and other relevant factors when
evaluating the loan portfolio. Specific factors considered by management when
determining the amount to be provided included internally generated loan quality
reports which analyze each problem loan to estimate amounts of probable loss and
previous loss experience with various loan categories.
20
Table 7 shows the balance and percentage of the Bank's allowance for
loan losses allocated to each major category of loans.
Table 7 - Allocation of Allowance For Loan Losses
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Allowance Total Loans Allowance Total Loans Allowance Total Loans Allowance Total Loans Allowance Total Loans
--------- ----------- --------- ----------- --------- ----------- --------- ----------- --------- -----------
(dollars in thousands)
Commercial,
Financial
And Agricultural $1,286 13.56% $518 22.44% $447 21.88% $251 17.84% $405 20.21%
Real Estate- 155 5.73% 0 5.14% 0 5.30% 0 6.77% 0 4.17%
Construction
Real Estate- 267 60.84% 918 51.56% 791 51.24% 738 53.83% 504 54.12%
Mortgage
Consumer 434 17.32% 521 18.79% 449 20.39% 447 21.11% 21.10%
298
All Other 20 2.55% 19 2.07% 16 1.19% 11 0.45% 19 .40%
------------------------------------------------------------------------------------------------------------------
$2,162 100.00% $1,976 100.00% $1,703 100.00% $1,447 100.00% $1,226 100.00%
==================================================================================================================
Non-Performing Assets. Management classifies as non-performing both
those loans on which payment has been delinquent 90 days or more and for which
there is a risk of loss to either principal or interest, and Other Real Estate
Owned. Other Real Estate Owned represents real property taken by the Bank either
through foreclosure or through a deed in lieu thereof from the borrower. Other
Real Estate Owned is booked at the lower of cost or market less estimated
selling costs, and is actively marketed by the Bank through brokerage channels.
Impairment of loans having recorded investments of $26,294 at December
31, 2002 and $80,783 at December 31, 2001 has been recognized in conformity with
FASB Statement No. 114. The average recorded investment in impaired loans during
2002 and 2001 was $47,520 and $58,722, respectively, while the total allowance
for loan losses related to these loans was $13,147 and $40,392, respectively.
Interest income on impaired loans recognized for cash payments received in 2001
were $3,136. There were no cash payments received on impaired loans in 2002 that
were recognized as interest income.
Nonaccrual loans excluded from impaired loan disclosure under FASB 114
amounted to $165,560 and $37,330 at December 31, 2002 and 2001, respectively. If
interest on these loans had been accrued, such income would have approximated
$4,511 and $500 for 2002 and 2001, respectively.
When a loan is placed on non-accrual status there are several negative
implications as a result. First, all interest accrued but unpaid at the time of
the classification is deducted from the interest income totals for the Bank.
Second, accruals of interest are discontinued until it becomes certain that both
principal and interest can be repaid. Third, there may be actual losses which
necessitate additional provisions for credit losses charged against earnings.
21
Table 8 - Non-Performing Assets
At December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Nonaccrual Loans $192 $118 $208 $34 $207
Restructured Loans -- -- -- -- --
Foreclosed Property -- -- -- 343 343
-----------------------------------------------------------
Total Nonperforming Assets $192 $118 $208 $377 $550
===========================================================
Loans Past Due 90 Days Accruing Interest $1,397 $988 $282 $126 $213
Allowance for Loan Losses to Period End Loans 1.02% 1.06% 1.02% 0.96% 0.95%
Nonperforming Assets to Period End Loans 0.09% 0.06% 0.13% 0.25% 0.42%
and Foreclosed Properties
Net Charge-Offs (Recoveries) to Average Loans 0.11% 0.08% 0.07% 0.20% 0.18%
The Bank has reserved $443,491 in the allowance for loan losses for
potential problem loans. These loans present potential risk of non-payment and
are not included in nonperforming assets above.
Securities. Securities at December 31, 2002 were $54.5 million, an
increase of $11.1 million or 25.7% from the $43.4 million at the end of 2001.
As of December 31, 2002, neither the Corporation nor the Bank held any
derivative financial instruments in their respective investment security
portfolios.
Table 9 summarizes the carrying value of the Corporation's securities
portfolio on the dates indicated.
Table 9 - Securities Portfolio
At December 31,
2002 2001 2000
---- ---- ----
Book Value: (dollars in thousands)
Securities Available for Sale
U.S. Government Securities $45,903 $33,929 $35,502
States and Political Subdivisions 6,236 6,726 6,822
Other Securities 2,346 2,700 2,507
---------------------------------------------
Total Securities $54,485 $43,355 $44,831
=============================================
22
Investment Portfolio Maturity Distribution/Yield Analysis
At December 31, 2002
Over Ten Years
One Year or One to Five Five to Ten And Equity
Less Years Years Securities Total
(dollars in thousands)
Available for Sale Securities
U.S. Government Securities
Amortized Cost 1,225 10,811 7,742 24,641 44,419
Market Value 1,254 11,430 7,887 25,332 45,903
Weighted Ave. Yield 5.04% 5.20% 4.57% 5.33%
State and Political Subdivisions
Amortized Cost 0 0 3,406 2,596 6,002
Market Value 0 0 3,560 2,676 6,236
Weighted Ave. Yield (1) 0.00% 0.00% 6.79% 6.80%
Other Securities
Amortized Cost 0 0 0 2,375 2,275
Market Value 0 0 0 2,346 2,346
Weighted Ave. Yield 0.00% 0.00% 0.00% 5.24%
Total Portfolio
Amortized Cost 1,225 10,811 11,148 29,512 52,696
Market Value 1,254 11,430 11,447 30,354 54,485
Weighted Ave. Yield (1) 5.04% 5.20% 5.25% 5.45%
(1) Yields on tax exempt securities have been computed on a tax-equivalent
basis.
This schedule has been prepared using the contractual maturities for
all securities with the exception of mortgaged-backed securities (MBS's) and
collateralized mortgage obligations (CMO's). Both MBS and CMO securities were
recorded using dealer median prepayment speed assumptions, which is an industry
standard.
Deposits. The Bank has made an effort in recent years to increase core
deposits and control costs of funds. Deposits provide funding for the
Corporation's investments in loans and securities, and the interest paid for
deposits must be managed carefully to control the level of interest expense.
Deposits at December 31, 2002 were $243.0 million, an increase of $45.5
million or 23.1% from $197.5 million at December 31, 2001. Savings and interest
bearing demand deposits increased $26.7 million or 33.2% while
non-interest-bearing demand deposits increased $9.7 million or 35.9% and time
deposits increased $9.1 million or 10.2%.
23
The following tables are a summary of average deposits and average
rates paid.
Table 10 - Average Deposits and Rates Paid
Year Ended December 31,
2002 2001 2000
(dollars in thousands)
Amount Rate Amount Rate Amount Rate
Noninterest Bearing Deposits $31,397 -- $23,981 -- $20,237 --
-------------- --------------- -------------
Interest Bearing Deposits
Interest Checking 35,598 1.91% $12,614 1.24% $12,083 1.31%
Money-Market 7,736 1.47% 6,588 2.42% 5,984 3.14%
Regular Savings 52,670 1.69% 61,210 3.33% 58,761 5.29%
Time Deposits
Less than $100,000 63,171 4.77% 56,584 5.67% 49,448 5.52%
$100,000 and more 29,118 4.38% 22,437 5.54% 15,889 5.96%
-------------- --------------- -------------
Total Interest Bearing $188,293 3.17% $159,433 4.27% $142,165 5.02%
-------------- --------------- -------------
Total $219,690 $183,414 $162,402
============== =============== =============
Maturities of CD's of $100,000 and More
Within Three to Six to Over
Three Six Twelve One
Months Months Months Year Total
(dollars in thousands)
At December 31, 2002 $8,454 $2,387 $5,655 $15,925 $32,421
Liquidity. Liquidity represents an institution's ability to meet
present and future financial obligations through either the sale or maturity of
existing assets or the acquisition of additional funds through liability
management. Liquid assets include cash, interest-bearing deposits with banks,
federal funds sold, investments in securities, and loans maturing within one
year. As a result of the Bank's management of liquid assets and the ability to
generate liquidity through liability funding, management believes that the Bank
maintains overall liquidity sufficient to satisfy its depositors' requirements
and to meet its customers' credit needs.
At December 31, 2002, cash, interest bearing and non-interest bearing
deposits with banks, federal funds sold, securities, and loans maturing within
one year were $66.7 million. As of December 31, 2002, approximately 22.3% or
$47.7 million of the loan portfolio would mature or reprice within a one year
period.
As of December 31, 2002, non-deposit sources of funds totaled $26.6
million, primarily comprised of Federal Home Loan Bank (FHLB) borrowings.
Activity during the year included monthly principal reductions associated with
the Principal Reducing Credit (PRC) advances. During 2001, the bank booked a new
borrowing in the amount of $300,000 in relation to a real estate transaction,
whereby the new branch site was purchased for the
24
Front Royal Financial Services Center. Certainly, the bank would not typically
utilize such financing; however, it was necessary to consummate the transaction.
Table 11 - Interest Sensitivity Analysis
(dollars in thousands)
Within 90-365 1 to 5 Over
90 days Days years 5 years
Total
----------------- ---------------- ----------------------------------- -----------------
Earning Assets
Loans (1) $ 18,231 $ 29,839 $ 140,413 $ 25,467 $ 213,950
Investment securities - 1,254 11,430 41,801 54,485
Deposits with other institution 1,138 - - - 1,138
Federal funds sold 2,791 - - - 2,791
----------------- ---------------- ----------------------------------- -----------------
Total earning assets $ 22,160 $ 31,093 $ 151,843 $ 67,268 $ 272,364
================= ================ =================================== =================
Interest-Bearing Liabilities
Interest bearing checking (2) $ - $ - $ 53,663 $ - $ 53,663
Savings (2) - - 45,391 - 45,391
Money market deposit 8,065 - - - 8,065
Time deposits 77 46,266 52,969 - 99,312
Long-term debt - 50 16,370 10,185 26,605
----------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 8,142 $ 46,316 $ 168,393 $ 10,185 $ 233,036
================= ==================================================== =================
Period gap 14,018 (15,223) (16,550) 57,083 39,328
Cumulative gap 14,018 (1,205) (17,755) 39,328
Ratio of cumulative gap to
Total earning assets 5.15% (0.44%) 6.52% 14.44%
(1) Includes nonaccrual loans and loans held for sale.
(2) The Bank has determined that interest checking and savings accounts are not
sensitive to changes in related market rates and, therefore, the Bank has placed
them in the 1 to 5 years category.
Capital Resources. The adequacy of the Corporation's capital is
reviewed by management on an ongoing basis with reference to the size,
composition, and quality of the Corporation's asset and liability levels and
consistent with regulatory requirements and industry standards. Management seeks
to maintain a capital structure that will assure an adequate level of capital to
support anticipated asset growth and absorb potential losses.
The Board of Governors of the Federal Reserve System has adopted
capital guidelines to supplement the existing definitions of capital for
regulatory purposes and to establish minimum capital standards. Specifically,
the guidelines categorize assets and off-balance sheet items into four risk
weighted categories. The minimum ratio of qualifying total capital to
risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital,
composed of common equity, retained earnings and a limited amount of perpetual
preferred stock, less certain goodwill items. The Corporation had a ratio of
risk-weighted assets to total capital of 11.42% at December 31, 2002 and a ratio
of
25
risk-weighted assets to Tier 1 capital of 10.43%. Both of these exceed the
capital requirements adopted by the federal regulatory agencies.
Table 12- Analysis of Capital
At December 31,
2002 2001 2000
(Dollars in Thousands)
Tier 1 Capital
Common Stock $3,950 $3,950 $3,950
Surplus 1,465 1,465 1,465
Retained Earnings 17,659 15,770 14,201
------------------------------------
Total Tier 1 Capital $23,074 $21,185 $19,616
Tier 2 Capital:
Allowance for Loan Losses (1) 2,162 1,976 1,703
------------------------------------
Total Risk Based Capital $25,236 $23,161 $21,319
====================================
Risk-Weighted Assets $221,050 $204,842 $173,967
Capital Ratios:
Tier 1 Risk-Based Capital Ratio 10.43% 10.34% 11.28%
Total Risk-Based Capital Ratio 11.42% 11.31% 12.26%
Tier 1 Capital to Average Total Assets 7.88% 8.97% 8.67%
(1) Limited to 1.25% of risk weighted assets.
Trust Preferred Capital Notes
On March 11, 2003, First National (VA) Statutory Trust I ("the Trust"),
a wholly-owned subsidiary of the Corporation, was formed for the purpose of
issuing redeemable capital securities. On March 26, 2003, $3 million of trust
preferred securities were issued through a pooled underwriting. The securities
have a LIBOR-indexed floating rate of interest. The interest rate at March 31,
2002 was 4.41%. The securities have a mandatory redemption date of March 26,
2033, and are subject to varying call provisions beginning March 26, 2008. The
principal asset of the Trust is $3 million of the Corporation's junior
subordinated debt securities with maturities and interest rates like the capital
securities.
The trust preferred securities may be included in Tier I capital for
regulatory capital adequacy purposes as long as their amount does not exceed 25%
of Tier I capital, including total trust preferred securities. The portion of
the trust preferred securities not considered as Tier I capital, if any, may be
included in Tier 2 capital. The total amount ($3 million) of trust preferred
securities issued by the Trust can be included in the Corporation's Tier I
capital.
Recent Accounting Pronouncements
In December 2001, the American Institute of Certified Public
Accountants ("AICPA") issued Statement of Position 01-6, "Accounting by Certain
Entities (Including Entities with Trade Receivables) That Lend to or Finance the
Activities of Others," to reconcile and conform the accounting and financial
reporting provisions established by various AICPA industry audit guides. This
Statement is effective for annual and interim financial statements issued for
fiscal years beginning after December 15, 2001, and did not have a material
impact on the Corporation's consolidated financial statements.
26
On March 13, 2002, the Financial Accounting Standard Board determined
that commitments for the origination of mortgage loans that will be held for
sale must be accounted for as derivatives instruments, effective for fiscal
quarters beginning after April 10, 2002. The Bank enters into commitments to
originate loans whereby the interest rate on the loan is determined prior to
funding. Such rate lock commitments on mortgage loans to be sold in the
secondary market are considered derivatives. Accordingly, these commitments,
including any fees received from the potential borrower, are recorded at fair
value in derivative assets or liabilities, with changes in fair value recorded
in the net gain or loss on sale of mortgage loans. Fair value is based on fees
currently charged to enter into similar agreements and, for fixed-rate
commitments, also considers the difference between current levels of interest
rates and the committed rates. The cumulative effect of adopting Statement No.
133 for rate lock commitments as of December 31, 2002, was not material. The
Corporation originally adopted Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities on January 1, 2001.
In April 2002, the Financial Accounting Standards Board issued
Statement 145, Rescission of FASB No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections. The amendment to Statement 13 eliminates an
inconsistency between the required accounting for sale-leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. The provisions of this Statement related to the rescission of
Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The
provisions of this Statement related to Statement 13 are effective for
transactions occurring after May 15, 2002, with early application encouraged.
In June 2002, the Financial Accounting Standards Board issued Statement
146, Accounting for Costs Associated with Exit or Disposal Activities. This
Statement requires recognition of a liability, when incurred, for costs
associated with an exit or disposal activity. The liability should be measured
at fair value. The provisions of the Statement are effective for exit or
disposal activities initiated after December 31, 2002.
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over their estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to
include in its scope core deposit intangibles of financial institutions.
Accordingly, such intangibles are subject to a recoverability test based on
undiscounted cash flows, and to the impairment recognition and measurement
provisions required for other long-lived assets held and used.
The adoption of Statement No. 145, 146 and 147 did not have a material
impact on the Corporation's consolidated financial statements.
The Financial Accounting Standards Board issued Statement No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of Statement No. 123, in December 2002. The Statement amends Statement
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, the Statement amends the disclosure requirements of Statement 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported
27
results. Finally, this Statement amends APB Opinion No. 28, Interim Financial
Reporting, to require disclosure about the effects of stock options in interim
financial information. The amendments to Statement No. 123 are effective for
financial statements for fiscal years ending after December 15, 2002. The
amendments to APB No. 28 are effective for financial reports containing
condensed financial statements for interim periods beginning after December 15,
2002. Early application is encouraged for both amendments. The Corporation
continues to record stock options under APB Opinion No. 25, Accounting for Stock
Issued to Employees, and has not adopted the alternative methods allowable under
Statement No. 148. There are presently no stock options outstanding.
Item 7. Financial Statements
Pursuant to General Instruction E(2) of form 10-KSB, the information
required by this Item is incorporated by reference from pages 18 to 44 of the
Corporation's Annual Report to Shareholders for the fiscal year ended December
31, 2002, as follows.
Page
Independent Auditor's Report 18
First National Corporation and Subsidiaries:
Consolidated Balance Sheets at December 31, 2002 and 2001 19
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000 20-21
Consolidated Statements of Cash Flows for the years
ended December 31, 2002, 2001 and 2000 22-23
Consolidated Statements of Changes in Stockholders'
Equity for the years ended December 31, 2002, 2001 and 2000 24
Notes to Consolidated Financial Statements 25-44
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
28
PART III
Item 9. Directors, Executive Officers Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act
Pursuant to General Instruction E(3) of Form 10-KSB, the information
contained under the headings "Election of Directors," "Nominees," "Executive
Officers Who Are Not Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Corporation's Proxy Statement for the 2003 Annual
Meeting of Shareholders is incorporated herein by reference.
Item 10. Executive Compensation
Pursuant to General Instruction E(3) of Form 10-KSB, the information
contained under the headings "Summary of Cash and Certain Other Compensation,"
"Directors' Fees" and "Employment Agreement" in the Corporation's Proxy
Statement for the 2003 Annual Meeting of Shareholders is incorporated herein by
reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Pursuant to General Instruction E(3) of Form 10-KSB, the information
contained under the headings "Security Ownership of Management" and "Security
Ownership of Certain Beneficial Owners" in the Corporation's Proxy Statement for
the 2003 Annual Meeting of Shareholders is incorporated herein by reference.
The Corporation does not have compensation plans or other arrangements
under which equity securities are authorized for issuance.
Item 12. Certain Relationships and Related Transactions
Pursuant to General Instruction E(3) of Form 10-KSB, the information
contained under the heading "Transactions with Management" in the Corporation's
Proxy Statement for the 2003 Annual Meeting of Shareholders is incorporated
herein by reference.
Item 13. Exhibits, List and Reports on Form 8-K
(a) The following documents are attached hereto or incorporated herein by
reference as Exhibits:
3.1 Articles of Incorporation, including amendments thereto
(incorporated herein by reference to Exhibit 2 to the
Corporation's Form 10 filed with the SEC on May 2, 1994).
3.2 Bylaws (incorporated herein by reference to Exhibit 3 to the
Corporation's Form 10 filed with the SEC on May 2, 1994).
4.1 Specimen of Common Stock Certificate (incorporated herein by
reference to Exhibit 1 to the Corporation's Form 10 filed with
SEC on May 2, 1994).
10.1 Employment Agreement, dated as of October 1, 2002, between the
Corporation and Harry S. Smith.
13.1 Annual Report to Shareholders for the year ended December 31,
2002.
21.1 Subsidiaries of the Corporation (incorporated herein by
reference to Exhibit 1 to the Company's Form 10-K filed with
SEC on April 2, 2001).
29
23.1 Consent of Yount, Hyde & Barbour, P.C.
99.1 Statement of Chief Executive Officer Pursuant to 18
U.S.C.ss.1350.
99.2 Statement of Chief Financial Officer Pursuant to 18
U.S.C.ss.1350.
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended December 31,
2002.
With the exception of the information herein expressly incorporated by
reference, the 2002 Annual Report to Shareholders and the Proxy Statement for
the 2003 Annual Meeting of Shareholders are not to be deemed filed as part of
this Annual Report on Form 10-KSB.
Item 14. Controls and Procedures
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this annual report.
Based on that evaluation, our principal executive officer and principal
financial officer have concluded that these controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are our controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosure.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
FIRST NATIONAL CORPORATION
Date: March 28, 2003 By: /s/ Harry S. Smith
------------------------ -------------------------------------------
Harry S. Smith
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Harry S. Smith President and March 28, 2003
----------------------------------- Chief Executive Officer
Harry S. Smith (Principal Executive Officer)
Director
/s/ Stephen C. Pettit Controller and Chief March 28, 2003
----------------------------------- Financial Officer (Principal
Stephen C. Pettit Financial and Accounting Officer)
/s/ Noel M. Borden Chairman of the Board March 28, 2003
----------------------------------- Director
Noel M. Borden
Vice Chairman of the Board
----------------------------------- Director
Douglas C. Arthur
Director
-----------------------------------
Dr. Byron A. Brill
/s/ Elizabeth H. Cottrell Director March 28, 2003
-----------------------------------
Elizabeth H. Cottrell
Director
-----------------------------------
Dr. James A. Davis
Director
-----------------------------------
Christopher E. French
31
Signature Title Date
--------- ----- ----
/s/ Charles E. Maddox, Jr. Director March 28, 2003
-----------------------------------
Charles E. Maddox, Jr.
/s/ John K. Marlow Director March 28, 2003
-----------------------------------
John K. Marlow
Director
-----------------------------------
W. Allen Nicholls
/s/ Henry L. Shirkey Director March 28, 2003
-----------------------------------
Henry L. Shirkey
Director
-----------------------------------
Alson H. Smith, Jr.
/s/ James R. Wilkins, III Director March 28, 2003
-----------------------------------
James R. Wilkins, III
SECTION 302 CERTIFICATION
I, Harry S. Smith, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of the First
National Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
32
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors:
a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial
data and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003 /s/ Harry S. Smith
---------------- --------------------------------------------
Harry S. Smith, President & Chief Executive
Officer
SECTION 302 CERTIFICATION
I, Stephen C. Pettit, Senior Vice President and Chief Financial
Officer, certify that:
1. I have reviewed this annual report on Form 10-KSB of First
National Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
33
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors :
a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial
data and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 27, 2003 /s/ Stephen C. Pettit
---------------- --------------------------------------------
Stephen C. Pettit, Sr. Vice President
and Chief Financial Officer
34
EXHIBIT INDEX
Number Document
------ --------
3.1 Articles of Incorporation, including amendments thereto
(incorporated herein by reference to Exhibit 2 to the
Corporation's Form 10 filed with the SEC on May 2, 1994).
3.2 Bylaws (incorporated herein by reference to Exhibit 3 to the
Corporation's Form 10 filed with the SEC on May 2, 1994).
4.1 Specimen of Common Stock Certificate (incorporated herein by
reference to Exhibit 1 to the Corporation's Form 10 filed with
SEC on May 2, 1994).
10.1 Employment Agreement, dated as of October 1, 2002, between the
Corporation and Harry S. Smith.
13.1 Annual Report to Shareholders for the year ended December 31,
2002.
21.1 Subsidiaries of the Corporation (incorporated herein by
reference to Exhibit 1 to the Company's Form 10-K filed with
SEC on April 2, 2001).
23.1 Consent of Yount, Hyde & Barbour, P.C.
99.1 Statement of Chief Executive Officer Pursuant to 18
U.S.C.ss.1350.
99.2 Statement of Chief Financial Officer Pursuant to 18
U.S.C.ss.1350.
35