MIDDLEBURG FINANCIAL CORP - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - MIDDLEBURG FINANCIAL CORP	Financial_Report.xls
EX-31.2 - EXHIBIT - MIDDLEBURG FINANCIAL CORP	mbrg93014ex-312.htm
EX-31.1 - EXHIBIT - MIDDLEBURG FINANCIAL CORP	mbrg93014ex311.htm
EX-32.1 - EXHIBIT - MIDDLEBURG FINANCIAL CORP	mbrg_ex-3219x30x14.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014

[ ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 0-24159

MIDDLEBURG FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)



Virginia (State or other jurisdiction of incorporation or organization)	54-1696103 (I.R.S. Employer Identification No.)
111 West Washington Street Middleburg, Virginia (Address of principal executive offices)	20117 (Zip Code)

(703) 777-6327

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



	Yes þ	No o

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



	Yes þ	No o

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



Large accelerated filer o		Accelerated filer þ
Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).



	Yes o	No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 7,123,914 shares of Common Stock as of November 7, 2014.

MIDDLEBURG FINANCIAL CORPORATION

INDEX



Part I. Financial Information			Page No.

	Item 1.	Financial Statements	3

		Consolidated Balance Sheets	3

		Consolidated Statements of Income	4

		Consolidated Statements of Comprehensive Income (Loss)	5

		Consolidated Statements of Changes in Shareholders’ Equity	6

		Consolidated Statements of Cash Flows	7

		Notes to Consolidated Financial Statements	8

	Item 2.	Management's Discussion and Analysis of Financial
		Condition and Results of Operations	32

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47

	Item 4.	Controls and Procedures	48


Part II. Other Information
			48
	Item 1.	Legal Proceedings

	Item 1A.	Risk Factors	48

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48

	Item 3.	Defaults upon Senior Securities	48

	Item 4.	Mine Safety Disclosures	48

	Item 5.	Other Information	48

	Item 6.	Exhibits	48

Signatures			49

Table of Contents


ITEM 1.	FINANCIAL STATEMENTS

PART I



MIDDLEBURG FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
	(Unaudited)
	September 30,		December 31,
	2014		2013
ASSETS
Cash and due from banks	$	5,861	$	6,648
Interest bearing deposits with other institutions	73,264		60,695
Total cash and cash equivalents	79,125		67,343
Securities available for sale	335,034		328,423
Loans held for sale, net	—		33,175
Restricted securities, at cost	4,829		6,780
Loans, net of allowance for loan losses of $11,423 and $13,320, respectively	717,329		715,160
Premises and equipment, net	17,796		20,017
Goodwill and identified intangibles	3,850		5,346
Other real estate owned, net of valuation allowance of $867 and $398, respectively	5,064		3,424
Bank owned life insurance	22,450		21,955
Accrued interest receivable and other assets	22,250		26,130
TOTAL ASSETS	$	1,207,727	$	1,227,753
LIABILITIES
Deposits:
Non-interest bearing demand deposits	$	210,112	$	185,577
Savings and interest bearing demand deposits	528,229		528,879
Time deposits	248,225		267,940
Total deposits	986,566		982,396
Securities sold under agreements to repurchase	36,469		34,539
Federal Home Loan Bank borrowings	45,000		80,000
Subordinated notes	5,155		5,155
Accrued interest payable and other liabilities	13,615		10,590
TOTAL LIABILITIES	1,086,805		1,112,680
SHAREHOLDERS' EQUITY
Common stock ($2.50 par value; 20,000,000 shares authorized; 7,123,914 and 7,080,591 issued and outstanding, respectively)	17,480		17,403
Capital surplus	44,683		44,251
Retained earnings	54,937		50,689
Accumulated other comprehensive income	3,822		232
Total Middleburg Financial Corporation shareholders' equity	120,922		112,575
Non-controlling interest in consolidated subsidiary	—		2,498
TOTAL SHAREHOLDERS' EQUITY	120,922		115,073
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	1,207,727	$	1,227,753

See accompanying notes to the consolidated financial statements.



MIDDLEBURG FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except for per share data)
	(Unaudited)						(Unaudited)
	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2014			2013			2014		2013
INTEREST INCOME
Interest and fees on loans	$	8,357		$	8,744		$	25,656	$	26,504
Interest and dividends on securities available for sale
Taxable	1,763			1,468			5,173		4,467
Tax-exempt	535			640			1,656		1,917
Dividends	84			59			230		169
Interest on deposits in banks and federal funds sold	51			43			123		101
Total interest and dividend income	10,790			10,954			32,838		33,158
INTEREST EXPENSE
Interest on deposits	955			1,190			2,952		3,817
Interest on securities sold under agreements to repurchase	81			82			243		243
Interest on short-term borrowings	—			59			—		106
Interest on FHLB borrowings and other debt	209			303			876		896
Total interest expense	1,245			1,634			4,071		5,062
NET INTEREST INCOME	9,545			9,320			28,767		28,096
Provision for (recovery of) loan losses	550			3			1,510		(1		)
NET INTEREST INCOME AFTER PROVISION FOR (RECOVERY OF) LOAN LOSSES	8,995			9,317			27,257		28,097
NON-INTEREST INCOME
Service charges on deposit accounts	635			590			1,815		1,699
Trust services income	1,119			963			3,224		2,937
Gains on loans held for sale	1			4,162			4,859		12,538
Gains on securities available for sale, net	12			23			141		397
Commissions on investment sales	193			159			479		363
Bank owned life insurance	168			125			494		367
Gain on sale of majority interest in consolidated subsidiary	—			—			24		—
Other operating income	152			106			1,399		835
Total non-interest income	2,280			6,128			12,435		19,136
NON-INTEREST EXPENSE
Salaries and employee benefits	4,441			7,750			17,467		23,242
Occupancy and equipment	1,262			1,820			4,841		5,412
Advertising	136			318			430		1,021
Computer operations	439			456			1,408		1,375
Other real estate owned	(33		)	416			145		1,377
Other taxes	220			186			637		565
Federal deposit insurance	220			149			687		683
Other operating expenses	1,706			2,210			6,042		6,666
Total non-interest expense	8,391			13,305			31,657		40,341
Income before income taxes	2,884			2,140			8,035		6,892
Income tax expense	763			491			2,179		1,628
NET INCOME	2,121			1,649			5,856		5,264
Net (income) loss attributable to non-controlling interest	—			(38		)	98		(233		)
Net income attributable to Middleburg Financial Corporation	$	2,121		$	1,611		$	5,954	$	5,031
Earnings per share:
Basic	$	0.30		$	0.23		$	0.84	$	0.71
Diluted	$	0.30		$	0.23		$	0.84	$	0.71

See accompanying notes to the consolidated financial statements.



MIDDLEBURG FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
	(Unaudited)						(Unaudited)
	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2014			2013			2014			2013

Net income	$	2,121		$	1,649		$	5,856		$	5,264
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) arising during the period, net of tax of $89, $902, $1,911 and $2,870, respectively	173			(1,748		)	3,710			(5,572		)
Reclassification adjustment for gains included in net income, net of tax of $4, $8, $48 and $135, respectively	(8		)	(15		)	(93		)	(262		)
Unrealized gain (loss) on interest rate swaps, net of tax of $39, $2, $14 and $103, respectively	81			(4		)	(27		)	200
Reclassification adjustment for gain on interest rate swap ineffectiveness included in net income, net of tax of $3, $0, $0 and $0, respectively	(5		)	—			—			—
Total other comprehensive income (loss)	241			(1,767		)	3,590			(5,634		)
Total comprehensive income (loss)	2,362			(118		)	9,446			(370		)
Comprehensive (income) loss attributable to non-controlling interest	—			(38		)	98			(233		)
Comprehensive income (loss) attributable to Middleburg Financial Corporation	$	2,362		$	(156	)	$	9,544		$	(603	)

See accompanying notes to the consolidated financial statements.



MIDDLEBURG FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
(Unaudited)

	For the Nine Months Ended September 30, 2014 and 2013
	Common Stock			Capital Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Non-Controlling Interest			Total
Balance December 31, 2012	$	17,357		$	43,869		$	46,235		$	6,467		$	3,194		$	117,122

Net income	—			—			5,031			—			233			5,264
Other comprehensive loss, net of tax	—			—			—			(5,634		)	—			(5,634		)
Cash dividends declared ($0.17 per share)	—			—			(1,203		)	—			—			(1,203		)
Distributions to non-controlling interest	—			—			—			—			(682		)	(682		)
Exercise of stock options (2,743 shares)	7			31			—			—			—			38
Restricted stock vesting (21,455 shares)	53			(53		)	—			—			—			—
Repurchase of restricted stock (5,467 shares)	(14		)	(88		)	—			—			—			(102		)
Share-based compensation	—			380			—			—			—			380
Balance September 30, 2013	$	17,403		$	44,139		$	50,063		$	833		$	2,745		$	115,183

Balance December 31, 2013	$	17,403		$	44,251		$	50,689		$	232		$	2,498		$	115,073

Net income	—			—			5,954			—			(98		)	5,856
Other comprehensive income, net of tax	—			—			—			3,590			—			3,590
Cash dividends ($0.24 per share)	—			—			(1,706		)	—			—			(1,706		)
Sale of majority interest in consolidated subsidiary	—			—			—			—			(2,400		)	(2,400		)
Exercise of stock options (19,772 shares)	50			250			—						—			300
Restricted stock vesting (15,425 shares)	39			(39		)	—			—			—			—
Repurchase of restricted stock (4,732 shares)	(12		)	(76		)	—			—			—			(88		)
Share-based compensation	—			297			—			—			—			297
Balance September 30, 2014	$	17,480		$	44,683		$	54,937		$	3,822		$	—		$	120,922

See accompanying notes to the consolidated financial statements.

MIDDLEBURG FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS



	(Unaudited)
	For the Nine Months Ended
	September 30,
(Dollars in thousands)	2014			2013
Cash Flows From Operating Activities
Net income	$	5,856		$	5,264
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	1,536			1,466
Provision for (recovery of) loan losses	1,510			(1		)
Gain on securities available for sale, net	(141		)	(397		)
Loss on disposal of assets, net	59			141
Premium amortization on securities, net	2,114			2,764
Decrease in loans held for sale, net	33,175			40,259
Share-based compensation	297			380
Gain on sale of majority interest in consolidated subsidiary	(24		)	—
(Gain) loss on sale of other real estate owned and repossessed assets, net	(238		)	747
Valuation adjustment on other real estate owned	222			235
Valuation adjustment on property held for sale	200			—
Decrease in prepaid FDIC insurance	—			3,015
Changes in assets and liabilities:
Decrease in other assets	(2,431		)	(73		)
Decrease in other liabilities	3,025			2,123
Net cash provided by operating activities	$	45,160		$	55,923
Cash Flows from Investing Activities
Proceeds from maturity, calls and sales of securities available for sale	102,344			83,253
Purchase of securities available for sale	(105,448		)	(103,380		)
Redemption (purchase) of restricted stock	1,951			(15		)
(Sales) purchases of bank premises and equipment, net	988			(1,273		)
Increase in loans, net	(8,117		)	(9,946		)
Proceeds from sale of majority interest in consolidated subsidiary, net	3,618			—
Proceeds from sale of other real estate owned and repossessed assets	1,680			6,806
Net cash provided by (used in) investing activities	$	(2,984	)	$	(24,555	)
Cash Flows from Financing Activities
Increase (decrease) in demand, interest-bearing demand and savings deposits	$	23,885		$	(3,849	)
Decrease in certificates of deposit	(19,715		)	(19,485		)
Increase in securities sold under agreements to repurchase	1,930			1,030
Decrease in short-term borrowings	—			(6,422		)
(Decrease) increase in FHLB borrowings	(35,000		)	7,088
Distributions to non-controlling interest	—			(233		)
Payment of dividends on common stock	(1,706		)	(1,203		)
Proceeds from issuance of common stock, net	300			38
Repurchase of common stock	(88		)	(102		)
Net cash provided by (used in) financing activities	$	(30,394	)	$	(23,138	)
Increase in cash and and cash equivalents	11,782			8,230
Cash and cash equivalents at beginning of the period	67,343			54,415
Cash and cash equivalents at end of the period	$	79,125		$	62,645
Supplemental Disclosures of Cash Flow Information
Interest paid	$	4,194		$	5,189
Income taxes	$	500		$	—
Supplemental Disclosure of Non-Cash Transactions
Unrealized gain (loss) on securities available for sale	$	5,480		$	(8,839	)
Change in market value of interest rate swap	$	(41	)	$	303
Transfer of loans to other real estate owned and repossessed assets	$	4,438		$	2,389

See accompanying notes to the consolidated financial statements.

Table of Contents

MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Note 1. General

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at September 30, 2014 and December 31, 2013, the results of operations, comprehensive income (loss), for the three and nine month periods ending September 30, 2014 and 2013 and changes in shareholders’ equity and cash flows for the nine months ended September 30, 2014 and 2013, in accordance with accounting principles generally accepted in the United States of America. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”) of Middleburg Financial Corporation (the “Company”). The results of operations for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year.

In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued. Management has concluded there were no additional material subsequent events to be disclosed.

Certain amounts in the 2013 consolidated financial statements have been reclassified to conform to the 2014 presentation. The amounts of these items are not considered to be material variations from the original classifications and presentations.

On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage to a consortium of banks and the President of Southern Trust Mortgage. While the Company no longer has a direct financial interest in Southern Trust Mortgage, the Company has maintained a warehouse participation agreement with Southern Trust Mortgage in the amount of $17.00 million.

Note 2. Share-Based Compensation Plan

The Company sponsors one share-based compensation plan, the 2006 Equity Compensation Plan, which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards, and stock units. The 2006 Equity Compensation Plan was approved by the Company’s shareholders at the Annual Meeting held on April 26, 2006, and has succeeded the Company’s 1997 Stock Incentive Plan. Under the plan, the Company may grant share-based compensation to its directors, officers, employees, and other persons the Company determines have contributed to the profits or growth of the Company. During 2013, the Company's Board of Directors and shareholders approved an amendment to this Plan to increase the number of shares reserved for issuance from 255,000 shares to 430,000 shares, an increase of 175,000 shares.

For the nine months ended September 30, 2014, the Company recorded $297,000 in share-based compensation expense related to restricted stock. As of September 30, 2014, there was $1.5 million of total unrecognized compensation expense related to the non-vested service and performance awards under the 2006 Equity Compensation Plan. For the nine months ended September 30, 2014, the Company recorded no compensation expense related to option awards. As of September 30, 2014 all outstanding option awards were previously vested and, accordingly, there was no unrecognized compensation expense as of September 30, 2014.

The aggregate intrinsic value, noted in the tables below, represents the amount by which the current market value of the underlying stock exceeds the exercise price. This amount changes based on changes in the market value of the Company’s common stock.

The Company granted 35,000 shares of restricted stock on May 7, 2014 to certain employees and executive officers. The restricted stock awards are performance based awards that contain performance based acceleration provisions if certain financial performance targets are met during pre-defined monitoring periods. Under the terms of the award, vesting may be accelerated on a partial basis depending on financial results for the years 2014 - 2018 based on the percentile ranking of the Company compared to its peer group over the period 2014 - 2018. All unearned restricted stock awards are forfeited if the employee leaves the Company prior to vesting. On January 27, 2014 and May 7, 2014 the Company awarded 133 shares and 4,400 shares, respectively, of restricted stock to members of the board of directors. These shares became fully vested on April 30, 2014 and will become fully vested on April 30, 2015, respectively.

The following table summarizes restricted stock service and performance awards under the 2006 Equity Compensation Plan:



	September 30, 2014
	Shares		Weighted-Average Grant Date Fair Value		Aggregate Intrinsic Value (in thousands)
Non-vested at December 31, 2013	119,250		$	16.39
Granted	39,533		17.45
Vested	(15,425	)	15.57
Forfeited	(11,250	)	16.05
Non-vested at September 30, 2014	132,108		$	16.83	$	2,344

The weighted-average remaining contractual term for non-vested service award grants at September 30, 2014, was 3.78 years.

The following table summarizes options outstanding under the 2006 Equity Compensation Plan and remaining outstanding unexercised options under the 1997 Stock Incentive Plan.



	September 30, 2014
	Shares		Weighted-Average Exercise Price		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2013	58,513		$	15.30	$	160
Granted	—		—		—
Exercised	(19,772	)	14.00		74
Forfeited	(3,000	)	39.40		—
Outstanding at September 30, 2014	35,741		$	14.00	$	134
Options exercisable at September 30, 2014	35,741		$	14.00	$	134

As of September 30, 2014, options outstanding and exercisable are summarized as follows:



Exercise Prices		Options Outstanding	Weighted-Average Remaining Contractual Life (years)	Options Exercisable
$	14.00	30,741	4.45	30,741
$	14.00	5,000	5.09	5,000
$	14.00	35,741	4.52	35,741

Note 3. Securities

Amortized costs and fair values of securities available for sale are summarized as follows:



	September 30, 2014
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale
U.S. government agencies	$	32,330	$	243	$	(210	)	$	32,363
Obligations of states and political subdivisions	58,141		2,351		(482		)	60,010
Mortgage-backed securities:
Agency	164,872		4,691		(800		)	168,763
Non-agency	27,978		124		(151		)	27,951
Other asset backed securities	27,215		523		(48		)	27,690
Corporate preferred stock	15		—		—			15
Corporate securities	18,608		151		(517		)	18,242
Total	$	329,159	$	8,083	$	(2,208	)	$	335,034



	December 31, 2013
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for Sale
U.S. government agencies	$	21,367	$	304	$	(332	)	$	21,339
Obligations of states and political subdivisions	68,904		1,083		(2,749		)	67,238
Mortgage-backed securities:
Agency	166,095		3,539		(1,624		)	168,010
Non-agency	22,029		116		(211		)	21,934
Other asset backed securities	33,883		710		(175		)	34,418
Corporate preferred stock	69		5		—			74
Corporate securities	15,680		58		(328		)	15,410
Total	$	328,027	$	5,815	$	(5,419	)	$	328,423

The amortized cost and fair value of securities available for sale as of September 30, 2014, by contractual maturity are shown below. Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.



	September 30, 2014
(Dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	6,564	$	6,629
Due after one year through five years	43,635		45,418
Due after five years through ten years	39,747		39,516
Due after ten years	19,133		19,052
Mortgage-backed securities	192,850		196,714
Other asset backed securities	27,215		27,690
Corporate preferred stock	15		15
Total	$	329,159	$	335,034

Proceeds from sales of securities during the nine months ended September 30, 2014, were $52.2 million. Gross gains of $679,000 and gross losses of $538,000 were realized on those sales, respectively. The tax expense applicable to these net realized gains amounted to $48,000.

The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $163.3 million at September 30, 2014.

Investments in an unrealized loss position that are temporarily impaired are as follows:



(Dollars in thousands)	Less than Twelve Months					Twelve Months or Greater					Total
September 30, 2014	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. government agencies	$	9,746	$	(116	)	$	4,254	$	(94	)	$	14,000	$	(210	)
Obligations of states and political subdivisions	2,642		(14		)	7,209		(468		)	9,851		(482		)
Mortgage-backed securities:
Agency	26,289		(306		)	12,507		(494		)	38,796		(800		)
Non-agency	19,317		(151		)	—		—			19,317		(151		)
Other asset backed securities	2,452		(35		)	1,077		(13		)	3,529		(48		)
Corporate preferred stock	—		—			—		—			—		—
Corporate securities	9,293		(344		)	1,792		(173		)	11,085		(517		)
Total	$	69,739	$	(966	)	$	26,839	$	(1,242	)	$	96,578	$	(2,208	)



(Dollars in thousands)	Less than Twelve Months					Twelve Months or Greater					Total
December 31, 2013	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. government agencies	$	10,218	$	(273	)	$	1,416	$	(59	)	$	11,634	$	(332	)
Obligations of states and political subdivisions	24,568		(2,539		)	1,798		(210		)	26,366		(2,749		)
Mortgage-backed securities:
Agency	50,048		(1,264		)	8,228		(360		)	58,276		(1,624		)
Non-agency	14,505		(152		)	1,351		(59		)	15,856		(211		)
Other asset backed securities	1,585		(39		)	2,187		(136		)	3,772		(175		)
Corporate preferred stock	—		—			—		—			—		—
Corporate securities	6,247		(274		)	4,446		(54		)	10,693		(328		)
Total	$	107,171	$	(4,541	)	$	19,426	$	(878	)	$	126,597	$	(5,419	)

A total of 93 securities have been identified by the Company as temporarily impaired at September 30, 2014. Of the 93 securities, 92 are investment grade and one is speculative grade. Mortgage-backed securities, municipal securities and corporate securities make up the majority of the gross unrealized losses for temporarily impaired securities at September 30, 2014. Market prices change daily and are affected by conditions beyond the control of the Company. Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered. No such sales were anticipated or required as of September 30, 2014. Investment decisions reflect the strategic asset/liability objectives of the Company. The investment portfolio is analyzed frequently by the Company and managed to provide an overall positive impact to the Company’s consolidated income statement and balance sheet.

Other-than-temporary impairment losses

At September 30, 2014, the Company evaluated the investment portfolio for possible other-than-temporary impairment losses and concluded that no adverse change in cash flows occurred and did not consider any portfolio securities to be other-than-temporarily impaired. Based on this analysis and because the Company does not intend to sell securities prior to maturity and it is more likely than not the Company will not be required to sell any securities before recovery of amortized cost basis, which may be at maturity. For debt securities related to corporate securities, the Company determined that there was no other adverse change in the cash flows as viewed by a market participant; therefore, the Company does not consider the investments in these assets to be other-than-temporarily impaired at September 30, 2014. However, there is a risk that the Company’s continuing reviews could result in recognition of other-than-temporary impairment charges in the future. For the nine months ended September 30, 2014 and the year ended December 31, 2013, no credit related impairment losses were recognized by the Company.

The Company’s investment in FHLB stock totaled $3.1 million at September 30, 2014. FHLB stock is generally viewed as a long-term investment and as a restricted security which is carried at cost because there is no market for the stock other than the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider this investment to be other-than-temporarily impaired at September 30, 2014, and no impairment has been recognized. FHLB stock is shown in restricted securities on the consolidated balance sheets and is not part of the available for sale portfolio.

Note 4. Loans, Net

The Company segregates its loan portfolio into three primary loan segments: Real Estate Loans, Commercial Loans, and Consumer Loans. Real estate loans are further segregated into the following classes: construction loans, loans secured by farmland, loans secured by 1-4 family residential real estate, and other real estate loans. Other real estate loans include commercial real estate loans. The consolidated loan portfolio was composed of the following:



	September 30, 2014				December 31, 2013
(Dollars in thousands)	Outstanding Balance		Percent of Total Portfolio		Outstanding Balance		Percent of Total Portfolio
Real estate loans:
Construction	$	32,057	4.4	%	$	36,025	5.0	%
Secured by farmland	17,332		2.4		16,578		2.3
Secured by 1-4 family residential	267,216		36.7		273,384		37.5
Other real estate loans	254,686		34.9		260,333		35.7
Commercial loans	140,555		19.3		129,554		17.8
Consumer loans	16,906		2.3		12,606		1.7
Total Gross Loans ⁽¹⁾	$	728,752	100.0	%	$	728,480	100.0	%
Less allowance for loan losses	11,423				13,320
Net loans	$	717,329			$	715,160


⁽¹⁾	Gross loan balances at September 30, 2014 and December 31, 2013 are net of deferred loan costs of $2.7 million and $2.4 million, respectively.

Loans presented in the table above exclude loans held for sale. The Company had no mortgages held for sale at September 30, 2014 and $33.2 million in mortgages held for sale at December 31, 2013.

The Company sold, on a non-recourse basis, $6.6 million in portfolio loans during the nine months ended September 30, 2014. Of this amount, $5.9 million were on nonaccrual status and $6.3 million were classified as TDRs. Specific reserves associated with these loans totaled $655,000.

The following tables present a contractual aging of the recorded investment in past due loans by class of loans:



	September 30, 2014
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans
Real estate loans:
Construction	$	—	$	—	$	76	$	76	$	31,981	$	32,057
Secured by farmland	—		—		—		—		17,332		17,332
Secured by 1-4 family residential	629		—		748		1,377		265,839		267,216
Other real estate loans	—		—		—		—		254,686		254,686
Commercial loans	650		—		328		978		139,577		140,555
Consumer loans	1		1		3		5		16,901		16,906
Total	$	1,280	$	1	$	1,155	$	2,436	$	726,316	$	728,752



	December 31, 2013
(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans
Real estate loans:
Construction	$	76	$	1,649	$	554	$	2,279	$	33,746	$	36,025
Secured by farmland	—		—		—		—		16,578		16,578
Secured by 1-4 family residential	590		3,751		1,022		5,363		268,021		273,384
Other real estate loans	116		—		4,197		4,313		256,020		260,333
Commercial loans	162		1,513		27		1,702		127,852		129,554
Consumer loans	31		9		38		78		12,528		12,606
Total	$	975	$	6,922	$	5,838	$	13,735	$	714,745	$	728,480

The following table presents the recorded investment in nonaccrual loans and loans past due 90 days or more and still accruing by class of loans:



	September 30, 2014				December 31, 2013
(Dollars in thousands)	Nonaccrual		Past due 90 days or more and still accruing		Nonaccrual		Past due 90 days or more and still accruing
Real estate loans:
Construction	$	258	$	—	$	2,368	$	268
Secured by 1-4 family residential	5,265		—		9,458		539
Other real estate loans	1,507		—		6,045		—
Commercial loans	299		30		1,844		—
Consumer loans	3		—		37		1
Total	$	7,332	$	30	$	19,752	$	808

If interest on nonaccrual loans had been accrued, such income would have approximated $325,600 and $1.1 million for the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively. The Company sold $6.6 million in loans during the nine months ended September 30, 2014. Of this amount, $5.9 million were on nonaccrual status.

The Company utilizes an internal asset classification system as a means of measuring and monitoring credit risk in the loan portfolio. Under the Company’s classification system, problem and potential problem loans are classified as “Special Mention”, “Substandard”, and “Doubtful”.

Special Mention: Loans with potential weaknesses that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in the deterioration of the repayment prospects for the credit.

Substandard: Loans with well-defined weakness that jeopardize the liquidation of the debt. Either the paying capacity of the borrower or the value of the collateral may be inadequate to protect the Company from potential losses.

Doubtful: Loans with a very high possibility of loss. However, because of important and reasonably specific pending factors, classification as a loss is deferred until a more exact status may be determined.

Loss: Loans are deemed uncollectible and are charged off immediately.

The following tables present the recorded investment in loans by class of loan that have been classified according to the internal classification system:



September 30, 2014
(Dollars in thousands)	Real Estate Construction		Real Estate Secured by Farmland		Real Estate Secured by 1-4 Family Residential		Other Real Estate Loans		Commercial		Consumer		Total
Pass	$	24,637	$	8,824	$	256,919	$	230,626	$	136,787	$	13,853	$	671,646
Special Mention	6,818		7,903		2,012		16,618		3,129		24		36,504
Substandard	602		605		7,740		7,442		389		3,026		19,804
Doubtful	—		—		545		—		250		3		798
Loss	—		—		—		—		—		—		—
Ending Balance	$	32,057	$	17,332	$	267,216	$	254,686	$	140,555	$	16,906	$	728,752



December 31, 2013
(Dollars in thousands)	Real Estate Construction		Real Estate Secured by Farmland		Real Estate Secured by 1-4 Family Residential		Other Real Estate Loans		Commercial		Consumer		Total
Pass	$	31,143	$	8,067	$	253,654	$	238,811	$	126,246	$	12,510	$	670,431
Special Mention	2,245		7,903		1,732		9,475		775		15		22,145
Substandard	2,090		608		16,158		12,047		2,419		44		33,366
Doubtful	547		—		1,840		—		114		37		2,538
Loss	—		—		—		—		—		—		—
Ending Balance	$	36,025	$	16,578	$	273,384	$	260,333	$	129,554	$	12,606	$	728,480

The following tables present loans individually evaluated for impairment by class of loan:



	September 30, 2014
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	140	$	140	$	—	$	172	$	—
Secured by farmland	—		—		—		—		—
Secured by 1-4 family residential	2,061		2,190		—		2,169		26
Other real estate loans	3,325		3,325		—		3,373		104
Commercial loans	451		451		—		456		18
Consumer loans	—		—		—		—		—
Total with no related allowance	$	5,977	$	6,106	$	—	$	6,170	$	148
With an allowance recorded:
Real estate loans:
Construction	$	119	$	119	$	69	$	125	$	—
Secured by farmland	—		—		—		—		—
Secured by 1-4 family residential	3,965		4,017		1,141		3,978		12
Other real estate loans	1,253		1,253		305		1,266		69
Commercial loans	421		421		309		794		8
Consumer loans	3,003		3,003		630		3,002		128
Total with a related allowance	$	8,761	$	8,813	$	2,454	$	9,165	$	217
Total	$	14,738	$	14,919	$	2,454	$	15,335	$	365



	December 31, 2013
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Real estate loans:
Construction	$	1,924	$	2,475	$	—	$	1,975	$	13
Secured by farmland	—		—		—		—		—
Secured by 1-4 family residential	3,930		4,452		—		4,415		6
Other real estate loans	4,458		4,458		—		4,552		104
Commercial loans	2,115		2,115		—		2,267		—
Consumer loans	—		—		—		—		—
Total with no related allowance	$	12,427	$	13,500	$	—	$	13,209	$	123
With an allowance recorded:
Real estate loans:
Construction	$	712	$	712	$	486	$	878	$	—
Secured by farmland	—		—		—		—		—
Secured by 1-4 family residential	6,481		6,428		3,045		6,632		47
Other real estate loans	4,684		4,684		812		4,840		71
Commercial loans	355		377		275		399		10
Consumer loans	37		37		37		39		—
Total with a related allowance	$	12,269	$	12,238	$	4,655	$	12,788	$	128
Total	$	24,696	$	25,738	$	4,655	$	25,997	$	251

The “Recorded Investment” amounts in the table above represent the outstanding principal balance net of charge-offs and nonaccrual payments to interest on each loan represented in the table. The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged-off on each loan and nonaccrual payments applied to principal.

Included in certain loan categories of impaired loans are troubled debt restructurings (“TDRs”). The total balance of TDRs at September 30, 2014 was $7.4 million of which $2.9 million were included in the Company’s nonaccrual loan totals at that date and $4.5 million represented loans performing as agreed according to the restructured terms. This compares with $15.6 million in total restructured loans at December 31, 2013. The amount of the valuation allowance related to TDRs was $730,200 and $2.8 million as of September 30, 2014 and December 31, 2013, respectively.

Loan modifications that were classified as TDRs during the three and nine months ended September 30, 2014 and 2013 were as follows:



	Loans Modified as TDRs
	For the Three Months Ended September 30,
(Dollars in thousands)	2014					2013
Class of Loan	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans:
Construction	—	$	—	$	—	1	$	45	$	41
Secured by farmland	—	—		—		—	—		—
Secured by 1-4 family residential	—	—		—		6	2,300		1,986
Other real estate loans	—	—		—		3	701		676
Total real estate loans	—	$	—	$	—	10	$	3,046	$	2,703
Commercial loans	—	—		—		1	50		49
Consumer loans	—	—		—		—	—		—
Total	—	$	—	$	—	11	$	3,096	$	2,752



	Loans Modified as TDRs
	For the Nine Months Ended September 30,
(Dollars in thousands)	2014					2013
Class of Loan	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans:
Construction	—	$	—	$	—	2	$	557	$	514
Secured by farmland	—	—		—		—	—		—
Secured by 1-4 family residential	4	1,190		1,142		11	3,549		3,227
Other real estate loans	1	200		173		5	869		824
Total real estate loans	5	$	1,390	$	1,315	18	$	4,975	$	4,565
Commercial loans	—	—		—		2	517		515
Consumer loans	—	—		—		—	—		—
Total	5	$	1,390	$	1,315	20	$	5,492	$	5,080

Of the five TDRs identified during the nine months ended September 30, 2014, two loans had previously been measured under the general allowance methodology of the allowance for loan losses. Upon identifying these loans as TDRs, the Company evaluated them for impairment. Accounting guidance requires prospective application of the impairment measurement for those loans newly identified as impaired. As of September 30, 2014, the recorded investment in the loans restructured during the period for which the allowance was previously measured under the general allowance methodology was $916,000. There was no allowance for loan losses associated with those loans on the basis of a current evaluation of loss.

Of the five TDRs identified above, one paid off and two were sold totaling $707,000 during the nine months ended September 30, 2014. There were no outstanding commitments to lend additional amounts to troubled debt restructured borrowers at September 30, 2014.

TDR payment defaults during three and nine months ended September 30, 2014 and 2013 were as follows:



	For the Three Months Ended September 30,
(Dollars in thousands)	2014			2013
Class of Loan	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Real estate loans:
Construction	—	$	—	—	$	—
Secured by farmland	—	—		—	—
Secured by 1-4 family residential	—	—		—	—
Other real estate loans	1	91		—	—
Total real estate loans	1	$	91	—	$	—
Commercial loans	1	49		—	—
Consumer loans	—	—		—	—
Total	2	$	140	—	$	—



	For the Nine Months Ended September 30,
(Dollars in thousands)	2014			2013
Class of Loan	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Real estate loans:
Construction	—	$	—	—	$	—
Secured by farmland	—	—		—	—
Secured by 1-4 family residential	—	—		1	712
Other real estate loans	1	91		—	—
Total real estate loans	1	$	91	1	$	712
Commercial loans	1	49		—	—
Consumer loans	—	—		—	—
Total	2	$	140	1	$	712

For purposes of this disclosure, a TDR payment default occurs when, within 12 months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 days or more past due.

Note 5. Allowance for Loan Losses

The following table presents, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology(individually evaluated for impairment or collectively evaluated for impairment).



	September 30, 2014
(Dollars in thousands)	Real Estate Construction			Real Estate Secured by Farmland		Real Estate Secured by 1-4 Family Residential			Other Real Estate Loans			Commercial			Consumer			Total
Allowance for loan losses:
Balance at December 31, 2013	$	847		$	166	$	6,734		$	3,506		$	1,890		$	177		$	13,320
Adjustment for the sale of majority interest in consolidated subsidiary	—			—		(95		)	—			—			—			(95		)
Charge-offs	(1,187		)	—		(1,186		)	(748		)	(958		)	(35		)	(4,114		)
Recoveries	181			—		321			109			101			90			802
Provision	582			13		(1,279		)	526			1,084			584			1,510
Balance at September 30, 2014	$	423		$	179	$	4,495		$	3,393		$	2,117		$	816		$	11,423
Ending allowance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	69		$	—	$	1,141		$	305		$	309		$	630		$	2,454
Collectively evaluated for impairment	354			179		3,354			3,088			1,808			186			8,969
Total ending allowance balance	$	423		$	179	$	4,495		$	3,393		$	2,117		$	816		$	11,423
Loans:
Individually evaluated for impairment	$	259		$	—	$	6,026		$	4,578		$	872		$	3,003		$	14,738
Collectively evaluated for impairment	31,798			17,332		261,190			250,108			139,683			13,903			714,014
Total ending loans balance	$	32,057		$	17,332	$	267,216		$	254,686		$	140,555		$	16,906		$	728,752



	December 31, 2013
(Dollars in thousands)	Real Estate Construction			Real Estate Secured by Farmland		Real Estate Secured by 1-4 Family Residential			Other Real Estate Loans			Commercial			Consumer			Total
Allowance for loan losses:
Balance at December 31, 2012	$	1,258		$	135	$	6,276		$	4,348		$	2,098		$	196		$	14,311
Charge-offs	(394		)	—		(785		)	(97		)	(75		)	(30		)	(1,381		)
Recoveries	68			—		140			37			9			27			281
Provision	(85		)	31		1,103			(782		)	(142		)	(16		)	109
Balance at December 31, 2013	$	847		$	166	$	6,734		$	3,506		$	1,890		$	177		$	13,320
Ending allowance:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	486		$	—	$	3,045		$	812		$	275		$	37		$	4,655
Collectively evaluated for impairment	361			166		3,689			2,694			1,615			140			8,665
Total ending allowance balance	$	847		$	166	$	6,734		$	3,506		$	1,890		$	177		$	13,320
Loans:
Individually evaluated for impairment	$	2,636		$	—	$	10,411		$	9,142		$	2,470		$	37		$	24,696
Collectively evaluated for impairment	33,389			16,578		262,973			251,191			127,084			12,569			703,784
Total ending loans balance	$	36,025		$	16,578	$	273,384		$	260,333		$	129,554		$	12,606		$	728,480

Note 6. Earnings Per Share

The following shows the weighted-average number of shares used in computing earnings per share and the effect on weighted-average number of shares of diluted potential common stock. Potential dilutive common stock had no effect on income available to common stockholders.



	For the Three Months Ended September 30,
	2014			2013
	Shares	Per Share Amount		Shares	Per Share Amount
Earnings per share, basic	7,108,450	$	0.30	7,080,244	$	0.23
Effect of dilutive securities:
Stock options, grants and warrant	25,812	—		37,964	—
Earnings per share, diluted	7,134,262	$	0.30	7,118,208	$	0.23



	For the Nine Months Ended September 30,
	2014			2013
	Shares	Per Share Amount		Shares	Per Share Amount
Earnings per share, basic	7,099,506	$	0.84	7,072,372	$	0.71
Effect of dilutive securities:
Stock options, grants and warrant	24,669	—		32,777	—
Earnings per share, diluted	7,124,175	$	0.84	7,105,149	$	0.71

The warrant and none of the stock options were considered anti-dilutive for the three and nine months ended September 30, 2014. Stock options and restricted stock representing approximately 6,000 shares and 14,833 shares for the three and nine months ended September 30, 2013, respectively, were not included in the calculation of earnings per share because they would have been anti-dilutive.

Note 7. Segment Reporting

The Company operates in a decentralized fashion in the following principal business activities: retail banking services; wealth management services; and mortgage banking services.


•	Revenue from retail banking activity consists primarily of interest earned on loans and investment securities and service charges on deposit accounts.


•	Revenue from the wealth management activities is comprised of fees based upon the market value of the accounts under administration as well as commissions on investment transactions.

•

Revenue from the mortgage banking activities is comprised of interest earned on loans and fees received as a result of the mortgage origination process through the Company's affiliation with Southern Trust Mortgage. The Company recognized gains on the sale of loans as part of other income. On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage and as a result, any mortgage banking activity for the Company for the third quarter of 2014 is included with the results of the retail banking segment. Any activity since the sale of Southern Trust Mortgage is considered to be immaterial and incidental to the Company's retail banking activities. The mortgage banking activities will continue to be evaluated and will be separately reported as a distinguishable segment if determined to be of significance to the reader of these financial statements or if the related operating results are believed to meet the quantitative tests for disclosure. Mortgage banking activities for the nine months ended September 30, 2014 are the result of Southern Trust Mortgage activity that was consolidated with the Company through the date of sale.

Middleburg Bank and the Company have assets in custody with Middleburg Trust Company and accordingly pay Middleburg Trust Company a monthly fee. Middleburg Bank also pays interest to Middleburg Trust Company on deposit accounts with Middleburg Bank. Middleburg Bank provided a warehouse line and office space, data processing and accounting services to Southern Trust Mortgage for which it received income. Transactions related to these relationships are eliminated to reach consolidated totals.

The following tables represent reportable segment information for the three and nine months ended September 30, 2014 and 2013, respectively:



	For the Three Months Ended											For the Three Months Ended
	September 30, 2014											September 30, 2013
(In Thousands)	Retail Banking		Wealth Management		Mortgage Banking		Elimina-tions			Consolidated		Retail Banking		Wealth Management		Mortgage Banking			Elimina-tions			Consolidated
Revenues:
Interest income	$	10,876	$	4	$	—	$	(90	)	$	10,790	$	10,750	$	4	$	520		$	(320	)	$	10,954
Trust and investment fee income	193		1,158		—		(38		)	1,313		—		1,000		—			(37		)	963
Other income	969		—		—		(21		)	948		899		—		4,358			(92		)	5,165
Total operating income	12,038		1,162		—		(149		)	13,051		11,649		1,004		4,878			(449		)	17,082
Expenses:
Interest expense	1,335		—		—		(90		)	1,245		1,574		—		380			(320		)	1,634
Salaries and employee benefits	3,877		564		—		—			4,441		4,183		393		3,174			—			7,750
Provision for loan losses	550		—		—		—			550		—		—		3			—			3
Other	3,703		287		—		(59		)	3,931		4,240		223		1,221			(129		)	5,555
Total operating expenses	9,465		851		—		(149		)	10,167		9,997		616		4,778			(449		)	14,942
Income before income taxes and non-controlling interest	2,573		311		—		—			2,884		1,652		388		100			—			2,140
Income tax expense	635		128		—		—			763		440		51		—			—			491
Net Income	1,938		183		—		—			2,121		1,212		337		100			—			1,649
Non-controlling interest in income of consolidated subsidiary	—		—		—		—			—		—		—		(38		)	—			(38		)
Net income attributable to Middleburg Financial Corporation	$	1,938	$	183	$	—	$	—		$	2,121	$	1,212	$	337	$	62		$	—		$	1,611
Total assets	$	1,322,493	$	12,505	$	—	$	(127,271	)	$	1,207,727	$	1,202,151	$	12,192	$	52,281		$	(51,297	)	$	1,215,327
Capital expenditures	$	307	$	1	$	3	$	—		$	311	$	693	$	5	$	115		$	—		$	813
Goodwill and other intangibles	$	—	$	3,850	$	—	$	—		$	3,850	$	—	$	4,022	$	1,867		$	—		$	5,889



	For the Nine Months Ended												For the Nine Months Ended
	September 30, 2014												September 30, 2013
(In Thousands)	Retail Banking		Wealth Management		Mortgage Banking			Elimina-tions			Consolidated		Retail Banking			Wealth Management		Mortgage Banking			Elimina-tions			Consolidated
Revenues:
Interest income	$	32,665	$	11	$	450		$	(288	)	$	32,838	$	32,742		$	11	$	1,398		$	(993	)	$	33,158
Trust and investment fee income	479		3,339		—			(115		)	3,703		—			3,052		—			(115		)	2,937
Other income	3,659		—		5,121			(46		)	8,734		3,363			—		13,161			(325		)	16,199
Total operating income	36,803		3,350		5,571			(449		)	45,275		36,105			3,063		14,559			(1,433		)	52,294
Expenses:
Interest expense	4,055		—		304			(288		)	4,071		4,956			—		1,099			(993		)	5,062
Salaries and employee benefits	11,996		1,699		3,772			—			17,467		12,485			1,623		9,134			—			23,242
Provision for (recovery of) loan losses	1,476		—		34			—			1,510		(9		)	—		8			—			(1		)
Other	11,794		837		1,722			(161		)	14,192		12,930			910		3,699			(440		)	17,099
Total operating expenses	29,321		2,536		5,832			(449		)	37,240		30,362			2,533		13,940			(1,433		)	45,402
Income before income taxes and non-controlling interest	7,482		814		(261		)	—			8,035		5,743			530		619			—			6,892
Income tax expense	1,847		332		—			—			2,179		1,403			225		—			—			1,628
Net Income	5,635		482		(261		)	—			5,856		4,340			305		619			—			5,264
Non-controlling interest in income of consolidated subsidiary	—		—		98			—			98		—			—		(233		)	—			(233		)
Net income attributable to Middleburg Financial Corporation	$	5,635	$	482	$	(163	)	$	—		$	5,954	$	4,340		$	305	$	386		—			$	5,031
Total assets	$	1,322,493	$	12,505	$	—		$	(127,271	)	$	1,207,727	$	1,202,151		$	12,192	$	52,281		$	(51,297	)	$	1,215,327
Capital expenditures	$	748	$	11	$	3		$	—		$	762	$	1,144		$	5	$	124		$	—		$	1,273
Goodwill and other intangibles	$	—	$	3,850	$	—		$	—		$	3,850	$	—		$	4,022	$	1,867		$	—		$	5,889

Note 8. Capital Purchase Program

On January 30, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008, the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 22,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $2.50 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 208,202 shares of the Company’s common stock, par value $2.50 per share, at an initial exercise price of $15.85 per share. As a result of the completion of a public stock offering in 2009, the number of shares of common stock underlying the Warrant was reduced by one-half to 104,101 and the Company redeemed all 22,000 shares of Preferred Stock pursuant to the Purchase Agreement. During 2011, the Warrant was sold by the U.S. Treasury at public auction and has not been exercised as of September 30, 2014.

Note 9. Fair Value Measurements

The Company follows ASC 820, "Fair Value Measurements" to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies 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.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:


Level I.	Quoted prices are available in active markets for identical assets or liabilities as of the reported date.


Level II.	Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.


Level III.	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Measured on a recurring basis

The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a recurring basis in the financial statements.

Securities Available for Sale

The Company primarily values its investment portfolio using Level II fair value measurements, but may also use Level I or Level III measurements if required by the composition of the portfolio. 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 II). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified as Level III of the valuation hierarchy.

Loans Held for Sale

Loans held for sale are carried at market value. These loans currently consist of 1-4 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 (Level II). Gains and losses on the sale of loans are recorded within income from mortgage banking activities on the consolidated statements of income. There has been no activity since May 15, 2014, the date the Company sold its majority interest in Southern Trust Mortgage, and therefore, there were no loans held for sale on the consolidated balance sheet as of September 30, 2014.

Mortgage Interest Rate Locks

The Company recognizes mortgage interest rate locks at fair value. Fair value is based on either (i) the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis or (ii) the observable price for individual loans traded in the secondary market for loans that will be delivered on a mandatory basis. All of the Company's mortgage interest rate locks are classified as Level II. On May 15, 2014, the Company sold its majority interest in Southern Trust Mortgage. Activity subsequent to the sale is deemed immaterial.

Mortgage Banking Hedge Instruments

Mortgage banking hedge instruments are used to mitigate interest rate risk for certain residential mortgage loans held for sale and interest rate locks. These instruments are considered derivatives and are recorded at fair value, based on (i) committed sales prices from investors for commitments to sell mortgage loans or (ii) observable market data inputs for commitments to sell mortgage backed securities. The Company's mortgage banking hedge instruments are classified as Level II. On May 15, 2014, the Company sold its majority interest in Southern Trust Mortgage and on this date, this activity ceased.

Interest Rate Swaps

Interest rate swaps are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data (Level II).

Mortgage Servicing Rights

The Company obtains the fair value of mortgage servicing rights from an independent valuation service. The model used by the independent service to value mortgage servicing rights incorporates inputs and assumptions such as loan characteristics, contractually specified servicing fees, prepayment speeds, delinquency rates, late charges, escrow income, other ancillary revenue, costs to service and other economic factors. Fair value estimates from the model are adjusted for recent market activity, actual experience and, when available, other observable market data (Level II). On May 15, 2014, the Company sold its majority interest in Southern Trust Mortgage and on this date, mortgage servicing rights ceased.

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013.



(Dollars in thousands)	September 30, 2014
Description	Total		Level I		Level II		Level III
Assets:
U.S. government agencies	$	32,363	$	—	$	32,363	$	—
Obligations of states and political subdivisions	60,010		—		60,010		—
Mortgage-backed securities:
Agency	168,763		—		168,763		—
Non-agency	27,951		—		27,951		—
Other asset backed securities	27,690		—		27,690		—
Corporate preferred stock	15		—		15		—
Corporate securities	18,242		—		17,752		490
Mortgage loans held for sale	5,344		—		5,344		—
Interest rate swaps	164		—		164		—
Liabilities:
Interest rate swaps	248		—		248		—



(Dollars in thousands)	December 31, 2013
Description	Total		Level I		Level II		Level III
Assets:
U.S. government agencies	$	21,339	$	—	$	21,339	$	—
Obligations of states and political subdivisions	67,238		—		67,238		—
Mortgage-backed securities:
Agency	168,010		—		168,010		—
Non-agency	21,934		—		21,934		—
Other asset backed securities	34,418		—		34,418		—
Corporate preferred stock	74		—		74		—
Corporate securities	15,410		—		14,922		488
Mortgage loans held for sale	33,175		—		33,175		—
Mortgage interest rate locks	16		—		16		—
Interest rate swaps	334		—		334		—
Mortgage servicing rights	203		—		203		—
Mortgage banking hedge instruments	202		—		202		—
Liabilities:
Interest rate swaps	303		—		303		—

The following table presents changes in Level III assets measured at fair value on a recurring basis during the nine months ended September 30, 2014:



(Dollars in thousands)	September 30, 2014
Description	Balance December 31, 2013		Included in Earnings		Included in Other Comprehensive Income		Transfers In/Out of Level II and III		Balance September 30, 2014
Available for sale securities - corporate securities	$	488	$	—	$	2	$	—	$	490

The following table presents quantitative information as of September 30, 2014 and December 31, 2013 related to Level III fair value measurements for assets measured at fair value on a recurring basis:



	Fair Value (Dollars in thousands)		Valuation Technique	Unobservable Inputs
September 30, 2014
Corporate securities	$	490	Third party trading desk	Prices heavily influenced by unobservable market inputs.



	Fair Value (Dollars in thousands)		Valuation Technique	Unobservable Inputs
December 31, 2013
Corporate securities	$	488	Third party trading desk	Prices heavily influenced by unobservable market inputs.

Measured on nonrecurring basis

The Company may be required, from time to time, to measure and recognize certain other assets at fair value on a nonrecurring basis in accordance with GAAP. The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the financial statements.

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level II). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. 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 III). 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.

When collateral-dependent loans are performing in accordance with the original terms of their contract, the Company continues to use the appraisal that was performed at origination as the basis for the collateral value. When collateral-dependent loans are considered nonperforming, they are reviewed to determine the next appropriate course of action, either foreclosure or modification with forbearance agreement. The loans would then be reappraised prior to foreclosure or before a forbearance agreement is executed. This process does not vary by loan type.

The Company's procedure to monitor the value of collateral for collateral-dependent impaired loans between the receipt of the original appraisal and an updated appraisal is to review annual tax assessment records. At this time, adjustments are made, if necessary. Information considered in the determination not to order an updated appraisal includes the availability and reliability of tax assessment records and significant changes in capitalization rates for income properties. Other facts and circumstances on a case-by-case basis may be considered relative to a decision not to order an updated appraisal. If, in the judgment of management, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.

Circumstances that may warrant a reappraisal for nonperforming loans might include foreclosure proceedings or a material adverse change in the borrower's condition or that of the collateral underlying the loan. In some cases, management may decide that an updated appraisal for a nonperforming loan is not necessary, In such cases, an estimate of the fair value of the collateral would be made by management by reference to current tax assessments, the latest appraised value, and knowledge of collateral value fluctuations in a loan's market area. If, in management's judgment, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.

For the purpose of evaluating the allowance for loan losses, new appraisals are discounted 10% for estimated selling costs when determining the amount of specific reserves. Thereafter, for collateral-dependent impaired loans, we consider each loan on a case-by-case basis to determine whether or not the recorded values are appropriate given current market conditions. When necessary, new appraisals are obtained. If an appraisal is less than 12 months old, the only adjustment made is the 10% discount for selling costs. If an appraisal is older than 12 months, management will use judgment based on knowledge of current market values and specific facts surrounding any particular property to determine if an additional valuation adjustment may be necessary.

Other Real Estate Owned

The value of other real estate owned (“OREO”) is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II). For other real estate owned properties that may be in construction, the Company’s policy is to obtain “as-is” appraisals on an annual basis as opposed to “as-completed” appraisals. This approach provides current values without regard to completion of any construction or renovation that may be in process. Accordingly, the Company considers the valuations to be Level II valuations even though some properties may be in process of renovation or construction. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability or other factors, then the fair value is considered Level III. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Any subsequent fair value adjustments are recorded in the period incurred and included in other non-interest expense on the consolidated statements of income.

For the purpose of OREO valuations, appraisals are discounted 10% for selling costs and it is the policy of the Company to obtain annual appraisals for properties held in OREO. Any fair value adjustments are recorded in the period incurred as loss on other real estate owned on the consolidated statements of income.

Repossessed Assets

The value of repossessed assets is determined by the Company based on marketability and other factors and is considered Level III.

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



(Dollars in thousands)	September 30, 2014
	Total		Level I		Level II		Level III
Assets:
Impaired loans	$	6,307	$	—	$	1,396	$	4,911
Other real estate owned	$	5,064	$	—	$	5,064	$	—
Repossessed assets	$	1,132	$	—	$	—	$	1,132

(Dollars in thousands)	December 31, 2013
	Total		Level I		Level II		Level III
Assets:
Impaired loans	$	7,614	$	—	$	5,756	$	1,858
Other real estate owned	$	3,424	$	—	$	3,424	$	—

The following table presents quantitative information as of September 30, 2014 and December 31, 2013 about Level III fair value measurements for assets measured at fair value on a non-recurring basis:



September 30, 2014	Fair Value (in thousands)		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	4,911	Discounted appraised value	Discount for selling costs and age of appraisals	0% - 100% (7%)
Repossessed assets	$	1,132	Market analysis	Historical sales activity	50%



December 31, 2013	Fair Value (in thousands)		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	1,858	Discounted appraised value	Discount for selling costs and age of appraisals.	0% - 100% (4%)

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 Company’s various financial instruments. In cases where quoted market prices are not available, fair

values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. U.S. generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments (not previously described) for which it is practicable to estimate that value:

Cash and Cash Equivalents

For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Loans, Net

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, the fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Fair value for impaired loans is described above.

Bank Owned Life Insurance

The carrying amount of bank owned life insurance is a reasonable estimate of fair value.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximate fair values.

Deposits

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

Securities Sold Under Agreements to Repurchase and Short-Term Debt

The carrying amounts approximate fair values.

FHLB Borrowings and Subordinated Debt

For variable rate long-term debt, fair values are based on carrying values. For fixed rate debt, fair values are estimated based on observable market prices and discounted cash flow analysis using interest rates for borrowings of similar remaining maturities and characteristics. The fair values of the Company's Subordinated Debentures are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance Sheet Financial Instruments

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At September 30, 2014 and December 31, 2013, the fair values of loan commitments and standby letters of credit were deemed immaterial; therefore, they have not been included in the tables below.

Fair Value of Financial Instruments

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



(Dollars in thousands)	September 30, 2014
					Fair value measurements using:
	Carrying Amount		Total Fair Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents	$	79,125	$	79,125	$	79,125	$	—	$	—
Securities available for sale	335,034		335,034		—		334,544		490
Loans held for sale	—		—		—		—		—
Loans, net	717,329		726,311		—		1,396		724,915
Bank owned life insurance	22,450		22,450		—		22,450		—
Accrued interest receivable	3,964		3,964		—		3,964		—
Interest rate swaps	164		164		—		164		—
Financial liabilities:
Deposits	$	986,566	$	987,276	$	—	$	987,276	$	—
Securities sold under agreements to repurchase	36,469		36,469		—		36,469		—
FHLB borrowings	45,000		45,275		—		45,275		—
Subordinated notes	5,155		5,186		—		5,186		—
Accrued interest payable	378		378		—		378		—
Interest rate swaps	248		248		—		248		—



(Dollars in thousands)	December 31, 2013
					Fair value measurements using:
	Carrying Amount		Total Fair Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents	$	67,343	$	67,343	$	67,343	$	—	$	—
Securities available for sale	328,423		328,423		—		327,935		488
Loans held for sale	33,175		33,175		—		33,175		—
Net loans	715,160		726,239		—		5,756		720,483
Bank-owned life insurance	21,955		21,955		—		21,955		—
Accrued interest receivable	3,992		3,992		—		3,992		—
Mortgage interest rate locks	16		16		—		16		—
Interest rate swap	334		334		—		334		—
Mortgage banking hedge instruments	202		202		—		202		—
Mortgage servicing rights	203		203		—		203		—
Financial liabilities:
Deposits	$	982,396	$	984,420	$	—	$	984,420	$	—
Securities sold under agreements to repurchase	34,539		34,539		—		34,539		—
FHLB borrowings and other debt	80,000		80,666		—		80,666		—
Subordinated notes	5,155		5,198		—		5,198		—
Accrued interest payable	501		501		—		501		—
Interest rate swap	303		303		—		303		—

The Company assumes interest rate risk as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change, which may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.

Note 10. Recent Accounting Pronouncements

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 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 Company 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 Company is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606”. This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition”, most industry-specific guidance, and some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts”. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation. Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-10, “Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation”. The amendments in this ASU remove all incremental financial reporting requirements from U.S. GAAP for development stage entities, including the removal of Topic 915, “Development Stage Entities”, from the FASB Accounting Standards Codification. In addition, this ASU adds an example disclosure and removes an exception provided to development stage entities in Topic 810, “Consolidation”, for determining whether an entity is a variable interest entity. The presentation and disclosure requirements in Topic 915 will no longer be required for the first annual period beginning after December 15, 2014. The revised consolidation standards are effective

for annual periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-10 to have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”. This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-11 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation - Stock Compensation (Topic 718)”, should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-14, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure”. The amendments in this ASU apply to creditors that hold government-guaranteed mortgage loans and is intended to eliminate the diversity in practice related to the classification of these guaranteed loans upon foreclosure. The new guidance stipulates that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if (1) the loan has a government guarantee that is not separable from the loan prior to foreclosure, (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the other receivable should be measured on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. Entities may adopt the amendments on a prospective basis or modified retrospective basis as of the beginning of the annual period of adoption; however, the entity must apply the same method of transition as elected under ASU 2014-04. Early adoption is permitted provided the entity has already adopted ASU 2014-04. The Company is currently assessing the impact that ASU 2014-14 will have on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. This update is intended to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

Note 11. Accumulated Other Comprehensive Income

Changes in accumulated other comprehensive income for the nine months ended September 30, 2014 and 2013 were:



(Dollars in thousands)	Unrealized Gains on Securities			Cash Flow Hedges			Accumulated Other Comprehensive Income
Balance December 31, 2012	$	6,771		$	(304	)	$	6,467
Unrealized holding losses (net of tax, $2,870)	(5,572		)	—			(5,572		)
Reclassification adjustment (net of tax, $135)	(262		)	—			(262		)
Unrealized gain on interest rate swaps (net of tax, $103)	—			200			200
Balance September 30, 2013	$	937		$	(104	)	$	833

Balance December 31, 2013	$	261		$	(29	)	$	232
Unrealized holding gains (net of tax of $1,911)	3,710			—			3,710
Reclassification adjustment (net of tax, $48)	(93		)	—			(93		)
Unrealized loss on interest rate swap (net of tax, $14)	—			(27		)	(27		)
Balance September 30, 2014	$	3,878		$	(56	)	$	3,822

The following table presents information related to reclassifications from accumulated other comprehensive income:



Details about Accumulated Other Comprehensive Income	Amount Reclassified from Accumulated Other Comprehensive Income						Affected Line Item in the Consolidated Statements of Income
	For the Three Months Ended September 30,
(Dollars in thousands)	2014			2013
Securities available for sale ⁽¹⁾:
Net securities gains reclassified into earnings	$	(12	)	$	(23	)	Gain on securities available for sale
Related income tax expense	4			8			Income tax expense
Derivatives⁽²⁾:
Gain on interest rate swap ineffectiveness	(8		)	—			Other operating expenses
Related income tax expense	3			—			Income tax expense
Net effect on accumulated other comprehensive income	(13		)	(15		)	Net of tax
Total reclassifications	$	(13	)	$	(15	)	Net of tax

⁽¹⁾For more information related to unrealized gains on securities available for sale, see Note 3, "Securities".

⁽²⁾For more information related to unrealized losses on derivatives, see Note 12, "Derivatives".



Details about Accumulated Other Comprehensive Income	Amount Reclassified from Accumulated Other Comprehensive Income						Affected Line Item in the Consolidated Statements of Income
	For the Nine Months Ended September 30,
(Dollars in thousands)	2014			2013
Securities available for sale ⁽¹⁾:
Net securities gains reclassified into earnings	$	(141	)	$	(397	)	Gain on securities available for sale
Related income tax expense	48			135			Income tax expense
Derivatives⁽²⁾:
Loss (gain) on interest rate swap ineffectiveness	—			—			Other operating expenses
Related income tax expense	—			—			Income tax expense
Net effect on accumulated other comprehensive income	(93		)	(262		)	Net of tax
Total reclassifications	$	(93	)	$	(262	)	Net of tax

⁽¹⁾For more information related to unrealized gains on securities available for sale, see Note 3, "Securities".

⁽²⁾For more information related to unrealized losses on derivatives, see Note 12, "Derivatives".

Note 12. Derivatives

The Company utilizes derivative instruments as a part of its asset-liability management program to control fluctuation of market values and cash flows to changes in interest rates associated with certain financial instruments. The Company accounts for derivatives in accordance with ASC 815, "Derivatives and Hedging". Under current guidance, derivative transactions are classified as either cash flow hedges or fair value hedges or they are not designated as hedging instruments. The Company designates each derivative instrument at the inception of the derivative transaction in accordance with this guidance. Information concerning each of the Company's categories of derivatives as of September 30, 2014 and December 31, 2013 is presented below.

Derivatives designated as cash flow hedges

During 2010, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap was designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s trust preferred capital securities. The swap hedges the cash flow associated with the trust preferred capital notes wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 2.59% to the same counterparty. The swap is calculated on a notional amount of $5.2 million. The term of the swap is 10 years and commenced on October 23, 2010. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.

During 2013, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap has been designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s FHLB borrowings. The swap hedges the cash flows associated with the FHLB borrowings wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 1.43% to the same counterparty. The swap is calculated on a notional amount of $10.0 million. The term of the swap is 5 years and commenced on November 25, 2013. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.

Amounts receivable or payable are recognized as accrued under the terms of the agreement, with the effective portion of the derivative’s unrealized gain or loss recorded as a component of other comprehensive income. The ineffective portion of the unrealized gain or loss, if any, would be recorded in other income or other expense. The Company has assessed the effectiveness of the hedging relationship by comparing the changes in cash flows on the designated hedged item. As a result of this assessment, there was no hedge ineffectiveness identified for the nine months ended September 30, 2014 or the year ended December 31, 2013.

The amounts included in accumulated other comprehensive income (loss) as unrealized losses (market value net of tax) were $55,800 and $29,100 as of September 30, 2014 and December 31, 2013, respectively.

Information concerning the derivative designated as a cash flow hedge at September 30, 2014 and December 31, 2013 is presented in the following tables:



	September 30, 2014
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	5,155	$	—	$	142	0.23	%	2.59	%	6.1
Pay fixed - receive floating interest rate swap	1	$	10,000	$	58	$	—	0.15	%	1.43	%	4.2



	December 31, 2013
	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	5,155	$	—	$	72	0.32	%	2.59	%	6.8
Pay fixed - receive floating interest rate swap	1	$	10,000	$	102	$	—	0.17	%	1.43	%	5.0

Derivatives not designated as hedging instruments

Two-way client loan swaps

During the fourth quarter of 2012, the Company entered into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which we enter into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on an identical notional amount at a fixed interest rate. At the same time, the Company agrees to pay the counterparty the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our clients to effectively convert a variable rate loan into a fixed rate loan. Because the Company acts as an intermediary for our customers, changes in the fair value of the underlying derivatives contracts offset each other and do not significantly impact our results of operations. The Company had no undesignated interest rate swaps at September 30, 2014 and December 31, 2013.

Certain additional risks arise from interest rate swap contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. We do not expect any counterparty to fail to meet its obligations.

Information concerning two-way client interest rate swaps not designated as either fair value or cash flow hedges is presented in the following table:



	September 30, 2014
(Dollars in thousands)	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	4,061	$	—	$	106	1 month LIBOR plus 200 BP		3.90	%	13.2
Pay floating - receive fixed interest rate swap	1	4,061		106		—		3.90	%	1 month LIBOR plus 200 BP		13.2
Total derivatives not designated		$	8,122	$	106	$	106					13.2



	December 31, 2013
(Dollars in thousands)	Positions (#)	Notional Amount (in thousands)		Asset (in thousands)		Liability (in thousands)		Receive Rate		Pay Rate		Life (Years)
Pay fixed - receive floating interest rate swap	1	$	4,235	$	—	$	232	1 month LIBOR plus 200 BP		3.90	%	13.9
Pay floating - receive fixed interest rate swap	1	4,235		232		—		3.90	%	1 month LIBOR plus 200 BP		13.9
Total derivatives not designated		$	8,470	$	232	$	232					13.9


ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITON AND RESULTS OF OPERATIONS

The following discussion and analysis of the financial condition at September 30, 2014 and results of operations of the Company for the three and nine months ended September 30, 2014 should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report and in the 2013 Form 10-K. It should also be read in conjunction with the “Caution About Forward Looking Statements” section at the end of this discussion.

Overview

The Company is headquartered in Middleburg, Virginia and conducts its primary operations through two wholly owned subsidiaries, Middleburg Bank and Middleburg Investment Group, Inc. Middleburg Bank is a community bank serving the Virginia counties of Prince William, Loudoun, Fairfax, Fauquier, the Town of Williamsburg and the City of Richmond with twelve financial service centers and one limited service facility. Middleburg Investment Group is a non-bank holding company with one wholly owned subsidiary, Middleburg Trust Company. Middleburg Trust Company is a trust company headquartered in Richmond, Virginia, and maintains offices in Williamsburg, Virginia and in several of Middleburg Bank’s facilities. On May 15, 2014, the Company sold its membership interests in Southern Trust Mortgage to a consortium of banks and the President of Southern Trust Mortgage.

The Company generates a significant amount of its income from the net interest income earned by Middleburg Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. Middleburg Bank’s cost of funds is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on nonaccrual loans and the amount of additions to the allowance for loan losses or potential other-than-temporary impairment of securities. Middleburg Investment Group’s subsidiary, Middleburg Trust Company, generates fee income by providing investment management and trust services to its clients. Investment management and trust fees are generally based upon the value of assets under management, and, therefore can be significantly affected by fluctuations in the values of securities caused by changes in the capital markets.

Net income attributable to Middleburg Financial Corporation for the quarter ended September 30, 2014 increased 31.66% to $2.12 million from $1.61 million over the same period in 2013. Earnings per diluted share for the quarter ended September 30, 2014 were $0.30 per share compared to $0.23 per share for the same period in 2013. Net income attributable to Middleburg Financial Corporation for the nine months ended September 30, 2014 increased 18.35% to $5.95 million from $5.03 million over the same period in 2013. Earnings per diluted share for the nine months ended September 30, 2014 were $0.84 per share compared to $0.71 per share for the same period in 2013.

Annualized return on average assets for the quarter ended September 30, 2014 was 0.69%, compared to 0.52% for the same period in 2013. Annualized return on average equity of Middleburg Financial Corporation for the quarter ended September 30, 2014 was 7.00%, compared to 5.70% for the same period in 2013. Annualized return on average assets for the nine months ended September 30, 2014 was 0.65%, compared to 0.55% for the same period in 2013. Annualized return on average equity of Middleburg Financial Corporation for the nine months ended September 30, 2014 was 6.77%, compared to 6.00% for the same period in 2013.

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The net interest margin, a non-GAAP measure more fully described in the “Results of Operations” section below, increased from 3.33% for the quarter ended September 30, 2013 to 3.36% for the quarter ended September 30, 2014. The net interest margin increased from 3.39% for the nine months ended September 30, 2013 to 3.43% for the nine months ended September 30, 2014.

The provision for loan losses increased to $550,000 for the quarter ended September 30, 2014 compared to $3,000 for the same period in 2013. The provision for loan losses increased to $1.51 million for the nine months ended September 30, 2014 compared to $(1,000) for the same period in 2013.

Non-interest income for the quarter and nine months ended September 30, 2014 was lower by 62.79% and 35.02% compared to the quarter and nine months ended September 30, 2013 primarily due to lower mortgage revenue which was partially offset by income from a large recovery of expense during the first quarter of 2014 related to a previously charged-off loan.

Non-interest expense fell by 36.93% compared to the quarter ended September 30, 2013 and fell by 21.53% compared to the nine months ended September 30, 2013. Actions taken by the Company to cut costs as well as the Company's sale of all its interest in Southern Trust Mortgage during the second quarter of 2014 were the primary reasons for the decline in non-interest expense for the nine months ended 2014. Expenses attributable to Southern Trust Mortgage were consolidated in the Company's financial statement through the date of the sale.

The Company’s capital ratios remain well above regulatory minimum capital ratios as of September 30, 2014:


•	Tier 1 Leverage ratio was 9.71%, 5.71% over the regulatory minimum of 4.00%


•	Tier 1 Risk-Based Capital Ratio was 16.04%, 12.04% over the regulatory minimum of 4.00%


•	Total Risk Based Capital Ratio was 17.30%, 9.30% over the regulatory minimum of 8.00%.

At September 30, 2014, total assets were $1.21 billion, a decrease of 1.63% since December 31, 2013. Net loans held-for-investment increased by $2.17 million to $717.33 million, an increase of 0.30% since December 31, 2013. Total deposits were $986.57 million, an increase of 0.42% since December 31, 2013. Non-maturity deposits, including demand checking, interest checking and savings increased $23.89 million from December 31, 2013 to $738.34 million at September 30, 2014. Time deposits decreased 7.36% or $19.72 million from December 31, 2013 to $248.23 million at September 30, 2014.

Critical Accounting Policies

General

The financial condition and results of operations presented in the Consolidated Financial Statements, the accompanying Notes to the Consolidated Financial Statements and this section are, to some degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is discussion of those accounting policies that management believes are the most important (“Critical Accounting Policies”) to the portrayal and understanding of Middleburg Financial Corporation’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

Allowance for Loan Losses

Middleburg Bank monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. Middleburg Bank maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

Middleburg Bank evaluates various loans individually for impairment as required by applicable accounting standards. Loans evaluated individually for impairment include nonperforming loans, such as loans on nonaccrual, loans past due by 90 days or more, troubled debt restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment with a group of loans that have similar characteristics.

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For loans without individual measures of impairment, Middleburg Bank makes estimates of losses for groups of loans as required by applicable accounting standards. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loans losses. This estimate of losses is compared to the allowance for loan losses of Middleburg Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. Middleburg Bank recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high or low based on a reasonable range. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the consolidated financial statements.

Goodwill and Intangibles

With the adoption of Accounting Standards Update 2011-08, "Intangible-Goodwill and Other-Testing Goodwill for Impairment", the Company is no longer required to perform a test for impairment unless, based on an assessment of qualitative factors related to goodwill, we determine that it is more likely than not that the fair value of each applicable reporting unit is less than its carrying amount. If the likelihood of impairment is more than 50%, the Company must perform a test for impairment and may be required to record impairment charges. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit is greater than zero and its fair value exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; thus, the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill shall be its new accounting basis. Subsequent reversal of a previously recognized goodwill impairment loss is prohibited once the measurement of that loss is recognized.

Management estimates fair value utilizing multiple methodologies which include discounted cash flows, comparable companies, third-party sale and assets under management analysis. Determining the fair value of the Company’s reporting units requires management to make judgments and assumptions related to various items, including estimates of future operating results, allocations of indirect expenses, and discount rates. Management believes its estimates and assumptions are reasonable; however, the fair value of each reporting unit could be different in the future if actual results or market conditions differ from the estimates and assumptions used.

The Company’s forecasted cash flows for its reporting units assume a stable economic environment and consistent long-term growth in loan originations and assets under management over the projected periods. Additionally, expenses are assumed to be consistently correlated with projected asset and revenue growth over the time periods projected. Although we believe the key assumptions underlying the financial forecasts to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond the control of the Company. Accordingly, there can be no assurance that the forecasted results will be realized and variations from the forecast may be material. If weak economic conditions continue or worsen for a prolonged period of time, or if the reporting unit loses key personnel, the fair value of the reporting unit may be adversely affected which may result in impairment of goodwill or other intangible assets in the future. Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse effect on the Company’s financial condition and results of operations.

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Middleburg Investment Group has intangible assets in the form of certain customer relationships that were acquired in 2002. We amortize those intangible assets on a straight line basis over their estimated useful life.

Other-Than-Temporary Impairment (OTTI) for Securities

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.

Results of Operations

The Company's net income for the third quarter of 2014 was $2.12 million, an increase of $510,000 or 31.66% from the third quarter of 2013. For the third quarter of 2014, earnings per diluted share was $0.30 compared to earnings per diluted share of $0.23 for the third quarter of 2013.

The following tables reflect an analysis of the Company’s net interest income for the quarter ended September 30, 2014 and 2013 using the daily average balances of the Company’s assets and liabilities for the periods indicated. Nonaccrual loans are included in the loan balances.

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	Three Months Ended September 30,
	2014							2013
	Average Balance			Income/ Expense		Yield/ Rate⁽²⁾		Average Balance			Income/ Expense		Yield/ Rate⁽²⁾
	(Dollars in thousands)
Assets:
Securities:
Taxable	$	282,860		$	1,847	2.59	%	$	266,197		$	1,527	2.28	%
Tax-exempt ⁽¹⁾	54,410			811		5.91	%	64,678			970		5.95	%
Total securities	$	337,270		$	2,658	3.13	%	$	330,875		$	2,497	2.99	%
Loans:
Taxable	$	730,006		$	8,351	4.54	%	$	748,145		$	8,738	4.63	%
Tax-exempt ⁽¹⁾	652			9		5.48	%	687			9		5.20	%
Total loans ⁽³⁾	$	730,658		$	8,360	4.54	%	$	748,832		$	8,747	4.63	%
Interest on deposits in banks and federal funds sold	90,463			51		0.22	%	70,710			43		0.24	%
Total earning assets	$	1,158,391		$	11,069	3.79	%	$	1,150,417		$	11,287	3.89	%
Less: allowances for loan losses	(11,309		)					(13,555		)
Total nonearning assets	74,477							81,287
Total assets	$	1,221,559						$	1,218,149
Liabilities:
Interest-bearing deposits:
Checking	$	354,080		$	163	0.18	%	$	314,504		$	210	0.26	%
Regular savings	113,607			53		0.19	%	110,904			63		0.23	%
Money market savings	72,034			34		0.19	%	73,625			41		0.22	%
Time deposits:
$100,000 and over	121,274			297		0.97	%	136,730			388		1.13	%
Under $100,000	129,578			408		1.25	%	140,643			488		1.38	%
Total interest-bearing deposits	$	790,573		$	955	0.48	%	$	776,406		$	1,190	0.61	%
Short-term borrowings	—			—		—	%	7,217			59		3.24	%
Securities sold under agreements to repurchase	39,142			81		0.82	%	37,566			82		0.87	%
FHLB borrowings and other debt	60,372			209		1.37	%	90,155			303		1.33	%
Federal funds purchased	—			—		—	%	—			—		—	%
Total interest-bearing liabilities	$	890,087		$	1,245	0.55	%	$	911,344		$	1,634	0.71	%
Non-interest bearing liabilities:
Demand deposits	200,768							183,539
Other liabilities	10,539							8,467
Total liabilities	$	1,101,394						$	1,103,350
Non-controlling interest	—							2,766
Shareholders' equity	120,165							112,033
Total liabilities and shareholders' equity	$	1,221,559						$	1,218,149
Net interest income				$	9,824						$	9,653
Interest rate spread						3.24	%						3.18	%
Cost of Funds						0.45	%						0.59	%
Interest expense as a percent of average earning assets						0.43	%						0.56	%
Net interest margin						3.36	%						3.33	%


⁽¹⁾	Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%.


⁽²⁾	All yields and rates have been annualized on a 365 day year.


⁽³⁾	Total average loans include loans on non-accrual status.

The Company's net income for the nine months ended September 30, 2014 was $5.95 million, an increase of $923,000 or 18.35% from the nine months ended September 30, 2013. For the nine months ended September 30, 2014, earnings per diluted share was $0.84 compared to earnings per diluted share of $0.71 for the nine months ended September 30, 2013.

The following tables reflect an analysis of the Company’s net interest income for the nine months ended September 30, 2014 and 2013 using the daily average balances of the Company’s assets and liabilities for the periods indicated. Nonaccrual loans are included in the loan balances.

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	Nine Months Ended September 30,
	2014							2013
	Average Balance			Income/ Expense		Yield/ Rate ⁽²⁾		Average Balance			Income/ Expense		Yield/ Rate ⁽²⁾
	(Dollars in thousands)
Assets:
Securities:
Taxable	$	278,650		$	5,403	2.59	%	$	266,847		$	4,636	2.32	%
Tax-exempt ⁽¹⁾	57,556			2,509		5.83	%	67,097			2,904		5.79	%
Total securities	$	336,206		$	7,912	3.15	%	$	333,944		$	7,540	3.02	%
Loans:
Taxable	$	743,703		$	25,639	4.61	%	$	754,621		$	26,486	4.69	%
Tax-exempt ⁽¹⁾	652			26		5.33	%	687			27		5.25	%
Total loans ⁽³⁾	$	744,355		$	25,665	4.61	%	$	755,308		$	26,513	4.69	%
Interest on deposits in banks and federal funds sold	73,759			123		0.22	%	58,042			101		0.23	%
Total earning assets	$	1,154,320		$	33,700	3.90	%	$	1,147,294		$	34,154	3.98	%
Less: allowances for loan losses	(12,497		)					(13,770		)
Total nonearning assets	78,292							81,990
Total assets	$	1,220,115						$	1,215,514
Liabilities:
Interest-bearing deposits:
Checking	$	342,551		$	485	0.19	%	$	322,344		$	656	0.27	%
Regular savings	113,378			158		0.19	%	110,132			185		0.22	%
Money market savings	73,910			105		0.19	%	75,798			131		0.23	%
Time deposits:
$100,000 and over	125,036			937		1.00	%	141,048			1,327		1.26	%
Under $100,000	130,776			1,267		1.30	%	142,070			1,518		1.43	%
Total interest-bearing deposits	$	785,651		$	2,952	0.50	%	$	791,392		$	3,817	0.64	%
Short-term borrowings	—			—		—	%	4,005			106		3.54	%
Securities sold under agreements to repurchase	36,682			243		0.88	%	35,303			243		0.92	%
FHLB borrowings and other debt	76,803			876		1.52	%	87,274			896		1.37	%
Federal funds purchased	1			—		0.00	%	—			—		0.00	%
Total interest-bearing liabilities	$	899,137		$	4,071	0.61	%	$	917,974		$	5,062	0.74	%
Non-interest bearing liabilities:
Demand deposits	193,501							172,751
Other liabilities	9,947							7,691
Total liabilities	$	1,102,585						$	1,098,416
Non-controlling interest	—							2,882
Shareholders' equity	117,530							114,216
Total liabilities and shareholders' equity	$	1,220,115						$	1,215,514

Net interest income				$	29,629						$	29,092

Interest rate spread						3.29	%						3.24	%
Cost of Funds						0.50	%						0.62	%
Interest expense as a percent of average earning assets						0.47	%						0.59	%
Net interest margin						3.43	%						3.39	%


(1)	Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%.


(2)	All yields and rates have been annualized on a 365 day year.


(3)	Total average loans include loans on non-accrual status.

Net Interest Income

Net interest income represents the principal source of earnings of the Company. Net interest income is the amount by which interest generated from earning assets exceeds the expense of funding those assets. Changes in volume and mix of interest earning

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assets and interest bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income.

Net interest income was $9.55 million for the quarter ended September 30, 2014. This is an increase of 2.41% over net interest income reported for the same period for 2013. The net interest margin for the quarter ended September 30, 2014 was 3.36% compared to 3.33% for the same period for 2013. Net interest income was $28.77 million for the nine months ended September 30, 2014. This is an increase of 2.39% over net interest income reported for the same period for 2013. The net interest margin for the nine months ended September 30, 2014 was 3.43% compared to 3.39% for the same period for 2013.

The following factors contributed to the changes in the net interest margin:


•	Yields on earning assets during the quarter and nine months ended September 30, 2014 declined by 10 bp and 8 bp, respectively, compared to the same periods for 2013. These changes are primarily due to a 9 bp and 8 bp decrease in loan yields for the same periods, respectively and a 14 bp and 13 bp increase in yields on investments for the same periods, respectively.


•	Loan yields were lower for the following reasons:


•	continued decline in mortgage loans held for sale and;


•	payoffs in commercial and 1-4 family loans and lower yields on loans booked during the quarter, which had the collective effect of lowering the effective yield on the loan portfolio.


•	Yields on investments increased due to lower premium amortization on mortgage backed securities in the portfolio.


•	Cost of funds declined by 14 bp to 45 bp for the quarter ended September 30, 2014 compared to the same period for 2013 and declined by 12 bp for the nine months ended September 30, 2014 compared to the same period for 2013 as the Company paid off $35.00 million of maturing FHLB advances and added non-interest bearing deposits.

The net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. The tax rate utilized in calculating the tax benefit for each of the reported periods is 34%. The reconciliation of tax equivalent net interest income, which is not a measurement under accounting principles generally accepted in the United States, to net interest income is reflected in the table below.



	For the Three Months Ended September 30,
(Dollars in thousands)	2014		2013
GAAP measures:
Interest Income - Loans	$	8,357	$	8,744
Interest Income - Investments & Other	2,433		2,210
Interest Expense - Deposits	955		1,190
Interest Expense - Other Borrowings	290		444
Total Net Interest Income	$	9,545	$	9,320
Non-GAAP measures:
Tax Benefit Realized on:
Non-taxable interest income - municipal securities	276		330
Non-taxable interest income - loans	3		3
Total Tax Benefit Realized on Non-Taxable Interest Income	$	279	$	333
Total Tax Equivalent Net Interest Income	$	9,824	$	9,653

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	For the Nine Months Ended September 30,
(Dollars in thousands)	2014		2013
GAAP measures:
Interest Income - Loans	$	25,656	$	26,504
Interest Income - Investments & Other	7,182		6,654
Interest Expense - Deposits	2,952		3,817
Interest Expense - Other Borrowings	1,119		1,245
Total Net Interest Income	$	28,767	$	28,096
Non-GAAP measures:
Tax Benefit Realized on:
Non-taxable interest income - municipal securities	853		987
Non-taxable interest income - loans	9		9
Total Tax Benefit Realized on Non-Taxable Interest Income	$	862	$	996
Total Tax Equivalent Net Interest Income	$	29,629	$	29,092

Based on our internal interest rate risk models and the assumption of a sustained low rate environment, the Company expects net interest income to trend downward throughout the next 12 months as loans and securities reprice lower and the decline in funding costs slows. It is anticipated that targeted growth in earning assets and liability repricing opportunities will help mitigate the impact to the Company’s net interest margin. The Asset/Liability Management Committee continues to focus on various strategies to maintain the net interest margin.

Non-Interest Income

Non-interest income has been and will continue to be an important factor for increasing profitability. Management recognizes this and continues to review and consider areas where non-interest income can be increased. Non-interest income includes fees generated by the commercial and retail banking segment and the wealth management segment. We expect to have limited gain on sale revenue from mortgage loans in the foreseeable future following the sale of our majority interest in Southern Trust Mortgage in the second quarter of 2014. Non-interest income was lower by 62.79% and 35.02% compared to the quarter and nine months ended September 30, 2014 and 2013, respectively. A more detailed discussion of non-interest income follows:


•	The primary reason for the decline in non-interest income compared to the three and nine month periods ended September 30, 2013 was lower mortgage revenue from a decline in loan originations which was partially offset by income from a large recovery of expense during the first quarter of 2014 related to a previously charged-off loan.


•	Gains on securities available for sale decreased 47.83% and 64.48% for the three and nine months ended September 30, 2014, respectively.


•	Fees earned by Middleburg Investment Group (“MIG”) increased by 16.93% compared to the quarter ended September 30, 2013 and were higher by 12.21% compared to the nine months ended September 30, 2013. Fee income is based primarily upon the market value of the accounts under administration which were $1.78 billion at September 30, 2014 compared to $1.50 billion at September 30, 2013.


•	Bank owned life insurance (BOLI) income increased 34.40% and 34.60% for the three and nine months ended September 30, 2014, respectively due to an increase of $5.00 million in BOLI during the fourth quarter of 2013.


•	Other operating income increased 43.40% and 67.54% for the three and nine months ended September 30, 2014, respectively primarily due to income received from a large recovery in the first quarter of 2014 related to a previously charged-off loan.

The following table depicts the changes in non-interest income:



(Dollars in thousands)	For the Three Months Ended September 30,
	2014		2013
Service charges on deposit accounts	$	635	$	590
Trust services income	1,119		963
Gains on loans held for sale	1		4,162
Gains on securities available for sale, net	12		23
Commissions on investment sales	193		159
Bank owned life insurance	168		125
Other operating income	152		106
Total non-interest income	$	2,280	$	6,128

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(Dollars in thousands)	For the Nine Months Ended September 30,
	2014		2013
Service charges on deposit accounts	$	1,815	$	1,699
Trust services income	3,224		2,937
Gains on loans held for sale	4,859		12,538
Gains on securities available for sale, net	141		397
Commissions on investment sales	479		363
Bank owned life insurance	494		367
Gain on sale of majority interest in consolidated subsidiary	24		—
Other operating income	1,399		835
Total non-interest income	$	12,435	$	19,136

Non-Interest Expense

Non-interest expense fell by 36.93% during the third quarter of 2014 compared to the same period in 2013. Non-interest expense fell by 21.53% compared to the nine months ended September 30, 2013. Principal reasons for the improvement of non-interest expense were the following:


•	Salaries and employee benefit expense decreased by 42.70% compared to the quarter ended September 30, 2013 and was lower by 24.85% compared to the nine months ended September 30, 2013. The primary reasons for lower salary and employee benefit expenses were the sale of the Company's majority interest in Southern Trust Mortgage on May 15, 2014 and staff reductions at the bank.


•	Continued streamlining of campaign and product promotions reduced advertising expenses. Advertising expenses for the quarter ended September 30, 2014 declined by 57.23% compared to the same quarter in 2013 and were lower by 57.88% compared to the nine months ended September 30, 2013.


•	Costs related to other real estate owned (OREO) declined by 107.93% and by 89.47% compared to the three and nine months ended September 30, 2013 as ongoing expenses to maintain the properties fell and net gains were recognized on OREO of $238,000 for the nine months ended September 30, 2014.

•

Occupancy and equipment expenses for the quarter ended September 30, 2014 declined by 30.66% compared to the same quarter in 2013 and were lower by 10.55% compared to the nine months ended September 30, 2013. The primary reason for lower expenses in this category was the sale of Southern Trust Mortgage on May 15, 2014. Expenses attributable to Southern Trust Mortgage were consolidated in the Company's financial statements through the date of the sale.


•	Other operating expenses decreased 22.81% and 9.36% for the three and nine months ended September 30, 2014, respectively. Primary reasons for declines in expenses in this category were the sale of Southern Trust Mortgage on May 15, 2014. The significant components in this category include expenses related to deposit processing, fees for advisory services, telephone and professional fees.

The following table depicts the changes in non-interest expense:



(Dollars in thousands)	For the Three Months Ended September 30,
	2014			2013
Salaries and employee benefits	$	4,441		$	7,750
Occupancy and equipment	1,262			1,820
Advertising	136			318
Computer operations	439			456
Other real estate owned	(33		)	416
Other taxes	220			186
Federal deposit insurance	220			149
Other operating expenses	1,706			2,210
Total non-interest expense	$	8,391		$	13,305

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(Dollars in thousands)	For the Nine Months Ended September 30,
	2014		2013
Salaries and employee benefits	$	17,467	$	23,242
Occupancy and equipment	4,841		5,412
Advertising	430		1,021
Computer operations	1,408		1,375
Other real estate owned	145		1,377
Other taxes	637		565
Federal deposit insurance	687		683
Other operating expenses	6,042		6,666
Total non-interest expense	$	31,657	$	40,341

The adjusted efficiency ratio is not a measurement under accounting principles generally accepted in the United States. The Company calculates its efficiency ratio by dividing non interest expense (adjusted for amortization of intangibles, other real estate expenses, and non-recurring one-time charges) by the sum of tax equivalent net interest income and non interest income excluding gains and losses on the investment portfolio. The tax rate utilized in calculating tax equivalent amounts is 34%. The Company calculates and reviews this ratio as a means of evaluating operational efficiency. The calculation of the adjusted efficiency ratio for the three and nine months ended September 30, 2014 and 2013 is as follows:



	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(Dollars in thousands)	2014			2013			2014			2013
Summary of Operating Results:
Non-interest expense	$	8,391		$	13,305		$	31,657		$	40,341
Less: Amortization expense	43			43			129			129
Less: Other real estate owned expenses, net	(33		)	416			145			1,377
Less: Other	—			—			—			351
Adjusted non-interest expense	$	8,381		$	12,846		$	31,383		$	38,484

Net interest income	$	9,545		$	9,320		$	28,767		$	28,096

Non-interest income	2,280			6,128			12,435			19,136
Less: Gains on securities available for sale, net	12			23			141			397
Adjusted non-interest income	$	2,268		$	6,105		$	12,294		$	18,739
Tax equivalent adjustment	365			397			1,117			1,186
Total net interest income and non-interest income, adjusted	$	12,178		$	15,822		$	42,178		$	48,021

Efficiency ratio, adjusted	68.82		%	81.19		%	74.41		%	80.14		%
Efficiency ratio, GAAP ⁽¹⁾	70.96		%	86.13		%	76.83		%	85.41		%

⁽¹⁾ Computed by dividing non-interest expense by the sum of net interest income and non-interest income.

Financial Condition

Assets, Liabilities and Shareholders’ Equity

Total consolidated assets at September 30, 2014 were $1.21 billion, a decrease of 1.63% compared to December 31, 2013. Changes in major asset categories were as follows:

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•	Cash and cash equivalents increased by $11.78 million compared to December 31, 2013.


•	Securities available for sale increased by $6.61 million compared to December 31, 2013.


•	Net loans held for investment increased by $2.17 million compared December 31, 2013.


•	Balances of mortgages held for sale decreased by $33.18 million compared to December 31, 2013. Mortgages held for sale declined as a result of the sale of the Company's majority interest in Southern Trust Mortgage on May 15, 2014.


•	Goodwill decreased by $1.50 million compared to December 31, 2013, primarily due to the sale of the Company's majority interest in Southern Trust Mortgage.


•	Other real estate owned (OREO) increased by $1.64 million compared to December 31, 2013.


•	Accrued interest receivable and other assets decreased by $3.88 million compared to December 31, 2013. The majority of the decline was a decrease in accounts receivable of $3.0 million as we repatriated excess cash from repurchase accounts.

Total consolidated liabilities at September 30, 2014 were $1.09 billion, a decrease of 2.33% compared to December 31, 2013. The most significant change in liabilities was the change in Federal Home Loan Bank (FHLB) borrowings. Total FHLB borrowings decreased by $35.00 million from December 31, 2013 to $45.00 million as of September 30, 2014. Total deposits increased by $4.17 million from December 31, 2013 to $986.57 million as of September 30, 2014.

Shareholders’ equity attributable to Middleburg Financial Corporation shareholders at September 30, 2014 was $120.92 million, compared to $112.58 million at December 31, 2013. Retained earnings at September 30, 2014 were $54.94 million compared to $50.69 million at December 31, 2013. The book value of the Company’s common stock at September 30, 2014 was $16.97 per share versus $15.90 per share at December 31, 2013.

Loans

The Company’s loan portfolio totaled 63.13% of average earning assets with a tax equivalent yield of 4.61% for the nine months ended September 30, 2014. There were no loans held for sale at September 30, 2014, compared to $33.18 million at December 31, 2013. The decrease in balances of loans held-for-sale was due to the sale of Southern Trust Mortgage.

The following table summarized total loans by category:



	September 30,		Years Ended December 31,
(Dollars in thousands)	2014		2013		2012		2011		2010
Real estate loans:
Construction	$	32,057	$	36,025	$	50,218	$	42,208	$	68,110
Secured by farmland	17,332		16,578		11,876		10,047		11,532
Secured by 1-4 family residential	267,216		273,384		260,620		236,760		242,620
Other real estate loans	254,686		260,333		254,930		275,428		268,262
Commercial loans	140,555		129,554		118,573		94,427		56,385
Consumer loans	16,906		12,606		13,260		12,523		12,403
Total gross loans	728,752		728,480		709,477		671,393		659,312
Less allowance for loan losses	11,423		13,320		14,311		14,623		14,967
Net loans	$	717,329	$	715,160	$	695,166	$	656,770	$	644,345

Changes in the loan portfolio at September 30, 2014 compared to December 31, 2013 were as follows.


•	Real estate construction loans consist primarily of pre-sold 1-4 family residential loans along with a marginal amount of commercial construction loans. These loans represented 4.40% of total loans, a decrease of approximately $3.97 million from $36.03 million.


•	Loans secured by farmland increased by $754,000 from $16.58 million.


•	Loans secured by 1-4 family residential real estate represented 36.70% of total loans, a decrease of $6.17 million.


•	Other real estate loans are typically non-farm, non-residential real estate loans which are, in most cases, owner-occupied commercial buildings. Other real estate loans represented 34.90% of total loans, a decrease of $5.65 million.


•	Commercial loans, which consist of secured and unsecured loans to small businesses, increased 8.49%.


•	Consumer loans increased by $4.30 million or 34.11%.

Asset Quality

The Company continues to experience improved asset quality. Factors contributing to these improvements include:


•	Loans that were delinquent for more than 90 days and still accruing declined to $30,000 as of September 30, 2014 from $808,000 as of December 31, 2013.

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•	Nonaccrual loans declined to $7.33 million as of September 30, 2014 from $19.75 million as of December 31, 2013, representing a decrease of 62.88%.


•	Total troubled debt restructurings were $7.41 million at September 30, 2014 compared to $15.60 million at December 31, 2013, representing a decrease of 52.47%.


•	Total nonperforming assets were $18.08 million or 1.50% of total assets at September 30, 2014 compared to $28.66 million or 2.33% to total assets at December 31, 2013.


•	Substandard and doubtful loans were $20.60 million at September 30, 2014 compared to $35.90 million at December 31, 2013, representing a decrease of 42.62%.


•	Past due loans declined from $13.74 million at December 31, 2013 to $2.44 million at September 30, 2014, a decrease of 82.26%.

•

Nonperforming loans declined due to the Company selling $6.6 million of nonperforming loans during the first half of 2014. Of this amount, $5.9 million of the loans were on nonaccrual status and $6.3 million in loan balances were classified as TDRs. Specific reserves associated with these loans totaled $655,000. This is the primary reason for the decrease in nonaccrual loans and nonperforming assets.


•	Nonperforming loans also declined due to foreclosures of $3.82 million and repossessed assets of $2.28 million as of September 31, 2014 compared to foreclosures of $2.39 million as of December 31, 2013.

The table below summarizes nonperforming assets for the periods indicated.



	September 30,			December 31,
(Dollars in thousands)	2014			2013			2012			2011			2010
Nonaccrual loans	$	7,332		$	19,752		$	21,664		$	25,346		$	29,386
Restructured loans ⁽¹⁾	4,522			4,674			5,132			3,853			1,254
Repossessed assets ⁽²⁾	1,132			—			—			—			—
Accruing loans greater than 90 days past due	30			808			1,044			1,233			909
Total nonperforming loans	$	13,016		$	25,234		$	27,840		$	30,432		$	31,549
Other real estate owned	5,064			3,424			9,929			8,535			8,394
Total nonperforming assets	$	18,080		$	28,658		$	37,769		$	38,967		$	39,943

Allowance for loan losses	$	11,423		$	13,320		$	14,311		$	14,623		$	14,967

Nonperforming loans to total loans	1.63		%	3.46		%	3.92		%	4.53		%	4.79		%
Allowance for loan losses to nonperforming loans	87.76		%	52.79		%	51.40		%	48.05		%	47.44		%
Nonperforming assets to total assets	1.50		%	2.33		%	3.05		%	3.27		%	3.62		%

⁽¹⁾Amount reflects restructured loans that are not included in nonaccrual loans.

⁽²⁾ Included in other assets.

Included in nonperforming loans are troubled debt restructurings (“TDRs”). The total balance of TDRs at September 30, 2014 was $7.4 million of which $2.9 million were included in the Company’s nonaccrual loan totals at that date and $4.5 million represented loans performing as agreed to the restructured terms. This compares with $15.6 million in total TDRs at December 31, 2013. The amount of the valuation allowance related to TDRs was $730,200 and $2.8 million as of September 30, 2014 and December 31, 2013, respectively.

During the quarter ended September 30, 2014, the Company modified no loans, compared to eleven modifications, which totaled $3.10 million for the same period in 2013. During the nine months ended September 30, 2014, the Company modified five loans considered to be TDRs, which totaled $1.39 million compared to twenty modifications, which totaled $5.49 million for the same period in 2013.

The Company requires six timely consecutive monthly payments be made and future payments be reasonably assured, before a restructured loan that has been placed on nonaccrual can be returned to accrual status. The Company does not utilize formal modification programs or packages when loans are considered for restructuring. Any loan restructuring is based on the borrower’s circumstances and may include modifications to more than one of the terms and conditions of the loan.

The Company has not performed any commercial real estate or other type of loan workout whereby the existing loan would have been structured into multiple new loans.

Allowance For Loan Losses

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For a discussion of the Company’s accounting policies with respect to the allowance for loan losses, see “Critical Accounting Policies – Allowance for Loan Losses”.

The allowance for loans losses was $11.42 million or 1.57% of total loans at September 30, 2014 compared to $13.32 million or 1.83% of total loans at December 31, 2013 and $13.38 million or 1.87% of total loans at September 30, 2013.

The following table depicts the transactions, in summary form, related to the allowance for loan losses.



	For the Nine Months Ended			For the Year Ended
(Dollars in thousands)	September 30, 2014			December 31, 2013
Balance, beginning of period	$	13,320		$	14,311
Add: Provision for loan losses	1,510			109
Adjustment for the sale of majority interest in consolidated subsidiary	$	(95	)	$	—
Less: Charge-offs:
Real estate loans:
Construction	$	(1,187	)	$	(394	)
Secured by 1-4 family residential	(1,186		)	(785		)
Other real estate loans	(748		)	(97		)
Commercial loans	(958		)	(75		)
Consumer loans	(35		)	(30		)
Total charge-offs	$	(4,114	)	$	(1,381	)
Add: Recoveries:
Real estate loans:
Construction	$	181		$	68
Secured by 1-4 family residential	321			140
Other real estate loans	109			37
Commercial loans	101			9
Consumer loans	90			27
Total recoveries	$	802		$	281
Net charge-offs	$	(3,312	)	$	(1,100	)
Balance, end of period	$	11,423		$	13,320

Allowance for loan losses to total loans	1.57		%	1.83		%
Net charge-offs to average loans	0.44		%	0.15		%

The allocation of the allowance (dollars in thousands) at September 30, 2014 and December 31, 2013 were:



	September 30, 2014		December 31, 2013
Real Estate Construction	$	423	$	847
Real Estate Secured by Farmland	179		166
1-4 Family Residential	4,495		6,734
Other Real Estate Loans	3,393		3,506
Commercial	2,117		1,890
Consumer	816		177
	$	11,423	$	13,320

The Company has allocated the allowance according to the amount deemed reasonably necessary to provide for the possibility of losses being incurred within each loan category. The allocation of the allowance should not be interpreted as an indication that loan losses in future years will occur in the same proportions that they may have in prior periods or that the allocation indicates future loan loss trends. Additionally, the proportion allocated to each loan category is not the total amount that may be available for future losses that could occur within such categories since the total allowance is available to absorb losses on the total portfolio.

Securities

The carrying value of the securities portfolio was $335.03 million at September 30, 2014, an increase of $6.61 million compared to the carrying value of $328.42 million at December 31, 2013. The unrealized losses on available for sale securities were $2.21 million and $5.42 million at September 30, 2014 and December 31, 2013, respectively.

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The securities portfolio represented approximately 29.02% and 28.60% of the average earning assets of the Company at September 30, 2014 and December 31, 2013, respectively.

Goodwill and Other Identified Intangibles

Goodwill and other identified intangibles decreased by $1.50 million to $3.85 million at September 30, 2014. The majority of this decrease is attributable to the Company's sale of its majority interest in Southern Trust Mortgage. The remainder of the decrease represented amortization expense related to intangibles.

Deposits

Total deposits increased by $4.17 million from December 31, 2013 to $986.57 million as of September 30, 2014, primarily due to strong deposit inflows during the second quarter of 2014.

The Company has an interest bearing product, known as Tredegar Institutional Select, that integrates the use of the cash within client accounts at Middleburg Trust Company for overnight funding at the Bank. The overall balance of this product was $41.95 million at September 30, 2014 and $42.1 million as of December 31, 2013 and is reflected in both the savings and interest bearing demand deposits on the consolidated balance sheet. Fluctuations in these balances are due to cash entering and exiting the market as a result of trends within the marketplace and changes in investors' confidence. These funds are anticipated to be short term in nature and therefore were not deployed into earning assets.

Time deposits decreased by $19.72 million or 7.36% from December 31, 2013 to $248.23 million at September 30, 2014. Time deposits include brokered certificates of deposit and CDARS deposits. Securities sold under agreements to repurchase (“Repo Accounts”) increased by $1.93 million from $34.54 million at December 31, 2013 to $36.47 million at September 30, 2014. The Repo Accounts include certain long-term commercial checking accounts with average balances that typically exceed $100,000. All repurchase agreement transactions entered into by the Company are accounted for as collateralized financings and not as sales.

Short-term Borrowings and FHLB Borrowings

The Company had no overnight advances from the Federal Home Loan Bank of Atlanta (“FHLB”) outstanding at September 30, 2014. FHLB term advances were $45.00 million at September 30, 2014, lower by $35.00 million compared to December 31, 2013 due to advances maturing during the first nine months of 2014.

Non-controlling Interest in Consolidated Subsidiary

On May 15, 2014, the Company sold its membership interests in Southern Trust Mortgage to a consortium of banks and the President of Southern Trust Mortgage resulting in a $24,000 gain included in non-interest income for the quarter and nine months ended September 30, 2014.

Capital Resources and Dividends

Shareholders' equity attributable to Middleburg Financial Corporation was $120.92 million at September 30, 2014 compared with $112.58 million at December 31, 2013. During the quarter ended September 30, 2014 the Company declared common stock dividends of $0.10 per share, compared to $0.07 per share for the same period in 2013. During the nine months ended September 30, 2014 the Company declared common stock dividends of $0.24 per share, compared to $0.17 per share for the same period in 2013. The book value of common stock was $16.97 per share at September 30, 2014 and $15.90 at December 31, 2013.

The Company had a ratio of total capital to risk-weighted assets of 17.30% and 15.41% at September 30, 2014 and 2013, respectively. The ratio of Tier 1 capital to risk-weighted assets was 16.04% and 14.15% at September 30, 2014 and 2013, respectively. The Company’s leverage ratio was 9.71% at September 30, 2014 compared to 9.32% at September 30, 2013. These ratios exceed the minimum capital requirements adopted by the federal banking regulatory agencies.

The Company’s Tier 1 capital and total capital include $5.0 million of trust preferred securities. Under the changes to the regulatory capital framework that were approved on July 9, 2013 by the federal banking agencies (Basel III Final Rule), the Company's trust preferred securities will continue to be included in Tier 1 capital and total capital until they mature, pursuant to a "grandfathering" provision that exempts Middleburg Financial Corporation's securities from the more stringent regulatory capital treatment contained in the Basel III Final Rule for trust preferred securities. In addition to "grandfathering" certain previously outstanding trust preferred securities for community banks, the Basel III Final Rule introduces a new Common Equity Tier 1 capital measure, increases the

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applicable minimum regulatory capital levels and certain prompt corrective action capital levels, and establishes a capital conservation buffer and new risk weights for certain types of assets. The Basel III Final Rule is effective for community banks on January 1, 2015 and has a transition period applicable to certain regulatory capital changes until January 1, 2019. The Company believes that it maintains sufficient levels of Tier 1 and Common Equity Tier 1 capital to comply with the Basel III Final Rules, as currently scheduled to be effective and implemented.

Liquidity

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, short-term investments, securities classified as available for sale and loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company also maintains additional sources of liquidity through a variety of borrowing arrangements. Middleburg Bank maintains federal funds lines with large regional and money-center banking institutions. These available lines total approximately $24.0 million, none of which were outstanding at September 30, 2014. Middleburg Bank is also able to borrow from the discount window of the Federal Reserve Bank of Richmond. At September 30, 2014, available borrowing capacity from this source was $34.07 million. At the end of the third quarter of 2014, Middleburg Bank had $36.49 million of outstanding borrowings pursuant to securities sold under agreement to repurchase transactions (“Repo Accounts”), with maturities of one day. The Repo Accounts are long-term commercial checking accounts with average balances that typically exceed $100,000. At September 30, 2014, the Company had $7.2 million and $5.0 million of outstanding borrowings pursuant to securities sold under agreement to repurchase transactions with remaining maturities of less than one year and greater than one year, respectively.

As of September 30, 2014, Middleburg Bank had remaining credit availability in the amount of $161.70 million at the Federal Home Loan Bank of Atlanta. This line may be utilized for short and/or long-term borrowing.

At September 30, 2014, cash, interest-bearing deposits with financial institutions, federal funds sold, short-term investments and unencumbered securities available for sale were 20.55% of total deposits and liabilities.

Off-Balance Sheet Arrangements

As of September 30, 2014, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Caution About Forward Looking Statements

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.

Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:


•	further adverse changes in general economic and business conditions in the Company’s market area;


•	changes in banking and other laws and regulations applicable to the Company;


•	maintaining asset qualities;


•	the ability to properly identify risks in our loan portfolio and calculate an adequate loan loss allowance;


•	risks inherent in making loans such as repayment risks and fluctuating collateral values;


•	concentration in loans secured by real estate;


•	changing trends in customer profiles and behavior;


•	changes in interest rates and interest rate policies;


•	maintaining cost controls as the Company opens or acquires new facilities;


•	competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;


•	the ability to continue to attract low cost core deposits to fund asset growth;


•	the ability to successfully manage the Company’s growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future;


•	reliance on the Company’s management team, including its ability to attract and retain key personnel;

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•	demand, development and acceptance of new products and services;


•	problems with technology utilized by the Company;


•	maintaining capital levels adequate to support the Company’s growth; and


•	other factors described in Item 1A, “Risk Factors,” discussed in more detail in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk, though it should be noted that the assets under management by Middleburg Trust Company are affected by equity price risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (“ALCO”) of Middleburg Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also employs additional tools to monitor potential longer-term interest rate risk.

The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet. The simulation model is prepared and updated four times during each year. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) upward shift and a 200 basis point downward shift in interest rates. The following reflects the range of the Company’s net interest income sensitivity analysis as of September 30, 2014 and December 31, 2013.



Estimated Net Interest Income Sensitivity
Rate Change	September 30, 2014	December 31, 2013
+ 200 bps	5.1%	2.7%
- 200 bps	(15.9)%	(11.6)%

At September 30, 2014, the Company’s interest rate risk model indicated that for an immediate 200 basis points increase in interest rates, net interest income was expected to increase by 5.10% over a 12-month period. For the same time period, the interest rate risk model indicated that, for an immediate 200 basis points decrease in interest rates, net interest income was expected to decrease by 15.9% over a 12-month period. While these numbers are subjective based upon the parameters used within the model, management believes the balance sheet is very balanced and is working to minimize risks to rising rates in the future.

The Company’s specific goal is to lower, where possible, the cost of its borrowed funds.

The preceding sensitivity analysis does not represent the Company's forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

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Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to or anticipation of changes in interest rates.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended.) Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

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

PART II

ITEM 1. LEGAL PROCEEDINGS

There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.

ITEM 1A. RISK FACTORS

Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities. The risk factors that are applicable to us are outlined in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material changes in our risk factors from those disclosed in this report.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS



31.1		Rule 13a-14(a) Certification of Chief Executive Officer



31.2		Rule 13a-14(a) Certification of Chief Financial Officer



32.1		Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350

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101		The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 formatted in Extensible Business reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



MIDDLEBURG FINANCIAL CORPORATION

Date:	November 7, 2014	By:	/s/ Gary R. Shook
			Gary R. Shook
			Chief Executive Officer


Date:	November 7, 2014	By:	/s/ Raj Mehra
			Raj Mehra
			Chief Financial Officer

EXHIBIT INDEX

Exhibits



31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350
101	The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 formatted in Extensible Business reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.

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