First National Corporation 2012 Form 10-K 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 nonprofit organizations in Virginia’s northern Shenandoah Valley. The Bank operates 10 branches and 26 ATMs and provides lending, deposit, trust, investment and financial advisory services.
This Form 10-K covers the fiscal year ended December 31, 2012, with comparisons primarily to 2011 and 2010. The consolidated financial statements were audited by Yount, Hyde & Barbour, P.C., which issued an unqualified opinion. Management reported effective internal control over financial reporting and no material weakness.
Financial performance and condition
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Total interest and dividend income | $23.4 million | $25.6 million | Down $2.2 million |
| Net interest income | $19.3 million | $20.2 million | Down 5% |
| Provision for loan losses | $3.6 million | $12.4 million | Down $8.8 million |
| Noninterest income | $7.2 million | $5.8 million | Up 24% |
| Noninterest expense | $19.1 million | $20.7 million | Down 8% |
| Income before taxes | $3.8 million | $(7.1) million | Improved |
| Net income | $2.8 million | $(11.0) million | Improved |
| Net income available to common shareholders | $1.9 million | $(11.9) million | Improved |
| Basic and diluted earnings per share | $0.48 | $(4.01) | Improved |
| Net interest margin | 3.89% | 3.98% | Down 9 basis points |
| Return on average assets | 0.53% | (1.96)% | Improved |
| Return on average equity | 6.80% | (22.46)% | Improved |
Net interest income declined because average earning assets decreased and the asset mix shifted from loans toward lower-yielding securities and other investments. Interest expense fell substantially as deposit and borrowing costs declined.
Noninterest income benefited primarily from $1.3 million of gains on securities sales. Noninterest expense declined mainly because other-real-estate-owned expenses decreased to $1.4 million from $3.0 million.
At December 31, 2012, total assets were $532.7 million, compared with $539.1 million in 2011. Gross loans were $383.6 million, down from $392.4 million, while net loans were $370.5 million. Deposits were $466.9 million, down modestly from $469.2 million. Shareholders’ equity increased to $44.9 million from $37.1 million, helped by the 2012 common-stock rights offering.
Cash flow from operating activities was $12.2 million, compared with $10.4 million in 2011. Investing activities used $2.3 million, including a $9.0 million purchase of bank-owned life insurance and significant securities purchases. Financing activities used $8.4 million, reflecting repayment of borrowings, a decline in time deposits and $0.8 million of preferred-stock dividends. Cash and cash equivalents ended at $31.0 million.
Asset quality, debt and liquidity
- Nonperforming assets declined to $14.0 million, or 2.62% of assets, from $18.2 million, or 3.38%, in 2011.
- Nonaccrual loans decreased to $8.4 million from $11.8 million; OREO declined to $5.6 million from $6.4 million.
- Other potential problem loans remained elevated at $44.6 million, compared with $45.1 million in 2011.
- Net charge-offs declined to $3.4 million from $15.5 million. The allowance for loan losses was $13.1 million, or 3.41% of gross loans, compared with 3.30% in 2011.
- Approximately 92% of loans were secured by real estate, creating material geographic and collateral concentration risk.
- Other borrowings totaled $6.1 million, down from $19.1 million. Trust preferred capital notes totaled $9.3 million and have mandatory redemption dates in 2034 and 2036.
- Management reported $123.4 million of liquid assets and $105.4 million of available non-deposit funding, including $65.2 million from the Federal Home Loan Bank, $37.0 million of correspondent-bank federal funds lines and $3.2 million through the Federal Reserve Discount Window.
- The Company and Bank exceeded regulatory capital minimums. Company total and Tier 1 risk-based capital ratios were 15.34% and 14.07%; Bank ratios were 13.59% and 12.31%. The Bank was categorized as well capitalized.
Material changes versus the prior comparable period
- The Company returned to profitability in 2012 after two consecutive years of net losses.
- Credit costs improved materially, with the loan-loss provision down 71% and net charge-offs down 78%.
- Asset quality improved, although problem loans and real-estate concentration remained significant.
- The Company completed a rights offering of 1,945,815 common shares at $4.00 per share, raising net proceeds of $7.6 million. Shares outstanding increased to 4.9 million from 3.0 million.
- The U.S. Treasury sold all of its preferred stock and warrant preferred stock to private investors on August 29, 2012. The preferred-stock terms and dividend rates did not change, but TARP executive compensation and corporate-governance restrictions no longer applied.
- Common-stock dividends remained suspended, and the Bank could not pay dividends to the holding company without prior regulatory approval.
- The Company purchased $9.0 million of bank-owned life insurance and recognized $1.3 million of securities-sale gains.
- The full valuation allowance on net deferred tax assets increased to $6.6 million. Management expects reversal only after a sustainable return to profitability and consecutive profitable quarters.
Guidance, outlook, commentary and risks
The filing does not provide formal earnings, revenue or balance-sheet guidance. Management stated that it expected to continue reducing nonperforming assets during 2013 through OREO sales, enhanced risk management and active monitoring of potential problem loans. Management also stated that liquidity and capital were expected to be sufficient to support operations, asset growth and potential charge-offs.
The principal risks are continued weakness in local economic and real-estate markets, additional deterioration in the concentrated loan portfolio, collateral-value declines, higher charge-offs or provisions, and losses on OREO dispositions. Other risks include reliance on secondary funding sources, interest-rate changes, competition, regulatory and accounting changes, FDIC assessment increases, cybersecurity and third-party technology risks, key-person dependence, pension underfunding and limitations on the realization of deferred tax assets.
Off-balance-sheet credit exposure included $52.8 million of commitments to extend credit or unfunded lines of credit, $8.3 million of standby letters of credit and $0.8 million of locked-rate mortgage commitments. The filing states that these commitments may not be fully drawn.
Most important facts for investors to verify
- Whether the improvement in profitability is sustainable without relying on securities-sale gains, lower credit costs or OREO recoveries.
- Trends in nonperforming assets, the $44.6 million of potential problem loans and the adequacy of the $13.1 million loan-loss allowance.
- The effect of the 2012 rights offering on per-share results, dilution and tangible common equity.
- The timing and conditions for resuming common-stock dividends, including required regulatory approval and preferred-stock obligations.
- The realizability of the $6.6 million deferred tax asset currently covered by a full valuation allowance.
- Access to FHLB advances, correspondent-bank lines and other secondary liquidity sources under stressed conditions.
- Future interest-rate effects on the 3.89% net interest margin and the value of the securities portfolio.
- Terms, pricing and maturity exposure of the $9.3 million trust preferred capital notes and other borrowings.