Quarterly Report (10-q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2013

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 000-28635

 

 

VIRGINIA COMMERCE BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

VIRGINIA		54-1964895
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5350 LEE HIGHWAY, ARLINGTON, VIRGINIA 22207

(Address of principal executive offices) (Zip Code)

703-534-0700

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

Indicate by check mark whether the registrant 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).     x   Yes     ¨   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		x
Non-accelerated filer		¨		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes   ¨     No   x

As of October 31, 2013, the number of outstanding shares of registrant’s common stock, par value $1.00 per share, was: 33,604,847.

 

 

 

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Table of Contents

TABLE OF CONTENTS

 

				Page
PART I – FINANCIAL INFORMATION
ITEM 1.		FINANCIAL STATEMENTS
		Consolidated Balance Sheets – September 30, 2013 (unaudited) and December 31, 2012			3
		Consolidated Statements of Income (unaudited) – Three and Nine months ended September 30, 2013 and 2012			4
		Consolidated Statements of Comprehensive Income (unaudited) – Three and Nine months ended September  30, 2013 and 2012			5
		Consolidated Statements of Changes in Stockholders’ Equity (unaudited) – Nine months ended September 30, 2013 and 2012			6
		Consolidated Statements of Cash Flows (unaudited) – Nine months ended September 30, 2013 and 2012			7
		Notes to Consolidated Financial Statements (unaudited)			8
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			31
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			53
ITEM 4.		CONTROLS AND PROCEDURES			54
PART II – OTHER INFORMATION
ITEM 1.		LEGAL PROCEEDINGS			55
ITEM 1A.		RISK FACTORS			55
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			55
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES			56
ITEM 4.		MINE SAFETY DISCLOSURES			56
ITEM 5.		OTHER INFORMATION			56
ITEM 6.		EXHIBITS			56
SIGNATURES					57

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

		(Unaudited) September 30, 2013				(Audited) December 31, 2012
Assets
Cash and due from banks		$	38,962			$	49,531
Interest bearing deposits in other banks			101,000				1,000
Cash and cash equivalents		$	139,962			$	50,531
Investment securities available-for-sale, at fair value			481,177				493,424
Restricted investments, at cost			10,928				10,147
Loans held-for-sale			847				15,195
Loans, net of allowance for loan losses of $40,909 and $42,773			2,018,996				2,142,872
Premises and equipment, net			8,780				10,072
Accrued interest receivable			7,706				8,563
Other real estate owned, net of valuation allowance of $3,293 and $6,374			9,923				12,302
Bank owned life insurance			45,303				44,393
Other assets			32,700				36,193
Total assets		$	2,756,322			$	2,823,692
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing demand deposits		$	445,256			$	416,091
Savings and interest-bearing demand deposits			1,103,173				1,200,397
Time deposits			547,155				628,904
Total deposits		$	2,095,584			$	2,245,392
Securities sold under agreement to repurchase			285,414				250,718
Other borrowed funds			40,000				7,000
Trust preferred capital notes			67,019				66,827
Accrued interest payable			1,763				1,885
Other liabilities			2,289				6,561
Total liabilities		$	2,492,069			$	2,578,383
Stockholders’ Equity
Common stock, $1.00 par value per share, 50,000,000 shares authorized, 33,526,210 issued and outstanding at September 30, 2013, including 183,195 in unvested restricted stock issued and 31,920,756 issued and outstanding at December 31, 2012, including 110,215 in unvested restricted stock issued			33,343				31,811
Surplus			125,197				118,508
Warrants			8,520				8,520
Retained earnings			103,939				83,487
Accumulated other comprehensive (loss) income, net			(6,746	)			2,983
Total stockholders’ equity		$	264,253			$	245,309
Total liabilities and stockholders’ equity		$	2,756,322			$	2,823,692

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands except per share data)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Interest and dividend income:
Interest on loans, including fees		$	27,429			$	29,820			$	84,325			$	90,868
Interest and dividends on investment securities:
Taxable			2,226				2,232				6,126				7,328
Tax-exempt			543				574				1,671				1,748
Dividend on restricted investments			113				105				340				310
Interest on deposits in other banks			29				132				109				257
Total interest and dividend income		$	30,340			$	32,863			$	92,571			$	100,511
Interest expense:
Interest on deposits		$	3,182			$	4,261			$	10,045			$	13,668
Interest on securities sold under agreement to repurchase and federal funds purchased			933				1,017				2,774				3,068
Interest on other borrowed funds			20				242				54				779
Interest on trust preferred capital notes			952				975				2,859				2,932
Total interest expense		$	5,087			$	6,495			$	15,732			$	20,447
Net interest income		$	25,253			$	26,368			$	76,839			$	80,064
Provision for loan losses			1,834				3,111				6,207				12,267
Net interest income after provision for loan losses		$	23,419			$	23,257			$	70,632			$	67,797
Non-interest income:
Service charges on deposits		$	900			$	882			$	2,736			$	2,638
Non-deposit investment services commissions			248				211				775				705
Gain on sale of mortgage loans held-for-sale			321				1,082				2,018				2,913
Gain on sale of investment securities available-for-sale			—				2,056				—				5,976
Increase in cash surrender value of bank owned life insurance			302				50				909				159
Other income			51				444				138				704
Total non-interest income		$	1,822			$	4,725			$	6,576			$	13,095
Non-interest expense:
Salaries and employee benefits		$	6,436			$	7,493			$	21,327			$	22,517
Premises and equipment expenses			2,314				2,380				7,038				7,142
FDIC insurance			504				660				1,536				2,488
(Gain) loss on other real estate owned			(71	)			(141	)			1,712				1,566
OREO expenses			406				322				879				902
Franchise tax expense			752				935				2,247				2,435
Data processing expenses			705				664				2,104				1,992
Merger-related expense			1,155				—				2,021				—
Other operating expenses			2,664				2,899				7,686				8,354
Total non-interest expense		$	14,865			$	15,212			$	46,550			$	47,396
Income before provision for income taxes		$	10,376			$	12,770			$	30,658			$	33,496
Provision for income taxes			3,423				4,284				10,206				11,148
Net income		$	6,953			$	8,486			$	20,452			$	22,348
Effective dividend on preferred stock			—			$	1,364				—			$	4,090
Net income available to common stockholders		$	6,953			$	7,122			$	20,452			$	18,258
Earnings per common share, basic		$	0.21			$	0.22			$	0.63			$	0.58
Earnings per common share, diluted		$	0.20			$	0.21			$	0.58			$	0.54

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net Income		$	6,953			$	8,486			$	20,452			$	22,348
Other Comprehensive Income (Loss):
Unrealized net (losses) gains on investment securities available-for-sale, net of tax (1)			(515	)			1,772				(9,729	)			1,929
Reclassification adjustment for transfer of investment securities from held-to-maturity to available-for-sale, net of tax of $895 in 2012			—				—				—				1,663
Reclassification adjustment for gains on sale of investment securities, net of tax (2)			—				(1,336	)			—				(3,884	)
Total Other Comprehensive (Loss) Income			(515	)			436				(9,729	)			(292	)
Total Comprehensive Income		$	6,438			$	8,922			$	10,723			$	22,056

 

(1)	Net of tax of $277 and $954 for the three months ended September 30, 2013 and 2012, respectively and $5,239 and $1,039 for the nine months ended September 30, 2013 and 2012, respectively.

(2)	Net of tax of $(720) for the three months ended September 30, 2012 and $(2,092) for the nine months ended September 30, 2012.

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands)

(Unaudited)

 

		Preferred Stock				Common Stock				Surplus				Warrants				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Total Stockholders’ Equity
Balance, January 1, 2012		$	67,195			$	30,214			$	111,042			$	8,520			$	60,999			$	5,801			$	283,771
Net income			—				—				—				—				22,348				—				22,348
Other comprehensive (loss)			—				—				—				—				—				(292	)			(292	)
Capital common stock issued			—				426				1,968				—				—				—				2,394
Stock options/warrants exercised			—				1,075				4,479				—				—				—				5,554
Stock based compensation expense			—				—				416				—				—				—				416
Discount on preferred stock			1,426				—				—				—				(1,426	)			—				—
Dividend on preferred stock			—				—				—				—				(2,663	)			—				(2,663	)
Balance, September 30, 2012		$	68,621			$	31,715			$	117,905			$	8,520			$	79,258			$	5,509			$	311,528
Balance, January 1, 2013		$	—			$	31,811			$	118,508			$	8,520			$	83,487			$	2,983			$	245,309
Net income			—				—				—				—				20,452				—				20,452
Other comprehensive (loss)			—				—				—				—				—				(9,729	)			(9,729	)
Capital common stock issued			—				1,500				8,745				—				—				—				10,245
Stock options/warrants exercised			—				432				3,225				—				—				—				3,657
Repurchase of common stock			—				(400	)			(5,644	)			—				—				—				(6,044	)
Stock based compensation expense			—				0				363				—				—				—				363
Balance, September 30, 2013		$	—			$	33,343			$	125,197			$	8,520			$	103,939			$	(6,746	)		$	264,253

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2013				2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	20,452			$	22,348
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			1,466				1,665
Provision for loan losses			6,207				12,267
Stock based compensation expense			363				416
Deferred income tax expense			774				982
Accretion of trust preferred securities discount			192				192
Amortization of security premiums and accretion of security discounts, net			3,396				6,127
Loans originated for sale			(81,346	)			(146,770	)
Sales of loans			97,712				148,498
(Gain) on sale of loans			(2,018	)			(2,573	)
Loss on sale/valuation of OREO			1,712				1,566
Gain on sale of investment securities available-for-sale			—				(5,976	)
Changes in other assets and other liabilities: Decrease in accrued interest receivable			857				466
Decrease in other assets			7,049				1,158
Decrease in other liabilities			(4,272	)			(2,883	)
Decrease in accrued interest payable			(122	)			(287	)
Net Cash Provided By Operating Activities		$	52,422			$	37,196
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in loans		$	113,908			$	(4,300	)
Purchase of investment securities available-for-sale			(128,878	)			(334,067	)
Proceeds from principal payments, calls and maturities on investment securities available-for-sale			122,760				256,274
Proceeds from principal payments, calls and maturities on investment securities held-to-maturity			—				1,873
Sales of investment securities available-for-sale			—				155,133
Purchase of FHLB stock			(781	)			(58	)
Purchase of premises and equipment			(174	)			(763	)
Proceeds from sale of other real estate owned			4,428				3,006
Net Cash Provided By Investing Activities		$	111,263			$	77,098
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in demand, NOW, money market and savings accounts		$	(68,059	)		$	53,976
Net (decrease) in time deposits			(81,749	)			(133,578	)
Net increase in securities sold under agreement to repurchase			34,696				146,047
Proceeds from exercise of stock options and warrants, net			7,858				5,554
Advance for (repayment) of borrowed funds, net			33,000				(22,606	)
Dividend paid on preferred stock			—				(2,663	)
Net Cash (Used In) Provided By Financing Activities		$	(74,254	)		$	46,730
Net Increase In Cash and Cash Equivalents			89,431				161,024
CASH AND CASH EQUIVALENTS – BEGINNING OF PERIOD			50,531				82,569
CASH AND CASH EQUIVALENTS – END OF PERIOD		$	139,962			$	243,593
Supplemental Disclosure of Cash Flow Information:
Income taxes paid		$	10,174			$	10,840
Interest paid			15,854				20,734
Supplemental Schedule of Noncash Investing Activities:
Unrealized (loss) gain on investment securities		$	(14,968	)		$	2,968
Unrealized gain on investment securities transferred from held-to-maturity to available-for-sale			—				2,558
OREO transferred from loans			3,761				14,634
Loans made on the disposition of OREO			—				4,898

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

General

The accompanying unaudited consolidated financial statements of Virginia Commerce Bancorp, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications consisting of a normal and recurring nature considered necessary to present fairly the consolidated balance sheets as of September 30, 2013 and December 31, 2012, the consolidated statements of income for the three and nine months ended September 30, 2013 and 2012, consolidated statements of comprehensive income for the three and nine month periods ended September 30, 2013 and 2012, and consolidated statements of cash flows and consolidated statements of changes in stockholders’ equity for the nine months ended September 30, 2013 and 2012. These consolidated statements should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2012. In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these consolidated financial statements were issued. Management has concluded there were no material subsequent events to be disclosed at this time.

Operating results for the three and nine month periods ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013, or any other period. Reclassifications of prior years’ amounts are made whenever necessary to conform to the current years’ presentation.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) , the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there had been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured 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.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

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Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on 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 asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

A financial asset’s or liability’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Investment securities available-for-sale : Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). Currently, the Company considers its valuation of available-for-sale PreTSL securities as Level 3. Based on financial market conditions, the Company feels that the fair values obtained from its third party vendor reflects forced liquidation and distressed sales of the PreTSL securities due to decreased volume and trading activity. Based upon management’s review of the market conditions for PreTSL securities, it was determined that an income approach valuation technique (present value) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs is more representative of fair value than the market approach valuation technique used by the third party vendor. The present value technique discounts expected future cash flows of a security to arrive at a present value. The cash flow analysis assumes discount rates equal to the credit spread at the time of purchase for each security and then adds the current 3-month LIBOR forward interest rate curve. The analysis includes other assumptions in determining present value, such as recoveries on deferrals and prepayments on securities.

The following table summarizes the Company’s financial assets measured at fair value on a recurring basis for September 30, 2013, and December 31, 2012, respectively (dollars in thousands):

 

						Carrying value at September 30, 2013
Description		Balance as of September 30, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Investment securities available-for-sale
U.S. Government Agency obligations		$	386,475			$	—			$	386,475			$	—
Pooled trust preferred securities		$	1,612			$	—			$	—			$	1,612
Obligations of states and political subdivisions		$	93,090			$	—			$	93,090			$	—

 

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						Carrying value at December 31, 2012
Description		Balance as of December 31, 2012				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Investment securities available-for-sale
U.S. Government Agency obligations		$	392,867			$	—			$	392,867			$	—
Pooled trust preferred securities		$	357			$	—			$	—			$	357
Obligations of states and political subdivisions		$	100,200			$	—			$	100,200			$	—

At September 30, 2013, and December 31, 2012, the Company did not have any liabilities measured at fair value on a recurring basis.

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans held for sale : Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended September 30, 2013, and December 31, 2012. Gains and losses on the sale of loans are recorded within gain on sale of mortgage loans held-for-sale on the Consolidated Statements of Income.

Impaired Loans : The Company does not record loans at fair value on a recurring basis. However, there are instances when a loan is considered impaired and an allowance for loan losses is established. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on the present value of the expected future cash flows discounted at the loans effective interest rate, the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate, financial assets, personal or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. An impaired loan that is collateralized by cash is considered Level 1. The value of real estate collateral is based solely on observable cash flows, market price or a current appraisal conducted by an independent, licensed appraiser outside of the Company, or using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, additional write-downs to fair value are required, or if an appraisal of the real estate property is over a year old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant, using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans are measured at fair value on a nonrecurring basis through the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned / Foreclosed Assets : Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at the lesser of carrying value or fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation are included in net expenses for other real estate owned. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as Level 2 valuation. 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 foreclosed asset as Level 3 valuation.

 

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The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis for September 30, 2013 and December 31, 2012, respectively (dollars in thousands):

 

						Carrying value at September 30, 2013
Description		Balance as of September 30, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans		$	62,464			$	—			$	23,899			$	38,565
Other real estate owned		$	9,923			$	—			$	3,724			$	6,199
Loans held for sale		$	847			$	—			$	847			$	—

 

						Carrying value at December 31, 2012
Description		Balance as of December 31, 2012				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans		$	68,427			$	1,486			$	40,389			$	26,552
Other real estate owned		$	12,302			$	—			$	7,694			$	4,608
Loans held for sale		$	15,195			$	—			$	15,195			$	—

At September 30, 2013 and December 31, 2012, the Company did not have any liabilities measured at fair value on a nonrecurring basis.

The following table displays quantitative information about Level 3 Fair Value Measurements for September 30, 2013 (dollars in thousands):

 

		Quantitative information about Level 3 Fair Value Measurements for September 30, 2013
Assets		Fair Value				Valuation Technique(s)		Unobservable input		Range
Impaired loans		$	25,741			Discounted appraised value		Selling cost		5% - 15%
								Discount for lack of marketability and age of appraisal		0% - 50%
		$	8,934			Discounted tax assessments		Tax assessment		5% - 10%
		$	3,890			Discounted cash flow		Discount for expected levels of future cash flows		10% - 50%
Other real estate owned		$	6,199			Discounted appraised value		Selling cost		5% - 10%
								Discount for lack of marketability and age of appraisal		0% - 20%

 

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		Quantitative information about Level 3 Fair Value Measurements for December 31, 2012
Assets		Fair Value				Valuation Technique(s)		Unobservable input		Range
Impaired loans		$	11,745			Discounted appraised value		Selling cost		5% - 25%
								Discount for lack of marketability and age of appraisal		0% - 50%
		$	5,815			Discounted tax assessments		Tax assessment		5% - 10%
		$	8,992			Discounted cash flow		Discount for expected levels of future cash flows		10% - 50%
Other real estate owned		$	4,608			Discounted appraised value		Selling cost		5% - 10%
								Discount for lack of marketability and age of appraisal		0% - 20%

The changes in Level 3 assets measured at estimated fair value on a recurring basis during the nine months ended September 30, 2013, were as follows (dollars in thousands):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Securities available-for-sale:		Balance as of January 1, 2013				Net Income				Other Comprehensive Income				Accretion of Purchase Discount				Transfer In (Out) of Level 3				Decrease in Carrying Value				Balances as of September 30, 2013
Pooled trust preferred securities		$	357			$	—			$	1,255			$	—			$	—			$	—			$	1,612

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Short-Term Investments

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities

For securities held for investment purposes, fair values are based upon quoted market prices, when available. If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data. The carrying value of restricted stock approximates fair value based on the redemption provisions of the issuers.

Loans Held for Sale

Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Bank Owned Life Insurance

Bank owned life insurance represents insurance policies on officers, directors and past employees of the Bank. The cash values of the policies are estimates using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.

Loan Receivables

For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

 

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Deposits and Borrowings

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. For all other deposits and borrowings, the fair value is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter 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.

At September 30, 2013, and December 31, 2012, the fair value of loan commitments and stand-by letters of credit were deemed immaterial, and therefore, are not included in the table below.

In the normal course of business, the Company is subject to market risk which includes interest rate risk (the risk that general interest rate levels will change). As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize this risk.

The balance sheet carrying amounts and estimated fair values of the Company’s financial instruments are as follows:

 

						Fair Value Measurements as of September 30, 2013, using
(Dollars in thousands)		Carrying Amount				Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
						Level 1				Level 2				Level 3
Financial assets:
Cash and short-term investments		$	139,962			$	139,962			$	—			$	—
Investment securities			481,177				—				474,565				1,612
Restricted stock			10,928				—				10,928				—
Loans held-for-sale			847				—				847				—
Loan receivables			2,018,996				—				23,899				2,085,605
Bank-owned life insurance			45,303				45,303				—				—
Accrued interest receivable			7,706				—				7,706				—
Financial liabilities:
Deposits		$	2,095,584			$	—			$	2,106,715			$	—
Securities sold under agreement to repurchase			285,414				223,080				75,000				—
Other borrowed funds			40,000				—				40,000				—
Trust preferred capital notes			67,019				—				90,858				—
Accrued interest payable			1,763				—				1,763				—

 

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						Fair Value Measurements as of December 31, 2012, using
(Dollars in thousands)		Carrying Amount				Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
						Level 1				Level 2				Level 3
Financial assets:
Cash and short-term investments		$	50,531			$	50,531			$	—			$	—
Investment securities			493,424				—				493,067				357
Restricted stock			10,147				—				10,147				—
Loans held-for-sale			15,195				—				15,195				—
Loan receivables			2,142,872				1,486				40,389				2,229,735
Bank owned life insurance			44,393				44,393				—				—
Accrued interest receivable			8,563				—				8,563				—
Financial liabilities:
Deposits		$	2,245,392			$	—			$	2,260,622			$	—
Securities sold under agreement to repurchase			250,718				190,866				75,000				—
Other borrowed funds			7,000				—				7,000				—
Trust preferred capital notes			66,827				—				73,761				—
Accrued interest payable			1,885				—				1,885				—

 

2.	Reclassifications Out of Accumulated Other Comprehensive Income/(Loss) and Changes in AOCI/(Loss) by Component

A summary of the Reclassifications Out of Accumulated Other Comprehensive Income/(Loss) and Changes in AOCI/(Loss) by Component as of September 30, 2013 and 2012, is summarized below:

Reclassification Out of AOCI/(Loss)

For the Three Months Ended September 30, 2013 and 2012

 

Details about AOCI Components		Amounts Reclassified from AOCI								Affected Line Item in the Statement Where Net Income is Presented
		9/30/2013				9/30/2012
Available-for-sale securities
Realized gain on sale of securities		$	—			$	2,056			Gain on sale of investment securities available-for-sale
		$	—			$	2,056			Total before tax
		$	—			$	720			Income tax expense
Total reclassifications, net of tax		$	—			$	1,336			Net income

Reclassification Out of AOCI/(Loss)

For the Nine Months Ended September 30, 2013 and 2012

 

Details about AOCI Components		Amounts Reclassified from AOCI								Affected Line Item in the Statement Where Net Income is Presented
		9/30/2013				9/30/2012
Available-for-sale securities
Realized gain on sale of securities		$	—			$	5,976			Gain on sale of investment securities available-for-sale
		$	—			$	5,976			Total before tax
		$	—			$	2,092			Income tax expense
Total reclassifications, net of tax		$	—			$	3,884			Net income

 

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Changes in AOCI/(Loss) by Component (Net of Tax)

For the Nine Months Ended September 30, 2013 and 2012

 

		Unrealized Gains/(Loss) by Component (Net of Tax)
		9/30/2013				9/30/2012
Beginning Balance		$	2,983			$	5,801
Other comprehensive income/(loss) before reclassifications			(9,729	)			1,929
Amounts reclassified to AOCI due to sales			—				(3,884	)
Amounts reclassified to AOCI due to transfers			—				1,663
Net current period other comprehensive (loss)			(9,729	)			(292	)
Ending Balance		$	(6,746	)		$	5,509

 

3.	Investment Securities

Amortized cost and fair value of the investment securities available-for-sale as of September 30, 2013, and December 31, 2012, are as follows (dollars in thousands). As of September 30, 2013 and December 31, 2012, the Company had no investment securities held-to-maturity.

 

September 30, 2013		Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Fair Value
Available-for-sale:
U.S. Government Agency obligations		$	395,769			$	1,599			$	(10,893	)		$	386,475
Pooled trust preferred securities			5,081				—				(3,469	)			1,612
Obligations of states and political subdivisions			90,820				3,131				(861	)			93,090
Total Investment securities available-for-sale		$	491,670			$	4,730			$	(15,223	)		$	481,177

 

December 31, 2012		Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Fair Value
Available-for-sale:
U.S. Government Agency obligations		$	390,075			$	3,913			$	(1,121	)		$	392,867
Pooled trust preferred securities			5,126				—				(4,769	)			357
Obligations of states and political subdivisions			93,634				6,627				(61	)			100,200
Total Investment securities available-for-sale		$	488,835			$	10,540			$	(5,951	)		$	493,424

The amortized cost of securities pledged as collateral for repurchase agreements, certain public deposits, and other purposes was $346.2 million and $444.9 million at September 30, 2013, and December 31, 2012, respectively.

Management evaluates securities for other-than-temporary impairment (or “OTTI”) at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. An impairment is considered to be other-than-temporary if the Company (1) intends to sell the security, (2) more likely than not will be required to sell the security before recovering its cost, or (3) does not expect to recover the security’s entire amortized cost basis.

 

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Provided below is a summary of all securities which were in an unrealized loss position at September 30, 2013, and December 31, 2012, that were evaluated for other-than-temporary impairment, and deemed to not have an other-than-temporary impairment. Presently, the Company does not intend to sell any of these securities, does not expect to be required to sell these securities, and expects to recover the entire amortized cost of all the securities. For U.S. Government Agency obligations and obligations of states and political subdivisions, the unrealized losses result from market or interest rate risk, while the unrealized losses pertaining to the pooled trust preferred securities are due to performance and credit ratings declines in prior years, as well as interest rate risk. There were 5 available-for-sale CMOs and 1 available-for-sale municipal investment security in an unrealized loss position for 12 months or longer as of September 30, 2013. This unrealized loss position of $280 thousand for CMOs and $47 thousand for the municipal investment security were a result of interest rate changes.

 

September 30, 2013		Less Than 12 Months								12 Months or Longer								Total
(Dollars in thousands)		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Available-for-sale:
U.S. Government agency obligations		$	287,193			$	(10,613	)		$	10,235			$	(280	)		$	297,428			$	(10,893	)
Pooled trust preferred securities			—				—				1,612				(3,469	)			1,612				(3,469	)
Obligations of states and political subdivisions			18,080				(814	)			1,793				(47	)			19,873				(861	)
		$	305,273			$	(11,427	)		$	13,640			$	(3,796	)		$	318,913			$	(15,223	)

 

December 31, 2012		Less Than 12 Months								12 Months or Longer								Total
(Dollars in thousands)		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Available-for-sale:
U.S. Government Agency obligations		$	130,909			$	(1,121	)		$	—			$	—			$	130,909			$	(1,121	)
Pooled trust preferred securities			—				—				357				(4,769	)			357				(4,769	)
Obligations of states and political subdivisions			5,016				(61	)			—				—				5,016				(61	)
		$	135,925			$	(1,182	)		$	357			$	(4,769	)		$	136,282			$	(5,951	)

As of September 30, 2013, the Company had one pooled trust preferred security that was deemed to be temporarily impaired based on a present value analysis of expected future cash flows. PreTSL XXVI has a fair value of $134 thousand and a $2.1 million loss recognized in other comprehensive income. Total “other than temporary” impairment losses on PreTSL XXVI are $2.2 million, of which $1.4 million was recognized in 2010 and $757 thousand was recognized in 2009. The following table provides further information on this security as of September 30, 2013 (dollars in thousands):

 

Security		Class				Current Moody’s Ratings (Lowest Assigned Rating)				Book Value				Market Value				Unrealized Loss				Current Defaults and Deferrals				% of Current Defaults and Deferrals to Current Collateral				Excess Sub (1)				Estimated Incremental Defaults Required to Break Yield  (2)				Cumulative Other Comprehensive Loss				Amount of OTTI Related to Credit Loss (3)
PreTSL XXVI			C-2				C			$	2,218			$	134			$	2,084			$	259,000				30.2	%			–19.47	%			BROKEN			$	2,084			$	—

 

(1)

Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.

(2)

A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.

(3)	Pre-tax credit losses recorded in 2013.

 

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As of September 30, 2013, the Company had one pooled trust preferred security that was deemed to be temporarily impaired based on a present value analysis of expected future cash flows. The security had a fair value of $1.5 million. The following table provides further information on this security as of September 30, 2013 (dollars in thousands):

 

Security		Class				Current Moody’s Ratings (Lowest Assigned Rating)				Book Value				Market Value				Unrealized Loss				Current Defaults and Deferrals				% of Current Defaults and Deferrals to Current Collateral				Excess Sub (1)				Estimated Incremental Defaults Required to Break Yield  (2)				Cumulative Other Comprehensive Loss				Amount of OTTI Related to Credit Loss (3)
PreTSL XXVII			B				Cc			$	2,863			$	1,478			$	1,385			$	81,800				26.1	%			4.53	%		$	—			$	1,385			$	—

 

(1)

Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.

(2)

A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.

(3)	Pre-tax credit losses recorded in 2013.

The following table presents a roll-forward of the credit loss component amount of OTTI recognized in earnings:

 

(in thousands)
Amount recognized through December 31, 2012		$	2,166
Additions:
Initial credit impairments			—
Subsequent credit impairments			—
Reductions:
Sale/redemption			—
Amount recognized through September 30, 2013		$	2,166

Management has evaluated each of these securities for potential impairment under ASC 325 “Investments-Other” and the most recently issued related guidance, and has reviewed each of the issues’ collateral participants’ most recent earnings, capital and loan loss reserve levels, and non-performing loan levels to estimate a future deferral and default rate in basis points for the remaining life of each security. For the quarter ending September 30, 2013, we used a consistent 75 basis points for all PreTSL securities, XXVI and XXVII, for expected deferrals and defaults as a percentage of remaining performing collateral for future periods. In performing a detailed present value cash flow analysis for each security, the deferral rate was treated the same. If this analysis results in a present value of expected cash flows that is less than the book value of a security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed used discount rates equal to the credit spread at the time of purchase for each security and then added the current 3-month LIBOR forward interest rate curve. The analysis also assumed 15% recoveries on deferrals after two years and prepayments of 1% per year on each security. As of September 30, 2013, performing issuers included 47 out of 68 issuers in PreTSL XXVI, and 33 out of 47 issuers in PreTSL XXVII.

Our investment in Federal Home Loan Bank (“FHLB”) stock totaled $5.2 million at September 30, 2013. FHLB stock is generally viewed as a long-term investment and as a restricted security, which is carried at cost, because there is no market for the stock, other than FHLBs or member institutions. As of September 30, 2013, the Company’s security portfolio also included $5.6 million of Federal Reserve Bank Stock and $145 thousand in stock with the Community Bankers Bank. These three stocks are reported as restricted securities on the balance sheet.

 

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4.

Loans

Major classes of loans, excluding loans held-for-sale, are summarized at September 30, 2013, and December 31, 2012, as follows (dollars in thousands):

 

		September 30, 2013				December 31, 2012
Commercial		$	218,197			$	261,007
Real estate-one-to-four family residential:
Permanent first and second			296,110				282,640
Home equity loans and lines			109,844				117,175
Total real estate-one-to-four family residential		$	405,954			$	399,815
Real estate multi-family residential			70,330				78,397
Real estate-non-farm, non-residential:
Owner-occupied			438,981				486,478
Non-owner-occupied			651,206				668,755
Total real estate-non-farm, non-residential		$	1,090,187			$	1,155,233
Real estate-construction:
Residential			160,688				169,977
Commercial			104,508				112,062
Total real estate-construction		$	265,196			$	282,039
Consumer			8,784				8,266
Farmland			5,560				4,888
Total Loans		$	2,064,208			$	2,189,645
Less unearned income			4,303				4,000
Less allowance for loan losses			40,909				42,773
Loans, net		$	2,018,996			$	2,142,872

Classes of loans by risk rating as of September 30, 2013, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades		Pass				Watch				Special Mention				Substandard				Doubtful				Total Loans
Commercial		$	162,914			$	21,739			$	8,257			$	23,497			$	1,790			$	218,197
Real estate-one-to-four family residential:
Permanent first and second			253,358				9,222				14,197				19,333				—				296,110
Home equity loans and lines			100,070				2,606				1,800				3,881				1,487				109,844
Total real estate-one-to-four family residential		$	353,428			$	11,828			$	15,997			$	23,214			$	1,487			$	405,954
Real estate-multi-family residential			66,782				3,548				—				—				—				70,330
Real estate-non-farm, non-residential:
Owner-occupied			353,479				36,235				23,069				26,198				—				438,981
Non-owner-occupied			505,643				91,680				20,785				33,098				—				651,206
Total real estate-non-farm, non-residential		$	859,122			$	127,915			$	43,854			$	59,296			$	—			$	1,090,187
Real estate-construction:
Residential			124,733				11,634				18,402				5,919				—				160,688
Commercial			64,946				15,201				584				23,777				—				104,508
Total real estate-construction		$	189,679			$	26,835			$	18,986			$	29,696			$	—			$	265,196
Consumer			8,307				183				175				119				—				8,784
Farmland			2,328				3,232				—				—				—				5,560
Total		$	1,642,560			$	195,280			$	87,269			$	135,822			$	3,277			$	2,064,208

 

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Classes of loans by risk rating as of December 31, 2012, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades		Pass				Watch				Special Mention				Substandard				Doubtful				Total Loans
Commercial		$	202,088			$	25,048			$	11,976			$	19,822			$	2,073			$	261,007
Real estate-one-to-four family residential:
Permanent first and second			235,672				15,585				12,233				19,038				112				282,640
Home equity loans and lines			106,872				2,724				1,871				4,165				1,543				117,175
Total real estate-one-to-four family residential		$	342,544			$	18,309			$	14,104			$	23,203			$	1,655			$	399,815
Real estate-multi-family residential			73,317				5,080				—				—				—				78,397
Real estate-non-farm, non-residential:
Owner-occupied			384,923				46,123				35,675				19,757				—				486,478
Non-owner-occupied			488,415				108,868				30,094				41,378				—				668,755
Total real estate-non-farm, non-residential		$	873,338			$	154,991			$	65,769			$	61,135			$	—			$	1,155,233
Real estate-construction:
Residential			104,835				17,651				20,720				26,771				—				169,977
Commercial			41,336				18,645				26,281				25,800				—				112,062
Total real estate-construction		$	146,171			$	36,296			$	47,001			$	52,571			$	—			$	282,039
Consumer			7,744				208				219				95				—				8,266
Farmland			1,000				3,888				—				—				—				4,888
Total		$	1,646,202			$	243,820			$	139,069			$	156,826			$	3,728			$	2,189,645

Loan risk-ratings for the Bank are defined as follows:

Pass. Loans to persons or entities with a strong to acceptable financial condition, adequate collateral margins, adequate cash flow to service long-term debt, adequate liquidity and sound net worth. These entities are profitable now, with projections indicating continued profitability into the foreseeable future. Closely held corporations or businesses where a majority of the profits are withdrawn by the owners or paid in dividends are included in this rating category. Overall, these loans are basically sound.

Watch. These loans are characterized by greater than average risk. Borrowers may have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class may include inadequate credit or financial information. This classification includes loans to established borrowers that are reasonably margined by collateral, but where potential for improvement in financial capacity appears limited.

Special Mention. Loans in this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deteriorating prospects for the asset or in the institution’s credit position at some future date. Other assets especially mentioned (“OAEMs”) are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

Substandard. A loan classified as substandard has a well-defined weakness and is inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Distinct loss potential, while existing in the aggregate amount of substandard loans, does not necessarily exist in individual assets that are rated substandard.

Doubtful. A loan classified as doubtful has all the weaknesses inherent in a loan classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full in a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status and have a defined work-out strategy.

 

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Loss. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The Bank takes losses in the period in which they become uncollectible.

As of September 30, 2013, and December 31, 2012, there were $182 thousand and $858 thousand, respectively, in checking account overdrafts that were reclassified on the consolidated balance sheets as loans.

 

5.	Allowance for Loan Losses

An analysis of the allowance for loan losses for the nine months ended September 30, 2013, and the year ended December 31, 2012, is shown below (dollars in thousands):

 

Allowance for Loan Losses - By Segment (dollars in thousands) For the nine months ended Sept. 30, 2013		Commercial				Non-Farm, Non-Res. Real Estate				Real Estate Construction				Consumer				Real Estate One-to- Four Family Residential				Real Estate Multi- Family Residential				Farmland				Unallocated				Total
Allowance for credit losses:
Beginning Balance		$	5,455			$	11,592			$	14,939			$	167			$	10,420			$	78			$	122			$	—			$	42,773
Charge-offs			(2,560	)			(1,783	)			(4,308	)			(72	)			(568	)			—				—				—				(9,291	)
Recoveries			189				88				601				34				308				—				—				—				1,220
Provision			5,405				4,719				(2,940	)			93				(1,126	)			63				(11	)			4				6,207
Ending Balance		$	8,489			$	14,616			$	8,292			$	222			$	9,034			$	141			$	111			$	4			$	40,909
Ending Balance:
Individually evaluated for impairment		$	4,972			$	6,960			$	2,179			$	61			$	5,622			$	—			$	—			$	—			$	19,794
Collectively evaluated for impairment			3,517				7,656				6,113				161				3,412				141				111				4				21,115
Financing Receivables:
Ending Balance		$	218,197			$	1,090,187			$	265,196			$	8,784			$	405,954			$	70,330			$	5,560			$	—			$	2,064,208
Ending Balance:
Individually evaluated for impairment			25,287				69,398				29,696				119				26,880				—				—				—				151,380
Collectively evaluated for impairment			192,910				1,020,789				235,500				8,665				379,074				70,330				5,560				—				1,912,828

 

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Allowance for Loan Losses - By Segment (dollars in thousands) For the year ended December 31, 2012		Commercial				Non-Farm, Non-Res. Real Estate				Real Estate Construction				Consumer				Real Estate One-to- Four Family Residential				Real Estate Multi- Family Residential				Farmland				Unallocated				Total
Allowance for credit losses:
Beginning Balance		$	10,378			$	12,554			$	15,161			$	245			$	9,724			$	608			$	59			$	—			$	48,729
Charge-offs			(5,904	)			(6,388	)			(7,587	)			(306	)			(4,022	)			—				—				—				(24,207	)
Recoveries			1,035				1,081				539				55				597				118				—				—				3,425
Provision			(54	)			4,345				6,826				173				4,121				(648	)			63				—				14,826
Ending Balance		$	5,455			$	11,592			$	14,939			$	167			$	10,420			$	78			$	122			$	—			$	42,773
Ending Balance:
Individually evaluated for impairment		$	1,580			$	2,390			$	6,228			$	48			$	6,132			$	—			$	—			$	—			$	16,378
Collectively evaluated for impairment			3,875				9,202				8,711				119				4,288				78				122				—				26,395
Financing Receivables:
Ending Balance		$	261,007			$	1,155,233			$	282,039			$	8,266			$	399,815			$	78,397			$	4,888			$	—			$	2,189,645
Ending Balance:
Individually evaluated for impairment			21,895				72,630				52,571				95				26,938				—				—				—				174,129
Collectively evaluated for impairment			239,112				1,082,603				229,468				8,171				372,877				78,397				4,888				—				2,015,516

A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on non-accrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across our loan portfolio.

Included in certain loan categories in the following impaired loans table are troubled debt restructurings (“TDRs”) that were classified as impaired. A TDR loan is a loan that has been restructured with a modification that could include interest rate modification, deferral of interest or principal or an extension of term. At September 30, 2013, the Company had $9.9 million in non-farm non-residential, $8.0 million in real estate construction, $1.4 million in real estate one-to-four family residential and $2.5 million in commercial that were modified in troubled debt restructurings and considered impaired. At September 30, 2013, there were three TDRs totaling $2.1 million that are not performing in accordance with their modified terms. At December 31, 2012, all TDRs were performing in accordance with their modified terms.

 

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Information about past due loans and impaired loans as of September 30, 2013, and December 31, 2012, is as follows (dollars in thousands):

 

Non Accrual and Past Due by class September 30, 2013		30-59 Days Past Due				60-89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Current  (1)				Total Loans				Greater than 90 Days Past Due and Still Accruing				Non- Accrual Loans
Commercial		$	6,110			$	247			$	2,140			$	8,497			$	209,700			$	218,197			$	250			$	2,663
Real estate-one-to-four family residential:
Permanent first and second			86				3,881				2,650				6,617				289,493				296,110				876				2,655
Home equity loans and lines			193				—				2,958				3,151				106,693				109,844				—				2,382
Total real estate-one-to-four family residential		$	279			$	3,881			$	5,608			$	9,768			$	396,186			$	405,954			$	876			$	5,037
Real estate multi-family residential			—				—				—				—				70,330				70,330				—				—
Real estate-non-farm, non-residential:
Owner-occupied			612				2,974				3,464				7,050				431,931				438,981				—				4,571
Non-owner-occupied			3,337				789				—				4,126				647,080				651,206				—				3,239
Total real estate-non-farm, non-residential		$	3,949			$	3,763			$	3,464			$	11,176			$	1,079,011			$	1,090,187			$	—			$	7,810
Real estate-construction:
Residential			283				—				408				691				159,997				160,688				—				4,112
Commercial			—				—				8,976				8,976				95,532				104,508				—				8,976
Total real estate-construction		$	283			$	—			$	9,384			$	9,667			$	255,529			$	265,196			$	—			$	13,088
Consumer			46				—				—				46				8,738				8,784				—				23
Farmland			—				—				—				—				5,560				5,560				—				—
Total Loans		$	10,667			$	7,891			$	20,596			$	39,154			$	2,025,054			$	2,064,208			$	1,126			$	28,621

 

(1)	For the purposes of this table, loans 1-29 days past due are included in the balance of “Current” loans.

 

Non Accrual and Past Due by class December 31, 2012		30-59 Days Past Due				60-89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Current  (1)				Total Loans				Greater than 90 Days Past Due and Still Accruing				Non- Accrual Loans
Commercial		$	366			$	—			$	1,872			$	2,238			$	258,769			$	261,007			$	—			$	3,317
Real estate-one-to-four family residential:
Permanent first and second			435				1,729				1,065				3,229				279,411				282,640				—				3,606
Home equity loans and lines			307				—				1,412				1,719				115,456				117,175				—				2,498
Total real estate-one-to-four family residential		$	742			$	1,729			$	2,477			$	4,948			$	394,867			$	399,815			$	—			$	6,104
Real estate multi-family residential			—				—				—				—				78,397				78,397				—				—
Real estate-non-farm, non-residential:
Owner-occupied			505				1,255				1,540				3,300				483,178				486,478				—				1,791
Non-owner-occupied			1,661				1,786				2,079				5,526				663,229				668,755				—				3,864
Total real estate-non-farm, non-residential		$	2,166			$	3,041			$	3,619			$	8,826			$	1,146,407			$	1,155,233			$	—			$	5,655
Real estate-construction:
Residential			—				—				13,471				13,471				156,506				169,977				—				16,976
Commercial			—				—				5,350				5,350				106,712				112,062				—				5,860
Total real estate-construction		$	—			$	—			$	18,821			$	18,821			$	263,218			$	282,039			$	—			$	22,836
Consumer			17				23				—				40				8,226				8,266				—				17
Farmland			—				—				—				—				4,888				4,888				—				—
Total Loans		$	3,291			$	4,793			$	26,789			$	34,873			$	2,154,772			$	2,189,645			$	—			$	37,929

 

(1)	For the purposes of this table, loans 1-29 days past due are included in the balance of “Current” loans.

 

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Impaired Loans as of September 30, 2013 (dollars in thousands)		Recorded Investment (Bank Balance)				Unpaid Principal Balance (Customer Balance)				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance:
Commercial		$	8,597			$	8,621			$	—			$	9,143			$	279
Real estate-one-to-four family residential:
Permanent first and second			5,505				6,314				—				6,306				193
Home equity loans and lines			2,520				2,010				—				2,286				70
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			15,756				15,912				—				12,006				367
Non-owner-occupied			20,507				20,528				—				29,508				902
Real estate-construction:
Residential			938				938				—				962				29
Commercial			15,297				15,401				—				15,213				465
Consumer			2				2				—				13				—
Farmland			—				—				—				—				—
With an allowance recorded:
Commercial		$	16,690			$	16,690			$	4,972			$	19,811			$	606
Real estate-one-to-four family residential:
Permanent first and second			15,476				15,499				3,462				15,541				475
Home equity loans and lines			3,379				3,478				2,160				3,273				100
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			12,591				12,785				1,378				11,880				363
Non-owner-occupied			20,544				20,544				5,582				15,575				476
Real estate-construction
Residential			4,981				5,002				808				5,365				164
Commercial			8,480				8,537				1,371				8,482				259
Consumer			117				122				61				121				4
Farmland			—				—				—				—				—
Total:
Commercial		$	25,287			$	25,311			$	4,972			$	28,954			$	885
Real estate-one-to-four family residential			26,880				27,301				5,622				27,405				838
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential			69,398				69,769				6,960				68,968				2,108
Real estate-construction			29,696				29,878				2,179				30,020				917
Consumer			119				124				61				134				4
Farmland			—				—				—				—				—
Total Impaired Loans		$	151,380			$	152,383			$	19,794			$	155,479			$	4,752

 

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Impaired Loans as of December 31, 2012 (dollars in thousands)		Recorded Investment (Bank Balance)				Unpaid Principal Balance (Customer Balance)				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance:
Commercial		$	14,459			$	14,481			$	—			$	17,671			$	727
Real estate-one-to-four family residential:
Permanent first and second			6,604				6,908				—				7,123				293
Home equity loans and lines			550				550				—				1,264				52
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			11,563				11,663				—				12,018				494
Non-owner-occupied			39,211				39,283				—				33,350				1,372
Real estate-construction:
Residential			1,868				1,881				—				11,389				469
Commercial			15,050				15,140				—				15,185				625
Consumer			19				19				—				19				1
Farmland			—				—				—				—				—
With an allowance recorded:
Commercial		$	7,436			$	7,457			$	1,580			$	4,997			$	206
Real estate-one-to-four family residential:
Permanent first and second			13,827				13,856				3,383				15,749				648
Home equity loans and lines			5,957				6,055				2,749				4,788				197
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			9,165				11,663				1,321				9,461				388
Non-owner-occupied			12,691				12,691				1,069				21,264				875
Real estate-construction
Residential			24,903				24,970				4,304				20,876				859
Commercial			10,750				10,786				1,924				11,683				481
Consumer			76				80				48				81				3
Farmland			—				—				—				—				—
Total:
Commercial		$	21,895			$	21,938			$	1,580			$	22,668			$	933
Real estate-one-to-four family residential			26,938				27,369				6,132				28,924				1,190
Real estate-multi-family residential			—				—				—				—				—
Real estate-non-farm, non-residential			72,630				75,300				2,390				76,092				3,131
Construction			52,571				52,777				6,228				59,133				2,434
Consumer			95				99				48				100				4
Farmland			—				—				—				—				—
Total Impaired Loans		$	174,129			$	177,483			$	16,378			$	186,915			$	7,690

In performing a specific reserve analysis on all impaired loans as of September 30, 2013, current third party appraisals or current tax-assessed values were used with respect to approximately 70% of impaired loans to assist with the evaluation of collateral values for the purpose of establishing specific reserves. Tax-assessed values are used primarily for residential properties within the Bank’s market area, supported by a current market analysis of actual sale prices to tax-assessed values for these individual counties. Other loans predominantly representing smaller individual balances were evaluated based upon current tax assessed values or estimated liquidation value of business assets. When a loan is identified as impaired and collateral dependent, a current evaluation of collateral value via third party appraisal or other valuation methodology is conducted within the calendar quarter of identification when possible but, not less than 90 days after identification. Charge-offs and specific reserves are established upon determination of collateral value. During the interim between identification of an impaired loan and receipt of a current appraisal of the related collateral, specific reserves are established based upon interim methodologies including discounted cash flow analysis, tax assessment values and review of market comparables.

 

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Costs of sale are estimated at 10% of value. Partially charged-off loans remain non-performing until such time as a viable restructuring plan is developed. Upon execution of a forbearance agreement including modified terms, an impaired loan will be re-classified from non-performing to a troubled debt restructuring, but will continue to be identified as impaired until the loan is repaid. Impaired loans which do not have a specific reserve are those loans which have been identified to have sufficient collateral coverage, based upon the fair value of collateral, to repay the entire principal balance due from collateral liquidation.

Information about new troubled debt restructurings during the three and nine months ended September 30, 2013, is as follows (dollars in thousands):

 

Troubled Debt Restructurings (TDRs) New TDRs by Loan Type		7/1/2013 to 9/30/2013												1/1/2013 to 9/30/2013
Loan Type:		# of Loans				Balance at Restructure				Balance at 9/30/2013				# of Loans				Balance at Restructure				Balance at 9/30/2013
Commercial			—			$	—			$	—				1			$	231			$	225
Real estate-one-to-four family residential:
Permanent first and seconds			—				—				—				1				113				111
Home equity loans and lines			—				—				—				—				—				—
Total real estate-one-to-four family residential:			—			$	—			$	—				1			$	113			$	111
Real estate-multi-family residential			—				—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			—				—				—				1				356				356
Non-owner-occupied			—				—				—				2				594				593
Total real estate-non-farm, non-residential:			—			$	—			$	—				3			$	950			$	949
Real estate-construction:
Residential			—				—				—				—				—				—
Commercial			1				1,123				1,123				1				1,123				1,123
Total real estate-construction:			1			$	1,123			$	1,123				1			$	1,123			$	1,123
Consumer			—				—				—				—				—				—
Farmland			—				—				—				—				—				—
Total Loans			1			$	1,123			$	1,123				6			$	2,417			$	2,408

 

Troubled Debt Restructurings (TDRs) New TDRs by Type of Restructure		7/1/2013 to 9/30/2013												1/1/2013 to 9/30/2013
Type of Restructure:		# of Loans				Balance at Restructure				Balance at 9/30/2013				# of Loans				Balance at Restructure				Balance at 9/30/2013
Interest-only conversion			—			$	—			$	—				—			$	—			$	—
Rate reduction			1				1,123				1,123				2				1,354				1,349
Extended amortization			—				—				—				—				—				—
Deferment of principal or interest payable			—				—				—				—				—				—
Combination *			—				—				—				4				1,063				1,059
Other			—				—				—				—				—				—
Total Loans			1			$	1,123			$	1,123				6			$	2,417			$	2,408

 

*	Represents a combination of any of the above restructure types.

 

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Information about new troubled debt restructurings during the three and nine months ended September 30, 2012, is as follows (dollars in thousands):

 

Troubled Debt Restructurings (TDRs) New TDRs by Loan Type As of September 30, 2012		7/1/2012 to 9/30/2012												1/1/2012 to 9/30/2012
Loan Type:		# of Loans				Balance at Restructure				Balance at 9/30/2012				# of Loans				Balance at Restructure				Balance at 9/30/2012
Commercial			—			$	—			$	—				1			$	—			$	—
Real estate-one-to-four family residential:
Permanent first and seconds			2				804				804				6				2,690				2,688
Home equity loans and lines			—				—				—				—				—				—
Total real estate-one-to-four family residential:			2			$	804			$	804				6			$	2,690			$	2,688
Real estate-multi-family residential			—				—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			—				—				—				—				—				—
Non-owner-occupied			1				8,000				8,000				1				8,000				8,000
Total real estate-non-farm, non-residential:			1			$	8,000			$	8,000				1			$	8,000			$	8,000
Real estate-construction:
Residential			—				—				—				—				—				—
Commercial			—				—				—				—				—				—
Total real estate-construction:			—				—				—				—				—				—
Consumer			—				—				—				—				—				—
Farmland			—				—				—				—				—				—
Total Loans			3			$	8,804			$	8,804				8			$	10,690			$	10,688

 

Troubled Debt Restructurings (TDRs) New TDRs by Type of Restructure As of September 30, 2012		7/1/2012 to 9/30/2012												1/1/2012 to 9/30/2012
Type of Restructure:		# of Loans				Balance at Restructure				Balance at 9/30/2012				# of Loans				Balance at Restructure				Balance at 9/30/2012
Interest-only conversion			—			$	—			$	—				1			$	70			$	70
Rate reduction			3				8,804				8,804				5				9,275				9,275
Extended amortization			—				—				—				—				—				—
Deferment of principal or interest payable			—				—				—				—				—				—
Combination *			—				—				—				2				1,345				1,343
Other			—				—				—				—				—				—
Total Loans			3			$	8,804			$	8,804				8			$	10,690			$	10,688

 

*	Represents a combination of any of the above restructure types.

 

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Information about troubled debt restructurings within the prior twelve months that defaulted during the three and nine months ended September 30, 2013 and 2012, is as follows (dollars in thousands):

 

Troubled Debt Restructurings (TDRs) TDRs Restructured Within Prior 12 Months that Defaulted in Selected Periods

Defaults occurring in 3 rd  Quarter 2013 (7/1/2013 – 9/30/2013)

Defaults occurring Year-to-date (1/1/2013 – 9/30/2013)

Loan Type:

# of Loans

Balance at Restructure

Balance at 9/30/2013

# of Loans

Balance at Restructure

Balance at 9/30/2013

Commercial

—

$

—

$

—

—

$

—

$

—

Real estate-one-to-four family residential:

Permanent first and seconds

—

—

—

—

—

—

Home equity loans and lines

—

—

—

—

—

—

Total real estate-one-to-four family residential:

—

$

—

$

—

—

$

—

$

—

Real estate-multi-family residential

—

—

—

—

—

—

Real estate-non-farm, non-residential:

Owner-occupied

—

—

—

—

—

—

Non-owner-occupied

—

—

—

—

—

—

Total real estate-non-farm, non-residential:

—

$

—

$

—

—

$

—

$

—

Real estate-construction:

Residential

—

—

—

—

—

—

Commercial

—

—

—

—

—

—

Total real estate-construction:

—

$

—

$

—

—

$

—

$

—

Consumer

—

—

—

—

—

—

Farmland

—

—

—

—

—

—

Total Loans

—

$

—

$

—

—

$

—

$

—

 

Troubled Debt Restructurings (TDRs) TDRs Restructured Within Prior 12 Months that Defaulted in Selected Periods As of September 30, 2012
		Defaults occurring in 3 rd  Quarter 2012 (7/1/2012 – 9/30/2012)												Defaults occurring Year-to-date (1/1/2012 – 9/30/2012)
Loan Type:		# of Loans				Balance at Restructure				Balance at 9/30/2012				# of Loans				Balance at Restructure				Balance at 9/30/2012
Commercial			3			$	753			$	380				3			$	753			$	380
Real estate-one-to-four family residential:
Permanent first and seconds			—				—				—				—				—				—
Home equity loans and lines			—				—				—				—				—				—
Total real estate-one-to-four family residential:			—			$	—			$	—				—			$	—			$	—
Real estate-multi-family residential			—				—				—				—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			—				—				—				—				—				—
Non-owner-occupied			—				—				—				—				—				—
Total real estate-non-farm, non-residential:			—			$	—			$	—				—			$	—			$	—
Real estate-construction:
Residential			—				—				—				—				—				—
Commercial			—				—				—				—				—				—
Total real estate-construction:			—			$	—			$	—				—			$	—			$	—
Farmland			—				—				—				—				—				—
Consumer			—				—				—				—				—				—
Total Loans			3			$	753			$	380				3			$	753			$	380

 

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6.	Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of dilutive potential common stock. As of September 30, 2013, and 2012, there were an average of 227,645 and 980,622 anti-dilutive stock options outstanding, respectively.

 

		Three Months Ended																Nine Months Ended
		September 30, 2013								September 30, 2012								September 30, 2013								September 30, 2012
		Shares				Per Share Amount				Shares				Per Share Amount				Shares				Per Share Amount				Shares				Per Share Amount
Basic earnings per share			33,068,722			$	0.21				31,824,656			$	0.22				32,702,828			$	0.63				31,713,132			$	0.58
Effect of dilutive securities:
Stock options and warrants			2,285,634								1,926,033								2,581,108								1,932,276
Diluted earnings per common share			35,354,356			$	0.20				33,750,689			$	0.21				35,283,936			$	0.58				33,645,408			$	0.54

 

7.	Stock Compensation Plan

At September 30, 2013, the Company had two stock-based compensation plans, the 1998 Stock Option Plan and the Company’s 2010 Equity Plan (the “2010 Plan”). The 2010 Plan replaced the 1998 Stock Option Plan and as such no further options may be granted under the 1998 Stock Option Plan. Included in salaries and employee benefits expense for the nine months ended September 30, 2013 and 2012, is $363 thousand and $416 thousand, respectively, of stock-based compensation expense which is based on the estimated fair value of 744,057 options granted between January 2008 and September 2013, as adjusted for stock dividends, amortized on a straight-line basis over a five year requisite service period. As of September 30, 2013, there was $475 thousand remaining of total unrecognized compensation expense related to these option awards which will be recognized over the remaining requisite service periods.

The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in the first nine months of 2013 and 2012:

 

		2013  1				2012
Expected volatility			—			33.68%
Expected dividends			—			0.00%
Expected term (in years)			—			7.2
Risk-free rate			—			1.10% to 1.44%

 

1	No option awards were granted during the nine months ended September 30, 2013.

Stock option plan activity for the nine months ended September 30, 2013, is summarized below:

 

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term				Aggregate Intrinsic Value
Outstanding at January 1, 2013			1,462,653			$	9.99
Granted			—				—
Exercised			403,322				8.09
Forfeited			79,047				10.97
Outstanding at September 30, 2013			980,284			$	10.69				3.9 years			$	5,005
Exercisable at September 30, 2013			799,580			$	11.65				3.1 years			$	3,357

The total value of in-the-money options exercised during the nine months ended September 30, 2013, was $1.9 million.

Restricted stock awards generally vest in equal installments over five years. The compensation expense associated with these awards is based on the grant date fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service period.

 

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A summary of the non-vested restricted stock activity under the 2010 Plan for the nine months ended September 30, 2013, is summarized below:

 

		Number of Shares				Weighted- Average Grant Date Fair Value
Non-vested at the beginning of year			110,215			$	7.70
Granted			97,950				13.49
Vested			(17,002	)			12.72
Forfeited			(7,967	)			13.49
Non-vested at end of the period			183,196			$	10.10

We recognized share-based compensation expense associated with shares of restricted stock of $176 thousand for the nine months ended September 30, 2013.

 

8.	Capital Requirements

A comparison of the September 30, 2013, capital ratios of the Company and its wholly-owned subsidiary, Virginia Commerce Bank (the “Bank”), with the minimum regulatory guidelines is as follows:

 

		Actual Capital				Minimum Capital Requirements				Minimum to be “Well-Capitalized” Under Prompt Corrective Action Provisions
Total Risk-Based Capital :
Company			16.84	%			8.00	%			—
Bank			16.19	%			8.00	%			10.00	%
Tier 1 Risk-Based Capital :
Company			15.58	%			4.00	%			—
Bank			14.93	%			4.00	%			6.00	%
Leverage Ratio :
Company			12.07	%			4.00	%			—
Bank			11.80	%			4.00	%			5.00	%

 

9.	Other Borrowed Funds and Lines of Credit

The Bank maintains a $425.1 million line of credit with the FHLB of Atlanta. The interest rate and term of each advance from the line is dependent upon the advance and commitment type. Advances on the line are secured by all of the Bank’s qualifying first liens and home equity lines-of-credit on one-to-four unit single-family dwellings. As of September 30, 2013, the carrying value of these qualifying loans totaled approximately $266.1 million and the amount of available credit using this collateral was $173.4 million. Advances on the line of credit in excess of this amount require pledging of additional assets, including other types of loans and investment securities. As of September 30, 2013 the Bank had $40.0 million in advances outstanding that matured in October 2013. The Bank had a $7.0 million secured borrowing relating to two loan participations to a related party with cash flow priority as of December 31, 2012. The Bank has additional short-term lines of credit totaling $47.0 million with nonaffiliated banks at September 30, 2013, on which there were no amounts outstanding.

 

10.	Trust Preferred Capital Notes

On December 19, 2002, the Company completed a private placement issuance of $15.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust II) which issued $470 thousand in common equity to the Company. These securities bear a floating rate of interest, adjusted semi-annually, of 330 basis points over six month LIBOR, which as of November 2, 2013, was 3.72%. These securities have been callable at par since December 30, 2007, on any semi-annual interest payment date, but have not been redeemed to date. On December 20, 2005, the Company completed a private placement of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust III) which issued $774 thousand in common equity to the Company. These securities had a fixed rate of interest of 6.19% until February 23,

 

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2011, at which time they converted to a floating rate, adjusted quarterly, of 142 basis points over three month LIBOR, which as of November 2, 2013, was 1.68%. These securities became callable at par beginning February 23, 2011.

On September 24, 2008, the Company completed a private placement, to its directors and certain executive officers, of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust IV) which issued $775 thousand in common equity to the Company. These securities bear a fixed rate of interest of 10.20% and are callable at par beginning September 24, 2013. In connection with the issuance of the trust preferred securities, the Company also issued warrants to purchase an aggregate of 1.5 million shares of common stock to the purchasers. The warrants had a five year term and an exercise price of $6.83 per share. All warrants were exercised prior to September 30, 2013.

The principal asset of each trust is a similar amount of the Company’s junior subordinated debt securities with an approximately 30 year term from issuance and like interest rates to the trust preferred securities. The obligations of the Company with respect to the trust preferred securities constitute a full and unconditional guarantee by the Company of each trust’s obligations with respect to the trust preferred securities to the extent set forth in the related guarantees. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, resulting in a deferral of distribution payments on the related trust preferred securities. If the Company defers interest payments on the junior subordinated debt securities, or otherwise is in default of the obligations in respect to the trust preferred securities, the Company would be prohibited from making dividend payments to its stockholders, and from most purchases, redemptions or acquisitions of the Company’s common stock.

Under currently applicable capital standards, the trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes up to 25.0% of Tier 1 capital after its inclusion. The portion of the trust preferred securities not qualifying as Tier 1 capital may be included as part of total qualifying capital in Tier 2 capital, subject to limitations set forth in applicable bank capital regulatory guidelines.

 

11.	Preferred Stock and Warrant

On December 12, 2008, the Company entered into a Letter Agreement (“Agreement”) with the United States Department of the Treasury (“Treasury”) under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), whereby the Company issued and sold to the Treasury 71,000 shares of fixed rate cumulative perpetual preferred stock with a par value of $1.00 and a liquidation amount of $1,000 per share, for a total price of $71.0 million. In addition, the Treasury received a warrant to purchase 2,696,203 shares of the Company’s common stock at an exercise price of $3.95 per share. Subject to certain restrictions, the preferred stock and the warrant are transferable by the Treasury.

On December 11, 2012, the Company repurchased all of its preferred stock that was issued to the Treasury under the TARP CPP. Pursuant to the redemption, the Treasury received from the Company $71.3 million, consisting of $71.0 million in liquidation value of the preferred stock and approximately $256 thousand in accrued and unpaid dividends for the fourth quarter of 2012. The preferred stock had a carrying value of $68.9 million prior to repayment on December 11, 2012, net of unaccreted discount. The Company accelerated the accretion of the preferred stock discount in the fourth quarter of 2012, which reduced net income available to common shareholders for the year ended December 31, 2012 by approximately $2.1 million.

The warrant has a ten year term, is immediately exercisable and remained outstanding at September 30, 2013. Pursuant to the terms of the Agreement, the Treasury will not exercise voting rights with respect to any shares of common stock it acquires upon exercise of the warrant; voting rights may be exercised by any other holder. As of September 30, 2013 and December 31, 2012, the allocated carrying value of the warrant, based on its fair value at the time of issuance, was $8.5 million.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless the context otherwise requires, the terms “we”, “us” and “our” refer to Virginia Commerce Bancorp, Inc. and its subsidiaries on a consolidated basis. The following discussion and analysis, the purpose of which is to provide investors and others with information that we believe to be necessary for an understanding of our current financial condition, changes in financial condition and results of operations, should be read in conjunction with the consolidated financial statements, notes and other information contained in this report.

Cautionary Note Regarding Forward-Looking Statements

This management’s discussion and analysis and other portions of this report, contain forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies, including but not limited to our outlook on earnings, statements regarding asset quality, concentrations of credit risk, our deposit portfolio and expected future changes in our deposit portfolio, the adequacy of the allowance for loan losses, projected growth, capital position, our plans regarding and expected future levels of our non-performing assets, the pending merger with United Bankshares, Inc., business opportunities in our markets and strategic initiatives to capitalize on those opportunities, and general economic conditions. When we use words such as “may,” “will,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,” “continue,” “should,” and similar words or phrases you should consider them as identifying forward-looking statements. These forward-looking statements are not guarantees of future performance. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors, and other conditions which by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results may differ materially from those indicated herein.

Our forward-looking statements are subject to the following principal risks and uncertainties:

 

•

adverse governmental or regulatory policies may be enacted;

 

•

the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) could increase our regulatory compliance burden and associated costs, place restrictions on certain products and services, and limit our future capital raising strategies;

 

•

the interest rate environment may compress margins and adversely affect net interest income;

 

•

adverse effects may be caused by changes to credit quality;

 

•

competition from other financial services companies in our markets could adversely affect operations;

 

•

our concentrations of commercial, commercial real estate and construction loans, may adversely affect our earnings and results of operations;

 

•

we may not be able to consummate the proposed merger between us and United Bankshares, Inc. on our anticipated timeline, or at all;

 

•

an economic slowdown could adversely affect credit quality, loan originations and the value of collateral securing the Company’s loans; and

 

•

social and political conditions such as war, political unrest and terrorism or natural disasters could have unpredictable negative effects on our businesses and the economy.

Other factors, risks and uncertainties that could cause our actual results to differ materially from estimates and projections contained in these forward-looking statements are discussed under “Risk Factors” in the Company’s annual report on Form 10-K for the year ended December 31, 2012.

 

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Readers are cautioned against placing undue reliance on any such forward-looking statements. The Company disclaims any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.

Non-GAAP Presentations

The Company prepares its financial statements under accounting principles generally accepted in the United States, or “GAAP”. However, this quarterly report on Form 10-Q also refers to certain non-GAAP financial measures that we believe, when considered together with GAAP financial measures, provide investors with important information regarding our operational performance. An analysis of any non-GAAP financial measures should be used in conjunction with results presented in accordance with GAAP.

Adjusted operating earnings is a non-GAAP financial measure that reflects net income available to common stockholders excluding impairment loss on investment securities, realized gains and losses on sale of investment securities, merger-related expenses and certain other non-recurring items. These excluded items are difficult to predict and we believe that adjusted operating earnings provides the Company and investors with a valuable measure of the Company’s operational performance and a valuable tool to evaluate the Company’s financial results. Calculation of adjusted operating earnings for the three and nine months ended September 30, 2013 and September 30, 2012, is as follows:

 

(dollars in thousands)		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net Income Available to Common Stockholders		$	6,953			$	7,122			$	20,452			$	18,258
Adjustments to net income:
Realized gain on sale of investment securities available-for-sale			—				(2,056	)			—				(5,976	)
Merger-related expense			1,155				—				2,021				—
Net tax effect adjustments			(166	)			720				(1,615	)			2,092
Adjusted Operating Earnings		$	7,942			$	5,786			$	20,858			$	14,374

The adjusted efficiency ratio is a non-GAAP financial measure that is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis, and non-interest income excluding merger-related expenses, realized gains and losses on sale of investment securities, and certain other non-recurring items. We believe that this measure provides investors with important information about our operating efficiency. Comparison of our adjusted efficiency ratio with those of other companies may not be possible because other companies may calculate the adjusted efficiency ratio differently. Calculation of the adjusted efficiency ratio for the three months and nine months ended September 30, 2013 and September 30, 2012, is as follows:

 

(dollars in thousands)		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Summary Operating Results:
Non-interest expense		$	14,865			$	15,212			$	46,550			$	47,396
Merger-related expenses			1,155				—				2,021				—
Adjusted non-interest expense		$	13,710			$	15,212			$	44,529			$	47,396
Net interest income		$	25,253			$	26,368			$	76,839			$	80,064
Non-interest income			1,822				4,725				6,576				13,095
Gain on sale of investment securities available-for-sale			—				(2,056	)			—				(5,976	)
Adjusted non-interest income		$	1,822			$	2,669			$	6,576			$	7,119
Tax equivalent adjustment		$	344			$	360			$	1,053			$	1,091
Total net interest income and non-interest income, adjusted		$	27,419			$	29,397			$	84,468			$	88,274
Efficiency Ratio, adjusted			50.0	%			51.8	%			52.7	%			53.7	%
Efficiency Ratio, GAAP (1)			54.9	%			48.9	%			55.8	%			50.9	%

 

(1)	Computed by dividing non-interest expense by the sum of net interest income and non-interest income.

 

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The tangible common equity ratio is a non-GAAP financial measure representing the ratio of tangible common equity to tangible assets. Tangible common equity and tangible assets are non-GAAP financial measures derived from GAAP-based amounts. We calculate tangible common equity for the Company by excluding the balance of intangible assets from total stockholders’ equity. We calculate tangible assets by excluding the balance of intangible assets from total assets. We had no intangible assets for the periods presented. We believe that this is consistent with the treatment by regulatory agencies, which exclude intangible assets from the calculation of regulatory capital ratios. Accordingly, we believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our capital position and ratios. However, these non-GAAP financial measures are supplemental and are not substitutes for an analysis based on a GAAP measure. As other companies may use different calculations for non-GAAP measures, our presentation may not be comparable to other similarly titled measures reported by other companies. Calculation of the Company’s tangible common equity ratio as of September 30, 2013 and December 31, 2012 is as follows:

 

(in thousands)		As of September 30,				December 31,
		2013				2012
Tangible common equity:
Total stockholders’ equity		$	264,253			$	245,309
Less:
Intangible assets			—				—
Tangible common equity		$	264,253			$	245,309
Total tangible assets		$	2,756,322			$	2,823,692
Tangible common equity ratio			9.59	%			8.69	%

Additional Information

Our common stock is listed for quotation on the Global Select Market of The NASDAQ Stock Market under the symbol “VCBI.” Additional information can be found through our website at www.vcbonline.com by selecting “About VCB/Investor Relations/SEC Filings”. Electronic copies of our 2012 Annual Report on Form 10-K are available free of charge by visiting the “SEC Filings” section of our website. Electronic copies of quarterly reports on Form 10-Q, current reports on Form 8-K and other filings with the Securities and Exchange Commission (the “SEC”) are also available. These reports are posted as soon as reasonably practicable after they are electronically filed with the SEC.

Where we have included website addresses in this Report, such as our website address, we have included those addresses as inactive textual references only. Except if specifically incorporated by reference into this report, information on those websites is not part hereof.

General

The following presents management’s discussion and analysis of the consolidated financial condition and results of operations of Virginia Commerce Bancorp, Inc. and subsidiaries (the “Company”) as of the dates and for the periods indicated. The purpose of the following discussion and analysis is to provide investors and others with information that we believe to be necessary in understanding the financial condition, changes in financial condition, and results of operations of our Company. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto, and other financial data appearing elsewhere in this report.

The Company is the parent bank holding company for Virginia Commerce Bank (the “Bank”), a Virginia state-chartered bank that commenced operations in May 1988. The Bank pursues a traditional community banking strategy, offering a full range of business and consumer banking services through twenty-eight branch offices, one residential mortgage office and one wealth management office.

Headquartered in Arlington, Virginia, the Bank serves the Northern Virginia suburbs of Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince William, Spotsylvania and Stafford Counties and the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park. Its service area also covers, to a lesser extent, Washington, D.C. and the nearby Maryland counties of Montgomery and Prince Georges. The Bank’s

 

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customer base includes small-to-medium sized businesses including firms that have contracts with the U.S. government, associations, retailers and industrial businesses, professionals and their firms, business executives, investors and consumers.

Merger between the Company and United Bankshares, Inc.

After the close of business on January 29, 2013, the Company entered into an Agreement and Plan of Reorganization (the “Agreement”) with United Bankshares, Inc. (“United”). In accordance with the Agreement, the Company will merge with and into a wholly-owned subsidiary of United (the “Merger”). At the effective time of the Merger, the Company will cease to exist and the wholly-owned subsidiary of United shall survive and continue to exist as a Virginia corporation.

The Agreement provides that at the effective time of the Merger, each outstanding share of common stock of the Company will be converted into the right to receive 0.5442 shares of United common stock, par value $2.50 per share, subject to adjustment as provided in the Agreement.

Pursuant to the Agreement, at the effective time of the Merger the Company’s outstanding stock options will be converted into options to purchase United’s common stock. In addition, the warrant held by the United States Department of Treasury to purchase common stock of the Company will be converted into a warrant to purchase common stock of United if Treasury’s warrant is outstanding when the Merger closes.

After the effective time of the Merger, the Bank, will merge with and into United Bank, a wholly-owned indirect subsidiary of United (the “Bank Merger”). United Bank will survive the Bank Merger and continue to exist as a Virginia banking corporation.

Under the Agreement and subject to certain exceptions, the Company agreed to conduct its business in the ordinary course while the Merger is pending and, except as permitted under the Agreement, refrain from taking certain specific actions without the consent of United. Shareholders of the Company and of United have approved the Agreement and the Merger, and the Company and United have received regulatory approval for the Merger from the Virginia State Corporation Commission. The Company and United have not yet received regulatory approval from the Board of Governors of the Federal Reserve System (the “Board of Governors”). Completion of the Merger remains subject to receipt of regulatory approval from the Board of Governors and certain other customary closing conditions.

For a description of risks related to the Merger and the Bank Merger, see “Risks Related to the Merger with United Bankshares, Inc. (“UBSI”)” in Item 1A of the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2012, and the registration statement filed by United with the SEC on Form S-4 on May 29, 2013 and all amendments thereof and prospectus supplements thereunder.

Critical Accounting Policies

For the period ended September 30, 2013, there were no changes in the Company’s critical accounting policies as reflected in the Company’s most recent annual report.

The Company’s financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

The allowance for loan losses is an estimate of the losses that are inherent in our loan portfolio. The allowance is based on two basic principles of accounting: (i) Accounting for Contingencies (ASC 450, “Contingencies”), which requires that losses be accrued when they are probable of occurring and estimable and (ii) Accounting by Creditors for Impairment of a Loan (ASC 310, “Receivables”), which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

 

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Our allowance for loan losses has two basic components: the specific allowance and the general allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for impaired loans. Impairment testing includes consideration of the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the fair market value of collateral. These factors are combined to estimate the probability and severity of inherent losses based on the Company’s calculation of the loss embedded in the individual loan. Large groups of smaller balance, homogeneous loans, representing 1-4 family residential first and second trusts, including home equity lines-of-credit, are collectively evaluated for impairment based upon factors such as levels and trends in delinquencies, trends in loss and problem loan identification, trends in volumes and concentrations, local and national economic trends and conditions including estimated levels of housing price depreciation/homeowners’ loss of equity, competitive factors and other considerations. These factors are converted into reserve percentages and applied against the homogenous loan pool balances. Impaired loans which meet the criteria for substandard, doubtful and loss are segregated from performing loans within the portfolio. Internally classified loans are then grouped by loan type (commercial, real estate-one-to-four family residential, real estate-multi-family residential, real estate-non-farm, non-residential, real estate-construction, consumer, and farmland). The general formula is used to estimate the loss of non-classified loans. These un-criticized loans are also segregated by loan type and allowance factors are assigned by management based on delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of management, national and local economic trends, concentrations of credit, quality of the loan review system and the effect of external factors (i.e. competition and regulatory requirements). The factors assigned differ by loan type. The general allowance recognizes potential losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each factor. Further information regarding the allowance for loan losses is provided under the caption “Provision for Loan Losses and Allowance for Loan Losses” later in this report and in Note 5 to the Consolidated Financial Statements.

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time properties have been held, and our ability and intention with regard to continued ownership of the properties. The Company may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions.

The Company’s 1998 Stock Option Plan (the “1998 Plan”), which is stockholder approved, permitted the grant of share options to its directors and officers for up to 2.3 million shares of common stock. The Company’s 2010 Equity Plan (the “2010 Plan”), which is also stockholder approved and replaces the 1998 Plan, permits the grant of share based awards in the form of stock options, stock appreciation rights, restricted and unrestricted stock, performance units, options and other awards to its directors, officers and employees for up to 1.5 million shares of common stock. To date, the Company has granted stock options and restricted stock under the 2010 Plan. The Company also has option awards outstanding under its 1998 Plan, but since May 2, 2010, the effective date of the 2010 Plan, no new awards can be granted under the 1998 Plan.

The Company recognizes expense for its share-based compensation based on the fair value of the awards that are granted.

Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest in equal annual installments based on five years of continuous service and have ten-year contractual terms. The fair value of each option award is estimated on the date of grant using a Black-Scholes option pricing model that currently uses historical volatility of the Company’s stock based on a 7.2 year expected term, before exercise, for the options granted, and a risk-free interest rate based on the U.S. Treasury Department (the “Treasury”) curve in effect at the time of the grant to estimate total stock-based compensation expense. This amount is then amortized on a straight-line basis over the requisite service period, currently five years, to salaries and benefits expense.

Restricted stock awards generally vest in equal installments over five years. The compensation expense associated with these awards is based on the grant date fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized as salaries and benefits expense ratably over the requisite service period, currently five years.

 

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See Note 7 to the Consolidated Financial Statements for additional information regarding the plans and related expense.

On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance, to determine if the impairment is deemed to be other-than-temporary. If it is determined that the impairment is other-than-temporary, i.e. impaired because of credit issues rather than interest rate, the investment is written down through a reduction in non-interest income on the Statement of Income in accordance with accounting guidance. With regard to debt securities, if we do not intend to sell a debt security and it is more likely than not that we will not be required to sell the debt security prior to recovery, we will then evaluate whether a credit loss has occurred. To determine whether a credit loss has occurred, we compare the amortized cost of the debt security to the present value of the cash flows we expect to be collected. If we expect a cash flow shortfall, we will consider a credit loss to have occurred and will then consider the impairment to be other than temporary. We will recognize the amount of the impairment loss related to the credit loss in the results of operations, with the remaining portion of the loss recorded through comprehensive income, net of applicable taxes. See Note 3 to the Consolidated Financial Statements for additional information regarding our securities and related impairment testing.

Results of Operations

Summary Financial Results

Net Income and Adjusted Operating Earnings

For the nine months ended September 30, 2013, the Company recorded net income available to common stockholders of $20.5 million, or $0.58 per diluted common share, compared to net income available to common stockholders of $18.3 million, or $0.54 per diluted common share for the same period in 2012. The Company recorded net income available to common stockholders of $7.0 million, or $0.20 per diluted common share, for the quarter ending September 30, 2013 compared to $7.1 million, or $0.21 per diluted common share, in the third quarter of 2012.

Adjusted operating earnings (a non-GAAP measure) for the three months ended September 30, 2013, were $7.9 million, or $0.23 per diluted common share, compared to $5.8 million, or $0.17 per diluted common share, for the same period in 2012. The year-over-year improvement in adjusted operating earnings was largely attributable to the Company’s repurchase of all of its TARP preferred stock during the fourth quarter of 2012, and related elimination of a $1.4 million effective quarterly dividend on preferred stock for the third quarter of 2013, a $1.3 million decrease in provision for loan losses, a $347 thousand decrease in non-interest expense (which includes $1.2 million of merger-related expenses in the third quarter of 2013) and a decrease in provision for income taxes of $861 thousand (with a related tax effect adjustment of ($886) thousand). These items were partially offset by a decrease in net interest income of $1.1 million, a $2.9 million decrease in non-interest income (which includes the impact of gains of $2.1 million generated by the sales of investment securities in the third quarter 2012).

Adjusted operating earnings for the nine months ended September 30, 2013, were $20.9 million, compared to $14.4 million for the same period in 2012. The year-to-date earnings improvement was largely attributable to the Company’s repurchase of all of its TARP preferred stock during the fourth quarter of 2012, and related elimination of $4.1 million of effective quarterly dividends on preferred stock for the first nine months of 2013, a $6.1 million decrease in provision for loan losses and an $846 thousand decrease in non-interest expense (which includes $2.0 million of merger-related expenses in the first nine months of 2013). These items were partially offset by a decrease in net interest income of $3.2 million, and a decrease in provision for income taxes of $942 thousand (with a related tax effect adjustment of $1.6 million). The Company calculates adjusted operating earnings by excluding impairment loss on investment securities, realized gains and losses on sale of investment securities, merger-related expenses, and certain other non-recurring items from net income available to common stockholders.

Net Interest Income

Net interest income is the excess of interest earned on loans and investments over the interest paid on deposits and borrowings. Net interest income is the most significant component of our total revenue. Net interest income is affected by overall balance sheet growth, changes in interest rates and changes in the mix of investments, loans,

 

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deposits and borrowings. Net interest income was $25.3 million for the third quarter of 2013 and declined $1.1 million, or 4.2%, from the same quarter last year. Net interest income for the nine months ended 2013 of $76.8 million was down $3.2 million, or 4.0%, from $80.1 million for the nine months ended September 30, 2012. The net interest margin increased 26 basis points from 3.62% in the third quarter of 2012, to 3.88% for the same period in 2013. The year-over-year increase in the third quarter net interest margin was due to an improvement in the mix of interest-earning assets and interest-bearing deposits and a reduction in average interest-bearing deposit rates, the impact of which was partially offset by lower average yield on loans. Average loan yields declined 25 basis points, from 5.46% to 5.21%, compared to average rates paid on interest-bearing deposits declining 16 basis points, from 0.91% to 0.75%.

Interest and dividend income decreased $2.5 million on average total interest-earnings assets of $2.62 billion for the three months ended September 30, 2013, compared to interest and dividend income generated by average total interest-earnings assets of $2.94 billion for the same period in 2012. The average rate earned on total interest-earning assets was 4.65% for the third quarter of 2013, as compared to 4.50% for the third quarter 2012, and 4.58% for the second quarter 2013.

Interest expense decreased $1.4 million to $5.1 million generated on an average total interest-bearing liability balance of $2.02 billion for the quarter ended September 30, 2013, from $6.5 million generated on an average total interest-bearing liability balance of $2.31 billion for the same period in 2012. The decline in interest expense is mostly attributable to a series of interest rate reductions on interest-bearing deposit products and the continued repricing and run-off of higher cost deposits in the time deposit portfolio. The average rate paid on total interest-bearing liabilities was 1.00% for the third quarter of 2013, as compared to 1.12% for the third quarter 2012, and 0.98% for the second quarter of 2013.

For the nine months ended September 30, 2013, interest and dividend income decreased $7.9 million on average total interest-earnings assets of $2.71 billion, compared to interest and dividend income generated by average total interest-earnings assets of $2.90 billion for the same period in 2012. The average rate earned on total interest-earning assets was 4.63% for the nine months ended September 30, 2013, as compared to 4.68% for the same period in 2012.

For the nine months ended September 30, 2013, interest expense decreased $4.7 million to $15.7 million generated on an average total interest-bearing liability balance of $2.1 billion, from $20.4 million generated on an average total interest-bearing liability balance of $2.3 billion for the same period in 2012. The average rate paid on total interest-bearing liabilities was 1.00% for the nine months ended September 30, 2013, as compared to 1.19% for the same period in 2012.

 

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The following tables provide a comparative average balance sheet and net interest income analysis for the three and nine months ended September 30, 2013, as compared to the same period in 2012. Average rates are presented on a fully taxable-equivalent (FTE) basis, using a statutory Federal tax rate of 35% for 2013, and 2012.

 

		Three Months Ended September 30,
		2013												2012
(Dollars in thousands)		Average Balance				Interest Income- Expense				Average Yields /Rates				Average Balance				Interest Income- Expense				Average Yields /Rates
Assets
Investment Securities (1)		$	483,096			$	2,769				2.53	%		$	550,210			$	2,806				2.26	%
Restricted investments			10,800				113				4.13	%			11,272				105				3.68	%
Loans, net of unearned income (2)			2,092,844				27,429				5.21	%			2,176,109				29,820				5.46	%
Interest-bearing deposits in other banks			30,823				29				0.37	%			200,966				132				0.26	%
Total interest-earning assets		$	2,617,563			$	30,340				4.65	%		$	2,938,557			$	32,863				4.50	%
Other assets			165,054												82,555
Total Assets		$	2,782,617											$	3,021,112
Liabilities and Stockholders’ Equity
Interest-bearing deposits:
NOW accounts		$	416,985			$	288				0.27	%		$	380,623			$	357				0.37	%
Money market accounts			235,005				182				0.31	%			242,896				248				0.41	%
Savings accounts			464,945				352				0.30	%			569,339				585				0.41	%
Time deposits			565,986				2,360				1.70	%			665,193				3,071				1.84	%
Total interest-bearing deposits		$	1,682,921			$	3,182				0.75	%		$	1,858,051			$	4,261				0.91	%
Securities sold under agreement to repurchase (3)			236,637				933				1.56	%			365,235				1,017				1.11	%
Other borrowed funds			37,120				20				0.21	%			22,282				242				4.25	%
Trust preferred capital notes			66,983				952				5.56	%			66,727				975				5.72	%
Total interest-bearing liabilities		$	2,023,661			$	5,087				1.00	%		$	2,312,295			$	6,495				1.12	%
Noninterest-bearing demand and other liabilities			501,628												401,460
Total liabilities		$	2,525,289											$	2,713,755
Stockholders’ equity			257,328												307,357
Total liabilities and stockholders’ equity		$	2,782,617											$	3,021,112
Interest rate spread											3.65	%											3.38	%
Net interest income and margin						$	25,253				3.88	%						$	26,368				3.62	%
Ratio of average interest-earning assets to average interest-bearing liabilities			129.4	%											127.1	%

 

(1)

Yields on securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which are reflected as a component of stockholders’ equity. Average yields on securities are stated on a tax equivalent basis, using a 35% rate.

(2)	Loans placed on non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $1.1 million and $2.0 million for the three months ended September 30, 2013 and 2012, respectively.

(3)

The securities sold under agreement to repurchase related to customers had an average balance of $161.6 million at an average rate of 0.19% for the three months ended September 30, 2013, and $290.2 million at an average rate of 0.23% for the same period 2012. Also, included are wholesale agreements with an average balance of $75.0 million at an average rate of 4.51% for the three months ended September 30, 2013, and $75.0 million at an average rate of 4.52% for the same period for 2012.

 

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		Nine Months Ended September 30,
		2013												2012
(Dollars in thousands)		Average Balance				Interest Income- Expense				Average Yields /Rates				Average Balance				Interest Income- Expense				Average Yields /Rates
Assets
Investment securities (1)		$	490,078			$	7,797				2.33	%		$	581,381			$	9,076				2.26	%
Restricted investments			10,702				340				4.24	%			11,254				310				3.68	%
Loans, net of unearned income (2)			2,157,464				84,325				5.24	%			2,172,353				90,868				5.60	%
Interest-bearing deposits in other banks			47,165				109				0.31	%			132,897				257				0.26	%
Total interest-earning assets		$	2,705,409			$	92,571				4.63	%		$	2,897,885			$	100,511				4.68	%
Other assets			121,832												75,569
Total Assets		$	2,827,241											$	2,973,454
Liabilities and Stockholders’ Equity
Interest-bearing deposits:
NOW accounts		$	430,695			$	934				0.29	%		$	354,154			$	972				0.37	%
Money market accounts			226,830				515				0.30	%			227,301				704				0.41	%
Savings accounts			484,528				1,097				0.30	%			599,799				2,001				0.45	%
Time deposits			589,847				7,499				1.70	%			710,515				9,991				1.88	%
Total interest-bearing deposits		$	1,731,900			$	10,045				0.78	%		$	1,891,769			$	13,668				0.97	%
Securities sold under agreement to repurchase (3)			281,098				2,774				1.32	%			321,871				3,068				1.27	%
Other borrowed funds			30,582				54				0.23	%			24,088				779				4.25	%
Trust preferred capital notes			66,921				2,859				5.63	%			66,663				2,932				5.78	%
Total interest-bearing liabilities		$	2,110,501			$	15,732				1.00	%		$	2,304,391			$	20,447				1.19	%
Noninterest-bearing demand and other liabilities			446,730												369,169
Total liabilities		$	2,557,231											$	2,673,560
Stockholders’ equity			270,010												299,894
Total liabilities and stockholders’ equity		$	2,827,241											$	2,973,454
Interest rate spread											3.63	%											3.49	%
Net interest income and margin						$	76,839				3.85	%						$	80,064				3.74	%
Ratio of average interest-earning assets to average interest-bearing liabilities			128.2	%											125.8	%

 

(1)

Yields on investment securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which are reflected as a component of stockholders’ equity. Average yields on loans and securities are stated on a fully taxable-equivalent basis, using a 35% rate.

(2)	Loans placed on non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $3.7 million and $3.7 million for the nine months ended September 30, 2013, and 2012, respectively.

(3)

The sold under agreement to repurchase related to customers had an average balance of $205.5 million at an average rate of 0.16% for the nine months ended September 30, 2013, and $246.9 million at an average rate of 0.29% for the same period 2012. Also, included are wholesale agreements with an average balance of $75.0 million at an average rate of 4.51% for the nine months ended September 30, 2013, and $75.0 million at an average rate of 4.52% for the same period for 2012.

 

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Provision for Loan Losses and Allowance for Loan Losses

Provision for loan losses was $1.8 million for the quarter ended September 30, 2013, down $1.3 million, or 41.0%, compared to $3.1 million in the same period in 2012. Net charge-offs were $2.1 million for the three months ended September 30, 2013, compared to $8.5 million for the quarter ended September 30, 2012. For the nine months ended September 30, 2013, provision for loan losses totaled $6.2 million, compared to $12.3 million for the prior-year period, with 2013 year-to-date net charge-offs amounting to $8.1 million, compared to $19.7 million in the nine months ended September 30, 2012. The decrease in non-accruing loans from $37.9 million at December 31, 2012 to $28.6 million at September 30, 2013, and the reduction in the allowance for loan losses from $42.8 million at December 31, 2012 to $40.9 million at September 30, 2013, drove changes to the Company’s loan loss reserve and non-performing loan coverage ratios. As of September 30, 2013, reserves for loan losses represented 1.98% of total loans, up from 1.95% at December 31, 2012, with reserves covering 137.5% of total non-performing loans as of September 30, 2013. The increase in the allowance for loan losses as a percentage of total loans from December 31, 2012, to September 30, 2013, is due to higher specific reserves related to certain credits, partially offset by the decrease in total loans outstanding. As a result, the third quarter analysis of the adequacy of the loan loss reserve indicated that loan loss provisioning of $1.8 million was sufficient to maintain appropriate coverage. The $6.4 million decrease in net charge-offs for the three months ended September 30, 2013, compared to the same period in 2012, was primarily due to net charge-offs of non-farm, non-residential real estate loans decreasing $4.9 million, from $5.5 million in the third quarter of 2012, to $630 thousand in the third quarter of 2013. The Company’s ratio of net charge-offs to average total loans outstanding improved to 0.37% for the nine months ended September 30, 2013, compared to 0.91% for the same period in 2012.

Total non-performing assets and loans 90+ days past due declined from $50.2 million at December 31, 2012, to $39.7 million at September 30, 2013. Non accruing loans were reduced on a net basis by $9.3 million based on reductions of $23.0 million, partially offset by additions to non-accruing loans of $13.7 million. Reductions to non-accruing loans included note sale proceeds of $2.8 million, payoff of a land loan of $2.3 million, and an upgrade of a $1.6 million residential mortgage loan. New loans placed on non-accrual status include an owner-occupied commercial real estate loan of $2.7 million and a loan secured by a residential construction project of $1.3 million. The $2.3 million net reduction to OREO was based on reductions of $6.1 million and partially offset by new OREO properties totaling $3.8 million. Reductions to OREO included the sale of a land project zoned for residential condominium usage for $1.3 million and the sale of a single-family residence for $1.0 million. Additions to OREO included a land project zoned for hotel use in the amount of $2.1 million. See “Risk Elements and Non-Performing Assets” later in this discussion for more information on non-performing assets and loans 90+ days past due and other impaired loans.

Management believes that the allowance for loan losses is adequate at September 30, 2013. However, there can be no assurance that additional provisions for loan losses will not be required in the future, including as a result of possible changes in the economic assumptions underlying management’s estimates and judgments, adverse developments in the economy, and the residential real estate market in particular, on a national basis or in the Company’s market area, or changes in the circumstances of particular borrowers.

The Company generates a quarterly analysis of the allowance for loan losses, with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on at least semi-annual independent external loan reviews and monthly internal reviews. The determination of the allowance for loan losses is based on applying and summing the results of eight qualitative factors and a historical loss factor to each category of loans along with any specific allowance for impaired and adversely classified loans within the particular category. Each factor is assigned a percentage weight and that total weight is applied to each loan category. The resulting sum from each loan category is then combined to arrive at a total allowance for all categories. Factors are different for each loan category. Qualitative factors include: levels and trends in delinquencies and non-accruals, trends in volumes and terms of loans, effects of any changes in lending policies, the experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit, quality of the Company’s loan review system, and regulatory requirements. The total allowance required thus changes as the percentage weight assigned to each factor is increased or decreased due to its particular circumstance, as historical loss factors are updated, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required on impaired loans and charge-offs occur. The decision to specifically reserve for or to charge-off or partially charge-off an impaired loan balance is based upon an evaluation of that loan’s potential to improve, based upon near term change in financial or market conditions, which would enable collection of the portion of the loan determined to be impaired. If these conditions are determined to be favorable, a specific reserve would be established as opposed to a charge-off. For further information regarding the allowance for loan losses see Note 5 to the Consolidated Financial Statements.

 

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The following schedule summarizes the changes in the allowance for loan losses:

 

		Nine Months Ended September 30, 2013				Nine Months Ended September 30, 2012				Twelve Months Ended December 31, 2012
		(Dollars in thousands)
Allowance, beginning of period		$	42,773			$	48,729			$	48,729
Provision for loan losses			6,207				12,267				14,826
Charge-Offs
Commercial			2,560				5,904				5,904
Real estate-non-farm, non-residential			1,783				6,387				6,388
Real estate-construction			4,309				5,593				7,587
Consumer			72				292				306
Real estate-one-to-four family residential			568				3,613				4,022
Real estate-multi-family residential			—				—				—
Farmland			—				—				—
Total charge-offs		$	9,291			$	21,789			$	24,207
Recoveries
Commercial			189				929				1,035
Real estate-non-farm, non-residential			88				43				1,081
Real estate-construction			601				487				539
Consumer			34				34				55
Real estate-one-to-four family residential			308				470				597
Real estate-multi-family residential			—				118				118
Farmland			—				—				—
Total recoveries		$	1,220			$	2 ,081			$	3,425
Net charge-offs			8,070				19,708				20,782
Allowance, end of period		$	40,909			$	41,288			$	42,773
Ratio of net charges-offs to average total loans outstanding during period			0.37	%			0.91	%			0.95	%

The following schedule provides a breakdown of the allowance for loan loss by loan type:

 

		September 30, 2013				September 30, 2012				December 31, 2012
		(Dollars in thousands)
Allocation of the allowance for loan losses:
Commercial		$	8,489			$	4,331			$	5,455
Real estate-non-farm, non-residential			14,616				10,039				11,592
Real estate-construction			8,292				11,301				14,939
Consumer			222				237				167
Real estate-one-to-four family residential			9,034				14,607				10,420
Real estate-multi-family residential			141				651				78
Farmland			111				122				122
Unallocated			4				—				—
Balance		$	40,909			$	41,288			$	42,773

For a more detailed allocation of the allowance for loan losses, including general and specific allowances for each segment of the loan portfolio, see Note 5 to the Consolidated Financial Statements.

Risk Elements and Non-Performing Assets

Non-performing assets consist of non-accrual loans and OREO (foreclosed properties). For the nine months ended September 30, 2013, total non-performing assets and loans 90+ days past due and still accruing interest decreased by $10.5 million, from $50.2 million at December 31, 2012, to $39.7 million at September 30, 2013. As a result, the

 

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ratio of non-performing assets and loans 90+ days past due and still accruing to total assets decreased from 1.78% of total assets at December 31, 2012, to 1.44% of total assets at September 30, 2013. The decrease during the first nine months of 2013 in non-performing assets and loans 90+ days past due and still accruing as a percent of total assets was primarily due to decreased non-performing assets in the Company’s real estate construction and residential and one-to-four family residential real estate segments of the loan portfolio and decreased OREO balances, partially offset by an increase in non-performing, non-residential real estate loans. Loans are placed in non-accrual status when in the opinion of management the collection of additional interest is unlikely or a specific loan meets the criteria for non-accrual status established by regulatory authorities. No interest is taken into income on non-accrual loans. A loan remains on non-accrual status until the loan is current as to both principal and interest or the borrower demonstrates the ability to pay and remain current, or both.

Our underwriting for new acquisition, development, and construction loans always includes the interest cost for the loan whether an interest reserve is approved or not. In other words, the equity requirement in the new loan is established reflecting the amount of interest required to serve the project. We continually monitor the adequacy of reserve requirements, including interest reserves, during the draw process to ensure the project is being completed on time and within budget. We have restructured loans due to the slow market, re-underwriting each loan based on time and cost to complete. We do not continue funding interest reserves just to keep the loan from becoming non-performing. We consider whether the loan to value ratio will support current and future advances and whether the project is meeting certain completion criteria necessary to successfully complete the project. Once a loan becomes non-performing, we do not allow draws on interest reserves.

Other impaired loans that are currently performing, and TDRs, performing in accordance with their modified terms, decreased from $134.1 million at December 31, 2012, to $107.3 million at September 30, 2013. These loans have been identified by the Company as having certain weaknesses as a result of the Company’s specific knowledge about the customer or recent credit events, and are classified as substandard and subject to impairment testing at each balance sheet date.

Included in the loan portfolio at September 30, 2013, are loans classified as TDRs totaling $21.8 million, a reduction of $21.7 million from $43.5 million at December 31, 2012. The reduction in TDRs during the first nine months of 2013, was attributable to $2.4 million in new TDRs, removal from TDR classification of loans based on payment performance of $11.0 million, principal payments of $5.1 million, charge-offs of $643 thousand, and $7.3 million in loans moved to non-accrual status. Non-farm, non-residential real estate TDRs accounted for $15.4 million of the decrease in TDRs from December 31, 2012 to September 30, 2013. These loans, which have been provided concessions such as rate reductions, payment deferrals, and in some cases forgiveness of principal, are all on accrual status. If the loan was on non-accrual at the time of the concession it is the Company’s policy that it remain on non-accrual status and perform in accordance with the modified terms for a period of six months. All loans reported as troubled debt restructurings accrue interest. The Company does not report any non-accrual loans as troubled debt restructurings. If a troubled debt restructuring is on non-accrual status, it is reported as a non-accrual asset and not as a troubled debt restructuring.

Foreclosed real properties (or OREO) include properties that have been substantively repossessed or acquired in complete or partial satisfaction of debt. The reduction in OREO during the first nine months of 2013 was attributable to sales proceeds of $4.4 million, and write-downs totaling $1.7 million, partially offset by new OREO totaling $3.7 million. Write-downs for the first nine months were primarily attributable to a single relationship with multiple OREO properties that face certain legal, title, and or maintenance issues. Such properties, which are held for resale, are carried at fair value, including a reduction for the estimated selling expenses. Reviews and discussions with regard to value and disposition of each foreclosed property are conducted monthly by the Company’s Special Asset Committee. The carrying value of a foreclosed asset is immediately adjusted down when new information is obtained, including a potentially acceptable offer, the sale of a similar property in the vicinity of one of the Company’s assets, and/or a change in the price the property is being listed for. The Company also uses the advice of outside consultants and real estate agents with knowledge of the markets the properties are located in. Appraisals are ordered when the property is foreclosed on, but are not routinely updated at each balance sheet date. The Company confirms that it performed the above noted procedures and made the proper impairment adjustments, if any, at the balance sheet date.

 

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Total non-performing assets as of the dates indicated consisted of the following:

 

		September 30, 2013				September 30, 2012				December 31, 2012
		(In Thousands of Dollars)
Non-accrual loans:
Commercial		$	2,663			$	3,443			$	3,317
Real estate-one-to-four family residential:
Permanent first and second			2,655				5,689				3,606
Home equity loans and lines			2,382				2,576				2,498
Total real estate-one-to-four family residential		$	5,037			$	8,265			$	6,104
Real estate-multi-family residential			—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			4,571				1,804				1,791
Non-owner-occupied			3,239				4,731				3,864
Total real estate-non-farm, non-residential		$	7,810			$	6,535			$	5,655
Real estate-construction:
Residential			4,112				10,510				16,976
Commercial			8,976				16,679				5,860
Total real estate-construction:		$	13,088			$	27,189			$	22,836
Consumer			23				18				17
Total non-accrual loans		$	28,621			$	45,450			$	37,929
OREO			9,923				14,089				12,302
Total non-performing assets		$	38,544			$	59,539			$	50,231
Loans 90+ days past due and still accruing:
Commercial		$	250			$	—			$	—
Real estate-one-to-four family residential:
Permanent first and second			876				—				—
Home equity loans and lines			—				—				—
Total real estate-one-to-four family residential		$	876			$	—			$	—
Real estate multi-family residential			—				—				—
Real estate-non-farm, non-residential:
Owner-occupied			—				—				—
Non-owner-occupied			—				—				—
Total real estate-non-farm, non-residential		$	—			$	—			$	—
Real estate-construction:
Residential			—				—				—
Commercial			—				—				—
Total real estate-construction:		$	—			$	—			$	—
Consumer			—				—				—
Total loans past due 90+ days and still accruing		$	1,126			$	—			$	—
Total non-performing assets and loans past due 90+days		$	39,670			$	59,539			$	50,231

 

		September 30, 2013				September 30, 2012				December 31, 2012
Non-performing assets
to total loans:			1.87	%			2.77	%			2.29	%
to total assets:			1.40	%			1.98	%			1.78	%
Non-performing assets and 90+ days past due loans
to total loans:			1.92	%			2.77	%			2.29	%
to total assets:			1.44	%			1.98	%			1.78	%
Allowance for loan losses to total loans			1.98	%			1.92	%			1.95	%
Allowance for loan losses to non-performing loans			137.52	%			90.84	%			112.77	%

 

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Non-performing loans continue to be concentrated in residential and commercial construction and land development loans in outer sub-markets that continue to be impacted by the downturn in residential real estate markets and current economic and employment conditions. As of September 30, 2013, $13.1 million, or 45.7%, of non-performing loans represented acquisition, development and construction (“ADC”) loans; $7.8 million, or 27.3%, represented non-farm, non-residential loans; $2.7 million, or 9.3%, represented commercial and industrial (“C&I”) loans; and $5.0 million, or 17.6%, represented loans on one-to-four family residential properties. As of September 30, 2013, specific reserves of $19.8 million have been established for non-performing loans and other loans determined to be impaired. There was no interest actually received on non-accrual loans in the nine months ended September 30, 2012, and $249 thousand for the nine months ended September 30, 2013. The Company continues to pursue an aggressive campaign to further reduce non-performing assets and other impaired loans and is implementing and executing various disposition strategies on an ongoing basis. See Note 5 to the Consolidated Financial Statements for additional information regarding the Company’s non-performing loans.

The following provides a breakdown of the construction and non-farm/non-residential loan portfolios by location, including loans on non-accrual status:

 

		As of September 30, 2013
Residential, Acquisition, Development and Construction By County/Jurisdiction of Origination: (Dollars in thousands)		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge- offs as a % of Outstandings
District of Columbia		$	1,146				0.7	%		$	314				0.2	%			—
Montgomery, MD			—				0.0	%			—				—				—
Prince Georges, MD			7,122				4.4	%			3,042				1.9	%			—
Other Counties in MD			3,542				2.2	%			56				—				—
Arlington/Alexandria, VA			41,848				26.0	%			700				0.5	%			0.4	%
Fairfax, VA			28,515				17.7	%			—				—				—
Culpeper/Fauquier, VA			10,377				6.5	%			—				—				—
Frederick, VA			—				0.0	%			—				—				-0.1	%
Henrico, VA			943				0.6	%			—				—				—
Loudoun, VA			12,972				8.1	%			—				—				—
Prince William, VA			29,332				18.3	%			—				—				—
Spotsylvania, VA			611				0.4	%			—				—				—
Stafford, VA			19,412				12.1	%			—				—				—
Other Counties in VA			2,600				1.6	%			—				—				-0.1	%
Outside VA, D.C. & MD			2,268				1.4	%			—				—				—
		$	160,688				100.0	%		$	4,112				2.6	%			0.2	%

 

		As of September 30, 2013
Commercial, Acquisition, Development and Construction By County/Jurisdiction of Origination: (Dollars in thousands)		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge- offs as a % of Outstandings
District of Columbia		$	1,054				1.0	%		$	—				—				—
Montgomery, MD			2,000				1.9	%			—				—				—
Prince Georges, MD			6,333				6.1	%			—				—				—
Other Counties in MD			2,034				1.9	%			—				—				—
Arlington/Alexandria, VA			495				0.5	%			495				0.4	%			—
Fairfax, VA			1,509				1.5	%			—				—				0.2	%
Culpeper/Fauquier, VA			1,348				1.3	%			1,108				1.1	%			1.0	%
Frederick, VA			2,000				1.9	%			—				—				—
Henrico, VA			—				—				—				—				—
Loudoun, VA			14,058				13.5	%			—				—				—
Prince William, VA			42,956				41.1	%			—				—				—
Spotsylvania, VA			1,580				1.5	%			—				—				—
Stafford, VA			23,764				22.7	%			6,538				6.3	%			2.1	%
Other Counties in VA			5,377				5.1	%			835				0.8	%			—
Outside VA, D.C. & MD			—				—				—				—				—
		$	104,508				100.0	%		$	8,976				8.6	%			3.3	%

 

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		As of September 30, 2013
Non-Farm/Non-Residential By County/Jurisdiction of Origination: (Dollars in thousands)		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge- offs as a % of Outstandings
District of Columbia		$	64,150				5.9	%		$	—				—				—
Montgomery, MD			16,382				1.5	%			—				—				—
Prince Georges, MD			64,249				5.9	%			—				—				—
Other Counties in MD			51,170				4.7	%			—				—				—
Arlington/Alexandria, VA			144,508				13.3	%			910				0.1	%			—
Fairfax, VA			272,876				25.0	%			—				—				0.1	%
Culpeper/Fauquier, VA			4,793				0.5	%			1,576				0.1	%			—
Frederick, VA			7,567				0.7	%			—				—				—
Henrico, VA			18,646				1.7	%			—				—				—
Loudoun, VA			131,033				12.0	%			3,661				0.3	%			—
Prince William, VA			197,854				18.1	%			—				—				—
Spotsylvania, VA			21,292				2.0	%			—				—				—
Stafford, VA			18,930				1.7	%			—				—				0.1	%
Other Counties in VA			67,973				6.2	%			1,663				0.2	%			—
Outside VA, D.C. & MD			8,764				0.8	%			—				—				—
		$	1,090,187				100.0	%		$	7,810				0.7	%			0.2	%

Total TDRs as of the dates indicated consisted of the following:

 

		September 30, 2013				September 30, 2012				December 31, 2012
		(Dollars in thousands)
Troubled debt restructurings:
Commercial		$	2,477			$	6,910			$	6,875
Real estate-one-to-four family residential:
Permanent first and second		$	1,437				4,585				4,303
Home equity loans and lines			—				—				—
Total real estate-one-to-four family residential		$	1,437			$	4,585			$	4,303
Real estate-multi-family residential			—				—				—
Real estate-non-farm, non-residential:
Owner-occupied		$	7,127				3,395				9,528
Non-owner-occupied			2,739				19,160				15,779
Total real estate-non-farm, non-residential		$	9,866			$	22,555			$	25,307
Real estate-construction:
Residential		$	—				3,622				73
Commercial			8,014				7,220				6,890
Total real estate-construction:		$	8,014			$	10,842			$	6,963
Consumer			—				—				—
Farmland			—				—				—
Total troubled debt restructurings		$	21,794			$	44,892			$	43,448

Included in this amount of $21.8 million, the Bank had TDRs that were performing in accordance with their modified terms of $19.7 million at September 30, 2013. At December 31, 2012, all of the Company’s TDRs were performing in accordance with their modified terms.

Concentrations of Credit Risk

The Bank does general banking business, serving the commercial and personal banking needs of its customers. The Bank’s market area consists of the Northern Virginia suburbs of Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince William, Spotsylvania and Stafford Counties, the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park, and, to a lesser extent, certain Maryland suburbs and the city of Washington, D.C. Substantially all of the Company’s loans are made within its market area.

 

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The ultimate collectability of the Bank’s loan portfolio and the ability to realize the value of any underlying collateral, if needed, are influenced by the economic conditions of the market area. The Company’s operating results are therefore closely related to the economic conditions and trends in the Metropolitan Washington, D.C. area.

At September 30, 2013, the Company had $1.43 billion, or 69.1%, of total loans concentrated in commercial real estate. Commercial real estate for purposes of this discussion includes all construction loans, loans secured by multi-family residential properties and loans secured by non-farm, non-residential properties. At December 31, 2012, commercial real estate loans were $1.52 billion, or 69.2%, of total loans. Total construction loans of $265.2 million at September 30, 2013, represented 12.8% of total loans, loans secured by multi-family residential properties of $70.3 million represented 3.4% of total loans, and loans secured by non-farm, non-residential properties of $1.1 billion represented 52.8%.

Construction loans at September 30, 2013 included $145.3 million in loans to commercial builders of single family residential property and $15.4 million to individuals on single family residential property, together representing 7.8% of total loans. These loans are made to a number of unrelated entities and generally have a term of twelve to eighteen months. In addition, the Company had $104.5 million of construction loans on non-residential commercial property at September 30, 2013, representing 5.1% of total loans. Total construction loans of $265.2 million include $120.3 million in land acquisition and/or development loans on residential property and $53.8 million in land acquisition and/or development loans on commercial property, together totaling $174.1 million, or 8.4% of total loans. Potential adverse developments in the Northern Virginia real estate market or economy, including substantial increases in mortgage interest rates, slower housing sales, and increased commercial property vacancy rates, could have an adverse impact on these groups of loans and the Bank’s income and financial position. At September 30, 2013, the Company had no other concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of counterparties that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Bank has commercial loans of $218.2 million, or 10.6% of the Bank’s total loan portfolio, to businesses and organizations, including trade associations, professional corporations, community associations, government contractors, medical practitioners, property management companies, religious organizations and houses of worship, heavy equipment contractors and others primarily located in the Northern Virginia market.

The Bank has established formal policies relating to the credit and collateral requirements in loan originations including policies that establish limits on various loan types as a percentage of total loans and total capital. Loans to purchase real property are generally collateralized by the related property with limitations based on the property’s appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower and guarantors and/or the individual project, to include an analysis of cash flows and secondary repayment sources.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land which represent in total 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio. The Company is well-capitalized. Nevertheless, it is possible that the Company could be required to maintain higher levels of capital as a result of our commercial real estate concentration, which could require us to obtain additional capital, and may adversely affect stockholder returns.

Non-Interest Income

Non-interest income represented 7.9% and 14.1% of total revenue for the nine months ended September 30, 2013, and September 30, 2012, respectively. Although interest income is our primary source of revenue, we remain committed to increasing non-interest income as a way to improve profitability and diversify our sources of revenue.

 

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For the three months ended September 30, 2013, the Company recognized $1.8 million in non-interest income, compared to non-interest income of $4.7 million for the three months ended September 30, 2012. For the nine months ended September 30, 2013, the Company recognized $6.6 million in non-interest income, compared to non-interest income of $13.1 million for the nine months ended September 30, 2012.

The following table presents the components of non-interest income for the three and nine months ended September 30, 2013, and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,								From the Nine Months Ended September, 2012 to the Nine Months Ended September 30, 2013
(dollars in thousands)		2013				2012				2013				2012				$ change				% change
Service charges and other fees		$	900			$	882			$	2,736			$	2,638			$	98				3.7	%
Non-deposit investment services commissions			248				211				775				705				70				9.9	%
Gains on loans held-for-sale			321				1,082				2,018				2,913				(895	)			-30.7	%
Gain on sale of securities available-for-sale			—				2,056				—				5,976				(5,976	)			-100.0	%
Increase in cash surrender value of bank-owned life insurance			302				50				909				159				750				471.7	%
Other			51				444				138				704				(566	)			-80.4	%
Total Non-Interest Income		$	1,822			$	4,725			$	6,576			$	13,095			$	(6,519	)			-49.8	%

Included in the third quarter 2012 non-interest income was a gain on sale of securities of $2.1 million, while the third quarter of 2013 did not include a gain or loss on sale of securities. For the nine months ended September 30, 2012, non-interest income included a gain on sale of securities of $6.0 million, while non-interest income for the nine months ended September 30, 2013, did not include a gain or loss on sale of securities.

Fees and net gains on loans held-for-sale decreased in the third quarter 2013, on a year-over-year basis, by $761 thousand, or 70.3%. The decrease can be attributed to a lower volume of mortgage loans originated for sale in the secondary market due to higher interest rates that decreased refinance activity, and the Company’s focus on holding one-to-four family residential loans held in portfolio due to less competitive rates on mortgage products offered by correspondents in the secondary mortgage market. For the nine months ended September 30, 2013, fees and net gains on loans held-for-sale decreased $895 thousand, or 30.7%, compared to the nine months ended September 30, 2012.

Income generated by bank-owned life insurance increased $252 thousand for the three months ended September 30, 2013, and $750 thousand for the nine months ended September 30, 2013, compared to the same periods in the prior year. The increase can be primarily attributed to $30.0 million in bank-owned life insurance assets purchased during the second half of 2012 that have contributed to earnings during the nine months ended September 30, 2013.

 

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Non-Interest Expense

For the three months ended September 30, 2013, the Company recognized $14.9 million in non-interest expense, compared to non-interest expense of $15.2 million for the three months ended September 30, 2012. For the nine months ended September 30, 2013, the Company recognized $46.6 million in non-interest expense, compared to non-interest expense of $47.4 million for the nine months ended September 30, 2012. The following table presents the components of non-interest expense for the three and nine months ended September 30, 2013, and 2012:

 

		Three Months Ended September 30,								Nine Months Ended September 30,								From the Nine Months Ended September, 2012 to the Nine Months Ended September 30, 2013
(dollars in thousands)		2013				2012				2013				2012				$ change				% change
Salaries and employee benefits		$	6,436			$	7,493			$	21,327			$	22,517			$	(1,190	)			-5.3	%
Premises and equipment expense			2,314				2,380				7,038				7,142				(104	)			-1.5	%
FDIC insurance			504				660				1,536				2,488				(952	)			-38.3	%
(Gain) loss on other real estate owned			(71	)			(141	)			1,712				1,566				146				9.3	%
OREO expense			406				322				879				902				(23	)			-2.5	%
Franchise tax expense			752				935				2,247				2,435				(188	)			-7.7	%
Data processing expense			705				664				2,104				1,992				112				5.6	%
Merger-related expense			1,155				—				2,021				—				2,021				100.0	%
Other operating expense			2,664				2,899				7,686				8,354				(668	)			-8.0	%
Total Non-Interest Expense		$	14,865			$	15,212			$	46,550			$	47,396			$	(846	)			-1.8	%

Non-interest expense decreased $347 thousand, or 2.3%, from $15.2 million in the third quarter of 2012, to $14.9 million in the third quarter of 2013. The year-over-year decrease was primarily related to a decrease of $1.1 million in salaries and employee benefits, a decrease of $156 thousand in FDIC insurance premiums, a $235 thousand decrease in other operating expense, partially offset by $1.2 million in merger-related expenses during the third quarter of 2013. The decrease for the nine months ended September 30, 2012, to the nine months ended September 30, 2013, of $846 thousand was primarily related to a decrease of $1.2 million in salaries and employee benefits, a decrease of $952 thousand in FDIC insurance premiums, and a $668 thousand decrease in other operating expense, partially offset by $2.0 million in merger-related expenses.

Provision for Income Taxes

The Company’s income tax provisions are adjusted for non-deductible expenses and non-taxable income before applying the U.S. federal income tax rate of 35%. For the nine months ended September 30, 2013, the Company recorded an income tax provision of $10.2 million compared to a provision of $11.1 million for the same period in 2012. Our effective tax rate was 33.3% for both the nine months ended September 30, 2013 and September 30, 2012. Our provision for income taxes was positively impacted by non-taxable income generated by the bank-owned life insurance earnings, and earnings from tax-exempt investment securities, which provided the greatest benefit to our effective tax rate.

Financial Condition

Total Assets

Total assets decreased by $67.4 million, or 2.4%, to $2.76 billion at September 30, 2013, as compared to $2.82 billion at December 31, 2012. The decrease was largely the result of a decrease in loans, net of allowance for loan loss, of $123.9 million, a decrease of $14.3 million in loans held-for-sale, a decrease of $12.2 million in investment securities and a decrease of $10.6 million in cash and due from banks, partially offset by an increase in interest-bearing deposits in other banks of $100.0 million from December 31, 2012 to September 30, 2013.

Loans, net of allowance for loan losses, declined in our commercial portfolio, ADC portfolio, real estate non-farm, non-residential portfolio, and real estate multi-family residential portfolio, as these portfolios decreased $42.8 million, $16.8 million, $65.0 million, and $8.1 million, respectively during the first nine months of 2013.

Investment securities were down $12.2 million from December 31, 2012 to September 30, 2013. We held 17.5% of our total assets in the investment security portfolio at September 30, 2013 and December 31, 2012.

Loans held-for-sale decreased $14.3 million, to $847 thousand at September 30, 2013, compared to $15.2 million at December 31, 2012. The level of loans held-for-sale is driven by various market and economic conditions, including mortgage loan demand in our housing markets, and the interest rate environment.

 

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Investment Securities

Investment securities were $481.2 million representing a decrease of $12.2 million from December 31, 2012. There was no gain on sale of securities during the third quarter 2013. During the third quarter of 2012, the Company sold $26.0 million of investment securities resulting in a $1.6 million realized gain on sale of securities, and PreTSL VI was redeemed resulting in a gain of $436 thousand. The purchase of investment securities made during the first nine months of 2013 were predominantly of U.S. Government Agency obligations at a discount or modest premium to book value in pass-through securities, with an average expected life of three to seven years.

The investment portfolio contains two pooled trust preferred securities with a book value of $5.1 million, and a market value of $1.6 million at September 30, 2013, for which the Company performs a quarterly analysis to determine whether any other-than-temporary impairment exists. The analysis includes stress tests on the underlying collateral and cash flow estimates based on the current and projected future levels of deferrals, defaults, and prepayments within each pool. There was no recorded impairment loss for the three or nine months ended September 30, 2013 and September 30, 2012.

Loans

Loans, net of allowance for loan losses, decreased $123.9 million, or 5.8%, from $2.14 billion at December 31, 2012, to $2.02 billion at September 30, 2013. The decreases in non-farm, non-residential real estate and multi-family real estate loans were driven by a highly competitive loan origination environment which drove increased refinancing activity and strategic loan sales, and by problem loan workouts initiated to improve asset quality. The decrease in C&I loans was attributable to lower borrowing activity due to the impact of sequestration on the level of borrowing by government contracting sector borrowers and pay downs resulting from problem loan resolution activities.

Loans held-for-sale

Loans held-for-sale, which are originated by our mortgage division and intended for sale in the secondary market, decreased $14.3 million from $15.2 million at December 31, 2012, to $847 thousand at September 30, 2013. The decrease in loans held-for-sale was mostly driven by various market and economic conditions, including mortgage loan demand in our housing markets, and the interest rate environment. Loans sold to correspondent banks are subject to repurchase as a result of specific events outlined in the correspondent purchase agreements. The repurchase events include but are not limited to, deficiencies in documentation standards, and defaults or pay-offs within a specified period of time. The Company did not maintain a reserve for repurchases at September 30, 2013, and December 31, 2012, and has historically experienced an insignificant amount of repurchases.

Deposits

Total deposits at September 30, 2013 were $2.10 billion, a decrease of $149.8 million, or 6.7%, from December 31, 2012 to September 30, 2013 with non-interest bearing demand deposits increasing by $29.2 million, or 7.0%, savings and interest-bearing demand accounts decreasing $97.2 million, or 8.1%, and time deposits decreasing by $81.7 million, or 13.0%. The reduction in interest-bearing and time deposits has been intentional, resulting from a series of interest rate reductions that continued throughout 2012 and into 2013. As a result of deposit rate decreases and an improving deposit mix, the cost of total interest-bearing deposits and total deposits declined from 0.91% and 0.76%, respectively, for the quarter ended September 30, 2012, to 0.75% and 0.60% for the quarter ended September 30, 2013. The Company’s deposit mix continues to be weighted heavily in lower cost non-interest bearing demand deposits, savings and interest-bearing demand deposits, which comprised 73.9% of total deposits at September 30, 2013, compared to 72.0% at December 31, 2012. As of September 30, 2013, non-interest bearing demand deposits represented 21.3% of total deposits, compared to 18.5% at December 31, 2012.

Capital Levels and Stockholders’ Equity

Stockholders’ equity increased $18.9 million, or 7.7%, from $245.3 million at December 31, 2012, to $264.3 million at September 30, 2013, with approximately $8.2 million in net proceeds from stock issuances, net income to common stockholders of $20.5 million for the first nine months of 2013, partially offset by a decrease of $9.7 million in other comprehensive income related to the decline in the fair market value of the investment securities portfolio, net of tax. The Company’s Tier 1 and total qualifying capital ratios are both up 233 basis points, from December 31, 2012, to September 30, 2013.

 

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Liquidity

The Company’s principal source of liquidity and funding is its customer deposit base. The level of deposits necessary to support the Company’s lending and investment activities is determined through monitoring loan demand. Considerations in managing the Company’s liquidity position include, but are not limited to, scheduled cash flows from existing loans and investment securities, anticipated deposit activity including the maturity of time deposits, pricing and dollar amount of in-market customer deposits, use of wholesale funding such as Certificate of Deposit Account Registry Service (“CDARS”) reciprocal deposits, borrowing capacity at the FHLB, and projected needs from anticipated extensions of credit. The Company’s liquidity position is monitored daily by management to maintain a level of liquidity that can efficiently meet current needs and is evaluated for both current and longer term needs as part of the asset/liability management process. On a monthly basis, the Asset/Liability Committee (“ALCO”) of the board of directors reviews a comprehensive liquidity analysis and updates the Company’s liquidity strategy as necessary.

The Company has taken a very prudent and disciplined approach to wholesale funding as a source of liquidity. Our successful strategy in gathering in-market customer deposits to fund loan growth has limited our reliance on wholesale funding. Wholesale funding sources include, but are not limited to, Federal funds, public funds (such as state and local municipalities), FHLB advances, securities sold under agreement to repurchase, and brokered deposits. We have set limits on the use of wholesale funding sources, which includes limiting brokered deposits to no more than $50.0 million maturing in any one-month and to no more than 10.0% of total deposits maturing within one-year.

As of September 30, 2013, and September 30, 2012, we did not have any brokered deposits, other than CDARS reciprocal deposits, on our balance sheet. CDARS reciprocal deposits are deposits that have been placed into a deposit placement service which allows us to place our customers’ funds in FDIC-insured time deposits at other banks and at the same time, receive an equal sum of funds from customers of other banks within the deposit placement service. CDARS reciprocal deposits of $37.4 million and $49.0 million are included in our time deposit portfolio and account for 1.8% and 2.2% of our total deposits at September 30, 2013 and December 31, 2012, respectively. Time deposits comprise approximately $547.2 million, or 26.1%, of our total deposit liabilities at September 30, 2013, and $628.9 million, or 28.0% of our total deposit portfolio at December 31, 2012. At September 30, 2013 and December 31, 2012, we had customer securities sold under agreement to repurchase of $210.4 million and $175.7 million, respectively. We also had wholesale securities sold under agreement to repurchase of $75.0 million as of September 30, 2013 and December 31, 2012.

The Company measures total liquidity through cash and cash equivalents, investment securities available-for-sale, mortgage loans held-for-sale, other loans and investment securities maturing within one year, less securities pledged as collateral for repurchase agreements, public deposits and other purposes, and less any outstanding Federal funds purchased. These liquidity sources decreased $62.6 million, or 9.1%, from $690.6 million at December 31, 2012, to $628.0 million at September 30, 2013, primarily due to a $100.0 million increase in interest-bearing deposit accounts at other banks and an $18.4 million increase in securities pledged as collateral for repurchase agreements, partially offset by a $107.1 million decrease in loans maturing within one year. Total liquidity as a percentage of total deposits was 29.97% at September 30, 2013, compared to 30.76% at December 31, 2012. Additional sources of liquidity available to the Bank include the capacity to borrow funds through established short-term lines of credit with various correspondent banks and the Federal Home Loan Bank of Atlanta. See Note 9 to the Consolidated Financial Statements for further information regarding these additional liquidity sources.

It is our opinion that our liquidity position at September 30, 2013, is adequate to respond to fluctuations “on” and “off” balance sheet. In addition, we know of no trends, demands, commitments, events or uncertainties that may result in, or that are reasonably likely to result in our inability to meet anticipated or unexpected liquidity needs.

Off-Balance Sheet Arrangements

The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include unfunded lines of credit, commitments to extend credit, standby letters of credit and financial guarantees, totaling $608.9 million and $610.8 million as of September 30, 2013, and December 31, 2012, respectively. These arrangements would impact the Company’s liquidity and capital resources to the extent customers accept and/or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. With the exception of these off-balance sheet arrangements, and the Company’s obligations in

 

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connection with its trust preferred securities, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors.

Unfunded lines of credit and commitments to extend credit totaled $537.3 million at September 30, 2013, and $550.1 million at December 31, 2012. These represent legally binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Unfunded lines of credit and commitments to extend credit were $527.3 million and $10.0 million, respectively, at September 30, 2013, and were $533.3 million and $16.8 million at December 31, 2012. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. At September 30, 2013, and December 31, 2012, the Company had $71.6 million and $60.8 million, respectively, in outstanding standby letters of credit.

Contractual Obligations

Since December 31, 2012, there have been no significant changes in the Company’s contractual obligations.

Capital

The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, changing competitive conditions and economic forces, and the overall level of growth. The adequacy of the Company’s current and future capital is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

We are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on our financial condition and the consolidated financial statements. Both the Company’s and the Bank’s capital levels continue to meet regulatory requirements. The primary indicators relied on by bank regulators in measuring the capital position are the Tier 1 risk-based capital, total risk-based capital, and leverage ratios. Tier 1 capital consists of common and qualifying preferred stockholders’ equity, less goodwill, and for the Company includes certain minority interests relating to bank subsidiary issued securities, and a limited amount of restricted core capital elements. Restricted core capital elements include qualifying cumulative preferred stock interests, certain minority interests in subsidiaries and qualifying trust preferred securities. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance for loan losses, and for the Company, a limited amount of excess restricted core capital elements. Risk-based capital ratios are calculated with reference to risk-weighted assets. The leverage ratio compares Tier 1 capital to total average assets. The Bank’s Tier 1 risk-based capital ratio was 14.93% at September 30, 2013, compared to 12.82% at December 31, 2012, and its total risk-based capital ratio was 16.19% at September 30, 2013, compared to 14.08% at December 31, 2012. These ratios are in excess of the minimum regulatory requirement of 4.00% and 8.00%, respectively. The Bank’s leverage ratio was 11.80% at September 30, 2013, compared to 10.03% at December 31, 2012, and in excess of the minimum regulatory requirement of 4.00%. The Company’s Tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio was 15.58%, 16.84%, and 12.07%, respectively, at September 30, 2013, compared to 13.25%, 14.51%, and 10.29% at December 31, 2012. In addition the Company’s and the Bank’s capital ratios exceeded the amounts required to be considered “well capitalized” as defined in applicable banking regulations. The increases in these capital ratios during the nine months ended September 30, 2013 are primarily due to net income generated by operations, proceeds from issuance of common stock on exercise of stock options and warrants, and lower levels of risk-weighted assets.

The ability of the Company to continue to maintain its overall asset size, or to grow, is dependent on its earnings and the ability to obtain additional funds for contribution to the Bank’s capital, through earnings, borrowing, the sale of additional common stock, or the issuance of additional other qualifying securities. In the event that the Company is unable to obtain additional capital for the Bank on a timely basis, the growth of the Company and the Bank may be curtailed, and the Company and the Bank may be required to reduce their level of assets in order to maintain

 

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compliance with regulatory capital requirements. In addition, in connection with the pending Merger with United, under the Agreement and Plan of Merger the Company is restricted from pursuing many capital-raising strategies until the Merger closes. If the Company cannot maintain sufficient capital or is forced to restrict growth or shrink its balance sheet, net income and stockholders’ equity may be adversely affected.

Guidance by the federal banking regulators provides that banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that we may be required to maintain higher levels of capital than we would otherwise be expected to maintain as a result of our levels of construction, development and commercial real estate loans.

Pursuant to the Basel III Final Rules adopted by the federal bank regulatory agencies in July 2013, trust preferred securities issued prior to May 19, 2010 by bank holding companies with less than $15 billion of total assets can be counted as Tier 1 capital at the holding company level, together with other restricted core capital elements, up to 25% of total capital (net of goodwill), and any excess as Tier 2 capital, subject to limitation. At September 30, 2013, trust preferred securities represented 19.4% of the Company’s Tier 1 capital and 17.9% of its total risk-based capital. See Note 10 to the Consolidated Financial Statements for further information regarding trust preferred securities.

Capital Issuances. As noted above, during 2008, the Company accepted an investment by Treasury under the Capital Purchase Program. In connection with that investment, the Company entered into and consummated a Securities Purchase Agreement with the Treasury, pursuant to which the Company issued 71,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $71.0 million. The Series A Preferred Stock paid cumulative dividends at a rate of 5% per year for the first five years, and thereafter would have paid dividends at a rate of 9% per year. The Series A Preferred Stock was non-voting, except in limited circumstances. Prior to the third anniversary of issuance, unless the Company has redeemed all of the Series A Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock to a third party, the consent of the Treasury was required for the Company to commence paying a cash common stock dividend or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement. On December 11, 2012, the Company announced that it had repurchased all of the $71.0 million in preferred stock that was issued to the Treasury under the Capital Purchase Program.

In connection with the purchase of the Series A Preferred Stock, the Treasury was issued a warrant (the “Warrant”) to purchase 2,696,203 shares of the Company’s common stock at an initial exercise price of $3.95 per share. The Warrant provides for the adjustment of the exercise price and the number of shares of the common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the common stock, and upon certain issuances of the common stock (or securities exercisable or exchangeable for, or convertible into, common stock) at or below 90% of the market price of the common stock on the trading day prior to the date of the agreement on pricing such securities. The Warrant expires ten years from the date of issuance. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant. As of September 30, 2013, the warrant issued to the Treasury to purchase shares of the Company’s common stock remains outstanding.

Please refer to Note 10 to the Consolidated Financial Statements for additional information regarding the issuance in 2008 of $25 million of trust preferred securities and warrants to purchase shares of the Company’s common stock to certain directors and executive officers of the Company.

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

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In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this Update provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, the Company is exposed to market risk, or interest rate risk, as its net income is largely dependent on its net interest income. Market risk is managed by the Company’s Asset/Liability Management

 

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Committee that formulates and monitors the performance of the Company based on established levels of market risk as dictated by policy. In setting tolerance levels, or limits on market risk, the Committee considers the impact on earnings and capital, the level and general direction of interest rates, liquidity, local economic conditions and other factors. Interest rate risk, or sensitivity, can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing of interest-earning assets differs from the maturing or repricing of interest-bearing liabilities and as a result of the difference between total interest-earning assets and interest-bearing liabilities. The Company seeks to manage interest rate sensitivity while enhancing net interest income by periodically adjusting this asset/liability position. In order to closely monitor and measure interest rate sensitivity, the Company uses earnings simulation models on a quarterly basis.

We use a duration gap of equity approach to manage our long-term interest rate risk. This approach uses a model which generates estimates of the change in our market value of portfolio equity (“MVPE”) over a range of interest rate scenarios. Given the current low interest rate environment, we limited the downward shock to 100 basis points. MVPE is the present value of expected cash flows from assets and liabilities using various assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates all discounted to a measurement date.

Our short term interest rate sensitivity is managed through the use of a model that generates estimates of the change in the net interest income when interest rates are shocked upward and downward from the base case. Given the current rate environment, we limited the downward change to 100 basis points. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The model captures the timing of the repricing of interest sensitive assets and interest sensitive liabilities as well as the degree of change (“beta”) in the interest rates of particular asset and liability products that occurs as interest rates move upward or downward. The model assumes that the composition of the interest sensitive assets and interest sensitive liabilities existing at September 30, 2013, remains constant over a two year period (base case) and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.

The following table provides an analysis of our interest rate risk as measured by the estimated change in MVPE and net interest income from the base case, resulting from instantaneous and sustained parallel shifts in interest rates as of September 30, 2013:

 

Interest Rate Scenario		Sensitivity of Market Value of Portfolio Equity September 30, 2012 Market Value of Portfolio Equity Percent Change from Base				Sensitivity of Net Interest Income September 30, 2012 Net Interest Income Percent Change from Base
Up 200 bps			–14.2	%			+4.2	%
Up 300 bps			–22.5	%			+6.1	%
Down 100 bps			+1.5	%			–8.4	%

Management believes the modeled results are consistent with the short duration of its balance sheet, given the many variables that affect the actual timing of when assets and liabilities will reprice. Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net income and the effect on net income from sudden changes in interest rates. Actual results will differ from the simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains a system of controls and procedures designed to ensure that information required to be disclosed in reports that the company files with the SEC is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period

 

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covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2013, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There was no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

The Company and its subsidiaries may be involved in certain litigation matters arising in the ordinary course of business. Although the ultimate outcome of these matters cannot be ascertained at this time, and the results of legal proceedings cannot be predicted with certainty, we believe, based on current knowledge, that the resolution of any such matters arising in the ordinary course of business will not have a material adverse effect on the Company.

Item 1A. RISK FACTORS

There have been no material changes in the risk factors faced by the Company from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)

Sales of Unregistered Securities. – As initially disclosed on a Form 8-K filed on September 25, 2008, on September 24, 2008, the Company completed a private placement, to its directors and certain executive officers, of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust. In connection with the issuance of the trust preferred securities, the Company also issued warrants (the “Warrants”) to purchase an aggregate of 1.5 million shares of common stock to the purchasers. The Warrants had a five year term, expiring September 24, 2013, and an exercise price of $6.83 per share.

In the first nine months of 2013, the Company issued an aggregate of 1,500,000 shares of common stock in connection with the following Warrant exercises:

 

•

On January 1, 2013, the Company issued 270,000 shares of common stock for gross proceeds of $1.8 million in connection with a Warrant exercise;

 

•

On April 12, 2013, the Company issued 120,000 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

•

On August 1, 2013, the Company issued 43,812 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

•

On August 21, 2013, the Company issued 15,000 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

•

On August 26, 2013, the Company issued 240,000 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

•

On August 29, 2013, the Company issued 1,188 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

•

On September 10, 2013, the Company issued 810,000 shares of common stock in connection with a Warrant exercise pursuant to the Warrant’s cashless exercise provisions.

 

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The shares of common stock issued upon exercise of the Warrants have not been registered under the Securities Act of 1933, as amended, and were issued pursuant to the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.

As of September 30, 2013, no Warrants to purchase shares of the Company’s common stock remain outstanding.

 

(b)

Use of Proceeds. – Not Applicable.

 

(c)

Issuer Purchases of Securities. – During the three months ended September 30, 2013, and in connection cashless exercises of Warrants in August 2013 and September 2013 described above, investors surrendered to the Company shares of the Company’s common stock to pay the exercise price of the Warrants. The following table sets forth the shares surrendered in this cashless Warrants exercise.

 

		Issuer Purchases of Equity Securities
Period		Total Number of Shares Purchased				Average Price Paid Per Share (1)				Total Number of Shares Purchased as Part of Publicly Announced Plan				Maximum Number of Shares that may yet be Purchased Under the Plan
July 1 – July 31, 2013			—			$	—				—				—
August 1 – August 31, 2013			20,452				15.03				—				—
September 1 – September 30, 2013			319,950				15.37				—				—
			340,402			$	15.35				—				—

 

(1)	Represents the closing price per share of the Company’s common stock on the last trading day prior to the cashless exercise of the Warrant.

Item 3. DEFAULTS UPON SENIOR SECURITIES - None

Item 4. MINE SAFETY DISCLOSURES - None

Item 5. OTHER INFORMATION

 

(a)

Required 8-K Disclosures. None

 

(b)

Changes in Procedures for Director Nominations by Securityholders. None

Item 6. EXHIBITS

 

Exhibit No.		Description
2.1		Agreement and Plan of Reorganization, dated as of January 29, 2013, by and between United Bankshares, Inc. and Virginia Commerce Bancorp, Inc. (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on January 31, 2013)
3.1		Articles of Incorporation of Virginia Commerce Bancorp, Inc., as amended (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006)
3.2		Articles of Amendment to the Articles of Incorporation relating to the Series A Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 15, 2008)
3.3		Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on July 27, 2007)
3.4		Amendment to the Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to exhibit 3.4 to the Company’s Current Report on Form 8-K filed on January 28, 2011)
31.1		Certification of Peter A. Converse, President and Chief Executive Officer
31.2		Certification of Mark S. Merrill, Executive Vice President and Chief Financial Officer
32.1		Certification of Peter A. Converse, President and Chief Executive Officer
32.2		Certification of Mark S. Merrill, Executive Vice President and Chief Financial Officer
101		The following materials from Virginia Commerce Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements

 

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Table of Contents

SIGNATURES

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

 

				Virginia Commerce Bancorp, Inc.
				(Registrant)
Date: November 7, 2013				BY		/s/ Peter A. Converse
				Peter A. Converse, President and Chief Executive Officer
				(Principal Executive Officer)
Date: November 7, 2013				BY		/s/ Mark S. Merrill
				Mark S. Merrill, Executive Vice President and Chief Financial Officer
				(Principal Financial Officer)

 

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