PINX:CZBT Citizens Bancorp of Virginia Inc 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
──────
 [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

or

[   ] 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: 0-50576

CITIZENS BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)

Virginia
(State of incorporation or organization)
 
20-0469337
(I.R.S. Employer Identification No.)
126 South Main Street
Blackstone, VA  23824
(434) 292-7221
 (Address and telephone number of principal executive offices)
 

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  R   No  £

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 (§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  R   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
£
Smaller Reporting Company
R
 
(Do not check if smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes  £    No  R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  2,312,047 shares of Common Stock as of May 4, 2012.
 



 
 

 

 
FORM 10-Q
 
For the Period Ended March 31, 2012
 
TABLE OF CONTENTS
 
Part I.    
Financial Information
Page No.
     
Item 1.
Financial Statements
 
   
Consolidated Balance Sheets
3
   
Consolidated Statements of Income
4
   
Consolidated Statements of Comprehensive Income
5
   
Consolidated Statements of Changes in Stockholders’ Equity
6
   
Consolidated Statements of Cash Flows
7
   
Notes to Interim Consolidated Financial Statements
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition
 
 
    and Results of Operations
32
     
Item 4.     
Controls and Procedures
44
     
Part II.     
Other Information
 
     
Item 1.
Legal Proceedings
45
     
Item 1A.
Risk Factors
45
     
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
45
     
Item 3.
Defaults upon Senior Securities
46
     
Item 4.
Mine Safety Disclosures
46
     
Item 5.
Other Information
46
     
Item 6.
Exhibits
46
   
Signatures
47

 
2

 

Part I.  Financial Information
 
Item 1.  Financial Statements
 
Consolidated Balance Sheets
 
(Dollars in thousands, except per share data)
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Assets
 
(Unaudited)
   
 
 
             
Cash and due from banks
  $ 6,528     $ 6,124  
Interest-bearing deposits in banks
    2,585       2,606  
Federal funds sold
    18,267       10,445  
Securities available for sale, at fair market value
    87,957       84,512  
Restricted securities, at cost
    933       933  
Loans, net of allowance for loan losses of $2,407
               
and $2,352
    195,649       197,363  
Premises and equipment, net
    6,746       6,790  
Accrued interest receivable
    1,615       1,635  
Other assets
    1,875       2,357  
Bank owned life insurance
    8,519       8,446  
Other real estate owned, net of valuation allowance of $45 in 2012
               
    and $191 in 2011
    7,325       7,430  
                 
Total assets
  $ 337,999     $ 328,641  
Liabilities and Stockholders' Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
  $ 45,013     $ 37,079  
Interest-bearing
    234,408       234,518  
Total deposits
  $ 279,421     $ 271,597  
FHLB advances
    5,000       5,000  
Other borrowings
    7,017       6,009  
Accrued interest payable
    520       608  
Accrued expenses and other liabilities
    3,788       3,581  
Total liabilities
  $ 295,746     $ 286,795  
                 
Commitments and Contingencies
    -       -  
                 
Stockholders' Equity
               
   Preferred stock, $0.50 par value; authorized 1,000,000 shares;
               
       none outstanding
  $ -     $ -  
Common stock, $0.50 par value; authorized 10,000,000 shares;
               
issued and outstanding, 2,312,047 in 2012 and
    1,156       1,163  
2,326,242 in 2011
               
Retained earnings
    40,842       40,533  
Accumulated other comprehensive income, net
    255       150  
Total stockholders' equity
  $ 42,253     $ 41,846  
                 
Total liabilities and stockholders' equity
  $ 337,999     $ 328,641  
                 
See accompanying Notes to Interim Consolidated Financial Statements.
 

 
3

 
 
CITIZENS BANCORP OF VIRGINIA, INC.
Consolidated Statements of Income (Unaudited)
(Dollars in thousands, except per share data)

             
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
Interest and Dividend Income
           
  Loans, including fees
  $ 3,148     $ 3,241  
  Investment securities:
               
Taxable
    340       484  
Tax-exempt
    261       258  
  Federal Funds sold
    7       7  
  Other
    9       4  
Total interest and dividend income
  $ 3,765     $ 3,994  
                 
Interest Expense
               
  Deposits
  $ 693     $ 982  
  Other borrowings
    31       38  
Total interest expense
  $ 724     $ 1,020  
                 
      Net interest income
  $ 3,041     $ 2,974  
                 
Provision for loan losses
    75       150  
                 
Net interest income after provision
               
       for loan losses
  $ 2,966     $ 2,824  
                 
Noninterest Income
               
  Service charges on deposit accounts
  $ 229     $ 239  
  Other-than-temporary impairment on securities
               
(no additional amounts were recognized in other
         
    comprehensive income)
    (28 )     -  
  Net gain on sales of loans
    42       14  
  Income from bank owned life insurance
    73       72  
  ATM fee income
    207       182  
  Other
    71       49  
Total noninterest income
  $ 594     $ 556  
                 
Noninterest Expense
               
  Salaries and employee benefits
  $ 1,403     $ 1,369  
  Net occupancy expense
    142       149  
  Equipment expense
    92       122  
  FDIC deposit insurance
    69       201  
  Net (gain) on sale of other real estate owned
    (99 )     (7 )
  Impairment - other real estate owned
    45       -  
  OREO expenses, net of rental income
    65       8  
  Other
    643       585  
Total noninterest expense
  $ 2,360     $ 2,427  
 
               
       Income before income taxes
  $ 1,200     $ 953  
                 
       Income taxes
    291       219  
                 
       Net income
  $ 909     $ 734  
Earnings per share, basic & diluted
  $ 0.39     $ 0.31  
                 
 

  See accompanying Notes to Interim Consolidated Financial Statements.
 

 
4

 


CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
 
Consolidated Statements of Comprehensive Income (Unaudited)
 
(Dollars in thousands)
 
             
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
             
Net income
  $ 909     $ 734  
Other comprehensive income:
               
  Unrealized gains on securities available
               
     for sale, net of deferred taxes of $55 and $226
  $ 87     $ 439  
  Add: reclassification adjustment on
               
     securities other-than-temporarily
               
     impaired, net of tax of ($10) and $0
    18       0  
Total other comprehensive income
  $ 105     $ 439  
                 
Comprehensive income
  $ 1,014     $ 1,173  
                 
                 
See accompanying Notes to Interim Consolidated Financial Statements.
         

 
 

 

 
 
(The remainder of this page is blank, intentionally.)
 

 
5

 

 

CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
 
                         
Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
 
For the Three Months Ended March 31, 2012 and 2011
 
                         
(Dollars in thousands)
 
                         
               
Accumulated
       
               
Other
       
               
Compre-
       
               
hensive
       
   
Common
   
Retained
   
Income
       
   
Stock
   
Earnings
   
(Loss)
   
Total
 
                         
Balance at December 31, 2010
  $ 1,177     $ 39,308     $ (848 )   $ 39,637  
   Net Income
    -       734       -       734  
     Other comprehensive income, net of taxes
    -       -       439       439  
Shares repurchased
    (3 )     (63 )     -       (66 )
Cash dividends declared ($0.17 per share)
    -       (399 )     -       (399 )
Balance at March 31, 2011
  $ 1,174     $ 39,580     $ (409 )   $ 40,345  
                                 
                                 
Balance at December 31, 2011
  $ 1,163     $ 40,533     $ 150     $ 41,846  
   Net income
    -       909       -       909  
     Other comprehensive income, net of taxes
    -       -       105     $ 105  
Shares repurchased
    (7 )     (207 )     -       (214 )
Cash dividends declared ($0.17 per share)
    -       (393 )     -       (393 )
Balance at March 31, 2012
  $ 1,156     $ 40,842     $ 255     $ 42,253  
                                 
 

 
See accompanying Notes to Interim Consolidated Financial Statements.

 
6

 

 

CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
 
 
 
Consolidated Statements of Cash Flows (Unaudited)
 
(Dollars in thousands)
 
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
Cash Flows from Operating Activities
           
  Net Income
  $ 909     $ 734  
  Adjustments to reconcile net income to net cash
               
     provided by operating activities:
               
         Depreciation
    120       271  
         Provision for loan losses
    75       150  
         Net (gain) on sales of loans
    (42 )     (14 )
         Origination of loans held for sale
    (2,691 )     (1,002 )
         Proceeds from sales of loans
    2,733       1,016  
         Other than temporary impairment of securities
    28       -  
         Net amortization of securities
    111       74  
         Impairment of other real estate owned
    45       -  
         Net (gain) on sale of other real estate owned
    (99 )     (7 )
         Changes in assets and liabilities:
               
             Decrease in accrued interest receivable
    20       109  
             Decrease in other assets
    354       35  
             (Decrease) increase in accrued interest payable
    (88 )     23  
             Increase in accrued expenses and other liabilities
    207       541  
         Net cash provided by operating activities
  $ 1,682     $ 1,930  
Cash Flows from Investing Activities
               
  Activity in available for sale securities:
               
         Calls and sales
  $ 1,036       3,125  
         Maturities and prepayments
    3,689       2,321  
         Purchases
    (8,149 )     (8,963 )
  Net decrease (increase) in loans
    1,243       (772 )
  Purchases of land, premises and equipment
    (68 )     (239 )
  Proceeds from sale of other real estate owned
    547       42  
         Net cash (used in) investing activities
  $ (1,702 )   $ (4,486 )
Cash Flows from Financing Activities
               
  Net increase (decrease) in deposits
  $ 7,824     $ (2,051 )
  Net increase in other borrowings
    1,008       1,365  
  Repurchase of common stock
    (214 )     (66 )
  Dividends paid
    (393 )     (399 )
         Net cash provided by (used in) financing activities
  $ 8,225     $ (1,151 )
         Net increase (decrease) in cash and cash equivalents
  $ 8,205     $ (3,707 )
Cash and Cash Equivalents
               
  Beginning of period
    19,175       22,744  
  End of period
  $ 27,380     $ 19,037  
Supplemental Disclosures of Cash Flow Information
               
  Cash paid during the period for:
               
      Interest
  $ 812     $ 997  
      Income Taxes
  $ -     $ -  
Supplemental Disclosures of Noncash Investing and
               
   Financing Activities
               
      Other real estate acquired in settlement of loans
  $ 396     $ 135  
      Unrealized gains on securities available for sale
  $ 160     $ 665  
                 
 
 See accompanying Notes to Interim Consolidated Financial Statements
 

 
7

 

 
Notes to Interim Consolidated Financial Statements
(Unaudited)
 
Note 1.    General
 
 
The Consolidated Balance Sheets at March 31, 2012 and December 31, 2011, the Consolidated Statements of Income for the three months ended March 31, 2012 and March 31, 2011, the Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and March 31, 2011, and the Consolidated Statements of Changes in Stockholders’ Equity and Cash Flows for the three months ended March 31, 2012 and 2011, were prepared in accordance with instructions for Form 10-Q, and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. However, in the opinion of Management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position at March 31, 2012 and the results of operations for the three months ended March 31, 2012 and 2011. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Citizens Bancorp of Virginia, Inc. Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for the three-month period ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year.
 
Citizens Bancorp of Virginia, Inc. (the “Company”) is a one-bank holding company formed on December 18, 2003.  The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the “Bank”).  The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System.   The Bank was incorporated in 1873 under the laws of Virginia.  Deposits are insured by the Federal Deposit Insurance Corporation.  As of March 31, 2012 the Bank employed 108 full-time employees. The address of the principal offices for the Company and the main office of the Bank is 126 South Main Street, Blackstone, Virginia, and all banking offices are located within the Commonwealth of Virginia.
 
 
 Note 2.   Securities
 
 
Investment decisions are made by the Management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company.  Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement, balance sheet and liquidity needs.  Securities available for sale are summarized below:
 
   
March 31, 2012
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
(Losses)
   
Value
 
U.S. government and
 
(Dollars in thousands)
 
     federal agency
  $ 10,467     $ 24     $ (19 )   $ 10,472  
State and municipal
    31,138       1,620       (38 )     32,720  
Agency mortgage-backed
    41,426       1,330       (18 )     42,738  
Non-agency mortgage-backed
    1,390       6       (225 )     1,171  
Corporate
    753       103       -       856  
Securities available for sale
  $ 85,174     $ 3,083     $ (300 )   $ 87,957  
                                 
 
 
8

 
   
December 31, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
(Losses)
   
Value
 
U.S. government
 
(Dollars in thousands)
 
   and federal agency
  $ 8,004     $ 35     $ (1 )   $ 8,038  
State and municipal
    31,029       1,519       (19 )     32,529  
Agency mortgage-backed
    40,456       1,272       (17 )     41,711  
Non-agency mortgage-backed
    1,647       -       (248 )     1,399  
Corporate
    753       82       -       835  
Securities available for sale
  $ 81,889     $ 2,908     $ (285 )   $ 84,512  
                                 
 
 
The amortized cost and fair value of securities available for sale by contractual maturity at March 31, 2012 follows. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties.
 
   
Amortized
   
Fair
 
   
Cost
   
Value
 
   
(Dollars in thousands)
 
Maturing within one year
  $ 2,578     $ 2,593  
Maturing after one year through five years
    6,035       6,182  
Maturing after five years through ten years
    10,160       10,563  
Maturing after ten years
    23,585       24,710  
Agency mortgage-backed securities
    41,426       42,738  
Non-agency mortgage-backed securities
    1,390       1,171  
Securities available for sale
  $ 85,174     $ 87,957  
                 

 
Information pertaining to securities with gross unrealized losses at March 31, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is summarized as follows:
 
   
Less than 12 Months
   
12 Months or More
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2012
 
Value
   
(Loss)
   
Value
   
(Loss)
 
   
(Dollars in thousands)
 
U.S. government
                       
and federal agency
  $ 4,945     $ (19 )   $ -     $ -  
State and municipal
    1,957       (38 )     -       -  
Agency mortgage-backed
    4,483       (18 )     -       -  
Non-agency mortgage-backed
    101       (1 )     783       (224 )
Total temporarily
                               
impaired securities
  $ 11,486     $ (76 )   $ 783     $ (224 )
                                 
 
 
9

 
   
Less than 12 Months
   
12 Months or More
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2011
 
Value
   
(Loss)
   
Value
   
(Loss)
 
   
(Dollars in thousands)
 
U.S. government
                       
and federal agency
  $ 999     $ (1 )   $ -     $ -  
State and municipal
    1,397       (15 )     503       (4 )
Agency mortgage-backed
    4,897       (17 )     -       -  
Non-agency mortgage-backed
    569       (3 )     830       (245 )
Total temporarily
                               
impaired securities
  $ 7,862     $ (36 )   $ 1,333     $ (249 )
                                 
 
Except as explained below, the unrealized losses in the investment portfolio as of March 31, 2012 are considered temporary and are a result of general market fluctuations that occur daily.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to (1) the intent of the Company to sell the security, (2) whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, and (3) whether the Company expects to recover the securities entire amortized cost basis regardless of the Company’s intent to sell the security. With the exception of the Company’s investment in non-agency CMO securities, unrealized losses in the investment portfolio are considered temporary. The discussion regarding the OTTI analysis for the non-agency CMO securities is discussed below in greater detail.
 
 
In the Company’s Form 10-K report for December 31, 2011, management discussed its ongoing review of five non-agency collateralized mortgage obligations, also referred to as CMOs, four of which had credit agency ratings that were below investment grade as of December 31, 2011. Management’s analysis for the first quarter of 2012 was performed with reported data as of January 2012. This analysis indicated that four of the non-agency CMOs remain rated below investment grade, according to the Moody’s and Standard & Poor’s credit rating agencies. Management’s analysis also indicated that all five securities have made consistent monthly payments through January 31, 2012. As of January 31, 2012, the five securities showed a net unrealized loss of 14.3% of the $1.7 million book value, which is a decline of 140 basis points from the 12.9% net unrealized loss on $1.9 million of book value at October 31, 2011.
 
 
Management’s first quarter review of the non-agency CMO securities resulted in the conclusion that an additional impairment of $28,000 was needed for two of the securities due to a decline in credit quality and earlier than projected “date of first loss”, beyond the cumulative credit-related other-than-temporary-impairment (OTTI) write-down of $110,000 that has been recorded to date. Previously, management recorded a $60,000 write-down as of December 31, 2009, $40,000 as of June 30, 2011 and an additional $10,000 as of December 31, 2011. The data used for the stress testing model includes: the most current “delinquency pipeline” statistics, actual losses realized from the sale of foreclosed properties, and the level of borrower repayments that have been experienced over the life of the CMO security, to date. The credit-related other-than-temporary-impairment estimate of $138,000, which was computed by the stress testing model, is believed to be a conservative estimate of future losses in three of the five non-agency CMOs. There are a number of factors that management considers when determining a proper OTTI level for each of the CMOs, among them are: the projected date of first loss, the remaining credit support and coverage ratio for each CMO. Consideration is also given to general economic conditions that impact the borrowers and their homes, such as refinancing opportunities for jumbo mortgage borrowers, mortgage interest rates, home values, etc.
 
 
10

 
 
A roll-forward of the OTTI amount related to credit losses on debt securities for the period ended March 31, 2012 is as follows:
 
   
(Dollars in thousands)
 
       
Cumulative credit losses recognized in earnings, through the
     
   beginning of the period
  $ 110  
         
Recognition of credit losses for which an OTTI was not
       
   previously recognized
    28  
         
Cumulative credit losses recognized in earnings, through the
       
   beginning of the period
  $ 138  
         
 
 
Federal Home Loan Bank Stock
 
The Bank’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $777 thousand at March 31, 2012. FHLB stock is generally viewed as a long-term restricted investment security which is carried at cost, because there is no market for the stock other than for the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider this investment to be other than temporarily impaired at March 31, 2012 and no impairment has been recognized on the Federal Home Loan Bank stock.
 
Note  3.           Loans
 
The loan portfolio was composed of the following:
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(Dollars in thousands)
 
Residential Real Estate:
           
   1-4 family
  $ 85,055     $ 86,073  
   Home equity
    12,713       13,068  
Commercial Real Estate:
               
   Owner occupied
    22,767       23,203  
   Non-owner occupied
    30,332       29,595  
Farmland
    9,788       9,782  
Construction
    16,563       15,939  
        Total real estate
    177,218       177,660  
                 
Commercial & industrial loans
    13,219       13,700  
Consumer loans
    7,619       8,355  
        Total loans
  $ 198,056     $ 199,715  

 
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 the Board of Directors approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board 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.
 
The Company has six loan portfolio level segments and eight loan class levels for reporting purposes.
 
The six loan portfolio level segments include:
 
 
 
11

 
 
 
 
·
Residential real estate loans are loans made to borrowers for the purchase of residential dwellings.
 
 
·
Commercial real estate loans are loans made to business entities for the purchase of real estate and buildings that will be used in the business.
 
 
·
Farmland loans are loans made to farming entities to acquire land used for agricultural purposes such as in the cultivation of crops or livestock.
 
 
·
Construction and land development loans are loans made to individuals or developers in order to construct homes, develop raw land into buildable acreage, or for commercial construction purposes.
 
 
 
·
Commercial and industrial loans are loans made to small and medium-sized businesses for any number of reasons especially working capital. Loans are typically secured by inventory, business equipment, furniture or receivables and they are frequently guaranteed by principals of the business.
 
 
·
Consumer loans are loans made to individuals and the loans may be secured by personal property or be unsecured.
 
Residential real estate loans, including home equity loans and lines of credit, are subject to underwriting standards that are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, debt-to-income ratios, credit history, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. The Company tracks the concentrations in 1-4 family loans secured by a first deed of trust and home equity loans and lines of credit separately.   While many of the statutory requirements are for the protection of the consumer, underwriting standards aid at mitigating the risks to the Company by setting acceptable loan-approval standards that marginal borrowers may not meet. Additional risk mitigating factors include: residential real estate typically serves as a borrower’s primary residence which encourages timely payments and the avoidance of foreclosure, the average dollar amount of a loan is typically less than that of a commercial real estate loan, and there are a large number of loans which help to diversify the risk potential.
 
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 markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry.  Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. Management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately 42.88% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties. This is a decrease from 43.95% at December 31, 2011.
 
Farmland loans are subject to underwriting standards and processes similar to commercial real estate loans. The loans are considered primarily on the borrower’s ability to make payments originating primarily from the cash flow of the business and secondarily as loans secured by real estate.
 
With respect to construction, land and land development loans that are secured by non-owner occupied properties, 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 with independent appraisal reviews, lease rates and financial analysis of the borrowers. Construction loans are generally based upon estimates of costs and value associated with the complete project. 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 on-site inspections 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.
 
 
12

 
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 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.
 
To monitor and manage consumer loan risk, policies and procedures are developed and modified by credit administration and senior management. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, debt-to-income ratios, credit history, and the number of such loans a borrower can have at one time.
 
The Company maintains a credit review department that reviews and validates the credit risk program on a periodic basis. In addition, the Company’s Audit and Risk Management Committee contracts with an independent loan review consulting firm the work of reviewing, among other things, loan relationships exceeding $250,000, a sample of loans underwritten within the authority of loan officers, and the risk grading of criticized and classified assets with a balance in excess of $100,000. The firm provides a report to the Audit and Risk Management Committee upon the completion of their annual review. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
 
Concentrations of Credits
 
Most of the Company’s lending activity occurs within the Commonwealth of Virginia, more specifically within the South-Central Virginia markets that include Richmond. The majority of the Company’s loan portfolio consists of residential and commercial real estate loans. A substantial portion of its debtors’ ability to honor their contracts and the Company’s ability to realize the value of any underlying collateral, if needed, is influenced by the economic conditions in this market. As of March 31, 2012, there were no concentrations of commercial real estate loans related to any individual purpose that was in excess of 6.31% of total loans.
 
Nonaccrual and Past Due Loans
 
All loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due in accordance with the contractual terms of the underlying loan agreement. 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. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Aging and nonaccrual loans, by individual loan class, as of March 31, 2012 and December 31, 2011 were as follows:
 
 
13

 
 
   
Loans
   
Loans
                     
Accruing Loans
       
   
30 - 89 Days
   
Loans 90 or
More Days
   
Total Past Due
   
Current
   
Total
   
90 or More
Days
   
Nonaccrual
 
At March 31, 2012
 
Past Due
   
Past Due
   
Loans
   
Loans
   
Loans
   
Loans 1
   
Loans 1
 
Residential Real Estate:
 
(In thousands)
 
    1-4 family
  $ 1,622     $ 570     $ 2,192     $ 82,863     $ 85,055     $ -     $ 1,347  
    Home equity
    8       49       57       12,656       12,713       -       362  
Commercial Real Estate
                                                       
    Owner occupied
    243       11       254       22,513       22,767               11  
    Non-owner occupied
    142       35       177       30,155       30,332               35  
Farmland
    -       4       4       9,784       9,788       -       4  
Construction
    210       211       421       16,142       16,563       -       303  
Total real estate
    2,225       880       3,105       174,113       177,218       -       2,062  
Commercial and industrial
    22       116       138       13,081       13,219       -       116  
Consumer
    45       30       75       7,544       7,619       -       41  
                                                         
           Total loans
  $ 2,292     $ 1,026     $ 3,318     $ 194,738     $ 198,056     $ -     $ 2,219  
 
   
Loans
   
Loans
                     
Accruing Loans
       
   
30 - 89 Days
   
Loans 90 or
More Days
   
Total Past Due
   
Current
   
Total
   
90 or More
Days
   
Nonaccrual
 
At December 31, 2011
 
Past Due
   
Past Due
   
Loans
   
Loans
   
Loans
   
Loans 1
   
Loans 1
 
Residential Real Estate:
 
(In thousands)
 
    1-4 family
  $ 1,698     $ 1,017     $ 2,715     $ 83,358     $ 86,073     $ -     $ 1,170  
    Home equity
    86       49       135       12,933       13,068       -       49  
Commercial Real Estate
                                                       
    Owner occupied
    7       13       20       23,183       23,203       -       13  
    Non-owner occupied
    -       468       468       29,127       29,595       -       468  
Farmland
    -       5       5       9,777       9,782       -       5  
Construction
    94       214       308       15,631       15,939       -       214  
Total real estate
    1,885       1,766       3,651       174,009       177,660       -       1,919  
Commercial and industrial
    27       118       145       13,555       13,700       -       118  
Consumer
    115       20       135       8,220       8,355       -       49  
                                                         
           Total loans
  $ 2,027     $ 1,904     $ 3,931     $ 195,784     $ 199,715     $ -     $ 2,086  
 
1Accruing loans 90 or more days past due and nonaccrual loans are included in the aging and current loan columns of the tables based on their contractual payments above.
 
Impaired Loans
 
Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, which represents either the present value of estimated future cash flows using the loans existing rate or the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
 
 
14

 
Impaired loans, by class, as of March 31, 2012 and December 31, 2011 are shown in the tables below:
 
   
Loans
                         
At March 31, 2012
 
Unpaid Contractual
   
Total
         
Average
   
Interest
 
With no related allowance
 
Principal
Balance
   
Recorded Investment
   
Related Allowance
   
Recorded Investment
   
Income 
Recognized
 
Residential Real Estate:
 
(In thousands)
       
    1-4 family
  $ 584     $ 584     $ -     $ 591     $ 10  
    Home equity
    -       -       -       -       -  
Commercial Real Estate:
                                       
    Owner occupied
    43       11       -       11       1  
    Non-owner occupied
    80       32       -       35       1  
Farmland
    1,380       1,377       -       1,377       26  
Construction
    94       87       -       88       2  
Commercial and industrial
    110       107       -       106       2  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 2,291     $ 2,198     $ -     $ 2,208     $ 42  
With an allowance recorded
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 340     $ 331     $ 106     $ 332     $ 6  
    Home equity
    350       349       116       349       1  
Commercial Real Estate:
                                       
    Owner occupied
    -       -       -       -       -  
    Non-owner occupied
    -       -       -       -       -  
Farmland
    -       -       -       -       -  
Construction
    127       125       37       125       3  
Commercial and industrial
    13       10       5       10       -  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 830     $ 815     $ 264     $ 816     $ 10  
Total impaired loans1
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 924     $ 915     $ 106     $ 923     $ 16  
    Home equity
    350       349       116       349       1  
Commercial Real Estate:
                                       
        Owner occupied
    43       11       -       12       1  
        Non-owner occupied
    80       32       -       35       1  
Farmland
    1,380       1,377       -       1,377       26  
Construction
    221       212       37       212       5  
Commercial and industrial
    123       117       5       116       2  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 3,121     $ 3,013     $ 264     $ 3,024     $ 52  
                                         
 
 
15

 
 
   
Loans
                         
At December 31, 2011
 
Unpaid Contractual
   
Total
         
Average
   
Interest
 
With no related allowance
 
Principal
Balance
   
Recorded Investment
   
Related Allowance
   
Recorded Investment
   
Income 
Recognized
 
Residential Real Estate:
 
(In thousands)
       
    1-4 family
  $ -     $ -     $ -     $ -     $ -  
    Home equity
    301       300       -       300       10  
Commercial Real Estate:
                                       
    Owner occupied
    43       13       -       101       10  
    Non-owner occupied
    85       35       -       41       5  
Farmland
    1,382       1,377       -       1,381       104  
Construction
    307       302       -       330       23  
Commercial and industrial
    282       279       -       280       8  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 2,400     $ 2,306     $ -     $ 2,433     $ 160  
With an allowance recorded
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 176     $ 168     $ 88     $ 304     $ 21  
    Home equity
    50       49       4       49       2  
Commercial Real Estate:
                                       
    Owner occupied
    -       -       -       -       -  
    Non-owner occupied
    446       427       14       442       35  
Farmland
    -       -       -       -       -  
Construction
    127       125       38       127       10  
Commercial and industrial
    14       11       5       13       1  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 813     $ 780     $ 149     $ 935     $ 69  
Total impaired loans1
                                       
Residential Real Estate:
                                       
    1-4 family
  $ 176     $ 168     $ 88     $ 304     $ 21  
    Home equity
    351       349       4       349       12  
Commercial Real Estate:
                                       
        Owner occupied
    43       13       -       101       10  
        Non-owner occupied
    531       462       14       483       40  
Farmland
    1,382       1,377       -       1,381       104  
Construction
    434       427       38       457       33  
Commercial and industrial
    296       290       5       293       9  
Consumer installment
    -       -       -       -       -  
           Total loans
  $ 3,213     $ 3,086     $ 149     $ 3,368     $ 229  
                                         
1 Troubled Debt Restructurings included in the impaired loan tables above at March 31, 2012
 
and December 31, 2011 totaled $139 thousand and $472 thousand respectively.
         
 
Troubled Debt Restructurings
 
As a result of adopting the amendments in ASU 2011-02 on July 1, 2011, the Company reassessed all loans that were renewed on or after January 1, 2011 for identification as a troubled debt restructuring (“TDR”). The Company identified as troubled debt restructurings certain loans for which impairment had previously been measured collectively within their homogeneous pool. Upon identifying those loans as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective evaluation of the impairment measurement guidance for those receivables newly identified as impaired. The impact of this new guidance did not have a material impact on the Company’s non-performing assets, allowance for loan losses, earnings, or capital.
 
 
16

 
The Company considers troubled debt restructurings to be impaired loans. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. Included in the impaired loan disclosure above is a loan for $139 thousand that is considered to be a troubled debt restructuring as of March 31, 2012. Any loan that is considered to be a TDR is specifically evaluated for impairment in accordance with the Company’s allowance for loan loss methodology.
 
The following table provides a summary of modified loans that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing as of March 31, 2012 (dollars in thousands):
 
   
Three Months Ended
 
   
March 31, 2012
 
                   
         
Pre
   
Post
 
   
Number of
   
Modification
   
Modification
 
   
Loans
   
Balance
   
Balance
 
Real estate loans:
                 
    1-4 family
    1     $ 174     $ 139  
    Home equity
    -       -       -  
Commercial real estate loans:
                       
         Owner occupied
    -       -       -  
         Non-owner occupied
    -       -       -  
    Farmland
    -       -       -  
    Construction
    -       -       -  
Total real estate loans
    1     $ 174     $ 139  
                         
Commercial and industrial
    -       -       -  
Consumer
    -       -       -  
                         
           Total loans
    1     $ 174     $ 139  
                         
 
 
The Company had no Troubled Debt Restructurings that were modified during the last twelve months that have gone into default under the restructured loan terms during the three months ended March 31, 2012.
 
Credit Quality
 
The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows:
 
Grade 1 – “Excellent” This grade includes loans to borrowers with superior capacity to pay interest and principal. Foreseeable economic changes are unlikely to impair the borrowers’ strength. Typically, borrowers have an excellent organizational structure in place with highly regarded and experienced management.  Stable business, relatively unaffected by business, credit, or product cycles.  Business is significant in its market and has a well-defined market share. Borrower will have ready access to both public debt and equity markets under most conditions. Collateral is highly liquid, substantial margins are maintained, and primary/secondary sources of repayment are excellent.
 
Grade 2 – “Good” This grade includes loans to borrowers that represent a solid, demonstrated capacity to pay interest and principal, but material downturns in economic conditions may impact the borrowers’ financial condition. Typically, borrowers exhibit low levels of leverage and the overall capitalization of the company is deemed satisfactory. Trends for revenue, core profitability and financial ratios are consistently above average with industry peers. Cash flow adequately covers dividends/withdrawals, and historic debt service in excess of 1.5 times. Collateral coverage is greater
 
 
17

 
 
than 2.0 times or less than 50% loan-to-value ratio. Borrower has a stable, well-regarded and qualified management team in place, along with strong financial controls being evident. Normal industry stability, sales and profits are affected by business, credit or product cycles.  Market share is stable. Borrower has the capability to refinance with another institution.
 
Grade 3 – “Standard” This grade includes loans to borrowers which have historically demonstrated an above adequate capacity to repay forecasted principal and interest charges, with debt service coverage of 1.20 times based on at least two years of historical earnings. Borrowers have inherent, definable weaknesses; however the weaknesses are not necessarily uncommon to a particular business, loan type or industry. Changes in economic circumstances could have non-material immediate repercussions on the borrowers’ financial condition. Collateral support is deemed to be satisfactory based on appropriate discount factoring to allow a recovery sufficient to pay-off the debt. Collateral could be reasonably collected and/or liquidated in the general market. Additional collateral may be deemed an abundance of caution. Earnings are generally positive, subject to influences of current market conditions and distributions are reasonable in relation to the overall financial picture of the company. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full, if needed.
 
Grade 4 – “Acceptable” This grade includes loans to borrowers that will have inherent, definable weaknesses, however these weaknesses are not necessarily uncommon to a particular business, loan type, or industry. Economic changes could have negative repercussions on the financial condition. Borrowers overall financial position would indicate financing in the market is feasible, at rates and terms typical of current market conditions. Debt service coverage is deemed acceptable at 1.00 to 1.19 times on a combined basis for at least two years of historical earnings. Borrowers exhibit moderately high to high levels of leverage as noted against policy and Risk Management Association industry averages. Tangible net worth is marginally positive or even showing signs of a deficit net worth. Collateral support is deemed to be acceptable or even marginal, but not strong based on appropriate discounting, asset quality may be questionable given specific nature of assets, and often secondary non-business assets are required. Earnings are marginally positive or a trend of negative earnings is identified and distributions are considered to be in excess of reasonableness. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full if needed. Repayment history also shows a discernable level of delinquent payments.
 
Grade 5 – This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.
 
Grade 6 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.
 
Grade 7 – This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not have been stopped. This grade also includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but does not exceed 30% of the principal balance.
 
Grade 8 – This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.
 
Grade 9 – This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be repaid, nor does it in any way imply that there has been a forgiveness of debt.
 
 
18

 
 
The following tables present credit quality by loan class as of March 31, 2012 and December 31, 2011.
 
               
Special
                         
At March 31, 2012
 
Pass
   
Watch
   
Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
Residential Real Estate:
 
(In thousands)
 
    1-4 family
  $ 77,349     $ 2,898     $ 1,747     $ 3,061     $ -     $ -     $ 85,055  
Home equity
    11,791       519       41       362       -       -       12,713  
Commercial Real Estate:
                                                       
Owner occupied
    19,881       1,687       1,188       11       -       -       22,767  
Non-owner occupied
    28,898       1,095       304       35       -       -       30,332  
Farmland
    7,402       516       494       1,376       -       -       9,788  
Construction
    15,530       485       246       230       72       -       16,563  
Total real estate loans
    160,851       7,200       4,020       5,075       72       -       177,218  
Commercial and industrial
    10,412       1,419       1,272