XNAS:VYFC Valley Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2012

o
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:  000-28342

VALLEY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

VIRGINIA
54-1702380
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)
   
36 Church Avenue, S.W.
 
Roanoke, Virginia
24011
(Address of principal executive offices)
(Zip Code)
 
(540) 342-2265
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          Yes x  No o

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

Large accelerated filer o
Accelerated filer o
 
 
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company x

Indicate by checkmark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act.) Yes o No x
 
At May 11, 2012, 4,742,295 shares of common stock, no par value, of the registrant were outstanding.
 
 



VALLEY FINANCIAL CORPORATION
FORM 10-Q
March 31, 2012
 
 
   
 
 
   
 
   
4
   
5
   
6
   
7
   
8
   
39
   
47
   
47
   
 
   
47
   
47
   
48
   
48
   
48
   
48
   
48
   
49
   
50
   





Forward-Looking and Cautionary Statements
The Private Securities Litigation Reform Act of 1995 (the “1995 Act”) provides a safe harbor for forward-looking statements made by or on our behalf.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared.
 
This report includes forward-looking statements within the meaning of the 1995 Act. These statements are included throughout this report and relate to, among other things, projections of revenues, earnings, earnings per share, cash flows, capital expenditures, or other financial items, expectations regarding acquisitions, discussions of estimated future revenue enhancements, potential dispositions, and changes in interest rates. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. The words “believe”, “anticipate”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, and similar terms and phrases identify forward-looking statements in this report.
 
Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. Our operations involve risks and uncertainties, many of which are outside of our control, and any one of which, or a combination of which, could materially affect our results of operations and whether the forward-looking statements ultimately prove to be correct.  Actual results and trends in the future may differ materially from those suggested or implied by the forward-looking statements depending on a number of factors. Factors that may cause actual results to differ materially from those expected include the following:
 
 
 
General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances;
 
 
 
General decline in the residential real estate construction and finance market;
 
 
 
Decline in market value of real estate in the Company’s markets;
 
 
 
Changes in interest rates could reduce net interest income and/or the borrower’s ability to repay loans;
 
 
 
Competitive pressures among financial institutions may reduce yields and profitability;
 
 
 
Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses that the Company is engaged in;
 
 
 
Increased regulatory supervision could limit our ability to grow and could require considerable time and attention of our management and board of directors;
 
 
 
New products developed or new methods of delivering products could result in a reduction in business and income for the Company;
 
 
 
The Company’s ability to continue to improve operating efficiencies;
 
 
 
Natural events and acts of God such as earthquakes, fires and floods;
 
 
 
Loss or retirement of key executives; and
 
 
 
Adverse changes may occur in the securities market.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein.  We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.

 
             
           
           
VALLEY FINANCIAL CORPORATION
 
 
(In 000s, except share data)
 
   
(Unaudited)
   
(Audited)
 
Assets
 
March 31, 2012
   
December 31, 2011
 
Cash and due from banks
  $ 6,518     $ 8,428  
Interest bearing deposits
    15,362       22,296  
Total cash and cash equivalents
    21,880       30,724  
                 
Securities available for sale
    168,176       160,465  
Securities held to maturity (fair value 3/31/12: $29,269; 12/31/11: $29,723)
    28,130       28,770  
Loans, net of allowance for loan losses, 3/31/12: $9,287; 12/31/11: $9,650)
    505,366       498,936  
Foreclosed assets
    20,672       17,040  
Premises and equipment, net
    7,518       7,491  
Bank owned life insurance
    16,722       16,565  
Accrued interest receivable
    2,344       2,401  
Other assets
    10,546       11,112  
Total assets
  $ 781,354     $ 773,504  
                 
Liabilities and Shareholders' Equity
               
Liabilities:
               
Non-interest bearing deposits
  $ 20,875     $ 17,903  
Interest bearing deposits
    618,510       612,805  
Total deposits
    639,385       630,708  
                 
Federal funds purchased and securities sold under agreements to repurchase
    15,730       18,646  
FHLB borrowings
    43,000       43,000  
Junior subordinated debentures
    16,496       16,496  
Accrued interest payable
    505       533  
Other liabilities
    4,261       4,008  
Total liabilities
    719,377       713,391  
                 
Shareholders' equity:
               
Preferred stock, no par value; 10,000,000 shares authorized; 16,019 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively.  Liquidation Value $1,000.
    15,705       15,661  
Common stock, no par value; 10,000,000 shares authorized; 4,742,095 shares issued and outstanding at March 31, 2012 and 4,711,123 shares issued and outstanding at December 31, 2011
    23,789       23,654  
Retained earnings
    21,546       20,131  
Accumulated other comprehensive income
    937       667  
Total shareholders' equity
    61,977       60,113  
Total liabilities and shareholders' equity
  $ 781,354     $ 773,504  
                 
See accompanying notes to consolidated financial statements
               

VALLEY FINANCIAL CORPORATION
 
 
(In 000s, except share and per share data)
 
   
Three Months Ended
(Unaudited)
 
   
3/31/2012
   
3/31/2011
 
Interest income
           
Interest and fees on loans
  $ 6,728     $ 7,051  
Interest on securities - taxable
    1,081       1,013  
Interest on securities - nontaxable
    133       160  
Interest on deposits in banks
    12       19  
Total interest income
    7,954       8,243  
Interest expense
               
Interest on deposits
    1,276       1,794  
Interest on borrowings
    341       429  
Interest on junior subordinated debentures
    101       93  
Interest on federal funds purchased and securities sold under agreements to repurchase
    11       11  
Total interest expense
    1,729       2,327  
Net interest income
    6,225       5,916  
Provision for loan losses
    -       (436 )
Net interest income after provision for loan losses
    6,225       6,352  
Noninterest income
               
Service charges on deposit accounts
    351       331  
Income earned on bank owned life insurance
    157       143  
Mortgage fee income
    132       67  
Brokerage fee income, net
    271       55  
Realized gain on sale of securities reclassified from other comprehensive income
    40       14  
Other  income
    80       31  
Total noninterest income
    1,031       641  
Noninterest expense
               
Compensation expense
    2,630       2,347  
Occupancy and equipment expense
    377       393  
Data processing expense
    285       273  
Advertising and marketing expense
    88       79  
Insurance expense
    300       1,047  
Professional fees
    223       461  
State franchise taxes
    107       124  
Foreclosed asset expense, net
    273       199  
Other operating expense
    588       535  
Total noninterest expense
    4,871       5,458  
Income before income taxes
    2,385       1,535  
Income tax expense
    726       434  
Net income
  $ 1,659     $ 1,101  
Preferred dividends and accretion of discounts on warrants
    244       242  
Net income available to common shareholders
  $ 1,415     $ 859  
Earnings per share
               
Basic earnings per common share
  $ 0.30     $ 0.18  
Diluted earnings per common share
  $ 0.30     $ 0.18  
Weighted average common shares outstanding
    4,729,429       4,688,286  
Diluted average common shares outstanding
    4,782,557       4,714,961  
Dividends declared per common share
  $ -     $ -  
                 
See accompanying notes to consolidated financial statements
               
 
             
VALLEY FINANCIAL CORPORATION
 
Consolidated Statements of Comprehensive Income
 
(In 000s)
 
             
             
 
Three Months Ended (Unaudited)
 
   
3/31/2012
   
3/31/2011
 
Net Income
  $ 1,659     $ 1,101  
Other Comprehensive income:
               
Unrealized gains on securities:
               
Unrealized holding gains arising during period
    453       1,136  
Tax related to unrealized gains
    (154 )     (386 )
Reclassification adjustment for gains included in net income
    (40 )     (14 )
Tax related to realized gains
    14       5  
Holding gains on securities transferred to HTM from AFS:
               
Holding gains amortized during period
    (4 )     -  
Tax related to amortized holding gains
    1       -  
Total other comprehensive income
    270       741  
Total comprehensive income
  $ 1,929     $ 1,842  
                 
See accompanying notes to consolidated financial statements
               


 
             
VALLEY FINANCIAL CORPORATION
 
 
(In 000s)
 
 
Three Months Ended
(Unaudited)
 
   
3/31/2012
   
3/31/2011
 
Cash flows from operating activities
           
Net income
  $ 1,659     $ 1,101  
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
               
Provision for loan losses
    -       (436 )
Depreciation and amortization of bank premises, equipment and software
    174       186  
Net amortization of bond premiums/discounts
    530       380  
Stock compensation expense
    133       56  
Net gains on sale of securities
    (40 )     (14 )
Net losses and impairment writedowns on foreclosed assets and premises
    70       111  
Increase in value of life insurance contracts
    (157 )     (143 )
Decrease in other assets
    676       1,329  
Increase in other liabilities
    225       323  
Net cash and cash equivalents provided by operating activities
    3,270       2,893  
Cash flows from investing activities
               
Purchases of bank premises, equipment and software
    (219 )     (162 )
Purchases of securities available-for-sale
    (46,170 )     (12,897 )
Proceeds from maturities, calls, and paydowns of securities available-for-sale
    38,270       16,091  
Proceeds from maturities, calls, and paydowns of securities held-to-maturity
    609       995  
Proceeds from sale of foreclosed assets
    162       1,708  
Capitalized costs related to foreclosed assets
    (477 )     -  
(Increase) decrease in loans, net
    (9,852 )     6,566  
Net cash and cash equivalents provided by / (used in) investing activities
    (17,677 )     12,301  
Cash flows from financing activities
               
Increase (decrease) in non-interest bearing deposits
    2,972       (729 )
Increase in interest bearing deposits
    5,705       30,062  
Proceeds from borrowings
    -       15,000  
Principal repayments of borrowings
    -       (15,000 )
Increase (decrease) in securities sold under agreements to repurchase
    (2,916 )     262  
Net proceeds from issuance of common stock
    2       -  
Cash dividends paid
    (200 )     -  
Net cash and cash equivalents provided by financing activities
    5,563       29,595  
Net increase (decrease) in cash and cash equivalents
    (8,844 )     44,789  
                 
Cash and cash equivalents at beginning of period
    30,724       24,312  
Cash and cash equivalents at end of period
  $ 21,880     $ 69,101  
Supplemental disclosure of cash flow information
               
        Cash paid during the period for interest
  $ 1,757     $ 2,368  
        Cash paid during the period for income taxes
  $ -     $ -  
Noncash financing and investing activities
               
        Transfer of loans to foreclosed property
  $ 3,387     $ 1,602  
See accompanying notes to consolidated financial statements.
               
 
 
7

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 1.  Organization and Summary of Significant Accounting Policies

Valley Financial Corporation (the "Company") was incorporated under the laws of the Commonwealth of Virginia on March 15, 1994, primarily to serve as a holding company for Valley Bank (the "Bank"), which opened for business on May 15, 1995. The Company's fiscal year end is December 31.

The consolidated financial statements of the Company conform to generally accepted accounting principles and to general banking industry practices. The interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments of a normal recurring nature which are necessary for a fair presentation of the consolidated financial statements herein have been included. The consolidated financial statements herein should be read in conjunction with the Company's 2011 Annual Report on Form 10-K.

Interim financial performance is not necessarily indicative of performance for the full year.

The Company reports its activities as a single business segment.

Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Subsequent Events
In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure.


Recent and Future Accounting Considerations

None.


Note 2.  Securities

The carrying values, unrealized gains, unrealized losses, and approximate fair values of available-for-sale and held-to-maturity investment securities at March 31, 2012 are shown in the tables below. As of  March 31, 2012, investments (including both available-for-sale and held-to-maturity) and restricted equity securities with amortized costs and fair values of $66,987 and $68,742 respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as required or permitted by law.



 
8

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 2.  Securities, continued

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale (“AFS”) as of March 31, 2012 and December 31, 2011 were as follows:
 
                         
   
Amortized
   
Unrealized
   
Unrealized
       
March 31, 2012
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 7,791     $ 3     $ (10 )   $ 7,784  
Government-sponsored enterprises *
    29,583       103       (98 )     29,588  
Mortgage-backed securities
    106,039       1,138       (102 )     107,075  
Collateralized mortgage obligations
    16,249       159       (18 )     16,390  
States and political subdivisions
    7,260       131       (52 )     7,339  
    $ 166,922     $ 1,534     $ (280 )   $ 168,176  
 
                         
   
Amortized
   
Unrealized
   
Unrealized
       
December 31, 2011
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 2,770     $ 2     $ -     $ 2,772  
Government-sponsored enterprises *
    38,748       131       (37 )     38,842  
Mortgage-backed securities
    98,836       836       (182 )     99,490  
Collateralized mortgage obligations
    15,280       125       (15 )     15,390  
States and political subdivisions
    3,990       -       (19 )     3,971  
    $ 159,624     $ 1,094     $ (253 )   $ 160,465  

* Such as FNMA, FHLMC and FHLB.

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity (“HTM”) as of March 31, 2012 and December 31, 2011 were as follows:
 
                         
   
Amortized
   
Unrealized
   
Unrealized
       
March 31, 2012
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 8,642     $ 192     $ -     $ 8,834  
Mortgage-backed securities
    312       23       -       335  
Collateralized mortgage obligations
    2,314       118       -       2,432  
States and political subdivisions
    16,862       806       -       17,668  
    $ 28,130     $ 1,139     $ -     $ 29,269  


                         
   
Amortized
   
Unrealized
   
Unrealized
       
December 31, 2011
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 8,981     $ 160     $ -     $ 9,141  
Mortgage-backed securities
    346       25       -       371  
Collateralized mortgage obligations
    2,555       126       -       2,681  
States and political subdivisions
    16,888       653       (11 )     17,530  
    $ 28,770     $ 964     $ (11 )   $ 29,723  
 
 
9

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 2.  Securities, continued

The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $2,140 and $2,247 as of March 31, 2012.  The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $2,358 and $2,472 as of December 31, 2011.

The following tables present the maturity ranges of securities available-for-sale and held-to-maturity as of March 31, 2012 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.
 
Investment Portfolio Maturity Distribution
 
                                     
   
Available-for-Sale
   
Held-to-Maturity
 
   
Amortized
   
Fair
         
Amortized
   
Fair
       
In thousands
 
Costs
   
Value
   
Yield
   
Costs
   
Value
   
Yield
 
U.S. Government and federal agency:
                                   
Less than one year
  $ 200     $ 201       1.38 %   $ -     $ -       -  
After five but within ten years
    3,048       3,048       2.66 %     4,718       4,837       3.45 %
After ten years
    4,543       4,535       3.53 %     3,924       3,997       3.20 %
Government-sponsored enterprises:
                                               
After one but within five years
    5,500       5,572       2.00 %     -       -       -  
After five but within ten years
    12,083       12,065       2.66 %     -       -       -  
After ten years
    12,000       11,951       3.53 %     -       -       -  
Obligations of states and subdivisions:
                                               
After one but within five years
    -       -       -       599       627       3.90 %
After five but within ten years
    261       263       2.55 %     4,648       4,844       4.31 %
After ten years
    6,999       7,076       4.66 %     11,615       12,197       4.32 %
Mortgage-backed securities
    106,039       107,075       2.49 %     312       335       4.63 %
Collateralized mortgage obligations
    16,249       16,390       2.03 %     2,314       2,432       5.62 %
Total
  $ 166,922     $ 168,176             $ 28,130     $ 29,269          
                                                 
Total Securities by Maturity Period
                                               
Less than one year
  $ 200     $ 201             $ -     $ -          
After one but within five years
    5,500       5,572               599       627          
After five but within ten years
    15,392       15,376               9,366       9,681          
After ten years
    23,542       23,562               15,539       16,194          
Mortgage-backed securities*
    106,039       107,075               312       335          
Collateralized mortgage obligations*
    16,249       16,390               2,314       2,432          
Total by Maturity Period
  $ 166,922     $ 168,176             $ 28,130     $ 29,269          


 
10

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 2.  Securities, continued

*  Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms due to early repayments of principal.

The following tables detail unrealized losses and related fair values in the Bank’s available-for-sale and held-to-maturity investment securities portfolios.  This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2012 and December 31, 2011, respectively.
 
Temporarily Impaired Securities in AFS Portfolio
 
                                     
In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
March 31, 2012
 
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
U.S. Government and federal agency
  $ 2,010     $ (10 )   $ -     $ -     $ 2,010     $ (10 )
Government-sponsored enterprises *
    15,902       (98 )     -       -       15,902       (98 )
Mortgage-backed securities
    34,763       (102 )     -       -       34,763       (102 )
Collateralized mortgage obligations
    4,191       (18 )     -       -       4,191       (18 )
States and political subdivisions
    2,990       (52 )     -       -       2,990       (52 )
    $ 59,856     $ (280 )   $ -     $ -     $ 59,856     $ (280 )

 
                                     
In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
December 31, 2011
 
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
Government-sponsored enterprises *
  $ 10,558     $ (30 )   $ 2,993     $ (7 )   $ 13,551     $ (37 )
Mortgage-backed securities
    42,828       (182 )     -       -       42,828       (182 )
Collateralized mortgage obligations
    6,884       (14 )     16       (1 )     6,900       (15 )
States and political subdivisions
    3,971       (19 )     -       -       3,971       (19 )
    $ 64,241     $ (245 )   $ 3,009     $ (8 )   $ 67,250     $ (253 )

There were no securities with unrealized losses in the HTM portfolio at March 31, 2012.


                                     
Temporarily Impaired Securities in HTM Portfolio
 
                                     
In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
December 31, 2011
 
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
States and political subdivisions
  $ 1,005     $ (11 )   $ -     $ -     $ 1,005     $ (11 )
    $ 1,005     $ (11 )   $ -     $ -     $ 1,005     $ (11 )


 
11

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 2.  Securities, continued

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At March 31, 2012, there are no securities in the portfolio with unrealized losses for a period greater than 12 months.


Note 3.  Loans and Allowance for Loan and Lease Losses

The major components of loans in the consolidated balance sheets at March 31, 2012 and December 31, 2011 are as follows:


             
In thousands
 
3/31/2012
   
12/31/2011
 
Commercial
  $ 89,192     $ 87,711  
Real estate:
               
Commercial real estate
    256,553       257,578  
Construction real estate
    39,774       36,081  
Residential real estate
    124,479       122,450  
Consumer
    4,238       4,314  
Deferred loan fees, net
    417       452  
Gross loans
    514,653       508,586  
                 
Allowance for loan losses
    (9,287 )     (9,650 )
Net loans
  $ 505,366     $ 498,936  

Substantially all one-four family residential and commercial real estate loans collateralize the line of credit available from the Federal Home Loan Bank and substantially all commercial and construction loans collateralize the line of credit with the Federal Reserve Bank of Richmond Discount Window.  The aggregate amount of deposit overdrafts that have been reclassified as loans and included in the consumer category in the above table as of March 31, 2012 and December 31, 2011 was $181 and $74, respectively.

Loan Origination.  The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a periodic basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts

 
12

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 3.  Loans and Allowance for Loan and Lease Losses, continued

receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate market or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus income producing loans. At March 31, 2012, approximately 44% of the outstanding
principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties and 49% was secured by income-producing properties.

With respect to construction and development loans that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by recurring on-site inspections during the construction phase and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential real estate loans are secured by deeds of trust on 1-4 family residential properties.  The Bank also serves as a broker for residential real estate loans placed in the secondary market.  There are occasions when a borrower or the real estate does not qualify under secondary market criteria, but the loan request represents a reasonable credit risk.  On these occasions, if the loan meets the Bank’s internal underwriting criteria, the loan will be closed and placed in the Company’s portfolio.  Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of collateral.

The Company routinely makes consumer loans, both secured and unsecured, for financing automobiles, home improvements, education, and personal investments.  The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit decision.  Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property.  Negative changes in a

customer’s financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk.  In addition, deterioration in collateral value can add risk to consumer loans.

Risk Management. It is the Company’s policy that loan portfolio credit risk shall be continually evaluated and categorized on a consistent basis.  The Board of Directors recognizes that commercial, commercial real estate and construction lending involve varying degrees of risk, which must be identified, managed, and monitored through established risk rating procedures.  Management’s ability to accurately segment the loan portfolio by the various degrees of risk enables the

 
13

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 3.  Loans and Allowance for Loan and Lease Losses, continued

Bank to achieve the following objectives:

1.           Assess the adequacy of the Allowance for Loan and Lease Losses
2.           Identify and track high risk situations and ensure appropriate risk management
3.           Conduct portfolio risk analysis and make informed portfolio planning and strategic decisions.
4.   Provide risk profile information to management, regulators and independent accountants as requested in a timely manner.

There are three levels of accountability in the risk rating process:
1.
Risk Identification -  The primary responsibility for risk identification lies with the account officer.  It is the account officer's responsibility for the initial and ongoing risk rating of all notes and commitments in his or her portfolio.  The account officer is the one individual who is closest to the credit relationship and is in the best position to identify changing risks.  Account officers are required to continually review the risk ratings for their credit relationships and make timely adjustments, up or down, at the time the circumstances warrant a change.  Account officers are responsible for ensuring that accurate and timely risk ratings are maintained at all times.   Account officers are allowed a maximum 30-day period to assess current financial information (e.g. prepare credit analysis) which may influence the current risk rating. Account officers are required to review the risk ratings of loans assigned to their portfolios on a monthly basis and to certify to the accuracy of the ratings.  Certifications are submitted to the Chief Credit Officer and Chief Lending Officer for review.  All risk rating changes (upgrades and downgrades) must be approved by the Chief Credit Officer prior to submission for input onto the Fidelity Commercial Loan System.
2.
Risk Supervision -  In addition to the account officer’s process of assigning and managing risk ratings, the Chief Credit Officer is responsible for periodically reviewing the risk rating process employed by lending officers.  Through credit administration, the Chief Credit Officer manages the credit process which, among other things, includes maintaining and managing the risk identification process.  The Chief Credit Officer is responsible for the accuracy and timeliness of account officer risk ratings and has the authority to override account officer risk ratings and initiate rating changes, if warranted.  Upgrades from a criticized or classified category to a pass category or upgrades within the criticized/classified categories require the approval of the Senior Loan Committee or Directors’ Loan Committee based upon aggregate exposure. Upgrades must be reported to the Directors' Loan Committee and Board of Directors at their next scheduled meetings.
3.
Risk Monitoring - Valley Bank has a loan review program to provide an independent validation of portfolio quality. This independent review is intended to assess adherence to underwriting guidelines, proper credit analysis and documentation.  In addition, the loan review process is required to test the integrity, accuracy, and timeliness of account officer risk ratings and to test the effectiveness of the credit administration function's controls over the risk identification process.  Portfolio quality and risk rating accuracy are evaluated during regularly scheduled portfolio reviews.  Risk Management is required to report all loan review findings to the quarterly joint meeting of the Audit Committee and Directors’ Loan Committee.

Related party loans.  In the ordinary course of business, the Company has granted loans to certain directors, executive officers, significant shareholders and their affiliates (collectively referred to as “related parties”). These loans were made on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other unaffiliated persons, and do not involve more than normal credit risk or present other unfavorable features.




 
14

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 3.  Loans and Allowance for Loan and Lease Losses, continued

Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following schedule is an aging of past due loans receivable by portfolio segment as of March 31, 2012 and December 31, 2011:


                                           
In thousands
 
30 - 59 Days
Past Due
   
60 - 89 Days
Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
   
Current
   
Total Loans
   
Recorded Investment > 90 Days and Accruing
 
March 31, 2012
                                         
Commercial
  $ 871     $ -     $ 494     $ 1,365     $ 87,827     $ 89,192     $ -  
Commercial real estate
                                                       
Owner occupied
    7,008       502       -       7,510       104,149       111,659       -  
Income producing
    -       -       -       -       126,966       126,966       -  
Multifamily
    -       -       -       -       17,928       17,928       -  
Construction real estate
                                                       
1 - 4 Family
    -       469       -       469       17,976       18,445       -  
Other
    565       1,527       3,965       6,057       13,769       19,826       -  
Farmland
    -       -       -       -       1,503       1,503       -  
Residential real estate
                                                       
Equity Lines
    130       400       -       530       29,717       30,247       -  
1 - 4 Family
    1,038       138       755       1,931       86,710       88,641       225  
Junior Liens
    -       -       -       -       5,591       5,591       -  
Consumer
                                                       
Credit Cards
    7       -       -       7       1,347       1,354       4  
Other
    3       1       3       7       2,877       2,884       -  
Deferred loan fees, net
    -       -       -       -       417       417       -  
Total
  $ 9,622     $ 3,037     $ 5,217     $ 17,876     $ 496,777     $ 514,653     $ 229  











 
15

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)



Note 3.  Loans and Allowance for Loan and Lease Losses, continued


                                           
In thousands
 
30 - 59 Days
Past Due
   
60 - 89 Days
Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
   
Current
   
Total Loans
   
Recorded Investment > 90 Days and Accruing
 
December 31, 2011
                                         
Commercial
  $ 93     $ 813     $ 1,957     $ 2,863     $ 84,848     $ 87,711     $ -  
Commercial real estate
                                                       
Owner occupied
    1,265       495       1,012       2,772       110,697       113,469       -  
Income producing
    -       -       808       808       129,333       130,141       -  
Multifamily
    -       -       -       -       13,968       13,968       -  
Construction real estate
                                                       
1 - 4 Family
    -       -       -       -       11,171       11,171       -  
Other
    -       569       3,713       4,282       19,266       23,548       -  
Farmland
    -       -       -       -       1,362       1,362       -  
Residential real estate
                                                       
Equity Lines
    164       -       -       164       30,241       30,405       -  
1 - 4 Family
    775       -       93       868       86,284       87,152       -  
Junior Liens
    1       -       -       1       4,892       4,893       -  
Consumer
                                                       
Credit Cards
    10       -       -       10       1,345       1,355       -  
Other
    15       -       -       15       2,944       2,959       4  
Deferred loan fees, net
    -       -       -       -       452       452       -  
Total
  $ 2,323     $ 1,877     $ 7,583     $ 11,783     $ 496,803     $ 508,586     $ 4  

The increase in past dues for the quarter are primarily concentrated in the 30 – 59 day category.  It should be noted that 93% of the loans included in this category are also carried as impaired and as such have been individually evaluated for loss exposure as part of the Company’s ALLL determination.  Two large relationships added close to $7 million in this category at March 31, 2012.  The Company is currently in negotiations with both borrowers on work-out solutions that if successful, will bring both current during the second quarter of 2012.

Nonaccrual Loans.  Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Loans will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of collection.  In this case, the loan will continue to accrue interest despite its past due status.  When interest accrual is discontinued, all unpaid accrued interest is reversed and any subsequent payments received are applied to the outstanding principal balance. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  The following is a schedule of loans receivable, by portfolio segment, on nonaccrual status as of March 31, 2012 and December 31, 2011:


 
16

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 3.  Loans and Allowance for Loan and Lease Losses, continued
 
             
In thousands
 
March 31, 2012
   
December 31, 2011
 
Commercial
  $ 625     $ 2,183  
Commercial real estate
               
Owner occupied
    -       1,013  
Income producing
    -       808  
Construction real estate
               
1 - 4 Family
    469       471  
Other
    3,965       3,713  
Residential real estate
               
Equity Lines
    63       64  
1 - 4 Family
    990       334  
Junior Liens
    48       49  
Consumer
               
Other
    3       3  
Total
  $ 6,163     $ 8,638  

Had nonaccrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income in the amount of $126 during the three-months ended March 31, 2012; $550 during the year ended December 31, 2011, and $152 during the three-months ended March 31, 2011.  There were twelve restructured loans totaling $2,301 at March 31, 2012 and there were twelve restructured loans totaling $2,305 at December 31, 2011.

Impaired Loans.  Impaired loans are identified by the Company as loans in which it is determined to be probable that the borrower will not make interest and principal payments according to the contract terms of the loan.  In determining impaired loans, our credit administration department reviews past-due loans, examiner classifications, Bank classifications, and a selection of other loans to provide evidence as to whether the loan is impaired.  All loans rated as substandard are evaluated for impairment by the Bank’s Allowances for Loan and Lease Losses (“ALLL”) Committee.  Once classified as impaired, the ALLL Committee individually evaluates the total loan relationship, including a detailed collateral analysis, to determine the reserve appropriate for each one.  Any potential loss exposure identified in the collateral analysis is set aside as a specific reserve (valuation allowance) in the allowance for loan and lease losses.  If the impaired loan is subsequently resolved and it is determined the reserve is no longer required, the specific reserve will be taken back into income on the income statement for the period the determination is made.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Impaired loans as of March 31, 2012 and December 31, 2011 are set forth in the following table:

 
 
17

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)


Note 3.  Loans and Allowance for Loan and Lease Losses, continued


                               
In thousands
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
March 31, 2012
                             
With no related allowance:
                             
Commercial
  $ 2,532     $ 2,743     $ -     $ 3,134     $ 29  
Commercial real estate
                                       
Owner occupied
    13,466       13,466       -       13,543       217  
Income producing
    1,304       1,304       -       1,304       16  
Multifamily
    -       -       -       -       -  
Construction real estate
                                       
1 - 4 Family
    1,787       1,667       -       1,657       18  
Other
    3,155       4,790       -       2,910       25  
Farmland
    333       333       -       334       5  
Residential real estate
                                       
Equity Lines
    628       630       -       665       7  
1 - 4 Family
    6,042       6,614       -       6,465       70  
Junior Liens
    18       18       -       18       -  
Consumer
                                       
Credit Cards
    -       -       -       -       -  
Other
    14       14       -       15       -  
Total loans with no allowance
  $ 29,279     $ 31,579     $ -     $ 30,045     $ 387  
                                         
With an allowance recorded:
                                       
Commercial
    110       229       113       230       -  
Construction real estate
                                       
1 - 4 Family
    422       490       47       490       -  
Other
    1,902       3,741       1,839       3,741       11  
Residential real estate
                                       
1 - 4 Family
    947       1,040       92       1,043       13  
Junior Liens
    19       49       28       49       -  
Total loans with an allowance
  $ 3,400     $ 5,549     $ 2,119     $ 5,553     $ 24  
                                         
Total:
                                       
Commercial
    2,642       2,972       113       3,364       29  
Commercial real estate
    14,770       14,770       -       14,847       233  
Construction real estate
    7,599       11,021       1,886       9,132       59  
Residential real estate
    7,654       8,351       120       8,240       90  
Consumer
    14       14       -       15       -  
Totals
  $ 32,679     $ 37,128     $ 2,119     $ 35,598     $ 411  
 
 
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2012 (Unaudited)
(In thousands, except share and per share data)
 
Note 3.  Loans and Allowance for Loan and Lease Losses, continued
 
                               
In thousands
 
Recorded Investment
   
Unpaid Principal Balance