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WFBI > SEC Filings for WFBI > Form 10-K on 19-Mar-2014All Recent SEC Filings




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, 2013 and 2012.
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." Cautionary Note Regarding Forward-Looking Statements This report, as well as other periodic reports filed with the SEC, and written or oral communications made from time to time by or on behalf of WashingtonFirst, may contain statements relating to future events or future results and their effects that are considered "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of words such as "believe," "expect," "anticipate," "plan," "estimate," "intend" and "potential," or words of similar meaning, or future or conditional verbs such as "should," "could," or "may" or the negative of those terms or other variations of them or comparable terminology. Forward-looking statements include statements of WashingtonFirst's goals, intentions and expectations; statements regarding its business plans, prospects, growth and operating strategies; statements regarding the quality of its loan and investment portfolios; and estimates of its risks and future costs and benefits.
Forward-looking statements reflect our expectation or prediction of future conditions, events or results based on information currently available. These forward-looking statements are subject to significant risks and uncertainties that may cause actual results to differ materially from those in such statements. These risk and uncertainties include, but are not limited to, the risks identified in Item 1A "Risk Factors" and the following:
competition among financial services companies may increase and adversely affect operations of WashingtonFirst;

changes in the level of nonperforming assets and charge-offs;

changes in the availability of funds resulting in increased costs or reduced liquidity;

changes in accounting policies, rules and practices;

changes in the assumptions underlying the establishment of reserves for possible loan losses and other estimates;

impairment concerns and risks related to WashingtonFirst's investment portfolio, and the impact of fair value accounting, including income statement volatility;

changes in the interest rate environment and market prices may reduce WashingtonFirst's net interest margins, asset valuations and expense expectations;

general business and economic conditions in the markets WashingtonFirst serve change or are less favorable than expected;

legislative or regulatory changes adversely affect WashingtonFirst's businesses;

reactions in financial markets related to potential or actual downgrades in the sovereign credit rating of the United States and the budget deficit or national debt of the United States government;

changes in the way the FDIC insurance premiums are assessed;

increase in personal or commercial bankruptcies or defaults; and

technology-related changes are harder to make or more expensive than expected.

Forward-looking statements included herein speak only as of the date of this report. WashingtonFirst does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of this report or to reflect the occurrence of unanticipated events except as required by federal securities laws.

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WashingtonFirst generates the majority of its revenues from interest income on loans, income from investment securities, and service charges on customer accounts. Revenues are partially offset by interest expense paid on deposits and other borrowings, and non-interest expenses such as compensation and employee benefits, other operating costs and occupancy expenses. Net interest income is the difference between interest income on earning assets such as loans and securities and interest expense on liabilities such as the deposits and borrowings used to fund those assets. Net interest income is the Company's largest source of revenue. Net interest income for the year ended December 31, 2013 was $40.0 million, compared to $22.9 million for the year ended December 31, 2012. 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 primarily due to the increase in the volume of interest-earning assets resulting from its acquisition of Alliance bank in December 2012.
Net income available to common shareholders was $6.2 million and $2.1 million for the years ended December 31, 2013 and 2012, respectively, and diluted earnings per share were $0.80 per common share and $0.59 per common share for these same periods. The increase in net income available to common shareholders during fiscal year 2013 compared to 2012 is primarily the result of the acquisition of Alliance in December 2012. In addition to the increased revenues earned as a result of the larger loan portfolio, increased costs were incurred during fiscal year 2013 compared to fiscal year 2012. Compensation and employee benefit expenses for the year ended December 31, 2013 increased by $5.6 million compared to same period in 2012 primarily due to an increase in the number of employees resulting from the additional branches in the acquisition of Alliance. Premises and equipment expenses increased by $2.8 million for the year ended December 31, 2013 compared to the year ended December 31, 2012 as a result of the increase in number of branches. The Company's other operating expenses also increased for fiscal year ended 2013, compared to the fiscal year ended 2012, primarily as a result of the increased size of operations.
As of December 31, 2013 and 2012, total assets were $1.1 billion. Total net loans increased $82.5 million from December 31, 2012 to December 31, 2013. Tier 1 capital increased by $7.8 million to $112.8 million as of December 31, 2013, compared to $105.0 million as of December 31, 2012.
As of December 31, 2013, WashingtonFirst had $22.3 million in nonperforming assets, an increase of $0.2 million from December 31, 2012. The Company had an increase of $2.3 million in the allowance for loan losses during the year ended December 31, 2013, resulting in an $8.5 million allowance for loan losses as of December 31, 2013, compared to $6.3 million as of December 31, 2012. A further discussion of WashingtonFirst's financial condition and results of operations is contained in the following sections.

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Critical Accounting Policies and Estimates The Company's 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 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;

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 52.0 percent of the total allowance at December 31, 2013 and 50.5 percent at December 31, 2012. 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. Allowances on those loans subsequent to the acquisition have been recorded in the allowance for loan losses.

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As of December 31, 2013, the specific allowance accounted for 48.0 percent percent of the total allowance as compared to 49.5 percent at December 31, 2012. The estimated losses on impaired loans can differ substantially from actual 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 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.

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 net fair value exceeds the net 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 each fiscal year end 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 the years ended December 31, 2013 and 2012. Core deposit intangible assets arise when a bank has a stable deposit base comprised 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 is be amortized over a five year period ending December 2017. 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
For the year ended December 31, 2013, WashingtonFirst's net income available to common shareholders was $6.2 million or $0.80 per diluted common share, compared to $2.1 million or $0.59 per diluted common share for the year ended December 31, 2012. Basic net income per common share for the year ended December 31, 2013 was $0.81 per common share compared to $0.60 per common share for the year ended December 31, 2012. The increase in net income during 2013 as compared to the same period in 2012 is primarily the result of the increased size of the loan portfolio and operations of the Company due to the Alliance acquisition in December 2012. The following sections provide more detail regarding specific components of WashingtonFirst's results of operations.

Selected Performance Ratios
                                                   For the Year Ended December 31,
                                                    2013                     2012
                                                       (dollars in thousands)
Average total assets                       $         1,060,309       $           575,751
Average shareholders' equity                           105,489                    56,801
Net income                                               6,339                     2,235
Return on average assets                                  0.60 %                    0.39 %
Return on average shareholders' equity                    6.01 %                    3.92 %
Return on average common equity                           7.03 %                    5.28 %
Average shareholders' equity to average
total assets                                              9.95 %                    9.87 %
Efficiency ratio                                         67.20 %                   75.26 %
Dividend payout ratio                                     4.94 %                       - %

Net Interest Income.
Net interest income was $40.0 million for 2013 compared to $22.9 million for 2012. The overall net interest margin was 3.90 percent for the year ended December 31, 2013 compared to 4.08 percent for the year ended December 31, 2012. The decrease in interest spread and net interest margin is primarily the result of a lower yield on the loan portfolio in the 2013, resulting from the early payoff of certain loans that had positive purchase accounting marks associated with them. These purchase accounting marks were being recognized over the life of the loans into interest income and, due to the early payoff, these amounts were fully recognized in 2013, thus decreasing the yield on the loan portfolio. Additionally, the Bank had higher liquidity and a lower loan-to-deposit ratio during 2013 which lead to a lower yield on earnings assets. This, in turn, led to a reduction in the interest spread and net interest margin for the year ending December 31, 2013.

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The following tables provide information regarding interest-earning assets and funding for the years ended December 31, 2013 and 2012. 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 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.
Average Balances, Interest Income and Expense and Average Yield and Rates

                                                    For the Year Ended December 31,
                                              2013                                    2012
                                Average       Income/      Yield/       Average      Income/      Yield/
                                Balance       Expense       Rate        Balance      Expense       Rate
                                                        (dollars in thousands)
Interest-earning assets:
Loans (1)                    $   783,683     $ 43,538        5.56 %   $ 443,578     $ 26,305        5.93 %
Interest-bearing balances          8,726           48        0.55 %       9,746           53        0.54 %
Investment securities (2)        124,418        2,254        1.81 %      66,675        1,410        2.11 %
Federal funds sold               109,291          260        0.24 %      42,268          108        0.26 %
Total interest earning
assets                         1,026,118       46,100        4.49 %     562,267       27,876        4.96 %
Non-interest earning assets:
Cash and due from banks            4,030                                  2,565
Premises and equipment             3,755                                  2,790
Other real estate owned
(OREO)                             2,432                                    744
Other assets                      30,738                                 13,198
Less: allowance for loan
losses                            (6,764 )                               (5,813 )
Total non-interest earning
assets                            34,191                                 13,484
Total Assets                 $ 1,060,309                              $ 575,751

Liabilities and
Shareholders' Equity
Interest-bearing demand
deposits                     $    88,479     $    167        0.19 %   $  19,817     $     58        0.29 %
Money market deposit
accounts                         134,514          666        0.50 %      60,723          376        0.62 %
Savings accounts                 104,590          803        0.77 %      77,666          716        0.92 %
Time deposits                    342,880        3,128        0.91 %     212,134        2,924        1.38 %
Total interest-bearing
deposits                         670,463        4,764        0.71 %     370,340        4,074        1.10 %
FHLB advances                     33,269          672        2.02 %      28,013          724        2.58 %
Other borrowings and
long-term borrowings              23,424          694        2.96 %       1,301          151       11.61 %
Total interest-bearing
liabilities                      727,156        6,130        0.84 %     399,654        4,949        1.24 %
Demand deposits                  221,704                                116,978
Other liabilities                  5,960                                  2,318
Total non-interest-bearing
liabilities                      227,664                                119,296
Total Liabilities                954,820                                518,950
Shareholders' Equity             105,489                                 56,801
Total Liabilities and
Shareholders' Equity         $ 1,060,309                              $ 575,751

Interest Spread (3)                                          3.65 %                                 3.72 %
Net Interest Margin (4)(5)                   $ 39,970        3.90 %                 $ 22,927        4.08 %

(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 yield are presented on a fully taxable equivalent basis.

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

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The following tables set forth information regarding the changes in the components of WashingtonFirst's net interest income for the periods indicated. For each category, information is provided for 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 . . .

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