EAGLE BANCORP INC - FORM 8-K/A - EX-99.1

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8-K/A - 8-K/A - EAGLE BANCORP INC	a2222096z8-ka.htm
EX-99.4 - EX-99.4 - EAGLE BANCORP INC	a2222096zex-99_4.htm
EX-23.1 - EX-23.1 - EAGLE BANCORP INC	a2222096zex-23_1.htm
EX-99.3 - EX-99.3 - EAGLE BANCORP INC	a2222096zex-99_3.htm
EX-99.2 - EX-99.2 - EAGLE BANCORP INC	a2222096zex-99_2.htm

Exhibit 99.1

Certified Public Accountants
and Consultants

INDEPENDENT AUDITOR’S REPORT

To the Audit Committee of the Board of Directors
Virginia Heritage Bank
Tysons Corner, Virginia

Report on the Financial Statements

We have audited the accompanying consolidated financial statements of Virginia Heritage Bank and its subsidiary which comprise the consolidated balance sheets as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in stockholder’s equity and cash flows for the years then ended and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the

reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Virginia Heritage Bank and its subsidiary as of December 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

Winchester, Virginia
March 21, 2014

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Consolidated Balance Sheets
(Dollars in thousands, except per share data)

	December 31,
	2013			2012
Assets

Cash and due from banks	$	24,855		$	12,761
Securities available for sale, at fair value	126,834			118,629
Loans, net of allowance for loan losses of $9,790 and $8,262, respectively	696,097			579,284
Loans held for sale	10,730			48,136
Premises and equipment, net	1,861			2,051
Accrued interest receivable	2,379			2,368
Federal Home Loan Bank stock, at cost	4,223			2,352
Federal Reserve Bank stock, at cost	2,417			1,751
Other real estate owned, net of valuation allowance of $76 and $81, respectively	519			479
Bank owned life insurance	15,408			5,178
Deferred income taxes	5,973			3,671
Other assets	3,545			4,913

Total assets	$	894,841		$	781,573

Liabilities and Stockholders’ Equity

Liabilities:
Noninterest-bearing demand deposits	$	189,583		$	182,790
NOW, money-market and savings deposits	107,064			85,160
Time deposits	414,753			392,188

Total deposits	711,400			660,138

Federal funds purchased	10,000			13,000
Federal Home Loan Bank advances	73,000			33,000
Securities sold under agreements to repurchase	1,067			1,600
Accrued expenses and other liabilities	3,168			4,518

Total liabilities	798,635			712,256

Stockholders’ equity:
Preferred stock, Series A, $4 par value, non-cumulative, $1,000 per share liquidation preference, 5,000,000 shares authorized, 15,300 shares issued and outstanding	61			61
Common stock, $4 par value, 15,000,000 shares authorized, 6,014,801 and 4,333,209 shares issued and outstanding, respectively	24,059			17,333
Additional paid-in capital	56,632			41,038
Retained earnings	19,774			10,927
Accumulated other comprehensive loss	(4,320		)	(42		)

Total stockholders’ equity	96,206			69,317

Total liabilities and stockholders’ equity	$	894,841		$	781,573

See Accompanying Notes to Consolidated Financial Statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Consolidated Statements of Income
(Dollars in thousands, except per share data)

	Years Ended December 31,
	2013			2012
Interest income:
Interest and fees on loans	$	31,453		$	28,223
Investment securities	2,430			2,559
Interest on deposits in other banks	54			32
Total interest income	33,937			30,814

Interest expense:
Interest on deposits	4,906			5,765
Interest on federal funds purchased	12			5
Interest on Federal Home Loan Bank advances	319			374
Interest on securities sold under agreements to repurchase	3			3
Total interest expense	5,240			6,147

Net interest income	28,697			24,667

Provision for loan losses	1,764			3,410

Net interest income after provision for loan losses	26,933			21,257

Noninterest income:
Gain on sale of loans	7,919			11,028
Service charges on deposit accounts	652			72
Gain on sale of securities available for sale	557			1,759
Cash surrender value on bank owned life insurance	229			166
Other income	1,319			1,616
Total noninterest income	10,676			14,641

Noninterest expenses:
Salaries and employee benefits	14,277			13,647
Occupancy and equipment expense	2,414			2,248
Mortgage closing cost promotions	1,299			2,161
Bank franchise tax	698			613
FDIC deposit insurance assessments	514			394
Litigation settlement (recovery) expense	(49		)	964
Other operating expenses	5,110			4,600
Total noninterest expenses	24,263			24,627

Income before income tax expense	13,346			11,271

Income tax expense	4,346			3,625

Net income	9,000			7,646
Effective dividend on preferred stock	153			289
Net income available to common stockholders	$	8,847		$	7,357

Income per common share:
Basic	$	1.70		$	1.70
Diluted	$	1.65		$	1.68

Weighted average common shares outstanding:
Basic	5,217,531			4,333,209
Diluted	5,359,521			4,371,355

See Accompanying Notes to Consolidated Financial Statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2013 and 2012
(Dollars in thousands)

			Year Ended December 31, 2013

Net income			$	9,000
Other comprehensive loss, net of tax
Unrealized loss on securities
Net change in unrealized loss on investment securities, net of tax of $(2,014)	(3,910	)
Reclassification adjustment for gains recognized in income, net of tax of $(189)	(368	)
Total other comprehensive loss			(4,278		)
Total comprehensive income			$	4,722

			Year Ended December 31, 2012

Net income			$	7,646
Other comprehensive loss, net of tax
Unrealized gains on securities
Net change in unrealized gain on investment securities, net of tax of $292	569
Reclassification adjustment for gains recognized in income, net of tax of $(598)	(1,161	)
Total other comprehensive loss			(592		)
Total comprehensive income			$	7,054

See Accompanying Notes to Consolidated Financial Statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2013 and 2012
(Dollars in thousands)

	Preferred Stock			Common Stock			Additional Paid-in		Retained			Accumulated Other Comprehensive
	Shares	Amount		Shares	Amount		Capital		Earnings			Income (Loss)			Total

Balance at December 31, 2011	15,300	$	61	4,333,209	$	17,333	$	40,962	$	3,570		$	550		$	62,476
Net income	—	—		—	—		—		7,646			—			7,646
Other comprehensive loss	—	—		—	—		—		—			(592		)	(592		)
Stock compensation expense	—	—		—	—		76		—			—			76
Dividends paid on preferred stock - Series A	—	—		—	—		—		(289		)	—			(289		)
Balance at December 31, 2012	15,300	$	61	4,333,209	$	17,333	$	41,038	$	10,927		$	(42	)	$	69,317
Net income	—	—		—	—		—		9,000			—			9,000
Other comprehensive loss	—	—		—	—		—		—			(4,278		)	(4,278		)
Stock compensation expense	—	—		—	—		105		—			—			105
Stock options exercised	—	—		14,092	56		103		—			—			159
Dividends paid on preferred stock - Series A	—	—		—	—		—		(153		)	—			(153		)
Sale of common stock	—	—		1,667,500	6,670		15,386		—			—			22,056
Balance at December 31, 2013	15,300	$	61	6,014,801	$	24,059	$	56,632	$	19,774		$	(4,320	)	$	96,206

See Accompanying Notes to Consolidated Financial Statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Consolidated Statements of Cash Flows
(Dollars in thousands)

	Years Ended December 31,
	2013			2012
Cash flows from operating activities:
Net income	$	9,000		$	7,646
Reconciliation of net income to net cash (used in) provided by operating activities:
Provision for loan losses	1,764			3,410
Change in valuation for foreclosed assets	(77		)	(41		)
Deferred income tax	(764		)	(412		)
Depreciation	594			630
Amortization and accretion on securities available for sale, net	1,270			1,296
Gain on sale of securities available for sale	(557		)	(1,759		)
Loss on sale of other real estate owned	27			247
Loss on sale of premises and equipment	—			3
Cash surrender value on bank owned life insurance	(230		)	(166		)
Stock compensation expense	105			76
Proceeds from sales of loans held for sale	309,255			347,210
Loans originated for resale	(263,930		)	(367,457		)
Gain on sale of loans	(7,919		)	(11,028		)
Changes in assets and liabilities:
Increase in accrued interest receivable	(11		)	(166		)
Decrease (increase) in other assets	2,064			(4,053		)
(Decrease) increase in other liabilities	(1,350		)	370
Net cash provided (used in) by operating activities	49,241			(24,194		)

Cash flows from investing activities:
Net increase in loans	(119,172		)	(148,560		)
Proceeds from sale of other real estate owned	574			295
Purchases of premises and equipment	(404		)	(765		)
Net proceeds from sale of premises and equipment	—			5
Purchases of securities available for sale	(120,731		)	(256,557		)
Proceeds from repayments of securities available for sale	15,900			15,197
Proceeds from maturities and calls of securities available for sale	1,000			11,750
Proceeds from sale of securities available for sale	88,432			211,164
Purchase of bank owned life insurance	(10,000		)	(1,250		)
Purchase of FHLB stock	(1,871		)	(738		)
Purchase of FRB stock	(666		)	(2		)
Net cash (used in) investing activities	(146,938		)	(169,461		)

Cash flows from financing activities:
Net increase in demand, savings, interest-bearing checking and money market deposits	28,697			146,913
Net increase in time deposits	22,565			21,512
Net (decrease) increase federal funds purchased	(3,000		)	13,000
Net increase in FHLB advances	40,000			15,000
Net decrease in securities sold under agreements to repurchase	(533		)	(150		)
Issuance of common stock	22,056			—
Stock options exercised	159			—
Dividends paid on preferred stock-	(153		)	(289		)
Net cash provided by financing activities	109,791			195,986

Net increase in cash and cash equivalents	12,094			2,331

Cash and cash equivalents at beginning of period	12,761			10,430

Cash and cash equivalents at end of period	$	24,855		$	12,761

Supplemental disclosure of cash flow information:
Cash payments for interest	$	5,266		$	6,178
Cash payments for income taxes	$	4,602		$	4,846

Supplemental disclosure of noncash investing activities:
Fair value adjustment on securities	$	(6,481	)	$	(898	)
Loans transferred to other real estate owned	$	595		$	160

See Accompanying Notes to Consolidated Financial Statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 1. Organization and Summary of Significant Accounting Policies

Organization

Virginia Heritage Bank (the “Bank”) is a commercial bank chartered by the Commonwealth of Virginia. The Bank began operations on November 21, 2005. The Bank offers a variety of financial services to individual and corporate customers through its five full service banking branches located in Fairfax City, Fairfax, Prince William and Loudoun Counties, Virginia.

The Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation (“FDIC”). It is subject to the regulations of the Federal Reserve System and the Bureau of Financial Institutions of the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.

Principles of Consolidation

The consolidated financial statements include the accounts of the Bank’s wholly owned subsidiary, VHB Real Estate, LLC. All material intercompany balances and transactions have been eliminated in consolidation.

Significant Accounting Policies

The following is a description of the significant accounting policies and practices followed by the Bank, which conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry.

Use of Estimates

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheets and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed assets, the valuation of deferred tax assets, the valuation of stock compensation benefits and the fair value of financial instruments.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and federal funds sold. Generally, federal funds purchased and sold mature within ninety days.

The Bank is required under Federal Reserve Board regulations to maintain reserves against its transaction deposit accounts. At December 31, 2013 and 2012, these required reserves were $12.6 million and $11.5 million, respectively.

Interest Bearing Deposits

Interest bearing deposits held in banks mature within one year and are carried at cost.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Securities

Securities may be classified as either trading, held to maturity or available for sale. Trading securities are held principally for resale and recorded at their fair values. Unrealized gains and losses on trading securities are included immediately in operations. Held to maturity securities are those which the Bank has the positive intent and ability to hold to maturity and are reported at amortized cost. Available for sale securities consist of securities not classified as trading securities nor as held to maturity securities. Unrealized holding gains and losses on available for sale securities are excluded from operations and reported in accumulated other comprehensive income (loss). Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Premiums and discounts on securities are recognized in interest income using the interest method over the period to maturity.

Management evaluates securities for other than temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Bank intends to sell the security or (ii) it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis. If, however, the Bank does not intend to sell the security and it is not more-than-likely that the Bank will be required to sell the security before recovery, management must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

For equity securities, impairment is considered to be other-than-temporary based on the Bank’s ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in income.

Loans

Loans that management has the intent and the Bank has the ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs.

Loan origination fees are deferred and direct origination costs are capitalized. The net amount is amortized as an adjustment of the loan yield over the contractual life of the related loans.

The accrual of interest on all segments of loans is discontinued at the time the loan is ninety days delinquent unless the loan is well collateralized and in process of collection. In all cases, loans for each segment are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans Held for Sale

Loans held for sale, which are composed of residential first mortgage loans, are reported at the lower of cost or fair value on an aggregate loan portfolio basis. Gains or losses realized on the sales of loans held for sale are accrued when the loan is booked. Net unrealized losses, if any, are recognized through a market adjustment by charges to operations. The mortgage repurchase reserve is provisioned at a rate of five basis points of total mortgage loan originations for the period.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Allowance for Loan Losses

The Bank has a credit risk management strategy that includes a combination of exposure limits significantly below legal lending limits and comprehensive underwriting, documentation and collection standards. The strategy also emphasizes diversification on an industry and customer level, regular credit examinations and management reviews of large credit exposures. Even with this lending strategy, loan losses are inherent in our portfolio. The allowance for loan losses is established as losses are estimated through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The Bank’s charge-off policy on all loan segments, with the exception of the sales finance portfolio, is to charge-off the appropriate principal balance to the allowance for loan losses when specific losses exist within the loan portfolio. Collection efforts will continue even though the value of the asset has been partially or fully reduced. A consumer loan from the sales finance portfolio is subject to repossession after fifty-five days. The automobile is sold at auction and the remaining balance is charged-off.

The allowance for loan losses is evaluated on a quarterly basis by management and is approved by the Audit Committee. The allowance is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

During these evaluations, particular characteristics associated with a segment of the loan portfolio are also considered. These characteristics are detailed below:

· Commercial loans not secured by real estate carry risks associated with the successful operation of a business, and the repayments of these loans depend on the profitability and cash flows of the business. Additional risk relates to the value of the collateral where depreciation occurs and the valuation is less precise.

· Loans secured by commercial real estate also carry risks associated with the success of the business and the ability to generate a positive cash flow sufficient to service debts. Real estate security diminishes risks only to the extent that a market exists for the subject collateral.

· Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral, such as automobiles which may depreciate more rapidly than other assets. In addition, these loans may be unsecured. Consumer loans are more likely than real estate loans to be immediately affected in an adverse manner by job loss, divorce, illness or personal bankruptcy. Consumer loans are further segmented into credit card lines and all other consumer loans.

· Real estate secured construction loans carry risks that a project will not be completed as scheduled and budgeted and that the value of the collateral may, at any point, be less than the principal amount of the loan. Additional risks may occur if the general contractor, who may not be a loan customer, is unable to finish the project as planned due to financial pressures unrelated to the project.

· Residential real estate loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

The allowance consists of specific and general components. The specific component relates to loans that are considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller-balance

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify consumer loans for impairment evaluations.

For loans considered impaired, an allowance is established when the discounted cash flows or the collateral value of the impaired loan is lower than the carrying value of that loan. A specific allowance may not be necessary if the discounted cash flows or the underlying collateral value is deemed sufficient by management to cover any estimated exposures.

The general component of the allowance covers non-impaired loans and is estimated for inherent losses within the remaining portfolio. As part of the quarterly analysis, management stratifies the loan portfolio into several segments: commercial, commercial real estate, construction & development, home equity, and other consumer loans. Management applies the historical loss experience which is compiled using data from the previous four quarters. However, due to the Bank’s limited historical loss experience, management determines the average loss experience for comparable banks in the same market and applies this amount in its calculation of the general allowance. The historical loss experience for each segment is then weighted to adjust for outliers or other anomalies that may be present. Management then applies a series of qualitative factors to adjust the historical losses to arrive at a targeted reserve for the general component of the allowance for each loan segment. The qualitative factors can include a number of adjustments regarding the economic environment on a national basis as well as a regional or local basis. Additionally, the qualitative factors can include adjustments driven by changes in the Bank’s loan underwriting; sophistication of the loan review process; changes in personnel; or isolated stress in a particular loan or industry segment. The Bank will begin using its own historical loss experience when there is sufficient data available.

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank — put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Premises and Equipment

Leasehold improvements, furniture, fixtures and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expense are computed using the straight-line method over the shorter of the estimated useful life of each type of asset or remaining lease term.

Foreclosed Properties

Assets acquired through, or in lieu of, loan foreclosure are held for sale. They are initially recorded at the assets’ fair market value at the date of foreclosure, less estimated selling costs thus establishing a new cost basis. Subsequent to foreclosure, valuations of the assets are periodically performed by management. Adjustments are made to the lower of the carrying amount or fair market value of the assets less selling costs. Revenue and expenses from operations and valuation changes are included in net expenses from foreclosed assets. At December 31, 2013 and 2012, the Bank had foreclosed assets in the amount of $519,000 and $479,000, respectively. These assets are held in the name of VHB Real Estate, LLC which is a wholly owned subsidiary of the Bank. See Note 1 for additional information.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Bank Owned Life Insurance

The Bank has purchased life insurance policies on certain key employees. Bank owned life insurance is recorded at its cash surrender value. The Bank is the sole beneficiary of the insurance contracts.

Income Taxes

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss carry forwards, and tax credit carry forwards. Deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statements of income.

Advertising and Marketing Costs

The Bank follows the policy of charging the production costs of advertising and marketing to expense as incurred. For the years ended December 31, 2013 and 2012, total advertising and marketing costs were $259,000 and $298,000, respectively.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income.

Net Income Per Common Share

Net income per common share is computed based on the weighted-average number of shares of common stock outstanding during the year. Average stock options of 289,121 as of December 31, 2013 and 338,433 as of December 31, 2012 were excluded from the calculation of net income per common share because their effect was anti-dilutive.

Stock Compensation Plan

Stock compensation accounting guidance requires the measurement and recognition of compensation for all stock-based awards made to employees and directors, including stock options, based on estimated fair values. The Bank recognizes stock-based compensation in salaries and employee benefits in the consolidated statements of income on a straight-line basis over the vesting period.

The Bank uses the Black-Scholes option pricing model in order to value stock-based awards. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by the Bank’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

variables include, but are not limited to the expected life of the award, our estimated stock price volatility over the term of the award, dividend yield and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with accounting guidance, the assumptions used in calculating fair value of stock-based awards and the Black-Scholes option pricing model are highly subjective, and other reasonable assumptions could provide differing results. As a result, if factors change and the Bank uses different assumptions, stock-based compensation expense could be materially different in the future.

Off-Balance Sheet Instruments

In the ordinary course of business the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, standby letters of credit, undisbursed construction loans and unused lines of credit. Such financial instruments are recorded in the financial statements when they are funded.

Fair Values of Financial Instruments

Fair value of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 16. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Recent Pronouncements

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Bank has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this ASU provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the consolidated financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the consolidated financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of the new guidance did not have a material impact on the Bank’s consolidated financial statements.

In January 2014, the FASB issued ASU 2014-01, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the consolidated income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Bank is currently assessing the impact that ASU 2014-01 will have on its consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Bank is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 2. Securities

The carrying amount of securities available for sale and their approximate fair values are summarized as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

At December 31, 2013:
U.S. Treasury notes	$	15,141	$	—	$	(188	)	$	14,953
U.S. Government agency securities	19,828		30		(681		)	19,177
Municipal securities	26,761		—		(2,390		)	24,371
Corporate securities	6,970		—		(240		)	6,730
Mortgage-backed securities	64,478		52		(3,132		)	61,398
SBA Loan Pool Certificate RMOF	201		4		—			205
Total	$	133,379	$	86	$	(6,631	)	$	126,834

At December 31, 2012:
U.S. Treasury notes	$	43,065	$	18	$	—		$	43,083
U.S. Government agency securities	23,528		86		(73		)	23,541
Municipal securities	32,632		256		(300		)	32,588
Corporate securities	8,563		18		(103		)	8,478
Mortgage-backed securities	10,604		83		(49		)	10,638
SBA Loan Pool Certificate RMOF	301		—		—			301
Total	$	118,693	$	461	$	(525	)	$	118,629

The scheduled maturities of securities available for sale at December 31, 2013 are as follows (in thousands):

	Amortized Cost		Fair Value
Due from one to five years	$	17,707	$	17,469
Due from five to ten years	11,986		11,380
Due over 10 years	39,007		36,382
Mortgage-backed securities	64,679		61,603
Total	$	133,379	$	126,834

Actual principal repayments could differ from scheduled maturities due to callable options held by the issuer. Management expects a portion of the securities will be called or paid down by the issuer prior to their stated maturities.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

During the years ended December 31, 2013 and 2012, the Bank sold $88.4 million and $211.2 million, respectively in securities available for sale. The Bank recognized gross gains of $620,000 and gross losses of $63,000 for the year ended December 31, 2013. For the year ended December 31, 2012, the Bank recognized gross gains of $2.2 million and gross losses of $400,000.

At December 31, 2013 and 2012, securities with amortized costs of approximately $52.6 million and $45.6 million, respectively, and with estimated fair values of $50.3 million and $45.6 million, respectively, were pledged as collateral for the U.S. Bankruptcy Trustee deposit accounts and customer repurchase agreements.

Securities in an unrealized loss position at December 31, 2013 and 2012, by duration of the unrealized loss, are shown below (in thousands). The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management intends to hold these securities until recovery of value and it is more likely than not that the Bank will not be required to sell these securities before a recovery of unrealized losses. At December 31, 2013 and 2012, the Bank had 110 and 33 securities, respectively, in an unrealized loss position.

	2013
	Less than 12 Months					12 Months or More
	Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)
Obligations of U.S.
U.S. Treasury notes	$	14,953	$	(188	)	$	—	$	—
U.S. Government agency securities	13,992		(391		)	1,705		(290		)
Municipal securities	12,167		(1,037		)	12,204		(1,353		)
Corporate securities	4,813		(56		)	1,917		(184		)
Mortgage-backed securities	53,489		(3,026		)	2,637		(106		)
Total temporarily impaired securities	$	99,414	$	(4,698	)	$	18,463	$	(1,933	)

	2012
	Less than 12 Months					12 Months or More
	Fair Value		Gross Unrealized (Losses)			Fair Value		Gross Unrealized (Losses)
Obligations of U.S.
U.S. Government agency securities	$	10,832	$	(73	)	$	—	$	—
Municipal securities	16,879		(300		)	—		—
Corporate securities	4,331		(49		)	1,446		(54		)
Mortgage-backed securities	5,173		(49		)	—		—
Total temporarily impaired securities	$	37,215	$	(471	)	$	1,446	$	(54	)

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 3. Loans

The components of loans by segment are as follows (in thousands):

	December 31,
	2013			2012

Commercial loans	$	52,032		$	38,856
Commercial real estate loans	374,038			288,919
Construction and development loans	109,107			91,598
Residential real estate loans	71,631			63,966
Consumer and other loans	100,117			104,590
Total loans	706,925			587,929

Less:
Allowance for loan losses	(9,790		)	(8,262		)
Deferred loan fees, net of origination costs	(1,038		)	(383		)
Loans, net	$	696,097		$	579,284

At December 31, 2013 and 2012, overdraft demand deposits reclassified to loans totaled $55,000 and $182,000, respectively, and are included in the consumer and other loan category above.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 4. Allowance for Loan Losses

The allocation of the allowance for loan losses by segments at December 31, 2013 and 2012 are as follows (in thousands):

	December 31, 2013
	Commercial			Commercial Real Estate			Construction and Land Development			Residential Real Estate			Consumer			Unallocated		Total

Beginning balance	$	811		$	4,821		$	1,302		$	409		$	916		$	3	$	8,262
Provision for loan losses	(352		)	1,261			739			84			(113		)	145		1,764
Charge-offs	—			(157		)	—			—			(208		)	—		(365		)
Recoveries	7			—			—			6			116			—		129
Ending balance	$	466		$	5,925		$	2,041		$	499		$	711		$	148	$	9,790

Ending balance:
Individually evaluated for impairment	$	—		$	265		$	—		$	134		$	—		$	—	$	399
Collectively evaluated for impairment	466			5,660			2,041			365			711			148		9,391

Financing Receivables:
Ending balance	$	52,032		$	374,038		$	109,107		$	71,631		$	100,117				$	706,925
Individually evaluated for impairment	40			1,539			—			612			—					2,191
Collectively evaluated for impairment	51,992			372,499			109,107			71,019			100,117					704,734

	December 31, 2012
				Commercial			Construction and			Residential
	Commercial			Real Estate			Land Development			Real Estate			Consumer			Unallocated		Total

Beginning balance	$	919		$	3,277		$	1,021		$	481		$	421		$	3	$	6,122
Provision for loan losses	885			1,544			452			(71		)	600			—		3,410
Charge-offs	(993		)	—			(171		)	(1		)	(194		)	—		(1,359		)
Recoveries	—			—			—			—			89			—		89
Ending balance	$	811		$	4,821		$	1,302		$	409		$	916		$	3	$	8,262

Ending balance
Individually evaluated for impairment	$	—		$	161		$	—		$	266		$	—		$	—	$	427
Collectively evaluated for impairment	811			4,660			1,302			143			916			3		7,835

Financing Receivables:
Ending balance	$	38,856		$	288,919		$	91,598		$	63,966		$	104,590				$	587,929
Individually evaluated for impairment	53			3,645			250			535			—					4,483
Collectively evaluated for impairment	38,803			285,274			91,348			63,431			104,590					583,446

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following is a summary of information pertaining to impaired loans by class at December 31, 2013 and 2012 (in thousands):

	December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial	$	40	$	43	$	—	$	47	$	3

With an allowance recorded:
Commercial Real Estate
Owner occupied	1,539		1,539		265		1,782		51
Residential
Single family	101		101		3		237		—
Equity lines	511		535		131		535		25

Total	$	2,191	$	2,218	399		$	2,601	$	79

	December 31, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial	$	53	$	53	$	—	$	57	$	4
Commercial Real Estate
Owner occupied	1,283		1,283		—		1,286		9
Non-owner occupied	1,595		1,595		—		1,600		86
Construction
Other	250		250		—		250		11

With an allowance recorded:
Commercial Real Estate
Non-owner occupied	767		767		161		769		20
Residential
Equity lines	535		535		266		536		25

Total	$	4,483	$	4,483	427		$	4,498	$	155

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following is a summary of the Bank’s credit quality information by class at December 31, 2013 and 2012 (in thousands). The Bank does not risk weight the consumer loan portfolio. These loans are categorized by loans that are performing in accordance with their contractual terms versus those that are not.

	December 31, 2013
	All Pass
INTERNAL RISK RATING GRADES	Categories		Special Mention		Substandard		Doubtful		Loss

Commercial	$	49,078	$	422	$	2,492	$	40	$	—
Commercial Real Estate
Owner occupied	116,919		—		3,340		299		—
Non-owner occupied	247,873		2,074		3,533		—		—
Construction
Residential	63,675		—		1,473		242		—
Other	43,717		—		—		—		—
Residential
Single family	38,034		3,075		—		101		—
Equity lines	12,213		—		204		511		—
Multifamily	17,493		—		—		—		—

Totals	$	589,002	$	5,571	$	11,042	$	1,193	$	—

			Performing		Nonperforming
Consumer Credit Exposure - By Payment Activity
Credit cards/Overdraft lines of credit			$	55	$	—
Consumer and other loans			100,062		—

	December 31, 2013
	All Pass
INTERNAL RISK RATING GRADES	Categories		Special Mention		Substandard		Doubtful		Loss

Commercial	$	34,387	$	—	$	4,416	$	53	$	—
Commercial Real Estate
Owner occupied	109,893		2,100		1,283		—		—
Non-owner occupied	171,147		2,134		1,595		767		—
Construction
Residential	42,331		—		3,662		—		—
Other	45,605		—		—		—		—
Residential
Single family	32,279		424		250		—		—
Equity lines	9,369		—		205		535		—
Multifamily	20,904		—		—		—		—

Totals	$	465,915	$	4,658	$	11,411	$	1,355	$	—

			Performing		Nonperforming
Consumer Credit Exposure - By Payment Activity
Credit cards/Overdraft lines of credit			$	54	$	—
Consumer and other loans			104,536		—

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The Bank assesses credit quality based on internal risk ratings of loans. Pass categories consist of Superior, Good, Average and Pass. Internal risk ratings are as follows:

Superior: Borrowers are generally major corporations, persons or business entities with virtually no credit risk due to the borrower’s unquestioned financial strength, superior liquidity and asset quality, strong income, substantial net worth, and outstanding debt service coverage or loans fully secured by liquid collateral.

Good: Borrowers are well established entities with a proven track record, or individuals with substantial financial capacity. Borrowers will have excellent liquidity and strong debt service coverage, excellent balance sheet with minimal leverage, financial performance above industry peers, sophisticated management, systems and reporting, and access to capital markets, private placement financing or bank financing with very favorable terms. Borrowers pose a minor credit risk.

Average: Borrowers generally exhibit acceptable business credit and some negative operating trends, little excess liquidity and modest debt service coverage, moderately high balance sheet leverage, financial ratios slightly below industry peers, and management, systems, and reporting is generally good. Borrowers pose average credit risk.

Pass: Loan conditions require more frequent monitoring due to lack of stability in the secondary repayment source. Weaknesses in earnings or in the balance sheet are considered temporary. Any unfavorable factors are mitigated by structuring, collateral or administrative controls.

Special Mention: Borrowers currently posing a higher than normal risk that deserve management’s close attention. Potential weaknesses may result in deterioration of the repayment ability of the borrower. Credits may exhibit one or a combination of the following characteristics: some degree of difficulty in servicing the debt, increased leverage, marginal profitability or interim losses indicative of a possible transition in financial condition, inadequate liquidity and declining operating trends, management weaknesses, or weak financial reporting.

Substandard: Relationships with unacceptable business credit, normal repayment in jeopardy, and necessitating a workout situation. Well defined weaknesses include: serious negative operating trends, insufficient debt service coverage, guarantors with limited resources, highly leveraged balance sheet, collateral shortfalls, management issues, and alternative financing is not evident.

Doubtful: Relationships display many of the same weaknesses of a substandard credit; however, the risk factors are more dominant. Full repayment is highly questionable and improbable, debt service coverage is insufficient, the balance sheet may be insolvent, the company may be in liquidation, and management is weak and uncooperative. Partial loss of principal is likely.

Loss: The assets have been determined to be uncollectible and of such little value that the continuance as a bankable asset is not warranted. Asset is to be charged off in the month the loss rating is assigned.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following is a summary of past due and nonaccrual loans by category at December 31, 2013 and 2012 (in thousands):

	December 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Nonaccrual Loans
Commercial	$	150	$	—	$	—	$	150	$	51,882	$	52,032	$	—	$	40
Commercial Real Estate
Owner occupied	299		—		—		$	299	120,259		120,558		—		299
Non-owner occupied	—		—		—		$	—	253,480		253,480		—		—
Construction
Residential	—		—		242		$	242	65,148		65,390		—		242
Other	—		—		—		$	—	43,717		43,717		—		—
Residential
Single family	—		—		101		$	101	41,109		41,210		—		101
Equity lines	—		—		—		$	—	12,928		12,928		—		511
Multifamily	—		—		—		$	—	17,493		17,493		—		—
Consumer
Credit cards	—		—		—		$	—	55		55		—		—
Other consumer	152		46		17		215		99,847		100,062		17		—
Total	$	601	$	46	$	360	$	1,007	$	705,918	$	706,925	$	17	$	1,193

	December 31, 2012
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Nonaccrual Loans
Commercial	$	—	$	32	$	—	$	32	$	38,824	$	38,856	$	—	$	53
Commercial Real Estate
Owner occupied	—		—		—		—		113,276		113,276		—		—
Non-owner occupied	671		—		539		1,210		174,433		175,643		—		767
Construction
Residential	250		—		—		250		45,743		45,993		—		—
Other	—		—		—		—		45,605		45,605		—		—
Residential
Single family	752		236		—		988		31,965		32,953		—		—
Equity lines	—		—		—		—		10,109		10,109		—		535
Multifamily	—		—		—		—		20,904		20,904		—		—
Consumer
Credit cards	—		—		—		—		54		54		—		—
Other consumer	322		95				417		104,119		104,536		—		—
Total	$	1,995	$	363	$	539	$	2,897	$	585,032	$	587,929	$	—	$	1,355

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following is an analysis by class of troubled debt restructurings which were modified during the year ended December 31, 2013 and 2012 (dollars in thousands):

	December 31, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings

Commercial Real Estate
Owner occupied	1	$	730	$	299
Total	1	$	730	$	299

	December 31, 2012
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings

Commercial Real Estate
Owner occupied	1	$	1,290	$	1,283
Non-owner occupied	1	228		228
Construction
Other	1	250		250
Residential
Single family	1	299		299
Total	4	$	2,067	$	2,060

During the year ended December 31, 2013 and 2012, there were no troubled debt restructurings that subsequently defaulted. Total troubled debt restructurings at December 31, 2013 and 2012 totaled $2.1 million and $3.7 million, respectively.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 5. Premises and Equipment

A summary of premises and equipment is as follows (in thousands):

	December 31,
	2013			2012
Furniture, fixtures and equipment	$	3,226		$	2,993
Leasehold improvements	2,178			2,008
Total	5,404			5,001
Less accumulated depreciation and amortization	(3,543		)	(2,950		)
Premises and equipment, net	$	1,861		$	2,051

For the years ended December 31, 2013 and 2012, depreciation expense was $594,000 and $630,000, respectively.

The Bank leases all of its offices under operating leases. These leases have ten year terms. Rent expense for the year ended December 31, 2013 and 2012 was approximately $1.3 million and $1.1 million, respectively. At December 31, 2013, future minimum rental commitments under these non-cancelable leases are approximately as follows (in thousands):

Years Ending December 31,		Amount
	2014	$	1,280
	2015	1,337
	2016	1,286
	2017	987
	2018	980
	Thereafter	3,241
		$	9,111

Note 6. Deposits

The aggregate amount of time deposits, each with a minimum denomination of $100,000, was approximately $250.5 million and $240.1 million at December 31, 2013 and 2012, respectively. At December 31, 2013, the scheduled maturities of time deposits are as follows (in thousands):

2014	$	214,982
2015	132,160
2016	34,337
2017	20,031
2018	13,243
	$	414,753

Brokered deposits totaled $118.7 million and $95.0 million at December 31, 2013 and 2012, respectively.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 7. Other Borrowings

The Bank has unsecured lines of credit with correspondent banks totaling $39.0 million available for overnight borrowing. At December 31, 2013 and 2012, the balance outstanding on these lines was $10.0 million and $13.0 million, respectively.

The Bank established a Borrower-In-Custody (BIC) arrangement with the Federal Reserve Bank of Richmond. The BIC program allows the Bank to pledge assets as collateral to secure advances from the discount window. The Bank pledged automobile loans as of December 31, 2013 and 2012 with a collateral value of approximately $70.4 million and $73.2 million, respectively. At December 31, 2013 and 2012, the Bank did not utilize this line.

Additional credit facilities are available to the Bank through its membership in the Federal Home Loan Bank of Atlanta. Based upon the Bank’s credit standing and available collateral, which consists of certain investment securities and real estate secured loans, the Bank may borrow up to 20% of its total assets on a short term or long term basis subject to available collateral. The Bank has pledged real estate secured loans with a collateral value of approximately $110.1 million at December 31, 2013. Federal Home Loan Bank advances as of December 31, 2013 and December 31, 2012 are summarized as follows (in thousands):

December 31, 2013
Amount		Interest Rate		Maturity
$	10,000	0.27	%	April 18, 2014
15,000		0.29	%	May 29, 2014
5,000		0.39	%	April 15, 2015
15,000		0.45	%	December 14, 2015
18,000		1.01	%	December 27, 2016
5,000		2.27	%	May 9, 2018
5,000		1.97	%	September 17, 2018
$	73,000

December 31, 2012
Amount		Interest Rate		Maturity
$	5,000	1.90	%	April 1, 2013
10,000		0.28	%	April 15, 2013
3,000		3.84	%	September 12, 2013
10,000		0.32	%	December 24, 2013
5,000		2.27	%	May 9, 2018
$	33,000

The Bank enters into repurchase agreements with customers that sweep funds from deposit accounts into investment accounts. These investment accounts are not federally insured and are treated as borrowings. These agreements require the Bank to pledge securities as collateral for these borrowings. At December 31, 2013 and 2012, the outstanding balance of such borrowings totaled $1.1 million and $1.6 million, respectively. At December 31, 2013, the Bank pledged securities with a carrying value of approximately $2.7 million as collateral for these agreements.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 8. Off-Balance Sheet Financial Instruments

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are commitments to extend credit, unused lines of credit and standby letters of credit and may involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments reflect the extent of involvement the Bank has in these financial instruments. The Bank uses the same credit policies for all off- balance sheet financial instruments as it does for on-balance-sheet instruments.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments.

Commitments to extend credit, including lines of credit, are 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 some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank generally holds collateral supporting these commitments.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support third-party borrowing arrangements and generally have expiration dates within one year of issuance. A summary of the amounts of the Bank’s financial instruments with off-balance-sheet risk are as follows (in thousands):

	December 31,
	2013		2012

Undisbursed lines of credit and construction loans	$	143,612	$	93,437

Commitments to extend credit	$	68,441	$	213,629

Commercial and standby letters of credit	$	9,662	$	8,054

The Bank maintains its cash accounts in several correspondent banks. The cash on deposit in those banks did not exceed the federally insured limits as of December 31, 2013 and 2012. The Federal Home Loan Bank balances of $112,000 and $118,000 at December 31, 2013 and 2012, respectively, are not federally insured. This credit risk is evaluated and monitored by the Bank through financial analysis of each institution.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 9. Income Taxes

The Bank files income tax returns in the U.S. federal jurisdiction. With few exceptions, the Bank is no longer subject to U.S. federal income tax examinations by tax authorities for years prior to 2010.

The components of income tax expense are as follows (in thousands):

	Years Ended December 31,
	2013			2012

Current	$	3,582		$	4,037
Deferred	(764		)	(412		)
Income tax	$	4,346		$	3,625

A reconciliation of income tax expense computed at the statutory federal income tax rate included in the Consolidated Statements of Income is as follows (in thousands):

	Years Ended December 31,
	2013			2012

Tax at statutory federal rate	$	4,538		$	3,832
Employee benefit expense	17			17
Tax-exempt interest income	(227		)	(225		)
Other	18			1
Income tax	$	4,346		$	3,625

The significant components of net deferred tax assets and liabilities are summarized as follows (in thousands):

	Years Ended December 31,
	2013		2012
Deferred tax assets
Pre-opening expenses	$	120	$	136
Non-qualified stock option expense	92		95
Allowance for loan losses	3,244		2,667
Unrealized loss on securities AFS	2,245		22
Promotional expense for home equity loans	53		46
Other real estate owned	29		30
Net deferred origination fees	356		130
Mortgage repurchase reserve	172		131
Nonaccrual loan interest	9		—
Deferred tax assets	6,320		3,257
Deferred tax liabilities
Accumulated depreciation	450		391
Discount accretion	49		31
Deferred tax liabilities	499		422
Net deferred tax assets	$	5,821	$	2,835

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 10. Stock Compensation Plan

The Bank’s shareholders approved the 2010 Incentive Plan (the “Incentive Plan”) on May 20, 2010, to replace the Stock Option Plan, previously approved on June 15, 2006 for 250,000 shares of common stock. The Bank’s Incentive Plan reserves an additional 250,000 shares of common stock and may grant up to 25,000 options to each of its directors, officers and key employees of the Bank in any calendar year. Both incentive stock options and non- qualified stock options may be granted under the Plan. The exercise price of each option equals the market price of the Bank’s stock on the date of grant and an option’s maximum term is ten years.

The Stock Option Plan also provided for stock options to be granted to seed investors as a reward for the contribution of organizational funds which were at risk if the Bank’s organization had not been successful. The stock options granted to seed investors were fully vested upon date of grant. All shares granted in 2006 related to seed investors. A summary of stock option transactions and options outstanding for both plans as of and for December 31, 2013 are as follows:

			Weighted			Weighted
			Average			Average	Intrinsic
			Exercise			Contractual	Value
	Shares		Price			Term	(in thousands)
Outstanding at December 31, 2012	376,578		$	9.64
Granted	77,250		14.91
Exercised	(14,092	)	(9.96		)
Forfeited	(8,625	)	(10.65		)
Outstanding at December 31, 2013	431,111		$	11.83		6.07 years	$	3,186

Options exercisable at end of year	298,203		$	9.70		6.26 years	$	2,964

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Years Ended
	December 31,
	2013			2012
Weighted-average risk-free interest rate	0.81		%	0.84		%
Dividend yield	0.00		%	0.00		%
Estimated stock price volatility	17.50		%	17.50		%
Expected life	7 years			5 years
Per share weighted-average grant-date fair value of options issued during the period	$	3.08		$	1.66

The Bank recognized compensation expense of $105,000 and $76,000 in 2013 and 2012, respectively relating to employee and director stock options. The unrecognized compensation expense remaining at December 31, 2013 is $300,000, which will be recognized over an average remaining period of approximately 3.5 years.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 11. Related Party Transactions

In the ordinary course of business, the Bank has granted loans to its principal officers and directors and their affiliates. These related-party transactions are summarized as follows (in thousands):

	Years Ended December 31,
	2013			2012
Loan balances at the beginning of the period	$	3,193		$	3,314
New loans or advances	1,179			465
Principal repayments	(862		)	(586		)
Loan balances at the end of the period	$	3,510		$	3,193

Deposits of principal officers and directors and their affiliates totaled $3.3 million and $3.7 million as of December 31, 2013 and 2012, respectively.

Note 12. Retirement Plan

The Bank established a 401(k) retirement plan (the “Plan”) to which eligible employees may contribute a percentage of their salaries. Currently, the Bank makes matching contributions to the Plan each payroll period at an amount equal to 100% of the first 3% and 50% of the next 2% contributed by the employees not exceeding maximum allowances. The Bank recognized compensation expense related to the Plan of $355,000 and $323,000 for the years ended December 31, 2013 and 2012, respectively.

Note 13. Dividends

We may pay cash dividends out of legally available funds as and when determined by our Board of Directors after consideration of our earnings, general economic conditions, our financial condition and other factors as may be appropriate in determining dividend policy. To date, we have not paid any cash dividends on common stock. At present, we intend to retain current and future earnings to support our long-term growth. Holders of our common stock are entitled to receive and share equally in any dividends declared by our Board of Directors. The Bank is required to pay dividends on the preferred stock issued under the Small Business Lending Fund program.

Note 14. Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and percents (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2013 and 2012, that the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2013, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage percents as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts and percentages are also presented in the following table (in thousands):

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

	Actual				Minimum Capital Requirement				Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
*As of December 31, 2013:*
Total Capital (to Risk Weighted Assets)	$	109,768	14.86	%	$	59,106	8.00	%	$	73,882	10.00	%
Tier 1 Capital (to Risk Weighted Assets)	$	100,526	13.61	%	$	29,553	4.00	%	$	44,329	6.00	%
Tier 1 Capital (to Average Assets)	$	100,526	11.72	%	$	34,307	4.00	%	$	42,884	5.00	%
*As of December 31, 2012:*
Total Capital (to Risk Weighted Assets)	$	77,383	12.06	%	$	51,332	8.00	%	$	64,165	10.00	%
Tier 1 Capital (to Risk Weighted Assets)	$	69,359	10.81	%	$	25,666	4.00	%	$	38,499	6.00	%
Tier 1 Capital (to Average Assets)	$	69,359	9.28	%	$	29,911	4.00	%	$	37,388	5.00	%

Note 15. Legal Contingencies

The prior year’s consolidated financial statements (for the year ended December 31, 2012) included a legal contingency disclosure regarding a claim brought against the Bank by a Bankruptcy Trustee in the United States Bankruptcy Court for the Eastern District of Virginia. The Trustee was seeking to require the Bank to return $4.7 million of loans that had been fully repaid by the Borrower in 2008. The loans had been collateralized by life insurance policies which the Bank had later learned were fraudulent. The Trustee claimed that these fraudulent loans were part of a massive fraudulent scheme by the Borrower involving numerous other banks. The Trustee claimed the Bank was required to return the repaid loan proceeds to the Bankruptcy Estate to be shared among all the bank victims. The Bank vigorously defended against the Trustee’s claim, and as a result, the Trustee was ultimately willing to settle the $4.7 million claim for $1.0 million ($36,000 of which was paid by the Bank’s insurance carrier). The Settlement Agreement reiterated that the Bank did not agree that it had any responsibility to return any funds to the Trustee, but that it was settling the matter to avoid the vagaries and risks of litigation. The Bank received a $49,000 recovery in 2013 from the Trustee representing pro-rata distribution of proceeds to creditors included in the Bankruptcy filing. The expense and recovery of this settlement is included in noninterest expense on the Consolidated Statements of Income.

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 16. Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’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. Accounting standards exclude certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of our Bank.

The accounting standards clarify that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Additional guidance was issued to clarify the application of fair value measurements in a market that is not active and to provide key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.

Accounting standards specify a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

· Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

· Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

· Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities available for sale:

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

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012 (in thousands). There have been no changes in the methodologies used at December 31, 2013 and 2012.

			Fair Value Measurements at December 31, 2013 Using
			(in thousands)
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Treasury notes	$	14,953	$	—	$	14,953	$	—
U.S. Government agency securities	19,177		—		19,177		—
Municipal securities	24,371		—		24,371		—
Corporate securities	6,730		—		6,730		—
Mortgage-backed securities	61,398		—		61,398		—
SBA Loan Pool Certificate RMOF	205		—		205		—

			Fair Value Measurements at December 31, 2012 Using
			(in thousands)
Description	Balance as of December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury notes	$	43,083	$	—	$	43,083	$	—
U.S. Government agency securities	23,541		—		23,541		—
Municipal securities	32,588		—		32,588		—
Corporate securities	8,478		—		8,478		—
Mortgage-backed securities	10,638		—		10,638		—
SBA Loan Pool Certificate RMOF	301		—		301		—

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 to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements.

Loans Held for Sale:

Loans held for sale are carried at the lower of cost or market value on an individual loan basis. 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 Bank records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the years ended December 31, 2013 and 2012. Gains and losses on sale of loans are recorded 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

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

the loans. Collateral may be in the form of real estate or business assets, including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed external appraiser 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 a year 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 receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned:

Other real estate owned (“OREO”) is measured at fair value using a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside the Bank using observable market data (Level 2). However, if an appraisal of the real estate property is over a year old, then the fair value is considered to be Level 3.

The following table summarizes our assets that were measured at fair value on a nonrecurring basis as of December 31, 2013 and 2012 (in thousands).

			Fair Value Measurements at December 31, 2013 Using
			(in thousands)
			Quoted Prices in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Assets:
Loans Held for Sale	$	10,730	$	—	$	10,730	$	—
Impaired Loans	1,792		—		—		1,792
Other Real Estate Owned	519		—		—		519

			Fair Value Measurements at December 31, 2012 Using
			(in thousands)
			Quoted Prices in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	Balance as of		Assets		Inputs		Inputs
Description	December 31, 2012		(Level 1)		(Level 2)		(Level 3)
Assets:
Loans Held for Sale	$	48,136	$	—	$	48,136	$	—
Impaired Loans	875		—		—		875
Other Real Estate Owned	479		—		—		479

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2013 and 2012 (in thousands):

	Quantitative information about Level 3 Fair Value Measurements at December 31, 2013
	(in thousands)
	Fair Value		Valuation Technique(s)	Unobservable input	Range
Assets

Impaired loans	$	1,792	Discounted appraised value	Selling cost	5% - 10%

Other real estate owned	519		Discounted appraised value	Selling cost	5% - 10%

	Quantitative information about Level 3 Fair Value Measurements at December 31, 2012
	(in thousands)
	Fair Value		Valuation Technique(s)	Unobservable input	Range
Assets

Impaired loans	$	719	Discounted appraised value	Selling cost	5% - 10%

	156		Discounted tax assessed value	Selling cost	5% - 10%

Other real estate owned	479		Discounted appraised value	Selling cost	5% - 10%

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’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 aggregate fair value amounts presented may not be realized in an immediate settlement of the instrument or may not necessarily represent the underlying fair value of the Bank. The following methods and assumptions were used by the Bank in estimating fair values of financial instruments:

Cash and Cash Equivalents. The carrying amounts of cash and cash equivalents approximate their fair values.

Interest Bearing Deposits in Banks. The carrying amounts of interest bearing deposits maturing within ninety days approximate their fair values.

Available for sale securities. Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or third party pricing models.

Loans. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed-rate loans are estimated using discounted cash flow analyses, applying interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. See above for valuation of impaired loans.

Loans Held for Sale. The fair value of loans held for sale is based on outstanding commitments from investors.

Federal Home Loan Bank Stock and Federal Reserve Bank Stock. Fair value of the Bank’s investment in Federal Home Loan Bank stock and Federal Reserve Bank stock is based on its redemption value.

Bank Owned Life Insurance. Bank owned life insurance represents insurance policies on certain key employees. The cash value of the policies is estimated using information provided by the insurance carrier. These policies are carried at their cash value, which approximate their fair values.

Deposits. The fair values disclosed for demand, NOW, money-market and savings deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). Fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits.

Federal Home Loan Bank Advances. Fair values are estimated using discounted cash flow analysis based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements.

Other Borrowings. The carrying amounts of borrowings under retail customer repurchase agreements and federal funds purchased approximate fair value.

Accrued Interest. The carrying amounts of accrued interest approximate their fair value.

Off-Balance-Sheet Financial Instruments. Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair values of these instruments were deemed immaterial at December 31, 2013 and 2012.

The estimated fair values of the Bank’s financial instruments at December 31, 2013 and 2012 are as follows (in thousands):

			Fair Value Measurements at December 31, 2013 Using
			(in thousands)
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	24,855	$	24,855	$	—	$	—
Securities available for sale	126,834		—		126,834		—
Loans	696,097		—		689,646		—
Loans held for sale	10,730		—		10,730		—
Federal Home Loan Bank stock	4,223		—		4,223		—
Federal Reserve Bank stock	2,417		—		2,417		—
Accrued interest receivable	2,379		—		2,379		—
Bank owned life insurance	15,408		—		15,408		—

Financial liabilities:
Deposits	711,400		—		711,803		—
Federal funds purchased	10,000		—		10,000		—
FHLB advances	73,000		—		74,131		—
Securities sold under agreements to repurchase	1,067		—		1,067		—
Accrued interest payable	201		—		201		—

			Fair Value Measurements at December 31, 2012 Using
			(in thousands)
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and cash equivalents	$	12,761	$	12,761	$	—	$	—
Securities available for sale	118,629		—		118,629		—
Loans	579,284		—		576,661		—
Loans held for sale	48,136		—		48,136		—
Federal Home Loan Bank stock	2,352		—		2,352		—
Federal Reserve Bank stock	1,751		—		1,751		—
Accrued interest receivable	2,368		—		2,368		—
Bank owned life insurance	5,178		—		5,178		—

Financial liabilities:
Deposits	660,138		—		660,835		—
Federal funds purchased	13,000		—		13,000		—
FHLB advances	33,000		—		34,016		—
Securities sold under agreements to repurchase	1,600		—		1,600		—
Accrued interest payable	227		—		227		—

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 17. Business Segments

The Bank operates three principal business segments: Retail Banking, Mortgage Banking and Indirect Lending. Revenues from Retail Banking operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Mortgage Banking operating revenues consist principally of gains on sales of loans in the secondary market, loan origination fee income and interest earned on mortgage loans held for sale. Revenues from Indirect Lending consist primarily of interest earned on automobile retail installment sales contracts. Operating expenses for the Mortgage Banking and Indirect Lending segments consist largely of direct expenses only while the majority of the Bank’s operating expenses and income tax expense is shown in the Retail Banking segment (in thousands).

	Year Ended December 31, 2013
	Retail Banking		Mortgage Banking		Indirect Lending		Combined
Revenues:
Interest income	$	30,823	$	925	$	2,189	$	33,937
Gains on sales of loans	557		7,362		—		7,919
Other noninterest income	1,911		742		104		2,757
Total operating income	33,291		9,029		2,293		44,613

Expenses:
Provision for loan losses	1,727		—		37		1,764
Interest expense	4,457		159		624		5,240
Salaries and employee benefits	9,103		4,684		490		14,277
Other noninterest expenses	7,211		2,507		268		9,986
Total operating expenses	22,498		7,350		1,419		31,267

Income before income tax expense	10,793		1,679		874		13,346

Income tax expense	4,346		—		—		4,346

Net income	$	6,447	$	1,679	$	874	$	9,000

Total assets	$	779,937	$	15,985	$	98,919	$	894,841

Capital expenditures	$	347	$	57	$	1	$	405

	Year Ended December 31, 2012
	Retail Banking		Mortgage Banking		Indirect Lending		Combined
Revenues:
Interest income	$	27,308	$	929	$	2,577	$	30,814
Gains on sales of loans	303		10,725		—		11,028
Other noninterest income	2,440		1,044		129		3,613
Total operating income	30,051		12,698		2,706		45,455

Expenses:
Provision for loan losses	3,063		—		347		3,410
Interest expense	5,122		218		807		6,147
Salaries and employee benefits	7,302		6,161		184		13,647
Other noninterest expenses	7,370		3,300		310		10,980
Total operating expenses	22,857		9,679		1,648		34,184

Income before income tax expense	7,194		3,019		1,058		11,271

Income tax expense	3,625		—		—		3,625

Net income	$	3,569	$	3,019	$	1,058	$	7,646

Total assets	$	624,475	$	52,104	$	104,994	$	781,573

Capital expenditures	$	689	$	75	$	1	$	765

VIRGINIA HERITAGE BANK AND SUBSIDIARY

Notes to Consolidated Financial Statements
At December 31, 2013 and 2012 and for the Years Ended December 31, 2013 and 2012

Note 18. Reclassifications Out of Other Comprehensive Income

The reclassifications out of other comprehensive income are as follows (in thousands):

	Amounts Reclassified from
	Other Comprehensive Income
Details about Other	December 31,				Affected Line Item in the Statement
Comprehensive Components	2013		2012		Where Net Income is Presented
*Available for sale securities*
Realized gain on sale of securities	$	557	$	1,759	Gain on sale of securities available for sale
	189		598		Income tax expense
	$	368	$	1,161	Net income

Note. 19. Subsequent Events

The Bank evaluates subsequent events that have occurred after the balance sheet date but before the consolidated financial statements are issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing consolidated financial statements, and (2) non-recognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

Based on the evaluation, the Bank did not identify any recognized or non-recognized subsequent events that would have required adjustment to or disclose in the consolidated financial statements as of March 21, 2014.

EAGLE BANCORP INC - FORM 8-K/A - EX-99.1 - November 6, 2014

Attached files

EAGLE BANCORP INC Reports