UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

   

 

For the quarterly period ended September 30, 2009

 

OR

 

   

 

For the transition period from ____________ to _____________

 

Commission file number: 000-24002

 

CENTRAL VIRGINIA BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]

 

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate web site, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

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.

Non-accelerated filer __ Smaller reporting company X

(Do not check if smaller reporting company)

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

 

CENTRAL VIRGINIA BANKSHARES, INC.

QUARTERLY REPORT ON FORM 10-Q

 

INDEX

 

 

 

Consolidated Balance Sheets -

 

Consolidated Statements of Operations – Three and Nine Months

 

Consolidated Statements of Stockholders’ Equity - Nine

 

Consolidated Statements of Cash Flows - Nine

 

Notes to Consolidated Financial Statements -

 

 

 

 

Part II. Other Information

 

 

 

 

 

 

 

 

 

 

 

 

PART I

FINANCIAL INFORMATION

 

 

CENTRAL VIRGINIA BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

September 30, 2009 and December 31, 2008

 

 

See Notes to Consolidated Financial Statements.

 

 

CENTRAL VIRGINIA BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

CENTRAL VIRGINIA BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Continued)

 

(1) Total of other-than-temporary impairment losses on securities in the nine months ended September 30, 2009 is $6,066,018 of which $2,631,732 has been recognized in other comprehensive loss, and impairment losses of $3,434,286 have been recognized in earnings in the nine months ended September 30, 2009.

 

See Notes to Consolidated Financial Statements.

 

 

 

 

 

 

 

(1(1) Total accumulated other comprehensive loss includes an other-than-temporary impairment of $2,631,732, or $1,736,943, net of tax of  $894,789.

 

See Notes to Consolidated Financial Statements

CENTRAL VIRGINIA BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2009 and 2008

(Unaudited)

See Notes to Consolidated Financial Statements.

 

CENTRAL VIRGINIA BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)

 

Note 1. Basis of Presentation

 

Principles of consolidation: The accompanying consolidated financial statements include the accounts of Central Virginia Bankshares, Inc., and its subsidiary, Central Virginia Bank, including its subsidiary, CVB Title Services, Inc. and Central Virginia Bankshares Statutory Trust I. All significant intercompany transactions and balances have been eliminated in consolidation. Generally Accepted Accounting Principles requires that the Company no longer eliminate through consolidation the equity investment in Central Virginia Bankshares Statutory Trust I by the parent company, Central Virginia Bankshares, Inc., which equaled $155,000 at September 30, 2009. The subordinated debt of the Trust is reflected as a liability on the Company’s balance sheet.

 

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles. In preparing these consolidated financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through November 16, 2009, the date of the consolidated financial statements issued.

 

In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 2009, and December 31, 2008, the results of operations, and cash flows and statements of changes in stockholders’ equity for the nine months ended September 30, 2009 and 2008. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the annual report for the year ended December 31, 2008. The results of operations for the nine month period ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year.

 

The consolidated financial statements of Central Virginia Bankshares, Inc. (the Company) and its wholly-owned subsidiary, Central Virginia Bank, (the Bank), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentations.

 

Capital Purchase Program through the U.S. Treasury Department

 

On January 22, 2009, the Company held a Special Meeting of Shareholders for the purpose of approving an amendment and restatement of the Articles of Incorporation of Central Virginia Bankshares, Inc. to authorize the issuance of preferred stock. The primary purpose of authorizing preferred stock was to allow participation in the Capital Purchase Program (“Capital Purchase Program”) established by the U.S. Department of the Treasury (“Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”). At the meeting, affirmative votes were received from not less than two-thirds of the shares of common stock then outstanding thereby approving the amendment of the Articles of Incorporation and authorizing the Company to issue up to 1,000,000 shares of preferred stock.

 

On January 30, 2009, as part of the Capital Purchase Program, the Company issued and sold to the U.S. Treasury for an aggregate purchase of $11,385,000 in cash (i) 11,385 shares of the Company’s fixed rate cumulative perpetual preferred stock, Series A, par value $1.25 per share, having a liquidation preference of $1,000 per share (“Series A Preferred Stock”) and (ii) a ten-year warrant to purchase up to 263,542 shares of the Company’s common stock, par value $1.25 per share (“Common Stock”), at an initial

 

 

 

Note 1. Basis of Presentation (Continued)

 

exercise price of $6.48 per share (“Warrant”). The Series A Preferred Stock may be treated as Tier 1 capital for regulatory capital adequacy determination purposes. Cumulative dividends on the Series A Preferred Stock will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter. The Series A Preferred Stock has no maturity date and ranks senior to the Common Stock with respect to the payment of dividends. The Company may redeem the Series A Preferred Stock at 100% of their liquidation preference (plus any accrued and unpaid dividends) beginning on January 30, 2012. Prior to this date, the Company may redeem the Series A Preferred Stock at 100% of their liquidation preference (plus any accrued and unpaid dividends) if (i) the Company has raised aggregate gross proceeds in one or more qualified equity offerings (as defined in the purchase agreement with Treasury) of at least $2.85 million, and (ii) the aggregate redemption price does not exceed the aggregate net proceeds from such qualified equity offerings. Any redemption is subject to the consent of the FDIC. Pursuant to the terms of the American Reinvestment and Recovery Act of 2009, the Company alternatively may, subject to consultation with its federal banking agency, repay the funds it received under the Capital Purchase Program at any time.

 

The purchase agreement pursuant to which the Series A Preferred Stock and the Warrant were sold contains limitations on the payment of dividends or distributions on the Common Stock (including the payment of the cash dividends in excess of the Company’s current quarterly cash dividend of $0.0525 per share) and on the Company’s ability to repurchase, redeem or acquire its Common Stock or other securities, and subjects the Company to certain of the executive compensation limitations included in the

EESA until such time as Treasury no longer owns any debt or equity securities acquired through the Capital Purchase Program.

 

Securities Impairment: During the nine months ended September 30, 2009, the Company recorded $3,434,286 in other-than-temporary impairment charges, net of tax $1,167,657. This non-cash charge to earnings is related to Collateralized Debt Obligation (CDO) investment securities.

 

Recent Accounting Pronouncements

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)) (ASC 805 Business Combinations). The Standard significantly changed the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. The Company does not expect the implementation of SFAS 141(R) to have a material impact on its consolidated financial statements, at this time.

 

In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (ASC 805 Business Combinations). FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of FSP FAS 141(R)-1 to have a material impact on its consolidated financial statements.

 

 

Recent Accounting Pronouncements (Continued)

 

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (ASC 820 Fair Value Measurements and Disclosures). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. The Company recognizes that the adoption of FSP FAS 157-4 may have a material impact on its consolidated financial statements.

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASC 825 Financial Instruments and ASC 270 Interim Reporting). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009. The Company does not expect the adoption of FSP FAS 107-1 and APB 28-1 to have a material impact on its consolidated financial statements.

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (ASC 320 Investments – Debt and Equity Securities). FSP FAS 115-2 and FAS 124-2 amends other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009. The Company recognizes that the adoption of FSP FAS 115-2 and FAS 124-2 may have a material impact on its consolidated financial statements.

 

In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities.” SAB 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. The Company does not expect the implementation of SAB 111 to have a material impact on its consolidated financial statements.

 

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, “Subsequent Events” (ASC 855 Subsequent Events). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. The Company does not expect the adoption of SFAS 165 to have a material impact on its (consolidated) financial statements.

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” (ASC 860 Transfers and Servicing). SFAS 166 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that a report entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. SFAS 166 is effective for

 

 

Recent Accounting Pronouncements (Continued)

 

interim and annual periods beginning after November 15, 2009. The Company does not expect the adoption of SFAS 166 to have a material impact on its consolidated financial statements.

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (ASC 810 Consolidation). SFAS 167 improves financial reporting by enterprises involved with variable interest entities. SFAS 167 is effective for interim and annual periods beginning after November 15, 2009. Early adoption is prohibited. The Company does not expect the adoption of SFAS 167 to have a material impact on its consolidated financial statements.

 

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – replacement of FASB Statement No. 162” (ASC 105 Generally Accepted Accounting Principles). SFAS 168 establishes the FASB Accounting Standards Codification which will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. SFAS 168 is effective immediately. The Company does not expect the adoption of SFAS 168 to have a material impact on its consolidated financial statements.

 

In June 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 112 (SAB 112). SAB 112 revises or rescinds portions of the interpretative guidance included in the codification of SABs in order to make the interpretive guidance consistent with current U.S. GAAP. The Company does not expect the adoption of SAB 112 to have a material impact on its consolidated financial statements.

 

In June 2009, the FASB issued EITF Issue No. 09-1, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing” (ASC 470 Debt). EITF Issue No. 09-1 clarifies how an entity should account for an own-share lending arrangement that is entered into in contemplation of a convertible debt offering. EITF Issue No. 09-1 is effective for arrangements entered into on or after June 15, 2009. Early adoption is prohibited. The Company does not expect the adoption of EITF Issue No. 09-1 to have a material impact on its consolidated financial statements.

 

In August 2009, the FASB issued Accounting Standards Update No. 2009-05 (ASU 2009-05), “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value.” ASU 2009-05 amends Subtopic 820-10, “Fair Value Measurements and Disclosures – Overall,” and provides clarification for the fair value measurement of liabilities. ASU 2009-05 is effective for the first reporting period including interim period beginning after issuance. The Company does not expect the adoption of ASU 2009-05 to have a material impact on its consolidated financial statements.

 

In September 2009, the FASB issued Accounting Standards Update No. 2009-12 (ASU 2009-12), “Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” ASU 2009-12 provides guidance on estimating the fair value of alternative investments. ASU 2009-12 is effective for interim and annual periods ending after December 15, 2009. The Company does not expect the adoption of ASU 2009-12 to have a material impact on its consolidated financial statements.

 

In October 2009, the FASB issued Accounting Standards Update No. 2009-15 (ASU 2009-15), “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The Company does not

 

 

Recent Accounting Pronouncements (Continued)

 

expect the adoption of ASU 2009-15 to have a material impact on its consolidated financial statements.

 

In October 2009, the Securities and Exchange Commission issued Release No. 33-99072, “Internal Control over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers.” Release No. 33-99072 delays the requirement for non-accelerated filers to include an attestation report of their independent auditor on internal control over financial reporting with their annual report until the fiscal year ending on or after June 15, 2010.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note 2. Securities

 

Carrying amounts and approximate market values of securities available for sale are as follows:

 

 

Carrying amounts and approximate market value of securities classified as held to maturity are as follows:

 

 

 

 

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2. Securities (Continued)

 

The following table sets forth securities classified as available for sale and securities classified as held to maturity with unrealized losses for less than twelve months and twelve months or longer at September 30, 2009 and December 31, 2008. Securities identified as other-than-temporary impaired are excluded from this table.

 

Changes in market interest rates and changes in credit spreads may result in temporary impairment or unrealized losses, as the fair value of securities will fluctuate in response to these market factors. Of the securities in a net unrealized loss position longer than 12 months as of September 30, 2009, $5.3 million of the total $6.8 million unrealized loss is in the corporate and other debt category, where the Company has a number of corporate debt securities issued by companies within the financial sector and other pooled trust preferred securities where the underlying instruments are commercial bank or insurance company trust preferred issues. Due to the multitude of negative economic issues, and the resulting general market unrest, most all of the financial sector debt instruments have experienced historical lows in their market value. While this is not considered a permanent condition, the Company cannot predict with any degree of accuracy when prices will return to historical levels.

 

In accordance with generally accepted accounting principles, securities are evaluated for other than temporary impairment on a quarterly or more frequent basis if market concerns warrant such evaluation. Impairment is considered to be “other than temporary” if the Company does not anticipate being able to

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2. Securities (Continued)

 

recover substantially all of its cost, and intends to sell the security, or it is more likely than not to be required to sell the security before recovering its cost basis. Impairment is measured based on the entity’s intention to sell the security, it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, or the entity does not expect to recover the security’s entire amortized cost basis. For certain of the Company’s Collateralized Debt Obligations (CDO) investments, where there are quarterly or semiannual cash flows, an evaluation utilizing discounted net cash flow analysis is performed to ascertain if there was a significant deterioration, (adverse change) in the instrument’s cash flows and thereby indicating impairment. This analysis utilizes Intex information on cash flows. EITF 99-20 (ASC 325 Investments and Other) prescribes using a discount rate "equal to the current yield used to accrete the beneficial interest." This discount rate is calculated using the original discount margin (or credit spread) calculated as of the purchase date based on the purchase price. The original discount margin is then added to the appropriate forward 3-month LIBOR rate to determine the discount rate. For fixed/floating securities, the original coupon is used as the discount rate for the remaining fixed-rate portion of the security's estimated life. Forward interest rates are used to project future principal and interest payments. This permits modeling the impact of over or under collateralization for each transaction, e.g. higher interest rates generally increase the credit stress on under-collateralized transactions by reducing excess interest, which is the difference between the interest received from the underlying collateral and the interest paid on the bonds. The analysis assumes a level of annual deferrals and defaults, which are treated the same at 75 basis points for the remaining life of the security, a 15 percent recovery on deferrals after two years, and no prepayments by issuers.

After such an analysis and in connection with the preparation of financial statements to be included in this Form 10-Q, a determination of the credit portion of the impairment that would be recognized through earnings was made during the nine months ended September 30, 2009 and management recorded an Other Than Temporary Impairment (OTTI) related to five CDO investment securities with current par value of $7,960,999 of which $2,631,732 has been recognized in other comprehensive loss, and impairment losses of $3,434,000, net of tax of $1,167,560, have been recognized in earnings during the nine months of 2009. The following table provides additional information on the impaired securities at September 30, 2009.

 

Security	Tranche Level	Ratings Moody/Fitch	Current Defaults and Deferrals (in 000's)	Percent of Current Defaults & Deferrals to Current Collateral	Estimated incremental defaults required to break yield (1) (in 000's)	Par Value 9-30-2009	Book Value 9-30-09	Estimated Fair Value 9-30-09	Cumulative Other Comprehensive Loss (2)	Amount of OTTI related to Credit Loss (2)
ALESC	D-1	CaCC	191,451	29.8%	Broken	1,037,984	5,101	5,101	158,529	874,354
PreTSL II	Mezz	CaCC	96,500	45.1%	Broken	2,357,418	880,237	880,237	738,738	738,443
PreTSL XII	B-3	CaCC	184,600	31.3%	900	2,011,420	801,480	801,480	942,628	267,312
PreTSL XVI	D-1	NR C	157,150	39.1%	Broken	1,554,177	0	0	0	1,554,177
PreTSL XXIII	D-1	NR CC	237,500	20.6%	122	1,000,000	208,163	208,163	791,837	0
						7,960,999	1,894,981	1,894,981	2,631,732	3,434,286

(1)

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

(2)

Pre-tax

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

	Quarter Ended September 30, 2009	Nine Months Ended September 30, 2009
Balance beginning of period	1,202,955	0
Additions:     Initial credit impairments	267,312	3,434,286
Subsequent credit impairments	1,964,019	0
Balance, end of period	3,434,286	3,434,286

The Company monitors these and other Pooled Trust Preferred Securities in its portfolio as to additional collateral issuer defaults and deferrals, which, as a general rule, indicate that additional impairment may have occurred. These events are predominantly related to issuer banks in default and as a result, the likelihood of failure is high. Due to the continuing stress on banks in general due to the overall economic conditions, the Company anticipates having to recognize additional impairment in future periods, however the extent and timing of any additional impairment can not be reasonably estimated at this time. 
  
 

  
 

 

 

The Company’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $3.6 million at September 30, 2009. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock other than the FHLB’s or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Although the FHLB temporarily suspended cash dividend payments and repurchase of excess capital stock in 2009, they have resumed dividend payments and the Company does not consider this investment to be other than temporarily impaired at September 30, 2009 and no impairment has been recognized.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 3. Loans

 

Major classifications of loans are summarized as follows:

 

 

Impaired loan balances at September 30, 2009 and December 31, 2008 are summarized as follows:

 

 

 

No additional funds are committed to be advanced in connection with impaired loans.

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 4. FHLB Borrowings

 

The borrowings from the Federal Home Loan Bank of Atlanta, Georgia, are secured by qualifying first mortgage loans and certain securities. The borrowings consist of the following:

 

 

 

 

 

 

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 5. Stock-Based Compensation

 

The Company has a Stock Plan that provides for the grant of Incentive Stock Options up to a maximum of 341,196 shares of common stock of which 184,085 shares have not been issued. This Plan was adopted to foster and promote the long-term growth and financial success of the Company by assisting in recruiting and retaining directors and key employees by enabling individuals who contribute significantly to the Company

to participate in its future success and to associate their interests with those of the Company. The options were granted at the market value on the date of each grant. The maximum term of the options is ten years. The Company has not issued new options, and no expense has been recognized, in 2009, 2008 and 2007. The number of shares presented herein has been adjusted to reflect a 5% common stock dividend that was paid June 13, 2008.

 

The following table presents a summary of options under the Plan at September 30, 2009:

 

 

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2009. This amount changes based on changes in the market value of the Company’s stock.

 

Information pertaining to options outstanding at September 30, 2009 is as follows:

 

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6. Fair Value Measurements

 

Generally accepted accounting principles, defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the markets in which the assets are traded, and the transparency and reliability of the assumptions or other inputs used to determine the fair value of an asset or liability as of the measurement date. The three levels are defined as follows:

 

 

 

 

The Company groups assets at fair value based upon prices obtained from the markets in which the assets are typically traded and the reliability of assumptions used to determine fair value. The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

 

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2009:

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

 

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

 

Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market and SBA certificates held pending being pooled into an SBA security. Fair value is based on the price secondary markets are currently offering for similar loans and SBA certificates using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the nine months ended September 30, 2009. Gains and losses on the sale of loans are recorded within income from mortgage banking on the Consolidated Statements of Operations.

 

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of theCompany using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.

 

Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are recorded at the lower of the loan balance or fair value less cost to sell.  At September 30, 2009, no OREO was recorded at fair value.

 

 

 

 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6. Fair Value Measurements (Continued)

 

The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period.

 

 

Generally accepted accounting principles requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company and subsidiary. The following methods and assumptions were used by the Company and subsidiary in estimating the fair value of financial instruments:

 

Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.

 

Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

 

Loans held for sale: The carrying amount of loans held for sale approximate their fair values.

 

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.

 

Accrued interest receivable and accrued interest payable: The carrying amounts of accrued interest receivable and accrued interest payable approximate their fair values.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6. Fair Value Measurements (Continued)

 

Deposit liabilities: The fair values of demand deposits equal their carrying amounts which represents the amount payable on demand. The carrying amounts for variable-rate fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected maturities on time deposits.

 

Federal funds purchased and securities sold under repurchase agreements: The carrying amounts for federal funds purchased and securities sold under repurchase agreements approximate their fair values.

 

FHLB borrowings: The carrying amounts of FHLB borrowings is estimated to be the discounting its future cash flows using net rates offered for similar borrowings.

 

Capital trust preferred securities: The carrying amount of the capital trust preferred securities approximates their fair values.

 

The following is a summary of the carrying amounts and estimated fair values of the Company’s financial assets and liabilities at September 30, 2009 and December 31, 2008:

 

At September 30, 2009 and December 31, 2008, the Company had outstanding standby letters of credit and commitments to extend credit. These off-balance sheet financial instruments are generally

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6. Fair Value Measurements (Continued)

 

exercisable at the market rate prevailing at the date the underlying transaction will be completed, and, therefore, they were deemed to have an immaterial affect on the current fair market value.

 

 

Critical Accounting Policies

 

General. The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we may use historical loss factors as one of the many factors and estimates utilized in determining the inherent losses that may be present in our loan portfolio. Actual losses could differ substantially from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would affect our transactions could change. A summary of the significant accounting policies of the Company is set forth in Note 1 to the Company’s consolidated financial statements.

 

Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectibility of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.

 

Impairment of Loans: We measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan (or, as a practical expedient, at the loan’s observable market price) or the fair value of the collateral if the loan is collateral dependent. We consider a loan impaired when it is probable that the Company will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment.

 

Impairment of Securities: Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the

 

cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.

 

Results of Operations

 

The following discussion is intended to assist in understanding the results of operations and financial condition of the Company.  This discussion should be read in conjunction with the accompanying consolidated financial statements.

 

For the quarter ended September 30, 2009, the Company reported a loss of $1,050,669 compared to a loss of $16,893,841 in the quarter ended September 30, 2008. The reduction in net loss is $15,843,172 or 93.8 percent when compared to the loss in the third quarter of 2008. Net income available to common shareholders was a loss of $1,211,257 after accrued dividends and accretion of discount on preferred stock totaling $160,588. Basic and diluted loss on a per share basis was -$0.46, an improvement of $6.10 or 93.0 percent from the comparable quarter in 2008. For the nine-month period in 2009, net loss was $884,889 compared to a loss of $15,088,759 for the same period in 2008. Net income available to common shareholders for the nine-month period of 2009 was a loss of $1,314,703 after accrued dividends and accretion of discount on preferred stock totaling $429,814. Basic and diluted loss on a per share basis was -$0.50, an increase of $5.36 or 91.5 percent for basic and diluted loss per share compared to the same period in 2008.

 

During the three months ended September 30, 2009, the Company recorded $2,231,331 in other-than-temporary impairment charges, net of tax of $1,472,678. This non-cash charge to earnings is related to Collateralized Debt Obligation (CDO) investment securities and was previously discussed in Note 2. Also, on May 22, 2009, the FDIC levied a special assessment on insured institutions as part of the agency’s effort to rebuild the Deposit Insurance Fund (DIF). The final rule established a special assessment of five basis points on each FDIC-insured depository institution’s assets, minus its Tier 1 capital as of June 30, 2009. The Company accrued $225,000 for the FDIC’s special assessment during the second quarter of 2009 and paid the FDIC $226,328 on September 30, 2009, the additional amount paid was expensed in the third quarter.

 

The loss during the third quarter is the result of the non-cash write-down of $2,231,331 in Collateralized Debt Obligation (CDO) securities during the third quarter of 2009 versus zero in the prior year and contributions to the Bank’s provision for loan losses of $968,236 compared to $300,000 for the third quarter of 2008. The loss was positively impacted by improvement in the net interest margin, due to a reduction in interest expense resulting from lower levels of FHLB and Repo borrowings during the quarter and the lower rate environment. The reduction in interest expense has mitigated the loss of interest income from the decline in earning assets of over $18 million due to the non-cash write-down of perpetual preferred stock issued by Fannie Mae and Freddie Mac (collectively, “the GSE”) during the third quarter of 2008, and an additional loss of interest income from the $12.6 million of non-accrual loans and other real estate. Excluding the loss on the write-down of CDO securities and the net gains on sale of securities during the third quarter of 2009, third quarter net income would have been $570,493 or $.22 per basic and diluted shares while net income available to common shareholders for the three-month period would have been $409,905 or $.16 per basic and diluted shares. For the three-month period ended September 30, 2008 comparable net income, excluding the loss on the write-down of the Fannie Mae and Freddie Mac

 

preferred stock, CDO securities and the net gains on sale of securities was $927,868 or $0.36 per basic and diluted share.

 

The return on average assets for the third quarter was -0.85 percent and excluding the write-down and gain on sale of securities would have been 0.46 percent versus the prior year’s 0.75 percent. The return on shareholders’ equity was -12.94 percent and exclusive of the write-down and gain on sale of securities would have been 7.02 percent, compared to 12.47 percent in 2008.

 

                  Notwithstanding the impact of the non-cash impairment write-down and the increase in the provision for loan losses, the decrease in net income for the third quarter was positively impacted by improvement in the net interest margin as interest rates have stabilized since earlier in the year and the Company has reduced the level of FHLB and Repo borrowings. Primary factors that have had a negative affect on the net interest margin in prior periods include earning assets with variable interest rates tied to prime outweighing corresponding variable funding sources; the loss of $21.3 million in earning assets due to the aforementioned write-off of Fannie Mae and Freddie Mac preferred stock and CDO investments during the last two quarters of 2008 and first three quarters of 2009, respectively; an additional loss of interest income from the $12.6 million of non-accrual loans and other real estate; significant competition for retail deposits in our markets; all of which had been further exacerbated by interest rate cuts by the Federal Reserve that started in September 2007 with the Federal Funds rate target at 5.25 percent and continued through December 2008 when the Federal Funds target range was set to 0 percent to 0.25 percent, where it remained at September 30, 2009. As a result, the cost of funding asset growth declined at a slower rate than did income on all earning assets, particularly interest sensitive earning assets. The Company has historically been asset sensitive, thus in a period of declining rates, the income from earning assets declines more and/or faster than the interest expense on deposits. Over the past several quarters, the Company has endeavored to become more liability sensitive because in a declining rate environment, it is generally advantageous to restructure the composition of earning assets and their corresponding funding sources such that the interest expense on deposits and borrowings will decline with the market, however interest income on loans and securities will not decline as much or as fast, resulting in an increasing net interest margin. In the past, the Company has relied on higher cost retail certificates of deposit for funding earning assets but given the current interest rate environment coupled with the growth in loans during 2009, the Company has emphasized acquisition of demand deposits over time deposits and has relied on wholesale borrowings thereby lowering our interest expense. This strategy has resulted in a reduction in total interest expense and positively impacted our net interest margin.

    

                Excluding the after tax effect of the OTTI write-down of CDO securities, the net gains and losses on sale of securities and the FDIC special assessment, year-to date net income would have been 1,215,162 while net income available to common shareholders would have been $785,348 or $.30 per basic and diluted shares. For the nine-month period ended September 30, 2008 comparable net income available to common shareholders, excluding the after tax effect of the OTTI write-down of the Fannie Mae and Freddie Mac preferred stock and another debt security, and the net gains and losses on sale of securities would have been $2,670,560 or $1.04 per basic and diluted share.

 

Net Interest Income. The Company’s net interest income was $3,717,915 in the third quarter of 2009, compared to $3,563,609 for the third quarter of 2008, an increase of $154,306 or 4.3 percent. The increase is primarily the result of the effect of improving interest margins due to the stabilization of interest rates and the shrinkage of the balance sheet. The net interest margin for the third quarter of 2009 was 3.29 percent compared to 3.08 percent in the third quarter of 2008. Factors that were present during the latter part of 2008 continued to impact net interest margin during the early part of 2009 and have now been mitigated by the stable interest rate environment.  Average earning assets were $461.8 million at September 30, 2009, a decrease of $17.7 million or 3.7 percent from $479.5 million in the third quarter of 2008. The tax-equivalent yield on total interest earning assets dropped to 5.89 percent in 2009 from 6.21 percent in 2008 resulting in a decrease of $587,292 in total interest income. Interest expense also decreased as the yield on interest-bearing liabilities decreased to

 

2.87 percent in the third quarter of 2009 compared to 3.53 percent in 2008 resulting in a decrease of $741,598 in total interest expense to $3.0 million compared to $3.7 million in the third quarter of 2008. This decrease in total interest expense was also impacted by the decline in average interest-bearing liabilities of $5.8 million or 1.4 percent to $418.0 million in the third quarter of 2009 compared to $423.9 million in the third quarter of 2008. The changes in average interest-bearing liabilities were in interest-bearing deposits, up $23.2 million or 7.3 percent; FHLB advances down $11.5 million or 19.4 percent; federal funds purchased and repurchase agreements down $17.5 million or 41.2 percent.

 

For the nine-month period ended September 30, 2009, net interest income totaled $10,146,347, a decrease of $926,618 or 8.4 percent compared to $11,072,965 for the same period in 2008. The net interest margin for the 2009 period was 2.95 percent compared to 3.26 percent in 2008. Interest and fees on loans decreased $1,056,219 or 7.1 percent as the volume of loans increased $2,296,917, or 0.77 percent, from December 31, 2008 to September 30, 2009. Interest on securities decreased $1,891,055 and interest on federal funds sold increased $12,917. Combined, total interest income was down $2,934,357 or 12.9 percent. Total interest expense decreased 17.3 percent as interest on deposits decreased $1,274,046 or 14.1 percent as the volume of deposits increased 6.3 percent. Interest on borrowings decreased $733,693, or 28.6 percent.

 

The net interest margin is a measure of net interest income performance. It represents the difference between interest income, including recognition of a portion of previously deferred net loan fees and costs and interest expense, reflected as a percentage of average interest earning assets. The Company continues to be asset sensitive, although much less so than in the past. The Company has allowed many of its higher rate retail deposits to run off and replaced this funding source with a combination of non-interest and lower interest cost deposits and variable rate overnight borrowings, which will more closely track future changes in interest rates, thereby mitigating margin compression. Additionally, the Company has experienced a reduction in earning assets to match the reduction in funding sources.

 

                During the third quarter of 2009, average loans totaled $298.4 million, an increase of $5.0 million or 1.7 percent from $293.3 million in the third quarter of 2008, while average investment securities totaled $154.0 million, a decrease of $31.4 million from $185.3 million in the third quarter of 2008. The fully taxable equivalent annualized yield on loans decreased to 6.56 percent from 6.63 percent in the comparable quarter of 2008, while investment securities in the third quarter of 2009 yielded 4.86 percent, compared to 5.53 percent in the third quarter of 2008. The decrease in loan yields reflects the effects of a reduction in the prime interest rate from 5.0 percent during the first quarter of 2008 to its current level of 3.25 percent during the third quarter of 2009. Like the yield on the loan portfolio, security yields have been affected by the declining rate environment as reinvestment of $46.7 million in called securities have been at lower yields, and the reduction in higher yielding assets from the write-down of the CDO security investments in 2009 and Fannie Mae and Freddie Mac preferred stock security investments in 2008. Average total deposits for the third quarter of 2009 increased by $20.3 million or 5.7 percent, to $377.6 million from $357.3 million in the third quarter of 2008. Total interest bearing deposits in the third quarter averaged $340.0 million, an increase of $23.2 million or 7.3 percent as compared to $316.8 million in the third quarter of 2008. Total borrowings averaged $78.0 million in the third quarter of 2009 compared to $107.1 million in the comparable quarter of 2008.

 

The following table sets forth the Company’s average interest earning assets (on a taxable equivalent basis) and average interest bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin, for the periods indicated.

 

 

 

 

 

Non-Interest Income. The Company’s non-interest income for the third quarter of 2009 was $654,963, a decrease of $234,851 or 26.4 percent from $889,814 in the same period of 2008. Deposit fees and charges decreased 1.0 percent or $4,774 to $472,858 as the volume of overdraft fees remained relatively steady. Bank card fees increased by $13,190 to $142,904 in 2009. Income recognized on the increase in cash surrender value of life insurance improved by 12.4 percent or $11,847 to $107,517. Secondary market mortgage loan fees increased $36,977 to $59,541. Securities gains and losses decreased $246,722 to $(224,975), due largely to the sale of certain securities in the ordinary course of business. Investment and insurance commissions declined $66,657 or 70.3 percent to $28,224 in the third quarter of 2009 due to a continued decline in transaction levels given the existing investment environment. Other income was up 44.7 percent to $68,894 largely due to the addition of check sales commissions.

 

Year to date 2009 non-interest income totaled $2,997,231, an increase of $311,960 or 11.6 percent when compared to $2,685,271 in the first nine months of 2008. The categories with the most significant year to date increases or decreases were deposit fees and charges, down 4.9 percent; secondary market mortgage fees, up 173.3 percent due to an increase in purchasing activity within the local housing market during the last two quarters; investment and insurance commissions declined 57.8 percent; net gains on sales of securities was up 245.2 percent due to a higher volume of sales as well as a high volume of calls at par of agency securities originally purchased at a discount; other income was up 7.5 percent largely due to largely due to the addition of check sales commissions.

 

Non-Interest Expenses. Total non-interest expense for the third quarter of 2009 was $5,276,720, a decrease of $15,966,864 compared to $21,243,584 in the comparable period in 2008. Excluding the write-down of securities previously discussed of $2,231,331 and $17,850,850 during the third quarters of 2009 and 2008, respectively, non-interest expenses in the third quarter of 2009 would have been $3,045,389, a decrease of $347,345, or 10.3 percent compared to $3,392,734 in the comparable period in 2008. Cost control and efficiency continue to be stressed by the Company wherever possible and practicable. Salaries and benefits totaled $1,570,924, a decrease of $323,515 or 17.1 percent compared to $1,894,439 in the third quarter of 2008. The decrease reflects lower staffing levels and a freeze on normal annual increases during 2009 combined with lower benefit accruals. Legal and professional fees totaled $62,812, an decrease of $4,488 or 6.7 percent from the third quarter of last year’s total of $67,300 as costs reflect accounting and legal expense associated with the Company’s participation in the Capital Purchase Program, accounting audit services and testing of the Bank’s compliance with Section 404 of the Sarbanes-Oxley Act. Equipment repairs and maintenance expense decreased $44,480 or 43.7 percent to $57,362 reflecting reduced costs from software and equipment maintenance contracts due to the outsourcing of our data and item processing units in the fourth quarter of 2008. Consulting fees decreased $37,843 or 40.7 percent as the Company continues to reduce its use of outside consultants. Equipment depreciation decreased by $22,221 or 14.3 percent to $133,582 as management has deferred many capital purchases. Advertising and public relations expense decreased by $24,012 or 26.2 percent for the quarter as management has reduced costs by selectively identifying advertising opportunities that provide the best value for exposure within our marketplace. Insurance premiums for FDIC insurance increased to $145,820, an increase of $72,419 or 98.7 percent from $73,401 in the third quarter of 2008 primarily due to premium increases from the FDIC. Office supplies, telephone, and postage expense increased to $129,572, an increase of $3,992 or 3.2 percent from $125,580 in the third quarter 2008. Data processing was $88,837 and is associated with the outsourcing of our data and item processing units in the fourth quarter of 2008 there was no expense in the third quarter of 2008.

 

For year to date 2009, total non-interest expense was $12,874,963, a decrease of $14,416,564 or 53.5 percent compared to $27,688,508 for the year to date 2008. Again, excluding the write-down of securities previously discussed of $3,434,286 and $17,850,850 during the nine months of 2009 and 2008, respectively. Non-interest expenses during 2009 would have been $9,440,677, a decrease of $396,981, or 4.1 percent compared to $9,837,658 in the comparable period in 2008. For the first nine months of 2009, the categories with the most significant increases or decreases were salaries and benefits, down 12.7 percent or $714,637; occupancy expense was up 2.5 percent or $11,941; equipment depreciation is down 15.5 percent or $76,123; equipment repairs and maintenance is down 44.4 percent; advertising and public relations is down $71,.623 or 28.9 percent; office supplies, telephone, and postage expense was down 3.2 percent; legal and professional fees were up $33,348 or 18.9 percent; and federal insurance premiums were up 244.0 percent for the reasons stated above and the FDIC special assessment of $226 thousand in the second quarter of 2009.

 

Income Taxes. The Company reported income tax benefit of $821,409 in the third quarter of 2009, compared to a benefit of $196,320 in the third quarter of 2008. These amounts yielded effective tax rates (benefits) of -43.9 percent and -1.2 percent, respectively.  On a year to date basis, income tax benefit was $739,732 in 2009 compared to income taxes of $278,487 in 2008. Due to the loss before income taxes in the third quarter of 2009, presentation of comparable tax rates for each period would not be meaningful.

 

Financial Condition

 

Loan Portfolio. The Company is an active residential mortgage and residential construction lender and generally extends commercial loans to small and medium sized businesses within its primary service area. The Company’s commercial lending activity extends across its primary service area of Powhatan, Cumberland, eastern Goochland County, western Chesterfield, and western Henrico Counties. Consistent with its focus on providing community-based financial services, the Company generally does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area.

 

The principal economic risk associated with each of the categories of loans in the Company’s portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased depending on prevailing economic conditions. The risk associated with the real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of the Company’s market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction. Builders are limited as to the number and dollar amount of loans for speculative home construction based on the financial strength of the borrower and the prevailing market conditions.

 

At September 30, 2009, total loans net of unearned income were $299.1 million and had increased by $5.7 million or 1.9 percent from December 31, 2008, and had grown $2.3 million or 0.8 percent from September 30, 2008. The loan to deposit ratio was 79.0 percent at September 30, 2009, compared to 84.3 percent at December 31, 2008 and 85.0 percent at September 30, 2008. Though growth has slowed as a result of declining demand in our marketplace these results are reflective of the Company’s strategy to increase the loan portfolio which has been ongoing since late 2006. At September 30, 2009, real estate related loans accounted for 74.1 percent of the total loan portfolio, consumer loans were 2.9 percent of the total portfolio, and commercial and industrial loans represented 23.0 percent of the total portfolio as compared to 76.6, 3.2, and 20.2 percent respectively at December 31, 2008 and 78.1, 3.1, and 18.8 percent respectively at September 30, 2008.

 

Asset Quality. Non-performing assets include non-accrual loans, loans 90 days or more past due, restructured loans, other real estate owned, and other non-performing assets. Non-accrual loans are loans on which interest accruals have been discontinued. Loans that reach non-accrual status may not be restored to accrual status until all delinquent principal and interest has been paid. Restructured loans are loans with respect to which a borrower has been granted a concession on the interest rate or the original repayment terms because of financial difficulties. Other non-performing assets are earning assets other than loans, generally securities. In this case, the Company has suspended accruing interest on several of its impaired pooled trust preferred securities, as they are no longer paying interest to bondholders, any interest that was capitalized in lieu of being paid in cash, has been reversed from income in the third quarter 2009.  The Company now considers these bonds as “non-performing.” Other real estate owned (OREO) is real estate acquired through foreclosure. The Company has no “sub-prime” mortgages within its mortgage loan portfolios.

 

 

 

Management forecloses on delinquent real estate loans when all other repayment possibilities have been exhausted. The Bank’s practice is to value real estate acquired through foreclosure at fair value, which is the lower of (i) an independent current appraisal or market analysis less anticipated costs of disposal, or (ii) the existing loan balance. Nonperforming loans totaled $16,920,792, an increase of $3,837,983 as compared to $13,082,809 at December 31, 2008 and an increase of $6,683,656 as compared to $10,237,136 at September 30, 2008. The current decline in the national economy has also affected the local real estate market. The majority of the non-performing loans are real estate related. As such, management expects an increase in total non-performing assets over the next several quarters as changes occur within the national and local economy and real estate market. Management further believes the majority of non-performing loans is adequately secured and should be covered by additions to the reserve.

 

Management has analyzed the potential risk of loss on the Company’s loan portfolio, given the loan balances and the value of the underlying collateral, and has recognized losses where appropriate. Non-performing loans are monitored on an ongoing basis as part of the Company’s periodic internal and external loan review process. Given the increase in non-performing assets, management is concerned, however it does not believe that the level of non-performing loans at September 30, 2009 is reflective of any significant systemic problem within the Company’s loan portfolio and rather is a reflection of the current economic environment. Management reviews the adequacy of its loan loss allowance at the end of each month. Based primarily on the Company’s loan risk classification system, which classifies all loans, including impaired or problem credits as substandard, doubtful, or loss, according to a scale of 1-8 with 8 being a loss. Additionally, management evaluates non-performing loans relative to their collateral value and may make appropriate reductions to the carrying value of those loans to approximate fair value based on that review. Management believes, based on its review, and the current status of the credits that the Company has adequate reserves at the present time. Should any of the individual nonperforming loans deteriorate further in the future, additional write downs on these loans may be required. The ratio of the allowance for loan losses to total loans was 1.61 percent at September 30, 2009; 1.29 percent at December 31, 2008; and 1.21 percent at September 30, 2008. Management believes that the allowance for loan losses, which may or may not increase at the same rate as the loan portfolio grows, is currently adequate to provide for potential losses. However, considering the current decline in the local real estate markets, and the risk as identified by periodic qualitative and quantitative analysis, the Company has elected to continue regular additions to its reserve for possible loan losses, and these additions are expected to continue in the foreseeable future. At September 30, 2009, the ratio of the allowance for loan losses to total non-performing assets net of non-performing securities was 28.6 percent compared to 29.0 percent at December 31, 2008 and 35.1 percent at September 30, 2008.

 

For each period presented, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all factors connected with the collectibility of the existing portfolio. Management evaluates the loan portfolio in light of economic conditions, changes in the nature and value of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include internally generated loan review reports as well as reports from an outside loan reviewer, previous loan loss experience with the borrower, the status of past due interest and principal payments on the loan, the quality of financial information supplied by the borrower, the general financial condition of the borrower, and the value of any collateral securing the loan.

 

Given the significant growth in the total loan balances since 2007, the stability in the net charged-off loan amount, the ratio of the reserve for loan losses to outstanding loans, the generally depressed real estate markets, and the increase in the total non performing assets, management concluded that it would be appropriate to continue additions to the reserve. Accordingly, there was a provision for loan losses of $1,893,236 in the first nine months of 2009, compared to $880,000 in the first nine months of 2008. Management will continue to evaluate, on a monthly basis, the adequacy of the total reserve for loan losses. At this time, management believes there is a strong evidence to support additions to the reserve for loan losses in subsequent periods. The decision to continue, increase or decrease additions to the reserve would be based on the monthly qualitative analysis of the loan portfolio, considering, among other factors, increases in the risk profile of certain types of lending, loan growth, overall economic conditions, and the volume of non-performing loans. Despite management’s best efforts, the reserve may be adjusted in future periods if there are significant changes in the assumptions or factors utilized when making valuations, or conditions differ materially from the assumptions originally utilized. Any such adjustments are made in the reporting period when the relevant factor(s) become known and when applied as part of the analysis indicate a change in the level of potential loss is warranted.

 

Securities

 

The Company’s investment securities portfolio serves primarily as a source of liquidity, safety and yield. Certain of the securities are pledged to secure public or government deposits and others are specifically identified as collateral for borrowings from the Federal Home Loan Bank or repurchase agreements with correspondent banks and customers. The remaining portion of the portfolio is held for investment yield, availability for sale in the event liquidity is needed to fund loan growth or cover deposit outflows, and for general asset/liability management purposes. At the end of the third quarter 2009, total securities were $122.5 million, a decrease of $23.4 million or 16.1 percent compared to December 31, 2008 balances of $145.9 million, and have decreased by $17.3 million or 12.4 percent since the September 30, 2008 balance of $139.8 million. This is largely due to the $18.9 million write-off of Fannie Mae and Freddie Mac preferred stock and a Lehman Brothers debt security and the adjustment to market value from book value of the securities by its associated FASB 115 unrealized losses during 2008 and 2009, and $42.5 million in agency securities called during the first nine months of 2009. Investment securities represented 26.0 percent of total assets, and 28.4 percent of earning assets at September 30, 2009, compared to 30.0 percent and 33.2 percent, respectively, at December 31, 2008 and 29.1 percent and 31.8 percent, respectively, at September 30, 2008.

 

The securities portfolio consists of two components, securities available for sale and securities held to maturity. Securities are classified as held to maturity when management has the intent and the Company has the ability at the time of purchase to hold the securities to maturity. Securities so classified are carried at cost adjusted for amortization of premiums and accretion of discounts. Securities to be held for indefinite periods of time are classified as available for sale and accounted for at market value. Securities available for sale include securities that may be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, general liquidity needs and other similar factors. The Company’s investment policy requires that all rated securities that are purchased must be investment grade or better. Recent purchases of securities have been securities of investment grade credit quality with short to intermediate and occasionally, longer term maturities.

 

                The Company reviews and evaluates all securities quarterly or more frequently as necessary for possible impairment. If, in the judgment of management, there is serious doubt as to the probability of collecting substantially all the Company’s basis in a security within a reasonable period of time, an impairment write down will be recognized. The Company presently holds the following securities with credit ratings that, subsequent to purchase, have declined below minimum investment grade however all securities are paying interest in accordance with their terms, and the evaluation has concluded that there is no other than temporary impairment at this time: $1 million, Ford Motor Corporation 9.5% maturing September 2011; $825 thousand, GMAC 7.00% maturing February 2012 and $175 thousand GMAC Perpetual Preferred Stock, $1 million, Deluxe Corporation 5.125% maturing October 2014; $2 million in Sallie Mae 6.97% preferred stock; $1 million PFDCPO Ltd. 8.95% maturing July 2030; $1 million MBIA 5.07% maturing June 2015.

 

The Company holds thirteen CDO securities where the underlying pooled collateral is various bank and insurance company trust preferred (see Note 2 to the financial statements for more detail). Subsequent to purchase, the securities have received revised ratings that are below minimum investment grade. Following the quarterly EITF 99-20-1 evaluation of these securities, management has concluded that, with the exception of the four securities where the previously noted non-cash OTTI charges have been recognized, the impairment within the remaining CDO securities is considered temporary as of September 30, 2009. Additionally, the Company does not own any securities collateralized by “sub-prime” or “alt A” mortgage loans.

 

The fully taxable equivalent annualized average yield on the entire portfolio was 4.86 percent for the third quarter of 2009, compared to 5.53 percent for the same period in 2008. Due to the lower rate environment, over the next several quarters, it is anticipated that there will continue to be a significant number of agency securities called by the issuer. Reinvesting the called bond proceeds in securities with lower coupons, or utilizing the funds to reduce borrowings or fund loan growth, will likely result in a lower overall portfolio yield in the future.

 

Deposits and Borrowings

 

The Company’s predominate source of funds is deposit accounts. The Company’s deposit base is comprised of demand deposits, savings and money market accounts and other time deposits. The Company’s deposits are provided by individuals and businesses located within the communities served. The Company generally does not accept out of market deposits, nor does it solicit or accept any brokered deposits.

 

Total deposits were $378.7 million as of September 30, 2009, an increase of $30.7 million or 8.8 percent from $348.0 million at December 31, 2008. Total deposits have increased by $29.4 million or 8.4 percent from the September 30, 2008 level of $349.3 million. The average aggregate interest rate paid on interest bearing deposits was 3.09 percent in the first nine months of 2009, compared to 3.75 percent for the corresponding period in 2008. The majority of the Company’s deposits are higher yielding certificates of deposit because many of its customers are individuals who seek higher yields than those offered on regular savings, money market savings and interest checking accounts. At September 30, 2009 certificates of deposit represented 61.1 percent of total deposits as compared to 63.7 percent at December 31, 2008 and 61.8 percent at September 30, 2008.

 

The following table is a summary of time deposits of $100,000 or more by remaining maturities at September 30, 2009, June 30, 2009, March 31, 2009, and December 31, 2008:

 

 

Total borrowings at September 30, 2009 were $63.0 million, and consisted of overnight borrowings of $17.8 million, term borrowings of $40.0 million, and capital trust preferred long-term debt of $5.2 million. The weighted average cost of these borrowings in the first nine months of 2009 was 2.59 percent compared to 3.54 percent in the comparable period of 2008.

 

The overnight borrowings of $17.8 million consisted of $7.8 million in federal funds purchased and repurchase agreements with $10.0 million overnight advances from the Federal Home Loan Bank at September 30, 2009, compared to $43.3 million and $14.5 million at December 31, 2008 and $37.7 million and $20.5 million at September 30, 2008, for the respective borrowing facilities. The $40.0 million in term borrowings at September 30, 2009 were structured borrowings from the Federal Home Loan Bank, compared to $45.0 million in Federal Home Loan Bank structured borrowings and $7.0 million were in a loan from a local financial institution at December 31, 2008, and $45.0 million in Federal Home Loan Bank structured borrowings and $7.0 million were in a loan from a local financial institution at September 30, 2008. The weighted average cost of the term borrowings in the first nine months of 2009 was 4.18 percent compared to 4.12 percent in the comparable period of 2008. The capital trust preferred debt is unchanged at $5.2 million, and is described in more detail below.

 

As of September 30, 2009, the Company had $5.2 million in capital trust preferred debt outstanding which originated on December 17, 2003 at a variable interest rate of 3 month LIBOR plus

 

285 basis points and which resets quarterly. The debt matures on December 17, 2033. The current weighted average cost of these borrowings in the first nine months of 2009 was 3.85 percent compared to 6.18 percent in the comparable period of 2008. The aggregate yields on all interest bearing liabilities for the first nine months of 2009 was 2.98 percent, compared to 3.70 percent in the comparable period of 2008.

 

Capital Resources

 

The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance and changing competitive conditions and economic forces. The Company seeks to maintain a strong capital base to support its growth and expansion activities, to provide stability to current operations and to promote public confidence. The Bank’s capital position continues to exceeds regulatory requirements and the Bank is considered to be “Well-Capitalized” with a Total risk-based capital ratio of 10.7 percent at September 30, 2009.The primary indicators relied on by the Federal Reserve Board and other bank regulators in measuring strength of capital position are the Tier 1 capital, Total Capital and Leverage ratios. Tier 1 Capital consists of common and qualifying preferred stockholders’ equity less goodwill. Total Capital consists of Tier 1 Capital, qualifying subordinated debt and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk-weighted assets, which consist of both on and off-balance sheet risks. The Leverage Ratio consists of Tier 1 Capital divided by quarterly average assets.

 

Banking regulations also require the Bank to maintain certain minimum capital levels in relation to Bank Assets. A comparison of the Bank’s actual regulatory capital as of September 30, 2009, with minimum requirements, as defined by regulation, is shown below:

 

 

 

Liquidity and Interest Rate Sensitivity

 

Liquidity. Liquidity is the ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

 

Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, and the ability to obtain deposits through the adjustment of interest rates, borrowing from the Federal Home Loan Bank, purchasing of federal funds, and selling securities under repurchase agreements. To further meet its liquidity needs, the Company also has access to the Federal Reserve System discount window. In the past, growth in deposits and proceeds from the maturity of investment securities has been more than sufficient to fund the net increase in loans, however in recent quarters, deposits have decreased, loan growth has been strong, and investment securities have remained largely stable, resulting in the need to utilize several different types of borrowings. The Company expects current conditions to be continued in future quarters. The Company has previously used portions of its borrowing availability when interest rates were favorable, to purchase marketable securities in an effort to increase net interest income and at the same time lock in lower rate cost of funds for up to five years.

 

Interest Rate Sensitivity. In conjunction with maintaining a satisfactory level of liquidity, management must also control the degree of interest rate risk assumed on the balance sheet. Managing this risk involves periodic monitoring of the interest sensitive assets relative to interest sensitive liabilities over specific time intervals, and under various interest rate or yield curve shifts upward and downward.

 

At September 30, 2009, the Company had a positive 19.3% 1 month and a negative 9.6% 12-month period gap position, the cumulative gap for the next six months remains positive, but at the one-year point was negative. Since the largest amount of interest sensitive assets and liabilities mature or reprice within 12 months, the Company monitors this area closely. The Company does not emphasize interest sensitivity analysis beyond this time frame because it believes various unpredictable factors could result in erroneous interpretations. Early withdrawal of deposits, prepayments of loans and loan delinquencies are some of the factors that could have such an effect. In addition, changes in rates on interest sensitive assets and liabilities may not be equal, which could result in a change in net interest margin. While the Company does not match each of its interest sensitive assets against specific interest sensitive liabilities, it does seek to enhance the net interest margin while minimizing exposure to interest rate fluctuations.

 

Effects of Inflation

 

Inflation significantly affects industries having high proportions of fixed assets or high levels of inventories. Although the Company is not significantly affected in these areas, inflation does have an impact on the growth of assets. As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios. Traditionally, the Company’s earnings and high capital retention levels have enabled the Company to meet these needs.

 

The Company’s reported earnings results have been affected by inflation, but isolating the effect is difficult. The different types of income and expense are affected in various ways. Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index. Management actively monitors interest rate sensitivity in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.

 

 

Forward-Looking Statements

 

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company. Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. For a description of factors that may cause actual results to differ materially from such forward-looking statements, see our Annual Report on Form 10-K for the year ended December 31, 2008, and other reports from time to time filed with or furnished to the Securities and Exchange Commission. We caution investors not to place undue reliance on any forward-looking statements as these statements speak only as of the date when made. We undertake no obligation to update any forward-looking statements made in this report.          

 

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no material changes from the quantitative and qualitative disclosures about market risk made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, as discussed in the section on interest rate sensitivity in Item 2 above.

 

 

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are operating effectively in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings with the Securities and Exchange Commission.

 

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no significantchanges in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

 

PART II

OTHER INFORMATION

 

 

 

There are no pending or threatened legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of either the Company or its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

 

ITEM 1A RISK FACTORS

 

There have been no material changes from the risk factors made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

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

 

 

 

 

 

 

 

 

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