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FBSS > SEC Filings for FBSS > Form 10-K on 20-Mar-2014All Recent SEC Filings

Show all filings for FAUQUIER BANKSHARES, INC.

Form 10-K for FAUQUIER BANKSHARES, INC.


20-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In addition to the historical information contained herein, this report contains forward-looking statements. Forward-looking statements are based on certain assumptions and describe future plans, strategies, and expectations of the Company and are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" "may," "will" or similar expressions. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in:
interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System, the quality or composition of the Bank's loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area, our plans to expand our branch network and increase our market share, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements in this report and you should not place undue reliance on such statements, which reflect our position as of the date of this report.

CRITICAL ACCOUNTING POLICIES

GENERAL. The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in our estimates. In addition, GAAP itself may change from one previously acceptable accounting method to another method. Although the economics of the Company's transactions would be the same, the timing of events that would impact the Company's transactions could change.

ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on three basic principles of accounting: (i) Accounting Standards Codification ("ASC") 450 "Contingencies" which requires that losses be accrued when they are probable of occurring and estimable, (ii) ASC 310 "Receivable" which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance and (iii) SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues," which requires adequate documentation to support the allowance for loan losses estimate.

The Company's allowance for loan losses has three basic components: the specific allowance, the general allowance and the unallocated component. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for larger balance and/or non-homogeneous loans identified as impaired. The specific allowance uses various techniques to arrive at an estimate of loss. Analysis of the borrower's overall financial condition, resources and payment record, the prospects for support and financial guarantors, and the fair market value of collateral are used to estimate the probability and severity of inherent losses. The general allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans; including 1-4 family mortgage loans, installment loans and other consumer loans. Also, the general allowance is used for the remaining pool of larger balance and/or non-homogeneous loans which were not identified as impaired. The general allowance begins with estimates of probable losses inherent in the homogeneous portfolio based upon various statistical analyses. These include analysis of historical delinquency and credit loss experience, together with analyses that reflect current trends and conditions. The Company also considers trends and changes in the volume and term of loans, changes in the credit process and/or lending policies and procedures, and an evaluation of overall credit quality. The general allowance uses a historical loss view as an indicator of future losses. As a result, even though this history is regularly updated with the most recent loss information, it could differ from the loss incurred in the future. The general allowance also captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Specifically, the Company uses both external and internal qualitative factors when determining the non-loan-specific allowances. The external factors utilized include: unemployment in the Company's defined market area of Fauquier County, Prince William County, and the City of Manassas ("market area"), as well as state and national unemployment trends; new residential construction permits for the market area; bankruptcy statistics for the Virginia Eastern District and trends for the United States; and foreclosure statistics for the market area and the state. Quarterly, these external qualitative factors as well as relevant anecdotal information are evaluated from data compiled from local periodicals such as The Washington Post, The Fauquier Times, and The Bull Run Observer, which cover the Company's market area. Additionally, data is gathered from the Federal Reserve Beige Book for the Richmond Federal Reserve District, Global Insight's monthly economic review, the George Mason School of Public Policy Center for Regional Analysis, and daily economic updates from various other sources. Internal Bank data utilized includes: loans past due aging statistics, non-performing loan trends, trends in collateral values, loan concentrations, loan review status downgrade trends, and lender turnover and experience trends. Both external and internal data is analyzed on a rolling eight quarter basis to determine risk profiles for each qualitative factor. Ratings are assigned through a defined matrix to calculate the allowance consistent with authoritative accounting literature. A narrative summary of the reserve allowance is produced quarterly and reported directly to the Company's Board of Directors. The Company's application of these qualitative factors to the allowance for loan losses has been consistent over the reporting period.

The Company employs an independent outsourced loan review function, which annually substantiates and/or adjusts internally generated risk ratings. This independent review is reported directly to the Company's Board of Directors' audit committee, and the results of this review are factored into the calculation of the allowance for loan losses.


INTEREST RATE SWAP AGREEMENTS USED FOR INTEREST RATE RISK MANAGEMENT. Interest rate swaps are recorded at fair value on a recurring basis. The Company utilizes an interest rate swap agreement as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company's interest-bearing assets and liabilities. The Company has contracted with a third party vendor to provide valuations for interest rate swaps using standard swap valuation techniques. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.

INCOME TAXES AND DEFERRED INCOME TAX ASSETS AND LIABILITIES. Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. There were no unrecognized tax benefits recorded as a liability as of December 31, 2013 and 2012. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income. The Company has no uncertain tax positions.

EXECUTIVE OVERVIEW

This discussion is intended to focus on certain financial information regarding the Company and the Bank and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of our financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.

The Bank is the primary independent community bank in its immediate market area as measured by deposit market share. It seeks to be the primary financial service provider for its market area by providing the right mix of consistently high quality customer service, efficient technological support, value-added products, and a strong commitment to the community.

Net income of $4.33 million in 2013 was an 111.0% increase from the 2012 net income of $2.05 million. The Company and the Bank's primary operating businesses are in commercial and retail lending, deposit accounts and core deposits, and assets under WMS management. Loans, net of reserve, were $444.7 million at year-end 2013 and $445.1 year-end 2012, a decrease of 0.1%, compared with a decrease of 1.5% from year-end 2011 to year-end 2012. Deposits increased 4.9% from year-end 2012 to year-end 2013 compared with a decrease of 2.9% from year-end 2011 to year-end 2012. The market value of assets under WMS management increased 18.6% from year-end 2012 to year-end 2013, and increased 12.2% from year-end 2011 to year-end 2012. The changes in assets under WMS management reflect both the changes in the U.S. stock market, as well as the net increase in WMS customers.

Net interest income is the largest component of net income, and equals the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from non-performing assets, the amount of prepaying loans, the mix and amount of various deposit types, and many other factors, as well as the overall volume of interest-earning assets. These factors are individually difficult to predict, and when taken together, the uncertainty of future trends compounds. Based on management's current projections, net interest income may increase in 2014 with the growth of average loans, but this may be offset in part or in whole by a possible contraction in the Bank's net interest margin resulting from the prolonged historically low levels in market interest rates. The Bank is also subject to a decline in net interest income due to competitive market conditions and/or a flat or inverted yield curve. A steeper yield curve is projected to result in an increase in net interest income, while a flatter or inverted yield curve is projected to result in a decrease in net interest income.

The Bank's non-performing assets totaled $7.6 million or 1.23% of total assets at December 31, 2013, as compared with $12.4 million or 2.06% of total assets at December 31, 2012. The provision for loan losses was $1.80 million for 2013 compared with $5.81 million for 2012. Loan chargeoffs, net of recoveries, totaled $1.4 million or 0.31% of total average loans for 2013, compared with $6.3 million or 1.38% of total average loans for 2012.

Management seeks to continue the expansion of its branch network. The Bank's eleventh full service branch is projected to open in Gainesville, Virginia during 2014. In addition, the Bank will be closing its current Old Town-Manassas branch office and opening a new branch office on Centreville Road, Manassas in mid 2014. This move will provide greater accessability and convenience for its Old Town-Manassas customers.The Bank is looking toward these new retail markets for growth in deposits and WMS income. Management seeks to increase the level of its fee income through the increase of its market share within its marketplace.


The following table presents a quarterly summary of earnings for the last two years.

                                    Earnings

                               Three Months Ended 2013                             Three Months Ended 2012
(Dollars in
thousands,
except per share
data)              Dec. 31      Sep. 30      June 30      Mar. 31      Dec. 31      Sep. 30      June 30      Mar. 31
Interest income    $  5,735     $  5,841     $  5,748     $  5,721     $  5,794     $  6,288     $  6,365     $  6,507
Interest expense        671          689          824          878          898          977        1,042        1,112
Net interest
income                5,064        5,152        4,924        4,843        4,896        5,311        5,323        5,395
Provision for
loan losses             500          333          800          167        1,957          550        2,800          500
Net interest
income after
provision for
loan losses           4,564        4,819        4,124        4,676        2,939        4,761        2,523        4,895
Other income          1,683        1,689        1,739        1,440        1,573        1,542        1,602        1,482
Securities gains
(losses)                144            -            -            -            -            2          163            1
Other expense         4,513        4,926        4,826        4,841        4,971        4,641        4,347        5,111
Income before
income taxes          1,878        1,582        1,037        1,275         (459 )      1,664          (59 )      1,267
Income tax
expense                 477          418          233          313         (267 )        452         (138 )        313
Net income
(loss)             $  1,401     $  1,164     $    804     $    962     $   (192 )   $  1,212     $     79     $    954

Net income per
share, basic       $   0.38     $   0.31     $   0.22     $   0.26     $  (0.05 )   $   0.33     $   0.02     $   0.26

Net income per
share, diluted     $   0.37     $   0.31     $   0.22     $   0.26     $  (0.06 )   $   0.33     $   0.02     $   0.26

2013 COMPARED WITH 2012
Net income of $4.33 million in 2013 was an 111.0% increase from 2012 net income of $2.05 million. Earnings per share on a fully diluted basis were $1.16 in 2013 compared to $0.55 in 2012. Profitability as measured by return on average equity increased from 4.25% in 2012 to 8.89% in 2013. Profitability as measured by return on average assets increased from 0.35% in 2012 to 0.72% in 2013. The year to year increase in net income was primarily due to a $4.01 million decrease in the provision for loan losses and a $330,000 increase in total other income, partially offset by a $942,000 decrease in net interest income and a $36,000 increase in total other expenses.

2012 COMPARED WITH 2011
Net income of $2.05 million in 2012 was a 50.1% decrease from 2011 net income of $4.12 million. Earnings per share on a fully diluted basis were $0.55 in 2012 compared to $1.12 in 2011. Profitability as measured by return on average equity decreased from 8.93% in 2011 to 4.25% in 2012. Profitability as measured by return on average assets decreased from 0.69% in 2011 to 0.35% in 2012. The year to year decrease in net income was primarily due to a $3.87 million increase in the provision for loan losses, as well as a $1.15 million decrease in net interest income, partially offset by a $1.79 million decrease in other expenses.


NET INTEREST INCOME AND EXPENSE

2013 COMPARED WITH 2012
Net interest income decreased $942,000 or 4.5% to $19.98 million for the year ended December 31, 2013 from $20.93 million for the year ended December 31, 2012. The decrease in net interest income was due to the impact of the average loan portfolio decreasing from $455.9 million in 2012 to $450.9 million in 2013, as well as the decline on the rate earned on loans over the same period from 5.20% to 4.83%. This led to the Company's net interest margin decreasing from 3.85% in 2012 to 3.64% in 2013. Total average earning assets increased from $551.6 million in 2012 to $557.3 million in 2013. The percentage of average earning assets to total assets decreased from 93.6% in 2012 to 93.2% in 2013.

Total interest income decreased $1.91 million or 7.7% to $23.05 million in 2013 from $24.95 million in 2012. This decrease was due to the 39 basis point decrease in the average yield on assets, partially offset by the increase in total average earning assets of $5.7 million or 1.0%, from 2012 to 2013. The yield on earning assets declined from 4.58% in 2012 to 4.19% in 2013 due to the decline in market interest rates in the economy at large over the last four years, as well as the decrease in average loan balances and the $842,000 increase in average non-accrual loans.

Average total loan balances decreased $5.0 million or 1.1% from $455.9 million in 2012 to $450.9 million in 2013. The tax-equivalent average yield on loans decreased to 4.83% in 2013 compared with 5.20% in 2012. Together, this resulted in a $1.87 million decrease in interest and fee income from loans for 2013 compared with 2012. On a tax-equivalent basis, the year-to-year decrease in interest and fee income on loans was $1.90 million.

Average investment security balances decreased $6.5 million from $57.0 million in 2012 to $50.5 million in 2013. This was partially offset by the tax-equivalent average yield on investments increasing from 2.56% in 2012 to 2.70% in 2013. Together interest and dividend income on security investments decreased $95,000 from 2012 to 2013 on a tax-equivalent basis.

Interest income on deposits at other banks increased from $114,000 in 2012 to $169,000 in 2013 due to the increase in average balances from $38.7 million in 2012 to $55.9 million in 2013. The average interest rate earned on these deposits was 0.30% for both 2012 and 2013.

Total interest expense decreased $967,000 or 24.0% from $4.03 million in 2012 to $3.06 million in 2013, primarily due to the replacement of more costly time deposits with less expensive demand deposit accounts, NOW accounts, and savings deposits. Interest paid on deposits decreased $614,000 or 21.4% from $2.87 million in 2012 to $2.26 million in 2013. Average NOW deposit balances increased $21.0 million from 2012 to 2013 while the average rate on NOW accounts decreased from 0.28% to 0.22%, resulting in $55,000 less interest expense in 2013. Average money market account deposit balances decreased $600,000 from 2012 to 2013 while the average rate on money market account deposits decreased from 0.20% to 0.18%, resulting in $8,000 less interest expense in 2013. Average savings account deposit balances increased $8.5 million from 2012 to 2013 while the average rate on savings account deposits decreased from 0.16% to 0.12%, resulting in $12,000 less interest expense in 2013. Average time deposit balances decreased $22.3 million from 2012 to 2013 while the average rate on time deposits decreased from 1.54% to 1.38%, resulting in a decrease of $539,000 in interest expense from 2012 to 2013.

Interest expense on FHLB of Atlanta advances decreased $352,000 from 2012 to 2013 due to the decrease on the average rate paid from 3.81% in 2012 to 3.12% in 2013, as well as a $5.7 million decrease in average balances over the same time periods. The interest expense on trust preferred capital securities decreased $1,000 from 2012 to 2013. The average rate on total interest-bearing liabilities decreased from 0.89% in 2012 to 0.67% in 2013.


2012 COMPARED WITH 2011
Net interest income decreased $1.15 million or 5.2% to $20.93 million for the year ended December 31, 2012 from $22.07 million for the year ended December 31, 2011. The decrease in net interest income was due to the impact of the higher yielding average loan portfolio decreasing from $459.1 million in 2011 to $455.9 million in 2012, and being replaced by lower yielding deposits in other banks. This led to the Company's net interest margin decreasing from 4.00% in 2011 to 3.85% in 2012. Total average earning assets decreased from $561.6 million in 2011 to $551.6 million in 2012. The percentage of average earning assets to total assets increased from 93.5% in 2011 to 93.6% in 2012.

Total interest income decreased $2.20 million or 8.1% to $24.95 million in 2012 from $27.15 million in 2011. This decrease was due to the 32 basis point decrease in the average yield on assets, as well as the decrease in total average earning assets of $10.0 million or 1.8%, from 2011 to 2012.The yield on earning assets declined from 4.90% in 2011 to 4.58% in 2012 due to the decline in market interest rates in the economy at large, as well as the decrease in loan balances.

Average total loan balances decreased 0.7% from $459.1 million in 2011 to $455.9 million in 2012. The tax-equivalent average yield on loans decreased to 5.20% in 2012 compared with 5.66% in 2011. Together, this resulted in a $2.21 million decrease in interest and fee income from loans for 2012 compared with 2011. On a tax-equivalent basis, the year-to-year decrease in interest and fee income on loans was $2.30 million.

Average investment security balances increased $4.9 million from $52.1 million in 2011 to $57.0 million in 2012. The tax-equivalent average yield on investments decreased from 2.72% in 2011 to 2.56% in 2012. Together, there was an increase in interest and dividend income on security investments of $38,000 or 2.9%, from $1.30 million in 2011 to $1.34 million in 2012. On a tax-equivalent basis, the year-to-year increase in interest and dividend income on security investments was $44,000.

Interest income on deposits at other banks decreased from $140,000 in 2011 to $114,000 in 2012 due to the decrease in average balances from $50.4 million in 2011 to $38.7 million in 2012. The average interest rates paid on these deposits increased from 0.28% in 2011 to 0.30% in 2012.

Total interest expense decreased $1.05 million or 20.6% from $5.08 million in 2011 to $4.03 million in 2012, primarily due to the decline in market interest rates in the economy. Interest paid on deposits decreased $1.01 million or 26.1% from $ 3.89 million in 2011 to $ 2.87 million in 2012. Average NOW deposit balances increased $28.6 million from 2011 to 2012 while the average rate on NOW accounts decreased from 0.41% to 0.28%, resulting in $110,000 less interest expense in 2012. Average money market account deposit balances decreased $31.4 million from 2011 to 2012 while the average rate on money market account deposits decreased from 0.47% to 0.20%, resulting in $272,000 less interest expense in 2012. Average savings account deposit balances increased $8.2 million from 2011 to 2012 while the average rate on savings account deposits decreased from 0.22% to 0.16%, resulting in $23,000 less interest expense in 2012. Average time deposit balances decreased $25.1 million from 2011 to 2012 while the average rate on time deposits decreased from 1.67% to 1.54%, resulting in a decrease of $609,000 in interest expense from 2011 to 2012.

Interest expense on FHLB of Atlanta advances decreased $33,000 from 2011 to 2012 due to the decrease on the average rate paid from 3.96% in 2011 to 3.81% in 2012. The interest expense on trust preferred capital securities increased $1,000 from 2011 to 2012. The average on total interest-bearing liabilities decreased from 1.07% in 2011 to 0.89% in 2012.

The following table sets forth information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balances of assets and liabilities, respectively, for the periods presented.


      Average Balances, Income and Expenses, and Average Yields and Rates

(Dollars in                       12 Months Ended                            12 Months Ended                            12 Months Ended
thousands)                       December 31, 2013                          December 31, 2012                          December 31, 2011
                        Average       Income/       Average        Average       Income/       Average        Average       Income/       Average
Assets                 Balances       Expense         Rate        Balances       Expense         Rate        Balances       Expense         Rate
Loans
Taxable                $ 435,962     $  21,337           4.89 %   $ 440,585     $  23,147           5.25 %   $ 443,846     $  25,183           5.67 %
Tax-exempt (1)             7,147           454           6.35 %       8,357           541           6.48 %      11,983           801           6.69 %
Non-accrual (2)            7,785             -                        6,943             -                        3,221             -
Total Loans              450,894        21,791           4.83 %     455,885        23,688           5.20 %     459,050        25,984           5.66 %

Securities
Taxable                   43,855           995           2.27 %      50,135         1,090           2.17 %      46,016         1,061           2.31 %
Tax-exempt (1)             6,687           373           5.57 %       6,903           373           5.40 %       6,115           358           5.85 %
Total securities          50,542         1,368           2.70 %      57,038         1,463           2.56 %      52,131         1,419           2.72 %
. . .
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