Annual Report (10-k)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x	Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended: December 31, 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: 000-53380

 

 

Xenith Bankshares, Inc.

Exact name of registrant as specified in its charter

 

 

 

Virginia		80-0229922
State or other jurisdiction of incorporation or organization		I.R.S. Employer Identification No.
One James Center, 901 E. Cary Street, Suite 1700 Richmond, Virginia		23219
Address of principal executive offices		Zip Code

[phone]

Registrant’s telephone number including area code

Securities registered under Section 12(b) of the Exchange Act:

 

Common Stock, par value $1.00		The NASDAQ Stock Market LLC
Title of each Class		Name of each exchange on which registered

Securities registered under Section 12(g) of the Exchange Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ¨     No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ¨     No   x

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 filings requirements for the past 90 days.    Yes   x     No   ¨

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨

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

 

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

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

The aggregate market value of the issuer’s common stock held by non-affiliates as of June 30, 2013: $34,156,358.

APPLICABLE ONLY TO CORPORATE REGISTRANTS

The number of shares outstanding of the issuer’s common stock as of February 28, 2014: 10,431,689 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Company’s Annual Meeting of Shareholders to be held on May 1, 2014 are incorporated by reference in Part III of this report.

 

 

 

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Table of Contents

XENITH BANKSHARES, INC. AND SUBSIDIARY

2013 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

				Page
PART I
Item 1		Business			3
Item 1A		Risk Factors			20
Item 2		Properties			32
Item 3		Legal Proceedings			32
Item 4		Mine Safety Disclosures			32
PART II
Item 5		Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities			33
Item 7		Management’s Discussion and Analysis of Financial Condition and Results of Operations			34
Item 8		Financial Statements and Supplementary Data			57
Item 9		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			94
Item 9A		Controls and Procedures			94
Item 9B		Other Information			94
PART III
Item 10		Directors, Executive Officers and Corporate Governance			95
Item 11		Executive Compensation			97
Item 12		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			97
Item 13		Certain Relationships and Related Transactions, and Director Independence			98
Item 14		Principal Accounting Fees and Services			98
PART IV
Item 15		Exhibits, Financial Statement Schedules			99

 

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Item 1—Business

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, a Virginia banking corporation and a member of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Xenith Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients, and select retail banking clients, which we refer to as our target customers. We are focused geographically on the Greater Washington, DC, Richmond, Virginia, and the Greater Hampton Roads, Virginia, metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk in the merger (discussed below) of Xenith Corporation with and into First Bankshares, Inc., the parent company of its wholly-owned subsidiary, SuffolkFirst Bank. Prior to the merger, SuffolkFirst Bank opened its first branch in Suffolk, Virginia, in 2003 under the name of SuffolkFirst Bank.

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

Unless the context requires otherwise or unless otherwise noted:

 

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

 

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all references to the “Bank” are to Xenith Bank, a wholly-owned subsidiary of Xenith Bankshares;

 

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all references to “the merger” are to the merger of Xenith Corporation with and into First Bankshares, which was effective on December 22, 2009;

 

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all references to “First Bankshares” are to First Bankshares, Inc., the surviving corporation in the merger with Xenith Corporation, which amended and restated its articles of incorporation in connection with the merger to, among other things, change its name to Xenith Bankshares, Inc.;

 

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all references to “Xenith Corporation” are to Xenith Corporation, which was merged with and into First Bankshares in the merger;

 

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all references to “SuffolkFirst Bank” are to SuffolkFirst Bank, a wholly-owned subsidiary of First Bankshares, which amended its articles of incorporation in connection with the merger to change its name to Xenith Bank; and

 

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all references to “BankCap Partners” are to BankCap Partners Fund I, L.P., BCP Fund I Virginia Holdings, LLC, BankCap Partners GP, L.P. and BankCap Equity Fund, LLC, collectively.

Merger of First Bankshares, Inc. and Xenith Corporation

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

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity in the merger. The merger was completed in accordance with the terms of an Agreement of Merger and related Plan of Merger, dated as of May 12, 2009, as amended. At the effective time of the merger, First Bankshares amended and restated its articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank.

Acquisitions

Effective on July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office (the “Paragon Branch”) of Paragon Commercial Bank, a North Carolina banking

 

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

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

Issuances of Stock

In April 2011, we issued and sold 4.6 million shares of our common stock at a public offering price of $4.25 per share, pursuant to an effective registration statement filed with the Securities and Exchange Commission (“SEC”). Net proceeds, after the underwriters’ discount and expenses, were $17.7 million.

On September 21, 2011, as part of the Small Business Lending Fund (the “SBLF”) of the United States Department of the Treasury (“U.S. Treasury”), we entered into a Small Business Lending Fund-Securities Purchase Agreement (the “SBLF Purchase Agreement”) with the Secretary of the U.S. Treasury, pursuant to which we sold 8,381 shares of the company’s Senior Non-Cumulative Perpetual Preferred Stock, Series A (“SBLF Preferred Stock”) to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The terms of the SBLF Preferred Stock were established pursuant to an amendment to the company’s Amended and Restated Articles of Incorporation on September 20, 2011. Of the $8.4 million received, $7.5 million was invested in the Bank; the remainder was retained by the holding company to fund the quarterly dividend payable on the SBLF Preferred Stock.

Competition

While our banking model has been implemented in other parts of the United States, we believe the model is unique in Virginia. The Virginia banking landscape is fragmented with many small banks having very little market share for deposits, while the large out-of-state national and super-regional banks control the majority of deposits.

Competition among financial institutions is based on many factors. We believe the most important factors that determine success are the quality and experience of bankers and their relationships with customers. Other factors include the quality of services and products offered, interest rates offered on deposit accounts, interest rates charged on loans, service charges and, in the case of loans to larger commercial borrowers, applicable lending capacity. There are banks with which we compete that have greater financial resources, access to capital and lending capacity, and offer a wider range of services than we do.

Our key competitive advantage lies in our ability to target, underwrite and manage commercial and industrial and commercial real estate loans. While these skills exist at the large banks, they generally do not exist at community banks. Our management team and bankers have spent substantially all of their careers working with middle market and small business management teams on their business and strategic plans and providing financing to these businesses in a broad array of industries. Our bankers are skilled salespeople and consultants, with well-honed credit skills, that allow them to work with customers and prospects to determine how and under what conditions we can provide financing and other banking services to meet their needs.

Products and Services

We offer a range of sophisticated and competitively priced banking products and services, including commercial and consumer checking accounts, noninterest-bearing demand accounts, money market accounts, savings accounts, as well as

 

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time deposits. We offer secured and unsecured commercial and industrial loans, commercial real estate loans (including construction and land development loans), residential real estate loans and consumer loans. We further offer comprehensive Internet and mobile banking services. We are a member of the START™ and PLUS™ automated teller (“ATM”) networks, which provide customers with access to ATMs worldwide.

We offer a high level of personalized service to our customers through our relationship managers and branch personnel. We believe that a banking relationship that includes multiple services, such as loan and deposit services, is the key to profitable and long-lasting customer relationships and that our local focus and local decision-making provide us with a competitive advantage over banks that do not have these attributes.

Deposits and Treasury Management Services

To maintain existing deposits and attract new deposits, we offer a broad product line and competitive rates and services. We expect to continue to obtain deposits through effectively leveraging our branch offices and solicitation by our bankers.

We view treasury management capabilities as key to our middle market business and other target customers and an important factor in building core deposits. We have dedicated treasury sales personnel who are exclusively focused on providing sophisticated cash management services and products to customers. Many of our customers use an account analysis system that allows them to pay for services by holding sufficient levels of deposits with us. The results are that our customers can avoid hard dollar charges for services and our core deposit base is enhanced. Our product offerings include retail and commercial on-line banking (our on-line capabilities include images, statements, stop payment, deposit reporting, account transfers, account reconciliation, and EDI (electronic data interchange) reporting), ACH (automated clearing house), wire transfers (both domestic and international), ZBA (zero balance accounts), sweeps, commercial charge card, commercial lock box and mobile banking services. We also offer fraud prevention tools, including debit block, check positive pay, and ACH positive pay. In addition to these services, we offer remote deposit capture, direct deposit and merchant services. Our technology platform is designed and well-suited to support our existing suite of services and products on a greater scale, as well as capable of supporting an expanded product set. We evaluate new products and may choose to offer additional products in the future.

Types of Lending Products

We offer a full range of lending products to commercial and industrial, commercial real estate, private banking and select retail clients. Fundamental to our business is to have skilled bankers building full banking relationships with high-quality customers. We believe that there is no substitute for knowing and understanding your customer when seeking attractive risk-adjusted returns in the extension of credit. We will continue to evaluate and adapt our services and product offerings as our customer base grows and evolves.

Our loan types include commercial and industrial loans, real estate loans, including commercial income-producing real estate loans, construction and development loans, residential real estate loans and consumer loans. We believe our target customers often have credit needs that community banks cannot meet, and these customers seek a relationship-oriented banking experience that is increasingly difficult to find at large banks.

Commercial and Industrial Loans. Our commercial borrowers are primarily small to middle market businesses engaged in a broad spectrum of businesses. Commercial and industrial (“C&I”) loans can be a source of working capital, or used to finance the purchase of equipment or to complete an acquisition. The terms of these loans vary by purpose and by type of underlying collateral, if any, and we typically require the principals of the business to guarantee the loans. Working capital loans are usually secured by accounts receivable and inventory, and structured as revolving lines of credit with terms not exceeding one year. In some cases, we use an independent third party to assess and recommend appropriate advance rates ( i.e., how much we will lend) based on the value of collateral. We may use third-party monitoring of advance rates in some cases. For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash. Typically, we make equipment loans for a term of three to five years at fixed or variable interest rates with the loan amortized over the term. Equipment loans are generally secured by the financed equipment at advance rates that we believe are appropriate given the equipment type and the financial strength of the borrower.

We also make owner-occupied real estate (“OORE”) loans. OORE loans are secured in part by the value of real estate that is generally the offices or production facilities of the borrower. In some cases, the real estate is not held by the commercial enterprise, rather it is owned by the principals of the business or an entity controlled by the principals. We classify OORE loans as C&I, as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

 

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Real Estate Loans. We make commercial real estate loans (“CRE”), construction and land development loans, and residential real estate loans.

We make CRE loans on income-producing properties. The primary collateral for CRE loans is a first lien mortgage on multi-family, office, warehouse, hotel or retail property, plus assignments of all rents and leases related to the property. Our CRE loans generally have maturity dates that do not exceed five years, with amortization schedules of 15 to 25 years, with both fixed and variable rates of interest. We seek to reduce the risks associated with commercial mortgage lending by focusing our lending in our target markets and obtaining financial statements, tax returns or both from borrowers and guarantors at regular intervals. It is also generally our policy to obtain personal guarantees from the principals of the borrowers.

When underwriting CRE loans, we consider the liquidity, financial condition, operating performance and reputation of the borrower and any guarantors. We also consider the borrower’s equity investment in the project or property, as well as evidence of market acceptance (pre-leasing for commercial construction, pre-sales for residential construction). For construction and land development loans, proceeds are disbursed periodically with funds advanced tied to the percentage of construction completed. We carefully monitor these loans through site inspections and title rundowns prior to making disbursements. Typically, our loan-to-value benchmark for CRE loans is below 80% at inception, with satisfactory debt-service coverage ratios as well.

We also make construction and land development loans generally to builders and developers who are located in our target markets. Our construction and land development loans are intended to provide interim financing on the property and are originated with the general expectation that the borrower will repay the loan through permanent loan financing and/or the sale of the property securing the loan.

Our lending activities include the origination of first and second lien loans, including home equity line of credit loans, secured by residential real estate that is located primarily in our target markets offered to select customers. These customers would primarily include branch and private banking customers. Our underwriting guidelines include minimum debt coverage ratio and maximum loan to value requirements. Generally our benchmarks include a minimum debt coverage ratio of 1.20 and maximum loan to value of 80%, at inception.

Consumer Loans. Consumer loans largely include home equity lines secured by borrower’s primary residence in our target markets and loans to our branch customers and private banking clients for consumer or business purposes.

Our credit policy provides procedures for making loans to individuals along with the regulatory requirements to ensure that all loan applications are evaluated subject to fair lending requirements. Our credit policy addresses the common credit standards for making loans to individuals, the credit analysis and financial statement requirements, the collateral requirements, including insurance coverage where appropriate, as well as the documentation required. Our ability to analyze a borrower’s current financial health and credit history, as well as the value of collateral as a secondary source of repayment, when applicable, are significant factors in determining the credit worthiness of loans to individuals.

Guaranteed Student Loans. During the third quarter of 2013, we began purchasing guaranteed student loans, a significant portion of which are guaranteed by the federal government. These loans were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, the student loans are substantially guaranteed by a guaranty agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program (“FRLP”), under which borrowers on defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders. The Bank is an approved FFLEP lender.

Credit Policies and Administration

We seek to maintain a high-quality loan portfolio as an essential part of our business strategy. We follow general credit standards appropriate to each loan type in order to properly assess, price and manage credit risk. These standards are detailed in our credit policy. Material exceptions to these standards require approval of our senior credit staff, Management Credit Committee (“MCC”), or the Credit Policy Committee of our board of directors (“CPC”).

The principal risk associated with each type of loan we make is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and/or the attributes of the borrower’s business or industry segment or personal circumstances. Attributes of the relevant business or industry segment include the competitive environment, customer and supplier power, threat of substitutes, and barriers to entry and exit. We believe the quality of the commercial borrower’s management is the most important factor driving creditworthiness. Management’s ability to properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to respond

 

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effectively to such changes, among other abilities, are significant factors that determine a commercial borrower’s creditworthiness. Our credit policy requires that key risks be identified and measured, documented and mitigated, to the extent possible, to seek to ensure the soundness of our loan portfolio.

Loan Origination Procedure and Approval. Loan originations follow a process requiring a comprehensive evaluation of credit risk. This process includes a thorough evaluation of the borrower, collateral and any guarantor support, covenant structure, monitoring plan and pricing. Our bankers and credit analysts originating the loan are responsible for preparing a thorough credit analysis covering these matters, including the preliminary assignment of the credit risks and collateral ratings. Our new and renewed loans are approved either by (1) certain senior credit officers with approval authority, (2) our MCC, or (3) the CPC of our board of directors. Our MCC approves the vast majority of loans. Credit approval is required by the CPC for exposures that exceed house limits.

Credit Risk Ratings. A key element of our credit policies and administration is our risk rating system. All credit exposures are risk rated based on our assessment of the level of risk associated with the loan. We employ a dual risk-rating system, with scales of 1-10 for the obligor, and scales of A-D for the collateral. The obligor rating is based on our assessment of the borrower’s probability of default, while the collateral rating describes the type of our collateral and estimated loan to value.

The obligor rating scale is a 1-10 scale with a rating of 1 representing likelihood of default similar to that of the U.S. government. A rating of 10 represents a transaction where either a loss has already occurred or is anticipated in the near future. The obligor rating is determined through thorough credit analysis and is the responsibility of the banker and credit risk officer responsible for the credit relationship.

Risk and collateral ratings are recommended by the banker in concert with the credit risk officer as a part of their credit analysis while underwriting a transaction or performing ongoing monitoring of an account. It is the responsibility of the banker and credit risk officer to ensure that our ratings are accurate and updated as needed.

Asset and Liability Management

Our asset and liability management is governed by an asset and liability management (“ALM”) policy. Our ALM policy defines the following financial management functions: (1) overall asset/liability management and strategy; (2) interest rate risk management; and (3) liquidity management. The ALM committee, which is comprised of the Bank’s management, addresses the management of the assets and liabilities of the Bank and is responsible for actively monitoring interest rate risk and liquidity risk. We also have an ALM committee of our board of directors (“ALCO”), which approves our ALM policy and regularly reviews our results and analysis relative to the policy.

We evaluate the impact to our earnings and market value of equity based on changes in interest rates in both immediate and ramped interest rate shock scenarios. We evaluate the effect of a change in interest rates of +/-100 basis points (bps), +/- 200 bps, +/-300 bps, and +/- 400 bps on both net interest income and its impact on the market value of equity. These impacts are measured relative to policy limits as defined in the ALM policy. As of December 31, 2013, we were within all applicable policy limits.

The objective of our liquidity risk management is to ensure that we maintain sufficient liquidity to efficiently address loan demand, deposit fluctuations, debt service requirements and other funding needs. In addition to the day-to-day management of liquidity, we have developed a contingency funding plan that outlines funding alternatives under various stress situations. The contingency funding plan details the conditions and potential causes of the liquidity stress, as well as key action plans for reducing the stress, including the assignment of responsibilities to key personnel.

We also have a capital policy that defines the approach we use to establish, monitor and maintain appropriate capital levels. The capital policy details metrics and thresholds that we review, and it delineates various events that may drive the needs for additional capital, along with our primary capital alternatives.

We also have an investment policy, which addresses permitted investments, permitted broker-dealers, safekeeping and accounting classifications. Our investment portfolio serves as both a primary and secondary source of liquidity, and it contributes to net interest margin.

Our contingency funding plan, capital policy and investment policies are also approved by our ALCO.

 

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Supervision and Regulation

General

Xenith Bank is a Virginia state-chartered member bank regulated by the Federal Reserve and the Bureau of Financial Institutions of the Virginia State Corporation Commission (the “Bureau of Financial Institutions”). The Bank operates as a subsidiary under Xenith Bankshares, a one bank holding company. The Bank’s deposits are insured by the FDIC to the maximum amount permitted by law. Xenith Bankshares and the Bank are required by the Federal Reserve and the Bureau of Financial Institutions to file semi-annual and quarterly financial reports, respectively, on their respective financial condition and performance. In addition, the Federal Reserve and the Bureau of Financial Institutions conduct periodic onsite examinations of the Bank. We must comply with a variety of reporting requirements and banking regulations. The laws and regulations governing us generally have been promulgated to protect depositors, the deposit insurance funds, and the banking system as a whole and are not intended to protect our shareholders and other creditors. Additionally, we must bear the cost of compliance with reporting and other regulations, and this cost is significant.

The Federal Reserve, Bureau of Financial Institutions and FDIC have the authority and responsibility to ensure that financial institutions are managed in a safe and sound manner and to prevent the continuation of unsafe and unsound practices. Additionally, they must generally approve significant business activities undertaken by financial institutions. Typical examples of such activities requiring approval include branch locations, mergers, capital transactions and major organizational structure changes. Obtaining regulatory approval for these types of activities can be time consuming and expensive and ultimately may not be successful.

Insurance of Accounts and Regulatory Assessments

The Bank’s deposit accounts are insured by the Deposit Insurance Fund of the FDIC (“DIF”), up to the maximum legal limits of the FDIC, and are subject to regulation, supervision and regular examination by the Bureau of Financial Institutions and the Federal Reserve. The regulations of these various agencies govern most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends, and location and number of branch offices.

The Bank is subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon an institution’s average consolidated total assets minus average tangible equity. Since 2008, higher levels of bank failures and related resolutions costs have depleted the DIF. To maintain a strong funding position and restore reserve ratios of the DIF, the FDIC has increased assessments and may continue to do so in the future.

The assessment rates, range from approximately 2.5 bps to 45 bps (depending on applicable adjustments for unsecured debt and brokered deposits), until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio equals or exceeds 1.15%, the applicable assessment rates may range from 1.5 bps to 40 bps. For the years ended December 31, 2013 and 2012, we reported $409 thousand and $326 thousand, respectively, in expense for FDIC insurance.

The current basic limit on federal deposit insurance coverage is $250,000 per depositor. Under the Federal Deposit Insurance Act (“FDIA”), the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Bank Capital Adequacy Guidelines

The Federal Reserve has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, we are generally required to maintain a minimum “total risk-based capital ratio” of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8.0%. At least half of total capital (4%) must be composed of “Tier 1 capital,” which is defined as common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles. The remainder may consist of “Tier 2 capital,” which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock, and the allowance for loan and lease losses, subject to certain adjustments. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no risk-based capital) for assets such as cash and certain U.S. government and agency securities to 100% for the bulk of assets that are typically held by a bank, including certain multi-family residential and commercial real estate loans, commercial and industrial loans, and consumer loans. Residential first mortgage loans on one- to four-family residential real estate and certain seasoned multi-family residential real estate loans, which are not 90 days or more past due or nonperforming and which have been made in accordance with prudent underwriting standards, are assigned a 50% level in the risk-weighting system, as are certain privately issued mortgage-backed securities representing indirect ownership of such loans.

 

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In addition to the risk-based capital requirements, the Federal Reserve has established a minimum 4.0% “Tier 1 leverage ratio” requirement (i.e., Tier 1 capital to average total consolidated assets). A bank having less than the minimum Tier 1 leverage ratio requirement is required, within 60 days of the date as of which it fails to comply with such requirement, to submit a reasonable plan describing the means and timing by which it will achieve its minimum Tier 1 leverage ratio requirements. A bank that fails to file such a plan is deemed to be operating in an unsafe and unsound manner and could be subject to a cease-and-desist order. Any insured depository institution with a Tier 1 leverage ratio that is less than 2.0% is deemed to be operating in an unsafe and unsound condition pursuant to Section 8(a) of the FDIA and is subject to potential termination of deposit insurance. However, such an institution will not be subject to an enforcement proceeding solely on account of its capital ratios, provided it has entered into and is in compliance with a written agreement to increase its Tier 1 leverage ratio and to take such other action as may be necessary to operate in a safe and sound manner. The capital regulations also provide, among other things, for the issuance of a capital directive, which is a final order issued to a bank that fails to maintain minimum capital or to restore its capital to the minimum capital requirement within a specified time period. Such directive is enforceable in the same manner as a final cease-and-desist order.

Under these regulations, a commercial bank will be:

 

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“well-capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater and is not subject to any written capital order or directive;

 

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“adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and a Tier 1 leverage ratio of 4% or greater (3% in certain circumstances) and does not meet the definition of “well-capitalized”;

 

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“undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, and a Tier 1 leverage ratio of less than 4% (3% in certain circumstances);

 

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“significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, and a Tier 1 leverage ratio of less than 3%; or

 

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“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2%.

The risk-based capital standards of the Federal Reserve explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

In July 2013, the Federal Reserve, FDIC and the Office of the Comptroller of the Currency (the “OCC”) approved a final rule establishing a regulatory capital framework that implements in the United States the Basel Committee’s Revised Framework to the International Convergence of Capital Management and Capital Standards regulatory capital reforms from the Basel Committee on Banking Supervision (the “Basel Committee”) and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) (the “Basel III Rules”). Under the Basel III Rules, minimum requirements will increase for both the quantity and quality of capital held by banking organizations. In addition, following the implementation of the new Basel III Rules, a bank holding company must satisfy an increased Tier 1 risk-based capital ratio of 8% and a new common equity Tier 1 risk-based capital ratio of 6.5% in order to be deemed “well capitalized.” The total risk-based capital ratio and Tier 1 leverage ratio requirements will remain unchanged. The phase-in period for the Basel III Rules is not scheduled to begin until January 2015. See “—New Capital Adequacy Guidelines under Basel III” below.

In December 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained conditions related to BankCap Partners, as well as the conduct of the Bank’s business. The condition applicable to the Bank provided that, during the first three years of operation after the merger, the Bank must operate within the parameters of its business plan submitted in connection with BankCap Partner’s application to the Federal Reserve, and the Bank must obtain prior written regulatory consent to any material change in its business plan. The business plan sets forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012, which were met. Subsequent to meeting the requirements set forth in our business plan, we are required to maintain capital ratios categorizing us as “well-capitalized.” As of December 31, 2013, we met all minimum capital adequacy requirements to which we were subject, including those contained in our business plan as submitted to the Federal Reserve, and were

 

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categorized as “well-capitalized.” Since December 31, 2013, there are no conditions or events that management believes have changed our status as “well-capitalized.” For additional information regarding our capital ratios, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Adequacy.”

New Capital Adequacy Guidelines under Basel III

In July 2013, the Federal Reserve, FDIC and OCC adopted the Basel III Rules. The Basel III Rules apply to both depository institutions and (subject to certain exceptions not applicable to the company) their holding companies. Although parts of the Basel III Rules apply only to large, complex financial institutions, substantial portions of the Basel III Rules apply to the company and the Bank. The Basel III Rules include requirements contemplated by the Dodd-Frank Act, as well as certain standards initially adopted by the Basel Committee in December 2010.

The Basel III Rules include new risk-based and leverage capital ratio requirements and refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements applicable to the company and the Bank under the Basel III Rules are: (i) a new common equity Tier 1 risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. Common equity Tier 1 capital will consist of retained earnings and common stock instruments, subject to certain adjustments.

The Basel III Rules will also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements. The conservation buffer, when added to the capital requirements, will result in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%; (ii) a Tier 1 risk-based capital ratio of 8.5%; and (iii) a total risk-based capital ratio of 10.5%. The new capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers, if its capital level is below the buffer amount.

The Basel III Rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels do not meet certain thresholds. These revisions are to be effective January 1, 2015. The prompt correction action rules will be modified to include a common equity Tier 1 capital component and to increase certain other capital requirements for the various thresholds. For example, under the proposed prompt corrective action rules, insured depository institutions will be required to meet the following capital levels in order to qualify as “well capitalized:” (i) a new common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from current rules).

The Basel III Rules set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn will affect the calculation of risk-based ratios. Under the Basel III Rules, higher or more sensitive risk weights would be assigned to various categories of assets, including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. In addition, the Basel III Rules include (i) alternative standards of credit worthiness consistent with the Dodd-Frank Act, (ii) greater recognition of collateral and guarantees, and (iii) revised capital treatment for derivatives and repo-style transactions.

In addition, the Basel III Rules include certain exemptions to address concerns about the regulatory burden on community banks. For example, banking organizations with less than $15 billion in consolidated assets as of December 31, 2009 are permitted to include in Tier 1 capital trust preferred securities and cumulative perpetual preferred stock issued and included in Tier 1 capital prior to May 19, 2010 on a permanent basis, without any phase out. Community banks may also elect on a one time basis in their March 31, 2015 quarterly filings to opt-out of the onerous requirement to include most accumulated other comprehensive income (“AOCI”) components in the calculation of a common equity Tier 1 capital and, in effect, retain the AOCI treatment under the current capital rules. The company may make a one-time, permanent election to continue to exclude AOCI from capital. If the company does not make this election, unrealized gains and losses would be included in the calculation of its regulatory capital. Overall, the Basel III Rules provide some important concessions for smaller, less complex financial institutions.

The Basel III Rules generally become effective beginning January 1, 2015. The conservation buffer will be phased in beginning in 2016 and will take full effect on January 1, 2019.

 

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Bank Holding Company Regulation

Under the Federal Reserve guidelines, every bank holding company must serve as a “source of strength” for each of their bank subsidiaries. The bank holding company is expected to commit resources to support a subsidiary bank, including at times when the holding company may not be in a financial position to provide such support. A bank holding company’s failure to meet its source of strength obligations may constitute an unsafe and unsound practice or a violation of the Federal Reserve’s regulations, or both. The source-of-strength doctrine most directly affects bank holding companies in situations where the bank holding company’s subsidiary bank fails to maintain adequate capital levels. This doctrine was codified by the Dodd-Frank Act, but the Federal Reserve has not yet adopted regulations to implement this requirement.

The Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”), limits the investments and activities of bank holding companies. In general, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, providing services for its subsidiaries, and various non-bank activities that are deemed to be closely related to banking. The activities of the company are subject to these legal and regulatory limitations under the Bank Holding Company Act and the implementing regulations of the Federal Reserve. Federal bank regulatory agencies have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary, if the agency determines that divestiture may aid the depository institution’s financial condition.

Currently, BankCap Partners is deemed a bank holding company for Atlantic Capital Bank and the Bank. The position of BankCap Partners as a source of strength to other depository institutions may limit its ability to serve as a source of strength for the Bank and could adversely affect the Bank’s ability to access resources of BankCap Partners. Federal bank regulatory agencies have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary, if the agency determines that divestiture may aid the depository institution’s financial condition.

A bank for which BankCap Partners is deemed to be a bank holding company may be required to indemnify, or cross-guarantee, the FDIC against losses the FDIC incurs with respect to any other bank controlled by BankCap Partners. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires that an insured depository institution shall be liable for the loss incurred or anticipated by the FDIC arising from the default of a commonly controlled insured depository institution or any assistance provided by the FDIC to any commonly controlled insured depository institution in danger of default. Accordingly, the Bank may be obligated to provide financial assistance to Atlantic Capital Bank or any other financial institution for which BankCap Partners is deemed to be a bank holding company. Atlantic Capital Bank is a Georgia state non-member bank headquartered in Atlanta, Georgia, founded in 2007. Atlantic Capital Bank operates as a full-service, locally-managed commercial bank that specifically targets the financial needs of middle market corporations, emerging growth companies, real estate developers and investors, and the principals of these companies, as well as affluent families. Atlantic Capital Bank’s primary geographic market is Metropolitan Atlanta, the state of Georgia and the southeastern United States.

Atlantic Capital Bank’s common stock is not registered under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) and, as a result, Atlantic Capital Bank does not file annual, quarterly and current reports, proxy statements or other information with the SEC. Financial and regulatory information about Atlantic Capital Bank is included, among other information, in publicly available Reports of Condition and Income (also known as “call reports”) filed by Atlantic Capital Bank with the FDIC, which reports are not incorporated by reference herein. We have not been, and in the future will not be, involved in the preparation and filing of Atlantic Capital Bank’s call reports or the conduct of its business.

Prompt Corrective Action

Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (a) restrict payment of capital distributions and management fees; (b) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (c) require submission of a capital restoration plan; (d) restrict the growth of the institution’s assets; and (e) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions, if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (a) requiring the institution to raise additional capital; (b) restricting transactions with affiliates; (c) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (d) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.

Any bank holding company that controls a subsidiary bank that has been required to submit a capital restoration plan will be required to provide assurances of compliance by the bank with the capital restoration plan, subject to limitations on

 

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the bank holding company’s aggregate liability in connection with providing such required assurances. Failure to restore capital under a capital restoration plan can result in the bank being placed into receivership, if it becomes critically undercapitalized. A bank subject to prompt corrective action also may affect its parent holding company in other ways. These include possible restrictions or prohibitions on dividends or subordinated debt payments to the parent holding company by the bank, as well as limitations on other transactions between the bank and the parent holding company. In addition, the Federal Reserve may impose restrictions on the ability of the bank holding company itself to pay dividends, or require divestiture of holding company affiliates that pose a significant risk to the subsidiary bank, or require divestiture of the undercapitalized subsidiary bank.

Dodd-Frank Act

The Dodd-Frank Act was signed by President Obama in July 2010. The Dodd-Frank Act will result in a major overhaul of the financial institution regulatory system. A summary of certain provisions of the Dodd-Frank Act is set forth below, along with information set forth in the applicable sections of this “Supervision and Regulation” section. Among other things, the Dodd-Frank Act established a new, independent Consumer Financial Protection Bureau (“CFPB”) tasked with protecting American consumers from unfair, deceptive and abusive financial products and practices. The Dodd-Frank Act also created the Financial Stability Oversight Council, which focuses on identifying, monitoring and addressing systemic risks in the financial system. The Financial Stability Oversight Council, among other tasks, makes recommendations for increasingly strict rules for capital, leverage and other requirements as a company’s size and complexity increase. The Dodd-Frank Act also requires the implementation of the “Volcker Rule” for banks and bank holding companies, which prohibits, with certain limited exceptions, proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and generally otherwise limits the relationships with such funds. The Dodd-Frank Act also includes provisions that, among other things, reorganize bank supervision and strengthen the Federal Reserve.

The Dodd-Frank Act includes savings associations and industrial loan companies, as well as banks, in the nationwide deposit limitation. Thus, no acquisition of any financial institution, not just a commercial bank, can be approved if the effect of the acquisition would be to increase the acquirer’s nationwide deposits to more than 10% of all deposits. The Dodd-Frank Act also requires fees charged for debit card transactions to be both “reasonable and proportional” to the cost incurred by the card issuer. In June 2011, the Federal Reserve set the interchange rate cap at $0.24 per transaction. While these restrictions do not apply to banks with less than $10 billion in assets, the rule could affect the competitiveness of debit cards issued by smaller banks. We believe that market forces may erode the effectiveness of this exemption now that merchants can select more than one network for transaction routing.

Further, the Dodd-Frank Act provides that the appropriate federal regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other “covered financial institution” that provides an insider or other employee with “excessive compensation” or could lead to a material financial loss to such firm. In June 2010, prior to the Dodd-Frank Act, the bank regulatory agencies promulgated the Interagency Guidance on Sound Incentive Compensation Policies, which requires that financial institutions establish metrics for measuring the impact of activities to achieve incentive compensation with the related risk to the financial institution of such behavior. In February 2011, federal banking and securities regulators released proposed regulations that set forth standards for incentive-based compensation that prohibit compensation considered to be excessive or encourage risk that could result in a material financial loss. While the proposed regulation applies only to “covered financial institutions,” meaning those institutions with $1 billion or more in assets, the proposal rests on principles set forth in the Dodd-Frank Act and the Interagency Guidance on Sound Incentive Compensation Policies. Accordingly, we anticipate that federal banking regulators will apply certain of those standards to all financial institutions in determining whether they are in compliance with the Guidance on Sound Incentive Compensation Policies, so that, together with the Dodd-Frank Act and the recent guidance, the proposed rules may impact the current compensation policies at the Bank.

We anticipate that the requirements of the Dodd-Frank Act will be implemented over time and will be subject to regulatory rule-making and implementation over the course of several years. Although we cannot predict the specific impact and long-term effects that the Dodd-Frank Act and the regulations promulgated thereunder will have on us and our prospects, our target markets and the financial industry in general, we believe that the Dodd-Frank Act and the regulation promulgation thereunder will impose additional administrative burdens that will obligate us to incur additional expenses.

Consumer Financial Protection Bureau

The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) and certain other statutes. Banking institutions with total assets of $10 billion or less, such as the Bank, remain subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws and such additional regulations as may be adopted by the CFPB.

 

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The CFPB has promulgated rules relating to remittance transfers under the Electronic Fund Transfer Act, which require companies to provide consumers with certain disclosures before the consumer pays for a remittance transfer. These new rules took effect in February 2013. The CFPB has also amended certain rules under Regulation C relating to home mortgage disclosure, to reflect a change in the asset-size exemption threshold for depository institutions based on the annual percentage change in the Consumer Price Index for Urban Wage Earners and Clerical Workers. In addition, on January 10, 2013, the CFPB released its final “Ability-to-Repay/Qualified Mortgage” rules, which amend the Trust in Lending Act (“Regulation Z”). Regulation Z currently prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer’s ability to repay the loan. The final rule implements sections 1411 and 1412 of the Dodd-Frank Act, which generally require creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for “qualified mortgages.” The final rule also implements section 1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. The rule became effective January 10, 2014.

Small Business Lending Fund

The Small Business Jobs and Credit Act of 2010 created the Small Business Lending Fund to invest capital into community banking organizations. Through the fund, the U.S. Treasury invested in financial institutions through the purchase of senior preferred stock or indebtedness. The U.S. Treasury could invest up to 5% of risk-weighted assets for financial institutions with $1 billion of total assets or less as of December 31, 2009, or up to 3% of risk-weighted assets for financial institutions with more than $1 billion, but less than $10 billion, in total assets on that date.

The starting point for dividend rates on the senior preferred stock issued by participants to the U.S. Treasury is 5% for “C” corporations. Financial institutions could “buy down” the rate to as low as 1% by increasing the level of small business loans. The increase is measured based on the increase over a “baseline level,” which is generally the average amount of small business lending reported by that institution in its call report for the four full quarters immediately preceding the date of enactment of the Small Business Jobs and Credit Act, less (a) net loan charge-offs with respect to small business lending, and (b) gains realized from mergers, acquisitions or purchases of loans after origination. For every 2.5% by which the amount of small business lending has increased, the dividend or interest rate on senior preferred stock will be reduced by 1%. If, however, small business lending has remained the same or decreased relative to the baseline level in the eighth quarter, the rate the participant would pay would increase to 7% beginning in the tenth quarter and continuing until the end of the four-and-a-half year period from initial funding. After the four-and-a-half-year period from initial funding, the rate will increase to 9% until the senior preferred stock issued to the U.S. Treasury is redeemed.

On September 21, 2011, we sold 8,381 shares SBLF Preferred Stock to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The SBLF Preferred Stock is senior to our common stock. In connection with our participation in the fund, we were required to develop a small business lending plan describing our business strategy and operating goals to address the needs of small businesses in the areas we serve, as well as a plan to provide linguistically and culturally appropriate outreach, where appropriate, to certain groups. On an on-going basis, we must comply with certain reporting requirements of the fund in order for the U.S. Treasury to assess whether we are complying with the requirements of the fund and to determine the dividend rate on the SBLF Preferred Stock. As of December 31, 2013, we believe we were in compliance with all the requirements of the SBLF. Our effective dividend rate has been 1% since the issuance and sale of the SBLF Preferred Stock.

Gramm-Leach-Bliley Act of 1999

The GLB Act implemented major changes to the statutory framework for providing banking and other financial services in the United States. The GLB Act, among other things, eliminated many of the restrictions on affiliations among banks and securities firms, insurance firms and other financial service providers. A bank holding company that qualifies as a financial holding company will be permitted to engage in activities that are financial in nature or incident or complimentary to financial activities. The activities that the GLB Act expressly lists as financial in nature include insurance activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.

To be eligible for these expanded activities, a bank holding company must qualify as a financial holding company. To qualify as a financial holding company, each insured depository institution controlled by the bank holding company must be well-capitalized and well-managed and have at least a satisfactory rating under the Community Reinvestment Act of 1977 (See “—Community Reinvestment Act” below). In addition, the bank holding company must file with the Federal Reserve a declaration of its intention to become a financial holding company. The Dodd-Frank Act amended this provision to require that financial holding companies also be well-capitalized and well-managed.

 

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Although the GLB Act is considered one of the most significant banking laws since Depression-era statutes were enacted, the GLB Act has not, and we do not expect that the GLB Act will in the future, materially affect our products, services or other business activities, nor do we believe that the GLB Act will have a material adverse impact on our operations. To the extent that it allows banks, securities firms and insurance firms to affiliate, the financial services industry may experience further consolidation and greater competition.

Payment of Cash Dividends

Xenith Bankshares is a legal entity, separate and distinct from Xenith Bank. Both Xenith Bankshares and Xenith Bank are subject to laws and regulations that limit the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Xenith Bankshares is incorporated under the Virginia Stock Corporation Act, which has restrictions prohibiting the payment of dividends if, after giving effect to the dividend payment, Xenith Bankshares would not be able to pay its debts as they become due in the usual course of business, or if Xenith Bankshares’ total assets would be less than the sum of its total liabilities plus the amount that would be required, if Xenith Bankshares were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.

Consistent with its policy that bank holding companies should serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudence, banks generally should not maintain a rate of distributions to shareholders unless our net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. Further, the Federal Reserve issued Supervisory Letter SR 09-4 on February 4, 2009 and revised March 27, 2009, which provides guidance on the declaration and payment of dividends, capital redemptions and capital repurchases by bank holding companies. Supervisory Letter SR 09-4 provides that, as a general matter, a bank holding company should eliminate, defer or significantly reduce its dividends, if: (1) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition; or (3) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Failure to do so could result in a supervisory finding that the bank holding company is operating in an unsafe and unsound manner.

Banking regulators have indicated that Virginia banking organizations should generally pay dividends only (1) from net undivided profits of the bank, after providing for all expenses, losses, interest and taxes accrued or due by the bank, and (2) if the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. In particular, under the current supervisory practices of the Federal Reserve, prior approval from the Federal Reserve and a supermajority of the Bank’s shareholders is required, if cash dividends declared in any given year exceed net income for that year plus retained earnings of the two preceding years. In addition, under the FDIA, insured depository institutions such as the Bank are prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the statute).

Under Virginia law, no dividend may be declared or paid out of a bank’s paid-in capital. Xenith Bankshares may be prohibited under Virginia law from the payment of dividends, if the Bureau of Financial Institutions determines that a limitation of dividends is in the public interest and is necessary to ensure our financial soundness, and the Bureau of Financial Institutions may also permit the payment of dividends not otherwise allowed by Virginia law. The terms of the SBLF Preferred Stock also impose limits on our ability to pay dividends on shares of our common stock.

Loans to Insiders

The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act, any loan to a director, executive officer or principal shareholder of a bank, or to entities controlled by any of the foregoing, may not exceed, together with all outstanding loans to such persons or entities controlled by such person, the bank’s loan to one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed two times the bank’s unimpaired capital and unimpaired surplus until the bank’s total assets equal or exceed $100 million, at which time the aggregate is limited to the bank’s unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and principal shareholders of a bank or bank holding company, and to entities controlled by such persons, unless such loans are approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Our policy on loans to insiders establishes a maximum amount, which includes all other outstanding loans to such persons, as to which prior board of director’s approval is required, of the greater of $25,000 or 5% of capital and surplus (up to $500,000). Section 22(h) requires that loans

 

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to directors, executive officers and principal shareholders be made in terms and underwriting standards substantially the same as offered in comparable transactions to other persons. The Dodd-Frank Act expanded coverage of transactions with insiders by including credit exposure arising from derivative transactions. In addition, the Dodd-Frank Act prohibits an insured depository institution from purchasing or selling an asset to an executive officer, director or principal shareholder (or any related interest of such a person) unless the transaction is on market terms, and if the transaction exceeds 10% of the institution’s capital, it is approved in advance by a majority of the disinterested directors.

Restrictions on Transactions with Affiliates

The Bank is subject to the provisions of Section 23A of the Federal Reserve Act with respect to affiliates, including Xenith Bankshares. These provisions place limits on the amount of:

 

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loans or extensions of credit to affiliates;

 

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investment in affiliates;

 

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assets that the Bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;

 

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the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

 

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the Bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions are limited in amount, as to any one affiliate, to 10% of capital and surplus and, as to all affiliates combined, to 20% of capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets from an affiliate.

The Dodd-Frank Act expanded the scope of Section 23A to include investment funds managed by an institution as an affiliate, as well as other procedural and substantive hurdles.

The Bank also is subject to the provisions of Section 23B of the Federal Reserve Act, which, among other things, prohibits the Bank from engaging in any transaction with an affiliate unless the transaction is on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with non-affiliated companies.

Certain Acquisitions

The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of the voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy. As a result of the USA PATRIOT Act of 2001 (the “Patriot Act”), which is discussed below, the Federal Reserve is required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions. The Dodd-Frank Act also amended the Bank Holding Company Act to require consideration of the extent to which a proposed acquisition, merger or consolidation would result in greater or more concentrated risks to the stability of the U.S. banking or financial system.

Under the Bank Holding Company Act, if well-capitalized and well-managed, any bank holding company located in Virginia may purchase a bank located outside of Virginia. Conversely, a well-capitalized and well-managed bank holding company located outside of Virginia may purchase a bank located inside Virginia. In each case, however, restrictions currently exist on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.

Change in Bank Control

Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if a person or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities.

 

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Sound Banking Practices

Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a bank holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid together with the consideration paid for any repurchases in the preceding year is equal to 10% or more of the bank holding company’s consolidated net worth. The Federal Reserve may oppose the transaction, if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) expanded the Federal Reserve’s authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. FIRREA increased the amount of civil money penalties which the Federal Reserve can assess for activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues. FIRREA also expanded the scope of individuals and entities against which such penalties may be assessed.

Under FIRREA, a depository institution, the deposits of which are insured by the FDIC, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (1) the default of a commonly controlled FDIC-insured depository institution, or (2) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution “in danger of default.” “Default” is defined generally as the appointment of a conservator or a receiver, and “in danger of default” is defined generally as the existence of certain conditions indicating that default is likely to occur in the absence of regulatory assistance. The Bank is an FDIC-insured depository institution, and with respect to which BankCap Partners is a bank holding company. BankCap Partners is also a bank holding company for Atlantic Capital Bank. In some circumstances (depending upon the amount of the loss or anticipated loss suffered by the FDIC), cross-guarantee liability may result in the ultimate failure or insolvency of one or more insured depository institutions in a holding company structure. Any obligation or liability owed by a subsidiary bank to its parent company is subordinated to the subsidiary bank’s cross-guarantee liability with respect to commonly controlled insured depository institutions.

Anti-Tying Restrictions

The Bank is prohibited from tying the provision of services, such as extensions of credit, to certain other services offered by the Bank, its holding company or its affiliates.

Standards for Safety and Soundness

The Federal Reserve has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other benefits, and asset quality and earnings. If the Bank were to fail to meet these standards, the Federal Reserve could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The Federal Reserve has authority to issue orders to secure adherence to the safety and soundness standards.

Reserve Requirement

Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain cash reserves against a stated percentage of their transaction accounts. Current reserve requirements for calendar year 2014 are as follows:

 

•

for transaction accounts totaling $13.3 million or less, a reserve of 0%;

 

•

for transaction accounts in excess of $13.3 million up to and including $89.0 million, a reserve of 3%; and

 

•

for transaction accounts totaling in excess of $89.0 million, a reserve requirement of $2.67 million plus 10% of that portion of the total transaction accounts greater than $89.0 million.

The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve. As of December 31, 2013, the Bank had a reserve requirement of $8.5 million.

 

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Privacy

Financial institutions are required to disclose their policies for collecting and protecting confidential information. Under the GLB Act, financial institutions may not disclose non-public personal information about a customer to unaffiliated third parties, unless the institution satisfies various disclosure requirements and the consumer has not elected to opt-out of the disclosure (with some exceptions). Additionally, financial institutions generally may not disclose consumer account numbers to any non-affiliated third party for use in telemarketing, direct-mail marketing or other marketing through electronic mail to consumers.

Monetary Policy

Banking is a business that depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute a major portion of earnings. Thus, our earnings and growth will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the U.S. and its agencies, particularly the Federal Reserve, which regulates the supply of money through various means including open market transactions in United States government securities. These transactions include the purchase and sale of securities to expand or contract the general liquidity in the financial system. Additionally, the Federal Reserve establishes a target Federal Fund Rate and the Discount Rate. Actions taken by the Federal Reserve influence the general condition of interest rates in the marketplace.

The Bank’s earnings are primarily a function of differentials between interest rates. Depending on the Bank’s asset/liability strategy, actions taken by the Federal Reserve may have a positive or negative effect on profitability. We cannot predict the actions of the Federal Reserve, nor can we guarantee that our asset/liability strategy is consistent with action taken by the Federal Reserve.

Community Reinvestment Act

The Community Reinvestment Act (“CRA”) requires federal banking regulators to evaluate the record of financial institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers and acquisitions, and applications to open a branch or facility. Federal regulators are required to provide and make public a written examination report of an institution’s CRA performance. The Bank continues to maintain a satisfactory CRA rating.

Branch and Interstate Banking

The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Such interstate bank mergers and branch acquisitions, described below, are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act.

Under the Dodd-Frank Act, national banks and state banks are able to establish branches in any state, if that state would permit the establishment of the branch by a state bank chartered in that state. Virginia law permits a state bank to establish a branch of the bank anywhere in the state; therefore, a bank with its headquarters outside the Commonwealth of Virginia may establish branches anywhere within Virginia.

Regulatory Enforcement Authority

Federal and state banking law grants substantial enforcement powers to federal and state banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

Concentrated Commercial Real Estate Lending Regulations

The Federal Reserve, OCC and FDIC have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending, if (1) total reported loans for construction, land development and other land represent 100% or more of total capital, or (2) total reported loans secured by multi-family and non-farm residential properties and loans for construction, land development, and

 

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other land represent 300% or more of total capital, and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices, including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and increasing capital requirements.

Allowance for Loan and Lease Losses

Federal bank regulatory agencies have released the Interagency Policy Statement on the allowance for loan and lease losses to ensure consistency with U.S. generally accepted accounting principles (“GAAP”) and more recent supervisory guidance, including, among other things, considerations for measuring impairment and estimating credit losses and illustrations of effective loss migration analysis. Additionally, the agencies issued 16 Frequently Asked Questions to assist institutions in complying with both GAAP and allowance for loan and lease losses supervisory guidance. Highlights of the statement include the following:

 

•

the statement emphasizes that the allowance for loan and lease losses represents one of the most significant estimates in an institution’s financial statements and regulatory reports and that an assessment of the appropriateness of the allowance for loan and lease losses is critical to an institution’s safety and soundness;

 

•

each institution has a responsibility to develop, maintain and document a comprehensive, systematic and consistently applied process for determining the amounts of the allowance for loan and lease losses. An institution must maintain an allowance for loan and lease losses that is sufficient to cover estimated credit losses on individual impaired loans as well as estimated credit losses inherent in the remainder of the portfolio; and

 

•

the statement updated the previous guidance on the following issues regarding allowance for loan and lease losses: (1) responsibilities of the board of directors, management and bank examiners; (2) factors to be considered in the estimation of allowance for loan and lease losses; and (3) objectives and elements of an effective loan review system.

Monitoring and Reporting Suspicious Activity

Under the Bank Secrecy Act (the “BSA”), we are required to monitor and report unusual or suspicious account activity that might signify money laundering, tax evasion or other criminal activities, as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. The BSA is sometimes referred to as an “anti-money laundering” law (“AML”). Several AML acts, including provisions in Title III of the Patriot Act, have been enacted up to the present to amend the BSA. The Patriot Act was enacted in response to the September 11, 2001 terrorist attacks and is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. Under the Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:

 

•

to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 

•

to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 

•

to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and

 

•

to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

Under the Patriot Act, financial institutions are also required to establish anti-money laundering programs. The Patriot Act sets forth minimum standards for these programs, including:

 

•

the development of internal policies, procedures and controls;

 

•

the designation of a compliance officer;

 

•

an ongoing employee training program; and

 

•

an independent audit function to test the programs.

In addition, under the Patriot Act, the Secretary of the U.S. Treasury has adopted rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these

 

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rules will not be deemed to violate the privacy provisions of the GLB Act that are discussed under “—Gramm-Leach-Bliley Act of 1999” above. Finally, under the regulations of the Office of Foreign Asset Control (“OFAC”), we are required to monitor and block transactions with certain “specially designated nationals” who OFAC has determined pose a risk to U.S. national security.

Technology Risk Management and Consumer Privacy

State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology.

Under Section 501 of the GLB Act, the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records, and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.

Under the GLB Act, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing non-public personal information about a customer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements, and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution’s ability to disclose non-public personal information about customers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices that describe in general terms the bank’s information sharing practices. Banks that share non-public personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit or transaction accounts to any nonaffiliated third party for use in marketing.

UDAP and UDAAP

Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act (the “FTC Act”), which is the primary federal law that prohibits unfair or deceptive acts or practices (“UDAP”), and unfair methods of competition in or affecting commerce. “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with UDAP laws and regulations. However, UDAP laws and regulations have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”), which have been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.

Other Regulation

The Bank is subject to a variety of other regulations. State and federal laws restrict interest rates on loans. The Truth in Lending Act and the Home Mortgage Disclosure Act impose information requirements on the Bank in making loans. The Equal Credit Opportunity Act prohibits discrimination in lending on the basis of race, creed or other prohibited factors. The Fair Credit Reporting Act governs the use and release of information to credit reporting agencies. The Truth in Savings Act requires disclosure of yields and costs of deposits and deposit accounts. Other acts govern confidentiality of consumer financial records, automatic deposits and withdrawals, check settlement, endorsement and presentment, and reporting of cash transactions as required by the Internal Revenue Service.

Future Regulatory Uncertainty

Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. Although the U.S. Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, we fully expect that the our industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted, further regulating specific banking practices.

 

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Employees

At December 31, 2013, we had 102 employees, including 98 full-time employees. All of our employees were employed by the Bank. None of our employees are represented by a collective bargaining unit, and we believe that relations with our employees are good.

Available Information

We are required to file annual, quarterly and current reports, proxy statements and other information with the SEC. Investors and other interested parties may read and copy any document that we file, including this Annual Report on Form 10-K, at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Investors and other interested parties may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, from which investors and other interested parties can electronically access our SEC filings.

We make available free of charge on or through our website (www.xenithbank.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

The information on, or that can be accessed through, our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings we make with the SEC.

Executive Officers of the Registrant

The information set forth in Part III, Item 10 under the caption “Executive Officers of the Registrant” (included herein pursuant to Item 401(b) of Regulation S-K) is incorporated by reference into this Part I.

Item 1A—Risk Factors

In addition to the other information included in this Annual Report on Form 10-K, the following factors should be carefully considered in connection with evaluating our business and the forward-looking statements contained herein. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial condition, liquidity, results of operations, regulatory capital levels and prospects. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, we could be materially and adversely affected. There may be additional risks that we do not presently know or that we currently believe are immaterial that could also materially and adversely affect our business, financial condition, liquidity, results of operations, regulatory capital levels and prospects.

The slow economic recovery, especially in our target markets, could materially and adversely affect us.

The most recent recession contributed to a rise in unemployment and underemployment, a decline in the value of real estate and other assets, and a lack of confidence in the financial markets and the economy both among financial institutions and their customers. Economic growth has been slow and the economic pressure on consumers and commercial borrowers and lack of confidence in the economy and financial markets resulting from the slow recovery have adversely affected, and continue to affect, the willingness of companies to borrow to fund their future growth, which negatively impacts our business. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates for financial institutions, which may impact charge-offs and provisions for credit losses. A protracted continuation or worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the banking industry and our business.

Unlike many of our larger competitors, the majority of our middle market business and individual customers are located or doing business in our target markets. As a result, we may be more impacted by a local slow economic recovery or downturn than those of larger, more geographically diverse competitors. Furthermore, based on the size and resources of our middle market and small business customers, they may be less able to withstand sustained difficult economic conditions than larger companies with which they compete. Factors that adversely affect the economy in our target markets could reduce our deposit base and demand for our services and products and increase our credit losses. Consequently, we may be adversely affected, potentially materially, by adverse changes in economic conditions in and around Virginia.

 

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Although we have monitored the impact of slow economic growth on the values of real estate in our target markets and have set discounts and reserves against our loan portfolio, our discounts and reserves may be insufficient.

Fluctuations in interest rates could reduce our operating results as we expect to realize income primarily from the difference between interest earned on our loans and investments and interest paid on our deposits and borrowings.

Our operating results are significantly dependent on our net interest income, as we expect to realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We will experience “gaps” in the interest rate sensitivities of our assets and liabilities, as measured by the relative duration of our interest-earning assets and interest-bearing liabilities. The net position of those assets and liabilities, subject to re-pricing in specified time periods, will positively or negatively affect our operating results. If market interest rates should move contrary to our position, this “gap” may work against us and negatively affect our operating results, potentially materially. We cannot predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, unemployment, monetary policy, and conditions in domestic and foreign financial markets. Although our asset-liability management strategy is intended to manage our risk from changes in market interest rates, changes in interest rates could materially and adversely affect us. As reflected in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity—Gap Analysis,” on a cumulative basis for maturities and re-pricings within the next 12 months, we reflect interest rate-sensitive assets exceeding interest rate-sensitive liabilities resulting in an asset sensitive position as of December 31, 2013 of $232.5 million, which would reduce our operating results if market interest rates were to decline during that period.

Changes in market interest rates could reduce the value of our financial assets. Fixed-rate investments, mortgage-backed and related securities, and loans generally decrease in value as interest rates rise. In addition, volatile interest rates affect the volume of our lending activities. For example, when interest rates rise, the cost of borrowing increases and loan originations tend to decrease. This could result in lower net interest income, lower loan origination fee income, and a decline in sales of treasury services. If we are unsuccessful in managing the effects of changes in interest rates, we could be materially and adversely affected.

We face significant competition in our target markets.

The financial services industry, including commercial banking, is highly competitive, and we have encountered and will continue to encounter strong competition for deposits, loans and other financial services and products in our target markets. Our principal competitors for loans and some or all of our other services and products are other commercial banks and community banks in our target markets. Our principal competitors for deposits include commercial banks, community banks, money market funds, credit unions and trust companies. Our non-bank competitors are not subject to the same degree of regulation as we are and, accordingly, have advantages over us in providing certain products and services. Many of our competitors are significantly larger than we are and have greater access to capital and other resources that permit them to offer attractive terms and broader selections to gain market share for their products and services and also have higher lending capacity and larger branch networks. Weak loan demand has increased competition resulting in aggressive pricing terms for borrowers. As a result, we could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract customers, either of which would adversely affect us.

Failure to implement our business strategies could materially and adversely affect us.

We have developed a business plan that details the business strategies we intend to implement. Our business plan includes organic growth and, if appropriate, growth through acquisitions. Our organic growth may involve an expansion into related banking lines of business and related services and products, which would involve additional risks. Growth through acquisitions includes additional risks, which are further discussed below. If we cannot implement our business strategies, we will be hampered in our ability to maintain and grow our business and serve our customers, which would in turn materially and adversely affect us. Even if our business strategies are successfully implemented, they may not have the favorable impact on our operations that we anticipate.

Failure to manage expansion could materially and adversely affect our business.

Our ability to offer services and products and implement our business strategies successfully in a highly competitive market requires an effective planning and management process. Future expansion efforts, internally or through acquisitions, could be expensive and put a strain on our management, financial, operational and technical resources. To manage growth effectively, we will likely have to continue to enhance our operating systems and controls, as well as integrate new personnel, including relationship managers, and manage expanded operations. If we are unable to grow our business or manage our growth effectively, we could be materially and adversely affected.

 

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We will face risks with respect to future expansion and acquisitions or mergers.

We may seek to acquire other financial institutions or branches or assets of those institutions. We may also expand into new markets or lines of business or offer new products or services. These activities would involve a number of risks, including:

 

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the time and expense associated with identifying and evaluating potential acquisitions and merger partners;

 

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using inaccurate estimates and judgments on lack of information to evaluate credit, operations, management and market risks with respect to the target institution or its branches or assets;

 

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diluting our existing shareholders in an acquisition;

 

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the time and expense associated with evaluating new markets for expansion, hiring experienced local management and opening new offices or branches, as there may be a substantial time lag between these activities and when we generate sufficient assets and deposits to support the costs of the expansion;

 

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taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s time and attention being diverted from the operation of our existing business;

 

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the time and expense associated with integrating the operations and personnel of the combined businesses;

 

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the ability to realize the anticipated benefits of the acquisition;

 

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creating an adverse short-term effect on our results of operations;

 

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losing key employees and customers as a result of an acquisition that is poorly received or executed;

 

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time and costs associated with regulatory approvals;

 

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inability to obtain additional financing, if necessary, on favorable terms or at all; and

 

•

unforeseen adjustments, write-downs, write-offs, or restructuring or other impairment charges.

The soundness of other financial institutions with which we do business could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, including counterparties in the financial industry, such as commercial banks. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions will expose us to risk of loss in the event of default of a counterparty or client. In addition, this risk may be exacerbated when any collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. Our losses from these events could be material.

Our earnings are sensitive to the credit risks associated with lending.

The credit risk associated with commercial and industrial loans is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, which is generally larger than consumer-type loans, and the effects of general economic conditions on a borrower’s business. Our commercial and industrial loan portfolio represented approximately 45.8% of our total loan portfolio as of December 31, 2013. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.

Our commercial and industrial loans include owner-occupied real estate loans that are secured in part by the value of the real estate. Owner-occupied real estate loans represented approximately 20.1% of our total commercial and industrial loan portfolio as of December 31, 2013. The primary source of repayment for owner-occupied real estate loans is the cash flow produced by the related commercial enterprise, and the value of the real estate is a secondary source of repayment of the loan.

Our commercial real estate loan portfolio represented approximately 32.1% of our total loan portfolio as of December 31, 2013. Underwriting and portfolio management activities cannot eliminate all risks related to these loans. Commercial real estate loans will typically be larger than consumer-type loans and may pose greater risks than other types of loans. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers’ abilities to repay their loans frequently depends on the successful development of their properties. In addition, we may incur losses on commercial real estate loans due to declines in occupancy rates and rental rates, which may decrease property values and may decrease the likelihood that a borrower may find permanent financing alternatives. Given the weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. A further weakening of the commercial real estate

 

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market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. In addition, banking regulators are giving greater scrutiny to commercial real estate lending and may require banks with higher levels of commercial real estate loans to implement improved or additional underwriting, internal controls, risk management policies and portfolio stress testing. In banks with certain levels of commercial real estate loan concentrations, regulators are also considering requiring increased levels of reserves for loan losses, as well as the need for additional capital. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us.

Decisions regarding credit risk in our investment or loan portfolios could be inaccurate and our allowance for loan and lease losses may be inadequate to absorb future losses inherent in the loan portfolio, which could materially and adversely affect us.

Our loan portfolio and a portion of our investment portfolio expose us to credit risk. Only $10.5 million, or 15.2%, of our $69.2 million investment portfolio was represented by securities other than U.S. agency securities as of December 31, 2013. Inherent risks in lending include the deterioration of the credit of borrowers and adverse changes in the industries and competitive environments in which they operate, changes in borrowers’ management and business prospects, fluctuations in interest rates and collateral values, principally real estate, and economic downturns. Making loans is an essential element of our business, and there is a high risk that some portion of the loans we make will not be repaid and, accordingly, will result in losses. Given our size, these losses could be concentrated in one or more borrowers and could be significant.

The risk of loss is affected by a number of factors, including:

 

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credit risks of a particular borrower;

 

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the duration of the loan;

 

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changes in economic or industry conditions; and

 

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in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

In addition, we may suffer higher credit losses because of federal or state legislation or other regulatory action that reduces the amount that our borrowers are required to pay to us, prohibits or otherwise limits our ability to foreclose on properties or other collateral, or makes foreclosures less economically viable.

As with all financial institutions, our management makes various assumptions and judgments about the ultimate collectability of our loan portfolio, and we maintain an allowance for loan and lease losses and other reserves to absorb anticipated future losses inherent in our portfolio.

In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require us to increase reserves or recognize loan charge-offs. Because our allowance methodologies take into account qualitative factors within our institution as well as the external economic environment, there is potential for inconsistencies in our methodology and the methodologies deemed appropriate for us by the bank regulatory agencies.

If management’s assumptions and judgments prove to be inaccurate and our allowance for loan and lease losses is inadequate to absorb future losses inherent in our loan portfolio, or if bank regulatory agencies require us to increase our allowance for loan and lease losses or to recognize loan charge-offs, our capital could be significantly reduced, and we could be materially and adversely affected.

Our decisions regarding the fair value of assets acquired could be different than initially estimated which could materially and adversely affect our business, financial condition, results of operations and future prospects.

As required by acquisition accounting rules, we record acquired loans at estimated fair values by creating a discount and eliminating the allowance for loan and lease losses. To the extent the credit losses of the purchased loan portfolios are greater than fair value adjustments determined at the effective date of acquisitions, we could be materially and adversely affected.

We acquired a significant portion of our loans held for investment in the merger, the Paragon Transaction and the VBB Acquisition. Although these loans were marked down to their estimated fair values, as of the effective dates of the transactions, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in additional charge-offs. Fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs in the loan portfolios that we acquired and correspondingly reduce our net income.

 

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We depend on the accuracy and completeness of information about our customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we rely on information furnished by or on behalf of our customers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of those customers or counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could result in losses that materially and adversely affect us. Even if we receive accurate information, we may misjudge that information and fail to assess the credit risks in a manner that materially and adversely affects us.

Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and an error in fact or judgment could adversely affect the reliability of an appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of these factors, the value of collateral backing a loan may be less than supposed, and if a default occurs, we may not recover the outstanding balance of the loan.

Commercial real estate lending guidance issued by the federal banking regulators could impact our operations and capital requirements.

The Federal Reserve, OCC and FDIC, along with the other federal banking regulators, issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” directed at financial institutions that have particularly high concentrations of commercial real estate loans within their lending portfolios. This guidance suggests that institutions whose commercial real estate loans exceed certain percentages of capital should implement heightened risk management practices appropriate to their concentration risk and may be required to maintain higher capital ratios than institutions with lower concentrations in commercial real estate lending. Based on our commercial real estate concentration as of December 31, 2013, we are not subject to additional supervisory analysis but could be in the future. Our management has implemented controls to monitor our commercial real estate lending and will continue to enhance and monitor those controls, but we cannot predict the extent to which this guidance may impact our future operations or capital requirements. Moreover, any risk management practices that we implement may not be effective to prevent losses in our loan portfolio, including our commercial real estate portfolio.

Our ability to maintain regulatory capital levels and adequate sources of funding and liquidity may be adversely affected by market conditions, concentration of customer deposits within certain businesses and industries, and changes in capital requirements made by our regulators.

We are required to maintain certain capital levels sufficient to maintain capital ratios that classify the Bank as “well-capitalized” in accordance with banking regulations. We must also seek to maintain adequate funding sources in the normal course of business to support our lending and investment operations and repay our outstanding liabilities as they become due. Our ability to maintain regulatory capital levels, available sources of funding, and sufficient liquidity could be impacted by the concentration of customer deposits within certain businesses and industries and deteriorating economic and market conditions.

Our failure to meet any applicable regulatory guideline related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital, and the termination of deposit insurance by the FDIC.

In determining the adequacy of our capital levels, we use risk-based capital ratios established by regulations. In calculating our risk-based ratios, we must apply risk weights to our various asset classes. In July 2013, the Federal Reserve, FDIC and OCC, adopted Basel III Rules. The Basel III Rules include requirements contemplated by the Dodd-Frank Act, as well as certain standards initially adopted by the Basel Committee in December 2010.

The Basel III Rules establish a stricter regulatory capital framework that requires banking organizations to hold more and higher-quality capital to act as a financial cushion to absorb losses and help banking organizations better withstand periods of financial stress. The Basel III Rules will, when fully implemented, increase capital ratios for all banking organizations and introduce a “capital conservation buffer,” which is in addition to each capital ratio. If a banking organization dips into its capital conservation buffer, it would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers. The Basel III Rules assign a higher risk

 

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weight (150%) to exposures to various categories of assets, including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. The Basel III Rules also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. We may make a one-time, permanent election to continue to exclude AOCI from capital. If we do not make this election, unrealized gains and losses would be included in the calculation of our regulatory capital. The Basel III Rules also include changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period.

The Basel III Rules generally become effective beginning January 1, 2015. The conservation buffer will be phased in beginning in 2016 and will take full effect on January 1, 2019. Although we must generally begin complying with the Basel III Rules on January 1, 2015, we would satisfy the higher capital ratios imposed by the Basel III Rules as of December 31, 2013.

Although we currently cannot predict the specific impact and long-term effects that the Basel III Rules will have on us and the banking industry more generally, we will be required to maintain higher regulatory capital levels, which could impact our operations, net income and ability to grow. Furthermore, our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us, which could restrict our future growth or operations.

The CFPB may reshape the consumer financial laws through rulemaking and enforcement of unfair, deceptive or abusive acts or practices, which may directly impact the business operations of depository institutions offering consumer financial products or services including the Bank.

The CFPB has broad rulemaking authority to administer and carry out the purposes and objectives of the “Federal consumer financial laws, and to prevent evasions thereof,” with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider identifying and prohibiting acts or practices that are “unfair, deceptive, or abusive” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service (“UDAAP authority”). The potential reach of the CFPB’s broad new rulemaking powers and UDAAP authority on the operations of financial institutions offering consumer financial products or services, including the Bank, is currently unknown.

The Bank is subject to federal and state and fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to the Bank’s performance under the fair lending laws and regulations could adversely impact the Bank’s rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact the Bank’s reputation, business, financial condition and results of operations.

We may not be able to access funding sufficient to support our growth.

Our business strategies are based on access to funding from local customer deposits, such as checking and savings accounts and certificates of deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments, and general economic conditions. If our deposit levels fall, we could lose a relatively low cost source of funding and our costs would increase from alternative funding. If local customer deposits are not sufficient to fund our growth, we will look to outside sources such as borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”), which is a secured funding source. Our ability to access borrowings from the FHLB will be dependent upon whether and the extent to which we can provide collateral. We may also look to federal funds purchased and brokered deposits as discussed below under “—Our use of brokered deposits may be limited or discouraged by bank regulators, which could adversely impact our liquidity” or seek to raise funds through the issuance of shares of our common stock or other equity or equity-related securities or the incurrence of debt as additional sources of liquidity. If we are unable to access funding sufficient to support our growth or are only able to access such funding on unattractive terms, we may not be able to implement our business strategies.

 

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We rely substantially on deposits made by our customers in our target markets, which can be materially and adversely affected by local and general economic conditions.

As of December 31, 2013, $364.2 million, or 64.0%, of our total deposits, consisted of noninterest bearing demand accounts and interest-bearing savings, money market and checking accounts. The $205.0 million remaining balance of deposits includes time deposits, of which approximately $127.7 million, or 22.4% of our total deposits, are due to mature within one year. Our ability to attract and maintain deposits, as well as our cost of funds, has been and will continue to be significantly affected by money market and general economic conditions. We have significant deposits from certain customers that are in excess of the FDIC insurance amounts. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with our Bank is fully insured or may place them in other financial institutions that they perceive as being more secure. The loss of a customer that maintains significant deposits with the Bank could have an adverse effect on this critical funding source. If we fail to attract new deposits or maintain existing deposits or are forced to increase interest rates paid to customers to attract and maintain deposits, our net interest income would be negatively impacted, and we could be materially and adversely affected.

Our use of brokered deposits may be limited or discouraged by bank regulators, which could adversely impact our liquidity.

Depositors that invest in brokered deposits are generally interest rate sensitive and well-informed about alternative markets and investments. Consequently, these types of deposits may not provide the same stability to a bank’s deposit base as traditional local retail deposit relationships. In addition, our liquidity may be negatively affected if that funding source experiences supply difficulties due to loss of investor confidence or a flight to other investments. Regulatory developments with respect to wholesale funding, including increased FDIC insurance costs for, or limits on the use of, these deposits, may further limit the availability of that alternative. In light of regulatory pressure, there may be a cost premium for locally generated certificates of deposit as compared to brokered deposits, which may increase our cost of funding.

We may not be able to raise additional capital on terms favorable to us or at all.

We may need additional capital to support our business, expand our operations or maintain our minimum capital requirements; however, we may not be able to raise additional funds through the issuance of shares of our common stock or other equity or equity-related securities. Furthermore, the significant amount of our common stock that BankCap Partners owns may discourage other potential investors from acquiring newly-issued shares of our common stock or other equity or equity-related securities.

We may not be able to meet the cash flow requirements of our depositors and other creditors unless we maintain sufficient liquidity.

Our liquidity is used to make loans and investments and to repay liabilities (including deposits) as they become due or are demanded by depositors and other creditors. Our main source of liquidity is customer deposits. Our liquidity may be adversely affected where we have a concentration of customer deposits within certain businesses and industries or with individual customers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. Potential alternative sources of liquidity include federal funds purchased and investment securities sold under repurchase agreements, as well as the repayment or sale of loans, securities (to the extent not pledged as collateral) or other assets, the utilization of available government and regulatory assistance programs, brokered deposits, borrowings from the FHLB, borrowings through the Federal Reserve’s discount window, and the issuance of our debt securities and equity securities. Without sufficient liquidity from these potential sources of liquidity, we generally may not be able to meet our cash flow requirements to operate and grow our business and repay our obligations.

As we continue to grow, we may become more dependent on wholesale funding sources, which may include FHLB borrowings and borrowings through the Federal Reserve’s discount window. As of December 31, 2013, we had $20.0 million of FHLB borrowings and $71.3 million of brokered deposits outstanding. If we are required to rely more heavily on wholesale funding sources to support our operations or growth in the future and such funding is expensive at such time, our revenues may not increase proportionately to cover our costs. In that case, our operating margins would be reduced, and we could be materially and adversely affected.

 

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We may become subject to significant liabilities in the event the Bank forecloses upon, or takes title to, real property.

When underwriting a commercial or residential real estate loan, we will generally take a lien on the real property and, in some instances upon a default by the borrower, we may foreclose upon and take title to the property, which may lead to potential financial risk for us under applicable environmental laws. We may also take over the management of commercial properties whose owners have defaulted on loans. We may also own and lease premises where branches and other facilities are located. While we have lending, foreclosure and facilities guidelines intended to exclude properties with an unreasonable risk of contamination, hazardous substances could exist on some of the properties that the Bank may own, manage or occupy. We face the risk that environmental laws could force us to clean up the properties at our expense. It may cost much more to remediate a property than the property is worth. We could also be liable for pollution generated by a borrower’s operations, if the Bank takes a role in managing those operations after a default. Many environmental laws impose liability, regardless of whether we knew of, or were responsible for, any contamination that existed or exists for the property. The Bank may also find it difficult or impossible to sell contaminated properties.

The disposition processes related to our nonperforming assets could result in losses in the future that would materially and adversely affect us.

We may incur additional losses relating to an increase in nonperforming loans and other real estate owned (“OREO”), and such losses could be material. When we acquire title to collateral in foreclosures and similar proceedings, we are required by accounting rules to mark such collateral to the then fair market value, less costs of disposal, which could result in a loss. Nonperforming assets adversely affect net income in various ways. While we pay interest expense to fund nonperforming assets, no interest income is recorded on nonaccrual loans or OREO, thereby adversely affecting income and returns on assets and equity. Additionally, we incur loan administration costs and the costs of maintaining properties carried as OREO. Nonperforming loans and OREO also increase our risk profile, and increases in the level of nonperforming loans and OREO could impact our regulators’ view of appropriate capital levels in light of such risks.

While we seek to manage our problem assets through loan sales, workouts, restructurings, foreclosures and otherwise, decreases in the value of these assets, or in the underlying collateral, or in these borrowers’ results of operations, liquidity or financial condition, whether or not due to economic and market conditions beyond our or their control, could materially and adversely affect us. In addition, the resolution of nonperforming assets requires significant amount of management’s time and attention, diverting their time from other business, which could be detrimental to the performance of their other responsibilities on our behalf.

Given the geographic concentration of our operations, we could be significantly affected by any natural or man-made disaster that affects Virginia and surrounding areas.

Our operations are concentrated in, and our loan portfolio consists almost entirely of, loans to persons and businesses located in and around Virginia. The collateral for many of our loans consists of real and personal property located in areas susceptible to hurricanes and other natural disasters as well as man-made disasters that can cause extensive damage to the general region. Disaster conditions that hit in our target markets would adversely affect the local economies and real estate markets. Adverse economic conditions resulting from such a disaster could negatively affect the ability of our customers to repay their loans and could reduce the value of the collateral securing these loans. Furthermore, damage resulting from any natural or man-made disaster could also result in continued economic uncertainty that could negatively impact businesses in those areas. As a result, we could be materially and adversely affected by any natural or man-made disaster that affects our target markets.

We are dependent on our key personnel, including our executive officers, and the loss of such persons could negatively impact our ability to execute our business strategies.

We will be for the foreseeable future dependent on the services of T. Gaylon Layfield, III, who is our President and Chief Executive Officer; Thomas W. Osgood, who is our Chief Financial Officer and Chief Administrative Officer; Judy C. Gavant, who is our Controller and Principal Accounting Officer; Wellington W. Cottrell, III, who is an Executive Vice President and our Chief Credit Officer; Ronald E. Davis, who is an Executive Vice President and our Chief Operations and Technology Officer; Edward H. Phillips, Jr., who is an Executive Vice President and our Chief Lending Officer; and W. Jefferson O’Flaherty, who is an Executive Vice President responsible for our private banking business. Should the services of these individuals or other key executive officers become unavailable, we may be unable to find a suitable successor who would be willing to be employed upon the terms and conditions that we would offer. A failure to replace any of these individuals in a timely and effective manner could negatively affect our ability to execute our business strategies and otherwise disrupt our business.

 

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Our business is dependent on technology and an inability to invest in technological improvements or obtain reliable technological support may materially and adversely affect us.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven services and products. In addition to better service to customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our ability to grow and compete will depend in part upon our ability to address the needs of customers by using technology to provide services and products that will satisfy their operational needs, while managing the costs of expanding our technology infrastructure. Many competitors have substantially greater resources to invest in technological improvements and third-party support. For the foreseeable future, we expect to rely on third-party service providers for our core technology systems and on other third parties for technical support and related services. If we are unable to implement and market new technology-driven services and products successfully, or if those services and products become unreliable or fail, our customer relationships and operations could be adversely affected, which could materially and adversely affect us.

System failure or breaches of our network security could lead to increased operating costs as well as litigation and other liabilities.

The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking” and “identity theft.” Our operations are dependent in part upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, damage our reputation, and inhibit current and potential customers from our Internet banking services. Each year, we incur expenses to add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches, including firewalls and penetration testing. A security breach could also subject us to additional regulatory scrutiny and expose us to civil litigation and possible financial liability.

On February 12, 2013, the Obama administration released an executive order, Improving Critical Infrastructure Cybersecurity (the “Executive Order”), which is focused primarily on government actions to support critical infrastructure owners and operators in protecting their systems and networks from cyber threats. The Executive Order requires the development of risk-based cybersecurity standards, methodologies, procedures and processes, a so-called “Cybersecurity Framework,” that can be used voluntarily by critical infrastructure companies to address cyber risks. The Executive Order also will steer certain private sector companies to comply voluntarily with the Cybersecurity Framework. It is unclear at this time what impact the Executive Order will have on our Internet-based systems and online commerce security, but its implementation could require us to incur additional costs.

We are subject to extensive regulation in the conduct of our business operations, which could materially and adversely affect us.

The banking industry is heavily regulated by several governmental agencies. Banking regulations are primarily intended to protect the depositors, deposit insurance funds and the banking system as a whole, and not shareholders and other creditors. These regulations affect lending practices, capital structure, investment practices, dividend policy and growth, among other things. For example, federal and state consumer protection laws and regulations limit the manner in which the Bank may offer and extend credit. In addition, the laws governing bankruptcy generally favor debtors, making it more expensive and more difficult to collect from customers who become subject to bankruptcy proceedings.

From time to time, the U.S. Congress and state legislatures consider changing these laws and may enact new laws or amend existing laws to further regulate the financial services industry. In July 2010, President Obama signed the Dodd-Frank Act, which has resulted, and will continue to result, in sweeping changes in the regulation of financial institutions. The Dodd-Frank Act contains numerous provisions that affect all banks and bank holding companies, including provisions that, among other things:

 

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change the assessment base for federal deposit insurance from the amount of insured deposits to total consolidated assets less tangible capital, eliminate the ceiling on the size of the federal deposit insurance fund, and increase the floor of the size of the federal deposit insurance fund, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion;

 

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repeal the federal prohibitions on the payment of interest on demand deposits, thereby generally permitting the payment of interest on all deposit accounts;

 

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centralize responsibility for promulgating regulations under and enforcing federal consumer financial protection laws in a new bureau of consumer financial protection that will have direct supervision and examination authority over banks with more than $10 billion in assets;

 

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require the FDIC to seek to make its capital requirements for banks counter-cyclical;

 

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impose comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself;

 

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implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions;

 

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establish new rules and restrictions regarding the origination of mortgages; and

 

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permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question.

Many of these and other provisions in the Dodd-Frank Act remain subject to regulatory rule-making and implementation, the effects of which are not yet known. Although we cannot predict the specific impact and long-term effects that the Dodd-Frank Act and the regulations promulgated thereunder will have on us and our prospects, our target markets and the financial industry more generally, we believe that the Dodd-Frank Act and the regulations promulgated thereunder will impose additional administrative burdens that will obligate us to incur additional costs.

Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could, among other things, subject us to additional costs and lower revenues, limit the types of financial services and products we may offer, increase the ability of non-banks to offer competing financial services and products, and require a significant amount of management’s time and attention. Failure to comply with statutes, regulations or policies could result in sanctions by regulatory agencies, civil money penalties or reputational damage, which could materially and adversely affect us.

BankCap Partners is a bank holding company that is deemed to be a multi-bank holding company for two institutions.

Under the Federal Reserve guidelines, every bank holding company must serve as a “source of strength” for each of their bank subsidiaries. Currently, BankCap Partners is deemed a bank holding company for Atlantic Capital Bank, an Atlanta, Georgia-based bank, and the Bank. The position of BankCap Partners as a source of strength to other depository institutions may limit its ability to serve as a source of strength for the Bank and could adversely affect the Bank’s ability to access resources of BankCap Partners. Federal bank regulatory agencies have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary, if the agency determines that divestiture may aid the depository institution’s financial condition.

The Bank may be obligated to provide financial assistance to any other financial institution as to which BankCap Partners is deemed to be a bank holding company.

A bank for which BankCap Partners is deemed to be a bank holding company may be required to indemnify, or cross-guarantee, the FDIC against losses the FDIC incurs with respect to any other bank controlled by BankCap Partners. In addition, the FDICIA requires that an insured depository institution shall be liable for the loss incurred or anticipated by the FDIC arising from the default of a commonly controlled insured depository institution or any assistance provided by the FDIC to any commonly controlled insured depository institution in danger of default. Accordingly, the Bank may be obligated to provide financial assistance to Atlantic Capital Bank, as well as any other financial institution for which BankCap Partners is deemed to be a bank holding company as a result of its future acquisition activity, if any. Any financial assistance that the Bank is required to provide would reduce our capital and could materially and adversely affect us.

If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, current and potential shareholders may lose confidence in our financial reporting and disclosures and could subject us to regulatory scrutiny.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), we are required to include in our Annual Reports on Form 10-K our management’s assessment of the effectiveness of our internal control over financial reporting. While our management’s assessment included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2013 did not identify any material weaknesses, we cannot guarantee that we will not have any material weaknesses identified by our management or our independent registered public accounting firm in the future.

 

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The Dodd-Frank Act includes a provision to permanently exempt non-accelerated filers from complying with the requirements of Section 404(b), which requires an issuer to include in its Annual Report on Form 10-K an attestation report from the issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting. Since we were a non-accelerated filer as of June 30, 2013 (the last day of our most recently completed second quarter), we are not required to comply with the requirements of Section 404(b) in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. However, if the market value of our common stock held by non-affiliates equals $75 million or more as of the end of the last day of our most recently completed second quarter, we will be required to provide an attestation report from our independent registered public accounting firm on our internal control over financial reporting in our Annual Report on Form 10-K for the year in which we equal or exceed the $75 million threshold.

Compliance with the requirements of Section 404 is expensive and time-consuming. If, in the future, we fail to comply with these requirements in a timely manner, or if our management or independent registered public accounting firm expresses a qualified or otherwise negative opinion on the effectiveness of our internal control over financial reporting, we could be subject to regulatory scrutiny and a loss of confidence in our internal control over financial reporting. In addition, any failure to maintain an effective system of disclosure controls and procedures could cause our current and potential shareholders and customers to lose confidence in our financial reporting and disclosure required under the Exchange Act, which could materially and adversely affect us.

The accuracy of our financial statements and related disclosures could be affected if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies.

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which we summarize in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies,” describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates about the future that materially impact our consolidated financial statements and related disclosures. For example, material estimates that are particularly susceptible to significant change relate to the determination of our allowance for loan and lease losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the application of acquisition accounting principles relating to acquisitions. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events could have a material impact on the accuracy of our consolidated financial statements and related disclosures.

The market value of our investments may decline, which could cause a decline in our shareholders’ equity and negatively affect our results of operations.

We have designated our investment portfolio as securities available for sale pursuant to applicable accounting standards relating to accounting for investments. These standards require that unrealized gains and losses in the estimated fair value of the available-for-sale investment securities portfolio be reflected as a separate item in shareholders’ equity, net of tax, as accumulated other comprehensive income. As of December 31, 2013, we had $69.2 million, or 10.2% of our total assets, in securities available for sale at fair value. Shareholders’ equity reflects the unrealized gains and losses, net of tax, of these investments. Management believes that several factors will affect the market values of our investment securities portfolio. These include changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation, the slope of the interest rate yield curve (i.e., the differences between shorter-term and longer-term interest rates) and reduced investor demand. Lower market values for our available-for-sale securities may result in recognition of an other-than-temporary impairment charge to our net income. The decline in the market value of our investment securities portfolio results in a corresponding decline in shareholders’ equity, whether through accumulated other comprehensive income or lower results of operations.

Our loans held for sale are also carried at the lower of cost or fair market value, determined on an aggregate basis. As of December 31, 2013, we had $3.4 million in loans held for sale. These loans are held for short periods, usually less than 30 days, and more typically 10-25 days. A rapid increase in interest rates may affect the market value of our loans held for sale. If the market value of our loans held for sale declines, there would be a charge to our net income and corresponding reduction in our shareholders’ equity.

 

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While we were profitable in 2013, 2012 and 2011, we are uncertain as to future profitability.

For the years ended December 31, 2013, 2012 and 2011, we reported pretax net income of $3.1 million, $2.8 million and $4.5 million, respectively. However, for the year ended December 31, 2012, our net income was due in part to the reversal of the valuation allowance on our deferred tax asset. For the year ended December 31, 2011, our pretax net income was due to the bargain purchase gain resulting from the VBB Acquisition. Prior to 2011, we had not recorded a profit since the quarterly period ended March 31, 2009, which was prior to the merger. For the year ended December 31, 2010 and for the period from January 1, 2009 through December 22, 2009, we incurred pretax net losses of $5.9 million and $6.5 million, respectively. As of December 31, 2013, we had an accumulated deficit of $1.8 million.

The primary reasons for our losses in these periods were noninterest expenses related to the development of our technology and other infrastructure and the hiring of experienced personnel to support our business strategy and projected growth. We made substantial progress in building our infrastructure and our team during the years ended December 31, 2011 and 2010. In particular, our investments to date have been critical to our business strategy, as they have allowed us to put into place the majority of the technology infrastructure and core operating platform to support our business strategy for the foreseeable future. We believe, however, that we will need to make additional investments, especially related to hiring skilled bankers and, as needed, expanding our technology infrastructure to respond to new technologically-driven services and products. We expect these investments will be modest relative to the investments made in 2011 and 2010. Our ability to continue to generate a profit in the future requires successful growth in revenues and management of expenses, among other factors. We expect to recruit additional talented bankers who will help us attract target customers and grow our business. While we expect the productivity of these additional bankers to exceed their incremental expenses over time, our operating results will be adversely impacted, if it does not happen promptly or at all.

We do not intend to pay dividends on our common stock in the foreseeable future, and we may never pay, or legally be able to pay, dividends.

We have not paid any dividends on our common stock since our inception, and we presently do not intend to pay any dividends on common stock in the foreseeable future. We are limited in the amount of dividends that we may pay to our shareholders pursuant to state and federal laws and regulations. See “Item 1—Our Business—Supervision and Regulation—Payment of Cash Dividends.” The terms of the SBLF Preferred Stock also impose limits on our ability to pay dividends. Any future financing arrangements that we enter into may also limit our ability to pay dividends to our shareholders. Accordingly, we may never legally be able to pay dividends to our shareholders of common stock. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders of common stock, our board of directors, in its sole discretion, may decide to retain them and therefore not pay dividends in the future.

BankCap Partners owns a significant number of shares of our common stock, which will enable it to influence the vote on all matters submitted to a vote of our shareholders.

As of December 31, 2013, BankCap Partners beneficially owned 3,671,500 shares of our common stock (including warrants to purchase 391,500 shares of our common stock at an exercise price of $11.49 per share, all of which warrants are currently exercisable), representing a 33.9% beneficial ownership of the outstanding shares of our common stock.

In addition, under the terms of the investor rights agreement, BankCap Partners and all of the former directors and executive officers of Xenith Corporation who became directors and executive officers of Xenith Bankshares and who purchased shares of Xenith Corporation common stock in its June 2009 private offering agreed to vote their shares of our common stock in favor of (1) one designee of BankCap Partners for election to our board of directors for so long as BankCap Partners is a registered bank holding company under the Bank Holding Company Act, with respect to Xenith Bankshares, and (2) one additional designee of BankCap Partners for election to our board of directors for so long as BankCap Partners and its affiliates own 25% or more of our outstanding voting capital stock. They have also agreed to vote their shares of our common stock in favor of (1) removing the designee of BankCap Partners on our board of directors at the request of BankCap Partners and the election to our board of directors of a substitute designee of BankCap Partners, and (2) ensuring that any vacancy on our board of directors caused by resignation, removal or death of a BankCap Partners designated director is filled in accordance with the agreement above. Scott A. Reed, a principal of BankCap Partners and a member of our board of directors, is a current designee of BankCap Partners.

Accordingly, BankCap Partners, through its beneficial ownership of our common stock and board rights, will be able to participate in matters that come before our board of directors and influence the vote on all matters submitted to a vote of our shareholders, including the election of directors, amendments to the amended and restated articles of incorporation or amended and restated bylaws, mergers or other business combination transactions and certain sales of assets outside the usual and regular course of business. The interests of BankCap Partners may not coincide with the interests of our other shareholders, and they could take actions that advance their own interests to the detriment of our other shareholders.

 

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Item 2—Properties

The following table summarizes certain information about our headquarters and the locations of our branch and administrative offices as of December 31, 2013:

 

Office Location		Owned or Leased		Lease Terms		Square Feet
One James Center (Headquarters) 901 E. Cary Street, Suite 1700 Richmond, VA 23219		Leased		Term expires June 30, 2019, with one option to extend for a three-year period			16,131
Boulders Branch and Operations Center 1011 Boulder Spring Drive, Suite 410 Richmond, VA 23225		Leased		Term expires March 31, 2017, with one option to extend for a three-year period			10,592
McLean Branch 8200 Greensboro Drive, Suite 1400 McLean, VA 22102		Leased		Initial term of 87 months beginning November 1, 2008, with one option to extend for a three-year period			6,935
North Suffolk Branch 3535 Bridge Road Suffolk, VA 23435		Owned					12,255
Plaza Branch 1000 N. Main Street Suffolk, VA 23434		Leased		Term expires January 31, 2019, with automatic five-year renewals			2,512
Bosley Branch 100 Bosley Avenue Suffolk, VA 23434		Owned					2,596

We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs.

Item 3—Legal Proceedings

From time to time, we and the Bank are party, either as a defendant or plaintiff, to lawsuits in the normal course of our business. While any litigation involves an element of uncertainty, management is of the opinion that the liability, if any, resulting from pending legal proceedings will not have a material adverse effect on our financial condition, liquidity or results of operations.

Item 4—Mine Safety Disclosures

None

 

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PART II

Item 5—Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock trades on The NASDAQ Capital Market under the symbol “XBKS.” As of February 28, 2014, we had 10,431,689 shares of common stock issued and outstanding and approximately 1,130 record holders. The following table sets forth the high and low sales price for our common stock on The NASDAQ Capital Market during the periods indicated.

 

		2013								2012
Quarter		High				Low				High				Low
First		$	6.15			$	4.54			$	4.40			$	3.49
Second			5.92				4.75				4.50				3.51
Third			6.40				5.15				4.82				3.86
Fourth			6.12				5.50				5.91				4.17

Issuer Purchases of Equity Securities

On July 31, 2013, our board of directors approved a share repurchase program under which we may repurchase in the open market or otherwise up to 210,000 shares of our outstanding common stock, or approximately 2% of our then outstanding shares. There is no guarantee as to the number of shares that we repurchase under the program. The program has no time limit and can be discontinued at any time.

The following table presents monthly stock repurchases and maximum number of shares that may yet be purchased, during the fourth quarter of 2013. The average price per share paid is also presented. All purchases were made using available cash resources and occurred in the open market.

 

Period		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Program				Maximum Number of Shares that May Yet Be Purchased Under the Program
October 1, 2013 - October 31, 2013			10,600			$	5.77				10,600				182,550
November 1, 2013 - November 30, 2013			8,720			$	5.98				8,720				173,830
December 1, 2013 - December 31, 2013			14,260			$	5.87				14,260				159,570
Total			33,580			$	5.87				33,580

Dividend Policy

We have not paid any dividends on our common stock since our inception, and we presently do not intend to pay any dividends on our common stock in the foreseeable future. We are limited in the amount of dividends that we may pay to our shareholders of common stock pursuant to state and federal laws and regulations. See “Item 1—Business—Supervision and Regulation—Payment of Cash Dividends.” The terms of the SBLF Preferred Stock also impose limits on our ability to pay dividends. Any future financing arrangements that we enter into may also limit our ability to pay dividends to our shareholders of common stock. Accordingly, we may never be able to pay dividends to our shareholders of common stock. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders of common stock, our board of directors, in its sole discretion, may decide to retain them and therefore not pay dividends in the future.

 

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Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of our consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in “Item 8—Financial Statements and Supplementary Data” below.

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

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail clients, which we refer to as our target customers. We are geographically focused on the Greater Washington, DC, Richmond, Virginia, and the Greater Hampton Roads, Virginia, metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk in the merger of Xenith Corporation with and into First Bankshares, the parent company of its wholly-owned subsidiary SuffolkFirst Bank. Prior to the merger, SuffolkFirst Bank opened the first branch in Suffolk, Virginia, in 2003 under the name of SuffolkFirst Bank. All of the SuffolkFirst Bank branches operate under the name Xenith Bank. As of December 31, 2013, we had total assets of $679.9 million, total loans, net of our allowance for loan and lease losses, of $536.5 million, total deposits of $569.2 million and shareholders’ equity of $87.7 million.

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

In the third quarter of 2013, we began purchasing rehabilitated student loans, a significant portion of which are guaranteed by the federal government. These loans were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, the student loans are substantially guaranteed by a guaranty agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program (“FRLP”), under which borrowers on defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders. Commensurate with the purchase of the guaranteed student loans, we entered into an agreement with a third-party servicer of student loans to provide all day-to-day operational requirements for the servicing of the loans. As of December 31, 2013, we held guaranteed student loans in the amount of $94.0 million, which are classified as loans held for investment in our consolidated balance sheet. The purchased loans carry a nearly 98% guarantee of principal and accrued interest.

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on liabilities used to fund those assets. Interest-earning assets include loans, available-for-sale securities and federal funds sold. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include service charges on deposit accounts, gains on the sale of securities, income from derivative products offered to customers and other miscellaneous income. Deposits, FHLB borrowed funds and federal funds purchased are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. Measures of our performance include net interest margin, return on average assets (“ROAA”), return on average equity (“ROAE”) and efficiency ratio. Such measures are common performance indicators in the banking industry.

 

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The following table presents selected financial performance measures, as of the dates stated:

 

		For the Years Ended December 31,
		2013				2012
Net interest margin (1)			3.89	%			4.47	%
Return on average assets (2)			0.33	%			1.42	%
Return on average common equity (3)			2.49	%			9.89	%
Efficiency ratio (4)			81	%			80	%

 

(1)	Net interest margin is net interest income divided by average interest-earning assets. Average interest-earning assets are presented within the average balances, income and expenses, yields and rates table below.

(2)	ROAA is net income divided by average total assets. Average total assets are presented within the average balances, income and expenses, yields and rates table below.

(3)	ROAE is net income divided by average shareholders’ equity less average preferred stock. Average shareholders’ equity is presented within the average balances, income and expenses, yields and rates table below.

(4)	Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

Merger of First Bankshares, Inc. and Xenith Corporation

First Bankshares was incorporated in Virginia on March 4, 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002.

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity in the merger. The merger was completed in accordance with the terms of an Agreement of Merger and related Plan of Merger, dated as of May 12, 2009, as amended (collectively, the “Merger Agreement”). At the effective time of the merger, First Bankshares amended and restated its articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank.

From its inception on February 19, 2008 until the completion of the merger on December 22, 2009, Xenith Corporation (formerly Xenith Bank [In Organization]) had no banking charter, did not engage in any banking business, and had no substantial operations. Although the merger was structured as a merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes. The merger was accounted for under the acquisition method of accounting, and accordingly, the assets and liabilities of First Bankshares were recorded at their estimated fair values on December 22, 2009 in the consolidated balance sheet of Xenith Bankshares.

Acquisitions

Effective on July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office (the “Paragon Branch”) of Paragon Commercial Bank, a North Carolina banking corporation (“Paragon”), and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the Paragon Branch (the “Paragon Transaction”). Under the terms of the Paragon Agreement, Paragon retained the real and personal property associated with the Paragon Branch and, following the receipt of required regulatory approvals, the Paragon Branch was closed.

At the closing of the Paragon Transaction, Paragon made a cash payment to the Bank in the amount of $17.3 million, which represented the excess of approximately all of the liabilities assumed at a premium of 3.92%, over approximately all of the assets acquired at a discount of 3.77%.

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

 

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

Issuances of Stock

In April 2011, we issued and sold 4.6 million shares of our common stock at a public offering price of $4.25 per share pursuant to an effective registration statement filed with the Securities Exchange Commission (“SEC”). Net proceeds, after the underwriters’ discount and expenses, were $17.7 million.

In September 2011, as part of the Small Business Lending Fund (“SBLF”) of the United States Department of the Treasury (“U.S. Treasury”), we entered into a Small Business Lending Fund - Securities Purchase Agreement with the Secretary of the U.S. Treasury, pursuant to which the company sold 8,381 shares of the company’s Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “SBLF Preferred Stock”) to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The terms of the SBLF Preferred Stock were established pursuant to an amendment to the company’s Amended and Restated Articles of Incorporation on September 20, 2011. Of the $8.4 million received, $7.5 million was invested in the Bank; the remainder was retained at the holding company to fund the quarterly dividend payable on the SBLF Preferred Stock.

Industry Conditions

The economy showed signs of improvement in 2013, with a slight decline in unemployment, an improvement in consumer confidence, and some stabilization in housing markets. The national unemployment rate, seasonally adjusted and as published by the Bureau of Labor Statistics, for December 2013 was reported at 6.7%, a decline from 7.9% in December 2012. In the Fifth District of the Federal Reserve Bank (the “Fifth District”), which includes our target markets, the December 2013 unemployment rate was 6.2%, down from 7.4% at the end of 2012. More specifically, the unemployment rate in Virginia in December 2013 was 5.2%, based on data published by the Fifth District. Additionally as published by the Fifth District, in the last year, all industry sectors in the Fifth District grew except for government and other, which showed only modest declines.

The Federal Open Market Committee (the “FOMC”) stated in a January 29, 2014 release that economic activity has been expanding at a moderate pace, and although labor market conditions have shown some improvement, the unemployment rate remains elevated. The FOMC stated the housing sector slowed somewhat, but business and household spending advanced.

The FOMC stated it will reduce the pace of its asset purchase program until the outlook for the labor market or inflation changes, with the future pace of the asset purchase program based on the efficacy and cost of the program. The FOMC stated it expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time. In particular, the FOMC reaffirmed its expectation and stated “the current exceptionally low target range for the federal funds rate of 0 to  ¹ ⁄ ₄ percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Low interest rates and intense competition, due to limited business investment, in addition to other factors, have put pressure on net interest margins of banks, including the Bank. Banks with which we compete are offering aggressive terms and may be loosening credit underwriting standards. We anticipate intense competition in our markets until the economy shows stronger signs of improvement.

Outlook

We are well positioned to take advantage of competitive opportunities. We will benefit from (1) our team of skilled bankers, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team and board of directors. We intend to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets.

Intense competition for quality loans in the low interest rate environment requires that we remain firm to our established credit underwriting practices, provide exceptional customer service, and offer competitive treasury services products, as well as cautiously step-down rates on our deposits and be judicious in our investments.

 

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

Critical Accounting Policies

General

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with U.S. generally accepted accounting principles (“GAAP’) and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and the amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations. Our significant accounting policies are discussed further in the notes to the consolidated financial statements in this Annual Report on Form 10-K.

We consider a policy critical, if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate, and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe our most critical accounting policy relates to the allowance for loan and lease losses which reflects the estimated losses in the event of borrower default. An additional accounting policy that we deem critical using these criteria is our measurement of probable cash flows with respect to acquired credit-impaired loans accounted for under FASB ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). Yield and impairment for acquired credit-impaired loans is based on management’s estimate of future cash flows, which are re-estimated on a periodic basis.

If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan losses could be required, which could have a material adverse impact on our results of operations and financial condition. The following is a summary of our critical accounting policies that are highly dependent on estimates, assumptions and judgments.

Loans

Loans held for sale represent loans we hold through our sub-participation in a nationwide warehouse lending program with a commercial bank (the “participating bank”). The participating bank and the Bank purchase interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis. As of December 31, 2013 and 2012, we had $3.4 million and $80.9 million, respectively, in loans held for sale.

Loans that we originate are carried at their principal amount outstanding plus or minus unamortized fees, origination costs and fair value adjustments for acquired loans. Interest income is recorded as earned on an accrual basis. It is our general policy that accrual of interest income is discontinued when a loan is 90 days or greater past due as to principal or interest or when the collection of principal and/or interest is in doubt, unless the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection. Subsequent cash receipts are applied to principal until the loan is in compliance with stated terms. Due to the guarantee of both principal and accrued interest on a significant portion of our guaranteed student loan balances, we do not discontinue the accrual of interest income on these loans when a loan is 90 days or more past due. We use the allowance method in providing for possible loan losses.

Management considers loans to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Factors that influence management’s judgments include, but are not limited to, loan payment pattern, source of repayment and value of any collateral. A loan would not be considered impaired if an insignificant delay in loan payment occurs and we expect to collect all amounts due. The major sources for identification of loans to be evaluated for impairment include past due and nonaccrual reports, internally generated lists of certain risk ratings and loan review. The value of impaired loans is measured using either the discounted expected cash flow method or the value of collateral method. We consider all of our nonperforming loans to be impaired loans.

 

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

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC 310-30. We concluded that a portion of the loans acquired in the VBB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

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

The excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield. This amount is accreted into interest income over the period of expected cash flows from the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

ASC 310-30 requires periodic re-evaluation of expected cash flows for acquired credit-impaired loans subsequent to acquisition date. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The increased accretable yield is recognized in income over the remaining period of expected cash flows from the loan. Any impairment charge recorded as a result of a re-evaluation is recorded as an increase in our allowance for loan and lease losses.

Acquired loans for which we cannot predict the amount or timing of cash flows are accounted for under the cost recovery method, whereby principal and interest payments received reduce the carrying value of the loan until such amount has been received. Amounts received in excess of the carrying value are reported in interest income.

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “ Contingencies, ” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “ Receivables. ”

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

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

In evaluating loans accounted for under ASC 310-30, we periodically estimate the amount and timing of cash flows expected to be collected. Upon re-estimation, any deterioration in the timing and/or amount of cash flows results in an

 

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impairment charge, which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. A subsequent improvement in the expected timing or amount of future cash flows for those loans could result in the reduction of the allowance for loan and lease losses and an increase in our net income.

In evaluating our acquired guaranteed student loans, our allowance for loan and lease losses is based on historical default rates for similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guaranty.

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

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

Management believes that the allowance for loan and lease losses is adequate. While management uses the best information available to make evaluations, future adjustments may be necessary if economic and other conditions differ substantially from the assumptions used.

Other Real Estate Owned (“OREO”)

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at estimated fair value less costs of disposal at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and, if required, a reserve is established to reflect the net carrying value of the asset at the lower of the then existing carrying value or the fair value less costs of disposal. Revenue and expenses from operations and changes in the valuation of OREO are included in our consolidated statements of operations.

Accounting for Acquisitions

The merger with First Bankshares was treated as a reverse acquisition for accounting purposes, with Xenith Corporation deemed the acquirer. The merger was accounted for using the acquisition method of accounting in accordance with FASB ASC Topic 805 , “Business Combinations” (“ASC 805”) and, accordingly the assets acquired and liabilities assumed of First Bankshares were recorded at estimated fair value as of the date of the merger, which was December 22, 2009. The Paragon Transaction and the VBB Acquisition were determined to be acquisitions of businesses in accordance with ASC 805; therefore, these transactions were also accounted for under the acquisition method of accounting, with the assets acquired and liabilities assumed recorded at their estimated fair values as of the effective date of the acquisitions, which was July 29, 2011.

The determination of these fair values requires management to make estimates about future cash flows, market conditions and other events, which are highly subjective in nature. Actual results may differ materially from the estimates made.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired. Goodwill is tested at least annually for impairment, which requires as a first step the comparison of the fair value of each reporting unit to its carrying value. For purposes of determining fair value of the reporting unit, fair value is defined as “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.” If the fair value of the reporting unit is determined to be less than the reporting unit’s carrying value of its equity, a second step of the impairment test is required, which involves allocating the fair value of the reporting unit to all of the assets and liabilities of the unit, with the excess of fair value over allocated net assets representing the fair value of the unit’s goodwill. Impairment is measured as the amount, if any, by which the carrying value of the reporting unit’s goodwill exceeds the estimated fair value of that goodwill. Our recorded goodwill as of December 31, 2013 was $13.0 million, all of which resulted from the merger with First Bankshares. Management has concluded that none of its recorded goodwill was impaired as of the testing date, which was October 31, 2013. There have been no events since the testing date that would indicate the company’s goodwill is impaired.

Other intangible assets, which represent core deposit intangibles, are amortized over their estimated useful life. Our core deposit intangibles were acquired in the merger and the Paragon Transaction and are being amortized on a straight-line basis over 10 years. No events have occurred since December 31, 2013, that would indicate impairment in the carrying amounts of intangibles.

 

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We periodically assess whether events or changes in circumstances indicate that the carrying amounts of intangible assets may be impaired.

Income Taxes

We compute our income taxes in accordance with the provisions of FASB ASC Topic 740, “ Accounting for Income Taxes, ” under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements’ carrying amount of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Deferred tax assets are evaluated for recoverability, and a valuation allowance is provided until it is more likely than not that these tax benefits will be realized. This determination requires us to evaluate both historical and future factors and to conclude as to the likelihood that our deferred tax assets will be utilized in the future. Changes in factors in future periods could require us to record a valuation allowance on all or a portion of our deferred tax asset in these periods.

In addition, we are required to establish a tax contingency reserve for any estimated tax exposure items identified based on our tax return filings or anticipated filings. Changes in any tax contingency reserve would be based on specific development, events or transactions.

Cautionary Notice about Forward-Looking Statements

Certain statements included in this Annual Report on Form 10-K are “forward-looking statements.” All statements other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our plans, objectives and goals, future events or results, our competitive strengths and business strategies, and the trends in our industry are forward-looking statements. The words “believe,” “will,” “may,” “could,” “estimate,” “project,” “predict,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “appear,” “future,” “likely,” “probably,” “suggest,” “goal,” “potential” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements made in this Annual Report on Form 10-K reflect beliefs, assumptions and expectations of future events or results, taking into account the information currently available to us. These beliefs, assumptions and expectations may change as a result of many possible events, circumstances or factors, not all of which are currently known to us. If a change occurs, our business, financial condition, liquidity, results of operations and prospects may vary materially from those expressed in, or implied by, our forward-looking statements. Accordingly, you should not place undue reliance on these forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by our forward-looking statements include the risks outlined in “Item 1A—Risk Factors” of this Annual Report on Form 10-K. Except as required by applicable law or regulations, we do not undertake, and specifically disclaim any obligation, to update or revise any forward-looking statement.

Results of Operations

Net Income

For the year ended December 31, 2013, we reported net income of $2.0 million compared to net income of $7.4 million for the year ended December 31, 2012. Net income for the year ended December 31, 2012 included a $5.0 million income tax benefit due to the reversal of the valuation allowance on our net deferred tax assets.

The following table presents net income and earnings per common share information for the periods stated:

 

		For the Years Ended December 31,
		2013				2012
Net income		$	1,986			$	7,379
Preferred stock dividend			(84	)			(89	)
Net income available to common shareholders		$	1,902			$	7,290
Earnings per common share, basic and diluted		$	0.18			$	0.70

 

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Net Interest Income

For the year ended December 31, 2013, net interest income was $22.1 million compared to $22.0 million for the year ended December 31, 2012. Greater interest income in 2013 due to higher average balances in loans held for investment was offset by lower yields on these loans and investment securities, resulting in a slight decrease in interest income in 2013 compared to 2012. Interest expense decreased in 2013 compared to 2012 primarily due to lower deposit costs, partially offset by higher average balances of deposits. As presented in the table below, net interest margin decreased 58 basis points to 3.89% for the year ended December 31, 2013, from 4.47% for the year ended December 31, 2012. Net interest margin is defined as the percentage of net interest income to average interest-earning assets. Average interest-earning assets increased $77.1 million, while related interest income decreased $336 thousand for the year ended December 31, 2013 compared to the year ended 2012. Average interest-bearing liabilities increased $57.3 million, while related interest expense decreased $461 thousand, for the year ended December 31, 2013 compared to the year ended 2012. Yields on interest-earning assets declined 77 basis points to 4.50% for the year ended December 31, 2013 compared to the year ended 2012, while costs of interest-bearing liabilities decreased 25 basis points to 0.81% for 2012. Our purchase of guaranteed student loans resulted in a decrease in our overall yield on interest-earning assets for the year ended 2013 compared to the year ended 2012; however, we believe these assets are an efficient use of excess liquidity and provide an adequate risk-adjusted return. Average interest-earning assets as a percentage of total assets were 93.8% and 94.9%, respectively, for the years ended December 31, 2013 and 2012. Lower average interest-earning assets as a percentage of total assets were primarily due to the addition of bank-owned life insurance (“BOLI”) in 2013 and higher average cash balances.

Our loan portfolios acquired in the merger, the Paragon Transaction and the VBB Acquisition were discounted to estimated fair values (for expected credit losses and for interest rates) immediately following the merger and the acquisitions, as applicable. A portion of the purchase accounting adjustments (discounts) to record the acquired loans at estimated fair values is being recognized (accreted) into interest income over the remaining life of the loans or the period of estimated cash flows. Amounts received in excess of the carrying value of loans accounted for on cost recovery are accreted into interest income at the time of recovery. Loan discount accretion for the years ended December 31, 2013 and 2012 was $2.6 million and $3.3 million, respectively.

For the year ended December 31, 2012, net interest income was $22.0 million compared to $16.2 million for the year ended December 31, 2011. Net interest margin decreased 41 basis points to 4.47% for the year ended December 31, 2012 compared to 4.88% for the year ended December 31, 2011. Greater net interest income was primarily due to higher average loan balances, partially offset by lower yields on loans and investments. Loan discount accretion for the years ended December 31, 2012 and 2011 was $3.3 million and $3.6 million, respectively. In addition, time deposits acquired in the merger were adjusted to fair value at the date of the merger for interest rates. The total adjustment at the date of the merger was $2.1 million and was amortized as a reduction of interest expense over a two-year period. The effect of this amortization is a decrease in interest expense of $1.1 million for the year ended December 31, 2011. This fair value adjustment had no effect on the year ended December 31, 2012. Average interest-earning assets as a percentage of total assets were 94.9% and 92.5%, respectively, for the years ended December 31, 2012 and 2011.

The following table presents the impact of purchase accounting adjustments on our net interest margin for the periods stated:

 

		For the Years Ended December 31,
		2013				2012				2011
Net interest margin			3.89	%			4.47	%			4.88	%
Purchase accounting adjustments impact (1)			0.47	%			0.68	%			1.39	%
Net interest margin excluding the impact of purchase accounting adjustments			3.42	%			3.79	%			3.49	%

 

(1)	Purchase accounting adjustments for the years ended December 31, 2013 and 2012, include accretion of discounts on acquired loans. For the year ended December 31, 2011, purchase accounting adjustments include both accretion and an adjustment for interest rates on acquired time deposits.

 

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The following tables provide a detailed analysis of the average yields and rates on average interest-earning assets and average interest-bearing liabilities for the periods stated:

 

		Average Balances, Income and Expenses, Yields and Rates As of and For the Years Ended December 31,
																										2013 vs. 2012
		Average Balances (1)								Yield / Rate								Income / Expense (7)(8)								Increase				Change due to (2)
		2013				2012				2013				2012				2013				2012				(Decrease)				Rate				Volume
Assets
Interest-earning assets:
Federal funds sold		$	5,624			$	1,951				0.22	%			0.19	%		$	12			$	4			$	8			$	1			$	7
Interest-earning deposits			37,972				36,747				0.26	%			0.27	%			100				98				2				(1	)			3
Investments			69,346				67,839				2.10	%			2.39	%			1,454				1,620				(166	)			(202	)			36
Loans held for sale			46,257				49,579				3.27	%			3.51	%			1,514				1,739				(225	)			(113	)			(112	)
Guaranteed Student Loans, gross			17,039				—				3.09	%			0.00	%			527				—				527				—				527
Loans held for investment, gross (3)			393,851				336,914				5.59	%			6.68	%			22,033				22,515				(482	)			(3,970	)			3,488
Total interest-earning assets			570,089				493,031				4.50	%			5.27	%			25,640				25,976				(336	)			(4,285	)			3,949
Allowance for loan and lease losses			(4,570	)			(4,407	)
Noninterest-earning assets:
Cash and due from banks			8,819				4,112
Premises and fixed assets			5,304				5,799
Other assets			28,428				20,794
Total noninterest-earning assets			42,551				30,705
Total assets		$	608,070			$	519,330
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Demand deposits		$	25,478			$	12,599				0.20	%			0.23	%		$	52			$	30			$	22			$	(5	)		$	27
Savings and money market deposits			230,167				205,406				0.57	%			0.80	%			1,316				1,642				(326	)			(506	)			180
Time deposits			152,864				133,915				1.14	%			1.42	%			1,744				1,903				(159	)			(406	)			247
Federal funds purchased and borrowed funds			20,861				20,176				1.79	%			1.84	%			374				372				2				(10	)			12
Total interest-bearing liabilities			429,370				372,096				0.81	%			1.06	%			3,486				3,947				(461	)			(927	)			466
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits			88,254				61,889
Other liabilities			2,451				2,335
Total noninterest-bearing liabilities			90,705				64,224
Shareholders’ equity			87,995				83,010
Total liabilities and shareholders’ equity		$	608,070			$	519,330
Interest rate spread (4)											3.69	%			4.21	%
Net interest income (5)																		$	22,154			$	22,029			$	125			$	(3,358	)		$	3,483
Net interest margin (6)											3.89	%			4.47	%

 

(1)	Average balances are computed on a daily basis.

(2)	Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

(3)	Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.

(4)	Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.

(5)	Net interest income is interest income less interest expense.

(6)	Net interest margin is net interest income divided by average interest-earning assets.

(7)	Tax-exempt interest income is stated on a taxable equivalent basis.

(8)	Interest income on loans in 2013 and 2012 includes $2,644 thousand and $3,335 thousand, respectively, in accretion related to acquired loans.

 

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		Average Balances, Income and Expenses, Yields and Rates As of and For the Years Ended December 31,
																										2012 vs. 2011
		Average Balances (1)								Yield / Rate								Income / Expense (7)(8)(9)								Increase				Change due to (2)
		2012				2011				2012				2011				2012				2011				(Decrease)				Rate				Volume
Assets
Interest-earning assets:
Federal funds sold		$	1,951				978				0.19	%			0.25	%		$	4			$	2			$	1			$	(1	)		$	2
Interest-earning deposits			36,747				39,710				0.27	%			0.21	%			98				85				13				20				(7	)
Investments			67,839				64,879				2.39	%			2.97	%			1,620				1,925				(305	)			(389	)			85
Loans held for sale			49,579				—				3.51	%			0.00	%			1,739				—				1,739				—				1,739
Loans held for investment, gross (3)			336,914				227,261				6.68	%			7.43	%			22,515				16,879				5,635				(1,833	)			7,468
Total interest-earning assets			493,031				332,828				5.27	%			5.68	%			25,976				18,891				7,085				(2,204	)			9,288
Allowance for loan and lease losses			(4,407	)			(3,086	)
Noninterest-earning assets:
Cash and due from banks			4,112				4,158
Premises and fixed assets			5,799				6,224
Other assets			20,794				19,602
Total noninterest-earning assets			30,705				29,984
Total assets		$	519,330			$	359,726
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Demand deposits		$	12,599				8,712				0.23	%			0.31	%		$	30			$	27			$	2			$	(8	)		$	10
Savings and money market deposits			205,406				106,404				0.80	%			0.97	%			1,642				1,034				608				(210	)			819
Time deposits			133,915				119,308				1.42	%			0.86	%			1,903				1,032				871				732				139
Federal funds purchased and borrowed funds			20,176				23,572				1.84	%			2.34	%			372				553				(181	)			(108	)			(73	)
Total interest-bearing liabilities			372,096				257,996				1.06	%			1.03	%			3,947				2,646				1,300				405				896
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits			61,889				33,894
Other liabilities			2,335				2,068
Total noninterest-bearing liabilities			64,224				35,962
Shareholders’ equity			83,010				65,768
Total liabilities and shareholders’ equity		$	519,330			$	359,726
Interest rate spread (4)											4.21	%			4.65	%
Net interest income (5)																		$	22,029			$	16,245			$	5,784			$	(2,609	)		$	8,393
Net interest margin (6)											4.47	%			4.88	%

 

(1)	Average balances are computed on a daily basis.

(2)	Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

(3)	Nonaccrual loans have been included in the average balances.

(4)	Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.

(5)	Net interest income is interest income less interest expense.

(6)	Net interest margin is net interest income divided by average interest-earning assets.

(7)	Tax-exempt interest income is stated on a taxable equivalent basis.

(8)	Interest income on loans in 2012 and 2011 includes $3,335 thousand and $3,569 thousand, respectively, in accretion related to acquired loans.

(9)	Interest expense on time deposits in 2011 is reduced by $1,052 thousand related to acquisition fair value adjustments. There is no fair value adjustment in 2012.

 

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Noninterest Income

Noninterest income was $1.7 million for the year ended December 31, 2013 compared to $0.7 million for the year ended December 31, 2012. Higher noninterest income in 2013 was primarily due to higher service charges and fees on deposit accounts, including fees from treasury management services, earnings on BOLI, and income from derivative products. Additionally, noninterest income in 2013 included a gain of $361 thousand on the sale of collateral related to an impaired loan acquired in the VBB Acquisition, while in the 2012 period noninterest income included net losses on sales and write-downs of OREO of $11 thousand.

Noninterest Expense

For the year ended December 31, 2013, noninterest expense was $19.3 million compared to $18.1 million for the year ended December 31, 2012. Greater noninterest expenses in 2013 were primarily due to higher compensation and benefit costs of $738 thousand, higher bank franchise taxes of $173 thousand, and higher FDIC insurance of $83 thousand. Compensation and benefit costs increases were primarily due to the addition of relationship managers and performance-based incentives. Higher bank franchise taxes, which are capital based, and higher FDIC insurance increased due to growth in our balance sheet. The addition of guaranteed student loans in 2013 increased noninterest expense by $138 thousand due to servicing fees paid to a third-party for servicing these loans.

Income Taxes

For the year ended December 31, 2013, we reported income tax expense of $1.1 million compared to an income tax benefit of $4.6 million for the year ended 2012. The income tax benefit in 2012 included a $5.0 million deferred tax benefit recorded in the third quarter due to the reversal of the valuation allowance recorded against our net deferred tax asset.

As of September 30, 2012, we assessed the need for a valuation allowance, evaluating both positive and negative evidence, and concluded that it was more likely than not that our deferred taxes would be utilized in future periods. Our evaluation considered the following positive evidence:

 

•

We were in a positive cumulative pre-tax income position for the period since the merger with First Bankshares.

 

•

Our quarterly pre-tax operating results had improved each of the prior four quarters ending September 30, 2012.

 

•

Our financial projections were sufficient to absorb net deferred tax assets.

 

•

We expected to generate taxable income, before the utilization of net operating losses, in 2012 and in future years.

 

•

Deferred tax assets included $2.3 million related to $6.8 million of net operating losses, which under current law, can be carried forward for 20 years.

 

•

We believed we have not experienced a “change in control,” as defined under Internal Revenue Code Section 382 and related regulations, since the effective date of the merger with First Bankshares in 2009. Accordingly, we believed we had incurred no limitations on the use of our net operating losses.

 

•

We believed our allowance for loan and lease losses plus discounts recorded on acquired loans to be adequate to avoid significant charges to net income related to problem loans.

 

•

A significant portion of our net interest income is based on long-term contracts with a significant number of customers.

As of September 30, 2012, we also considered the following negative evidence:

 

•

We did not have taxable income in carryback periods available to offset existing deferred tax assets.

 

•

We had no executable tax planning strategies to utilize future tax deductible amounts.

 

•

We operate in a competitive and highly-regulated industry, which could impact our future profitability.

Based on the above evaluation, we concluded, and continue to conclude as of December 31, 2013, it is more likely than not that our deferred taxes will be utilized in future periods.

Our net deferred tax assets as of December 31, 2013 and 2012 were $4.3 million and $4.1 million, respectively.

 

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Financial Condition

Securities

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

 

		December 31, 2013
		Book Value				Fair Value				Weighted Average Life in Years				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	45,693			$	45,338				4.54				2.09	%
- Variable rate			4,903				4,852				4.20				1.68	%
Municipals
- Taxable			9,810				8,970				9.23				2.71	%
- Tax exempt (1)			1,634				1,573				8.12				2.95	%
Collateralized mortgage obligations			8,940				8,452				4.01				2.18	%
Total securities available for sale		$	70,980			$	69,185				5.16				2.17	%

 

(1)	Yields on tax-exempt securities are calculated on a tax equivalent basis.

 

		December 31, 2012
		Book Value				Fair Value				Weighted Average Life in Years				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	42,804			$	44,240				2.59				2.16	%
- Variable rate			2,038				2,181				11.20				3.21	%
Municipals			1,050				1,000				9.25				2.80	%
Collateralized mortgage obligations			9,977				10,130				2.84				1.85	%
Total securities available for sale		$	55,869			$	57,551				3.08				2.16	%

 

		December 31, 2011
		Book Value				Fair Value				Weighted Average Life in Years				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	53,518			$	54,771				2.81				2.57	%
- Variable rate			2,489				2,620				11.08				3.11	%
Collateralized mortgage obligations			9,866				10,065				3.19				2.76	%
Trust preferred securities			1,123				1,010				15.29				7.75	%
Total securities available for sale		$	66,996			$	68,466				3.39				2.70	%

 

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

 

		December 31, 2013
		Within 1 Year				Weighted Average Yield				After 1 Year Through 5 Years				Weighted Average Yield				After 5 Years Through 10 Years				Weighted Average Yield				After 10 Years				Weighted Average Yield				Total				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	—				—			$	—				—			$	26,308				1.88	%		$	19,030				2.37	%		$	45,338				2.09	%
- Variable rate			—				—				—				—				—				—				4,852				1.68	%			4,852				1.68	%
Municipals
- Taxable			—				—				—				—				5,343				2.63	%			3,627				2.81	%			8,970				2.71	%
- Tax exempt (1)			—				—				—				—				1,573				2.95	%			—				—				1,573				2.95	%
Collateralized mortgage obligations			—				—				—				—				—				—				8,452				2.18	%			8,452				2.18	%
Total securities available for sale		$	—				—			$	—				—			$	33,224				2.05	%		$	35,961				2.07	%		$	69,185				2.17	%

 

(1)	Yields on tax-exempt securities are calculated on a tax equivalent basis.

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

 

		December 31, 2013
		Book Value				Fair Value				Book Value as a Percentage of Shareholders’ Equity
Mortgage-backed securities
- Federal National Mortgage Association		$	39,903			$	39,704				45.5	%
- Federal Home Loan Mortgage Corporation			9,675				9,479				11.0	%

 

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Loans

The following table presents our loan portfolio, by loan category and percentage to total loans for loans held for investment, as of the dates stated:

 

		December 31,
		2013								2012								2011								2010								2009
		Amount				Percent of Total				Amount				Percent of Total				Amount				Percent of Total				Amount				Percent of Total				Amount				Percent of Total
Commercial and industrial		$	246,324				45.75	%		$	203,880				53.11	%		$	168,417				51.64	%		$	68,045				44.43	%		$	43,467				42.59	%
Commercial real estate			172,711				32.08	%			150,796				39.28	%			126,525				38.80	%			57,035				37.24	%			34,979				34.28	%
Residential real estate			22,004				4.09	%			24,291				6.33	%			25,847				7.93	%			23,337				15.24	%			22,061				21.62	%
Consumer			3,191				0.59	%			4,886				1.27	%			5,285				1.62	%			4,715				3.08	%			1,524				1.49	%
Guaranteed student loans			94,028				17.46	%			—				0.00	%			—				0.00	%			—				0.00	%			—				0.00	%
Overdrafts			184				0.03	%			28				0.01	%			65				0.01	%			14				0.01	%			19				0.02	%
Loans held for investment		$	538,442				100.00	%		$	383,881				100.00	%		$	326,139				100.00	%		$	153,146				100.00	%		$	102,050				100.00	%
Allowance for loan and lease losses			(5,305	)							(4,875	)							(4,280	)							(1,766	)							—
Loans held for investment, net of allowance			533,137								379,006								321,859								151,380								102,050
Loans held for sale			3,363								80,867								—								—								—
Total loans		$	536,500							$	459,873							$	321,859							$	151,380							$	102,050

The following tables provide the maturity analysis of our loan portfolio as of the dates presented based on whether loans are variable-rate or fixed-rate loans:

 

		December 31, 2013
						Variable Rate												Fixed Rate
		Within 1 year				1 to 5 years				After 5 years				Total variable > 1 year				1 to 5 years				After 5 years				Total fixed > 1 year				Total Maturities
Commercial and industrial (1)		$	102,663			$	79,277			$	9,980			$	89,257			$	43,496			$	8,522			$	52,018			$	243,938
Commercial real estate (2)			57,749				78,167				8,489				86,656				23,029				4,394				27,423				171,828
Residential real estate (3)			6,994				3,615				5,006				8,621				5,355				481				5,836				21,451
Consumer			2,242				319				69				388				559				2				561				3,191
Guaranteed student loans			30				1,247				92,751				93,998				—				—				—				94,028
Overdrafts			185				—				—				—				—				—				—				185
Total loans		$	169,863			$	162,625			$	116,295			$	278,920			$	72,439			$	13,399			$	85,838			$	534,621

 

(1)	Excludes $1.5 million in nonaccrual fixed-rate loans and $874 thousand in nonaccrual variable-rate loans.

(2)	Excludes $384 thousand in nonaccrual fixed-rate loans and $499 thousand in nonaccrual variable-rate loans.

(3)	Excludes $119 thousand in nonaccrual fixed-rate loans and $434 thousand in nonaccrual variable-rate loans.

 

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		December 31, 2012
						Variable Rate												Fixed Rate
		Within 1 year				1 to 5 years				After 5 years				Total variable > 1 year				1 to 5 years				After 5 years				Total fixed > 1 year				Total Maturities
Commercial and industrial (1)		$	94,697			$	65,316			$	1,313			$	66,629			$	35,305			$	5,402			$	40,707			$	202,033
Commercial real estate (2)			58,309				62,117				9,988				72,105				16,443				791				17,234				147,648
Residential real estate (3)			8,515				5,740				3,473				9,213				5,736				753				6,489				24,217
Consumer			3,634				701				5				706				535				11				546				4,886
Overdrafts			28				—				—				—				—				—				—				28
Total loans		$	165,183			$	133,874			$	14,779			$	148,653			$	58,019			$	6,957			$	64,976			$	378,812

 

(1)	Excludes $1.1 million in nonaccrual fixed-rate loans and $781 thousand in nonaccrual variable-rate loans.

(2)	Excludes $2.2 million in nonaccrual fixed-rate loans and $925 thousand in nonaccrual variable-rate loans.

(3)	Excludes $39 thousand in nonaccrual fixed-rate loans and $35 thousand in nonaccrual variable-rate loans.

 

		December 31, 2011
						Variable Rate												Fixed Rate
		Within 1 year				1 to 5 years				After 5 years				Total variable > 1 year				1 to 5 years				After 5 years				Total fixed > 1 year				Total Maturities
Commercial and industrial (1)		$	67,515			$	50,694			$	4,953			$	55,647			$	40,672			$	4,078			$	44,750			$	167,912
Commercial real estate (2)			28,075				51,678				5,601				57,279				34,704				1,211				35,915				121,269
Residential real estate (3)			3,931				7,706				3,953				11,659				6,291				3,841				10,132				25,722
Consumer			2,518				1,827				251				2,078				680				10				690				5,286
Overdrafts			65				—				—				—				—				—				—				65
Total loans		$	102,104			$	111,905			$	14,758			$	126,663			$	82,347			$	9,140			$	91,487			$	320,254

 

(1)	Excludes $504 thousand in nonaccrual fixed-rate loans.

(2)	Excludes $5.3 million in nonaccrual variable-rate loans.

(3)	Excludes $125 thousand in nonaccrual fixed-rate loans.

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies and guidelines designed to control both the types and amounts of risks we take and to minimize losses. Such policies and guidelines include loan underwriting parameters, loan-to-value parameters, credit monitoring guidelines, adherence to regulations and other prudent credit practices. Loans secured by real estate comprised 47.9% of our loan portfolio as of December 31, 2013 and 68.0% as of December 31, 2012. Commercial real estate loans are secured by commercial properties. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt-service coverage ratios as well. Residential real estate loans consist of first and second lien loans, including home equity lines and credit loans, secured by residential real estate that is located primarily in our target markets offered to select customers. These customers primarily include branch and private banking customers. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt-to-income ratios as well. The repayment of both residential and owner-occupied commercial real estate (“OORE”) loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment. We classify OORE loans as commercial and industrial (“C&I”), as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

 

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Allowance for Loan and Lease Losses

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

 

		December 31,
		2013								2012								2011								2010								2009
		Amount				Percent of loans in each category to total loans held for investment				Amount				Percent of loans in each category to total loans held for investment				Amount				Percent of loans in each category to total loans held for investment				Amount				Percent of loans in each category to total loans held for investment				Amount				Percent of loans in each category to total loans held for investment
Balance at end of period applicable to:
Commercial and industrial		$	2,148				45.75	%		$	1,523				53.11	%		$	748				51.64	%		$	470				44.43	%		$	1,246				42.59	%
Commercial real estate			2,756				32.08	%			3,086				39.28	%			3,370				38.80	%			1,106				37.24	%			4,980				34.28	%
Residential real estate			194				4.09	%			245				6.33	%			133				7.93	%			164				15.24	%			434				21.62	%
Consumer			12				0.62	%			21				1.28	%			29				1.63	%			26				3.09	%			40				1.51	%
Guaranteed student loans			195				17.46	%			—				0.00	%			—				0.00	%			—				0.00	%			—				0.00	%
Total allowance for loan and lease losses			5,305				100.00	%			4,875				100.00	%			4,280				100.00	%			1,766				100.00	%			6,700				100.00	%
Acquisition fair value adjustment			—								—								—								—								(6,700	)
Total allowance for loan and lease losses		$	5,305							$	4,875							$	4,280							$	1,766							$	—

The following table presents the activity in the allowance for loan and lease losses for the dates stated:

 

		December 31,
		2013				2012				2011				2010				2009
Balance at beginning of period		$	4,875			$	4,280			$	1,766			$	—			$	1,687
Charge-offs:
Commercial and industrial			51				51				333				—				187
Commercial real estate			815				1,127				973				200				133
Residential real estate			52				—				93				52				215
Consumer			16				2				3				1				5
Guaranteed student loans			—				—				—				—				—
Overdrafts			9				9				13				15				—
Total charge-offs			943				1,189				1,415				268				540
Recoveries:
Commercial and industrial			—				—				72				—				32
Commercial real estate			—				20				12				43				19
Residential real estate			—				—				—				—				—
Consumer			—				3				—				—				1
Guaranteed student loans			—				—				—				—				—
Overdrafts			2				1				2				1				—
Total recoveries			2				24				86				44				52
Net charge-offs			941				1,165				1,329				224				488
Provision for loan and lease losses			1,486				1,819				4,005				1,990				5,501
Amount for unfunded commitments			(115	)			(59	)			(162	)			—				—
Allowance after additions			5,305				4,875				4,280				1,766				6,700
Acquisition fair value adjustment			—				—				—				—				(6,700	)
Balance at end of period		$	5,305			$	4,875			$	4,280			$	1,766			$	—

 

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For the years ended December 31, 2013 and 2012, we recorded provision for loan and lease losses of $1.5 million and $1.8 million, respectively. Lower provision expense in 2013 was primarily due to lower impairments recorded on acquired credit-impaired loans in 2013. In 2013, we recorded $191 thousand of impairment related to these loans, whereas in 2012, we recorded $677 thousand of impairment.

Our allowance for loan and lease losses on guaranteed student loans is based on historical default rates for similar types of loans applied to the portion of the carrying value in these loans that is not subject to federal guaranty.

The allowance for loan and lease losses excludes discounts recorded on our acquired loan portfolios, which as of December 31, 2013 and 2012 were $4.4 million and $8.1 million, respectively. Immediately following the merger, the allowance for loan and lease losses was reduced to $0, and loans were recorded at estimated fair value in accordance with acquisition accounting by recording an adjustment of $6.7 million. Likewise, the loans acquired in the Paragon Transaction and the VBB Acquisition were recorded at estimated fair values at the date of acquisition by recording a fair value adjustment of $1.8 million and $14.0 million, respectively.

Our purchased credit-impaired loans accounted for under ASC 310-30 require us to periodically re-evaluate the timing and amount of expected future cash flows. Any deterioration in the timing and/or amount of cash flows results in an impairment charge which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. For the period ended December 31, 2013, $191 thousand was included in our provision for loan and lease losses related to the re-evaluation of our purchased credit-impaired loans, and as of December 31, 2013, our allowance for loan and lease losses included $420 thousand for these loans. If upon remeasurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that improve compared to those previously determined, some portion of the impairment could be reversed.

The following table presents the activity in our discounts recorded for acquired loans as of the dates stated:

 

		December 31, 2013				December 31, 2012
Balance at beginning of period		$	8,133			$	14,007
Accretion (1)			(2,644	)			(3,335	)
Disposals (2)			(1,048	)			(2,539	)
Balance at end of period		$	4,441			$	8,133

 

(1)	Accretion amounts are reported in interest income.

(2)	Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2013 amount, $85 thousand relates to loans reclassified as OREO.

Nonperforming Assets

It is our general policy to discontinue the accrual of interest income on our nonperforming loans. We consider a loan as nonperforming when it is 90 days or greater past due as to principal or interest or when there is serious doubt as to collectability, unless the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection. We do not discontinue the accrual of interest income on guaranteed student loans when 90 days or greater past due, as a significant portion of principal and accrued interest carries a federal guaranty. As of December 31, 2013, there were no loans 90 days or greater past due with respect to principal or interest for which interest was accruing.

As of December 31, 2013 and 2012, we had $199 thousand and $276 thousand, respectively, in OREO. OREO held at December 31, 2013 consisted of residential properties and undeveloped land. OREO valuations are evaluated periodically, and any necessary reserve to carry the asset at the lower or carrying value or fair value is recorded as a charge to net income.

 

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The following table summarizes our nonperforming assets as of the dates stated:

 

		December 31,
		2013				2012				2011				2010				2009
Nonaccrual loans		$	3,822			$	5,069			$	5,862			$	2,841			$	4,129
Other real estate owned			199				276				808				1,485				464
Total nonperforming assets		$	4,021			$	5,345			$	6,670			$	4,326			$	4,593
Nonperforming assets as a percentage of total loans held for investment			0.75	%			1.39	%			2.05	%			2.82	%			4.50	%
Nonperforming assets as a percentage of total assets			0.59	%			0.95	%			1.40	%			1.72	%			2.28	%
Net charge-offs as a percentage of average loans held for investment			0.22	%			0.35	%			0.58	%			0.18	%			N/A
Allowance for loan and lease losses as a percentage of total loans held for investment			0.99	%			1.27	%			1.31	%			1.15	%			N/A
Allowance for loan and lease losses to nonaccrual loans			138.78	%			96.16	%			73.01	%			62.16	%			N/A

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of December 31, 2013 totaled $569.2 million, an increase of 26%, compared to deposits of $453.2 million as of December 31, 2012. Demand deposits, including money market accounts, increased $41.9 million, or 13%, over balances at December 31, 2012, while time deposits increased $73.3 million, or 56%. Of the increase in demand deposits, over 97% was in noninterest-bearing deposit accounts. Of the increase in time deposits, $38.5 million was in brokered deposits. As of December 31, 2013, $71.3 million of our deposits were in Insured Cash Sweep (“ICS”) and brokered CDs, which we refer to as brokered deposits. As of December 31, 2012, $28.5 million of our deposits were in Certificate of Deposit Account Registry Service (“CDARS”) and ICS, which we referred to as brokered deposits.

The following table presents the average balances and rates paid, by deposit category, as of the dates stated. Rates on time deposits in 2011 include the impact of purchase accounting adjustments.

 

		December 31, 2013								December 31, 2012								December 31, 2011
		Amount				Rate				Amount				Rate				Amount				Rate
Noninterest-bearing demand deposits		$	88,254				—			$	61,889				—			$	33,894				—
Interest-bearing deposits:
Demand and money market			251,110				0.54	%			214,194				0.77	%			111,554				0.96	%
Savings accounts			4,535				0.29	%			3,811				0.40	%			3,562				0.50	%
Time deposits $100,000 or greater			95,490				1.01	%			72,594				1.32	%			64,122				1.10	%
Time deposits less than $100,000			57,374				1.36	%			61,321				1.54	%			55,186				0.59	%
Total interest-bearing deposits			408,509				0.76	%			351,920				1.02	%			234,424				0.89	%
Total average deposits		$	496,763				0.63	%		$	413,809				0.86	%		$	268,318				0.78	%

Maturities of large denomination time deposits (equal or greater than $100,000) as of December 31, 2013 were as follows:

 

		Within 3 Months				3-6 Months				6-12 Months				Over 12 Months				Total				Percent of Total Deposits
Time deposits		$	5,936			$	27,791			$	69,326			$	43,780			$	146,833				25.80	%

 

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Borrowings

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

 

		December 31, 2013																December 31, 2012																December 31, 2011
		Year- End Balance				Highest Month- End Balance				Average Balance				Weighted Average Rate				Year- End Balance				Highest Month- End Balance				Average Balance				Weighted Average Rate				Year- End Balance				Highest Month- End Balance				Average Balance				Weighted Average Rate
Federal funds purchased		$	—			$	—			$	247				0.58	%		$	—			$	—			$	134				0.76	%		$	—			$	2,191			$	296				0.90	%
Other borrowings			—				5,000				805				0.31	%			—				—				42				0.44	%			—				1,000				779				0.55	%
Total short-term borrowings		$	—			$	5,000			$	1,052				0.37	%		$	—			$	—			$	176				0.69	%		$	—			$	3,191			$	1,075				0.65	%

We have one secured long-term borrowing with the FHLB in the amount of $20 million, which matures on September 28, 2015. The borrowing is a nonamortizing term loan and bears interest at a rate of 20 basis points over LIBOR, which resets quarterly. The borrowing was a modification of a then-existing borrowing, and in connection with the modification, we paid a fee of $533 thousand that is being recognized as interest expense over the remaining term of the borrowing.

At the time we modified the FHLB borrowing, we entered into a derivative (interest rate swap) whereby we pay fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without the exchange of the underlying notional amount, which is $20 million. Our objective in using interest rate derivatives is to manage our exposure to interest rate movements. During the second quarter of 2013, we entered into a forward-starting swap, whereby upon the renewal of the FHLB borrowing for a specified period we pay fixed amounts and receive variable payments on a portion of the underlying notional amount of this borrowing. The derivatives are designated as a cash flow hedges, whereby the effective portion of the hedge is recorded in accumulated other comprehensive (loss) income. The amount reported in accumulated other comprehensive (loss) income as of December 31, 2013 and 2012 related to these derivatives was an unrealized gain of $13 thousand (net of tax of $7 thousand) and an unrealized loss of $186 thousand (net of tax of $96), respectively. As of December 31, 2013, the ineffective portion of the derivatives was insignificant.

We have an agreement with the counterparty to our derivatives that contains a provision whereby if we fail to maintain our status as a well/an adequate capitalized institution, we could be required to terminate or fully collateralize the derivative contract. Additionally, if we default on any of our indebtedness, including default where repayment has not been accelerated by the lender, we could also be in default on our derivative obligations. We have minimum collateral requirements with our counterparty and, as of December 31, 2013, $250 thousand had been pledged as collateral under the agreement, as the valuation of the derivative had surpassed the contractually specified minimum transfer amount of $250 thousand. If we are not in compliance with the terms of the derivative agreement, we could be required to settle obligations under the agreement at termination value. As of December 31, 2013, an asset of $192 thousand was recorded in other assets and a hedge liability of $191 thousand was recorded in other liabilities on the consolidated balance sheets related to these derivatives.

For the period ended December 31, 2013, our effective interest rate on the $20 million FHLB borrowing, including the effect of the prepayment fee and cash flow hedge, was 1.85%.

Liquidity and Capital Adequacy

In the year ended December 31, 2013, cash and cash equivalents increased $18.3 million to $30.7 million, from $12.4 million at December 31, 2012. Net cash provided by operating activities was $80.6 million for the year ended December 31, 2013 compared to net cash used in operating activities of $77.1 million for the year ended December 31, 2012. The primary source of cash from operating activities in 2013 was the decrease in the purchase of loans held for sale that represented our participation in a mortgage warehouse lending program. Net cash used in investing activities was $177.9 million for the year ended December 31, 2013 compared to net cash used in investing activities of $44.6 million for the year ended 2012. The greater use of cash in the 2013 period was primarily due to net purchases of securities of $15.4 million, an increase in loans held for investment of $97.3 million, and the purchase of BOLI of $9.5 million. The increase in loans held for investment includes $94.0 million of guaranteed student loans, which we began purchasing in the third quarter of 2013. Net cash provided by financing activities in the year ended December 31, 2013 was $115.6 million compared to net cash provided by financing activities of $78.3 million for the year ended 2012. Cash provided by financing activities in 2013 was primarily due an increase in time deposits of $73.3 million and an increase in demand and savings deposits of $42.6 million. In the third quarter of 2013, we began a share repurchase program and $296 thousand was paid for the repurchase of our common stock.

 

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Liquidity

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

Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale portfolio. We have access to a credit line from our primary correspondent bank in the amount of $9.0 million. This line is for short-term liquidity needs, expires in March 2015, and is subject to the prevailing federal funds interest rate.

In addition, we have secured borrowing facilities with the FHLB and the Federal Reserve Bank (“FRB”). The total credit availability under the FHLB facility is equal to 30% of our total assets, which as of December 31, 2013 was $181.3 million based the most recent prior quarter-end, and with lendable collateral. Pledged collateral for this facility as of December 31, 2013 was $58.1 million. Under this facility, we have one non-amortizing term loan outstanding for $20 million. Credit availability under the FRB facility was $112.1 million as of December 31, 2013, which is also based on pledged collateral. Borrowings under this facility bear the prevailing current rate for primary credit. There were no amounts outstanding under this facility as of December 31, 2013.

We also have three additional uncommitted lines of credit by national banks to borrow federal funds up to $28.0 million in total on an unsecured basis. One line for $5 million expires on June 30, 2014. The remainder of the lines of credit can be cancelled at any time. As of December 31, 2013, no amounts were outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate.

In management’s opinion, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs that may arise, within realistic limitations, for the foreseeable future.

Capital Adequacy

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

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

On December 7, 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained conditions related to BankCap Partners, as well as the conduct of the Bank’s business. The condition applicable to the Bank provided that, during the first three years of operation after the merger, the Bank must operate within the parameters of its business plan submitted in connection with BankCap Partner’s application to the Federal Reserve, and the Bank must obtain prior written regulatory consent to any material change in its business plan. The business plan set forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012, which were met. Subsequent to meeting the requirements of set forth in this business plan, we are required to maintain capital ratios categorizing us as “well capitalized.” As of December 31, 2012, we met all minimum capital adequacy requirements to which we were subject, including those contained in our business plan as submitted to the Federal Reserve, and are categorized as “well-capitalized.”

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee and certain changes required by the Dodd-Frank Act. Under the final rule, minimum requirements will increase for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of

 

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common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. The phase-in period for this rule is not scheduled to begin until January 2015. Although we must generally begin complying with the Basel III Rules on January 1, 2015, we would satisfy the higher capital ratios imposed by the Basel III Rules as of December 31, 2013.

Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios. The following table presents our Tier 1 and Tier 2 capital ratios as of the date stated, and regulatory minimum capital ratios and “well-capitalized” ratios as defined by our regulators. Since December 31, 2013, there are no conditions or events that management believes have changed our status as “well-capitalized.”

 

		December 31, 2013								December 31, 2012
		Xenith Bank				Xenith Bankshares				Xenith Bank				Xenith Bankshares				Regulatory Minimum				Well Capitalized
Tier 1 leverage ratio			10.37	%			10.52	%			12.78	%			12.90	%			4.00	%			> 5.00	%
Tier 1 risk-based capital ratio			13.16	%			13.35	%			15.25	%			15.39	%			4.00	%			> 6.00	%
Total risk-based capital ratio			14.23	%			14.42	%			16.38	%			16.52	%			8.00	%			> 10.00	%

Interest Rate Sensitivity

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

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

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

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

Gap Analysis

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

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

 

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The following table, “Gap Report,” indicates that, on a cumulative basis through the next 12 months, our interest-sensitive assets exceed interest-sensitive liabilities, resulting in an asset-sensitive position as of December 31, 2013 of $232.5 million. This net asset-sensitive position was a result of $478.3 million in interest-sensitive assets being available for re-pricing during the next 12 months and $245.8 million in interest-sensitive liabilities being available for re-pricing during the same time period. Our gap position as of December 31, 2013 is considered by management to be favorable in a flat to increasing interest rate environment .

 

		0-180 Days				181-360 days				1-3 Years				Over 3 Years				Totals
Assets:
Cash and cash due		$	14,227			$	—			$	—			$	—			$	24,944
Fed funds sold			5,749				—				—				—				5,749
Securities			7,860				5,467				16,084				41,568				69,185
Loans			435,592				9,126				22,378				70,628				541,805
Allowance for loan and lease losses			—				—				—				—				(5,305	)
Premises and equipment			—				—				—				—				5,069
Intangibles			—				—				—				—				15,624
OREO			—				—				—				—				199
Deferred tax asset			—				—				—				—				4,345
Bank owned life insurance			—				—				—				—				9,690
Other assets			326				—				—				4,159				8,591
Total assets		$	463,754			$	14,593			$	38,462			$	116,355			$	679,896
Liabilities and Equity:
Demand deposits		$	—			$	—			$	—			$	—			$	116,082
Interest-bearing deposits			103,827				141,978				179,629				27,683				453,116
Borrowed funds			—				—				20,000				—				20,000
Other liabilities			—				—				—				—				3,012
Shareholders’ equity			—				—				—				—				87,686
Total liabilities and equity		$	103,827			$	141,978			$	199,629			$	27,683			$	679,896
Discrete gap:		$	359,927			$	(127,385	)		$	(161,167	)		$	88,672
Cumulative gap:		$	359,927			$	232,542			$	71,375			$	160,047

Commitments and Contingencies

In the normal course of business, we have commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the contracts. These commitments generally have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Additionally, we issue letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

 

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These commitments represent outstanding off-balance sheet commitments. The following table presents unfunded loan commitments outstanding, including letters of credit, as of the date stated:

 

		December 31, 2013
Commercial lines of credit		$	69,286
Commercial real estate			49,148
Residential real estate			7,183
Consumer			481
Letters of credit			6,796
Loans held for sale			5,637
Total commitments		$	138,531

We have four non-cancelable agreements to lease four banking facilities with, as of December 31, 2013, remaining terms of three to six years. The following table presents the current minimum annual commitments under non-cancelable leases in effect at December 31, 2013 for the dates stated:

 

Year		Commitment
2014		$	927
2015			971
2016			718
2017			560
2018			522
Thereafter			229
Total lease commitments		$	3,927

In addition, we have a commitment to invest in a limited partnership that operates as a small business investment company. As of December 31, 2013, we had invested $300 thousand in the partnership. An additional $700 thousand will be funded at the request of the general partner of the partnership.

Recent Accounting Pronouncements

Recent accounting pronouncements affecting us are described in the notes to the consolidated financial statements included in “Item 8—Financial Statements and Supplementary Data.”

 

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Item 8—Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Xenith Bankshares, Inc.

We have audited the accompanying consolidated balance sheets of Xenith Bankshares, Inc. and subsidiary (“the Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal controls over financial reporting. Our audits included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal controls over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Xenith Bankshares, Inc. and subsidiary as of December 31, 2013 and December 31, 2012, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.

/s/ GRANT THORNTON LLP

Charlotte, North Carolina

March 11, 2014

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2013 AND DECEMBER 31, 2012

 

(in thousands, except share data)		December 31, 2013				December 31, 2012
Assets
Cash and cash equivalents
Cash and due from banks		$	24,944			$	9,457
Federal funds sold			5,749				2,906
Total cash and cash equivalents			30,693				12,363
Securities available for sale, at fair value			69,185				57,551
Loans held for sale			3,363				80,867
Loans held for investment, net of allowance for loan and lease losses, 2013 - $5,305; 2012 - $4,875			533,137				379,006
Premises and equipment, net			5,069				5,397
Other real estate owned			199				276
Goodwill and other intangible assets, net			15,624				15,989
Accrued interest receivable			2,403				1,606
Deferred tax asset			4,345				4,094
Bank owned life insurance			9,690				—
Other assets			6,188				6,057
Total assets		$	679,896			$	563,206
Liabilities and Shareholders’ Equity
Deposits
Demand and money market		$	359,455			$	317,526
Savings			4,785				4,069
Time			204,958				131,636
Total deposits			569,198				453,231
Accrued interest payable			215				232
Borrowings			20,000				20,000
Other liabilities			2,797				2,196
Total liabilities			592,210				475,659
Shareholders’ equity
Preferred stock, $1.00 par value, $1,000 liquidation value, 25,000,000 shares authorized as of December 31, 2013 and 2012; 8,381 shares issued and outstanding as of December 31, 2013 and 2012			8,381				8,381
Common stock, $1.00 par value, 100,000,000 shares authorized as of December 31, 2013 and 2012; 10,437,630 shares issued and outstanding as of December 31, 2013 and 10,488,060 shares issued and outstanding as of December 31, 2012			10,438				10,488
Additional paid-in capital			71,797				71,414
Accumulated deficit			(1,758	)			(3,660	)
Accumulated other comprehensive (loss) income, net of tax			(1,172	)			924
Total shareholders’ equity			87,686				87,547
Total liabilities and shareholders’ equity		$	679,896			$	563,206

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012

 

(in thousands, except per share data)		December 31, 2013				December 31, 2012
Interest income
Interest and fees on loans		$	24,074			$	24,254
Interest on securities			1,249				1,437
Interest on federal funds sold and deposits in other banks			310				285
Total interest income			25,633				25,976
Interest expense
Interest on deposits			2,148				2,656
Interest on time certificates of $100,000 and over			964				919
Interest on federal funds purchased and borrowed funds			374				372
Total interest expense			3,486				3,947
Net interest income			22,147				22,029
Provision for loan and lease losses			1,486				1,819
Net interest income after provision for loan and lease losses			20,661				20,210
Noninterest income
Service charges on deposit accounts			442				304
Net gain (loss) on sale and write-down of other real estate owned and other collateral			324				(11	)
Gain on sales of securities			291				220
Increase in cash surrender value of bank owned life insurance			190				—
Other			449				230
Total noninterest income			1,696				743
Noninterest expense
Compensation and benefits			11,317				10,579
Occupancy			1,499				1,439
FDIC insurance			409				326
Bank franchise taxes			788				615
Technology			1,611				1,580
Communications			258				272
Insurance			297				295
Professional fees			1,083				1,187
Other real estate owned			39				16
Amortization of intangible assets			365				365
Guaranteed student loan servicing			138				—
Other			1,502				1,470
Total noninterest expense			19,306				18,144
Income before income tax			3,051				2,809
Income tax expense (benefit)			1,065				(4,570	)
Net income			1,986				7,379
Preferred stock dividend			(84	)			(89	)
Net income available to common shareholders		$	1,902			$	7,290
Earnings per common share (basic and diluted):		$	0.18			$	0.70

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012

 

(in thousands)		December 31, 2013				December 31, 2012
Net income		$	1,986			$	7,379
Other comprehensive (loss) income, before taxes:
Unrealized (loss) gain on available-for-sale securities:
Unrealized (loss) gain arising during the year			(3,186	)			432
Reclassification adjustment for gains included in net income			(291	)			(220	)
Unrealized (loss) gain on available-for-sale securities			(3,477	)			212
Unrealized loss on derivative:
Unrealized gain (loss) arising during the year			164				(375	)
Reclassification adjustment for losses included in net income			138				101
Unrealized gain (loss) on derivative			302				(274	)
Other comprehensive loss, before taxes			(3,175	)			(62	)
Income tax benefit (expense) related to other comprehensive income			1,079				(476	)
Comprehensive (loss) income		$	(110	)		$	6,841

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012

 

(in thousands)		Preferred Stock				Common Stock				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Income (Loss)				Total Shareholders’ Equity
Balance - January 1, 2012		$	8,381			$	10,447			$	70,964			$	(10,950	)		$	1,462			$	80,304
Net income			—				—				—				7,379				—				7,379
Share-based compensation expense			—				—				301				—				—				301
Issuance of common stock			—				41				149				—				—				190
Dividend on preferred stock			—				—				—				(89	)			—				(89	)
Change in net unrealized gain on available-for-sale securities, net of tax of $572			—				—				—				—				(360	)			(360	)
Change in net unrealized loss on derivative, net of tax of $96			—				—				—				—				(178	)			(178	)
Balance - December 31, 2012		$	8,381			$	10,488			$	71,414			$	(3,660	)		$	924			$	87,547
Net income			—				—				—				1,986				—				1,986
Share-based compensation expense			—				—				629				—				—				629
Repurchase of common stock			—				(50	)			(246	)			—				—				(296	)
Dividend on preferred stock			—				—				—				(84	)			—				(84	)
Change in net unrealized loss on available-for-sale securities, net of tax of $1,182			—				—				—				—				(2,295	)			(2,295	)
Change in net unrealized gain on derivative, net of tax of $103			—				—				—				—				199				199
Balance - December 31, 2013		$	8,381			$	10,438			$	71,797			$	(1,758	)		$	(1,172	)		$	87,686

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012

 

(in thousands)		December 31, 2013				December 31, 2012
Cash flows from operating activities
Net income		$	1,986			$	7,379
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan and lease losses			1,486				1,819
Depreciation and amortization			1,209				1,300
Net amortization of securities			620				745
Accretion of acquisition accounting adjustments			(2,644	)			(3,335	)
Deferred tax expense (benefit)			957				(4,570	)
Gain on sales of securities			(291	)			(220	)
Share-based compensation expense			629				301
Net (gain) loss on sale and write-down of other real estate owned and other collateral			(324	)			11
Increase in cash surrender value of bank owned life insurance			(190	)			—
Change in operating assets and liabilities:
Originations of loans held for sale			(456,845	)			(712,108	)
Proceeds from sales of loans held for sale			534,349				631,241
Accrued interest receivable			(797	)			(131	)
Other assets			(98	)			481
Accrued interest payable			(17	)			(119	)
Other liabilities			577				59
Net cash provided by (used in) operating activities			80,607				(77,147	)
Cash flows from investing activities
Proceeds from sales, maturities and calls of securities			26,527				26,107
Purchases of securities			(41,968	)			(15,505	)
Net increase in loans held for investment			(152,858	)			(55,572	)
Net proceeds from sale of other real estate owned and other collateral			401				522
Purchases of bank owned life insurance			(9,500	)			—
Net purchase of premises and equipment			(516	)			(324	)
Sale of FRB and FHLB stock			50				162
Net cash used in investing activities			(177,864	)			(44,610	)
Cash flows from financing activities
Net increase in demand and savings deposits			42,645				90,046
Net increase (decrease) in time deposits			73,322				(11,822	)
Proceeds from the issuance of common stock			—				190
Repurchase of common stock			(296	)			—
Preferred stock dividend			(84	)			(89	)
Net cash provided by financing activities			115,587				78,325
Net increase (decrease) in cash and cash equivalents			18,330				(43,432	)
Cash and cash equivalents
Beginning of period			12,363				55,795
End of period		$	30,693			$	12,363
Supplementary disclosure of cash flow information
Cash payments for:
Interest		$	3,502			$	4,066
Income taxes		$	295			$	—
Transfer of loans to foreclosed assets		$	327			$	459

See notes to consolidated financial statements.

 

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

For the years ended December 31, 2013 and 2012

Note 1—Organization

General

Xenith Bankshares, Inc. (“Xenith Bankshares” or the “company”) is the bank holding company for Xenith Bank (the “Bank”), a Virginia-based institution headquartered in Richmond, Virginia. As of December 31, 2013, the company, through the Bank, operates six full-service branches: one branch in Tysons Corner, Virginia, two branches in Richmond, Virginia, and three branches in Suffolk, Virginia.

Background

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

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

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

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

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

 

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Note 2—Summary of Significant Accounting Policies

Basis of Presentation

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

All dollar amounts included in the tables in these notes are in thousands, except share data.

Use of Estimates

The preparation of the financial statements in conformity with United States generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, as well as the amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

Accounting for Acquisitions

The merger, the Paragon Transaction and the VBB Acquisition were determined to be acquisitions of businesses and were accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805 , “Business Combinations” (“ASC 805”), with the assets acquired and liabilities assumed pursuant to the business combinations recorded at estimated fair values as of the effective date of the acquisitions. The determination of fair values requires management to make estimates about future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to actual results that may differ materially from the estimates made.

Cash and Cash Equivalents

The company considers all highly-liquid debt instruments with original maturities, or maturities when purchased, of three months or less to be cash equivalents. Cash and cash equivalents include cash on hand, due from banks and federal funds sold.

Securities

Marketable securities are classified into three categories:

 

1.

debt securities that the company has the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost;

 

2.

debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in net income; and

 

3.

debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as “available-for-sale securities” and reported at fair value, with unrealized gains and losses excluded from net income. Such unrealized gains and losses are reported in other comprehensive income, net of tax, and as a separate component of shareholders’ equity, net of tax.

As of December 31, 2013, the company holds no trading securities or held-to-maturity securities. Purchased premiums and discounts are recognized in interest income using the effective interest method over the terms of the securities. Gains or losses on disposition of securities are based on the net proceeds and adjusted carrying values of the securities called or sold, using the specific identification method.

A decline in the market value of any available-for-sale security below cost that is deemed other than temporary is charged to net income, resulting in the establishment of a new cost basis for the security.

 

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Loans Held for Sale

Loans held for sale represent loans held through the company’s sub-participation with a commercial bank (the “participating bank”), whereby the participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators and the participating bank deliver the loans to the investors. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

Loans Held for Investment

Loans held for investment are carried at their principal amount outstanding net of unamortized fees, origination costs and, in the case of acquired loans, unaccreted fair value adjustments. Interest income is recorded as earned on an accrual basis. Generally, the accrual of interest income is discontinued when a loan is 90 days or greater past due as to principal or interest or when the collection of principal and/or interest is in doubt, which may occur in advance of the loan being past due 90 days. Subsequent cash receipts are applied to principal until the loan is in compliance with stated terms. The accrual of interest is not discontinued on loans past due 90 days or greater if the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection. Loan origination fees, net of origination costs, are deferred and recognized as an adjustment to the yield (interest income) of the related loans. The company uses the allowance method in providing for possible loan losses.

Management considers loans to be impaired when, based on current information and events, it is probable that the company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Factors that influence management’s judgments include, but are not limited to, payment history, source of repayment and value of any collateral. A loan would not be considered impaired if an insignificant delay in loan payment occurs and management expects to collect all amounts due. The major sources for identification of loans to be evaluated for impairment include past due and non-accrual reports, internally generated lists of certain risk ratings and loan review. Impaired loans are measured using either the discounted expected cash flows or the value of collateral (less costs of disposal). All nonperforming loans are considered to be impaired loans.

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

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

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

For acquired credit-impaired loans, the excess of cash flows expected to be collected over the estimated acquisition-date fair value is referred to as the accretable yield and is accreted into interest income over the period of expected cash flows from the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected at acquisition, on an undiscounted basis, is referred to as the nonaccretable difference.

ASC 310-30 requires periodic re-evaluation of expected cash flows for acquired credit-impaired loans subsequent to acquisition date. Decreases in the amount or timing of expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Impairment charges are recorded as an increase in the provision for loan and lease losses in the company’s consolidated statements of operations and an increase in the allowance for loan and lease losses in the company’s consolidated balance sheets. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The new accretable yield is recognized in income over the remaining period of expected cash flows from the loan. The company re-evaluates expected cash flows no less frequent than annually and generally on a quarterly basis.

 

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Acquired loans for which the company cannot predict the amount or timing of cash flows are accounted for under the cost recovery method, whereby principal and interest payments received reduce the carrying value of the loan until such amount has been received. Amounts received in excess of the carrying value are reported in interest income.

Allowance for Loan and Lease Losses

The company’s allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “ Contingencies ,” and (2) a component for individual loan impairment recognized and measured pursuant to FASB ASC Topic 310, “ Receivables ” (“ASC 310”).

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

In assessing the adequacy of the allowance for loan and lease losses, the company evaluates loan risk ratings. Each loan is assigned two “risk ratings” at origination. One risk rating is based on management’s assessment of the borrower’s financial capacity and the other is based on the type of our collateral and estimated loan to value. In addition to risk ratings, management considers internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to policies, and external observable data such as industry and general economic trends.

In evaluating loans accounted for under ASC 310-30, management must periodically estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including management’s knowledge of the borrower’s financial condition at the time of measurement, historical payment activity, and the estimated liquidation value of underlying collateral, in addition to other factors. Upon re-estimation, any deterioration in the timing and/or amount of cash flows results in an impairment charge, which is reported as a provision for loan and lease losses in net income and a component of the company’s allowance for loan and lease losses. A subsequent improvement in the expected timing or amount of future cash flows for those loans could result in the reduction of the allowance for loan and lease losses and an increase in our net income.

In evaluating the company’s acquired guaranteed student loans, the allowance for loan and lease losses is based on historical default rates for similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guaranty.

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

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

Premises, Equipment and Depreciation

Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation or amortization. Premises and equipment acquired pursuant to a business combination are recorded at estimated fair values as of the acquisition date. Depreciation is calculated over the estimated useful lives of the respective assets on a straight-line basis. Leasehold improvements are amortized over a term which includes the remaining lease term and probable renewal periods. Land is not subject to depreciation. Maintenance and repairs are charged to expense as incurred. The costs of major additions and improvements are capitalized and depreciated over their estimated useful lives. Depreciable lives for major categories of assets are as follows:

 

Building and improvements			5 to 40 years
Equipment, furniture and fixtures			3 to 20 years

 

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Other Real Estate Owned (“OREO”)

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at estimated fair value less costs of disposal at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations, and, if required, a reserve is established to reflect the net carrying amount of the assets at the lower of carrying value or the fair value less costs of disposal. Revenue and expenses from operations and changes in the valuation of other real estate owned are included in net income.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired. Goodwill is tested at least annually for impairment, which requires as a first step the comparison of the fair value of each reporting unit to its carrying value. For purposes of determining fair value of the reporting unit, fair value is defined as “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.” If the fair value of the reporting unit is determined to be less than the reporting unit’s carrying value of its equity, a second step of the impairment test is required, which involves allocating the fair value of the reporting unit to all of the assets and liabilities of the unit, with the excess of fair value over allocated net assets representing the fair value of the unit’s goodwill. Impairment is measured as the amount, if any, by which the carrying value of the reporting unit’s goodwill exceeds the estimated fair value of that goodwill. The company’s recorded goodwill results from the merger with First Bankshares. Management has concluded that none of its recorded goodwill was impaired as of the testing date, which was October 31, 2013. There have been no events since the testing date that would indicate the company’s goodwill is impaired.

Other intangible assets, which represent core deposit intangibles, are amortized over their estimated useful life. The company’s core deposit intangibles were acquired in the merger and the Paragon Transaction and are being amortized on a straight-line basis over 10 years. The company has not identified any events or circumstances that would indicate impairment in the carrying amounts of other intangibles.

The company periodically assesses whether events or changes in circumstances indicate that the carrying amounts of intangible assets may be impaired.

Operating Leases

The company has operating leases for four of its locations. The lease agreements for certain locations contain rent escalation clauses, rent holidays and leasehold improvement allowances. Scheduled rent escalations during the lease terms, rental payments commencing at a date other than the date of initial occupancy and leasehold improvement allowances received are recognized on a straight-line basis over the terms of the leases in occupancy expense in the consolidated statements of operations. Liabilities related to the difference between actual payments and the straight-lining of rent are recorded in other liabilities on the consolidated balance sheets.

Income Taxes

The company computes its income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements’ carrying amount of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred tax assets are evaluated for recoverability, and a valuation allowance is provided until it is more likely than not that these tax benefits will be realized. The evaluation of the recoverability of deferred tax assets requires management to make significant judgments regarding the reversals of temporary differences and future profitability, among other items.

In accordance with ASC 740-10, any estimated tax exposure items identified are required to be considered in a tax contingency reserve. Changes in any tax contingency reserve would be based on specific developments, events or transactions.

 

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Share-based Compensation

The company accounts for share-based compensation awards at the estimated fair value at the grant date of the award, and compensation expense for the grant-date fair value of the award is recognized over the requisite service period in which the awards are expected to vest.

Derivatives

The company uses interest rate derivatives to manage its exposure to interest rate movements. To accomplish this objective, the company is a party to interest rate swaps whereby the company pays fixed amounts to a counterparty in exchange for receiving variable payments over the life of an underlying agreement without the exchange of underlying notional amounts.

Derivatives designated as cash flow hedges are used primarily to minimize the variability in cash flows of assets or liabilities caused by interest rates. Cash flow hedges are periodically tested for effectiveness, which measures the correlation of the cash flows of the hedged item with the cash flows from the derivative. The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recorded in accumulated other comprehensive income (“AOCI”) and is subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivative is recognized directly in earnings.

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

Bank Owned Life Insurance

The Bank invests in bank owned life insurance (“BOLI”), which is life insurance purchased by the Bank on a selected group of employees. The Bank is the owner and primary beneficiary of the policies. BOLI is recorded in the company’s balance sheet at the cash surrender value of the underlying policies. Earnings from the increase in cash surrender value of the policies are included in noninterest income on the statements of operations. The Bank has rights under the insurance contracts to redeem them for book value at any time.

Note 3—Restrictions on Equity Securities and Cash

As a member of the Board of Governors of the Federal Reserve System (“Federal Reserve”), the Bank is required to own shares of Federal Reserve stock in an amount equal to 0.06% of total capital stock and surplus. As a member of the Federal Home Loan Bank ( “FHLB”), the Bank is required to own shares of FHLB capital stock in an amount equal to at least 0.12% of total assets plus 4.50% of any outstanding advances.

Federal Reserve stock and FHLB stock are carried at cost. As of December 31, 2013 and 2012, the Bank had $4.2 million and $4.2 million, respectively, in Federal Reserve and FHLB stock, which is included in other assets on the company’s consolidated balance sheets.

Additionally, to comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement for the weeks closest to December 31, 2013 and 2012 was $8.5 million and $3.1 million, respectively.

 

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Note 4—Securities

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

 

		December 31, 2013
						Gross Unrealized
		Book Value				Gains				(Losses)				Fair Value
Mortgage-backed securities
- Fixed rate		$	45,693			$	368			$	(724	)		$	45,337
- Variable rate			4,903				77				(128	)			4,852
Municipals
- Taxable			9,810				—				(840	)			8,970
- Tax exempt			1,634				—				(61	)			1,573
Collateralized mortgage obligations			8,940				57				(544	)			8,453
Total securities available for sale		$	70,980			$	502			$	(2,297	)		$	69,185
		December 31, 2012
						Gross Unrealized
		Book Value				Gains				(Losses)				Fair Value
Mortgage-backed securities
- Fixed rate		$	42,804			$	1,436			$	—			$	44,240
- Variable rate			2,038				143				—				2,181
Municipals			1,050				—				(50	)			1,000
Collateralized mortgage obligations			9,977				158				(5	)			10,130
Total securities available for sale		$	55,869			$	1,737			$	(55	)		$	57,551

As of December 31, 2013 and 2012, the company had securities with a fair value of $6.3 million and $6.4 million, respectively, pledged as collateral for public deposits.

The following table presents the book value and fair value of available-for-sale securities by contractual maturity as of the date stated:

 

		December 31, 2013
		Book Value				Fair Value
Due within one year		$	—			$	—
Due after one year through five years			—				—
Due after five years through ten years			33,795				33,223
Due after ten years			37,185				35,962
Total securities available for sale		$	70,980			$	69,185

 

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

 

		December 31, 2013
						Less than 12 months								More than 12 months								Total
		Number				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Mortgage-backed securities
- Fixed rate			10			$	26,610			$	(724	)		$	—			$	—			$	26,610			$	(724	)
- Variable rate			2				3,214				(128	)			—				—				3,214				(128	)
Municipals
- Taxable			5				8,069				(697	)			901				(143	)			8,970				(840	)
- Tax exempt			1				1,573				(61	)			—				—				1,573				(61	)
Collateralized mortgage obligations			3				6,361				(544	)			—				—				6,361				(544	)
Total securities			21			$	45,827			$	(2,154	)		$	901			$	(143	)		$	46,728			$	(2,297	)

 

		December 31, 2012
						Less than 12 months								More than 12 months								Total
		Number				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Municipals			1			$	1,000			$	(50	)		$	—			$	—			$	1,000			$	(50	)
Collateralized mortgage obligations			1				3,288				(5	)			—				—				3,288				(5	)
Total securities			2			$	4,288			$	(55	)		$	—			$	—			$	4,288			$	(55	)

All securities held as of December 31, 2013 were investment grade. The unrealized loss position at December 31, 2013 was directly related to interest rate movements and management believes there is minimal credit risk exposure in these investments. There is no intent to sell investments that were in an unrealized loss position at December 31, 2013, and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses. These investments were not considered to be other-than-temporarily impaired at December 31, 2013; therefore, no permanent impairment has been recognized through earnings.

Note 5—Loans

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

 

		December 31, 2013								December 31, 2012
		Amount				Percent of Total				Amount				Percent of Total
Commercial and industrial		$	246,324				45.75	%		$	203,880				53.11	%
Commercial real estate			172,711				32.08	%			150,796				39.28	%
Residential real estate			22,004				4.09	%			24,291				6.33	%
Consumer			3,191				0.59	%			4,886				1.27	%
Guaranteed student loans			94,028				17.46	%			—				0.00	%
Overdrafts			184				0.03	%			28				0.01	%
Loans held for investment		$	538,442				100.00	%		$	383,881				100.00	%
Allowance for loan and lease losses			(5,305	)							(4,875	)
Loans held for investment, net of allowance			533,137								379,006
Loans held for sale			3,363								80,867
Total loans		$	536,500							$	459,873

 

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Total loans include unearned fees, net of capitalized origination costs, of $244 thousand and $245 thousand, respectively, for the years ended December 31, 2013 and 2012. As of December 31, 2013, $213.1 million of loans were pledged as collateral for borrowing capacity.

During the third quarter of 2013, the company began purchasing guaranteed student loans, which were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, these student loans are substantially guaranteed by a guaranty agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program, under which borrowers under defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor are brought current and sold to approved lenders.

As of December 31, 2013, the company had $94.0 million of guaranteed student loans recorded as loans held for investment on its consolidated balance sheet. This balance includes premium and acquisition costs of $2.6 million and $1.4 million, respectively, which are amortized into interest income on the effective interest method. The guaranteed student loans carry an approximate 98% federal government guaranty of principal and accrued interest.

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

 

		December 31, 2013
		Pass				Special Mention				Substandard				Doubtful				Total Loans
Commercial and industrial		$	238,655			$	1,990			$	5,679			$	—			$	246,324
Commercial real estate			166,398				2,366				3,947				—				172,711
Residential real estate			21,014				132				858				—				22,004
Consumer			2,849				—				342				—				3,191
Guaranteed student loans			94,028				—				—				—				94,028
Overdrafts			184				—				—				—				184
Total loans		$	523,128			$	4,488			$	10,826			$	—			$	538,442
		December 31, 2012
		Pass				Special Mention				Substandard				Doubtful				Total Loans
Commercial and industrial		$	196,004			$	4,813			$	3,063			$	—			$	203,880
Commercial real estate			139,206				6,407				5,183				—				150,796
Residential real estate			23,282				87				922				—				24,291
Consumer			4,466				154				266				—				4,886
Overdrafts			28				—				—				—				28
Total loans		$	362,986			$	11,461			$	9,434			$	—			$	383,881

 

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

 

		December 31, 2013				December 31, 2012
Balance at beginning of period		$	4,875			$	4,280
Charge-offs:
Commercial and industrial			51				51
Commercial real estate			815				1,127
Residential real estate			52				—
Consumer			16				2
Guaranteed student loans			—				—
Overdrafts			9				9
Total charge-offs			943				1,189
Recoveries:
Commercial and industrial			—				—
Commercial real estate			—				20
Residential real estate			—				—
Consumer			—				3
Guaranteed student loans			—				—
Overdrafts			2				1
Total recoveries			2				24
Net charge-offs			941				1,165
Provision for loan and lease losses			1,486				1,819
Amount for unfunded commitments			(115	)			(59	)
Balance at end of period		$	5,305				4,875

The following tables present the allowance for loan and lease losses, with the amount independently and collectively evaluated for impairment, and loan balances, by loan type, as of the dates stated:

 

		December 31, 2013
		Total Amount				Individually Evaluated for Impairment				Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Commercial and industrial		$	2,148			$	292			$	1,856
Commercial real estate			2,756				298				2,458
Residential real estate			194				10				184
Consumer			12				—				12
Guaranteed student loans			195				—				195
Total allowance for loan and lease losses		$	5,305			$	600			$	4,705
Loan balances applicable to:
Commercial and industrial		$	246,324			$	5,526			$	240,798
Commercial real estate			172,711				4,875				167,836
Residential real estate			22,004				632				21,372
Consumer			3,375				8				3,367
Guaranteed student loans			94,028				—				94,028
Total loans		$	538,442			$	11,041			$	527,401

 

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		December 31, 2012
		Total Amount				Individually Evaluated for Impairment				Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Commercial and industrial		$	1,523			$	296			$	1,227
Commercial real estate			3,086				782				2,304
Residential real estate			245				32				213
Consumer			21				16				5
Total allowance for loan and lease losses		$	4,875			$	1,126			$	3,749
Loan balances applicable to:
Commercial and industrial		$	203,880			$	3,803			$	200,077
Commercial real estate			150,796				8,590				142,206
Residential real estate			24,291				560				23,731
Consumer			4,914				72				4,842
Total loans		$	383,881			$	13,025			$	370,856

The company’s allowance for loan and lease losses related to guaranteed student loans is based on historical default rates for similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guaranty.

The following tables present loans that were individually evaluated for impairment, by loan type, as of the date stated. The table presents those loans with and without an allowance, and various additional data, for the periods stated.

 

		December 31, 2013
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Commercial and industrial		$	3,413			$	4,484			$	—			$	3,342			$	159
Commercial real estate			2,075				3,002				—				2,719				—
Residential real estate			444				474				—				447				8
Consumer			8				8				—				10				1
With an allowance recorded:
Commercial and industrial			2,113				2,194				292				2,220				50
Commercial real estate			2,800				3,085				298				2,934				197
Residential real estate			188				198				10				190				2
Consumer			—				—				—				—				—
Total loans individually evaluated for impairment		$	11,041			$	13,445			$	600			$	11,862			$	417

 

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		December 31, 2012
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Commercial and industrial		$	1,202			$	2,220			$	—			$	1,178			$	48
Commercial real estate			2,897				5,029				—				3,724				115
Residential real estate			120				140				—				121				11
Consumer			2				12				—				4				1
With an allowance recorded:
Commercial and industrial			2,601				2,680				296				2,665				116
Commercial real estate			5,693				6,663				782				5,613				343
Residential real estate			440				457				32				278				8
Consumer			70				60				16				77				5
Total loans individually evaluated for impairment		$	13,025			$	17,261			$	1,126			$	13,660			$	647

Pursuant to the merger with First Bankshares, the acquired loans were adjusted to estimated fair value with a discount of $7.6 million. As of July 29, 2011, the loans acquired in the Paragon Transaction and the VBB Acquisition were also adjusted to estimated fair values by recording a discount of $1.8 million and $14.0 million, respectively. The allowance for loan and lease losses does not include the remaining fair value adjustments (discounts) recorded as a result of these acquisitions.

Of the $14.0 million discount recorded on the VBB Acquisition, $12.7 million was related to $40.2 million of purchased credit-impaired loans. The remaining fair value adjustment on the purchased credit-impaired loans, as of December 31, 2013, was $2.9 million. The carrying value of purchased impaired loans, as of December 31, 2013, was approximately $9.9 million, which is net of any impairment charges recorded subsequent to acquisition.

For acquired credit-impaired loans, the excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield and accreted into interest income over the remaining life of the loan using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference. As of December 31, 2013 and 2012, the company had $904 thousand and $1.2 million, respectively, of nonaccretable difference related to the credit-impaired loans acquired in the VBB Acquisition.

During 2013, as a result of the periodic re-evaluation of expected cash flows, the company recorded impairment charges of $191 thousand due to deterioration in the timing and/or amount of cash flows of certain purchased credit-impaired loans. This charge is reported as a provision for loan and lease losses in the consolidated statements of operations. As of December 31, 2013, the company had $392 thousand in its allowance for loan and lease losses related to these loans. If upon remeasurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that have improved from those previously determined, some portion of the impairment could be reversed.

The following table presents the accretion activity related to acquired loans as of the dates stated:

 

		December 31, 2013				December 31, 2012
Balance at beginning of period		$	8,133			$	14,007
Accretion (1)			(2,644	)			(3,335	)
Disposals (2)			(1,048	)			(2,539	)
Balance at end of period		$	4,441			$	8,133

 

(1)	Accretion amounts are reported in interest income.

(2)	Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2013 amount, $85 thousand relates to loans reclassified as OREO.

 

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The following tables present the age analysis of loans past due as of the dates stated:

 

		December 31, 2013
		30-89 days Past Due				90+ days Past Due				Total Past Due
Commercial and industrial		$	1,034			$	781			$	1,815
Commercial real estate			—				17				17
Residential real estate			228				385				613
Consumer			4				—				4
Guaranteed student loans			43,875				—				43,875
Total		$	45,141			$	1,183			$	46,324
		December 31, 2012
		30-89 days Past Due				90+ days Past Due				Total Past Due
Commercial and industrial		$	1,592			$	1,657			$	3,249
Commercial real estate			1,762				2,256				4,018
Residential real estate			—				74				74
Consumer			3				—				3
Total		$	3,357			$	3,987			$	7,344

Guaranteed student loans comprise $43.9 million of the total amounts that are past due 30-89 days as of December 31, 2013. These loans are nearly 98% guaranteed as to principal and interest. Pursuant to the guaranty, the company may make a claim for payment on a loan after a period of 270 days during which no payment has been made on the loan.

The following table presents nonaccrual loans and OREO as of the dates stated. A loan is considered nonaccrual if it is 90 days or greater past due as to principal or interest or when there is serious doubt as to collectability, unless the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection.

 

		December 31, 2013				December 31, 2012
Commercial and industrial		$	2,386			$	1,847
Commercial real estate			883				3,148
Residential real estate			553				74
Consumer			—				—
Total nonaccrual loans		$	3,822			$	5,069
Other real estate owned			199				276
Total nonperforming assets		$	4,021			$	5,345

In accordance with Accounting Standards Update (“ASU”) No. 2011-02, “ Receivables: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” the company assesses all restructurings for potential identification as troubled debt restructurings (“TDRs”). A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. Modifications of terms for loans that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal payments, regardless of the period of the modification.

For loans classified as TDRs, the company further evaluates the loans as performing or nonperforming. If at the time of restructure the loan is on accrual status, it will be classified as performing and will continue to be classified as performing

 

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as long as the borrower continues making payments in accordance with the restructured terms. A modified loan will be classified as nonaccrual if the loan becomes 90 days delinquent. TDRs originally considered nonaccrual will be classified as nonperforming, but may be classified as performing TDRs if subsequent to restructure the loan experiences payment performance according to the restructured terms for a consecutive six-month period.

The following table presents performing and nonperforming loans identified as TDRs, by loan type, as of the dates stated:

 

		December 31, 2013				December 31, 2012
Performing:
Commercial and industrial		$	1,030			$	—
Commercial real estate			908				—
Residential real estate			—				123
Consumer			—				—
Total performing TDRs		$	1,938			$	123
Nonperforming:
Commercial and industrial		$	1,940			$	1,439
Commercial real estate			17				411
Residential real estate			120				—
Consumer			—				—
Total nonperforming TDRs		$	2,077			$	1,850
Total TDRs		$	4,015			$	1,973

The following tables present loans classified as TDRs, including the type of modification, number of loans and loan type, as of the dates stated:

 

		December 31, 2013
		Number of Loans Modified				Rate Modification (1)				Term Extension and/or Other Concessions				Total
Commercial and industrial			8			$	1,159			$	1,812			$	2,971
Commercial real estate			3				908				17				925
Residential real estate			1				—				119				119
Consumer			—				—				—				—
Total TDRs			12			$	2,067			$	1,948			$	4,015

 

(1)	Restructured loans that had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

 

		December 31, 2012
		Number of Loans Modified				Rate Modification (1)				Term Extension and/or Other Concessions				Total
Commercial and industrial			3			$	657			$	782			$	1,439
Commercial real estate			7				411				—				411
Residential real estate			1				—				123				123
Consumer			—				—				—				—
Total TDRs			11			$	1,068			$	905			$	1,973

 

(1)	Restructured loans that had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

 

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During the period ended December 31, 2013, the company identified eight loans as TDRs, which totaled $2.5 million and are included in the tables above. During the period ended December 31, 2013, two loans totaling $137 thousand have not complied with the terms of the restructuring.

Note 6—Goodwill and Other Intangible Assets

Goodwill of $13.0 million was recorded in the allocation of the purchase price for the merger with First Bankshares. Core deposit intangibles of $3.7 million were recorded in the allocation of the consideration in the merger and the Paragon Transaction.

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

 

		December 31, 2013				December 31, 2012
Amortizable core deposit intangibles:
Gross carrying value		$	3,710			$	3,710
Accumulated amortization			(1,075	)			(710	)
Net core deposit intangibles			2,635				3,000
Unamortizable goodwill			12,989				12,989
Total goodwill and other intangible assets, net		$	15,624			$	15,989

The following table presents the estimated future amortization expense for core deposit intangibles:

 

Year		Core Deposit Intangibles
2014		$	365
2015			365
2016			365
2017			365
2018			365
Thereafter			810
Total		$	2,635

Note 7—Premises and Equipment

The following table presents premises and equipment as of the dates stated:

 

		December 31, 2013				December 31, 2012
Land		$	1,040			$	1,040
Building and leasehold improvements			4,436				4,423
Equipment, furniture and fixtures			4,849				4,347
Vehicles			69				69
Total premises and equipment			10,394				9,879
Less: accumulated depreciation and amortization			(5,325	)			(4,482	)
Premises and equipment, net		$	5,069			$	5,397

Depreciation and amortization expense related to premises and equipment for the years ended December 31, 2013 and 2012 was $844 thousand and $935 thousand, respectively.

 

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Note 8—Deposits

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

 

		December 31, 2013				December 31, 2012
Noninterest-bearing demand deposits		$	116,083			$	74,539
Interest-bearing:
Demand and money market			243,372				242,987
Savings deposits			4,785				4,069
Time deposits of $100,000 or more			146,834				72,870
Other time deposits			58,124				58,766
Total deposits		$	569,198			$	453,231

The following table presents time deposit accounts by year of maturity and weighted average interest rates for the next five years and thereafter, as of December 31, 2013:

 

		Total				Weighted Average Rate
2014		$	127,711				0.68	%
2015			44,361				1.29	%
2016			27,434				1.25	%
2017			3,375				1.51	%
2018			2,077				1.28	%
Total time deposits		$	204,958

Note 9—Derivatives

Cash Flow Hedge

The company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements. To accomplish this objective, the company is a party to two interest rate swap agreements. Pursuant to one of the agreements, the company pays fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreements without exchange of the underlying notional amount of $20 million. Pursuant to the other agreement, the company has minimized its exposure to interest rate movements beginning at a specified future date without exchange of the underlying notional amount of $7.5 million. As of December 31, 2013, the company’s two interest rate swaps were designated as cash flow hedges, in accordance with FASB ASC Topic 815, “Derivatives and Hedging.”

The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recorded in AOCI and is subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivative is recognized directly in earnings. During the period ended December 31, 2013, the ineffective portion of the derivative was insignificant. The amount reported in AOCI related to cash flow hedges, as of December 31, 2013, was a gain of $13 thousand, net of a tax expense of $7 thousand. As of December 31, 2013 and 2012, an asset of $192 thousand and $0, respectively, was recorded in other assets on the consolidated balance sheets related to these derivatives. As of December 31, 2013 and 2012, a hedge liability of $191 thousand and $283 thousand, respectively, was recorded in other liabilities on the consolidated balance sheets related to these derivatives.

 

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The following table presents the impacts of the derivatives recorded in other comprehensive income (“OCI”) on the consolidated statements of comprehensive income, as of the dates stated:

 

		Amount of Gain (Loss) Recognized in OCI on Derivatives (Effective Portion) December 31,								Classification of Loss Reclassified from AOCI into Income (EffectivePortion)				Amount of Loss Reclassified from AOCI into Income (Effective Portion) December 31,
		2013				2012								2013				2012
Derivatives in cash flow hedging relationships:
Interest rate products		$	164			$	(375	)			Interest expense			$	(138	)		$	(101	)
Total derivatives in cash flow hedging relationships		$	164			$	(375	)						$	(138	)		$	(101	)

The company has agreements with the counterparty to its derivatives which contain a provision whereby if the company fails to maintain its status as a well/an adequately capitalized institution, the company could be required to terminate or fully collateralize the derivative contract. Additionally, if the company defaults on any of its indebtedness, including default where repayment has not been accelerated by the lender, the company could also be in default on its derivative obligations. The company has minimum collateral requirements with its counterparty, and as of December 31, 2013, $250 thousand has been pledged as collateral under the agreement, as the valuation of the derivative had surpassed the contractually specified minimum transfer amount of $250 thousand. If the company is not in compliance with the terms of the derivative agreement, it could be required to settle its obligations under the agreement at termination value.

Non-hedge Derivatives

Derivatives not designated as hedges are not speculative and result from a service the company provides to certain customers. The company executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the company executes with a third party, thus minimizing its net exposure from such transactions. These derivatives do not meet the hedge accounting requirements; therefore, changes in the fair value of both the customer derivative and the offsetting derivative are recognized in interest income on the consolidated statements of operations. As of December 31, 2013, $135 thousand was recorded in other assets and $113 thousand was recorded in other liabilities related to non-designated hedges. For the years ended December 31, 2013 and 2012, $204 thousand and $16 thousand, respectively, was recorded in net income related to non-designated hedges. As of December 31, 2013, the company had $200 thousand pledged as collateral with respect to non-hedge derivatives.

Note 10—Borrowings

Short-term borrowing sources include federal funds purchased and the FHLB. The Bank has a $9.0 million credit line with its correspondent bank, which expires in March 2014. The Bank also has three uncommitted lines of credit by national banks to borrow federal funds up to $28.0 million on an unsecured basis. The lines of credit are not confirmed lines or loans and can be cancelled at any time. One line for $5.0 million terminates on June 30, 2014, if not cancelled earlier. The other two lines for $23.0 million have no stated termination date. As of December 31, 2013, no amounts were outstanding under these uncommitted lines of credit.

The Bank also has secured facilities with the FHLB and the Federal Reserve Bank. Credit availability under the FHLB facility as of December 31, 2013 was $181.3 million based on 30% of total assets as of the most recent prior quarter-end. Credit availability under the Federal Reserve Bank facility as of December 31, 2013 was $112.1 million, which is based on pledged collateral. At December 31, 2013 and 2012, the Bank had no federal funds purchased or other short-term borrowings.

Interest on federal funds purchased is paid on a daily basis. Interest only is payable on a monthly basis on FHLB and Federal Reserve Bank short-term borrowings until maturity.

At December 31, 2013 and 2012, the Bank had long-term FHLB borrowings of $20.0 million, collateralized by whole loans. The borrowing is a nonamortizing term loan and bears interest at a rate of 20 basis points over LIBOR, which resets quarterly. The modified borrowing matures on September 28, 2015. In connection with a modification of the borrowing in 2011, the Bank paid a fee of $533 thousand, which is being recognized as interest expense over the remaining term of the borrowing. The amount to be expensed in future years, as of December 31, 2013, is $233 thousand and is recorded in other assets on the company’s consolidated balance sheet. As discussed above, the Bank has entered into a cash flow hedge that effectively converts this adjustable rate borrowing to a fixed rate borrowing. For the period ended December 31, 2013, the

 

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effective interest rate, including the effect of the prepayment fee and cash flow hedge, was 1.84%. Interest is payable on a quarterly basis on convertible borrowings until maturity. The following table presents the terms of the FHLB long-term borrowing as of December 31, 2013:

 

Maturity Date		Type				Interest Rate				Balance
September 28, 2015			Adjustable rate				0.48	%		$	20,000

Note 11—Income Taxes

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

Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities. These differences will result in deductible or taxable amounts in a future year(s) when the reported amounts of assets or liabilities are recovered or settled. A valuation allowance is recorded against all or a portion of deferred tax assets when it is more likely than not that all or a portion of the asset will not be realized.

As of September 30, 2012, the company assessed the need for a valuation allowance, evaluating both positive and negative evidence. As part of its evaluation, the company considered the following positive evidence:

 

•

The company was in a positive cumulative pre-tax income position for the period since the merger with First Bankshares.

 

•

The company’s quarterly pre-tax operating results had improved each of the prior four quarters ending September 30, 2012.

 

•

The company’s financial projections were sufficient to absorb net deferred tax assets.

 

•

The company expected to generate taxable income, before the utilization of net operating losses, in 2012 and in future years.

 

•

Deferred tax assets included $2.3 million related to $6.8 million of net operating losses, which under current law can be carried forward for 20 years from the date reported.

 

•

The company believed it has not experienced a “change in control,” as defined under Internal Revenue Code Section 382 and related regulations, since the effective date of the merger with First Bankshares in 2009. Accordingly, the company believed it had incurred no limitations on the use of its net operating losses since the date of the merger.

 

•

The company believed its allowance for loan and lease losses plus its discounts recorded on acquired loans to be adequate to avoid significant charges to net income related to problem loans.

 

•

A significant portion of the company’s net interest income is based on long-term contracts with a significant number of customers.

As part of its evaluation as of September 30, 2012, the company considered the following negative evidence:

 

•

The company did not have taxable income in carryback periods available to offset existing deferred tax assets.

 

•

The company had no executable tax planning strategies to utilize future tax deductible amounts.

 

•

The company operates in a competitive and highly-regulated industry, which could impact its future profitability.

Based on the weight of available evidence as of September 30, 2012, the company believed it is more likely than not that its net deferred tax asset would be utilized in future periods; therefore, at September 30, 2012 the company reversed the full valuation allowance. As of December 31, 2013, there has been no change in the evaluation criteria that would change the company’s conclusion that it believes it is more likely than not that its deferred tax assets will be utilized in future periods.

The company had no unrecognized tax benefits recorded as of December 31, 2013 and 2012.

 

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The following table presents the components of the net deferred tax asset as of the dates stated:

 

		December 31, 2013				December 31, 2012
Deferred tax assets
Allowance for loan and lease losses		$	2,900			$	2,428
Start-up costs			1,804				1,979
Incentives related to leases			95				99
Compensation related			215				110
Unrealized losses/expenses related to OREO			—				67
Unrealized losses on derivatives			—				96
Unrealized losses on available-for-sale securities			610				—
Unearned interest on non-accrual loans			40				—
Other tax assets			11				8
Net operating loss carryforward			—				1,804
Gross deferred tax assets			5,675				6,591
Deferred tax liabilities
Depreciation			86				101
Unearned loan costs in excess of loan fees			314				217
Acquisition accounting adjustments			88				129
Basis in acquired loans			813				1,478
Unrealized gains on derivatives			7				—
Unrealized gains/expenses related to OREO			22				—
Unrealized gains on available-for-sale securities			—				572
Gross deferred tax liabilities			1,330				2,497
Net deferred tax asset		$	4,345			$	4,094

The following table presents the current and deferred income tax expense for the date stated:

 

		December 31, 2013
Income before income tax expense		$	3,051
Current income tax expense		$	108
Deferred income tax expense			957
Total income tax expense		$	1,065

The following table presents the statutory tax rate reconciled to the company’s effective tax rate for the dates stated:

 

		December 31, 2013								December 31, 2012
		Tax				Rate				Tax				Rate
Income tax expense at statutory rate		$	1,037				34.00	%		$	955				34.00	%
Meals and entertainment			9				0.31	%			11				0.39	%
Share-based compensation			86				2.80	%			138				4.91	%
Valuation allowance			—				0.00	%			(5,674	)			(201.99	)%
Tax exempt income			(67	)			(2.21	)%			—				0.00	%
Income tax (benefit) expense reported		$	1,065				34.90	%		$	(4,570	)			(162.69	)%

 

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Note 12—Earnings per Share

The following table summarizes basic and diluted earnings per common share calculations for the periods stated. The number of shares are in thousands.

 

		For the Years Ended December 31,
		2013				2012
Net income		$	1,986			$	7,379
Preferred stock dividend			(84	)			(89	)
Net income available to common shareholders		$	1,902			$	7,290
Weighted average shares outstanding, basic (1)			10,491				10,448
Dilutive shares			51				1
Weighted average shares outstanding, diluted			10,542				10,449
Earnings per common share, basic		$	0.18			$	0.70
Earnings per common share, diluted		$	0.18			$	0.70

 

(1)	Includes vested restricted stock units.

Note 13—Share Repurchase Program

In July 2013, the company’s board of directors authorized a share repurchase program permitting the company to repurchase in the open market or otherwise up to 210,000, or approximately 2%, of shares of the company’s then outstanding common stock. The authorization has no time limit. There is no guarantee as to the number of shares that will be repurchased by the company, and the company may discontinue the program at any time.

The company repurchased the following shares of common stock, pursuant to the repurchase program for the periods stated. The repurchases were made using available cash resources and occurred in the open market.

 

		For the Year Ended December 31, 2013
Shares of common stock repurchased			50,430
Price paid for common stock repurchased		$	296
Average price paid per common share		$	5.88

Note 14—Share-based Compensation

The company has two share-based compensation plans. The 2003 Stock Incentive Plan was for directors, officers and employees of First Bankshares. Of the 137,500 shares of common stock available for granting stock options under this plan, 94,493 options were granted to First Bankshares directors and key employees under the plan and were fully vested. These stock options remained outstanding following the merger and are exercisable for shares of the company’s common stock. Of these options, 20,680 and 53,846 remain outstanding at December 31, 2013 and 2012, respectively. The company does not intend to grant any additional awards under this plan.

The 2012 Xenith Bankshares, Inc. Stock Incentive Plan (the “2012 Plan”), which amended and restated the Amended and Restated Xenith Bankshares, Inc. 2009 Stock Incentive Plan (the “2009 Plan”), was approved by the company’s shareholders in May 2012. The 2012 Plan covers all of the formerly awarded options under the 2009 Plan as well as any awards made since May 2012. Under the 2012 Plan, the company may grant options to purchase common stock, restricted stock, and restricted stock units to the company’s directors, officers and employees. As of December 31, 2013, there were 1,002,259 shares of the company’s common stock available for grant under the 2012 Plan.

Restricted stock and units awarded under the 2012 Plan generally vests over one or three years. Stock options awarded under the 2012 Plan generally vest over three years and expire ten years from the date of grant. The options are granted at a price equal to fair market value at the date of grant.

 

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The following table summarizes stock option activity for the periods stated:

 

		Number of Stock Options				Weighted Average Exercise Price				Options Exercisable				Weighted Average Exercise Price
Balance at December 31, 2011			484,307			$	8.27				221,593			$	9.98
Granted			351,100				4.17
Exercised			—				—
Forfeited/expired			(9,301	)			7.72
Balance at December 31, 2012			826,106				6.53				365,781			$	9.51
Granted			1,000				5.72
Exercised			—				—
Forfeited/expired			(47,516	)			6.95
Balance at December 31, 2013			779,590			$	6.51				499,564			$	7.84

A summary of stock options outstanding and exercisable as of December 31, 2013 is as follows:

 

		Options Outstanding																Options Exercisable
Range of Exercise Prices		Number Outstanding				Weighted Average Remaining Contractual Life				Weighted Average Exercise Price				Total Aggregate Intrinsic Value				Number Exercisable				Weighted Average Remaining Contractual Life				Weighted Average Exercise Price				Total Aggregate Intrinsic Value
3.52 -   3.90			135,500				8.04			$	3.61			$	309,140				64,822				8.00			$	3.60			$	148,531
4.01 -   4.64			359,600				8.32				4.31				569,829				151,919				8.11				4.34				236,129
5.24 -   5.95			30,000				6.76				5.90				1,470				28,333				6.64				5.92				866
8.36 - 11.49			254,490				5.56				11.24				—				254,490				5.56				11.24				—
			779,590				8.32			$	6.51			$	880,439				499,564				6.71			$	7.84			$	385,526

The fair value of each stock option was estimated on the date of grant using the Black-Scholes option valuation model. Expected volatilities are based on implied volatility of the company’s stock. The company estimates option exercises and forfeitures within the valuation model. All options are expected to vest. Changes in the fair value of options (in the event of an award modification) are reflected as an adjustment to compensation expense in the period in which the change occurs. The risk-free rate for the period within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The following table presents the assumptions for the periods stated:

 

		2013				2012
Expected life in years			6.0			6.0
Expected volatility			50.0	%		50.0%
Risk-free interest rate			1.63	%		0.83 - 1.40%
Weighted average interest rate			1.63	%		1.07%

 

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The following table summarizes non-vested stock option activity for the periods stated:

 

		Stock Options				Weighted Average Grant-Date Fair Value
Balance at December 31, 2011			262,714
Granted			351,100				1.93
Vested			150,984				1.51
Forfeited/expired			(2,505	)			1.93
Balance at December 31, 2012			460,325				1.92
Granted			1,000				2.78
Vested			174,632				2.03
Forfeited/expired			(6,667	)			1.70
Balance at December 31, 2013			280,026				1.95

The following table summarizes non-vested restricted stock activity, including restricted stock units, for the year ended December 31, 2013:

 

		Shares				Weighted Average Grant-Date Fair Value
Balance at December 31, 2012			—
Granted			91,153				5.78
Vested			24,071				5.73
Forfeited/expired			(2,878	)			5.79
Balance at December 31, 2013			64,204				5.80

Total share-based compensation expense for the years ended December 31, 2013 and 2012 was $629 thousand and $301 thousand, respectively. As of December 31, 2013, total unrecognized compensation cost related to non-vested awards was $624 thousand, expected to be recognized over a weighted-average period of 1.56 years.

Note 15—401(k) Plan

The company has a 401(k) defined contribution plan covering all eligible employees. There are no age or service requirements. Beginning in 2013, the company has elected to provide a safe harbor matching contribution of 100% of the first 1% of contributions made by the employee and 50% of the next 5% of contributions. The company had expense of $296 thousand and $163 thousand for the years ended December 31, 2013 and 2012, respectively, for plan matching contributions.

Note 16—Related Parties

Both the company’s and the Bank’s officers and directors and their related interests have various types of loans with the Bank. As of December 31, 2013 and 2012, the total of these related-party loans outstanding were $756 thousand and $1.6 million, respectively. New loans to officers and directors in 2013 and 2012 totaled $8 thousand and $897 thousand, respectively, and repayments in 2013 and 2012 amounted to $38 thousand and $953 thousand, respectively. Such transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.

Deposits of officers and directors as of December 31, 2013 and 2012 totaled $1.5 million and $2.2 million, respectively.

 

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The company reimburses BankCap Partners Fund (“BankCap Partners”), parent company of a significant shareholder of the company, for certain expenses it incurs on behalf of the company. For the years ended December 31, 2013 and 2012, the company reimbursed BankCap Partners $6 thousand and $14 thousand, respectively, for travel expenses.

Note 17—Senior Non-Cumulative Perpetual Preferred Stock

On September 21, 2011, the company issued and sold 8,381 shares of SBLF Preferred Stock to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. The SBLF Preferred Stock investment qualifies as Tier 1 capital. The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” (as defined in the SBLF Purchase Agreement) by the Bank. For the period ended December 31, 2013, the company’s dividend was $84 thousand, representing a 1% rate for the period.

Note 18—Warrants

An aggregate of 563,760 warrants to purchase shares of Xenith Bankshares common stock at an exercise price of $11.49 per share are outstanding. These warrants are exercisable immediately and expire on May 8, 2019.

Note 19—Dividend Restrictions

Under Virginia law, no dividend may be declared or paid out of a Virginia charter bank’s paid-in capital. Xenith Bankshares, as the holding company for Xenith Bank, may be prohibited under Virginia law from the payment of dividends if the Virginia Bureau of Financial Institutions determines that a limitation of dividends is in the public interest and is necessary to ensure the company’s financial soundness and may also permit the payment of dividends not otherwise allowed by Virginia law. The terms of the SBLF Preferred Stock also impose limits on the company’s ability to pay dividends. The company has not declared or paid any dividends on its common stock.

Note 20—Regulatory Matters

The company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the company must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the company to maintain minimum Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios. On December 7, 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained conditions related to BankCap Partners, as well as the conduct of the Bank’s business. The condition applicable to the Bank provided that, during the first three years of operation after the merger, the Bank must operate within the parameters of its business plan submitted in connection with BankCap Partner’s application to the Federal Reserve, and the Bank must obtain prior written regulatory consent to any material change in its business plan. The business plan set forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012, which were met. Subsequent to meeting the requirements of set forth in this business plan, the company is required to maintain capital ratios categorizing it as “well capitalized.”

As of December 31, 2013, the company is considered to be well-capitalized under the published regulatory definition of a well-capitalized bank. To be categorized as well-capitalized, the company must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since December 31, 2013 that management believes has changed the Bank’s status as “well-capitalized.”

 

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

 

		December 31, 2013								December 31, 2012
		Xenith Bank				Xenith Bankshares				Xenith Bank				Xenith Bankshares
Tier 1 capital		$	69,314			$	70,299			$	68,820			$	69,474
Total risk-based capital			74,955				75,940				73,916				74,570
Risk-weighted assets			526,841				526,752				451,208				451,357

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

 

		December 31, 2013								December 31, 2012
		Xenith Bank				Xenith Bankshares				Xenith Bank				Xenith Bankshares				Regulatory Minimum				Well Capitalized
Tier 1 leverage ratio			10.37	%			10.52	%			12.78	%			12.90	%			4.00	%			> 5.00	%
Tier 1 risk-based capital ratio			13.16	%			13.35	%			15.25	%			15.39	%			4.00	%			> 6.00	%
Total risk-based capital ratio			14.23	%			14.42	%			16.38	%			16.52	%			8.00	%			> 10.00	%

Note 21—Commitments and Contingencies

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

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

 

		December 31, 2013				December 31, 2012
Commercial lines of credit		$	69,286			$	57,681
Commercial real estate			49,148				28,566
Residential real estate			7,183				7,130
Consumer			481				710
Letters of credit			6,796				2,308
Loans held for sale			5,637				25,133
Total commitments		$	138,531			$	121,528

 

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The company has entered into non-cancelable agreements to lease four of its facilities with remaining terms of three to six years. The following table presents the future minimum annual commitments under non-cancelable leases in effect at December 31, 2013 for the periods stated:

 

Year		Commitment
2014		$	927
2015			971
2016			718
2017			560
2018			522
Thereafter			229
Total lease commitments		$	3,927

In addition, the Bank has a commitment to invest in a limited partnership that operates as a small business investment company. As of December 31, 2013, the Bank had invested $300 thousand. An additional $700 thousand will be funded at the request of the general partner of the partnership.

Rent expense under operating leases for banking facilities was $893 thousand and $949 thousand for the years ended December 31, 2013 and 2012, respectively.

Note 22—Concentration of Credit Risk

The Bank has a diversified loan portfolio consisting of commercial, real estate and consumer loans. Consumer loans are primarily to residents of or owners of businesses in the company’s market area. As of December 31, 2013 and 2012, the Bank had loans secured by commercial and residential real estate located primarily within the Bank’s market area representing $259.7 million, or 47.9% of total loans, and $316.1 million, or 68.0% of total loans, respectively. Therefore, a major factor in determining borrowers’ ability to honor their agreements, as well as the Bank’s ability to realize the value of any underlying collateral, if necessary, is influenced by economic conditions in this market area.

The Bank maintains cash balances with several financial institutions. These accounts are insured by the FDIC up to $250,000. At December 31, 2013 and 2012, the Bank had $5.7 million and $2.9 million, respectively, of uninsured funds in these financial institutions.

Note 23—Fair Value Measurements

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

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

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

 

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

 

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

Securities available for sale:

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

Other real estate owned:

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

Impaired loans:

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of December 31, 2013, all of the impaired loans accounted for under ASC 310-30 were evaluated based on discounted cash flows or on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the company records the impaired loan as nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, or management evaluates fair value based on discounted cash flows, the company records the impaired loan as nonrecurring Level 3.

Derivatives:

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

Although the company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2013 and 2012, the company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

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

Cash, cash equivalents and accrued interest:

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

 

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

Performing loans:

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

Deposit liabilities:

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

Borrowings:

The carrying amounts of federal funds purchased and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses at the company’s current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of long-term borrowings, for which interest rates reset quarterly or less, approximate their fair value.

Other commitments:

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

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

 

						Fair Value Measurements as of December 31, 2013 Using
		December 31, 2013 Balance				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	45,337			$	—			$	45,337			$	—
- Variable rate			4,852				—				4,852				—
Municipals
- Taxable			8,970				—				8,970				—
- Tax exempt			1,573				—				1,573				—
Collateralized mortgage obligations			8,453				—				8,453				—
Cash flow hedge - asset			192				—				192				—
Cash flow hedge - liability			(191	)			—				(191	)			—
Interest rate derivative - asset			135				—				135				—
Interest rate derivative - liability			(113	)			—				(113	)			—
Assets measured on a nonrecurring basis:
Impaired loans			11,041				—				—				11,041
Other real estate owned			199				—				—				199

 

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						Fair Value Measurements as of December 31, 2012 Using
		December 31, 2012 Balance				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale:
Mortgage-backed securities
- Fixed rate		$	44,240			$	—			$	44,240			$	—
- Variable rate			2,181				—				2,181				—
Municipals			1,000				—				1,000				—
Collateralized mortgage obligations			10,130				—				10,130				—
Cash flow hedge			(283	)			—				(283	)			—
Interest rate derivative - asset			124				—				124				—
Interest rate derivative - liability			(140	)			—				(140	)			—
Assets measured on a nonrecurring basis:
Impaired loans			13,148				—				—				13,148
Other real estate owned			276				—				—				276

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

 

		December 31, 2013								Fair Value Measurements as of December 31, 2013 Using
		Carrying Amount				Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks		$	24,944			$	24,944			$	24,944			$	—			$	—
Federal funds sold			5,749				5,749				—				5,749				—
Securities available for sale			69,185				69,185				—				69,185				—
Loans held for sale			3,363				3,363				—				3,363				—
Loans held for investment, net			533,137				534,232				—				—				534,232
Cash flow hedge			192				192				—				192				—
Interest rate derivative			135				135				—				135				—
Accrued interest receivable			2,403				2,403				—				2,403				—
Financial liabilities:
Cash flow hedge		$	191			$	191			$	—			$	191			$	—
Interest rate derivative			113				113				—				113				—
Long-term borrowings			20,000				20,000				—				20,000				—
Deposits			569,198				568,775				—				568,775				—
Accrued interest payable			215				215				—				215				—

 

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		December 31, 2012								Fair Value Measurements as of December 31, 2012 Using
		Carrying Amount				Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks		$	9,457			$	9,457			$	9,457			$	—			$	—
Federal funds sold			2,906				2,906				—				2,906				—
Securities available for sale			57,551				57,551				—				57,551				—
Loans held for sale			80,867				80,867				—				80,867				—
Loans held for investment, net			379,006				380,322				—				—				380,322
Interest rate derivative			124				124				—				124				—
Accrued interest receivable			1,606				1,606				—				1,606				—
Financial liabilities:
Cash flow hedge		$	283			$	283			$	—			$	283			$	—
Interest rate derivative			140				140				—				140				—
Long-term borrowings			20,000				20,000				—				20,000				—
Deposits			453,231				453,813				—				453,813				—
Accrued interest payable			232				232				—				232				—

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

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

 

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Note 24—Parent Company Financial Statements

Xenith Bankshares, Inc. is the parent company of Xenith Bank. The following table presents the assets, liabilities and shareholders’ equity of Xenith Bankshares, Inc. for the dates stated:

 

		December 31, 2013				December 31, 2012
Assets
Cash		$	1,225			$	740
Investment in subsidiary			86,375				86,893
Deferred tax asset			195				—
Other assets			8				—
Total assets		$	87,803			$	87,633
Liabilities and shareholders’ equity
Accounts payable			20				—
Due to subsidiary		$	97			$	86
Total liabilities		$	117			$	86
Shareholders’ equity
Preferred stock, $1.00 par value, $1,000 liquidation value, 25,000,000 shares authorized as of December 31, 2013 and 2012; 8,381 shares issued and outstanding as of December 31, 2013 and 2012			8,381				8,381
Common stock, $1.00 par value, 100,000,000 shares authorized as of December 31, 2013 and 2012; 10,437,630 and 10,488,060 shares issued and outstanding as of December 31, 2013 and 2012, respectively			10,438				10,488
Additional paid-in capital			71,797				71,414
Accumulated deficit			(1,758	)			(3,660	)
Accumulated other comprehensive (loss) income, net of tax			(1,172	)			924
Total shareholders’ equity			87,686				87,547
Total liabilities and shareholders’ equity		$	87,803			$	87,633

The following table presents the income statements of Xenith Bankshares, Inc. for the dates stated:

 

		December 31, 2013				December 31, 2012
Income		$	—			$	—
Total income			—				—
Expense
Other operating expenses			370				496
Total expense			370				496
Loss before income taxes and equity in undistributed income of subsidiaries			(370	)			(496	)
Income tax benefit			126				169
Equity in undistributed income of subsidiaries			2,230				7,706
Net income		$	1,986			$	7,379

Note 25—Recent Accounting Pronouncements

In July 2013, the FASB issued ASU 2013-10, Derivatives and Hedging (ASU 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 are intended to provide for the inclusion of the Fed Funds Effective Swap Rate (OIS) as a U.S.

 

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benchmark interest rate for hedge accounting purposes, in addition to UST (the interest rates on direct U.S. Treasury obligations of the U.S. government) and LIBOR. This ASU is effective prospectively for qualifying new or redesignated hedges entered into on or after July 17, 2013. The adoption of this standard had no effect on the company’s financial statements for the year ended December 31, 2013

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (ASU 220), “ Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ” The amendments in this ASU are intended to improve the reporting of reclassifications out of AOCI by requiring an entity to report the effect of significant reclassifications out of AOCI on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. This ASU became effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. The adoption of this standard had no effect on the company’s financial statements for the year ended December 31, 2013.

In January 2013, the FASB issued ASU 2013-01, Balance Sheet (ASU 210), “ Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ” The amendments in this ASU are intended to address implementation issues regarding the scope of ASU 2011-11, Balance Sheet (ASU 210), “ Disclosures about Offsetting Assets and Liabilities,” and clarify the scope of the offsetting disclosures and address any unintended consequences. The amendments provide a user of financial statements with comparable information as it relates to certain reconciling differences between financial statements prepared in accordance with GAAP. This ASU became effective for fiscal years, and interim periods within those annual periods, beginning on or after January 1, 2013. The adoption of this standard had no effect on the company’s financial statements for the year ended December 31, 2013.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (ASU 210), “ Disclosures about Offsetting Assets and Liabilities. ” The amendments in this ASU are intended to require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (IFRS). This ASU became effective for annual periods, and interim periods within those annual periods, beginning on or after January 1, 2013. The adoption of this standard had no effect on the company’s financial statements for the year ended December 31, 2013.

 

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Item 9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None

Item 9A—Controls and Procedures

Disclosure Controls and Procedures

The company maintains a system of disclosure controls and procedures that is designed to ensure that material information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As required, management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that disclosure controls and procedures were effective to ensure that information required to be disclosed in reports that the company files or submits pursuant to the rules and regulations of the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and the 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 disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the company to disclose material information otherwise required to be set forth in periodic reports.

Internal Control over Financial Reporting

Management is also responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control—Integrated Framework.” Based on this assessment, management concluded that, as of December 31, 2013, the company’s internal control over financial reporting was effective based on those criteria.

As of result of a provision of the Dodd-Frank Act, which, among other things, permanently exempted non-accelerated filers, such as the company, from complying with the requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, which requires an issuer to include an attestation report from an issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting, this Annual Report on Form 10-K does not include an attestation report of the company’s registered public accounting firm regarding the company’s internal control over financial reporting.

Changes in Internal Controls

There has been no change in our internal control over financial reporting during the fiscal quarter ended December 31, 2013, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B—Other Information

None

 

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PART III

Except as otherwise indicated, information called for by the following items under Part III is contained in the Proxy Statement for the company’s 2014 Annual Meeting of Shareholders (“Proxy Statement”) to be held on May 1, 2014.

Item 10—Directors, Executive Officers and Corporate Governance

Executive Officers of the Registrant

T. Gaylon Layfield, III, 62, has been President and Chief Executive Officer of both our company and the Bank since December 22, 2009, having previously served as President and Chief Executive Officer of Xenith Corporation from February 18, 2008 until December 22, 2009. He has also served as director of both the company and the Bank since December 22, 2009. He is the former President of Timber Resource Management, L.L.C., a privately held timber investment management organization, having previously served in various increasing roles of responsibility with Signet Banking Corporation (“Signet”), a $12 billion bank holding company that was acquired by First Union Corporation (now Wells Fargo & Company), from 1975 until Signet’s acquisition in November 1997. From December 1996 to November 1997, Mr. Layfield was President and Chief Operating Officer of Signet and served on Signet’s board of directors, its management committee, its asset and liability committee and its credit policy committee. Mr. Layfield served as Senior Executive Vice President and on Signet’s management and senior credit committees from 1988 to 1996. From 1991 until 1996, Mr. Layfield was responsible for Signet’s Consumer Banking, which included the branch delivery system, Signet Financial Services, Signet Mortgage Company, Educational Funding, Telephone Banking Center, Trust/Affluent and Small Business banking, having previously been head of Signet’s commercial line of business from 1987 to 1991. Mr. Layfield served as Signet’s Executive Vice President from 1986 to 1988, Regional Executive Officer of Signet’s Hampton Roads Region from 1983 to 1986, officer-in-charge of Signet’s National/International division from 1982 to 1983 and officer-in-charge of Commercial Lending for Signet’s Capital Division from 1980 to 1982. He joined Signet in 1975 as an international credit analyst and for the next five years, he held various positions in the International Division, including officer-in-charge of Business Development.

Thomas W. Osgood , 58, has been Executive Vice President, Chief Financial Officer, Chief Administrative Officer and Treasurer of Xenith Bankshares and the Bank, since December 22, 2009, having previously served as Chief Financial Officer and Chief Administrative Officer of Xenith Corporation from February 19, 2008 until December 22, 2009. He served as a director of Xenith Bank from December 22, 2009 until January 2, 2012. From January 1998 to May 2007, he was with East Coast Fire Protection, Inc. (“ECFP”), a fire protection firm, where he was Executive Vice President and served in numerous finance, operating and marketing capacities.

Prior to his employment with ECFP, Mr. Osgood was with Signet from 1983 until its acquisition by First Union Corporation (now Wells Fargo & Company) in November 1997. In 1996-1997, Mr. Osgood helped lead a year long process focusing on total bank re-engineering and reported to the President and Chief Operating Officer. From 1992 to 1996, Mr. Osgood was a Senior Vice President and reported to the Chief Credit Officer. He developed and led an integrated risk management practice; implemented quantitative tools to measure risks in credit portfolios; led credit portfolio reporting and industry risk analysis; managed the bank’s allowance for loan and lease losses; and worked directly with outside auditors and regulators to verify its adequacy. From 1988 to 2002, Mr. Osgood was a Vice President and then a Managing Director of Signet Investment Banking Corporation where he worked with clients in many industries on business plans and implications for financing strategies; raised debt and equity capital to fund organic growth and acquisitions; performed valuations and worked on numerous purchase and sale transactions; and developed and executed interest rate hedging strategies for clients. From 1983 to 1988, Mr. Osgood was a lender and relationship manager working with clients in many industries.

Prior to joining Signet, Mr. Osgood was with Wachovia Bank from 1978 to 1983, where he completed the retail banking program and was promoted to branch manager then completed the corporate banking development program and was promoted to bank officer and corporate banker handling commercial credit relationships in Raleigh and Durham, North Carolina.

Ronald E. Davis , 62, has been Executive Vice President and Corporate Secretary of the company since December 22, 2009, having previously served as Executive Vice President of Xenith Corporation from June 2008 until December 22, 2009. He currently serves Xenith Bank as Executive Vice President and Chief Operations and Technology Officer, having previously served as Chief Lending Officer from December 22, 2009 until October 2011. He also served as a director of Xenith Bank from December 22, 2009 until January 2, 2012. From December 2001 until June 2008, he served as President and Chief Executive Officer of Virginia Heartland Bank and then its successor, Second Bank and Trust (now StellarOne Corporation) in Fredericksburg, Virginia.

From August 1998 until December 2001, Mr. Davis was President and Chief Executive Officer of Metro County Bank, a de novo bank in Richmond, Virginia. Mr. Davis was responsible for setting strategic direction, staffing, underwriting and approving loans and credit quality, overseeing retail, commercial, investment, and operations, and achieving financial goals established for the organization.

 

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Mr. Davis was also with First Union National Bank and its predecessor, Signet, from 1984 to August 1998, in various roles, including managing the Small Business Credit Center and working as a Senior Credit Officer for Small Business, Private Banking, and Retail Business segments. Mr. Davis was also a manager in Signet’s National Division.

Mr. Davis began his banking career in 1974 at the National Bank of Commerce in Lincoln, Nebraska and joined Citizens and Southern Bank in Atlanta, where he was employed from 1978 to 1984.

Wellington W. Cottrell, III , 59, has been Executive Vice President and Chief Credit Officer of Xenith Bank since December 22, 2009, having previously served as Executive Vice President of Xenith Corporation from May 2008 until December 22, 2009. He served as a director of Xenith Bank from December 22, 2009 until January 2, 2012. From 2000 until May 2008, Mr. Cottrell served as Managing Director of Risk Management in the Corporate and Investment Banking Group at SunTrust Bank. Mr. Cottrell was a member of the Senior Loan Committee and a part-time member of the Debt Capital Markets Committee, which primarily reviewed syndications, bridge loans, and market risk. From 1999 until 2000, Mr. Cottrell was a risk manager in SunTrust’s Corporate & Investment Banking group, progressing from Director to Managing Director in 2000 and from risk coverage of the Media & Communications Portfolio, adding the Mid-Atlantic Diversified Portfolio also in 2000.

From 1992 through 1998, Mr. Cottrell was in Regional Credit Administration as Senior Vice President—Risk Manager for the Corporate Banking Group of Crestar Bank (predecessor to SunTrust), managing corporate, middle-market, and international credits. From 1990 until 1992, he was a Vice President and relationship manager with Crestar Bank in the Corporate Banking Group. His duties included managing media and communications clients and workouts. From 1988 until 1990, Mr. Cottrell was with Investors Savings Bank in Retail Credit Administration. Mr. Cottrell was Senior Vice President, chaired the commercial loan committee, was a member of the commercial real estate loan committee, and managed commercial business credit analysis, loan review, the credit card portfolio, and work-outs.

From 1984 until 1988, Mr. Cottrell was with Crestar Bank as a Vice President and relationship manager in the Southeast Division. From 1981 until 1983, Mr. Cottrell was with Manufacturers Hanover Trust Co. as trainee progressing to Assistant Vice President in the Metropolitan Division of the commercial bank.

Mr. Cottrell started his banking career at Central National Bank (predecessor to Central Fidelity Bank) in 1977 as a credit analyst in commercial banking.

W. Jefferson O’Flaherty , 61, has been Executive Vice President of Xenith Bank responsible for its private banking business since December 22, 2009, having previously served as Executive Vice President of Xenith Corporation from May 2008 until December 22, 2009. He served as a director of Xenith Bank from December 22, 2009 until January 2, 2012. Mr. O’Flaherty served as Regional Managing Director of Wachovia Wealth Management for Wachovia Bank (now Wells Fargo & Company), from 2001, when First Union Bank merged with Wachovia Corporation, until December 2007. From November 1997 to 2001, Mr. O’Flaherty served as Managing Director with First Union Bank, and in this capacity he led the private banking practice in Richmond, Norfolk and Roanoke, Virginia. Mr. O’Flaherty started his career with Bank of Virginia, a predecessor to Signet, in 1974 and served in various capacities of increasing responsibility, culminating in his role as Senior Vice President and Manager of Private Banking for Signet, which was acquired by First Union in 1997.

Edward H. Phillips, Jr ., 46, has been Executive Vice President and Chief Lending Officer of Xenith Bank since October 2011. Mr. Phillips joined Xenith Bank in September 2008 as Senior Vice President – Commercial Lending. Prior to joining Xenith Bank, he served as Senior Vice President and Regional Corporate Banker for Branch, Banking &Trust Corporation (“BB&T”), a position he held from 2004 until 2008, and before that he served as Senior Vice President and Commercial Relationship Manager from 2000 until 2003. Prior to BB&T, Mr. Phillips served as Vice President and Commercial Relationship Manager at Bank of America from 1998 until 2000. Mr. Phillips began his career at Wachovia Bank (now Wells Fargo & Company) in 1990 in Commercial Loan Administration, and served in multiple roles of increasing responsibility in credit and relationship management at Wachovia Bank and Central Fidelity Bank until 1998.

Judy C. Gavant , 54, has been the Senior Vice President and Controller of Xenith Bank since August 2010. From September 2005 until the end of July 2010, she held the positions of Director, Finance—Corporate and Business Development, as well as Director and Assistant Controller overseeing financial reporting for Owens & Minor, Inc., a leading national distributor of name-brand medical and surgical supplies and a healthcare supply chain management company. From 2001 to 2004, Ms. Gavant was Director of Finance and Controller for Tredegar Film Products, Inc, a wholly-owned subsidiary of Tredegar Corporation, primarily a global manufacturer of plastic films and aluminum extrusions. From 2000 to

 

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2001, Ms. Gavant worked as the Chief Financial Officer and Company Secretary of Envera LLC, an industry-owned start-up that provided web-enabled supply chain services for the chemical industry. From 1990 to 2000, Ms. Gavant held various roles in the areas of taxation and mergers, acquisitions and divestitures at Dominion Resources, Inc., one of the nation’s largest producers and transporters of energy and served as Controller and Assistant Treasurer of Dominion Energy, Inc., a wholly-owned subsidiary of Dominion Resources, Inc. From 1981 to 1990, she served in the audit and tax practices at PricewaterhouseCoopers LLP, a provider of audit and assurance, tax and advisory services.

The information set forth under the captions “Proposal No. 1—Election of Directors—Nominees for the Board of Directors,” “Election of Directors—Committees of the Board of Directors—Audit and Compliance Committee,” and “The Audit and Compliance Committee Report” in the Proxy Statement and is incorporated herein by reference. The information set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement is incorporated herein by reference.

We have a Code of Conduct and Ethics (the “Code”) that applies to all directors, officers and employees of the company and its subsidiaries, including the company’s principal executive officer, principal financial officer and principal accounting officer. The Code is available on our website at www.xenithbank.com . We intend to satisfy the disclosure requirements of Form 8-K with respect to any waivers of or amendments to the Code with respect to certain officers by posting such disclosures on our website at www.xenithbank.com . We may, however, elect to disclose any such amendment or waiver in a report on Form 8-K filed with the SEC in addition to or in lieu of the website disclosure. The information on, or that can be accessed through our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings that we make with the SEC.

Item 11—Executive Compensation

The information set forth under the captions “Proposal No. 1—Election of Directors—Compensation of Directors” and “Compensation of Executive Officers” in the Proxy Statement is incorporated herein by reference.

Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

The information set forth under the caption “Stock Ownership” in the Proxy Statement and is incorporated herein by reference.

The following table sets forth information as of December 31, 2013 with respect to certain compensation plans under which equity securities of the company are authorized for issuance.

 

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted-average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans  (excluding securities reflected in column (a))
		(a)				(b)				(c)
Equity compensation plans approved by security holders:
2003 Stock Incentive Plan (1)			20,680			$	7.76				111,320
2012 Stock Incentive Plan (2)			758,910				6.46				243,349
Total			779,590			$	6.51				354,669

 

(1)	We do not intend to grant any additional awards under our 2003 Stock Option Plan.

(2)

In connection with the merger, Xenith Bankshares assumed the Xenith Corporation 2009 Stock Incentive Plan, which was subsequently amended and restated to become the Amended and Restated Xenith Bankshares, Inc. 2009 Stock Incentive Plan, which was further amended and restated, continuing as the 2012 Xenith Bankshares, Inc. Stock Incentive Plan, as amended.

 

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Item 13—Certain Relationships and Related Transactions, and Director Independence

The information set forth under the captions “Certain Relationships and Related Transactions” and “Proposal No. 1—Election of Directors—Board of Directors—Independence of Directors” in the Proxy Statement is incorporated herein by reference.

Item 14—Principal Accounting Fees and Services

The information set forth under the captions “The Audit and Compliance Committee Report—Fees Billed by Independent Registered Public Accounting Firm” and “The Audit and Compliance Committee Report—Pre-Approval Policy” in the Proxy Statement is incorporated herein by reference.

 

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PART IV

Item 15—Exhibits, Financial Statement Schedules

 

Exhibit Number		Description
2.1		Agreement and Plan of Reorganization and Plan of Share Exchange, by and between First Bankshares, Inc. and SuffolkFirst Bank, dated March 5, 2008 (incorporated herein by reference to Exhibit 2.1 to Current Report on Form 8-K filed August 18, 2008 (File No. 000-53380)).
2.2		Agreement of Merger, dated as of May 12, 2009, between First Bankshares, Inc. and Xenith Corporation (incorporated herein by reference to Exhibit 2.1 to Current Report on Form 8-K filed May 14, 2009 (File No. 000-53380)). (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Xenith Bankshares, Inc. agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted schedule upon request.)
2.2.1		Amendment No. 1, dated as of August 14, 2009, to Agreement of Merger, dated May 12, 2009, between First Bankshares, Inc. and Xenith Corporation (incorporated herein by reference to Exhibit 2.2.1 to Current Report on Form 8-K filed August 14, 2009 (File No. 000-53380)).
2.2.2		Amendment No. 2, dated as of October 15, 2009, to Agreement of Merger, dated May 12, 2009 and amended as of August 14, 2009, between First Bankshares, Inc. and Xenith Corporation (incorporated herein by reference to Exhibit 2.2.2 to Current Report on Form 8-K filed October 16, 2009 (File No. 000-53380)).
2.2.3		Amendment No. 3, dated as of October 30, 2009, to Agreement of Merger, dated May 12, 2009 and amended as of August 14, 2009 and as of October 15, 2009, between First Bankshares, Inc. and Xenith Corporation (incorporated herein by reference to Exhibit 2.2.3 to Current Report on Form 8-K filed November 5, 2009 (File No. 000-53380)).
2.2.4		Amendment No. 4, dated as of November 19, 2009, to Agreement of Merger, dated May 12, 2009 and amended as of August 14, 2009, as of October 15, 2009, and as of October 30, 2009, between First Bankshares, Inc. and Xenith Corporation (incorporated herein by reference to Exhibit 2.2.4 to Current Report on Form 8-K filed November 25, 2009 (File No. 000-53380)).
2.3		Purchase and Assumption Agreement, dated as of June 1, 2011, by and between Xenith Bank and Paragon Commercial Bank (incorporated herein by reference to Exhibit 2.1 to Current Report on Form 8-K filed June 3, 2011 (File No. 000-53380)). (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Xenith Bankshares, Inc. agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted schedule upon request.)
2.3.1		Amended and Restated Purchase Assumption Agreement, dated as of July 25, 2011, by and between Xenith Bank and Paragon Commercial Bank (incorporated herein by reference to Exhibit 2.2 to Current Report on Form 8-K filed August 4, 2011 (File No. 000-53380)). (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Xenith Bankshares, Inc. agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted schedule upon request.)
2.4		Purchase and Assumption Agreement, dated as of July 29, 2011, among the Federal Insurance Deposit Corporation, Receiver of Virginia Business Bank, the Federal Insurance Corporation and Xenith Bank (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed August 4, 2011 (File No. 000-53380)). (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Xenith Bankshares, Inc. agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted schedule upon request.)
3.1		Amended and Restated Articles of Incorporation of Xenith Bankshares, Inc. (incorporated herein by reference to Exhibit 3.1 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
3.1.1		Articles of Amendment to the Amended and Restated Articles of Incorporation of Xenith Bankshares, Inc. (incorporated herein by reference to Exhibit 3.1 to Current Report on Form 8-K filed September 27, 2011 (File No. 000-53380)).
3.2		Amended and Restated Bylaws of Xenith Bankshares, Inc. (incorporated herein by reference to Exhibit 3.2 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
4.1		Investor Rights Agreement, dated as of June 26, 2009, among Xenith Corporation and the Investor Shareholders and Other Shareholders Listed on Exhibit A thereto (incorporated herein by reference to Exhibit 4.1 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-57380)).

 

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4.2		First Amendment to Investor Rights Agreement, dated as of December 21, 2009, among Xenith Corporation, BCP Fund I Virginia Holdings, LLC and the Holders listed on Exhibit A thereto (incorporated herein by reference to Exhibit 4.2 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
4.3		Amended and Restated Investor Rights Agreement, dated as of December 23, 2010, among Xenith Bankshares, Inc., BCP Fund I Virginia Holdings, LLC and the Holders (as defined therein) (incorporated herein by reference to Exhibit 4.1 to Amendment No. 1 to Registration Statement on Form S-1 filed December 30, 2010 (Registration No. 333-170856)).
10.1		First Bankshares, Inc. Stock Option Plan (incorporated herein by reference to Exhibit 99.1 to registration statement on Form S-8 filed August 21, 2008 (Registration No. 333-153118)).
10.2		Form of Director Stock Option Agreement (incorporated herein by reference to Exhibit 10.4 to Quarterly Report on Form 10-Q filed August 7, 2009 (File No. 000-53380)).
10.3		Form of Employee Stock Option Agreement (incorporated herein by reference to Exhibit 10.5 to Quarterly Report on Form 10-Q filed August 7, 2009 (File No. 000-53380)).
10.4		Xenith Bankshares, Inc. 2012 Stock Incentive Plan, as amended (incorporated herein by reference to Exhibit 10.4 to Annual Report on Form 10-K filed March 15, 2013 (File No. 000-53380)).
10.5		Form of Executive Officer Stock Option Agreement (incorporated herein by reference to Exhibit 10.5 to Annual Report on Form 10-K filed March 31, 2010 (File No. 000-53380)).
10.6		Form of Non-Employee Director Stock Option Agreement (incorporated herein by reference to Exhibit 10.6 to Annual Report on Form 10-K filed March 31, 2010 (File No. 000-53380)).
10.7		Employment Agreement dated as of May 8, 2009, between Xenith Corporation and T. Gaylon Layfield, III (incorporated herein by reference to Exhibit 10.4 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.8		Employment Agreement, dated as of May 8, 2009, between Xenith Corporation and Thomas W. Osgood (incorporated herein by reference to Exhibit 10.5 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.9		Employment Agreement, dated as of May 8, 2009, between Xenith Corporation and Ronald E. Davis (incorporated herein by reference to Exhibit 10.9 to Annual Report on Form 10-K filed March 31, 2010 (File No. 000-53380)).
10.10		Employment Agreement dated as of May 8, 2009, between Xenith Corporation and Wellington W. Cottrell, III (incorporated herein by reference to Exhibit 10.10 to Annual Report on Form 10-K filed March 31, 2010 (File No. 000-53380)).
10.11		Employment Agreement, dated as of May 8, 2009, between Xenith Corporation and W. Jefferson O’Flaherty (incorporated herein by reference to Exhibit 10.11 to Annual Report on Form 10-K filed March 31, 2010 (File No. 000-53380)).
10.12		Employment Agreement, dated as of December 22, 2009, between Xenith Bankshares, Inc. and Darrell G. Swanigan (incorporated herein by reference to Exhibit 10.6 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.13		Employment Agreement, dated as of December 22, 2009, between Xenith Bankshares, Inc. and Keith B. Hawkins (incorporated herein by reference to Exhibit 10.7 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.14		Loan Officer Incentive Bonus Plan Summary (incorporated herein by reference to Exhibit 10.11 to Quarterly Report on Form 10-Q filed August 7, 2009 (File No. 000-53380)).
10.15		Deed of Lease, dated October 7, 2003, by and between Suffolk Plaza Shopping Center, L.C., SuffolkFirst Bank and S.L. Nusbaum Realty Co. (incorporated herein by reference to Exhibit 10.9 to Quarterly Report on Form 10-Q filed August 7, 2009 (File No. 000-53380)).
10.16		Deed of Lease, dated as of July 14, 2008, between James Center Property, LLC, and Xenith Bank (in organization) (incorporated herein by reference to Exhibit 10.16 to Amendment No. 1 to Registration Statement on Form S-1 filed December 30, 2010 (Registration No. 333-170836)).

 

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10.17		Office Lease, dated as of November 5, 2008, between Greensboro Drive Property LLC and Xenith Bank (in organization) (incorporated herein by reference to Exhibit 10.17 to Amendment No. 1 to Registration Statement on Form S-1 filed December 30, 2010 (Registration No. 333-170836)).
10.17.1		First Modification Agreement, dated as of June 8, 2009, between Greensboro Drive Property LLC and Xenith Corporation (formerly known as Xenith Bank (in organization)) (incorporated herein by reference to Exhibit 10.2.1 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.18		Service Agreement, dated as of September 26, 2008, between Parkway Properties LP and Xenith Bank (in organization) (incorporated herein by reference to Exhibit 10.18 to Amendment No. 1 to Registration Statement on Form S-1 filed December 30, 2010 (Registration No. 333-170836)).
10.18.1		First Amendment to Service Agreement, dated as of July 10, 2009, between Parkway Properties LP and Xenith Corporation (formerly known as Xenith Bank (in organization)) (incorporated herein by reference to Exhibit 10.3.1 to Current Report on Form 8-K filed December 29, 2009 (File No. 000-53380)).
10.19		Small Business Lending Fund-Securities Purchase Agreement, dated September 21, 2011, between Xenith Bankshares, Inc. and the Secretary of the Treasury (incorporated herein by reference to Exhibit 10.1 to Current Report on Form 8-K filed September 27, 2011 (File No. 000-53380)).
21.1		Subsidiaries.
23.1		Consent of Grant Thornton LLP.
31.1		Certification of CEO pursuant to Rule 13a-14(a).
31.2		Certification of CFO pursuant to Rule 13a-14(a).
32.1		CEO Certification pursuant to 18 U.S.C. § 1350.
32.2		CFO Certification pursuant to 18 U.S.C. § 1350.
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

						XENITH BANKSHARES, INC. (Registrant)
March 11, 2014						/ S /    T. G AYLON L AYFIELD , III
Date						T. Gaylon Layfield, III President and Chief Executive Officer (Principal Executive Officer)

 

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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature		Title		Date
/s/    T. G AYLON L AYFIELD , III         T. Gaylon Layfield, III		President, Chief Executive Officer and Director (Principal Executive Officer)		March 11, 2014
/ S /    T HOMAS W. O SGOOD         Thomas W. Osgood		Executive Vice President, Chief Financial Officer, Chief Administrative Officer, and Treasurer (Principal Financial Officer)		March 11, 2014
/s/    J UDY C. G AVANT         Judy C. Gavant		Senior Vice President and Controller (Principal Accounting Officer)		March 11, 2014
/s/    M ALCOLM S. M C D ONALD         Malcolm S. McDonald		Chairman and Director		March 11, 2014
/s/    L ARRY L. F ELTON         Larry L. Felton		Director		March 11, 2014
/s/    P ALMER P. G ARSON         Palmer P. Garson		Director		March 11, 2014
/s/    P ATRICK D. H ANLEY         Patrick D. Hanley		Director		March 11, 2014
/s/    P ETER C. J ACKSON         Peter C. Jackson		Director		March 11, 2014
/s/    M ICHAEL A. M ANCUSI         Michael A. Mancusi		Director		March 11, 2014
/s/    R OBERT J. M ERRICK         Robert J. Merrick		Director		March 11, 2014
/s/    S COTT A. R EED         Scott A. Reed		Director		March 11, 2014
/s/    M ARK B. S ISISKY         Mark B. Sisisky		Director		March 11, 2014
/s/    T HOMAS G. S NEAD         Thomas G. Snead		Director		March 11, 2014

 

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