XNAS:XBKS Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

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

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: 000-53380

 

 

Xenith Bankshares, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia   80-0229922

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

One James Center

901 E. Cary Street, Suite 1700

Richmond, Virginia

  23219
(Address of principal executive offices)   (Zip Code)

(804) 433-2200

(Registrant’s telephone number, including area code)

N/A

(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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant 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  x    No  ¨

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.

 

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

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

The number of shares of Common Stock, par value $1.00 per share, outstanding at May 1, 2012 was 10,446,928.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  
PART I - FINANCIAL INFORMATION   

Item 1 Financial Statements

     1   

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

     20   

Item 3 Quantitative and Qualitative Disclosures About Market Risk

     36   

Item 4 Controls and Procedures

     36   
PART II - OTHER INFORMATION   

Item 1 Legal Proceedings

     36   

Item 1A Risk Factors

     36   

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

     36   

Item 3 Defaults Upon Senior Securities

     36   

Item 4 Mine Safety Disclosures

     36   

Item 5 Other Information

     36   

Item 6 Exhibits

     37   

SIGNATURES

  


Table of Contents

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2012 AND DECEMBER 31, 2011

 

(in thousands, except share data)    (Unaudited)
March 31, 2012
    December 31, 2011  

Assets

    

Cash and cash equivalents

    

Cash and due from banks

   $ 41,320      $ 50,540   

Federal funds sold

     2,067        5,255   
  

 

 

   

 

 

 

Total cash and cash equivalents

     43,387        55,795   

Securities available for sale, at fair value

     67,142        68,466   

Loans held for sale

     29,098        —     

Loans held for investment, net of allowance for loan and lease losses, 2012 - $4,137; 2011 - $4,280

     324,980        321,859   

Premises and equipment, net

     5,884        6,009   

Other real estate owned

     478        808   

Goodwill and other intangible assets, net

     16,263        16,354   

Accrued interest receivable

     1,528        1,475   

Other assets

     6,430        6,699   
  

 

 

   

 

 

 

Total assets

   $ 495,190      $ 477,465   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Deposits

    

Demand and money market

   $ 247,908      $ 228,031   

Savings

     3,593        3,517   

Time

     140,762        143,459   
  

 

 

   

 

 

 

Total deposits

     392,263        375,007   

Accrued interest payable

     289        351   

Borrowings

     20,000        20,000   

Other liabilities

     2,051        1,803   
  

 

 

   

 

 

 

Total liabilities

     414,603        397,161   
  

 

 

   

 

 

 

Shareholders’ equity

    

Preferred stock, $1.00 par value, 25,000,000 shares authorized as of March 31, 2012 and December 31, 2011; 8,381 shares issued and outstanding as of March 31, 2012 and December 31, 2011

     8,381        8,381   

Common stock, $1.00 par value, 100,000,000 shares authorized as of March 31, 2012 and December 31, 2011; 10,446,928 shares issued and outstanding as of March 31, 2012 and December 31, 2011

     10,447        10,447   

Additional paid-in capital

     71,025        70,964   

Accumulated deficit

     (10,659     (10,950

Accumulated other comprehensive income, net of tax

     1,393        1,462   
  

 

 

   

 

 

 

Total shareholders’ equity

     80,587        80,304   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 495,190      $ 477,465   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Table of Contents

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(Unaudited)

 

(in thousands, except per share data)    March 31, 2012     March 31, 2011  

Interest income

    

Interest and fees on loans

   $ 5,616      $ 2,786   

Interest on securities

     468        478   

Interest on federal funds sold

     39        2   
  

 

 

   

 

 

 

Total interest income

     6,123        3,266   
  

 

 

   

 

 

 

Interest expense

    

Interest on deposits

     680        182   

Interest on time certificates of $100,000 and over

     285        170   

Interest on federal funds purchased and borrowed funds

     92        148   
  

 

 

   

 

 

 

Total interest expense

     1,057        500   
  

 

 

   

 

 

 

Net interest income

     5,066        2,766   

Provision for loan and lease losses

     360        970   
  

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     4,706        1,796   
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     59        45   

Net (loss) gain on sale and write-down of OREO

     (9     61   

Gain on sales of investment securities

     219        —     

Other

     86        40   
  

 

 

   

 

 

 

Total noninterest income

     355        146   
  

 

 

   

 

 

 

Noninterest expense

    

Compensation and benefits

     2,938        2,086   

Occupancy

     389        356   

FDIC insurance

     90        70   

Bank franchise taxes

     150        60   

Technology

     416        286   

Communications

     72        66   

Insurance

     75        30   

Professional fees

     247        212   

Travel

     53        27   

OREO expenses

     2        83   

Supplies

     38        33   

Amortization of intangible assets

     91        30   

Other expenses

     188        77   
  

 

 

   

 

 

 

Total noninterest expense

     4,749        3,416   
  

 

 

   

 

 

 

Income (loss) before income tax expense

     312        (1,474

Income tax expense

     —          —     
  

 

 

   

 

 

 

Net income (loss)

     312        (1,474
  

 

 

   

 

 

 

Preferred stock dividend

     (21     —     
  

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 291      $ (1,474
  

 

 

   

 

 

 

Other comprehensive income:

    

Net unrealized (loss) gain on available-for-sale securities, net of tax

     (15     261   

Net unrealized loss on derivative, net of tax

     (54     —     
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ 243      $ (1,213
  

 

 

   

 

 

 

Earnings (loss) per common share (basic and diluted):

   $ 0.03      $ (0.25
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(Unaudited)

 

(in thousands)    March 31, 2012     March 31, 2011  

Cash flows from operating activities

    

Net income (loss)

   $ 312      $ (1,474

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     321        274   

Net amortization of securities

     181        156   

Accretion of acquisition accounting adjustments

     (684     (809

Gain on sales of securities

     (219     —     

Share-based compensation expense

     61        29   

Net loss (gain) on sale and write-down of OREO

     9        (61

Provision for loan and lease losses

     360        970   

Change in operating assets and liabilities:

    

Accrued interest receivable

     (53     (45

Other assets

     407        (272

Accrued interest payable

     (62     (28

Other liabilities

     119        (56
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     752        (1,316
  

 

 

   

 

 

 

Cash flows from investing activities

    

Proceeds from sales, maturities and calls of securities

     9,624        4,033   

Purchase of securities

     (8,278     (3,117

Net increase in loans

     (31,820     (22,913

Net proceeds from sale of OREO

     322        1,271   

Net purchase of premises and equipment

     (105     (74

Purchase of FRB and FHLB stock

     (138     (389
  

 

 

   

 

 

 

Net cash used in investing activities

     (30,395     (21,189
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in demand and savings deposits

     19,953        10,082   

Net (decrease) increase in time deposits

     (2,697     7,537   

Net decrease in federal funds purchased and borrowed funds

     —          (2,809

Preferred stock dividend

     (21     —     
  

 

 

   

 

 

 

Net cash provided by financing activities

     17,235        14,810   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (12,408     (7,695

Cash and cash equivalents

    

Beginning of period

     55,795        12,201   
  

 

 

   

 

 

 

End of period

   $ 43,387      $ 4,506   
  

 

 

   

 

 

 

Supplementary disclosure of cash flow information

    

Cash payments for:

    

Interest

   $ 118      $ 770   
  

 

 

   

 

 

 

Transfer of loans to foreclosed assets

   $ —        $ 876   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Xenith Bankshares, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

March 31, 2012

 

 

Note 1. Organization

General

Xenith Bankshares, Inc. (“Xenith Bankshares” or the “company”) is the bank holding company for Xenith Bank (the “Bank”), a Virginia-based institution headquartered in Richmond, Virginia. As of March 31, 2012, the company, through the Bank, operates six full-service branches: one branch in Tysons Corner, Virginia, two branches in Richmond, Virginia, and three branches in Suffolk, Virginia.

Background

In December 2009, First Bankshares, Inc. (“First Bankshares”), the bank holding company for SuffolkFirst Bank, and Xenith Corporation completed the merger of Xenith Corporation with and into First Bankshares (the “merger”), with First Bankshares being the surviving entity in the merger. At the effective time of the merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank. Although the merger was structured as a merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes. Accordingly, the assets and liabilities of First Bankshares were recorded at their estimated fair values in the consolidated financial statements of Xenith Bankshares as of the date of the merger.

In April 2011, the company completed the issuance and sale of 4.6 million shares of common stock at a public offering price of $4.25 per share, pursuant to an effective registration statement filed with the Securities and Exchange Commission. Net proceeds, after the underwriters’ discount and expenses, were $17.7 million.

Effective on July 29, 2011, the Bank completed the acquisition of select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office (the “Paragon Branch”) of Paragon Commercial Bank, a North Carolina banking corporation (“Paragon”), and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the Paragon Branch (the “Paragon Transaction”). The Paragon Transaction was completed in accordance with the terms of the Amended and Restated Purchase and Assumption Agreement, dated as of July 25, 2011 (the “Paragon Agreement”), between the Bank and Paragon. Under the terms of the Paragon Agreement, Paragon retained the real and personal property associated with the Paragon Branch and, following the receipt of required regulatory approvals, the Paragon Branch was closed. Under the terms of the Paragon Agreement, at the closing of the Paragon Transaction, Paragon made a cash payment to the Bank in the amount of $17.3 million, which represented the excess of approximately all of the liabilities assumed at a premium of 3.92%, over approximately all of the assets acquired at a discount of 3.77%.

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (the “FDIC”) is acting as court-appointed receiver of VBB. The VBB Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement, dated as of July 29, 2011 (the “VBB Agreement”), among the FDIC, receiver for VBB, the FDIC and the Bank. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Agreement, the Bank received a discount of approximately $23.8 million on the net assets and did not pay a deposit premium. The Bank also received a cash payment from the FDIC in the amount of $17.8 million based on the difference between the discount received ($23.8 million) and the net assets of VBB ($5.9 million). The VBB Acquisition was completed without any shared-loss agreement.

On September 21, 2011, as part of the Small Business Lending Fund of the United States Department of the Treasury (“U.S. Treasury”), the company entered into a Small Business Lending Fund - Securities Purchase Agreement (the “SBLF Purchase Agreement”) with the Secretary of the U.S Treasury, pursuant to which the company sold 8,381 shares of the company’s Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “SBLF Preferred Stock”) to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The terms of the SBLF Preferred Stock were established pursuant to an amendment to the company’s Amended and Restated Articles of Incorporation.

Note 2. Basis of Presentation

The consolidated financial statements include the accounts of Xenith Bankshares and its wholly-owned subsidiary, Xenith Bank. All significant intercompany accounts have been eliminated.

In management’s opinion, the accompanying unaudited consolidated financial statements, which have been prepared in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim period reporting, and reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial positions at

 

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March 31, 2012 and December 31, 2011, the results of operations for the three months ended March 31, 2012 and 2011, and the statements of cash flows for the three months ended March 31, 2012 and 2011. The results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2012. The unaudited consolidated financial statements and accompanying notes should be read in conjunction with the company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Certain amounts reported in prior periods’ financial statements have been reclassified to conform to the current presentation. Such reclassifications have no effect on previously reported total assets, liabilities, shareholders’ equity or net income.

All dollar amounts included in the tables in these notes are in thousands.

Note 3. Business Combinations

The company has accounted for the Paragon Transaction and the VBB Acquisition under the acquisition method of accounting, and accordingly, the acquired assets and assumed liabilities were recorded by the company at estimated fair value as of the acquisition date, which was July 29, 2011, for both acquisitions. Fair value estimates are based on management’s assessment of the best information available as of the acquisition date.

Paragon Transaction

The allocation of the consideration received to the acquired assets and assumed liabilities in the Paragon Transaction as of the acquisition date is as follows:

 

Assets acquired:

     

Cash

   $ 146      

Loans

     58,291      

Transportation equipment

     5      

Accrued interest receivable

     212      
  

 

 

    

Total assets acquired

     58,654      
  

 

 

    

Liabilities assumed:

     

Deposits

     76,550      

Accrued interest payable

     39      
  

 

 

    

Total liabilities assumed

     76,589      
  

 

 

    

Net (liabilities) assumed

      $ (17,935

Adjustments to reflect assets and liabilities at fair value:

     

Loan discount

        (1,823

Core deposit intangible

        2,470   
     

 

 

 

Transaction consideration received

      $ 17,288   
     

 

 

 

All of the loans acquired in the Paragon Transaction were performing loans as of the acquisition date. As of March 31, 2012, the remaining fair value adjustment related to the acquired loans was $1.4 million.

 

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VBB Acquisition

The allocation of the consideration received to the acquired assets and assumed liabilities in the VBB Acquisition as of the acquisition date is as follows:

 

Assets acquired:

     

Cash

   $ 19,192      

Loans

     70,893      

Other real estate owned

     1,500      

Accrued interest receivable

     254      

Other assets

     1,038      
  

 

 

    

Total assets acquired

     92,877      
  

 

 

    

Liabilities assumed:

     

Deposits

     77,525      

FHLB borrowings

     9,371      

Accrued interest payable

     46      

Other liabilities

     1      
  

 

 

    

Total liabilities assumed

     86,943      
  

 

 

    

Net assets acquired

      $ 5,934   

Adjustments to reflect assets and liabilities at fair value:

     

Loan discount

        (13,964

Other real estate owned discount

        (620

FHLB borrowing

        (514
     

 

 

 

Net (liabilities) acquired after fair value adjustments

        (9,164

Transaction consideration received

        17,822   
     

 

 

 

Bargain purchase gain

        8,658   

Deferred tax liability

        (2,944
     

 

 

 

Bargain purchase gain, net of tax

      $ 5,714   
     

 

 

 

The following table presents the purchased loans receivable at the date of the VBB Acquisition and the fair value adjustment recorded immediately following the acquisition:

 

     Purchased
Performing
    Purchased
Impaired
    Total  

Contractual principal payments receivable

   $ 30,671      $ 40,222      $ 70,893   

Fair value adjustment

   $ (1,274     (12,690     (13,964
  

 

 

   

 

 

   

 

 

 

Fair value of acquired loans

   $ 29,397      $ 27,532      $ 56,929   
  

 

 

   

 

 

   

 

 

 

The remaining fair value adjustment related to the acquired loans as of March 31, 2012 was $10.0 million. The outstanding carrying value of purchased loans identified as impaired as of the acquisition date that remains outstanding as of March 31, 2012 was approximately $20.5 million.

Note 4. Restrictions of Cash

To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement for the weeks closest to March 31, 2012 and December 31, 2011 was $1.5 million, respectively.

 

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Note 5. Securities

The following tables present the book value and fair value of available-for-sale securities as of the dates stated:

 

     March 31, 2012  
            Gross Unrealized        
     Book Value      Gains      (Losses)     Fair Value  

Mortgage-backed securities

          

- Fixed rate

   $ 52,770       $ 1,164       $ (29   $ 53,905   

- Variable rate

     2,454         137         —          2,591   

Collateralized mortgage obligations

     9,342         193         —          9,535   

Trust preferred securities

     1,121         —           (10     1,111   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 65,687       $ 1,494       $ (39   $ 67,142   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2011  
            Gross Unrealized        
     Book Value      Gains      (Losses)     Fair Value  

Mortgage-backed securities

          

- Fixed rate

   $ 53,518       $ 1,254       $ (1   $ 54,771   

- Variable rate

     2,489         131         —          2,620   

Collateralized mortgage obligations

     9,866         199         —          10,065   

Trust preferred securities

     1,123         —           (113     1,010   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 66,996       $ 1,584       $ (114   $ 68,466   
  

 

 

    

 

 

    

 

 

   

 

 

 

At March 31, 2012 and December 31, 2011, the company had securities with a fair value of $7.8 million and $20.2 million, respectively, pledged as collateral for public deposits.

The following tables present fair values and the related unrealized losses in the company’s securities portfolio, with the information aggregated by investment category, and by the length of time that individual securities have been in continuous unrealized loss positions, as of the dates stated. The number of loss securities in each category is also noted.

 

     March 31, 2012  
            Less than 12 months     More than 12 months      Total  
     Number      Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Mortgage-backed securities

                   

- Fixed rate

     1       $ 4,117       $ (29   $ —         $ —         $ 4,117       $ (29

Trust preferred securities

     1         1,111         (10     —           —           1,111         (10
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

     2       $ 5,228       $ (39   $ —         $ —         $ 5,228       $ (39
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
            Less than 12 months     More than 12 months      Total  
     Number      Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Mortgage-backed securities

                   

- Fixed rate

     2       $ 5,998       $ (1   $ —         $ —         $ 5,998       $ (1

Trust preferred securities

     1         1,010         (113     —           —           1,010         (113
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

     3       $ 7,008       $ (114   $ —         $ —         $ 7,008       $ (114
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012, the company held an interest in one trust preferred security with a book value and fair value of $1.1 million. The trust preferred security had a rating of Ba1 by Moody’s Investors Service, Inc. and BB+ by Standard and Poor’s Rating Services. All other securities are investment grade. The unrealized loss positions at March 31, 2012 were directly related to interest rate movements and management believes there is minimal credit risk exposure in these investments. There is no intent to sell investments that are in an unrealized loss position at March 31, 2012, and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses. These investments are not considered to be other-than-temporarily impaired at March 31, 2012; therefore, no impairment has been recognized.

 

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Note 6. Loans

The following table presents the company’s composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total for loans held for investment as of the dates stated:

 

     March 31, 2012     December 31, 2011  
     Amount     Percent of
Total
    Amount     Percent of
Total
 

Commercial and industrial

   $ 170,548        51.82   $ 168,417        51.64

Commercial real estate

     126,882        38.55     126,525        38.80

Residential real estate

     25,560        7.77     25,847        7.93

Consumer

     6,127        1.86     5,350        1.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Loans held for investment

     329,117        100.00     326,139        100.00

Allowance for loan and lease losses

     (4,137       (4,280  
  

 

 

     

 

 

   

Loans held for investment, net of allowance

     324,980          321,859     

Loans held for sale

     29,098          —       
  

 

 

     

 

 

   

Total loans

   $ 354,078        $ 321,859     
  

 

 

     

 

 

   

Loans held for investment include unearned fees, net of capitalized origination costs, of $425 thousand and $288 thousand, as of March 31, 2012 and December 31, 2011, respectively. As of March 31, 2012, $126.4 million of loans were pledged as collateral for borrowing capacity.

Loans Held for Sale

During the first quarter of 2012, the Bank entered into a sub-participation agreement with a leading national bank (the “participating bank”) that lends to mortgage companies that originate single-family residential mortgage loans for sale in the secondary market. Pursuant to the sub-participation agreement, the Bank purchases participations from selected non-bank mortgage originators that seek funding to facilitate the origination of loans. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators deliver the loans to the investor. Typically, the Bank, together with the participating bank, purchase up to an aggregate of a 99% participation interest with the originators financing the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-15 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

Loans Held for Investment

The following table presents the company’s loans held for investment by regulatory risk ratings classification and by loan type as of the dates stated. As defined by the Federal Reserve, “special mention” loans are defined as having potential weaknesses that deserve management’s close attention; “substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any; and “doubtful” loans have all the weaknesses inherent in substandard loans, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans not categorized as special mention, substandard or doubtful are classified as “pass”.

 

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Table of Contents
     March 31, 2012  
     Pass      Special
Mention
     Substandard      Doubtful      Total Loans  

Commercial and industrial

   $ 166,892       $ 580       $ 2,750       $ 326       $ 170,548   

Commercial real estate

     106,996         9,717         10,169         —           126,882   

Residential real estate

     24,859         141         560         —           25,560   

Consumer

     5,565         371         56         —           5,992   

Overdrafts

     135         —           —           —           135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 304,447       $ 10,809       $ 13,535       $ 326       $ 329,117   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Pass      Special
Mention
     Substandard      Doubtful      Total Loans  

Commercial and industrial

   $ 165,590       $ 562       $ 1,923       $ 342       $ 168,417   

Commercial real estate

     104,493         9,650         11,837         545         126,525   

Residential real estate

     25,083         181         583         —           25,847   

Consumer

     4,966         274         45         —           5,285   

Overdrafts

     65         —           —           —           65   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 300,197       $ 10,667       $ 14,388       $ 887       $ 326,139   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for Loan and Lease Losses

The allowance for loan and lease losses consists of (1) a component for individual loan impairment recognized and measured pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 310, “Receivables” (“ASC 310”), and (2) components of collective loan impairment recognized pursuant to FASB ASC Topic 450, “Contingencies.” A loan is impaired when, based on current information and events, it is probable that all amounts due (principal and interest) according to the contractual terms of the loan agreement will not be collected.

The allowance for loan and lease losses is determined based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans as are originated by the company. In evaluating the loan portfolio, qualitative factors, such as general economic conditions, nationally and in our target markets, are considered, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors and estimates may be subject to significant change. Increases to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in the consolidated statements of operations and comprehensive income (loss). Loans deemed to be uncollectible are charged against the allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses.

In assessing the adequacy of the allowance for loan and lease losses as of the end of a reporting period, loan risk ratings are evaluated. Each loan is assigned two “risk ratings” at origination. One risk rating is based on the company’s assessment of the borrower’s financial capacity and the other is based on the assessment of the quality of collateral. In addition to the assessment of risk ratings, internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to policies and procedures, and external observable data such as industry and general economic trends is considered.

Although various data and information sources are used to establish the allowance for loan and lease losses, future adjustments to the allowance for loan and lease losses may be necessary, if conditions, circumstances or events are substantially different from the assumptions used in making the assessments. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the company’s allowance for loan and lease losses. Such agencies may require additions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.

 

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The following table presents the allowance for loan and lease loss activity, by loan category, as of the dates stated:

 

     March 31, 2012     December 31, 2011  

Balance at beginning of period

   $ 4,280      $ 1,766   

Charge-offs:

    

Commercial and industrial

     —          333   

Commercial real estate

     429        973   

Residential real estate

     —          93   

Consumer

     —          3   

Overdrafts

     3        13   
  

 

 

   

 

 

 

Total charge-offs

     432        1,415   
  

 

 

   

 

 

 

Recoveries:

    

Commercial and industrial

     —          72   

Commercial real estate

     3        12   

Residential real estate

     —          —     

Consumer

     —          —     

Overdrafts

     1        2   
  

 

 

   

 

 

 

Total recoveries

     4        86   
  

 

 

   

 

 

 

Net charge-offs

     428        1,329   
  

 

 

   

 

 

 

Additions to the allowance for loan and lease losses

     360        4,005   

Less amount for unfunded commitments

     (75     (162
  

 

 

   

 

 

 

Balance at end of period

   $ 4,137      $ 4,280   
  

 

 

   

 

 

 

The following table presents the allowance for loan and lease losses and the amount independently and collectively evaluated for impairment by loan type as of the dates stated:

 

     March 31, 2012  
     Amount      Individually
Evaluated

for  Impairment
     Collectively
Evaluated

for  Impairment
 

Balance at end of period applicable to:

        

Commercial and industrial

   $ 938       $ —         $ 938   

Commercial real estate

     3,068         908         2,160   

Residential real estate

     125         —           125   

Consumer

     6         —           6   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 4,137       $ 908       $ 3,229   
  

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Amount      Individually
Evaluated

for Impairment
     Collectively
Evaluated

for Impairment
 

Balance at end of period applicable to:

        

Commercial and industrial

   $ 748       $ —         $ 748   

Commercial real estate

     3,370         1,318         2,052   

Residential real estate

     133         —           133   

Consumer

     29         —           29   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 4,280       $ 1,318       $ 2,962   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

At March 31, 2012, there were two commercial real estate loans totaling $2.8 million that were individually evaluated for impairment. At December 31, 2011, there were three commercial real estate loans totaling $3.2 million that were individually evaluated for impairment.

Acquired loans are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in the allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that all contractually required principal and interest payments will not be collected are accounted for under FASB ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). The company has concluded that a portion of the loans acquired in the VBB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

Acquired loans for which the timing or amount of expected future cash flows cannot be predicted are accounted for on cost recovery, whereby the fair value adjustment is not recognized into income until which time the company has recovered its full carrying value of the loan receivable.

Pursuant to the merger with First Bankshares, the acquired loans were adjusted to estimated fair value with a discount of $7.6 million. As of July 29, 2011, the loans acquired in the Paragon Transaction and the VBB Acquisition were also adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively.

For acquired loans deemed impaired at acquisition (credit-impaired loans), the excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield and accreted into interest income over the remaining life of the loan, or pool of loans, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected at acquisition, on an undiscounted basis, is referred to as the nonaccretable difference. As of March 31, 2012 and December 31, 2011, the company had $308 thousand of nonaccretable difference related to the loans acquired in the VBB Acquisition.

In applying ASC 310-30 to acquired loans, the company must estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including default rates and the amount and timing of prepayments, in addition to other factors. ASC 310-30 allows the purchaser to estimate cash flows on credit-impaired loans on a loan-by-loan basis or aggregate credit-impaired loans into one or more pools if the loans have common risk characteristics. The company has estimated cash flows expected to be collected on a loan-by-loan basis.

ASC 310-30 requires periodic re-evaluation of expected cash flows for acquired credit-impaired loans subsequent to acquisition date. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The new accretable yield is recognized in income over the remaining period of expected cash flows from the loan. No changes have been made to the accretable yield estimates during the first quarter of 2012.

The following table presents the accretion activity as of the dates stated. Disposals represent reductions of discounts through the resolution of acquired loans at amounts less than the contractually owed receivable.

 

     March 31, 2012     December 31, 2011  

Balance at beginning of period

   $ 14,007      $ 3,833   

Additions

     —          15,787   

Accretion

     (684     (3,568

Disposals

     (1,524     (2,045
  

 

 

   

 

 

 

Balance at end of period

   $ 11,799      $ 14,007   
  

 

 

   

 

 

 

 

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Table of Contents

The following table presents the age analysis of loans past due as of the dates stated:

 

     March 31, 2012  
     31-90 days
Past Due
     Greater than
90 days
     Total
Past Due
 

Commercial and industrial

   $ 2,061       $ 468       $ 2,529   

Commercial real estate

     —           5,147         5,147   

Residential real estate

     321         126         447   

Consumer

     18         7         25   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,400       $ 5,748       $ 8,148   
  

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     31-90 days
Past Due
     Greater than
90 days
     Total
Past Due
 

Commercial and industrial

   $ 1,536       $ 514       $ 2,050   

Commercial real estate

     804         5,223         6,027   

Residential real estate

     269         125         394   

Consumer

     22         —           22   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,631       $ 5,862       $ 8,493   
  

 

 

    

 

 

    

 

 

 

The following table presents nonaccrual loans and other real estate owned (“OREO”) as of the dates stated. As of March 31, 2012, there were no loans past due greater than 90 days for which interest is accruing.

 

     March 31, 2012      December 31, 2011  

Commercial and industrial

   $ 468       $ 514   

Commercial real estate

     5,147         5,223   

Residential real estate

     126         125   

Consumer

     7         —     
  

 

 

    

 

 

 

Nonaccrual loans

   $ 5,748       $ 5,862   

Other real estate owned

     478         808   
  

 

 

    

 

 

 

Total nonperforming assets

   $ 6,226       $ 6,670   
  

 

 

    

 

 

 

In accordance with Accounting Standards Update (“ASU”) No. 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring”, the company assesses all restructurings for potential identification as troubled debt restructurings (“TDRs”). 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. Modifications of terms for loans that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal payments, regardless of the period of the modification. As of March 31, 2012, the company had identified three loans as TDRs, which totaled $924 thousand. Of this amount, one loan in the amount of $785 thousand was identified as a credit-impaired loan acquired in the VBB Acquisition. At December 31, 2011, one loan in the amount of $124 thousand was identified at a TDR. All loans identified as TDRs were performing loans at restructuring and as of March 31, 2012.

Note 7. Goodwill and Other Intangible Assets

Goodwill of $13.0 million and core deposit intangibles of $1.2 million were recorded in the allocation of the purchase price for the merger with First Bankshares. An additional $2.5 million of core deposit intangibles was recorded in the allocation of the consideration in the Paragon Transaction. Goodwill is not amortized, but is tested at least annually for impairment and more frequently if impairment indicators are evident. Core deposit intangible assets are being amortized over a 10-year period and are also evaluated for impairment if indicators are evident.

 

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Table of Contents

The following table presents goodwill and other intangible assets as of the dates stated:

 

     March 31, 2012     December 31, 2011  

Amortizable core deposit intangibles:

    

Gross carrying value

   $ 3,710      $ 3,710   

Accumulated amortization

     (436     (345
  

 

 

   

 

 

 

Net core deposit intangibles

   $ 3,274      $ 3,365   
  

 

 

   

 

 

 

Unamortizable goodwill

   $ 12,989      $ 12,989   
  

 

 

   

 

 

 

Total goodwill and other intangible assets, net

   $ 16,263      $ 16,354   
  

 

 

   

 

 

 

Note 8. Deposits

The following table presents a summary of deposit accounts as of the dates stated:

 

     March 31, 2012      December 31, 2011  

Noninterest-bearing demand deposits

   $ 53,304       $ 47,489   

Interest-bearing:

     

Demand and money market

     194,604         180,542   

Savings deposits

     3,593         3,517   

Time deposits of $100,000 or more

     77,721         80,742   

Other time deposits

     63,041         62,717   
  

 

 

    

 

 

 

Total deposits

   $ 392,263       $ 375,007   
  

 

 

    

 

 

 

Note 9. Derivatives

Cash Flow Hedges

The company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements. To accomplish this objective, the company is a party to an interest rate swap whereby the company pays fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreements without exchange of the underlying notional amount. As of March 31, 2012, the company had one interest rate swap with a notional amount of $20 million that is designated as a cash flow hedge, in accordance with FASB ASC Topic 815, “Derivatives and Hedging”.

The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivative is recognized directly in earnings. During the period ended March 31, 2012, the interest rate swap was used to hedge the variable cash outflows associated with a LIBOR-based borrowing. There was no ineffective portion of the derivative during this period. The amount reported in accumulated other comprehensive income as of March 31, 2012 was a loss of $62 thousand.

The company has an agreement with the counterparty to its derivative which contains a provision whereby if the company fails to maintain its status as a well/an adequately capitalized institution, the company could be required to terminate or fully collateralize the derivative contract. Additionally, if the company defaults on any of its indebtedness, including default where repayment has not been accelerated by the lender, the company could also be in default on its derivative obligations. The company has minimum collateral requirements with its counterparty and, as of March 31, 2012, $0 has been pledged as collateral under the agreement, because the valuation of the derivative has not surpassed contractually specified minimum transfer amounts. If the company is not in compliance with the terms of the derivative agreement, it could be required to settle its obligations under the agreement at termination value.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the company provides to certain customers. The company executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the company executes with a third party, thus minimizing its net exposure from such transactions. These derivatives do not meet the hedge accounting requirements; therefore, changes in the fair value of both the customer derivative and the offsetting derivative are recognized in earnings. As of

 

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Table of Contents

March 31, 2012, $16 thousand was recorded in other assets and $18 thousand was recorded in other liabilities related to non-designated hedges. For the period ended March 31, 2012, the amount recognized in net income related to non-designated hedges was insignificant. The company had no non-designated hedges prior to the first quarter of 2012.

Note 10. Income Taxes

The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income and non-deductible expenses. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes resulting in temporary differences. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit.

Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities. These differences will result in deductible or taxable amounts in a future year(s) when the reported amounts of assets or liabilities are recovered or settled. Deferred tax assets and liabilities are stated at tax rates expected to be in effect in the year(s) the differences reverse.

As of March 31, 2012, net deferred tax assets were $5.2 million, for which a full valuation allowance is recorded, based primarily on the fact that the company experienced cumulative losses over the past three years. Future realization of the tax benefit of existing deductible temporary differences and net operating loss carryforwards is dependent on the company generating sufficient future taxable income within the carryforward period, which under current law is 20 years.

Note 11. Earnings (Loss) per Common Share

The following table summarizes basic and diluted earnings (loss) per common share calculations for the periods stated. The earnings (loss) per common share calculations for the three months ended March 31, 2012 and 2011 do not include shares of common stock issuable upon the exercise of 569,307 and 354,688, of stock options outstanding as of March 31, 2012 and 2011, respectively or upon the exercise of 563,760 warrants to purchase shares of common stock outstanding as of March 31, 2012 and 2011, because the exercise of the stock options and warrants would not be dilutive.

 

     For the Three Months Ended March 31,  
     2012     2011  

Net income (loss)

   $ 312      $ (1,474

Preferred stock dividend

     (21     —     
  

 

 

   

 

 

 

Net income (loss) available to common shareholders

     291        (1,474

Weighted average number of shares outstanding

     10,467        5,847   

Earnings (loss) per common share, basic

   $ 0.03      $ (0.25
  

 

 

   

 

 

 

Earnings (loss) per common share, diluted

   $ 0.03      $ (0.25
  

 

 

   

 

 

 

Note 12. Senior Non-Cumulative Perpetual Preferred Stock

On September 21, 2011, the company sold 8,381 shares of SBLF Preferred Stock to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The SBLF Preferred Stock investment qualifies as Tier 1 capital. The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” (as defined in the SBLF Purchase Agreement) (“QSBL”) by the Bank. The initial dividend rate through September 30, 2011 was 1% per annum. For the second through ninth calendar quarters after issuance, the dividend rate may be adjusted to between 1% per annum and 5% per annum to reflect changes to the Bank’s QSBL. If the level of the Bank’s qualified small business loans declines so that the percentage increase in QSBL as compared to the baseline level of QSBL is less than 10%, then the dividend rate payable on the SBLF Preferred Stock will increase. For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between 1% and 7% based upon the increase in QSBL as of the ninth calendar quarter as compared to the baseline. After four and one half years from issuance, the dividend rate will increase to 9% per annum until the SBLF funding is repaid in full. For the period ended March 31, 2012, the company’s dividend rate was 1%, resulting in a dividend of $21 thousand.

The SBLF Preferred Stock is non-voting, except in limited circumstances. In the event that the company misses five dividend payments, whether or not consecutive, the holder of the SBLF Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the company’s board of directors. In the event that the company misses six dividend payments, whether or not consecutive, and if the then outstanding aggregate liquidation amount of the SBLF Preferred Stock is at least $25 million, then the holder of the SBLF Preferred Stock will have the right to designate two directors to the company’s board of directors.

 

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Table of Contents

The SBLF Preferred Stock may be redeemed at any time at the company’s option, in whole or in part (provided that any partial redemption is at least 25% of the original funding amount), at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of its federal banking regulator.

The terms of the SBLF Preferred Stock impose limits on the ability of the company to pay dividends and repurchase shares of its common stock. Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the company’s common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

Under the terms of the SBLF Preferred Stock, the company may only declare and pay a dividend on its common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the company’s Tier 1 Capital would be at least 90% of the Signing Date Tier 1 Capital, as set forth in the Articles of Amendment relating to the SBLF Preferred Stock, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of issuance and ending on the tenth anniversary, by 10% for each 1% increase in QSBL over the baseline level.

Note 13. Commitment and Contingencies

In the normal course of business, the Bank has commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the loan agreements. These commitments have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Additionally, the Bank issues letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. Management believes the credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

The following table presents unfunded commitments outstanding as of the dates stated:

 

     March 31, 2012      December 31, 2011  

Commercial lines of credit

   $ 67,022       $ 33,014   

Commercial real estate

     20,565         9,822   

Residential real estate

     6,577         5,915   

Consumer

     840         772   

Letters of credit

     3,194         3,050   
  

 

 

    

 

 

 

Total commitments

   $ 98,198       $ 52,573   
  

 

 

    

 

 

 

Note 14. Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

FASB ASC Topic 820, “Fair Value Measurements and Disclosure,” (“ASC 820”) establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Under the guidance in ASC 820, the company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1    Quoted prices in active markets for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2    Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3    Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value to such assets or liabilities.

 

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The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The company evaluates its hierarchy disclosures each quarter, and, based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. An adjustment to the pricing method used within either Level 1 or Level 2 inputs could generate a fair value measurement that effectively falls in a lower level in the hierarchy. The company expects changes in classifications between levels will be rare.

Securities available for sale:

Available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Other real estate owned:

Other real estate owned is measured at the asset’s fair value less costs for disposal. The company estimates fair value at the asset’s liquidation value less disposal costs using management’s assumptions, which are based on current market analysis or recent appraisals. Other real estate owned is classified as a nonrecurring Level 3 valuation.

Impaired loans:

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of March 31, 2012, substantially all of the impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the company records the impaired loan as nonrecurring Level 3.

Derivatives:

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

Although the company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2012, the company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

In conjunction with the FASB’s fair value measurement guidance, the company has elected to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Cash, cash equivalents and accrued interest:

The carrying value for cash and cash equivalents and accrued interest approximates fair value.

The methodology for measuring the fair value of other financial assets and financial liabilities that are not recorded at fair value on a recurring or nonrecurring basis are discussed below.

 

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Performing loans:

For variable-rate loans that re-price frequently and with no significant changes in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. The carrying value of loans held for sale approximates fair value.

Deposit liabilities:

The balance of demand, money market and savings deposits approximates the fair value payable on demand to the accountholder. The fair value of fixed-maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.

Borrowings:

The carrying amounts of federal funds purchased and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses at the company’s current incremental borrowing rates for similar types of borrowing arrangements. Fair values of long-term borrowings are estimated using discounted cash flow analyses using interest rates currently offered for borrowings with similar terms.

Other commitments:

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of stand-by letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date or “settlement date”.

As noted, certain assets and liabilities are measured at fair value on a recurring and nonrecurring basis. The following tables present assets measured at fair value on a recurring and nonrecurring basis as of the dates stated:

 

           Fair Value Measurements as of March 31, 2012 Using  
     March 31, 2012
Balance
    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs  (Level 3)
 

Assets and liabilities measured on a recurring basis:

        

Securities available for sale:

        

Mortgage-backed securities

        

- Fixed rate

   $ 53,905      $ 4,132      $ 49,773      $ —     

- Variable rate

     2,591        —          2,591        —     

Collateralized mortgage obligations

     9,535        —          9,535        —     

Trust preferred securities

     1,111        —          1,111        —     

Loans held for sale

     29,098        —          29,098        —     

Cash flow hedge

     (62     —          (62     —     

Interest rate derivative - asset

     16        —          16        —     

Interest rate derivative - liability

     (18     —          (18     —     

Assets measured on a nonrecurring basis:

        

Impaired loans

     6,672        —          —          6,672   

Other real estate owned

     478        —          —          478   

 

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          Fair Value Measurements as of December 31, 2011 Using  
    December 31, 2011
Balance
    Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs (Level 3)
 

Assets and liabilities measured on a recurring basis:

       

Securities available for sale:

       

Mortgage-backed securities

       

- Fixed rate

  $ 54,771      $ —        $ 54,771      $ —     

- Variable rate

    2,620        —          2,620        —     

Collateralized mortgage obligations

    10,065        4,154        5,911        —     

Trust preferred securities

    1,010        —          1,010        —     

Cash flow hedge

    (8     —          (8     —     

Assets measured on a nonrecurring basis:

       

Impaired loans

    5,986        —          —          5,986   

Other real estate owned

    808        —          —          808   

The following table presents the carrying amounts and approximate fair values of the company’s financial assets and liabilities as of the dates stated:

 

     March 31, 2012      Fair Value Measurements as of March 31, 2012 Using  
     Carrying
Amount
     Estimated
Fair Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Financial assets:

              

Cash and due from banks

   $ 41,320       $ 41,320       $ 41,320       $ —         $ —     

Federal funds sold

     2,067         2,067         —           2,067         —     

Securities available for sale

     67,142         67,142         4,132         63,010         —     

Loans held for sale

     29,098         29,098         —           29,098         —     

Loans held for investment, net

     324,980         325,692         —           —           325,692   

Interest rate derivative

     16         16         —           16         —     

Accrued interest receivable

     1,528         1,528         —           1,528         —     

Financial liabilities:

              

Cash flow hedge

   $ 62       $ 62       $ —         $ 62       $ —     

Interest rate derivative

     18         18         —           18         —     

Long-term borrowings

     20,000         20,000         —           20,000         —     

Deposits

     392,263         392,769         —           392,769         —     

Accrued interest payable

     289         289         —           289         —     

 

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     December 31, 2011      Fair Value Measurements as of December 31, 2011 Using  
     Carrying
Amount
     Estimated
Fair Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Financial assets:

              

Cash and due from banks

   $ 50,540       $ 50,540       $ 50,540       $ —         $ —     

Federal funds sold

     5,255         5,255         —           5,255         —     

Securities available for sale

     68,466         68,466         4,154         64,312         —     

Loans held for investment, net

     321,859         323,294         —           —           323,294   

Accrued interest receivable

     1,475         1,475         —           1,475         —     

Financial liabilities:

              

Cash flow hedge

   $ 8       $ 8       $ —         $ 8       $ —     

Long-term borrowings

     20,000         20,000         —           20,000         —     

Deposits

     375,007         376,026         —           376,026         —     

Accrued interest payable

     351         351         —           351         —     

Fair value estimates are made at a specific point in time and are based on relevant market information, as well as information about the financial instruments or other assets. These estimates do not reflect any premium or discount that could result from offering for sale the company’s entire holdings of a particular financial instrument at one time. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets, premises and equipment, and OREO. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Note 15. Accounting Pronouncements

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220) “Presentation of Comprehensive Income”. This ASU requires companies to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Presentation of comprehensive income in the statement of changes in stockholders’ equity will no longer be acceptable. The update does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income, the option for an entity to present components of other comprehensive income net or before related tax effects, or how earnings per share is calculated or presented. This guidance was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this standard did not have a significant impact on the company’s financial statements.

In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other (Topic 350), “Testing Goodwill for Impairment”. This standard allows companies to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The “more likely than not” threshold is defined as having a likelihood of more than 50 percent. A company is not required to calculate the fair value of a reporting unit unless it determines that it is more likely than not that its fair value is less than its carrying amount. The objective of the update is to simplify the goodwill impairment testing process in terms of both cost and complexity. The guidance becomes effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Management is in the process of assessing the effect of this standard on the company and does not anticipate the adoption of this standard will have an effect on its financial statements.

 

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

The following is management’s discussion and analysis of the company’s consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes in Part I, Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q (“Form 10-Q”) and Part II, Item 8, “Financial Statements and Supplementary Data” in the company’s Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Form 10-K”). The data presented as of March 31, 2012 and for the three-month periods ended March 31, 2012 and 2011 is derived from our unaudited interim financial statements and include, in the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the data for such period. The data presented as of December 31, 2011 is derived from our audited financial statements as of and for the year ended December 31, 2011, which is included in the 2011 Form 10-K.

All references to “Xenith Bankshares”, “our company”, “we”, “our” or “us” are to Xenith Bankshares, Inc. and its wholly-owned subsidiary, Xenith Bank, collectively. All references to “the Bank” are to Xenith Bank.

All dollar amounts included in the tables in this discussion and analysis are in thousands. Columns and rows of amount presented in tables may not total due to rounding.

BUSINESS OVERVIEW

Xenith Bankshares is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Federal Reserve. The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail banking clients, which we refer to as our target customers. We are geographically focused on the Washington, D.C.-MD-VA-WV, Richmond-Petersburg, VA, and the Norfolk-Virginia Beach-Newport News, VA-NC metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk, Virginia in the merger with First Bankshares, Inc., the parent company of its wholly-owned subsidiary SuffolkFirst Bank. SuffolkFirst Bank opened its first branch in Suffolk, Virginia in 2003 under the name of SuffolkFirst Bank. All of the former SuffolkFirst Bank branches operate under the name Xenith Bank. As of March 31, 2012, we had total assets of $495.2 million, total loans, net of the allowance for loan and lease losses, of $354.1 million, total deposits of $392.3 million and shareholders’ equity of $80.6 million.

Our services and products consist primarily of taking deposits from, and making loans to, our target customers within our target markets. We provide a broad selection of commercial and retail banking products, including commercial and industrial loans, commercial and residential real estate loans, and select consumer loans. We also offer a wide range of checking, savings and treasury products, including remote deposit capture, automated clearing house transactions, debit cards, 24-hour ATM access, and Internet banking and bill pay service. We do not engage in any activities other than banking activities.

During the first quarter of 2012, the Bank began participating in a warehouse lending program with a leading national bank (the “participating bank”) by entering into a sub-participation agreement with the participating bank. The participating bank and the Bank lend to mortgage companies that originate single-family residential mortgage loans for sale in the secondary market. Pursuant to the sub-participation agreement, the Bank purchases participations from selected non-bank mortgage originators that seek funding to facilitate the origination of loans. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators deliver the loans to the investor. Substantially all of the loans are conforming loans. Typically, the Bank, together with the participating bank, purchases up to an aggregate of a 99% participation interest with the originators financing the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-15 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis. As of March 31, 2012, we had $29.1 million in loans held for sale.

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities used to fund those assets. Interest-earning assets include loans, available-for-sale securities, and federal funds sold. Interest-bearing liabilities include deposits and borrowings. Sources of non-interest income include service charges on deposit accounts, gains on the sale of securities and other miscellaneous income. Deposits and Federal Home Loan Bank borrowed funds are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits.

Merger of First Bankshares, Inc. and Xenith Corporation

First Bankshares, Inc. (“First Bankshares”) was incorporated in Virginia in 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002.

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares (the “merger”), with First Bankshares being the surviving entity in the merger. The merger

 

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was completed in accordance with the terms of an agreement of merger and related plan of merger, dated as of May 12, 2009, as amended. At the effective time of the merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank.

Acquisitions

Effective on July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office (the “Paragon Branch”) of Paragon Commercial Bank, a North Carolina banking corporation (“Paragon”), and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the Paragon Branch (the “Paragon Transaction”). The Paragon Transaction was completed in accordance with the terms of the Amended and Restated Purchase and Assumption Agreement, dated as of July 25, 2011 (the “Paragon Agreement”), between the Bank and Paragon. Under the terms of the Paragon Agreement, Paragon retained the real and personal property associated with the Paragon Branch and, following the receipt of required regulatory approvals, the Paragon Branch was closed. At the closing of the Paragon Transaction, Paragon made a cash payment to the Bank in the amount of $17.3 million, which represented the excess of approximately all of the liabilities assumed at a premium of 3.92%, over approximately all of the assets acquired at a discount of 3.77%.

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (“FDIC”) is acting as court-appointed receiver of VBB. The VBB Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement, dated as of July 29, 2011 (the “VBB Agreement”), among the FDIC, receiver for VBB, the FDIC and the Bank.

The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Agreement, the Bank received a discount of approximately $23.8 million on the net assets and did not pay a deposit premium. The Bank also received a cash payment from the FDIC in the amount of $17.8 million based on the difference between the discount received ($23.8 million) and the net assets of VBB ($5.9 million). The VBB Acquisition was completed without any shared-loss agreement.

We believe the Paragon Transaction and the VBB Acquisition provide strategic and financial growth for the Bank, while leveraging our existing infrastructure costs.

Industry Conditions

Across the country, the recent recession and tepid recovery have impacted businesses, consumers and real estate values, and has taken a toll on banks. Since the beginning of 2009, the FDIC has closed over 400 failed banks. Georgia, Florida, California and Illinois account for over half of all the failures. In Virginia, there have been four failures, one of which was Virginia Business Bank, the assets and liabilities of which we acquired in July 2011. Besides the number of actual bank failures, the recession and weak recovery have taken a toll on many banks that are still operating. In our target markets alone, there are numerous banks that are undercapitalized, have high levels of criticized and non-performing assets, and some are under written agreements with their regulators requiring that they address their short-comings.

The Federal Open Market Committee (“FOMC”) publicly stated in April 2012 that the economy has been expanding moderately and labor market conditions have improved. However, despite some improvement, the housing sector remains depressed and the unemployment rate remains elevated. The FOMC expects moderate economic growth over the coming quarters and then to pick up gradually, as well as a gradual improvement in employment. The FOMC stated that inflation has picked up somewhat due to increases in prices of crude oil and gasoline; though, it does not predict higher inflation longer term. The FOMC expects “to maintain a highly accommodative stance for monetary policy” and that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate for at least through late 2014.” The FOMC also stated that it is maintaining its existing policy of reinvesting principal payments from its securities holdings. The unemployment rate, as published by the Bureau of Labor Statistics, was 8.2% at the end of the first quarter of 2012, which is down only slightly from 8.5% at the end of 2011.

Our nation’s unemployment and underemployment problems have led to a prolonged period of very low interest rates, squeezing the net interest margins of all banks and making it harder for banks to make a profit.

Outlook

We believe we are well positioned to take advantage of competitive opportunities. We believe that we will benefit from (1) our capital base, which we believe will allow us to compete effectively with both the larger, more established super-regional and national banks, as well as the smaller, locally managed community banks operating in our target markets, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team and board of directors. We intend to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets.

 

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In our continuing evaluation of our business strategy, we believe properly priced acquisitions can complement our organic growth. We may seek to acquire other financial institutions or branches or assets of those institutions. Although our principal acquisition focus is to expand our presence in our target markets, we may also expand into new markets or lines of business or offer new services or products. We evaluate potential acquisitions to determine what is in the best interest of our company. Our goal in making these decisions is to maximize shareholder value.

Critical Accounting Policies

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations.

We consider a policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate, and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe that our most critical accounting policy relates to the allowance for loan and lease losses, which reflects the estimated losses resulting from the inability of borrowers to make required loan payments. If the financial condition of borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan and lease losses could be required, which could have a material adverse impact on our results of operations and financial condition. Further discussion of the estimates used in determining the allowance for loan and lease losses is contained in the discussion under “ - Allowance for Loan and Lease Losses” below.

Our critical accounting policies are discussed in detail in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” and “Summary of Significant Accounting Policies” in the notes to the consolidated financial statements in our 2011 Form 10-K. Since December 31, 2011, there have been no changes in these policies that have had or could reasonably expect to have a material impact on our results of operations or financial condition.

RESULTS OF OPERATIONS

Net Income (Loss)

For the three months ended March 31, 2012, we reported net income of $0.3 million, compared to a net loss of $1.5 million for the three months ended March 31, 2011. Net income for the three-month period ended March 31, 2012 compared to the same period in 2011 was driven by greater net interest income, which increased $2.3 million, partially offset by greater noninterest expense, which increased $1.3 million. Also contributing to net income in the three-month period ended March 31, 2012 compared to the net loss for the same period of 2011 was a lower provision for loan and lease losses of $0.6 million and higher noninterest income of $0.2 million in the 2012 period.

The following table presents net income (loss) and net earnings (loss) per common share information for the periods stated. In April 2011, common shares outstanding increased 4.6 million as a result of the completion of our underwritten public offering of shares of our common stock. In September 2011, we received $8.4 million from the U.S. Department of Treasury pursuant to its Small Business Lending Fund Program (“SBLF”) and issued 8,361 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A.

 

     For the Three Months Ended March 31,  
     2012     2011  

Net income (loss)

   $ 312      $ (1,474
  

 

 

   

 

 

 

Preferred stock dividend

     (21     —     
  

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ 291      $ (1,474
  

 

 

   

 

 

 

Earnings (loss) per common share, basic and diluted

   $ 0.03      $ (0.25
  

 

 

   

 

 

 

Net Interest Income

For the three months ended March 31, 2012, net interest income was $5.1 million compared to $2.8 million for the three months ended March 31, 2011. Higher net interest income was primarily due to higher average loan and investment balances, partially offset by both lower yields on these balances and higher balances of interest-bearing liabilities. As presented in the table below, net

 

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interest margin for the three-month period ended March 31, 2012 was 4.44%, a 48 basis point decrease from 4.92% for the same period in 2011. Net interest margin is defined as the percentage of net interest income to average interest-earning assets. Excluding the effect of acquisition accounting adjustments, net interest margin for the three months ended March 31, 2012 increased 36 basis points to 3.84% from 3.48% for the same period in 2011. Higher net interest margin, excluding acquisition accounting adjustments, was primarily due to higher average investment and loan balances, partially offset by lower yields on investment balances and higher average savings and money market balances; however, these balances were at lower yields.

Average interest-earning assets and related interest income increased $231.9 million and $2.9 million, respectively, for the three-month period ended March 31, 2012 compared to the same period in 2011. Average interest-bearing liabilities and related interest expense increased $169.5 million and $557 thousand, respectively, for the three-month period ended March 31, 2012 compared to the same period in 2011. Yields on interest-earning assets decreased 45 basis points to 5.36%, while costs of interest-bearing liabilities increased 10 basis points to 1.21%, when comparing the three-month period ended March 31, 2012 to the same period in 2011.

Our loan portfolios acquired in the merger, the Paragon Transaction and VBB Acquisition were discounted to estimated fair value (for credit and interest rates) as of the acquisition dates. A portion of the discounts taken to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans or the period of expected cash flows from the loans. Amounts received in excess of the carrying value of loans accounted for on cost recovery are also accreted into interest income at the time of recovery. Loan discount accretion for the three months ended March 31, 2012 and 2011 was $684 thousand and $539 thousand, respectively. The effect of this accretion on net interest margin was 60 basis points and 96 basis points, respectively, for the three-month periods ended March 31, 2012 and 2011.

In addition, acquired time deposits were adjusted to estimated fair value at the date of the merger for interest rates. The total adjustment at the date of the merger was $2.1 million and was amortized as a reduction of interest expense over a two-year period beginning December 2009. The effect of this amortization was a decrease in interest expense of $270 thousand for the three-month period ended March 31, 2011 and no effect on the three-month period ended March 31, 2012. Excluding the effect of this fair value adjustment, the cost of interest-bearing liabilities decreased 49 basis points in the period ended March 31, 2012 compared to the same period of 2011.

 

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The following table provides a detailed analysis of the effective yields and rates on average interest-earning assets and average interest-bearing liabilities as of and for the periods stated. The average balances and other statistical data used in this table were calculated using daily average balances.

 

    Average Balances, Income and Expenses, Yields and Rates
As of and For the Three Months Ended March 31,
 
                                        2012 vs. 2011  
    Average Balances (1)     Yield / Rate     Income / Expense (7), (8)     Increase
(Decrease)
    Change due to (2)  
    2012     2011     2012     2011     2012     2011       Rate     Volume  

Assets

                 

Interest-earning assets:

                 

Federal funds sold

  $ 1,924      $ 447        0.11     0.00   $ 1      $ —        $ 1      $ 1      $ —     

Investments / Interest-earning deposits

    125,928        62,743        1.61     3.06     506        480        26        (302     328   

Loans held for sale

    4,255        —          3.87     0.00     41        —          41        —          41   

Loans held for investment, gross (3)

    324,596        161,650        6.87     6.89     5,575        2,786        2,789        (9     2,799   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    456,703        224,840        5.36     5.81     6,123        3,266        2,857        (311     3,167   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest-earning assets:

                 

Cash and due from banks

    4,673        2,330                 

Premises and fixed assets

    6,018        6,387                 

Other assets

    20,344        21,725                 

Allowance for loan and lease losses

    (4,345     (2,532              
 

 

 

   

 

 

               

Total noninterest-earning assets

    26,690        27,910                 
 

 

 

   

 

 

               

Total assets

  $ 483,393      $ 252,750                 
 

 

 

   

 

 

               

Liabilities and Shareholders’ Equity

                 

Interest-bearing liabilities:

                 

Demand deposits

  $ 12,210      $ 5,631        0.28     0.23   $ 8      $ 3      $ 5      $ —        $ 4   

Savings and money market deposits

    176,194        46,713        0.90     0.89     397        104        294        3        292   

Time deposits

    141,834        100,752        1.58     0.97     559        245        314        190        125   

Federal funds purchased and borrowed funds

    20,074        27,753        1.84     2.13     92        148        (55     (18     (37
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    350,312        180,849        1.21     1.11     1,057        500        557        174        384   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest-bearing liabilities:

                 

Noninterest-bearing demand deposits

    50,332        21,109                 

Other liabilities

    2,229        2,289                 
 

 

 

   

 

 

               

Total noninterest-bearing liabilities

    52,561        23,398                 
 

 

 

   

 

 

               

Shareholders’ equity

    80,520        48,503                 
 

 

 

   

 

 

               

Total liabilities and shareholders’ equity

  $ 483,393      $ 252,750                 
 

 

 

   

 

 

               

Interest rate spread (4)

        4.15     4.70          

Net interest income (5)

          $ 5,066      $ 2,766      $ 2,300      $ (485   $ 2,784   
         

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest margin (6)

        4.44     4.92          

 

(1) Average balances are computed on a daily basis.
(2) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.
(3) Nonaccrual loans have been included in the average balances. Only the interest collected on such loans has been included as income.
(4) Interest rate spread is the average yield on interest-earning assets less the average rate on interest-bearing liabilities.
(5) Net interest income is interest income less interest expense.
(6) Net interest margin is net interest income expressed as a percentage of average interest-earning assets.
(7) Interest income on loans in 2012 and 2011 includes $684 thousand and $539 thousand, respectively, in accretion related to acquired loans.
(8) Interest expense on time deposits in 2011 is reduced by $270 thousand related to acquistion fair value adjustments. There is no fair value adjustment in 2012.

Noninterest Income

For the three months ended March 31, 2012, noninterest income increased $209 thousand compared to the same period of 2011. This increase was primarily due to gains on sales of investment securities.

Noninterest Expense

Noninterest expense increased $1.3 million to $4.7 million for the three months ended March 31, 2012 from the same period in 2011. Higher noninterest expenses were primarily due to higher compensation and benefits of $852 thousand as we hired the personnel associated with the Paragon Branch, which was acquired in July 2011, and other personnel. Technology expenses increased $130 thousand, approximately one-half of which was due to the conversions that occurred in the fourth quarter of 2011 related to the acquired loans and assumed deposits. The remaining increase was to support our growth.

 

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Income Taxes

In the three months ended March 31, 2012 and 2011, we reported no income tax expense or benefit. Deferred tax assets, as of March 31, 2012, were $5.2 million for which a full valuation allowance was recorded, based primarily on the fact that we experienced cumulative losses over the past three years. Future realization of the tax benefit of existing deductible temporary differences and net operating loss carryforwards is dependent on the company generating sufficient future taxable income within the carryforward period, which under current law is 20 years.

FINANCIAL CONDITION

Securities

The following tables present information about our securities portfolio as of the dates stated. Weighted average life calculations and weighted average yields are based on the current level of contractual maturities and expected prepayments as of the dates stated.

 

     March 31, 2012  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 52,770       $ 53,905         3.59         2.52

- Variable rate

     2,454         2,591         11.09         3.40

Collateralized mortgage obligations

     9,342         9,535         4.32         2.91

Trust preferred securities

     1,121         1,111         5.04         7.76
  

 

 

    

 

 

       

Total securities available for sale

   $ 65,687       $ 67,142         4.01         2.70
  

 

 

    

 

 

       
     December 31, 2011  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 53,518       $ 54,771         2.81         2.57

- Variable rate

     2,489         2,620         11.08         3.11

Collateralized mortgage obligations

     9,866         10,065         3.19         2.76

Trust preferred securities

     1,123         1,010         15.29         7.75
  

 

 

    

 

 

       

Total securities available for sale

   $ 66,996       $ 68,466         3.39         2.70
  

 

 

    

 

 

       

 

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The following tables present a maturity analysis of our securities portfolio as of the dates stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the dates stated.

 

    March 31, 2012  
    Within 1
Year
    Weighted
Average
Yield
    After 1 Year
Through 5
Years
    Weighted
Average
Yield
    After 5 Years
Through 10
Years
    Weighted
Average
Yield
    After 10
Years
    Weighted
Average
Yield
    Total     Weighted
Average
Yield
 

Securities available for sale:

                   

Mortgage-backed securities

                   

- Fixed rate

    —          —          —          —          17,604        2.03     36,301        2.77     53,905        2.52

- Variable rate

    —          —          —          —          —          —          2,591        3.40     2,591        3.40

Collateralized Mortgage Obligations

    —          —          —          —          —          —          9,535        2.91     9,535        2.91

Trust preferred securities

    —          —          —          —          —          —          1,111        7.76     1,111        7.76
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities available for sale

  $ —          —        $ —          —        $ 17,604        2.03   $ 49,538        2.94   $ 67,142        2.70
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   
    December 31, 2011  
    Within 1
Year
    Weighted
Average
Yield
    After 1 Year
Through 5
Years
    Weighted
Average
Yield
    After 5 Years
Through 10
Years
    Weighted
Average
Yield
    After 10
Years
    Weighted
Average
Yield
    Total     Weighted
Average
Yield
 

Securities available for sale:

                   

Mortgage-backed securities

                   

- Fixed rate

    —          —          —          —          18,613        2.16     36,158        2.78     54,771        2.57

- Variable rate

    —          —          —          —          —          —          2,620        3.11     2,620        3.11

Collateralized Mortgage Obligations

    —          —          —          —          —          —          10,065        2.76     10,065        2.76

Trust preferred securities

    —          —          —          —          —          —          1,010        7.75     1,010        7.75
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities available for sale

  $ —          —        $ —          —        $ 18,613        2.16   $ 49,853        2.91   $ 68,466        2.70
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following table presents the book value and fair value of securities for which the book value exceeded 10% of shareholders’ equity as of the date stated:

 

     March 31, 2012  
     Book Value      Fair Value      Book Value as a
Percentage of
Shareholders’
Equity
 

Mortgage-backed securities

        

- Federal National Mortgage Association

   $ 42,870       $ 43,861         53.2

- Federal Home Loan Mortgage Corporation

     12,353         12,634         15.3

Loans

The following table presents the company’s composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total for loans held for investment as of the dates stated:

 

     March 31, 2012     December 31, 2011  
     Amount     Percent of
Total
    Amount     Percent of
Total
 

Commercial and industrial

   $ 170,548        51.82   $ 168,417        51.64

Commercial real estate

     126,882        38.55     126,525        38.80

Residential real estate

     25,560        7.77     25,847        7.93

Consumer

     6,127        1.86     5,350        1.63
  

 

 

   

 

 

   

 

 

   

 

 

 

Loans held for investment

     329,117        100.00     326,139        100.00

Allowance for loan and lease losses

     (4,137       (4,280  
  

 

 

     

 

 

   

Loans held for investment, net of allowance

     324,980          321,859     

Loans held for sale

     29,098          —       
  

 

 

     

 

 

   

Total loans

   $ 354,078        $ 321,859     
  

 

 

     

 

 

   

 

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Loans held for sale

The Bank entered into a sub-participation agreement with a leading national bank (the “participating bank”) that lends to mortgage companies that originate single-family residential mortgage loans for sale in the secondary market. Pursuant to the sub-participation agreement, the participating bank and the Bank purchase participations from selected non-bank mortgage originators that seek funding to facilitate the origination of loans. The originators underwrite and close mortgage loans consistent with established underwriting standards of approved investors and, once the loans close, the originators deliver the loans to the investor. Typically, we, together with the participating bank, purchase up to an aggregate of a 99% participation interest with the originators financing the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-15 days. Accordingly, we classify these loans as held for sale and they are carried at the lower of cost or fair value, determined on an aggregate basis. As of March 31, 2012, we had $29.1 million in loans held for sale.

Loans held for investment

The following tables provide the maturity analysis of our loans held for investment portfolio as of the dates stated based on whether loans are variable-rate or fixed-rate loans:

 

     March 31, 2012  
            Variable Rate      Fixed Rate         
     Within
1 year
     1 to 5
years
     After
5 years
     Total      1 to 5
years
     After
5 years
     Total      Total
Maturities
 

Commercial and industrial (1)

   $ 73,834       $ 51,958       $ 2,094       $ 54,052       $ 38,214       $ 3,980       $ 42,194       $ 170,080   

Commercial real estate (2)

     35,783         52,281         5,420         57,701         27,035         1,216         28,251         121,735   

Residential real estate (3)

     4,668         8,268         3,507         11,775         5,315         3,676         8,991         25,434   

Consumer (4)

     3,030         1,613         476         2,089         856         10         866         5,985   

Overdrafts

     135         —           —           —           —           —           —           135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 117,450       $ 114,120       $ 11,497       $ 125,617       $ 71,420       $ 8,882       $ 80,302       $ 323,369   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $468 thousand in nonaccrual fixed-rate loans.
(2) Excludes $2.3 million in nonaccrual fixed-rate loans and $2.9 million in nonaccrual variable-rate loans.
(3) Excludes $125 thousand in nonaccrual fixed-rate loans.
(4) Excludes $8 thousand in nonaccrual fixed-rate loans.

 

     December 31, 2011  
            Variable Rate      Fixed Rate         
     Within
1 year
     1 to 5
years
     After
5 years
     Total      1 to 5
years
     After
5 years
     Total      Total
Maturities
 

Commercial and industrial (1)

   $ 67,515       $ 50,694       $ 4,953       $ 55,647       $ 40,672       $ 4,078       $ 44,750       $ 167,912   

Commercial real estate (2)

     28,075         51,678         5,601         57,279         34,704         1,211         35,915         121,269   

Residential real estate (3)

     3,931         7,706         3,953         11,659         6,291         3,841         10,132         25,722   

Consumer

     2,518         1,827         251         2,078         680         10         690         5,286   

Overdrafts

     65         —           —           —           —           —           —           65   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 102,104       $ 111,905       $ 14,758       $ 126,663       $ 82,347       $ 9,140       $ 91,487       $ 320,254   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $504 thousand in nonaccrual fixed-rate loans.
(2) Excludes $5.3 million in nonaccrual variable-rate loans.
(3) Excludes $125 thousand in nonaccrual fixed-rate loans.

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies and guidelines designed to control both the types and amounts of risks we take and to minimize losses. Such policies and guidelines include loan underwriting parameters, loan-to-value parameters, credit monitoring guidelines, adherence to regulations, and other prudent credit practices.

Loans secured by real estate comprised of 60.6% of the loan portfolio at March 31, 2012, and 68.1% at December 31, 2011. Residential real estate loans consist primarily of first and second lien loans, including home equity lines and credit loans, secured by residential real estate located primarily in our target markets. Typically, our loan-to-value benchmark for these loans is at or below 80% at inception, with satisfactory debt-to-income ratios as well. Commercial real estate (“CRE”) loans are secured by business and commercial properties. Typically, our loan-to-value benchmark for these loans is at or below 80% at inception, with satisfactory debt service coverage ratios as well. The repayment of both residential and owner-occupied commercial real estate loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment.

 

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Table of Contents

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for individual loan impairment recognized and measured pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310, “Receivables” (“ASC 310”), and (2) components of collective loan impairment recognized pursuant to FASB ASC Topic 450, “Contingencies.” We maintain specific reserves for individually impaired loans pursuant to ASC 310. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement.

We determine the allowance for loan and lease losses based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans as we originate in our portfolio. In evaluating our loan portfolio, we consider qualitative factors, such as general economic conditions, nationally and in our target markets, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors and estimates may be subject to significant change. Increases to our allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in the consolidated statements of operations and comprehensive income (loss). Loans deemed to be uncollectible are charged against our allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to our allowance for loan and lease losses.

In assessing the adequacy of our allowance for loan and lease losses as of the end of a reporting period, we also evaluate our loan risk ratings. Each loan is assigned two “risk ratings” at origination. One risk rating is based on our assessment of our borrower’s financial capacity and the other is based on our assessment of the quality of our collateral. In addition to our assessment of risk ratings, we also consider internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to our policies and procedures, and external observable data such as industry and general economic trends.

Although we use various data and information sources to establish our allowance for loan and lease losses, future adjustments to our allowance for loan and lease losses may be necessary, if conditions, circumstances or events are substantially different from the assumptions used in making the assessments. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to recognize additions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.

For the three months ended March 31, 2012 and 2011, we recorded provision expense of $360 thousand and $970 thousand, respectively. Higher provision expense in the 2011 period is primarily due to greater growth in loans held for investment during this period. Our allowance for loan and lease losses as of March 31, 2012 was primarily for organic loan production and changes in credit quality related to the purchased loan portfolios.

The following table presents the allowance for loan and losses by loan type and the percent of loans in each category to total loans as of the dates stated:

 

     March 31, 2012     December 31, 2011  
     Amount      Percent of loans
in each category
to total loans held
for investment
    Amount      Percent of loans
in each category
to total loans held
for investment
 

Balance at end of period applicable to:

          

Commercial and industrial

   $ 938         51.82   $ 748         51.64

Commercial real estate

     3,068         38.55     3,370         38.80

Residential real estate

     125         7.77     133         7.93

Consumer

     6         1.86     29         1.63
  

 

 

    

 

 

   

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 4,137         100.00   $ 4,280         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Acquired loans

Acquired loans are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in the allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that all contractually required principal and interest payments will not be collected are accounted for under FASB ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). We concluded that a portion of the loans acquired in the VBB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

 

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Acquired loans for which the timing or amount of expected future cash flows cannot be predicted are accounted for on cost recovery, whereby the fair value adjustment is not recognized into income until which time the company has recovered its full carrying value of the loan receivable.

Pursuant to the merger with First Bankshares, the acquired loans were adjusted to estimated fair value with a discount of $7.6 million. As of July 29, 2011, the loans acquired in the Paragon Transaction and the VBB Acquisition were also adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively.

For acquired loans deemed impaired at acquisition (credit-impaired loans), the excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield and accreted into interest income over the remaining life of the loan, or pool of loans, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected at acquisition, on an undiscounted basis, is referred to as the nonaccretable difference. As of March 31, 2012 and December 31, 2011, we had $308 thousand of nonaccretable difference related to the loans acquired in the VBB Acquisition.

In applying ASC 310-30 to acquired loans, we must estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including default rates and the amount and timing of prepayments, in addition to other factors. ASC 310-30 allows the purchaser to estimate cash flows on credit-impaired loans on a loan-by-loan basis or aggregate credit-impaired loans into one or more pools if the loans have common risk characteristics. We have estimated cash flows expected to be collected on a loan-by-loan basis.

ASC 310-30 requires periodic re-evaluation of expected cash flows for acquired credit-impaired loans subsequent to acquisition date. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield which is a reclassification from the nonaccretable difference. The new accretable yield is recognized in income over the remaining period of expected cash flows from the loan. No changes have been made to the accretable yield estimates during the first quarter of 2012.

The following table presents the accretion activity as of the dates stated. Disposals represent reduction of discounts through the resolution of acquired loans at amounts less than the contractually owed receivable.

 

     March 31, 2012     December 31, 2011  

Balance at beginning of period

   $ 14,007      $ 3,833   

Additions

     —          15,787   

Accretion

     (684     (3,568

Disposals

     (1,524     (2,045
  

 

 

   

 

 

 

Balance at end of period

   $ 11,799      $ 14,007   
  

 

 

   

 

 

 

Nonperforming Assets

It is our policy to discontinue the accrual of interest income on nonperforming loans. We consider a loan as nonperforming when it is greater than 90 days past due as to interest and principal or when there is serious doubt as to collectability, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of March 31, 2012 and December 31, 2011, there were no loans greater than 90 days past due with respect to principal and interest for which interest was accruing.

At March 31, 2012 and December 31, 2011, we had $478 thousand and $808 thousand, respectively, in other real estate owned (“OREO”) consisting of single family properties, commercial properties and undeveloped land. All of these properties resulted from the VBB Acquisition. OREO asset valuations are evaluated periodically, and any necessary write down to fair value is recorded as impairment. We reported a loss of $9 thousand and a gain of $61 thousand, respectively, for the three-month periods ended March 31, 2012 and 2011 due to the disposition or adjustment to fair value of the properties.

All of our nonperforming assets at March 31, 2012 were acquired in the merger and the VBB Acquisition and their carrying values were adjusted to fair value immediately following the merger, in applying the acquisition method of accounting.

 

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The following table presents our nonperforming assets and various performance ratios as of the dates stated. Ratios presented are based on loans that do not include loans held for sale.

 

     March 31, 2012     December 31, 2011  

Nonaccrual loans

   $ 5,748      $ 5,862   

Other real estate owned

     478        808   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 6,226      $ 6,670   
  

 

 

   

 

 

 

Nonperforming assets as a percentage of total loans

     1.89     2.05

Nonperforming assets as a percentage of total assets

     1.26     1.40

Net charge-offs as a percentage of average loans

     0.13     0.58

Allowance for loan and lease losses as a percentage of total loans

     1.26     1.31

Allowance for loan and lease losses to nonaccrual loans

     71.98     73.01

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of March 31, 2012 totaled $392.3 million, compared to deposits of $375.0 million at December 31, 2011, an increase of $17.3 million, or 5%. Demand deposits, including money market accounts, increased $19.9 million, or 9%, over balances at December 31, 2011, while time deposits decreased $2.7 million, or 2%. Approximately $70 million of the deposits we acquired in the VBB Acquisition were Internet time deposits, which we believe may be liquidated at or before maturity. As of March 31, 2012, approximately 60% of these Internet time deposits had been liquidated. Brokered deposits totaling $5.1 million held at March 31, 2012 were redeemed subsequent to the end of first quarter.

The following table presents average balances and rates paid, by deposit category, as of the dates stated. Rates on time deposits in 2011 include fair value adjustments which reduced interest expense by $270 thousand.

 

     March 31, 2012     December 31, 2011  
     Amount      Rate     Amount      Rate  

Noninterest-bearing demand deposits

   $ 50,332         —        $ 33,894         —     

Interest-bearing deposits:

          

Demand and money market

     184,908         0.87     111,554         0.96

Savings accounts

     3,497         0.46     3,562         0.50

Time deposits $100,000 or greater (1)

     78,653         1.52     64,122         1.10

Time deposits less than $100,000

     63,180         1.64     55,186         0.59
  

 

 

      

 

 

    

Total interest-bearing deposits

     330,238         1.17     234,424         0.89
  

 

 

      

 

 

    

Total average deposits

   $ 380,570         1.01   $ 268,318         0.78
  

 

 

      

 

 

    

 

(1) Includes brokered deposits of $5.1 million at March 31, 2012 and December 31, 2011 and CDAR deposits of $6.3 and $1.5 million at March 31, 2012 and December 31, 2011, respectively.

The following table presents maturities of large denomination time deposits (equal to or greater than $100,000) as of March 31, 2012:

 

     Within 3
Months (1)
     3-6 Months (2)      6-12 Months (3)      Over 12
Months
     Total      Percent of Total
Deposits
 

Time deposits

   $ 11,208       $ 20,060       $ 16,120       $ 29,910       $ 77,298         19.71

 

(1) Includes CDAR deposits of $1.7 million
(2) Includes brokered deposits of $5.1 million
(3) Includes CDAR deposits of $4.4 million

 

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Borrowings

The following table summarizes the period-end balance, highest month-end balance, average balance and weighted average rate of short-term borrowings for each of the periods stated:

 

     March 31, 2012     December 31, 2011  
     Year End
Balance
     Highest
Month End
Balance
     Average
Balance
     Weighted
Average
Rate
    Year End
Balance
     Highest
Month End
Balance
     Average
Balance
     Weighted
Average
Rate
 

Federal funds purchased

   $ —         $ —         $ 74         0.76   $ —         $ 2,191       $ 296         0.90

Other borrowings

     —           —           —           0.00     —           1,000         779         0.55
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term borrowings

   $ —         $ —         $ 74         0.76   $ —         $ 3,191       $ 1,075         0.65
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

    

We have one secured long-term borrowing with the Federal Home Loan Bank (“FHLB”) in the amount of $20 million. In the third quarter of 2011, we modified the then-existing borrowing, which was a non-amortizing, fixed rate (2.495%) term loan maturing on January 25, 2013. The modified borrowing is also a non-amortizing term loan and bears interest at a rate of 20 basis points over LIBOR, which resets quarterly. The modified borrowing matures on September 28, 2015. In connection with the modification, we paid a fee of $533 thousand, which is recorded in other assets on our consolidated balance sheet and is being recognized as interest expense over the remaining term of the borrowing.

At the time we modified the FHLB borrowing, we entered into a derivative (interest rate swap) whereby we pay fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without the exchange of the underlying notional amount, which is $20 million. Our objective in using interest rate derivatives is to manage our exposure to interest rate movements. The derivative is designated as a cash flow hedge, whereby the effective portion of the hedge is recorded in accumulated other comprehensive income. The amount reported in accumulated other comprehensive income as of March 31, 2012 was an unrealized loss of $62 thousand. As of March 31, 2012, there was no ineffective portion of the derivative.

We have an agreement with the counterparty to our derivative that contains a provision whereby if we fail to maintain our status as a well/an adequate capitalized institution, we could be required to terminate or fully collateralize the derivative contract. Additionally, if we default on any of our indebtedness, including default where repayment has not been accelerated by the lender, we could also be in default on our derivative obligations. We had minimum collateral requirements with our counterparty and, as of March 31, 2012, $0 had been pledged as collateral under the agreement, because the valuation of the derivative has not surpassed contractually specified minimum transfer amounts. If we are not in compliance with the terms of the derivative agreement, we could be required to settle obligations under the agreement at termination value.

For the period ended March 31, 2012, our effective interest rate on the $20 million FHLB borrowing, including the effect of the prepayment fee and cash flow hedge, was 1.84%.

LIQUIDITY AND CAPITAL RESOURCES

In the three-month period ended March 31, 2012, cash and cash equivalents decreased $12.4 million compared to a decrease of $7.7 million in the same period in 2011. Net cash provided by operating activities was $0.8 million for the three-month period ended March 31, 2012 compared to net cash used in operating activities of $1.3 million for the same period in 2011. Net cash used in investing activities was $30.4 million for the three-month period ended March 31, 2012 compared to net cash used in investing activities of $21.2 million for the same period in 2011. The greater use of cash in the 2012 period was primarily due to cash used to fund loans, which was nearly $9.0 million greater in the three-month period ended March 31, 2012 compared to the same period in 2011. Net cash provided by financing activities in the three-month period ended March 31, 2012 was $17.2 million compared to $14.8 million for the same period of 2011. Greater cash provided by financing activities in the 2012 period was primarily due to the decrease in borrowings which occurred in the 2011 period.

Liquidity

Liquidity is the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate deposit withdrawals, payments of debt and operating expenses and increased loan demand, and to achieve stated objectives (including working capital requirements). These events may occur daily or in other short-term intervals in the normal operation of business. Historical trends may help management predict the amount of cash required. In assessing liquidity, management gives consideration to various factors, including stability of deposits, maturity of time deposits, quality, volume and maturity of assets, sources and costs of borrowings, concentrations of business and industry, competition and our overall financial condition and cash flows.

Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale portfolio. We have access to a credit line from our primary correspondent bank in the amount of $9.0 million. This line is for short-term liquidity needs and is subject to the prevailing federal funds interest rate.

We have secured borrowing facilities with the FHLB and the Federal Reserve. The total credit availability under the FHLB facility is equal to 30% of our total assets. Under this facility, we have one non-amortizing term loan outstanding for $20 million, which was modified from a previous facility in September 2011. This borrowing bears a rate of 20 basis points over LIBOR, which resets quarterly, and matures on September 28, 2015. As of March 31, 2012, our total credit availability under this facility was $142.8

 

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million, based on our December 31, 2011 balance sheet. At the time we entered into the FHLB term loan, we entered into an interest rate swap whereby we pay fixed amounts to a counterparty in exchange for receiving variable payments over the life of the agreement without the exchange of the underlying notional amount which is $20 million. The total credit availability under the Federal Reserve facility as of March 31, 2012 was $69.4 million and is based on our pledged collateral. Borrowings under this facility bear the prevailing current rate for primary credit. There were no amounts outstanding under this facility as of March 31, 2012.

We also have two uncommitted lines of credit by national banks to borrow federal funds up to $13.0 million in total on an unsecured basis. The uncommitted lines of credit are not confirmed lines or loans and can be cancelled at any time. One line for $5.0 million terminates on June 30, 2012, if not cancelled earlier, and the other line for $8.0 million has no stated termination date. As of March 31, 2012, no amounts were outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate. In management’s opinion, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs that may arise, within realistic limitations, for the foreseeable future.

Capital Adequacy

Capital management in a regulated financial services industry must properly balance return on equity to shareholders, while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Our capital management strategies have been developed to maintain our “well-capitalized” position.

We are subject to various regulatory capital requirements administered by federal and other bank regulators. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on us and our financial performance. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios. On December 7, 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained conditions related to BankCap Partners, as well as the conduct of the Bank’s business. The condition applicable to the Bank provided that, during the first three years of operation after the merger, which is the period beginning December 22, 2009 and ending December 22, 2012, the Bank must operate within the parameters of its business plan submitted in connection with BankCap Partners’ application to the Federal Reserve, and the Bank must obtain prior written regulatory consent to any material change in its business plan. The business plan sets forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012. As of March 31, 2012, we met all minimum capital adequacy requirements to which we are subject, including those contained in our business plan as submitted to the Federal Reserve, and are categorized as “well- capitalized.” Since March 31, 2012, there are no conditions or events that management believes have changed our status as “well-capitalized.”

The following table presents Tier 1 and total risk-based capital and risk-weighted assets for the Bank and Xenith Bankshares as of the dates stated:

 

     March 31, 2012      December 31, 2011  
     Xenith Bank      Xenith Bankshares      Xenith Bank      Xenith Bankshares  

Tier 1 capital

   $ 61,933       $ 62,932       $ 61,417       $ 62,488   

Total risk-based capital

     66,070         67,069         65,697         66,768   

Risk-weighted assets

     376,815         376,543         350,060         349,886   

The following capital ratios and minimum capital ratios required by our regulators for the Bank and Xenith Bankshares as of the date stated:

 

     March 31, 2012     December 31, 2011              
     Xenith Bank     Xenith Bankshares     Xenith Bank     Xenith Bankshares     Regulatory
Minimum
    Well Capitalized  

Tier 1 leverage ratio

     13.32     13.53     13.19     13.42     4.00     > 5.00

Tier 1 risk-based capital ratio

     16.44     16.70     17.54     17.86     4.00     > 6.00

Total risk-based capital ratio

     17.53     17.80     18.76     19.08     8.00     > 10.00

 

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Interest Rate Sensitivity

Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of an organization. Our primary market risk is interest rate risk. Interest rate risk is inherent in banking, because as a financial institution, we derive a significant amount of our operating revenue from “purchasing” funds (customer deposits and borrowings) at various terms and rates. These funds are invested into interest-earning assets (e.g., loans and investments) at various terms and rates.

Interest rate risk is the exposure to fluctuations in future earnings (earnings at risk) and value (market value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that re-price within a specific time period as a result of scheduled maturities and repayment and contractual interest rate changes.

The balance sheet may be asset or liability sensitive at a given time. We intend to manage the Bank’s asset or liability sensitivity to optimize earnings, to minimize interest rate risk and to preserve capital within policy limits.

Management strives to control the Bank’s exposure to interest rate volatility, and we operate under an asset and liability management policy approved by our board of directors. In addition, we emphasize the loan and deposit pricing characteristics that best meet our current view on the future direction of interest rates and use sophisticated analytical tools to support our asset and liability processes.

Gap Analysis

Gap analysis tools monitor the “gap” between interest-sensitive assets and interest-sensitive liabilities. The Bank uses a simulation model to forecast future balance sheet and income statement behavior. By studying the effects on net interest income of rising, stable and falling interest rate scenarios, we attempt to mitigate risks associated with anticipated interest rate movements by understanding the dynamic nature of our balance sheet components. We evaluate our balance sheet components (securities, loan and deposit portfolios) to manage our interest rate risk position.

A negative interest-sensitive gap results when interest-sensitive liabilities exceed interest-sensitive assets for a specific re-pricing “time horizon”. The gap is positive when interest-sensitive assets exceed interest-sensitive liabilities for a given time period. For a bank with a positive gap, rising interest rates would be expected to have a positive effect on net interest income, and falling rates would be expected to have a negative effect. The following table reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their re-pricing or maturity dates. Variable-rate loans are reflected at the earliest re-pricing interval since they re-price according to their terms. Borrowed funds are reflected at the earlier of their maturity or contractual re-pricing interval. Interest-bearing liabilities, with no contractual maturity, such as interest-bearing transaction accounts and savings deposits, are reflected at expected rates of attrition. Time deposits and fixed-rate loans are reflected at their respective contractual maturity dates.

 

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The following table, “Gap Report”, indicates that, on a cumulative basis through the next 12 months, our interest rate-sensitive assets exceed interest rate-sensitive liabilities, resulting in an asset-sensitive position at March 31, 2012 of $153.2 million. This net asset-sensitive position was a result of $323.3 million in interest rate-sensitive assets being available for re-pricing during the next 12 months and $170.1 million in interest rate-sensitive liabilities being available for re-pricing during the same time period. Our gap position at March 31, 2012 is considered by management to be favorable in a flat to increasing interest rate environment.

 

     0-180 Days      181-360 days     1-3 Years     Over 3 Years      Totals  

Assets:

            

Cash and cash due

   $ 36,487       $ —        $ —        $ —         $ 41,320   

Fed funds sold

     2,067         —          —          —           2,067   

Securities

     2,157         2,146        8,851        57,075         71,687   

Loans

     267,922         12,515        48,333        29,442         358,215   

Allowance for loan and lease losses

     —           —          —          —           (4,137

Premises and equipment

     —           —          —          —           5,884   

Intangibles

     —           —          —          —           16,263   

OREO

     —           —          —          —           478   

Other assets

     —           —          —          —           3,413   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total assets

   $ 308,633       $ 14,661      $ 57,184      $ 86,517       $ 495,190   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Liabilities and Equity:

            

Demand deposits

   $ —         $ —        $ —        $ —         $ 53,304   

Interest-bearing deposits

     89,966         80,113        149,839        19,045         338,959   

Fed funds purchased

     —           —          —          —           —     

Borrowed funds

     —           —          —          20,000         20,000   

Other liabilities

     —           —     </