FIRST NATIONAL CORP /VA/ (Form: 10-Q, Received: 08/13/2007 17:10:32)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 0-23976

LOGO

(Exact name of registrant as specified in its charter)


Virginia		54-1232965
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

112 West King Street, Strasburg, Virginia		22657
(Address of principal executive offices)		(Zip Code)

(540) 465-9121

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of August 13, 2007, 2,922,860 shares of common stock, par value $1.25 per share, of the registrant were outstanding.

TABLE OF CONTENTS


		Page
Part I – Financial Information

Item 1.	Financial Statements

	Consolidated Balance Sheets	3

	Consolidated Statements of Income	4

	Consolidated Statements of Cash Flows	6

	Consolidated Statements of Changes in Shareholders’ Equity	8

	Notes to Consolidated Financial Statements	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25

Item 4.	Controls and Procedures	26

Part II – Other Information

Item 1.	Legal Proceedings	26

Item 1A.	Risk Factors	26

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

Item 3.	Defaults upon Senior Securities	27

Item 4.	Submission of Matters to a Vote of Security Holders	27

Item 5.	Other Information	27

Item 6.	Exhibits	27

Part I – Financial Information

Item 1.

Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Balance Sheets

(in thousands, except share and per share data)


	(unaudited) June 30, 2007			December 31, 2006
Assets
Cash and due from banks	$	8,583		$	10,368
Interest-bearing deposits in banks		3,811			1,759
Federal funds sold		—			8,430
Securities available for sale, at fair value		60,564			60,340
Loans held for sale		398			105
Loans, net of allowance for loan losses, 2007, $3,997, 2006, $3,978		430,250			423,151
Premises and equipment, net		18,646			17,603
Interest receivable		2,064			2,038
Foreclosed assets		377			—
Other assets		4,542			4,150

Total assets	$	529,235		$	527,944

Liabilities and Shareholders’ Equity

Liabilities
Deposits:
Noninterest-bearing demand deposits	$	82,561		$	83,386
Savings and interest-bearing demand deposits		178,852			167,419
Time deposits		172,818			184,239

Total deposits	$	434,231		$	435,044
Federal funds purchased		5,260			—
Other borrowings		40,690			45,750
Company obligated mandatorily redeemable capital securities		12,372			12,372
Accrued expenses and other liabilities		2,652			2,223
Commitments and contingencies		—			—

Total liabilities	$	495,205		$	495,389

Shareholders’ Equity
Common stock, par value $1.25 per share; authorized 8,000,000 shares; issued and outstanding, 2,922,860 shares	$	3,653		$	3,653
Surplus		1,464			1,465
Retained earnings		31,032			29,104
Unearned ESOP shares		(495	)		(546	)
Accumulated other comprehensive loss, net		(1,624	)		(1,121	)

Total shareholders’ equity	$	34,030		$	32,555

Total liabilities and shareholders’ equity	$	529,235		$	527,944

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Income

Three months ended June 30, 2007 and 2006

(in thousands, except per share data)


	(unaudited) June 30, 2007		(unaudited) June 30, 2006
Interest and Dividend Income
Interest and fees on loans	$	8,065	$	7,282
Interest on federal funds sold		10		1
Interest on deposits in banks		25		32
Interest and dividends on securities available for sale:
Taxable interest		535		633
Tax-exempt interest		116		106
Dividends		48		60

Total interest and dividend income	$	8,799	$	8,114

Interest Expense
Interest on deposits	$	3,551	$	2,623
Interest on federal funds purchased		41		91
Interest on company obligated mandatorily redeemable capital securities		238		158
Interest on other borrowings		538		779

Total interest expense	$	4,368	$	3,651

Net interest income	$	4,431	$	4,463
Provision for loan losses		67		84

Net interest income after provision for loan losses	$	4,364	$	4,379

Noninterest Income
Service charges	$	772	$	699
Fees for other customer services		601		489
Gains on sale of loans		52		52
Gains on sale of securities available for sale		—		3
Gains on sale of premises and equipment		1		—
Other operating income		14		44

Total noninterest income	$	1,440	$	1,287

Noninterest Expense
Salaries and employee benefits	$	2,207	$	1,855
Occupancy		228		190
Equipment		310		298
Marketing		162		171
Stationery and supplies		135		140
Legal and professional fees		174		132
ATM and check card		134		104
Other operating expense		561		587

Total noninterest expense	$	3,911	$	3,477

Income before income taxes	$	1,893	$	2,189
Provision for income taxes		613		709

Net income	$	1,280	$	1,480

Earnings per common share, basic and diluted	$	0.44	$	0.50

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Income

Six months ended June 30, 2007 and 2006

(in thousands, except per share data)


	(unaudited) June 30, 2007		(unaudited) June 30, 2006
Interest and Dividend Income
Interest and fees on loans	$	16,018	$	13,918
Interest on federal funds sold		24		2
Interest on deposits in banks		50		60
Interest and dividends on securities available for sale:
Taxable interest		1,070		1,287
Tax-exempt interest		231		212
Dividends		95		113

Total interest and dividend income	$	17,488	$	15,592

Interest Expense
Interest on deposits	$	7,093	$	4,860
Interest on federal funds purchased		80		168
Interest on company obligated mandatorily redeemable capital securities		474		305
Interest on other borrowings		1,088		1,437

Total interest expense	$	8,735	$	6,770

Net interest income	$	8,753	$	8,822
Provision for loan losses		67		169

Net interest income after provision for loan losses	$	8,686	$	8,653

Noninterest Income
Service charges	$	1,391	$	1,362
Fees for other customer services		1,177		960
Gains on sale of loans		125		97
Gains on sale of securities available for sale		—		3
Gains on sale of premises and equipment		1		—
Other operating income		36		87

Total noninterest income	$	2,730	$	2,509

Noninterest Expense
Salaries and employee benefits	$	4,073	$	3,639
Occupancy		474		389
Equipment		628		568
Marketing		290		309
Stationery and supplies		242		245
Legal and professional fees		342		256
ATM and check card		252		196
Other operating expense		1,149		1,132

Total noninterest expense	$	7,450	$	6,734

Income before income taxes	$	3,966	$	4,428
Provision for income taxes		1,283		1,436

Net income	$	2,683	$	2,992

Earnings per common share, basic and diluted	$	0.92	$	1.02

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows

Six months ended June 30, 2007 and 2006

(in thousands)


	(unaudited) June 30, 2007			(unaudited) June 30, 2006
Cash Flows from Operating Activities
Net income	$	2,683		$	2,992
Adjustments to reconcile net income to cash and cash equivalents provided by operating activities:
Depreciation and amortization		553			473
Origination of loans held for sale		(10,295	)		(7,736	)
Proceeds from sale of loans available for sale		10,127			6,975
Provision for loan losses		67			169
Gains on sale of securities available for sale		—			(3	)
Gains on sale of premises and equipment		(1	)		—
Gains on sale of loans		(125	)		(97	)
Accretion of security discounts		(17	)		(24	)
Amortization of security premiums		50			84
Shares acquired by leveraged ESOP		50			—
Changes in assets and liabilities:
Increase in interest receivable		(26	)		(8	)
Increase in other assets		(133	)		(77	)
Increase in accrued expenses and other liabilities		429			237

Net cash provided by operating activities	$	3,362		$	2,985

Cash Flows from Investing Activities
Proceeds from sales of securities available for sale	$	1,013		$	2,974
Proceeds from maturities, calls, and principal payments of securities available for sale		5,068			4,378
Purchase of securities available for sale		(7,100	)		(4,231	)
Decrease in federal funds sold		8,430			—
Proceeds from sale of premises and equipment		1			—
Purchase of premises and equipment		(1,596	)		(2,861	)
Net increase in loans		(7,543	)		(31,086	)

Net cash used in investing activities	$	(1,727	)	$	(30,826	)

Cash Flows from Financing Activities
Net increase (decrease) in demand deposits and savings accounts	$	10,608		$	(12,117	)
Net increase (decrease) in time deposits		(11,421	)		38,923
Proceeds from other borrowings		83,500			81,100
Principal payments on other borrowings		(88,560	)		(66,109	)
Cash dividends paid		(755	)		(702	)
Increase (decrease) in federal funds purchased		5,260			(7,997	)

Net cash provided by (used in) financing activities	$	(1,368	)	$	33,098

Increase in cash and cash equivalents	$	267		$	5,257

Cash and Cash Equivalents
Beginning	$	12,127		$	10,447
Ending	$	12,394		$	15,704

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows

(Continued)

Six months ended June 30, 2007 and 2006

(in thousands)


	(unaudited) June 30, 2007			(unaudited) June 30, 2006
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	8,724		$	6,437

Income taxes	$	833		$	1,647

Supplemental Disclosures of Noncash Investing Activities
Unrealized loss on securities available for sale	$	(762	)	$	(1,035	)

Transfer from loans to other real estate	$	377		$	—

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Changes in Shareholders’ Equity

Six months ended June 30, 2007 and 2006

(in thousands, except share and per share data)

(unaudited)


	Common Stock		Surplus		Retained Earnings			Unearned ESOP Shares		Accumulated Other Comprehensive Loss			Comprehensive Income			Total
Balance, December 31, 2005	$	3,653	$	1,465	$	24,735		$	—	$	(462	)				$	29,391
Comprehensive income:
Net income		—		—		2,992			—		—		$	2,992			2,992
Other comprehensive loss, net of tax, unrealized holding losses arising during the period (net of tax, $351)		—		—		—			—		—			(681	)		—
Reclassification adjustment (net of tax, $1)		—		—		—			—		—			(2	)		—

Other comprehensive loss (net of tax, $352)		—		—		—			—		(683	)		(683	)		(683	)

Total comprehensive income													$	2,309

Cash dividends ($0.24 per share)		—		—		(702	)		—		—						(702	)

Balance, June 30, 2006	$	3,653	$	1,465	$	27,025		$	—	$	(1,145	)				$	30,998


	Common Stock		Surplus			Retained Earnings			Unearned ESOP Shares			Accumulated Other Comprehensive Loss			Comprehensive Income			Total
Balance, December 31, 2006	$	3,653	$	1,465		$	29,104		$	(546	)	$	(1,121	)				$	32,555
Comprehensive income:
Net income		—		—			2,683			—			—		$	2,683			2,683
Other comprehensive loss, net of tax, unrealized holding losses arising during the period (net of tax, $259)		—		—			—			—			(503	)		(503	)		(503	)

Total comprehensive income															$	2,180

Shares acquired by leveraged ESOP		—		(1	)		—			51			—						50
Cash dividends ($0.26 per share)		—		—			(755	)		—			—						(755	)

Balance, June 30, 2007	$	3,653	$	1,464		$	31,032		$	(495	)	$	(1,624	)				$	34,030

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Notes to Consolidated Financial Statements

(unaudited)

Note 1. General

The accompanying unaudited consolidated financial statements of First National Corporation (the Company) and its subsidiaries, including First Bank (the Bank), have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications consisting of a normal and recurring nature considered necessary to present fairly the financial positions at June 30, 2007 and December 31, 2006, the results of operations for the three and six month periods ended June 30, 2007 and 2006 and cash flows and changes in shareholders’ equity for the six months ended June 30, 2007 and 2006. The statements should be read in conjunction with the consolidated financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2006. Operating results for the three and six month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

Note 2. Securities

The Company invests in U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate equity securities and restricted securities. Restricted securities include required equity investments in certain correspondent banks. All of the Company’s securities were classified as available for sale at June 30, 2007 and December 31, 2006. Amortized costs and fair values were as follows:


	*(in thousands)* June 30, 2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. agency and mortgage-backed securities	$	47,060	$	2	$	(1,168	)	$	45,894
Obligations of states and political subdivisions		11,335		40		(203	)		11,172
Corporate equity securities		10		156		—			166
Restricted securities		3,332		—		—			3,332

	$	61,737	$	198	$	(1,371	)	$	60,564


	*(in thousands)* December 31, 2006
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. agency and mortgage-backed securities	$	47,076	$	6	$	(653	)	$	46,429
Obligations of states and political subdivisions		10,273		123		(30	)		10,366
Corporate equity securities		10		143		—			153
Restricted securities		3,392		—		—			3,392

	$	60,751	$	272	$	(683	)	$	60,340

Notes to Consolidated Financial Statements

(unaudited)

At June 30, 2007 and December 31, 2006, investments in an unrealized loss position that were temporarily impaired were as follows:


	Less than 12 months					*(in thousands)* June 30, 2007 12 months or more					Total
	Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)
U.S. agency and mortgage-backed securities	$	9,529	$	(130	)	$	36,081	$	(1,038	)	$	45,610	$	(1,168	)
Obligations of states and political subdivisions		4,565		(123	)		2,256		(80	)		6,821		(203	)

	$	14,094	$	(253	)	$	38,337	$	(1,118	)	$	52,431	$	(1,371	)


	Less than 12 months					*(in thousands)* December 31, 2006 12 months or more					Total
	Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)
U.S. agency and mortgage-backed securities	$	15,340	$	(48	)	$	29,488	$	(605	)	$	44,828	$	(653	)
Obligations of states and political subdivisions		1,142		(5	)		1,618		(25	)		2,760		(30	)

	$	16,482	$	(53	)	$	31,106	$	(630	)	$	47,588	$	(683	)

The tables above provide information about securities that have been in an unrealized loss position for less than twelve consecutive months and securities that have been in an unrealized loss position for twelve consecutive months or more. All of the securities with unrealized losses are considered temporarily impaired and are a result of interest rate factors. These securities have not suffered credit deterioration and the Company has the ability and intent to hold these issues until maturity. At June 30, 2007, there were forty-three U.S. agency and mortgage-backed securities and twenty obligations of state and political subdivisions in an unrealized loss position. Ninety-seven percent of the Company’s investment portfolio had AAA credit ratings with a weighted-average repricing term of 4.4 years at June 30, 2007.

Note 3. Loans

Loans at June 30, 2007 and December 31, 2006 are summarized as follows:


	*(in thousands)*
	June 30, 2007		December 31, 2006
Mortgage loans on real estate:
Construction	$	69,938	$	60,913
Secured by farm land		1,763		2,507
Secured by 1-4 family residential		108,565		112,323
Other real estate loans		174,687		168,754
Loans to farmers (except those secured by real estate)		2,198		2,150
Commercial and industrial loans (except those secured by real estate)		50,684		50,854
Consumer loans		20,993		24,423
Deposit overdrafts		493		232
All other loans		4,926		4,973

Total loans	$	434,247	$	427,129
Allowance for loan losses		3,997		3,978

Loans, net	$	430,250	$	423,151

Notes to Consolidated Financial Statements

(unaudited)

The Company has a credit concentration in mortgage loans on real estate. These loans totaled $355.0 million, or 82.5% of loans, net of the allowance for loan losses, and $344.5 million, or 81.4% of loans, net of the allowance for loan losses, at June 30, 2007 and December 31, 2006, respectively. Although the Company believes that its underwriting standards are generally conservative, the ability of its borrowers to meet their mortgage obligations may be affected by local economic conditions. Construction loans totaled $69.9 million and $60.9 million, or 16.3% and 14.4% of loans, net of the allowance for loan losses, at June 30, 2007 and December 31, 2006, respectively.

The Company has another concentration of credit risk involving loans secured by hotels. This concentration totaled $31.9 million at June 30, 2007, representing 93.7% of total shareholders’ equity and 7.4% of loans, net of the allowance for loan losses. At December 31, 2006, this concentration totaled $28.9 million representing 88.6% of total shareholders’ equity and 6.8% of loans, net of the allowance for loan losses. These loans are included in other real estate loans in the above table. The Company experienced no loan losses related to this concentration of credit risk during the six month period ended June 30, 2007 and the year ended December 31, 2006.

Note 4. Allowance for Loan Losses

Transactions in the allowance for loan losses for the six months ended June 30, 2007 and 2006 and for the year ended December 31, 2006 were as follows:


	*(in thousands)*
	June 30, 2007			December 31, 2006			June 30, 2006
Balance at beginning of year	$	3,978		$	3,528		$	3,528
Provision charged to operating expense		67			378			169
Loan recoveries		105			320			187
Loan charge-offs		(153	)		(248	)		(114	)

Balance at end of period	$	3,997		$	3,978		$	3,770

Note 5. Other Borrowings

The Bank had unused lines of credit totaling $76.6 million available with non-affiliated banks at June 30, 2007. This amount primarily consists of a blanket floating lien agreement with the Federal Home Loan Bank of Atlanta (FHLB) under which the Bank can borrow up to 19% of its total assets.

At June 30, 2007, the Bank had borrowings from the FHLB system totaling $40.0 million which mature through March 29, 2010. The interest rate on these notes payable ranged from 4.88% to 5.52% and the weighted average rate was 5.25%. The Bank had collateral pledged on these borrowings, including real estate loans totaling $29.8 million at June 30, 2007 and FHLB stock and other investment securities with a book value of $32.8 million at June 30, 2007.

At June 30, 2007, the Bank had a $195 thousand note payable, secured by a deed of trust, which requires monthly payments of $2 thousand and matures January 3, 2016. The fixed interest rate on this loan is 4.00%. The Company also had an unsecured note payable of $495 thousand, which requires monthly payments of $11 thousand and matures September 12, 2011. The fixed interest rate on this loan is 7.35%.

Notes to Consolidated Financial Statements

(unaudited)

Note 6. Capital Requirements

A comparison of the capital of the Company and the Bank at June 30, 2007 and December 31, 2006 with the minimum regulatory guidelines were as follows:


	Actual				*(dollars in thousands)* Minimum Capital Requirement				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2007:
Total Capital (to Risk Weighted Assets):
Consolidated	$	52,180	11.62	%	$	35,919	8.00	%		N/A	N/A
First Bank	$	51,532	11.49	%	$	35,865	8.00	%	$	44,832	10.00	%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated	$	48,183	10.73	%	$	17,959	4.00	%		N/A	N/A
First Bank	$	47,535	10.60	%	$	17,933	4.00	%	$	26,899	6.00	%
Tier 1 Capital (to Average Assets):
Consolidated	$	48,183	9.23	%	$	20,890	4.00	%		N/A	N/A
First Bank	$	47,535	9.11	%	$	20,868	4.00	%	$	26,086	5.00	%

December 31, 2006:
Total Capital (to Risk Weighted Assets):
Consolidated	$	49,747	11.34	%	$	35,101	8.00	%		N/A	N/A
First Bank	$	49,585	11.32	%	$	35,042	8.00	%	$	43,802	10.00	%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated	$	45,769	10.43	%	$	17,551	4.00	%		N/A	N/A
First Bank	$	45,607	10.41	%	$	17,521	4.00	%	$	26,281	6.00	%
Tier 1 Capital (to Average Assets):
Consolidated	$	45,769	8.76	%	$	20,908	4.00	%		N/A	N/A
First Bank	$	45,607	8.73	%	$	20,885	4.00	%	$	26,107	5.00	%

Notes to Consolidated Financial Statements

(unaudited)

Note 7. Company Obligated Mandatorily Redeemable Capital Securities

On March 11, 2003, First National (VA) Statutory Trust I (Trust I), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities. On March 26, 2003, $3.0 million of trust preferred securities were issued through a pooled underwriting. The securities have a LIBOR-indexed floating rate of interest. The interest rate at June 30, 2007 was 8.51%. The securities have a mandatory redemption date of March 26, 2033, and are subject to varying call provisions beginning March 26, 2008. The principal asset of Trust I is $3.1 million of the Company’s junior subordinated debt securities with maturities and interest rates comparable to the trust preferred securities. The Trust’s obligations under the trust preferred securities are fully and unconditionally guaranteed by the Company.

On June 8, 2004, First National (VA) Statutory Trust II (Trust II), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities. On June 17, 2004, $5.0 million of trust preferred securities were issued through a pooled underwriting. The securities have a LIBOR-indexed floating rate of interest. The interest rate at June 30, 2007 was 7.96%. The securities have a mandatory redemption date of June 17, 2034, and are subject to varying call provisions beginning June 17, 2009. The principal asset of Trust II is $5.2 million of the Company’s junior subordinated debt securities with maturities and interest rates comparable to the trust preferred securities. The Trust’s obligations under the trust preferred securities are fully and unconditionally guaranteed by the Company.

On July 24, 2006, First National (VA) Statutory Trust III (Trust III), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities. On July 31, 2006, $4.0 million of trust preferred securities were issued through a pooled underwriting. The securities have a LIBOR-indexed floating rate of interest. The interest rate at June 30, 2007 was 7.26%. The securities have a mandatory redemption date of October 1, 2036, and are subject to varying call provisions beginning October 1, 2011. The principal asset of Trust III is $4.1 million of the Company’s junior subordinated debt securities with maturities and interest rates comparable to the trust preferred securities. The Trust’s obligations under the trust preferred securities are fully and unconditionally guaranteed by the Company.

While these securities are debt obligations of the Company, they are included in capital for regulatory capital ratio calculations. Under present regulations, the trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes as long as their amount does not exceed 25% of Tier 1 capital, including total trust preferred securities. The portion of the trust preferred securities not considered as Tier 1 capital, if any, may be included in Tier 2 capital. At June 30, 2007, $12.1 million of trust preferred securities issued by the Trusts were included in the Company’s Tier 1 capital.

Note 8. Benefit Plans

The Bank has a noncontributory, defined benefit pension plan for all full-time employees over 21 years of age with at least one year of credited service. Benefits are generally based upon years of service and average compensation for the five highest-paid consecutive years of service. The Bank’s funding practice has been to make at least the minimum required annual contribution permitted by the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended.

Components of the net periodic benefit cost of the plan for the three and six months ended June 30, 2007 and 2006 were as follows:


	*(in thousands)*
	For the three months ended June 30,						For the six months ended June 30,
	2007			2006			2007			2006
Service cost	$	70		$	59		$	140		$	119
Interest cost		66			60			132			120
Expected return on plan assets		(64	)		(58	)		(128	)		(116	)
Amortization of net obligation at transition		(2	)		(1	)		(3	)		(3	)
Amortization of prior service cost		1			1			2			2
Amortization of net loss		11			13			22			26

Net periodic benefit cost	$	82		$	74		$	165		$	148

Notes to Consolidated Financial Statements

(unaudited)

The Company previously disclosed in its consolidated financial statements in its Annual Report on Form 10-K for the year ended December 31, 2006, that it expected to contribute $329 thousand to its pension plan for the 2007 plan year. The Company did not make a contribution to the pension plan for the 2007 plan year during the six months ended June 30, 2007. The Company is planning to make the contribution for the 2007 plan year during the fourth quarter of 2007.

In addition to the defined benefit pension plan, the Company maintains a 401(k) plan and an employee stock ownership plan (ESOP) for eligible employees. The Bank also maintains a Split Dollar Life Insurance Plan that provides life insurance coverage to insurable directors. See Note 11 of the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for additional information about the Company’s benefit plans.

Note 9. Earnings per Share

Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. There are no potential common shares that would have a dilutive effect. Shares not committed to be released under the Company’s leveraged ESOP are not considered to be outstanding. See Note 11 of the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for additional information about the Company’s leveraged ESOP. The average number of common shares outstanding used to calculate basic and diluted earnings per share were 2,905,574 and 2,922,860 for the three months ended June 30, 2007 and 2006, respectively and 2,904,786 and 2,922,860 for the six months ended June 30, 2007 and 2006, respectively.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of operations of the Company for the three and six month periods ended June 30, 2007 should be read in conjunction with the consolidated financial statements and related notes included in Part I, Item 1, of this Form 10-Q. The results of operations for the three and six month periods ended June 30, 2007 may not be indicative of the results to be achieved for the year.

Executive Overview

First National Corporation (the Company) is the financial holding company of First Bank (the Bank), First National (VA) Statutory Trust I (Trust I), First National (VA) Statutory Trust II (Trust II) and First National (VA) Statutory Trust III (Trust III). The Trusts were formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities. The Bank owns First Bank Financial Services, Inc., which invests in partnerships that provide title insurance and investment services.

The Bank offers loan, deposit, trust and investment products and services through 11 offices, 29 ATMs and its website, www.firstbank-va.com . Customers include individuals, small and medium-sized businesses and governmental entities in the northern Shenandoah Valley region of Virginia.

The Company’s primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank’s interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is another important source of revenue for the Company. Noninterest income is derived primarily from service charges on loans and deposits and fees earned from bank services. The Bank generates fee income from services that include trust, asset management and investment services and through the origination and sale of residential mortgages.

Other factors impacting net income include the provision for loan losses, noninterest income and noninterest expense. The provision is determined by asset quality, net charge-offs, loan growth and economic conditions. Changing economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs and ultimately the required provision for loan losses. Noninterest income is not expected to increase significantly in future periods as the trust and asset management department is no longer experiencing high rates of growth. The department began operations in 2005 and experienced rapid growth during 2005 and 2006 from initial market demand. In order to improve profitability, the Company has delayed expansion plans while leveraging existing branches. As a result, noninterest expense is not expected to continue at recent growth rates in future periods. The Company is adjusting to an environment of slower balance sheet growth and lower net interest margins by controlling expenses and seeking other sources of noninterest income.

For the three months ended June 30, 2007, net income was $1.3 million, a decrease of $200 thousand or 13.5%, compared to $1.5 million for the same period in 2006. The decrease in earnings reflects a 12.5% increase in noninterest expense primarily from the addition of two branch locations. In addition, there was a slight decrease in net interest income that resulted from a 17 basis point decrease in the net interest margin. These decreases were offset by noninterest income that increased 11.9%, primarily from fee income generated from other customer services.

Net income per share, basic and diluted, decreased $0.06 to $0.44 for the three months ended June 30, 2007 from $0.50 for the same period in 2006. The annualized return on average assets was 0.98% for the second quarter of 2007, compared to 1.18% for the same period in 2006, and the annualized return on average equity was 15.10% for the second quarter of 2007, compared to 19.20% for the same period in 2006.

The net interest margin was 3.66% for the second quarter of 2007, compared to 3.83% for the same period of 2006. The decrease in the net interest margin was a result of higher cost of funds caused by increased competition for deposits and price sensitive deposit customers. The Company first experienced net interest margin compression during the third quarter of 2006 when the net interest margin decreased 20 basis points to 3.63%, and then dropped another 8 basis points during the fourth quarter of 2006 to 3.55%. The net interest margin has improved during 2007, increasing 8 basis points to 3.63% during the first quarter of 2007 and then increasing another 3 basis points to 3.66% during the second quarter of 2007. The Company expects the net interest margin to remain stable throughout the remainder of 2007, as funding costs and the yield on earning assets are not anticipated to change significantly. Therefore, increases in net interest income during the second half of 2007 will be determined primarily from the Company’s ability to attract deposits and grow earning assets.

For the six months ended June 30, 2007, net income was $2.7 million, a decrease of $309 thousand or 10.3%, compared to $3.0 million for the same period in 2006. The decrease in earnings was attributed to a 10.6%, or $716 thousand, increase in noninterest expense and no growth in net interest income. The increase in noninterest expense primarily resulted from the costs associated with the addition of two branches during the second half of 2006. Although the Company experienced moderate balance sheet growth over the last twelve months, net interest income remained unchanged at $8.8 million. Earnings that are typically generated from additional balance sheet volume were offset by the net interest margin that was 25 basis points lower during the six months ended June 30, 2007, compared to the same period in 2006. Noninterest income increased 8.8%, or $221 thousand, and the provision for loan losses decreased 60.4%, or $102 thousand, when comparing the periods. The decrease in the provision reflected less loan growth in 2007 when compared to 2006. The allowance for loan losses totaled $4.0 million at each of June 30, 2007 and December 31, 2006, representing 0.92% and 0.93% of total loans, respectively.

Net income per share, basic and diluted, decreased $0.10 to $0.92 for the six months ended June 30, 2007 from $1.02 for the same period in 2006. The annualized return on average assets was 1.04% for the first six months of 2007, compared to 1.23% for the same period in 2006. The annualized return on average equity was 16.13% for the six months ended June 30, 2007 compared to 19.81% for the same period in 2006.

Total assets increased $1.3 million during the first six months of 2007 to $529.2 million at June 30, 2007 from $527.9 million at December 31, 2006. Loans, net of the allowance for loan losses, increased 1.7%, or $7.1 million, during the first six months of 2007, while deposits decreased $813 thousand to $434.2 million at June 30, 2007 from $435.0 million at December 31, 2006. The Company is planning for the balance sheet to continue growing at its current pace during the remainder of 2007. However, there are opportunities to gain market share from recent merger and acquisition activity in the Company’s market area. Although it is uncertain whether this activity will benefit the Company, marketing efforts have been focused on gaining market share.

Cautionary Statement Regarding Forward-Looking Statements

The Company makes forward-looking statements in this Form 10-Q that are subject to risks and uncertainties. These forward- looking statements include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

•

the ability to successfully manage and implement balance sheet growth strategies;

•

competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

•

maintaining capital levels adequate to support growth;

•

successful management of credit risk including certain concentrations in loans secured by real estate;

•

risks inherent in the loan portfolio such as repayment risks, fluctuating collateral values and concentrations;

•

the adequacy of the allowance for loan losses related to changes in general economic and business conditions in the market area;

•

the ability to identify attractive markets, locations or opportunities to expand in the future;

•

the successful management of interest rate risk;

•

reliance on the management team, including the ability to attract and retain key personnel;

•

changes in banking and other laws and regulations applicable to the Company;

•

problems with technology utilized by the Company;

•

changing trends in customer profiles and behavior; and

•

demand, development and acceptance of new products and services.

Because of these uncertainties, actual future results may be materially different from the results indicated by these forward- looking statements. In addition, past results of operations do not necessarily indicate future results.

Non-GAAP Financial Measures

The Company measures the net interest margin as an indicator of profitability. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax-equivalent net interest income is considered in the calculation of this ratio. Tax-equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total

interest expense. The tax rate utilized in calculating the tax benefit for 2007 and 2006 is 34%. The reconciliation of tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.


	Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income *(in thousands)*
	For the three months ended				For the six months ended
	June 30, 2007		June 30, 2006		June 30, 2007		June 30, 2006
GAAP measures:
Interest income - loans	$	8,065	$	7,282	$	16,018	$	13,918
Interest income - investments and other		734		832		1,470		1,674
Interest expense - deposits		3,551		2,623		7,093		4,860
Interest expense - other borrowings		538		779		1,088		1,437
Interest expense - other		279		249		554		473

Total net interest income	$	4,431	$	4,463	$	8,753	$	8,822

Non-GAAP measures:
Tax benefit realized on non-taxable interest income - loans	$	12	$	13	$	24	$	26
Tax benefit realized on non-taxable interest income - municipal securities		60		55		119		109

Total tax benefit realized on non-taxable interest income	$	72	$	68	$	143	$	135

Total tax-equivalent net interest income	$	4,503	$	4,531	$	8,896	$	8,957

Critical Accounting Policies

General

The Company’s consolidated financial statements and related notes are prepared in accordance with GAAP. The financial information contained within the statements is, to a significant extent, financial information that is 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. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact transactions could change. For further information about the Bank’s loans and the allowance for loan losses, see Notes 3 and 4 to consolidated financial statements, included in Item 1 of this Form 10-Q.

Presented below is a discussion of those accounting policies that management believes are the most important (“Critical Accounting Policies”) to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

Allowance for loan losses

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on three basic principles of accounting: (i) Statement of Financial Accounting Standards (SFAS) No. 5, “Accounting for Contingencies,” which requires that losses be accrued when they are probable of occurring and estimable, (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” 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) U.S. Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues,” which requires adequate documentation to support the allowance for loan losses estimate.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Bank’s allowance for loan losses has two basic components: the specific allowance and the general allowance. Both of these components are determined based upon estimates that can and do change when the actual events occur. The allowance for loan losses is comprised of the sum of the specific allowance and the general allowance.

The specific allowance is typically used to individually allocate an allowance for larger balance, commercial, non-homogeneous loans. The specific allowance uses various techniques to arrive at an estimate of loss. First, analysis of the borrower’s overall financial condition, resources and payment record; the prospects for support from financial guarantors; and the fair market value of collateral, net of selling costs are used to estimate the probability and severity of inherent losses. Second, historical default rates and loss severities, internal risk ratings, industry and market conditions and trends, and other environmental factors are considered. The use of these values is inherently subjective and actual losses could differ from the estimates.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value (net of selling costs), and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair market value of the collateral, net of selling costs, if the loan repayment is collateral dependent. The Bank does not separately identify individual consumer and residential loans for impairment disclosures.

The general allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans including residential mortgage loans, installment loans and other consumer loans. This formula is also used for the remaining pool of larger balance, non-homogeneous loans, which were not allocated a specific allowance upon impairment review. The general allowance begins with estimates of probable losses inherent in the loan portfolio based upon various statistical analyses. These include analysis of delinquency rates, historical charge-offs over a five-year period, and current economic trends and conditions. The general allowance uses historical losses as an indicator of future losses. Historical losses are comprised of all loan charge-offs, including commercial loans, residential mortgage loans, consumer loans and deposit overdraft balances. 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.

Lending Policies

General

The principal risk associated with each of the categories of loans in the Bank’s portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. The risk associated with real estate mortgage loans and commercial and consumer loans varies, based on economic conditions, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction.

In an effort to manage the risk, the Bank’s loan policy authorizes loan amount approval limits for individual loan officers based on their position within the Bank and level of experience. The Bank’s Board of Directors and its Loan Committee approve all loan relationships greater than $1.5 million. The President and CEO and the Executive Vice President—Loan Administration can combine their lending limits to approve loan relationships up to $1.5 million. All loan relationships greater than $750 thousand are reported to the Board or its Loan Committee. The Loan Committee consists of five non-management directors and the President and CEO. The Committee approves the Bank’s Loan Policy and reviews loans that have been charged-off. It also reviews the allowance for loan loss adequacy calculation as well as the loan watch list and other management reports. The Committee meets on a monthly basis and the Chairman of the Committee then reports to the Board of Directors.

Residential loan originations are primarily generated by Bank loan officer solicitations, referrals by real estate professionals, and customers. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. All completed loan applications are reviewed by the Bank’s loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant. If commercial real estate is involved, information is also obtained concerning cash flow available for debt service. Loan quality is analyzed based on the Bank’s experience and credit underwriting guidelines as well as the guidelines issued by the purchasers of loans, depending on the type of loan involved. Real estate collateral is appraised by independent fee appraisers who have been pre-approved by the Executive Vice President—Loan Administration.

In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities that are disclosed but not reflected in its financial statements, including commitments to extend credit. At June 30, 2007, commitments to extend credit, stand-by letters of credit and rate lock commitments totaled $87.5 million.

Commercial Business Lending

Commercial business loans generally have a higher degree of risk than loans secured by real estate, but typically have higher yields. Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as real estate. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower’s principal owners and monitors the financial condition of its business borrowers. At June 30, 2007, commercial loans not secured by real estate totaled $50.7 million, or 11.7% of gross loans, as compared to $50.9 million, or 11.9%, at December 31, 2006.

Commercial Real Estate Lending

Commercial real estate loans are secured by various types of commercial real estate typically in the Bank’s market area, including multi-family residential buildings, commercial buildings and offices, hotels, small shopping centers, farms and churches. At June 30, 2007, commercial real estate loans totaled $176.5 million or 40.6% of the Bank’s gross loans, as compared to $171.3 million, or 40.1%, at December 31, 2006. In its underwriting of commercial real estate, the Bank may lend, under federal regulation, up to 85% of the secured property’s appraised value, although the Bank’s loan to original appraised value ratio on such properties is typically 80% or less. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy, in general. The Bank’s commercial real estate loan underwriting criteria require an examination of debt service coverage ratios and the borrower’s creditworthiness, prior credit history and reputation. The Bank typically requires personal guarantees of the borrower’s principal owners and carefully evaluates the location and environmental condition of the real estate collateral.

Construction Lending

The Bank makes local construction loans, including residential and land acquisition and development loans. These loans are secured by the property under construction and the underlying land for which the loan was obtained. Construction and land development loans outstanding at June 30, 2007 and December 31, 2006, were $69.9 million, or 16.1% of gross loans, and $60.9 million, or 14.3% of gross loans, respectively. The majority of these loans have an average life of approximately one year and reprice monthly as key rates change. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction lending is attributable to the fact that loan funds are advanced upon the security of the land or property under construction, which value is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To mitigate the risks associated with construction lending, the Bank generally limits loan amounts to 80% of appraised value, in addition to analyzing the creditworthiness of its borrowers. The Bank typically obtains a first lien on the property as security for its construction loans, requires personal guarantees from the borrower’s principal owners, and monitors the progress of the construction project during the draw period.

Residential Real Estate Lending

Residential lending activity may be generated by Bank loan officer solicitations, referrals by real estate professionals, and bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank’s underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank’s Executive Vice President-Loan Administration.

Typically, the Bank originates all fixed rate mortgage loans with the intent to sell to correspondent lenders. Depending on the financial goals of the Company, the Bank occasionally originates and retains these loans. At June 30, 2007, $108.6 million, or 25.0%, of the Bank’s loan portfolio consisted of one-to-four-family residential real estate loans as compared to $112.3 million, or 26.3%, at December 31, 2006.

In connection with residential real estate loans, the Bank requires title insurance, hazard insurance and, if required, flood insurance. Flood determination letters with life of loan tracking are obtained on all federally related transactions with improvements serving as security for the transaction. The Bank does require escrows for real estate taxes and insurance for secondary market loans.

Consumer Lending

The Bank offers various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, and credit card loans. At June 30, 2007, consumer loans, including deposit overdraft balances, were $21.5 million, or 4.9% of gross loans, as compared to $24.7 million, or 5.8%, at December 31, 2006.

Consumer loans typically entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on a proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the collateral in relation to the proposed loan amount.

Results of Operations

General

Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings and trust preferred securities. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for loan losses, noninterest income and noninterest expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts; fees charged for other customer services, including trust, asset management and brokerage fee income; gains and losses from the sale of assets, including loans held for sale, securities and premises and equipment; general and administrative expenses; and income tax expense.

Comparing the quarter ended June 30, 2007 to the same period in 2006, net income decreased to $1.3 million from $1.5 million. The decrease in earnings reflected a 12.5% increase in noninterest expense and a slight decrease in net interest income, offset by noninterest income that increased 11.9% and the provision for loan losses that decreased 20.2% when comparing the periods.

For the six months ended June 30, 2007, net income was $2.7 million or $0.92 per basic and diluted share. This is a 10.3% decrease compared to net income of $3.0 million or $1.02 per basic and diluted share for the same period in 2006. The decrease reflected a 10.6% increase in noninterest expense and no change in net interest income, offset by an 8.8% increase in noninterest income and a 60.4% decrease in the provision for loan losses. The decrease in the provision reflected less loan growth in 2007 when compared to 2006. The allowance for loan losses totaled $4.0 million at each of June 30, 2007 and December 31, 2006, representing 0.92% and 0.93% of total loans, respectively.

The Company expects the net interest margin to remain stable throughout the remainder of 2007. Therefore, increases in net interest income will be determined primarily from the Company’s ability to attract deposits and grow interest-earning assets. Other factors impacting net income include the provision for loan losses, noninterest income and noninterest expense. Noninterest income is not expected to increase significantly in future periods as the trust and asset management department is no longer experiencing high rates of growth. In order to improve profitability, the Company has delayed expansion plans while leveraging existing branches. As a result, noninterest expense is not expected to continue increasing at recent growth rates during future periods. The Company is adjusting to an environment of slower growth and lower net interest margins by controlling expenses and seeking other sources of noninterest income.

Net Interest Income

Net interest income was $4.4 million for the second quarter of 2007, which was a decrease of $32 thousand, or 0.7%, over $4.5 million for the same period in 2006. Growth in average interest-earning assets was offset by a decline in the net interest margin. Average interest-earning assets increased 4.0%, or $18.9 million, when comparing the periods. The net interest margin was 3.66% for the second quarter of 2007, compared to 3.83% for the same quarter of 2006. The lower net interest margin was a result of increased competition for deposits and price sensitive deposit customers.

Net interest income was $8.8 million for each of the six months ended June 30, 2007 and the comparable period in 2006. Growth in average interest-earning assets was offset by a decline in the net interest margin. Average interest-earning assets increased 6.0%, or $28.0 million, when comparing the periods. The net interest margin decreased 25 basis points to 3.64% for the six months ended June 30, 2007 compared to 3.89% for the same period of 2006.

Based on the interest rate sensitivity analysis included in Item 3 (Quantitative and Qualitative Disclosures about Market Risk) below, the Company does not anticipate market rate changes to have a significant impact on net interest income during the next 12 months. The Company does not expect significant changes in the net interest margin during the remainder of 2007. Therefore, increases in net interest income will be primarily determined by the Company’s ability to attract deposits and grow interest-earning assets.

Noninterest Income

Noninterest income increased 11.9% to $1.4 million for the second quarter of 2007, compared to $1.3 million for the same quarter of 2006. Fees for other customer services increased 22.9% to $601 thousand for the second quarter of 2007, compared to $489 thousand for the same period in 2006. This resulted from an increase in fee income from trust and asset management services and ATM fees. Service charges increased 10.4%, or $73 thousand, when comparing the periods. This was related to higher fee income from overdrafts.

Noninterest income was $2.7 million for the six months ended June 30, 2007, which was an increase of $221 thousand, or 8.8%, over $2.5 million for the same period in 2006. Fees for other customer services increased 22.6% to $1.2 million for the six months ended June 30, 2007, compared to $960 thousand for the same period in 2006. This resulted from an increase in fee income from trust and asset management services and ATM fees.

The Company does not expect noninterest income to increase significantly in future periods as the trust and asset management department is no longer experiencing high rates of growth. The department began operations in 2005 and experienced rapid growth during 2005 and 2006 from initial market demand.

Noninterest Expense

For the three months ended June 30, 2007, noninterest expense increased 12.5% to $3.9 million, compared to $3.5 million for the same period in 2006. For the six months ended June 30, 2007, noninterest expense increased 10.6% to $7.5 million, compared to $6.7 million for the same period in 2006. Salaries and employee benefits, occupancy and equipment expenses increased over the comparable period in 2006 primarily due to the addition of two branches during the last half of 2006. Growth in the trust and asset management department increased investment management expenses, which are included in legal and professional fees. Noninterest expense is not anticipated to continue increasing at recent growth rates during future periods. The Company has delayed branch expansion in order to improve profitability during periods of slower balance sheet growth and lower net interest margins.

Income Taxes

The Company has adopted Financial Accounting Standards Board (FASB) Statement No. 109, “Accounting for Income Taxes”. The Company’s income tax provision differed from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the three and six month periods ended June 30, 2007 and 2006. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income. The effective income tax rate for each of the three months ended June 30, 2007 and 2006 was 32.4%. The effective income tax rate for the six months ended June 30, 2007 and 2006 was 32.3% and 32.4%, respectively. A more detailed discussion of the Company’s tax calculation is contained in Note 9 of the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Financial Condition

General

Total assets increased $1.3 million during the first six months of 2007 to $529.2 million at June 30, 2007 from $527.9 million at December 31, 2006. Loans, net of the allowance for loan losses, increased 1.7%, or $7.1 million, during the first six months of 2007, while deposits decreased $813 thousand to $434.2 million at June 30, 2007 from $435.0 million at December 31, 2006. The Company is planning for the balance sheet to continue growing at its current pace during the remainder of 2007. Even though minimal loan and deposit growth is expected, there are new opportunities to gain market share from recent merger and acquisition activity in the Company’s market area. Although it is uncertain whether this activity will benefit the Company, marketing efforts have been focused on gaining market share.

Loans

The Bank is an active lender with a loan portfolio that includes commercial and residential real estate loans, commercial loans, consumer loans (both installment and credit card), real estate construction loans and home equity loans. The Bank’s lending activity is concentrated on individuals, small and medium-sized businesses and local governmental entities in its market area. As a provider of community-oriented financial services, the Bank does not attempt to geographically diversify its loan portfolio by undertaking significant lending activity outside its market area. Loans, net of the allowance for loan losses, were $430.3 million at June 30, 2007, compared to $423.2 million at December 31, 2006.

Asset Quality

Management classifies as nonperforming assets both loans on which payment has been delinquent 90 days or more and loans for which there is a risk of loss to either principal or interest, and other real estate owned (OREO). OREO represents real property taken by the Bank either through foreclosure or through a deed in lieu thereof from the borrower. OREO is recorded at the lower of cost or market, less estimated selling costs, and is actively marketed by the Bank through brokerage channels. The Bank had $377 thousand in foreclosed real estate at June 30, 2007 and no foreclosed real estate at December 31, 2006.

Nonperforming assets were $1.6 million at June 30, 2007 and $721 thousand at December 31, 2006, representing 0.36% and 0.17% of total loans, respectively. Net charge-offs were $48 thousand for the first half of 2007, compared to net recoveries of $73 thousand for the same period of 2006. Minimal loan growth during the first six months of the year resulted in a lower loan loss provision of $67 thousand for the second quarter of 2007 compared to $84 thousand for the same period in 2006. Nonperforming assets could increase due to other potential problem loans identified by management totaling $6.1 million at June 30, 2007. Potential problem loans at December 31, 2006 totaled $3.5 million. Certain risks, including the borrower’s ability to pay and the collateral value securing the loan, have been identified that may result in these loans not being repaid in accordance with their terms. However, these loans are currently performing and $5.9 million of the identified loans are considered well-secured.

The provision for loan losses represents management’s analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management’s estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled $4.0 million at each of June 30, 2007 and December 31, 2006, representing 0.92% and 0.93% of total loans, respectively.

Impaired loans of $49 thousand at each of June 30, 2007 and December 31, 2006, have been recognized in conformity with SFAS No. 114. The related allowance for loan losses provided for these loans totaled $25 thousand at each of June 30, 2007 and December 31, 2006. The average recorded investment in impaired loans during the six months ended June 30, 2007 and the year ended December 31, 2006 was $49 thousand and $59 thousand, respectively.

Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover any losses inherent within the loan portfolio. For each period presented, the provision for loan losses charged to expense was based on management’s judgment after taking into consideration all factors connected with the collectibility of the existing portfolio. Management considers economic conditions, historical loss factors, past due percentages, internally generated loan quality reports and other relevant factors when evaluating the loan portfolio. There can be no assurance, however, that an additional provision for loan losses will not be required in the future, including as a result of changes in the economic assumptions underlying management’s estimates and judgments, adverse developments in the economy, on a national basis or in the Company’s market area, or changes in the circumstances of particular borrowers. For further discussion regarding the allowance for loan losses, see “Critical Accounting Policies” above.

Securities

Securities at June 30, 2007 were $60.6 million, a slight increase from $60.3 million at December 31, 2006. The Company plans to maintain its current level of securities in relation to total assets in order to maintain minimum liquidity ratios that are required by Company policy. Investment securities are comprised of U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate equity securities and certain restricted securities. As of June 30, 2007, neither the Company nor the Bank held any derivative financial instruments in its respective investment security portfolios.

Deposits

Deposits were $434.2 million at June 30, 2007, a slight decrease from $435.0 million at December 31, 2006. Time deposits decreased $11.4 million or 6.2% during the first six months of 2007 to $172.8 million compared to $184.2 million at December 31, 2006. Savings and interest-bearing demand deposits increased $11.4 million or 6.8% when comparing the same periods. The decrease in time deposits and the increase in savings and interest-bearing demand deposits were attributed to a new savings account product that the Company promoted during the fourth quarter of 2006 and first quarter of 2007. Non-interest bearing demand deposits decreased slightly during the first six months of 2007. Although the Company plans to fund future asset growth with deposits, increasing competition could make this challenging.

Liquidity

Liquidity represents the ability to meet present and future financial obligations through either the sale or maturity of existing assets or with borrowings from correspondent banks or other deposit markets. Liquid assets include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, investment securities and loans maturing within one year. As a result of the Bank’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Bank maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ borrowing needs.

At June 30, 2007, cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, securities and loans maturing within one year totaled $143.8 million. At June 30, 2007, 42.7% or $185.3 million of the loan portfolio would mature or reprice within one year. At June 30, 2007, non-deposit sources of available funds totaled $76.6 million, which included $60.4 million available from FHLB. During the first six months of 2007, other borrowing activity included repayment of an adjustable rate credit (ARC) advance in the amount of $30.0 million, repayment of a fixed rate credit (FRC) advance in the amount of $5.0 million and three new FRC advances totaling $30.0 million. The Bank also borrowed and repaid Daily Rate Credit (DRC) advances as an alternative to purchasing federal funds.

Company Obligated Mandatorily Redeemable Capital Securities

See Note 7 of the notes to consolidated financial statements of this Form 10-Q.

Capital Resources

The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.

The Board of Governors of the Federal Reserve System has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.00%, of which at least 4.00% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The Company had a ratio of total capital to risk-weighted assets of 11.62% at June 30, 2007 and a ratio of Tier 1 capital to risk-weighted assets of 10.73%. Both of these exceed the capital requirements adopted by the federal regulatory agencies.

Contractual Obligations

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Off-Balance Sheet Arrangements

The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.

Commitments to extend credit, which amounted to $79.4 million at June 30, 2007, and $68.7 million at December 31, 2006, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and might not be drawn upon to the total extent to which the Bank is committed.

Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. At June 30, 2007 and December 31, 2006, the Company had $7.2 million and $7.0 million, respectively, in outstanding standby letters of credit.

At June 30, 2007 and December 31, 2006, the Company had entered into locked-rate commitments to originate mortgage loans amounting to $906 thousand and $2.2 million, respectively. The Company had loans held for sale of $398 thousand and $105 thousand at June 30, 2007 and December 31, 2006, respectively. The Company has entered into commitments, on a best-effort basis to sell loans of approximately $1.3 million. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Bank does not expect any counterparty to fail to meet its obligations.

Reclassifications

Certain reclassifications have been made to prior period balances to conform to the current year presentation.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but may change current practice for some entities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The Company does not expect the implementation of SFAS 157 to have a material impact on its consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. The Company is in the process of evaluating the impact SFAS 159 may have on its consolidated financial statements.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

General

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Company’s market risk is composed primarily of interest rate risk. The Funds Management Committee of the Company’s Board of Directors is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. The Board of Directors reviews and approves the guidelines established by its Funds Management Committee.

Interest rate risk is monitored through the use of three complimentary modeling tools: static gap analysis, earnings simulation and economic value simulation (net present value estimation). Each of these models measures changes in a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap, which measures aggregate repricing values, is less utilized since it does not effectively measure the investment options risk impact on the Company. Earnings simulation and economic value models, which more effectively measure the cash flow impacts, are utilized by management on a regular basis and are explained below.

Earnings Simulation Analysis

Management uses simulation analysis to measure the sensitivity of net income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.

Assumptions used in the model, including loan and deposit growth rates, are derived from seasonal trends, economic forecasts and management’s outlook, as are the assumptions used to project yields and rates for new loans and deposits. Maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios.

The flat interest rate scenario is utilized by the Company for rate shock scenarios when preparing the earnings simulation analysis. From this base, immediate, parallel rate shocks in 100 basis point increments are applied to see the impact on the Company’s earnings. The following table represents the interest rate sensitivity on projected net income for the twelve months ending June 30, 2008 (fully tax-equivalent basis) for the Company using different rate scenarios:


Change in Yield Curve	*(in thousands)* Change in Net Income
+200 basis points	$	(65	)
+100 basis points		(31	)
Flat		—
- 100 basis points		89
- 200 basis points		106

Economic Value Simulation

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The following chart reflects the change in net market value over different rate environments at June 30, 2007:


Change in Yield Curve	*(in thousands)* Change in Economic Value of Equity
+200 basis points	$	1,518
+100 basis points		1,003
Flat		—
- 100 basis points		(1,150	)
- 200 basis points		(3,604	)

Item 4.

Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to provide assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the SEC. An evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2007 was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based on and as of the date of such evaluation, the aforementioned officers concluded that the Company’s disclosure controls and procedures were effective.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

Part II – Other Information

Item 1.

Legal Proceedings

There are no material pending legal proceedings to which the Company is a party or to which the property of the Company is subject.

Item 1A.

Risk Factors

There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults upon Senior Securities

None

Item 4.

Submission of Matters to a Vote of Security Holders

The Company held its annual meeting of shareholders on May 8, 2007. The following matter was voted on during the meeting:

The election of the 11 directors to serve for a term of one year:


	For	Withheld
Douglas C. Arthur	2,391,025	16,887
Byron A. Brill	2,388,340	19,572
Elizabeth H. Cottrell	2,404,419	3,493
James A. Davis	2,406,155	1,757
Christopher E. French	2,404,598	3,314
Charles E. Maddox Jr.	2,394,098	13,814
John K. Marlow	2,406,091	1,821
W. Allen Nicholls	2,401,793	6,119
Henry L. Shirkey	2,404,418	3,494
Harry S. Smith	2,387,721	20,191
James R. Wilkins, III	2,405,974	1,938

Item 5.

Other Information

None

Item 6.

Exhibits

The following documents are attached hereto as Exhibits:


10.1		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and Harry S. Smith.

10.2		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and M. Shane Bell.

10.3		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and Marshall J. Beverley, Jr.

31.1		Certification of Chief Executive Officer, Section 302 Certification

31.2		Certification of Chief Financial Officer, Section 302 Certification

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

FIRST NATIONAL CORPORATION

(Registrant)

EXHIBIT INDEX


Number		Document
10.1		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and Harry S. Smith.

10.2		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and M. Shane Bell.

10.3		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and Marshall J. Beverley, Jr.

31.1		Certification of Chief Executive Officer, Section 302 Certification

31.2		Certification of Chief Financial Officer, Section 302 Certification

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

Exhibit 10.1

AMENDED AND RESTATED

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT made and entered into as of the first day of October, 2002, and hereby amended and restated as of the first day of June, 2007, by and between FIRST NATIONAL CORPORATION , a Virginia corporation, hereinafter called the “Corporation”, and HARRY S. SMITH hereinafter called “Employee”, and provides as follows:

RECITALS

WHEREAS, the Corporation is a bank holding company engaged in the operation of a bank; and

WHEREAS, Employee has been involved in the management of the business and affairs of the Corporation and, therefore, possesses managerial experience, knowledge, skills and expertise in such type of business; and

WHEREAS, the continued employment of Employee by the Corporation is in the best interests of the Corporation and Employee; and

WHEREAS, the parties have mutually agreed upon the terms and conditions of Employee’s continued employment by the Corporation as hereinafter set forth;

TERMS OF AGREEMENT

NOW, THEREFORE, for and in consideration of the premises and of the mutual promises and undertakings of the parties as hereinafter set forth, the parties covenant and agree as follows:

Section 1. Employment . (a) Employee shall be employed as the President and Chief Executive Officer of the Corporation and its wholly owned subsidiary, First Bank. He shall perform such services for the Corporation and/or one or more Affiliates as may be assigned to Employee by the Corporation from time to time upon the terms and conditions hereinafter set forth. Employee’s services shall be rendered in a senior management or executive capacity and shall be of the type for which he is suited by background and training.

(b) References in this Agreement to services rendered for the Corporation and compensation and benefits payable or provided by the Corporation shall include services rendered for and compensation and benefits payable or provided by any Affiliate. References in this Agreement to the “Corporation” also shall mean and refer to each Affiliate for which Employee performs services. References in this Agreement to “Affiliate” shall mean any business entity that, directly or indirectly, through one or more intermediaries, is controlled by the Corporation.

Section 2. Term . The term of this Agreement shall at all times be two (2) years, which means that at the end of every day, the term of this Agreement shall be extended for one day. With thirty (30) days notice, however, either party may notify the other that the term of this Agreement shall no longer be extended and that this Agreement will terminate two (2) years after the effective date of such notice.

Section 3. Exclusive Service . Employee shall devote his best efforts and full time to rendering services on behalf of the Corporation in furtherance of its best interests. Employee shall comply with all policies, standards and regulations of the Corporation now or hereafter promulgated, and shall perform his duties under this Agreement to the best of his abilities and in accordance with standards of conduct applicable to executive officers of banks.

Section 4. Salary . (a) As compensation while employed hereunder, Employee, during his faithful performance of this Agreement, in whatever capacity rendered, shall receive an annual base salary of $270,000.00 payable on such terms and in such installments as the parties may from time to time mutually agree upon. The Board of Directors, in its discretion, may increase Employee’s base salary during the term of this Agreement; provided, however, that Employee’s salary after being increased may not be decreased.

(b) The Corporation shall withhold state and federal income taxes, social security taxes and such other payroll deductions as may from time to time be required by law or agreed upon in writing by Employee and the Corporation. The Corporation shall also withhold and remit to the proper party any amounts agreed to in writing by the Corporation and Employee for participation in any corporate sponsored benefit plans for which a contribution is required.

(c) Except as otherwise expressly set forth hereunder, no compensation shall be paid pursuant to this Agreement in respect of any month or portion thereof subsequent to any termination of Employee’s employment by the Corporation.

Section 5. Corporate Benefit Plans . Employee shall be entitled to participate in or become a participant in any employee benefit plan maintained by the Corporation for which he is or will become eligible on such terms as the Board of Directors may, in its discretion, establish, modify or otherwise change.

Section 6. Bonuses . Employee shall receive only such bonuses as the Board of Directors, in its discretion, decides to pay to Employee.

Section 7. Expense Account . The Corporation shall reimburse Employee for reasonable and customary business expenses incurred in the conduct of the Corporation’s business. Such expenses will include business meals, out-of-town lodging and travel expenses. Employee agrees to timely submit records and receipts of reimbursable items and agrees that the Corporation can adopt reasonable rules and policies regarding such reimbursement. The Corporation agrees to make prompt payment to Employee following receipt and verification of such reports. Such payment shall be made no later than March 15 following the calendar year in which the expense was incurred.

Section 8. Personal and Sick Leave . Employee shall be entitled to the same personal and sick leave as the Board of Directors may from time to time designate for all full-time employees of the Corporation.

Section 9. Vacations . Employee shall be entitled to vacations in accordance with policies the Board of Directors sets for all full time employees of the Corporation and during which Employee’s compensation hereunder shall continue to be paid.

Section 10. Termination . (a) Notwithstanding the termination of Employee’s employment pursuant to any provision of this Agreement, the parties shall be required to carry out any provisions of this Agreement which contemplate performance by them subsequent to such termination. In addition, no termination shall affect any liability or other obligation of either party which shall have accrued prior to such termination, including, but not limited to, any liability, loss or damage on account of breach. No termination of employment shall terminate the obligation of the Corporation to make payments of any vested benefits provided hereunder or the obligations of Employee under Sections 11, 12 and 13.

(b) Employee’s employment hereunder may be terminated by Employee upon thirty (30) days written notice to the Corporation or at any time by mutual agreement in writing.

(c) Except as otherwise provided in this Section 10(c), this Agreement shall terminate upon death of Employee. In such event the Corporation shall pay to the estate of Employee the compensation including salary and accrued bonus, if any, which otherwise would be payable to Employee through the end of the month in which his death occurs. In addition, Employee’s death is not intended to, and shall not, prevent amounts to which Employee would have been entitled under Sections 10(d)(2) or 10(i) had he lived from being paid under this Agreement to Employee’s estate or beneficiaries at the time or times such amounts would have been paid had Employee lived.

(d)(1) The Corporation may terminate Employee’s employment other than for “Cause,” as defined in Section 10(e), at any time upon written notice to Employee, which termination shall be effective immediately. Employee may resign thirty (30) days after notice to the Corporation for “Good Reason”, as hereafter defined.

(2) If the Corporation terminates the Employee’s employment without Cause or the Employee resigns for Good Reason, then in either event:

(i)(A) The Employee shall be paid for the remainder of the then current term of this Agreement, at such times as payment was theretofore made, the salary required under Section 4 (taking into account any salary increases) that the Employee would have been entitled to receive during the remainder of the then current term of this Agreement had such termination not occurred.

(B) Notwithstanding the foregoing, if such termination or resignation occurs within one year after a Change of Control (as defined below), the time at which the amount described in Section 10(d)(2)(i)(A) is paid shall be determined not under that Section but under Section 10(i), below.

(C) Further, payments due under Section 10(d)(2)(i)(A), Section 10(d)(2)(iii), or Section 10(d)(3) and made to a Key Employee shall commence or be paid on the first day of the month following the six-month anniversary of the Employee’s termination or resignation. The initial payment made under the preceding sentence shall include amounts that would have been paid under Section 10(d)(2)(i)(A), Section 10(d)(2)(iii), or Section 10(d)(3) through the date of such initial payment had the Employee not been a Key Employee. This Section 10(d)(2)(i)(C) shall apply to amounts payable to a Key Employee under Section 10(d)(2)(i)(A) even if the timing of the payments is determined under Section 10(i); and

(ii) The Corporation shall maintain in full force and effect for the continued benefit of the Employee for the remainder of the then current term of this Agreement all employee welfare benefit plans and programs or arrangements in which the Employee was entitled to participate immediately prior to such termination, provided that continued participation is possible under the general terms and provisions of such plans and programs. In the event that Employee’s participation in any such plan or program is barred, the Corporation shall arrange to provide the Employee with benefits substantially similar to those which the Employee was entitled to receive under such plan or program. Payments under this Section 10(d)(2)(ii) that do not constitute (i) welfare benefits exempt from Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”) and Treasury Regulations thereunder (the “409A Regulations”) or (ii) reimbursed medical expenses exempt under 409A Regulations Section 1.409A-1(b)(9)(v)(B) shall be limited in the aggregate to the applicable dollar amount under Code Section 402(g)(1)(B) for the year of the separation from service. In addition, any benefits provided to a Key Employee under this Section 10(d)(2)(ii) that are considered deferred compensation subject to Code Section 409A shall not commence until the first day of the month following the six-month anniversary of the Employee’s termination or resignation. All determinations required under this Section 10(d)(2)(ii) shall be made by independent counsel selected by the Corporation and reasonably acceptable to the Employee or Key Employee, in accordance with Code Section 409A, the 409A Regulations and other applicable guidance; and

(iii) The Employee shall receive a payment in cash on the date his employment terminates equal to the amount of any cash bonus paid to him in respect of the fiscal year of the Corporation prior to the fiscal year in which his employment terminates, multiplied by a fraction, the numerator of which is the number of days that elapse before the date his employment terminates in the fiscal year of the Corporation in which his employment terminates and the denominator of which is three hundred sixty-five (365).

(3) If, (1) pursuant to the second sentence of Section 2 of this Agreement, the Corporation notifies Employee that this Agreement shall no longer be extended, (2) the Employee’s employment by the Corporation does not terminate during the two (2) years after the effective date of such notice and (3) the Employee’s employment by the Corporation terminates after such two (2) year period, then, beginning on the first day of the month that follows the month in which his employment terminates and continuing for the succeeding eleven (11) months, the Corporation shall pay to the Employee an amount equal to one-twelfth (1/12) of his then current salary.

Notwithstanding the foregoing, at any time after payments begin under the preceding paragraph, the Corporation may, for any reason and without liability, terminate all payments under this Section 10(d)(3); provided, however, from and after the date that the Corporation terminates such payments pursuant to this Section 10(d)(3), the Employee shall no longer be bound by Section 12; and provided further, if the Employee breaches Section 11 or any provision of Section 12 while receiving payments under this Section 10(d)(3) (or during any delay in the receipt of payment required by Code Section 409A) and, pursuant to Section 10(d)(4), the Corporation then terminates payments on account of such breach, the Employee shall remain bound by Section 12.

(4) Notwithstanding anything in this Agreement to the contrary, if Employee breaches Section 11 or 12, Employee will not thereafter be entitled to receive any further compensation or benefits pursuant to this Section 10(d). In addition, notwithstanding anything in this Agreement to the contrary, the Corporation shall not be required to make any payment that is prohibited by the terms of the regulations presently found at 12 C.F.R. part 359 or to the extent that any other governmental approval of the payment required by law is not received.

(5) For purposes of this Agreement, “Good Reason” shall mean:

(i) The assignment of duties to the Employee by the Corporation which result in the Employee having significantly less authority or responsibility than he has on the date hereof, without his express written consent;

(ii) Requiring the Employee to maintain his principal office anywhere outside of the Virginia Counties of Frederick, Warren and Shenandoah, or cities located therein;

(iii) The failure of the Corporation to provide the Employee with substantially the same fringe benefits that are provided to him at the inception of this Agreement;

(iv) The Corporation’s failure to comply with any material term of this Agreement;

(v) The failure of the Corporation to obtain the assumption of and agreement to perform this Agreement by any successor as contemplated in Section 14 hereof; or

(vi) The Corporation’s elimination, on or after a Change of Control, of any benefit plan, program or arrangement (including without limitation a tax-qualified retirement plan) or any change, made on or after a Change of Control, to such plan, program or arrangement that reduces the value of the affected benefit to the Employee.

(6) For purposes of this Agreement, “Key Employee” shall mean any Employee who, as of December 31 of any calendar year, satisfies the requirement of Code Section 416(i)(1)(A)(i), (ii), or (iii) (applied in accordance with Treasury Regulations thereunder and disregarding Code Section 416(i)(5)). An Employee who meets the criteria set forth in the preceding sentence will be considered a Key Employee for purposes of this Agreement for the 12-month period commencing on the next following April 1. For example, an Employee who meets the definition of Key Employee as of December 31, 2008, will be considered a Key Employee from April 1, 2009 through March 31, 2010, when applying the special rules for Key Employees found in this Agreement.

(e) The Corporation shall have the right to terminate Employee’s employment under this Agreement at any time for Cause, which termination shall be effective immediately. Termination for “Cause” shall include termination for Employee’s failure, neglect or refusal to perform his duties and responsibilities without the same being corrected after ten days prior written notice or termination because of his personal dishonesty, incompetence, willful misconduct, breach of a fiduciary duty involving personal profit, willful violation of any law, rule or regulation (other than traffic violations or similar offenses), conviction of a felony or of a misdemeanor involving moral turpitude, misappropriation of the Corporation’s assets (determined on a reasonable basis) or those of its Affiliates, or material breach of any other provision of this Agreement. Termination for Cause also shall include termination as a result of the Employee’s failure to correct a material deficiency in the performance of his duties within 60 days after a written notice from the Board of Directors or such other reasonable period of time specified by the Board of Directors if such deficiency cannot be cured within 60 days. Any notice given under this subsection shall state that it is a notice pursuant to Section 10(e) of this Agreement and shall set forth the Board’s complaints in detail sufficient to allow Employee to understand and correct them. In the event Employee’s employment under this Agreement is terminated for Cause, Employee shall thereafter have no right to receive compensation or other benefits under this Agreement.

(f) The Corporation may terminate Employee’s employment under this Agreement, after having established the Employee’s disability by giving to Employee written notice of its intention to terminate his employment for disability and his employment with the Corporation shall terminate effective on the 90th day after receipt of such notice if within 90 days after such receipt Employee shall fail to return to the full-time performance of the essential functions of his position (and if Employee’s disability has been established pursuant to the definition of “disability” set forth below). For purposes of this Agreement, “disability” means either (i) disability which after the expiration of more than 13 consecutive weeks after its commencement is determined to be total and permanent by a physician selected and paid for by the Corporation or its insurers, and acceptable to Employee or his legal representative, which consent shall not be unreasonably withheld or (ii) disability as defined in the policy of disability insurance maintained by the Corporation or its Affiliates for the benefit of Employee, whichever shall be more favorable to Employee. Notwithstanding any other provision of this Agreement, the Corporation shall comply with all requirements of the Americans with Disabilities Act, 42 U.S.C. § 12101 et. seq .

(g) If Employee is suspended and/or temporarily prohibited from participating in the conduct of the Corporation’s affairs by a notice served pursuant to the Federal Deposit Insurance Act, the Corporation’s obligations under this Employment Agreement shall be suspended as of the date of service unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Corporation may in its discretion (i) pay Employee all or part of the compensation withheld while its contract obligations were suspended, and (ii) reinstate (in whole or in part) any of its obligations which were suspended. If any payment of withheld compensation is made under this Section 10(g) in the Corporation’s sole discretion, it shall be made by March 15 following the calendar year in which the charges in the applicable notice are dismissed.

(h) If Employee is removed and/or permanently prohibited from participating in the conduct of the Corporation’s affairs by an order issued under the Federal Deposit Insurance Act or the Code of Virginia, all obligations of the Corporation under this Employment Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected.

(i)(1) If Employee’s employment is terminated without Cause or if he resigns for Good Reason within one year after a Change of Control shall have occurred, then on Employee’s last day of employment with the Corporation, the Corporation shall pay to Employee as compensation for services rendered to the Corporation and its Affiliates a lump sum cash amount (subject to any applicable payroll or other taxes required to be withheld) equal to the excess, if any, of 299% of Employee’s “annualized includable compensation for the base period”, as defined in Code Section 280G, over the total amount payable to Employee under Section 10(d). In addition, under such circumstances, if an election has been made pursuant to Section 10(i)(2), below, the amount to which Employee is entitled under Section 10(d)(2)(i) shall not be subject to the payment schedule called for under Section 10(d)(2)(i) but instead shall be paid in accordance with such election.

(2) Employee may elect, prior to December 31, 2007, to have the total cash amount to which he is entitled under Sections 10(d)(2)(i) and 10(i)(1) paid in a single lump sum or in 24 or 36 equal monthly installments, with the lump sum or first installment paid on the date of termination or resignation and the remaining installments, if any, paid on the first day of each succeeding month. Such election shall not apply to amounts otherwise payable in the year the election is made nor cause amounts to be paid in the year the election is made that would not otherwise be payable in that year. Subsequent changes to the time or form of payment of such cash amount shall be made only in accordance with Code Section 409A, the 409A Regulations, and other applicable guidance, including any transition rules promulgated by the Internal Revenue Service.

(3) Notwithstanding the foregoing, the timing of an amount payable to a Key Employee under the first sentence of Section 10(i)(1) (whether or not subject to an installment election) above shall be determined as follows: the lump sum payment shall be made or installments shall commence on the first day of the month following the six-month anniversary of the Key Employee’s

termination or resignation date. The initial payment made under the preceding sentence shall include amounts that would have been paid under the first sentence of Section 10(i)(1) through the date of such initial payment had the Employee not been a Key Employee.

(4) For purposes of this Agreement, a Change of Control occurs if, after the date of this Agreement, (i) any person, including a “group” as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the owner or beneficial owner of Corporation securities having 50% or more of the combined voting power of the then outstanding Corporation securities that may be cast for the election of the Corporation’s directors other than a result of an issuance of securities initiated by the Corporation, or open market purchases approved by the Board of Directors, as long as the majority of the Board of Directors approving the purchases is a majority at the time the purchases are made; or (ii) as the direct or indirect result of, or in connection with, a tender or exchange offer, a merger or other business combination, a sale of assets, a contested election of directors, or any combination of these events, the persons who were directors of the Corporation before such events cease to constitute a majority of the Corporation’s Board, or any successor’s board, within two years of the last of such transactions. For purposes of this Agreement, a Change of Control occurs on the date on which an event described in (i) or (ii) occurs. If a Change of Control occurs on account of a series of transactions or events, the Change of Control occurs on the date of the last of such transactions or events.

(5) It is the intention of the parties that no payment be made or benefit provided to Employee pursuant to this Agreement that would constitute an “excess parachute payment” within the meaning of Section 280G of the Code and any regulations thereunder, thereby resulting in a loss of an income tax deduction by the Corporation or the imposition of an excise tax on Employee under Section 4999 of the Code. If the independent accountants serving as auditors for the Corporation on the date of a Change of Control (or any other accounting firm designated by the Corporation) determine that some or all of the payments or benefits scheduled under this Agreement, as well as any other payments or benefits on a Change of Control, would be nondeductible by the Company under Section 280G of the Code, then the payments scheduled under this Agreement will be reduced to one dollar less than the maximum amount which may be paid without causing any such payment or benefit to be nondeductible. The determination made as to the reduction of benefits or payments required hereunder by the independent accountants shall be binding on the parties. Employee shall have the right to designate within a reasonable period, which payments or benefits will be reduced; provided, however, that if no direction is received from Employee, the Corporation shall implement the reductions in its discretion.

Section 11. Confidentiality/Nondisclosure . Employee covenants and agrees that any and all information concerning the customers, businesses and services of the Corporation of which he has knowledge or access as a result of his association with the Corporation in any capacity, shall be deemed confidential in nature and shall not, without the proper written consent of the Corporation, be directly or indirectly used, disseminated, disclosed or published by Employee to third parties other than in connection with the usual conduct of the business of the Corporation. Such information shall expressly include, but shall not be limited to,

information concerning the Corporation’s trade secrets, business operations, business records, customer lists or other customer information. Upon termination of employment Employee shall deliver to the Corporation all originals and copies of documents, forms, records or other information, in whatever form it may exist, concerning the Corporation or its business, customers, products or services. In construing this provision it is agreed that it shall be interpreted broadly so as to provide the Corporation with the maximum protection. This Section 11 shall not be applicable to any information which, through no misconduct or negligence of Employee, has previously been disclosed to the public by anyone other than Employee.

Section 12. Covenant Not to Compete . During the term of this Agreement and throughout any further period that he is an officer or employee of the Corporation, and for a period of twelve (12) months from and after the date that Employee is (for any reason) no longer employed by the Corporation or for a period of twelve (12) months from the date of entry by a court of competent jurisdiction of a final judgment enforcing this covenant in the event of a breach by Employee, whichever is later, Employee covenants and agrees that he will not, directly or indirectly, either as a principal, agent, employee, employer, stockholder, co-partner or in any other individual or representative capacity whatsoever: (i) engage in a Competitive Business anywhere within a ten (10) mile straight-line radius of any office operated by the Corporation on the date Employee’s employment terminates; or (ii) solicit, or assist any other person or business entity in soliciting, any depositors or other customers of the Corporation to make deposits in or to become customers of any other financial institution conducting a Competitive Business; or (iii) induce any individuals to terminate their employment with the Corporation or its Affiliates. As used in this Agreement, the term “Competitive Business” means all banking and financial products and services that are substantially similar to those offered by the Corporation on the date that Employee’s employment terminates. Except as otherwise expressly provided in Section 10(d)(3) of this Agreement, the parties intend that the covenants and restrictions in this Section 12 be enforceable against Employee regardless of the reason that his employment by the Corporation may terminate and that such covenants and restrictions shall be enforceable against Employee even if this Agreement expires after a notice of nonrenewal given by Employee or the Corporation under Section 2 of this Agreement.

Section 13. Injunctive Relief, Damages, Etc . Employee agrees that given the nature of the positions held by Employee with the Corporation, that each and every one of the covenants and restrictions set forth in Sections 11 and 12 above are reasonable in scope, length of time and geographic area and are necessary for the protection of the significant investment of the Corporation in developing, maintaining and expanding its business. Accordingly, the parties hereto agree that in the event of any breach by Employee of any of the provisions of Sections 11 or 12 that monetary damages alone will not adequately compensate the Corporation for its losses and, therefore, that it may seek any and all legal or equitable relief available to it, specifically including, but not limited to, injunctive relief and Employee shall be liable for all damages, including actual and consequential damages, costs and expenses, including legal costs and actual attorneys’ fees, incurred by the Corporation as a result of taking action to enforce, or recover for any breach of, Section 11 or Section 12. The covenants contained in Sections 11 and 12 shall be construed and interpreted in any judicial proceeding to permit their enforcement to the maximum extent permitted by law. Should a court of competent jurisdiction determine that any provision of

the covenants and restrictions set forth in Section 12 above is unenforceable as being overbroad as to time, area or scope, the court may strike the offending provision or reform such provision to substitute such other terms as are reasonable to protect the Corporation’s legitimate business interests.

Section 14. Binding Effect/Assignability . This Employment Agreement shall be binding upon and inure to the benefit of the Corporation and Employee and their respective heirs, legal representatives, executors, administrators, successors and assigns, but neither this Agreement, nor any of the rights hereunder, shall be assignable by Employee or any beneficiary or beneficiaries designated by Employee. The Corporation will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business, stock or assets of the Corporation, by agreement in form and substance reasonably satisfactory to the Employee, to expressly assume and agree to perform this Agreement in its entirety. Failure of the Corporation to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Employee to the compensation described in Sections 10(d) and 10(i). As used in this Agreement, “Corporation” shall mean First National Corporation, a Virginia corporation, and any successor to its respective business, stock or assets as aforesaid which executes and delivers the agreement provided for in this Section 14 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.

Section 15. Governing Law . This Employment Agreement shall be subject to and construed in accordance with the laws of Virginia.

Section 16. Invalid Provisions . The invalidity or unenforceability of any particular provision of this Employment Agreement shall not affect the validity or enforceability of any other provisions hereof, and this Employment Agreement shall be construed in all respects as if such invalid or unenforceable provisions were omitted.

Section 17. Notices . Any and all notices, designations, consents, offers, acceptance or any other communications provided for herein shall be given in writing and shall be deemed properly delivered if delivered in person or by registered or certified mail, return receipt requested, addressed in the case of the Corporation to its registered office or in the case of Employee to his last known address.

Section 18. Entire Agreement.

(a) This Employment Agreement constitutes the entire agreement among the parties with respect to the subject matter hereof and supersedes any and all other agreements, either oral or in writing, among the parties hereto with respect to the subject matter hereof.

(b) This Employment Agreement may be executed in one or more counterparts, each of which shall be considered an original copy of this Agreement, but all of which together shall evidence only one agreement.

Section 19. Amendment and Waiver . This Employment Agreement may not be amended except by an instrument in writing signed by or on behalf of each of the parties hereto. No waiver of any provision of this Employment Agreement shall be valid unless in writing and signed by the person or party to be charged.

Section 20. Case and Gender . Wherever required by the context of this Employment Agreement, the singular or plural case and the masculine, feminine and neuter genders shall be interchangeable.

Section 21. Captions . The captions used in this Employment Agreement are intended for descriptive and reference purposes only and are not intended to affect the meaning of any Section hereunder.

Section 22. Code Section 409A . This Employment Agreement is intended to satisfy the requirements of Code Section 409A, the 409A Regulations, and other guidance, including transition rules, issued thereunder. Each provision and term of this Employment Agreement should be interpreted accordingly, but if any provision or term would be prohibited by or inconsistent with Code Section 409A, the 409A Regulations, or such other guidance, the parties agree that such provision or term may be amended to the extent necessary to comply with or qualify for an exemption from Code Section 409A, the 409A Regulations, and such other guidance, in a manner determined by independent counsel selected by the Corporation and reasonably acceptable to Employee.

IN WITNESS WHEREOF, the Corporation has caused this amended and restated Employment Agreement to be signed by its duly authorized officer and Employee has hereunto set his hand and seal on the day of , 2007.


FIRST NATIONAL CORPORATION

By:
		Douglas C. Arthur
Title:		Chairman of the Board of Directors

ATTEST:


EMPLOYEE

		(SEAL)
Harry S. Smith

ATTEST:

Exhibit 10.2

AMENDED AND RESTATED

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT is made and entered into as of the twenty-seventh day of January, 2004, and hereby amended and restated as of the first day of June, 2007, by and between FIRST NATIONAL CORPORATION , a Virginia corporation, hereinafter called the “Corporation”, and M. SHANE BELL hereinafter called “Employee”, and provides as follows:

RECITALS

WHEREAS, the Corporation is a bank holding company engaged in the operation of a bank; and

WHEREAS, the continued employment of Employee by the Corporation is in the best interests of the Corporation and Employee; and

WHEREAS, the parties have mutually agreed upon the terms and conditions of Employee’s continued employment by the Corporation as hereinafter set forth;

TERMS OF AGREEMENT

NOW, THEREFORE, for and in consideration of the premises and of the mutual promises and undertakings of the parties as hereinafter set forth, the parties covenant and agree as follows:

Section 1. Employment . (a) Employee shall be employed as the Executive Vice President and Chief Financial Officer of the Corporation and its wholly owned subsidiary, First Bank. He shall perform such services for the Corporation and/or one or more Affiliates as may be assigned to Employee by the Corporation from time to time upon the terms and conditions hereinafter set forth. Employee’s services shall be rendered in a senior management or executive capacity and shall be of the type for which he is suited by background and training.

Section 4. Salary . (a) As compensation while employed hereunder, Employee, during his faithful performance of this Agreement, in whatever capacity rendered, shall receive an annual base salary of $140,000.00 payable on such terms and in such installments as the parties may from time to time mutually agree upon. The Board of Directors, in its discretion, may increase Employee’s base salary during the term of this Agreement; provided, however, that Employee’s salary after being increased may not be decreased.

Section 6. Bonuses . Employee shall receive only such bonuses as the Board of Directors, in its discretion, decides to pay to Employee.

(b) Employee’s employment hereunder may be terminated by Employee upon thirty (30) days written notice to the Corporation or at any time by mutual agreement in writing.

(2) If the Corporation terminates the Employee’s employment without Cause or the Employee resigns for Good Reason, then in either event:

(ii) The Corporation shall maintain in full force and effect for the continued benefit of the Employee for the remainder of the then current term of this Agreement, all employee welfare benefit plans and programs or arrangements in which the Employee was entitled to participate immediately prior to such termination, provided that continued participation is possible under the general terms and provisions of such plans and programs. In the event that Employee’s participation in any such plan or program is barred, the Corporation shall arrange to provide the Employee with benefits substantially similar to those which the Employee was entitled to receive under such plan or program. Payments under this Section 10(d)(2)(ii) that do not constitute (i) welfare benefits exempt from Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”) and Treasury Regulations thereunder (the “409A Regulations”) or (ii) reimbursed medical expenses exempt under 409A Regulations Section 1.409A-1(b)(9)(v)(B) shall be limited in the aggregate to the applicable dollar amount under Code Section 402(g)(1)(B) for the year of the separation from service. In addition, any benefits provided to a Key Employee under this Section 10(d)(2)(ii) that are considered deferred compensation subject to Code Section 409A and the 409A Regulations shall not commence until the first day of the month following the six-month anniversary of the Employee’s termination or resignation. All determinations required under this Section 10(d)(2)(ii) shall be made by independent counsel selected by the Corporation and reasonably acceptable to the Employee or Key Employee, in accordance with Code Section 409A, the 409A Regulations and other applicable guidance; and

(5) For purposes of this Agreement, “Good Reason” shall mean:

(ii) Requiring the Employee to maintain his principal office anywhere outside of the Virginia Counties of Frederick, Warren and Shenandoah, or cities located therein;

(iii) The failure of the Corporation to provide the Employee with substantially the same fringe benefits that are provided to him at the inception of this Agreement;

(iv) The Corporation’s failure to comply with any material term of this Agreement;

(v) The failure of the Corporation to obtain the assumption of and agreement to perform this Agreement by any successor as contemplated in Section 14 hereof; or

(e) The Corporation shall have the right to terminate Employee’s employment under this Agreement at any time for Cause, which termination shall be effective immediately. Termination for “Cause” shall include termination for Employee’s failure, neglect or refusal to perform his duties and responsibilities without the same being corrected after ten days prior written notice or termination because of his personal dishonesty, incompetence, willful misconduct, breach of a fiduciary duty involving personal profit, willful violation of any law, rule or regulation (other than traffic violations or similar offenses) conviction of a felony or of a misdemeanor involving moral turpitude, misappropriation of the Corporation’s assets (determined on a reasonable basis) or those of its Affiliates, or material breach of any other provision of this Agreement. Termination for Cause also shall include termination as a result of the Employee’s failure to correct a material deficiency in the performance of his duties within 60 days after a written notice from the Board of Directors or such other reasonable period of time specified by the Board of Directors if such deficiency cannot be cured within 60 days. Any notice given under this subsection shall state that it is a notice pursuant to Section 10(e) of this Agreement and shall set forth the Board’s complaints in detail sufficient to allow Employee to understand and correct them. In the event Employee’s employment under this Agreement is terminated for Cause, Employee shall thereafter have no right to receive compensation or other benefits under this Agreement.

Section 15. Governing Law . This Employment Agreement shall be subject to and construed in accordance with the laws of Virginia.

Section 18. Entire Agreement.

Section 20. Case and Gender . Wherever required by the context of this Employment Agreement, the singular or plural case and the masculine, feminine and neuter genders shall be interchangeable.

Section 21. Captions . The captions used in this Employment Agreement are intended for descriptive and reference purposes only and are not intended to affect the meaning of any Section hereunder.

Section 22. Code Section 409A . This Employment Agreement is intended to satisfy the requirements of Code Section 409A, the 409A Regulations, and other guidance, including transition rules, issued thereunder. Each provision and term of this Employment Agreement should be interpreted accordingly, but if any provision or term would be prohibited by or inconsistent with Code Section 409A, the 409A Regulations, or such other guidance, the parties agree that such provision or term may be amended to the extent necessary to comply with or qualify for an exemption from Code Section 409A, the 409A Regulations, and such other guidance in a manner determined by independent counsel selected by the Corporation and reasonably acceptable to Employee.


FIRST NATIONAL CORPORATION

		(SEAL)
Harry S. Smith, President and Chief Executive Officer

ATTEST:


EMPLOYEE

		(SEAL)
M. Shane Bell

ATTEST:

Exhibit 10.3

AMENDED AND RESTATED

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT, as hereby amended and restated, is made by and between FIRST NATIONAL CORPORATION, a Virginia corporation (First National Corporation and its wholly owned subsidiary, First Bank, hereinafter referred to as the “Bank”), and Marshall J. Beverley, Jr. (the “Employee”), and provides as follows:

RECITALS

WHEREAS, the Bank is a bank holding company engaged in the operation of a bank; and

WHEREAS, the Employee has knowledge, skills and expertise as a trust officer; and

WHEREAS, the Bank desires to employ Employee and Employee desires to accept such employment.

NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth herein, the sufficiency of which are hereby acknowledged, the parties agree as follows:

TERMS OF AGREEMENT

Section 1. Employment . (a) Employee shall be employed as Executive Vice President – Senior Trust Officer of the Bank and its wholly owned subsidiary, First Bank. He shall perform such services for the Bank upon the terms and conditions hereinafter set forth.

(b) The parties recognize that the President of the Bank, with the advice and consent of the Board of Directors, shall manage the business affairs of the Bank and that the relationship between the Bank and Employee shall be that of an employer and an employee. The President shall have the sole authority to set and establish the hours of operation of the business and to set and establish reasonable work schedules and standards applicable to Employee.

Section 2. Effective Date and Term . The effective date of this amended and restated Agreement shall be June 1, 2007 (“Effective Date”). The term of this Agreement shall at all times be two (2) years, which means that at the end of every day, the term of this Agreement shall be extended for one day. With thirty (30) days notice, however, either party may notify the other that the term of this Agreement shall no longer be extended and that this Agreement will terminate two (2) years after the effective date of such notice.

Section 3. Exclusive Service .

a. Employee shall devote his best efforts and full time to rendering services on behalf of the Bank in furtherance of its best interests. Employee shall comply with all policies, standards and regulations of the Bank now or hereafter promulgated, and shall perform the duties of a Trust Officer, as described below, to the best of his abilities and in accordance with standards of conduct applicable to trust officers in the banking industry.

b. Employee and the Bank recognize and agree that Employee’s duties as a Trust Officer of the Bank shall be as follows:

i. Employee shall be responsible for administration of personal/trust fiduciary relationship and/or duties related to fiduciary accounts, such as trusts, estates, agency accounts, investment management accounts, custody accounts, and bank power of attorney accounts.

ii. In the performance of his duties, Employee shall ensure that fiduciary standards are being met and that Trust Department policies and procedures are being observed. Employee shall participate in the creation and revision, as may be necessary from time to time, of the Bank’s Trust Department policies and procedures.

iii. Employee shall seek to contribute to the growth, profitability and retention of trust accounts through active participation in business development for new business.

iv. Employee shall maintain good working relationships with clients, attorneys, CPAs and other related professionals to assure quality service and enhance business development.

v. Employee shall keep up to date on legal issues, regulations, investment and tax issues and developments in the trust industry and shall inform the Bank of any changes in the legal environment pertaining to trusts of which Employee becomes aware which may cause the Bank to modify its Trust Department policies and procedures.

vi. Although the Employee will work with the Bank’s retail banking operation in a concerted effort to achieve overall banking growth, both Employee and the Bank recognize that the Employee is a Trust Specialist and Employee shall not be directed to perform tasks directed related to retail banking (loans, deposit accounts, etc.).

vii. Employee shall have the responsibility to assist in the management and oversight of the Bank’s Trust Department and its employees.

Section 4. Salary .

(a) As compensation while employed hereunder, Employee, during his faithful performance of this Agreement, shall receive an annual base salary of $135,000.00 payable on such terms and in such installments as the parties may from time to time mutually agree upon. The Board of Directors, in its discretion, may increase Employee’s base salary during the term of this Agreement; provided, however, that Employee’s salary after being increased may not be decreased without Employee’s consent.

(b) The Bank shall withhold state and federal income taxes, social security taxes and such other payroll deductions as may from time to time be required by law or otherwise agreed upon in writing by Employee and the Bank. The Bank shall also withhold and remit to the proper party any amounts agreed to in writing by the Bank and Employee for participation in any corporate sponsored benefit plan for which a contribution is required.

Section 5. Corporate Benefit Plans . Employee shall be entitled to participate in or become a participant in any employee benefit plan maintained by the Bank for which he is or will become eligible on such terms and the Board of Directors may, in its discretion, establish, modify or otherwise change.

Section 6. Bonuses . Employee shall receive only such bonuses as the Board of Directors, in its discretion, decides to pay to Employee.

Section 7. Expense Account . The Bank shall reimburse Employee for reasonable and customary business expenses incurred in the conduct of the Bank’s business. Such expenses will include business meals, out-of-town lodging and travel expenses. Employee agrees to timely submit records and receipts of reimbursable items and agrees that the Bank may adopt reasonable rules and policies regarding such reimbursement. The Bank agrees to make prompt payment to Employee following receipt and verification of such reports. Such payment shall be made no later than March 15 following the calendar year in which the expense was incurred.

Section 8. Personal and Sick Leave . Employee shall be entitled to the same personal and sick leave as the Board of Directors may from time to time designate for all full-time employees of the Bank.

Section 9. Vacations . Employee will be entitled to paid vacation in accordance with the most favorable plans, policies, and programs of the Bank, but in no event less than four weeks of paid vacation per year.

Section 10. Country Club Dues . During Employee’s active employment with the Bank, the Bank shall pay the Employee’s entrance and membership dues at the Winchester Country Club as well as the monthly charges as may be established by the Club from time to time. Employee shall be responsible for the tax consequences of such benefits as may be required under the Internal Revenue Code.

Section 11. Termination of Employment .

(a) Death . The Employee’s employment will terminate automatically upon the Employee’s death.

(b) Disability . The Bank may terminate Employee’s employment under this Agreement, after having established the Employee’s disability by giving to Employee written notice of its intention to terminate his employment for disability and his employment with the Bank shall terminate effective on the 90 day after receipt of such notice if within 90 days after such receipt Employee shall fail to return to the full-time performance of the essential functions of his position (and if Employee’s disability has been established pursuant to the definition of “disability” set forth below). For purposes of this Agreement, “disability” means either (i) disability which after the expiration of more than 13 consecutive weeks after its commencement is determined to be total and permanent by a physician selected and paid for by the Bank or its insurers, and acceptable to Employee or his legal representative, which consent shall not be unreasonably withheld or (ii) disability as defined in the policy of disability insurance maintained by the Bank for the benefit of Employee, whichever is more favorable to the Employee. Notwithstanding any other provision of this Agreement, the Bank shall comply with all requirements of the Americans with Disabilities Act, 42 U.S.C. § 12101 et seq .

(c) Cause . The Bank may terminate the Employee’s employment for Cause. Termination for “Cause” shall mean a good faith determination by the Bank that Employee has committed acts of personal dishonesty, incompetence, willful misconduct, breach of a fiduciary duty involving personal profit, intentional failure to perform state duties, willful violation of law (other than traffic violations or similar offenses) or final cease-and-desist order, conviction of a felony or of a misdemeanor involving moral turpitude, misappropriation of the Bank’s assets or material breach of this Agreement. Termination for Cause also shall include termination as a result of Employee’s failure to correct a material deficiency in the performance of his duties within 60 days after a written notice from the Board of Directors or such other reasonable period of time specified by the Board of Directors if such deficiency cannot be cured within 60 days. Any notice given under this subsection shall state that it is a notice pursuant Section 11(c) of this Agreement and shall set forth the Board’s complaints in detail sufficient to allow Employee to understand and correct them.

(d) Good Reason . The Employee’s employment may be terminated (i) by the Employee for Good Reason, or (ii) during the Window Period by the Employee without any reason. For purposes of this Agreement, the “Window Period” means the 12-month period after a “Change of Control” as defined in Section 12. For purposes of this Agreement, “Good Reason” means:

(i) without the express written consent of the Employee, (A) the assignment to the Employee of any duties inconsistent in any substantial respect with the Employee’s position, authority or responsibilities as contemplated by Section 3 of this Agreement, or (B) any other substantial change in such position (including titles), authority or responsibilities;

(ii) requiring Employee to maintain his principal office outside 25 miles proximity to the City of Winchester;

(iii) failure of the Bank to provide the Employee with substantially the same fringe benefits that are provided to him at the inception to this Agreement;

(iv) failure of the Bank to comply with any material term of this Agreement;

(v) failure of the Bank to obtain the assumption of and agreement to perform this Agreement by any successor as contemplated by Section 17 of this Agreement; or

(vi) The Bank’s elimination, on or after a Change of Control, of any benefit plan, program or arrangement (including without limitation a tax-qualified retirement plan) or any change, made on or after a Change of Control, to such plan, program or arrangement that reduces the value of the affected benefit to the Employee.

Employee shall not be deemed to have resigned for Good Reason hereunder unless with respect to each of (i-vi) above, the Employee has provided written notice to the Bank within 90 days after the event that the Employee believes gives rise to Employee’s right to terminate employment under this Section 11(d), describing in reasonable detail the facts that provide the basis for such belief, and the Bank has failed within 30 days from the date of such notice to cure any basis for the Employee’s resignation for Good Reason.

(e) Without Cause or Good Reason . The Bank may terminate Employee’s employment other than for “Cause” at any time upon written notice to Employee. Employee may resign without “Good Reason” upon 30 days written notice to the Bank.

(f) Notice of Termination . Any termination by the Bank or the Employee shall be communicated by written Notice of Termination to the other party. For purposes of this Agreement, a “Notice of Termination” shall mean a written notice which shall indicate the specific termination provision in this Agreement upon which the party is relying.

(g) Date of Termination . “Date of Termination” means (i) if the Employee’s employment is terminated by the Bank for Cause, or during the Window Period, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if the Employee’s employment is terminated by the Bank other than for Cause or Disability, or by the Employee other than for Good Reason or during the Window Period, the date specified in the Notice of Termination (which shall not be less than 30 days after the Notice of Termination is given), and (iii) if the Employee’s employment is terminated by the Employee for Good Reason, the date which is 30 days after the date of receipt of the Notice of Termination if the Bank has not, prior to such date, cured the basis for the notice as provided for in Section 11(d); and (iv) if the Employee’s employment is terminated for Disability, 30 days after Notice of Termination is given, provided that the employee shall not have returned to full-time performance of his duties during such 30-day period.

(h) If Employee is suspended and/or temporarily prohibited from participating in the conduct of the Bank’s affairs by a notice served pursuant to the Federal Deposit Insurance Act, the Bank’s obligations under this Employment Agreement shall be suspended as of the date of service unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank may in its discretion (i) pay Employee all or part of the compensation withheld while its contract obligations were suspended, and

(ii) reinstate (in whole or in part) any of its obligations which were suspended. If any payment of withheld compensation is made under this Section 11(h) in the Bank’s sole discretion, it shall be made by March 15 following the calendar year in which the charges in the applicable notice are dismissed.

(i) If Employee is removed and/or permanently prohibited from participating in the conduct of the Bank’s affairs by an order issues under the Federal Deposit Insurance Act or the Code of Virginia, all obligations of the Bank under this Employment Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected.

Section 12. Compensation Upon Termination .

(a) Good Reason or Without Cause . If the Bank terminates the Employee’s employment without Cause or the Employee resigns for Good Reason and such termination or resignation has not occurred within twelve (12) months following a Change of Control, then in either event:

(i) Employee shall be paid for the remainder of the then current term of this Agreement, at such times as payment was theretofore made, the salary required under Section 4 of this Agreement (taking into account any salary increases) had such termination not occurred. Notwithstanding the foregoing or the timing of payment established in Section 12(a)(iii), if the Employee is a “Key Employee”, as hereafter defined, payments under this Section 12(a)(i) and Section 12(a)(iii), to the extent considered “deferred compensation” under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), shall commence or be paid on the first day of the month following the six-month anniversary of the Employee’s termination or resignation. The initial payment made under the preceding sentence shall include amounts that would have been paid under this Section 12(a)(i) and Section 12(a)(iii) through the date of such initial payment had the Employee not been a Key Employee; and

(ii) The Bank shall maintain in full force and effect for the continued benefit of the Employee for the remainder of the then current term of this Agreement all employee welfare benefit plans and programs or arrangements in which the Employee was entitled to participate immediately prior to such termination, provided that continued participation is possible under the general terms and provisions of such plans and programs. In the event that Employee’s participation in any such plan or program is barred, the Bank shall arrange to provide the Employee with benefits substantially similar to those which the Employee was entitled to receive under such plan or program. Payments under this Section 12(a)(ii) that do not constitute (i) welfare benefits exempt from Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”) and Treasury Regulations thereunder (the “409A Regulations”) or (ii) reimbursed medical expenses exempt under 409A Regulations Section 1.409A-1(b)(9)(v)(B) shall be limited in the aggregate to the applicable dollar amount under Code Section 402(g)(1)(B) for the year of the separation from service. In addition, any benefits provided to a Key Employee under this Section 12(a)(ii) that are considered deferred compensation subject to Code Section 409A and the 409A Regulations shall not commence until the first day of the month following the six-month anniversary of the Employee’s termination or resignation. All determinations required under this Section 12(a)(ii) shall be made by independent counsel selected by the Bank and reasonably acceptable to the Employee or Key Employee, in accordance with Code Section 409A, the 409A Regulations, and other applicable guidance; and

(iii) A lump sum payment in cash shall be made to Employee on the date his employment terminates equal to the amount of his Accrued Obligations. “Accrued Obligations” shall be defined as the sum of:

(1) the Executive’s Annual Base Salary earned but not yet paid through the Date of Termination at the rate in effect just before a Notice of Termination is given;

(2) the amount, if any, of any incentive or bonus compensation theretofore earned which has not yet been paid;

(3) a pro-rated bonus for the year in which the termination occurs which equals the product of any bonus paid or payable, including by reason of deferral, for the most recently completed year multiplied by a fraction, the numerator of which is the number of days in the current year through the Date of Termination and the denominator of which is 365; and

(4) any benefits or awards (including both the cash and stock components) which pursuant to the terms of any plans, policies or programs have been earned prior to the date of termination, but which have not yet been paid to the Employee (but not including amounts that previously had been deferred at the Employee’s request, which amounts will be paid in accordance with the Employee’s existing directions, to the extent permitted by applicable law, including tax laws).

(iv) For purposes of this Agreement, “Key Employee” shall be defined as any Employee who, as of December 31 of any calendar year, satisfies the requirement of Code Section 416(i)(1)(A)(i), (ii), or (iii) (applied in accordance with Treasury Regulations thereunder and disregarding Code Section 416(i)(5)). An Employee who meets the criteria set forth in the preceding sentence will be considered a Key Employee for purposes of this Agreement for the 12-month period commencing on the next following April 1. For example, an Employee who meets the definition of Key Employee as of December 31, 2008, will be considered a Key Employee from April 1, 2009 through March 31, 2010, when applying the special rules for Key Employees found in this Agreement.

Notwithstanding anything in this Agreement to the contrary, if Employee breaches Section 13 or 14, Employee will not thereafter be entitled to receive any further compensation or benefits pursuant to this Section 12(a). In addition, notwithstanding anything in this Agreement to the contrary, the Bank shall not be required to make any payment that is prohibited by the terms of the regulations presently found at 12 C.F.R. part 359 or to the extent that any other governmental approval of the payment is not received.

(b) Death or Disability . If this Agreement terminates as a result of Employee’s death or disability, the Bank will have no further obligation under this Agreement other than for payment of the Accrued Obligations (as defined in Section 12(a)(iii)); provided, however, that Employee’s death is not intended to, and shall not, prevent amounts to which Employee would have been entitled under Sections 12(a), 12(c) or 12(d) had he lived from being paid to Employee’s estate or beneficiaries at the time or times such amounts would have been paid had Employee lived.

(c) Cause; Voluntary Termination Without Good Reason . If the Employee’s employment is terminated for Cause, this Agreement will terminate without further obligation to the Employee other than the payment to the Employee of salary earned but not yet paid through the Date of Termination. If the Employee terminates employment, excluding a termination for Good Reason or during the Window Period, this Agreement will terminate without further obligation to the Employee other than the Accrued Obligations (as defined in Section 12(a)(iii) above, but not including the sum in Section 12(a)(iii)(3)), which will be paid in a lump sum in cash 30 days following the Date of Termination, and any other benefits to which the Employee may be entitled pursuant to the terms of any plan, program or arrangement of the Bank. Notwithstanding the foregoing, if Employee is a Key Employee on his Date of Termination, to the extent Accrued Obligations or other amounts payable under this Section 12(c) are considered to provide for a deferral of compensation under Code Section 409A, they shall be paid on the first day of the month following the six-month anniversary of Employee’s Date of Termination.

(d) Termination After a Change in Control .

(i) If the Employee terminates his employment with the Bank for any reason during the Window Period after a Change in Control or the Employee’s employment is terminated without Cause during the Window Period after a Change in Control, the Employee will be entitled to the sum of Accrued Obligations (as defined in Section 12(a)(iii)) plus a cash amount (subject to any applicable payroll or other taxes required to be withheld) equal to the excess, if any, of 299% of the Employee’s “annualized includable compensation for the base period,” as defined in Code Section 280G, over the total amount payable to the Employee under Section 12(a)(i), payable in a single lump sum on the Date of Termination.

(ii) Employee may elect, prior to December 31, 2007, to have the cash amount (other than the Accrued Obligations) to which he is entitled under Section 12(d)(i) paid in 24 or 36 equal monthly installments, with the first installment paid on the date of termination or resignation and the remaining installments paid on the first day of each succeeding month. Such election shall not apply to amounts otherwise payable in the year the election is made, nor cause amounts to be paid in the year the election is made that would not otherwise be payable in that year. Subsequent changes to the time or form of payment of such cash amount shall be made only in accordance with Code Section 409A, the 409A Regulations, and other applicable guidance, including any transition rules promulgated by the Internal Revenue Service.

(iii) Notwithstanding the foregoing, the timing of an amount payable to a Key Employee under Section 12(d) (whether or not subject to an installment election) shall be determined as follows: the lump sum payment shall be made or installments shall commence on the first day of the month following the six-month anniversary of Employee’s Date of Termination.

The initial payment made under the preceding sentence shall include amounts that would have been paid under Section 12(d) through the date of such initial payment had the Employee not been a Key Employee. Accrued Obligations payable to a Key Employee under Section 12(d) shall be paid on the first day of the month following the six-month anniversary of the Employee’s Date of Termination.

(iv) For purposes of this Agreement, a “Change of Control” occurs if, after the date of this Agreement, (i) any person, including a “group” as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the owner or beneficial owner of Bank securities having 50% or more of the combined voting power of the then outstanding Bank securities that may be cast for the election of the Bank’s directors other than as a result of an issuance of securities initiated by the Bank, or open market purchases approved by the Board of Directors, as long as the majority of the Board of Directors approving the purchases is a majority at the time the purchases are made; or (ii) as the direct or indirect result of, or in connection with, a tender or exchange offer, a merger or other business combination, a sale of assets, a contested election of directors, or any combination of these events, the persons who were directors of the Bank before such events cease to constitute a majority of the Bank’s Board, or any successor’s board, within two years of the last of such transactions. For purposes of this Agreement, a Change of Control occurs on the date on which an event described in (i) or (ii) occurs. If a Change of Control occurs on account of a series of transactions or events, the Change of Control occurs on the date of the last of such transactions or events.

(v) It is the intention of the parties that no payment be made or benefit provided to Employee pursuant to this Agreement that would constitute an “excess parachute payment” within the meaning of Section 280G of the Code and any regulations thereunder, thereby resulting in a loss of an income tax deduction by the Bank or the imposition of an excise tax on Employee under Section 4999 of the Code. If the independent accountants serving as auditors for the Bank on the date of a Change of Control (or any other accounting firm designated by the Bank) determine that some or all of the payments or benefits scheduled under this Agreement, as well as any other payments or benefits on a Change of Control, would be nondeductible by the Company under Section 280G of the Code, then the payments scheduled under this Agreement will be reduced to one dollar less than the maximum amount which may be paid without causing any such payment or benefit to be nondeductible. The determination made as to the reduction of benefits or payments required hereunder by the independent accountants shall be binding on the parties. Employee shall have the right to designate within a reasonable period, which payments or benefits will be reduced; provided, however, that if no direction is received from Employee, the Bank shall implement the reductions in its discretion.

Section 13. Confidentiality/Nondisclosure .

Employee covenants and agrees that any and all information concerning the customers, businesses and services of the Bank of which he has knowledge or access as a result of his association with the Bank in any capacity, shall be deemed confidential in nature and shall not, without the written consent of the Bank, be directly or indirectly used, disseminated, disclosed or published by Employee to third parties other than in connection with the usual conduct of the business of the Bank. Such information shall

expressly include, but shall not be limited to, information concerning the Bank’s trade secrets, business operations, business records, customer lists or other customer information. Upon termination of employment, Employee shall deliver to the Bank all originals and copies of documents, forms, records or other information, in whatever form it may exist, concerning the Bank or its business, customers, products or services. This Section 13 shall not be applicable to any information which, through no misconduct of Employee, has previously been disclosed to the public by anyone other than Employee.

Section 14. Covenant Not to Compete

If Employee resigns for Good Reason or during the Window Period or if the Bank terminates the Employee’s employment other than for Cause and Employee receives the payments provided for in Section 12(a) or (d), then for a period of twelve (12) months from and after Employee is no longer employed by the Bank or for a period of twelve (12) months from the date of entry by a court of competent jurisdiction of a final judgment enforcing this covenant in the event of a breach by Employee, whichever is later, Employee covenants and agrees that he will not, directly or indirectly, either as a principal, agent, employee, employer, stockholder, co partner or in any other individual or representative capacity whatsoever: (i) engage in a Competitive Business anywhere within a ten (10) mile radius of any office operated by the Bank as of the date of the execution of this Agreement; or (ii) solicit, or assist any other person or business entity in soliciting, any depositors or other customers of the Bank to make deposits in or to become customers of any other financial institution conducting a Competitive Business; or (iii) induce any individuals to terminate their employment with the Bank.

As used in this Agreement, the terms “solicit” and “soliciting” shall include, but not be limited to contacting customers of the Bank for the purpose of advising them of Employee’s new contact information; however, it does not include placement of announcements in a publication by a subsequent employer of the Employee announcing Employee’s new place of employment, nor does it include responding to inquiries initiated by a customer about Employee’s new contact information.

As used in this Agreement, the term “Competitive Business” means establishing an office within the restricted geographic area that provides banking and financial products and services that are substantially similar to those offered by the Bank on the date that Employee’s employment terminates. Nothing in this Section 14 is intended to prohibit Employee from meeting with Employee’s clients within the restricted geographic area.

Section 15. Injunctive Relief, Damages, Etc .

Employee agrees that given the nature of the positions to be held by Employee with the Bank, that each and every one of the covenants and restrictions in Sections 13 and 14 above are reasonable in scope, length of time and geographic area and are necessary for the protection of the Bank in developing, maintaining and expanding its business. Accordingly, the parties hereto agree that in the event of any breach by Employee of any of the provisions of Sections 13 and 14 that monetary damages alone will not adequately compensate the Bank for its losses and, therefore, that it may seek any and all legal or equitable relief available to it, specifically

including, but not limited to, injunctive relief and if relief is awarded in favor of the Bank, Employee shall be liable for all damages, including actual and consequential damages, costs and expenses (excluding attorneys fees) incurred by the Bank as a result of taking to enforce, or recover for any breach of Sections 13 and 14. Should a court of competent jurisdiction determine that any provision of the covenants set forth in Section 14 is unenforceable as being overbroad as to time, area or scope, the court may strike the offending provision or reform such provision to substitute such other terms as are reasonable to protect the Bank’s legitimate business interests.

Section 16. Binding Effect/Assignability .

This Employment Agreement shall be binding upon and inure to the benefit of the Bank and Employee and their respective heirs, legal representatives, executors, administrators, successors and assigns, but neither this Agreement, nor any of the rights hereunder, shall be assignable by Employee or any beneficiary or beneficiaries designated by Employee. The Bank will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business, stock or assets of the Bank, by agreement in form and substance reasonably satisfactory to Employee, to expressly assume and agree to perform this Agreement in its entirety. Failure to the Bank to obtain such agreement prior to the effectiveness of any such succession shall be a breach this Agreement and shall entitle the Employee to the compensation described in Sections 12(a) and 12(d). As used in this Agreement, “Bank” shall mean First National Corporation and its wholly owned subsidiaries, and any successor to its respective business, stock or assets as aforesaid which executes and delivers the agreement provided for in this Section 16 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.

Section 17. Resignation and Release of Claims .

Notwithstanding anything in this Agreement to the contrary, in order to be eligible to receive the payments provided for under Section 12(a) as a result of termination by the Employee for Good Reason or by the Employer without Cause or payments provided for under Section 12(d) as a result of a termination by the Employee during the Window Period after a Change of Control Employee must on his own behalf and on behalf of his estate, heirs and representatives, execute a release in form and substance reasonably satisfactory to the Bank, releasing the Bank and its respective officers, Directors, employees, agents, representatives, shareholders, successors and assigns from any and all claims related to Employee’s employment with the Bank or the termination of employment.

Section 18. Governing Law .

This Employment Agreement shall be subject to and construed in accordance with the laws of Virginia.

Section 19. Invalid Provisions .

The invalidity or unenforceability of any particular provision of this Employment Agreement shall not affect the validity or enforceability of any other provisions hereof, and this Employment Agreement shall be construed in all respects as if such invalid or unenforceable provisions were omitted.

Section 20. Notices .

Any and all notices, designations, consents, offers, acceptance or any other communications provided for herein shall be given in writing and shall be deemed properly delivered if delivered in person or by registered or certified mail, return receipt requested, addressed as follows: if to the Bank, to its President at the headquarters office of the Bank; if to the Employee, to his last known address on record at the Bank.

Section 21. Entire Agreement .

(b) This Employment Agreement may be executed in one or more counterparts, each of which shall be considered an original.

Section 22. Amendment and Waiver .

This Employment Agreement may not be amended except by an instrument in writing signed by or on behalf of each of the parties hereto. No waiver of any provision of this Employment Agreement shall be valid unless in writing and signed by the party to be charged.

Section 23. Case and Gender .

Wherever required by the context of this Employment Agreement, the singular or plural case and the masculine, feminine and neuter genders shall be interchangeable.

Section 24. Captions .

The captions used in this Employment Agreement are intended for descriptive and reference purposes only and are not intended to affect the meaning of any Section hereunder.

Section 25. Code Section 409A .

This Employment Agreement is intended to satisfy the requirements of Code Section 409A, the 409A Regulations, and other guidance, including transition rules, issued thereunder. Each provision and term of this Employment Agreement should be interpreted accordingly, but if any provision or term would be prohibited by or inconsistent with Code Section 409A, the 409A Regulations, or

such other guidance, the parties agree that such provision or term may be amended to comply with or qualify for an exemption from Code Section 409A, the 409A Regulations, and such other guidance, in a manner determined by independent counsel selected by the Bank and reasonably acceptable to the Employee.

IN WITNESS WHEREOF, the Bank has caused this amended and restated Employment Agreement to be executed by its duly authorized officer and Employee has executed this amended and restated Employment Agreement on the dates specified below.


EMPLOYEE	FIRST NATIONAL CORPORATION

	By:
Marshall J. Beverley, Jr.		Harry S. Smith
		President and Chief Executive Officer


Date	Date

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

SECTION 302 CERTIFICATION

I, Harry S. Smith, certify that:

1.	I have reviewed the Quarterly Report on Form 10-Q of First National Corporation for the period ended June 30, 2007;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

EXHIBIT 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

SECTION 302 CERTIFICATION

I, M. Shane Bell, certify that:

1.	I have reviewed the Quarterly Report on Form 10-Q of First National Corporation for the period ended June 30, 2007;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

EXHIBIT 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Form 10-Q of First National Corporation for the period ended June 30, 2007, I, Harry S. Smith, President and Chief Executive Officer of First National Corporation, hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge and belief:

(1)	such Form 10-Q for the period ended June 30, 2007, fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)	the information contained in such Form 10-Q for the period ended June 30, 2007, fairly presents, in all material respects, the financial condition and results of operations of First National Corporation.

EXHIBIT 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350

In connection with the Form 10-Q of First National Corporation for the period ended June 30, 2007, I, M. Shane Bell, Executive Vice President and Chief Financial Officer of First National Corporation, hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge and belief:

(1)	such Form 10-Q for the period ended June 30, 2007, fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)	the information contained in such Form 10-Q for the period ended June 30, 2007, fairly presents, in all material respects, the financial condition and results of operations of First National Corporation.

Harry S. Smith

August 13, 2007

President and Chief Executive Officer

M. Shane Bell

August 13, 2007

Executive Vice President and Chief Financial Officer