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EX-31.1 - EXHIBIT 31.1 - Xenith Bankshares, Inc.dex311.htm
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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, 2010

Or

 

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

For the transition period from                      to                     

Commission File Number: 000-53380

 

 

Xenith Bankshares, Inc.

Exact name of registrant as specified in its charter

 

Virginia   80-0229922
State or other jurisdiction of incorporation or organization   I.R.S. Employer Identification No.

One James Center, 901 E. Cary Street, Suite 1700

Richmond, Virginia

  23219
Address of principal executive offices   Zip Code

(804) 433-2200

Registrant’s telephone number including area code

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  ¨    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   ¨    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, 2010: $15,224,859.

APPLICABLE ONLY TO CORPORATE REGISTRANTS

The number of shares outstanding of the issuer’s common stock as of February 14, 2011: 5,846,928 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Company’s Annual Meeting of Shareholders to be held on May 5, 2011 are incorporated by reference in Part III of this report.

 

 

 


Table of Contents

XENITH BANKSHARES, INC. AND SUBSIDIARY

2010 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

 

          Page  
PART I   

Item 1

  

Business

     3   

Item 1A

  

Risk Factors

     21   

Item 2

  

Properties

     36   

Item 3

  

Legal Proceedings

     36   
PART II   

Item 5

  

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

     37   

Item 7

  

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

     37   

Item 8

  

Financial Statements and Supplementary Data

     61   

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     94   

Item 9A

  

Controls and Procedures

     94   

Item 9B

  

Other Information

     95   
PART III   

Item 10

  

Directors, Executive Officers and Corporate Governance

     96   

Item 11

  

Executive Compensation

     98   

Item 12

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     98   

Item 13

  

Certain Relationships and Related Transactions, and Director Independence

     99   

Item 14

  

Principal Accounting Fees and Services

     99   
PART IV   

Item 15

  

Exhibits, Financial Statement Schedules

     100   

 

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Item 1—Business

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Federal Reserve. The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail banking clients, which we refer to as our target customers. We are focused geographically on the Washington, DC-MD-VA-WV, Richmond-Petersburg, VA, and the Norfolk-Virginia Beach-Newport News, VA-NC metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its five branches, with one branch located in Tysons Corner, Virginia, one branch 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 the first branch in Suffolk in 2003 under the name of SuffolkFirst Bank, and the Bank currently operates its three Suffolk branches under that trade name.

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

Unless the context requires otherwise or unless otherwise noted:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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 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

 

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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 referred to as the merger agreement. 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. Xenith Bank currently operates under the trade name SuffolkFirst Bank at its locations in Suffolk.

Under the terms of the merger agreement, First Bankshares shareholders were entitled to elect to retain their shares of First Bankshares common stock or to receive $9.23 in cash per share for some or all of their shares of First Bankshares common stock, subject to proration in the event the aggregate cash elections exceeded 569,074 shares (or 25% of shares outstanding immediately prior to the effective time of the merger). As of 5:00 p.m., Eastern Time, on October 15, 2009, the deadline for First Bankshares shareholders to elect to receive cash for some or all of their shares of First Bankshares common stock, First Bankshares had received aggregate cash elections with respect to 1,165,311 shares of First Bankshares common stock, representing approximately 51.2% of the shares of First Bankshares common stock outstanding immediately prior to the effective time of the merger.

As a result of aggregate cash elections exceeding 569,074 shares, the cash elections were reduced proportionally and each cash election share that was not converted into the right to receive $9.23 in cash and each share of First Bankshares common stock for which a cash election was not made represented one share of Xenith Bankshares common stock immediately following the effective time of the merger.

Under the terms of the merger agreement, each share of Xenith Corporation common stock outstanding immediately prior to the effective time of the merger was cancelled and converted automatically into the right to receive 0.8700 share of Xenith Bankshares common stock. Based on this exchange ratio, an aggregate of 4,139,704 shares of Xenith Bankshares common stock were issued to the former shareholders of Xenith Corporation in exchange for their shares of Xenith Corporation common stock with fractional shares being cashed out in the merger.

Options to purchase shares of First Bankshares common stock outstanding at the effective time of the merger remain outstanding as options to purchase 94,493 shares of Xenith Bankshares common stock at a weighted average exercise price of $7.81 per share. An aggregate of 906,000 options and warrants to purchase shares of Xenith Corporation’s common stock outstanding at the effective time of the merger were converted into an aggregate of 788,220 options and warrants to purchase shares of Xenith Bankshares common stock based on the exchange ratio set forth in the merger agreement at an exercise price of $11.49 per share.

There were an aggregate of 5,846,928 shares of Xenith Bankshares common stock outstanding immediately following the effective time of the merger, with First Bankshares shareholders immediately prior to the effective time of the merger beneficially owning approximately 26.8% of the Xenith Bankshares’ outstanding shares of common stock and Xenith Corporation shareholders immediately prior to the effective time of the merger beneficially owning approximately 73.2% of Xenith Bankshares’ outstanding shares of common stock, on a fully diluted basis.

Competition

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

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 banking relationships with customers. Other factors include the quality of services and products offered, interest rates offered on deposit accounts,

 

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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 deposit and lending instruments 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 skill sets exist at some of the large banks, they generally do not exist at community banks. Our management team and bankers have spent their entire 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 side by side with customers and prospects to determine how and under what conditions we provide financing and other banking services to serve their needs.

Products and Services

We offer a range of sophisticated and competitively priced banking products and services, including commercial and consumer checking accounts, non-interest-bearing demand accounts, money market accounts, savings accounts, as well as 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, consumer loans and other products. We further offer comprehensive internet banking services. We are a member of the START and PLUS automated teller, or 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 a variety of means, including effectively leveraging our branch system and solicitation by our bankers.

In addition, 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 such as online banking, ACH and wires services, as well as debit block, positive pay, reverse positive pay and fraud protection. In addition to these services, we also offer remote deposit capture, direct deposit and merchant services. Our technology platform is designed and well-suited to supporting these services and products on a greater scale.

Types of Lending Products

We offer a full range of lending products to commercial and industrial, commercial real estate, private banking and select retail market 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 plan to continue to evaluate and adapt our services and product offerings as our customer base grows and the needs of the marketplace evolve.

Our categories of loans include commercial and industrial loans, real estate loans, including commercial income-producing real estate loans, construction and development loans, residential real estate loans and

 

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consumer loans. These loan categories have been selected because we believe our target customers often have credit needs that community banks cannot meet, and they seek a relationship-oriented banking experience that is increasingly difficult for customers to find in 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 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. Loans to support working capital typically have terms not exceeding one year and are usually secured by accounts receivable and inventory with the personal guarantees of the principals of the business. 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 liquidation value of collateral. Additionally, 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 ratios that we believe are appropriate for the equipment type.

Real Estate Loans. We make commercial real estate loans, construction and land development loans, and residential real estate loans.

We make commercial real estate loans, or 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 leases related to the properties. Our CRE loans generally have maturity dates that do not exceed five years, with amortization schedules of 15 to 25 years, with both floating and fixed 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 or tax returns or both from borrowers and guarantors at regular intervals. It is also our policy to obtain personal guarantees from the principals of the borrowers. Exceptions to our policy occur only rarely.

We also make construction and land development loans generally to local builders, developers or persons who will ultimately not occupy the property being developed. We have no loans to national developers. Our construction and land development loans are intended to provide interim financing on the property and the principal amounts are based on percentages of the cost or as-completed appraised value of the property securing the loans. Additionally, when underwriting the loan, we consider the operating performance, liquidity, financial condition and the reputation of the borrower and any guarantors, the amount of the borrower’s equity in the project, independent appraisals, cost estimates and pre-construction sale information. Construction and land development loan funds are disbursed periodically at pre-specified stages of completion of construction. We carefully monitor these loans with on-site inspections and by closely monitoring disbursements.

CRE loans are secured by business and commercial properties. Typically our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt service coverage ratios as well.

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. Typically our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt-to-income ratios as well.

Consumer Loans. Consumer loans largely include automobile loans in our target markets, and loans to our branch customers and private banking clients for consumer or business purposes.

 

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

Our credit policy also provides detailed procedures for making loans to individuals along with the regulatory requirements to ensure that all loan applications are evaluated subject to our fair lending policy. 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.

Credit Policies and Administration

We seek to maintain a high quality loan portfolio as an essential part of our business strategy. We follow a specific set of 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. Depending on the materiality of the exception and the amount of the loan commitment, exceptions to these standards may occur only with approval from our President and Chief Executive Officer, our Chief Credit Officer, our management credit committee (which is comprised of our President and Chief Executive Officer, Chief Credit Officer, Chief Financial Officer, Chief Lending Officer and Executive Vice President for Private Banking), or the credit policy committee of our board of directors.

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 officers with approval authority, (2) our management credit committee, or (3) the credit policy committee of our board of directors. Our management credit committee approves the vast majority of loans. Credit approval is required by the credit policy committee of our board of directors for certain policy exceptions.

Credit Risk Ratings. A key element of our credit policies and administration is our credit risk rating system. All significant commercial credit exposures carry risk ratings that are intended to convey accurately the current level of risk associated with the credit. We employ a dual rating system, the numbers 1-10 for the obligor, and the letters A-D for the collateral. The obligor rating is based on our assessment of the borrower’s probability of default while the collateral rating is our assessment of the probability of loss in the event of default.

Our obligor rating is used to describe the likelihood of a default by the borrower. 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 and is able to be estimated. 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.

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. There are four

 

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letter grades (A through D) used to describe the value to the bank that the collateral package represents in a default scenario. It is the responsibility of the banker and credit risk officer to ensure that our risk ratings are accurate and changed in a timely fashion.

Asset and Liability Management

Our asset and liability management is governed by an asset and liability management policy, or ALCO policy. Our ALCO policy defines and coordinates each of the financial management functions, including (1) overall asset/liability management and strategy, (2) interest rate risk management, (3) liquidity management, and (4) investment policy. The ALCO management committee addresses the day-to-day management of the assets and liabilities in the Bank and is responsible for actively monitoring interest rate risk exposure.

We evaluate the impact to our earnings and market value of equity based on changes in interest rates in both extreme and steadily increasing interest rate scenarios. We evaluate the effect of a change in interest rates of +/- 100 basis points (bps), +/- 200bps, +/-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 ALCO policy. With respect to net interest income, our maximum policy limit is a negative change of 25% and the maximum policy limit for market value of equity is negative 30%. As of December 31, 2010, we were within all applicable policy limits.

The objective of our liquidity management is to ensure that we always maintain sufficient liquidity to address deposit fluctuations, loan demand changes and debt service requirements, and we track cash inflows and outflows intraday. In addition to the day-to-day management of liquidity, we have also developed a contingency liquidity funding plan that addresses the actions we would take in the event of low to severe liquidity stresses. These action plans detail the conditions and potential causes of the liquidity problems as well as key action plans for reducing the stress, including the assignment of responsibilities to key personnel.

Our ALCO policy includes our investment policy and addresses permitted investments, safekeeping and accounting classifications. Our investment portfolio serves as both a primary and secondary source of liquidity, and it contributes to net interest margin.

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, or 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 furthest extent 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 and offsite 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 various shareholders and other creditors. Additionally, we must bear the cost of compliance with reporting and other regulations; this cost can be significant and could affect our financial performance.

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 activities. 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 might not be successful.

 

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Insurance of Accounts and Regulatory Assessments

The Bank’s deposit accounts are insured by the Deposit Insurance Fund of the FDIC, or 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.

Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating, or CAMELS rating. The risk matrix utilizes four risk categories which are distinguished by capital levels and supervisory ratings.

In December 2008, the FDIC issued a final rule that raised the then current assessment rates uniformly by 7 basis points for the first quarter of 2009 assessment, which resulted in annualized assessment rates for institutions in the highest risk category, or Risk Category 1 institutions, ranging from 12 to 14 basis points (basis points representing cents per $100 of assessable deposits). In February 2009, the FDIC issued final rules to amend the DIF restoration plan, change the risk-based assessment system and set assessment rates for Risk Category 1 institutions beginning in the second quarter of 2009. For Risk Category 1 institutions that have long-term debt issuer ratings, the FDIC determines the initial base assessment rate using a combination of weighted-average CAMELS component ratings, long-term debt issuer ratings (converted to numbers and averaged) and the financial ratios method assessment rate (as defined), each equally weighted. The initial base assessment rates for Risk Category 1 institutions range from 12 to 16 basis points, on an annualized basis. After the effect of potential base-rate adjustments, total base assessment rates range from 7 to 24 basis points. The potential adjustments to a Risk Category 1 institution’s initial base assessment rate include (i) a potential decrease of up to 5 basis points for long-term unsecured debt, including senior and subordinated debt, and (ii) a potential increase of up to 8 basis points for secured liabilities in excess of 25% of domestic deposits.

In May 2009, the FDIC issued a final rule that levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits. The special assessment was part of the FDIC’s efforts to rebuild the DIF. The special assessment was collected by the FDIC on September 30, 2009.

In November 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC also adopted a uniform three-basis point increase in assessment rates effective on January 1, 2011. In December 2009, the Bank paid approximately $1.019 million in prepaid risk-based assessments, which is being expensed over the applicable period. The portion to be expensed in future periods is included in other assets on our consolidated balance sheets.

The Bank also bears assessments related to outstanding Financing Corporation, or FICO, bonds. FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987, the sole purpose of which was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. The current annualized assessment rate is 1.14 basis points, or approximately 0.285 basis points per quarter. These assessments will continue until the FICO bonds mature in 2019.

The enactment of Emergency Economic Stabilization Act of 2008 temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The temporary increase in deposit insurance coverage became effective on October 3, 2008. In addition, on May 20, 2009, President Obama signed the Helping Families Save Their Homes Act, which extends the temporary increase in the standard maximum deposit insurance amount to $250,000 per depositor through December 31, 2013. This extension of the temporary $250,000 coverage limit became permanent under the Dodd-Frank Wall Street Reform and Consumer Protection

 

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Act of 2010, or the Dodd-Frank Act. The Dodd-Frank Act also changes the basis for deposit assessments from an assessment based on deposits to one based on assets. The assessment base will be calculated based on the average consolidated total assets of the financial institution minus its tangible equity. In addition, the Dodd-Frank Act increases the minimum reserve ratio of the DIF, but the burden of the increase will be on institutions with total assets in excess of $10 billion.

Under the Federal Deposit Insurance Act, or 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%. 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 holding company, 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 non-performing 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. We are also generally required to maintain a minimum “Tier 1 risk-based capital ratio” of Tier 1 capital to risk-weighted assets.

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).

The highest rated banks are those that have well-diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, and good earnings; and that, in general, are considered a strong banking organization. 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:

 

   

“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”;

 

   

“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);

 

   

“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

 

   

“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.

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 sets forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012. As of December 31, 2010, we met all minimum capital adequacy requirements to which we are subject, including those contained in our business plan as submitted to the Federal Reserve, and are categorized as “well-capitalized.” Since December 31, 2010, there are no conditions or events that our 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.”

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. 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 Act of 1991 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 that was 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

 

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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 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 note that 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 deposit insurance fund, 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.

Basel III

On December 17, 2009, the Basel Committee, proposed significant changes to bank capital and liquidity regulation, including revisions to the definitions of Tier 1 capital and Tier 2 capital applicable to Basel III.

The short-term and long-term impact of the new Basel III capital standards and the forthcoming new capital rules to be proposed for non-Basel III U.S. banks is uncertain. As a result of the recent deterioration in the global credit markets and the potential impact of increased liquidity risk and interest rate risk, it is unclear what the short-term impact of the implementation of Basel III may be or what impact a pending alternative standardized approach to Basel III option for non-Basel III U.S. banks may have on the cost and availability of different types of credit and the potential compliance costs of implementing the new capital standards.

On September 12, 2010, the oversight body of the Basel Committee announced a package of reforms which will increase existing capital requirements substantially over the next four years. These capital reforms were endorsed by the G20 at the summit held in Seoul, South Korea in November 2010. In December 2010, the Basel Committee issued final rules on the Basel III framework, which sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards. The various requirements will be phased in gradually, and should be implemented in their final form by 2019.

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 current 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 establishes a new, independent

 

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Consumer Financial Protection Bureau tasked with protecting American consumers from unfair, deceptive and abusive financial products and practices. The Dodd-Frank Act also creates the Financial Stability Oversight Council, which would focus on identifying, monitoring and addressing systemic risks in the financial system. The Financial Stability Oversight Council would, among other tasks, make recommendations for increasingly strict rules for capital, leverage, and other requirements as a company’s size and complexity increased. The Dodd-Frank Act also requires the implementation of the “Volcker Rule” for banks and bank holding companies, which would prohibit, with certain limited exceptions, proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and generally otherwise limit the relationships with such funds. The Dodd-Frank Act also includes provisions that, among other things, reorganize bank supervision and strengthen the Federal Reserve Board.

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.

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, 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.

Senator Collins proposed an amendment that was incorporated into the Dodd-Frank Act requiring bank regulators to establish minimum capital levels for holding companies that are at least of the same nature as those applicable to financial institutions. All trust preferred securities, or TRUPs, issued by bank or thrift holding companies after May 19, 2010 will be counted as Tier 2 capital (with an exception for certain small bank holding companies). Bank holding companies with $15 billion in assets as of December 31, 2009 will have five years to comply with this provision, and starting on January 1, 2013, these holding companies will share in the requirement by deducting one-third of TRUPs a year for the following three years from Tier 1 capital. TRUPs issued prior to May 19, 2010 by bank holding companies with less than $15 billion in assets as of December 31, 2009 are exempt from these capital deductions entirely. In addition, the Dodd-Frank Act codified the Federal Reserve’s Source-of-Strength Policy Statement.

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 may impose additional administrative obligations that will obligate us to incur additional expenses.

Small Business Lending Fund

The Small Business Jobs and Credit Act of 2010 created a $30 billion small business lending fund to invest capital into community banking organizations. Through the fund, the U.S. Treasury will invest in financial

 

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institutions through the purchase of senior preferred stock or indebtedness. The U.S. Treasury can 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. Participants must develop a small business lending plan. The plan must describe how the applicant’s business strategy and operating goals allow it to address needs of small businesses in the areas it serves, as well as plan to provide linguistically and culturally appropriate outreach, where appropriate to certain groups.

The starting point for dividend rates on the senior preferred stock issued by participants to the U.S. Treasury will be 5% for C corporations. Financial institutions can “buy down” the rate to as low as 1% by increasing the level of small business loans. The increase will be 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.

We have applied to participate in the small business lending fund, for which the application deadline is March 31, 2011. We do not know when the U.S. Treasury will make a decision on our application or whether we will be accepted to participate. In addition, we do not know that we will elect to participate if accepted by the U.S. Treasury. If we are accepted and elect to participate in the small business lending fund, the senior preferred stock issued to the U.S. Treasury would be senior to our common stock. We will also have to comply with the 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 rates on the preferred stock issued under the fund.

Gramm-Leach-Bliley Act of 1999

The Gramm-Leach-Bliley Act, or 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.

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.

 

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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, Xenith Bankshares 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 company. 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 Board, prior approval from the Federal Reserve Board 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 Virginia Bureau of Financial Institutions determines that a limitation of dividends is in the public interest and is necessary to ensure our financial soundness, and may also permit the payment of dividends not otherwise allowed by Virginia law.

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

 

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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 directors 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 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.

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:

 

   

loans or extensions of credit to affiliates;

 

   

investment in affiliates;

 

   

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

 

   

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

 

   

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

Certain Acquisitions

The Bank Holding Company Act of 1956, as amended, or 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, which is discussed below. As a result of the Patriot Act, which is also 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 United States banking or financial system.

 

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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. In addition, pursuant to certain commitments entered into prior to the completion of the merger between BankCap Partners Fund and the Federal Reserve Bank of Richmond and the Federal Reserve Bank of Dallas, any acquisition by Xenith Bankshares or the Bank will require prior approval of our bank regulatory authorities.

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.

Sound Banking Practice

Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a 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 Xenith Bankshares’ 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, or 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.

 

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Temporary Liquidity Guarantee Program

On November 21, 2008, the FDIC adopted final regulations implementing the Temporary Liquidity Guarantee Program, or the TLGP, pursuant to which depository institutions could elect to participate. Pursuant to the TLGP, the FDIC will (1) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009, or the Debt Guarantee, and (2) provide full FDIC deposit insurance coverage for non-interest bearing deposit transaction accounts (including NOW accounts restricted during the guarantee period to interest rates of 0.50% or less through June 30, 2010 and 0.25% beginning July 1, 2010) regardless of dollar amount for an additional fee assessment by the FDIC, or the Transaction Account Guarantee. These accounts are mainly payment-processing accounts, such as business payroll accounts. The Dodd-Frank Act has extended full deposit insurance coverage for non-interest bearing transaction accounts for two years starting December 31, 2010, and all financial institutions are required to participate in this extended guarantee program. Xenith Bankshares and the Bank opted out of participating in the TLGP.

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. Effective October 9, 2008, Federal Reserve banks are now authorized to pay interest on such reserves. The current reserve requirements are as follows:

 

   

for transaction accounts totaling $10.7 million or less, a reserve of 0%;

 

   

for transaction accounts in excess of $10.7 million up to and including $58.8 million, a reserve of 3%; and

 

   

for transaction accounts totaling in excess of $58.8 million, a reserve requirement of $1.656 million plus 10% of that portion of the total transaction accounts greater than $58.8 million.

The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve. As of December 31, 2010, the Bank had a reserve requirement of $460 thousand.

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.

 

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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 United States 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. The actions taken by the Federal Reserve will influence the general condition of interest rates in the market place.

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 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, 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 Community Reinvestment Act performance. To the knowledge of management, the Bank is meeting its obligations under this act.

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, or 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. Accordingly, under the Dodd-Frank Act, 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, the Office of the Comptroller of the Currency and the 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 (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or (ii) total reported loans

 

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secured by multifamily and non-farm residential properties and loans for construction, land development, and 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

On December 13, 2006, the federal bank regulatory agencies released the Interagency Policy Statement on the allowance for loan and lease losses, which revised and replaced the banking agencies’ 1993 policy statement on the allowance for loan and lease losses. The revised statement was issued to ensure consistency with U.S. generally accepted accounting principles, or GAAP, and more recent supervisory guidance. 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 revised statement include the following:

 

   

the revised 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 revised 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.

USA PATRIOT Act of 2001

The USA PATRIOT Act of 2001, or the Patriot Act, was enacted in response to the terrorist attacks, which occurred on September 11, 2001, 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. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

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 us 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.

 

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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 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.

Employees

At December 31, 2010, we had 78 employees, including 72 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 Securities and Exchange Commission, or 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 Securities Exchange Act of 1934, as amended, or 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

Incorporated by reference into this Part I is 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).

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.

 

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An economic downturn or recession, especially one affecting our target markets, could materially and adversely affect us.

The 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. Dramatic declines in the housing market over the past several years, with falling home prices and increasing foreclosures, negatively impacted the credit performance of real estate related loans and resulted in poor operating results and significant write-downs of asset values by many financial institutions. Asset write-downs, which initially were focused on asset-backed securities and later spread to other securities and loans, such as commercial and residential real estate loans, caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors reduced or ceased providing funding to borrowers, including to other financial institutions, or made such funding more costly. This market disruption and tightening of credit led to a lack of liquidity, an increased level of commercial and consumer delinquencies, increased market volatility, widespread reduction of business activity generally and increased competition for deposits and quality loans among financial institutions. Although the economy has started to rebound from the recent recession, economic growth has been sluggish. The economic pressure on consumers and commercial borrowers and lack of confidence in the economy and financial markets resulting from the recent recession 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 and fraud losses. A 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 businesses and individuals are located or doing business in our target markets. As a result, we may be more impacted by a local economic downturn or recession 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.

Although we have monitored the impact of the recent recession 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. Furthermore, the economy could slip back into recession and the recent decline in real estate values could continue, either of which could lead to increased portfolio losses in the future that would materially and adversely affect us.

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 credit risk in the event of default of a counterparty or client. In addition, this credit 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 us. Our losses from these events could be material.

 

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Because our loan portfolio includes a substantial amount of commercial and industrial loans and commercial real estate loans, our earnings are sensitive to the credit risks associated with these types of loans.

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 44.4% of our total loan portfolio as of December 31, 2010. 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 real estate loan portfolio represented approximately 37.2% of our total loan portfolio as of December 31, 2010. 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. Currently, the availability of permanent financing alternatives in the market has been reduced and the terms have become more onerous, thereby increasing the re-financing risks inherent in our loan portfolio. Given the continued weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. The weakening of the commercial real estate 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.

In addition to commercial real estate loans that are or will be secured by commercial real estate, 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 19.7% of our total commercial and industrial loan portfolio as of December 31, 2010. 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.

Because our loan portfolio includes a substantial amount of residential real estate loans and some consumer loans, our earnings are sensitive to the credit risks associated with these types of loans.

As of December 31, 2010, we had a total of $23.3 million in outstanding residential real estate loans, comprising 15.2% of our total loan portfolio, and a total of $4.7 million in outstanding consumer loans or 3.1% of our total loan portfolio. While residential real estate loans and consumer loans are more diversified than loans to commercial borrowers, a systematic decline in the economic health of a community, such as major job loss, could materially and adversely affect us. Also, a broad-based decline in the value of residential real estate that serves as our secondary source of repayment could also materially and adversely affect us.

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

Our loan portfolio and a small portion of our investment portfolio expose us to credit risk. Only $2.2 million, or 3.8%, of our $58.9 million investment portfolio was represented by securities other than U.S. agency

 

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securities as of December 31, 2010. 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 non-payment is affected by a number of factors, including:

 

   

the type and duration of the loan;

 

   

credit risks of a particular borrower;

 

   

assumptions about cash flows;

 

   

changes in a particular borrower’s competitive position;

 

   

changes in economic or industry conditions; and

 

   

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.

As of the effective date of the merger, and as required by acquisition accounting rules, we recorded SuffolkFirst Bank’s loans at fair value by creating a discount and eliminating the allowance for the loan and lease losses. However, to the extent that the credit losses of the purchased loan portfolio are greater than our fair value adjustment at the effective date of the merger, we could be materially and adversely affected.

In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require us to establish additional 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 portfolio, or if bank regulatory agencies require us to increase the 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.

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

The Federal Reserve, the Office of the Comptroller of the Currency and the FDIC, along with the other federal banking regulators, issued final guidance on December 6, 2006, 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

 

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higher capital ratios than institutions with lower concentrations in commercial real estate lending. Based on our commercial real estate concentration as of December 31, 2010, 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.

We are required to maintain certain capital levels 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 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.

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

Our directors and executive officers have developed a business plan that details the business strategies we intend to implement. Our business plan includes organic growth and potentially 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. 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.

In addition, our business plan was presented to the Federal Reserve in connection with the application of BankCap Partners to acquire control of First Bankshares (now Xenith Bankshares), and indirectly SuffolkFirst Bank (now Xenith Bank). As a condition to approval of that application, BankCap Partners committed that the Bank would operate within the parameters of the business plan for three years from the date of the acquisition, which was December 22, 2009. The business plan includes minimum leverage and risk-based capital ratios for that three-year period. Any material changes to the business plan require the prior approval of the Federal Reserve.

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, FDIC insurance costs, 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, or FHLB, which is a secured funding outlet. 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”

 

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or seek to raise funds through the issuance of additional 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.

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

Depositors that invest in brokered certificates of deposit 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 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, 2010, $73.5 million, or 42.0%, of our total deposits, consisted of non-interest bearing demand accounts and interest-bearing savings, money market and checking accounts. The $101.6 million remaining balance of deposits includes time deposits, of which approximately $61.0 million, or 34.8% 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. 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.

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 additional 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.

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 financial and accounting 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.

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

 

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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.

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 repricing 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 repricings 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, 2010 of $38.4 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 the 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, mortgage banking, consumer lending and home equity lending, 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. We have branches in Richmond, Virginia and Tysons Corner in Northern Virginia. SuffolkFirst Bank did not have branches in Richmond or Tysons Corner previously, so we are not able to build from a pre-existing customer base in either of these markets. To expand our customer base at these branches and Northern Virginia generally,

 

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we must successfully compete against competitors with established businesses, relationships and reputations in those markets. This competition could result in decreased demand for our services and products and our loss of, or inability to gain, market share, which could materially and adversely affect us.

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. Many environmental laws impose liability, regardless of whether we knew of, or were responsible for, any contamination that existed or exists for the property.

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 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.

We are dependent on our key personnel, including our executive officers and directors, 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 Mr. Layfield, who is our President and Chief Executive Officer; Mr. Osgood, who is our Chief Financial Officer and Chief Administrative Officer; Ms. Gavant, who is our Senior Vice President and Controller; Mr. Cottrell, who is an Executive Vice President and our Chief Credit Officer; Mr. Davis, who is an Executive Vice President and the President of the Bank’s Northern Virginia Region; and Mr. O’Flaherty, who is an Executive Vice President of the Bank 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. We do not maintain key man insurance coverage on any of these individuals or other key executive officers. 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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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 that we use could be vulnerable to unforeseen problems. 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 operations could have an adverse effect on customers. In addition, we must be able to protect the computer systems and network infrastructure utilized by us against physical damage, security breaches and service disruption 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 and deter potential customers.

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. On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act will result in sweeping changes in the regulation of financial institutions. The Dodd-Frank Act contains numerous provisions that will affect all banks and bank holding companies. The Dodd-Frank Act includes provisions that, among other things:

 

   

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;

 

   

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

 

   

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;

 

   

require the FDIC to seek to make its capital requirements for banks countercyclical;

 

   

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;

 

   

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;

 

   

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

 

   

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.

 

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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 are likely to impose additional administrative burdens that will obligate us to incur additional expenses.

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.

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, referred to as 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 our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 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.

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. Non-accelerated filers were to have commenced complying with the requirements of Section 404(b) starting with their Annual Reports on Form 10-K for fiscal years ending on or after June 15, 2010. Since we were a non-accelerated filer as of June 30, 2010 (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, 2010. 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.

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

 

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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 Federal Deposit Insurance Corporation Act of 1991 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.

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

Although we do not have any current plans to do so, 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:

 

   

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

 

   

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

 

   

diluting our existing shareholders in an acquisition;

 

   

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 before we generate sufficient assets and deposits to support the costs of the expansion;

 

   

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;

 

   

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

 

   

the ability to realize the anticipated benefits of the acquisition, including tax benefits;

 

   

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

 

   

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

 

   

time and costs associated with regulatory approvals;

 

   

competition from other purchasers;

 

   

lack of information on a target institution or its branches or assets;

 

   

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.

 

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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 the merger. 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.

Our ability to use net operating loss carryovers to reduce future tax payments may be limited.

Although we reported operating losses for the year ended December 31, 2009 (the successor) and the period ended December 22, 2009 (the predecessor) due to the application of tax rules and regulations, we have no net operating losses, or NOLs, for federal income tax purposes for years prior to 2010 that carry forward to 2010. We have NOLs for the year ended December 31, 2010, a significant portion of which will be available for carryforward to reduce taxable income in future years. Our NOLs as of December 31, 2010 are subject to a 20-year carryforward period; however, our ability to utilize the NOLs is subject to the rules of Section 382 of the Internal Revenue Code. Section 382 generally restricts the use of NOLs after an “ownership change.” An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation’s common stock or are otherwise treated as 5% shareholders under Section 382 and the Treasury regulations promulgated thereunder increase their aggregate percentage ownership of that corporation’s stock by more than 50 percentage points over the lowest percentage of the stock owned by these shareholders over a three-year rolling period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carry forwards. This annual limitation is generally equal to the product of the value of the corporation’s stock on the date of the ownership change, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service (3.67% as of December 31, 2010). Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carry forwards.

The rules of Section 382 are complex and subject to varying interpretations. Although we cannot predict the number of shares to be sold in a future offering, we expect that we will undergo an ownership change for purposes of Section 382 as a result of a future offering. Even if a future offering does not cause an ownership change, it may increase the likelihood that we may undergo an ownership change in the future. Based on our recent common stock price, we believe any ownership change would limit the timing of our ability to use the NOLs. Moreover, our NOLs may not be fully available. As a result, we could pay taxes earlier and in larger amounts than would be the case if the NOLs were available to reduce our federal income taxes without restriction.

We had net losses during the year ended December 31, 2010 and the period from January 1, 2009 through December 22, 2009, and we are uncertain as to whether or when we will again be profitable.

We have 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 the period from January 1, 2009 through December 22, 2009, we incurred net losses of $5.9 million and $4.3 million, respectively. As of December 31, 2010, we had an accumulated deficit of $15.4 million.

 

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For the year ended December 31, 2010, the primary reasons for our losses were non-interest expense related to the development of our technology and other infrastructure and the hiring of experienced personnel to support our business strategy and projected growth. For the year ended December 31, 2010, our non-interest expense was $13.0 million compared to $6.0 million for the period from January 1 to December 22, 2009. Greater non-interest expense was primarily comprised of higher compensation and benefits expense of $4.6 million, occupancy expenses of $782 thousand and technology and communication expenses of $1.2 million. With respect to compensation and benefits expense, we increased the number of our full-time employees, as we added relationship managers and support staff to generate loans and deposits, operations and technology personnel to manage our day-to-day infrastructure and outsourced vendor relationships, and professional staff in compliance, human resources, finance and accounting. With respect to occupancy expenses, the increase was related to our new offices in Richmond and Tysons Corner, Virginia, as well as our new operations center in Richmond. With respect to technology expenses, the increase was related to our conversion to a more robust technology infrastructure and core operating platform required to support our business strategy and projected growth. For the period from January 1, 2009 through December 22, 2009, the primary reasons for our losses were a provision for loan losses of $5.5 million and merger-related expenses of $1.1 million.

We made substantial progress in building our infrastructure and our team during the year ended December 31, 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 recruiting 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 2010. Our ability 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.

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

As of December 31, 2010, our non-performing loans totaled $2.8 million, or 1.9% of our loan portfolio. As of December 31, 2010, our non-performing assets (which include other real estate owned, or OREO) were $4.3 million, or 1.7% of our total assets. We had no loans accruing interest that were more than 90 days delinquent. Until economic and real estate market conditions improve, particularly in our target markets in and around Virginia, but also nationally, we may incur additional losses relating to an increase in non-performing loans and OREO, and such losses could be material. We do not record interest income on non-performing loans or OREO. 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, which often results in a loss. Non-performing loans and OREO also increase our risk profile, and increases in the level of non-performing 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 non-performing 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.

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 entire investment portfolio as securities available-for-sale pursuant to applicable accounting standards relating to accounting for investments. These standards require that unrealized gains and

 

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losses in the estimated value of the available-for-sale investment securities portfolio be “marked to market” and reflected as a separate item in shareholders’ equity, net of tax, as accumulated other comprehensive income. As of December 31, 2010, we had $58.9 million, or 23.4% of our total assets, in securities available-for-sale at fair value. Shareholders’ equity will continue to reflect 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 results of operations. If the market value of our investment securities portfolio declines, there will be a corresponding decline in shareholders’ equity, whether through accumulated other comprehensive income or lower results of operations.

The short-term and long-term impact of the new Basel III capital standards and the forthcoming new capital rules to be proposed for non-Basel III U.S. banks is uncertain.

On December 17, 2009, the Basel Committee on Banking Supervision, or the Basel Committee, proposed significant changes to bank capital and liquidity regulation, including revisions to the definitions of Tier 1 capital and Tier 2 capital applicable to the Basel Committee’s Revised Framework for the International Convergence of Capital Measurement and Capital Standards, or Basel III.

The short-term and long-term impact of the new Basel III capital standards and the forthcoming new capital rules to be proposed for non-Basel III U.S. banks is uncertain. As a result of the recent deterioration in the global credit markets and the potential impact of increased liquidity risk and interest rate risk, it is unclear what the short-term impact of the implementation of Basel III may be or what impact a pending alternative standardized approach to Basel III option for non-Basel III U.S. banks may have on the cost and availability of different types of credit and the potential compliance costs of implementing the new capital standards.

On September 12, 2010, the oversight body of the Basel Committee announced a package of reforms that will increase existing capital requirements substantially over the next four years. These capital reforms were endorsed by the G20 at the summit held in Seoul, South Korea in November 2010.

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. We had negative cash flow from operations of $5.1 million and $1.1 million, respectively, for the year ended December 31, 2010 and the period from January 1 through December 22, 2009. As a result, our main source of liquidity is customer deposits. 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, the ability to acquire 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, 2010, we had $25.0 million of FHLB borrowings and $10.2 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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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, 2010, BankCap Partners beneficially owned 3,436,500 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 55.1% 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 have 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. Brian D. Jones and Scott A. Reed, each a principal of BankCap Partners and a member of our board of directors, are the current designees 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.

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

We have not paid any dividends since our inception and we presently do not intend to pay any dividends 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.” 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. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders, 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 2—Properties

The following table summarizes certain information about our headquarters and the locations of our branch and administrative offices as of December 31, 2010:

 

Office Location

 

Owned or Leased

  

Lease Terms

   Square
Feet
 

One James Center (Headquarters)

901 E. Cary Street, Suite 1700

Richmond, VA 23219

  Leased    Initial term of 62 months beginning November 1, 2008, with two options to extend for a three year period each      16,131   

Boulders (Operations Center)

1011 Boulder Spring Drive, Suite 410

Richmond, VA 23225

  Leased    Initial term of 65 months beginning December 1, 2008, with two options to extend for a three year period each      7,026   

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    Initial term of five years beginning January 1, 2004, with an automatic five-year renewal      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.

 

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PART II

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

Market Information

Our common stock trades on The NASDAQ Capital Market under the symbol “XBKS.” As of February 14, 2011, we had 5,846,928 shares of common stock issued and outstanding and approximately 1,266 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.

 

     (Successor)      (Successor)  
     2010      2009 (1)  

Quarter

   High      Low      High      Low  

First

   $ 7.00       $ 3.02       $ 4.01       $ 1.57   

Second

     9.00         5.25         8.00         1.85   

Third

     7.40         4.86         7.39         5.00   

Fourth

     6.10         5.11         9.00         3.50   

 

(1) The merger was effective on December 22, 2009. In connection with the merger, the trading symbol for our common stock was changed from “SUFB” to “XBKS.”

Dividend Policy

We have not paid any dividends since our inception and we presently do not intend to pay any dividends 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—Business—Supervision and Regulation—Payment of Cash Dividends.” Any future financing arrangements that we enter into may also limit our ability to pay dividends to our shareholders. Accordingly, we may never be able to pay dividends to our shareholders. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders, our board of directors, in its sole discretion, may decide to retain them and therefore not pay dividends in the future.

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.

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Federal Reserve. The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail banking clients, which we refer to as our target customers. We are geographically focused on the Washington, DC-MD-VA-WV, Richmond-Petersburg, VA, and the Norfolk-Virginia Beach-Newport News, VA-NC metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its five branches, with one branch located in Tysons Corner, Virginia, one branch 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,

 

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SuffolkFirst Bank opened the first branch in Suffolk in 2003 under the name of SuffolkFirst Bank, and the Bank currently operates its three Suffolk branches under that trade name. As of December 31, 2010, we had total assets of $251.2 million, total loans, net of our allowance for loan and lease losses, of $151.4 million, total deposits of $175.1 million and shareholders’ equity of $48.8 million.

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

The primary source of our revenue is net interest income, which represents the difference between interest income on 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 non-interest income include service charges on deposit accounts, fees from loan originations, gains on the sale of securities and other miscellaneous income. Deposits and FHLB borrowed funds, including federal funds purchased, are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. We measure our performance by calculating our return on average common equity, return on average assets and net interest margin.

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 referred to as the merger agreement. 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. Xenith Bank currently operates under the trade name SuffolkFirst Bank at its locations in Suffolk.

Under the terms of the merger agreement, First Bankshares shareholders were entitled to elect to retain their shares of First Bankshares common stock or to receive $9.23 in cash per share for some or all of their shares of First Bankshares common stock, subject to proration in the event the aggregate cash elections exceeded 569,074 shares (or 25% of shares outstanding immediately prior to the effective time of the merger). As of 5:00 p.m., Eastern Time, on October 15, 2009, the deadline for First Bankshares shareholders to elect to receive cash for some or all of their shares of First Bankshares common stock, First Bankshares had received aggregate cash elections with respect to 1,165,311 shares of First Bankshares common stock, representing approximately 51.2% of the shares of First Bankshares common stock outstanding immediately prior to the effective time of the merger.

As a result of aggregate cash elections exceeding 569,074 shares, the cash elections were reduced proportionally and each cash election share that was not converted into the right to receive $9.23 in cash and each share of First Bankshares common stock for which a cash election was not made represented one share of Xenith Bankshares common stock immediately following the effective time of the merger.

Under the terms of the merger agreement, each share of Xenith Corporation common stock outstanding immediately prior to the effective time of the merger was cancelled and converted automatically into the right to

 

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receive 0.8700 share of Xenith Bankshares common stock. Based on this exchange ratio, an aggregate of 4,139,704 shares of Xenith Bankshares common stock were issued to the former shareholders of Xenith Corporation in exchange for their shares of Xenith Corporation common stock with fractional shares being cashed out in the merger.

Options to purchase shares of First Bankshares common stock outstanding at the effective time of the merger remain outstanding as options to purchase 94,493 shares of Xenith Bankshares common stock at a weighted average exercise price of $7.81 per share. An aggregate of 906,000 options and warrants to purchase shares of Xenith Corporation’s common stock outstanding at the effective time of the merger were converted into an aggregate of 788,220 options and warrants to purchase shares of Xenith Bankshares common stock based on the exchange ratio set forth in the merger agreement at an exercise price of $11.49 per share.

There were an aggregate of 5,846,928 shares of Xenith Bankshares common stock outstanding immediately following the effective time of the merger, with First Bankshares shareholders immediately prior to the effective time of the merger beneficially owning approximately 26.8% of the Xenith Bankshares’ outstanding shares of common stock and Xenith Corporation shareholders immediately prior to the effective time of the merger beneficially owning approximately 73.2% of Xenith Bankshares’ outstanding shares of common stock, on a fully diluted basis.

Industry Conditions

The economic environment, which showed some initial signs of improvement in early 2010, demonstrated during the remainder of 2010 that the economic recovery will be slow due to high unemployment and a soft housing market. However, as recently as January 25, 2011, the Conference Board reported that the Consumer Confidence Index was at its highest level since May, 2010.

In addition, the Federal Open Market Committee (the Committee) reaffirmed that on January 26, 2011, economic conditions “are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” The Committee also stated that it is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion in longer term treasury securities by the end of the second quarter of 2011.

Regulatory reform was a focal point in the financial services industry during 2010. The Dodd-Frank Act, which is discussed under “Item 1-Our Business-Supervision and Regular-Dodd-Frank Act” above, was signed into law in July 2010 and is likely to result in sweeping changes to the financial services industry in how business is conducted and regulated. However, the ultimate impact on us and the financial services industry as a whole remains largely to be determined, as the work of translating legislative policies into practices and procedures has just commenced. We are monitoring these regulatory and legislative developments so that we will be in a position to adapt our business at the appropriate time. While it is not determinable at the present time what the absolute impacts will be when the regulations are eventually finalized, we expect that the regulations will impose additional administrative obligations on us that may require additional expenses and otherwise affect our business.

The banking industry was especially hard hit in 2010, with a reported 157 failed institutions. Although early 2011 stock market indicators show some strength in financial services stocks, an additional 22 institutions have failed through February 18, 2011. Of these failures in 2010 and 2011, none are in our target market.

Outlook

We believe that we are well positioned to take advantage of competitive opportunities. We believe that we will benefit from (1) our capital base, which we believe will allow us to compete effectively with both the larger, more established regional and super-regional banks, as well as the smaller, locally managed community banks operating in our target markets, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products and (4) our experienced management team and board of directors.

 

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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.

In our continuing evaluation of our business strategy, we believe properly priced acquisitions can complement our organic growth. Although we do not have any current plans to do so, 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. Our goal in making these decisions is to maximize shareholder value.

Presentation of Financial Information

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 fair value on December 22, 2009 in the consolidated balance sheet of Xenith Bankshares. The merger was accounted for under the acquisition method of accounting.

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. Accordingly, because Xenith Corporation’s operating activities prior to the merger were insignificant relative to those of First Bankshares, we view First Bankshares as our predecessor. Our determination that First Bankshares should be viewed as our predecessor is based upon an evaluation of facts and circumstances, including the historical life of First Bankshares, the historical level of operations of First Bankshares, the purchase price paid for First Bankshares and the fact that our combined operations, revenues and expenses after the merger are most similar in all respects to those of First Bankshares’ historical periods.

Accordingly, our discussion and analysis of the results of operations reflects a comparison of the results of operations of Xenith Bankshares (the successor) for the year ended December 31, 2010 versus the results of operations of First Bankshares (the predecessor) for the period ended December 22, 2009. Due to the adjustments to the basis of assets and liabilities as a result of the application of the acquisition method of accounting, the financial statements of Xenith Bankshares (the successor) and First Bankshares (the predecessor) are not directly comparable. The results of operations of Xenith Bankshares (the successor) for the year ended December 31, 2009 include the operations of the combined entity for the period from December 23, 2009 through December 31, 2009. A comparison of the results for this period is not made, as we deem this comparison to be insignificant.

Independent Registered Public Accounting Firm

The merger was treated as a “reverse acquisition” for accounting purposes. The SEC has released guidance that, unless the same independent registered public accounting firm reported on the most recent financial statements of both the accounting acquirer (Xenith Corporation) and the acquired company (First Bankshares), a reverse acquisition results in a change in independent registered public accounting firms. Prior to the completion of the merger, Xenith Corporation’s independent accountant was Ernst &Young LLP, or E&Y, and First Bankshares’ independent registered public accounting firm was Witt Mares, PLC, or Witt Mares.

On December 22, 2009, following the completion of the merger, we dismissed E&Y as our independent registered public accounting firm upon the approval of the audit and compliance committee of our board of directors. The audit and compliance committee also approved the engagement of Witt Mares to audit Xenith Bankshares’ consolidated financial statements as of and for the fiscal year ended December 31, 2009, including First Bankshares’ consolidated financial statements for the period from January 1, 2009 through December 22, 2009. On April 2, 2010, we dismissed Witt Mares as our independent registered public accounting firm, upon the

 

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approval of the audit and compliance committee of our board of directors. The audit and compliance committee also approved the engagement of Grant Thornton LLP to audit our consolidated financial statements as of and for the fiscal year ending December 31, 2010.

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 GAAP and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations. The company’s 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 that our most critical accounting policy relates to the allowance for loan and lease losses which reflects the estimated losses resulting from the inability of our borrowers to make required loan payments. 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 the company’s critical accounting policies that are highly dependent on estimates, assumptions and judgments.

Loans

Loans are carried at their principal amount outstanding plus or minus unamortized fair value adjustments for acquired loans. Interest income is recorded as earned on an accrual basis. It is our policy that accrual of interest income is discontinued when a loan is greater than 90 days past due as to interest and principal. Subsequent cash receipts are applied to principal until the loan is in compliance. We use the allowance method in providing for possible loan losses. Loans that are deemed impaired at acquisition, due to a decline in credit quality since origination, are accounted for using the cost recovery method, as an appropriate accretable yield cannot be determined.

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 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 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, loan review and regulatory examinations. Impaired loans are measured using either the discounted expected cash flow method or the value of collateral method. We consider all of our non-performing loans to be impaired loans. All cash receipts are applied to principal after any loan becomes non-performing. As of both December 31, 2010 and December 31, 2009, we had $2.8 million and $4.1 million, respectively, of impaired loans. The balance of impaired loans at December 31, 2010 and 2009 is after the merger date fair value adjustment of $1.4 million and $3.6 million, respectively. Impaired loans represent 1.9% and 4.1%, respectively, of total loans at December 31, 2010 and 2009.

 

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Allowance for Loan and Lease Losses

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

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

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

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

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

As of December 22, 2009, prior to the merger, our allowance for loan and lease losses was $6.7 million and reflected a provision expense of $5.5 million for the period January 1 through December 22, 2009. Immediately following the merger, the allowance for loan and lease losses was reduced to $0 due to adjustments attributable to the acquisition method of accounting. For the year ended December 31, 2010, we recorded provision expense of $2.0 million. Our allowance for loan and lease losses as of December 31, 2010 is primarily for new loan production since December 31, 2009 and negative changes in credit quality related to the purchased loan portfolio.

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 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, the carrying amount of the assets are adjusted to the lower of carrying amount or the fair value less costs of disposal. Revenue and expenses from operations and changes in the valuation of OREO are included in net income.

 

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Accounting for the Merger

The merger was treated as a reverse acquisition for accounting purposes. Therefore, the merger was accounted for using the acquisition method of accounting, and accordingly, the assets acquired and liabilities assumed of First Bankshares were recognized at fair value on the date of the merger, with Xenith Corporation being treated as the acquirer.

In a reverse acquisition, fair value of the consideration transferred is based on the number of shares Xenith Corporation would have had to issue to give the owners of First Bankshares the same percentage equity interest in the combined entity that resulted from the merger. Cash consideration is also included. The merger agreement provided for consideration of $9.23 per share paid in cash based on elections by the First Bankshares shareholders, subject to pro-ration since aggregate cash elections exceeded 25% of shares outstanding (the maximum allowed per the merger agreement) immediately prior to the effective time of the merger.

As a result of the merger, the shareholders of Xenith Corporation as of the merger date owned 73.2% of Xenith Bankshares, and the shareholders of First Bankshares as of the merger date owned the remaining 26.8% of Xenith Bankshares.

The consideration paid for First Bankshares and the amounts of acquired identifiable assets and liabilities assumed as of the merger date were as follows:

 

Costs to acquire First Bankshares:

  

Issuance of Xenith Corporation common stock

   $ 15,758,196   

Cash consideration paid

     5,251,804   
        

Total consideration to acquire First Bankshares

   $ 21,010,000   
        

First Bankshares’ net assets at fair value:

  

First Bankshares shareholders’ equity at December 22, 2009

     12,611,140   

Adjustments to reflect assets acquired at fair value:

  

Interest rate on loans

     (900,000

Other real estate owned

     (100,000

Premises and equipment

     (500,000

Core deposit intangibles

     1,240,000   

Net valuation allowance of deferred tax assets

     (2,067,065

Adjustments to reflect liabilities acquired at fair value:

  

Interest-bearing deposits

     (2,132,000

Other

     (130,899
        

Adjusted identifiable net assets acquired

   $ 8,021,176   
        

Total goodwill resulting from merger

   $ 12,988,824   
        

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. Similar to goodwill, other intangible assets, which include core deposit intangibles, also lack physical substance, but, as required by GAAP, portions of the cost of an acquired entity have been assigned to such assets. We account for goodwill and other intangible assets in accordance with GAAP, which, in general, requires that goodwill not be amortized, but rather that it is tested for impairment at least annually at the reporting unit level, which is either at the same level or one level below an operating segment. Other acquired intangible assets with finite lives, such as core deposit intangibles, are required to be amortized over their estimated lives. As of December 31, 2010, the core deposit intangible subject to amortization, on a straight-line basis for a period of ten years, totaled $1.1 million. We periodically assess whether events or changes in circumstances indicate that the carrying amounts of intangible assets may be impaired.

 

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Income Taxes

We compute our income taxes in accordance with the provisions of Financial Accounting Standards Board, or FASB, Accounting Standards Codification Topic 740, “Accounting for Income Taxes.” Under Topic 740, 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. Any estimated tax exposure items identified would be considered in a tax contingency reserve. 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, 2010, we reported a net loss of $5.9 million, compared to a net loss of $4.3 million for the period from January 1 through December 22, 2009. Greater losses for the year ended December 31, 2010 compared to the period ended December 22, 2009 were primarily driven by higher non-interest expenses related to the development of the Bank’s infrastructure, including our management team and bankers, which we believe will support the Bank’s growth, partially offset by higher net interest income.

The following table presents (loss) per share information for the periods stated:

 

     (Successor)           (Predecessor)  
     For the Year Ended  
     December 31,
2010
          December 22,
2009
 

(Loss) per share, basic and diluted

   $ (1.01        $ (1.90
                     

 

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Net Interest Income

For the year ended December 31, 2010, net interest income was $8.6 million compared to $4.4 million for the period January 1 through December 22, 2009. As presented in the tables below, net interest margin increased 157 basis points to 4.39% for the year ended December 31, 2010 from 2.82% for the year ended December 31, 2009. Net interest margin is defined as the percentage of net interest income to average interest-earning assets. Contributing to higher net interest income and net interest margin was the accretion of fair value adjustments of acquired loans and deposits, greater average loan and securities balances, and a decrease in the cost of interest-bearing liabilities. Average interest-earning assets and related interest income increased $33.5 million and $1.9 million, respectively, for the year ended December 31, 2010 compared to 2009. Average interest-bearing liabilities increased $15.1 million; however, related interest expense declined $2.1 million for the year ended December 31, 2010 compared to 2009. Yields on interest-earning assets improved 4 basis points to 5.50% while costs of interest-bearing liabilities declined 166 basis points to 1.40% for the year ended December 31, 2010 compared to the year ended December 31, 2009.

Our acquired loan portfolio was discounted to fair value (for expected credit losses and for interest rates) immediately following the merger. The total performing loan discount of $4.1 million at the merger date is being recognized into interest income over the estimated remaining life of the loans. The performing loan discount accretion, for the year ended December 31, 2010, was $1.6 million, or 84 basis points of net interest margin. Acquired time deposits were also adjusted to fair value as of the date of the merger for interest rates. The total adjustment as of the date of the merger was $2.1 million and is being amortized as a reduction of interest expense over a two-year period. The effect of this amortization is a decrease in interest expense for the year ended December 31, 2010 of $1.1 million, or 55 basis points of net interest margin. For the year ended December 31, 2010, the effect of these acquisition adjustments on interest rate spread and net interest margin is 154 and 139 basis points, respectively.

For the year ended December 31, 2009, net interest income was $4.6 million compared to $4.2 million for the year ended December 31, 2008. Net interest margin decreased slightly to 2.82% in 2009 from 2.84% in 2008. Greater net interest income was due primarily to decreases in the cost of interest-bearing liabilities. Fair value adjustments due to acquisition accounting had no impact on 2009 results.

 

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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. The average balances and other statistical data used in this table were calculated using daily average balances.

 

    Average Balances, Income and Expenses, Yields and Rates
As of and For the Years Ended December 31, (1)
 
    (Successor)     (Successor)                 (Successor)          (Predecessor)     2010 vs. 2009  
    Average Balances (2)     Yield / Rate     Income / Expense (8), (9)     Increase
(Decrease)
    Change due to (3)  
(Dollars in thousands)   2010     2009     2010     2009     2010          2009         Rate         Volume    

Assets

                     

Interest-earning assets:

                     

Federal funds sold

  $ 772      $ 1,121        0.11     0.18   $ 1          $ 2      $ (1   $ 0      $ (1

Investments / Interest-earning deposits

    74,076        47,555        2.83     5.10     2,097            2,423        (326     (1,344     1,018   

Loans, gross (4)

    120,842        113,523        7.17     5.66     8,662            6,428        2,234        1,800        434   
                                                                           

Total interest-earning assets

    195,690        162,199        5.50     5.46     10,760            8,853        1,907        456        1,451   
                                                                           

Noninterest-earning assets:

                     

Cash and due from banks

    2,789        4,160                     

Premises and fixed assets

    6,772        5,471                     

Other assets

    21,253        3,172                     

Allowance for loan losses

    (624     (2,344                  
                                 

Total noninterest-earning assets

    30,189        10,459                     
                                 

Total assets

  $ 225,879      $ 172,658                     
                                 

Liabilities and Shareholders’ Equity

                     

Interest-bearing liabilities:

                     

Demand deposits

  $ 5,835      $ 6,963        0.21     0.30   $ 12          $ 21      $ (9   $ (6   $ (3

Savings and money market deposits

    24,127        3,433        0.94     0.76     226            26        200        7        193   

Time deposits

    98,659        101,483        1.33     3.55     1,317            3,602        (2,285     (2,188     (97

Federal funds purchased and borrowed funds

    26,464        28,078        2.31     2.24     611            628        (17     19        (36
                                                                           

Total interest-bearing liabilities

    155,085        139,957        1.40     3.06     2,167            4,277        (2,110     (2,167     57   
                                                                           

Noninterest-bearing liabilities:

                     

Noninterest-bearing demand deposits

    16,564        14,032                     

Other liabilities

    2,174        1,429                     
                                 

Total noninterest-bearing liabilities

    18,738        15,461                     
                                 

Shareholders’ equity

    52,056        17,240                     
                                 

Total liabilities and shareholders’ equity

  $ 225,879      $ 172,658                     
                                 

Interest rate spread (5)

        4.10     2.40              
                                 

Net interest income (6)

          $ 8,593          $ 4,576      $ 4,017      $ 2,623      $ 1,394   
                                                   

Net interest margin (7)

        4.39     2.82              
                                 

 

(1) 2009 yields, rates, income, expense and comparisons to 2010 reflect the results of First Bankshares (the predecessor) for the period January 1, 2009 through December 22, 2009 and of Xenith Bankshares (the successor) for the period December 23, 2009 through December 31, 2009.
(2) Average balances are computed on a daily basis.
(3) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.
(4) Non-accrual loans have been included in the average balances. Only the interest collected on such loans has been included as income.
(5) Interest rate spread is the average yield on interest-earning assets less the average rate on interest-bearing liabilities.
(6) Net interest income is interest income less interest expense.
(7) Net interest margin is net interest income expressed as a percentage of average interest-earning assets.
(8) Interest income on loans in 2010 includes $1,645.6 thousand in accretion related to fair value adjustments related to the merger.
(9) Interest expense on time deposits in 2010 is reduced by $1,080.0 thousand related to fair value adjustments related to the merger.

 

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    Average Balances, Income and Expenses, Yields and Rates
As of and For the Years Ended December 31, (1)
 
    (Successor)          (Predecessor)                 (Predecessor)     (Predecessor)     2009 vs. 2008  
    Average Balances (2)     Yield / Rate     Income / Expense     Increase
(Decrease)
    Change due to (3)  
(Dollars in Thousands)   2009          2008      2009       2008      2009     2008        Rate       Volume   

Assets

                     

Interest-earning assets:

                     

Federal funds sold

  $ 1,121          $ 4,745        0.18     1.26   $ 2      $ 60      $ (58   $ (31   $ (27

Investments / Interest-earning deposits

    47,555            46,402        5.10     5.16     2,423        2,396        27        (31     58   

Loans, gross (4)

    113,523            113,433        5.66     6.48     6,428        7,348        (920     (927     7   
                                                                           

Total interest-earning assets

    162,199            164,580        5.46     5.96     8,853        9,804        (951     (989     38   
                                                                           

Noninterest-earning assets:

                     

Cash and due from banks

    4,160            2,996                 

Premises and fixed assets

    5,471            5,728                 

Other assets

    3,172            1,990                 

Allowance for loan losses

    (2,344         (1,050              
                                 

Total noninterest-earning assets

    10,459            9,664                 
                                 

Total assets

  $ 172,658          $ 174,244                 
                                 

Liabilities and Shareholders’ Equity

                     

Interest-bearing liabilities:

                     

Demand deposits

  $ 6,963          $ 6,246        0.30     1.17   $ 21      $ 73      $ (52   $ (60   $ 8   

Savings and money market deposits

    3,433            2,621        0.76     1.18     26        31        (5     (13     8   

Time deposits

    101,483            103,669        3.55     4.39     3,602        4,551        (949     (855     (94

Federal funds purchased and borrowed funds

    28,078            30,075        2.24     3.00     628        903        (275     (218     (57
                                                                           

Total interest-bearing liabilities

    139,957            142,611        3.06     3.90     4,277        5,558        (1,281     (1,145     (135
                                                                           

Noninterest-bearing liabilities:

                     

Noninterest-bearing demand deposits

    14,032            14,212                 

Other liabilities

    1,429            1,284                 
                                 

Total noninterest-bearing liabilities

    15,461            15,496                 
                                 

Shareholders’ equity

    17,240            16,137                 
                                 

Total liabilities and shareholders’ equity

  $ 172,658          $ 174,244                 
                                 

Interest rate spread (5)

            2.40     2.32          
                                 

Net interest income (6)

              $ 4,576      $ 4,246      $ 330      $ 157      $ 173   
                                                   

Net interest margin (7)

            2.82     2.84          
                                 

 

(1) 2009 yields, rates, income, expense and comparisons to 2008 reflect the results of First Bankshares (the predecessor) for the period January 1, 2009 through December 22, 2009 and of Xenith Bankshares (the successor) for the period December 23, 2009 through December 31, 2009.
(2) Average balances are computed on a daily basis.
(3) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.
(4) Non-accrual loans have been included in the average balances. Only the interest collected on such loans has been included as income.
(5) Interest rate spread is the average yield on interest-earning assets less the average rate on interest-bearing liabilities.
(6) Net interest income is interest income less interest expense.
(7) Net interest margin is net interest income expressed as a percentage of average interest-earning assets.

 

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Non-interest Income

Non-interest income decreased to $483 thousand for the year ended December 31, 2010 from $552 thousand for the period January 1 through December 22, 2009. The decrease was primarily due to a decrease in gains on sales of investments partially offset by greater fee income.

Non-interest Expense

Non-interest expense of Xenith Bankshares is not directly comparable to that of First Bankshares as our strategy and corresponding expense structure is substantially different. Xenith Bankshares’ non-interest expenses are higher in several areas, including compensation and technology related to building our team and infrastructure, to support our growth strategy.

For the year ended December 31, 2010, non-interest expense was $13.0 million compared to $6.0 million for the period from January 1 through December 22, 2009. Greater non-interest expense was primarily comprised of higher compensation and benefits expense of $4.6 million, occupancy expenses of $782 thousand, and technology and communications expenses of $1.2 million. Bank franchise taxes and other insurance were collectively higher by $337 thousand. Professional fees expense for the year ended December 31, 2010 includes $320 thousand pursuant to a licensing and administrative support agreement with an affiliate of BankCap Partners that was paid immediately prior to the effective time of the merger. Other non-interest expenses include $120 thousand of amortization expense related to core deposit intangibles. Partially offsetting these higher expenses in 2010 were merger related expenses of $1.1 million incurred in 2009.

Income Taxes

As of December 31, 2010, net deferred tax assets were $7.0 million, for which a full valuation allowance is recorded, based primarily on the fact that we experienced cumulative losses over the past three years. Future realization of the tax benefit of existing deductible temporary differences and net operating losses which are carried forward is dependent on our generating sufficient future taxable income. The statutory carryforward period for net operating losses under current law is 20 years. Estimated net operating losses available for carryforward at December 31, 2010 are $7.8 million, which would expire, if not utilized, in 2030.

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. Yields on tax-exempt securities are calculated on a tax equivalent basis, which converts the income on investments for which no income taxes are paid using the federal corporate income tax rate of 34%.

 

     December 31, 2010 (Successor)  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

—Fixed rate

     43,445,430         43,743,859         2.69         2.81

—Variable rate

     5,034,406         5,271,643         11.14         3.36

Collateralized mortgage obligations

     7,555,277         7,641,061         2.32         3.00

Trust preferred securities

     2,253,094         2,233,000         5.16         7.48
                                   

Total securities available for sale

   $ 58,288,207       $ 58,889,563         3.48         3.06
                                   

 

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     December 31, 2009 (Successor)  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

U.S. agencies

   $ 17,700,601       $ 17,810,442         13.07         5.16

Mortgage-backed securities

           

—Fixed rate

     4,983,564         5,000,110         1.97         5.47

—Variable rate

     7,102,185         7,160,290         7.96         3.57

Municipals

           

—Taxable

     2,111,980         2,073,280         8.08         6.32

—Tax exempt

     535,600         534,615         0.92         5.64

Trust preferred securities

     4,262,500         4,268,000         17.16         7.44
                                   

Total securities available for sale

   $ 36,696,430       $ 36,846,737         10.71         5.25
                                   

 

     December 31, 2008 (Predecessor)  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

U.S. agencies

   $ 23,658,025       $ 23,960,625         1.49         5.20

Mortgage-backed securities

           

—Fixed rate

     15,801,604         16,284,963         5.62         5.48

—Variable rate

     9,153,315         8,993,426         7.08         4.48

Municipals

           

—Tax exempt

     525,933         520,735         1.92         5.59

Other securities

     4,539,565         3,652,962         18.16         6.96
                                   

Total securities

   $ 53,678,442       $ 53,412,711         5.04         5.33
                                   

The reduction in the weighted average life and yield of the securities portfolio from December 31, 2009 to December 31, 2010 was a result of restructuring the portfolio, including investing a portion of the proceeds from the stock offering, to one with a shorter average life and duration and reduced volatility.

The following tables present a maturity analysis of our securities portfolio as of the dates stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the dates stated. Yields on tax-exempt securities are calculated on a tax equivalent basis, which converts the income on investments for which no income taxes are paid using the federal corporate income tax rate of 34%.

 

    December 31, 2010 (Successor)  
    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

  $ —          —        $ —          —        $ 4,694,555        1.92   $ 39,049,304        2.92   $ 43,743,859        2.81

—Variable rate

    —          —          —          —          —          —          5,271,642        3.40     5,271,642        3.40

Collateralized Mortgage Obligations

    —          —          —          —          —          —          7,641,062        3.00     7,641,062        3.00

Trust preferred securities

    —          —          —          —          —          —          2,233,000        7.48     2,233,000        7.48
                                                                               

Total securities available for sale

  $ —          —        $ —          —        $ 4,694,555        1.92   $ 54,195,008        3.17   $ 58,889,563        3.06
                                                                               

 

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    December 31, 2009 (Successor)  
    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:

                   

U.S. agencies

  $ —          —        $ —          —        $ —          —        $ 17,810,442        5.16   $ 17,810,442        5.16

Mortgage-backed securities

                   

—Fixed rate

    —          —          —          —          —          —          5,000,110        5.47     5,000,110        5.47

—Variable rate (1)

    —          —          —          —          —          —          7,160,290        3.57     7,160,290        3.57

Municipals

                   

—Taxable

    —          —          —          —          2,073,280        6.32     —          —          2,073,280        6.32

—Tax exempt

    —          —          —          —          —          —          534,615        5.64     534,615        5.64

Trust preferred securities

    —          —          —          —          —          —          4,268,000        7.44     4,268,000        7.44
                                                                               

Total securities available for sale

  $ —          —        $ —          —        $ 2,073,280        6.32   $ 34,773,457        5.25   $ 36,846,737        5.25
                                                                               

 

(1) Includes $6,966,339 in variable rate mortgage-backed securities that reset within one to 10 years.

 

    December 31, 2008 (Predecessor)  
    Within 1
Year
    Weighted
Average
Yield
    After 1
Year
Through
5 Years
    Weighed
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:

                   

U.S. agencies

    —          —          —          —          —          —          23,960,625        5.20     23,960,625        5.20

Mortgage-backed securities

                   

—Fixed rate

    —          —          —          —          —          —          16,284,963        5.48     16,284,963        5.48

—Variable rate (1)

    —          —          —          —          —          —          8,993,426        4.48     8,993,426        4.48

Other securities

    —          —          —          —          —          —          4,173,697        6.96     4,173,697        6.96
                                                                               

Total securities

    —          —          —          —          —          —          53,412,711        5.33     53,412,711        5.33
                                                                               

 

(1) Includes $8,993,426 in variable rate mortgage-backed securities that reset within one to 10 years.

Loans

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

 

    (Successor)
December 31, 2010
    (Successor)
December 31, 2009
          (Predecessor)
December 31, 2008
    (Predecessor)
December 31, 2007
    (Predecessor)
December 31, 2006
 
    Amount     Percent of
Total
    Amount     Percent of
Total
          Amount     Percent of
Total
    Amount     Percent of
Total
    Amount     Percent of
Total
 

Commercial and industrial

  $ 68,045,194        44.43   $ 43,467,134        42.59       $ 46,801,108        39.92   $ 38,055,913        36.36   $ 39,935,903        17.44

Commercial real estate

    57,035,207        37.24     34,978,917        34.28         40,325,987        34.39     40,553,316        38.74     13,140,234        53.01

Residential real estate

    23,337,126        15.24     22,061,275        21.62         27,766,166        23.68     23,394,949        22.35     19,803,612        26.29

Consumer

    4,714,520        3.08     1,523,660        1.49         2,343,175        2.00     2,612,593        2.50     2,449,667        3.25

Overdrafts

    13,554        0.01     18,711        0.02         10,859        0.01     48,929        0.05     2,934        0.01

Unearned fees, net

                    62,215          (51,935  
                                                                                   

Total loans

    153,145,601        100.00     102,049,697        100.00         117,247,295        100.00     104,727,915        100.00     75,280,415        100.00

Allowance for loan and lease losses

    (1,765,627       —                (1,687,284       (941,820       (826,595  
                                                     

Total loans, net of allowance for loan and lease losses

  $ 151,379,974        $ 102,049,697            $ 115,560,011        $ 103,786,095        $ 74,453,820     
                                                     

 

(1) Classifications for 2006 are not comparative to presentation for 2007-2010 due to changes in categorization after 2006.

 

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The following table provides 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, 2010 (Successor)  
          Variable Rate     Fixed Rate        
    Within 1
year
    1 to 5
years
    After 5
years
    Total     1 to 5
years
    After 5
years
    Total     Total
Maturities
 

Commercial and industrial (1)

  $ 35,446,050      $ 13,895,354      $ 375,642      $ 14,270,996      $ 15,875,911      $ 1,077,802      $ 16,953,713      $ 66,670,759   

Commercial real estate (2)

    21,208,084        22,426,229        —          22,426,229        9,457,267        1,246,314        10,703,581        54,337,894   

Residential real estate

    6,507,755        4,053,363        581,904        4,635,267        7,952,964        4,241,140        12,194,104        23,337,126   

Consumer (3)

    711,840        3,055,275        1,113        3,056,388        911,550        14,304        925,854        4,694,082   

Overdrafts

    13,554        —          —          —          —          —          —          13,554   
                                                               

Total loans

  $ 63,887,283      $ 43,430,221      $ 958,659      $ 44,388,880      $ 34,197,692      $ 6,579,560      $ 40,777,252      $ 149,053,415   
                                                               

 

(1) Excludes $1,374,435 in nonaccrual fixed-rate loans.
(2) Excludes $2,697,313 in nonaccrual variable-rate loans.
(3) Excludes $20,438 in nonaccrual fixed-rate loans.

 

    December 31, 2009 (Successor)  
          Variable Rate     Fixed Rate        
    Within 1
year
    1 to 5
years
    After 5
years
    Total     1 to 5
years
    After 5
years
    Total     Total
Maturities
 

Commercial and industrial (1)

  $ 13,678,581      $ 1,312,025      $ 4,469      $ 1,316,494      $ 26,974,618      $ 1,150,580      $ 28,125,198      $ 43,120,273   

Commercial real estate (2)

    16,499,422        10,207,841        —          10,207,841        4,570,906        45,256        4,616,162        31,323,425   

Residential real estate

    3,784,921        3,104,027        825,380        3,929,407        8,316,319        5,903,400        14,219,719        21,934,047   

Consumer (3)

    580,126        70,843        —          70,843        847,248        25,443        872,691        1,523,660   

Overdrafts

    18,711        —          —          —          —          —          —          18,711   
                                                               

Total loans

  $ 34,561,761      $ 14,694,736      $ 829,849      $ 15,524,585      $ 40,709,091      $ 7,124,679      $ 47,833,770      $ 97,920,116   
                                                               

 

(1) Excludes $346,861 in nonaccrual fixed-rate loans.
(2) Excludes $3,150,167 in nonaccrual variable-rate loans and $505,325 in nonaccrual fixed-rate loans.
(3) Excludes $127,228 in nonaccrual variable-rate loans.

 

    December 31, 2008 (Predecessor)  
          Variable Rate     Fixed Rate        
    Within 1
year
    1 to 5
years
    After 5
years
    Total     1 to 5
years
    After 5
years
    Total     Total
Maturities
 

Commercial and industrial

  $ 6,587,425      $ 1,287,076      $ —        $ 1,287,076      $ 8,555,474      $ 10,754      $ 8,566,228      $ 16,440,729   

Commercial real estate (1)

    26,835,670        16,385,605        —          16,385,605        24,201,503        2,479,093        26,680,596        69,901,871   

Residential real estate

    4,019,978        5,295,136        326,649        5,621,785        7,357,357        10,699,663        18,057,020        27,698,783   

Consumer

    777,333        187,720        49,618        237,338        1,305,305        38,933        1,344,238        2,358,909   

Overdrafts

    10,859        —          —          —          —          —          —          10,859   
                                                               

Total loans

  $ 38,231,265      $ 23,155,537      $ 376,267      $ 23,531,804      $ 41,419,639      $ 13,228,443      $ 54,648,082      $ 116,411,151   
                                                               

 

(1) Excludes $676,566 in nonaccrual variable-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 73.1% of our loan portfolio as of December 31, 2010 and 88.5% as of December 31, 2009. 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

 

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well. Commercial real estate, or CRE, loans are secured by business and commercial properties. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt service coverage ratios as well. The repayment of both residential and owner-occupied commercial real estate loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment.

Allowance for Loan and Lease Losses

As of December 22, 2009, prior to the merger, our allowance for loan and lease losses was $6.7 million and reflected a provision expense of $5.5 million for the period January 1 through December 22, 2009. Immediately following the merger, the allowance for loan and lease losses was reduced to $0 due to adjustments attributable to the acquisition method of accounting. For the year ended December 31, 2010, we recorded provision expense of $2.0 million which is for new loan production since December 31, 2009 and any changes in credit quality related to the purchased loan portfolio.

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 as of the dates stated:

 

    (Successor)     (Successor)          (Predecessor)     (Predecessor)     (Predecessor)  
    December 31, 2010     December 31, 2009          December 31, 2008     December 31, 2007     December 31, 2006  
    Amount     Percent of
loans
in each
category
to total
loans
    Amount     Percent of
loans
in each
category
to total
loans
         Amount     Percent of
loans
in each
category
to total
loans
    Amount     Percent of
loans
in each
category
to total
loans
    Amount     Percent of
loans
in each
category
to total
loans
 

Balance at end of period applicable to:

                       

Commercial and industrial

  $ 469,640        44.43   $ 1,245,830        42.59       $ 588,957        39.92   $ 208,762        36.36   $ 174,501        17.44

Commercial real estate

    1,105,898        37.24     4,980,026        34.28         863,536        34.39     597,056        38.74     477,983        53.01

Residential real estate

    163,675        15.24     434,396        21.62         187,650        23.68     120,274        22.35     131,777        26.29

Consumer

    26,414        3.09     39,748        1.51         32,930        2.01     39,304        2.50     36,363        3.25

Unallocated

    —          0.00     —          0.00         14,211        0.00     (23,576     0.05     5,971        0.01
                                                                                   

Total allowance for loan and lease losses

    1,765,627        100.00     6,700,000        100.00         1,687,284        100.00     941,820        100.00     826,595        100.00
                                                     

Acquisition fair value adjustment

    —            (6,700,000           —            —            —       
                                                     

Total allowance for loan and lease losses

  $ 1,765,627        $ —              $ 1,687,284        $ 941,820        $ 826,595     
                                                     

 

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

 

     (Successor)     (Successor)           (Predecessor)      (Predecessor)      (Predecessor)  
     December 31,
2010
    December 31,
2009
          December 31,
2008
     December 31,
2007
     December 31,
2006
 

Balance at beginning of period

   $ —        $ 1,687,283           $ 941,820       $ 826,595       $ 611,504   

Charge-offs:

                 

Commercial and industrial

     —          187,065             79,032         3,950         3,950   

Commercial real estate

     200,000        133,267             —           —           —     

Residential real estate

     51,913        214,352             —           —           —     

Consumer

     606        4,953             10,660         1,418         300   

Overdrafts

     15,591        —               —           —           —     
                                               

Total charge-offs

     268,110        539,637             89,692         5,368         4,250   
                                               

Recoveries:

                 

Commercial and industrial

     —          31,644             6,311         3,949         —     

Commercial real estate

     43,000        18,954             —           —           —     

Residential real estate

     140        —               —           —           —     

Consumer

     —          1,110             188         575         —     

Overdrafts

     597        —               —           —           —     
                                               

Total recoveries

     43,737        51,708             6,499         4,524         —     
                                               

Net charge-offs

     224,373        487,929             83,193         844         4,250   
                                               

Allowance, net of charge-offs and recoveries

     (224,373     1,199,354             858,627         825,751         607,254   

Additions to the allowance for loan and lease losses

     1,990,000        5,500,646             828,657         116,069         219,341   
                                               

Allowance after additions

     1,765,627        6,700,000             1,687,284         941,820         826,595   

Acquisition fair value adjustment

     —          (6,700,000          —           —           —     
                                               

Balance at end of period

   $ 1,765,627      $ —             $ 1,687,284       $ 941,820       $ 826,595   
                                               

Non-performing Assets

It is our policy to discontinue the accrual of interest income on our non-performing loans. We consider a loan as non-performing when it is greater than 90 days past due as to interest and principal or when there is serious doubt as to collectability, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of December 31, 2010 and 2009, there were no loans greater than 90 days past due with respect to principal and interest for which interest was accruing.

As of December 31, 2010 and 2009, we had $1.5 million and $464 thousand, respectively, in other real estate owned, or OREO, consisting of hotel/mixed-use and single family properties resulting from foreclosure. OREO asset valuations are evaluated periodically, and any necessary write down to fair value is recorded as impairment.

All of our non-performing assets as of December 31, 2010 were acquired in the merger, and their carrying values were adjusted to fair value immediately following the merger, in applying the acquisition method of accounting.

 

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The following table summarizes our non-performing assets as of the dates stated:

 

     (Successor)
December 31,
2010
    (Successor)
December 31,
2009
           (Predecessor)
December 31,
2008
    (Predecessor)
December 31,
2007
    (Predecessor)
December 31,
2006
 

Nonaccrual loans

   $ 2,841,553      $ 4,129,581           $ 676,566      $ —        $ —     

Other real estate owned

     1,484,606        463,700             —          —          —     
                                             

Total nonperforming assets

   $ 4,326,159      $ 4,593,281           $ 676,566      $ —        $ —     
                                             

Nonperforming assets as a percentage of total loans

     2.82     4.50          0.58     N/A        N/A   

Nonperforming assets as a percentage of total assets

     1.72     2.28          0.37     N/A        N/A   

Net charge-offs as a percentage of average loans

     0.18     N/A             0.08     0.00     0.01

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

     1.15     N/A             1.44     0.90     1.10

Allowance for loan and lease losses to non-accrual loans

     43.15     N/A             249.39     N/A        N/A   

The allowance for loan and lease losses excludes the discount recorded on our acquired loan portfolio.

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of December 31, 2010 totaled $175.1 million compared to deposits of $114.1 million as of December 31, 2009, an increase of 54%. Demand deposits, including money market accounts, increased $47.7 million, or approximately 200%, over balances as of December 31, 2009, and time deposits increased $13.1 million, or approximately 15%, over balances as of December 31, 2009.

The following table presents the average balances and rates paid, by deposit category, as of the dates stated:

 

    (Successor)     (Successor)           (Predecessor)  
    December 31, 2010     December 31, 2009           December 31, 2008  
    Amount     Rate     Amount     Rate           Amount     Rate  

Noninterest-bearing demand deposits

  $ 16,564,234        —        $ 14,032,483        —            $ 14,212,300        —     

Interest-bearing deposits:

               

Checking (NOW) accounts

    5,835,159        0.21     4,667,838        0.19         4,266,732        0.89

Money market accounts

    20,590,043        1.01     2,295,349        0.52         1,978,869        1.77

Savings accounts

    3,536,605        0.50     3,432,598        0.76         2,620,795        1.19

Time deposits $100,000 or greater (1)

    38,325,872        1.63     23,023,613        3.82         27,091,313        4.44

Time deposits less than $100,000

    60,333,304        1.15     78,459,376        3.47         76,577,954        4.37
                                                   

Total interest-bearing deposits

    128,620,983        1.21     111,878,774        3.26         112,535,663        4.14
                                                   

Total average deposits

  $ 145,185,217        1.07   $ 125,911,257        2.90       $ 126,747,963        3.67
                                                   

 

(1) Includes brokered deposits of $10.2 million at December 31, 2010 and $15.3 million at December 31, 2009 and 2008.

Maturities of large denomination time deposits (equal or greater than $100,000) as of December 31, 2010 (successor) were as follows:

 

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

Time deposits

   $ 7,812,332       $ 11,187,808       $ 8,969,060       $ 19,546,587       $ 47,515,787         27.13

 

(1) Includes brokered deposits of $5.1 million.
(2) Includes brokered deposits of $5.1 million.

 

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Borrowings

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

 

    December 31, 2010 (Successor)     December 31, 2009 (Successor)          December 31, 2008 (Predecessor)  
    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

  $ —        $ —        $ 36,758        0.76   $ 1,552,000      $ 2,526,000      $ 518,841        0.79       $ —        $ 2,270,000      $ 374,164        2.76

Other borrowings

    —          4,700,000        741,667        0.81     4,700,000        12,000,000        3,472,329        0.53         16,000,000        21,000,000        11,006,284        3.77
                                                                                                   

Total short-term borrowings

  $ —        $ 4,700,000      $ 778,425        0.57   $ 6,252,000      $ 14,526,000      $ 3,991,170        0.57       $ 16,000,000      $ 23,270,000      $ 11,380,448     

 

3.74

                                                                                                   

Liquidity and Capital Resources

In the year ended December 31, 2010, cash and cash equivalents decreased $23.0 million to $12.2 million from $35.2 million at December 31, 2009. Net cash used in operating activities was $5.1 million for the year ended December 31, 2010 compared to net cash used in operating activities of $1.1 million for the period from January 1 through December 22, 2009. Greater use of cash in 2010 than in 2009 was due to a higher net loss in 2010 of $1.6 million and a higher provision for loan and lease losses in 2009 of $3.5 million partially offset by a deferred tax benefit of $2.4 million, both of which are non-cash items.

Net cash used in investing activities was $73.7 million for the year ended December 31, 2010 compared to net cash provided by investing activities of $23.2 million for the period January 1 through December 22, 2009. This increased use of cash resulted from an increase in net loans of $50.7 million in 2010 compared to a decrease in net loans of $5.5 million in 2009. Additionally, higher investments in securities of $65.9 million, partially offset by a $44.0 million increase in proceeds from maturities and calls of securities, contributed to the increased use of cash. Net cash provided by financing activities in the year ended December 31, 2010 was $55.8 million compared to net cash used in financing activities of $25.2 million for the period January 1 through December 31, 2009. Net cash inflows from deposits was $62.1 million in the year ended December 31, 2010, whereas net cash outflows from deposits was $19.2 million in 2009 period.

Liquidity

Liquidity is the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate deposit withdrawals, payments of debt and operating expenses and increased loan demand, and to achieve stated objectives (including working capital requirements). These events may occur daily or in other short-term intervals in the normal operation of business. Historical trends may help management predict the amount of cash required. In assessing liquidity, management gives consideration to various factors, including stability of deposits, maturity of time deposits, quality, volume and maturity of assets, sources and costs of borrowings, concentrations of business and industry, competition, and our overall financial condition and cash flows. Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale portfolio. We have access to a credit line from our primary correspondent bank in the amount of $5.0 million. This line is for short-term liquidity needs and is subject to the prevailing federal funds interest rate.

In addition, we have a secured borrowing facility with the FHLB. The total credit availability is equal to 30% of our total assets. As of December 31, 2010, our total credit availability was $73.1 million, based on our September 30, 2010 balance sheet. Under this facility, we have two terms loans outstanding. One loan is for $20 million and was originated on January 25, 2008 at a fixed rate of 2.5% per annum and matures on January 25, 2013. The second loan is for $5.0 million and was originated on March 4, 2009 at a fixed rate of 2.07% per annum and matures March 4, 2011. Neither loan amortizes. Together, these facilities have a weighted average interest rate of 2.41% per annum.

We also were extended an uncommitted line of credit by a national bank to borrow federal funds up to $5.0 million on an unsecured basis. The uncommitted line of credit is not a confirmed line or loan and terminates on August 30, 2011, if not cancelled earlier. Borrowings under this arrangement will bear interest at the prevailing federal funds rate. There have been no borrowings under this uncommitted line of credit.

 

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On November 24, 2010, we filed a registration statement on Form S-1 with the SEC for a proposed public offering of up to $42.0 million of our common stock. The registration statement has not been declared effective by the SEC, and we cannot make any offering under the registration statement until the SEC declares it effective. We intend to contribute the net proceeds from any sale of our common stock to the Bank, and intend that the Bank use the contributed proceeds primarily to fund organic growth of loans to customers in its target markets, for continued investment in its infrastructure and personnel and for other general purposes, which may include acquisitions.

In management’s opinion, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs which 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.

Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios. On December 7, 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained conditions related to BankCap Partners, as well as the conduct of the Bank’s business. The condition applicable to the Bank provided that, during the first three years of operation after the merger, 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. As of December 31, 2010, we met all minimum capital adequacy requirements to which we are subject, including those contained in our business plan as submitted to the Federal Reserve, and are categorized as “well-capitalized.” Since December 31, 2010, there are no conditions or events that management believes have changed our status as “well-capitalized.”

 

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The following tables present Tier 1 and Tier 2 capital ratios and the minimum capital ratios required by our regulators as of the dates stated:

 

     (Successor)     (Successor)  
(In thousands)    December 31,
2010
    December 31,
2009
 

Tier 1 capital:

    

Common stock

   $ 5,847      $ 5,847   

Additional paid-in capital

     57,714        57,614   

Retained (deficit)

     (15,374     (9,457

Accumulated other comprehensive income

     601        68   
                

Total bank equity capital

     48,788        54,072   

Net unrealized (gain) on available-for-sale securities

     (601     (68

Disallowed goodwill and other disallowed intangible assets

     (14,109     (14,229
                

Total Tier 1 capital

   $ 34,078      $ 39,775   
                

Tier 2 capital:

    

Allowance for loan and lease losses (1)

   $ 1,766      $ —     
                

Total risk-based capital

   $ 35,844      $ 39,775   
                

Average total assets for leverage capital

   $ 230,510      $ 161,988