10-Q 1 d10q.txt QUARTERLY FINANCIAL REPORT 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 MARCH 31, 2001 [_] 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) 256-401-2041 (Issuer's telephone number, including area code) (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 __X__ No ____ 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 April 30, 2001: 3,424,329 FRONTIER NATIONAL CORPORATION March 31, 2001 Form 10-Q TABLE OF CONTENTS

PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES

See notes to consolidated financial statements. 2 CONSOLIDATED STATEMENTS OF INCOME FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES Three Months Ended March 31, 2001 (Unaudited)

See notes to consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF CASH FLOWS FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES Three Months Ended March 31, 2001 (Unaudited)

See notes to consolidated financial statements. 4 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES Three Months Ended March 31, 2001 (Unaudited)

See notes to consolidated financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) Note A - Basis of Presentation The consolidated financial statements include the accounts of Frontier National Corporation (the "Company") and its wholly-owned subsidiaries, Frontier National Bank, Lanett, Alabama, Frontier National Bank, Sylacauga, Alabama, Frontier Finance Company, Inc., and Frontier Financial Services, Inc., collectively, the Bank. The accompanying unaudited consolidated 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 three-month period ended March 31, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. For further information, refer to the consolidated financial statements and footnotes thereto for Frontier National Corporation and subsidiaries for the year ended December 31, 2000, included in Form 10-K filed in March 2001. Note B - Income Taxes The effective tax rates of approximately 24 percent and 28 percent for the three months ended March 31, 2001 and 2000, respectively, are less than the statutory rate principally because of the effect of tax-exempt interest income. Note C - 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 ("SFAS 115"). 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 March 31, 2001, the Company had net unrealized gains of $550,089 in available-for-sale securities that are reflected in the presented assets and resulted in an increase in shareholders' equity of $355,221, net of deferred tax asset. There were no trading securities. The net increase in shareholders' equity as a result of the SFAS 115 adjustment from December 31, 2000 to March 31, 2001 was $265,706. See also Note D - Shareholders' Equity. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) Note D - Shareholders' Equity During the first three months of 2001, cash dividends of $821,269 were charged against equity. Equity was increased by $265,706 for the increase in net unrealized holding gains on securities. Treasury stock was reissued increasing shareholders' equity $30,889. See also Note E - Treasury Stock. Note E - Treasury Stock During the first quarter, 2,376 shares were reissued and accounted for on a first-in-first-out method. The treasury stock balance represents 75,544 shares at December 31, 2000 and 73,168 shares at March 31, 2001, respectively. Note F - Segment Reporting All of the Company's offices offer similar products and services, are located in the same geographic region, and serve the same customer segments of the market. As a result, management considers all units as one operating segment and therefore feels that the basic financial statements and related footnotes provide details related to segment reporting. Note G - Subsequent Events On April 9, 2001, the Board declared a regular dividend of $0.0925 and a special dividend of $0.0350 payable to stockholders of record as of April 17, 2001, and to be paid on June 27, 2001. 7 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) 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 consolidated financial statements and related notes appearing in Item 1 of the March 31, 2001, Form 10-Q. Forward-Looking Statements Certain statements in this report are forward-looking in nature and relate to trends and events that may affect the Company's future financial position and operating results. Such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The terms "expect," "anticipate," "intend," and "project" and similar words or expressions are intended to identify forward-looking statements. These statements speak only as of the date of this report. The statements are based on current expectations, are inherently uncertain, are subject to risks, and should be viewed with caution. Actual results and experience may differ materially from the forward- looking statements as a result of many factors, including changes in economic conditions in the markets served by the Company, increasing competition and other unanticipated events and conditions. It is not possible to foresee or identify all such factors. The Company makes no commitment to update any forward-looking statements or to disclose any facts, events, or circumstances after the date hereof that may affect the accuracy of any forward-looking statement. FINANCIAL CONDITION March 31, 2001, compared to December 31, 2000 Loans Loans comprised the largest single category of the Company's earning assets on March 31, 2001. Loans, net of unearned income and reserve for loan losses, were 65.1% of total assets at March 31, 2001, and 68.1% of total assets at December 31, 2000. Total net loans were $154,716,341 at March 31, 2001, representing a 2.4% decrease from the December 31, 2000, total of $158,487,456. This decrease is the result of two factors: a general decrease in the economy and lower residential interest rates. The slower economy has resulted in lower demand for the company's residential construction products. The lower demand has not been sufficient to match payoffs in the construction portfolio. In addition, the banking subsidiaries have historically funded and maintained adjustable rate mortgages in their loan portfolios. Historically low residential fixed rates have resulted in consumer demand for refinancing the company's current portfolio of residential mortgages into long term fixed rates for sale to investors. The effect has been lower loan outstandings but higher loan origination income. 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 $2,579,657 from December 31, 2000 to March 31, 2001. Investment securities and federal funds sold at March 31, 2001, were $53,482,881 compared with $50,903,224 at December 31, 2000, reflecting an 5.1% increase. 8 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) Asset Quality Between December 31, 2000 and March 31, 2001, the Company experienced an increase in nonperforming assets (defined as nonaccrual loans, loans past due 90 days or more, restructured loans, nonaccruing securities, and other real estate) from $2.319 million to $3.130 million. The ratio of loan loss allowance to total nonperforming assets decreased from .738 to .541, the ratio of nonperforming loans to total loans increased from .012 to .017. All of these 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. Deposits Total deposits of $181,807,444 at March 31, 2001, increased $3,837,288 (2.2%) over total deposits of $177,970,156 at year-end 2000. Deposits are the Company's primary source of funds with which to support its earning assets. Non-interest bearing deposits decreased $797,061 or 3.3% from year-end 2000 to March 31, 2001, and interest bearing deposits increased $4,634,349 (3.0%) from year-end 2000. Long-term Debt At March 31, 2001 and December 31, 2000, the Company had notes payable totaling $30,592,000 and $25,442,000, respectively. Maturities of long-term debt for the years ending December 31 are as follows: Maturities of Long-term Debt (In thousands) 2001 2002 2003 2004 2005 ------ ------ ------ ------ ------ Interest in indebtedness.... $1,632 $1,613 $1,484 $1,423 $1,284 Repayment of principal...... 350 -- 2,500 500 2,500 ------ ------ ------ ------ ------ $1,982 $1,613 $3,984 $1,923 $3,784 ====== ====== ====== ====== ====== Shareholders' Equity Company shareholders' equity decreased $59,266 from December 31, 2000 to March 31, 2001, due to net income of $465,408, the declaration of cash dividends of $821,269, the increase of unrealized gains on securities available-for-sale totaling $265,706 net of deferred tax asset and the reissuance of treasury stock of $30,889. 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 Banks' 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. 9 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) 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. The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and sales of investment and trading account securities. Loans that mature in one year or less equaled approximately $50.933 million or 32.6% of the total loan portfolio at March 31, 2001, and there are $1.228 million of 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 non-interest bearing deposit accounts. At March 31, 2001, funds were also available through the purchase of federal funds from correspondent commercial banks from available lines of up to an aggregate of $14,000,000. 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. The Company has also established a line of credit under the parent company for $5,000,000. 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 approximately $21,572,402 at March 31, 2001. 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 are referred to as Total Risk-Based capital and was approximately $23,266,062 at March 31, 2001. The Company's current capital positions exceed the regulatory 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 requirements. RESULTS OF OPERATIONS Three months ended March 31, 2001 and 2000 Summary Net earnings of the Company for the three months ended March 31, 2001, were $465,408 compared to $684,019 for the same period in 2000, representing an 32.0% decrease. This decrease was due to an increase in deposit interest expense coupled with rising salary and benefits expense and other operating expenses partially offset by a decline in the provision for loan losses and taxes. 10 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) 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 three months ended March 31, 2001, increased $16,626 (0.4%) from the same period in 2000. This increase was due to improving interest income and fees on loans. Interest expense for the three months ended March 31, 2001, increased $294,594 or 14.6% over the corresponding period of 2000. As a result of these factors, net interest income decreased $277,968 or 11.4% in the three months ended March 31, 2001, compared to the same period of 2000. 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 the Company'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 $50,707 for the three months ended March 31, 2001, compared to $196,767 for the same period of 2000. Charge-offs exceeded recoveries by $68,712 for the three months ended March 31, 2001. The reserve for loan losses as a percent of outstanding loans, net of unearned income, was 1.08% at March 31, 2001, compared to 1.07% at year-end 2000. Non-interest Income Non-interest income for the three months ended March 31, 2001, was $826,187 compared to $832,028 for the same period of 2000. This 0.7% decrease was primarily due to insurance commissions of $316,144 in the first three months of 2001 as compared to $358,853 in the same period of 2000. Significant components of non-interest income are as follows: Service charges on deposits decreased $10,437 (3.3%), other operating income decreased $36,635 and gains on the sale of securities increased $83,940. Non-interest Expenses Non-interest expenses for the three months ended March 31, 2001, were $2,334,440 reflecting a 9.8% increase over the same period of 2000. The primary components of non-interest expenses are salaries and employee benefits, which increased to $1,238,935 for the three months ended March 31, 2001, 11.9% higher than in the same period of 2000. This increase resulted from additional employees added for a new branch opened in July of 2000, bonuses being paid in January of 2001, and the addition of a Corporate Counsel and a Technology Office to the staff. Occupancy costs decreased $21,712 and other operating expenses increased $97,882. Income Taxes The Company attempts to maximize its net income through active tax planning. The provision for income taxes of $143,739 for the three months ended March 31, 2001, decreased $126,819 compared to the same period of 2000, due to the decrease in income before income taxes. Taxes as a percent of earnings decreased from 28.3% to 23.6%. The effective tax rate of approximately 23.6% is less than the statutory rate principally because of the effect of tax-exempt interest income. 11 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) Recently Issued Accounting Standards In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125. While SFAS No. 140 carries over most of the provisions of SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, it provides new standards for reporting financial assets transferred as collateral and new standards for the derecognition of financial assets, in particular transactions involving the use of special purpose entities. SFAS No. 140 also prescribes additional disclosures for collateral transactions and for securitization transactions accounted for as sales. The new collateral standards and disclosure requirements are effective for fiscal years ending after December 15, 2000, while the new standards for the derecognition of financial assets are effective for transfers made after March 31, 2001. The adoption of this statement did not have a material effect on the Company's consolidated financial statements. 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 March 31, 2001, Frontier's cumulative gap is well within this range through a five-year time frame with the one-year cumulative gap at -7.21%, the two-year at -6.17% and the three-year at -2.58%. 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. 12 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) PART 2. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 11 - Statement Re: Computation of Earnings per Share (b) Reports on Form 8-K During the quarter ended March 31, 2001, one report was filed for Frontier National Corporation on Form 8-K announcing the 2000 earnings of the corporation. 13 FRONTIER NATIONAL CORPORATION AND SUBSIDIARIES March 31, 2001 (Unaudited) 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 May 14, 2001 ---------------------- -------------- Steven R. Townson Chief Executive Officer, President and Chief Financial Officer 14

FRONTIER NATIONAL CORP 10-Q