<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission File Number: 000-24853
FRONTIER NATIONAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Alabama 72-1355228
(State of Incorporation) (IRS Employer Identification No.)
43 N. Broadway
Sylacauga, AL 35150
(Address of Principal Executive Office)
334-644-5419
(Issuer's telephone number, including area code)
Valley National Corporation, 1011 N. Lanier Avenue, Lanett, AL 36863
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class A, Common Stock, .001 par Outstanding at October 31, 1998: 2,262,846
<PAGE>
FRONTIER NATIONAL CORPORATION
September 30, 1998 Form 10-Q
TABLE OF CONTENTS
Page No.
--------
Part 1. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Comprehensive Income 5
Consolidated Statements of Cash Flows 6
Consolidated Statement of Shareholder's Equity 7
Notes to Consolidated Financial Statements 8 - 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10 - 14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 15
PART 2. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
(UNAUDITED) DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
ASSETS
CASH AND DUE FROM BANKS $ 6,806,789 $ 4,892,409
FEDERAL FUNDS SOLD 10,955,000 2,040,000
SECURITIES AVAILABLE FOR SALE 48,592,274 24,125,028
LOANS, NET OF UNEARNED INCOME 138,699,489 96,631,213
ALLOWANCE FOR LOAN LOSSES (1,527,608) (1,120,012)
PREMISES AND EQUIPMENT, NET 5,152,474 2,259,006
CASH SURRENDER VALUE ON LIFE INSURANCE 4,776,856 3,030,465
ACCRUED INTEREST 1,527,853 864,137
INTANGIBLE ASSETS, NET 1,471,806 1,450,925
OTHER ASSETS 1,206,517 792,963
------------ ------------
TOTAL ASSETS $217,661,450 $134,966,134
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
DEPOSITS:
NON-INTEREST BEARING DEPOSITS $ 23,738,853 $ 15,586,562
INTEREST BEARING DEPOSITS 142,528,487 85,271,218
------------ ------------
TOTAL DEPOSITS 166,267,340 100,857,780
------------ ------------
SHORT-TERM BORROWINGS 1,542,232 -
NOTES PAYABLE 24,292,000 19,042,000
ACCRUED INTEREST & OTHER LIABILITIES 2,398,900 998,536
------------ ------------
TOTAL LIABILITIES 194,500,472 120,898,316
------------ ------------
SHAREHOLDERS' EQUITY
COMMON STOCK ($.001 PAR VALUE; 10,000,000 SHARES
AUTHORIZED, 2,272,346 ISSUED AND OUTSTANDING AT
SEPTEMBER 30, 1998; $10 PAR VALUE, 120,000 SHARES
AUTHORIZED, 100,995 ISSUED AND OUTSTANDING AT
DECEMBER 31, 1997) 2,272 1,200,000
TREASURY STOCK,
AT COST (19,005 SHARES AT DECEMBER 31, 1997) - (1,409,957)
ADDITIONAL PAID-IN CAPITAL 14,048,592 1,008,739
RETAINED EARNINGS 8,310,181 12,975,719
ACCUMULATED COMPREHENSIVE INCOME: NET UNREALIZED
HOLDING GAINS ON SECURITIES AVAILABLE FOR SALE,
NET OF DEFERRED INCOME TAX 799,933 293,317
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 23,160,978 14,067,818
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $217,661,450 $134,966,134
============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE>
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
--------------- -------------- -------------- --------------
1998 1997 1998 1997
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
INTEREST INCOME
INTEREST AND FEES ON LOANS $2,652,997 $2,432,659 $7,810,843 $7,006,762
INTEREST ON INVESTMENT SECURITIES
TAXABLE SECURITIES 124,573 266,787 512,545 767,855
NONTAXABLE SECURITIES 399,047 128,915 806,922 385,122
INTEREST EARNED ON DEPOSIT ACCOUNTS 4,315 494 16,387 2,374
INTEREST EARNED ON FEDERAL FUNDS SOLD 162,113 6,806 311,882 39,767
-------------- ------------- ------------- -------------
TOTAL INTEREST INCOME 3,343,045 2,835,661 9,458,579 8,201,880
INTEREST EXPENSE
INTEREST ON DEPOSITS 1,264,188 965,672 3,384,597 2,749,717
INTEREST ON BORROWED FUNDS 315,606 192,287 879,540 646,692
-------------- ------------- ------------- -------------
TOTAL INTEREST EXPENSE 1,579,794 1,157,959 4,264,137 3,396,409
NET INTEREST INCOME 1,763,251 1,677,702 5,194,442 4,805,471
PROVISION FOR LOAN LOSSES (194,144) (193,325) (790,944) (473,305)
-------------- ------------- ------------- -------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,569,107 1,484,377 4,403,498 4,332,166
NONINTEREST INCOME
SERVICE CHARGES ON DEPOSIT ACCOUNTS 242,167 211,297 745,924 638,719
INSURANCE COMMISSIONS 125,289 - 186,314 -
OTHER OPERATING INCOME 150,923 95,849 406,146 284,140
INVESTMENT SECURITIES GAINS - (468) 60,172 6,333
-------------- ------------- ------------- -------------
TOTAL NONINTEREST INCOME 518,379 306,678 1,398,556 929,192
NONINTEREST EXPENSE
SALARIES AND EMPLOYEE BENEFITS 784,382 643,052 2,543,876 1,925,135
NET OCCUPANCY EXPENSE 255,496 237,944 660,727 667,964
OTHER OPERATING EXPENSES 587,322 384,889 1,390,676 1,159,179
-------------- ------------- ------------- -------------
TOTAL NONINTEREST EXPENSES 1,627,200 1,265,885 4,595,279 3,752,278
INCOME BEFORE INCOME TAXES 460,286 525,170 1,206,775 1,509,080
PROVISION FOR INCOME TAXES (141,427) (159,751) (265,417) (516,828)
-------------- ------------- ------------- -------------
NET INCOME $318,859 $365,419 $941,358 $992,252
============== ============= ============= =============
BASIC EARNINGS PER COMMON SHARE $0.18 $0.25 $0.63 $0.68
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 1,794,094 1,457,546 1,504,392 1,457,546
EARNINGS PER COMMON SHARE ASSUMING DILUTION $0.18 $0.25 $0.62 $0.68
WEIGHTED AVERAGE SHARES
OUTSTANDING ASSUMING DILUTION 1,809,502 1,457,546 1,509,584 1,457,546
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
----------- -----------
1998 1997
----------- -----------
<S> <C> <C>
NET INCOME $ 941,358 $ 992,252
OTHER COMPREHENSIVE, NET OF TAX:
UNREALIZED GAINS ON SECURITIES:
UNREALIZED HOLDING GAINS (LOSSES) ARISING DURING THE PERIOD 476,668 102,005
LESS: RECLASSIFICATION ADJUSTMENTS FOR GAINS INCLUDED IN NET INCOME (60,172) (6,333)
----------- -----------
NET UNREALIZED GAINS 416,496 95,672
INCOME TAX RELATED TO ITEMS OF OTHER COMPREHENSIVE INCOME (120,146) (36,833)
----------- -----------
OTHER COMPREHENSIVE INCOME 296,350 58,839
COMPREHENSIVE INCOME $ 1,237,708 $ 1,051,091
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
</TABLE>
<PAGE>
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
------------------------------------
1998 1997
------------ -----------
<S> <C> <C>
OPERATING ACTIVITIES:
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 1,834,667 $ 1,483,858
INVESTING ACTIVITIES:
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE 7,827,139 5,787,608
PURCHASES OF SECURITIES AVAILABLE FOR SALE (13,212,172) (4,158,294)
FEDERAL FUNDS SOLD, NET (8,463,000) (1,730,000)
NET DECREASE IN LOANS TO CUSTOMERS 6,393,020 (9,250,456)
CAPITAL EXPENDITURES (839,687) (239,375)
PROCEEDS FROM SALES OF FIXED ASSETS 20,200 -
PROCEEDS FROM SALES OF FORECLOSED REAL ESTATE - 2,624
EFFECT OF BUSINESS COMBINATION 3,970,156 -
------------ -----------
NET CASH USED BY INVESTING ACTIVITIES (4,304,344) (9,587,893)
------------ -----------
FINANCING ACTIVITIES
NET INCREASE (DECREASE) IN NONINTEREST BEARING DEPOSITS (1,864,175) (157,101)
NET INCREASE IN INTEREST BEARING DEPOSITS 5,129,875 1,723,225
NET INCREASE IN SHORT-TERM BORROWINGS 1,433,929 (3,440,000)
PURCHASES OF TREASURY STOCK - (15,000)
DIVIDENDS PAID (565,572) (303,105)
PROCEEDS FROM NOTES PAYABLE 5,000,000 10,600,000
PAYMENTS ON NOTES PAYABLE (4,750,000) (1,250,000)
------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,384,057 7,158,019
------------ -----------
NET INCREASE (DECREASE IN CASH AND DUE FROM BANKS) 1,914,380 (946,016)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,892,409 5,755,747
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 6,806,789 $ 4,809,731
============ ===========
SUPPLEMENTAL DISCLOSURES: THE FOLLOWING CONDENSED BALANCES WERE
TRANSFERRED DURING THE BUSINESS COMBINATION THAT OCCURRED ON
AUGUST 24, 1998 (SEE NOTE E - BUSINESS COMBINATION)
SECURITIES AVAILABLE FOR SALE $ 18,697,117
LOANS, NET OF UNEARNED INCOME $ 48,461,296
PREMISES AND EQUIPMENT, NET $ 2,418,524
OTHER ASSETS $ 2,336,025
DEPOSITS $ 62,143,860
BORROWINGS $ 5,108,303
OTHER LIABILITIES $ 737,805
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE>
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON CAPITAL RETAINED COMPREHENSIVE TREASURY
STOCK SURPLUS EARNINGS INCOME STOCK TOTAL
----------- ----------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT
DECEMBER 31, 1997 $ 1,200,000 $ 1,008,739 $12,975,719 $293,317 $(1,409,957) $14,067,818
CASH DIVIDENDS -
COMMON - - (789,129) - - (789,129)
EFFECT OF
BUSINESS COMBINATION (1,197,872) 9,713,944 (81,757) 210,266 - 8,644,581
RETIREMENT OF
TREASURY STOCK - - (1,409,957) - 1,409,957 -
ISSUANCE OF 144,611
SHARES OF STOCK
FROM STOCK DIVIDEND 144 3,325,909 (3,326,053) - - -
NET CHANGE IN
UNREALIZED GAINS
ON SECURITIES - - - 296,350 - 296,350
NET INCOME - 1998 - - 941,358 - - 941,358
--------- ----------- ----------- -------- --------- -----------
BALANCE AT
SEPTEMBER 30, 1998 $ 2,272 $14,048,592 $ 8,310,181 $799,933 $ - $23,160,978
=========== =========== =========== ======== =========== ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
SEPTEMBER 30, 1998
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Frontier National
Corporation (the "Company")(formerly Valley National Corporation) and its
wholly-owned subsidiaries, Valley National Bank, First National America's Bank,
and Frontier Financial Services Corporation, collectively, the Bank. The
accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the nine-month period ended September 30, 1998, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. For further information, refer to the consolidated financial
statements and footnotes thereto for Valley National Corporation and First
National Sylacauga Corporation for the year ended December 31, 1997, included in
the Registration Statement on Form S-4 filed in July, 1998.
NOTE B - INCOME TAXES
The effective tax rate of approximately 22 percent for the nine months ended
September 30, 1998, is less than the statutory rate principally because of the
effect of tax-exempt interest income.
NOTE C - INVESTMENT SECURITIES
The Company applies the accounting and reporting requirements of Statement of
Financial Accounting Standards No. 115, Accounting for Certain Investments in
Debt and Equity Securities ("SFAS115"). This pronouncement requires that all
investments in debt securities be classified as either "held-to-maturity"
securities, which are reported at amortized cost; trading securities, which are
reported at fair value, with unrealized gains and losses included in earnings;
or "available-for-sale" securities, which are reported at fair value, with
unrealized gains and losses excluded from earnings and reported in a separate
component of shareholders' equity (net of deferred tax effect).
At September 30, 1998, the Company had net unrealized gains of $1,212,018 in
available-for-sale securities which are reflected in the presented assets and
resulted in an increase in shareholders' equity of $799,933, net of deferred tax
liability. There were no trading securities. The net increase in shareholders'
equity as a result of the SFAS 115 adjustment from December 31, 1997 to
September 30, 1998 was $296,350. See also Note D - Shareholders' Equity.
8
<PAGE>
NOTE D - SHAREHOLDERS' EQUITY
During 1998, the Company merged with First National Sylacauga Corporation (See
Note E - Business Combination) resulting in an increase in shareholders' equity
of $8,644,581. Additionally, cash dividends of $789,129 are reflected as a
charge against equity during the first nine months of 1998. Treasury stock of
$1,409,957 was retired and a stock dividend of 144,611 shares was issued,
neither of which affected total shareholders' equity. See also Note F - Stock
Dividend.
NOTE E - BUSINESS COMBINATION
On August 24, 1998, the Company merged with First National Sylacauga Corporation
("FNSC"). FNSC was a bank holding company which owned 100% of First National
America's Bank, a national bank of approximately $136 million in assets. The
merger was effected as a reverse purchase acquisition of the Company by FNSC,
whereby, the financial statements reflect the ongoing operations of FNSC
combined with the accounts of the Company as of the merger date and thereafter.
Operating results and balance sheet information prior to the merger reflect only
the balances of FNSC. The impact of the merger on financial condition was an
increase to FNSC total assets of approximately $76 million and an increase in
liabilities and equity of approximately $67.4 million and $8.6 million,
respectively.
NOTE F - STOCK DIVIDEND
In September, 1998, the Company's Board of Directors declared a 6.8 percent
common stock dividend to shareholders of record as of September 21, 1998. This
stock dividend resulted in the issuance of an additional 144,611 shares of the
Company's common stock. Total shareholders' equity was unaffected from this
stock dividend.
NOTE G - PENDING BUSINESS COMBINATIONS
On September 24, 1998, the company signed Letters of Intent to purchase two
insurance agencies. Brown Insurance Agency located in Sylacauga, Alabama will
be purchased with cash for $219,175 and accounted for by the purchase method of
accounting. Wright-Sprayberry, Inc. also located in Sylacauga, Alabama will be
purchased for $986,783 with 49,339 shares of Frontier National Corporation stock
and accounted for by the pooling of interest method of accounting. All real
estate will be purchased with cash at fair market values.
NOTE H - STOCK OPTIONS
On August 24, 1998, options to purchase 100,000 shares of common stock were
granted at an option price of $10 per share.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion is intended to assist an understanding of the Company and its
Subsidiaries' financial condition and results of operations. Unless the context
otherwise indicates, "the Company" shall include the Company and its
Subsidiaries. This analysis should be read in conjunction with the financial
statements and related notes appearing in Item 1 of the September 30, 1998 Form
10-Q.
FINANCIAL CONDITION
September 30, 1998 compared to December 31, 1997
Loans
Loans comprised the largest single category of the Company's earning assets
on September 30, 1998. Loans, net of unearned income and reserve for loan
losses, were 63.02% of total assets at September 30, 1998 and 70.76% of total
assets at December 31, 1997. Total net loans were $137,171,881 at September 30,
1998, representing a 43.62% increase from the December 31, 1997 total of
$95,511,201. This increase is the result of the merger with Valley National
Corporation on August 24, 1998.
Investment Securities and Other Earning Assets
The investment securities portfolio is used to make various term
investments, to provide a source of liquidity and to serve as collateral to
secure certain government deposits. Federal funds sold are a tool in managing
the daily cash position of the company. Investment securities and federal funds
sold increased $33,382,246 from December 31, 1997 to September 30, 1998. This
increase was due primarily to the merger with Valley National Corporation and
deposit growth. Investment securities and federal funds sold at September 30,
1998 were $59,547,274 compared with $26,165,028 at December 31, 1997, reflecting
a 127% increase.
Asset Quality
Between December 31,1997 and September 30,1998, the Company experienced an
improvement in the quality of its assets as measured by three key ratios. The
ratio of loan loss allowance to total nonperforming assets (defined as
nonaccrual loans, loans past due 90 days or greater, restructured loans,
nonaccruing securities, and other real estate) improved from 0.811 to 1.30. The
ratio of nonperforming assets to total assets decreased from 0.0090 to 0.0054,
the ratio of nonperforming loans to total loans decreased to 0.00856 from
.01307. These ratios improved due to a decrease in past dues and nonaccruals.
All three ratios are favorable as compared to industry averages, and management
is aware of no factors that would suggest that they are prone to erosion in
future periods.
10
<PAGE>
Deposits
Total deposits of $166,267,340 at September 30, 1998 increased $65,409,560
(64.85%) over total deposits of $100,857,780 at year-end 1997. Deposits are the
Company's primary source of funds with which to support its earning assets.
Noninterest-bearing deposits increased $8,152,291 or 52.30% from year-end 1997
to September 30, 1998, and interest-bearing deposits increased $57,257,269
(67.15%) from year-end 1997. Deposit growth consisted of $62,143,860 of
deposits purchased during the merger with Valley National Corporation.
Long-term Debt
At September 30, 1998 and December 31, 1997, the Company had notes payable
totaling $24,292,000, and $19,042,000, respectively.
Maturities of long-term debt for the years ending December 31 are as follows:
1998 $ 5,750,000
1999 1,500,000
2000 1,100,000
2001 350,000
2002 10,000,000
Thereafter 5,592,000
-----------
Total $24,292,000
===========
Shareholders' Equity
Company shareholders' equity increased $9,093,160 from December 31, 1997 to
September 30, 1998, due to the effect of the business combination of
$8,644,581, net income of $941,358, the declaration of cash dividends of
$789,129 and the increase of unrealized gains on securities available for sale
totaling $296,350 net of deferred tax liability.
Liquidity Management
Liquidity is defined as the ability of a company to convert assets into
cash or cash equivalents without significant loss. Liquidity management
involves maintaining the Bank's ability to meet the day-to-day cash flow
requirements of its customers, whether they are depositors wishing to withdraw
funds or borrowers requiring funds to meet their credit needs. Without proper
liquidity management, the Bank would not be able to perform the primary function
of a financial intermediary and would, therefore, not be able to meet the
production and growth needs of the communities it serves.
The primary function of asset and liability management is not only to
assure adequate liquidity in order for the Bank to meet the needs of its
customer base, but to maintain an appropriate balance between interest-sensitive
assets and interest-sensitive liabilities so that the Bank can also meet the
investment requirements of its shareholders. Daily monitoring of the sources
and uses of funds is necessary to maintain an acceptable cash position that
meets both requirements. In the banking environment, both assets and
liabilities are considered sources of liquidity funding and both are, therefore,
monitored on a daily basis.
11
<PAGE>
The asset portion of the balance sheet provides liquidity primarily through
loan principal repayments on sales of investment and trading account securities.
Loans that mature in one year or less equaled approximately $60,989,000 or 44%
of the total loan portfolio at September 30, 1998 and there are no investment
securities maturing within one year. Other sources of liquidity include short-
term investments such as federal funds sold.
The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts.
At September 30, 1998, funds were also available through the purchase of federal
funds from correspondent commercial banks from available lines of up to an
aggregate of $14,700,000. Each of the company's subsidiary banks is a member of
the Federal Home Loan Bank of Atlanta. Membership provides the company with
additional lines of credit for liquidity needs.
Capital Resources
A strong capital position is vital to the continued profitability of the
Company because it promotes depositor and investor confidence and provides a
solid foundation for future growth of the organization. The Company has
provided the majority of its capital requirements through the retention of
earnings.
Bank regulatory authorities are placing increased emphasis on the
maintenance of adequate capital. In 1990, new risk-based capital requirements
became effective. The guidelines take into consideration risk factors, as
defined by regulators, associated with various categories of assets, both on and
off the balance sheet. Under the guidelines, capital strength is measured in
two tiers which are used in conjunction with risk-adjusted assets to determine
the risk-based capital ratios. The Company's Tier I capital, which consists of
common equity less goodwill, amounted to $19,858,000 at September 30, 1998.
Tier II capital components include supplemental capital components such as
qualifying allowance for loan losses and qualifying subordinated debt. Tier I
capital plus the Tier II capital components is referred to as Total Risk-Based
capital and was $21,385,000 at September 30, 1998.
The Company's current capital positions exceed the new guidelines.
Management has reviewed and will continue to monitor the Company's asset mix and
product pricing, and the loan loss allowance, which are the areas determined to
be most affected by these new requirements.
RESULTS OF OPERATIONS
Nine months ended September 30, 1998 and 1997
Summary
Net earnings of the company for the nine months ended September 30, 1998
were $941,358 compared to $992,252 for the same period in 1997, representing a
5.13% decrease. This decrease was due principally to the increase of provision
for loan losses and noninterest expenses in excess of net interest income and
noninterest income. The increase in noninterest expense is a result of expenses
incurred for the preparation of the merger that occurred on August 24, 1998 with
Valley National Corporation. The $317,639 increase in the provision for loan
losses is a result of a charge-off of loans and the replenishment of the loan
loss reserve at Frontier Financial Services, Inc., a subsidiary of First
National America's Bank. The decline in earnings is expected to be purely
short-term as the company realizes efficiencies as a result of the merger with
Valley National Corporation.
12
<PAGE>
Net Interest Income
Net interest income, the difference between interest earned on assets and
the cost of interest-bearing liabilities, is the largest component of the
Company's net income. Revenue from earning assets of the Company during the
nine months ended September 30, 1998 increased $1,256,699 (15.32%) from the same
period in 1997. This increase was due to higher average outstanding balances of
earning assets. Interest expense for the nine months ended September 30, 1998
increased $867,728 or 25.54% over the corresponding period of 1997. As a result
of these factors, net interest income increased $388,971 or 8.09% in the nine
months ended September 30, 1998, compared to the same period of 1997.
Provision for Loan Losses
The provision for loan losses represents the charge against current
earnings necessary to maintain the reserve for loan losses at a level which
management considers appropriate. This level is determined based upon Bank's
historical charge-offs, management's assessment of current economic conditions,
the composition of the loan portfolio and the levels of nonaccruing and past due
loans. The provision for loan losses was $790,944 for the nine months ended
September 30, 1998 compared to $473,305 for the same period of 1997. Charge-
offs exceeded recoveries by $881,000 for the nine months ended September 30,
1998. The reserve for loan losses as a percent of outstanding loans, net of
unearned income, was 1.10% at September 30, 1998 compared to 1.16% at year-end
1997.
Noninterest Income
Noninterest income for the nine months ended September 30, 1998 was
$1,398,556 compared to $929,192 for the same period of 1997. This 50.51%
increase was primarily due to an increase in insurance commissions realized of
$186,314 in the first nine months of 1998 as compared to the same period of
1997. Significant components of noninterest income are as follows: Service
charges on deposits increased $107,205 (16.78%), insurance commissions increased
$186,314, security gains of $60,172 were realized, as opposed to $6,333 of gains
in the first nine months of 1997, and other operating income increased $122,006.
Noninterest Expenses
Noninterest expenses for the nine months ended September 30, 1998 were
$4,595,279 reflecting a 22.47% increase over the same period of 1997. The
primary components of noninterest expenses are salaries and employee benefits,
which increased to $2,543,876 for the nine months ended September 30, 1998,
32.14% higher than in the same period of 1997. Occupancy costs decreased $7,237
primarily because many depreciable assets became fully depreciated at the end of
last year causing depreciation expense to decrease. The company has invested
extensively this year in data processing equipment in preparation for the
merger, the combination of each subsidiary's data processing functions and
preparation for the year 2000. Because of this investment, occupancy costs are
expected to increase going forward.
13
<PAGE>
Income Taxes
The Company attempts to maximize its net income through active tax
planning. The provision for income taxes of $265,417 for the nine months ended
September 30, 1998 decreased $251,411 compared to the same period of 1997, due
to the decrease in income before tax and an increase in nontaxable interest
income. Taxes as a percent of earnings decreased from 34% to 22%. The
effective tax rate of approximately 22% is less than the statutory rate
principally because of the effect of tax-exempt interest income.
14
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk arising from adverse changes in the fair value of
financial instruments due to a change in interest rates, exchange rates and
equity prices. Frontiers' primary risk is interest rate risk.
The primary objective of Asset/Liability Management at Frontier is to
manage interest rate risk and achieve reasonable stability in net interest
income throughout interest rate cycles. This is achieved by maintaining the
proper balance of rate sensitive earning assets and rate sensitive liabilities.
The relationship of rate sensitive earning assets to rate sensitive liabilities
is the principal factor in projecting the effect that fluctuating interest rates
will have on future net interest income. Rate sensitive earning assets and
interest-bearing liabilities are those that can be repriced to current market
rates within a relatively short time period. Management monitors the rate
sensitivity of earning assets and interest-bearing liabilities over the entire
life of these instruments, but places particular emphasis on the first year and
through three years. Frontier's Asset/Liability Management policy requires
cumulative gap (the ratio of rate sensitive assets to rate sensitive
liabilities) to stay within a +/-20%. At September 30, 1998, Frontier's
cumulative gap is well within this range through a five-year time frame with the
one-year cumulative gap at +4%, the two-year at +5% and the three-year at +3%.
Frontier has not experienced a high level of volatility in net interest
income primarily because of the relatively large base of core deposits that do
not reprice on a contractual basis. These deposit products include regular
savings, interest-bearing transaction accounts and money market savings
accounts. Balances for these accounts are reported based on historical
repricing experienced at each bank. However, the rates paid are typically not
directly related to market interest rates, since management has some discretion
in adjusting these rates as market rates change.
Frontier uses additional tools to monitor and manage interest rate
sensitivity. One of the primary tools is simulation analysis. Simulation
analysis is the primary method of estimating earnings at risk and capital at
risk under varying interest rate conditions. Simulation analysis is used to
test the sensitivity of Frontier's net interest income and stockholders' equity
to both the level of interest rates and the slope of the yield curve.
Simulation analysis accounts for the expected timing and magnitude of assets and
liability cash flows, as well as the expected timing and magnitude of deposits
that do not reprice on a contractual basis. In addition, simulation analysis
includes adjustments for the lag between movements in market interest rates on
loans and interest-bearing deposits. These adjustments are made to reflect more
accurately possible future cash flows, repricing behavior and ultimately net
interest income. Although net income is not materially impacted during
simulation analysis under different rate scenarios, Frontier is slightly asset
sensitive meaning that net interest income would increase with an increase in
interest rates.
15
<PAGE>
PART 2. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 - Articles of Incorporation of Frontier
National Corporation*
3.2 - By-Laws of Frontier National Corporation*
4.0 - Form of Common Stock Certificate*
11.0 - Statement of Computation of Per Share Earnings
27.0 - Financial Data Schedule
(b) Reports on Form 8-K
During the quarter ended September 30, 1998, Frontier National
Corporation filed the following reports on Form 8-K:
Current Report on Form 8-K filed with the Securities and Exchange
Commission dated September 24, 1998, reporting under Item 5 (Other
Events) the signing of Letters of Intent to acquire Wright-
Sprayberry, Inc. and Brown Insurance Agency, Inc. and filing under
Item 7(c) (Exhibits) a press release announcing a 6.8% stock
dividend, a $.14 regular cash dividend and a $.05 special cash
dividend to all shareholders of record as of September 21, 1998.
* Filed previously with S-4 Registration Statement No. 333-52465, dated May 12,
1998.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTIER NATIONAL CORPORATION
By: /s/ STEVEN R. TOWNSON
------------------------------------
Steven R. Townson
President and Chief Operating Officer
17
<PAGE>
EXHIBIT 11
FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
The following tabulation presents the calculation of basic and diluted earnings
per common share for the three and nine-month periods ended September 30, 1998
and 1997. Average shares outstanding have been retroactively adjusted on an
equivalent share basis for the effects of the business combination and the stock
dividend as discussed in the notes to consolidated financial statements.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30 Ended September 30
------------------------ -----------------------
1998 1997 1998 1997
------------ ---------- ----------- ----------
<S> <C> <C> <C> <C>
Basic net income..................... $ 318,859 $ 365,419 $ 941,358 $ 992,252
========== ========== ========== ==========
Basic earnings on common shares...... $ 318,859 $ 365,419 $ 941,358 $ 992,252
========== ========== ========== ==========
Weighted average common shares
outstanding-basic.................. 1,794,094 1,457,546 1,504,392 1,457,546
========== ========== ========== ==========
Basic earnings per common share...... $ .18 $ .25 $ .63 $ .68
========== ========== ========== ==========
Basic net income per common share.... $ .18 $ .25 $ .63 $ .68
========== ========== ========== ==========
Diluted net income................... $ 318,859 $ 365,419 $ 941,358 $ 992,252
========== ========== ========== ==========
Diluted earnings on common shares.... $ 318,859 $ 365,419 $ 941,358 $ 992,252
========== ========== ========== ==========
Weighted average common shares
outstanding-diluted................ 1,809,502 1,457,546 1,509,584 1,457,546
========== ========== ========== ==========
Diluted earnings per common share.... $ .18 $ .25 $ .62 $ .68
========== ========== ========== ==========
Diluted net income per common share.. $ .18 $ .25 $ .62 $ .68
========== ========== ========== ==========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 6,052,915
<INT-BEARING-DEPOSITS> 753,874
<FED-FUNDS-SOLD> 10,955,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 48,592,274
<INVESTMENTS-CARRYING> 47,380,256
<INVESTMENTS-MARKET> 48,592,274
<LOANS> 138,699,489
<ALLOWANCE> 1,527,608
<TOTAL-ASSETS> 217,661,450
<DEPOSITS> 166,267,340
<SHORT-TERM> 1,542,232
<LIABILITIES-OTHER> 2,398,900
<LONG-TERM> 24,292,000
0
0
<COMMON> 2,272
<OTHER-SE> 23,158,706
<TOTAL-LIABILITIES-AND-EQUITY> 217,661,450
<INTEREST-LOAN> 7,810,843
<INTEREST-INVEST> 1,319,467
<INTEREST-OTHER> 328,269
<INTEREST-TOTAL> 9,458,579
<INTEREST-DEPOSIT> 3,384,597
<INTEREST-EXPENSE> 4,264,137
<INTEREST-INCOME-NET> 5,194,442
<LOAN-LOSSES> 790,944
<SECURITIES-GAINS> 60,172
<EXPENSE-OTHER> 4,595,279
<INCOME-PRETAX> 1,206,775
<INCOME-PRE-EXTRAORDINARY> 1,206,775
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 941,358
<EPS-PRIMARY> .63
<EPS-DILUTED> .62
<YIELD-ACTUAL> 0
<LOANS-NON> 394,000
<LOANS-PAST> 448,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,120,012
<CHARGE-OFFS> 1,129,000
<RECOVERIES> 248,000
<ALLOWANCE-CLOSE> 1,527,608
<ALLOWANCE-DOMESTIC> 1,527,608
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
