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EX-32.1 - SECTION 906 CEO CERTIFICATION - VIRGINIA COMMERCE BANCORP INCdex321.htm
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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2011

or

 

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

For the transition period from              to             

Commission file number 000-28635

 

 

VIRGINIA COMMERCE BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

VIRGINIA   54-1964895

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

5350 LEE HIGHWAY, ARLINGTON, VIRGINIA 22207

(Address of principal executive offices) (Zip Code)

703-534-0700

(Registrant’s telephone number, including area code)

N/A

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

 

 

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

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

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

As of May 9, 2011, the number of outstanding shares of registrant’s common stock, par value $1.00 per share, was: 29,644,925.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

           Page  

PART I – FINANCIAL INFORMATION

  
ITEM 1.    FINANCIAL STATEMENTS   
   Consolidated Balance Sheets – March 31, 2011 (unaudited) and December 31, 2010      3   
   Consolidated Statements of Income (unaudited) – Three months ended March 31, 2011 and 2010      4   
   Consolidated Statements of Changes in Stockholders’ Equity (unaudited) – Three months ended March 31, 2011 and 2010      5   
   Consolidated Statements of Cash Flows (unaudited) – Three months ended March 31, 2011 and 2010      6   
   Notes to Consolidated Financial Statements (unaudited)      7   
ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      25   
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      43   
ITEM 4.    CONTROLS AND PROCEDURES      44   

PART II – OTHER INFORMATION

  
ITEM 1.    LEGAL PROCEEDINGS      44   
ITEM 1A.    RISK FACTORS      44   
ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS      44   
ITEM 3.    DEFAULTS UPON SENIOR SECURITIES      44   
ITEM 4.    (REMOVED AND RESERVED)      44   
ITEM 5.    OTHER INFORMATION      44   
ITEM 6.    EXHIBITS      45   
SIGNATURES      46   

 

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share and per share data)

 

     (Unaudited)
March 31,
2011
    (Audited)
December 31,
2010
 

Assets

    

Cash and due from banks

   $ 41,089      $ 36,932   

Federal funds sold

     85,399        10,455   

Investment securities (fair value: 2011, $418,122; 2010, $412,653)

     417,072        411,761   

Restricted stocks, at cost

     11,751        11,751   

Loans held-for-sale

     4,650        10,049   

Loans, net of allowance for loan losses of $56,465 in 2011 and $62,442 in 2010

     2,122,309        2,149,591   

Bank premises and equipment, net

     11,666        12,000   

Accrued interest receivable

     10,832        10,003   

Other real estate owned, net of valuation allowance of $6,543 in 2011 and $6,782 in 2010

     18,879        17,165   

Other assets

     59,986        71,941   
                

Total assets

   $ 2,783,633      $ 2,741,648   
                

Liabilities and Stockholders’ Equity

    

Deposits

    

Demand deposits

   $ 290,385      $ 264,744   

Savings and interest-bearing demand deposits

     1,187,395        1,201,288   

Time deposits

     779,190        781,169   
                

Total deposits

   $ 2,256,970      $ 2,247,201   

Securities sold under agreement to repurchase and federal funds purchased

     177,732        152,726   

Other borrowed funds

     25,000        25,000   

Trust preferred capital notes

     66,378        66,314   

Accrued interest payable

     2,753        2,751   

Other liabilities

     1,427        2,062   

Commitments and contingencies

     —          —     
                

Total liabilities

   $ 2,530,260      $ 2,496,054   
                

Stockholders’ Equity

    

Preferred stock, net of discount, $1.00 par, 1,000,000 shares authorized, Series A; $1,000 stated value; 71,000 issued and outstanding in 2011 and 2010

   $ 65,873      $ 65,445   

Common stock, $1.00 par, 50,000,000 shares authorized, issued and outstanding 2011, 29,552,737 including 38,748 in unvested restricted stock issued; 2010, 28,962,935

     29,514        28,954   

Surplus

     107,372        105,056   

Warrants

     8,520        8,520   

Retained earnings

     42,859        39,208   

Accumulated other comprehensive loss, net

     (765     (1,589
                

Total stockholders’ equity

   $ 253,373      $ 245,594   
                

Total liabilities and stockholders’ equity

   $ 2,783,633      $ 2,741,648   
                

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

 

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Table of Contents

VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands of dollars except per share data)

(Unaudited)

 

     Three Months Ended March 31,  
     2011     2010  

Interest and dividend income:

    

Interest and fees on loans

   $ 31,923      $ 32,905   

Interest and dividends on investment securities:

    

Taxable

     2,861        3,280   

Tax-exempt

     592        426   

Dividend on restricted stocks

     96        88   

Interest on federal funds sold

     45        28   
                

Total interest and dividend income

   $ 35,517      $ 36,727   
                

Interest expense:

    

Deposits

   $ 7,023      $ 9,428   

Securities sold under agreement to repurchase and federal funds purchased

     934        989   

Other borrowed funds

     266        266   

Trust preferred capital notes

     1,111        1,228   
                

Total interest expense

   $ 9,334      $ 11,911   
                

Net interest income

   $ 26,183      $ 24,816   

Provision for loan losses

     5,843        4,238   
                

Net interest income after provision for loan losses

   $ 20,340      $ 20,578   
                

Non-interest income:

    

Service charges and other fees

   $ 792      $ 876   

Non-deposit investment services commissions

     253        129   

Fees and net gains on loans held-for-sale

     521        346   

Gain on sale of securities available-for-sale

     503        —     

Total other-than-temporary impairment losses

     (2,948     (4,466

Portion of loss recognized in other comprehensive income

     2,216        3,615   
                

Net impairment losses

     (732     (851

Other

     139        107   
                

Total non-interest income

   $ 1,476      $ 607   
                

Non-interest expense:

    

Salaries and employee benefits

   $ 6,659      $ 5,995   

Occupancy expense

     2,470        2,710   

FDIC insurance

     1,289        1,309   

Loss on other real estate owned

     156        918   

Franchise tax expense

     772        717   

Data processing

     655        674   

Other operating expense

     2,449        2,384   
                

Total non-interest expense

   $ 14,450      $ 14,707   
                

Income before taxes

   $ 7,366      $ 6,478   

Provision for income taxes

     2,400        2,009   
                

Net income

   $ 4,966      $ 4,469   
                

Effective dividend on preferred stock

     1,315        1,250   
                

Net income available to common stockholders

   $ 3,651      $ 3,219   
                

Earnings per common share, basic

   $ 0.13      $ 0.12   

Earnings per common share, diluted

   $ 0.12      $ 0.11   

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

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the three months ended March 31, 2011 and 2010

(In thousands of dollars)

(Unaudited)

 

     Preferred
Stock
     Common
Stock
     Surplus      Warrants      Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Comprehensive
Income
    Total
Stockholders’
Equity
 

Balance, January 1, 2010

   $ 63,993       $ 26,745       $ 96,588       $ 8,520       $ 22,671      $ 351        $ 218,868   

Comprehensive Income:

                    

Net income

                 4,469        $ 4,469        4,469   

Other comprehensive income:

                    

reclassification adjustment for impairment loss on securities (net of tax of $298)

                   553        553        553   

unrealized holding gains arising during the period (net of tax of $424)

                   787        787        787   
                          

Total comprehensive income

                   $ 5,809     
                          

Stock options exercised

     —           189         118         —           —          —            307   

Stock option expense

     —           —           162         —           —          —            162   

Discount on preferred stock

     363         —           —           —           (363     —            —     

Dividend on preferred stock

     —           —           —           —           (887     —            (887
                                                              

Balance, March 31, 2010

   $ 64,356       $ 26,934       $ 96,868       $ 8,520       $ 25,890      $ 1,691        $ 224,259   
                                                              

Balance, January 1, 2011

   $ 65,445       $ 28,954       $ 105,056       $ 8,520       $ 39,208      $ (1,589     $ 245,594   

Comprehensive Income:

                    

Net income

                 4,966        $ 4,966        4,966   

Other comprehensive income:

                    

reclassification adjustment for impairment loss on securities (net of tax of $256)

                   476        476        476   

reclassification adjustment for gain on securities (net of tax of $176)

                   (327     (327     (327

unrealized holding gains arising during the period (net of tax of $363)

                   675        675        675   
                          

Total comprehensive income

                   $ 5,790     
                          

Common stock issued

        426         2,075                  2,501   

Stock options exercised

     —           134         109         —           —          —            243   

Stock option expense

     —           —           132         —           —          —            132   

Discount on preferred stock

     428         —           —           —           (428     —            —     

Dividend on preferred stock

     —           —           —           —           (887     —            (887
                                                              

Balance, March 31, 2011

   $ 65,873       $ 29,514       $ 107,372       $ 8,520       $ 42,859      $ (765     $ 253,373   
                                                              

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

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

 

    

Three Months Ended

March 31,

 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 4,966      $ 4,469   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     566        701   

Provision for loan losses

     5,843        4,238   

Stock based compensation expense

     132        162   

Deferred tax expense (benefit)

     3,175        (1,894

Accretion of trust preferred securities discount

     64        64   

Amortization of premiums and accretion of security discounts, net

     202        147   

Origination of loans held-for-sale

     (24,023     (18,668

Sales of loans

     28,986        21,909   

Gain on sale of loans

     436        246   

Loss on other real estate owned

     156        918   

Gain on sale of securities available-for-sale

     (503     —     

Impairment loss on securities

     732        851   

Changes in other assets and other liabilities:

    

(Increase) decrease in accrued interest receivable

     (829     524   

Decrease in other assets

     7,834        4,447   

Decrease in other liabilities

     (635     (754

Increase in accrued interest payable

     2        —     
                

Net Cash Provided by Operating Activities

   $ 27,104      $ 17,360   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease in loans

     18,464        2,669   

Purchase of securities available-for-sale

     (34,823     (40,893

Proceeds from principal payments on securities available-for-sale

     12,608        13,884   

Proceeds from principal payments on securities held-to-maturity

     1,520        1,962   

Proceeds from calls and maturities of securities available-for-sale

     3,503        39,786   

Proceeds from calls and maturities of securities held-to-maturity

     575        747   

Proceeds from sale of securities available-for-sale

     12,645        —     

Purchase of bank premises and equipment

     (232     (160

Proceeds from sale of other real estate owned

     1,105        —     
                

Net Cash Provided By Investing Activities

   $ 15,365      $ 17,995   
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase in deposits

   $ 9,769      $ 70,662   

Net increase in repurchase agreements and Federal funds purchased

     25,006        2,344   

Net proceeds from exercise of stock options and warrants

     243        307   

Net proceeds from issuance of common stock

     2,501        —     

Dividend paid on preferred stock

     (887     (887
                

Net Cash Provided by Financing Activities

   $ 36,632      $ 72,426   
                

Net Increase In Cash and Cash Equivalents

     79,101        107,781   

CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD

     47,387        25,211   
                

CASH AND CASH EQUIVALENTS - END OF PERIOD

   $ 126,488      $ 132,992   
                

Supplemental Schedule of Noncash Investing Activities:

    

Unrealized gain on available-for-sale securities

   $ 1,267      $ 2,062   

Tax benefits on stock options exercised

     37        32   

Other real estate owned transferred from loans

     2,975        450   

Supplemental Disclosure of Cash Flow Information:

    

Taxes Paid

   $ —        $ —     

Interest Paid

     9,332        12,229   

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

 

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VIRGINIA COMMERCE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. General

The accompanying unaudited consolidated financial statements of Virginia Commerce Bancorp, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications consisting of a normal and recurring nature considered necessary to present fairly the financial positions as of March 31, 2011 and December 31, 2010, the results of operations for the three months ended March 31, 2011 and 2010, and statements of cash flows and stockholders’ equity for the three months ended March 31, 2011 and 2010. These statements should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2010. In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued. Management has concluded there were no material subsequent events to be disclosed at this time.

Operating results for the three month periods ended March 31, 2011, are not necessarily indicative of the results that may be expected for the year ending December 31, 2011, or any other period.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurements and Disclosures” Topic 820 of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

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

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities and certain non-financial assets generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

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

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

 

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

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

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

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

The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis for March 31, 2011 and December 31, 2010, respectively:

 

            Fair Value Measurements at March 31, 2011 Using  

(in thousands)

Description

   Balance as of
March 31,
2011
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Available-for-sale securities

           

U.S. Government Agency obligations

   $ 316,871       $ —         $ 316,871       $ —     

Pooled trust preferred securities

   $ 444       $ —         $ 444       $ —     

Obligations of states and political subdivisions

   $ 64,581       $ —         $ 64,581       $ —     

 

            Fair Value Measurements at December 31, 2010 Using  

(in thousands)

Description

   Balance as of
December 31,
2010
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Available-for-sale securities

           

U.S. Government Agency obligations

   $ 310,610       $ —         $ 310,610       $ —     

Pooled trust preferred securities

   $ 430       $ —         $ 430       $ —     

Obligations of states and political subdivisions

   $ 63,463       $ —         $ 63,463       $ —     

At March 31, 2011 and December 31, 2010, the Company did not have any liabilities measured at fair value on a recurring basis.

 

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

Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended March 31, 2011, and December 31, 2010. Gains and losses on the sale of loans are recognized in fees and net gains on loans held-for-sale on the Consolidated Statements of Income.

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

Other Real Estate Owned / Foreclosed Assets: Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at the lesser of book value or fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation are included in net expenses for foreclosed assets.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis for March 31, 2011 and December 31, 2010, respectively:

 

            Carrying value at March 31, 2011  

(in thousands)

Description

   Balance as of
March 31,
2011
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Impaired loans

   $ 90,133       $ —         $ 77,702       $ 12,431   

Other real estate owned

   $ 18,879       $ —         $ 17,111       $ 1,768   

 

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            Carrying value at December 31, 2010  

(in thousands)

Description

   Balance as of
March 31,
2011
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Impaired loans

   $ 88,764       $ —         $ 77,061       $ 11,703   

Other real estate owned

   $ 17,165       $ —         $ 17,127       $ 38   

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

Cash and Short-Term Investments

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

Securities

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

Loans Held-for-Sale

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

Loan Receivables

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

Deposits and Borrowings

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

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments

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

 

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At March 31, 2011 and December 31, 2010, the fair value of loan commitments and stand-by letters of credit were deemed immaterial, and therefore, are not included in the table below.

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

 

     March 31, 2011      December 31, 2010  

(Dollars in thousands)

   Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial assets:

           

Cash and short-term investments

   $ 126,488       $ 126,488       $ 47,387       $ 47,387   

Securities

     417,072         418,122         411,761         412,653   

Restricted stock

     11,751         11,751         11,751         11,751   

Loans held-for-sale

     4,650         4,650         10,049         10,049   

Loan receivables

     2,122,309         2,185,472         2,149,591         2,224,687   

Accrued interest receivable

     10,832         10,832         10,003         10,003   
     March 31, 2011      December 31, 2010  

(Dollars in thousands)

   Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial liabilities:

           

Deposits

   $ 2,256,970       $ 2,158,902       $ 2,247,201       $ 2,206,542   

Securities sold under agreements to repurchase and federal funds purchased

     177,732         197,370         152,726         173,105   

Other borrowed funds

     25,000         25,475         25,000         25,533   

Trust preferred capital notes

     66,378         81,221         66,314         81,461   

Accrued interest payable

     2,753         2,753         2,751         2,751   

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

 

2. Investment Securities

Amortized cost and fair value of the securities available-for-sale and held-to-maturity as of March 31, 2011 and December 31, 2010, are as follows (dollars in thousands):

 

March 31, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
(Losses)
    Fair Value  

Available-for-sale:

          

U.S. Government Agency obligations

   $ 314,743       $ 4,353       $ (2,225   $ 316,871   

Pooled trust preferred securities

     5,272         —           (4,828     444   

Obligations of states and political subdivisions

     63,061         1,817         (297     64,581   
                                  
   $ 383,076       $ 6,170       $ (7,350   $ 381,896   

Held-to-maturity:

          

U.S. Government Agency obligations

   $ 5,459       $ 275       $ —        $ 5,734   

Obligations of state and political subdivisions

     29,717         916         (141     30,492   
                                  
   $ 35,176       $ 1,191       $ (141   $ 36,226   
                                  

 

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December 31, 2010

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
(Losses)
    Fair Value  

Available-for-sale:

          

U.S. Government Agency obligations

   $ 307,973       $ 5,527       $ (2,890   $ 310,610   

Pooled trust preferred securities

     5,919         —           (5,489     430   

Obligations of states and political subdivisions

     63,051         1,077         (665     63,463   
                                  
   $ 376,943       $ 6,604       $ (9,044   $ 374,503   

Held-to-maturity:

          

U.S. Government Agency obligations

   $ 6,113       $ 309       $ —        $ 6,422   

Obligations of state and political subdivisions

     31,145         827         (244     31,728   
                                  
   $ 37,258       $ 1,136       $ (244   $ 38,150   
                                  

The amortized cost of securities pledged as collateral for repurchase agreements, certain public deposits, and other purposes was $223.7 million and $258.2 million at March 31, 2011 and December 31, 2010, respectively.

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

Provided below is a summary of all securities which were in an unrealized loss position at March 31, 2011 and December 31, 2010, that were evaluated for other-than-temporary impairment, and deemed to not have an other-than-temporary impairment. Presently, the Company does not intend to sell any of these securities, does not expect to be required to sell these securities, and expects to recover the entire amortized cost of all the securities. For U.S. Government Agency obligations and obligations of states and political subdivisions, the unrealized losses result from market or interest rate risk, while the unrealized losses pertaining to the pooled trust preferred securities are due to both performance and credit ratings, as well as interest rate risk.

 

March 31, 2011

   Less Than 12 Months     12 Months or Longer     Total  

(Dollars in thousands)

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

Available-for-sale:

               

U.S. Government Agency obligations

   $ 141,973       $ (2,225   $ —         $ —        $ 141,973       $ (2,225

Pooled trust preferred securities

     —           —          444         (4,828     444         (4,828

Obligations of states and political subdivisions

     10,233         (297     —           —          10,233         (297
                                                   
   $ 152,206       $ (2,522   $ 444       $ (4,828   $ 152,650       $ (7,350
                                                   

Held-to maturity:

               

Obligations of states and political subdivisions

   $ 1,359       $ (141   $ —         $ —        $ 1,359       $ (141

 

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Table of Contents

December 31, 2010

   Less Than 12 Months     12 Months or Longer     Total  

(Dollars in thousands)

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

Available-for-sale:

               

U.S. Government Agency obligations

   $ 124,111       $ (2,890   $ —         $ —        $ 124,111       $ (2,890

Pooled trust preferred securities

     —           —          430         (5,489     430         (5,489

Obligations of states and political subdivisions

     22,579         (665     —           —          22,579         (665
                                                   
   $ 146,690       $ (3,555   $ 430       $ (5,489   $ 147,120       $ (9,044
                                                   

Held-to-maturity:

               

Obligations of states and political subdivisions

   $ 4,608       $ (244   $ —         $ —        $ 4,608       $ (244

As of March 31, 2011 the Company had three pooled trust preferred securities that were deemed to be other-than-temporarily impaired (“OTTI”) based on a present value analysis of expected future cash flows. The following table provides further information on these three securities as of March 31, 2011 (in thousands):

 

Security

   Class      Current
Moody’s
Ratings
(Lowest
Assigned
Rating)
     Par
Value
     Book
Value/

Fair
Value
     Unrealized
Loss
     Current
Defaults
and
Deferrals
     % of Current
Defaults and
Deferrals to
Current
Collateral
    Excess
Sub (1)
    Estimated
Incremental
Defaults
Required to
Break Yield
(2)
     Cumulative Other
Comprehensive
(Income) Loss (3)
    Amount of
OTTI
Related to
Credit
Loss (3)
 

PreTSL VI

     Mez         D       $ 375       $ 135       $ 240       $ 30,000         74     -61.11     BROKEN       $ (43   $ 283   

PreTSL X

     B-1         C         924         27         897         217,595         46     -66.92     BROKEN         448        449   

PreTSL
XXVI

     C-2         C         1,819         8         1,811         285,000         30     -24.21     BROKEN         1,811        —     
                                                           

Total

         $ 3,118       $ 170       $ 2,948                 $ 2,216      $ 732   
                                                           

 

(1) Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.
(2) A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.
(3) Pre-tax.

As of March 31, 2011, the Company had one pooled trust preferred security that was deemed to be temporarily impaired based on a present value analysis of expected future cash flows. The security had a fair value of $274 thousand. The following table provides further information on this security as of March 31, 2011 (in thousands):

 

Security

   Class      Current
Moody’s
Ratings
(Lowest
Assigned
Rating)
     Par
Value
     Book
Value/

Fair
Value
     Unrealized
Loss
     Current
Defaults
and
Deferrals
     % of Current
Defaults and
Deferrals to
Current
Collateral
    Excess
Sub (1)
    Estimated
Incremental
Defaults
Required to
Break Yield
(2)
     Cumulative Other
Comprehensive
Loss (3)
     Amount of
OTTI
Related to
Credit
Loss (3)
 

PreTSL
XXVII

     B         Cc       $ 2,886       $ 274       $ 2,612       $ 88,300         27     -2.13   $ 69,000       $ 2,612         —     

 

(1) Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.
(2) A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.

 

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Table of Contents
(3) Pre-tax.

These securities had a fair value of $170 thousand and a cumulative other-than-temporary impairment loss of $6.4 million, of which $2.2 million has been recognized in other comprehensive loss, and $4.2 million has been recognized in earnings (in prior periods). The following table presents a roll-forward of the credit loss component amount of OTTI recognized in earnings:

 

(in thousands)       

Amount recognized through December 31, 2010

   $ 3,468   

Additions:

  

Initial credit impairments

     —     

Subsequent credit impairments

     732   
        

Amount recognized through March 31, 2011

   $ 4,200   

Management has evaluated each of these securities for potential impairment under ASC 325 “Investments-Other” and the most recently issued related guidance, and has reviewed each of the issues’ collateral participants’ most recent earnings, capital and loan loss reserve levels, and non-performing loan levels to estimate a future deferral and default rate in basis points for the remaining life of each security. As of March 31, 2011, we used 25 basis points for PreTSLs VI and X following an internal credit assessment of one bank holding company whose issues were significant in relationship to the totals outstanding in each pool. The result was a down grading of that issuer from deferral to default. We used 75 basis points for PreTSL XXVI and 25 basis points for PreTSL XXVII in expected deferrals and defaults as a percentage of remaining collateral for future periods. In performing a detailed present value cash flow analysis for each security, the deferral and default rate was treated the same. If this analysis results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed used discount rates equal to the credit spread at the time of purchase for each security and then added the current 3-month LIBOR spot rate. The analysis also assumed 15% recoveries on deferrals after two years and prepayments of 1% per year on each security. As of March 31, 2011, there were 3 out of 5 performing issuers in PreTSL VI, 34 out of 54 in PreTSL X, 50 out of 74 in PreTSL XXVI, and 36 out of 49 in PreTSL XXVII.

Our investment in Federal Home Loan Bank (“FHLB”) stock totaled $6.0 million at March 31, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted security, which is carried at cost, because there is no market for the stock, other than FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess stock in 2010, in light of the FHLB’s consistent payment of dividends in 2010 and consistent net income since the quarter ended June 30, 2009 through the first quarter of 2011, we do not consider this investment to be other-than-temporarily impaired at March 31, 2011, and no impairment has been recognized. FHLB stock is shown in restricted stocks on the Consolidated Balance Sheets and is not part of the available-for-sale securities portfolio.

 

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3. Loans

Major classes of loans, excluding loans held-for-sale, are summarized at March 31, 2011 and December 31, 2010 as follows (dollars in thousands):

 

     March 31, 2011      December 31, 2010  

Commercial

   $ 226,845       $ 218,600   

Real estate 1-to-4 family residential:

     

Permanent first and second

     265,696         269,514   

Home equity loans and lines

     126,413         131,397   
                 

Total Real estate 1-to-4 family residential

   $ 392,109       $ 400,911   

Real estate multi-family residential

     89,771         77,316   

Real estate non-farm/non-residential:

     

Owner occupied

     462,744         464,368   

Non-owner occupied

     651,729         674,448   
                 

Total Real estate non-farm/non-residential

   $ 1,114,473       $ 1,138,816   

Real estate construction:

     

Residential

     165,547         177,582   

Commercial

     180,544         187,028   
                 

Total Real estate construction

   $ 346,091       $ 364,610   

Consumer

     10,650         12,557   

Farmland

     2,456         2,418   
                 

Total Loans

   $ 2,182,395       $ 2,215,228   
                 

Less unearned income

     3,621         3,195   

Less allowance for loan losses

     56,465         62,442   
                 

Loans, net

   $ 2,122,309       $ 2,149,591   
                 

Classes of loans by risk rating as of March 31, 2011, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades

   Pass      Watch      Special
Mention
     Substandard      Doubtful      Total
Loans
 

Commercial

   $ 147,967       $ 41,806       $ 4,353       $ 30,575       $ 2,144       $ 226,845   

Real estate 1-to-4 family residential:

                 

Permanent first and second

     212,875         18,700         7,392         26,729         —           265,696   

Home equity loans and lines

     110,532         5,359         1,646         8,621         255         126,413   
                                                     

Total real estate 1-to-4 family residential

   $ 323,407       $ 24,059       $ 9,038       $ 35,350       $ 255       $ 392,109   

Real estate multi-family residential

     73,053         16,223         495         —           —           89,771   

Real estate non-farm/non-residential:

                 

Owner occupied

     358,709         55,031         16,700         32,304         —           462,744   

Non-owner occupied

     433,978         141,492         12,343         63,916         —           651,729   
                                                     

Total Real estate non-farm/non-residential

   $ 792,687       $ 196,523       $ 29,043       $ 96,220       $ —         $ 1,114,473   

Real estate construction:

                 

Residential

     52,595         30,994         26,008         55,950         —           165,547   

Commercial

     55,863         68,415         28,000         28,266         —           180,544   
                                                     

Total Real estate construction

   $ 108,458       $ 99,409       $ 54,008       $ 84,216       $ —         $ 346,091   

Consumer

     10,229         212         37         172         —           10,650   

Farmland

     2,456         —           —           —           —           2,456   
                                                     

Total

   $ 1,458,257       $ 378,232       $ 96,974       $ 246,533       $ 2,399       $ 2,182,395   
                                                     

 

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Table of Contents

Classes of loans by risk rating as of December 31, 2010, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades

   Pass      Watch      Special
Mention
     Substandard      Doubtful      Total
Loans
 

Commercial

   $ 135,287       $ 34,544       $ 16,332       $ 30,305       $ 2,132       $ 218,600   

Real estate 1-to-4 family residential:

                 

Permanent first and second

     214,844         12,832         14,294         25,944         1,600         269,514   

Home equity loans and lines

     113,600         6,685         1,736         9,118         258         131,397   
                                                     

Total real estate 1-to-4 family residential

   $ 328,444       $ 19,517       $ 16,030       $ 35,062       $ 1,858       $ 400,911   

Real Estate - multi-family residential

     62,651         14,665         —           —           —           77,316   

Real Estate Non-farm/Non-residential:

                 

Owner Occupied

     351,744         46,026         27,652         38,946         —           464,368   

Non-Owner Occupied

     455,172         122,993         36,997         59,286         —           674,448   
                                                     

Total Real Estate Non-farm/Non-residential

   $ 806,916       $ 169,019       $ 64,649       $ 98,232       $ —         $ 1,138,816   

Real Estate Construction:

                 

Residential

     55,646         34,123         34,649         53,164         —           177,582   

Commercial

     52,286         52,006         52,169         30,567         —           187,028   
                                                     

Total Real Estate Construction

   $ 107,932       $ 86,129       $ 86,818       $ 83,731       $ —         $ 364,610   

Consumer

     12,153         170         67         167         —           12,557   

Farmland

     2,418         —           —           —           —           2,418   
                                                     

Total

   $ 1,455,801       $ 324,044       $ 183,896       $ 247,497       $ 3,990       $ 2,215,228   
                                                     

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

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

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

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

Substandard. A loan classified as substandard is inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual assets.

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

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

 

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Table of Contents

As of March 31, 2011 and 2010, there were $270 thousand and $230 thousand, respectively, in checking account overdrafts that were reclassified on the consolidated balance sheets as loans.

 

4. Allowance for Loan Losses

An analysis of the allowance for loan losses for the three months ended March 31, 2011, and the year ended December 31, 2010 is shown below (dollars in thousands):

 

     March 31, 2011     December 31, 2010  

Allowance, at beginning of period

   $ 62,442      $ 65,152   

Provision charged against income

     5,843        20,594   

Recoveries added to reserve

     311        4,174   

Losses charged to reserve

     (12,131     (27,478
                

Allowance, at end of period

   $ 56,465      $ 62,442   
                

 

Allowance for Loan
Losses - By Segment

(dollars in thousands)

For the three

months ended

March 31, 2011

   Commercial     Non-Farm,
Non-Res.

Real Estate
    Real Estate
Construction
    Consumer     Real Estate
1-4 Family

Residential
    Real Estate
Multi-
Family
     Farmland      Unallocated     Total  

2011 Allowance for credit losses:

                    

Beginning Balance

   $ 9,972      $ 16,453      $ 26,584      $ 373      $ 8,337      $ 619       $ 63       $ 41      $ 62,442   

Charge-offs

     (639     (1,587     (7,557     (18     (2,330     —           —           —          (12,131

Recoveries

     245        3        51        8        4        —           —           —          311   

Provision

     (24     321        1,880        18        3,584        99         18         (53     5,843   
                                                                          

Ending Balance

   $ 9,554      $ 15,190      $ 20,958      $ 381      $ 9,595      $ 718       $ 81       $ (12   $ 56,465   
                                                                          

Ending Balance:

                    

Individually evaluated for impairment

   $ 4,000      $ 8,052        9,740      $ 67      $ 4,446      $ —         $ —         $ —        $ 26,305   

Collectively evaluated for impairment

     5,554        7,138        11,218        314        5,149        718         81         (12     30,160   

Financing Receivables:

                    

Ending Balance

   $ 226,845      $ 1,114,473      $ 346,091      $ 10,650      $ 392,109      $ 89,771       $ 2,456       $ —        $ 2,182,395   

Ending Balance:

                    

Individually evaluated for impairment

     32,719        100,697        89,644        176        36,313        —           —           —          259,549   

Collectively evaluated for impairment

   $ 194,126      $ 1,013,776      $ 256,447      $ 10,474      $ 355,796      $ 89,771       $ 2,456       $ —        $ 1,922,846   

 

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Table of Contents

Allowance for Loan
Losses - By Segment

(dollars in thousands)

For the twelve months
December 31, 2010

   Commercial      Non-Farm,
Non-Res.

Real Estate
     Real Estate
Construction
     Consumer      Real Estate
1-4 Family

Residential
     Real Estate
Multi-
Family
     Farmland      Unallocated     Total  

2010 Allowance for credit losses:

                         
                                                                               

Ending Balance

   $ 9,972       $ 16,453       $ 26,666       $ 373       $ 8,337       $ 619       $ 63       $ (41   $ 62,442   
                                                                               

Ending Balance:

                         

Individually evaluated for impairment

     4,009         9,689         14,999         60         3,423         —           —           —          32,180   

Collectively evaluated for impairment

     5,963         6,764         11,667         313         4,914         619         63         (41     30,262   

Financing Receivables:

                         

Ending Balance

   $ 218,600       $ 1,138,816       $ 364,610       $ 12,557       $ 400,911       $ 77,316       $ 2,418       $ —        $ 2,215,228   

Ending Balance:

                         

Individually evaluated for impairment

     33,660         105,756         90,444         167         37,628         —           —           —          267,655   

Collectively evaluated for impairment

   $ 184,940       $ 1,033,060       $ 274,166       $ 12,390       $ 363,283       $ 77,316       $ 2,418       $ —        $ 1,947,573   

Information about impaired loans as of and for the three months ended March 31, 2011 and the year ended December 31, 2010 is as follows (dollars in thousands):

 

     March 31, 2011      December 31, 2010  

Non-accrual loans for which a specific allowance has been provided

   $ 30,128       $ 27,717   

Non-accrual loans for which no specific allowance has been provided

     24,481         29,441   

Other impaired loans for which a specific allowance has been provided

     86,309         93,227   

Other impaired loans for which no specific allowance has been provided

     118,631         117,270   

Total impaired loans

   $ 259,549       $ 267,655   
                 

Allowance provided for impaired loans, included in the allowance for loan losses

   $ 26,305       $ 32,180   
                 

Average balance in impaired loans

   $ 259,533       $ 254,014   
                 

Interest income recognized

   $ 2,981       $ 10,977   
                 

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

Included in certain loan categories in the impaired loans are troubled debt restructurings that were classified as impaired. At March 31, 2011, the Company had $29.8 million in real estate construction, $5.5 million in real estate permanent one-to-four- family, $46.5 million in non-farm/non-residential and $10.1 million in commercial that were modified in troubled debt restructurings and considered impaired. Included in this amount of $91.9 million, the Bank had troubled debt restructurings that were performing in accordance with their modified terms of $87.2 million at March 31, 2011.

 

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Table of Contents

Information about past due loans and impaired loans as of March 31, 2011 and December 31, 2010, is as follows (dollars in thousands):

 

March 31, 2011

Non Accrual and Past Due by Class

   30-59
Days
Past
Due
     60-89
Days
Past

Due
     90+ Days
Past Due
     Total
Past Due
     Current(1)      Total Loans      90+ Days
Past Due
and Still
Accruing
     Non-
Accrual
Loans
 

Commercial

   $ 1,105       $ 254       $ 4,866       $ 6,225       $ 220,620       $ 226,845       $ —         $ 5,622   

Real estate 1-to-4 family residential:

                       

Home equity loans and lines

     89         —           2,610         2,699         123,714         126,413         —           3,325   

Permanent first and second

     2,271         853         949         4,073         261,623         265,696         —           2,781   
                                                                       

Total real estate 1-to-4 family residential

   $ 2,360       $ 853       $ 3,559       $ 6,772       $ 385,337       $ 392,109       $ —         $ 6,106   

Real estate multi-family residential

     —           495         —           495         89,276         89,771         —           —     

Real estate nonfarm/nonresidential:

                       

Owner occupied

     —           —           8,553         8,553         454,191         462,744         25         8,016   

Non-owner occupied

     1,593         4,347         1,079         7,019         644,710         651,729         —           1,988   
                                                                       

Total real estate nonfarm/nonresidential

   $ 1,593       $ 4,347       $ 9,632       $ 15,572       $ 1,098,901       $ 1,114,473       $ 25       $ 10,004   

Real estate-construction

                       

Residential

     968         951         16,241         18,160         147,387         165,547         —           24,234   

Commercial

     —           3,154         5,472         8,626         171,918         180,544         —           8,625   
                                                                       

Total Real estate construction

   $ 968       $ 4,105       $ 21,713       $ 26,786       $ 319,305       $ 346,091       $ —         $ 32,859   

Consumer

     63         —           —           63         10,587         10,650         —           18   

Farmland

     —           —           —           —           2,456         2,456         —           —     
                                                                       

Total Loans

   $ 6,089       $ 10,054       $ 39,770       $ 55,913       $ 2,126,482       $ 2,182,395       $ 25       $ 54,609   
                                                                       

 

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

 

December 31, 2010

Non Accrual and Past Due by Class

   30-59
Days
Past
Due
     60-89
Days
Past
Due
     90+ Days
Past Due
     Total
Past Due
     Current(1)      Total Loans      90+ Days
Past Due
and Still
Accruing
     Non-
Accrual
Loans
 

Commercial

   $ 2,642       $ 157       $ 3,542       $ 6,341       $ 212,259       $ 218,600       $ —         $ 3,719   

Real estate 1-to-4 family residential:

                       

Home equity loans and lines

     734         4,028         4,631         9,393         260,121         269,514            5,285   

Permanent first and second

     2,225         679         1,472         4,376         127,021         131,397         242         1,529   
                                                                       

Total real estate 1-to-4 family residential

   $ 2,959       $ 4,707       $ 6,103       $ 13,769       $ 387,142       $ 400,911       $ 242       $ 6,814   

Real estate multi-family residential

     —           —           —           —           77,316         77,316         —           —     

Real estate nonfarm, nonresidential:

                       

Owner occupied

     1,909         —           8,942         10,851         453,517         464,368         —           8,942   

Non-owner occupied

     —           —           4,114         4,114         670,334         674,448         —           4,114   
                                                                       

Total real estate nonfarm/nonresidential

   $ 1,909       $ —           13,056       $ 14,965       $ 1,123,851       $ 1,138,816       $ —           13,056   

Real estate-construction

                       

Residential

     —           —           27,189         27,189         150,393         177,582         —           27,189   

Commercial

     —           —           6,361         6,361         180,667         187,028         —           6,361   
                                                                       

Total Real estate-construction

   $ —         $ —         $ 33,550       $ 33,550       $ 331,060       $ 364,610       $ —           33,550   

Consumer

     347         —           19         366         12,191         12,557         —           19   

Farmland

     —           —           —           —           2,418         2,418         —           —     
                                                                       

Total Loans

   $ 7,857       $ 4,864       $ 56,270       $ 68,991       $ 2,146,237       $ 2,215,228       $ 242       $ 57,158   
                                                                       

 

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

 

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Table of Contents

Impaired Loans as of 3/31/2011

   Recorded
Investment
(Bank
Balance)
     Unpaid
Principal
Balance
(Customer
Balance)
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance:

              

Commercial

   $ 16,592       $ 16,674       $ —         $ 20,323       $ 233   

Real estate 1-4 family

              

Home equity loans and lines

     3,670         3,671         —           3,774         190   

Permanent first and second

     15,257         15,363         —           16,500         43   

Real estate multi-family residential

     —           —           —           —           —     

Real estate non-farm/non-residential

              

Owner occupied

     31,906         32,223         —           34,018         391   

Non-owner occupied

     30,435         30,440         —           30,129         346   

Real estate construction

              

Residential

     16,227         17,068         —           15,135         174   

Commercial

     29,020         29,020         —           22,290         256   

Consumer

     5         5         —           13         —     

With an allowance recorded:

              

Commercial

   $ 16,127       $ 16,146       $ 4,000       $ 12,865       $ 148   

Real estate 1-4 family

              

Home equity loans and lines

     5,015         5,047         924         5,257         60   

Permanent first and second

     12,371         12,406         3,522         11,440         131   

Real estate multi-family residential

     —           —           —           —           —     

Real estate non-farm/non-residential

              

Owner occupied

     3,765         3,777         768         5,555         64   

Non-owner occupied

     34,591         34,591         7,284         32,183         370   

Real estate construction

              

Residential

     39,723         39,747         9,383         39,774         457   

Commercial

     4,674         4,674         357         10,117         116   

Consumer

     171         173         67         160         2   

Total:

              

Commercial

   $ 32,719       $ 32,820       $ 4,000       $ 33,188       $ 381   

Real estate 1-4 family

     36,313         36,487         4,446         36,971         424   

Real estate multi-family residential

     —           —           —           —           —     

Real estate non-farm/non-residential

     100,697         101,031         8,052         101,885         1,171   

Construction

     89,644         90,509         9,740         87,316         1,003   

Consumer

     176         178         67         173         2   

Total Impaired Loans

   $ 259,549       $ 261,025       $ 26,305       $ 259,533       $ 2,981   
                                            

 

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Table of Contents

Impaired Loans as of 12/31/10

   Recorded
Investment
(Bank
Balance)
     Unpaid
Principal
Balance
(Customer
Balance)
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance:

              

Commercial

   $ 24,054       $ 30,794       $ —         $ 14,916       $ 645   

Real estate 1-4 family

              

Home equity loans and lines

     3,878         3,878         —           2,846         123   

Permanent first and second

     17,743         20,462         —           13,852         599   

Real estate multi-family residential

     —           —           —           799         35   

Real estate non-farm/non-residential

              

Owner occupied

     36,130         36,738         —           26,259         1,135   

Non-owner occupied

     29,823         30,734         —           23,124         999   

Real estate construction

              

Residential

     14,042         19,947         —           20,069         867   

Commercial

     21,020         21,070         —           14,300         618   

Consumer

     21         21         —           30         1   

With an allowance recorded:

              

Commercial

   $ 9,602       $ 9,614       $ 4,009       $ 15,180       $ 656   

Real estate 1-4 family

              

Home equity loans and lines

     5,498         5,634         1,187         4,367         189   

Permanent first and second

     10,508         10,925         2,236         12,024         520   

Real estate multi-family residential

     —           —           —           —           —     

Real estate non-farm/non-residential

              

Owner occupied

     7,345         8,211         2,197         9,409         407   

Non-owner occupied

     32,459         32,831         7,492         31,090         1,344   

Real estate construction

              

Residential

     39,824         47,602         10,071         48,009         2,079   

Commercial

     15,559         17,959         4,928         17,398         752   

Consumer

     149         151         60         257         11   

Total:

              

Commercial

   $ 33,660       $ 40,408       $ 4,009       $ 30,096       $ 1,301   

Real estate 1-4 family

     37,628         40,899         3,423         33,088         1,430   

Real estate multi-family residential

     —           —           —           799         35   

Real estate non-farm/non-residential

     105,756         108,081         9,689         89,880         3,884   

Construction

     90,444         107,011         14,999         99,865         4,316   

Consumer

     167         248         60         287         12   

Total Impaired Loans

   $ 267,655       $ 296,647       $ 32,180       $ 254,014       $ 10,977   
                                            

In performing a specific reserve analysis on all impaired loans as of March 31, 2011, current third party appraisals were used with respect to approximately 60% of impaired loans to assist with the evaluation of collateral values for the purpose of establishing specific reserves. When a loan is identified as impaired and collateral dependent, a current evaluation of collateral value via third party appraisal or other valuation methodology is conducted within the calendar quarter of identification when possible, but not less than 90 days after identification. Charge-offs and specific reserves are established upon determination of collateral value. During the interim between identification of an impaired loan and receipt of a current appraisal of the related collateral, specific reserves are established based upon interim methodologies including discounted cash flow analysis, tax assessment values and review of market comparables. In general, variances between charge-offs and fair value of collateral is limited to estimates of projected costs of sale. Costs of sale are estimated at 10% of value. Partially charged-off loans remain non-performing until such time as a viable restructuring plan is developed. Upon execution of a forbearance agreement including modified terms, an impaired loan will be re-classified from non-performing to a troubled debt restructuring, but will continue to be identified as impaired until the loan performs under the modified terms for the remainder of the calendar year in which it was restructured, but not less than 90 days. As noted above, in the

 

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majority of cases, external appraisals are used to establish fair value of the related collateral. In the interim prior to receipt of a current appraisal or in those situations where a current appraisal is not deemed practical or necessary, discounted cash flow analysis, tax assessment values, review of market comparables and other methodologies are used to establish fair value. Impaired loans which do not have a specific reserve are those loans which have been identified to have sufficient collateral coverage, based upon the fair value of collateral, to repay the entire principal balance due from collateral liquidation.

 

5. Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of dilutive potential common stock. As of March 31, 2011, and 2010, there were 4,556,525 and 3,568,224 anti-dilutive stock options and warrants outstanding, respectively.

 

     Three Months Ended      Three Months Ended  
     March 31, 2011      March 31, 2010  
            Per             Per  
            Share             Share  
     Shares      Amount      Shares      Amount  

Basic earnings per common share

     29,264,610       $ 0.13         26,933,923       $ 0.12   

Effect of dilutive securities:

           

Stock options and warrants

     1,139,478            1,076,955      
                       

Diluted earnings per common share

     30,404,088       $ 0.12         28,010,878       $ 0.11   
                                   

 

6. Stock Compensation Plan

At March 31, 2011, the Company had two stock-based compensation plans, the 1998 Stock Option Plan and the Company’s 2010 Equity Plan (the “2010 Plan”). The 2010 Plan replaced the 1998 Stock Option Plan and as such no further options may be granted under the 1998 Stock Option Plan. Included in salaries and employee benefits expense for the three months ended March 31, 2011 and 2010, is $132 thousand and $162 thousand, respectively, of stock-based compensation expense which is based on the estimated fair value of 1,038,618 options granted between January 2006 and March 2011, as adjusted for stock dividends, amortized on a straight-line basis over a five year requisite service period. As of March 31, 2011, there was $1.4 million remaining of total unrecognized compensation expense related to these option awards which will be recognized over the remaining requisite service periods.

The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 2011 and 2010:

 

     2011     2010  

Expected volatility

     32.21     30.59

Expected dividends

     0.00     0.00

Expected term (in years)

     7.2        7.2   

Risk-free rate

     2.71 % to 2.81%      2.04 % to 3.50% 

Stock option plan activity for the three months ended March 31, 2011, is summarized below:

 

     Number of
Shares
    Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic

Value
 

Outstanding at January 1, 2011

     1,685,178      $ 8.69         

Granted

     167,327        6.06         

Exercised

     (134,389     1.54         

Forfeited

     (7,940     12.44         
                                  

Outstanding at March 31, 2011

     1,710,176      $ 8.98         4.8 years       $ —     

Exercisable at March 31, 2011

     1,292,435      $ 9.56         3.6 years       $ —     

 

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The total value of in-the-money options exercised during the three months ended March 31, 2011 was $590 thousand.

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

A summary of the nonvested restricted stock activity under the 2010 Plan for the three months ended March 31, 2011 is summarized below:

 

     Number of
Shares
     Weighted-
Average
Exercise
Price
     Aggregate
Intrinsic
Value
 

Non-vested at the beginning of year

     9,335       $ 6.65      

Granted

     29,413         6.00      

Vested

     —           —        

Forfeited

     —           —        
                    

Non-vested at end of the year

     38,748       $ 6.16       $ 222,414   
                    

We recognized share-based compensation expense associated with shares of restricted stock of $11 thousand for the three months ended March 31, 2011.

 

7. Capital Requirements

A comparison of the March 31, 2011 capital ratios of the Company and its wholly-owned subsidiary, Virginia Commerce Bank (the “Bank”), with the minimum regulatory guidelines is as follows:

 

     Actual Capital     Minimum
Capital
Requirements
    Minimum to  be
“Well-Capitalized”
Under Prompt
Corrective Action
Provisions
 

Total Risk-Based Capital:

      

Company

     15.21     8.00     —     

Bank

     14.82     8.00     10.00

Tier 1 Risk-Based Capital:

      

Company

     13.96     4.00     —     

Bank

     13.57     4.00     6.00

Leverage Ratio:

      

Company

     11.48     4.00     —     

Bank

     11.16     4.00     5.00

 

8. Other Borrowed Funds and Lines of Credit

The Bank maintains a $435.9 million line of credit with the FHLB of Atlanta. The interest rate and term of each advance from the line is dependent upon the advance and commitment type. Advances on the line are secured by all of the Bank’s qualifying first liens and home equity lines-of-credit on one-to-four unit single-family dwellings. As of March 31, 2011, the book value of these qualifying loans totaled approximately $239.4 million and the amount of available credit using this collateral was $109.3 million. Advances on the line of credit in excess of this amount require pledging of additional assets, including other types of loans and investment securities. As of March 31, 2011 and December 31, 2010, the Bank had $25.0 million in advances outstanding that mature on September 21, 2012, but are callable by the FHLB on any quarterly interest payment date. The Bank has additional short-term lines of credit totaling $47.0 million with nonaffiliated banks at March 31, 2011, on which there were no amounts outstanding.

 

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9. Trust Preferred Capital Notes

On December 19, 2002, the Company completed a private placement issuance of $15.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust II) which issued $470 thousand in common equity to the Company. These securities bear a floating rate of interest, adjusted semi-annually, of 330 basis points over six month LIBOR, which as of May 9, 2011 was 3.76%. These securities have been callable at par since December 30, 2007, on any semi-annual interest payment date, but have not been redeemed to date. On December 20, 2005, the Company completed a private placement of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust III) which issued $774 thousand in common equity to the Company. These securities had a fixed rate of interest of 6.19% until February 23, 2011, at which time they converted to a floating rate, adjusted quarterly, of 142 basis points over three month LIBOR, which as of May 9, 2011 was 1.73%. These securities became callable at par beginning February 23, 2011.

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

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

The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes up to 25.0% of Tier 1 capital after its inclusion. The portion of the trust preferred securities not qualifying as Tier 1 capital may be included as part of total qualifying capital in Tier 2 capital, subject to limitation.

 

10. Preferred Stock and Warrant

On December 12, 2008, the Company entered into a Letter Agreement (“Agreement”) with the United States Department of the Treasury (“Treasury”) under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, whereby the Company issued and sold to the Treasury 71,000 shares of fixed rate cumulative perpetual preferred stock with a par value of $1.00 and a liquidation amount of $1,000 per share, for a total price of $71.0 million. In addition, the Treasury received a warrant to purchase 2,696,203 shares of the Company’s common stock at an exercise price of $3.95 per share. Subject to certain restrictions, the preferred stock and the warrant are transferable by the Treasury. The allocated carrying values at March 31, 2011, of the preferred stock and the warrant, based on their relative fair values, were $62.5 million and $8.5 million, respectively.

The preferred stock pays dividends quarterly, beginning February 2009, at a rate of 5% per year for the first five years, then increases to 9% thereafter. The Company may redeem the preferred stock at any time, subject to approval by the Treasury after consultation with the Board of Governors of the Federal Reserve System (the “Federal Reserve”), at the liquidation amount of $1,000 per share plus any accrued and unpaid dividends. Approval from the Treasury is required to pay common stock dividends or to repurchase shares of the Company’s common stock prior to December 12, 2011, unless the preferred stock has been fully redeemed.

The warrant has a ten year term and is immediately exercisable. Pursuant to the terms of the Agreement, the Treasury will not exercise voting rights with respect to any shares of common stock it acquires upon exercise of the warrant; voting rights may be exercised by any other holder.

 

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

Cautionary Note Regarding Forward-Looking Statements

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

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

 

   

adverse governmental or regulatory policies may be enacted;

 

   

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

 

   

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

 

   

adverse effects may be caused by changes to credit quality;

 

   

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

 

   

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

 

   

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

 

   

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

Other factors, risks and uncertainties that could cause our actual results to differ materially from estimates and projections contained in these forward-looking statements are discussed under “Risk Factors” in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

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

Non-GAAP Presentations

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

 

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Core operating earnings is a non-GAAP financial measure that reflects net income excluding taxes, loan loss provisions, losses on other real estate owned (also referred to as “OREO” or “foreclosed properties”), impairment losses on securities and gain on sale of securities. These excluded items are difficult to predict and we believe that core operating earnings provides the Company and investors with a valuable measure of the performance of the Company’s operational performance and a valuable tool to evaluate the Company’s financial results. Calculation of core operating earnings for the three months ended March 31, 2011 and March 31, 2010 is as follows:

 

    Three Months Ended
March 31,
 
(in thousands)   2011     2010  

Net Income

  $ 4,966      $ 4,469   

Adjustments to net income:

   

Provision for loan losses

    5,843        4,238   

Loss on other real estate owned

    156        918   

Impairment loss on securities

    732        851   

Gain on sale of securities

    (503     —     

Provision for income taxes

    2,400        2,009   

Core Operating Earnings

  $ 13,594      $ 12,485   

The adjusted efficiency ratio is a non-GAAP financial measure that is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income before impairment losses on securities and gain on sale of securities. We believe that this measure provides investors with important information about our operating efficiency. Comparison of our adjusted efficiency ratio with those of other companies may not be possible because other companies may calculate the adjusted efficiency ratio differently. Calculation of the adjusted efficiency ratio for the three months ended March 31, 2011 and March 31, 2010 is as follows:

 

     Three Months Ended
March 31,
 
(in thousands)   2011     2010  

Summary Operating Results:

   

Non-interest expense

  $ 14,450      $ 14,707   

Net interest income

  $ 26,183      $ 24,816   

Non-interest income

    1,476        607   

Impairment loss on securities

    732        851   

Gain on sale of securities

    (503     —     
               

Total

  $ 27,888      $ 26,274   

Efficiency Ratio, adjusted

    51.1     55.4

The tangible common equity ratio is a non-GAAP financial measure representing the ratio of tangible common equity to tangible assets. Tangible common equity and tangible assets are non-GAAP financial measures derived from GAAP-based amounts. We calculate tangible common equity for the Company by excluding the balance of intangible assets and outstanding preferred stock issued to the U.S. Treasury from total stockholders’ equity. We calculate tangible assets by excluding the balance of intangible assets from total assets. We had no intangible assets for the periods presented. We believe that this is consistent with the treatment by bank regulatory agencies, which exclude intangible assets from the calculation of regulatory capital ratios. Accordingly, we believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our capital position and ratios. However, these non-GAAP financial measures are supplemental and are not substitutes for an analysis based on a GAAP measure. As other companies may use different calculations for non-GAAP measures, our presentation may not be comparable to other similarly titled measures reported by other companies. Calculation of the Company’s tangible common equity ratio as of March 31, 2011, March 31, 2010, and December 31, 2010 is as follows:

 

    As of March 31,     December 31,  
(in thousands)   2011     2010     2010  

Tangible common equity:

     

Total stockholders’ equity

  $ 253,373      $ 224,259      $ 245,594   

Less:

     

Outstanding TARP senior preferred stock

    65,873        64,356        65,445   

Intangible assets

    —          —          —     

Tangible common equity

  $ 187,500      $ 159,903      $ 180,149   

Total tangible assets

  $ 2,783,633      $ 2,803,004      $ 2,741,648   

Tangible common equity ratio

    6.74     5.70     6.57

 

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General

The following presents management’s discussion and analysis of the consolidated financial condition and results of operations of Virginia Commerce Bancorp, Inc. and subsidiaries (the “Company”) as of the dates and for the periods indicated. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto, and other financial data appearing elsewhere in this report. The Company is the parent bank holding company for Virginia Commerce Bank (the “Bank”), a Virginia state-chartered bank that commenced operations in May 1988. The Bank pursues a traditional community banking strategy, offering a full range of business and consumer banking services through twenty-eight branch offices, one residential mortgage office and one wealth management office.

Headquartered in Arlington, Virginia, the Bank serves the Northern Virginia suburbs of Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince William, Spotsylvania and Stafford Counties and the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park. Its service area also covers, to a lesser extent, Washington, D.C. and the nearby Maryland counties of Montgomery and Prince Georges. The Bank’s customer base includes small-to-medium sized businesses including firms that have contracts with the U.S. government, associations, retailers and industrial businesses, professionals and their firms, business executives, investors and consumers.

Critical Accounting Policies

For the period ended March 31, 2011, there were no changes in the Company’s critical accounting policies as reflected in the Company’s most recent annual report.

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

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

Our allowance for loan losses has two basic components: the specific allowance and the general allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for impaired loans. Impairment testing includes consideration of the borrower’s overall financial condition, resources and payment record, support available from

 

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

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

Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest based on 5 years of continuous service and have 10-year contractual terms. The fair value of each option award is estimated on the date of grant using a Black-Scholes option pricing model that currently uses historical volatility of the Company’s stock based on a 7.2 year expected term, before exercise, for the options granted, and a risk-free interest rate based on the United States Department of the Treasury (the “Treasury”) curve in effect at the time of the grant to estimate total stock-based compensation expense. This amount is then amortized on a straight-line basis over the requisite service period, currently 5 years, to salaries and benefits expense. Restricted stock awards generally vest in equal installments over 5 years. The compensation expense associated with these awards is based on the grant date fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized ratably over the requisite service period. See Note 6 to the Consolidated Financial Statements for additional information regarding the plans and related expense.

On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance, to determine if the impairment is deemed to be other-than-temporary. If it is determined that the impairment is other-than-temporary, i.e. impaired because of credit issues rather than interest rate, the investment is written down through the Consolidated Statements of Income in accordance with accounting guidance. See Note 2 to the Consolidated Financial Statements for additional information regarding security impairments deemed to be other than temporary.

Results of Operations

For the three months ended March 31, 2011, the Company recorded net income of $5.0 million. After an effective dividend of $1.3 million to the U.S. Treasury on preferred stock, the Company reported net income to common stockholders of $3.7 million, or $0.12 per diluted common share, compared to net income to common shareholders of $3.2 million, or $0.11 per diluted common share in the first quarter of 2010. The year-over-year earnings improvement was largely attributable to a 5.5% increase in net interest income over the previous year, which was principally due to reduced interest expenses as more fully described below. However, the Company’s net income was negatively impacted primarily by provisions for loan losses and an impairment loss on securities of $732 thousand.

 

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Total assets increased $42.0 million, or 1.5%, from $2.74 billion at December 31, 2010, to $2.78 billion at March 31, 2011, as total deposits grew $9.8 million, or 0.4%, from $2.25 billion to $2.26 billion. Loans, net of allowance for loan losses, decreased $27.3 million or 1.3% from $2.15 billion on December 31, 2010 to $2.12 billion on March 31, 2011. Non-farm, non-residential real estate loans decreased $9.5 million, or 0.8%, multifamily real estate loans increased $17.2 million, or 23.7%, acquisition, development and construction (“ADC”) loans fell by $76.2 million, or 18.1%, and commercial and industrial (“C&I”) loans were up $2.3 million, or 1.0%. Loan production has been negatively impacted over the last year by lower economic activity and demand for credit in both the business and consumer sectors, a reallocation of lending personnel to problem loan identification and resolution, a strategic decision to restrict acquisition, development and construction lending and an increased emphasis on deposit generation and non-credit products. Lending efforts in 2011 are being focused on building greater market share in commercial lending, especially in sectors forecast for growth, such as government contract lending, professional practices and associations and select service industries, with strategic hiring, marketing campaigns, calling efforts and sales management restructuring. Progress with this strategy was evident in the first quarter of 2011 with commercial loans increasing $8.2 million sequentially, while ADC loans and non-farm, non-residential non-owner occupied loans decreased $18.5 million and $22.7 million, respectively. Additionally, efforts to grow multi-family residential loans, considered to be a strong local asset class, were successful with a sequential increase of $12.5 million.

For the quarter ended March 31, 2011, total deposits increased $9.8 million or 0.4% from $2.25 billion to $2.26 billion with demand deposits increasing $25.6 million or 9.7%, savings and interest-bearing demand accounts decreasing $13.9 million or 1.2% and time deposits decreasing $1.9 million of 0.3%. While opportunities for balance sheet growth have been limited in recent periods, the Company has focused on improving deposit mix. Demand deposit growth has been the top priority, with the year-over-year increase in demand deposits primarily due to the successful efforts of the Company’s team of eight business development officers, who are focused on acquisition and retention of commercial operating funds, treasury management services and other related cross-sales. In other deposit categories, strategic pricing and customer preference for liquidity has resulted in a desired reduction in time deposits and an increase in NOW, savings and money market accounts. The decline in time deposits as a percentage of total deposits, now at 34.5%, is generally complete as evidenced by sequential results. At March 31, 2011 and December 31, 2010, the Bank had no brokered certificates of deposit, down from $80.1 million at March 31, 2010.

As noted, for the three months ended March 31, 2011, the Company recorded net income to common stockholders of $3.7 million compared to $3.2 million for the three months ended March 31, 2010, as net interest income increased $1.4 million, or 5.5%, non-interest income increased $869 thousand, non-interest expense decreased $257 thousand, or 1.75% and provisions for loan losses were up $1.6 million. The Company’s return on average assets and return on average equity were 0.73% and 8.09% for the three months ended March 31, 2011, compared to 0.65% and 8.16% for the same period in 2010.

On March 31, 2011, the Company issued 426,000 shares of its common stock at a price of $5.87 per share in a registered direct placement with a Company director for total gross proceeds of approximately $2.5 million. In addition, the Company issued to the investor warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $4.8 million in gross proceeds to the Company. The warrants each have an exercise price of $5.62 per share. The Series A warrants, exercisable for a total of 426,000 shares of common stock, are exercisable for a period of seven months following the closing date. The Series B warrants, also exercisable for a total of 426,000 shares of common stock, are exercisable for a period of twelve months following the closing date.

On September 29, 2010, the Company issued 1,904,766 shares of its common stock at a price of $5.25 per share in a registered direct placement with several institutional investors for total gross proceeds of $10.0 million. In addition, the Company issued to the investors warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $11.4 million in gross proceeds to the Company. The warrants each have an exercise price of $6.00 per share, which represents a 14.3% premium to the offering price of the shares of common stock sold in the registered direct placement. The Series A warrants, exercisable for a total of 952,383 shares of common stock, are exercisable for a period of seven months following the closing date. On April 29, 2011, 130,851 of the Series A warrants were exercised resulting in approximately $746 thousand in additional capital while 821,532 Series A warrants expired under the original terms. The Series B warrants, also exercisable for a total of 952,383 shares of common stock, are exercisable for a period of twelve months following the closing date.

 

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Stockholders’ equity increased $7.8 million, or 3.2%, from $245.6 million at December 31, 2010, to $253.4 million at March 31, 2011, with approximately $2.5 million in net proceeds from the above referenced stock issuances, net income to common stockholders of $3.7 million over the three-month period, a $824 thousand decrease in other comprehensive losses related to the investment securities portfolio, and $243 thousand million in proceeds and tax benefits related to the exercise of options by the Company’s directors and officers, and stock option expense credits. As a result of these changes, the Company’s Tier 1 Capital ratio increased from 13.20% at December 31, 2010, to 13.96% at March 31, 2011, and its total qualifying capital ratio increased from 14.45% to 15.21%. The Bank’s ratios increased by similar levels. Sequentially, the Company’s tangible common equity ratio is up 17 basis points from December 31, 2010, to 6.74% as of March 31, 2011.

Net Interest Income

Net interest income is the excess of interest earned on loans and investments over the interest paid on deposits and borrowings and is the Company’s primary revenue source. Net interest income is thereby affected by overall balance sheet growth, changes in interest rates and changes in the mix of investments, loans, deposits and borrowings. Net interest income for the first quarter of 2011 of $26.2 million was up $1.4 million, or 5.5%, over the same quarter last year, as the net interest margin increased from 3.79% in the first quarter of 2010 to 3.99% for the same period in 2011. On a sequential basis, the margin was up three basis points. The year-over-year increase in the net interest margin was driven by lower deposit costs due to significant reductions in the level of time deposits, and increased levels of demand deposits and lower rate interest-bearing transaction accounts. Also, the average rate paid on savings and time deposits decreased significantly from the three-months ended March 31, 2010 to the same period 2011. As a result, the average cost of interest-bearing deposits fell from 1.88% in the first quarter of 2010, to 1.44% in the current period, while the yield on interest-earning assets declined twenty basis points from 5.59% to 5.39%. Management anticipates the net interest margin will range between 3.7% and 4.0% over the next two quarters, but may come under some pressure later in the year if short-term interest rates begin to rise.

The following table shows the average balance sheets for each of the three months ended March 31, 2011 and 2010. In addition, the amounts of interest earned on interest-earning assets, with related yields on a tax-equivalent basis, and interest expense on interest-bearing liabilities, with related rates, are shown. Loans placed on a non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $687 thousand and $747 thousand for the three months ended March 31, 2011 and 2010, respectively.

 

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     Three Months Ended March 31,  
     2011     2010  
(Dollars in thousands)    Average
Balance
     Interest
Income-
Expense
     Average
Yields /
Rates
    Average
Balance
     Interest
Income-
Expense
     Average
Yields /
Rates
 

Assets

                

Securities (1)

   $ 406,103       $ 3,453         3.59   $ 338,138       $ 3,706         4.55

Restricted stock

     11,752         96         3.31     11,752         88         3.00

Loans, net of unearned income (2)

     2,203,117         31,923         5.89     2,280,980         32,905         5.86

Interest-bearing deposits in other banks

     388         —           0.13     98         —           0.04

Federal funds sold

     67,622         45         0.27     48,732         28         0.23
                                                    

Total interest-earning assets

   $ 2,688,982       $ 35,517         5.39   $ 2,679,700       $ 36,727         5.59

Other assets

     84,679              93,712         
                            

Total Assets

   $ 2,773,661            $ 2,773,412         
                            

Liabilities and Stockholders’ Equity

                

Interest-bearing deposits:

                

NOW accounts

   $ 321,564       $ 653         0.82   $ 281,142       $ 812         1.17

Money market accounts

     177,183         469         1.07     146,609         492         1.36

Savings accounts

     692,647         1,916         1.12     603,703         2,497         1.68

Time deposits

     783,462         3,985         2.06     1,002,008         5,627         2.28
                                                    

Total interest-bearing deposits

   $ 1,974,856       $ 7,023         1.44   $ 2,033,462       $ 9,428         1.88

Securities sold under agreement to repurchase and federal funds purchased

     166,272         934         2.28     181,955         989         2.20

Other borrowed funds

     25,000         266         4.25     25,000         266         4.25

Trust preferred capital notes

     66,346         1,111         6.70     66,090         1,228         7.43
                                                    

Total interest-bearing liabilities

   $ 2,232,474       $ 9,334         1.70   $ 2,306,507       $ 11,911         2.09

Demand deposits and other liabilities

     292,094              244,836         
                            

Total liabilities

   $ 2,524,568            $ 2,551,343         

Stockholders’ equity

     249,093              222,069         
                            

Total liabilities and stockholders’ equity

   $ 2,773,661            $ 2,773,412         
                            

Interest rate spread

           3.69           3.50

Net interest income and margin

      $ 26,183         3.99      $ 24,816         3.79

 

(1) Yields on securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which are reflected as a component of stockholders’ equity. Average yields on securities are stated on a tax equivalent basis, using a 35% rate.
(2) Loans placed on non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $687 thousand and $747 thousand for the three months ended March 31, 2011 and 2010, respectively.

 

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Allowance for Loan Losses / Provision for Loan Loss Expense

Provisions for loan losses were $5.8 million for the quarter ended March 31, 2011, compared to $4.2 million in the same period in 2010, with total net charge-offs of $11.8 million in the first quarter of 2011, versus $7.0 million for the first quarter of 2010. Higher provisioning for the quarter was primarily driven by the downgrade of two mid-seven figure borrowing relationships, representing a construction sub-contractor and a residential builder which required specific reserves of $3.2 million based upon a collateral analysis. Increased charge-offs were largely attributable to the decision to write down certain identified problem loans with substantial specific reserves totaling $8.2 million in anticipation of negotiated settlements or pending sales of underlying collateral properties. Since the expected settlements or pending sales prices were approaching book values net of specific reserves that were previously set aside, excess specific reserves were charged off. This process enabled a more aggressive approach for resolution of the subject problem assets.

Total non-performing assets and loans 90+ days past due declined from $108.8 million at March 31, 2010, to $73.5 million at March 31, 2011, a reduction of 32.4%, and decreased $1.1 million sequentially from $74.6 million as of December 31, 2010. As of March 31, 2011, reserves for loan losses represented 2.59% of total loans, down from 2.82% at December 31, 2010, with reserves covering 103.4% of total non-performing loans as of March 31, 2011. See “Risk Elements and Non-Performing Assets” later in this discussion for more information on non-performing assets and loans 90+ days past due and other impaired loans.

Management believes that the allowance for loan losses is adequate at March 31, 2011. However, there can be no assurance that additional provisions for loan losses will not be required in the future, including as a result of possible changes in the economic assumptions underlying management’s estimates and judgments, adverse developments in the economy, and the residential real estate market in particular, on a national basis or in the Company’s market area, or changes in the circumstances of particular borrowers.

The Company generates a quarterly analysis of the allowance for loan losses, with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on at least semi-annual independent external loan reviews and monthly internal reviews. The determination of the allowance for loan losses is based on applying and summing the results of eight qualitative factors and a historical loss factor to each category of loans along with any specific allowance for impaired and adversely classified loans within the particular category. Each factor is assigned a percentage weight and that total weight is applied to each loan category. The resulting sum from each loan category is then combined to arrive at a total allowance for all categories. Factors are different for each loan category. Qualitative factors include: levels and trends in delinquencies and non-accruals, trends in volumes and terms of loans, effects of any changes in lending policies, the experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit, quality of the Company’s loan review system, and regulatory requirements. The total allowance required thus changes as the percentage weight assigned to each factor is increased or decreased due to its particular circumstance, as historical loss factors are updated, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required on impaired loans and charge-offs occur. The decision to specifically reserve for or to charge-off or partially charge-off an impaired loan balance is based upon an evaluation of that loan’s potential to improve, based upon near term change in financial or market conditions, which would enable collection of the portion of the loan determined to be impaired. If these conditions are determined to be favorable, a specific reserve would be established as opposed to a charge-off. For further information regarding the allowance for loan losses see Note 4 to the Consolidated Financial Statements.

 

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

 

    Three Months
Ended
March 31, 2011
    Three Months
Ended
March 31, 2010
    Twelve Months
Ended
December 31, 2010
 
    (Dollars in thousands)  

Allowance, at beginning of period

  $ 62,442      $ 65,152      $ 65,152   

Provision charged against income

    5,843        4,238        20,594   

Recoveries:

     

Consumer loans

    8        4        20   

Commercial

    245        10        2,858   

Real estate one-to-four family residential:

     

Permanent first and second

    3        6        42   

Home equity loans and lines

    1        274        289   

Real estate-nonfarm, nonresidential

    3        51        58   

Real estate-construction

    51        203        907   

Losses charged to reserve:

     

Consumer loans

    (18     (654     (345

Commercial loans

    (639     (2,501     (7,761

Real Estate one-to-four family residential:

     

Permanent first and second

    (1,600     (1,970     (3,445

Home equity loans and liens

    (730     (260     (543

Real estate-multi-family residential

    —          —          (1,050

Real estate-nonfarm, nonresidential

    (1,587     (999     (5,260

Real estate-construction

    (7,557     (1,147     (9,075
                       

Net charge-offs

    (11,820     (6,983     (23,304

Allowance, at end of period

  $ 56,465      $ 62,407      $ 62,442   
                       

Ratio of net charge-offs to average total loans outstanding during period

    0.54     0.31     1.03

Allowance for loan losses to total loans

    2.59     2.75     2.82

The following schedule provides a breakdown of general reserves and specific reserves for impaired loans by loan type:

 

    March 31, 2011     March 31, 2010     December 31, 2010  
    (Dollars in thousands)  

Allocation of the allowance for loan losses:

     

Real estate – mortgage-general

  $ 13,005      $ 13,097      $ 12,296   

Real estate – mortgage-specific

    12,498        11,468        13,112   

Real estate – construction-general(1)

    11,299        12,475        11,648   

Real estate – construction-specific

    9,740        14,170        15,000   

Commercial-general

    5,554        6,158        5,963   

Commercial-specific

    4,000        4,629        4,009   

Consumer-general

    314        307        313   

Consumer-specific

    67        117        60   

Unallocated

    (12     (14     41   
                       

Total

  $ 56,465      $ 62,407      $ 62,442   

 

(1) Includes Farmland.

 

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Risk Elements and Non-Performing Assets

Non-performing assets consist of non-accrual loans and OREO (foreclosed properties). For the three months ended March 31, 2011, total non-performing assets and loans 90+ days past due and still accruing interest decreased by $1.1 million, from $74.6 million at December 31, 2010, to $73.5 million at March 31, 2011, and have declined $35.3 million from $108.8 million at March 31, 2010. As a result, the ratio of non-performing assets and loans 90+ days past due and still accruing to total assets decreased from 3.88% at March 31, 2010, to 2.64% at March 31, 2011, and decreased from 2.72% of total assets at December 31, 2010. Loans are placed in non-accrual status when in the opinion of management the collection of additional interest is unlikely or a specific loan meets the criteria for non-accrual status established by regulatory authorities. No interest is taken into income on non-accrual loans. A loan remains on non-accrual status until the loan is current as to both principal and interest or the borrower demonstrates the ability to pay and remain current, or both.

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

Other impaired loans, that are currently performing, and troubled debt restructurings, performing in accordance with their modified terms, decreased from $297.3 million at December 31, 2010, to $286.2 million at March 31, 2011. These loans have been identified by the Company as having certain weaknesses as a result of the Company’s specific knowledge about the customer or recent credit events, and are classified as substandard and subject to impairment testing at each balance sheet date.

Troubled debt restructurings which represented $91.9 million of other impaired loans as of March 31, 2011, were down from $103.0 million at December 31, 2010. These loans, which have been provided concessions such as rate reductions, payment deferrals, and in some cases forgiveness of principal, are all on accrual status. If the loan was on non-accrual at the time of the concession it is the Company’s policy that it remain on non-accrual status and perform in accordance with the modified terms for a period of six months. As of March 31, 2011, all troubled debt restructurings were accruing interest. The Company does not report any non-accrual loans as troubled debt restructurings. If a troubled debt restructuring is on non-accrual status, it is reported as a non-accrual asset. Since early 2008, the Company has had $18.4 million of accruing troubled debt restructurings that were subsequently placed on non-accrual status.

Foreclosed real properties include properties that have been substantively repossessed or acquired in complete or partial satisfaction of debt. Such properties, which are held for resale, are carried at the lower of book value or fair value, including a reduction for the estimated selling expenses, or principal balance of the related loan. Reviews and discussions with regard to value and disposition of each foreclosed property are conducted monthly by the Company’s Special Asset Committee. The carrying value of a foreclosed asset is immediately adjusted down when new information is obtained, including a potentially acceptable offer, the sale of a similar property in the vicinity of one of the Company’s assets, and/or a change in the price the property is being listed for. The Company also uses the advice of outside consultants and real estate agents with knowledge of the markets the properties are located in. Appraisals are ordered when the property is foreclosed on, but are not routinely updated at each balance sheet date. The Company confirms that it performed the above noted procedures and made the proper impairment adjustments, if any, at the balance sheet date.

 

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Table of Contents

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

 

     March 31, 2011      March 31, 2010      December 31, 2010  
     (In Thousands of Dollars)  

Non-accrual loans:

        

Commercial

   $ 5,622       $ 9,931       $ 3,719   

Real estate-one-to-four family residential:

        

Closed end first and seconds

     2,781         4,610         5,285   

Home equity lines

     3,325         693         1,529   
                          

Total real estate-one-to-four family residential

   $ 6,106       $ 5,303       $ 6,814   

Real estate-non-farm, non-residential:

        

Owner occupied

     8,016         9,019         8,942   

Non-owner occupied

     1,988         14,871         4,114   
                          

Total real estate-non-farm, non-residential

   $ 10,004       $ 23,890       $ 13,056   

Real estate-construction:

        

Residential-owner occupied

     —           —           —     

Residential-builder

     24,234         36,078         27,189   

Commercial

     8,625         6,911         6,361   
                          

Total real estate-construction:

   $ 32,859       $ 42,989       $ 33,550   

Consumer

     18         119         19   
                          

Total non-accrual loans

   $ 54,609       $ 82,232         57,158   

OREO

     18,879         26,269         17,165   
                          

Total non-performing assets

   $ 73,488       $ 108,501       $ 74,323   

Loans 90+ days past due and still accruing:

        

Commercial

   $ —         $ 45       $ —     

Real estate-one-to-four family residential:

        

Closed end first and seconds

     —           238         —     

Home equity lines

     —           —           242   
                          

Total real estate-one-to-four family residential

   $ —         $ 238       $ 242   

Real estate multi-family residential

     —           —           —     

Real estate-non-farm, non-residential:

        

Owner occupied

     25         —           —     

Non-owner occupied

     —           —           —     
                          

Total real estate-non-farm, non-residential

   $ 25       $ —         $ —     

Real estate-construction:

        

Residential-owner occupied

     —           —           —     

Residential-builder

     —           26         —     

Commercial

     —           —           —     
                          

Total real estate-construction:

   $ —         $ 26       $ —     

Consumer

     —           9         —     
                          

Total loans past due 90 days and still accruing

   $ 25       $ 318       $ 242   

Total non-performing assets and past due loans

   $ 73,513       $ 108,819       $ 74,565   

 

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Table of Contents
    March 31, 2011     March 31, 2010     December 31, 2010  
    (In Thousands of Dollars)  

Non-performing assets

     

to total loans:

    3.37     4.78     3.36

to total assets:

    2.64     3.87     2.71

Non-performing assets and 90+ days past due loans

     

to total loans:

    3.37     4.79     3.37

to total assets:

    2.64     3.88     2.72

Allowance for loan losses to total loans

    2.59     2.75     2.82

Allowance for loan losses to non-performing loans

    103.35     75.60     108.79

Troubled debt restructurings:

     

Commercial

  $ 10,100      $ 8,550      $ 12,175   

Real estate-one-to-four family residential:

     

Closed end first and seconds

    5,541        5,464        5,437   

Home equity lines

    —          —          —     
                       

Total Real estate-one-to-four family residential

  $ 5,541      $ 5,464      $ 5,437   

Real estate multi-family residential

    —          —          —     

Real estate-non-farm, non-residential:

     

Owner Occupied

    6,692        3,804        14,667   

Non-owner occupied

    39,712        13,178        35,001   
                       

Total Real estate-non-farm, non-residential

  $ 46,404      $ 16,982      $ 49,668   

Real estate-construction:

     

Residential-Owner Occupied

    —          —          —     

Residential-Builder

    9,142        13,598        9,760   

Commercial

    20,649        36,383        25,908   
                       

Total Real estate-construction:

  $ 29,791      $ 49,981      $ 35,668   

Consumer

    40        16        48   
                       

Total troubled debt restructurings

  $ 91,876      $ 80,993      $ 102,996   

Non-performing loans continue to be concentrated in residential and commercial construction and land development loans in outer sub-markets hardest hit by the residential downturn and commercial and consumer credits experiencing the after shocks in sub-contracting businesses and workforce employment. Overall, as of March 31, 2011, $32.9 million, or 60.2%, of non-performing loans represented ADC loans, $10.0 million, or 18.3%, represented non-farm, non-residential loans, $6.1 million, or 11.2%, represented loans on one-to-four family residential properties, and $5.6 million, or 10.3%, represented C&I loans. Interest actually received on non-accrual loans was $158 thousand in the three months ended March 31, 2010 and $120 thousand for the three months ended March 31, 2011. See Note 4 to the Consolidated Financial Statements for additional information regarding the Company’s non-performing loans.

 

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Table of Contents

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

Residential, Acquisition, Development and Construction

 

     As of March 31, 2011  
By County/Jurisdiction of Origination:    Total
Outstandings
     Percentage
of Total
    Non-accrual
Loans
     Non-accruals
as a % of
Outstandings
    Net charge-
offs as a % of
Outstandings
 

District of Columbia

   $ 3,347         2.0   $ —           —          —     

Montgomery, MD

     1,250         0.8     535         0.3     —     

Prince Georges, MD

     18,887         11.4     5,283         3.2     —     

Other Counties in MD

     4,796         2.9     —           —          —     

Arlington/Alexandria, VA

     24,240         14.6     2,236         1.4     —     

Fairfax, VA

     39,405         23.7     826         0.5     0.1

Culpeper/Fauquier, VA

     4,445         2.7     3,695         2.2     —     

Frederick, VA

     6,281         3.8     6,250         3.8     —     

Loudoun, VA

     32,456         19.6     —           —          0.4

Prince William, VA

     7,864         4.8     1,045         0.6     —     

Spotsylvania, VA

     297         0.2     —           —          —     

Stafford, VA

     20,411         12.3     4,364         2.6     —     

Other Counties in VA

     1,762         1.1     —           —          —     

Outside VA, D.C. & MD

     106         0.1     —           —          —     
                                          
   $ 165,547         100.0   $ 24,234         14.6     0.5

Commercial, Acquisition, Development and Construction

 

     As of March 31, 2011  
By County/Jurisdiction of Origination:    Total
Outstandings
     Percentage
of Total
    Non-accrual
Loans
     Non-accruals
as a % of
Outstandings
    Net charge-offs
(recoveries) as
a % of
Outstandings
 

District of Columbia

   $ 10,084         5.6   $ —           —          —     

Montgomery, MD

     —           0.0     —           —          —     

Prince Georges, MD

     12,491         6.9     —           —          —     

Other Counties in MD

     3,376         1.9     —           —          —     

Arlington/Alexandria, VA

     9,312         5.2     3,153         1.8     —     

Fairfax, VA

     27,799         15.4     2,800         1.6     —     

Culpeper/Fauquier, VA

     3,020         1.7     —           —          —     

Frederick, VA

     2,399         1.3     —           —          —     

Henrico, VA

     864         0.5     —           —          —     

Loudoun, VA

     20,153         11.2     608         0.3     2.5

Prince William, VA

     55,992         30.9     2,064         1.1     1.2

Spotsylvania, VA

     1,740         1.0     —           —       

Stafford, VA

     28,301         15.6     —           —          —     

Other Counties in VA

     5,013         2.8     —           —          —     

Outside VA, D.C. & MD

     —           0.0     —           —          —     
                                          
   $ 180,544         100.0   $ 8,625         4.8     3.7

Non-Farm/Non-Residential

 

     As of March 31, 2011  
By County/Jurisdiction of Origination:    Total
Outstandings
     Percentage
of Total
    Non-accrual
Loans
     Non-accruals
as a % of
Outstandings
    Net charge-
offs as a % of
Outstandings
 

District of Columbia

   $ 81,357         7.3   $ —           —          —     

Montgomery, MD

     34,534         3.1     —           —          —     

Prince Georges, MD

     47,778         4.3     —           —          —     

Other Counties in MD

     44,482         4.0     —           —          —     

Arlington/Alexandria, VA

     180,094         16.2     2,296         0.2     —     

Fairfax, VA

     257,562         23.0     4,847         0.4     —     

Culpeper/Fauquier, VA

     5,709         0.5     —           —          —     

Frederick, VA

     6,347         0.6     —           —          —     

Henrico, VA

     28,565         2.6     —           —          —     

Loudoun, VA

     113,903         10.2     1,952         0.2     0.1

Prince William, VA

     209,558         18.8     909         0.1     —     

Spotsylvania, VA

     16,922         1.5     —           —          —     

Stafford, VA

     20,737         1.9     —           —          —     

Other Counties in VA

     58,151         5.2     —           —          —     

Outside VA, D.C. & MD

     8,774         0.8     —           —          —     
                                          
   $ 1,114,473         100.0   $ 10,004         0.9     0.1

 

 

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Table of Contents

Concentrations of Credit Risk

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

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

At March 31, 2011, the Company had $1.55 billion, or 71.0%, of total loans concentrated in commercial real estate. Commercial real estate for purposes of this discussion includes all construction loans, loans secured by multi-family residential properties and loans secured by non-farm, non-residential properties. At December 31, 2010, commercial real estate loans were $1.58 billion, or 71.4%, of total loans. Total construction loans of $346.1 million at March 31, 2011 represented 15.9% of total loans, loans secured by multi-family residential properties of $89.8 million represented 4.1% of total loans, and loans secured by non-farm, non-residential properties of $1.1 billion represented 51.1%.

Construction loans at March 31, 2011, included $149.2 million in loans to commercial builders of single family residential property and $16.3 million to individuals on single family residential property, together representing 7.6% of total loans. These loans are made to a number of unrelated entities and generally have a term of twelve to eighteen months. In addition, the Company had $180.5 million of construction loans on non-residential commercial property at March 31, 2011, representing 8.3% of total loans. Total construction loans of $346.1 million include $123.7 million in land acquisition and/or development loans on residential property and $96.2 million in land acquisition and/or development loans on commercial property, together totaling $219.9 million, or 10.1% of total loans. Potential adverse developments in the Northern Virginia real estate market or economy, including substantial increases in mortgage interest rates, slower housing sales, and increased commercial property vacancy rates, could have an adverse impact on these groups of loans and the Bank’s income and financial position. At March 31, 2011, the Company had no other concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of counterparties that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.

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

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

 

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Non-Interest Income

For the three months ended March 31, 2011, the Company recognized $1.5 million in non-interest income, compared to non-interest income of $607 thousand for the three months ended March 31, 2010. Fees and net gains on loans held-for-sale were up for the first quarter 2011 on a year-over-year basis by $175 thousand, or 50.1%. Sequentially, fees and net gains on loans held-for-sale were down $1.2 million from the fourth quarter of 2010. Included in the current quarter income is an impairment loss on securities of $732 thousand, which was partially offset by a gain on sale of securities available-for-sale of $503 thousand. The impairment loss on securities was due to additional deferrals and defaults by the underlying issuers of three pooled trust preferred securities. For the three months ended March 31, 2010, the Company recognized an impairment loss of $851 thousand. Management is carefully monitoring its holdings of the securities which caused the impairment losses and at this time can not be assured that there will not be further losses in the future.

Non-Interest Expense

Non-interest expense decreased $257 thousand, or 1.7%, from $14.7 million in the first quarter of 2010, to $14.5 million in the current period. The majority of the year-over-year decrease was due to the $762 thousand decrease in losses on other real estate owned. The reduction in losses on OREO offset an increase in salaries and employee benefits related to commissions payable in connection with greater than anticipated mortgage production. However, due to the $1.4 million increase in net interest income and $869 thousand increase in non-interest income year-over-year, the adjusted efficiency ratio improved from 55.4% in the first quarter of 2010, to 51.1% in the first quarter of 2011. Non-interest expense in future periods may be impacted by new regulatory complexity and compliance costs related to recent legislation passed by congress.

Provision for Income Taxes

The Company’s income tax provisions are adjusted for non-deductible expenses and non-taxable income after applying the U.S. federal income tax rate of 35%. For the three months ended March 31, 2011, the Company recorded an income tax provision of $2.4 million compared to a provision of $2.0 million for the same period in 2010. The effects of non-deductible expenses and non-taxable income on the Company’s income tax provisions are minimal.

Liquidity

The Company’s principal source of liquidity and funding is its deposit base. The level of deposits necessary to support the Company’s lending and investment activities is determined through monitoring loan demand. Considerations in managing the Company’s liquidity position include, but are not limited to, scheduled cash flows from existing loans and investment securities, anticipated deposit activity including the maturity of time deposits, and projected needs from anticipated extensions of credit. The Company’s liquidity position is monitored daily by management to maintain a level of liquidity that can efficiently meet current needs and is evaluated for both current and longer term needs as part of the asset/liability management process.

The Company measures total liquidity through cash and cash equivalents, securities available-for-sale, mortgage loans held-for-sale, other loans and investment securities maturing within one year, less securities pledged as collateral for repurchase agreements, public deposits and other purposes, and less any outstanding Federal funds purchased. These liquidity sources increased $121.1 million, or 20.7%, from $585.1 million at December 31, 2010, to $706.2 million at March 31, 2011, due to a $74.9 million increase in Federal funds sold and a higher balance of loans maturing within one year. Additional sources of liquidity available to the Bank include the capacity to borrow funds through established short-term lines of credit with various correspondent banks and the Federal Home Loan Bank of Atlanta. See Note 8 to the Consolidated Financial Statements for further information regarding these additional liquidity sources.

Off-Balance Sheet Arrangements

The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and financial guarantees which would impact the Company’s liquidity and capital resources to the extent customers accept and/or use these commitments. These instruments involve, to varying degrees,

 

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elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. With the exception of these off-balance sheet arrangements, and the Company’s obligations in connection with its trust preferred securities, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors.

Commitments to extend credit, which amounted to $522.0 million at March 31, 2011, and $436.3 million at December 31, 2010, represent legally binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Company guaranteeing the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. At March 31, 2011, and December 31, 2010, the Company had $27.8 million and $28.8 million, respectively, in outstanding standby letters of credit.

Contractual Obligations

Since December 31, 2010, there have been no significant changes in the Company’s contractual obligations.

Capital

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

Both the Company’s and the Bank’s capital levels continue to meet regulatory requirements. The primary indicators relied on by bank regulators in measuring the capital position are the Tier 1 risk-based capital, total risk-based capital, and leverage ratios. Tier 1 capital consists of common and qualifying preferred stockholders’ equity, less goodwill, and for the Company includes certain minority interests relating to bank subsidiary issued shares, and a limited amount of restricted core capital elements. Restricted core capital elements include qualifying cumulative preferred stock interests, certain minority interests in subsidiaries and qualifying trust preferred securities. All of the $71 million in preferred stock interests issued to the Treasury under the Capital Purchase Program qualify as Tier 1 capital. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance for loan losses, and for the Company, a limited amount of excess restricted core capital elements. Risk-based capital ratios are calculated with reference to risk-weighted assets. The leverage ratio compares Tier 1 capital to total average assets. The Bank’s Tier 1 risk-based capital ratio was 13.57% at March 31, 2011, compared to 12.87% at December 31, 2010, and its total risk-based capital ratio was 14.82% at March 31, 2011, compared to 14.12% at December 31, 2010. These ratios are in excess of the mandated minimum requirement of 4.00% and 8.00%, respectively. The Bank’s leverage ratio was 11.16% at March 31, 2011, compared to 10.76% at December 31, 2010, and in excess of the mandated minimum requirement of 4.00%. The Company’s Tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio was 13.96%, 15.21%, and 11.48%, respectively, at March 31, 2011, compared to 13.20%, 14.45%, and 11.07% at December 31, 2010. The increases in these capital ratios in 2011 are due to additional capital and lower levels of risk-weighted assets.

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

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

 

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may be required to maintain higher levels of capital than we would otherwise be expected to maintain as a result of our levels of construction, development and commercial real estate loans, which may require us to obtain additional capital.

Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve has revised the capital treatment of trust preferred securities to provide that, beginning in 2011, such securities can be counted as Tier 1 capital at the holding company level, together with other restricted core capital elements, up to 25% of total capital (net of goodwill), and any excess as Tier 2 capital, subject to limitation. At March 31, 2011, trust preferred securities represented 20.2% of the Company’s Tier 1 capital and 18.6% of its total risk-based capital. See Note 9 to the Consolidated Financial Statements for further information regarding trust preferred securities.

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

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

On March 31, 2011, the Company issued 426,000 shares of its common stock at a price of $5.87 per share in a registered direct placement with a Company director for total gross proceeds of approximately $2.5 million. In addition, the Company issued to the investor warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $4.8 million in gross proceeds to the Company. The warrants each have an exercise price of $5.62 per share. The Series A warrants, exercisable for a total of 426,000 shares of common stock, are exercisable for a period of seven months following the closing date. The Series B warrants, also exercisable for a total of 426,000 shares of common stock, are exercisable for a period of twelve months following the closing date.

On September 29, 2010, the Company issued 1,904,766 shares of its common stock at a price of $5.25 per share in a registered direct placement with several institutional investors for total gross proceeds of $10.0 million. In addition, the Company issued to the investors warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $11.4 million in gross proceeds to the Company. The warrants each have an exercise price of $6.00 per share, which represents a 14.3% premium to the offering price of the shares of common stock sold in the registered direct placement. The Series A warrants, exercisable for a total of 952,383 shares of common stock, are exercisable for a period of seven months following the closing date. On April 29, 2011, 130,851 of the Series A warrants were exercised resulting in approximately $746 thousand in additional capital while 821,532 Series A warrants expired under the original terms. The Series B warrants, also exercisable for a total of 952,383 shares of common stock, are exercisable for a period of twelve months following the closing date.

 

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Please refer to Note 9 to the Consolidated Financial Statements for additional information regarding the issuance of $25 million of trust preferred securities and warrants to purchase 1.5 million shares to certain directors and executive officers of the Company.

Recent Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures and require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll-forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance roll-forward and modification disclosures, will be required for periods beginning after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of the new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption was not permitted. The adoption of the new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

The Securities and Exchange Commission (the “SEC”) has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting”, which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using accounting principles generally accepted in the United States were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.

In March 2011, the SEC issued Staff Accounting Bulletin (“SAB”) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

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In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company is currently assessing the impact that ASU 2011-02 will have on its consolidated financial statements.

Internet Access To Company Documents

The Company provides access to its SEC filings through the Bank’s web site at www.vcbonline.com. After accessing the web site, the filings are available upon selecting “About VCB/Investor Relations/SEC Filings.” The annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are made available as soon as reasonably practicable after the reports are electronically filed or furnished to the SEC.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

We use a duration gap of equity approach to manage our long term interest rate risk. This approach uses a model which generates estimates of the change in our market value of portfolio equity (“MVPE”) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets and liabilities using various assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

Our short term interest rate sensitivity is managed through the use of a model that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The model assumes that the composition of interest sensitive assets and liabilities existing at March 31, 2011, remains constant over a two year period (base case) and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.

The following table provides an analysis of our interest rate risk as measured by the estimated change in MVPE and net interest income from the base case, resulting from instantaneous and sustained parallel shifts in interest rates as of March 31, 2011, (in thousands):

 

    

Sensitivity of Market Value of Portfolio Equity

March 31, 2011

   

Sensitivity of Net Interest Income

March 31, 2011

 
     Market Value of Portfolio Equity     Net Interest Income     Net Interest Margin  

Interest Rate Scenario

   Amount      $ Change
from Base
    Percent     % of Total
Assets
    Amount      $ Change
from Base
    Percent     % Change
from Base
 

Up 300 bps

   $ 236,583       $ (82,568     -25.87     8.49   $ 221,008       $ 10,871        4.05     5.12

Up 200 bps

     264,945         (54,206     -16.98     9.50     217,470         7,332        3.99     3.46

Base Case

     319,151         —          0.00     11.45     210,138         —          3.85     0.00

Down 100 bps

     330,321         11,170        3.50     11.85     202,864         (7,274     3.72     -3.42

 

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Management believes the modeled results are consistent with the short duration of the Company’s balance sheet and given the many variables that affect the actual timing of when assets and liabilities will reprice and the extent of that repricing. In shocking the current two year projection upward, interest-bearing liabilities are repricing slightly higher than interest-earning assets; however, that decline in interest income is being offset by a higher level of interest-earning assets relative to interest-bearing liabilities. Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net income and the effect on net income from sudden changes in interest rates. Actual results will differ from the simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

ITEM 4. CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Interim Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Interim Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2011, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

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

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS – None

Item 1A. RISK FACTORS

There have been no material changes in the risk factors faced by the Company from those disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

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

 

  (a) Sales of Unregistered Securities.- None

 

  (b) Use of Proceeds.- Not Applicable.

 

  (c) Issuer Purchases of Securities.- None

Item 3. DEFAULTS UPON SENIOR SECURITIES - None

Item 4. (REMOVED AND RESERVED)

Item 5. OTHER INFORMATION

 

  (a) Required 8-K Disclosures. None

 

  (b) Changes in Procedures for Director Nominations by Securityholders. None

 

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Item 6. EXHIBITS

 

Exhibit No.    Description
  3.1    Articles of Incorporation of Virginia Commerce Bancorp, Inc., as amended (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006)
  3.2    Articles of Amendment to the Articles of Incorporation relating to the Series A Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 15, 2008)
  3.3    Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on July 27, 2007)
  3.4    Amendment to the Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to exhibit 3.4 to the Company’s Current Report on Form 8-K filed on January 28, 2011)
  4.13    Form of Common Stock Purchase Warrant (incorporated by reference to Exhibit 4.13 to the Company’s Current Report on Form 8-K filed on March 22, 2011)
10.9    Form of Restricted Stock Agreement (for employee) under the Virginia Commerce Bancorp, Inc. 2010 Equity Plan (incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed on January 28, 2011)
10.10    Form of Incentive Stock Option Agreement (for employee) under the Virginia Commerce Bancorp, Inc. 2010 Equity Plan (incorporated by reference to Exhibit 10.10 to the Company’s Current Report on Form 8-K filed on January 28, 2011)
10.11    Securities Purchase Agreement, dated March 21, 2011, among Virginia Commerce Bancorp, Inc. and an affiliated investor identified therein (incorporated by reference to Exhibit 10.11 to the Company’s Current Report on Form 8-K filed on March 22, 2011)
31.1    Certification of Peter A. Converse, President and Chief Executive Officer
31.2    Certification of Wilmer L. Tinley, Jr., Interim Chief Financial Officer
32.1    Certification of Peter A. Converse, President and Chief Executive Officer
32.2    Certification of Wilmer L. Tinley, Jr., Interim Chief Financial Officer

 

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SIGNATURES

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

 

    Virginia Commerce Bancorp, Inc.
    (Registrant)
Date: May 10, 2011     BY  

/s/ Peter A. Converse

    Peter A. Converse, President and Chief Executive Officer
    (Principal Executive Officer)
Date: May 10, 2011     BY  

/s/ Wilmer L. Tinley, Jr.

    Wilmer L. Tinley, Jr., Interim Chief Financial Officer
    (Principal Financial Officer)

 

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