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VABK > SEC Filings for VABK > Form 10-K on 27-Mar-2014All Recent SEC Filings

Show all filings for VIRGINIA NATIONAL BANKSHARES CORP

Form 10-K for VIRGINIA NATIONAL BANKSHARES CORP


27-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion provides information about the major components of the results of consolidated operations and financial condition, liquidity and capital resources of Virginia National Bankshares Corporation. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements.

Application of Critical Accounting Policies and Critical Accounting Critical Estimates

The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States ("GAAP") and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.


The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company's financial statements. The Company's accounting policies are fundamental to understanding management's discussion and analysis of financial condition and results of operations.

Following are the accounting policies and estimates that the Company considers as critical:

Allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Accounting policies related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. The Company's allowance for loan loss methodology includes allowance allocations calculated in accordance with Accounting Standards Codification ("ASC") Topic 310, "Receivables" and allowance allocations calculated in accordance with ASC Topic 450, "Contingencies." The level of the allowance reflects management's continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company's control, including the performance of the Company's loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned "Allowance for Loan Losses" elsewhere in this discussion and Note 3 - Loans and Note 4 - Allowance for Loan Loss in the notes to consolidated financial statements, included in Item 8. Financial Statements and Supplementary Data, elsewhere in this report for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.

Impaired loans are loans so designated when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. Additional information on impaired loans, which includes both Troubled Debt Restructurings ("TDRs") and non-accrual loans, is included in Note 3 - Loans and Note 4 - Allowance for Loan Loss in the notes to consolidated financial statements.

Fair value measurements are used by the Company to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realized value or reflective of future fair values. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Additional discussion of valuation methodologies is presented in Note 14 - Fair Value Measurements of the Company's consolidated financial statements.

Securities Available for Sale are carried at fair value in accordance with ASC 320, "Investments - Debt and Equity Securities." The Company's unrestricted securities are classified as available for sale, meaning that the Company intends to hold these securities 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 Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Unrealized gains or losses are reported as a separate component of other comprehensive income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. See the section captioned "Securities" later in this discussion and Note 1 - Summary of Significant Accounting Policies and Note 2 - Securities in the notes to consolidated financial statements.


Other-than-temporary impairment of securities accounting policies require a periodic review by management to determine if the decline in the fair value of any security appears to be other-than-temporary. Factors considered in determining whether the decline is other-than-temporary include, but are not limited to: the length of time and the extent to which fair value has been below cost; the financial condition and near-term prospects of the issuer; and the Company's intent to sell. See Note 1 - Summary of Significant Accounting Policies and Note 2 - Securities, in the notes to consolidated financial statements, for further details on the accounting policies for other-than-temporary impairment of securities and the methodology used by management to make this evaluation.

Other real estate owned ("OREO") are assets acquired through, or in lieu of, loan foreclosures and are held for sale. Initially the OREO is recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of carrying amount or fair value less cost to sell. More information regarding the valuation methods used as well as the accounting for OREO is presented in Note 5 - Other Real Estate Owned and Note 14 - Fair Value Measurements of the Company's consolidated financial statements.

Income tax accounting policies have the objective to recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact the Company's consolidated financial condition or results of operations. Additional discussion on the accounting for income taxes is presented in Note 1 - Summary of Significant Accounting Policies and in Note 8 - Income Taxes of the Company's consolidated financial statements.

Non-GAAP Presentations

The Company, in referring to its net income, is referring to income computed under GAAP. Management's Discussion and Analysis of Financial Condition and Results of Operations also refers to various calculations that are non-GAAP presentations. They include:

Fully taxable-equivalent ("FTE") adjustments are the result of increasing income from tax-free investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 34% Federal income tax rate, thus making tax-exempt yields comparable to taxable asset yields.

Efficiency ratio is computed as a percentage of non-interest expense divided by the sum of net interest income (on an FTE basis) and non-interest income. This is a financial measure which may provide important information concerning the Company's operational efficiency. Comparison of the Company's efficiency ratio with those of other companies may not be possible because other companies may calculate the efficiency ratio differently.


Results of Operations

The Company reported net income totaled $6.896 million, or $2.56 diluted per common share, in 2013 compared to $5.481 million, or $2.04 diluted per common share in 2012. Net income increased $1.415 million for 2013 compared to 2012. The increase was primarily the result of a $5.814 million increase in non-interest income that was offset by an increase of $2.385 million in non-interest expense, a decrease of $1.174 million in net interest income, and an increase in provision for loan losses and provision for income taxes of $239 thousand and $601 thousand, respectively.

Virginia National Bankshares Corporation has two reportable segments, the commercial bank and VNBTrust. Commercial banking involves making loans and generating deposits from individuals and businesses. Loan fee income, service charges from deposit accounts, and other non-interest-related fees such as automatic teller machine fees and safe deposit box fees generate additional income for the commercial bank. VNBTrust services include investment management, trust account administration, and estate planning. VNBTrust receives fees on both a fixed basis and a performance basis for providing of these services.

The commercial bank earned net income of $2.049 million in 2013, $111 thousand more than the $1.938 million earned in 2012. VNBTrust earned net income of $4.847 million in 2013, compared to net income of $3.543 million in 2012, an increase of $1.304 million.

Details of the changes in the various components of net income are further discussed below.

                    Consolidated Return on Equity and Assets

The annualized ratio of net income to average total assets and average
shareholders' equity and certain other ratios for the periods indicated are as
follows:

                                      2013       2012       2011
Return on average assets              1.40%      1.11%      0.51%
Return on average equity             12.70%     10.90%      4.95%
Average equity to average assets     11.04%     10.21%     10.21%
Cash dividend payout ratio            5.86%      0.00%      0.00%

One of the ratios the Company examines in its evaluation of net income is the efficiency ratio, which measures the cost to produce one dollar of revenue. A lower ratio, computed by dividing non-interest expense by the sum of net interest income (on an FTE basis) and non-interest income, is an indicator of increased efficiency. The efficiency ratio for 2013 was positively impacted as a result of a revenue increase of $4.732 million as compared to 2012 and despite an increase in non-interest expense of $2.385 million in 2013 over 2012. The increases in revenue and expense in 2013 from 2012 was primarily attributable to VNBTrust's performance fee revenue and VNBTrust's incentive compensation expense. Similarly, the efficiency ratio for 2012 improved from 2011 as a result of an increase in revenue of $6.542 million that came namely from VNBTrust's performance fee revenue. Non-interest expense for 2012 was $2.277 million greater than 2011 due in part to OREO valuation write downs and an increase in VNBTrust's incentive compensation that was associated with the higher performance fee revenue.

The efficiency ratio for the years ended December 31, 2013, 2012, and 2011 is shown below.

2013 2012 2011 Efficiency Ratio 67.9% 70.9% 82.0%

Net Interest Income

Net interest income is computed as the difference between the interest income on earning assets and the interest expense on deposits and other interest bearing liabilities. Net interest income represents the principal source of revenue. Net interest income represented 45.0% of total revenue in 2013. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.


During 2013, net interest income, on a tax equivalent basis, was $14.601 million compared to $15.683 million in 2012. The $1.082 million decline in tax-equivalent net interest income year to year was mainly attributed to interest margin compression during this period of historically low interest rates. The net interest margin, which is net interest income expressed as a percentage of average earning assets, declined 21 basis points to 3.21% for the year ended December 31, 2013 from 3.42% reported for 2012. Further, the decrease in the net interest margin for 2012 was 31 basis points from the 3.73% net interest margin reported for the year ended December 31, 2011.

Total interest income, on a tax equivalent basis, aggregated $15.598 million for 2013, down $1.366 million from 2012, primarily as a result of a decline in loan interest income of $1.722 million. The decline in total interest income from loan income was partially offset by an increase of $389 thousand in tax equivalent interest income from the investment portfolio when comparing 2013 to 2012. In comparing 2012 to 2011, total interest income, on a tax equivalent basis, declined $884 thousand to $16.964 million in 2012 from $17.848 million in 2011. The tax-equivalent yield on interest-earning assets was 3.43% for 2013, compared to 3.70% for 2012 and 4.14% for 2011.

The $1.722 million decrease in interest income earned on the loan portfolio for 2013, from $14.720 million in 2012, was mainly attributable to rate adjustments and lower rates on new loans. The yield on the loan portfolio decreased to 4.43% for 2013 from 4.99% for 2012, resulting in a decrease of $1.567 million in loan income. The remaining $155 thousand decline in interest earned on loans for 2013 was due to a slight decrease in average loan balances to $293.5 million in 2013, fairly level with the average balance of $294.8 million for 2012.

The decline in interest income earned on the loan portfolio during 2013 was a continuation of the rate compression experienced over the past few years during this period of historically low rates and intense competition for loans. Loan interest income had decreased $1.061 million for 2012 from $15.781 million in 2011. The yield on the loan portfolio decreased 44 basis points in 2012 from 5.43% for 2011.

Although earning assets averaged $4.153 million less in 2013 than in 2012, the change in the mix of earning assets contributed positively to the change in net interest income. The major volume changes occurred with the average balances in low yielding federal funds sold declining $24.650 million year over year, offset by the Company's securities portfolio averaging $21.357 million more in 2013 versus 2012. The increase in the securities portfolio balances was the result of management's efforts to deploy excess funds in overnight federal funds sold, which earned on average 0.22% during 2013, by investing in securities which earned on average 1.99%.

Interest earned on the securities portfolio, on a tax-equivalent basis, increased to $2.513 million for 2013 from $2.124 million in 2012 and $2.019 million in 2011. Average securities balances increased to $126.157 million (27.7% of average earning assets) for 2013 from $104.800 million (22.8% of average earning assets) and $89.227 million (20.7% of average earning assets) in 2012 and 2011, respectively. The average yield on investment securities declined only 4 basis points from 2.03% in the corresponding 2012 period. In 2011, the average yield on the investment portfolio was 2.26%, or 23 basis points higher than in 2012. The continuing low rate environment continues to impact the overall portfolio yield.

Management's asset/liability strategy for the investment portfolio, starting in 2012, was to diversify the investment portfolio by adding mortgage-backed securities and bank-qualified municipal bonds. The average duration of the investment portfolio continues to be relatively short. Adding mortgage-backed securities has resulted in providing a consistent stream of cash flow that can be diverted to loan growth or re-invested in higher yielding securities when interest rates rise.

Total interest expense decreased by $284 thousand for 2013 to $997 thousand from $1.281 million for 2012, mainly due to a decline in the rates paid for interest-bearing liabilities from 0.43% for 2012 to 0.32% for 2013. The decrease in interest expense was partially a result of lower time deposit rates and a change in the mix of deposit balances. Time deposit rates averaged 0.59% in 2013, or 18 basis points lower than the 0.77% paid in 2012. In total, the average balance of interest-bearing liabilities increased $7.687 million. Average time deposit balances decreased $8.016 million in 2013, while average balances on interest checking accounts, daily overnight repurchase agreements, and money market accounts increased $10.056 million, $4.968 million, and $679 thousand, respectively.


Total interest expense decreased by $492 thousand for 2012 from $1.773 million for 2011. Further, rates paid for interest-bearing liabilities declined from 0.59% for 2011 to 0.43% for 2012. Over these same periods, time deposit rates averaged 30 basis points lower than the 1.07% paid in 2011. Average time deposit balances decreased $9.498 million in 2012 compared to 2011, while average interest checking and money market account balances increased $5.260 million and $2.710 million, respectively, for a net decline in the average balance of interest-bearing deposit accounts of $1.528 million.

A continuing primary driver of the Company's low cost of funds compared to peers is the Company's level of non-interest bearing demand deposits and low-cost deposit accounts. Below is a table illustrating the average balances of these accounts as a percentage of total deposit account balances.

Non-interest and low-cost deposit account analysis

(dollars in thousands)                     2013                             2012                             2011
                                 Average        % of Total        Average        % of Total        Average        % of Total
                                 Balance         Deposits         Balance         Deposits         Balance         Deposits
Non-interest demand deposits   $    127,480         29.7 %      $    139,741         31.9 %      $    111,649         27.1 %
Interest checking accounts           77,954         18.2 %            67,898         15.5 %            62,638         15.2 %
Money market deposit accounts        94,369         22.0 %            93,690         21.4 %            90,980         22.1 %
   Total non-interest and low-
   cost deposit accounts       $    299,803         69.9 %      $    301,329         68.8 %      $    265,267         64.4 %

Total deposit account balances $    428,619                     $    438,161                     $    411,597


     Consolidated Average Balance Sheet And Analysis of Net Interest Income

                                               Year Ended December 31, 2013           Year Ended December 31, 2012           Year Ended December 31, 2011
                                              Average       Interest    Average      Average       Interest    Average      Average       Interest    Average
(dollars in thousands)                        Balance        Income     Yield/       Balance        Income     Yield/       Balance        Income     Yield/
                                                            Expense      Cost                      Expense      Cost                      Expense      Cost
ASSETS

Interest Earning Assets:
     Securities
        Taxable Securities                 $   106,842     $    1,914     1.79%   $    96,776     $    1,890     1.95%   $    87,247     $    1,986     2.28%
        Tax Exempt Securities (1)               19,315            599     3.10%         8,024            234     2.92%         1,980             33     1.67%
        Total Securities (1)                   126,157          2,513     1.99%       104,800          2,124     2.03%        89,227          2,019     2.26%

     Loans:
        Real estate                            230,320         10,651     4.62%       238,958         12,481     5.22%       240,429         13,573     5.65%
        Commercial                              50,382          1,910     3.79%        42,876          1,765     4.12%        38,128          1,717     4.50%
        Consumer                                12,769            437     3.42%        12,996            474     3.65%        11,909            491     4.12%
        Total Loans                            293,471         12,998     4.43%       294,830         14,720     4.99%       290,466         15,781     5.43%
     Fed Funds Sold                             33,770             74     0.22%        58,420            112     0.19%        51,444             48     0.09%
     Other Interest Bearing Deposits             1,250             13     1.04%           751              8     0.00%             -              -     0.00%

Total Earning Assets                           454,648         15,598     3.43%       458,801         16,964     3.70%       431,137         17,848     4.14%

   Less: Allowance for Loan Losses              (3,439 )                               (3,704 )                               (3,732 )

Total Non-Earning Assets                        40,728                                 37,031                                 35,532

Total Assets                               $   491,937                            $   492,128                            $   462,937

LIABILITIES AND SHAREHOLDERS' EQUITY

Interest Bearing Liabilities:
     Interest Bearing Deposits:
        Interest Checking                  $    77,954     $       39     0.05%   $    67,898     $       34     0.05%   $    62,638     $       31     0.05%
        Money Market Deposits                   94,369            183     0.19%        93,690            194     0.21%        90,980            168     0.18%
        Time Deposits                          128,816            758     0.59%       136,832          1,049     0.77%       146,330          1,568     1.07%

     Total Interest-Bearing Deposits           301,139            980     0.33%       298,420          1,277     0.43%       299,948          1,767     0.59%

   Securities Sold Under Agreement
     to Repurchase                               7,941             17     0.21%         2,973              4     0.13%         2,672              6     0.22%

Total Interest-Bearing Liabilities             309,080            997     0.32%       301,393          1,281     0.43%       302,620          1,773     0.59%

Non-Interest-Bearing Liabilities:
     Demand deposits                           127,480                                139,741                                111,649
     Other liabilities                           1,067                                    730                                  1,389

Total Liabilities                              437,627                                441,864                                415,658

Shareholders' Equity                            54,310                                 50,264                                 47,279

Total Liabilities & Shareholders' Equity   $   491,937                            $   492,128                            $   462,937

Net Interest Income (Tax Equivalent)                       $   14,601                             $   15,683                             $   16,075

Interest Rate Spread (2)                                                  3.11%                                  3.27%                                  3.55%

Interest Expense as a Percentage                                          0.22%                                  0.28%                                  0.41%
     of Average Earning Assets

Net Interest Margin (3)                                                   3.21%                                  3.42%                                  3.73%

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