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WFBI > SEC Filings for WFBI > Form 10-K on 22-Mar-2013All Recent SEC Filings

Show all filings for WASHINGTONFIRST BANKSHARES, INC. | Request a Trial to NEW EDGAR Online Pro



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion and analysis of financial condition and results of operations should be read together with WashingtonFirst's financial statements and the related notes to the financial statements for the fiscal years ended December 31, 2012 and 2011.

The discussion below and the other sections to which WashingtonFirst has referred you contains management's comments on WashingtonFirst's business strategy and outlook, such discussions contain forward-looking statements. These forward-looking statements reflect the expectations, beliefs, plans and objectives of management about future financial performance and assumptions underlying management's judgment concerning the matters discussed, and accordingly, involve estimates, assumptions, judgments and uncertainties. WashingtonFirst's actual results could differ materially from those discussed in the forward-looking statements and the discussion below is not necessarily indicative of future results. Factors that could cause or contribute to any differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in Item 1A "Risk Factors" and below in " - Cautionary Note Regarding Information Regarding Forward-Looking Statements."

On December 21, 2012, WashingtonFirst consummated its acquisition of Alliance. The transaction, which was accounted for as a purchase and constituted a reorganization for U.S. federal income tax purposes, resulted in the issuance by WashingtonFirst of 1,812,933 shares of WashingtonFirst common stock and the payment of approximately $5.4 million in cash to the holders of Alliance common stock. In conjunction with the merger, WashingtonFirst listed its shares of common stock on the NASDAQ. As a condition of the merger agreement of WashingtonFirst and Alliance, WashingtonFirst agreed to raise at least $20.0 million of qualifying regulatory capital. Consequently, in connection with the Alliance merger and pursuant to private placements of 1,351,656 shares of its common stock and 1,044,152 shares of its Series A non-voting common stock, WashingtonFirst raised aggregate gross proceeds of approximately $27.1 million. During 2012, WashingtonFirst incurred approximately $4.9 million in expenses associated with the Alliance merger. In reviewing the business and financial information presented in this report and comparing the performance of WashingtonFirst to prior periods, readers must consider the effects of the Alliance merger on the performance of WashingtonFirst.


WashingtonFirst generates the majority of its revenues from interest income on loans, service charges on customer accounts and income from investment securities. Revenues are partially offset by interest expense paid on deposits and other borrowings and noninterest expenses such as compensation and employee benefits, other operating costs and occupancy expenses. During 2012, WashingtonFirst incurred $4.9 million in merger expenses associated with the Alliance merger. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as deposits and borrowings which are used to fund those assets. Net interest income is the Company's largest source of revenue. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and margin. The Company has recognized increased net interest income due primarily to an increase in the volume of interest-earning assets.

Net income available to common shareholders was $2.1 million and $1.9 million for the years ended December 31, 2012 and 2011, respectively, and diluted earnings per share were $0.62 and $0.65, respectively, for these same periods. The change in net income available to common shareholders during both 2012 and 2011 was principally due to increased interest and fees earned on loans partially offset by one-time net expense of $1.2 million related to the acquisition of Alliance. The net expense of the merger is a result of the merger expenses of $4.9 million less the tax benefit of those expenses of $1.2 million and the one-time gain of $2.5 million, resulting in the net one-time expense of $1.2 million. Excluding net one-time merger expenses, net income to common shareholders was $3.3 million ($0.98 per fully diluted share) for the year ended December 31, 2012. Total assets at December 31, 2012 were $1.1 billion, an increase of 105 percent compared to December 31, 2011. Total deposits at December 31, 2012 were $972 .6 million, a 103.1 percent increase over the $479 million in deposits at December 31, 2011. Total loans were $753.4 million at December 31, 2012, an increase of $333.5 million (or 79.4 percent) compared with $419.9 million at December 31, 2011. At December 31, 2012, WashingtonFirst had $22.1 million in nonperforming assets, an increase of $15.1 million over the period ending December 31, 2011, and its allowance for loan losses was $6.3 million compared with $4.9 million at December 31, 2011. Shareholders' equity was $101.5 million and $53.4 million at December 31, 2012 and 2011, respectively. The large increases in these balance sheet items include the effect of consummating the acquisition of Alliance on December 21, 2012, as well as organic changes in the underlying business of WashingtonFirst.

A further discussion of WashingtonFirst's financial condition and results of operations, including relative contributions of the Alliance and WashingtonFirst businesses, is contained in the sections following.

Critical Accounting Policies and Estimates

The Company's condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") in the United States of America and follow general practices within the banking industry. Application of these principles

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requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently rely to a greater extent on the use of estimates, assumptions, and judgments and as such may have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary for assets and liabilities that are required to be recorded at fair value. A decline in the value of assets required to be recorded at fair value will warrant an impairment write-down or valuation allowance to be established. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when readily available. Management believes the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results:

allowance for loan losses;

purchase accounting;

goodwill and other intangible asset impairment;

accounting for income taxes; and,

fair value measurements.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that are inherent in the loan portfolio at the balance sheet date. The allowance is based on the basic principle that a loss be accrued when it is probable that the loss has occurred at the date of the financial statements and the amount of the loss can be reasonably estimated.

Management believes that the allowance is adequate to absorb losses inherent in the loan portfolio. However, its determination of the allowance requires significant judgment, and estimates of probable losses in the lending portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future additions or reductions to the allowance may be necessary based on changes in the loans comprising the portfolio and changes in the financial condition of borrowers, resulting from changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Company periodically review the loan portfolio and the allowance. Such reviews may result in additional provisions based on their judgments of information available at the time of each examination.

The Company's allowance for loan and lease losses has two basic components: a general allowance reflecting historical losses by loan category, as adjusted by several factors the effects of which are not reflected in historical loss ratios, and specific allowances for individually identified loans. Each of these components, and the allowance methodology used to establish them, are described in detail in Note 2 of the Notes to the Consolidated Financial Statements included in this report. The amount of the allowance is reviewed monthly by the board of directors.

General allowances are based upon historical loss experience by portfolio segment measured over the prior 12 quarters. The historical loss experience is supplemented to address various risk characteristics of the Company's loan portfolio including:

trends in delinquencies and other non-performing loans;

changes in the risk profile related to large loans in the portfolio;

changes in the categories of loans comprising the loan portfolio;

concentrations of loans to specific industry segments;

changes in economic conditions on both a local and national level;

changes in the Company's credit administration and loan portfolio management processes; and

quality of the Company's credit risk identification processes.

The general allowance constituted 50.5 percent of the total allowance at December 31, 2012 and 56.3 percent at December 31, 2011. The general allowance is calculated in two parts based on an internal risk classification of loans within each portfolio segment. Allowances on loans considered to be impaired under regulatory guidance are calculated separately from loans considered to be "pass" rated under the same guidance. This segregation allows the Company to monitor the allowance applicable to higher risk loans separate from the remainder of the portfolio in order to better manage risk and ensure the sufficiency of the allowance for loan losses. The loans acquired in the acquisition of Alliance were recorded at fair value, and are not affecting the allowance for loan losses as of December 31, 2012. Future allowances on those loans will be recorded in the allowance for loan losses.

The portion of the allowance representing specific allowances is established on individually impaired loans. As a practical expedient, for collateral dependent loans, the Company measures impairment based on the net realizable value of the underlying collateral. For loans on which the Company has not elected to use a practical expedient to measure impairment, the Company will measure

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impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. In determining the cash flows to be included in the discount calculation the Company considers the following factors that combine to estimate the probability and severity of potential losses:

the borrower's overall financial condition;

resources and payment record;

demonstrated or documented support available from financial guarantors; and

the adequacy of collateral value and the ultimate realization of that value at liquidation.

At December 31, 2012, the specific allowance accounted for 49.5 percent of the total allowance as compared to 43.7 percent at December 31, 2011. The estimated losses on impaired loans can differ substantially from actual losses.

Goodwill and Other Intangible Asset Impairment

Goodwill represents the excess purchase price paid over the fair value of the net assets acquired in a business combination. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value be compared to the carrying amount of net assets, including goodwill. If the fair value exceeds their book value, no write-down of recorded goodwill is required. If the fair value is less than book value, an expense may be required to write-down the related goodwill to the proper carrying value. The Company tests for impairment of goodwill as of October 1 of each year using September 30 data and again at any quarter-end if any triggering events occur during a quarter that may affect goodwill. Examples of such events include, but are not limited to, a significant deterioration in future operating results, adverse action by a regulator or a loss of key personnel. Determining the fair value requires the Company to use a degree of subjectivity. No goodwill impairment was recognized for December 31, 2012.

Core deposit intangible assets arise when a bank has a stable deposit base comprising of funds associated with long-term customer relationships. The intangible asset value derives from customer relationships that provide a low-cost source of funding. With its acquisition of Alliance in December 2012, the Company recorded $0.4 million of core deposit intangibles, which is presented in other assets on the consolidated balance sheet. This will be amortized over a five year period.

Accounting for Income Taxes

The Company accounts for income taxes by recording deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. The Company's accounting policy follows the prescribed authoritative guidance that a minimal probability threshold of a tax position must be met before a financial statement benefit is recognized. The Company recognized, when applicable, interest and penalties related to unrecognized tax benefits in other non-interest expenses in its consolidated statements of income. Assessment of uncertain tax positions requires careful consideration of the technical merits of a position based on management's analysis of tax regulations and interpretations. Significant judgment may be involved in applying the applicable reporting and accounting requirements.

Management expects that the Company's adherence to the required accounting guidance may result in increased volatility in quarterly and annual effective income tax rates due to the requirement that any change in judgment or measurement of a tax position taken in a prior period be recognized as a discrete event in the period in which it occurs. Factors that could impact management's judgment include changes in income, tax laws and regulations, and tax planning strategies.

Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value in accordance with applicable accounting standards. Significant financial instruments measured at fair value on a recurring basis are investment securities available-for-sale, residential mortgages held for sale and commercial loan interest rate swap agreements. Loans where it is probable that the Company will not collect all principal and interest payments according to the contractual terms are considered impaired loans and are measured on a nonrecurring basis.

The Company conducts a quarterly review for all investment securities that have potential impairment to determine whether unrealized losses are other-than-temporary. Valuations for the investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, valuations are based on pricing models, quotes for similar investment securities, and, where necessary, an income valuation approach based on the present value of expected cash flows. In addition, the Company

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considers the financial condition of the issuer, the receipt of principal and interest according to the contractual terms and the intent and ability of the Company to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. See Note 5 of the Notes to the Consolidated Financial Statements included in this report.

Results of Operations

WashingtonFirst's net income available to common shareholders for 2012 was $2.1 million or $0.62 per diluted common share, compared to $1.9 million or $0.65 per diluted common share for 2011. Basic net income per common share was $0.63 per share and $0.67 per common share for 2012 and 2011, respectively. The key factors contributing to minimal change in net income as compared to the prior year were net one-time merger expenses of $1.2 million, a decreased net interest margin, net charge-offs and OREO write-downs. The following sections provide more detail regarding specific components of WashingtonFirst's results of operations.

Net Interest Income.

Net interest income was $22.9 million for 2012 compared to $19.4 million for 2011. The overall net interest margin was 4.08 percent for the year ended December 31, 2012, compared to 4.02 percent for the year ended December 31, 2011.

The following table provides information regarding interest-earning assets and funding for the years ended December 31, 2012 and 2011. The balance of non-accruing loans is included in the average balance of loans presented, though the related income is accounted for on a cash basis. Therefore, as the balance of non-accruing loans and the income received increases or decreases, the net interest yield will fluctuate accordingly. The average rate earned on interest-bearing balances reflects lower short-term market rates during 2012 compared to 2011. The lower average rate on loans during 2012 reflects the decline in market rates reflected in the rates on loans acquired or reset during the past year. The lower average rate on interest-bearing demand deposits, money market deposit accounts and savings accounts is consistent with general trends in average short-term rates during the periods presented. The downward trend in the average rate on time deposits reflects the maturity of older time deposits and the issuance of new time deposits at lower market rates.

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   Average Balances, Interest Income and Expense and Average Yield and Rates

                                                                   For the Year Ended December 31,
                                                            2012                                     2011
                                              Average       Income/      Yield/        Average       Income/      Yield/
                                              Balance       Expense       Rate         Balance       Expense       Rate
                                                                        (dollars in thousands)
Interest-earning assets:
Loans (1)                                    $ 443,578      $ 26,305        5.93 %    $ 369,009      $ 22,814        6.18 %
Interest-bearing balances                        9,746            53        0.54 %       26,105           224        0.86 %
Investment securities (2)                       66,675         1,410        2.11 %       54,609         1,277        2.34 %
Federal funds sold                              42,268           108        0.26 %       32,207            72        0.22 %

Total interest earning assets                  562,267        27,876        4.96 %      481,930        24,387        5.06 %
Non-interest earning assets:
Cash and due from banks                          2,565                                    1,123
Premises and equipment                           2,790                                      358
Other real estate owned (OREO)                     744                                    1,854
Other assets                                    13,198                                   12,923
Less: allowance for loan losses                 (5,813 )                                 (4,067 )

Total non-interest earning assets               13,484                                   12,191

Total Assets                                 $ 575,751                                $ 494,121

Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits             $  19,817      $     58        0.29 %    $  16,968      $     46        0.27 %
Money market deposit accounts                   60,723           376        0.62 %       36,935           270        0.73 %
Savings accounts                                77,666           716        0.92 %       78,637           780        0.99 %
Time deposits                                  212,134         2,924        1.38 %      188,895         2,977        1.58 %

Total interest-bearing deposits                370,340         4,074        1.10 %      321,435         4,073        1.27 %
FHLB advances                                   28,013           724        2.58 %       28,088           936        3.33 %
Other borrowings and long-term borrowings        1,301           151       11.61 %           -             -         0.00 %

Total interest-bearing liabilities             399,654         4,949        1.24 %      349,523         5,009        1.43 %
Non-interest-bearing liabilities:
Demand deposits                                116,978                                   93,133
Other liabilities                                2,318                                    1,738

Total liabilities                              518,950                                  444,394
Shareholders' Equity                            56,801                                   49,727

Total Liabilities and Shareholders' Equity   $ 575,751                                $ 494,121

Interest Spread (3)                                                         3.72 %                                   3.63 %

Net Interest Margin (4)(5)                                  $ 22,927        4.08 %                   $ 19,378        4.02 %

(1) Loans placed on non-accrual status are included in loan balances.

(2) Includes available-for-sale investment securities and other equity securities.

(3) Interest spread is the average yield earned on earning assets, less the average rate incurred on interest bearing liabilities.

(4) Interest income and yields are presented on a fully taxable equivalent basis using 38.5 percent tax rate.

(5) Net interest margin is net interest income, expressed as a percentage of average earning assets.

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The following table sets forth information regarding the changes in the components of WashingtonFirst's net interest income for the periods indicated. For each category, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate) and changes in rate (change in rate multiplied by old volume). Combined rate/volume variances, the third element of the calculation, are allocated based on their relative size. The decreases in income due to changes in rate reflect the reset of variable rate investments, variable rate deposit accounts and adjustable rate mortgages to lower rates and the acquisition of new lower yielding investments and loans, as described above. The decreases in expense reflect the decreased cost of funding due to lower interest rates in the debt markets. The increases due to changes in volume reflect the increase in on-balance sheet assets during 2012 and 2011.

                                                     2012 vs. 2011                            2011 vs. 2010
                                              (Decrease)/Increase Due to               (Decrease)/Increase Due to
                                            Rate         Volume        Total         Rate         Volume        Total
                                                                         (in thousands)
Income from interest-earning assets:
Loans                                     $    (955 )    $ 4,446      $ 3,491      $   (958 )     $ 4,984      $ 4,026
Interest-bearing balances                       (64 )       (107 )       (171 )         148           303          451
Investment securities                          (133 )        266          133            36           (58 )        (22 )
Federal funds sold                               13           23           36           (36 )          10          (26 )

Total income from interest-earning
assets                                       (1,139 )      4,628        3,489          (810 )       5,239        4,429
Expense from interest-bearing
Interest-bearing deposits                      (496 )        496           -           (964 )         606         (358 )
FHLB Advances                                  (210 )         (2 )       (212 )          22          (171 )       (149 )
Borrowed funds                                   -           152          152            -             -            -

Total expense from interest-bearing
liabilities                                    (706 )        646          (60 )        (942 )         435         (507 )

(Decrease)/increase in net interest
income                                    $    (433 )    $ 3,982      $ 3,549      $    132       $ 4,804      $ 4,936

Interest Earning Assets

Average loan balances were $443.6 million for the year ended December 31, 2012 compared to $369.06 million in 2011. Loans grew during this period because of an increase in construction and real estate loans. WashingtonFirst's longer-term strategy is to grow small business commercial loans and owner occupied commercial real estate, and focus on the greater Washington, D.C. metropolitan area. The related interest income from loans was $26.3 million for the year ended December 31, 2012 compared to $22.8 million for the year ended December 31, 2011. The average yield on loans of 5.93 percent during the year ended December 31, 2012, compared to 6.18 percent for 2011, reflecting a declining interest rate environment. Interest rates are established for classes of loans that include variable rates based on the prime rate as reported by The Wall Street Journal or other identifiable bases while others carry fixed rates with terms as long as 15 years. Most new variable rate originations include minimum start rates and/or floors.

Investment securities averaged $66.7 million for the year ended December 31, 2012, compared to $54.6 million for 2011. Interest income generated on these investment securities for the year ended December 31, 2012 totaled $1.4 million, or a 2.11 percent yield, compared to $1.3 million or a 2.34 percent yield for 2011.

Short-term investments in federal funds sold averaged $42.3 million for the year . . .

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