UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission File Number 0-23976
FIRST NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 54-1232965
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
112 West King Street, Strasburg, Virginia 22657
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (540) 465-9121
Securities registered pursuant to Section 12(B) of the Act:
Title of each class Name of each exchange on which registered:
------------------- ------------------------------------------
None None
Securities registered Pursuant to section 12(g) of the Act:
Common Stock, $5.00 par value per share
(Title of class)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K. [ X]
As of February 28, 1997, there were 774,406 shares of common stock, $5.00 par
value, outstanding and the aggregate market value of common stock of First
National Corporation held by nonaffiliates was approximately $15,250,053.
DOCUMENTS INCORPORATED BY REFERENCE
1996 Annual Report to Shareholders - Parts I and II
Notice of Annual Meeting and Proxy Statement Dated February 28, 1997 - Part III
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Part 1
Item 1. Business.
The Company
First National Corporation (the "Company") 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
national bank organized as a wholly-owned subsidiary of the Company, with each
outstanding share of common stock of the Bank being converted into one share of
common stock of the Company. The primary activity of the Company 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.
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 to their customers.
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.
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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 - 100 W. King St., Strasburg, VA 22657
Front Royal Office - 508 N. Commerce Ave., Front Royal, VA 22630
Winchester Office - 2210 Valley Ave., Winchester, VA 22601
Kernstown Office - 3143 Valley Pike, Winchester, VA 22602
Remote ATM site at Strasburg Square Shopping Center, Strasburg,
Virginia
Woodstock Office - 860 South Main Street, Woodstock, VA 22664
Remote ATM site at Judd's Inc., Strasburg, 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 Company is and will be competing with several state-wide and
regional banking institutions, including First Virginia Bank, Signet Bank,
Crestar Bank, NationsBank, N. A., First Union National Bank, F&M Bank, Jefferson
National Bank and Central Fidelity National Bank. 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 Company have greater
financial resources than the Company 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 interest margin (the difference
between interest income and interest expense), 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.
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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 Company'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 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's adjustable rate mortgages ("ARMs") generally are subject to
limitations of 2% per year on interest rate increases and decreases. In
addition, ARMs currently originated by the Bank provide for a lifetime cap of 6%
or less from the borrower's initial interest rate. All changes in the interest
rate must be based on the movement of an index agreed to by the Bank and the
borrower.
There are risks resulting from increased costs to a borrower as a
result of the periodic repricing mechanisms of these loans. Despite the benefits
of ARMs to an institution's Asset Liability management, they pose additional
risks, primarily because as interest rates rise the underlying payments by the
borrowers rise, increasing the potential for default. At the same time, the
marketability of the underlying property may be affected adversely by higher
interest rates.
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. In general, the Bank does not originate
construction loans on income-producing properties such as apartments, shopping
centers, hotels and office buildings. However, the Bank does make construction
loans for residential purposes. These loans are primarily used for construction
of owner-occupied pre-sold residential homes and are considered an attractive
type of lending due to their short-term maturities and higher 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
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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.
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 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, 1996, a total of 81 persons were employed by the
Company and the Bank in both full and part time positions. None are represented
by any collective bargaining unit. The Company 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 Company 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 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
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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. Furthermore, any acquisition by a bank holding company of more than 5%
of the voting shares, or of all or substantially all of the assets of a bank
located in another state may not be approved by the Federal Reserve unless such
acquisition is specifically authorized by the laws of that other state. 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 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.
A bank holding company and its subsidiaries are prohibited from
engaging uncertain tie-in arrangements in connection with the provision of any
credit, property or services. Thus, the subsidiary of a bank holding company may
not extend credit, lease or sell property, furnish any services or fix or vary
the consideration for these activities on the condition that (1) the customer
must obtain some additional credit, property or services from, or provide
additional property or services to, the bank holding company or any subsidiary
thereof, or (2) the customer may not obtain some other credit, property or
service from a competitor, except to the extent reasonable conditions are
imposed to insure the soundness of the credit extended. The subsidiary banks of
a bank holding company also 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 company 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 Virginia State Corporation Commission
(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.
In 1985, the Virginia General Assembly enacted legislation that allows
a bank holding company that has its principal place of business in a defined
region of states to acquire, subject to the approval of the SCC, a Virginia
based financial institution. Before approving the acquisition, the SCC must
determine that there is reciprocity between the laws of the state in which the
acquiring institution is based and the laws of Virginia governing acquisition by
out-of-state bank holding companies. The states that comprise the region are
Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi,
North
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Carolina, South Carolina, Tennessee, Virginia, West Virginia, and the District
of Columbia.
The Bank. Prior to June 1, 1994 the Bank was a national banking
association, supervised and regularly examined by the Office of the Comptroller
of the Currency (the "OCC"). The various laws and regulations administered by
the OCC affected corporate practices, such as the payment of dividends.
incurring debt and acquisition of financial institutions and other companies,
and affected business practices, such as payment of interest on deposits, the
charging of interest on loans, types of business conducted and location of
offices.
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 Company is a legal entity
separate and distinct from the Bank. Most of the Company's revenues result from
dividends paid to the Company by the Bank. The right of the Company, and
consequently the right of creditors and shareholders of the Company, 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 Company
in its capacity as a creditor may be recognized.
The amount of dividends payable by the Bank to the Company 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, 1996, the Bank had $2.58 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 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 Company. There are various legal restrictions on the
extent to which the Company 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 Company, to 10 percent of the Bank's capital stock and surplus, and as to
the Company 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 Company 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.
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Capital Requirements
Year Ended
December 31,
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1995
Required Capital Ratios:
Leverage Ratio 4.00%
Tier 1 risk-based capital ratio 4.00
Total risk-based capital ratio 8.00
The Company Capital Ratios:
Leverage Ratio 10.43%
Tier 1 risk-based capital ratio 15.58
Total risk-based capital ratio 16.60
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
Company's Tier 1 and total Capital ratios as of December 31, 1996 were 15.58%
and 16.60%, 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 Company's Leverage ratio as of December
31, 1996 was 10.43%. 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.
Bank regulators continue to indicate their desire to raise capital
requirements applicable to banking organizations beyond their current levels.
However, management is unable to predict whether higher capital ratios would be
imposed and, if so, at what levels and on what schedule.
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 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
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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. Assessment for the BIF and SAIF
will be 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. It's 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 will be 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.
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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 agency.
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 FIDICIA will be profound.
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 Company engaging in one or more non-banking
activities. Such legislative changes also could place the Company 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 effect of such
legislation on the business of the Company.
Item 2. Properties
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 Company operates four additional branches. The Company
owns three of these facilities without encumbrances and leases the fourth. The
lease on this facility, including renewal options, expires in 2001. See Note 14
to the Consolidated Financial Statements of the Company's 19965 Annual Report to
Shareholders for additional information concerning this lease commitment.
Item 3. Legal Proceedings
In the ordinary course of its operations, the Company 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 Company.
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to security holders for a vote in the fourth
quarter of 1996.
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
10
<PAGE>
Shares of the common stock of the Company are traded on the
over-the-counter (OTC) market and quoted in the National Association of
Securities Dealers Automated Quotations National Market System Bulletin Board
where our symbol is FXNC. However, similar to the trading of the Bank's common
stock prior to the reorganization, trading the Company's common stock is
generally the result of private negotiation. Occasionally a broker or dealer may
be involved, but the Company is aware of only one brokerage firm, Scott &
Stringfellow, that is attempting to make a market as such in the Company's
stock.
The Company has a limited record of variation in prices in the sense of
"bid" and "asked" or in highs or lows. The effort to accurately relate trading
prices throughout 1996 is made more difficult due to the fact that price per
share information is not required by the Company when shares of its stock have
been sold by holders and purchased by others. On the basis of trades known to
the Company, the Company's common stock traded in a range from $19.25 to $22.50
in 1996. The Company's common stock traded in the range of $21.00 to $25.00 in
1995. However, the Company may not be aware of the per share price of all trades
made.
The Company had 613 shareholders as of February 28, 1997.
The Company increased its dividend to $0.70 per share in 1996
representing a payout of 37.19%. The respective dividend per share and payout
ratios were $0.60 and 35.19% in 1995.
Quarterly Dividends
Date 1996 1995
---- ---- ----
March 31 $0.15 $0.13
June 30 0.15 0.13
September 30 0.15 0.13
December 31 0.25 0.21
Item 6. Selected Financial Data
Pursuant to General Instruction G(2), the information required by this
Item is incorporated by reference to page 23 of the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
First National Corporation (the "Company") is the holding company for
First Bank (the "Bank") and First Bank Financial Services Inc. ("Financial
Services"). The following discussion and analysis of the financial condition and
results of operations of the Company for the years ended December 31, 1996, 1995
and 1994 should be read in conjunction with the consolidated financial
statements and related notes.
Overview
Both earnings and assets increased in 1996. Net income for
1996 was $1,454,266 compared to $1,314,548 in 1995 and $1,041,150 in 1994. Net
income per share increased $0.18 in 1996 from 1995 ($1.88 per share versus $1.70
per share). The increase in earnings resulted primarily from an increase in the
Bank's interest income which was greater than the increase in interest expense.
Return on average assets was 1.06% in 1996, 1.03% in 1995 and .91% in 1994.
Return on average equity was
11
<PAGE>
10.36% in 1996, 10.28% in 1995 and 8.66% in 1994.
Assets grew 8.5% in 1995 but in 1996 the growth rate slowed slightly to
6.7%. Growth was concentrated in the loan portfolio where loans, net of unearned
income, increased $12.4 million to $98.4 million. Funding for this loan growth
was provided by an increase in deposits of $8.1 million and a decline in the
securities portfolio of $2.9 million.
Results of Operations
Net interest income represents the primary source of earnings for the
Company. 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 and short-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.
General. Net income has increased in each of the last two years, after
declining in 1994. The decline in income in 1994 was the result of a decline in
the net interest margin in conjunction with the costs associated with opening a
new branch and changing from a national banking charter to a state banking
charter with a change in name for the bank. Income increased in 1995 as a result
of a growth in earning assets and an increase in noninterest income from
nonrecurring items. The continued increase in income in 1996 was caused by
further growth in earning assets and by the funding of higher yielding assets,
in part, from lower yielding assets.
Net Interest Income. Net interest income, after provision for loan
losses, was $5.62 million for the year ended December 31, 1996, up $0.41 million
or 7.79% over the $5.21 million reported for the same period in 1995. This
increase in net interest income, after provision for loan losses, resulted from
a net increase in interest-bearing assets coupled with an increase in yields for
the period. In 1995 net interest income, after provision for loan losses
increased 7.73% or $0.37 million from $4.84 million in 1994.
Both the net interest margin and interest rate spread declined between
1994 and 1995, however they increased between 1995 and 1996. Interest expense as
a percent of average earning assets increased from 3.31% in 1994 to 3.86% in
1995 and increased again in 1996 to 3.92%. Interest income as a percent of
average earning assets, on the other hand, increased from 7.90% in 1994 to 8.26%
in 1995 and further increased in 1996 to 8.50% in 1996. These increases in 1996
resulted from most of the asset growth in the period being concentrated in the
in the higher yielding loan portfolio and an increase in yield in the investment
portfolio and continued growth in floating rate deposit products with slightly
higher interest costs.
The net interest spread increased to 3.78% in 1996 after declining to
3.49% in 1995 from 3.85% in 1994. The net interest margin also increased to
4.58% in 1996 from 4.40% in 1995 after declining from 4.59% in 1994. The above
ratios reflect management's attempt to increase the net interest margin by
funding growth in the loan portfolio with a mix of new deposits supplemented by
funds from the investment portfolio .
Provision for Loan Losses. There was no provision made in either 1994
or 1995 as a result of management's analysis of the allowance for loan losses
which consistently found that the balance was
12
<PAGE>
sufficient to cover anticipated losses. However in 1996, in anticipation of
growth in the loan portfolio, a provision of $120,000 was made to the allowance
for loan losses
Non-Interest Income. Non-interest income decreased $155,342 in 1996
over 1995. This decrease was the result of a $20,523 decrease in service charges
on customer accounts and an decrease in other income of $133,766. In 1995, other
income had increased $155,870 as a result of the settlement of several lawsuits.
Non-Interest Expense. In 1996, non-interest expenses increased $61,533
or 1.46% over 1995. This increase was less than the increase in 1995 of $165,070
or 4.07% and considerably less than the increase in 1994 when non-interest
expenses increased $695,855, or 20.7%. These increases can be attributed to the
asset growth of 28.74% since 1993 which would not have occurred without
increases in branch locations and staffing.
Income Taxes. The company has adopted FASB Statement No. 109,
"Accounting for Income Taxes". A more detailed discussion of the Company's tax
calculation is contained in Note 9 to the consolidated financial statements.
Net interest income is affected by changes in both average interest
rates and average volumes of interest earning assets and interest bearing
liabilities. Table 3 sets forth the amounts of the total change in interest
income that can be attributed to changes in the volume of interest earning
assets and interest bearing liabilities and the amount of the change that can be
attributed to changes in interest rates. The amount of change not solely due to
rate or volume changes was allocated between the change due to rate and the
change due to volume based on the relative size of the rate and volume changes.
13
<PAGE>
<TABLE>
Table 1 - Selected Consolidated Financial Data
<CAPTION>
Years Ended December 31,
1996 1995 1994 1993 1992
(in thousands, except ratios and per share amounts)
<S> <C>
Income Statement Data:
Interest income $10,833 $9,943 $8,441 $8,340 $8,856
Interest expense 5,097 4,733 3,605 3,428 4,118
----- ------ ----- ------ ------
Net interest income 5,736 5,210 4,836 4,912 4,738
Provision for loan losses 120 0 0 240 234
Net interest income after
provision for loan losses 5,616 5,210 4,836 4,672 4,504
Noninterest income 628 811 526 518 498
Securities gains (losses) 20 (8) 73 92 4
Noninterest expense 4,279 4,217 4,053 3,357 3,086
----- ------ ------ ------ ------
Income before income taxes 1,985 1,796 1,382 1,925 1,920
Income taxes 531 481 341 551 552
------ ------- ------ ------ ------
Net income $1,454 $1,315 $1,041 $1,374 $1,368
======= ======= ======= ======= ======
Per Share Data:
Net income $1.88 $1.70 $1.35 $1.79 $1.78
Cash dividends 0.70 0.60 0.52 0.48 0.43
Book value at period end 19.16 18.02 15.74 15.98 15.41
Balance Sheet Data:
Assets $141,225 $132,321 $122,008 $109,701 $105,156
Loans, net of unearned income 98,421 85,986 76,829 62,274 66,756
Securities 33,742 36,619 38,441 39,346 32,773
Deposits 123,984 115,906 106,129 96,758 89,653
Stockholders' equity 14,837 13,908 12,135 12,297 11,268
Average shares outstanding 773 771 771 768 768
Performance Ratios:
Return on average assets 1.06% 1.03% 0.91% 1.28% 1.31%
Return on average equity 10.36% 10.28% 8.66% 11.94% 13.08%
Dividend payout 37.19% 35.19% 38.50% 26.66% 24.03%
Capital and Liquidity Ratios
Leverage 10.43% 10.70% 11.19% 11.42% 10.78%
Risk-based capital ratios:
Tier 1 capital 15.58% 16.46% 17.89% 20.70% 18.63%
Total capital 16.60% 17.53% 19.27% 21.95% 19.88%
</TABLE>
14
<PAGE>
Table 2 Average Balances, Income and Expense, Yields and Rates
<TABLE>
<CAPTION>
<S> <C>
Twelve Months Ended December 31,
-----------------------------------
1996 1995
Annual Annual
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
ASSETS
Balances at correspondent banks -
interest bearing $174,458 $24,626 14.12% $309,236 $12,644 4.09%
Securities:
Taxable 26,455,493 1,640,495 6.20% 35,049,307 2,019,433 5.76%
Tax-exempt (1) 6,635,704 580,583 8.75% 4,688,213 439,226 9.37%
----------- ------- ----- ---------- ------- ------
Total Securities 33,091,197 2,221,078 6.71% 39,737,520 2,458,659 6.19%
Loans (net of earned income): (2)
Taxable 94,213,894 8,641,278 9.17% 80,670,641 7,512,220 9.31%
Tax-exempt (1) 647,870 68,764 10.61% 751,700 78,750 10.48%
------------ ----------- ------ ----------- --------- ------
Total Loans 94,861,764 8,710,042 9.18% 81,422,341 7,590,970 9.32%
Federal funds sold and repurchase
agreements 1,845,432 98,316 5.33% 981,577 56,714 5.78%
-------------- ----------- ----- ------------ ---------- -----
Total earning assets 129,972,851 11,054,062 8.50% 122,450,674 10,118,987 8.26%
Less: allowance for Loan Losses (949,853) (1,077,359)
Total nonearning assets 8,225,868 5,725,213
-------------- --------------
Total Assets $137,248,866 $127,098,528
============ ============
LIABILITIES AND SHAREHOLDER EQUITY
Interest bearing deposits:
Checking $9,949,675 $218,001 2.19% $9,171,323 $223,700 2.44%
Money market savings 7,533,802 254,996 3.38% 7,664,787 266,886 3.48%
Regular savings 32,582,668 1,515,184 4.65% 23,410,417 1,098,240 4.69%
Certificates of deposit:
Less than $100,000 45,093,776 2,398,451 5.32% 47,450,577 2,494,259 5.26%
$100,000 and more 11,182,450 609,303 5.45% 9,222,017 514,093 5.57%
------------- ---------- ----- ---------- -------- -----
Total interest bearing deposits 106,342,371 4,995,935 4.70% 96,919,121 4,597,178 4.74%
Fed funds purchased 44,396 2,799 6.30% 384,332 24,5770 6.39%
Short term borrowings 0 0 N/A 1,752,047 105,644 6.03%
Long term borrowings 1,495,687 98,241 6.57% 82,192 5,1376.25%
-------------- ---------- -------------------------------------
Total interest bearing liabilities 107,882,453 5,096,975 4.72% 99,137,692 4,732,536 4.77%
Noninterest bearing liabilities
Demand deposits 14,323,879 13,033,572
Other liabilities 992,066 2,210,946
--------------- --------------
Total liabilities 123,198,399 114,382,210
Stockholders' equity 14,050,467 12,716,318
-------------- ------------
Total liabilities and stockholders' equity $137,248,866 $127,098,528
============ ============
Net Interest income 5,957,087 5,386,451
========= =========
Interest rate spread 3.78% 3.49%
Interest expense as a percent of average
earning assets 3.92% 3.86%
Net interest margin 4.58% 4.40%
(1) Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 34% in 1996 and 1995.
(2) Loans placed on a nonaccrual status are reflected in the balances.
</TABLE>
15
<PAGE>
<TABLE>
Table 3 - Volume and Rate analysis
<CAPTION>
1996 1995
---- ----
Change in Change in
Volume Rate Income/ Volume Rate Income/
Effect Effect Expense Effect Effect Expense
------ ------ ------- ------ ------ -------
<S> <C>
Earning Assets:
Due From Banks $ (2,590) $ 14,572 $ 11,982 $ 11,126 $ 360 $ 11,486
Taxable Securities (550,420) 171,482 (378,938) 3,765 71,000 74,765
Tax-Exempt Securities 168,140 (26,783) 141,357 74,008 (20,974) 53,034
Taxable Loans 1,240,139 (110,081) 1,129,058 1,181,828 187,921 1,369,749
Tax-Exempt Loans (10,971) 985 (9,986) 21,430 (2,584) 18,846
Federal Funds Sold and
Repurchase Agreements 45,639 (4,037) 41,602 (8,239) 6,309 (1,930)
----------- ----------- ----------- ----------- ----------- -----------
Total Earning Assets $ 889,937 $ 45,158 $ 935,075 $ 1,283,918 $242,032 $1,525,950
----------- ----------- ----------- ----------- ----------- -----------
Interest Bearing Liabilities:
Interest Checking $ 27,495 $ (33,194) $ (5,699) $ (6,387) $ (1,961) $ (8,348)
Savings Deposits-Regular (4,434) (7,456) (11,890) 30,727 48,904 79,631
Savings Deposits-Money Market 426,222 (9,278) 416,944 322,813 330,976 653,789
CD's and Other Time Deposits
$100,000 and More (124,371) 28,563 (95,808) (87,992) 259,330 171,338
CD's and Other Time Deposits
Less Than $100,000 105,947 (10,737 95,210 135,140 52,034 187,174
----------- ----------- ----------- ----------- ----------- -----------
Total Interest-Bearing Deposits $ 430,859 $ (32,102) $ 398,757 $ 394,301 $689,283 $1,083,584
Short-Term Borrowings (127,081) (341) (127,422) 17,789 21,733 39,522
Long-Term Debt 92,828 276 93,104 4,662 (150) 4,512
----------- ----------- ----------- ----------- ----------- -----------
Total Interest-Bearing Liabilities $ 396,606 $ (32,167) $ 364,439 $ 416,752 $710,866 $1,127,618
----------- ----------- ----------- ----------- ----------- -----------
Change in Net Interest Income $ 493,331 $ 77,305 $ 570,636 $ 867,166 $ (468,834) $ 398,332
=========== =========== =========== =========== =========== ===========
</TABLE>
16
<PAGE>
Financial Condition
General. Management continued to aggressively increase the size of the
loan portfolio during 1996. Loans, net of unearned discounts and allowance for
loan losses, increased $12.4 million or 14.5% from $85.9 million in 1995 to
$98.4 million in 1996. This growth in loans was reflected in a 6.73% increase in
assets during the year. Assets began the year at $132.3 million and grew $8.9
million to $141.2 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, 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, 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, 1996 and 1995 are summarized as follows
1996 1995
------- ------
(thousands)
Commercial, Financial, and Agricultural $ 14,318 $ 6,417
Real Estate Construction 2,127 3,990
Real Estate-Mortgage:
Residential (1-4 Family) 43,615 42,236
Non-Farm. Non-Residential 16,959 13,549
Secured by Farmland 993 898
Consumer 21,397 20,288
All Other Loans 1,075 1,172
-------- --------
Total Loans $100,484 $ 88,550
Less Unearned Income 1,089 1,663
-------- --------
Loans-Net of Unearned Income $ 99,395 $ 86,887
======== ========
As shown in Table 4 above the total amount of commercial, financial and
agricultural loans increased $7.9 million in 1996. Residential real estate
mortgage loans increased $1.4 million in 1996 after increasing $1.5 million in
1995. Non-farm, non residential mortgage loans also increased in 1996 by $3.4
million and in 1995 by $1.2 million The growth in the consumer loan area
continued in 1996 with an increase of $1.1 million which was less than the
increase of $3.5 million in 1995.
There were no category of loans that exceeded 10% of outstanding loans
at December 31, 1996 which were not disclosed in Table 4.
17
<PAGE>
Table 5 Remaining Maturities of Selected Loans
At December 31, 1996
Commercial
Financial, and Real Estate
Agricultural Construction
------------ ------------
(Dollars in Thousands)
Within 1 Year: $6,443 $ 2,127
------ -------
Variable Rate:
1 to 5 Years $ 4,002 $ - -
After 5 Years - - - -
------ ----
Total $ 4,002 $ - -
------- -------
Fixed Rate:
1 to 5 Years $ 3,873 $ - -
After 5 Years - - - -
------ ------
Total $ 3,873 $ - -
------- -------
Total Maturities $ 14,318 $ 2,127
======== =======
Asset Quality. The Allowance for Loan Losses ("ALL") balance at
December 31, 1996 was $974,412, representing 0.98% of total loans and 115% of
non-performing assets. At December 31, 1995, these amounts were 1.04% and 92.7%.
These amounts were 1.50% and 74.9% at December 31, 1994.
Total losses charged against the ALL in 1996 were $62,825, compared to
$289,687 in 1995 and $69,886 in 1994. The losses in 1995 was due to a $200,000
charge off resulting from the Bank's receiving real estate by deed in lieu of
foreclosure. Recoveries, consisting of the recovery of principal on loans
previously charge against the allowance, totaled $ 16,425 in 1996, $35,395 in
1995, and $74,184 in 1994.
Management believes, based upon its review and analysis, that the Bank
has sufficient reserves to cover any projected losses within the total loan
portfolio.
18
<PAGE>
Allowance for Loan Losses. Changes in the allowance for loan and lease
losses are detailed in Table 6.
Table 6 - Allowance For Loan Losses
(in thousands of dollars)
<TABLE>
<CAPTION>
At December 31,
1996 1995
---- ----
<S> <C>
Balance, Beginning of Period $901 $ 1,155
Loans Charged-Off
Commercial, Financial and Agricultural 8 7
Real Estate-Construction -- --
Real Estate-Mortgage
Residential (1-4 Family) 11 16
Non-Farm, Non Residential -- 200
Secured by Farmland -- --
Consumer 44 67
All Other Loans -- --
------- -----
Total Loans Charged Off 63 290
-------- -----
Recoveries
Commercial, Financial and Agricultural 1 13
Real Estate-Construction -- --
Real Estate-Mortgage
Residential (1-4 Family) 11 3
Non-Farm, Non-Residential -- --
Secured by Farmland -- --
Consumer 4 20
All Other Loans -- --
------ -----
Total Recoveries 16 36
------ -----
Net Charge-Offs (Recoveries) 47 254
Provision For Loan Losses 120 0
----- -----
Balance, End of Period $ 974 $901
====== =====
Ratio of net charge-offs (recoveries) during the period
to average loans outstanding during the period 0.05% 0.31%
</TABLE>
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.
Table 7 shows the balance and percentage of the Bank's allowance for
loan losses allocated to each major category of loans.
19
<PAGE>
Table 7 Allocation of Allowance For Loan Losses
<TABLE>
<CAPTION>
<S> <C>
1996 1995
---- ----
Percent of Percent of
Loans in Each Loans in Each
Category to Category to
Allowance Total Loans Allowance Total Loans
--------- ----------- --------- -----------
(Dollars in Thousands)
Commercial, Financial
And Agricultural $417 14.25% $84 7.25%
Real Estate-Construction 5 2.12% 100 4.51%
Real Estate-Mortgage 177 61.27% 243 64.00%
Consumer 302 21.29% 268 22.91%
All Other 33 1.07% 5 1.33%
Unallocated 40 -- 201 --
--- -------- ----- -------
$ 974 100.00% $901 100.00%
====== ======== ===== ========
</TABLE>
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.
Non-accrual loans totaled $12,827 at year end, representing 0.013% of
the net loan portfolio. These numbers decreased over the 1995 balance of
$120,320 or 0.14% of the net loan portfolio. The Bank has allocated a portion of
the Allowance for Loan Losses to cover anticipated losses from these loans and
is included in Table 7 above.
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.
For the fiscal year 1996 interest income not recognized on non-accrual loans
amounted to $566.
.
Table 8 Non-Performing Assets
<TABLE>
<CAPTION>
At December 31,
1996 1995
(Dollars in Thousands)
<S> <C>
Nonaccrual Loans $ 13 $ 120
Restructured Loans 32 48
Foreclosed Property 804 804
------ ----
Total Nonperforming Assets $ 849 $972
===== ====
Loans Past Due 90 Days Accruing Interest $418 $21
Allowance for Loan Losses to Period End Loans 0.98% 1.04%
Nonperforming Assets to Period End Loans 0.84% 1.11%
and foreclosed Properties
Net Charge-Offs (Recoveries) to Average Loans 0.05% 0.31%
</TABLE>
20
<PAGE>
Securities. The Company adopted FASB No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" effective beginning January 1, 1994.
The Company reclassified its securities portfolio into those securities that
would be held to maturity and those that were available for sale. The securities
that were classified as available for sale were recorded at fair value in
accordance with FASB No. 115 and the Company recognized the effect of unrealized
gains/losses net of tax effects in stockholders' equity.
Table 9 summarizes the carrying value of the Company's securities
portfolio on the dates indicated.
Table 9 Securities Portfolio
Years Ended December 31
-----------------------
(Dollars in Thousands)
1996 1995
---- ----
Book Value:
Securities Held to Maturity
U.S. Government Securities $3,033 $6,076
States and Political Subdivisions 0 0
--------- ---------
Total Securities Held to Maturity $3,033 $6,076
======== ======
Securities Available for Sale
U.S. Government Securities $23,089 $22,512
States and Political Subdivisions 6,559 6,961
Other Securities 1,061 1,070
-------- ---------
Total Securities Available for Sale $30,709 $30,543
======= =======
Total Securities $33,742 $36,619
======= =======
Amount and Average Yield of Securities at December 31, 1996
<TABLE>
<CAPTION>
Over Ten Years
One Year or One to Five Five to Ten And Equity
Less Years Years Securities Total
---- ----- ----- ---------- -----
<S> <C>
Held to Maturity Securities
U.S. Government Securities
Amortized Cost 0 507 2,045 481 3,033
Market Value 0 509 2,044 478 3,031
Weighted Ave. Yield 0.00% 6.29% 5.90% 3.92%
State and Political Subdivisions
Amortized Cost 0 0 0 0 0
Market Value 0 0 0 0 0
Weighted Ave. Yield 0.00% 0.00% 0.00% 0.00%
Other Securities
Amortized Cost 0 0 0 0 0
Market Value 0 0 0 0 0
Weighted Ave. Yield 0.00% 0.00% 0.00% 0.00%
</TABLE>
21
<PAGE>
Table 9 Securities Portfolio - Continued
Amount and Average Yield of Securities at December 31, 1996
<TABLE>
<CAPTION>
Over Ten Years
One Year or One to Five Five to Ten And Equity
Less Years Years Securities Total
---- ----- ----- ---------- -----
<S> <C>
Available for Sale Securities
U.S. Government Securities
Amortized Cost 0 10,489 4,894 7,688 23,071
Market Value 0 10,549 4,836 7,705 23,089
Weighted Ave. Yield 0.00% 6.53% 6.24% 6.12%
State and Political Subdivisions
Amortized Cost 599 1,923 1,548 2,460 6,530
Market Value 608 1,986 1,567 2,398 6,559
Weighted Ave. Yield (1) 9.51% 9.52% 7.33% 7.35%
Other Securities
Amortized Cost 0 0 0 1,061 1,061
Market Value 0 0 0 1,061 1,061
Weighted Ave. Yield 0.00% 0.00% 0.00% 5.21%
Total Portfolio
Amortized Cost 599 12,919 8,487 11,690 33,695
Market Value 608 13,044 8,447 11,641 33,740
Weighted Ave. Yield (1) 9.51% 6.96% 6.36% 6.21%
</TABLE>
(1) Yields on tax exempt securities have been computed on a tax-equivalent
basis.
As of December 31, 1996, neither the Company nor the Bank held any
derivative financial instruments in their respective investment security
portfolios.
22
<PAGE>
Deposits. The Bank has made an effort in recent years to increase core
deposits and reduce costs of funds. Deposits provide funding for the Company'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, 1996 were $124.0 million, an increase of $8.1
million or 7.0% from $115.9 million at December 31, 1995. This increase was
concentrated in Savings Accounts which increased $7.9 million and was caused by
growth in floating rate money market savings account during the year. Large
local government deposits on which rates were set by competitive bid caused an
increase in Certificates of Deposit with balances equal to or in excess of $100
thousand.
The following tables are a summary of average deposits and average
rates paid.
Table 10 Average Deposits and Rates Paid
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
(Dollars in Thousands)
Amount Rate Amount Rate
------ ---- ------ ----
<S> <C>
Noninterest Bearing Deposits $14 324 -- $13,034 --
------- ----- ------- -----
Interest Bearing Deposits
Interest Checking $9,950 2.19% $9,171 2.44%
Money-Market 7,534 3.38% 7,665 3.48%
Regular Savings 32,583 4.65% 23,410 4.69%
Time Deposits
Less than $100,000 45,094 5.32% 47,451 5.26%
$100,000 and more 11,182 5.45% 9,222 5.57%
------- ----- -------- -----
Total Interest Bearing $106,343 4.70% $96,919 4.74%
-------- ----- ------- -----
Total $120,667 $109,953
======== ========
Maturities of CD's of $100,000 and More
<CAPTION>
Within Three to Six to Over
Three Six Twelve One
Months Months Months Year Total
------ ------ ------ ---- -----
At December 31, 1996 $4,415 $1,926 $2,075 $3,714 $12,130
</TABLE>
Liquidity. Liquidity represents an institutions 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 Treasury 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, 1996, cash, interest bearing and non-interest bearing
deposits with banks, federal funds sold, investments in Treasury securities, and
loans maturing within one year were $34.9 million. As of December 31, 1996,
approximately 41.93% or $41.3 million of the loan portfolio would mature or
reprice within a one year period.
Non-deposit sources of funds in use at December 31, 1996 consisted of a
Federal Home Loan Bank advance and Federal Funds Purchased. The Federal Home
Loan Bank advance was a draw by the Bank against its line at the
23
<PAGE>
Federal Home Loan Bank of Atlanta with an original balance of $1.5 million
bearing interest at 6.25% with a maturity of December 12, 2005. Security for the
advance consists of U.S. Government and Agency Securities. This advance was used
to fund growth in the loan portfolio.
Capital Resources. The adequacy of the Bank's capital is reviewed by
management on an ongoing basis with reference to the size, composition, and
quality of the Bank'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 quidelines 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 Company had a ratio of
risk-weighted assets to total capital of 16.60% at December 31, 1996 and a ratio
of riskweighted assets to Tier 1 capital of 15.58%. Both of these exceed the
capital requirements adopted by the federal regulatory agencies.
Table 11 Analysis of Capital
Year End December 31,
1996 1995
---- ----
(Dollars in Thousands)
Tier 1 Capital
Common Stock $3,872 $3,858
Surplus 1,133 1,090
Retained Earnings 9,801 8,888
----- -----
Total Tier 1 Capital $14,806 $13,836
Tier 2 Capital:
Allowance for Loan Losses (1) 974 901
------- ---
Total Risk Based Capital $15,780 $14,737
======= =======
Risk-Weighted Assets $95,050 $84,045
Capital Ratios:
Tier 1 Risk-Based Capital Ratio 15.58% 16.46%
Total Risk-Based Capital Ratio 16.60% 17.53%
Tier 1 Capital to Average Total Assets 10.43% 10.70%
- --------------
(1) Limited to 1.25% of risk weighted assets.
New Accounting Pronouncements. FASB Statement No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
was issued in June, 1996 and establishes, among other things, new criteria for
determining whether a transfer of financial assets in exchange for cash of other
consideration should be accounted for as a sale or as a pledge of collateral in
a secured borrowing. Statement 125 also establishes new accounting requirements
for pledged collateral. As issued, Statement 125 is effective for all transfers
and servicing of financial assets and extinguishments of liabilities occurring
after December 1996.
FASB Statement No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125", defers for one year the effective date
(a) paragraph 15 of Statement 125 and (b) for repurchase agreement, dollar-roll,
securities lending, or similar transactions, of paragraph 9-12 and 237(b) of
Statement 125.
The effects of these Statements on the Company's consolidated financial
statements are not expected to be material.
24
<PAGE>
Item 8. Financial Statements and Supplementary Data
Pursuant to General Instruction G(2), information required by this Item
is incorporated by reference from pages 5 to 21 of the Company's Annual Report
to Shareholders for the fiscal year ended December 31, 1996.
Item 9. Change in and Disagreements with Accountants on Accounting and Financial
Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
Pursuant to General Instruction G(3), the information called for this
Item is incorporated herein by reference from pages 2, 3, 5 and 6 of the
Company's proxy statement dated February 28, 1997, for the Company's Annual
Meeting of Shareholders held April 1, 1997.
Item 11. Executive Compensation
Pursuant to General Instruction G(3), the information called for this
Item is incorporated herein by reference from pages 6 and 7 of the Company's
proxy statement dated February 28, 1997, for the Company's Annual Meeting of
Shareholders held April 1, 1997.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Pursuant to General Instruction G(3), the information called for this
Item is incorporated herein by reference from pages 4 and 5 of the Company's
proxy statement dated February 28, 1997, for the Company's Annual Meeting of
Shareholders held April 1, 1997.
Item 13. Certain Relationships and Related Transactions
Pursuant to General Instruction G(3), the information called for this
Item is incorporated herein by reference from page 7 of the Company's proxy
statement dated February 28, 1997, for the Company's Annual Meeting of
Shareholders held April 1, 1997.
PART IV
Item 14. Exhibits, Financial Statement, Schedules and Reports on Form 8-K
(a) The following documents required in Part II, Item 8, are incorporated
by reference to pages 4 through 21 of the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996:
<TABLE>
<CAPTION>
<S> <C>
1. Financial Statements Page
----
Report of Independent Certified Public Accountants 4
First National Corporation and Subsidiaries:
Consolidated Balance Sheets at December 31, 1996 and 1995 5
Consolidated Statements of Income for years ended
December 31, 1996, 1995 and 1994 6
Consolidated Statements of Cash Flows for the years
ended December 31, 1996, 1995 and 1994 7 and 8
Consolidated Statements of Changes in Stockholders'
Equity for years ended December 31, 1996, 1995 and 1994 9
Notes to Financial Statements 10 - 21
</TABLE>
25
<PAGE>
2. Financial Statement schedules
All schedules are omitted because of the absence of conditions
under which they are required or because the required information
is given in the financial statements or notes thereto.
3. Exhibits
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
Registrant's form 10 filed with the SEC on May 2, 1994).
3.2 Bylaws (incorporated herein by reference to Exhibit 3 to the
Registrant's Form 10 filed with the SEC on May 2, 1994).
4.1 Specimen of Registrant's Common Stock Certificate
(incorporated herein by reference to Exhibit 1 to the
Registrant's Form 10 filed with SEC on May 2, 1994).
13.1 Registrant's Annual Report to Shareholders for the year ended
December 31, 1996.
21.1 Subsidiaries of the Registrant (incorporated herein by
reference to Exhibit 1 to the Registrant's Form 10 filed with
SEC on May 2, 1994).
27 Financial Data Schedule
(b) Reports on Form 8-K
No Reports on Form 8-K were filed during the quarter ended December 31,
1996.
With the exception of the information herein expressly incorporated by
reference, the 1996 Annual Report to Shareholders and the 1996 Proxy Statement
of the Registrant are not to be deemed filed as part of this Annual Report on
Form 10-K.
26
<PAGE>
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
Strasburg, Virginia
by Ronald F. Miller
----------------------------------
Ronald F. Miller, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ---- ----- ----
<S> <C>
Ronald F. Miller President and March 19, 1997
- ----------------------------------- Chief Executive Officer
Ronald F. Miller Director
Dana A. Froom Comptroller and Chief March 19, 1997
- ---------------------------------- Accounting Officer
Dana A. Froom
Noel M. Borden Chairman of the Board March 19, 1997
- ----------------------------------- Director
Noel M. Borden
Douglas C. Arthur Vice Chairman of the Board March 19, 1997
- ----------------------------------- Director
Douglas C. Arthur
Byron A. Brill Director March 19, 1997
- ---------------------------------
Dr. Byron A. Brill
Elizabeth H. Cottrell Director March 19, 1997
- ---------------------------------
Elizabeth H. Cottrell
Christopher E. French Director March 19, 1997
- ---------------------------------
Christopher E. French
Charles E. Maddox, Jr. Director March 19, 1997
- ---------------------------------
Charles E. Maddox, Jr.
W. Allen Nicholls Director March 19, 1997
- ---------------------------------
W. Allen Nicholls
Henry L. Shirkey Director March 19, 1997
- ---------------------------------
Henry L. Shirkey
</TABLE>
27
[FIRST NATIONAL LOGO HERE]
FIRST NATIONAL
CORPORATION
--------------------------------
NINETY YEARS OF SERVICE
1996 ANNUAL REPORT
--------------------------------
<PAGE>
Shareholder Information
- --------------------------------------------------------------------------------
COMMON STOCK
First National Corporation's common stock is traded on the over-the-counter
(OTC) market and quoted in the NASDAQ (National Association of Securities
Dealers Automated Quotations) National Market System Bulletin Board where our
symbol is FXNC.
PURCHASES AND SALES
To buy or sell First National stock please contact Scott & Stringfellow in
Winchester, Virginia at 800-476-9847; Harrisonburg, Virginia at 800-476-3547;
Richmond, Virginia at 800-446-7075.
COPIES OF FORM 10-K
Copies of First National Corporation's Annual Report to the Securities and
Exchange Commission on Form 10-K may be obtained by shareholders at no charge by
writing:
Harry S. Smith
Vice President and Secretary
First National Corporation
112 West King Street
Strasburg, Virginia 22657
STOCK TRANSFER AGENT AND REGISTRAR
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
800-368-5948
DIVIDEND REINVESTMENT
Registered holders of First National Corporation stock are eligible to
participate in the Corporation's Dividend Reinvestment Plan, a convenient and
economical way to purchase additional shares of First National Corporation
common stock. For an information and authorization form or to receive additional
information on this plan, contact: Registrar and Transfer Company, 10 Commerce
Drive, Cranford, New Jersey 07016, 800-368-5948.
SHAREHOLDER INFORMATION
For additional information, contact:
Debbie Bly
First National Corporation
112 West King Street
Strasburg, Virginia 22657
800-465-8515
INDEPENDENT AUDITORS
Yount, Hyde & Barbour, P.C.
Post Office Box 2560
Winchester, Virginia 2260
- --------------------------------------------------------------------------------
<PAGE>
Financial Highlights [LOGO]
- --------------------------------------------------------------------------------
1996 1995 % Change
For the Year
Total Operating Income $ 11,481,185 $ 10,746,117 6.8
Total Operating Expense 10,026,919 9,431,569 6.3
Net Income 1,454,266 1,314,548 10.6
Cash Dividends Declared 540,872 462,642 16.9
Year End
Assets $ 141,224,922 $132,321,200 6.7
Deposits 123,984,231 115,905,907 7.0
Stockholders' Equity 14,837,194 13,907,995 6.7
Net Loans 98,421,131 85,985,960 14.5
Per Share
Book Value $19.16 $18.02 6.3
Net Income 1.88 1.70 10.6
Cash Dividends Declared .70 .60 16.7
[Bar Chart Here]
NET INCOME
Percent Change
92 93 94 95 96
1,368,222 1,374,444 1,041,150 1,314,548 1,454,266
17.0 0.5 -24.2 26.3 10.6
[Bar Chart Here]
ASSETS
Percent Change
92 93 94 95 96
105,155,921 109,701,634 122,008,083 132,321,200 141,224,922
4.3 4.3 11.2 8.5 6.7
[Bar Chart Here]
DEPOSITS
Percent Change
92 93 94 95 96
89,652,633 96,757,778 106,129,405 115,905,907 123,984,231
-0.4 7.9 9.7 9.2 7.0
[Bar Chart Here]
STOCKHOLDERS' EQUITY
Percent Change
92 93 94 95 96
11,268,221 12,297,397 12,135,385 13,907,995 14,387,194
11.7 9.1 -1.3 14.6 6.7
[Bar Chart Here]
NET LOANS
Percent Change
92 93 94 95 96
65,824,657 61,122,696 75,674,087 85,985,960 98,421,131
7.4 -7.1 23.8 13.6 14.5
Market Information 1996
- --------------------------------------------------------------------------------
Quarter Transactions Shares Traded High Low
1st 34 24,800 $21.00 $19.25
2nd 26 10,800 $22.00 $20.25
3rd 19 6,700 $22.50 $20.75
4th 29 5,500 $21.50 $21.25
<PAGE>
[LOGO] To Our Shareholders, Customers and Friends
- --------------------------------------------------------------------------------
WE HAVE JUST COMPLETED A YEAR OF RECORD BANK PROFITABILITY. First National
Corporation and First Bank set new records for earnings, growth and total return
to shareholders during 1996. Earnings for the year topped $1,450,000, equating
to $1.88 per share compared to $1.70 per share for 1995, for an increase of
10.6%. Our dividend to shareholders was increased from $.60 per share to $.70
per share for a 16.7% increase. Our asset growth was led by an impressive loan
growth of $12.4 million or 14.5%, and our deposits grew by $8 million
representing a 7% increase. As can be noted, our total assets exceeded $141.2
million as of year end.
AS WE REFLECT ON THE COMPANY'S ACCOMPLISHMENTS over the past twelve months, it
is important to remember that financial statements are a "snapshot" frozen in
time. We are strong in every sense of the word. Every day brings new challenges
and changes in how we do business. We know that we cannot dwell on our
accomplishments but need to give our attention to future goals.
OUR INDUSTRY IS STRONG but continues to grapple with the technological
revolution sweeping through our nation. This affects how we do our day to day
banking here in the Northern Shenandoah Valley.
DOUGLAS C. ARTHUR WAS ELECTED VICE CHAIRMAN of the Board in 1996, to fill a
vacancy created by the untimely passing of Donald E. Sager. Mr. Arthur has
served our board since 1972.
WE HAD SOME POSITIVE DEVELOPMENTS with our stock during the year. Our shares are
now listed on the OTC Bulletin Board, and five brokers make a market in our
stock. Our symbol is FXNC. Your broker can presently give you a bid price and an
asking price on the shares you own in First National Corporation. Our Dividend
Reinvestment Plan continues to grow. The number of shareholders taking advantage
of this plan, to easily obtain additional shares of our stock through
reinvesting current dividends, increased during the year. Anyone on our
management team will be happy to assist shareholders with this plan.
<PAGE>
[LOGO]
WE HAVE INVESTED IN THE FUTURE OF OUR BANK by adding many new products and
services during the year. Our officer call program continues to be successful as
is evidenced by our increased loan demand. This effort allows us to visit
existing and potential new customers of our bank. We have implemented BankLine,
allowing our customers to have 24 hour automated access to their checking
accounts, savings accounts and loan information. We have opened PrimeVest
Investment Center, located at our main office, whereby we offer a full range of
investment products, including mutual funds, annuities, stocks, bonds, self
directed IRA's and complete financial planning. We have offered two new
successful checking accounts, "Hometown Checking" and "Fifty and Better," during
the year. Our VISA Debit Card is now being offered, and we located our sixth ATM
at Judd's Inc, in Strasburg for the exclusive use of their employees and guests.
The first stage of our expansion program is near completion with the new
addition at our main office, and we plan to be finished with the entire project
in the second quarter of 1997.
OUR ONE BANK HOLDING COMPANY AND BANK CONTINUE TO RECEIVE THE HIGHEST RATINGS
given by the Federal Reserve System and the Bureau of Financial Institutions.
The successful results of our company are possible only because of the steadfast
support of our shareholders, the advice and guidance of our Board of Directors,
the diligent work of our employees, and the loyalty and patronage of our
customers. Thank you to all who have contributed so much to make this
organization one of the best in our Commonwealth.
/s/ Noel M. Borden [PICTURE]
- ------------------ [Caption: Noel M. Borden
Noel M. Borden Chairman of the Board]
/s/ Ronald F. Miller [PICTURE]
- -------------------- [Caption: Ronald F. Miller
Ronald F. Miller President/Chief Executive Officer]
<PAGE>
[LOGO] Independent Auditor's Report
- --------------------------------------------------------------------------------
To the Stockholders and Directors
First National Corporation
Strasburg, Virginia
We have audited the accompanying consolidated balance sheets of First
National Corporation and Subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for the years ended December 31, 1996, 1995 and 1994. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First
National Corporation and Subsidiaries as of December 31, 1996 and 1995, and the
results of its operations and its cash flows for the years ended December 31,
1996, 1995 and 1994, in conformity with generally accepted accounting
principles.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 8, 1997
<PAGE>
<TABLE>
<CAPTION>
Consolidated Balance Sheet [LOGO]
- --------------------------------------------------------------------------------
<S> <C>
December 31 1996 1995
Assets Cash and due from banks $ 3,510,451 $ 4,314,015
Securities (fair value: 1996, $33,739,775 and
1995, $36,624,077) (Note 2) 33,742,045 36,618,534
Loans, net (Notes 3 and 4) 98,421,131 85,985,960
Bank premises and equipment (Note 5) 3,320,025 3,089,402
Interest receivable 891,350 840,273
Other real estate 803,808 803,808
Other assets (Note 9) 536,112 669,208
------------ ------------
Total assets $ 141,224,922 $ 132,321,200
============ ============
Liabilities and Liabilities
Stockholders' Deposits:
Equity Noninterest bearing $ 14,408,746 $ 12,946,216
Interest bearing 109,575,485 102,959,691
------------ ------------
Total deposits (Note 6) $ 123,984,231 $ 115,905,907
Federal funds purchased 315,000 382,000
Long-term debt (Note 8) 1,481,424 1,500,000
Accrued expenses (Note 11) 607,073 625,298
Commitments and contingent liabilities (Notes 12 and 16)
------------ ------------
Total liabilities $ 126,387,728 $ 118,413,205
Stockholders' Equity
Common stock, par value $5 per share; authorized
2,000,000 shares; issued and outstanding 774,406 and
771,698 shares (Note 15) $ 3,872,030 $ 3,858,490
Surplus 1,132,638 1,090,461
Retained earnings (Note 10) 9,801,091 8,887,697
Unrealized gain on securities available for sale, net 31,435 71,347
------------ ------------
Total stockholders' equity $ 14,837,194 $ 13,907,995
------------ ------------
Total liabilities and stockholders' equity $ 141,224,922 $ 132,321,200
============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
[LOGO] Consolidated Statements of Income
- ---------------------------------------------------------------------------------------------------------------------
Years Ended December 31 1996 1995 1994
<S> <C>
Interest Interest and fees on loans $ 8,686,663 $ 7,564,195 $ 6,182,007
Income Interest on federal funds sold 98,316 56,714 58,644
Interest on deposits in banks 24,626 12,644 1,158
Interest on investment
securities, taxable 237,132 606,318 604,545
Interest and dividends on securities
available for sale:
Taxable 1,336,188 1,353,292 1,292,052
Nontaxable 383,185 289,889 254,887
Dividends 67,175 59,823 48,071
------------- ------------ ------------
Total interest income $ 10,833,285 $ 9,942,875 $ 8,441,364
------------- ------------ ------------
Interest Interest on deposits (Note 6) $ 4,995,935 $ 4,597,178 $ 3,513,593
Expense Interest on federal funds purchased 2,799 24,577 13,662
Interest on Federal Home Loan Bank
advances -- 105,644 77,037
Interest on long-term debt 98,241 5,137 625
------------- ------------ ------------
Total interest expense $ 5,096,975 $ 4,732,536 $ 3,604,917
------------- ------------ ------------
Net interest income $ 5,736,310 $ 5,210,339 $ 4,836,447
Provision for loan losses (Note 4) 120,000 -- --
------------- ------------ ------------
Net interest income after
provision for loan losses $ 5,616,310 $ 5,210,339 $ 4,836,447
------------- ------------ ------------
Other Service charges $ 471,680 $ 492,203 $ 379,060
Operating Commissions and fees from fiduciary
Income activities -- 3,374 17,904
Fees for other customer services 87,545 87,919 58,795
Profits (loss) on securities available for sale 19,549 (7,818) 72,632
Gain (loss) on sale of assets and
other real estate (23,059) 1,613 143
Other 92,185 225,951 70,081
------------- ------------ ------------
Total other operating income $ 647,900 $ 803,242 $ 598,615
------------- ------------ ------------
Other Salaries and employee benefits (Note 11) $ 2,230,677 $ 2,204,369 $ 1,928,453
Operating Occupancy expense 215,270 212,222 209,405
Expenses Equipment expense 527,615 504,974 383,927
FDIC insurance assessment 2,000 121,250 217,552
Advertising 202,839 134,630 149,102
Supplies and stationery 123,600 113,953 158,615
Other 977,347 926,417 1,005,691
------------- ------------ ------------
Total other operating expenses $ 4,279,348 $ 4,217,815 $ 4,052,745
------------- ------------ ------------
Income before income taxes $ 1,984,862 $ 1,795,766 $ 1,382,317
Provision for income taxes (Note 9) 530,596 481,218 341,167
------------- ------------ ------------
Net income $ 1,454,266 $ 1,314,548 $ 1,041,150
============= ============ ============
Net Income Per Share (Note 1) $ 1.88 $ 1.70 $ 1.35
============= ============ ============
Cash Dividends Per Share (Note 1) $ .70 $ .60 $ .52
============= ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows [LOGO]
- ---------------------------------------------------------------------------------------------------------------------
Years Ended December 31 1996 1995 1994
<S> <C>
Cash Flows Net income $ 1,454,266 $ 1,314,548 $ 1,041,150
from Operating Adjustments to reconcile net income to net
Activities cash provided by operating activities:
Depreciation 443,274 424,141 323,841
Provision for loan losses 120,000 -- --
(Gain) loss on sale of assets and other
real estate 23,059 (1,613) (143)
(Profits) loss on securities available for sale (19,549) 7,818 (72,632)
Accretion of security discounts (30,764) (18,531) (29,142)
Amortization of security premiums 99,723 97,339 202,028
Deferred tax expense 9,726 95,649 13,158
Changes in assets and liabilities:
(Increase) in interest receivable (51,077) (154,887) (72,420)
(Increase) decrease in other assets 143,932 (127,094) 154,546
Decrease in other real estate -- -- 33,000
Increase (decrease) in accrued expenses (18,225) (117,995) 122,104
------------- ------------ ------------
Net cash provided by
operating activities $ 2,174,365 $ 1,519,375 $ 1,715,490
------------- ------------ ------------
Cash Flows Proceeds from sale of securities available
from Investing for sale $ 2,319,615 $ 14,779,108 $ 4,171,580
Activities Proceeds from maturities, calls, and principal
payments of investment securities 3,041,039 3,512,479 776,535
Proceeds from maturities, calls, and principal
payments of securities available for sale 6,399,218 2,963,092 3,968,425
Purchases of investment securities -- (253,281) (2,000,000)
Purchase of securities available for sale (8,993,267) (17,898,434) (7,370,877)
Proceeds on sale of equipment -- 7,123 143
Purchases of bank premises and equipment (673,897) (784,910) (845,946)
Net (increase) in loans (12,822,646) (10,772,500) (14,551,391)
Decrease in federal funds sold -- -- 3,094,000
Proceeds on sale of other real estate 244,416 -- --
------------- ------------ ------------
Net cash (used in)
investing activities $ (10,485,522) $ (8,447,323) $ (12,757,531)
------------- ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
[LOGO] Consolidated Statements of Cash Flows continued
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Years Ended December 31 1996 1995 1994
Cash Flows Net increase in demand deposits,
from Financing NOW accounts, and savings accounts $ 9,200,571 $ 12,545,376 $ 3,216,574
Activities Net increase (decrease) in certificates of
deposit (1,122,247) (2,768,874) 6,155,053
Principal payments on note payable -- -- (25,000
Proceeds from Federal Home Loan Bank
advances -- 6,000,000 3,000,000
Proceeds from long-term debt -- 1,500,000 --
Principal payments to Federal Home
Loan Bank -- (9,000,000) --
Principal payments on long-term debt (18,576) -- --
Net proceeds from issuance of common
stock 55,717 18,076 28,970
Cash dividends paid (540,872) (462,642) (400,851)
Increase (decrease) in federal funds
purchased (67,000) 382,000 --
------------- ------------ ------------
Net cash provided by
financing activities $ 7,507,593 $ 8,213,936 $ 11,974,746
------------- ------------ ------------
Increase (decrease) in cash
and cash equivalents $ (803,564) $ 1,285,988 $ 932,705
Cash and Cash Beginning 4,314,015 3,028,027 2,095,322
Equivalents ------------- ------------ ------------
Ending $ 3,510,451 $ 4,314,015 $ 3,028,027
============= ============ ============
Supplemental Cash payments for:
Disclosures of Interest $ 5,091,883 $ 4,705,842 $ 3,566,145
Cash Flow ============= ============ ============
Information Income taxes $ 540,281 $ 556,468 $ 383,653
============= ============ ============
Supplemental Other real estate acquired in
Disclosures of settlement of loans $ 267,475 $ 460,627 $ --
Noncash ============= ============ ============
Investing and
Financing Unrealized gain (loss) on securities
Activities available for sale $ (60,474) $ 1,367,619 $ (1,259,517)
============= ============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Consolidated Statements of [LOGO]
Changes in Stockholders' Equity
<TABLE>
<CAPTION>
Years Ended December 31, 1996, 1995 and 1994
Unrealized
Gain (Loss)
on Securities
Common Retained Available for
Stock Surplus Earnings Sale, Net Total
<S> <C>
Balances, December 31, 1993 $3,847,055 $1,054,850 $7,395,492 $ -- $12,297,397
Issuance of 1,491 shares of
common stock, employee
stock options 7,455 21,515 -- -- 28,970
Net income -- -- 1,041,150 -- 1,041,150
Cash dividends -- -- (400,851) -- (400,851)
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $428,236 -- -- -- (831,281) (831,281)
--------- --------- --------- --------- -----------
Balances, December 31, 1994 $3,854,510 $1,076,365 $8,035,791 $ (831,281) $12,135,385
Issuance of 210 shares of
common stock, employee
stock options 1,050 3,765 -- -- 4,815
Issuance of 586 shares of
common stock, dividend
reinvestment plan 2,930 10,331 -- -- 13,261
Net income -- -- 1,314,548 -- 1,314,548
Cash dividends -- -- (462,642) -- (462,642)
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $464,991 -- -- -- 902,628 902,628
--------- --------- --------- --------- -----------
Balances, December 31, 1995 $3,858,490 $1,090,461 $8,887,697 $ 71,347 $13,907,995
Issuance of 2,708 shares of
common stock, dividend
reinvestment plan 13,540 42,177 -- -- 55,717
Net income -- -- 1,454,266 -- 1,454,266
Cash dividends -- -- (540,872) -- (540,872)
Change in unrealized gain
(loss) on securities available
for sale, net of deferred
income taxes of $20,562 -- -- -- (39,912) (39,912)
--------- --------- --------- --------- -----------
Balances, December 31, 1996 $3,872,030 $1,132,638 $9,801,091 $ 31,435 $14,837,194
========= ========= ========= ======= ==========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Notes to Consolidated Financial Statements
[LOGO]
Note 1 Nature of Banking Activities and Significant Accounting
Policies
- --------------------------------------------------------------------------------
First National Corporation and Subsidiaries (the
Corporation) grant commercial, financial, agricultural,
residential and consumer loans to customers in the
Shenandoah Valley Region of Virginia. The loan portfolio is
well diversified and generally is collateralized by assets
of the customers. The loans are expected to be repaid from
cash flow or proceeds from the sale of selected assets of
the borrowers.
On July 6, 1994, First Bank (the Bank) formed First
Bank Financial Corporation (the Financial Corporation),
a wholly-owned subsidiary of the Bank. This subsidiary was
formed to acquire and hold an interest in Banker's Title
Insurance Company.
The accounting and reporting policies of the Corporation
conform to generally accepted accounting principles and
to accepted practices within the banking industry.
Principles of Consolidation: The consolidated financial
statements of First National Corporation and its
wholly-owned subsidiaries include the accounts of all
three companies. All material intercompany balances and
transactions have been eliminated in consolidation.
Securities: The Corporation has adopted FASB
No. 115, "Accounting for Certain Investment in Debt and
Equity Securities." This statement addresses the accounting
and reporting for investments in equity securities that
have readily determinable fair values and for all
investments in debt securities. Those investments are
classified in three categories and accounted for as
follows:
a. Securities Held to Maturity
Securities classified as held to maturity are those debt
securities the Corporation has both the intent and ability
to hold to maturity regardless of changes in market
conditions, liquidity needs or changes in general economic
conditions. These securities are carried at cost
adjusted for amortization of premium and accretion of
discount, computed by the interest method over their
contractual lives.
b. Securities Available for Sale
Securities classified as available for sale are those
debt and equity securities that the Corporation intends
to hold for an indefinite period of time, but not
necessarily to maturity. Any decision to sell a security
classified as available for sale would be based on
various factors, including significant movements in
interest rates, changes in the maturity mix of the
Corporation's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar
factors. Securities available for sale are carried at
fair value. Unrealized gains or losses are reported as
increases or decreases in stockholders' equity, net of the
related deferred tax effect. Realized gains or losses,
determined on the basis of the cost of specific
securities sold, are included in earnings.
c. Trading Securities
Trading securities, which are generally held for
the short term in anticipation of market gains, are carried
at fair value. Realized and unrealized gains and losses on
trading account assets are included in interest income on
trading account securities. The Corporation held no assets
classified as trading securities at December 31, 1996 and
1995.
Derivatives: The Corporation has no securities
defined as derivatives by FASB No. 119, "Disclosures for
Derivative Financial Instruments".
Loans: Loans are shown on the balance sheets net of
unearned discounts and the allowance for loan losses.
Interest is computed by methods which result in level rates
of return on principal. Loans are charged off when in the
opinion of management they are deemed to be uncollectible
after taking into consideration such factors as the
current financial condition of the customer and the
underlying collateral and guarantees.
On January 1, 1995, the Corporation adopted FASB No.
114, "Accounting by Creditors for Impairment of a Loan".
This statement has been amended by FASB No. 118,
"Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures". Statement 114, as amended,
requires that the impairment of loans that have been
separately identified for evaluation is to be measured
based on the present value of expected future cash flows
or, alternatively, the observable market price of the
loans or the fair value of the collateral. However, for
those loans that are collateral dependent (that is, if
repayment of those loans is expected to be provided
solely by the underlying collateral) and for which
management has determined foreclosure is probable, the
measure of impairment of those loans is to be based on the
fair value of the collateral. Statement 114, as
amended, also requires certain disclosures about
investments in impaired loans and the allowance for
credit losses and interest income recognized on loans. The
Corporation had no loans subject to FASB 114 at December
31, 1996 and 1995.
Loans are placed on nonaccrual when a loan is
specifically determined to be impaired or when principal
or interest is delinquent for 90 days or more. Any unpaid
interest previously accrued on those loans is reversed
from income. Interest income generally is not
recognized on specific impaired loans unless the
likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the
loan principal balance. Interest income on other
nonaccrual loans is recognized only to the extent of
interest payments received.
<PAGE>
Allowance for Loan Losses: The allowance for loan losses
is maintained at a level which, in management's judgment,
is adequate to absorb credit losses inherent in the loan
portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the
loan portfolio, including the nature of the portfolio,
credit concentrations, trends in historical loss
experience, specific impaired loans, and economic
conditions. Allowances for impaired loans are generally
determined based on the collateral values or the present
value of estimated cash flows. The allowance is
increased by a provision for loan losses, which is charged
to expense and reduced by charge-offs, net of recoveries.
Changes in the allowance relating to impaired loans are
charged or credited to the provision for loan losses.
Because of uncertainties inherent in the estimation
process, management's estimate of credit losses inherent in
the loan portfolio and the related allowance may change in
the near term.
Bank Premises and Equipment: Bank premises and equipment
are stated at cost less accumulated depreciation. For
financial reporting, depreciation is computed using the
straight-line method over the estimated useful lives of
the assets, which range from five to forty years. Gains
and losses on routine dispositions are reflected in
current operations.
Other Real Estate: Real estate acquired by foreclosure
is carried at the lower of cost or fair market value less
estimated costs of disposal.
Income Taxes: Deferred taxes are provided on a liability
method whereby deferred tax assets are recognized for
deductible temporary differences, operating loss
carryforwards, and tax credit carryforwards. Deferred tax
liabilities are recognized for taxable temporary
differences. Temporary differences are differences between
the reported amounts of assets and liabilities and their
tax bases. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred
tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax
laws and rates on the date of enactment.
Pension Plan: The Corporation has a trusteed,
noncontributory pension plan covering substantially all
employees. The Corporation computes the net periodic
pension cost of the plan in accordance with FASB No.
87, "Employers' Accounting for Pensions."
Per Share Amounts: Net income and dividends per common
share are based on the weighted average number of shares
outstanding during each year.
Nonrefundable Loan Fees and Costs: Loan origination and
commitment fees and certain direct loan origination costs
are being deferred and the net amount amortized as an
adjustment of the related loan's yield.
Cash and Cash Equivalents: The Corporation has defined
cash equivalents as those amounts included in the balance
sheet caption "Cash and Due from Banks".
Use of Estimates: The preparation of financial
statements in conformity with generally accepted accounting
principles requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates.
Advertising Costs: The Corporation follows the policy of
charging the production costs of advertising to expense
as incurred.
Note 2 Securities
- --------------------------------------------------------------------------------
Amortized costs and fair values of securities being held
to maturity as of December 31, 1996 and 1995, are as
follows:
<TABLE>
<CAPTION>
1996
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
<S> <C>
Mortgage-backed securities $ 3,032,999 $ 8,729 $ (10,999) $ 3,030,729
=========== =========== =========== =========
</TABLE>
<TABLE>
1995
<S> <C>
----------------------------------------------------------
Obligations of U.S. government
corporations and agencies $ 250,000 $ 13,640 $ - - $ 263,640
Mortgage-backed securities 5,826,484 18,026 (26,123) 5,818,387
----------- ---------- ----------- ---------
$ 6,076,484 $ 31,666 $ (26,123) $ 6,082,027
=========== ========== =========== =========
</TABLE>
Maturities may differ from contractual maturities in
mortgage-backed securities because the mortgages underlying
the securities may be called or repaid without any
penalties.
<PAGE>
Amortized costs and fair values of securities available for sale as of December
31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
<S> <C>
U. S. Treasury securities and
obligations of U.S. government
corporations and agencies $19,694,145 $ 122,220 $ (98,485) $19,717,880
Obligations of states and
political subdivisions 6,530,114 129,310 (100,340) 6,559,084
Corporate securities 4,010 -- -- 4,010
Mortgage-backed securities 3,376,438 14,427 (19,503) 3,371,362
Other 1,056,710 -- -- 1,056,710
---------- ------- ------ ---------
$30,661,417 $ 265,957 $ (218,328) $30,709,046
========== ======= ======= ==========
</TABLE>
<TABLE>
<CAPTION>
1995
<S> <C>
-----------------------------------------------------------
U. S. Treasury securities and
obligations of U.S. government
corporations and agencies $20,109,708 $ 135,401 $ (78,627) $20,166,482
Obligations of states and
political subdivisions 6,873,175 186,785 (98,757) 6,961,203
Corporate securities 4,010 -- -- 4,010
Mortgage-backed securities 2,381,784 -- (36,700) 2,345,084
Other 1,065,271 -- -- 1,065,271
----------- -------- -------- ----------
$30,433,948 $ 322,186 $ (214,084) $30,542,050
=========== ======== ======== ==========
</TABLE>
The amortized cost and fair value of securities available
for sale as of December 31, 1996, by contractual maturity
are shown below. Maturities may differ from contractual
maturities in corporate and mortgage-backed securities
because the securities and mortgages underlying the
securities may be called or repaid without any penalties.
Therefore, these securities are not included in the
maturity categories in the following maturity summary.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
<S> <C>
Due in one year or less $ 100,842 $ 102,906
Due after one year through five years 12,909,822 13,040,184
Due after five years through ten years 6,766,316 6,717,619
Due after ten years 6,447,279 6,416,255
Corporate securities 4,010 4,010
Mortgage-backed securities 3,376,438 3,371,362
Other 1,056,710 1,056,710
------------ ----------
$ 30,661,417 $ 30,709,046
============ ============
</TABLE>
There were no sales of securities being held to maturity
during 1996, 1995 and 1994.
Proceeds from sales of securities available for sale during
1996, 1995 and 1994 were $2,319,615, $14,779,108 and
$4,171,580, respectively. Gross gains of $19,549, $73,262
and $88,012 and gross losses of $-0-, $81,080 and $15,380
were realized on those sales.
As allowed by the Question and Answer Guide to FASB No.
115, "Accounting for Certain Investments in Debt and
Equity Securities" issued in November of 1995, debt
securities with an amortized cost of $1,496,790 were
transferred from held-to-maturity to
available-for-sale in December, 1995. The securities had an
unrealized loss of approximately $13,196.
Securities having a book value of $10,213,984 and
$11,122,200 at December 31, 1996 and 1995, were pledged to
secure public deposits and for other purposes required by
law.
<PAGE>
Note 3 Loans
- --------------------------------------------------------------------------------
Loans at December 31, 1996 and 1995, are summarized as
follows:
<TABLE>
<CAPTION>
1996 1995
(Thousands)
<S> <C>
Real estate loans:
Construction and land development $ 2,127 $ 3,990
Secured by farm land 993 898
Secured by 1-4 family residential 43,615 42,236
Other real estate loans 16,959 13,549
Loans to farmers (except those secured
by real estate) 770 574
Commercial and industrial loans (except
those secured by real estate) 13,548 5,843
Loans to individuals for personal expenditures 21,397 20,288
All other loans 1,075 1,172
-------- -------
Total loans $ 100,484 $ 88,550
Less: Unearned income 1,089 1,663
Allowance for loan losses 974 901
-------- ---------
Loans, net $ 98,421 $ 85,986
======== =========
</TABLE>
Note 4 Allowance for Loan Losses
- --------------------------------------------------------------------------------
Transactions in the allowance for loan losses for the
years ended December 31, 1996, 1995 and 1994, were
as follows:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C>
Balance at beginning of year $ 900,812 $ 1,155,104 $ 1,150,806
Provision charged to operating expense 120,000 -- --
Loan recoveries 16,425 35,395 74,184
Loan charge-offs (62,825) (289,687) (69,886)
--------- --------- ---------
Balance at end of year $ 974,412 $ 900,812 $ 1,155,104
========= ========= =========
</TABLE>
Nonaccrual loans excluded from impaired loan disclosure
under FASB 114 amounted to $12,827 and $120,320 at December
31, 1996 and 1995, respectively. If interest on these loans
had been accrued, such income would have approximated $566
and $9,627 for 1996 and 1995.
Note 5 Bank Premises and Equipment
- --------------------------------------------------------------------------------
Bank premises and equipment are summarized as follows at
December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
<S> <C>
Land $ 594,090 $ 578,431
Buildings and leasehold improvements 2,101,445 2,277,431
Furniture and equipment 3,316,908 3,108,494
Construction in progress 657,124 50,170
---------- -----------
$ 6,669,567 $ 6,014,526
Less accumulated depreciation 3,349,542 2,925,124
----------- -----------
$ 3,320,025 $ 3,089,402
=========== ===========
</TABLE>
Depreciation expense included in operating expenses for
1996, 1995 and 1994 was $443,274, $424,141, and $323,841,
respectively.
<PAGE>
Note 6 Deposits
- -------------------------------------------------------------------------------
Deposits outstanding at December 31, 1996, 1995 and 1994,
and the related interest expense for the periods then
ended, are summarized as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
-------------------------- -----------------
Amount Expense Amount Expense
<S> <C>
Noninterest bearing $14,408,746 $ -- $12,946,216 $ --
----------- --------- ----------- ------------
Interest bearing:
Interest checking $ 9,475,018 $ 218,001 $ 9,579,352 $ 223,700
Money-market accounts 7,031,866 254,996 7,136,259 266,886
Regular savings 37,100,033 1,515,184 29,153,265 1,098,240
Certificates of
deposit: Less than $100,000 43,838,539 2,398,451 46,037,315 2,494,259
$100,000 and more 12,130,029 609,303 11,053,500 514,093
---------- --------- ---------- ---------
$109,575,485 $4,995,935 $102,959,691 $ 4,597,178
------------ ---------- ----------- ----------
$123,984,231 $4,995,935 $115,905,907 $ 4,597,178
============ ========== ============ ===========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1994
-----------------------
Amount Expense
<S> <C>
Noninterest bearing $12,744,275 $ --
Interest bearing: ---------- ------------
Interest checking $ 9,119,479 $ 232,048
Money-market accounts 6,691,485 187,255
Regular savings 17,714,478 444,450
Certificates of deposit:
Less than $100,000 50,783,611 2,322,921
$100,000 and more 9,076,077 326,919
----------- ----------
$93,385,130 $ 3,513,593
----------- ----------
$106,129,405 $ 3,513,593
============ ============
</TABLE>
Note 7 Short-Term Borrowings
- -------------------------------------------------------------------------------
The Corporation had unused lines of credit totaling $36
million with non-affiliated banks at December 31, 1996.
Note 8 Long-Term Debt
- --------------------------------------------------------------------------------
At December 31, 1996, the Corporation had borrowings from
the Federal Home Loan Bank system totaling $1,481,424 which
mature on December 12, 2005. The interest rate on the note
payable is 6.25%. Principal payments on the note are due as
follows:
<TABLE>
<S> <C>
1997 $ 20,188
1998 21,940
1999 23,843
2000 25,912
2001 28,161
Later years 1,361,380
-----------
$ 1,481,424
===========
</TABLE>
<PAGE>
Note 9 Income Taxes
- -------------------------------------------------------------------------------
Net deferred tax assets consist of the following components
as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
<S> <C>
Deferred tax assets:
Allowance for loan losses $ 244,908 $ 219,884
Pension payable 58,528 64,916
Interest on nonaccrual loans 192 3,273
Other real estate expenses -- 23,002
___________ ___________
$ 303,628 $ 311,075
____________ ___________
Deferred tax liabilities:
Depreciation $ 43,865 $ 52,020
Bond accretion 8,893 7,149
Loan origination costs 51,406 42,716
Securities available for sale 16,194 36,755
___________ ___________
$ 120,358 $ 138,640
____________ ___________
$ 183,270 $ 172,435
============ ===========
</TABLE>
The provision for income taxes charged to operations for
the years ended December 31, 1996, 1995 and 1994 consists of
the following:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C>
Current tax expense $ 520,870 $ 385,569 $ 328,009
Deferred tax expense 9,726 95,649 13,158
____________ ___________ ___________
$ 530,596 $ 481,218 $ 341,167
============ =========== ===========
</TABLE>
The income tax provision differs from the amount of income tax
determined by applying the U.S. federal income tax rate to
pretax income for the years ended December 31, 1996, 1995 and
1994, due to the following:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C>
Computed "expected" tax expense $ 674,853 $ 610,560 $ 469,988
(Decrease) in income taxes resulting from:
Tax exempt interest income (128,063) (116,234) (91,295)
Other (16,194) (13,108) (37,526)
______________ _____________ ___________
$ 530,596 $ 481,218 $ 341,167
=============== ============== ===========
</TABLE>
Low income housing credits totalled $32,179 for each of the
years ended December 31, 1996, 1995 and 1994, respectively.
Note 10 Fund Restrictions and Reserve Balance
- ------------------------------------------------------------------------------
Transfers of funds from the banking subsidiary to the
parent corporation in the form of loans, advances and cash
dividends are restricted by federal and state regulatory
authorities. As of December 31, 1996, the aggregate amount of
unrestricted funds which could be transferred from the banking
subsidiary to the parent corporation, without prior regulatory
approval, totalled $2,588,115.
The Bank must maintain a reserve against its deposits in
accordance with Regulation D of the Federal Reserve Act. For
the final weekly reporting period in the years ended December
31, 1996 and 1995, the aggregate amounts of daily average
required balances were approximately $537,000 and $547,000,
respectively.
Note 11 Employee Benefit Plans
- --------------------------------------------------------------------------------
The amount charged to expense for the Company's pension plan
totalled $131,041, $110,565, and $90,209 for 1996, 1995 and
1994, respectively. The components of the pension cost charged
to expense consisted of the following:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C>
Service cost $ 133,691 $ 102,027 $ 93,602
Interest cost on projected benefit
obligation 91,351 75,910 67,357
Actual return on plan assets (91,375) (65,016) (66,961)
Net amortization and deferral (2,626) (2,356) (3,789)
_____________ ___________ ___________
$ 131,041 $ 110,565 $ 90,209
============= =========== ===========
</TABLE>
The following table sets forth the plan's funded status as of
September 30, 1996 and 1995 and the amount recognized in the
accompanying balance sheets as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
<S> <C>
Actuarial present value of benefit obligations:
Vested benefits $ 735,307 $ 622,623
============ ===========
Accumulated benefits $ 784,268 $ 655,446
============ ===========
Projected benefits $ (1,400,560) $ (1,218,007)
Plan assets at fair value 1,270,505 1,015,280
------------ -----------
Projected benefit obligation in excess of plan assets $ (130,055) $ (202,727)
Unrecognized net asset (26,448) (28,804)
Unrecognized net gain (166,426) (127,470)
____________ ___________
Liability on balance sheet as of September 30 $ (322,929) $ (359,001)
Fourth quarter entries, employer contribution 150,790 168,072
------------ -----------
Liability on balance sheet as of December 31 $ (172,139) $ (190,929)
============ ============
</TABLE>
The weighted-average discount rate and rate of increase in
future compensation levels used in determining the
actuarial present value of the benefit obligations were
7.5% and 6.0%, respectively. The expected long-term rate of
return on plan assets was 9.0%.
The Corporation provides a profit sharing thrift plan for
all eligible employees. Participating employees may elect to
contribute up to 6% of their salaries. The Corporation
contributes an amount equal to one-half of the employees'
contributions. The Corporation's contributions in 1996, 1995
and 1994 were $52,616, $47,456 and $36,858, respectively.
Note 12 Commitments and Contingencies
- ---------------------------------------------------------------------------
In the normal course of business, there are outstanding
various commitments and contingent liabilities, such as
guarantees, commitments to extend credit, etc., which are
not reflected in the accompanying financial statements. The
Corporation does not anticipate losses as a result of these
transactions.
See Note 16 with respect to financial instruments with
off-balance-sheet risk.
Note 13 Transactions With Related Parties
- ---------------------------------------------------------------------------
During the year, employees, executive officers and
directors (and companies controlled by them) were customers
of and had transactions with the Corporation in the normal
course of business. These transactions were made on
substantially the same terms as those prevailing for other
customers.
An analysis of loans (exclusive of loans to any such person
which in the aggregate did not exceed $60,000) made by the
Corporation to directors, executive officers, or principal
stockholders or to any associate of such persons is shown in
the following table:
Balance Balance
January 1, New Loan December 31,
1996 Loans Repayments 1996
$3,040,601 $445,131 $523,574 $2,962,158
========= ======= ======== ==========
Note 14 Winchester Branch Office
- ---------------------------------------------------------------------------
The branch office in Winchester has been leased for a
five-year period beginning June 1, 1986, with options to
renew for three additional five-year periods. The current
annual rent is $17,500, with an allowable increase based on
the Consumer Price Index. The annual rent for the third
five-year period cannot exceed $21,175.
<PAGE>
Note 15 Dividend Reinvestment Plan
- --------------------------------------------------------------------------------
The Company has in effect a Dividend Reinvestment Plan
which provides an automatic conversion of dividends into
common stock for enrolled shareholders. Stock is issued at
100% of fair market value on each dividend record date.
Note 16 Financial Instruments With Off-Balance-Sheet Risk
- --------------------------------------------------------------------------------
The Corporation is party to financial instruments with
off-balance-sheet risk in the normal course of business to
meet the financing needs of its customers and to reduce its
own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit
and standby letters of credit. Those instruments involve,
to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance
sheet. The contract or notional amounts of those
instruments reflect the extent of involvement the
Corporation has in particular classes of financial
instruments.
The Corporation's exposure to credit loss in the event of
nonperformance by the other party to the financial
instrument for commitments to extend credit and standby
letters of credit is represented by the contractual
notional amount of those instruments. The Corporation uses
the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet
instruments.
A summary of the contract or notional amount of the
Corporation's exposure to off-balance-sheet risk as of
December 31, 1996 and 1995, is as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C>
Financial instruments whose contract amounts represent
credit risk:
Commitments to extend credit $15,110,000 $15,944,340
Standby letters of credit $ 201,030 $ 118,967
</TABLE>
Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the contract. Commitments generally have
fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash
requirements. The Corporation evaluates each customer's
credit worthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Corporation
upon extension of credit, is based on management's credit
evaluation of the counterparty. Collateral held varies but
may include accounts receivable, inventory, property and
equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments
issued by the Corporation to guarantee the performance of a
customer to a third party. Those guarantees are primarily
issued to support public and private borrowing
arrangements, including commercial paper, bond financing,
and similar transactions. The credit risk involved in
issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The
Corporation holds security agreements on accounts
receivable, inventory and equipment as collateral
supporting those commitments for which collateral is deemed
necessary. The extent of collateral held for those
commitments at December 31, 1996, varies from 0 percent to
100 percent; the average amount collateralized is 34.8
percent.
The Corporation has cash accounts in other commercial
banks. The amount on deposit at these banks at December 31,
1996, exceeded the insurance limits of the Federal
Deposit Insurance Corporation by approximately $324,090.
Note 17 Disclosures about Fair Value of Financial Instruments
- --------------------------------------------------------------------------------
The following methods and assumptions were used to estimate
the fair value of each class of financial instruments for
which it is practicable to estimate that value:
Cash and Short-Term Investments: For those short-term
instruments, the carrying amount is a reasonable estimate
of fair value.
Securities: For securities held for investment purposes,
fair values are based on quoted market prices or dealer
quotes.
Loan Receivables: For certain homogeneous categories of
loans, such as some residential mortgages, and other
consumer loans, fair value is estimated using the quoted
market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The
fair value of other types of loans is estimated by
discounting the future cash flows using the current rates
at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining
maturities.
Deposit Liabilities: The fair value of demand deposits,
savings accounts, and certain money market deposits is
the amount payable on demand at the reporting date. The
fair value of fixed-maturity certificates of deposit is
estimated using the rates currently offered for deposits
of similar remaining maturities.
Off-Balance Sheet Financial Instruments: The fair value
of commitments to extend credit is estimated using the
fees currently charged to enter similar agreements,
taking into account the remaining terms of the
agreements and the present credit worthiness of the
counterparties. For fixed-rate loan commitments, fair
value also considers the difference between current
levels of interest rates and the committed rates.
The fair value of stand-by letters of credit is based on
fees currently charged for similar agreements or on
the estimated cost to terminate them or otherwise settle
the obligations with the counterparties at the reporting
date.
At December 31, 1996 and 1995, the carrying amounts and
fair values of loan commitments and stand-by letters of
credit were deemed immaterial.
The estimated fair values of the Corporation's financial
instruments are as follows:
<TABLE>
<CAPTION>
1996 1995
Carrying Fair Carrying Fair
Amount Value Amount Value
(in thousands) (in thousands)
---------------------------- ---------------------------
<S> <C>
Financial assets:
Cash and short-term investments $ 3,510 $ 3,510 $ 4,314 $ 4,314
Securities 33,742 33,740 36,619 36,624
Loans 99,395 99,007 86,887 87,175
Less: allowance for loan losses 974 -- 901 --
----------- ------------ ----------- -----------
Total financial assets $ 135,673 $ 134,257 $ 126,919 $ 128,113
=========== ============ =========== ===========
Financial liabilities:
Deposits $ 123,984 $ 124,000 $ 115,906 $ 116,416
Federal funds purchased 315 315 382 382
Long-term debt 1,481 1,437 1,500 959
----------- ------------ ----------- -----------
Total financial liabilities $ 125,780 $ 125,752 $ 117,788 $ 117,757
=========== ============ =========== ===========
</TABLE>
<PAGE>
Note 18 Regulatory Matters
- --------------------------------------------------------------------------------
The Corporation is subject to various regulatory capital
requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate
certain mandatory - possibly additional discretionary-
actions by regulators that, if undertaken, could have a
direct material effect on the Corporation's financial
statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the
Corporation must meet specific capital guidelines that
involve quantitative measures of the Corporation's assets,
liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The
Corporation's capital amounts and classification are also
subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to
ensure capital adequacy require the Corporation to
maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in
the regulations) to risk-weighted assets, and of Tier 1
capital to average assets. Management believes, as of
December 31, 1996, that the Corporation meets all capital
adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification
from the Federal Reserve Bank categorized the
Corporation as well capitalized under the regulatory
framework for prompt corrective action. To be categorized
as well capitalized, the Corporation must maintain
minimum total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table. There are no
conditions or events since that notification that
management believes have changed the institution's
category.
The Corporation's actual capital amounts and ratios are
also presented in the table.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Amount in Thousands)
As of December 31, 1996
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C>
Total Capital (to Risk Weighted Assets):
Consolidated $ 15,780 16.6% >$ 7,604 >8.0% N/A
First Bank $ 15,485 16.3% >$ 7,593 >8.0% > $ 9,491 >10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $ 14,806 15.6% >$ 3,802 >4.0% N/A
- -
First Bank $ 14,511 15.3% >$ 3,796 >4.0% > $ 5,695 > 6.0%
- - - -
Tier 1 Capital (to Average Assets):
Consolidated $ 14,806 10.4% >$ 5,680 >4.0% N/A
- -
First Bank $ 14,511 10.2% >$ 5,674 >4.0% > $ 7,093 > 5.0%
- - - -
As of December 31, 1995
- ----------------------------------------------------------------------------------------------------------------------------------
Total Capital (to Risk Weighted Assets):
Consolidated $ 14,737 17.5% >$ 6,724 >8.0% N/A
- -
First Bank $ 14,425 17.2% >$ 6,710 >8.0% > $ 8,387 >10.0%
- - - -
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $ 13,836 16.5% >$ 3,362 >4.0% N/A
- -
First Bank $ 13,524 16.1% >$ 3,355 >4.0% > $ 5,032 > 6.0%
- - - -
Tier 1 Capital (to Average Assets):
Consolidated $ 13,836 10.7% >$ 5,179 >4.0% N/A
- -
First Bank $ 13,524 10.5% >$ 5,172 >4.0% > $ 6,465 > 5.0%
- - - -
</TABLE>
<PAGE>
Note 19 Incentive Stock Option Plan
- --------------------------------------------------------------------------------
The Corporation has an incentive stock option plan for all
full-time employees. Under the plan, the Corporation may
grant options for up to 21,000 shares of the common stock.
The exercise price of each option is equal to the market
price of the Corporation's stock on the date of grant. The
maximum term of the option is five years, and they vest
immediately upon grant.
The Corporation applies APB Opinion 25 in accounting for
its incentive stock option plan. Accordingly, no
compensation cost has been recognized for the plan in 1996
and 1995. Had compensation cost been determined on the
basis of fair value pursuant to FASB Statement No. 123, net
income and earnings per share would not have been
materially different from the amounts presented.
The status of the stock option plan during 1996 and 1995 is
as follows:
<TABLE>
<CAPTION>
1996 1995
-------------------- -------------------
Weighted Weighted
Average Average
Number of Exercise Number of Exercise
Shares Price Shares Price
<S> <C> --------- --------- --------- --------
Outstanding at January 1 23,179 $ 23.40 20,832 $ 23.64
Granted - - 7,875 23.00
Exercised - - (210) 22.93
Forfeited (4,176) 22.72 (5,318) 23.79
------ ------
Outstanding at December 31 19,003 23.55 23,179 23.40
====== ======
</TABLE>
The status of the options outstanding at December 31, 1996
is as follows:
<TABLE>
<CAPTION>
Weighted
Weighted Number Average
Average Outstanding Remaining
Exercise and Contractual
Price Exercisable Life
--------- ----------- ------------
<S> <C>
$ 23.75 3,148 .13 years
23.75 3,255 1.33 years
24.00 5,615 2.46 years
23.00 6,985 3.29 years
------
23.55 19,003 2.19 years
======
</TABLE>
Note 20 Construction Project
- --------------------------------------------------------------------------------
During 1996, the Corporation entered into a construction
agreement for the building of an addition and major
renovations at the Main Office in Strasburg. The contract
amount of construction is $963,420, of which $565,602 has
been paid through December 31, 1996.
<PAGE>
Note 21 Parent Corporation Only Financial Statements
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
December 31, 1996 and 1995 1996 1995
<S> <C>
Balance Sheets Assets
Cash $ 89,196 $ 95,045
Investment in subsidiaries, at cost, plus
undistributed net income 14,542,190 13,595,584
Other assets 205,808 217,685
------------- -------------
Total assets $ 14,837,194 $ 13,908,314
============= =============
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ -- $ 319
------------- -------------
Stockholders' Equity
Common stock $ 3,872,030 $ 3,858,490
Surplus 1,132,638 1,090,461
Retained earnings 9,801,091 8,887,697
Unrealized gain on securities available for sale, net 31,435 71,347
------------- -------------
Total stockholders' equity $ 14,837,194 $ 13,907,995
------------- -------------
Total liabilities and stockholders' equity $ 14,837,194 $ 13,908,314
============= =============
</TABLE>
<PAGE>
Note 21 Parent Corporation Only Financial Statements continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Statements of Years Ended December 31 1996 1995 1994
Income
<S> <C>
Income, dividends from subsidiary $ 465,000 $ 365,000 $ 385,000
------------- ------------ ------------
Expenses:
Registration fees $ 850 $ 850 $ 1,185
Stationery and supplies 11,686 12,166 12,669
Legal and professional fees 12,610 18,253 22,635
Other 19,447 7,657 15,883
------------- ------------ ------------
Total expenses $ 44,593 $ 38,926 $ 52,372
------------- ------------ ------------
Income before allocated tax benefits
and undistributed income of subsidiary $ 420,407 $ 326,074 $ 332,628
Allocated income tax benefits 47,341 45,414 49,985
------------- ------------ ------------
Income before equity in undistributed
income of subsidiary $ 467,748 $ 371,488 $ 382,613
Equity in undistributed income of subsidiary 986,518 943,060 658,537
------------- ------------ ------------
Net income $ 1,454,266 $ 1,314,548 $ 1,041,150
============= ============ ============
Statements of Years Ended December 31 1996 1995 1994
Cash flows
Cash Flows from Operating Activities
Net income $ 1,454,266 $ 1,314,548 $ 1,041,150
Adjustments to reconcile net income to net
cash provided by operating activities:
Undistributed earnings of subsidiary (986,518) (943,060) (658,537)
(Increase) decrease in other assets 11,877 9,367 (3,876)
Increase (decrease) in accounts payable (319) 319 --
------------- ------------- -------------
Net cash provided by operating
activities $ 479,306 $ 381,174 $ 378,737
------------- ------------- -------------
Cash Flows from Financing Activities
Net proceeds from issuance of common
stock $ 55,717 $ 18,076 $ 28,970
Cash dividends paid (540,872) (462,642) (400,851)
------------- ------------- -------------
Net cash (used in) financing
activities $ (485,155) $ (444,566) $ (371,881)
------------- ------------- -------------
Increase (decrease) in cash and
cash equivalents $ (5,849) $ (63,392) $ 6,856
Cash and Cash Equivalents
Beginning 95,045 158,437 151,581
------------- ------------- -------------
Ending $ 89,196 $ 95,045 $ 158,437
============= ============= =============
</TABLE>
<PAGE>
[LOGO]
Management's Discussion and Analysis
of Financial Condition and Results of Operations
- --------------------------------------------------------------------------------
First National Corporation (the "Company") is the holding company for First Bank
(the "Bank") and First Bank Financial Services Inc. ("Financial Services"). The
following discussion and analysis of the financial condition and results of
operations of the Company for the years ended December 31, 1996, 1995 and 1994
should be read in conjunction with the consolidated financial statements and
related notes.
Overview
Both earnings and assets increased in 1996. Net income for 1996 was $1,454,266
compared to $1,314,548 in 1995 and $1,041,150 in 1994. Net income per share
increased $0.18 in 1996 from 1995 ($1.88 per share versus $1.70 per share). The
increase in earnings resulted primarily from an increase in the Bank's interest
income which was greater than the increase in interest expense. Return on
average assets was 1.06% in 1996, 1.03% in 1995 and .91% in 1994. Return on
average equity was 10.36% in 1996, 10.28% in 1995 and 8.66% in 1994.
Assets grew 8.6% in 1995 but in 1996 the growth rate slowed slightly to 6.7%.
Growth was concentrated in the loan portfolio where loans, net of unearned
income, increased $12.4 million to $98.4 million. Funding for this loan growth
was provided by an increase in deposits of $8.1 million and a decline in the
securities portfolio of $2.9 million.
Results of Operations
Net interest income represents the primary source of earnings for the Company.
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 and short-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 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.
General. Net income has increased in each of the last two years, after
declining in 1994. The decline in income in 1994 was the result of a decline in
the net interest margin in conjunction with the costs associated with
opening a new branch and changing from a national banking charter to a
state banking charter with a change in name for the bank. Income increased in
1995 as a result of a growth in earning assets and an increase in noninterest
income from nonrecurring items. The continued increase in income in 1996 was
caused by further growth in earning assets and by the funding of higher yielding
assets, in part, from lower yielding assets.
Net Interest Income. Net interest income, after provision for loan losses, was
$5.62 million for the year ended December 31, 1996, up $0.41 million or
7.79% over the $5.21 million reported for the same period in 1995. This
increase in net interest income, after provision for loan losses,
resulted from a net increase in interest-bearing assets coupled with an
increase in yields for the period. In 1995 net interest income, after
provision for loan losses increased 7.73% or $0.37 million from $4.84 million
in 1994.
Both the net interest margin and interest rate spread declined between 1994
and 1995, however they increased between 1995 and 1996. Interest expense as
a percent of average earning assets increased from 3.31% in 1994 to 3.86% in
1995 and increased again in 1996 to 3.92%. Interest income as a percent of
average earning assets, on the other hand, increased from 7.90% in 1994 to
8.14% in 1995 and further increased in 1996 to 8.43% in 1996. These increases
in 1996 resulted from most of the asset growth in the period being concentrated
in the higher yielding loan portfolio and an increase in yield in the
investment portfolio and continued growth in floating rate deposit products
with slightly higher interest costs.
The net interest spread increased to 3.71% in 1996 after declining to 3.49% in
1995 from 3.85% in 1994. The net interest margin also increased to 4.51% in
1996 from 4.40% in 1995 after declining from 4.59% in 1994. The above
ratios reflect management's attempt to increase the net interest margin by
funding growth in the loan portfolio with a mix of new deposits supplemented by
funds from the investment portfolio.
Provision for Loan Losses. There was no provision made in either 1994 or 1995 as
a result of management's analysis of the allowance for loan losses which
consistently found that the balance was sufficient to cover anticipated losses.
However in 1996, in anticipation of growth in the loan portfolio, a provision of
$120,000 was made to the allowance for loan losses.
Non-Interest Income. Non-interest income decreased $155,342 in 1996 over 1995.
This decrease was the result of a $20,523 decrease in service charges on
customer accounts and an decrease in other income of $133,766. In 1995, other
income had increased $155,870 as a result of the settlement of several lawsuits.
Non-Interest Expense. In 1996, non-interest expenses increased $61,533 or 1.45%
over 1995. This increase was less than the increase in 1995 of $165,070 or
4.07% and considerably less than the increase in 1994 when non-interest
expenses increased $695,855, or 20.73%. These increases can be attributed to
the asset growth of 28.74% since 1993 which would not have occurred
without increases in branch locations and staffing.
Income Taxes. The company has adopted FASB Statement No. 109, "Accounting for
Income Taxes". A more detailed discussion of the Company's tax calculation is
contained in Note 9 to the consolidated financial statements.
<PAGE>
Management`s Discussion and Analysis continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Selected Consolidated Financial Data
--------------------------------------------------------------------------------------------------
Years ended December 31, 1996 1995 1994 1993 1992
(In thousands, except ratios and per share amounts)
<S> <C>
Income Statement Data:
Interest income $ 10,833 $ 9,943 $ 8,441 $ 8,340 $ 8,856
Interest expense 5,097 4,733 3,605 3,428 4,118
--------- -------- ---------- --------- --------
Net interest income 5,736 5,210 4,836 4,912 4,738
Provision for loan losses 120 0 0 240 234
--------- -------- ---------- --------- --------
Net interest income after
provision for loan losses 5,616 5,210 4,836 4,672 4,504
Noninterest income 628 811 526 518 498
Securities gains (losses) 20 (8) 73 92 4
Noninterest expense 4,279 4,217 4,053 3,357 3,086
--------- -------- --------- --------- --------
Income before income taxes 1,985 1,796 1,382 1,925 1,920
Income taxes 531 481 341 551 552
--------- -------- --------- --------- --------
Net income $ 1,454 $ 1,315 $ 1,041 $ 1,374 $ 1,368
========= ======== ========= ========= ========
Per Share Data:
Net income $ 1.80 $ 1.70 $ 1.35 $ 1.79 $ 1.78
Cash dividends 0.70 0.60 0.52 0.48 0.43
Book value at period end 19.16 18.02 15.74 15.98 15.41
Balance Sheet Data:
Assets $ 141,225 $ 132,321 $ 122,008 $ 109,701 $ 105,156
Loans, net of unearned income 98,421 85,986 76,829 62,274 66,756
Securities 33,742 36,619 38,441 39,346 32,773
Deposits 123,984 115,906 106,129 96,758 89,653
Stockholders' equity 14,837 13,908 12,135 12,297 11,268
Average shares outstanding 773 771 771 768 768
Performance Ratios:
Return on average assets 1.06% 1.03% 0.91% 1.28% 1.31%
Return on average equity 10.36% 10.28% 8.66% 11.94% 13.08%
Dividend payout 37.19% 35.19% 38.50% 26.66% 24.03%
Capital and Liquidity Ratios
Leverage 10.43% 10.88% 11.19% 11.42% 10.78%
Risk-based capital ratios:
Tier 1 capital 15.58% 16.49% 17.89% 20.70% 18.63%
Total capital 16.60% 17.58% 19.27% 21.95% 19.88%
</TABLE>
Financial Condition
General. Management continued to aggressively increase the size of the loan
portfolio during 1996. Loans, net of unearned discounts and allowance for loan
losses, increased $12.4 million or 14.5% from $85.9 million in 1995 to $98.4
million in 1996. This growth in loans was reflected in a 6.73% increase in
assets during the year. Assets began the year at $132.3 million and grew $8.9
million to $141.2 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, 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, 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 total amount of commercial, industrial and agricultural loans increased
$7.9 million in 1996. Residential real estate mortgage loans increased $1.4
million in 1996 after increasing $1.5 million in 1995. Non farm, non
residential mortgage loans also increased in 1996 by $3.4 million and in
1995 by $1.2 million The growth in the consumer loan area continued in 1996
with an increase of $1.1 million which was less than the increase of $3.5
million in 1995.
<PAGE>
Management`s Discussion and Analysis continued
- -------------------------------------------------------------------------------
Asset Quality. The Allowance for Loan Losses ("ALL") balance at December 31,
1996 was $974,412, representing 0.98% of total loans and 119% of non-performing
assets. At December 31, 1995, these amounts were 1.04% and 97.5%. These amounts
were 1.50% and 91.7% at December 31, 1994.
Total losses charged against the ALL in 1996 were $62,825, compared to
$289,687 in 1995 and $69,886 in 1994. The increase in losses in 1995 was due
to a $200,000 charge off resulting from the Bank's receiving real estate by deed
in lieu of foreclosure. Recoveries, consisting of the recovery of
principal on loans previously charge against the allowance, totaled $16,425 in
1996, $35,395 in 1995, and $74,184 in 1994.
Management believes, based upon its review and analysis which considers
economic conditions, changes in the nature and value of the portfolio,
industry standards and other relevant factors, that the Bank has sufficient
reserves to cover any projected losses within the total loan portfolio.
Nonperforming Assets. Management classifies as nonperforming 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.
Nonaccrual loans totaled $12,827 at year end, representing 0.013% of the net
loan portfolio. These numbers decreased from the 1995 balance of $120,320 or
0.14% of the net loan portfolio. The Bank has allocated a portion of the
Allowance for Loan Losses to cover anticipated losses from these loans.
When a loan is placed on nonaccrual 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.
Securities. The Company adopted FASB No. 115, "Accounting for Certain Investment
in Debt and Equity Securities" effective beginning January 1, 1994. The Company
reclassified its securities portfolio into those securities that would be held
to maturity and those that were available for sale. The securities that were
classified as available for sale were recorded at fair value in accordance with
FASB No. 115 and the Company recognized the effect of unrealized gains/losses
net of tax effects in stockholders' equity.
The book value of the securities portfolio, including securities available
for sale, was $33.7 million at December 31, 1996, $36.6 million at
December 31, 1995, and $38.4 million at December 31, 1994. The securities
portfolio decreased $2.9 million in 1996 , decreased $1.8 million in 1995 and
decreased $0.9 million in 1994. Investment in U.S. Government issues decreased
$0.7 million in 1996, increased $5.2 million in 1995, and decreased $0.6
million in 1994. Investment in issues of state and political subdivisions
decreased $0.4 million in 1996 after increasing $3.1 million in 1995 and
declining $0.3 million in 1994. Mortgage-backed securities showed the greatest
decline in 1996 with their balances declining $1.8 million.
As of December 31, 1996, neither the Company nor the Bank held any derivative
financial instruments in their respective investment security portfolios.
Deposits. The Bank has made an effort in recent years to increase core deposits
and reduce costs of funds. Deposits provide funding for the Company'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, 1996 were $123.9 million, an increase of $8.1
million or 7.0% from $115.9 million at December 31, 1995. This increase was
concentrated in Savings Accounts which increased $7.9 million and was caused by
growth in floating rate money market savings accounts during the year. Large
local government deposits on which rates were set by competitive bid caused an
increase in Certificates of Deposit with balances equal to or in excess of $100
thousand.
Liquidity. Liquidity represents an institutions 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 Treasury 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, 1996, cash, interest bearing and noninterest bearing deposits
with banks, federal funds sold, investments in Treasury securities, and
loans maturing within one year were $34.9 million. As of December 31, 1996,
approximately 41.93% or $41.3 million of the loan portfolio would mature or
reprice within a one year period.
Nondeposit sources of funds in use at December 31, 1996 consisted of a Federal
Home Loan Bank advance and Federal Funds Purchased. The Federal Home Loan Bank
advance was a draw by the Bank against its line at the Federal Home Loan Bank of
Atlanta with an original balance of $1.5 million bearing interest at 6.25% with
a maturity of December 12, 2005. Security for the advance consists of U.S.
Government and Agency Securities. This advance was used to fund growth in the
loan portfolio.
Capital Resources. The adequacy of the Bank's capital is reviewed by
management on an ongoing basis with reference to the size, composition,
and quality of the Bank'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
quidelines 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 Company had a
ratio of risk-weighted assets to total capital of 16.60% at December 31, 1996
and a ratio of risk-weighted assets to Tier 1 capital of 15.58%. Both of these
exceed the capital requirements adopted by the federal regulatory agencies.
<PAGE>
Corporate Information
- -------------------------------------------------------------------------------
BOARD OF DIRECTORS
FIRST NATIONAL CORP.
FIRST BANK
Douglas C. Arthur
ATTORNEY AT LAW
Noel M. Borden
CHAIRMAN
FIRST NATIONAL CORPORATION
FIRST BANK
PRESIDENT, H.L. BORDEN LUMBER CO.
Dr. Byron A. Brill
PERIODONTIST
Elizabeth H. Cottrell
PRESIDENT
RIVERWOOD TECHNOLOGIES
Christopher E. French
PRESIDENT, SHENANDOAH
TELECOMMUNICATIONS CO. AND SUBSIDIARIES
Charles E. Maddox, Jr.
CHIEF ENGINEER
G.W. CLIFFORD & ASSOCIATES
Ronald F. Miller
PRESIDENT
CHIEF EXECUTIVE OFFICER
FIRST NATIONAL CORPORATION
FIRST BANK
W. Allen Nicholls
PRESIDENT
NICHOLLS CONSTRUCTION, INC.
Henry L. Shirkey
CUSTOMER SERVICE REPRESENTIVE
HOLTZMAN OIL COMPANY
RETIRED COMMUNITY BANKER
OFFICERS OF
FIRST NATIONAL CORP.
Noel M. Borden
CHAIRMAN OF THE BOARD
Douglas C. Arthur
VICE CHAIRMAN
Ronald F. Miller
PRESIDENT
CHIEF EXECUTIVE OFFICER
Harry S. Smith
VICE PRESIDENT/SECRETARY
Dana A. Froom
COMPTROLLER
OFFICERS OF FIRST BANK
Noel M. Borden
CHAIRMAN
Douglas C. Arthur
VICE CHAIRMAN
THE EXECUTIVE COMMITTEE
Ronald F. Miller
PRESIDENT/CHIEF EXECUTIVE OFFICER
Harry S. Smith
EXECUTIVE VICE PRESIDENT/CASHIER
Don Collins
SR. VICE PRESIDENT/SR. LOAN OFFICER
Dana A. Froom
SR. VICE PRESIDENT
OFFICERS OF
FIRST BANK CONTINUED
R. Mark Garber
VICE PRESIDENT
REGIONAL MANAGER, WINCHESTER
James E. Pomeroy, III
VICE PRESIDENT
BRANCH MANAGER, FRONT ROYAL
Kevin F. Smith
VICE PRESIDENT
COMMERCIAL LOAN OFFICER
Joseph L. Thompson, III
VICE PRESIDENT
MORTGAGE LOAN MANAGER
William B. Whipple
VICE PRESIDENT
BRANCH MANAGER, KERNSTOWN
Nancy F. Abe
VICE PRESIDENT
CONSUMER LOAN MANAGER
Gayle M. Davison
VICE PRESIDENT
C.R.A. OFFICER
COMPLIANCE OFFICER
Dennis A. Dysart
VICE PRESIDENT
INVESTMENT MANAGER
Greg T. Coons
ASSISTANT VICE PRESIDENT
COMMERCIAL LOAN OFFICER
Mary T. Levi
ASSISTANT VICE PRESIDENT
MAIN OFFICE MANAGER
Fay C. Miller
ASSISTANT VICE PRESIDENT
CONSUMER LOAN OFFICER
Sarah F. Miller
ASSISTANT VICE PRESIDENT
DATA PROCESSING
Patricia R. Clem
ASSISTANT CASHIER
CUSTOMER SERVICE REPRESENTATIVE
C. Renee Cummins
MORTGAGE LOAN OFFICER
Nancy T. Fitchett
ASSISTANT CASHIER
OPERATIONS OFFICER
Donald L. Miller
APPRAISER
SECURITY OFFICER
Jacquelyn B. Pomeroy
ASSISTANT CASHIER
HEAD BOOKKEEPER
Julia A. Tyler
BRANCH MANAGER, WINCHESTER
Cindy Larrick
BRANCH MANAGER, KERNSTOWN
Belita B. Ford
ASSISTANT BRANCH MANAGER,
FRONT ROYAL
Brenda LeDane
ASSISTANT BRANCH MANAGER,
WOODSTOCK
Audrey Pattyson
ASSISTANT BRANCH MANAGER,
WINCHESTER
Pam Ramey
ASSISTANT BRANCH MANAGER,
KERNSTOWN
Sherri Totten
LOAN OFFICER
Gail Shanholtz
LOAN OFFICER
OFFICE LOCATIONS
- -------------------------------------------------------------------------------
112 W. King St.
Strasburg, VA
22657
540-465-9121
2210 Valley Ave.
Ward Plaza
Winchester, VA
22601
540-667-83004
508 N. Commerce Ave.
Front Royal, VA
22630
540-636-6149
3143 Valley Pike
Winchester, VA
22602
540-662-9594
860 S. Main Street
Woodstock, VA
22664
540-459-9510
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