FIRST NATIONAL CORP /VA/ (Form: 10-Q, Received: 11/14/2007 16:06:09)

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 September 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 November 14, 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	27

Part II – Other Information

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	27

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)
	September 30, 2007			December 31, 2006
Assets
Cash and due from banks	$	14,653		$	10,368
Interest-bearing deposits in banks		1,965			1,759
Federal funds sold		—			8,430
Securities available for sale, at fair value		59,669			60,340
Loans held for sale		424			105
Loans, net of allowance for loan losses, 2007, $3,977, 2006, $3,978		430,616			423,151
Premises and equipment, net		19,341			17,603
Interest receivable		2,145			2,038
Foreclosed assets		377			—
Other assets		4,483			4,150

Total assets	$	533,673		$	527,944

Liabilities and Shareholders’ Equity

Liabilities
Deposits:
Noninterest-bearing demand deposits	$	87,629		$	83,386
Savings and interest-bearing demand deposits		173,003			167,419
Time deposits		175,817			184,239

Total deposits	$	436,449		$	435,044
Federal funds purchased		4,586			—
Other borrowings		40,660			45,750
Company obligated mandatorily redeemable capital securities		12,372			12,372
Accrued expenses and other liabilities		3,850			2,223
Commitments and contingencies		—			—

Total liabilities	$	497,917		$	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		1,459			1,465
Retained earnings		32,222			29,104
Unearned ESOP shares		(470	)		(546	)
Accumulated other comprehensive loss, net		(1,108	)		(1,121	)

Total shareholders’ equity	$	35,756		$	32,555

Total liabilities and shareholders’ equity	$	533,673		$	527,944

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Income

Three months ended September 30, 2007 and 2006

(in thousands, except per share data)


	(unaudited)			(unaudited)
	September 30, 2007			September 30, 2006
Interest and Dividend Income
Interest and fees on loans	$	8,315		$	7,740
Interest on federal funds sold		4			7
Interest on deposits in banks		31			26
Interest and dividends on securities available for sale:
Taxable interest		559			604
Tax-exempt interest		120			103
Dividends		52			56

Total interest and dividend income	$	9,081		$	8,536

Interest Expense
Interest on deposits	$	3,587		$	3,225
Interest on federal funds purchased		50			51
Interest on company obligated mandatorily redeemable capital securities		242			217
Interest on other borrowings		541			679

Total interest expense	$	4,420		$	4,172

Net interest income	$	4,661		$	4,364
Provision for loan losses		—			109

Net interest income after provision for loan losses	$	4,661		$	4,255

Noninterest Income
Service charges	$	769		$	681
Fees for other customer services		333			282
Trust and investment advisory fees		298			232
Gains on sale of loans		116			44
Losses on sale of securities available for sale		(19	)		—
Losses on sale of premises and equipment		(3	)		—
Other operating income		1			37

Total noninterest income	$	1,495		$	1,276

Noninterest Expense
Salaries and employee benefits	$	2,084		$	1,906
Occupancy		243			204
Equipment		327			296
Marketing		140			178
Stationery and supplies		144			115
Legal and professional fees		137			174
ATM and check card		130			105
Other operating expense		625			495

Total noninterest expense	$	3,830		$	3,473

Income before income taxes	$	2,326		$	2,058
Provision for income taxes		755			678

Net income	$	1,571		$	1,380

Earnings per common share, basic and diluted	$	0.54		$	0.47

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Income

Nine months ended September 30, 2007 and 2006

(in thousands, except per share data)


	(unaudited)			(unaudited)
	September 30, 2007			September 30, 2006
Interest and Dividend Income
Interest and fees on loans	$	24,333		$	21,658
Interest on federal funds sold		28			9
Interest on deposits in banks		81			86
Interest and dividends on securities available for sale:
Taxable interest		1,629			1,891
Tax-exempt interest		351			315
Dividends		147			169

Total interest and dividend income	$	26,569		$	24,128

Interest Expense
Interest on deposits	$	10,680		$	8,085
Interest on federal funds purchased		130			219
Interest on company obligated mandatorily redeemable capital securities		716			522
Interest on other borrowings		1,629			2,116

Total interest expense	$	13,155		$	10,942

Net interest income	$	13,414		$	13,186
Provision for loan losses		67			278

Net interest income after provision for loan losses	$	13,347		$	12,908

Noninterest Income
Service charges	$	2,160		$	2,043
Fees for other customer services		951			811
Trust and investment advisory fees		857			663
Gains on sale of loans		241			141
Gains (losses) on sale of securities available for sale		(19	)		3
Losses on sale of premises and equipment, net		(2	)		—
Other operating income		37			124

Total noninterest income	$	4,225		$	3,785

Noninterest Expense
Salaries and employee benefits	$	6,157		$	5,545
Occupancy		717			593
Equipment		955			864
Marketing		430			487
Stationery and supplies		386			360
Legal and professional fees		479			430
ATM and check card		382			301
Other operating expense		1,774			1,627

Total noninterest expense	$	11,280		$	10,207

Income before income taxes	$	6,292		$	6,486
Provision for income taxes		2,038			2,114

Net income	$	4,254		$	4,372

Earnings per common share, basic and diluted	$	1.46		$	1.50

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows

Nine months ended September 30, 2007 and 2006

(in thousands)


	(unaudited)			(unaudited)
	September 30, 2007			September 30, 2006
Cash Flows from Operating Activities
Net income	$	4,254		$	4,372
Adjustments to reconcile net income to cash and cash equivalents provided by operating activities:
Depreciation and amortization		841			728
Origination of loans held for sale		(15,050	)		(11,193	)
Proceeds from sale of loans available for sale		14,972			10,662
Provision for loan losses		67			278
(Gains) losses on sale of securities available for sale		19			(3	)
Losses on sale of premises and equipment, net		2			—
Gains on sale of loans		(241	)		(141	)
Accretion of security discounts		(26	)		(34	)
Amortization of security premiums		69			120
Shares acquired by leveraged ESOP		70			—
Changes in assets and liabilities:
Increase in interest receivable		(107	)		(338	)
Increase in other assets		(339	)		(61	)
Increase in accrued expenses and other liabilities		1,627			284

Net cash provided by operating activities	$	6,158		$	4,674

Cash Flows from Investing Activities
Proceeds from sales of securities available for sale	$	4,441		$	3,919
Proceeds from maturities, calls, and principal payments of securities available for sale		8,019			7,669
Purchase of securities available for sale		(11,832	)		(4,501	)
Decrease in federal funds sold		8,430			—
Proceeds from sale of premises and equipment		2			—
Purchase of premises and equipment		(2,583	)		(4,140	)
Net increase in loans		(7,909	)		(49,135	)

Net cash used in investing activities	$	(1,432	)	$	(46,188	)

Cash Flows from Financing Activities
Net increase (decrease) in demand deposits and savings accounts	$	9,827		$	(4,524	)
Net increase (decrease) in time deposits		(8,422	)		46,772
Proceeds from other borrowings		95,000			117,670
Principal payments on other borrowings		(100,090	)		(117,114	)
Proceeds from issuance of company obligated mandatorily redeemable securities		—			4,124
Cash dividends paid		(1,136	)		(1,052	)
Increase (decrease) in federal funds purchased		4,586			(3,655	)

Net cash provided by (used in) financing activities	$	(235	)	$	42,221

Increase in cash and cash equivalents	$	4,491		$	707

Cash and Cash Equivalents
Beginning	$	12,127		$	10,447

Ending	$	16,618		$	11,154

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows

(Continued)

Nine months ended September 30, 2007 and 2006

(in thousands)


	(unaudited)		(unaudited)
	September 30, 2007		September 30, 2006
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	12,418	$	10,432

Income taxes	$	1,429	$	2,398

Supplemental Disclosures of Noncash Investing Activities
Unrealized gain on securities available for sale	$	19	$	38

Transfer from loans to other real estate	$	377	$	—

See Notes to Consolidated Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Statements of Changes in Shareholders’ Equity

Nine months ended September 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		—		—			4,372			—			—		$	4,372			4,372
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period (net of tax, $14)		—		—			—			—			—			27			—
Reclassification adjustment (net of tax, $1)		—		—			—			—			—			(2	)		—

Other comprehensive income (net of tax, $13)		—		—			—			—			25		$	25			25

Total comprehensive income															$	4,397

Cash dividends ($0.36 per share)		—		—			(1,052	)		—			—						(1,052	)

Balance, September 30, 2006	$	3,653	$	1,465		$	28,055		$	—		$	(437	)				$	32,736


	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		—		—			4,254			—			—		$	4,254			4,254
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period (net of tax)		—		—			—			—			—			—			—
Reclassification adjustment (net of tax, $6)		—		—			—			—			—			13			—

Other comprehensive income (net of tax, $6)		—		—			—			—			13		$	13			13

Total comprehensive income															$	4,267

Shares acquired by leveraged ESOP		—		(6	)		—			76			—						70
Cash dividends ($0.39 per share)		—		—			(1,136	)		—			—						(1,136	)

Balance, September 30, 2007	$	3,653	$	1,459		$	32,222		$	(470	)	$	(1,108	)				$	35,756

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 September 30, 2007 and December 31, 2006, the results of operations for the three and nine month periods ended September 30, 2007 and 2006 and cash flows and changes in shareholders’ equity for the nine months ended September 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 nine month periods ended September 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 September 30, 2007 and December 31, 2006. Amortized costs and fair values were as follows:


	*(in thousands)*
	September 30, 2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. agency and mortgage-backed securities	$	44,054	$	43	$	(539	)	$	43,558
Obligations of states and political subdivisions		12,642		61		(160	)		12,543
Corporate equity securities		10		203		—			213
Restricted securities		3,355		—		—			3,355

	$	60,061	$	307	$	(699	)	$	59,669


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


	*(in thousands)* September 30, 2007
	Less than 12 months					12 months or more					Total
	Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)
U.S. agency and mortgage-backed securities	$	6,056	$	(25	)	$	26,552	$	(514	)	$	32,608	$	(539	)
Obligations of states and political subdivisions		4,498		(115	)		2,289		(45	)		6,787		(160	)

	$	10,554	$	(140	)	$	28,841	$	(559	)	$	39,395	$	(699	)


	*(in thousands)* December 31, 2006
	Less than 12 months					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 September 30, 2007, there were thirty-one U.S. agency and mortgage-backed securities and eighteen 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 4.1 years at September 30, 2007.

Note 3. Loans

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


	*(in thousands)*
	September 30, 2007		December 31, 2006
Mortgage loans on real estate:
Construction	$	73,148	$	60,913
Secured by farm land		1,740		2,507
Secured by 1-4 family residential		106,059		112,323
Other real estate loans		178,813		168,754
Loans to farmers (except those secured by real estate)		2,223		2,150
Commercial and industrial loans (except those secured by real estate)		52,155		50,854
Consumer loans		19,285		24,423
Deposit overdrafts		378		232
All other loans		792		4,973

Total loans	$	434,593	$	427,129
Allowance for loan losses		3,977		3,978

Loans, net	$	430,616	$	423,151

Notes to Consolidated Financial Statements

(unaudited)

The Company has a credit concentration in mortgage loans on real estate. These loans totaled $359.8 million, or 83.5% 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 September 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 $73.1 million and $60.9 million, or 17.0% and 14.4% of loans, net of the allowance for loan losses, at September 30, 2007 and December 31, 2006, respectively.

The Company has a concentration of credit risk within the loan portfolio involving loans secured by hotels. This concentration totaled $35.5 million at September 30, 2007, representing 99.4% of total shareholders’ equity and 8.3% 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 nine month period ended September 30, 2007 and the year ended December 31, 2006.

Note 4. Allowance for Loan Losses

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


	*(in thousands)*
	September 30, 2007			December 31, 2006			September 30, 2006
Balance at beginning of year	$	3,978		$	3,528		$	3,528
Provision charged to operating expense		67			378			278
Loan recoveries		163			320			252
Loan charge-offs		(231	)		(248	)		(174	)

Balance at end of period	$	3,977		$	3,978		$	3,884

Note 5. Other Borrowings

The Bank had unused lines of credit totaling $78.2 million available with non-affiliated banks at September 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 September 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 $37.6 million at September 30, 2007 and FHLB stock and other investment securities with a book value of $30.8 million at September 30, 2007.

At September 30, 2007, the Bank had a $190 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 $470 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 September 30, 2007 and December 31, 2006 with the minimum regulatory guidelines were as follows:


					*(dollars in thousands)*				Minimum To Be Well Capitalized Under
	Actual				Minimum Capital Requirement				Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2007:
Total Capital (to Risk Weighted Assets):
Consolidated	$	53,607	11.86	%	$	36,169	8.00	%		N/A	N/A
First Bank	$	52,741	12.00	%	$	35,156	8.00	%	$	43,945	10.00	%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated	$	49,630	10.98	%	$	18,085	4.00	%		N/A	N/A
First Bank	$	48,764	11.10	%	$	17,578	4.00	%	$	26,367	6.00	%
Tier 1 Capital (to Average Assets):
Consolidated	$	49,630	9.38	%	$	21,153	4.00	%		N/A	N/A
First Bank	$	48,764	9.23	%	$	21,140	4.00	%	$	26,425	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 (also 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 September 30, 2007 was 8.35%. 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 September 30, 2007 was 8.29%. 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 fixed rate of interest of 7.26% until July 31, 2011. The securities then have a LIBOR-indexed floating rate of interest. 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 September 30, 2007, the total amount of trust preferred securities issued by the Trusts was 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.

Notes to Consolidated Financial Statements

(unaudited)

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


	*(in thousands)*
	For the three months ended September 30,						For the nine months ended September 30,
	2007			2006			2007			2006
Service cost	$	70		$	59		$	209		$	178
Interest cost		66			60			199			180
Expected return on plan assets		(64	)		(58	)		(191	)		(174	)
Amortization of net obligation at transition		(2	)		(1	)		(4	)		(4	)
Amortization of prior service cost		1			1			2			3
Amortization of net loss		11			13			32			39

Net periodic benefit cost	$	82		$	74		$	247		$	222

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 nine months ended September 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 2,907,232 and 2,922,860 for the three months ended September 30, 2007 and 2006, respectively and 2,905,610 and 2,922,860 for the nine months ended September 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 nine month periods ended September 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 nine month periods ended September 30, 2007 may not be indicative of the results to be achieved for the year.

Executive Overview

The Company

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.

Products, Services, Customers and Locations

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.

Revenue Sources and Expense Factors

The 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 and represents approximately 75% of the Company’s total revenue. 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 other services. The Bank generates fee income from other services that include trust services and investment advisory services and through the origination and sale of residential mortgages.

The provision for loan losses and noninterest expense are the two expense categories. The provision is determined by loan growth, asset quality, net charge-offs 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. The largest component of noninterest expense is salaries and employee benefits, comprising 54% of expenses followed by occupancy and equipment expense, comprising 14% of expenses.

Quarterly Performance

For the quarter ended September 30, 2007, net income totaled $1.6 million, an increase of 14% compared to $1.4 million for the same period in 2006. The increase in earnings reflected a 7% increase in net interest income that resulted from a 14 basis point increase in the net interest margin and an increase in interest-earning assets. Noninterest income increased 17%, primarily from fee income from other customer services and service charge income. In addition, there was no provision for loan losses due to minimal loan growth and high asset quality. These increases to earnings were partially offset by noninterest expenses that increased 10%. Most expense categories that increased were primarily attributed to the addition of a branch office late in the third quarter of 2006.

Net income per share, basic and diluted, increased $0.07 to $0.54 for the third quarter of 2007 from $0.47 for the same period in 2006. The return on average assets and return on average equity were 1.18% and 17.81%, respectively, compared to 1.07% and 17.23% in 2006. The net interest margin was 3.77% for the third quarter of 2007, compared to 3.63% for the same period of 2006. The increase in the margin was a result of increasing yields from the loan portfolio, decreasing yields on deposits and improvements in the balance sheet mix. The margin has improved for three consecutive quarters, increasing a total of 22 basis points from 3.55% for the fourth quarter of 2006. The Company does not expect this trend to continue, but does expect the margin to stabilize in future periods.

Year-to-Date Performance

For the nine months ended September 30, 2007, net income decreased 3% to $4.3 million compared to $4.4 million for the same period in 2006. The decrease in earnings was a result of expense growth of 11% that outpaced revenue growth of 4%. The lower provision for loan losses in 2007 helped offset this difference. The decrease in the provision reflected high asset quality and less loan growth in 2007 when compared to 2006. Two new branch offices that opened during the second half of 2006 were the primary contributors to increased expense levels when comparing the periods. While the Company experienced 5% growth in average interest-earning assets over the last twelve months, net interest income increased only 2% as a result of the margin that was 11 basis points lower during the nine months ended September 30, 2007, when compared to the same period in 2006.

Net income per share, basic and diluted, decreased $0.04 to $1.46 for the nine months ended September 30, 2007 from $1.50 for the same period in 2006. The return on average assets and return on average equity were 1.09% and 16.69%, respectively, for the first nine months of 2007 compared to 1.17% and 18.90% for the same period in 2006.

Total assets increased 1%, or $5.7 million, to $533.7 million during the first nine months of 2007. Loans, net of the allowance for loan losses, increased 2%, or $7.5 million, during the first nine months of 2007, while deposits increased $1.4 million to $436.4 million.

Management Outlook

For the remainder of 2007 and throughout 2008, the Company is planning for earning assets to grow at a slower pace than in recent years. Deposit growth and loan demand have recently slowed. The Company does not expect this to change during the next several quarters, anticipating a slowing economy. The margin is expected to remain stable as funding costs and the yield on earning assets are not anticipated to significantly change. Increases in net interest income will be determined by the ability to grow earning assets at acceptable margins. Changing economic conditions caused by factors beyond the Company’s control may have a direct correlation with the required provision for loan losses.

The rate of growth in noninterest income is expected to decrease slightly in future periods, as the trust department is no longer experiencing rapid growth. The department began operations in 2005 and experienced high growth rates during 2005 and 2006 from initial market demand. Noninterest expense growth is also expected to decrease slightly. Although the Company is focused on leveraging existing branch capacity and does not plan to expand the branch network in the near term, an operations center is under construction and is scheduled to be in service the second quarter of 2008. The new operations center will support future growth and facilitate long-term operational efficiencies. The center is not anticipated to increase expenses at the same level as adding a new branch office because the Company plans to transfer existing employees to the facility instead of hiring new employees.

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 nine months ended
	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
GAAP measures:
Interest income—loans	$	8,315	$	7,740	$	24,333	$	21,658
Interest income—investments and other		766		796		2,236		2,470
Interest expense—deposits		3,587		3,225		10,680		8,085
Interest expense—other borrowings		541		679		1,629		2,116
Interest expense— other		292		268		846		741

Total net interest income	$	4,661	$	4,364	$	13,414	$	13,186

Non-GAAP measures:
Tax benefit realized on non-taxable interest income—loans	$	12	$	15	$	36	$	41
Tax benefit realized on non-taxable interest income—municipal securities		60		53		179		163

Total tax benefit realized on non-taxable interest income	$	72	$	68	$	215	$	204

Total tax-equivalent net interest income	$	4,733	$	4,432	$	13,629	$	13,390

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 September 30, 2007, commitments to extend credit, stand-by letters of credit and rate lock commitments totaled $76.0 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 September 30, 2007, commercial loans not secured by real estate totaled $52.2 million, or 12% of gross loans, as compared to $50.9 million, or 12%, 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 September 30, 2007, commercial real estate loans totaled $180.6 million or 42% of the Bank’s gross loans, as compared to $171.3 million, or 40%, 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 September 30, 2007 and December 31, 2006, were $73.1 million, or 17% of gross loans, and $60.9 million, or 14% 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 September 30, 2007, $106.1 million, or 24%, of the Bank’s loan portfolio consisted of one-to-four-family residential real estate loans as compared to $112.3 million, or 26%, 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.

The Company does not participate in sub-prime lending practices. Issues recently arising in the residential mortgage market from sub-prime lending are not expected to have a direct impact on earnings, although the Company is always generally subject to risks associated with economic and business conditions in our market area.

Consumer Lending

The Bank offers various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, deposit account loans and installment and demand loans. At September 30, 2007, consumer loans, including deposit overdraft balances, were $19.7 million, or 5% of gross loans, as compared to $24.7 million, or 6%, 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 September 30, 2007 to the same period in 2006, net income increased 14% to $1.6 million, or $0.54 per basic and diluted share, from $1.4 million, or $0.47 per basic and diluted share. The increase in earnings reflected a 7% increase in net interest income and a 17% increase in noninterest income. In addition, no provision for loan losses was recorded during the quarter. These increases to earnings were offset by a 10% increase in noninterest expense.

For the nine months ended September 30, 2007, net income was $4.3 million or $1.46 per basic and diluted share. This is a 3% decrease compared to net income of $4.4 million or $1.50 per basic and diluted share for the same period in 2006. The decrease in earnings was a result of expense growth of 11% that outpaced revenue growth of 4%. The lower provision for loan losses in 2007 helped offset this difference. 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 September 30, 2007 and December 31, 2006, representing 0.92% and 0.93% of total loans, respectively.

Net Interest Income

Net interest income was $4.7 million for the third quarter of 2007, which was an increase of $297 thousand, or 7%, over $4.4 million for the same period in 2006. Average interest-earning assets increased 3%, or $14.2 million, when comparing the periods. The net interest margin increased 14 basis points to 3.77% for the third quarter of 2007, compared to 3.63% for the same quarter of 2006. The increase in the margin was a result of increasing yields from the loan portfolio, decreasing yields on deposits and improvements in the balance sheet mix.

Net interest income increased slightly to $13.4 million for the nine months ended September 30, 2007, compared to $13.2 million for the same period in 2006. Growth in average interest-earning assets was partially offset by a decline in the net interest margin. Average interest-earning assets increased 5%, or $23.3 million, when comparing the periods. The margin decreased 11 basis points to 3.69% for the nine months ended September 30, 2007 compared to 3.80% 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 margin during the remainder of 2007. Therefore, increases in net interest income will be primarily determined by the Company’s ability to grow interest-earning assets at acceptable margins.

Noninterest Income

Noninterest income increased 17% to $1.5 million for the third quarter of 2007, compared to $1.3 million for the same quarter of 2006. Fees for other customer services increased 23% to $631 thousand, compared to $514 thousand for the third quarter of 2006. This increase resulted from an increase in ATM and check card fees and fee income from trust and investment advisory services. Service charges increased 13%, or $88 thousand, when comparing the periods. This was related to higher fee income from overdrafts.

Noninterest income was $4.2 million for the nine months ended September 30, 2007, which was an increase of $440 thousand, or 12%, compared to $3.8 million for the same period in 2006. Fees for other customer services increased 23% to $1.8 million, compared to $1.5 million in 2006. This increase was attributable to increases in fee income from trust and investment advisory services and ATM and check card fees.

The Company expects the rate of growth in noninterest income to decrease slightly in future periods as the trust department is no longer experiencing rapid growth. The department began operations in 2005 and experienced high growth during 2005 and 2006 from initial market demand.

Noninterest Expense

For the quarter ended September 30, 2007, noninterest expense increased 10% to $3.8 million, compared to $3.5 million for the same period in 2006. For the nine months ended September 30, 2007, noninterest expense increased 11% to $11.3 million, compared to $10.2 million for the same period in 2006. The increase in expenses was primarily attributable to the addition of two branch locations during the second and third quarters of 2006. The growth rate of noninterest expense is expected to decrease slightly in future periods. Although the Company is focused on leveraging existing branch capacity and does not plan to expand the branch network in the near term, an operations center is under construction and is scheduled to be placed in service during the second quarter of 2008. The new operations center will support future growth and facilitate long-term operational efficiencies.

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 nine month periods ended September 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 the three months ended September 30, 2007 and 2006 was 32.5% and 32.9%, respectively. The effective income tax rate for the nine months ended September 30, 2007 and 2006 was 32.4% and 32.6%, 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 $5.7 million during the first nine months of 2007 to $533.7 million at September 30, 2007 from $527.9 million at December 31, 2006. Loans, net of the allowance for loan losses, increased 2%, or $7.5 million, during the first nine months of 2007, while deposits increased $1.4 million to $436.4 million at September 30, 2007 from $435.0 million at December 31, 2006. For the remainder of 2007 and throughout 2008, the Company is planning for the balance sheet to grow at a slower pace than in recent years. Deposit growth and loan demand have recently slowed. The Company does not expect this will change during the next year.

Loans

The Bank is an active lender with a loan portfolio that includes commercial and residential real estate loans, commercial loans, consumer loans, 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 $430.6 million at September 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 September 30, 2007 and no foreclosed real estate at December 31, 2006.

Nonperforming assets were $1.6 million at September 30, 2007 and $721 thousand at December 31, 2006, representing 0.37% and 0.17% of total loans, respectively. Net charge-offs were $69 thousand for the first nine months of 2007, compared to net recoveries of $78 thousand for the same period of 2006. Although nonperforming assets have increased, less loan growth in 2007 when compared to 2006 resulted in a lower loan loss provision of $67 thousand for the nine months ended September 30, 2007 compared to $278 thousand for the same period in 2006. Nonperforming assets could increase due to other potential problem loans identified by management totaling $6.6 million at September 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 $6.5 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 September 30, 2007 and December 31, 2006, representing 0.92% and 0.93% of total loans, respectively.

Impaired loans of $90 thousand at September 30, 2007 and $49 thousand at December 31, 2006 have been recognized in conformity with SFAS No. 114. The related allowance for loan losses provided for these loans totaled $53 thousand and $25 thousand at September 30, 2007 and December 31, 2006, respectively. The average recorded investment in impaired loans during the nine months ended September 30, 2007 and the year ended December 31, 2006 was $90 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 September 30, 2007 were $59.7 million, a slight decrease 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 September 30, 2007, neither the Company nor the Bank held any derivative financial instruments in its respective investment security portfolios.

Deposits

Deposits were $436.4 million at September 30, 2007, a $1.4 million increase from $435.0 million at December 31, 2006. Non-interest bearing demand deposits increased $4.2 million or 5% during the first nine months of 2007. Time deposits decreased $8.4 million or 5% during the first nine months of 2007 to $175.8 million compared to $184.2 million at December 31, 2006. Savings and interest-bearing demand deposits increased $5.6 million or 3% when comparing the same periods. 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 September 30, 2007, cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, securities and loans maturing within one year totaled $162.4 million. At September 30, 2007, 46% or $197.5 million of the loan portfolio would mature or reprice within one year. At September 30, 2007, non-deposit sources of available funds totaled $78.2 million, which included $61.2 million available from FHLB. During the first nine 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 11.86% at September 30, 2007 and a ratio of Tier 1 capital to risk-weighted assets of 10.98%. 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 $67.9 million at September 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 September 30, 2007 and December 31, 2006, the Company had $7.2 million and $7.0 million, respectively, in outstanding standby letters of credit.

At September 30, 2007 and December 31, 2006, the Company had entered into locked-rate commitments to originate mortgage loans amounting to $909 thousand and $2.2 million, respectively. The Company had loans held for sale of $424 thousand and $105 thousand at September 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 September 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	$	(221	)
+100 basis points		(101	)
Flat		—
- 100 basis points		93
- 200 basis points		54

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 September 30, 2007:


Change in Yield Curve	*(in thousands)* Change in Economic Value of Equity
+200 basis points	$	12,330
+100 basis points		6,527
Flat		—
- 100 basis points		(8,305	)
- 200 basis points		(18,611	)

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 September 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

None

Item 5.

Other Information

On November 7, 2007 the Board of Directors declared a quarterly dividend of $0.14 per share, a 7.7% increase from the quarterly dividend paid September 7, 2007. The dividend is payable on December 14, 2007 to shareholders of record as of November 30, 2007.

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 Dennis A. Dysart

10.2		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and J. Andrew Hershey

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)

/s/ Harry S. Smith				November 14, 2007
Harry S. Smith				Date
President and Chief Executive Officer

/s/ M. Shane Bell				November 14, 2007
M. Shane Bell				Date
Executive Vice President and Chief Financial Officer

EXHIBIT INDEX


Number		Document
10.1		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and Dennis A. Dysart

10.2		Amended and Restated Employment Agreement, dated as of June 1, 2007, between the Company and J. Andrew Hershey

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

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 DENNIS A. DYSART 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 Executive Vice President and Chief Administrative 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 $157,500.00 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 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:
	Title:	President and Chief Executive Officer
ATTEST:



	EMPLOYEE

	/s/ Dennis A. Dysart		(SEAL)
	Dennis A. Dysart
ATTEST:

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 J. ANDREW HERSHEY 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 – Loan Administration 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 $152,500.00 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.

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.

(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:

(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.


	FIRST NATIONAL CORPORATION

	By:
	Title:	President

ATTEST:



	EMPLOYEE

	/s/ J. Andrew Hershey		(SEAL)
	J. Andrew Hershey

ATTEST:

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 September 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.


Date: November 14, 2007		/s/ Harry S. Smith
		Harry S. Smith
		President and Chief Executive Officer

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 September 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.


Date: November 14, 2007		/s/ M. Shane Bell
		M. Shane Bell
		Executive Vice President and Chief Financial Officer

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 September 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 September 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 September 30, 2007, fairly presents, in all material respects, the financial condition and results of operations of First National Corporation.


Date: November 14, 2007		/s/ Harry S. Smith
		Harry S. Smith
		President and Chief Executive Officer

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 September 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 September 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 September 30, 2007, fairly presents, in all material respects, the financial condition and results of operations of First National Corporation.


Date: November 14, 2007		/s/ M. Shane Bell
		M. Shane Bell
		Executive Vice President and Chief Financial Officer

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