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TABLE OF CONTENTS
Item 8. Financial Statements and Supplementary Data
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One) | ||
ý |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2010 |
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or |
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o |
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
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Commission file number: 0-24557 |
CARDINAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia | 54-1874630 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
8270 Greensboro Drive, Suite 500 McLean, Virginia (Address of principal executive offices) |
22102 (Zip Code) |
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Registrant's telephone number, including area code: (703) 584-3400 |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
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Common Stock, par value $1.00 per share | The Nasdaq Stock Market |
Securities registered pursuant to Section 12(g) of the 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 o No ý
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 o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of 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. o
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 o | Accelerated filer ý | Non-accelerated filer o (No not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2010: $255,063,335.
The number of shares outstanding of Common Stock, as of March 7, 2011, was 28,919,639.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.
This
Annual Report on Form 10-K has not been reviewed, or confirmed for accuracy or relevance,
by the Federal Deposit Insurance Corporation.
2
Overview
Cardinal Financial Corporation, a financial holding company, was formed in late 1997 as a Virginia corporation, principally in response to opportunities resulting from the consolidation of several Virginia-based banks. These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.
We own Cardinal Bank, (the "Bank"), a Virginia state-chartered community bank with 26 banking offices located in Northern Virginia and the greater Washington, D.C. metropolitan area. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.
Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC ("George Mason") and Cardinal First Mortgage, LLC ("Cardinal First"), collectively the "mortgage banking segment," retail securities brokerage through Cardinal Wealth Services, Inc. ("CWS"), asset management through Wilson/Bennett Capital Management, Inc. ("Wilson/Bennett") and trust, estate, custody, investment management and retirement planning through the trust division of Cardinal Bank.
George Mason engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis through six branches located throughout the metropolitan Washington, D.C. region. George Mason is one of the largest residential mortgage originators in the greater Washington metropolitan area, generating originations of approximately $3.2 billion in 2010 and $2.6 billion in 2009, excluding advances on construction loans and including loans purchased from other mortgage banking companies owned by local home builders but managed by George Mason. George Mason sells its mortgage loans to third party investors servicing released.
Cardinal First originates mortgage loans for new homes and refinancing in Virginia, Maryland, and Washington, D.C. principally for existing Cardinal Bank customers.
CWS provides brokerage and investment services through a contract with Raymond James Financial Services, Inc. Under this contract, financial advisors can offer our customers an extensive range of financial products and services, including estate planning, qualified retirement plans, mutual funds, annuities, life insurance, fixed income and equity securities and equity research and recommendations. CWS's principal source of revenue is the net commissions it earns on the purchases and sales of investment products to its customers.
Wilson/Bennett provides professional investment management of financial assets with asset preservation as the primary goal. Clients include individuals, pension plans and medium sized corporations. Wilson/Bennett utilizes a value oriented investment approach and focuses on large capitalization stocks as well as cash management services. Wilson/Bennett earns fees based upon the market value of its clients' portfolios.
Cardinal Bank has a trust division that acts as trustee or custodian for client assets and earns fees primarily based upon balances under management. The trust division diversifies the Bank's sources of non-interest income and allows us to provide additional services to our customers.
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Growth Strategy
We believe that the strong demographic characteristics of our market and the relative strength of the metropolitan Washington, D.C. area, particularly Northern Virginia, provide a significant opportunity to continue building a successful community-focused banking franchise. We intend to continue to expand our business through internal growth, as well as selective geographic expansion, while maintaining strong asset quality and achieving increasing profitability. The strategy for achieving these objectives includes the following:
Capitalize on the current market conditions. As the banking industry continues to restrict lending based on industry-wide asset quality limitations and capital constraints, we believe we are well positioned to take advantage of this void based on our strong balance sheet. We continue to see increased opportunities to grow our loan portfolio because the competition is distracted by current market conditions and their credit quality issues. In addition to loan growth, we believe that our margins should be enhanced going forward as risk-based pricing returns to the industry. We also continue to benefit from a move towards quality by well established business owners, including multi-generational businesses, seeking the safe and consistent reliable delivery of service that we are able to provide.
Penetrate our existing markets and further improve our branch positioning. We intend to continue to penetrate our existing markets with increased business development efforts through additional experienced bankers in communities that present attractive growth opportunities within Northern Virginia and other markets in the greater Washington, D.C. metropolitan area. We expect to continue to have opportunities to acquire or lease former branch sites from other financial institutions. As we have done in the past, we may acquire additional sites prior to planned branch openings when we believe the sites are attractive and are available on favorable terms. As we evaluate our branch positioning, we have considered and will continue to consider acquiring branches or deposits in FDIC assisted transactions that occur in our market area. Because the opening of each new branch increases our operating expenses, we intend to stage future branch openings in an effort to minimize the impact of these expenses on our results of operations.
Capitalize on the continued bank consolidation in our market. We anticipate that recently announced bank mergers as well as FDIC assisted transactions will result in further consolidation in our target market and we intend to capitalize on the dislocation of customers resulting from this consolidation. We believe this consolidation creates opportunities for expanding our branch network, as discussed above, as well as to increase our market share of bank deposits within our target market. We focus on building long term relationships with our clients and communities by providing personalized service from local management teams. We also will continue to explore the possibility of further growth through acquisition in Virginia, the metropolitan Washington, D.C. market, or other areas if we believe that such expansion will strengthen the Company by diversifying our customer base and sources of revenue and be accretive to earnings within a reasonable time frame.
Expand our lending activities. As of December 31, 2010, we have increased our legal lending limit to over $34.0 million as a result of retained earnings and our successful capital raise efforts during 2009. The increase in our legal lending limit allows us to further expand our commercial and real estate lending activities. It also improves our ability to seek business from larger government contractors, businesses who we believe are conservatively operated and well capitalized residential homebuilders. According to George Mason University's Center for Regional Analysis, federal government spending in the greater Washington D.C. region was approximately $130 billion in 2008, and we believe there are unique growth opportunities in this sector of our regional economy. Our goal is to aggressively grow our loan portfolio while maintaining superior asset quality through conservative underwriting practices.
4
Continue to recruit experienced bankers. Historically, we have been successful in recruiting senior bankers with experience in, and knowledge of, our market. We believe current market conditions and consolidation will allow us to continue to find bankers who have been displaced or have grown dissatisfied as a result of consolidation. We intend to continue our efforts to recruit seasoned bankers, particularly experienced lenders, who we expect can immediately generate additional loan volume through their existing credit relationships.
Business Segment Operations
We operate in three business segments, commercial banking, mortgage banking and wealth management and trust services. The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products, including demand deposit accounts, savings accounts and certificates of deposit. The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis. The wealth management and trust services segment provides investment and financial advisory services to businesses and individuals, including financial planning, retirement/estate planning, trust, estates, custody, investment management, escrows, and retirement plans.
For financial information about the reportable segments, see "Business Segment Operations" in Item 7 below and Note 22 of the notes to the consolidated financial statements in Item 8 below.
Market Area
We consider our primary target market to include the Virginia counties of Arlington, Fairfax, Loudoun, Prince William, and Stafford and the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park; Washington, D.C. and Montgomery County in Maryland. In addition to our primary market, we consider the Virginia counties of Spotsylvania, Culpeper and Fauquier and the Maryland county of Prince George's as secondary markets and the remaining Greater Washington Metropolitan area as a tertiary market. We will, however, consider expansion into other areas if we believe such expansion will strengthen the Company by diversifying its customer base and sources of revenue and be accretive to earnings within a reasonable time frame.
Based on estimates released by the U.S. Census Bureau, the population of the greater Washington metropolitan area was approximately 5.5 million people in 2009, the eighth largest statistical area in the country. The median annual household income for this area in 2009 was approximately $83,000, which makes it one of the wealthiest regions in the country. For 2010, based on estimates released by the Bureau of Labor Statistics of the U.S. Department of Labor, the unemployment rate for the greater Washington metropolitan area was approximately 5.7%, compared to a national unemployment rate of 9.4%. As of June 30, 2010, total deposits in this area were approximately $166 billion as reported by the Federal Deposit Insurance Corporation ("FDIC").
Our headquarters are located in the center of the business district of Fairfax County, Virginia. Fairfax County, with over one million people, is the most populous county in Virginia and the most populous jurisdiction in the Washington, D.C. area. According to the latest U.S. Census Bureau estimates, Fairfax County also has the second highest median household income of any county in the United States of $109,000, surpassed by its neighbor, Loudoun County with $116,000.
We believe the diversity of our economy, including the stability provided by businesses serving the U.S. Government, provides us with the opportunities necessary to prudently grow our business.
5
Competition
The greater Washington region is dominated by branches of large regional or national banks headquartered outside of the region. Our market area is a highly competitive, highly branched, banking market. We compete as a financial intermediary with other commercial banks, savings and loan associations, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, mutual fund groups and other types of financial institutions. George Mason faces significant competition from both traditional financial institutions and other national and local mortgage banking operations.
The competition to acquire deposits and to generate loans, including mortgage banking loans, is intense, and pricing is important. Many of our competitors are larger and have substantially greater resources and lending limits than we do. In addition, many competitors offer more extensive branch and ATM networks than we currently have. Larger institutions operating in the greater Washington market have access to funding sources at lower costs than are available to us since they have larger and more diverse fund generating capabilities. However, we believe that we have and will continue to be successful in competing in this environment due to an emphasis on a high level of personalized customer service, localized and more responsive decision making, and community involvement.
Of the $166 billion in bank deposits in the greater Washington region at June 30, 2010, approximately 83% were held by banks that are either based outside of the greater Washington region or are operating wholesale banks that generate deposits nationally. Excluding institutions based outside our region, we have grown to the fifth largest financial institution headquartered in the greater Washington region as measured by total deposits. By providing competitive products and more personalized service and being actively involved in our local communities, we believe we can continue to increase our share of this deposit market.
Customers
We believe that the recent and ongoing bank consolidation within Northern Virginia and the greater Washington region provides a significant opportunity to build a successful, locally-oriented banking franchise. We also believe that many of the larger financial institutions in our area do not emphasize the high level of personalized service to small and medium-sized commercial businesses, professionals or individual retail customers that we emphasize.
We expect to continue serving these business and professional markets with experienced commercial relationship managers, and we have increased our retail marketing efforts through the expansion of our branch network and development of additional retail products and services. We expanded our deposit market share through aggressive marketing of our President's Club, Chairman's Club, Simply Savings and Monster Money Market relationship products and our Totally Free Checking product.
Banking Products and Services
Our principal business is to accept deposits from the public and to make loans and other investments. The principal sources of funds for the Bank's loans and investments are demand, time, savings and other deposits, repayments of existing loans, and borrowings. Our principal source of income is interest collected on loans, investment securities and other investments. Non-interest income, which includes among other things deposit and loan fees and service charges, realized and unrealized gains on mortgage banking activities, investment fee income, and management fee income, is the next largest component of our revenues. Our principal expenses are interest expense on deposits and borrowings, employee compensation and benefits, occupancy-related expenses, and other overhead expenses.
6
The principal business of George Mason, the Bank's primary mortgage banking subsidiary, is to originate residential loans for sale into the secondary market on a best efforts basis. These loans are closed and serviced by George Mason on an interim basis pending their ultimate sale to a permanent investor. The mortgage subsidiary funds these loans through a line of credit from Cardinal Bank and cash available through its own operations. George Mason's income on these loans is generated from the fees it charges its customers, the gains it recognizes upon the sales of loans and the interest income it earns prior to the delivery of the loan to the investor. Costs associated with these loans are primarily comprised of salaries and commissions paid to loan originators and support personnel, interest expense incurred while the loans are held pending sale and other expenses associated with the origination of the loans. In addition, George Mason generates management fee income by providing specific services to other mortgage banking companies owned by local home builders.
Cardinal First, in addition to assisting Cardinal Bank customers in their residential mortgage needs, offers a construction-to-permanent loan program. This program provides variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market. These construction-to-permanent loans generate fee income as well as net interest income and are classified as loans held for sale.
The mortgage banking segment's business is both cyclical and seasonal. The cyclical nature of its business is influenced by, among other things, the levels of and trends in mortgage interest rates, national and local economic conditions and consumer confidence in the economy. Historically, the mortgage banking segment has its lowest levels of quarterly loan closings during the first quarter of the year.
Both Cardinal Bank and George Mason are committed to providing high quality products and services to their customers, and have made a significant investment in their core information technology systems. These systems provide the technology that fully automates the branches, processes bank transactions, mortgage originations, other loans and electronic banking, conducts database and direct response marketing, provides cash management solutions, streamlined reporting and reconciliation support.
With this investment in technology, the Bank offers internet-based delivery of products for both individuals and commercial customers. Customers can open accounts, apply for loans, check balances, check account history, transfer funds, pay bills, download account transactions into Quicken and Microsoft Money, and correspond via e-mail with the Bank over the internet. The internet provides an inexpensive way for the Bank to expand its geographic borders and branch activities while providing services offered by larger banks.
We offer a broad array of products and services to our customers. A description of our products and services is set forth below.
Lending
We offer a full range of short to long-term commercial, real estate and consumer lending products and services, which are described in further detail below. We have established target percentage goals for each type of loan to insure adequate diversification of our loan portfolio. These goals, however, may change from time to time as a result of competition, market conditions, employee expertise, and other factors. Commercial and industrial loans, real estate-commercial loans, real estate-construction loans, real estate-residential loans, home equity loans, and consumer loans account for approximately 14%, 45%, 17%, 15%, 8% and 1%, respectively of our loan portfolio at December 31, 2010.
Commercial and Industrial Loans. We make commercial loans to qualified businesses in our market area. Our commercial lending portfolio consists primarily of commercial and industrial loans for the financing of accounts receivable, property, plant and equipment. Our government contract lending
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group provides secured lending to government contracting firms and businesses based primarily on receivables from the federal government. We also offer Small Business Administration (SBA) guaranteed loans and asset-based lending arrangements to our customers. We are certified as a preferred lender by the SBA, which provides us with much more flexibility in approving loans guaranteed under the SBA's various loan guaranty programs.
Historically, commercial and industrial loans generally have a higher degree of risk than residential mortgage loans. Residential mortgage loans generally are made on the basis of the borrower's ability to repay the loan from his or her salary and other income and are secured by residential real estate, the value of which generally is readily ascertainable. In contrast, commercial loans typically are made on the basis of the borrower's ability to repay the loan from the cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory, the values of which may fluctuate over time and generally cannot be appraised with as much precision as residential real estate. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent upon the commercial success of the business itself.
To manage these risks, our policy is to secure the commercial loans we make with both the assets of the business, which are subject to the risks described above, and other additional collateral and guarantees that may be available. In addition, for larger relationships, we actively monitor certain attributes of the borrower and the credit facility, including advance rate, cash flow, collateral value and other credit factors that we consider appropriate.
Commercial Mortgage Loans. We originate commercial mortgage loans. These loans are primarily secured by various types of commercial real estate, including office, retail, warehouse, industrial and other non-residential types of properties and are made to the owners and/or occupiers of such property. These loans generally have maturities ranging from one to ten years.
Historically, commercial mortgage lending entails additional risk compared with traditional residential mortgage lending. Commercial mortgage loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income-producing properties is typically dependent upon the successful operation of a business or real estate project and thus may be subject, to a greater extent than has historically been the case with residential mortgage loans, to adverse conditions in the commercial real estate market or in the general economy. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness and prior credit history, and we generally require personal guarantees or endorsements with respect to these loans. In the loan underwriting process, we also carefully consider the location of the property that will be collateral for the loan.
Loan-to-value ratios for commercial mortgage loans generally do not exceed 80%. We permit loan-to-value ratios of up to 80% if the borrower has appropriate liquidity, net worth and cash flow.
Residential Mortgage Loans. Residential mortgage loans are originated by Cardinal Bank, Cardinal First and George Mason. Our residential mortgage loans consist of residential first and second mortgage loans, residential construction loans and home equity lines of credit and term loans secured by the residences of borrowers. Second mortgage and home equity lines of credit are used for home improvements, education and other personal expenditures. We make mortgage loans with a variety of terms, including fixed, floating and variable interest rates, with maturities ranging from three months to thirty years.
Residential mortgage loans generally are made on the basis of the borrower's ability to repay the loan from his or her salary and other income and are secured by residential real estate, the value of which is generally readily ascertainable. These loans are made consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and maturities. Residential mortgage
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loans and home equity lines of credit secured by owner-occupied property generally are made with a loan-to-value ratio of up to 80%. Loan-to-value ratios of up to 90% may be allowed on residential owner-occupied property if the borrower exhibits unusually strong creditworthiness. We generally do not make residential loans which, at the time of inception, have loan-to-value ratios in excess of 90%.
Construction Loans. Our construction loan portfolio consists of single-family residential properties, multi-family properties and commercial projects. Construction lending entails significant additional risks compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks since funds are advanced while the property is under construction, which property has uncertain value prior to the completion of construction. Thus, it is more difficult to accurately evaluate the total loan funds required to complete a project and related loan-to-value ratios. To reduce the risks associated with construction lending, we limit loan-to-value ratios to 80% of when-completed appraised values for owner-occupied residential or commercial properties and for investor-owned residential or commercial properties. We expect that these loan-to-value ratios will provide sufficient protection against fluctuations in the real estate market to limit the risk of loss. Maturities for construction loans generally range from 12 to 24 months for non-complex residential, non-residential and multi-family properties.
Consumer Loans. Our consumer loans consist primarily of installment loans made to individuals for personal, family and household purposes. The specific types of consumer loans we make include home improvement loans, automobile loans, debt consolidation loans and other general consumer lending.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. A loan may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan, such as the bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.
Our policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful credit and financial analysis of the borrower. In evaluating consumer loans, we require our lending officers to review the borrower's level and stability of income, past credit history, amount of debt currently outstanding and the impact of these factors on the ability of the borrower to repay the loan in a timely manner. In addition, we require our banking officers to maintain an appropriate differential between the loan amount and collateral value.
We also issue credit cards to certain of our customers. In determining to whom we will issue credit cards, we evaluate the borrower's level and stability of income, past credit history and other factors. Finally, we make additional loans that are not classified in one of the above categories. In making such loans, we attempt to ensure that the borrower meets our loan underwriting standards.
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Loan Participations
From time to time we purchase and sell commercial loan participations to or from other banks within our market area. All loan participations purchased have been underwritten using the Bank's standard and customary underwriting criteria and are in good standing.
Deposits
We offer a broad range of interest-bearing and non-interest-bearing deposit accounts, including commercial and retail checking accounts, money market accounts, individual retirement accounts, regular interest-bearing savings accounts and certificates of deposit with a range of maturity date options. The primary sources of deposits are small and medium-sized businesses and individuals within our target market. Senior management has the authority to set rates within specified parameters in order to remain competitive with other financial institutions in our market area. All deposits are insured by the FDIC up to the maximum amount permitted by law. We have a service charge fee schedule, which is generally competitive with other financial institutions in our market, covering such matters as maintenance fees and per item processing fees on checking accounts, returned check charges and other similar fees.
Courier Services
We offer courier services to our business customers. Courier services permit us to provide the convenience and personalized service that our customers require by scheduling pick-ups of deposits and other banking transactions.
Deposit on Demand
We provide our commercial banking customers electronic deposit capability through our Deposit on Demand product. Business customers who sign up for this service can scan their deposits and send electronic batches of their deposits to the Bank. This product reduces or eliminates the need for businesses with daily deposits and high check volume to visit the Bank and provides the benefit of viewing images of deposited checks.
Telephone and Internet Banking
We believe that there is a strong demand within our market for telephone banking and internet banking. These services allow both commercial and retail customers to access detailed account information and execute a wide variety of the banking transactions, including balance transfers and bill payment. We believe that these services are particularly attractive to our customers, as it enables them at any time to conduct their banking business and monitor their accounts. Telephone and internet banking assists us in attracting and retaining customers and encourages our existing customers to consider Cardinal for all of their banking and financial needs.
During 2007, we introduced Cardinal Mobile Banking to our customers. Customers who sign up for this service can access their accounts from any internet-enabled cell phone, PDA or mobile device. Customers can check their balance, view account activity, transfer funds between deposit accounts, and may pay their bill online. Cardinal Mobile Banking is encrypted using the Wireless Transport Layer Security (WTLS) protocol, which provides the highest level of security available today. As part of our Mobile Banking service, customers can also receive text messages about their account balances and recent transaction activity.
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Automatic Teller Machines
We have an ATM at each of our branch offices and we make other financial institutions' ATMs available to our customers.
Other Products and Services
We offer other banking-related specialized products and services to our customers, such as travelers' checks, coin counters, wire services, and safe deposit box services. We issue letters of credit for some of our commercial customers, most of which are related to real estate construction loans. We have not engaged in any securitizations of loans.
Credit Policies
Our chief credit officer and senior lending officers are primarily responsible for maintaining both a quality loan portfolio and a strong credit culture throughout the organization. The chief credit officer is responsible for developing and updating our credit policies and procedures, which are approved by the board of directors. The chief credit officer and senior lending officers may make exceptions to these credit policies and procedures as appropriate, but any such exception must be documented and made for sound business reasons.
Credit quality is controlled by the chief credit officer through compliance with our credit policies and procedures. Our risk-decision process is actively managed in a disciplined fashion to maintain an acceptable risk profile characterized by soundness, diversity, quality, prudence, balance and accountability. Our credit approval process consists of specific authorities granted to the lending officers and combinations of lending officers. Loans exceeding a particular lending officer's level of authority, or the combined limit of several officers, are reviewed and considered for approval by an officers' loan committee and, when above a specified amount, by a committee of the Bank's board of directors. Generally, loans of $1,500,000 or more require committee approval. Our policy allows exceptions for very specific conditions, such as loans secured by deposits at our Bank. The chief credit officer works closely with each lending officer at the Bank level to ensure that the business being solicited is of the quality and structure that fits our desired risk profile.
Under our credit policies, we monitor our concentration of credit risk. We have established credit concentration guideline limits for commercial and industrial loans, real estate-commercial loans, real estate-residential loans and consumer purpose loans, which include home equity loans. Furthermore, the Bank has established limits on the total amount of the Bank's outstanding loans to one borrower, all of which are set below legal lending limits.
Loans closed by George Mason are underwritten in accordance with guidelines established by the various secondary market investors to which George Mason sells its loans.
Brokerage and Asset Management Services
CWS provides brokerage and investment services through an arrangement with Raymond James Financial Services, Inc. Under this arrangement, financial advisors can offer our customers an extensive range of investment products and services, including estate planning, qualified retirement plans, mutual funds, annuities, life insurance, fixed income and equity securities and equity research and recommendations. Through Wilson/Bennett, we also offer asset management services to customers using a value-oriented approach that focuses on large capitalization stocks.
The Bank has a trust division, and services provided by our trust division include trust, estates, custody, investment management, escrows, and retirement plans. The addition of trust services diversifies the Bank's sources of non-interest income and allows us to provide additional services to our customers.
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Employees
At December 31, 2010, we had 417 full-time equivalent employees. None of our employees are represented by any collective bargaining unit. We believe our relations with our employees are good.
Government Supervision and Regulation
General
As a financial holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, and the examination and reporting requirements of the Board of Governors of the Federal Reserve System. Other federal and state laws govern the activities of our bank subsidiary, including the activities in which it may engage, the investments that it makes, the aggregate amount of loans that it may grant to one borrower, and the dividends it may declare and pay to us. Our bank subsidiary is also subject to various consumer and compliance laws. As a state-chartered bank, the Bank is primarily subject to regulation, supervision and examination by the Bureau of Financial Institutions of the Virginia State Corporation Commission. Our bank subsidiary also is subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation. As part of our bank subsidiary, George Mason and Cardinal First are subject to the same regulations as the Bank.
The following description summarizes the more significant federal and state laws applicable to us. To the extent that statutory or regulatory provisions are described, the description is qualified in its entirety by reference to that particular statutory or regulatory provision.
The Bank Holding Company Act
Under the Bank Holding Company Act, we are subject to periodic examination by the Federal Reserve and required to file periodic reports regarding our operations and any additional information that the Federal Reserve may require. Our activities at the bank holding company level are limited to:
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- banking, managing or controlling banks;
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- furnishing services to or performing services for our subsidiaries; and
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- engaging in other activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities.
Some of the activities that the Federal Reserve Board has determined by regulation to be closely related to the business of a bank holding company include making or servicing loans and specific types of leases, performing specific data processing services and acting in some circumstances as a fiduciary or investment or financial adviser.
With some limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
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- acquiring substantially all the assets of any bank; and
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- acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares), or merging or consolidating with another bank holding company.
In addition, and subject to some exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with their 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 an individual 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 acquires 10% or more, but less
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than 25%, of any class of voting securities and if the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenging this rebuttable control presumption.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act ("GLBA"), which made substantial revisions to the statutory restrictions separating banking activities from other financial activities. Under the GLBA, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become "financial holding companies." As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities, such as insurance underwriting and securities underwriting and distribution. In addition, financial holding companies may also acquire or engage in certain activities in which bank holding companies are not permitted to engage in, such as travel agency activities, insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary to these activities. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLBA applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. We became a financial holding company in 2004.
Payment of Dividends
We are a legal entity separate and distinct from Cardinal Bank, CWS, Wilson/Bennett, and Cardinal Statutory Trust I. Virtually all of our cash revenues will result from dividends paid to us by our bank subsidiary and interest earned on short term investments. Our bank subsidiary is subject to laws and regulations that limit the amount of dividends that it can pay. Under Virginia law, a bank may not declare a dividend in excess of its accumulated retained earnings. Additionally, our bank subsidiary may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by the bank in any calendar year exceeds the total of the bank's retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the FDIC. Our bank subsidiary may not declare or pay any dividend if, after making the dividend, the bank would be "undercapitalized," as defined in the banking regulations.
The FDIC and the state have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state and the FDIC have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsound and unsafe banking practice.
In addition, we are subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Regulators have indicated that financial holding companies should generally pay dividends only if the organization's net income available to common shareholders is sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition.
Insurance of Accounts, Assessments and Regulation by the FDIC
The deposits of our bank subsidiary are insured by the FDIC up to the limits set forth under applicable law. The deposits of our bank subsidiary are subject to the deposit insurance assessments of the Deposit Insurance Fund, or "DIF", of the FDIC.
The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to regulatory capital levels of the institution and other factors, including supervisory evaluations. In addition to being influenced by the
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risk profile of the particular depository institution, FDIC premiums are also influenced by the size of the FDIC insurance fund in relation to total deposits in FDIC insured banks. The FDIC has authority to impose special assessments.
The FDIC is required to maintain a designated minimum ratio of the DIF to insured deposits in the United States. In July 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act (the "Financial Reform Act") was signed into law. The Financial Reform Act requires the FDIC to assess insured depository institutions to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. The FDIC has recently adopted new regulations that establish a long-term target DIF ratio of greater than two percent. As a result of the ongoing instability in the economy and the failure of other U.S. depository institutions, the DIF ratio is currently below the required targets and the FDIC has adopted a restoration plan that will result in substantially higher deposit insurance assessments for all depository institutions over the coming years. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole.
Pursuant to the Financial Reform Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer. The Financial Reform Act also provides for unlimited FDIC insurance coverage for noninterest-bearing demand deposit accounts for a two year period beginning on December 31, 2010 and ending on December 31, 2012.
The Financial Reform Act also changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. On February 7, 2011, the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Financial Reform Act. The new regulation will be effective April 1, 2011 and will be reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, we expect to incur annual deposit insurance assessments that are higher than before the financial crisis. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.
The FDIC is authorized to prohibit any insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the DIF. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution's primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. We are unaware of any existing circumstances that could result in termination of any of our bank subsidiary's deposit insurance.
Capital Requirements
Each of the FDIC and the Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, we and our bank subsidiary are each generally required to maintain a minimum 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 the total capital must be composed of "Tier 1 Capital," which is defined as common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles. The
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remainder may consist of "Tier 2 Capital", which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance and pretax net unrealized holding gains on certain equity securities. In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization's overall safety and soundness. In summary, the capital measures used by the federal banking regulators are:
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- Total Risk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital (which
includes common shareholders' equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments) and Tier 2 Capital (which includes
preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to
1.25 percent of risk-weighted assets and other adjustments) as a percentage of total risk-weighted assets
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- Tier 1 Risk-Based Capital ratio (Tier 1 capital divided by total risk-weighted
assets), and
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- the Leverage ratio (Tier 1 capital divided by adjusted average total assets).
Under these regulations, a bank will be:
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- "well capitalized" if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier 1
Risk-Based Capital ratio of 6% or greater, a Leverage ratio of 5% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive
by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure
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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 Leverage ratio of 4% or greater (or 3% in certain circumstances) and is not well capitalized
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- "undercapitalized" if it has a Total Risk-Based Capital ratio of less than 8%, a Tier 1
Risk-Based Capital ratio of less than 4% (or 3% in certain circumstances), or a Leverage ratio of less than 4% (or 3% in certain circumstances)
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- "significantly undercapitalized" if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1
Risk-Based Capital ratio of less than 3%, or a Leverage ratio of less than 3%, or
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- "critically undercapitalized" if its tangible equity is equal to or less than 2% of tangible assets.
The risk-based capital standards of each of the FDIC and the Federal Reserve Board 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.
The FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan acceptable to the FDIC. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any financial holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers. We are considered "well-capitalized" at December 31, 2010 and, in addition, our bank subsidiary maintains sufficient capital to remain in compliance with capital requirements and is considered "well-capitalized" at December 31, 2010.
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The Financial Reform Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements. Under the Collins Amendment to the Financial Reform Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis. These minimum requirements can't be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions. The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets. Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013. Accordingly, our trust preferred securities will continue to qualify as Tier 1 capital.
Other Safety and Soundness Regulations
There are significant obligations and restrictions imposed on financial holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event that the depository institution is insolvent or is in danger of becoming insolvent. These obligations and restrictions are not for the benefit of investors. Regulators may pursue an administrative action against any financial holding company or bank which violates the law, engages in an unsafe or unsound banking practice, or which is about to engage in an unsafe or unsound banking practice. The administrative action could take the form of a cease and desist proceeding, a removal action against the responsible individuals or, in the case of a violation of law or unsafe and unsound banking practice, a civil monetary penalty action. A cease and desist order, in addition to prohibiting certain action, could also require that certain actions be undertaken. Under the Financial Reform Act and longstanding policies of the Federal Reserve Board, we are required to serve as a source of financial strength to our subsidiary depository institution and to commit resources to support the Bank in circumstances where we might not do so otherwise.
The Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury. In addition, financial institutions are required to file Suspicious Activity Reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001, enacted in response to the September 11, 2001 terrorist attacks, requires bank regulators to consider a financial institution's compliance with the BSA when reviewing applications from a financial institution. As part of its BSA program, the USA PATRIOT Act of 2001 also requires a financial institution to follow recently implemented customer identification procedures when opening accounts for new customers and to review U.S. government-maintained lists of individuals and entities that are prohibited from opening accounts at financial institutions.
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Monetary Policy
The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve Board. The instruments of monetary policy employed by the Federal Reserve Board include open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against deposits held by federally insured banks. The Federal Reserve Board's monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national and international economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of our bank subsidiary, its subsidiary, or any of our other subsidiaries.
Federal Reserve System
In 1980, Congress enacted legislation that imposed reserve requirements on all depository institutions that maintain transaction accounts or non-personal time deposits. NOW accounts and demand deposit accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to these reserve requirements. For net transaction accounts in 2011, the first $10.7 million of balances will be exempt from reserve requirements. A 3% reserve ratio will be assessed on net transaction account balances over $10.7 million to and including $58.8 million. A 10% reserve ratio will be applied to amounts in net transaction account balances in excess of $58.8 million. These percentages are subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at, or on behalf of, a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of our interest-earning assets. Beginning October 2008, the Federal Reserve Banks pay financial institutions interest on their required reserve balances and excess funds deposited with the Federal Reserve. The interest rate paid is the targeted federal funds rate.
Transactions with Affiliates
Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any bank or entity that controls, is controlled by or is under common control with such bank. Generally, Sections 23A and 23B (i) limit the extent to which the bank or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same as, or at least as favorable to those that, the bank has provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. Section 23B applies to "covered transactions" as well as sales of assets and payments of money to an affiliate. These transactions must also be conducted on terms substantially the same as, or at least favorable to those that, the bank has provided to non-affiliates.
The Financial Reform Act also provides that banks may not "purchase an asset from, or sell an asset to" a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the bank, it has been approved in advance by a majority of the bank's non-interested directors.
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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, loans to a director, an executive officer and to a principal shareholder of a bank, and to entities controlled by any of the foregoing, may not exceed, together with all other outstanding loans to such person and 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 $100,000,000, 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 loan is approved in advance by a majority of the board of directors of the bank with any "interested" director not participating in the voting. The FDIC has prescribed the loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, as being 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 on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.
Community Reinvestment Act
Under the Community Reinvestment Act and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. The Community Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act statement for each of its market areas describing the depository institution's efforts to assist in its community's credit needs. Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are periodically assigned ratings in this regard. Banking regulators consider a depository institution's Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a financial holding company or its depository institution subsidiaries.
The Gramm-Leach-Bliley Act ("GLBA") and federal bank regulators have made various changes to the Community Reinvestment Act. Among other changes, Community Reinvestment Act agreements with private parties must be disclosed and annual reports must be made to a bank's primary federal regulator. A financial holding company or any of its subsidiaries will not be permitted to engage in new activities authorized under the GLBA if any bank subsidiary received less than a "satisfactory" rating in its latest Community Reinvestment Act examination.
Consumer Laws Regarding Fair Lending
In addition to the Community Reinvestment Act described above, other federal and state laws regulate various lending and consumer aspects of our business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers may experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums of money, short of a full trial.
These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination
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under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.
The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating. We became a financial holding company in 2004.
The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in areas identified under the law. Under the law, the federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.
The GLBA adopts a system of functional regulation under which the Federal Reserve Board is designated as the umbrella regulator for financial holding companies, but financial holding company affiliates are principally regulated by functional regulators such as the FDIC for bank affiliates, the Securities and Exchange Commission for securities affiliates, and state insurance regulators for insurance affiliates. It repeals the broad exemption of banks from the definitions of "broker" and "dealer" for purposes of the Securities Exchange Act of 1934, as amended. It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a "broker," and a set of activities in which a bank may engage without being deemed a "dealer." Additionally, GLBA makes conforming changes in the definitions of "broker" and "dealer" for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.
The GLBA contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution's policies and procedures regarding the handling of customers' nonpublic personal financial information. The law provides that, except for specific limited exceptions,
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an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer credit reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are stricter than those contained in the act.
The Financial Reform Act
On July 21, 2010, the Financial Reform Act was signed into law. The Financial Reform Act provides for sweeping financial regulatory reform and will alter the way in which we conduct certain businesses.
The Financial Reform Act contains a broad range of significant provisions that could affect our businesses, including, without limitation, the following:
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- Mandating that the Federal Reserve limit debit card interchange fees;
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- Changing the assessment base used in calculating FDIC deposit insurance fees from assessable deposits to total assets less
tangible capital;
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- Creating a new regulatory body to set requirements around the terms and conditions of consumer financial products and
expanding the role of state regulators in enforcing consumer protection requirements over banks;
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- Increasing the minimum reserve ratio of the DIF to 1.35 percent and eliminating the maximum reserve ratio;
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- Making permanent the $250,000 limit for federal deposit insurance and providing unlimited federal deposit insurance until
December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions;
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- Allowing depository institutions to pay interest on demand deposits effective July 21, 2011;
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- Imposing new requirements on mortgage lending, including new minimum underwriting standards, prohibitions on certain
yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage
terms and various new mandated disclosures to mortgage borrowers;
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- Establishing minimum capital levels for holding companies that are at least as stringent as those currently applicable to
banks;
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- Allowing national and state banks to establish de novo interstate branches outside of their home state, and mandating that
bank holding companies and banks be well-capitalized and well managed in order to acquire banks located outside their home state;
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- Enhancing the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal
Reserve Act, including an expansion of the definition of "covered transactions" and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained;
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- Placing restrictions on certain asset sales to and from an insider to an institution, including requirements that such
sales be on market terms and, in certain circumstances, approved by the institution's board of directors;
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- Including a variety of corporate governance and executive compensation provisions and requirements.
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The Financial Reform Act is expected to have a negative impact on our earnings through fee reductions, higher costs and new restrictions. The Financial Reform Act may have a material adverse impact on the value of certain assets and liabilities on our balance sheet. As a result of the Financial Reform Act and its related rules and subject to final rulemaking over the next year, we believe that our debit card revenue could be adversely impacted beginning as soon as the third quarter of 2011. One provision of the Financial Reform Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. In December 2010, the Federal Reserve proposed capping the fee at 12 cents per debit card transaction, which is well below the average that banks currently charge. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, our debit card revenue could be adversely impacted if the interchange cap is implemented.
Most provisions of the Financial Reform Act require various federal banking and securities regulators to issue regulations to clarify and implement its provisions or to conduct studies on significant issues. These proposed regulations and studies are generally subject to a public notice and comment period. The timing of issuance of final regulations, their effective dates and their potential impacts to our businesses will be determined over the coming months and years. As a result, the ultimate impact of the Financial Reform Act's final rules on our businesses and results of operations will depend on regulatory interpretation and rulemaking, as well as the success of any of our actions to mitigate the negative earnings impact of certain provisions.
Future Regulatory Uncertainty
Because federal and state regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal and state regulation of financial institutions may change in the future and, as a result, impact our operations. We fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices. Congress and the federal government have continued to evaluate and develop legislation, programs, and initiatives designed to, among other things, stabilize the financial and housing markets, stimulate the economy, including the federal government's foreclosure prevention program, and prevent future financial crises by further regulating the financial services industry. As a result of the recent financial crisis and the ongoing challenging economic environment, we anticipate additional legislative and regulatory proposals and initiatives as well as continued legislative and regulatory scrutiny of the financial services industry. At this time, we cannot determine the final form of any proposed programs or initiatives or related legislation, the likelihood and timing of any other future proposals or legislation, and the impact they might have on us.
Additional Information
We file with or furnish to the Securities and Exchange Commission ("SEC") annual, quarterly and current reports, proxy statements, and various other documents under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The public may read and copy any materials that we file with or furnish to the SEC at the SEC's Public Reference Room, which is located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an internet website at www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, including us, that file or furnish documents electronically with the SEC.
We also make available free of charge on or through our internet website (www.cardinalbank.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and, if applicable, amendments to those reports as filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.
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We are subject to various risks, including the risks described below. Our operations, financial condition and performance and, therefore, the market value of our Common Stock could be adversely affected by any of these risks or additional risks not presently known or that we currently deem immaterial.
Difficult conditions in the economy and the capital markets continue to adversely affect our industry.
Dramatic declines in the housing market, with falling home prices and increasing foreclosures, followed by unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and consumer loans and resulted in significant write-downs of asset values by financial institutions. These write-downs spread to other securities and loans and have 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. In this environment, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and reduction of business activity generally. Continuing economic pressure on consumers may adversely affect our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for loan losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
The capital and credit markets have experienced volatility and disruption in recent years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers' underlying financial strength. If these levels of market disruption and volatility recur, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Our mortgage banking revenue is sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market and higher interest rates, any of which could adversely impact our profits.
Our mortgage banking segment is a significant portion of our consolidated business and maintaining our revenue stream in this segment is dependent upon our ability to originate loans and sell them to investors. Loan production levels are sensitive to changes in economic conditions and recently have suffered from a slowdown in the local housing market and tightening credit conditions. Any sustained period of decreased activity caused by further housing price pressure, loan underwriting restrictions or higher interest rates would adversely affect our mortgage originations and, consequently, reduce our income from mortgage banking activities. As a result, these conditions would also adversely affect our net income.
Deteriorating economic conditions may also cause home buyers to default on their mortgages. In certain of these cases where we have originated loans and sold them to investors, we may be required to repurchase loans or provide a financial settlement to investors if it is proven that the borrower failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor. Such repurchases or settlements would also adversely affect our net income.
George Mason, as part of the service it provides to its managed companies, purchases the loans managed companies originate at the time of origination. These loans are then sold by George Mason to
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investors. George Mason has agreements with its managed companies requiring that, for any loans that were originated by a managed company and for which investors have requested George Mason to repurchase due to the borrowers failure to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor, the managed company be responsible for buying back the loan. In the event that the managed company's financial condition deteriorates and it is unable to fund the repurchase of such loans, George Mason may have to provide the funds to repurchase these loans from investors.
Government measures to regulate the financial industry, including the Financial Reform Act, could require us to change certain of our business practices, impose significant additional costs on us, limit the products that we offer, limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the value of the assets we hold, significantly reduce our revenues or otherwise materially affect our businesses, financial condition or results of operations.
As a financial institution, we are heavily regulated at the state and federal levels. As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Financial Reform Act was signed into law. Many of the provisions of the Financial Reform Act have begun to be or will be phased in over the next several months or years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. Although we cannot predict the full effect of the Financial Reform Act on our operations, it could, as well as the future rules implementing its reforms, impose significant additional costs on us, limit the products we offer, could limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the values of assets that we hold, significantly reduce our revenues or otherwise materially and adversely affect our businesses, financial condition, or results of operations. For example, the Financial Reform Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. In December 2010, the Federal Reserve proposed capping the fee at 12 cents per debit card transaction, which is well below the average that banks currently charge. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, we believe that our debit card revenue could be adversely impacted as soon as the third quarter of 2011 if the interchange cap is implemented.
The ultimate impact of the final rules on our businesses and results of operations, however, will depend on regulatory interpretation and rulemaking, as well as the success of any of our actions to mitigate the negative earnings impact of certain provisions.
We have goodwill and other intangibles that may become impaired, and thus result in a charge against earnings.
At December 31, 2010, we had $10.1 million of goodwill related to the George Mason acquisition. In addition, we have identified and recorded other intangible assets, such as customer relationships and trade names, as a result of the George Mason acquisition. The carrying amount of these intangibles at December 31, 2010 was $544,000. Goodwill and other intangibles are tested for impairment on an annual basis or when facts and circumstances indicate that impairment may have occurred.
As noted above, our mortgage banking segment is sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market and higher interest rates. During the third quarter of 2008, we recorded a noncash impairment charge of $2.8 million in the mortgage banking segment. The aforementioned factors may result in an additional impairment charge related to
23
the goodwill and other intangibles at George Mason if we determine the carrying value of the reporting unit, including its goodwill and other intangible assets, is greater than their fair value.
We may be forced to recognize impairment charges in the future as operating and economic conditions change.
We may be adversely impacted by changes in the condition of financial markets.
We are directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. Market risk is inherent in the financial instruments associated with our operations and activities including loans, deposits, securities, short-term borrowings, long-term debt, trading account assets and liabilities, and derivatives. Just a few of the market conditions that may shift from time to time, thereby exposing us to market risk, include fluctuations in interest and currency exchange rates, equity and futures prices, and price deterioration or changes in value due to changes in market perception or actual credit quality of issuers. Accordingly, depending on the instruments or activities impacted, market risks can have adverse effects on our results of operations and our overall financial condition.
Recently, the subprime mortgage market dislocation has also impacted the ratings of certain monoline insurance providers which, in turn, has affected the pricing of certain municipal securities and the liquidity of the short term public finance markets. We have some exposure to monolines and, as a result, are continuing to monitor this exposure. Additionally, unfavorable economic or political conditions and changes in government policy could impact the operating budgets or credit ratings of U.S. States and U.S. municipalities and expose us to credit risk.
We have investments in pooled trust preferred securities, totaling $8.0 million at December 31, 2010. The collateral underlying these structured securities are instruments issued by financial institutions or insurers. We own the A-3 tranches in each issue. Each of these bonds are rated by more than one rating agency. Two of the securities have composite ratings of AA, one of the securities has a composite rating of BB- and the other security has a composite rating of B-. There is minimal observable trading activity for these types of securities. We have estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below our A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments and concluded that these securities are not other-than-temporarily impaired. However, if there are additional deferrals or defaults that impact the contractual cash flows within the tranches we own, we may be required to record an other-than-temporary impairment related to these securities. These securities are classified as held-to-maturity.
We may be adversely affected by economic conditions in our market area.
We are headquartered in Northern Virginia, and our market is the greater Washington, D.C. metropolitan area. Because our lending and deposit-gathering activities are concentrated in this market, we will be affected by the general economic conditions in the greater Washington area, which may, among other factors, be impacted by the level of federal government spending. Changes in the economy, and government spending in particular, may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing. A significant decline in general economic condition caused by inflation, recession, unemployment or other factors, would impact these local economic conditions and the demand for banking products and services generally, and could negatively affect our financial condition and performance.
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Our concentration in commercial real estate and business loans may increase our future credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Approximately 86% of our loans are secured by real estate, both residential and commercial, substantially all of which are located in our market area. A major change in the region's real estate market, resulting in a deterioration in real estate values, or in the local or national economy, including changes caused by raising interest rates, could adversely affect our customers' ability to pay these loans, which in turn could adversely impact us. Risk of loan defaults and foreclosures are inherent in the banking industry, and we try to limit our exposure to this risk by carefully underwriting and monitoring our extensions of credit. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.
Commercial real estate and business loans increase our exposure to credit risks.
At December 31, 2010, our portfolio of commercial and industrial and commercial real estate (including construction) totaled $1.07 billion, or 76% of total loans. We plan to continue to emphasize the origination of loans to small and medium-sized businesses as well as government contractors, professionals, such as physicians, accountants and attorneys, and commercial real estate developers and builders, which generally exposes us to a greater risk of nonpayment and loss than residential real estate loans because repayment of such loans often depends on the successful operations and cash flows of the borrowers. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Also, many of our borrowers have more than one commercial loan outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential real estate loan. In addition, these small to medium-sized businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions negatively impact these businesses, our results of operations and financial condition may be adversely affected. This concentration also exposes us more to the market risks of real estate sales leasing and other activity in the areas we serve. An adverse change in local real estate conditions and markets could materially adversely affect the values of our loans and the real estate held as collateral for such loans, and materially affect our results of operation and financial condition. During 2006, the federal bank regulatory agencies released guidance on "Concentrations in Commercial Real Estate Lending" (the "Guidance"). The Guidance defines commercial real estate ("CRE") loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. The Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The Guidance is triggered when CRE loan concentrations exceed either:
-
- Total reported loans for construction, land development, and other land of 100% or more of a bank's total capital; or
-
- Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land of 300% or more of a bank's capital.
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The Guidance applies to our CRE lending activities. Although our regulators have not required us to maintain elevated levels of capital or liquidity due to our CRE concentrations, the regulators may do so in the future, especially if there is a material downturn in our local real estate markets.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and analysis of the loan portfolio, management determines the adequacy of the allowance for loan losses by considering such factors as general and industry-specific market conditions, credit quality of the loan portfolio, the collateral supporting the loans and financial performance of our loan customers relative to their financial obligations to us. The amount of future losses is impacted by changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control. Actual losses may exceed our current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. Estimating loan loss allowances for an unseasoned portfolio is more difficult than with seasoned portfolios, and may be more susceptible to changes in estimates and to losses exceeding estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or assert that our loan loss allowance will be adequate in the future. Future loan losses that are greater than current estimates could have a material impact on our future financial performance.
Banking regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize additional loan charge-offs, based on credit judgments different than those of our management. Any increase in the amount of our allowance or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
Our liquidity could be impaired by our inability to access the capital markets on favorable terms.
Liquidity is essential to our business. Under normal business conditions, primary sources of funding for our parent company may include dividends received from banking and nonbanking subsidiaries and proceeds from the issuance of equity capital in the capital markets. The primary sources of funding for our banking subsidiary include customer deposits and wholesale market-based funding. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption, negative views about the financial services industry generally, or an operational problem that affects third parties or us.
For further discussion or our liquidity position and other liquidity matters, including policies and procedures we use to manage our liquidity risks, see "Capital Resources" and "Liquidity" in Item 7 of this report.
Increases in FDIC insurance premiums may cause our earnings to decrease.
Since the financial crisis began several years ago, an increasing number of bank failures have imposed significant costs on the FDIC in resolving those failures, and the regulator's deposit insurance fund has been depleted. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased, and may increase in the future, assessment rates of insured institutions, including Cardinal Bank.
Deposits are insured by the FDIC, subject to limits and conditions or applicable law and the FDIC's regulations. Pursuant to the Financial Reform Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer. The Financial Reform Act also provides for unlimited FDIC insurance coverage for noninterest-bearing demand deposit accounts for a two-year period
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beginning on December 31, 2010 and ending on December 31, 2012. The FDIC administers the deposit insurance fund, and all insured depository institutions are required to pay assessments to the FDIC that fund the deposit insurance fund. The Financial Reform Act changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. On February 7, 2011 the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Financial Reform Act. The new regulation will be effective April 1, 2011 and will be reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, we expect to incur higher annual deposit insurance assessments than we historically incurred before the financial crisis began several years ago. While the burden of replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.
A substantial decline in the value of our Federal Home Loan Bank of Atlanta common stock may result in an other-than temporary impairment charge.
We are a member of the Federal Home Loan Bank of Atlanta, or FHLB, which enables us to borrow funds under the Federal Home Loan Bank advance program. As a FHLB member, we are required to own FHLB common stock, the amount of which increases with the level of our FHLB borrowings. The carrying value of our FHLB common stock was $15.7 million as of December 31, 2010. The FHLB has suspended daily repurchases of FHLB common stock, which adversely affects the liquidity of these shares. If the financial condition of FHLB deteriorates further, there is a risk that our investment could be deemed other-than-temporarily impaired at some time in the future.
The soundness of other financial institutions 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, and we routinely execute transactions with counterparties in the financial industry. 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 expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the 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. There is no assurance that any such losses would not materially and adversely affect our results of operations.
We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition.
During the last five years, we have experienced significant growth, and a key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:
-
- open new branch offices or acquire existing branches or other financial institutions;
-
- attract deposits to those locations and cross-sell new and existing depositors additional products and
services; and
-
- identify attractive loan and investment opportunities.
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We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand. Our ability to successfully manage our growth will also depend upon our ability to maintain capital levels sufficient to support this growth, maintain effective cost controls and adequate asset quality such that earnings are not adversely impacted to a material degree.
As we continue to implement our growth strategy by opening new branches or acquiring branches or other banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of new branches, we must absorb those higher expenses while we begin to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch aggressively could depress our earnings in the short run, even if we efficiently execute our branching strategy.
We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel.
We are a customer-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our customers by our Chairman and Chief Executive Officer, Bernard H. Clineburg, and our other executive and senior lending officers. We have entered into employment agreements with Mr. Clineburg and four other executive officers. The existence of such agreements, however, does not necessarily assure us that we will be able to continue to retain their services. The unexpected loss of Mr. Clineburg or other key employees could have a significant adverse effect on our business and possibly result in reduced revenues and earnings. We maintain bank owned life insurance policies on all of our corporate executives.
The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships, as well as develop new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. While we have been recently successful in acquiring what we consider to be talented banking professionals, the market for talented people is competitive and we may not continue to be successful in attracting, hiring, motivating or retaining experienced banking professionals.
We may incur losses if we are unable to successfully manage interest rate risk.
Our future profitability will substantially depend upon our ability to maintain or increase the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. Changes in interest rates will affect our operating performance and financial condition. The shape of the yield curve can also impact net interest income. Changing rates will impact how fast our mortgage loans and mortgage backed securities will have the principal repaid. Rate changes can also impact the behavior of our depositors, especially depositors in non-maturity deposits such as demand, interest checking, savings and money market accounts. While we attempt to minimize our exposure to interest rate risk, we are unable to eliminate it as it is an inherent part of our business. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and industry-specific conditions and economic conditions generally.
Our future success is dependent on our ability to compete effectively in the highly competitive banking and financial services industry.
We face vigorous competition from other commercial banks, savings and loan associations, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms,
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insurance companies, money market funds and other types of financial institutions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. Many of our nonbank competitors are not subject to the same extensive regulations that govern us. As a result, these nonbank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
Our businesses and earnings are impacted by governmental, fiscal and monetary policy.
We are affected by domestic monetary policy. For example, the Federal Reserve Board regulates the supply of money and credit in the United States and its policies determine in large part our cost of funds for lending, investing and capital raising activities and the return we earn on those loans and investments, both of which affect our net interest margin. The actions of the Federal Reserve Board also can materially affect the value of financial instruments we hold, such as loans and debt securities, and its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Our businesses and earnings also are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States. Changes in fiscal or monetary policy are beyond our control and hard to predict.
Our profitability and the value of any equity investment in us may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.
We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels. Recently enacted, proposed and future banking and other legislation and regulations have had, and will continue to have, or may have a significant impact on the financial services industry. These regulations, which are generally intended to protect depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably, and can be expected to influence our earnings and growth. Our success depends on our continued ability to maintain compliance with these regulations. Many of these regulations increase our costs and thus place other financial institutions that may not be subject to similar regulation in stronger, more favorable competitive positions.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our common stock.
Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at existing and new branch locations, as well as expanded loan and other investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain desired capital levels. Our ability to raise capital through the sale of additional equity securities or the placement of financial instruments that qualify as regulatory capital will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
We have extended off-balance sheet commitments to borrowers which expose us to credit and interest rate risk.
We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and guarantees which would impact our liquidity and capital resources to the extent customers accept or use these commitments. These instruments involve, to
29
varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and guarantees written is represented by the contractual or notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
We have operational risk that could impact our ability to provide services to our customers.
We have potential operational risk exposure throughout our organization. Integral to our performance is the continued effectiveness and efficiency of our technical systems, operational infrastructure, relationships with third parties and key individuals involved in our ongoing activities. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or technical failures, unlawful tampering with our information technology infrastructure, terrorist activities, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of the key individuals to perform properly.
We may be parties to certain legal proceedings that may impact our earnings.
We face significant legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against us could have material adverse financial impact or cause significant reputational risk to us, which in turn could seriously harm our business prospects.
Our ability to pay dividends is limited and we may be unable to pay future dividends.
Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital in the Company and in our subsidiaries. The ability of our bank subsidiary to pay dividends to us is limited by their obligations to maintain sufficient capital, earnings and liquidity and by other general restrictions on their dividends under federal and state bank regulatory requirements. In addition, as a bank holding company, our ability to declare and pay dividends is subject to the guidelines of the Board of Governors of the Federal Reserve System, or the Federal Reserve, regarding capital adequacy and dividends. The Federal Reserve guidelines generally require us to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred debt) on our financial condition. These guidelines also require that we review our net income for the current and past four quarters, and the level of dividends on common stock and other Tier 1 capital instruments for those periods, as well as our projected rate or earnings retention. Under the Federal Reserve's policy, the board of directors of a bank holding company should also consider different factors to ensure that its dividend level is prudent relative to the organization's financial position and is not based on overly optimistic earnings scenarios such as any potential events that may occur before the payment date that could affect its ability to pay while still maintaining a strong financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer, or significantly reduce bank holding company's dividends if: (i) its 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; (ii) its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or (iii) it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. If we do not satisfy these regulatory requirements or the Federal Reserve's policies, we will be unable to pay dividends on our common stock.
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Item 1B. Unresolved Staff Comments
None.
Cardinal Bank, excluding its George Mason subsidiary, conducts its business from 26 branch offices. Nine of these facilities are owned and 17 are leased. Leased branch banking facilities range in size from 457 square feet to 11,182 square feet. Our leases on these facilities expire at various dates through 2022, and all but one of our leases have renewal options. The branch that does not have a renewal option is located at the headquarters location of George Mason (see below for additional lease information for George Mason). Fifteen of our branch banking locations have drive-up banking capabilities and all have ATMs.
Cardinal Wealth Services, Inc. conducts its business from one of Cardinal Bank's branch facilities.
George Mason conducts its business from six leased facilities which range in size from 1,476 square feet to 32,087 square feet. The leases have various expiration dates through 2011 and only three of their six locations have renewal options.
Wilson/Bennett conducts its business from office space located in our Tysons Corner, Virginia headquarters facility.
Our headquarters facility in Tysons Corner, Virginia comprises 41,818 square feet of leased office space. This lease expires in January 2022 and has renewal options. In addition to housing various administrative functionsincluding accounting, data processing, compliance, treasury, marketing, deposit and loan operationsour commercial and industrial and commercial real estate lending functions and various other departments are located there.
We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs.
In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings are, to management's knowledge, threatened against us.
Item 4. (Removed and Reserved)
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Price for Common Stock and Dividends. Our common stock is currently listed for quotation on the Nasdaq Global Select Market under the symbol "CFNL." As of February 10, 2011, our common stock was held by 614 shareholders of record. In addition, we estimate that there were 4,507 beneficial owners of our common stock who own their shares through brokers or banks.
The high and low sale prices per share for our common stock for each quarter of 2010 and 2009 as reported on the market at the time and dividends declared during those periods were as follows:
Periods Ended
|
High | Low | Dividends | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
2010 |
|||||||||||
First Quarter |
$ | 10.77 | $ | 8.38 | $ | 0.02 | |||||
Second Quarter |
11.56 | 8.89 | 0.02 | ||||||||
Third Quarter |
10.92 | 8.56 | 0.02 | ||||||||
Fourth Quarter |
12.15 | 9.42 | 0.03 | ||||||||
2009 |
|||||||||||
First Quarter |
$ | 6.47 | $ | 4.98 | $ | 0.01 | |||||
Second Quarter |
8.97 | 5.60 | 0.01 | ||||||||
Third Quarter |
8.69 | 6.56 | 0.01 | ||||||||
Fourth Quarter |
9.41 | 7.79 | 0.02 |
Dividend Policy. The board of directors intends to follow a policy of retaining any earnings necessary to operate our business in accordance with all regulatory policies while maximizing the long-term return for the Company's investors. Our future dividend policy is subject to the discretion of the board of directors and future dividend payments will depend upon a number of factors, including future earnings, alternative investment opportunities, financial condition, cash requirements, and general business conditions.
Our ability to distribute cash dividends will depend primarily on the ability of our subsidiaries to pay dividends to us. Cardinal Bank is subject to legal limitations on the amount of dividends it is permitted to pay. Furthermore, neither Cardinal Bank nor we may declare or pay a cash dividend on any of our capital stock if we are insolvent or if the payment of the dividend would render us insolvent or unable to pay our obligations as they become due in the ordinary course of business. For additional information on these limitations, see "Government Regulation and SupervisionPayment of Dividends" in Item 1 above.
Repurchases. On February 26, 2007, we publicly announced that the Board of Directors had adopted a program to repurchase up to 1,000,000 shares of our common stock. The timing and amount of repurchases, if any, will depend on market conditions, share price, trading volume, and other factors, and there is no assurance that we will purchase shares during any period. No termination date was set for the buyback program. Shares may be repurchased in the open market or through privately negotiated transactions.
Since the inception of the program, we have purchased 477,608 shares of our common stock at a total cost of $4.1 million. All of these shares have been cancelled and retired. No shares were repurchased during 2010.
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Stock Performance Graph. The graph set forth below shows the cumulative shareholder return on the Company's Common Stock during the five-year period ended December 31, 2010, as compared with: (i) an overall stock market index, the NASDAQ Composite; and (ii) a published industry index, the SNL Bank Index. The stock performance graph assumes that $100 was invested on December 31, 2005 in our common stock and each of the comparable indices and that dividends were reinvested.
Cardinal Financial Corporation
Total Return Performance
|
Period Ending | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Index
|
12/31/05 | 12/31/06 | 12/31/07 | 12/31/08 | 12/31/09 | 12/31/10 | |||||||||||||
Cardinal Financial Corporation |
100.00 | 93.51 | 85.38 | 52.40 | 80.92 | 108.53 | |||||||||||||
NASDAQ Composite |
100.00 | 110.39 | 122.15 | 73.32 | 106.57 | 125.91 | |||||||||||||
SNL Bank |
100.00 | 116.98 | 90.90 | 51.87 | 51.33 | 57.52 |
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Item 6. Selected Financial Data
Selected Financial Data
(In thousands, except per share data)
|
Years Ended December 31, | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||
Income Statement Data: |
||||||||||||||||||
Interest income |
$ | 96,633 | $ | 86,742 | $ | 88,611 | $ | 98,643 | $ | 87,401 | ||||||||
Interest expense |
27,588 | 36,200 | 45,638 | 58,324 | 46,047 | |||||||||||||
Net interest income |
69,045 | 50,542 | 42,973 | 40,319 | 41,354 | |||||||||||||
Provision for loan losses |
10,502 | 6,750 | 5,498 | 2,548 | 1,232 | |||||||||||||
Net interest income after provision for loan losses |
58,543 | 43,792 | 37,475 | 37,771 | 40,122 | |||||||||||||
Non-interest income |
27,389 | 23,348 | 17,812 | 19,480 | 21,684 | |||||||||||||
Non-interest expense |
59,469 | 52,427 | 55,913 | 51,884 | 51,245 | |||||||||||||
Net income (loss) before income taxes |
26,463 | 14,713 | (626 | ) | 5,367 | 10,561 | ||||||||||||
Provision (benefit) for income taxes |
8,021 | 4,388 | (912 | ) | 885 | 3,173 | ||||||||||||
Net income |
$ | 18,442 | $ | 10,325 | $ | 286 | $ | 4,482 | $ | 7,388 | ||||||||
Balance Sheet Data: |
||||||||||||||||||
Total assets |
$ | 2,072,018 | $ | 1,976,185 | $ | 1,743,757 | $ | 1,690,031 | $ | 1,638,429 | ||||||||
Loans receivable, net of fees |
1,409,302 | 1,293,432 | 1,139,348 | 1,039,684 | 845,449 | |||||||||||||
Allowance for loan losses |
24,210 | 18,636 | 14,518 | 11,641 | 9,638 | |||||||||||||
Loans held for sale |
206,047 | 179,469 | 157,009 | 170,487 | 338,731 | |||||||||||||
Total investment securities |
344,984 | 378,753 | 315,539 | 364,946 | 329,296 | |||||||||||||
Total deposits |
1,403,725 | 1,297,005 | 1,179,844 | 1,096,925 | 1,218,882 | |||||||||||||
Other borrowed funds |
389,586 | 427,579 | 367,198 | 400,060 | 194,631 | |||||||||||||
Total shareholders' equity |
222,902 | 204,507 | 158,006 | 159,463 | 155,873 | |||||||||||||
Common shares outstanding |
28,770 | 28,718 | 24,014 | 24,202 | 24,459 | |||||||||||||
Per Common Share Data: |
||||||||||||||||||
Basic net income |
$ | 0.63 | $ | 0.38 | $ | 0.01 | $ | 0.18 | $ | 0.30 | ||||||||
Fully diluted net income |
0.62 | 0.37 | 0.01 | 0.18 | 0.30 | |||||||||||||
Book value |
7.75 | 7.12 | 6.58 | 6.59 | 6.37 | |||||||||||||
Tangible book value(1) |
7.22 | 6.52 | 6.00 | 5.90 | 5.75 | |||||||||||||
Performance Ratios: |
||||||||||||||||||
Return on average assets |
0.92 | % | 0.57 | % | 0.02 | % | 0.27 | % | 0.51 | % | ||||||||
Return on average equity |
8.44 | 5.53 | 0.18 | 2.85 | 4.87 | |||||||||||||
Dividend payout ratio |
0.12 | 0.10 | 3.38 | 0.22 | 0.13 | |||||||||||||
Net interest margin(2) |
3.68 | 2.94 | 2.78 | 2.63 | 2.98 | |||||||||||||
Efficiency ratio(3)(4) |
61.72 | 70.95 | 82.03 | 81.02 | 82.41 | |||||||||||||
Non-interest income to average assets |
1.37 | 1.29 | 1.08 | 1.19 | 1.49 | |||||||||||||
Non-interest expense to average assets |
2.98 | 2.89 | 3.40 | 3.18 | 3.52 | |||||||||||||
Loans receivable, net of fees to total deposits |
100.40 | 99.72 | 96.57 | 94.78 | 69.36 |
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|
Years Ended December 31, | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||
Asset Quality Ratios: |
||||||||||||||||||
Net charge-offs to average loans receivable, net of fees |
0.37 | % | 0.22 | % | 0.24 | % | 0.06 | % | 0.00 | % | ||||||||
Nonperforming loans to loans receivable, net of fees |
0.53 | 0.05 | 0.41 | | 0.01 | |||||||||||||
Nonperforming loans to total assets |
0.36 | 0.04 | 0.27 | | 0.01 | |||||||||||||
Allowance for loan losses to nonperforming loans |
320.03 | 2,677.59 | 310.81 | | 11,822.87 | |||||||||||||
Allowance for loan losses to loans receivable, net of fees |
1.72 | 1.44 | 1.27 | 1.12 | 1.14 | |||||||||||||
Capital Ratios: |
||||||||||||||||||
Tier 1 risk-based capital |
12.67 | % | 12.97 | % | 11.67 | % | 12.10 | % | 13.25 | % | ||||||||
Total risk-based capital |
14.06 | 14.15 | 12.72 | 12.98 | 14.06 | |||||||||||||
Leverage capital ratio |
10.82 | 11.03 | 9.90 | 10.26 | 10.68 | |||||||||||||
Other: |
||||||||||||||||||
Average shareholders' equity to average total assets |
10.93 | % | 10.31 | % | 9.74 | % | 9.65 | % | 10.43 | % | ||||||||
Average loans receivable, net of fees to average total deposits |
96.28 | 97.57 | 96.00 | 78.87 | 68.42 | |||||||||||||
Average common shares outstanding: |
||||||||||||||||||
Basic |
29,123 | 27,186 | 24,370 | 24,606 | 24,424 | |||||||||||||
Diluted |
29,608 | 27,674 | 24,837 | 25,012 | 24,987 |
- (1)
- Tangible
book value is calculated as total shareholders' equity, excluding accumulated other comprehensive income, less goodwill and other intangible
assets, divided by common shares outstanding.
- (2)
- Net
interest margin is calculated as net interest income divided by total average earning assets and reported on a tax equivalent basis at a rate of 30%.
- (3)
- Efficiency
ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income,
excluding the impairment loss on Fannie Mae perpetual preferred stock and the settlement with a mortgage correspondent during 2008; the impairment loss on escrow arrangement during 2007; and the
litigation recovery during 2010, 2008, 2007, and 2006.
- (4)
- The calculation of the efficiency ratio, which is a financial measure not prepared in accordance with generally accepted accounting principles ("GAAP"), and a reconciliation of the efficiency ratio to our GAAP financial information are included in our Table 1 to Item 7 to this Annual Report on Form 10-K.
35
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following presents management's discussion and analysis of our consolidated financial condition at December 31, 2010 and 2009 and the results of our operations for the years ended December 31, 2010, 2009 and 2008. The discussion should be read in conjunction with the consolidated financial statements and related notes included in this report.
Caution About Forward-Looking Statements
We make certain forward-looking statements in this Form 10-K that are subject to risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
-
- the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and
liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
-
- changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchases of
mortgage loans sold and other estimates;
-
- changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and
disruption of the capital and credit markets, soundness of other financial institutions we do business with;
-
- risks inherent in making loans such as repayment risks and fluctuating collateral values;
-
- declines in the prices of assets and market illiquidity may cause us to record an
other-than-temporary impairment or other losses, specifically in our pooled trust preferred securities portfolio resulting from increases in underlying issuers' defaulting or
deferring payments;
-
- changes in operations of our wealth management and trust services segment, its customer base and assets under management;
-
- changes in operations of George Mason Mortgage, LLC as a result of the activity in the residential real estate
market and any associated impact on the fair value of goodwill in the future;
-
- legislative and regulatory changes, including the Financial Reform Act and other changes in banking, securities, and tax
laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
-
- exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or
related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
-
- the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;
36
-
- the ability to successfully manage our growth or implement our growth strategies as we implement new or change internal
operating systems or if we are unable to identify attractive markets, locations or opportunities to expand in the future;
-
- the effects of future economic, business and market conditions;
-
- governmental monetary and fiscal policies;
-
- changes in accounting policies, rules and practices;
-
- maintaining cost controls and asset quality as we open or acquire new branches;
-
- maintaining capital levels adequate to support our growth;
-
- reliance on our management team, including our ability to attract and retain key personnel;
-
- competition with other banks and financial institutions, and companies outside of the banking industry, including those
companies that have substantially greater access to capital and other resources;
-
- risks and uncertainties related to future trust operations;
-
- demand, development and acceptance of new products and services;
-
- problems with technology utilized by us;
-
- changing trends in customer profiles and behavior; and
-
- other factors described from time to time in our reports filed with the SEC.
Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results.
In addition, this section should be read in conjunction with the description of our "Risk Factors" in Item 1A above.
Overview
We are a financial holding company formed in 1997 and headquartered in Fairfax County, Virginia. We were formed principally in response to opportunities resulting from the consolidation of several Virginia-based banks. These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.
We own Cardinal Bank (the "Bank"), a Virginia state-chartered community bank with 26 banking offices located in Northern Virginia and the greater Washington, D.C. metropolitan area. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.
Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC ("George Mason") and Cardinal First Mortgage, LLC ("Cardinal First"), collectively the "mortgage banking segment," retail securities brokerage though Cardinal Wealth Services, Inc. ("CWS"), asset management through Wilson/Bennett Capital Management, Inc. ("Wilson/Bennett"), and trust, estate, custody, investment management and retirement planning through the trust division of Cardinal Bank.
37
George Mason, based in Fairfax, Virginia, engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis through six branches located throughout the metropolitan Washington, D.C. region. George Mason does business in eight states, primarily Virginia and Maryland, and the District of Columbia. George Mason is one of the largest residential mortgage originators in the greater Washington metropolitan area, generating originations of approximately $3.2 billion and $2.6 billion of loans in 2010 and 2009, respectively, excluding advances on construction loans and including loans purchased from other mortgage banking companies which are owned by local home builders but managed by George Mason (the "managed companies"). George Mason's primary sources of revenue include loan origination fees, net interest income earned on loans held for sale, gains on sales of loans and contractual management fees earned relating to services provided to other mortgage companies owned by local home builders. At the time we enter into an interest rate lock arrangement with the borrower, we enter into a loan forward sale commitment with a third party. Our mortgage loans are then sold servicing released.
Cardinal First originates mortgage loans for new homes and refinancing in Virginia, Maryland, and Washington, D.C. principally for existing Cardinal Bank customers. In addition, Cardinal First offers a construction-to-permanent loan program. This program provides variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market. These construction-to-permanent loans generate fee income as well as net interest income for Cardinal First and are classified as loans held for sale.
The mortgage banking segment's business is both cyclical and seasonal. The cyclical nature of its business is influenced by, among other factors, the levels of and trends in mortgage interest rates, national and local economic conditions and consumer confidence in the economy. Historically, the mortgage banking segment has its lowest levels of quarterly loan closings during the first quarter of the year.
Wilson/Bennett provides asset management services to certain of our customers. Wilson/Bennett uses a value-oriented approach that focuses on large capitalization stocks. Wilson/Bennett's primary source of revenue is management fees earned on the assets it manages for its customers. These management fees are generally based upon the market value of managed and custodial assets and, accordingly, revenues from Wilson/Bennett will be, assuming a consistent customer base, more when appropriate indices, such as the S&P 500, are higher and lower when such indices are depressed.
In July 2004, we formed a wholly-owned subsidiary, Cardinal Statutory Trust I, for the purpose of issuing $20.0 million of floating rate junior subordinated deferrable interest debentures ("trust preferred securities"). These trust preferred securities are due in 2034 and pay interest at a rate equal to LIBOR (London Interbank Offered Rate) plus 2.40%, which adjusts quarterly. These securities are redeemable at par beginning September 2009. The interest rate on this debt was 2.70% at December 31, 2010. We have guaranteed payment of these securities. The $20.6 million payable by us to Cardinal Statutory Trust I is included in other borrowed funds in the consolidated statements of condition since Cardinal Statutory Trust I is an unconsolidated subsidiary as we are not the primary beneficiary of this entity. We utilized the proceeds from the issuance of the trust preferred securities to make a capital contribution into the Bank.
Net interest income is our primary source of revenue. We define revenue as net interest income plus non-interest income. As discussed further in the interest rate sensitivity section, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to
38
these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is an important source of revenue for us and includes, among other things, service charges on deposits and loans, investment fee income, which includes trust revenues, gains and losses on sales of investment securities available-for-sale, gains on sales of mortgage loans, and management fee income.
Net interest income and non-interest income represented the following percentages of total revenue for the three years ended December 31, 2010:
|
Net Interest Income |
Non-Interest Income |
|||||
---|---|---|---|---|---|---|---|
2010 |
71.6 | % | 28.4 | % | |||
2009 |
68.4 | % | 31.6 | % | |||
2008 |
70.7 | % | 29.3 | % |
Non-interest income is a lower percentage of our total revenue in 2010 as compared to 2009 and 2008 as a result of the increase in our net interest income. During 2010, we managed our balance sheet growth and strategically decreased the interest rates we paid on our deposit liabilities in order improve our net interest margin.
2010 Economic Environment
The banking environment and the markets in which we conduct our businesses will continue to be strongly influenced by developments in the U.S. and global economies, as well as the continued implementation and rulemaking from recent financial reforms. The global economy continued to recover modestly during 2010. In the U.S., the economy began to recover early in 2010, fueled by moderate growth in consumption and inventory rebuilding, but slowed in late spring, as the sovereign debt crisis in Europe intensified. A slowdown in consumption and domestic demand growth contributed to weak employment gains and an unemployment rate that drifted close to 10 percent. Year-over-year inflation measures receded below one percent and stock market indices declined. Concerns about high unemployment and fears that U.S. might incur deflation led the Federal Reserve to adopt a second round or quantitative easing that involved purchases of $600 billion of U.S. Treasury securities scheduled to occur through June 2011. The announcement of this policy led to lower interest rates. Bond yields rebounded in the second half of 2010 as economic growth in the U.S. accelerated, driven by stronger consumer spending, rapid growth of exports and business investment in equipment and software. Despite only moderate economic growth in 2010, corporate profits rose sharply, benefiting from strong productivity gains and constraints on hiring and operating costs.
The housing market remained weak throughout 2010. Home sales were soft, despite lower home prices and low interest rates. There were delays in the foreclosure process on the large number of distressed mortgages and the supply of unsold homes remained high. Housing prices renewed a downward trend in the second half of 2010, due in part to the expiration of tax incentives for home buyers.
Despite the challenges in the national and global economies, the metropolitan Washington, D.C. area, the region we operate in, performed relatively well as compared to other geographic regions. The unemployment rate in the Washington, D.C. metropolitan area did not increase to the same level as the national unemployment rate, and commercial and residential real estate values held up comparatively well to other geographic regions.
At December 31, 2010, we have non-accrual loans totaling $7.5 million and loans contractually past due 90 days or more as to principal or interest of $49,000. Annualized net charge-offs were 0.37% of our average loans receivable for the year ended December 31, 2010. Due to historically low mortgage loan rates, originations from our mortgage banking segment for 2010 surpassed originations for 2009.
39
As a result, net income from our mortgage banking segment increased to $6.8 million for the year ended December 31, 2010 compared to net income of $4.0 million for the year ended December 31, 2009.
Market illiquidity continues to impact certain portions of our investment securities portfolio, specifically the ratings of certain corporate bonds in our portfolio. We hold investments of $8.0 million in par value of pooled trust preferred securities, which are significantly below book value as of December 31, 2010 due to the lack of liquidity in the market and investor apprehension for investing in these types of investments.
We expect challenging economic and operating conditions and an evolving regulatory regime to continue for the foreseeable future. These conditions could continue to affect the markets in which we do business and could adversely impact our results for 2011. The degree of the impact is dependent upon the duration and severity of the aforementioned conditions.
While our loan growth has continued to be strong, continued negative economic conditions could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which we expect could impact our charge-offs and provision for loan losses. Deterioration in real estate values and household incomes could result in higher credit losses for us. Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially. The systems by which we set limits and monitor the level of our credit exposure to individual entities and industries also may not function as we have anticipated.
Liquidity is essential to our business. The primary sources of funding for our Bank include customer deposits and wholesale funding. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events. While we believe we have a healthy liquidity position, any of the above factors could materially impact our liquidity position in the future.
The U.S. government continues to enact legislation and develop various programs and initiatives designed to stabilize the housing markets and stimulate the economy. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Financial Reform Act") was signed into law. We are unsure of the impact this legislation will have on our business, operations or our financial condition.
Critical Accounting Policies
General
U.S. generally accepted accounting principles are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters. Management must use assumptions, judgments, and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.
The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, the fair value measurements of
40
certain assets and liabilities, accounting for economic hedging activities, accounting for impairment testing of goodwill, accounting for the impairment of amortizing intangible assets and other long-lived assets, and the valuation of deferred tax assets.
Allowance for Loan Losses
We maintain the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in our loan portfolio. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies and non-accrual loans, national and local economic trends and conditions and concentrations of loans exhibiting similar risk profiles to support our estimates.
For purposes of our analysis, we categorize our loans into one of five categories: commercial and industrial, commercial real estate (including construction), home equity lines of credit, residential mortgages, and consumer loans. In the absence of meaningful historical loss factors, peer group loss factors are applied and are adjusted by the qualitative factors mentioned above. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans. In addition, we individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. Since we have limited historical data on which to base loss factors for classified loans, we typically apply, in accordance with regulatory guidelines, a 5% loss factor to loans classified as special mention, a 15% loss factor to loans classified as substandard and a 50% loss factor to loans classified as doubtful. Loans classified as loss loans are fully reserved or charged off. In certain instances, we evaluate the impairment of certain loans on a loan by loan basis. For these loans, we analyze the fair value of the collateral underlying the loan and consider estimated costs to sell the collateral on a discounted basis. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.
Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are adequate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded in the commercial banking or mortgage banking segments, as appropriate, and would negatively impact earnings.
Fair Value Measurements
We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. For certain of our held-to-maturity investment securities where there is minimal observable trading activity, we use a discounted cash flow approach to estimate fair value based on internal calculations and compare our results to information provided by external pricing sources. Our interest rate swap derivatives are recorded at fair value using
41
observable inputs from a national valuation service. These inputs are applied to a third party industry-wide valuation model.
We also fair value our interest rate lock commitments and forwards loan sales commitments. The fair value of our interest rate lock commitments considers the expected premium (discount) to par and we apply certain fallout rates for those rate lock commitments for which we do not close a mortgage loan. In addition, we calculate the effects of the changes in interest rates from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices. The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date. At loan closing, the fair value of the interest rate lock commitment is included in the cost basis of loans held for sale, which are carried at the lower of cost or market value.
Accounting for Economic Hedging Activities
We record all derivative instruments on the statement of condition at their fair values. We do not enter into derivative transactions for speculative purposes. For derivatives designated as hedges, we contemporaneously document the hedging relationship, including the risk management objective and strategy for undertaking the hedge, how effectiveness will be assessed at inception and at each reporting period and the method for measuring ineffectiveness. We evaluate the effectiveness of these transactions at inception and on an ongoing basis. Ineffectiveness is recorded through earnings. For derivatives designated as cash flow hedges, the fair value adjustment is recorded as a component of other comprehensive income, except for the ineffective portion which is recorded in earnings. For derivatives designated as fair value hedges, the fair value adjustments for both the hedged item and the hedging instrument are recorded through the income statement with any difference considered the ineffective portion of the hedge.
We discontinue hedge accounting prospectively when it is determined that the derivative is no longer highly effective. In situations in which cash flow hedge accounting is discontinued, we continue to carry the derivative at its fair value on the statement of condition and recognize any subsequent changes in fair value in earnings over the term of the forecasted transaction. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, we recognize immediately in earnings any gains and losses that were accumulated in other comprehensive income.
In the normal course of business, we enter into contractual commitments, including rate lock commitments, to finance residential mortgage loans. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by us. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings.
To mitigate the effect of interest rate risk inherent in providing rate lock commitments, we economically hedge our commitments by entering into best efforts delivery forward loan sales contracts. During the rate lock commitment period, these forward loan sales contracts are marked to market through earnings and are not designated as accounting hedges. The changes in fair value related to movements in market rates of the rate lock commitments and the forward loan sales contracts generally move in opposite directions, and the net impact of changes in these valuations on net income during the loan commitment period is generally inconsequential. At the closing of the loan, the loan commitment derivative expires and we record a loan held for sale and continue to be obligated under the same forward loan sales contract. The forward sales contract is then designated as a hedge against the variability in cash to be received from the loan sale. Loans held for sale are accounted for at the lower of cost or fair value.
42
Accounting for Impairment Testing of Goodwill
To test goodwill for impairment, we perform an analysis to compare the fair value of the reporting unit to which the goodwill is assigned to the carrying value of the reporting unit. We make estimates of the discounted cash flows from the expected future operations of the reporting unit. This discounted cash flow analysis involves the use of unobservable inputs including: estimated future cash flows from operations; an estimate of a terminal value; a discount rate; and other inputs. Our estimated future cash flows are largely based on our historical actual cash flows. If the analysis indicates that the fair value of the reporting unit is less than its carrying value, we do an analysis to compare the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. The implied fair value of the goodwill is determined by allocating the fair value of the reporting unit to all its assets and liabilities. If the implied fair value of the goodwill is less than the carrying value, an impairment loss is recognized.
Accounting for the Impairment of Amortizing Intangible Assets and Other Long-Lived Assets
We continually review our long-lived assets for impairment whenever events or changes in circumstances indicate that the remaining estimated useful life of such assets might warrant revision or that the balances may not be recoverable. We evaluate possible impairment by comparing estimated future cash flows, before interest expense and on an undiscounted basis, with the net book value of long-term assets, including amortizable intangible assets. If undiscounted cash flows are insufficient to recover assets, further analysis is performed in order to determine the amount of the impairment.
An impairment loss is recorded for the excess of the carrying amount of the assets over their fair values. Fair value is usually determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved.
Valuation of Deferred Tax Assets
We record a provision for income tax expense based on the amounts of current taxes payable or refundable and the change in net deferred tax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. When substantial uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset is reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.
New Financial Accounting Standards
In January 2010, we adopted Accounting Standards Update ("ASU") 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets. It eliminates the QSPE concept, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies the derecognition criteria, revises how retained interests are initially measured, and removes the guaranteed mortgage securitization recharacterization provisions. This statement requires additional year-end and interim disclosures for public companies. The adoption of this standard did not have any impact on our consolidated financial condition or results of operations.
In January 2010, we adopted ASU 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. This ASU amends the guidance on variable interest entities ("VIE") in ASC Topic 810 related to the consolidation of variable interest entities. It requires reporting entities to evaluate former QSPEs for consolidation, changes the approach to determining a VIE's primary beneficiary from a quantitative assessment to a qualitative assessment designed to identify a controlling financial interest, and increases the frequency of required
43
reassessments to determine whether a company is the primary beneficiary of a VIE. It also clarifies, but does not significantly change, the characteristics that identify a VIE. This statement requires additional year-end and interim disclosures for public companies. The adoption of this standard did not have any impact on our consolidated financial condition or results of operations.
In January 2010, we adopted ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements, which requires disclosures about recurring or nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information about purchases, sales, issuances and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. This standard also clarifies existing fair value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques.
In January 2010, the Financial Accounting Standards Board ("FASB") issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements, so that SEC filers, as defined in the ASU, no longer are required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements.
In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This guidance significantly expands required disclosures for the allowance for loan losses and the credit quality of financing receivables. The disclosures will provide information about the nature of credit risks inherent in entities' financing receivables, how credit risk is analyzed and assessed when determining the allowance for loan losses, and the reasons for the change in the allowance for loan losses. Public entities are required to provide disclosures for all periods ending on or after December 15, 2010. We have adopted the required disclosures.
Financial Overview
The year ended December 31, 2010 was our second consecutive year of record profitability for us. For the year, we reported net income of $18.4 million on a consolidated basis. The Bank recorded net income of $16.3 million and our mortgage banking operations recorded net income of $6.8 million. The wealth management and trust services business segment reported a net loss of $1.8 million for the year ended December 31, 2010, which was mostly attributable to a noncash goodwill and other intangibles impairment charge of $3.0 million.
For the year ended December 31, 2009, we reported net income of $10.3 million. The Bank recorded net income of $8.4 million and our mortgage banking operations recorded net income of $4.0 million. The wealth management and trust services segment reported net income of $321,000 for the year ended December 31, 2009.
2010 Compared to 2009
At December 31, 2010, total assets were $2.07 billion, an increase of 4.85%, or $95.8 million, from $1.98 billion at December 31, 2009. Total loans receivable, net of deferred fees and costs, increased 8.96%, or $115.9 million, to $1.41 billion at December 31, 2010, from $1.29 billion at December 31, 2009. Total investment securities decreased by $37.5 million, or 9.8%, to $345.0 million at December 31, 2010, from $382.5 million at December 31, 2009. Total deposits increased 8.2%, or $106.7 million, to $1.40 billion at December 31, 2010, from $1.30 billion at December 31, 2009. Other borrowed funds, which primarily include repurchase agreements and Federal Home Loan Bank ("FHLB") advances, decreased $38.0 million to $389.6 million at December 31, 2010, from $427.6 million at December 31, 2009.
44
Shareholders' equity at December 31, 2010 was $222.9 million, an increase of $18.4 million from $204.5 million at December 31, 2009. The increase in shareholders' equity was primarily attributable our recording net income of $18.4 million for the year ended December 31, 2010. Accumulated other comprehensive income increased $1.1 million for the year ended December 31, 2010. Total shareholders' equity to total assets at December 31, 2010 and 2009 was 10.8% and 10.3%, respectively. Book value per share at December 31, 2010 and 2009 was $7.75 and $7.12, respectively. Total risk-based capital to risk-weighted assets was 14.06% at December 31, 2010 compared to 14.15% at December 31, 2009. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2010.
We recorded net income of $18.4 million, or $0.62 per diluted common share, for the year ended December 31, 2010, compared to net income of $10.3 million, or $0.37 per diluted common share, in 2009. Net interest income increased $18.5 million to $69.0 million for the year ended December 31, 2010, compared to $50.5 million for the year ended December 31, 2009, a result of our balance sheet management and strategically decreasing the rates we pay on our deposit liabilities. Provision for loan losses increased $3.8 million to $10.5 million for the year ended December 31, 2010, compared to $6.8 million for the same period of 2009. Non-interest income increased $4.0 million to $27.4 million for the year ended December 31, 2010 as compared to $23.3 million for the same period of 2009 due primarily to increases in realized and unrealized gains on sales of loans and management fee income from our mortgage banking subsidiaries. Noninterest expense was $59.5 million for the year ended December 31, 2010, an increase of $7.0 million, or 13.4%, compared to $52.4 million for the year ended December 31, 2009. The increase in noninterest expense was primarily related to increases in salaries and benefits expense and a noncash impairment charge of goodwill and other intangible assets of $3.0 million in our wealth management and trust services segment.
The return on average assets for the years ended December 31, 2010 and 2009 was 0.92% and 0.57%, respectively. The return on average equity for the years ended December 31, 2010 and 2009 was 8.44% and 5.53%, respectively.
Our results of operations for the year ended December 31, 2010 were adversely impacted by two noncash impairment charges. Historically, we had three reporting units with associated goodwillWilson/Bennett, the Trust Division and George Mason Mortgage. Over time, the people and processes associated with the Wilson/Bennett and Trust Division reporting units were assimilated to the point where the same group of employees were performing services for both subsidiaries; the subsidiaries had common customers/clients; and, strategic and resource allocation decisions contemplated for the reporting units as if they were combined. Our annual assessment period for the goodwill associated with our Wilson/Bennett reporting unit was the second calendar quarter. Commencing on July 1, 2010, we made the decision to combine the Wilson/Bennett and Trust Division reporting units. We performed the annual Wilson/Bennett goodwill recoverability assessment in the second quarter and prior to the combination of the reporting units, and recognized an impairment loss of $451,000.
During the fourth quarter of 2010, we were notified by a large trust customer that it would solicit bids from other trust services providers. We were also notified that an institutional wealth management customer was also closing its account. Because of the uncertainty surrounding these events, we performed an updated analysis of the recoverability of the goodwill and intangible assets associated with this now combined reporting unit. While we were successful in retaining the large trust client, the projected reduction in net cash flows indicated that the goodwill and other intangible assets were impaired resulting in the write-off of approximately $2.4 million in goodwill and $200,000 in unamortized intangible assets. No goodwill or intangible assets remain on the balance sheet associated with this reporting unit as of December 31, 2010. Management continues to evaluate various operating strategies with respect to this reporting unit.
45
2009 Compared to 2008
At December 31, 2009, total assets were $1.98 billion, an increase of 13.3%, or $232.4 million, from $1.74 billion at December 31, 2008. Total loans receivable, net of deferred fees and costs, increased 13.5%, or $154.1 million, to $1.29 billion at December 31, 2009, from $1.14 billion at December 31, 2008. Total investment securities increased by $63.2 million, or 20.0%, to $378.8 million at December 31, 2009, from $315.5 million at December 31, 2008. Total deposits increased 9.9%, or $117.2 million, to $1.30 billion at December 31, 2009, from $1.18 billion at December 31, 2008. Other borrowed funds, which primarily include fed funds purchased, repurchase agreements and Federal Home Loan Bank ("FHLB") advances, increased $60.4 million to $427.6 million at December 31, 2009, from $367.2 million at December 31, 2008.
Shareholders' equity at December 31, 2009 was $204.5 million, an increase of $46.5 million from $158.0 million at December 31, 2008. The increase in shareholders' equity was primarily attributable to our completion of a common stock offering during May 2009, when we added $31.6 million in capital. In addition, we recorded net income of $10.3 million that further contributed to the increase in our shareholders' equity. Accumulated other comprehensive income increased $3.4 million for the year ended December 31, 2009. Total shareholders' equity to total assets at December 31, 2009 and 2008 was 10.3% and 9.1%, respectively. Book value per share at December 31, 2009 and 2008 was $7.12 and $6.58, respectively. Total risk-based capital to risk-weighted assets was 14.15% at December 31, 2009 compared to 12.72% at December 31, 2008. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2009.
We recorded net income of $10.3 million, or $0.37 per diluted common share, for the year ended December 31, 2009, compared to net income of $286,000, or $0.01 per diluted common share, in 2008. Our results for 2008 were impacted by impairments and nonrecurring noncash expenses which are more fully discussed below. Net interest income increased $7.6 million to $50.5 million for the year ended December 31, 2009, compared to $43.0 million for the year ended December 31, 2008. Provision for loan losses increased $1.3 million to $6.8 million for the year ended December 31, 2009, compared to $5.5 million for the same period of 2008. Non-interest income increased $5.5 million to $23.3 million for the year ended December 31, 2009 as compared to $17.8 million for the same period of 2008 due primarily to increases in realized and unrealized gains on sales of loans.
The return on average assets for the years ended December 31, 2009 and 2008 was 0.57% and 0.02%, respectively. The return on average equity for the years ended December 31, 2009 and 2008 was 5.53% and 0.18%, respectively.
Our operating results for the year ended December 31, 2008 were adversely impacted by several events. These events are discussed in detail below:
-
- During the third quarter of 2008, we performed our annual evaluation of the goodwill associated with our acquisition of
George Mason. Goodwill of $12.9 million was recognized as a result of this acquisition. We employed the services of a valuation consultant to assist us with the goodwill evaluation. The
analysis included certain valuation techniques, including a discounted cash flow approach. Following the acquisition, George Mason delivered excellent financial results and returns on our investment.
Recent and ongoing challenges in the regional residential real estate market negatively impacted the cash flows expected to be generated by George Mason in the near term. The valuation analysis
indicated that the goodwill was impaired and we recorded a noncash impairment charge of $2.8 million in the mortgage banking segment.
-
- During the third quarter of 2008, we recognized an other-than-temporary impairment charge of $4.4 million on our investment in Fannie Mae perpetual preferred stock. This impairment charge was recorded in the commercial banking segment.
46
-
- During the second quarter of 2008, George Mason recorded a cash settlement to one of its mortgage correspondents related to the loan purchase agreement between the two parties. This settlement agreement provided for the release of known and unknown claims by the mortgage correspondent in exchange for a $2.8 million payment to the correspondent. George Mason also entered into similar agreements with certain third party mortgage companies from which George Mason purchased mortgage loans and subsequently sold to this mortgage correspondent. These settlement agreements provided for a total payment of $1.0 million to George Mason by those third party mortgage companies.
Efficiency Ratio
The efficiency ratio measures the costs expended to generate a dollar of revenue. It represents noninterest expense as a percentage of net interest income and noninterest income. The lower the percentage, the more efficient we are operating. We believe use of the efficiency ratio, excluding nonrecurring expenses, which is a non-GAAP financial measure, provides additional clarity in assessing our operating results.
47
See Table 1 below for the components of our calculation of our efficiency ratio as of December 31, 2010, 2009 and 2008.
Table 1.
Efficiency Ratio Calculation
Years Ended December 31, 2010, 2009 and 2008
(In thousands, except per share data)
|
2010 | 2009 | 2008 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
GAAP reported non-interest expense |
$ | 59,469 | $ | 52,427 | $ | 55,913 | |||||
Less nonrecurring expenses |
|||||||||||
Impairment of Fannie Mae perpetual preferred stock |
| | 4,408 | ||||||||
Settlement with mortgage correspondent |
| | 1,800 | ||||||||
Loss related to escrow arrangement |
| | | ||||||||
Non-interest expense without nonrecurring expenses |
$ | 59,469 | $ | 52,427 | $ | 49,705 | |||||
GAAP reported non-interest income |
$ | 27,389 | $ | 23,348 | $ | 17,812 | |||||
Less nonrecurring income |
|||||||||||
Litigation recovery on previously impaired investment |
87 | | 190 | ||||||||
Non-interest income without nonrecurring income |
$ | 27,302 | $ | 23,348 | $ | 17,622 | |||||
Calculation of efficiency ratio(1): |
|||||||||||
Non-interest expense without nonrecurring expenses (from above) |
$ | 59,469 | $ | 52,427 | $ | 49,705 | |||||
GAAP reported net interest income |
69,045 | 50,542 | 42,973 | ||||||||
Non-interest income without nonrecurring income (from above) |
27,302 | 23,348 | 17,622 | ||||||||
Total net interest income and non-interest income for efficiency ratio |
$ | 96,347 | $ | 73,890 | $ | 60,595 | |||||
Efficiency ratio without nonrecurring income and expenses |
61.72 | % | 70.95 | % | 82.03 | % |
- (1)
- Efficiency ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income, excluding the impairment loss on Fannie Mae perpetual preferred stock and the settlement with a mortgage correspondent during 2008; the impairment loss on an escrow arrangement during 2007; and litigation recoveries during 2010, 2008 and 2007.
Statements of Operations
Net Interest Income/Margin
Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. During 2007, the Federal Reserve began easing the federal funds rate due to worsening economic conditions related to the tightening credit markets and decreased the rate four times to end at 4.25% at December 31, 2007. This easing continued into 2008, and as the economy continued to slow and go into a recessionary phase, the Federal Reserve continued to decrease the fed funds rate to ultimately 0.25% as of December 31, 2008 where it has remained during all of 2009 and 2010. See "Interest Rate Sensitivity" for further information.
48
Tables 2 and 3.
Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities
Years Ended December 31, 2010, 2009 and 2008
(In thousands)
|
2010 | 2009 | 2008 | ||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||
Interest-earning assets: |
|||||||||||||||||||||||||||||||
Loans(1): |
|||||||||||||||||||||||||||||||
Commercial and industrial |
$ | 163,497 | $ | 7,507 | 4.58 | % | $ | 157,703 | $ | 7,530 | 4.77 | % | $ | 130,608 | $ | 8,019 | 6.14 | % | |||||||||||||
Real estatecommercial |
609,568 | 38,193 | 6.23 | % | 546,593 | 34,203 | 6.26 | % | 440,746 | 28,905 | 6.56 | % | |||||||||||||||||||
Real estateconstruction |
204,167 | 11,474 | 5.62 | % | 181,365 | 8,707 | 4.80 | % | 190,354 | 11,175 | 5.87 | % | |||||||||||||||||||
Real estateresidential |
227,950 | 11,768 | 5.16 | % | 207,238 | 10,922 | 5.27 | % | 213,125 | 11,957 | 5.61 | % | |||||||||||||||||||
Home equity lines |
119,686 | 4,361 | 3.64 | % | 111,858 | 4,065 | 3.63 | % | 93,635 | 4,460 | 4.76 | % | |||||||||||||||||||
Consumer |
2,690 | 157 | 5.87 | % | 2,671 | 159 | 5.95 | % | 2,637 | 171 | 6.48 | % | |||||||||||||||||||
|
1,327,558 | 73,460 | 5.53 | % | 1,207,428 | 65,586 | 5.43 | % | 1,071,105 | 64,687 | 6.04 | % | |||||||||||||||||||
Loans held for sale |
194,928 | 9,039 | 4.64 | % | 160,790 | 7,358 | 4.58 | % | 124,993 | 7,140 | 5.71 | % | |||||||||||||||||||
Investment securities available-for-sale |
307,612 | 13,799 | 4.49 | % | 258,971 | 12,601 | 4.87 | % | 261,600 | 13,645 | 5.22 | % | |||||||||||||||||||
Investment securities held-to-maturity |
28,476 | 935 | 3.28 | % | 42,375 | 1,587 | 3.75 | % | 58,915 | 2,521 | 4.28 | % | |||||||||||||||||||
Other investments |
15,728 | 54 | 0.34 | % | 15,705 | 30 | 0.19 | % | 15,307 | 567 | 3.70 | % | |||||||||||||||||||
Federal funds sold |
20,011 | 46 | 0.23 | % | 49,864 | 118 | 0.24 | % | 32,077 | 569 | 1.77 | % | |||||||||||||||||||
Total interest-earning assets and interest income(2) |
1,894,313 | 97,333 | 5.14 | % | 1,735,133 | 87,280 | 5.03 | % | 1,563,997 | 89,129 | 5.70 | % | |||||||||||||||||||
Noninterest-earning assets: |
|||||||||||||||||||||||||||||||
Cash and due from banks |
12,893 | 1,427 | 7,833 | ||||||||||||||||||||||||||||
Premises and equipment, net |
16,436 | 15,854 | 17,523 | ||||||||||||||||||||||||||||
Goodwill and other intangibles, net |
13,587 | 14,060 | 16,404 | ||||||||||||||||||||||||||||
Accrued interest and other assets |
81,988 | 60,993 | 51,300 | ||||||||||||||||||||||||||||
Allowance for loan losses |
(21,306 | ) | (16,309 | ) | (12,568 | ) | |||||||||||||||||||||||||
Total assets |
$ | 1,997,911 | $ | 1,811,158 | $ | 1,644,489 | |||||||||||||||||||||||||
Liabilities and Shareholders' Equity |
|||||||||||||||||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||||||||||||||
Interest-bearing deposits: |
|||||||||||||||||||||||||||||||
Interest checking |
$ | 133,105 | $ | 466 | 0.35 | % | $ | 123,017 | $ | 1,207 | 0.98 | % | $ | 121,537 | $ | 2,732 | 2.25 | % | |||||||||||||
Money markets |
109,771 | 618 | 0.56 | % | 53,030 | 510 | 0.96 | % | 41,586 | 982 | 2.36 | % | |||||||||||||||||||
Statement savings |
272,843 | 1,423 | 0.52 | % | 291,751 | 4,034 | 1.38 | % | 341,059 | 9,987 | 2.93 | % | |||||||||||||||||||
Certificates of deposit |
661,906 | 13,054 | 1.97 | % | 622,617 | 17,947 | 2.88 | % | 480,408 | 18,390 | 3.83 | % | |||||||||||||||||||
Total interest-bearing deposits |
1,177,625 | 15,561 | 1.32 | % | 1,090,415 | 23,698 | 2.17 | % | 984,590 | 32,091 | 3.26 | % | |||||||||||||||||||
Other borrowed funds |
376,508 | 12,027 | 3.19 | % | 366,965 | 12,502 | 3.41 | % | 350,889 | 13,547 | 3.86 | % | |||||||||||||||||||
Total interest-bearing liabilities and interest expense |
1,554,133 | 27,588 | 1.78 | % | 1,457,380 | 36,200 | 2.48 | % | 1,335,479 | 45,638 | 3.42 | % | |||||||||||||||||||
Noninterest-bearing liabilities: |
|||||||||||||||||||||||||||||||
Demand deposits |
201,262 | 147,062 | 131,197 | ||||||||||||||||||||||||||||
Other liabilities |
24,059 | 19,965 | 17,645 | ||||||||||||||||||||||||||||
Common shareholders' equity |
218,457 | 186,751 | 160,168 | ||||||||||||||||||||||||||||
Total liabilities and shareholders' equity |
$ | 1,997,911 | $ | 1,811,158 | $ | 1,644,489 | |||||||||||||||||||||||||
Net interest income and net interest margin(2) |
$ | 69,745 | 3.68 | % | $ | 51,080 | 2.94 | % | $ | 43,491 | 2.78 | % | |||||||||||||||||||
- (1)
- Non-accrual
loans are included in average balances and do not have a material effect on the average yield. Interest income on
non-accruing loans was not material for the years presented.
- (2)
- Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 35% for 2010, 34.5% for 2009 and 34% for 2008.
49
Tables 2 and 3.
Rate and Volume Analysis
Years Ended December 31, 2010, 2009, and 2008
(In thousands)
|
2010 Compared to 2009 | 2009 Compared to 2008 | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Average Volume(3) |
Average Rate |
Increase (Decrease) |
Average Volume(3) |
Average Rate |
Increase (Decrease) |
|||||||||||||||||
Interest income: |
|||||||||||||||||||||||
Loans(1): |
|||||||||||||||||||||||
Commercial and industrial |
$ | 293 | $ | (316 | ) | $ | (23 | ) | $ | 1,664 | $ | (2,153 | ) | $ | (489 | ) | |||||||
Real estatecommercial |
4,184 | (194 | ) | 3,990 | 6,942 | (1,644 | ) | 5,298 | |||||||||||||||
Real estateconstruction |
1,095 | 1,672 | 2,767 | (528 | ) | (1,940 | ) | (2,468 | ) | ||||||||||||||
Real estateresidential |
1,092 | (246 | ) | 846 | (330 | ) | (705 | ) | (1,035 | ) | |||||||||||||
Home equity lines |
284 | 12 | 296 | 868 | (1,263 | ) | (395 | ) | |||||||||||||||
Consumer |
0 | (2 | ) | (2 | ) | 2 | (14 | ) | (12 | ) | |||||||||||||
Total loans |
6,948 | 926 | 7,874 | 8,618 | (7,719 | ) | 899 | ||||||||||||||||
Loans held for sale |
1,562 | 119 | 1,681 | 2,045 | (1,827 | ) | 218 | ||||||||||||||||
Investment securities available-for-sale |
2,367 | (1,169 | ) | 1,198 | (137 | ) | (907 | ) | (1,044 | ) | |||||||||||||
Investment securities held-to-maturity |
(521 | ) | (131 | ) | (652 | ) | (708 | ) | (226 | ) | (934 | ) | |||||||||||
Other investments |
0 | 24 | 24 | 15 | (552 | ) | (537 | ) | |||||||||||||||
Federal funds sold |
(71 | ) | (1 | ) | (72 | ) | 316 | (767 | ) | (451 | ) | ||||||||||||
Total interest income(2) |
10,285 | (232 | ) | 10,053 | 10,149 | (11,998 | ) | (1,849 | ) | ||||||||||||||
Interest expense: |
|||||||||||||||||||||||
Interest-bearing deposits: |
|||||||||||||||||||||||
Interest checking |
99 | (840 | ) | (741 | ) | 33 | (1,558 | ) | (1,525 | ) | |||||||||||||
Money markets |
546 | (438 | ) | 108 | 270 | (742 | ) | (472 | ) | ||||||||||||||
Statement savings |
(261 | ) | (2,350 | ) | (2,611 | ) | (1,444 | ) | (4,509 | ) | (5,953 | ) | |||||||||||
Certificates of deposit |
1,133 | (6,026 | ) | (4,893 | ) | 5,444 | (5,887 | ) | (443 | ) | |||||||||||||
Total interest-bearing deposits |
1,517 | (9,654 | ) | (8,137 | ) | 4,303 | (12,696 | ) | (8,393 | ) | |||||||||||||
Other borrowed funds |
325 | (800 | ) | (475 | ) | 621 | (1,666 | ) | (1,045 | ) | |||||||||||||
Total interest expense |
1,842 | (10,454 | ) | (8,612 | ) | 4,924 | (14,362 | ) | (9,438 | ) | |||||||||||||
Net interest income(2) |
$ | 8,443 | $ | 10,222 | $ | 18,665 | $ | 5,225 | $ | 2,364 | $ | 7,589 | |||||||||||
- (1)
- Non-accrual
loans are included in average balances and do not have a material effect on the average yield. Interest income on
non-accruing loans was not material for the years presented.
- (2)
- Interest
income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of
35% for 2010, 34.5% for 2009 and 34% for 2008.
- (3)
- Changes attributable to rate/volume have been allocated to volume.
2010 Compared to 2009
Net interest income for the year ended December 31, 2010 was $69.0 million, compared to $50.5 million for the year ended December 31, 2009, an increase of $18.5 million, or 36.6%. The increase in net interest income was primarily a result of our slightly increasing rates on our interest-earning assets while lowering the interest rates paid on deposits and other borrowed funds during 2010 compared with 2009, in addition to increases in our interest earnings assets during 2010.
50
Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2010 and 2009 was 3.68% and 2.94%, respectively, the increase for which was primarily a result of our ability to decrease interest rates on deposits faster as we managed our balance sheet in order to increase our yields on our interest-earning assets. We believe this financial measure provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our federal statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.
Our interest rates on our other borrowed funds decreased due to the continued significantly low interest rate environment of 2010. The average yield on interest-earning assets increased to 5.14% in 2010 from 5.03% in 2009, and our cost of interest-bearing liabilities decreased to 1.78% in 2010 from 2.48% in 2009. The cost of other borrowed funds, which generally are shorter term fundings and which we continued to utilize during 2010 to help fund our balance sheet growth and support our loans held for sale portfolio, decreased 22 basis points to 3.19% in 2010 from 3.41% in 2009. The cost of deposit liabilities decreased 85 basis points to 1.32% in 2010 from 2.17% for 2009.
Total average earning assets increased by 9.2% to $1.89 billion at December 31, 2010 compared to $1.74 billion at December 31, 2009. The increase in our earnings assets were primarily driven by an increase in average loans receivable of $120.1 million, an increase in our inventory of loans held for sale of $34.1 million and an increase in investment securities of $34.7 million. These increases were funded by an increase in interest-bearing deposits of $87.2 million, an increase in other borrowed funds of $9.5 million and an increase in noninterest-bearing deposits of $54.2 million.
Average loans receivable increased $120.1 million to $1.33 billion during 2010 from $1.21 billion in 2009. Average balances of nonperforming assets, which consist of non-accrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2010 and 2009. Additional interest income of approximately $643,000 for 2010 and $414,000 for 2009 would have been realized had all nonperforming assets performed as originally expected. Nonperforming assets exclude loans that are both past due 90 days or more and still accruing interest due to an assessment of collectibility.
Average interest-bearing deposits increased $87.2 million to $1.18 billion in 2010 from $1.09 billion in 2009. The largest increase in average interest-bearing deposit balances was in our money market deposits, which increased $56.7 million compared to 2009. In addition, certificates of deposit increased $39.3 million to $661.9 million for 2010 compared to $622.6 million for 2009. Overall, we have continued to see an increase in our deposits as a result of a "flight to safety" by consumers who were seeking the increase in FDIC insurance protection. Offsetting this increase was a decrease in average statement savings of $18.9 million to $272.8 million for 2010 compared to $291.8 million for 2009.
2009 Compared to 2008
Net interest income for the year ended December 31, 2009 was $50.5 million, compared to $43.0 million for the year ended December 31, 2008, an increase of $7.6 million, or 17.6%. The increase in net interest income was primarily a result of decreases in the interest rates paid on deposits and other borrowed funds, net of the impact of decreased yields on earning assets during 2009, compared with 2008. In addition, we were able to deploy $31.6 million as a result of our capital raising efforts during 2009 in interest-bearing assets at no cost.
Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2009 and 2008 was 2.94% and 2.78%, respectively, the increase for which was primarily a result of our ability to decrease interest rates on deposits faster than rates decreased on our interest earning assets. In addition, our interest rates on our other borrowed funds decreased due to the significantly low interest
51
rate environment of 2009. The average yield on interest-earning assets decreased to 5.03% in 2009 from 5.70% in 2008, and our cost of interest-bearing liabilities decreased to 2.48% in 2009 from 3.42% in 2008. The cost of other borrowed funds, which generally are shorter term fundings and which we continued to utilize during 2009 to help fund our balance sheet growth, decreased 45 basis points to 3.41% in 2009 from 3.86% in 2008. The cost of deposit liabilities decreased 109 basis points to 2.17% in 2009 from 3.26% for 2008.
Total average earning assets increased by 10.9% to $1.74 billion at December 31, 2009 compared to $1.56 billion at December 31, 2008. The increase in our earnings assets were primarily driven by an increase in average loans receivable of $136.3 million and an increase in our inventory of loans held for sale of $35.8 million and offset by a decrease in investment securities of $19.2 million. These increases were funded by an increase in interest-bearing deposits of $105.8 million, an increase in other borrowed funds of $16.1 million and an increase in noninterest-bearing deposits of $15.9 million.
Average loans receivable increased $136.3 million to $1.21 billion during 2009 from $1.07 million in 2008. Average balances of nonperforming assets, which consist of non-accrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2009 and 2008. Additional interest income of approximately $414,000 for 2009 and $59,000 for 2008 would have been realized had all nonperforming assets performed as originally expected. Nonperforming assets exclude loans that are both past due 90 days or more and still accruing interest due to an assessment of collectibility.
Average interest-bearing deposits increased $105.8 million to $1.1 billion in 2009 from $984.6 million in 2008. The largest increase in average interest-bearing deposit balances was in certificates of deposit, which increased $142.2 million compared to 2008. Overall, we saw an increase in our deposits as a result of a "flight to safety" by consumers who were seeking the increase in FDIC insurance protection. Offsetting this increase was a decrease in average statement savings of $49.3 million to $291.8 million for 2009 compared to $341.1 million for 2008.
Interest Rate Sensitivity
We are exposed to various business risks including interest rate risk. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee ("ALCO"). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.
We employ an independent consulting firm to model our interest rate sensitivity. We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates. In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.
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For the up 200 basis point scenario, rates are gradually moved up 200 basis points in the first year and then rates remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.
At December 31, 2010, our asset/liability position was neutral based on our interest rate sensitivity model. Our net interest income would decrease by less than 1% in a down 100 basis point scenario and would increase less than 0.5% in an up 200 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would decrease by less than 1.9% in a down 100 basis point scenario and would increase by less than 1.2% in an up 200 basis point scenario.
Provision Expense and Allowance for Loan Losses
Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of known and inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.
The provision for loan losses was $10.5 million and $6.8 million for the years ended December 31, 2010 and 2009, respectively. The allowance for loan losses at December 31, 2010 was $24.2 million compared to $18.6 million at December 31, 2009. Our allowance for loan loss ratio at December 31, 2010 was 1.72% compared to 1.44% at December 31, 2009. The increase in the allowance for loan loss ratio is a direct result of increases in non-performing loans and the adverse migration of certain loans through our allowance for loan losses calculation model because of current and ongoing adverse economic conditions. While we continue to report strong credit quality in our loan portfolio, we have experienced increases in our watch list credits and net charge-offs. Our provision was impacted by net new loan growth in addition to our evaluation of the credit quality in our loan portfolio and the qualitative factors we use to determine the adequacy of our loan loss reserves. We recorded net loan charge-offs of $4.9 million and $2.6 million for the years ended December 31, 2010 and 2009, respectively. During 2010, we charged-off $3.2 million in commercial and industrial loans, residential loans of $2.1 million and consumer loans of $50,000. Annualized net charged-off loans was 0.37% of average loans receivable for the year ended December 31, 2010, compared to 0.22% for the year ended December 31, 2009. Non-accrual loans totaled $7.5 million at December 31, 2010 compared to $696,000 at December 31, 2009.
Continued challenging economic conditions could adversely affect our home equity lines of credit, credit card and other loan portfolios, including causing increases in delinquencies and default rates, which we expect could impact our charge-offs and provision for loan losses. Continued deterioration in commercial and residential real estate values, employment data and household incomes could result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At December 31, 2010, our commercial real estate (including construction lending) portfolio was 62% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially, and the systems by which we set limits and monitor the level or our credit exposure to individual entities and industries, may not function as we have anticipated.
The provision for loan losses was $5.5 million for 2008. Net charge-offs for the year ended December 31, 2008 was $2.6 million.
See "Critical Accounting Policies" above for more information on our allowance for loan losses methodology.
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The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio.
Table 4.
Allowance for Loan Losses
Years Ended December 31, 2010, 2009, 2008, 2007, and 2006
(In thousands)
|
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Beginning balance, January 1 |
$ | 18,636 | $ | 14,518 | $ | 11,641 | $ | 9,638 | $ | 8,301 | |||||||
Provision for loan losses |
10,502 | 6,750 | 5,498 | 2,548 | 1,232 | ||||||||||||
Loans charged off: |
|||||||||||||||||
Commercial and industrial |
(3,187 | ) | (876 | ) | (1,188 | ) | (449 | ) | (42 | ) | |||||||
Residential |
(2,064 | ) | (1,756 | ) | (576 | ) | (100 | ) | | ||||||||
Consumer |
(50 | ) | (6 | ) | (892 | ) | (3 | ) | (1 | ) | |||||||
Total loans charged off |
(5,301 | ) | (2,638 | ) | (2,656 | ) | (552 | ) | (43 | ) | |||||||
Recoveries: |
|||||||||||||||||
Commercial and industrial |
3 | 5 | 8 | 7 | 148 | ||||||||||||
Residential |
219 | | | | | ||||||||||||
Consumer |
151 | 1 | 27 | | | ||||||||||||
Total recoveries |
373 | 6 | 35 | 7 | 148 | ||||||||||||
Net (charge offs) recoveries |
(4,928 | ) | (2,632 | ) | (2,621 | ) | (545 | ) | 105 | ||||||||
Ending balance, December 31, |
$ | 24,210 | $ | 18,636 | $ | 14,518 | $ | 11,641 | $ | 9,638 | |||||||
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Loans: |
||||||||||||||||
Balance at year end |
$ | 1,409,302 | $ | 1,293,432 | $ | 1,139,348 | $ | 1,039,684 | $ | 845,449 | ||||||
Allowance for loan losses to loans receivable, net of fees |
1.72 | % | 1.44 | % | 1.27 | % | 1.12 | % | 1.14 | % | ||||||
Net charge-offs to average loans receivable |
0.37 | % | 0.22 | % | 0.24 | % | 0.06 | % | 0.00 | % |
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Table 5.
Allocation of the Allowance for Loan Losses
At December 31, 2010, 2009, 2008, 2007, and 2006
(In thousands)
|
2010 | 2009 | 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Allocation | % of Total* | Allocation | % of Total* | Allocation | % of Total* | |||||||||||||
Commercial and industrial |
$ | 2,941 | 14.20 | % | $ | 2,797 | 12.45 | % | $ | 2,129 | 14.12 | % | |||||||
Real estatecommercial |
10,558 | 44.73 | % | 9,666 | 45.80 | % | 6,110 | 41.41 | % | ||||||||||
Real estateconstruction |
7,593 | 17.01 | % | 2,829 | 14.80 | % | 3,118 | 16.53 | % | ||||||||||
Real estateresidential |
1,875 | 15.39 | % | 2,096 | 17.67 | % | 2,138 | 18.57 | % | ||||||||||
Home equity lines |
1,175 | 8.46 | % | 1,182 | 9.07 | % | 965 | 9.16 | % | ||||||||||
Consumer |
68 | 0.21 | % | 66 | 0.21 | % | 58 | 0.21 | % | ||||||||||
Total allowance for loan losses |
$ | 24,210 | 100.00 | % | $ | 18,636 | 100.00 | % | $ | 14,518 | 100.00 | % | |||||||
|
2007 | 2006 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Allocation | % of Total* | Allocation | % of Total* | |||||||||
Commercial and industrial |
$ | 1,956 | 13.51 | % | $ | 1,670 | 12.09 | % | |||||
Real estatecommercial |
5,225 | 39.95 | % | 3,687 | 37.50 | % | |||||||
Real estateconstruction |
2,217 | 17.93 | % | 1,764 | 18.27 | % | |||||||
Real estateresidential |
1,402 | 20.50 | % | 2,025 | 23.80 | % | |||||||
Home equity lines |
772 | 7.81 | % | 384 | 7.75 | % | |||||||
Consumer |
69 | 0.30 | % | 108 | 0.59 | % | |||||||
Total allowance for loan losses |
$ | 11,641 | 100.00 | % | $ | 9,638 | 100.00 | % | |||||
- *
- Percentage of loan type to the total loan portfolio.
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Non-Interest Income
The following table provides detail for non-interest income for the years ended December 31, 2010, 2009, and 2008.
Table 6.
Non-Interest Income
Years Ended December 31, 2010, 2009 and 2008
(In thousands)
|
2010 | 2009 | 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Insufficient funds fee income |
$ | 515 | $ | 546 | $ | 664 | ||||
Service charges on deposit accounts |
559 | 488 | 463 | |||||||
Other fee income on deposit accounts |
107 | 217 | 283 | |||||||
ATM transaction fees |
700 | 683 | 655 | |||||||
Credit card fees |
99 | 77 | 67 | |||||||
Loan service charges |
2,212 | 2,649 | 1,643 | |||||||
Trust adminstration fee income |
3,538 | 3,134 | 2,949 | |||||||
Investment fee income |
550 | 480 | 528 | |||||||
Realized and unrealized gains on mortgage banking activities |
13,860 | 12,452 | 7,752 | |||||||
Net realized gains on investment securities available-for-sale |
726 | 760 | 913 | |||||||
Net realized gain on investment securitiestrading |
188 | (425 | ) | (9 | ) | |||||
Management fee income |
3,657 | 1,833 | 765 | |||||||
Bank-owned life insurance income |
646 | 536 | 860 | |||||||
Litigation recovery on previously impaired investment |
87 | | 190 | |||||||
Gain on debt extinguishments |
| | 275 | |||||||
Other income (loss) |
(55 | ) | (82 | ) | (186 | ) | ||||
Total non-interest income |
$ | 27,389 | $ | 23,348 | $ | 17,812 | ||||
Non-interest income includes service charges on deposits and loans, realized and unrealized gains on mortgage banking activities, investment fee income, management fee income, and gains on sales of investment securities available-for-sale, and continues to be an important factor in our operating results. Non-interest income for the years ended December 31, 2010 and 2009 was $27.4 million and $23.3 million, respectively. The increase in non-interest income for the year ended December 31, 2010, compared to the same period of 2009, is primarily the result of an increase in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking segment. Realized and unrealized gains on mortgage banking activities increased $1.4 million to $13.9 million for the year ended December 31, 2010, compared to $12.5 million for 2009. The increase in realized and unrealized gains on mortgage banking activities is directly related to an increase in loan origination and sales volume occurring in the mortgage banking segment as a result of decreased in mortgage rates and more affordable home prices during 2010. In addition, we have added mortgage loan originators during 2010 to help increase our market share. Included in realized and unrealized gains on mortgage banking activities are any origination, underwriting, and discount points and other funding fees and gains associated with our sales of loans to third party investors. Costs include direct costs associated with loan origination, such as commissions and salaries. Management fee income, which represents the income earned for services George Mason provides to other mortgage companies owned by local home builders and generally fluctuates based on the volume of loan sales, increased $1.8 million to $3.7 million during 2010 as compared to $1.8 million in 2009, again due to the origination volumes in the residential real estate market.
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Another contributing factor to the increase in our non-interest income was an increase in investment fee income, which increased $474,000 to $4.1 million for the year ended December 31, 2010, compared to $3.6 million for 2009. Investment fee income includes net commissions earned at CWS and income earned at Wilson/Bennett and from our trust division. The increase in the market values of managed and custodial assets and an increase in customer relationships in the wealth management and trust services segment have contributed to the increase in investment fee income during 2010. As previously mentioned, we recently completed negotiations of our service agreement with one of our largest wealth management clients. While we were successful in retaining this client, in order to remain competitive in the negotiations process, we had to significantly decrease the fees we charge for our services to this particular client. As a result, we anticipate fee income from this business line will decrease during 2011.
Service charges on deposit accounts decreased $130,000 to $1.9 million for the year ended December 31, 2010, compared to $2.0 million for the year ended December 31, 2009. Service charges on deposit accounts include insufficient funds fee income, service charges on deposit accounts, other fee income on deposit accounts and ATM transaction fees as shown in Table 6. Loan service charges totaled $2.3 million for the year ended December 31, 2010, a decrease of $338,000, compared to $2.6 million for the year ended December 31, 2009. The decrease in loan service charges is primarily a result of a decrease in fee income earned by George Mason's title company during 2010.
For the year ended December 31, 2010, the increase in the cash surrender value of our bank-owned life insurance was $646,000, an increase of $110,000 when compared to the same period of 2009. This increase is a result of the increase in the earnings of the underlying investment assets of our bank-owned life insurance.
For the year ended December 31, 2010, we recorded net gains on the sales of investment securities totaling $726,000 compared to $760,000 for the same period of 2009. In addition, we recorded trading gains of $188,000 for the year ended December 31, 2010, compared to trading losses of $425,000 for the year ended December 31, 2009. We have purchased investments to economically hedge against fair value changes of our nonqualified deferred compensation plan liability. These investments are designated as trading securities, and as such, the changes in fair value are reflected in earnings. These trading gains were primarily the result of increased stock prices and were mostly offset by a compensation expense associated with this benefit plan.
Non-interest income for the years ended December 31, 2009 and 2008 was $23.3 million and $17.8 million, respectively. The increase in non-interest income for the year ended December 31, 2009, compared to the same period of 2008, is primarily the result of an increase in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking segment. Realized and unrealized gains on mortgage banking activities increased $4.7 million to $12.5 million for the year ended December 31, 2009, compared to $7.8 million for 2008. The increase in realized and unrealized gains on mortgage banking activities is directly related to an increase in loan origination and sales volume occurring in the mortgage banking segment as a result of decreased in mortgage rates and more affordable home prices during 2009. Management fee income increased $1.1 million to $1.8 million during 2009 as compared to $765,000 in 2008, again due to the origination volumes in the residential real estate market.
Another contributing factor to the increase in our non-interest income was an increase in loan service charges of $1.0 million for the year ended December 31, 2009 to $2.6 million, compared to $1.6 million for the same period of 2008. The increase in loan service charges is primarily a result of fee income earned by George Mason's title company and again a result of an increase in loan origination and sales activity. Total investment fee income increased $137,000 to $3.6 million for the year ended December 31, 2009, compared to $3.5 million for 2008. The increase in the market values
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of managed and custodial assets and an increase in customer relationships in the wealth management and trust services segment have contributed to the increase in investment fee income during 2009.
Service charges on deposit accounts decreased $121,000 to $2.0 million for the year ended December 31, 2009, compared to $2.1 million for the year ended December 31, 2008. For the year ended December 31, 2009, the increase in the cash surrender value of our bank-owned life insurance was $536,000, a decrease of $324,000 when compared to the same period of 2008. This decrease is a result of the decrease in the earnings of the underlying investment assets of our bank-owned life insurance.
For the year ended December 31, 2009, we recorded net gains on the sales of investment securities totaling $760,000 compared to $913,000 for the same period of 2008. Included in our net gains on investment securities available-for-sale were losses totaling $217,000 which were related to our sale of all of our shares of Fannie Mae perpetual preferred stock during the first quarter of 2009. We elected to sell these shares as a result of these shares being traded well below their par value following the placement of Fannie Mae into conservatorship by federal regulators during 2008. In addition, we recorded trading losses of $425,000 for the year ended December 31, 2009. These trading losses were primarily the result of lower stock prices and were partially offset by a reduction in our compensation expense associated with this benefit plan.
For the year ended December 31, 2008 gains related to the extinguishment of four borrowings totaling $275,000.
One provision of the Financial Reform Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. In December 2010, the Federal Reserve proposed capping the fee at 12 cents per debit card transaction, which is well below the average that banks currently charge. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, we believe that our debit card revenue could be adversely impacted as soon as the third quarter of 2011 if the interchange cap is implemented.
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Non-Interest Expense
The following table reflects the components of non-interest expense for the years ended December 31, 2010, 2009 and 2008.
Table 7.
Non-Interest Expense
Years Ended December 31, 2010, 2009, and 2008
(In thousands)
|
2010 | 2009 | 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Salary and benefits |
$ | 27,445 | $ | 23,571 | $ | 21,939 | ||||
Occupancy |
5,723 | 5,442 | 5,547 | |||||||
Professional fees |
2,733 | 2,142 | 2,225 | |||||||
Depreciation |
1,938 | 1,948 | 2,390 | |||||||
Data communications |
4,295 | 3,352 | 2,685 | |||||||
FDIC insurance assessments |
1,853 | 2,692 | 721 | |||||||
Mortgage loan repurchases and settlements |
(686 | ) | 2,569 | 3,835 | ||||||
Bank franchise taxes |
1,897 | 1,525 | 1,482 | |||||||
Amortization of intangibles |
238 | 238 | 245 | |||||||
Impairment of Fannie Mae perpetual preferred stock |
| | 4,408 | |||||||
Impairment of goodwill and other intangible assets |
3,008 | | 2,821 | |||||||
Impairment of other real estate owned |
1,365 | | | |||||||
Loss related to escrow arrangement |
| | | |||||||
Premises and equipment |
2,149 | 2,156 | 1,965 | |||||||
Advertising and marketing |
2,310 | 2,084 | 2,116 | |||||||
Stationary and supplies |
1,084 | 936 | 881 | |||||||
Loan expenses |
482 | 748 | 264 | |||||||
Other taxes |
400 | 419 | 398 | |||||||
Travel and entertainment |
528 | 403 | 460 | |||||||
Miscellaneous |
2,707 | 2,202 | 1,531 | |||||||
Total non-interest expense |
$ | 59,469 | $ | 52,427 | $ | 55,913 | ||||
Non-interest expense includes, among other things, salaries and benefits, occupancy costs, professional fees, depreciation, data processing, telecommunications and miscellaneous expenses. Non-interest expense was $59.5 million and $52.4 million for the years ended December 31, 2010 and 2009, respectively, an increase of $7.0 million, or 13.4%. The increase in non-interest expense for the year ended December 31, 2010, compared to 2009, was primarily the result of the aforementioned noncash goodwill and other intangibles impairment charge related to our wealth management and trust services business segment of $3.0 million during 2010 and increases in salary and benefits costs. See the "Financial Overview" above for additional information on these transactions.
Salaries and benefits expense increased $3.9 million to $27.4 million for the year ended December 31, 2010 compared to $23.6 million for 2009. The increase in salaries and benefits expense is primarily related to increases in our business development personnel in all of our business lines. Also, we recorded $801,000 during 2010 related to our CEO's new employment agreement, which includes the immediate vesting of his supplemental executive retirement plan. In addition, accruals for incentive pay for 2010 have increased compared to 2009 as a result of better than expected financial results for 2010.
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Data communications expense increased $943,000 to $4.3 million for the year ended December 31, 2010 compared to $3.4 million for the same period of 2009. The increase in this expense is primarily related to our core operating system conversion costs which occurred during the second quarter of 2010. Professional fees increased $591,000 to $2.7 million for 2010 compared to $2.1 million for 2009. The increase in professional fees was due to an increase in consulting expenses to help support our core operating system conversion.
FDIC insurance premiums decreased $839,000 million to $1.9 million for the year ended December 31, 2010 compared to $2.7 million for the same period of 2009. The decrease in FDIC insurance premiums is a due to the special assessment imposed during the second quarter of 2009 of $844,000, a result of the FDIC's efforts in replenishing the levels of the Deposit Insurance Fund which has been depleted due to increasing levels of bank failures.
We recorded a benefit of $686,000 related to our mortgage loan repurchases and settlements for 2010 compared to an expense of $2.6 million for 2009. During the past two years, we have taken steps to limit our exposure to loan repurchases through agreements entered into with various investors. During 2010, we experienced favorable results in resolving various investor claims and reduced our reserves by $1.1 million. At December 31, 2010, there were no outstanding loan repurchase claims.
During 2010, we recorded an impairment related to other real estate owned of $1.4 million related to one property. This property was foreclosed upon in 2009, and the carrying value was recorded based on a then current appraisal. During the fourth quarter of 2010, we obtained an updated appraisal of the property which indicated a different highest and best use of the property resulting in the additional charge. The fair value of the property, which is discounted for estimated costs to sell, was less than the current value recorded on our balance sheet. No such expense was recorded during 2009. Additional increases in noninterest expense are related to branch expansion as we added a branch banking office and a mortgage banking office during 2010.
Non-interest expense was $52.4 million and $55.9 million for the years ended December 31, 2009 and 2008, respectively, a decrease of $3.5 million, or 6.2%. The decrease in non-interest expense for the year ended December 31, 2009, compared to 2008, was primarily the result of the aforementioned other-than temporary impairment charge related to an investment in Fannie Mae perpetual preferred stock, the goodwill impairment charge recorded at George Mason and the cash settlement George Mason made to a mortgage correspondent, all during 2008. See the "Financial Overview" above for additional information on these transactions.
Salaries and benefits expense increased $1.6 million to $23.6 million for the year ended December 31, 2009 as compared to $21.9 million for the same period of 2008. This increase was attributable to an increase in incentive pay at the Bank due to better than expected results for 2009. Depreciation expense decreased $442,000 to $1.9 million for the year ended December 31, 2009 as compared to $2.4 million for the year ended December 31, 2008 due to fixed assets becoming fully depreciated. Data communications expense increased $667,000 to end at $3.4 million for the year ended December 31, 2009 compared to $2.7 million for the same period of 2008. The increase in this expense is directly related to deconversion costs for our upcoming systems conversion which occurred during the second quarter of 2010.
FDIC insurance premiums increased $2.0 million to $2.7 million for the year ended December 31, 2009 compared to $721,000 for the same period of 2008. The increase in FDIC insurance premiums is a due to the special assessment imposed during the second quarter of 2009 of $844,000, and changes to the assessment calculation during 2009 all a result of the FDIC's efforts in replenishing the levels of the Deposit Insurance Fund which has been depleted due to increasing levels of bank failures.
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Mortgage loan repurchases and settlements decreased to $2.6 million for 2009 compared to $3.8 million for 2008, a result of a decrease in loan repurchases and settlements at George Mason during 2009.
Income Taxes
We recorded a provision for income tax expense of $8.0 million for the year ended December 31, 2010, compared to $4.4 million for the year ended December 31, 2009. Our effective tax rate for December 31, 2010 was 30.3%, compared to 29.8% for 2009.
We recorded an income tax benefit of $912,000 for the year ended December 31, 2008. The income tax benefit recorded during 2008 was primarily the result of the other-than-temporary impairment of our investment in Fannie Mae perpetual preferred stock and the result of our tax-exempt income from investments being a larger portion of our overall net income. During 2008, the Emergency Economic Stabilization Act of 2008 was enacted which included a provision permitting banks to recognize the other-than-temporary impairment charge related to Fannie Mae perpetual preferred stock as an ordinary loss rather than a capital loss which allowed us to record an additional benefit for this loss.
For more information, see "Critical Accounting Policies" above. In addition, Note 13 to the notes to consolidated financial statements provides additional information with respect to the deferred tax accounts and the net operating loss carryforward.
Statements of Condition
Loans Receivable, Net
Total loans receivable, net of deferred fees and costs, were $1.41 billion at December 31, 2010, an increase of $115.9 million, or 9.0%, compared to $1.29 billion at December 31, 2009. During 2010, we achieved growth in all our loan categories, with the exception or our residential real estate loan portfolio. Residential real estate loans decreased $11.6 million to $217.1 million at December 31, 2010 compared $228.7 million at December 31, 2009, primarily a result of repayments that occurred during 2010. Loans held for sale increased $26.6 million to $206.0 million at December 31, 2010 compared to $179.5 million at December 31, 2009.
At December 31, 2010, we had loans accounted for on a non-accrual basis totaling $7.5 million. Non-accrual loans at December 31, 2009 totaled $696,000. Accruing loans, which are contractually past due 90 days or more as to principal or interest payments, at December 31, 2010 and December 31, 2009 were $49,000 and $151,000, respectively, all of which were determined to be well secured and in the process of collection. The increase in non-accrual loans from December 31, 2009 is primarily a result of the continued deterioration in commercial and residential real estate markets, as all of our non-accrual loans are collateralized by real estate. There were no loans at December 31, 2010 and December 31, 2009 that were "troubled debt restructurings".
Interest income on non-accrual loans, if recognized, is recorded when cash is received . When a loan is placed on non-accrual, unpaid interest is reversed against interest income if it was accrued in the current year and is charged to the allowance for loan losses if it was accrued in prior years. While on non-accrual, the collection of interest is recorded as interest income only after all past-due principal has been collected. When all past contractual obligations are collected and, in our opinion, the borrower has demonstrated the ability to remain current, the loan is returned to an accruing status. At December 31, 2010, the loans on nonaccrual status had a valuation allowance of $1.5 million. We charged-off $3.5 million during 2010 related to the outstanding principal balances of those impaired loans which were unsecured based on the estimated values of the underlying collateral. Gross interest income that would have been recorded if our non-accrual loans had been current with their original
61
terms and had been outstanding throughout the period or since origination if held for part of the period for the years ended December 31, 2010 and 2009 was $337,000 and $414,000, respectively. The interest income realized prior to the loans being placed on non-accrual status for the year ended December 31, 2010 and 2009 was $325,000, and $120,000, respectively.
Total loans receivable, net of deferred fees and costs, were $1.29 billion at December 31, 2009, an increase of $154.1 million, or 13.5%, compared to $1.14 billion at December 31, 2008. During 2009, we achieved growth in all our loan categories. Loans held for sale increased $22.5 million to $179.5 million at December 31, 2009 compared to $157.0 million at December 31, 2008.
At December 31, 2009, we had loans accounted for on a non-accrual basis totaling $696,000. Non-accrual loans at December 31, 2008 totaled $4.7 million. Accruing loans, which are contractually past due 90 days or more as to principal or interest payments, at December 31, 2009 and December 31, 2008 were $151,000 and $379,000, respectively, all of which were determined to be well secured and in the process of collection. The decrease in non-accrual loans from December 31, 2008 was a result of these loans being paid off or charged off during 2009. There were no loans at December 31, 2008 that were "troubled debt restructurings".
At December 31, 2009, the loans on nonaccrual status did not have a valuation allowance as we charged-off $411,000 of the outstanding principal balances which were unsecured based on the estimated values of the underlying collateral. Gross interest income that would have been recorded if our non-accrual loans had been current with their original terms and had been outstanding throughout the period or since origination if held for part of the period for the years ended December 31, 2009 and 2008 was $414,000 and $59,000, respectively. The interest income realized prior to the loans being placed on non-accrual status for the year ended December 31, 2009 and 2008 was $120,000, and $348,000, respectively.
The ratio of non-performing loans to total loans was 0.53%, 0.05%, and 0.41% at December 31, 2010, 2009 and 2008, respectively.
62
The following tables present the composition of our loans receivable portfolio at the end of each of the five years ended December 31, 2010 and additional information on non-performing loans receivable.
Table 8.
Loans Receivable
At December 31, 2010, 2009, 2008, 2007, and 2006
(In thousands)
|
2010 | 2009 | 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 200,384 | 14.20 | % | $ | 161,156 | 12.45 | % | $ | 160,989 | 14.12 | % | |||||||
Real estatecommercial |
631,292 | 44.73 | % | 592,780 | 45.80 | % | 472,131 | 41.41 | % | ||||||||||
Real estateconstruction |
240,007 | 17.01 | % | 191,523 | 14.80 | % | 188,484 | 16.53 | % | ||||||||||
Real estateresidential |
217,130 | 15.39 | % | 228,693 | 17.67 | % | 211,651 | 18.57 | % | ||||||||||
Home equity lines |
119,403 | 8.46 | % | 117,392 | 9.07 | % | 104,370 | 9.16 | % | ||||||||||
Consumer |
3,042 | 0.21 | % | 2,859 | 0.21 | % | 2,393 | 0.21 | % | ||||||||||
Gross loans |
1,411,258 | 100.00 | % | 1,294,403 | 100.00 | % | 1,140,018 | 100.00 | % | ||||||||||
Net deferred (fees) costs |
(1,956 | ) | (971 | ) | (670 | ) | |||||||||||||
Less: allowance for loan losses |
(24,210 | ) | (18,636 | ) | (14,518 | ) | |||||||||||||
Loans receivable, net |
$ | 1,385,092 | $ | 1,274,796 | $ | 1,124,830 | |||||||||||||
|
2007 | 2006 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 140,531 | 13.51 | % | $ | 102,284 | 12.09 | % | |||||
Real estatecommercial |
415,471 | 39.95 | % | 317,201 | 37.50 | % | |||||||
Real estateconstruction |
186,514 | 17.93 | % | 154,525 | 18.27 | % | |||||||
Real estateresidential |
213,197 | 20.50 | % | 201,320 | 23.80 | % | |||||||
Home equity lines |
81,247 | 7.81 | % | 65,557 | 7.75 | % | |||||||
Consumer |
3,129 | 0.30 | % | 4,904 | 0.59 | % | |||||||
Gross loans |
1,040,089 | 100.00 | % | 845,791 | 100.00 | % | |||||||
Net deferred (fees) costs |
(405 | ) | (342 | ) | |||||||||
Less: allowance for loan losses |
(11,641 | ) | (9,638 | ) | |||||||||
Loans receivable, net |
$ | 1,028,043 | $ | 835,811 | |||||||||
Table 9.
Nonperforming Loans
At December 31, 2010, 2009, 2008, 2007, and 2006
(In thousands)
|
2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Nonaccruing loans |
$ | 7,516 | $ | 696 | $ | 4,671 | $ | | $ | 82 | ||||||
Loans contractually past-due 90 days or more |
49 | 151 | 379 | 963 | | |||||||||||
Total nonperforming loans |
$ | 7,565 | $ | 847 | $ | 5,050 | $ | 963 | $ | 82 | ||||||
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The following table presents information on loan maturities and interest rate sensitivity.
Table 10.
Loan Maturities and Interest Rate Sensitivity
At December 31, 2010
(Dollars in thousands)
|
One Year or Less |
Between One and Five Years |
After Five Years |
Total | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 101,159 | $ | 82,511 | $ | 16,714 | $ | 200,384 | |||||
Real estatecommercial |
199,357 | 330,938 | 100,997 | 631,292 | |||||||||
Real estateconstruction |
167,655 | 46,685 | 25,667 | 240,007 | |||||||||
Real estateresidential |
102,848 | 86,239 | 28,043 | 217,130 | |||||||||
Home equity lines |
119,403 | | | 119,403 | |||||||||
Consumer |
912 | 740 | 1,390 | 3,042 | |||||||||
Total loans receivable |
$ | 691,334 | $ | 547,113 | $ | 172,811 | $ | 1,411,258 | |||||
Fixed-rate loans |
$ | 253,109 | $ | 121,835 | $ | 374,944 | |||||||
Floating-rate loans |
294,004 | 50,976 | 344,980 | ||||||||||
Total loans receivable |
$ | 547,113 | $ | 172,811 | $ | 719,924 | |||||||
- *
- Payments due by period are based on the repricing characteristics and not contractual maturities.
Investment Securities
Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and trading securities. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. Investment securities-trading are securities we purchase to economically hedge against fair value changes of our nonqualified deferred compensation plan liability. These securities include cash equivalents, equities and mutual funds. See Note 4 to our notes to consolidated financial statements for additional information on our trading securities. Investment securities were $345.0 million at December 31, 2010, a decrease of $37.5 million or 9.8%, from $382.5 million in investment securities at December 31, 2009.
At December 31, 2010, the yield on the available-for-sale investment portfolio was 4.26% and the yield on the held-to-maturity portfolio was 3.19%.
We complete reviews for other-than-temporary impairment at least quarterly. As of December 31, 2010, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. At December 31, 2010, 97% of our mortgage-backed securities are guaranteed by the Federal National Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).
We have $7.1 million in non-government non-agency mortgage-backed securities. These securities are rated from AAA to AA. The various protective elements on the non agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.
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At December 31, 2010, certain of our investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe it is probable that we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.
The held-to-maturity portfolio includes investments in four pooled trust preferred securities, totaling $8.0 million of par value at December 31, 2010 (each security has a par value of $2.0 million). These securities are presented as corporate bonds in the table below. The collateral underlying these structured securities are instruments issued by financial institutions or insurers. We own the A-3 tranches in each issuance. Each of the bonds is rated by more than one rating agency. Two of the securities have a composite rating of AA, one of the securities has a composite rating of BB- and the other security has a composite rating of B-. There is minimal observable trading activity for these types of securities. We have estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments recovering the amortized cost basis of each of the four securities, and concluded that these securities are not other-than-temporarily impaired. We continuously monitor the financial condition of the underlying issues and the level of subordination below the A-3 tranches. We also utilize a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches. In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows. Significant judgment is involved in the evaluation of other-than-temporary impairment. We do not intend to sell nor do we believe it is probable that we will be required to sell these corporate bonds prior to the recovery of our investment.
In one of the pooled trust preferred securities issues, 40% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $151 million of the remaining $318 million, or 48% of the performing collateral defaulted or deferred payment. In another of the pooled trust preferred securities issues, 41% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $90 million of the remaining $265 million, or 35% of the performing collateral defaulted or deferred payment. In the third of the pooled trust preferred securities issues, 64% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $149 million of the remaining $160 million, or 85% of the performing collateral defaulted or deferred payment. In the fourth of the pooled trust preferred securities issues, 46% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $277 million of the remaining $324 million, or 73% of the performing collateral defaulted or deferred payment.
No other-than-temporary impairment has been recognized on the securities in our investment portfolio as of December 31, 2010 and 2009, and we do not continue to hold any investment securities for which we previously recognized other-than-temporary impairment. During 2008, we recognized an other-than-temporary impairment of $4.4 million related to an investment in Fannie Mae perpetual preferred stock as discussed above.
We hold $15.7 million in FHLB stock at December 31, 2010. During 2008, the FHLB of Atlanta announced a change in their dividend declaration and payment schedule beginning during the fourth quarter of 2008. The change was initiated so that the dividend can be declared and paid to member banks after the FHLB has calculated their net income for the preceding quarter. During 2009, the
65
FHLB announced changes to its capital stock requirements. Specifically, the FHLB Board of Directors increased the dollar cap on its stock purchases from $25 million to $26 million and repurchases of member excess stock will be evaluated on a quarterly basis instead of a daily basis. We do not expect the above changes to materially impact our liquidity position.
Investment securities were $378.8 million at December 31, 2009, an increase of $63.2 million or 20.0%, from $315.5 million in investment securities at December 31, 2008.
Of the $378.8 million in the investment portfolio at December 31, 2009, $35.2 million were classified as held-to-maturity, and $343.6 million were classified as available-for-sale. At December 31, 2009, the yield on the available-for-sale investment portfolio was 4.55% and the yield on the held-to-maturity portfolio was 3.66%.
The following table reflects the composition of the investment portfolio at December 31, 2010, 2009, and 2008.
Table 11.
Investment Securities
At December 31, 2010, 2009 and 2008
(In thousands)
Available-for-sale at December 31, 2010
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
U.S. government-sponsored agencies |
||||||||||||
Five to ten years |
$ | 30,941 | $ | 32,119 | 3.95 | % | ||||||
Total U.S. government-sponsored agencies |
30,941 | 32,119 | 3.95 | % | ||||||||
Mortgage-backed securities(1) |
||||||||||||
One to five years |
7 | 7 | 9.02 | % | ||||||||
Five to ten years |
21,976 | 22,997 | 4.24 | % | ||||||||
After ten years |
190,600 | 196,478 | 4.54 | % | ||||||||
Total mortgage-backed securities |
212,583 | 219,482 | 4.51 | % | ||||||||
Tax exempt municipal securities(2) |
||||||||||||
Five to ten years |
7,063 | 7,198 | 3.38 | % | ||||||||
After ten years |
52,907 | 52,776 | 3.98 | % | ||||||||
Taxable municipal securities |
||||||||||||
Five to ten years |
3,318 | 3,320 | 4.96 | % | ||||||||
After ten years |
996 | 989 | 5.10 | % | ||||||||
Total municipal securities |
64,284 | 64,283 | 3.73 | % | ||||||||
U. S. treasury securities |
||||||||||||
One to five years |
4,923 | 5,114 | 2.36 | % | ||||||||
Total U.S. treasury securities |
4,923 | 5,114 | 2.36 | % | ||||||||
Total investment securities available-for-sale |
$ | 312,731 | $ | 320,998 | 4.26 | % | ||||||
66
Held-to-maturity at December 31, 2010
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Mortgage-backed securities(1) |
||||||||||||
One to five years |
$ | 351 | $ | 368 | 4.14 | % | ||||||
Five to ten years |
3,766 | 3,965 | 4.63 | % | ||||||||
After ten years |
9,758 | 10,203 | 4.12 | % | ||||||||
Total mortgage-backed securities |
13,875 | 14,536 | 4.26 | % | ||||||||
Corporate bonds |
||||||||||||
After ten years |
8,004 | 3,197 | 1.34 | % | ||||||||
Total corporate bonds |
8,004 | 3,197 | 1.34 | % | ||||||||
Total investment securities held-to-maturity |
21,879 | 17,733 | 3.19 | % | ||||||||
Total investment securities |
$ | 334,610 | $ | 338,731 | 4.19 | % | ||||||
Available-for-sale at December 31, 2009
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
U.S. government-sponsored agencies |
||||||||||||
Five to ten years |
$ | 26,074 | $ | 26,030 | 4.15 | % | ||||||
After ten years |
29,974 | 29,629 | 5.01 | % | ||||||||
Total U.S. government-sponsored agencies |
56,048 | 55,659 | 4.61 | % | ||||||||
Mortgage-backed securities(1) |
||||||||||||
One to five years |
9 | 9 | 8.97 | % | ||||||||
Five to ten years |
33,079 | 33,964 | 4.21 | % | ||||||||
After ten years |
184,635 | 189,432 | 4.84 | % | ||||||||
Total mortgage-backed securities |
217,723 | 223,405 | 4.74 | % | ||||||||
Tax exempt municipal securities(2) |
||||||||||||
Five to ten years |
6,090 | 6,156 | 3.34 | % | ||||||||
After ten years |
50,270 | 50,227 | 4.01 | % | ||||||||
Taxable municipal securities |
||||||||||||
After ten years |
3,331 | 3,225 | 4.96 | % | ||||||||
Total municipal securities |
59,691 | 59,608 | 3.99 | % | ||||||||
U. S. treasury securities |
||||||||||||
One to five years |
4,901 | 4,897 | 2.36 | % | ||||||||
Total U.S. treasury securities |
4,901 | 4,897 | 2.36 | % | ||||||||
Total investment securities available-for-sale |
$ | 338,363 | $ | 343,569 | 4.55 | % | ||||||
67
Held-to-maturity at December 31, 2009
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Mortgage-backed securities(1) |
||||||||||||
One to five years |
$ | 1,833 | $ | 1,884 | 4.43 | % | ||||||
Five to ten years |
6,244 | 6,478 | 4.59 | % | ||||||||
After ten years |
19,103 | 19,731 | 4.26 | % | ||||||||
Total mortgage-backed securities |
27,180 | 28,093 | 4.35 | % | ||||||||
Corporate bonds |
||||||||||||
After ten years |
8,004 | 3,343 | 1.33 | % | ||||||||
Total corporate bonds |
8,004 | 3,343 | 1.33 | % | ||||||||
Total investment securities held-to-maturity |
35,184 | 31,436 | 3.66 | % | ||||||||
Total investment securities |
$ | 373,547 | $ | 375,005 | 4.47 | % | ||||||
Available-for-sale at December 31, 2008
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
U.S. government-sponsored agencies |
||||||||||||
Five to ten years |
$ | 24,917 | $ | 24,962 | 5.28 | % | ||||||
After ten years |
436 | 166 | 8.25 | % | ||||||||
Total U.S. government-sponsored agencies |
25,353 | 25,128 | 5.33 | % | ||||||||
Mortgage-backed securities(1) |
||||||||||||
One to five years |
4,263 | 4,277 | 4.19 | % | ||||||||
Five to ten years |
42,503 | 43,626 | 4.45 | % | ||||||||
After ten years |
158,969 | 160,301 | 5.27 | % | ||||||||
Total mortgage-backed securities |
205,735 | 208,204 | 5.08 | % | ||||||||
Municipal securities(2) |
||||||||||||
After ten years |
33,265 | 31,424 | 4.09 | % | ||||||||
Total municipal securities |
33,265 | 31,424 | 4.09 | % | ||||||||
U. S. treasury securities |
||||||||||||
One to five years |
598 | 600 | 1.02 | % | ||||||||
Total U.S. treasury securities |
598 | 600 | 1.02 | % | ||||||||
Total investment securities available-for-sale |
$ | 264,951 | $ | 265,356 | 4.97 | % | ||||||
68
Held-to-maturity at December 31, 2008
|
Amortized Cost |
Fair Value |
Average Yield |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
U.S. government-sponsored agencies |
||||||||||||
One to five years |
$ | 2,001 | $ | 2,025 | 4.30 | % | ||||||
Total U.S. government-sponsored agencies |
2,001 | 2,025 | 4.30 | % | ||||||||
Mortgage-backed securities(1) |
||||||||||||
One to five years |
1,836 | 1,867 | 4.26 | % | ||||||||
Five to ten years |
9,267 | 9,463 | 4.45 | % | ||||||||
After ten years |
29,075 | 29,142 | 4.39 | % | ||||||||
Total mortgage-backed securities |
40,178 | 40,472 | 4.40 | % | ||||||||
Corporate bonds |
||||||||||||
After ten years |
8,004 | 3,262 | 4.09 | % | ||||||||
Total corporate bonds |
8,004 | 3,262 | 4.09 | % | ||||||||
Total investment securities held-to-maturity |
50,183 | 45,759 | 4.34 | % | ||||||||
Total investment securities |
$ | 315,134 | $ | 311,115 | 4.87 | % | ||||||
- (1)
- Based
on contractual maturities.
- (2)
- Yields for our tax-exempt municipal securities are not reported on a tax-equivalent basis.
Deposits and Other Borrowed Funds
Total deposits were $1.40 billion at December 31, 2010, an increase of $106.7 million, or 8.2%, from $1.30 billion at December 31, 2009. We have had success in attracting deposit balances from customers seeking to deposit their money with smaller, local banks and depositors are increasing balances held with financial institutions as a result of the increased protection of their money by the FDIC. We are a member of the Certificates of Deposit Account Registry Service ("CDARS"). CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank. When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection. At December 31, 2010, we had brokered certificates of deposit of $88.4 million, of which $43.5 million were placed in the CDARS program. Brokered certificates of deposit at December 31, 2009 were $87.7 million, of which $59.4 million were in the CDARS program.
Other borrowed funds, which primarily include repurchase agreements, FHLB advances and our payable to Cardinal Statutory Trust I, were $389.6 million at December 31, 2010, a decrease of $40.0 million, from $427.6 million at December 31, 2009. The primary reason for the decrease in other borrowed funds at December 31, 2010 was due to us not having any federal funds purchased fundings at December 31, 2010 compared to $45.0 million at December 31, 2009. Advances from the Federal Home Loan Bank of Atlanta were $280.0 million at each of December 31, 2010 and 2009. These advances primarily leverage some of our larger commercial real estate fundings and assist in financing George Mason's inventory of loans held for sale.
Other borrowed funds at each of December 31, 2010 and 2009, included $20.6 million payable to Cardinal Statutory Trust I, the issuer of our trust preferred securities. This debt had an interest rate of 2.70% and 2.65% at December 31, 2010 and 2009, respectively. Cardinal Statutory Trust I is an unconsolidated entity as we are not the primary beneficiary of the trust.
69
At December 31, 2010, other borrowed funds also included $87.5 million in customer repurchase agreements and $1.5 million borrowed under the Federal Reserve Treasury, Tax & Loan note option.
The following table reflects the short-term borrowings and other borrowed funds outstanding at December 31, 2010.
Table 12.
Short-Term Borrowings and Other Borrowed Funds
At December 31, 2010
(In thousands)
Advance Date
|
Term of Advance | Maturity or Call Date |
Interest Rate | Amount Outstanding |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Other short-term borrowed funds: |
|||||||||||||
TT&L note option |
0.00 | % | $ | 1,470 | |||||||||
Customer repurchase agreements |
0.25 | % | 87,497 | ||||||||||
Federal Funds Purchased |
0.28 | % | | ||||||||||
Total other short-term borrowed funds and weighted average rate |
0.25 | % | $ | 88,967 | |||||||||
Other borrowed funds: |
|||||||||||||
Trust preferred |
3.98 | % | $ | 20,619 | |||||||||
FHLB advanceslong term |
3.90 | % | 280,000 | ||||||||||
Other borrowed funds and weighted average rate |
3.91 | % | 300,916 | ||||||||||
Total other borrowed funds and weighted average rate |
3.07 | % | $ | 389,586 | |||||||||
Total deposits were $1.30 billion at December 31, 2009, an increase of $117.2 million, or 9.9%, from $1.18 billion at December 31, 2008. At December 31, 2009, we had brokered certificates of deposit of $87.7 million, of which $59.4 million were placed in the CDARS program. Brokered certificates of deposit at December 31, 2008 were $89.2 million, of which $53.5 million were in the CDARS program.
Other borrowed funds, which primarily include repurchase agreements, FHLB advances and our payable to Cardinal Statutory Trust I, were $427.6 million at December 31, 2009, an increase of $60.4 million, up from $367.2 million at December 31, 2008. The primary reason for the increase in other borrowed funds at December 31, 2009 was an increase in federal funds purchased funding of $45.0 million at December 31, 2009 compared to none at December 31, 2008. Advances from the Federal Home Loan Bank of Atlanta were $280.0 million at each of December 31, 2009 and 2008.
Other borrowed funds at each of December 31, 2009 and 2008, included $20.6 million payable to Cardinal Statutory Trust I, the issuer of our trust preferred securities. This debt had an interest rate of 2.65% and 4.40% at December 31, 2009 and 2008, respectively.
At December 31, 2009, other borrowed funds also included $80.0 million in customer repurchase agreements and $2.0 million borrowed under the Federal Reserve Treasury, Tax & Loan note option.
70
The following table reflects the maturities of the certificates of deposit of $100,000 or more as of December 31, 2010, 2009 and 2008.
Table 13.
Certificates of Deposit of $100,000 or More
At December 31, 2010, 2009, and 2008
(In thousands)
Maturities:
|
Fixed Term | 2010 No-Penalty* |
Total | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Three months or less |
$ | 60,347 | $ | 16,341 | $ | 76,688 | ||||
Over three months through six months |
47,109 | 5,224 | 52,333 | |||||||
Over six months through twelve months |
81,625 | 16,344 | 97,969 | |||||||
Over twelve months |
121,368 | 20,494 | 141,862 | |||||||
|
$ | 310,449 | $ | 58,403 | $ | 368,852 | ||||
Maturities:
|
Fixed Term | 2009 No-Penalty* |
Total | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Three months or less |
$ | 116,527 | $ | 31,183 | $ | 147,710 | ||||
Over three months through six months |
44,528 | 10,394 | 54,922 | |||||||
Over six months through twelve months |
66,064 | 3,190 | 69,254 | |||||||
Over twelve months |
95,185 | 20,917 | 116,102 | |||||||
|
$ | 322,304 | $ | 65,684 | $ | 387,988 | ||||
Maturities:
|
Fixed Term | 2008 No-Penalty* |
Total | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Three months or less |
$ | 35,561 | $ | 68,190 | $ | 103,751 | ||||
Over three months through six months |
19,705 | 12,089 | 31,794 | |||||||
Over six months through twelve months |
27,095 | 5,614 | 32,709 | |||||||
Over twelve months |
71,433 | 1,585 | 73,018 | |||||||
|
$ | 153,794 | $ | 87,478 | $ | 241,272 | ||||
- *
- No-Penalty certificates of deposit can be redeemed at anytime at the request of the depositor.
Business Segment Operations
We provide banking and non-banking financial services and products through our subsidiaries. We operate in three business segments, commercial banking, mortgage banking and wealth management and trust services.
The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment also provides customers with various deposit products including demand deposit accounts, savings accounts and certificates of deposit.
The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis.
The wealth management and trust services segment provides investment and financial services to businesses and individuals, including financial planning, retirement/estate planning, trusts, estates, custody, investment management, escrows, and retirement plans.
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Information about the reportable segments, and reconciliation of this information to the consolidated financial statements at December 31, 2010, 2009 and 2008 follows.
Table 14.
Segment Reporting
December 31, 2010, 2009, and 2008
(In thousands)
At and for the Year Ended December 31, 2010:
|
Commercial Banking |
Mortgage Banking |
Wealth Management and Trust Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 67,480 | $ | 2,385 | $ | | $ | (820 | ) | $ | | $ | 69,045 | ||||||
Provision for loan losses |
10,502 | | | | | 10,502 | |||||||||||||
Non-interest income |
3,975 | 19,203 | 4,102 | 205 | (96 | ) | 27,389 | ||||||||||||
Non-interest expense |
37,226 | 11,103 | 6,798 | 4,438 | (96 | ) | 59,469 | ||||||||||||
Provision (benefit) for income taxes |
7,432 | 3,640 | (942 | ) | (2,109 | ) | | 8,021 | |||||||||||
Net income (loss) |
$ | 16,295 | $ | 6,845 | $ | (1,754 | ) | $ | (2,944 | ) | $ | | $ | 18,442 | |||||
Total Assets |
$ | 2,051,529 | $ | 220,946 | $ | 592 | $ | 251,100 | $ | (452,149 | ) | $ | 2,072,018 |
At and for the Year Ended December 31, 2009:
|
Commercial Banking |
Mortgage Banking |
Wealth Management and Trust Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 48,712 | $ | 2,717 | $ | | $ | (887 | ) | $ | | $ | 50,542 | ||||||
Provision for loan losses |
6,656 | 94 | | | | 6,750 | |||||||||||||
Non-interest income |
3,993 | 16,213 | 3,639 | (413 | ) | (84 | ) | 23,348 | |||||||||||
Non-interest expense |
34,104 | 12,779 | 3,156 | 2,472 | (84 | ) | 52,427 | ||||||||||||
Provision (benefit) for income taxes |
3,566 | 2,084 | 162 | (1,424 | ) | | 4,388 | ||||||||||||
Net income (loss) |
$ | 8,379 | $ | 3,973 | $ | 321 | $ | (2,348 | ) | $ | | $ | 10,325 | ||||||
Total Assets |
$ | 1,943,223 | $ | 199,704 | $ | 3,433 | $ | 230,962 | $ | (401,137 | ) | $ | 1,976,185 |
At and for the Year Ended December 31, 2008:
|
Commercial Banking |
Mortgage Banking |
Wealth Management and Trust Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 40,747 | $ | 3,418 | $ | | $ | (1,192 | ) | $ | | $ | 42,973 | ||||||
Provision for loan losses |
4,290 | 1,208 | | | | 5,498 | |||||||||||||
Non-interest income |
4,806 | 9,494 | 3,477 | 35 | | 17,812 | |||||||||||||
Non-interest expense |
34,152 | 15,824 | 3,402 | 2,535 | | 55,913 | |||||||||||||
Provision (benefit) for income taxes |
1,785 | (1,438 | ) | 28 | (1,287 | ) | | (912 | ) | ||||||||||
Net income (loss) |
$ | 5,326 | $ | (2,682 | ) | $ | 47 | $ | (2,405 | ) | $ | | $ | 286 | |||||
Total Assets |
$ | 1,708,233 | $ | 165,791 | $ | 3,505 | $ | 180,683 | $ | (314,455 | ) | $ | 1,743,757 |
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During the year ended December 31, 2010, we recorded a non-cash impairment loss of $3.0 million pretax ($2.0 million after tax) through the wealth management and trust services business segment. No such impairments occurred during 2009 and 2008.
We recorded a benefit of $686,000 related to our mortgage loan repurchases and settlements for 2010 compared to an expense of $2.6 million for 2009 and $3.8 million in 2008. During the second quarter of 2008, George Mason recorded a cash settlement to one of its mortgage correspondents related to the loan purchase agreement between the two parties. This settlement totaled $1.8 million pretax ($1.2 million after tax) and was recorded in the mortgage banking segment.
During the third quarter of 2008, we recorded a noncash impairment charge of $2.8 million pretax ($1.8 million after tax) to the goodwill associated with the mortgage banking segment. No such impairments occurred during 2010 and 2009.
During the third quarter of 2008, we recognized an other-than-temporary impairment charge of $4.4 million pretax ($2.9 million after tax) on our investment in Fannie Mae perpetual preferred stock. This impairment charge was recorded in the commercial banking segment. We recorded no other-than-temporary impairments during 2010 and 2009.
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of a financial institution. The guidelines define capital as both Tier 1 (which includes common shareholders' equity, defined to include certain debt obligations) and Tier 2 (to include certain other debt obligations and a portion of the allowance for loan losses and 45% of unrealized gains in equity securities).
Shareholders' equity at December 31, 2010 was $222.9 million, an increase of $18.4 million, compared to $204.5 million at December 31, 2009. For the year ended December 31, 2010, we recorded net income of $18.4 million, which primarily caused the increase in shareholders' equity during 2010. Accumulated other comprehensive income increased $1.1 million for the year ended December 31, 2010. Total shareholders' equity to total assets at December 31, 2010 and 2009 was 10.8% and 10.4%, respectively. Book value per share at December 31, 2010 and 2009 was $7.75 and $7.12, respectively. Total risk-based capital to risk-weighted assets was 14.06% at December 31, 2010 compared to 14.15% at December 31, 2009. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2010.
Shareholders' equity at December 31, 2009 was $204.5 million, an increase of $46.5 million, compared to $158.0 million at December 31, 2008. The increase in shareholders' equity was primarily attributable to our completion of a common stock offering during May 2009, from which we added $31.6 million in capital. In addition, for 2009 we recorded net income of $10.3 million. Accumulated other comprehensive income increased $3.4 million for the year ended December 31, 2009. Total shareholders' equity to total assets at December 31, 2009 and 2008 was 10.4% and 9.1%, respectively. Book value per share at December 31, 2009 and 2008 was $7.12 and $6.58, respectively. Total risk-based capital to risk-weighted assets was 14.15% at December 31, 2009 compared to 12.72% at December 31, 2008. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2009.
As noted above, regulatory capital levels for the bank and bank holding company meet those established for well-capitalized institutions. While we are currently considered well-capitalized, we may
73
from time-to-time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.
The following table shows the minimum capital requirement and our capital position at December 31, 2010, 2009, and 2008, for the Company and for the Bank.
Table 15.
Capital Components
At December 31, 2010, 2009, and 2008
(In thousands)
Cardinal Financial Corporation (Consolidated):
|
Actual | For Capital Adequacy Purposes |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||
At December 31, 2010 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 248,294 | 14.06 | % | $ | 141,284 | ³ | 8.00 | % | $ | 176,606 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
223,789 | 12.67 | % | 70,642 | ³ | 4.00 | % | 105,963 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
223,789 | 10.82 | % | 82,753 | ³ | 4.00 | % | 103,441 | ³ | 5.00 | % | ||||||||||||
At December 31, 2009 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 226,137 | 14.15 | % | $ | 127,869 | ³ | 8.00 | % | $ | 159,837 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
207,286 | 12.97 | % | 63,935 | ³ | 4.00 | % | 95,902 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
207,286 | 11.03 | % | 75,185 | ³ | 4.00 | % | 93,981 | ³ | 5.00 | % | ||||||||||||
At December 31, 2008 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 178,420 | 12.72 | % | $ | 112,207 | ³ | 8.00 | % | $ | 140,259 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
163,716 | 11.67 | % | 56,104 | ³ | 4.00 | % | 84,156 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
163,716 | 9.90 | % | 66,168 | ³ | 4.00 | % | 82,711 | ³ | 5.00 | % |
Cardinal Bank:
|
Actual | For Capital Adequacy Purposes |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||
At December 31, 2010 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 232,274 | 13.25 | % | $ | 140,262 | ³ | 8.00 | % | $ | 175,328 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
207,768 | 11.85 | % | 70,131 | ³ | 4.00 | % | 105,197 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
207,768 | 10.09 | % | 82,383 | ³ | 4.00 | % | 102,979 | ³ | 5.00 | % | ||||||||||||
At December 31, 2009 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 206,413 | 12.98 | % | $ | 127,257 | ³ | 8.00 | % | $ | 159,071 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
187,562 | 11.79 | % | 63,629 | ³ | 4.00 | % | 95,443 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
187,562 | 10.02 | % | 74,884 | ³ | 4.00 | % | 93,605 | ³ | 5.00 | % | ||||||||||||
At December 31, 2008 |
|||||||||||||||||||||||
Total risk-based capital |
$ | 168,513 | 12.04 | % | $ | 111,957 | ³ | 8.00 | % | $ | 139,946 | ³ | 10.00 | % | |||||||||
Tier I risk-based capital |
153,810 | 10.99 | % | 55,978 | ³ | 4.00 | % | 83,968 | ³ | 6.00 | % | ||||||||||||
Leverage capital ratio |
153,810 | 9.32 | % | 66,018 | ³ | 4.00 | % | 82,523 | ³ | 5.00 | % |
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Liquidity
Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service and pricing.
In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered CD market, the repurchase agreement market and the federal funds market. During 2008, we joined the Certificates of Deposit Account Registry Services ("CDARS"). CDARS allows our customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank. When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection. We also maintain secured lines of credit with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta. Having diverse funding alternatives reduces our reliance on any one source for funding.
Cash flow from amortizing assets or maturing assets can also provide funding to meet the needs of depositors and borrowers.
We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. In addition, one stress test combines all other stress tests to see how liquidity would react to several negative scenarios occurring at the same time. We believe that we have sufficient resources to meet our liquidity needs.
Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $348.9 million at December 31, 2010, or 16.7% of total assets. We held investments that are classified as held-to-maturity in the amount of $21.9 million at December 31, 2010. To maintain ready access to the Bank's secured lines of credit, the Bank has pledged roughly half of its investment securities and a portion of its residential real estate loan portfolio to the Federal Home Loan Bank of Atlanta with additional investment securities and certain loans in its commercial real estate and commercial & industrial loan portfolios pledged to the Federal Reserve Bank of Richmond. Additional borrowing capacity at the Federal Home Loan Bank of Atlanta at December 31, 2010 was approximately $154 million. Borrowing capacity with the Federal Reserve Bank of Richmond was approximately $107 million at December 31, 2010. These facilities are subject to the FHLB and the Federal Reserve approving disbursement to us. In addition, we have unsecured federal funds purchased lines of $315 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.
Contractual Obligations
We have entered into a number of long-term contractual obligations to support our ongoing activities. These contractual obligations will be funded through operating revenues and liquidity sources
75
held or available to us. The required payments under such obligations excluding interest were as follows:
Table 16.
Contractual Obligations
At December 31, 2010
(In thousands)
|
Payments Due by Period | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Total | Less than 1 Year |
1-3 Years | 3-5 Years | More than 5 Years |
||||||||||||
Long-Term Debt Obligations: |
|||||||||||||||||
Certificates of deposit |
$ | 571,070 | $ | 303,361 | $ | 103,880 | $ | 135,487 | $ | 28,342 | |||||||
Brokered certificates of deposit |
88,365 | 44,663 | 24,645 | 19,057 | | ||||||||||||
Advances from the Federal Home Loan Bank of Atlanta |
280,000 | 15,000 | 90,000 | 20,000 | 155,000 | ||||||||||||
Trust preferred securities |
20,619 | | | | 20,619 | ||||||||||||
Operating lease obligations |
29,065 | 4,369 | 3,448 | 8,967 | 12,281 | ||||||||||||
Total |
$ | 989,119 | $ | 367,393 | $ | 221,973 | $ | 183,511 | $ | 216,242 | |||||||
Financial Instruments with Off-Balance-Sheet Risk and Credit Risk
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.
Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.
The Bank's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
A summary of the contract amount of the Bank's exposure to off-balance-sheet risk as of December 31, 2010 and 2009, is as follows:
|
2010 | 2009 | ||||||
---|---|---|---|---|---|---|---|---|
|
(In thousands) |
|||||||
Financial instruments whose contract amounts represent potential credit risk: |
||||||||
Commitments to extend credit |
$ | 526,636 | $ | 409,341 | ||||
Standby letters of credit |
22,279 | 13,877 |
76