FIRST NATIONAL CORP quarterly report, Q3 FY2012

First National Corporation 10-Q Summary

Business context and reporting period

First National Corporation is a Virginia bank holding company whose principal subsidiary, First Bank, serves individuals, small and medium-sized businesses, governmental entities and nonprofits in the northern Shenandoah Valley. The Bank provides lending, deposit, trust, investment advisory, mortgage and related financial services through 10 branches, 27 ATMs and digital channels.

This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, with balance-sheet comparisons to December 31, 2011 and operating comparisons to the corresponding 2011 periods.

Key financial metrics

Metric	Three months ended September 30, 2012	Three months ended September 30, 2011	Nine months ended September 30, 2012	Nine months ended September 30, 2011
Net interest income	$4.736 million	$5.048 million	$14.611 million	$15.066 million
Provision for loan losses	$0.805 million	$5.575 million	$3.455 million	$9.395 million
Noninterest income	$1.609 million	$1.473 million	$5.585 million	$4.298 million
Noninterest expense	$4.657 million	$5.388 million	$13.995 million	$14.459 million
Net income	$0.688 million	$(2.886) million	$1.857 million	$(2.828) million
Net income available to common shareholders	$0.462 million	$(3.110) million	$1.180 million	$(3.498) million
Basic and diluted EPS	$0.09	$(1.05)	$0.33	$(1.18)

Total assets were $521.7 million at September 30, 2012, compared with $539.1 million at December 31, 2011.
Gross loans declined 3% to $380.8 million from $392.4 million; loans net of the allowance were $366.7 million.
Securities available for sale increased 5% to $95.8 million from $91.7 million.
Total deposits declined 3% to $457.0 million. Demand and savings deposits increased, while time deposits declined 12% to $166.0 million.
Cash and cash equivalents were $26.2 million at September 30, 2012, compared with $29.5 million at December 31, 2011.
Shareholders’ equity increased to $44.8 million from $37.1 million, principally reflecting the June 2012 common-stock offering.
Net interest margin was 3.78% for the third quarter and 3.93% for the first nine months, compared with 3.98% and 3.96%, respectively, in the prior-year periods.
Return on average assets was 0.52% for the quarter and 0.47% year to date; return on average equity was 6.11% and 6.18%, respectively.
The reported efficiency ratio was 75.31% for the quarter and 71.91% year to date, compared with 68.17% and 68.46% in the prior-year periods.

Material changes versus prior comparable periods

Profitability improved substantially: third-quarter net income changed from a $2.9 million loss to $0.7 million of income, while nine-month results changed from a $2.8 million loss to $1.9 million of income.
The principal earnings improvement was the reduction in loan-loss provisions, down $4.8 million in the quarter and $5.9 million year to date.
Noninterest income increased primarily because of securities gains of $167 thousand in the quarter and $1.285 million year to date, compared with none and $41 thousand, respectively, in the prior-year periods.
Net interest income declined because of lower average earning assets and a lower net interest margin. Management attributed the quarterly margin decline partly to a shift from loans toward lower-yielding securities, federal funds and bank deposits.
Asset quality improved. Nonperforming assets declined to $14.3 million, or 2.75% of assets, from $28.3 million, or 5.22%, at September 30, 2011. Nonaccrual loans declined to $9.0 million from $22.7 million.
The allowance for loan losses increased to $14.0 million, or 3.69% of gross loans, from $12.9 million, or 3.30%, at December 31, 2011. Impaired loans declined to $19.9 million from $25.9 million at year-end 2011.
Other real estate owned declined to $5.3 million from $6.4 million at December 31, 2011. Related provisions also declined materially from the prior-year periods.
The Company completed a rights offering and standby-investor transaction on June 29, 2012, issuing 1,945,815 common shares and raising $7.6 million net. The Treasury subsequently sold the Company’s preferred stock to private investors on August 29, 2012; the preferred-stock terms did not change.

Cash flow, debt, liquidity and capital

For the first nine months of 2012, operating activities provided $9.1 million of cash, investing activities provided $5.8 million and financing activities used $18.2 million, resulting in a $3.3 million decrease in cash and cash equivalents.
Financing cash use included $13.0 million of other-borrowing repayments, a $23.3 million decrease in time deposits, $7.6 million of common-stock proceeds and $0.6 million of preferred dividends.
Other borrowings were $6.1 million, compared with $19.1 million at December 31, 2011. Trust preferred capital notes remained $9.3 million.
The Bank reported $98.8 million of unused borrowing capacity, including $63.0 million from the Federal Home Loan Bank, $32.0 million of unsecured correspondent-bank federal-funds lines and $3.8 million through the Federal Reserve Discount Window.
Liquid assets and loans maturing within one year totaled $125.8 million. Management stated that liquidity was sufficient to meet depositor requirements and customer borrowing needs.
At September 30, 2012, consolidated total capital to risk-weighted assets was 15.39%, consolidated Tier 1 risk-based capital was 14.11%, and consolidated Tier 1 leverage capital was 10.28%. First Bank reported corresponding ratios of 13.55%, 12.27% and 8.93%, all above applicable minimum requirements.
Common-stock cash dividends remained suspended. The Company paid $568 thousand of preferred-stock dividends during the first nine months.

Outlook, commentary, risks and unusual items

Management did not provide quantified earnings or revenue guidance. It cautioned that interim results are not necessarily indicative of full-year results and identified asset quality, local economic conditions, collateral values, loan-loss estimates, interest rates, capital needs, liquidity sources, regulatory changes, FDIC premiums, technology, key personnel and deferred-tax-asset recoverability as significant uncertainties.

Other potential problem loans increased to $46.3 million from $45.1 million at December 31, 2011, indicating continuing credit risk despite lower reported nonperforming assets.
The loan portfolio remains concentrated in real estate lending in the northern Shenandoah Valley, exposing the Company to local real-estate and economic conditions. At September 30, 2012, 66% of nonperforming assets related to commercial real estate, 19% to construction and land development, and 15% to residential real estate.
Troubled debt restructurings totaled $5.4 million, of which $1.6 million was performing under restructured terms.
At September 30, 2012, commitments to extend credit, standby letters of credit and rate-lock commitments totaled $63.6 million. Commitments to extend credit were $53.5 million, standby letters of credit were $9.1 million and mortgage rate-lock commitments were $1.0 million.
The investment portfolio was entirely investment grade, but gross unrealized losses increased to $313 thousand from $16 thousand at December 31, 2011. Management considered the securities temporarily impaired and expected full recovery.
The Company expected to make a $509 thousand pension contribution during the fourth quarter of 2012.
No material changes to previously disclosed risk factors or contractual obligations were reported. No material legal proceedings were disclosed, and management concluded that disclosure controls were effective.

Most important facts for investors to verify

Whether the improvement in earnings is sustainable after excluding securities gains and the unusually large year-over-year reduction in credit provisions.
Whether nonperforming assets, potential problem loans, impaired loans and real-estate concentrations continue to decline without requiring additional provisions or charge-offs.
Whether the $14.0 million allowance for loan losses remains adequate under adverse local economic and collateral-value scenarios.
Whether declining loans and time deposits pressure future net interest income, liquidity or funding costs.
The terms, dividend burden and future redemption or refinancing implications of the $14.4 million of preferred stock and $9.3 million of trust preferred capital notes.
The effect of the common-stock offering on per-share results, ownership dilution and capital ratios.
Whether available borrowing capacity and liquid assets remain sufficient if deposit outflows or credit-line draws increase.