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 June 30, 2015

 

or

 

¨

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

 

For the transition period from ________ to ________

 

Commission File Number: 000-23565

 

EASTERN VIRGINIA BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

VIRGINIA		54-1866052
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
330 Hospital Road, Tappahannock, Virginia		22560
(Address of principal executive office)		(Zip Code)

 

(804) 443-8400

(Registrant’s telephone number, including area code)

 

N/A

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

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

The number of shares of the registrant’s Common Stock outstanding as of August 12, 2015 was 13,029,550.

 

 

EASTERN VIRGINIA BANKSHARES, INC.

 

INDEX

  

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of June 30, 2015 (unaudited) and December 31, 2014	2
	Consolidated Statements of Income (unaudited) for the Three Months Ended June 30, 2015 and June 30, 2014	3
	Consolidated Statements of Comprehensive (Loss) Income (unaudited) for the Three Months Ended June 30, 2015 and June 30, 2014	4
	Consolidated Statements of Income (unaudited) for the Six Months Ended June 30, 2015 and June 30, 2014	5
	Consolidated Statements of Comprehensive Income (unaudited) for the Six Months Ended June 30, 2015 and June 30, 2014	6
	Consolidated Statements of Shareholders’ Equity (unaudited) for the Six Months Ended June 30, 2015 and June 30, 2014	7
	Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2015 and June 30, 2014	8
	Notes to the Interim Consolidated Financial Statements (unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	49
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	74
Item 4.	Controls and Procedures	74
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	75
Item 1A.	Risk Factors	75
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 3.	Defaults Upon Senior Securities	75
Item 4.	Mine Safety Disclosures	75
Item 5.	Other Information	75
Item 6.	Exhibits	76
	SIGNATURES	77

 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share and per share amounts)

 

		June 30, 2015				December 31, 2014*
		(unaudited)
Assets:
Cash and due from banks		$	14,416			$	14,024
Interest bearing deposits with banks			6,467				5,272
Federal funds sold			-				334
Securities available for sale, at fair value			227,932				214,011
Securities held to maturity, at carrying value (fair value of $31,542 and $33,367, respectively)			30,671				32,163
Restricted securities, at cost			8,118				7,533
Loans, net of allowance for loan losses of $12,287 and $13,021, respectively			828,423				807,548
Deferred income taxes, net			16,937				17,529
Bank premises and equipment, net			28,628				27,433
Accrued interest receivable			3,990				4,013
Other real estate owned, net of valuation allowance of $3 and $76, respectively			1,344				1,838
Goodwill			17,085				17,085
Bank owned life insurance			24,786				24,463
Other assets			10,394				8,726
Total assets		$	1,219,191			$	1,181,972
Liabilities and Shareholders' Equity:
Liabilities
Noninterest-bearing demand accounts		$	178,844			$	162,328
Interest-bearing deposits			778,378				776,926
Total deposits			957,222				939,254
Federal funds purchased and repurchase agreements			8,489				14,885
Short-term borrowings			94,605				76,818
Junior subordinated debt			10,310				10,310
Senior subordinated debt			19,140				-
Accrued interest payable			530				316
Other liabilities			6,986				6,115
Total liabilities			1,097,282				1,047,698
Shareholders' Equity
Preferred stock, $2 par value per share, authorized 10,000,000 shares, issued:
Series A; $1,000 stated value per share, 0 and 14,000 shares fixed rate cumulative perpetual preferred in 2015 and 2014, respectively			-				14,000
Series B; 5,240,192 shares non-voting mandatorily convertible non-cumulative preferred			10,480				10,480
Common stock, $2 par value per share, authorized 50,000,000 shares, issued and outstanding 13,023,550 and 12,978,934 including 138,092 and 104,142 nonvested shares in 2015 and 2014, respectively			25,771				25,750
Surplus			48,797				47,339
Retained earnings			41,494				39,290
Warrant			-				1,481
Accumulated other comprehensive loss, net			(4,633	)			(4,066	)
Total shareholders' equity			121,909				134,274
Total liabilities and shareholders' equity		$	1,219,191			$	1,181,972

 

*Derived from audited consolidated financial statements.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share amounts)

 

		Three Months Ended
		June 30,
		2015				2014
Interest and Dividend Income
Interest and fees on loans		$	10,382			$	8,562
Interest on investments:
Taxable interest income			1,185				1,338
Tax exempt interest income			268				204
Dividends			96				89
Interest on deposits with banks			4				4
Total interest and dividend income			11,935				10,197
Interest Expense
Deposits			934				978
Federal funds purchased and repurchase agreements			13				5
Short-term borrowings			37				36
Junior subordinated debt			81				88
Senior subordinated debt			264				-
Total interest expense			1,329				1,107
Net interest income			10,606				9,090
Provision for Loan Losses			-				-
Net interest income after provision for loan losses			10,606				9,090
Noninterest Income
Service charges and fees on deposit accounts			673				837
Debit/credit card fees			442				378
Gain on sale of available for sale securities, net			26				109
(Loss) on sale of bank premises and equipment			(30	)			-
Other operating income			421				315
Total noninterest income			1,532				1,639
Noninterest Expenses
Salaries and employee benefits			5,523				4,748
Occupancy and equipment expenses			1,392				1,267
Telephone			210				211
FDIC expense			254				305
Consultant fees			546				279
Collection, repossession and other real estate owned			126				89
Marketing and advertising			347				270
(Gain) loss on sale of other real estate owned			(6	)			28
Impairment losses on other real estate owned			-				6
Other operating expenses			1,807				1,316
Total noninterest expenses			10,199				8,519
Income before income taxes			1,939				2,210
Income Tax Expense			432				555
Net Income		$	1,507			$	1,655
Effective dividend on Series A Preferred Stock			166				541
Net income available to common shareholders		$	1,341			$	1,114
Net income per common share: basic		$	0.07			$	0.06
Net income per common share: diluted		$	0.07			$	0.06

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive (Loss) Income (unaudited)

(dollars in thousands)

 

		Three Months Ended
		June 30,
		2015				2014
Net income		$	1,507			$	1,655
Other comprehensive (loss) income, net of tax:
Unrealized securities (losses) gains arising during period (net of tax, ($1,066) and $893, respectively)			(2,070	)			1,732
Amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $19 and $26, respectively)			38				52
Less: reclassification adjustment for securities gains included in net income (net of tax, $8 and $37, respectively)			(18	)			(72	)
Other comprehensive (loss) income			(2,050	)			1,712
Comprehensive (loss) income		$	(543	)		$	3,367

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share amounts)

 

		Six Months Ended
		June 30,
		2015				2014
Interest and Dividend Income
Interest and fees on loans		$	20,573			$	17,112
Interest on investments:
Taxable interest income			2,387				2,845
Tax exempt interest income			528				417
Dividends			204				191
Interest on deposits with banks			8				8
Total interest and dividend income			23,700				20,573
Interest Expense
Deposits			1,985				1,965
Federal funds purchased and repurchase agreements			31				10
Short-term borrowings			79				71
Junior subordinated debt			161				176
Senior subordinated debt			264				-
Total interest expense			2,520				2,222
Net interest income			21,180				18,351
Provision for Loan Losses			-				250
Net interest income after provision for loan losses			21,180				18,101
Noninterest Income
Service charges and fees on deposit accounts			1,336				1,659
Debit/credit card fees			805				687
Gain on sale of available for sale securities, net			51				489
(Loss) gain on sale of bank premises and equipment			(27	)			5
Other operating income			886				691
Total noninterest income			3,051				3,531
Noninterest Expenses
Salaries and employee benefits			11,113				9,334
Occupancy and equipment expenses			2,913				2,586
Telephone			407				422
FDIC expense			426				637
Consultant fees			951				622
Collection, repossession and other real estate owned			215				156
Marketing and advertising			668				437
Loss on sale of other real estate owned			26				15
Impairment losses on other real estate owned			5				11
Other operating expenses			3,442				2,477
Total noninterest expenses			20,166				16,697
Income before income taxes			4,065				4,935
Income Tax Expense			949				1,284
Net Income		$	3,116			$	3,651
Effective dividend on Series A Preferred Stock			386				1,059
Net income available to common shareholders		$	2,730			$	2,592
Net income per common share: basic		$	0.15			$	0.15
Net income per common share: diluted		$	0.15			$	0.15

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (unaudited)

(dollars in thousands)

 

		Six Months Ended
		June 30,
		2015				2014
Net income		$	3,116			$	3,651
Other comprehensive (loss) income, net of tax:
Unrealized securities (losses) gains arising during period (net of tax, ($308) and $2,248, respectively)			(597	)			4,364
Amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $33 and $41, respectively)			64				80
Less: reclassification adjustment for securities gains included in net income (net of tax, $17 and $166, respectively)			(34	)			(323	)
Other comprehensive (loss) income			(567	)			4,121
Comprehensive income		$	2,549			$	7,772

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited)

For the Six Months Ended June 30, 2015 and 2014

(dollars in thousands)

 

																						Accumulated
						Preferred				Preferred												Other
		Common				Stock				Stock								Retained				Comprehensive
		Stock				Series A (1)				Series B				Surplus				Earnings				(Loss) Income				Total
Balance, December 31, 2013		$	23,578			$	25,481			$	10,480			$	42,697			$	39,581			$	(8,868	)		$	132,949
Net income																			3,651								3,651
Other comprehensive income																							4,121				4,121
Stock based compensation															39												39
Restricted common stock vested			30				-				-				(30	)			-				-				-
Balance, June 30, 2014		$	23,608			$	25,481			$	10,480			$	42,706			$	43,232			$	(4,747	)		$	140,760
Balance, December 31, 2014		$	25,750			$	15,481			$	10,480			$	47,339			$	39,290			$	(4,066	)		$	134,274
Net income																			3,116								3,116
Other comprehensive (loss)																							(567	)			(567	)
Cash dividends - preferred, Series A																			(547	)							(547	)
Cash dividends - preferred, Series B																			(105	)							(105	)
Cash dividends - common ($0.02 per share)																			(260	)							(260	)
Repurchase of preferred stock							(14,000	)																			(14,000	)
Repurchase of common stock			(1	)																							(1	)
Repurchase of warrants							(1,481	)							1,366												(115	)
Stock based compensation															114												114
Restricted common stock vested			22				-				-				(22	)			-				-				-
Balance, June 30, 2015		$	25,771			$	-			$	10,480			$	48,797			$	41,494			$	(4,633	)		$	121,909

 

(1) For the purposes of this table, Preferred Stock Series A includes the effect of the warrant (prior to its repurchase by the Company during the second quarter of 2015) issued in connection with the sale of the Series A Preferred Stock and the discount on such preferred stock.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

(dollars in thousands)

 

		Six Months Ended
		June 30,
		2015				2014
Operating Activities:
Net income		$	3,116			$	3,651
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			-				250
Depreciation and amortization			1,250				1,048
Stock based compensation			114				39
Amortization of debt issuance costs			15				-
Net accretion of certain acquisition related fair value adjustments			(402	)			-
Net amortization of premiums and accretion of discounts on investment securities, net			1,506				1,626
(Gain) on sale of securities available for sale transactions, net			(51	)			(489	)
Loss (gain) on sale of bank premises and equipment			27				(5	)
Loss on sale of other real estate owned			26				15
Impairment losses on other real estate owned			5				11
Loss on LLC investments			145				23
Earnings on life insurance policies			(323	)			(274	)
Net change in:
Accrued interest receivable			23				131
Other assets			(1,942	)			(1,294	)
Accrued interest payable			214				(983	)
Other liabilities			1,756				1,108
Net cash provided by operating activities			5,479				4,857
Investing Activities:
Purchase of securities available for sale			(48,580	)			(17,000	)
Purchase of securities held to maturity			(22	)			-
Purchase of restricted securities			(4,347	)			(5,228	)
Purchases of bank premises and equipment			(2,727	)			(1,127	)
Improvements to other real estate owned			(1	)			-
Net change in loans			(21,363	)			(41,484	)
Proceeds from:
Maturities, calls, and paydowns of securities available for sale			12,537				9,053
Maturities, calls, and paydowns of securities held to maturity			1,351				1,248
Sale of securities available for sale			19,970				20,527
Sale of restricted securities			3,762				3,547
Sale of bank premises and equipment			255				5
Sale of other real estate owned			1,548				462
Net cash used in investing activities			(37,617	)			(29,997	)
Financing Activities:
Net change in:
Demand, interest-bearing demand and savings deposits			33,650				(13,723	)
Time deposits			(15,747	)			787
Federal funds purchased and repurchase agreements			(6,396	)			473
Short-term borrowings			17,787				34,820
Senior subordinated debt			20,000				-
Debt issuance costs			(875	)			-
Repurchase of preferred stock			(14,000	)			-
Repurchase of common stock			(1	)			-
Repurchase of warrants			(115	)			-
Dividends paid - preferred, Series A			(547	)			-
Dividends paid - preferred, Series B			(105	)			-
Dividends paid - common			(260	)			-
Net cash provided by financing activities			33,391				22,357
Net increase (decrease) in cash and cash equivalents			1,253				(2,783	)
Cash and cash equivalents, December 31			19,630				19,346
Cash and cash equivalents, June 30		$	20,883			$	16,563
Supplemental disclosure:
Interest paid		$	2,306			$	3,205
Supplemental disclosure of noncash investing and financing activities:
Unrealized (losses) gains on securities available for sale		$	(956	)		$	6,123
Loans transferred to other real estate owned		$	(1,084	)		$	(289	)

 

The accompanying notes are an integral part of the consolidated financial statements.

 

  

EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES

Notes to the Interim Consolidated Financial Statements

(unaudited)

 

Note 1. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The accompanying unaudited consolidated financial statements of Eastern Virginia Bankshares, Inc. (the “Parent”) and its subsidiaries, EVB Statutory Trust I (the “Trust”), and EVB (the “Bank”) and its subsidiaries, are in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”).

 

The accompanying unaudited consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as the “Company.” All significant intercompany balances and transactions have been eliminated in consolidation. In addition, the Parent owns the Trust which is an unconsolidated subsidiary. The subordinated debt owed to the Trust is reported as a liability of the Parent.

 

Nature of Operations

 

Eastern Virginia Bankshares, Inc. is a bank holding company headquartered in Tappahannock, Virginia that was organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997 and commenced operations on December 29, 1997. The Company conducts its primary operations through its wholly-owned bank subsidiary, EVB. Two of EVB’s three predecessor banks, Bank of Northumberland, Inc. and Southside Bank, were established in 1910. The third bank, Hanover Bank, was established as a de novo bank in 2000. In April 2006, these three banks were merged and the surviving bank was re-branded as EVB. Additionally, the Parent acquired Virginia Company Bank (“VCB”) (see Note 2 – Business Combinations) on November 14, 2014 and merged VCB with and into the Bank, with the Bank surviving, thus adding three additional branches to the Bank located in Newport News, Williamsburg, and Hampton, respectively. The Bank provides a full range of banking and related financial services to individuals and businesses through its network of retail branches. With twenty-four retail branches, the Bank serves diverse markets that primarily are in the counties of Essex, Gloucester, Hanover, Henrico, King and Queen, King William, Lancaster, Middlesex, New Kent, Northumberland, Southampton, Surry, Sussex and the cities of Colonial Heights, Hampton, Newport News, Richmond, and Williamsburg. The Bank also operates a loan production office in Chesterfield County, Virginia, that the Bank opened during the second quarter of 2014. The Bank operates under a state bank charter and as such is subject to regulation by the Virginia State Corporation Commission Bureau of Financial Institutions (the “Bureau”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

 

The Bank owns EVB Financial Services, Inc., which in turn has a 100% ownership interest in EVB Investments, Inc. EVB Investments, Inc. is a full-service brokerage firm offering a comprehensive range of investment services. On May 15, 2014, the Bank acquired a 4.9% ownership interest in Southern Trust Mortgage, LLC. Pursuant to an independent contractor agreement with Southern Trust Mortgage, LLC, the Company advises and consults with Southern Trust Mortgage, LLC and facilitates the marketing and brand recognition of their mortgage business. In addition, the Company provides Southern Trust Mortgage, LLC with offices at four retail branches in the Company’s market area and access to office equipment at these locations during normal business hours. For its services, the Company receives fixed monthly compensation from Southern Trust Mortgage, LLC in the amount of $3 thousand, which is adjustable on a quarterly basis.

 

 

The Bank had a 75% ownership interest in EVB Title, LLC, which primarily sold title insurance to the mortgage loan customers of the Bank and EVB Mortgage, LLC. Effective January 2014, the Bank ceased operations of EVB Title, LLC due to low volume and profitability. On October 1, 2014, the Bank acquired a 6.0% ownership interest in Bankers Title, LLC. Bankers Title, LLC is a multi-bank owned title agency providing a full range of title insurance settlement and related financial services. The Bank has a 2.33% ownership in Bankers Insurance, LLC, which primarily sells insurance products to customers of the Bank, and other financial institutions that have an equity interest in the agency. The Bank also has a 100% ownership interest in Dunston Hall LLC, POS LLC, Tartan Holdings LLC and ECU-RE LLC which were formed to hold the title to real estate acquired by the Bank upon foreclosure on property of real estate secured loans. The financial position and operating results of all of these subsidiaries are not significant to the Company as a whole and are not considered principal activities of the Company at this time. The Company’s common stock trades on the NASDAQ Global Select Market under the symbol “EVBS.”

 

Basis of Presentation

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, impairment of loans, impairment of securities, the valuation of other real estate owned, the projected benefit obligation under the defined benefit pension plan, the valuation of deferred taxes, goodwill impairment and fair value of financial instruments. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these interim financial statements, have been made. Certain prior year amounts have been reclassified to conform to the 2015 presentation. These reclassifications have no effect on previously reported net income.

 

Recent Accounting Pronouncements

 

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 adoption of the new guidance did not have a material impact on our 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 adoption of the new guidance did not have a material impact on our consolidated financial statements.

 

In June 2014, the FASB issued ASU 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 “Revenue Recognition (Topic 605),” most industry-specific guidance, and some cost guidance included in “Revenue Recognition—Construction-Type and Production-Type Contracts (Subtopic 605-35).” 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 were scheduled to be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. In April 2015, the FASB voted in favor of a one year deferral of the effective date of this amendment. An exposure draft is expected with a thirty day comment period. 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 2014-11, “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 adoption of the new guidance did not have a material impact on our consolidated financial statements.

 

In June 2014, the FASB issued ASU 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 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 are 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 mortgage loan has a government guarantee that is not separable from the mortgage 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 adoption of the new guidance did not have a material impact on our consolidated financial statements.

 

In August 2014, the FASB issued ASU 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.

 

  

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The amendments in this ASU eliminate from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.

 

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” The amendments in this ASU are intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). In addition to reducing the number of consolidation models from four to two, the new standard simplifies the FASB Accounting Standards Codification (“ASC”) and improves current U.S. GAAP by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity (“VIE”), and changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. ASU 2015-02 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated. The Company does not expect the adoption of ASU 2015-02 to have a material impact on its consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued, and as such, the Company adopted ASU 2015-03 in the second quarter of 2015. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” The amendments in this ASU provide guidance to customers regarding cloud computing arrangements that include a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments do not change the accounting for a customer’s accounting for service contracts. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets. The amendments in this ASU are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. An entity can elect to adopt the amendments either: (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively. The Company is currently assessing the impact that ASU 2015-05 will have on its consolidated financial statements.

 

  

In May 2015, the FASB issued ASU No. 2015-08, “Business Combinations (Topic 805): Pushdown Accounting – Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” The amendments in ASU 2015-08 amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115, Topic 5: Miscellaneous Accounting, regarding various pushdown accounting issues, and did not have a material impact on our consolidated financial statements.

 

Note 2. Business Combinations

 

On November 14, 2014, the Company completed its acquisition of VCB. Pursuant to the Agreement and Plan of Reorganization dated May 29, 2014, VCB's common shareholders received for each share of VCB common stock they owned either (i) cash at a rate of $6.25 per share of VCB common stock, or approximately $2.4 million in the aggregate, or (ii) the Company’s common stock at a rate of 0.9259 shares of the Company’s common stock per share of VCB common stock, which totaled approximately $6.7 million based on the Company’s closing common stock price on November 14, 2014 of $6.27 per share. In addition, the Company purchased VCB’s Series A Preferred Stock for $4.3 million. VCB was established in 2005 and was headquartered in Newport News, Virginia. VCB operated three branches, one each in Newport News, Hampton and Williamsburg, Virginia.

 

The Company accounted for the acquisition using the acquisition method of accounting in accordance with FASB ASC 805, “Business Combinations.” Under the acquisition method of accounting, the assets and liabilities of VCB were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date as additional information relative to the acquisition date fair values becomes available. The Company recognized goodwill of $1.1 million in connection with the acquisition, none of which is deductible for income tax purposes.

 

 

The following table details the total consideration paid by the Company on November 14, 2014 in connection with the acquisition of VCB, the fair values of the assets acquired and liabilities assumed, and the resulting goodwill.

  

										As Recorded
		As Recorded				Fair Value				by the
(dollars in thousands)		by VCB				Adjustments				Company
Consideration paid:
Cash										$	6,688
EVBS common stock											6,676
Total consideration paid										$	13,364
Identifiable assets acquired:
Cash and due from banks		$	1,377			$	-			$	1,377
Interest bearing deposits with banks			249				-				249
Securities available for sale, at fair value			11,277				-				11,277
Restricted securities, at cost			557				-				557
Loans			103,791				(2,322	)			101,469
Deferred income taxes			-				3,513				3,513
Bank premises and equipment			7,020				(1,044	)			5,976
Accrued interest receivable			344				-				344
Other real estate owned			211				(108	)			103
Core deposit intangible			-				1,010				1,010
Bank owned life insurance			2,742				-				2,742
Other assets			243				-				243
Total identifiable assets acquired			127,811				1,049				128,860
Identifiable liabilities assumed:
Noninterest-bearing demand accounts			18,797				-				18,797
Interest-bearing deposits			85,791				(149	)			85,642
Federal funds purchased and repurchase agreements			3,119				-				3,119
Federal Home Loan Bank advances			8,650				-				8,650
Accrued interest payable			30				-				30
Other liabilities			373				-				373
Total identifiable liabilities assumed			116,760				(149	)			116,611
Net identifiable assets acquired		$	11,051			$	1,198			$	12,249
Goodwill resulting from acquisition										$	1,115

 

The following table illustrates the unaudited pro forma revenue and net income of the combined entities had the acquisition taken place on January 1, 2014. The unaudited combined pro forma revenue and net income combines the historical results of VCB with the Company's consolidated statements of income for the periods listed below and, while certain adjustments were made for the estimated effect of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition actually taken place on January 1, 2014. Acquisition related expenses of $168 thousand and $224 thousand were included in the Company's actual consolidated statements of income for the three and six months ended June 30, 2015, respectively, but were excluded from the unaudited pro forma information listed below. Additionally, the Company expects to achieve further operational cost savings and other efficiencies as a result of the acquisition which are not reflected in the unaudited pro forma amounts below:

 

		Unaudited				Unaudited				Unaudited				Unaudited
		Pro Forma				Pro Forma				Pro Forma				Pro Forma
		Three Months Ended				Three Months Ended				Six Months Ended				Six Months Ended
		June 30,				June 30,				June 30,				June 30,
(dollars in thousands)		2015				2014				2015				2014
Net interest income		$	10,606			$	10,066			$	21,180			$	20,554
Net income			1,675				1,232				3,340				2,804

 

  

Note 3. Investment Securities

 

The amortized cost and estimated fair value, with gross unrealized gains and losses, of securities at June 30, 2015 and December 31, 2014 were as follows:

 

(dollars in thousands)		June 30, 2015
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Available for Sale:
Obligations of U.S. Government agencies		$	13,491			$	-			$	410			$	13,081
SBA Pool securities			71,966				114				1,073				71,007
Agency residential mortgage-backed securities			19,731				53				384				19,400
Agency commercial mortgage-backed securities			6,574				-				87				6,487
Agency CMO securities			53,589				285				720				53,154
Non agency CMO securities			670				34				-				704
State and political subdivisions			65,102				301				1,313				64,090
FNMA and FHLMC preferred stock			2				7				-				9
Total		$	231,125			$	794			$	3,987			$	227,932

 

(dollars in thousands)		December 31, 2014
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Available for Sale:
Obligations of U.S. Government agencies		$	14,991			$	-			$	422			$	14,569
SBA Pool securities			76,469				70				1,740				74,799
Agency residential mortgage-backed securities			28,740				208				319				28,629
Agency CMO securities			39,343				302				430				39,215
Non agency CMO securities			820				11				3				828
State and political subdivisions			55,877				510				461				55,926
FNMA and FHLMC preferred stock			7				38				-				45
Total		$	216,247			$	1,139			$	3,375			$	214,011

 

  

(dollars in thousands)		June 30, 2015
						Unrealized
						Losses								Gross				Gross
		Amortized				Recorded				Carrying				Unrealized				Unrealized				Fair
		Cost				in AOCI*				Value				Gains				Losses				Value
Held to Maturity:
Agency CMO securities		$	11,814			$	71			$	11,743			$	338			$	-			$	12,081
State and political subdivisions			19,484				556				18,928				536				3				19,461
Total		$	31,298			$	627			$	30,671			$	874			$	3			$	31,542

 

*Represents the unrealized holding gain or loss at the date of transfer from available for sale to held to maturity, net of any accretion.

 

(dollars in thousands)		December 31, 2014
						Unrealized
						Losses								Gross				Gross
		Amortized				Recorded				Carrying				Unrealized				Unrealized				Fair
		Cost				in AOCI*				Value				Gains				Losses				Value
Held to Maturity:
Agency CMO securities		$	12,073			$	80			$	11,993			$	294			$	-			$	12,287
State and political subdivisions			20,814				644				20,170				928				18				21,080
Total		$	32,887			$	724			$	32,163			$	1,222			$	18			$	33,367

 

*Represents the unrealized holding gain or loss at the date of transfer from available for sale to held to maturity, net of any accretion.

 

There are no securities classified as “Trading” at June 30, 2015 or December 31, 2014. During the fourth quarter of 2013, the Company transferred securities with an amortized cost of $35.5 million, previously designated as “Available for Sale”, to “Held to Maturity” classification. The fair value of those securities as of the date of the transfer was $34.5 million, reflecting a gross unrealized loss of $994 thousand. The gross unrealized loss net of tax at the time of transfer remained in Accumulated Other Comprehensive (Loss) and is being accreted over the remaining life of the securities as an adjustment to interest income. At June 30, 2015, the Company’s mortgage-backed securities consisted of commercial and residential mortgage-backed securities. The Company’s mortgage-backed securities are all backed by an Agency of the U.S. government and rated Aaa and AA+ by Moody and S&P, respectively, with no subprime issues.

 

The Company’s pooled trust preferred securities included one senior issue of Preferred Term Securities XXVII which remained current on all payments and on which the Company took an impairment charge in the third quarter of 2009 to reduce the Company’s book value to the market value at September 30, 2009. On December 9, 2014 the Company sold this security resulting in a gain on sale of $82 thousand and the Company reversed the related impairment reserve. During the second quarter of 2010, the Company recognized an impairment charge in the amount of $77 thousand on the Company’s investment in Preferred Term Securities XXIII mezzanine tranche, thus reducing the book value of this investment to $0. On September 22, 2014 the Company sold this security resulting in a gain on sale of $2 thousand and the Company reversed the related impairment reserve. The decision to recognize the other-than-temporary impairment had been based upon an analysis of the market value of the discounted cash flow for the security as provided by Moody’s at June 30, 2010, which indicated that the Company was unlikely to recover any of its remaining investment in these securities.

 

 

The amortized cost, carrying value and estimated fair values of securities at June 30, 2015, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

 

(dollars in thousands)		June 30, 2015
		Amortized Cost				Fair Value
Available for Sale:
Due in one year or less		$	2,378			$	2,327
Due after one year through five years			82,927				82,425
Due after five years through ten years			136,796				134,357
Due after ten years			9,024				8,823
Total		$	231,125			$	227,932

 

(dollars in thousands)		June 30, 2015
		Carrying Value				Fair Value
Held to Maturity:
Due in one year or less		$	-			$	-
Due after one year through five years			21,379				22,005
Due after five years through ten years			8,545				8,791
Due after ten years			747				746
Total		$	30,671			$	31,542

 

Proceeds from the sales of securities available for sale for the six months ended June 30, 2015 and 2014 were $20.0 million and $20.5 million, respectively. Net realized gains on the sales of securities available for sale for the six months ended June 30, 2015 and 2014 were $51 thousand and $489 thousand, respectively. Proceeds from maturities, calls and paydowns of securities available for sale for the six months ended June 30, 2015 and 2014 were $12.5 million and $9.1 million, respectively. Proceeds from maturities, calls and paydowns of securities held to maturity for the six months ended June 30, 2015 and 2014 were $1.4 million and $1.2 million, respectively.

 

The Company pledges securities to secure public deposits, balances with the Federal Reserve Bank of Richmond (the “Reserve Bank”) and repurchase agreements. Securities with an aggregate book value of $50.6 million and an aggregate fair value of $51.3 million were pledged at June 30, 2015. Securities with an aggregate book value of $86.9 million and an aggregate fair value of $87.1 million were pledged at December 31, 2014.

 

Securities in an unrealized loss position at June 30, 2015, by duration of the period of the unrealized loss, are shown below:

 

		June 30, 2015
(dollars in thousands)		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Description of Securities		Value				Loss				Value				Loss				Value				Loss
Obligations of U.S. Government agencies		$	4,385			$	110			$	8,696			$	300			$	13,081			$	410
SBA Pool securities			9,137				48				50,950				1,025				60,087				1,073
Agency residential mortgage-backed securities			7,619				111				9,967				273				17,586				384
Agency commercial mortgage-backed securities			6,487				87				-				-				6,487				87
Agency CMO securities			25,483				418				8,720				302				34,203				720
State and political subdivisions			41,816				960				9,258				356				51,074				1,316
Total		$	94,927			$	1,734			$	87,591			$	2,256			$	182,518			$	3,990

 

 

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment that may result due to adverse economic conditions and associated credit deterioration. A determination as to whether a security’s decline in market value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Company may consider in the other-than-temporary impairment analysis include the length of time the security has been in an unrealized loss position, changes in security ratings, financial condition of the issuer, as well as security and industry specific economic conditions. In addition, the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds, and the value of any underlying collateral. For certain securities in unrealized loss positions, the Company will enlist independent third-party firms to prepare cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

 

Based on the Company’s evaluation, management does not believe any unrealized losses at June 30, 2015, represent an other-than-temporary impairment as these unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, which rose during 2013 causing bond prices to decline, and are not attributable to credit deterioration. During 2014 and the first three months of 2015, interest rates had fallen, specifically in the middle and long-end of the yield curve, which had caused bond prices to rise and thereby reduced the amount of unrealized losses. However, during the second quarter of 2015, interest rates generally increased which caused bond prices to decline, which in turn increased the amount of unrealized losses at the end of that quarter. At June 30, 2015, there were 154 debt securities with fair values totaling $182.5 million considered temporarily impaired. Of these debt securities, 90 with fair values totaling $94.9 million were in an unrealized loss position of less than 12 months and 64 with fair values totaling $87.6 million were in an unrealized loss position of 12 months or more. Because the Company intends to hold these investments in debt securities until recovery of the amortized cost basis and it is more likely than not that the Company will not be required to sell these investments before a recovery of unrealized losses, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2015 and no impairment has been recognized. At June 30, 2015, there were no equity securities in an unrealized loss position.

 

Securities in an unrealized loss position at December 31, 2014, by duration of the period of the unrealized loss, are shown below.

 

		December 31, 2014
(dollars in thousands)		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Description of Securities		Value				Loss				Value				Loss				Value				Loss
Obligations of U.S. Government agencies		$	-			$	-			$	14,587			$	422			$	14,587			$	422
SBA Pool securities			3,520				73				63,290				1,667				66,810				1,740
Agency residential mortgage-backed securities			-				-				15,343				319				15,343				319
Agency CMO securities			5,140				34				16,478				396				21,618				430
Non agency CMO securities			281				3				44				-				325				3
State and political subdivisions			3,663				36				21,509				443				25,172				479
Total		$	12,604			$	146			$	131,251			$	3,247			$	143,855			$	3,393

 

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $5.1 million and $4.5 million at June 30, 2015 and December 31, 2014, respectively. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Because the FHLB generated positive net income for each quarterly period beginning July 1, 2014, and ending June 30, 2015, the Company does not consider this investment to be other-than-temporarily impaired at June 30, 2015 and no impairment has been recognized. FHLB stock is included in a separate line item on the consolidated balance sheets (Restricted securities, at cost) and is not part of the Company’s investment securities portfolio. The Company’s restricted securities also include investments in the Reserve Bank and Community Bankers Bank, which are carried at cost.

 

  

Note 4. Loan Portfolio

 

The following table sets forth the composition of the Company’s loan portfolio in dollar amounts and as a percentage of the Company’s total gross loans at the dates indicated:

 

		June 30, 2015								December 31, 2014
(dollars in thousands)		Amount				Percent				Amount				Percent
Commercial, industrial and agricultural		$	85,845				10.21	%		$	85,119				10.37	%
Real estate - one to four family residential:
Closed end first and seconds			243,072				28.91	%			236,761				28.86	%
Home equity lines			111,007				13.20	%			110,100				13.42	%
Total real estate - one to four family residential			354,079				42.11	%			346,861				42.28	%
Real estate - multifamily residential			29,802				3.54	%			25,157				3.07	%
Real estate - construction:
One to four family residential			19,091				2.27	%			19,698				2.40	%
Other construction, land development and other land			36,620				4.36	%			35,591				4.34	%
Total real estate - construction			55,711				6.63	%			55,289				6.74	%
Real estate - farmland			10,553				1.26	%			9,471				1.15	%
Real estate - non-farm, non-residential:
Owner occupied			168,861				20.09	%			157,745				19.22	%
Non-owner occupied			99,287				11.81	%			104,827				12.77	%
Total real estate - non-farm, non-residential			268,148				31.90	%			262,572				31.99	%
Consumer			14,443				1.72	%			15,919				1.94	%
Other			22,129				2.63	%			20,181				2.46	%
Total loans			840,710				100.00	%			820,569				100.00	%
Less allowance for loan losses			(12,287	)							(13,021	)
Loans, net		$	828,423							$	807,548

 

Deferred costs, net are included in the table above and totaled $1.5 million and $1.4 million for June 30, 2015 and December 31, 2014, respectively.

 

  

The following table presents the aging of the recorded investment in past due loans as of June 30, 2015 by class of loans:

 

(dollars in thousands)		30-59 Days Past Due				60-89 Days Past Due				Over 90 Days Past Due				Total Past Due				Total Current*				Total Loans
Commercial, industrial and agricultural		$	206			$	14			$	383			$	603			$	85,242			$	85,845
Real estate - one to four family residential:
Closed end first and seconds			6,038				1,662				3,359				11,059				232,013				243,072
Home equity lines			234				104				250				588				110,419				111,007
Total real estate - one to four family residential			6,272				1,766				3,609				11,647				342,432				354,079
Real estate - multifamily residential			-				-				-				-				29,802				29,802
Real estate - construction:
One to four family residential			80				-				189				269				18,822				19,091
Other construction, land development and other land			-				-				1				1				36,619				36,620
Total real estate - construction			80				-				190				270				55,441				55,711
Real estate - farmland			273				280				-				553				10,000				10,553
Real estate - non-farm, non-residential:
Owner occupied			172				1,686				568				2,426				166,435				168,861
Non-owner occupied			215				-				676				891				98,396				99,287
Total real estate - non-farm, non-residential			387				1,686				1,244				3,317				264,831				268,148
Consumer			8				26				4				38				14,405				14,443
Other			-				-				-				-				22,129				22,129
Total loans		$	7,226			$	3,772			$	5,430			$	16,428			$	824,282			$	840,710

 

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

 

The following table presents the aging of the recorded investment in past due loans as of December 31, 2014 by class of loans:

 

(dollars in thousands)		30-59 Days Past Due				60-89 Days Past Due				Over 90 Days Past Due				Total Past Due				Total Current*				Total Loans
Commercial, industrial and agricultural		$	278			$	6			$	373			$	657			$	84,462			$	85,119
Real estate - one to four family residential:
Closed end first and seconds			5,515				1,123				1,247				7,885				228,876				236,761
Home equity lines			366				-				360				726				109,374				110,100
Total real estate - one to four family residential			5,881				1,123				1,607				8,611				338,250				346,861
Real estate - multifamily residential			-				-				-				-				25,157				25,157
Real estate - construction:
One to four family residential			150				-				221				371				19,327				19,698
Other construction, land development and other land			5				-				-				5				35,586				35,591
Total real estate - construction			155				-				221				376				54,913				55,289
Real estate - farmland			-				-				590				590				8,881				9,471
Real estate - non-farm, non-residential:
Owner occupied			1,873				158				1,738				3,769				153,976				157,745
Non-owner occupied			-				-				-				-				104,827				104,827
Total real estate - non-farm, non-residential			1,873				158				1,738				3,769				258,803				262,572
Consumer			157				32				-				189				15,730				15,919
Other			-				-				-				-				20,181				20,181
Total loans		$	8,344			$	1,319			$	4,529			$	14,192			$	806,377			$	820,569

 

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

 

  

The following table presents nonaccrual loans, loans past due 90 days and accruing interest, and troubled debt restructurings (accruing) at the dates indicated:

 

		June 30,				December 31,
(dollars in thousands)		2015				2014
Nonaccrual loans		$	7,263			$	6,622
Loans past due 90 days and accruing interest			240				53
Troubled debt restructurings (accruing)			14,843				15,223

 

At June 30, 2015 and December 31, 2014, there were approximately $2.3 million and $3.4 million, respectively, in troubled debt restructurings (“TDRs”) included in nonaccrual loans.

 

The past due status of a loan is based on the contractual due date of the most delinquent payment due. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans greater than 90 days past due may remain on an accrual status if management determines it has adequate collateral to cover the principal and interest. If a loan or a portion of a loan is adversely classified, or is partially charged off, the loan is generally classified as nonaccrual. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on a nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due.

 

When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, and the amortization of related deferred loan fees or costs is suspended. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. These policies are applied consistently across our loan portfolio.

 

A loan (including a TDR) may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

 

 

Outstanding principal balance and the carrying amount of loans acquired pursuant to the Company’s acquisition of VCB (or “Acquired Loans”) that were recorded at fair value at the acquisition date and are included in the consolidated balance sheet at June 30, 2015 and December 31, 2014 were as follows:

 

		June 30, 2015												December 31, 2014
(dollars in thousands)		Acquired Loans - Purchased Credit Impaired				Acquired Loans - Purchased Performing				Acquired Loans - Total				Acquired Loans - Purchased Credit Impaired				Acquired Loans - Purchased Performing				Acquired Loans - Total
Commercial, industrial and agricultural		$	577			$	7,051			$	7,628			$	1,023			$	15,673			$	16,696
Real estate - one to four family residential:
Closed end first and seconds			1,347				7,758				9,105				1,374				6,475				7,849
Home equity lines			33				10,850				10,883				33				11,858				11,891
Total real estate - one to four family residential			1,380				18,608				19,988				1,407				18,333				19,740
Real estate - multifamily residential			-				3,790				3,790				-				3,539				3,539
Real estate - construction:
One to four family residential			-				1,945				1,945				-				3,206				3,206
Other construction, land development and other land			286				1,875				2,161				79				3,674				3,753
Total real estate - construction			286				3,820				4,106				79				6,880				6,959
Real estate - farmland			-				-				-				-				-				-
Real estate - non-farm, non-residential:
Owner occupied			4,408				17,998				22,406				1,841				21,037				22,878
Non-owner occupied			1,661				12,460				14,121				3,472				20,762				24,234
Total real estate - non-farm, non-residential			6,069				30,458				36,527				5,313				41,799				47,112
Consumer			-				435				435				-				1,462				1,462
Other			-				845				845				-				-				-
Total loans		$	8,312			$	65,007			$	73,319			$	7,822			$	87,686			$	95,508

 

The following table presents the recorded investment in nonaccrual loans and loans past due 90 days and accruing interest by class at June 30, 2015 and December 31, 2014:

 

										Over 90 Days Past
		Nonaccrual								Due and Accruing
		June 30,				December 31,				June 30,				December 31,
(dollars in thousands)		2015				2014				2015				2014
Commercial, industrial and agricultural		$	383			$	334			$	-			$	53
Real estate - one to four family residential:
Closed end first and seconds			4,996				3,364				240				-
Home equity lines			425				564				-				-
Total real estate - one to four family residential			5,421				3,928				240				-
Real estate - construction:
One to four family residential			189				221				-				-
Other construction, land development and other land			1				-				-				-
Total real estate - construction			190				221				-				-
Real estate - farmland			-				590				-				-
Real estate - non-farm, non-residential:
Owner occupied			568				1,521				-				-
Non-owner occupied			677				-				-				-
Total real estate - non-farm, non-residential			1,245				1,521				-				-
Consumer			24				28				-				-
Total loans		$	7,263			$	6,622			$	240			$	53

 

  

The Company uses a risk grading system for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans. Loans are graded on a scale from 1 to 9. Non-impaired real estate and commercial loans are assigned an allowance factor which increases with the severity of risk grading. A general description of the characteristics of the risk grades is as follows:

 

Pass Grades

·

Risk Grade 1 loans have little or no risk and are generally secured by cash or cash equivalents;

·

Risk Grade 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;

·

Risk Grade 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;

·

Risk Grade 4 loans are satisfactory loans with borrowers not as strong as risk grade 3 loans but may exhibit a higher degree of financial risk based on the type of business supporting the loan; and

·

Risk Grade 5 loans are loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay.

 

Special Mention

·

Risk Grade 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position.

 

Classified Grades

·

Risk Grade 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged. These have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;

·

Risk Grade 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and

·

Risk Grade 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as a bank asset is not warranted.

 

The Company uses a past due grading system for consumer loans, including one to four family residential first and seconds and home equity lines. The past due status of a loan is based on the contractual due date of the most delinquent payment due. The past due grading of consumer loans is based on the following categories: current, 1-29 days past due, 30-59 days past due, 60-89 days past due and over 90 days past due. The consumer loans are segregated between performing and nonperforming loans. Performing loans are those that have made timely payments in accordance with the terms of the loan agreement and are not past due 90 days or more. Nonperforming loans are those that do not accrue interest, or are greater than 90 days past due and accruing interest. Non-impaired consumer loans are assigned an allowance factor which increases with the severity of past due status. This component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

 

The allocation methodology applied by the Company includes management’s ongoing review and grading of the loan portfolio into criticized loan categories (defined as specific loans warranting either specific allocation, or a classified status of substandard, doubtful or loss). The allocation methodology focuses on evaluation of several factors, including but not limited to: evaluation of facts and issues related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of migration analysis tracking movement of loans through past due classifications and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of classified loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the portfolio. In determining the allowance for loan losses, the Company considers its portfolio segments and loan classes to be the same.

 

  

The following table presents commercial loans by credit quality indicator at June 30, 2015:

 

(dollars in thousands)		Pass				Special Mention				Substandard				Doubtful				Impaired				Acquired Loans - Purchased Credit Impaired				Total
Commercial, industrial and agricultural		$	80,879			$	3,269			$	553			$	230			$	337			$	577			$	85,845
Real estate - multifamily residential			29,802				-				-				-				-				-				29,802
Real estate - construction:
One to four family residential			18,623				87				121				-				260				-				19,091
Other construction, land development and other land			27,504				1,786				1,410				-				5,634				286				36,620
Total real estate - construction			46,127				1,873				1,531				-				5,894				286				55,711
Real estate - farmland			9,496				875				182				-				-				-				10,553
Real estate - non-farm, non-residential:
Owner occupied			141,218				8,012				3,955				-				11,268				4,408				168,861
Non-owner occupied			82,331				2,804				1,485				-				11,006				1,661				99,287
Total real estate - non-farm, non-residential			223,549				10,816				5,440				-				22,274				6,069				268,148
Total commercial loans		$	389,853			$	16,833			$	7,706			$	230			$	28,505			$	6,932			$	450,059

 

The following table presents commercial loans by credit quality indicator at December 31, 2014:

 

(dollars in thousands)		Pass				Special Mention				Substandard				Doubtful				Impaired				Acquired Loans - Purchased  Credit Impaired				Total
Commercial, industrial and agricultural		$	79,191			$	2,779			$	675			$	-			$	1,451			$	1,023			$	85,119
Real estate - multifamily residential			25,157				-				-				-				-				-				25,157
Real estate - construction:
One to four family residential			18,978				300				244				-				176				-				19,698
Other construction, land development and other land			26,916				1,791				1,144				-				5,661				79				35,591
Total real estate - construction			45,894				2,091				1,388				-				5,837				79				55,289
Real estate - farmland			9,471				-				-				-				-				-				9,471
Real estate - non-farm, non-residential:
Owner occupied			132,266				11,339				2,253				-				10,046				1,841				157,745
Non-owner occupied			84,951				4,771				1,817				-				9,816				3,472				104,827
Total real estate - non-farm, non-residential			217,217				16,110				4,070				-				19,862				5,313				262,572
Total commercial loans		$	376,930			$	20,980			$	6,133			$	-			$	27,150			$	6,415			$	437,608

  

At June 30, 2015 and December 31, 2014, the Company did not have any loans classified as Loss.

 

 

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at June 30, 2015:

 

(dollars in thousands)		Performing				Nonperforming				Total
Real estate - one to four family residential:
Closed end first and seconds		$	232,426			$	10,646			$	243,072
Home equity lines			110,132				875				111,007
Total real estate - one to four family residential			342,558				11,521				354,079
Consumer			14,091				352				14,443
Other			22,125				4				22,129
Total consumer loans		$	378,774			$	11,877			$	390,651

 

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at December 31, 2014:

 

(dollars in thousands)		Performing				Nonperforming				Total
Real estate - one to four family residential:
Closed end first and seconds		$	226,801			$	9,960			$	236,761
Home equity lines			109,565				535				110,100
Total real estate - one to four family residential			336,366				10,495				346,861
Consumer			15,548				371				15,919
Other			20,175				6				20,181
Total consumer loans		$	372,089			$	10,872			$	382,961

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. The Company measures impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are considered impaired loans. TDRs occur when we agree to modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions can be temporary and are made in an attempt to avoid foreclosure and with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include, without limitation, rate reductions to below market rates, payment deferrals, forbearance, and, in some cases, forgiveness of principal or interest.

 

At the time of a TDR, the loan is placed on nonaccrual status. A loan (including a TDR) may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

 

  

The following table presents a rollforward of the Company’s allowance for loan losses for the six months ended June 30, 2015:

 

		Beginning Balance																Ending Balance
(dollars in thousands)		January 1, 2015				Charge-offs				Recoveries				Provision				June 30, 2015
Commercial, industrial and agricultural		$	1,168			$	(80	)		$	21			$	510			$	1,619
Real estate - one to four family residential:
Closed end first and seconds			1,884				(332	)			13				134				1,699
Home equity lines			1,678				(137	)			5				467				2,013
Total real estate - one to four family residential			3,562				(469	)			18				601				3,712
Real estate - multifamily residential			89				-				-				13				102
Real estate - construction:
One to four family residential			235				(102	)			1				123				257
Other construction, land development and other land			2,670				-				-				(80	)			2,590
Total real estate - construction			2,905				(102	)			1				43				2,847
Real estate - farmland			144				-				-				(65	)			79
Real estate - non-farm, non-residential:
Owner occupied			2,416				(139	)			1				(440	)			1,838
Non-owner occupied			1,908				-				-				(740	)			1,168
Total real estate - non-farm, non-residential			4,324				(139	)			1				(1,180	)			3,006
Consumer			305				(7	)			34				(75	)			257
Other			524				(24	)			12				153				665
Total		$	13,021			$	(821	)		$	87			$	-			$	12,287

 

The following table presents a rollforward of the Company’s allowance for loan losses for the six months ended June 30, 2014:

 

		Beginning Balance																Ending Balance
(dollars in thousands)		January 1, 2014				Charge-offs				Recoveries				Provision				June 30, 2014
Commercial, industrial and agricultural		$	1,787			$	(290	)		$	30			$	(331	)		$	1,196
Real estate - one to four family residential:
Closed end first and seconds			2,859				(304	)			211				(188	)			2,578
Home equity lines			1,642				(54	)			13				244				1,845
Total real estate - one to four family residential			4,501				(358	)			224				56				4,423
Real estate - multifamily residential			79				-				-				29				108
Real estate - construction:
One to four family residential			364				-				6				(69	)			301
Other construction, land development and other land			1,989				-				2				501				2,492
Total real estate - construction			2,353				-				8				432				2,793
Real estate - farmland			116				-				-				11				127
Real estate - non-farm, non-residential:
Owner occupied			3,236				-				27				(1,144	)			2,119
Non-owner occupied			1,770				-				3				855				2,628
Total real estate - non-farm, non-residential			5,006				-				30				(289	)			4,747
Consumer			387				(86	)			55				(1	)			355
Other			538				(26	)			14				343				869
Total		$	14,767			$	(760	)		$	361			$	250			$	14,618

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of June 30, 2015:

 

		Allowance allocated to loans:																Total Loans:
(dollars in thousands)		Individually evaluated for impairment				Collectively evaluated for impairment				Acquired loans - purchased credit impaired				Total				Individually evaluated for impairment				Collectively evaluated for impairment				Acquired loans - purchased credit impaired				Total
Commercial, industrial and agricultural		$	309			$	1,310			$	-			$	1,619			$	337			$	84,931			$	577			$	85,845
Real estate - one to four family residential:
Closed end first and seconds			592				1,107				-				1,699				8,192				233,533				1,347				243,072
Home equity lines			265				1,748				-				2,013				625				110,349				33				111,007
Total real estate - one to four family residential			857				2,855				-				3,712				8,817				343,882				1,380				354,079
Real estate - multifamily residential			-				102				-				102				-				29,802				-				29,802
Real estate - construction:
One to four family residential			73				184				-				257				260				18,831				-				19,091
Other construction, land development and other land			1,604				986				-				2,590				5,634				30,700				286				36,620
Total real estate - construction			1,677				1,170				-				2,847				5,894				49,531				286				55,711
Real estate - farmland			-				79				-				79				-				10,553				-				10,553
Real estate - non-farm, non-residential:
Owner occupied			911				927				-				1,838				11,268				153,185				4,408				168,861
Non-owner occupied			718				450				-				1,168				11,006				86,620				1,661				99,287
Total real estate - non-farm, non-residential			1,629				1,377				-				3,006				22,274				239,805				6,069				268,148
Consumer			89				168				-				257				348				14,095				-				14,443
Other			-				665				-				665				4				22,125				-				22,129
Total		$	4,561			$	7,726			$	-			$	12,287			$	37,674			$	794,724			$	8,312			$	840,710

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of December 31, 2014:

 

		Allowance allocated to loans:																Total Loans:
(dollars in thousands)		Individually evaluated for impairment				Collectively evaluated for impairment				Acquired loans - purchased credit impaired				Total				Individually evaluated for impairment				Collectively evaluated for impairment				Acquired loans - purchased credit impaired				Total
Commercial, industrial and agricultural		$	-			$	1,168			$	-			$	1,168			$	1,451			$	82,645			$	1,023			$	85,119
Real estate - one to four family residential:
Closed end first and seconds			1,006				878				-				1,884				8,713				226,674				1,374				236,761
Home equity lines			-				1,678				-				1,678				175				109,892				33				110,100
Total real estate - one to four family residential			1,006				2,556				-				3,562				8,888				336,566				1,407				346,861
Real estate - multifamily residential			-				89				-				89				-				25,157				-				25,157
Real estate - construction:
One to four family residential			78				157				-				235				176				19,522				-				19,698
Other construction, land development and other land			1,632				1,038				-				2,670				5,661				29,851				79				35,591
Total real estate - construction			1,710				1,195				-				2,905				5,837				49,373				79				55,289
Real estate - farmland			-				144				-				144				-				9,471				-				9,471
Real estate - non-farm, non-residential:
Owner occupied			1,240				1,176				-				2,416				10,046				145,858				1,841				157,745
Non-owner occupied			1,262				646				-				1,908				9,816				91,539				3,472				104,827
Total real estate - non-farm, non-residential			2,502				1,822				-				4,324				19,862				237,397				5,313				262,572
Consumer			106				199				-				305				371				15,548				-				15,919
Other			-				524				-				524				6				20,175				-				20,181
Total		$	5,324			$	7,697			$	-			$	13,021			$	36,415			$	776,332			$	7,822			$	820,569

 

  

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2015:

 

(dollars in thousands)		Recorded Investment				Unpaid Principal Balance				Recorded Investment With  No Allowance				Recorded Investment With Allowance				Related Allowance				Average Recorded Investment				Interest Income Recognized
Commercial, industrial and agricultural		$	337			$	337			$	-			$	337			$	309			$	931			$	11
Real estate - one to four family residential:
Closed end first and seconds			8,192				8,755				3,481				4,711				592				8,517				199
Home equity lines			625				625				175				450				265				432				9
Total real estate - one to four family residential			8,817				9,380				3,656				5,161				857				8,949				208
Real estate - construction:
One to four family residential			260				362				89				171				73				246				4
Other construction, land development and other land			5,634				5,634				1				5,633				1,604				5,638				133
Total real estate - construction			5,894				5,996				90				5,804				1,677				5,884				137
Real estate - non-farm, non-residential:
Owner occupied			11,268				11,620				8,367				2,901				911				10,399				290
Non-owner occupied			11,006				11,006				6,642				4,364				718				10,918				262
Total real estate - non-farm, non-residential			22,274				22,626				15,009				7,265				1,629				21,317				552
Consumer			348				358				16				332				89				360				9
Other			4				4				4				-				-				5				-
Total loans*		$	37,674			$	38,701			$	18,775			$	18,899			$	4,561			$	37,446			$	917

 

* PCI loans are excluded from this table.

  

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2014:

 

(dollars in thousands)		Recorded Investment				Unpaid Principal Balance				Recorded Investment With  No Allowance				Recorded Investment With Allowance				Related Allowance				Average Recorded Investment				Interest Income Recognized
Commercial, industrial and agricultural		$	1,451			$	1,451			$	1,451			$	-			$	-			$	2,010			$	128
Real estate - one to four family residential:
Closed end first and seconds			8,713				8,813				3,611				5,102				1,006				9,800				474
Home equity lines			175				175				175				-				-				289				-
Total real estate - one to four family residential			8,888				8,988				3,786				5,102				1,006				10,089				474
Real estate - construction:
One to four family residential			176				176				-				176				78				312				7
Other construction, land development and other land			5,661				5,661				-				5,661				1,632				5,399				256
Total real estate - construction			5,837				5,837				-				5,837				1,710				5,711				263
Real estate - non-farm, non-residential:
Owner occupied			10,046				10,146				3,734				6,312				1,240				12,056				534
Non-owner occupied			9,816				9,816				4,262				5,554				1,262				9,356				456
Total real estate - non-farm, non-residential			19,862				19,962				7,996				11,866				2,502				21,412				990
Consumer			371				371				-				371				106				420				21
Other			6				6				6				-				-				328				-
Total loans*		$	36,415			$	36,615			$	13,239			$	23,176			$	5,324			$	39,970			$	1,876

 

* PCI loans are excluded from this table.

 

 

Determining the fair value of purchased credit-impaired (“PCI”) loans at November 14, 2014 required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of the cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable difference and is not recorded. In accordance with U.S. GAAP, the Company did not “carry over” any allowances for loan losses that were reserved for the VCB loan portfolio prior to the Company’s acquisition of VCB. PCI loans had unpaid principal balances of $9.3 million and $8.8 million and recorded carrying values of $8.3 million and $7.8 million at June 30, 2015 and December 31, 2014, respectively.

 

Loans acquired from VCB that constituted PCI loans were recorded by the Company at fair value on the date of acquisition as follows:

 

		November 14,
(dollars in thousands)		2014
Contractual principal and interest at acquisition		$	9,977
Nonaccretable difference			937
Accretable yield			1,185
PCI loans at acquisition, at estimated fair value		$	7,855

 

The following table presents a summary of the changes in the accretable yield of the PCI loan portfolio for the periods indicated:

 

		Three months ended				Six months ended
		June 30, 2015				June 30, 2015
(dollars in thousands)		Accretable Yield				Accretable Yield
Balance at beginning of period		$	1,029			$	1,131
Accretion			(104	)			(206	)
Reclassification of nonaccretable difference due to improvement in expected cash flows			-				-
Other changes, net			-				-
Balance at end of period		$	925			$	925

  

 

The following tables present, by loan class, information related to loans modified as TDRs during the three and six months ended June 30, 2015 and 2014:

 

		Three Months Ended June 30, 2015												Three Months Ended June 30, 2014
(dollars in thousands)		Number of Loans				Pre- Modification Recorded Balance				Post- Modification Recorded Balance*				Number of Loans				Pre- Modification Recorded Balance				Post- Modification Recorded Balance*
Real estate - one to four family residential:
Closed end first and seconds			-			$	-			$	-				3			$	512			$	513
Consumer			-				-				-				2				385				385
Total			-			$	-			$	-				5			$	897			$	898

 

*The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

 

		Six Months Ended June 30, 2015												Six Months Ended June 30, 2014
(dollars in thousands)		Number of Loans				Pre- Modification Recorded Balance				Post- Modification Recorded Balance*				Number of Loans				Pre- Modification Recorded Balance				Post- Modification Recorded Balance*
Real estate - one to four family residential:
Closed end first and seconds			-			$	-			$	-				3			$	512			$	513
Consumer			-				-				-				2				385				385
Total			-			$	-			$	-				5			$	897			$	898

 

* The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

 

The following tables present, by loan class, information related to the loans modified as TDRs that subsequently defaulted (i.e., 90 days or more past due following a modification) during the three and six months ended June 30, 2015 and 2014 and were modified as TDRs within the 12 months prior to default:

 

		Three Months Ended June 30, 2015								Three Months Ended June 30, 2014
(dollars in thousands)		Number of Loans				Recorded Balance				Number of Loans				Recorded Balance
Real estate - one to four family residential:
Closed end first and seconds			1			$	68				-			$	-
Total			1			$	68				-			$	-

 

		Six Months Ended June 30, 2015								Six Months Ended June 30, 2014
(dollars in thousands)		Number of Loans				Recorded Balance				Number of Loans				Recorded Balance
Real estate - one to four family residential:
Closed end first and seconds			1			$	68				-			$	-
Total			1			$	68				-			$	-

 

At June 30, 2015, there were no foreclosed residential real estate properties included in other real estate owned. However, at June 30, 2015, there were $514 thousand in residential real estate loans in the process of foreclosure.

 

  

Note 5. Deferred Income Taxes

 

As of June 30, 2015 and December 31, 2014, the Company had recorded net deferred income tax assets of approximately $16.9 million and $17.5 million, respectively. The realization of deferred income tax assets is assessed quarterly and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed.  Management’s assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company’s core earnings capacity and its prospects to generate core earnings in the future.  Projections of core earnings and taxable income are inherently subject to uncertainty and estimates that may change given the uncertain economic outlook, banking industry conditions and other factors. Further, management has considered future reversals of existing taxable temporary differences and limited, prudent and feasible tax-planning strategies, such as changes in investment security income (tax-exempt to taxable), additional sales of loans and sales of branches/buildings with an appreciated asset value over the tax basis. Based upon an analysis of available evidence, management has determined that it is “more likely than not” that the Company’s deferred income tax assets as of June 30, 2015 will be fully realized and therefore no valuation allowance to the Company’s deferred income tax assets was recorded. However, the Company can give no assurance that in the future its deferred income tax assets will not be impaired because such determination is based on projections of future earnings and the possible effect of certain transactions which are subject to uncertainty and based on estimates that may change due to changing economic conditions and other factors.  Due to the uncertainty of estimates and projections, it is possible that the Company will be required to record adjustments to the valuation allowance in future reporting periods.

 

The Company’s ability to realize its deferred income tax assets may be limited if the Company experiences an ownership change as defined by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). For additional information see Part I, Item 1A. “Risk Factors” included in the 2014 Form 10-K.

 

Note 6. Bank Premises and Equipment

 

Bank premises and equipment are summarized as follows:

 

		June 30,				December 31,
(dollars in thousands)		2015				2014
Land and improvements		$	6,699			$	6,929
Buildings and leasehold improvements			27,254				28,001
Furniture, fixtures and equipment			21,078				21,719
Construction in progress			2,658				553
			57,689				57,202
Less accumulated depreciation			(29,061	)			(29,769	)
Net balance		$	28,628			$	27,433

 

Depreciation and amortization of bank premises and equipment for the six months ended June 30, 2015 and 2014 amounted to $1.3 million and $1.0 million, respectively.

 

Note 7. Borrowings

 

Federal funds purchased and repurchase agreements. The Company has unsecured lines of credit with SunTrust Bank, Community Bankers Bank and Pacific Coast Bankers Bank for the purchase of federal funds in the amount of $20.0 million, $15.0 million and $5.0 million, respectively. These lines of credit have a variable rate based on the lending bank’s daily federal funds sold rate and are due on demand. Repurchase agreements are secured transactions and generally mature the day following the day sold. Customer repurchases are standard transactions that involve a Bank customer instead of a wholesale bank or broker. The Company offers this product as an accommodation to larger retail and commercial customers that request safety for their funds beyond the Federal Deposit Insurance Corporation (“FDIC”) deposit insurance limits. The Company does not use or have any open repurchase agreements with broker-dealers.

 

  

The tables below present selected information on federal funds purchased and repurchase agreements during the six months ended June 30, 2015 and the year ended December 31, 2014:

 

Federal funds purchased		June 30,				December 31,
(dollars in thousands)		2015				2014
Balance outstanding at period end		$	-			$	-
Maximum balance at any month end during the period		$	2,440			$	2,000
Average balance for the period		$	85			$	174
Weighted average rate for the period			0.71	%			0.78	%
Weighted average rate at period end			0.00	%			0.00	%

 

Repurchase agreements		June 30,				December 31,
(dollars in thousands)		2015				2014
Balance outstanding at period end		$	8,489			$	14,885
Maximum balance at any month end during the period		$	12,392			$	14,885
Average balance for the period		$	9,969			$	4,523
Weighted average rate for the period			0.62	%			0.59	%
Weighted average rate at period end			0.61	%			0.60	%

 

Short-term borrowings. Short-term borrowings consist of advances from the FHLB, which are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties. Short-term advances from the FHLB at June 30, 2015 consisted of $3.1 million using a daily rate credit, which was due on demand, and $91.5 million in fixed rate one month advances. Short-term advances from the FHLB at December 31, 2014 consisted of $16.4 million using a daily rate credit, which was due on demand, and $60.4 million in fixed rate one month advances.

 

The table below presents selected information on short-term borrowings during the six months ended June 30, 2015 and the year ended December 31, 2014:

 

Short-term borrowings		June 30,				December 31,
(dollars in thousands)		2015				2014
Balance outstanding at period end		$	94,605			$	76,818
Maximum balance at any month end during the period		$	94,605			$	82,930
Average balance for the period		$	77,453			$	72,565
Weighted average rate for the period			0.21	%			0.21	%
Weighted average rate at period end			0.21	%			0.22	%

 

Long-term borrowings. From time to time, the Company may obtain long-term borrowings from the FHLB, which consist of advances from the FHLB that are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties. At June 30, 2015 and December 31, 2014, the Company had no long-term FHLB advances outstanding.

 

The Company’s line of credit with the FHLB can equal up to 30% of the Company’s gross assets or approximately $365.9 million at June 30, 2015. This line of credit totaled $225.3 million with approximately $117.6 million available at June 30, 2015. As of June 30, 2015 and December 31, 2014, loans with a carrying value of $304.5 million are pledged to the FHLB as collateral for borrowings. Additional loans are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value. Short-term borrowings outstanding under the FHLB line of credit were $94.6 million and $76.8 million as of June 30, 2015 and December 31, 2014, respectively.

 

Note 8. Net Income Per Common Share

 

The Company applies the two-class method of computing basic and diluted net income per common share.  Under the two-class method, net income per common share is determined for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Based on FASB guidance, the Company considers its Series B Preferred Stock (defined below) to be a participating security. FASB guidance requires that all outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends participate in undistributed earnings with common shareholders.  Accordingly, the weighted average number of shares of the Company’s common stock used in the calculation of basic and diluted net income per common share includes unvested shares of the Company’s common stock outstanding.

  

  

The following tables show the computation of basic and diluted net income per common share for the periods presented. 

 

		Three Months Ended
		June 30, 2015				June 30, 2014
(dollars in thousands, except share and per share amounts)
Basic Net Income Per Common Share
Net income available to common shareholders		$	1,341			$	1,114
Less: Net income allocated to participating securities, Series B Preferred Stock			385				341
Net income allocated to common shareholders		$	956			$	773
Weighted average common shares outstanding for basic net income per common share			13,023,550				11,862,367
Basic net income per common share		$	0.07			$	0.06
Diluted Net Income Per Common Share
Net income available to common shareholders		$	1,341			$	1,114
Weighted average common shares outstanding for basic net income per common share			13,023,550				11,862,367
Effect of dilutive securities, stock options			-				-
Effect of dilutive securities, Series B Preferred Stock			5,240,192				5,240,192
Weighted average common shares outstanding for diluted net income per common share			18,263,742				17,102,559
Diluted net income per common share		$	0.07			$	0.06

 

		Six Months Ended
		June 30, 2015				June 30, 2014
(dollars in thousands, except share and per share amounts)
Basic Net Income Per Common Share
Net income available to common shareholders		$	2,730			$	2,592
Less: Net income allocated to participating securities, Series B Preferred Stock			784				794
Net income allocated to common shareholders		$	1,946			$	1,798
Weighted average common shares outstanding for basic net income per common share			13,004,595				11,862,367
Basic net income per common share		$	0.15			$	0.15
Diluted Net Income Per Common Share
Net income available to common shareholders		$	2,730			$	2,592
Weighted average common shares outstanding for basic net income per common share			13,004,595				11,862,367
Effect of dilutive securities, stock options			-				-
Effect of dilutive securities, Series B Preferred Stock			5,240,192				5,240,192
Weighted average common shares outstanding for diluted net income per common share			18,244,787				17,102,559
Diluted net income per common share		$	0.15			$	0.15

 

At June 30, 2015 and 2014, options to acquire 102,887 and 145,437 shares of common stock, respectively, were not included in computing diluted net income per common share because their effects were anti-dilutive.

 

On June 12, 2013, the Company issued 5,240,192 shares of non-voting mandatorily convertible non-cumulative preferred stock, Series B (the “Series B Preferred Stock”) through private placements to certain investors. Each share of Series B Preferred Stock can, under certain limited circumstances as set forth in the Company’s articles of incorporation, be converted into one share of the Company’s common stock, and is therefore reflected in the dilutive weighted average common shares outstanding. For more information related to the conversion rights on these preferred shares, see Note 12 – Preferred Stock and Warrant.

 

Additionally, the impact of warrants to acquire shares of the Company’s common stock that were issued to the U.S. Department of the Treasury (“Treasury”) in connection with the Company’s participation in the Capital Purchase Program is not included, as the warrants were anti-dilutive. As previously disclosed, these warrants were repurchased by the Company during May 2015. For additional information on preferred stock warrants, see Note 12 – Preferred Stock and Warrant.

 

The Company identified and corrected an immaterial error affecting the calculation of basic net income per common share for certain periods prior to the second quarter of 2015.  Previously, the Company did not consider the Series B Preferred Stock as a participating security when calculating basic net income per common share.  The Company will correct basic net income per common share for historical periods as such measures are disclosed in future public reports, filings and statements.  This immaterial error had no impact on previously reported diluted net income per common share for any historical periods.

 

 

Note 9. Stock Based Compensation Plans

 

On September 21, 2000, the Company adopted the Eastern Virginia Bankshares, Inc. 2000 Stock Option Plan (the “2000 Plan”) to provide a means for selected key employees and directors to increase their personal financial interest in the Company, thereby stimulating their efforts and strengthening their desire to remain with the Company. Under the 2000 Plan, up to 400,000 shares of Company common stock could be granted in the form of stock options. On April 17, 2003, the shareholders approved the Eastern Virginia Bankshares, Inc. 2003 Stock Incentive Plan, amending and restating the 2000 Plan (the “2003 Plan”) still authorizing the issuance of up to 400,000 shares of common stock under the plan, but expanding the award types available under the plan to include stock options, stock appreciation rights, common stock, restricted stock and phantom stock. Under the terms of the 2003 Plan, after April 17, 2013 no additional awards may be granted under the 2003 Plan. Any awards previously granted under the 2003 Plan that were outstanding as of April 17, 2013 remain outstanding and will vest in accordance with their regular terms.

 

On April 19, 2007, the Company’s shareholders approved the Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan (the “2007 Plan”) to enhance the Company’s ability to recruit and retain officers, directors, employees, consultants and advisors with ability and initiative and to encourage such persons to have a greater financial interest in the Company. The 2007 Plan authorizes the Company to issue up to 400,000 additional shares of common stock pursuant to grants of stock options, stock appreciation rights, common stock, restricted stock, performance shares, incentive awards and stock units. There were 225,642 shares still available to be granted as awards under the 2007 Plan as of June 30, 2015.

 

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of grant.

 

Accounting standards also require that new awards to employees eligible for accelerated vesting at retirement prior to the awards becoming fully vested be recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award.

 

Stock option compensation expense is the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for each stock option award. There were no stock options granted or exercised in the six months ended June 30, 2015 and 2014. There was no remaining unrecognized compensation expense related to stock options.

 

A summary of the Company’s stock option activity and related information is as follows:

 

										Remaining				Aggregate
		Options				Weighted Average				Contractual Life				Intrinsic Value
		Outstanding				Exercise Price				(in years)				(in thousands)
Stock options outstanding at January 1, 2015			110,487			$	18.76
Forfeited			(7,600	)			18.65
Stock options outstanding at June 30, 2015			102,887			$	18.77				1.56			$	-
Stock options exercisable at June 30, 2015			102,887			$	18.77				1.56			$	-

 

* Intrinsic value is the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date.

 

 

The table below summarizes information concerning stock options outstanding and exercisable at June 30, 2015:

 

Stock Options Outstanding and Exercisable
Exercise				Number				Weighted Average
Price				Outstanding				Remaing Term
$	20.57				26,862			0.00 years*
$	21.16				31,525			1.25 years
$	19.25				23,500			2.25 years
$	12.36				21,000			3.25 years
$	18.77				102,887			1.56 years

 

*These options expire on July 1, 2015.

 

On March 19, 2015, the Company granted 45,000 shares of restricted stock under the 2007 Plan to its executive officers. Fifty percent (50%) of the shares are subject to time vesting in five equal annual installments beginning on March 31, 2016.  The remaining fifty percent (50%) of the shares are subject to performance vesting and will vest on March 31, 2018 to the extent certain financial performance requirements for fiscal year 2017 are met. On October 15, 2014, the Company granted 42,500 shares of restricted stock under the 2007 Plan to its executive officers.  Fifty percent (50%) of the shares are subject to time vesting in five equal annual installments beginning on March 31, 2015.  The remaining fifty percent (50%) of the shares are subject to performance vesting and will vest on March 31, 2017 to the extent certain financial performance requirements for fiscal year 2016 are met. On November 20, 2014, the Company granted 3,242 shares of restricted stock under the 2007 Plan to one of its executive officers.  All of these shares are subject to time vesting over a two year period, and generally vest fifty percent (50%) on the first and second anniversaries of the grant date. On November 18, 2013, the Company granted 38,000 shares of restricted stock under the 2007 Plan to its executive officers in the form of Troubled Asset Relief Program (“TARP”) compliant restricted stock awards. All of these shares are subject to time vesting over a five year period, and generally vest forty percent (40%) on the second anniversary of the grant date and twenty percent (20%) on each of the third, fourth and fifth anniversaries of the grant date. On June 29, 2012, the Company granted 34,000 shares of restricted stock under the 2007 Plan to its executive officers in the form of TARP compliant restricted stock awards. All of these shares are subject to time vesting over a five year period, and generally vest forty percent (40%) on the second anniversary of the grant date and twenty percent (20%) on each of the third, fourth and fifth anniversaries of the grant date.

 

For the three and six months ended June 30, 2015 and 2014, restricted stock compensation expense was $63 thousand and $114 thousand, respectively, compared to restricted stock compensation expense of $19 thousand and $39 thousand, respectively, and was included in salaries and employee benefits expense in the consolidated statements of income. Restricted stock compensation expense is accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded, which was $6.28 per share for the March 19, 2015 awards, $6.10 per share for the October 15, 2014 awards, $6.17 per share for the November 20, 2014 award, $6.70 per share for the 2013 awards and $3.72 per share for the 2012 awards.

 

A summary of the status of the Company’s nonvested shares in relation to the Company’s restricted stock awards as of June 30, 2015, and changes during the six months ended June 30, 2015, is presented below; the weighted average price is the weighted average fair value at the date of grant:

 

						Weighted-Average
		Shares				Price
Nonvested as of January 1, 2015			104,142			$	5.85
Granted			45,000				6.28
Vested			(11,050	)			4.64
Nonvested as of June 30, 2015			138,092			$	6.09

 

At June 30, 2015, there was $615 thousand of total unrecognized compensation expense related to restricted stock awards. This unearned compensation is being amortized over the remaining vesting period for the time and performance based shares.

 

 

Note 10. Employee Benefit Plan – Pension

 

The Company has historically maintained a defined benefit pension plan covering substantially all of the Company’s employees. The plan was amended January 28, 2008 to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participants’ account will be credited with an “interest” credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Components of net periodic pension benefit related to the Company’s pension plan were as follows for the periods indicated:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(dollars in thousands)		2015				2014				2015				2014
Components of net periodic pension cost (benefit)
Interest cost		$	101			$	111			$	202			$	223
Expected return on plan assets			(179	)			(186	)			(357	)			(372	)
Amortization of prior service cost			3				2				5				4
Recognized net actuarial loss			27				-				54				-
Net settlement loss			53				-				53				-
Net periodic pension cost (benefit)		$	5			$	(73	)		$	(43	)		$	(145	)

 

The Company made no contributions to the pension plan during 2014. The Company has not determined at this time how much, if any, contributions to the plan will be made for the year ending December 31, 2015.

 

Note 11. Fair Value Measurements

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

 

·

Level 1 – Valuation is based upon quoted prices (unadjusted) for identical instruments traded in active markets.

 

·

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·

Level 3 – Valuation is determined using model-based techniques with significant assumptions not observable in the market.

 

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any fair value option elections as of June 30, 2015.

 

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

 

  

Assets Measured at Fair Value on a Recurring Basis

 

Securities Available For Sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s available for sale securities are considered to be Level 2 securities.

 

The following table summarizes financial assets measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

Assets Measured at Fair Value on a Recurring Basis at June 30, 2015 Using
		Quoted Prices in				Significant Other				Significant
		Active Markets for				Observable				Unobservable				Balance at
		Identical Assets				Inputs				Inputs				June 30,
(dollars in thousands)		(Level 1)				(Level 2)				(Level 3)				2015
Assets
Securities available for sale
Obligations of U.S. Government agencies		$	-			$	13,081			$	-			$	13,081
SBA Pool securities			-				71,007				-				71,007
Agency residential mortgage-backed securities			-				19,400				-				19,400
Agency commercial mortgage-backed securities			-				6,487				-				6,487
Agency CMO securities			-				53,154				-				53,154
Non agency CMO securities			-				704				-				704
State and political subdivisions			-				64,090				-				64,090
FNMA and FHLMC preferred stock			-				9				-				9
Total securities available for sale		$	-			$	227,932			$	-			$	227,932

  

Assets Measured at Fair Value on a Recurring Basis at December 31, 2014 Using
		Quoted Prices in				Significant Other				Significant
		Active Markets for				Observable				Unobservable				Balance at
		Identical Assets				Inputs				Inputs				December 31,
(dollars in thousands)		(Level 1)				(Level 2)				(Level 3)				2014
Assets
Securities available for sale
Obligations of U.S. Government agencies		$	-			$	14,569			$	-			$	14,569
SBA Pool securities			-				74,799				-				74,799
Agency residential mortgage-backed securities			-				28,629				-				28,629
Agency CMO securities			-				39,215				-				39,215
Non agency CMO securities			-				828				-				828
State and political subdivisions			-				55,926				-				55,926
FNMA and FHLMC preferred stock			-				45				-				45
Total securities available for sale		$	-			$	214,011			$	-			$	214,011

 

  

Assets Measured at Fair Value on a Non-Recurring Basis

 

Certain assets are measured at fair value on a non-recurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from the application of fair value accounting or impairment write-downs of individual assets.

 

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 when due. 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. 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 an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

 

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a non-recurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

 

Other Real Estate Owned. Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a non-recurring basis. Any initial fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statements of income.

 

The following table summarizes assets measured at fair value on a non-recurring basis as of June 30, 2015 and December 31, 2014, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

Assets Measured at Fair Value on a Non-Recurring Basis at June 30, 2015 Using
		Quoted Prices in			Significant Other				Significant
		Active Markets for			Observable				Unobservable				Balance at
		Identical Assets			Inputs				Inputs				June 30,
		(Level 1)			(Level 2)				(Level 3)				2015
		(dollars in thousands)
Assets
Impaired loans		$	-		$	-			$	14,338			$	14,338
Other real estate owned		$	-		$	-			$	1,344			$	1,344

 

Assets Measured at Fair Value on a Non-Recurring Basis at December 31, 2014 Using
		Quoted Prices in			Significant Other				Significant
		Active Markets for			Observable				Unobservable				Balance at
		Identical Assets			Inputs				Inputs				December 31,
		(Level 1)			(Level 2)				(Level 3)				2014
		(dollars in thousands)
Assets
Impaired loans		$	-		$	-			$	17,852			$	17,852
Other real estate owned		$	-		$	-			$	1,838			$	1,838

 

  

The following table displays quantitative information about Level 3 Fair Value Measurements as of June 30, 2015 and December 31, 2014:

 

Quantitative information about Level 3 Fair Value Measurements at June 30, 2015
(dollars in thousands)		Fair Value				Valuation Technique(s)		Unobservable Input		Range (Weighted Average)
Assets
Impaired loans		$	14,338			Discounted appraised value		Selling cost		0% - 24% (12%)
								Discount for lack of marketability and age of appraisal		0% - 25% (9%)
Other real estate owned		$	1,344			Discounted appraised value		Selling cost		10% (10%)
								Discount for lack of marketability and age of appraisal		0% -34% (29%)

 

Quantitative information about Level 3 Fair Value Measurements at December 31, 2014
(dollars in thousands)		Fair Value				Valuation Technique(s)		Unobservable Input		Range (Weighted Average)
Assets
Impaired loans		$	17,852			Discounted appraised value		Selling cost		0% - 30% (9%)
								Discount for lack of marketability and age of appraisal		0% - 35% (13%)
Other real estate owned		$	1,838			Discounted appraised value		Selling cost		10% (10%)
								Discount for lack of marketability and age of appraisal		0% - 22% (2%)

 

Fair Value of Financial Instruments

 

U.S. GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies and assumptions for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies and assumptions for other financial assets and financial liabilities are discussed below:

 

Cash and Short-Term Investments. For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Investment Securities. For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted prices for similar securities. All securities prices are provided by independent third party vendors.

 

Restricted Securities. The carrying amount approximates fair value based on the redemption provisions of the correspondent banks.

 

  

Loans. The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans such as the borrower’s creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note.

 

Bank Owned Life Insurance. Bank owned life insurance represents insurance policies on officers of the Company. The cash values of the policies are estimated using information provided by insurance carriers. The policies are carried at their cash surrender value, which approximates fair value.

 

Deposits. The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using market rates for deposits of similar remaining maturities.

 

Short-Term Borrowings. The carrying amounts of federal funds purchased and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the current incremental borrowing rates for similar types of borrowing arrangements.

 

Long-Term Borrowings. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

Accrued Interest Receivable and Accrued Interest Payable. The carrying amounts of accrued interest approximate fair value.

 

Off-Balance Sheet Financial Instruments. The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness 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. The fair value of guarantees of credit card accounts previously sold is based on the estimated cost to settle the obligations with the counterparty at the reporting date. At June 30, 2015 and December 31, 2014, the fair value of loan commitments, standby letters of credit and credit card guarantees are not significant and are not included in the table below.

 

  

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

 

						Fair Value Measurements at June 30, 2015 Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable				Balance at
						Identical Assets				Inputs				Inputs				June 30,
(dollars in thousands)		Carrying Amount				(Level 1)				(Level 2)				(Level 3)				2015
Assets:
Cash and short-term investments		$	14,416			$	14,416			$	-			$	-			$	14,416
Interest bearing deposits with banks			6,467				6,467				-				-				6,467
Securities available for sale			227,932				-				227,932				-				227,932
Securities held to maturity			30,671				-				31,542				-				31,542
Restricted securities			8,118				-				8,118				-				8,118
Loans, net			828,423				-				-				831,604				831,604
Bank owned life insurance			24,786				-				24,786				-				24,786
Accrued interest receivable			3,990				-				3,990				-				3,990
Total		$	1,144,803			$	20,883			$	296,368			$	831,604			$	1,148,855
Liabilities:
Noninterest-bearing demand deposits		$	178,844			$	178,844			$	-			$	-			$	178,844
Interest-bearing deposits			778,378				-				729,618				-				729,618
Short-term borrowings			103,094				103,094				-				-				103,094
Junior subordinated debt			10,310				-				10,310				-				10,310
Senior subordinated debt			19,140				-				19,359				-				19,359
Accrued interest payable			530				-				530				-				530
Total		$	1,090,296			$	281,938			$	759,817			$	-			$	1,041,755

  

						Fair Value Measurements at December 31, 2014 Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable				Balance at
						Identical Assets				Inputs				Inputs				December 31,
(dollars in thousands)		Carrying Amount				(Level 1)				(Level 2)				(Level 3)				2014
Assets:
Cash and short-term investments		$	14,024			$	14,024			$	-			$	-			$	14,024
Interest bearing deposits with banks			5,272				5,272				-				-				5,272
Securities available for sale			214,011				-				214,011				-				214,011
Securities held to maturity			32,163				-				33,367				-				33,367
Restricted securities			7,533				-				7,533				-				7,533
Loans, net			807,548				-				-				812,429				812,429
Bank owned life insurance			24,463				-				24,463				-				24,463
Accrued interest receivable			4,013				-				4,013				-				4,013
Total		$	1,109,027			$	19,296			$	283,387			$	812,429			$	1,115,112
Liabilities:
Noninterest-bearing demand deposits		$	162,328			$	162,328			$	-			$	-			$	162,328
Interest-bearing deposits			776,926				-				721,240				-				721,240
Short-term borrowings			91,703				91,703				-				-				91,703
Junior subordinated debt			10,310				-				10,310				-				10,310
Accrued interest payable			316				-				316				-				316
Total		$	1,041,583			$	254,031			$	731,866			$	-			$	985,897

 

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of the Company’s normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. The Company 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. 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. The Company 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 12. Preferred Stock and Warrant

 

On January 9, 2009, the Company signed a definitive agreement with the Treasury under the Emergency Economic Stabilization Act of 2008 to participate in the Treasury’s Capital Purchase Program. Pursuant to this agreement, the Company sold 24,000 shares of its Series A fixed rate cumulative perpetual preferred stock, liquidation value $1,000 per share (the “Series A Preferred Stock”), to the Treasury for an aggregate purchase price of $24 million. The Series A Preferred Stock paid a cumulative dividend at a rate of 5% for the first five years, and effective January 9, 2014, paid a rate of 9%. As part of its purchase of the Series A Preferred Stock, the Treasury was also issued a warrant (the “Warrant”) to purchase, on its initial terms, up to 373,832 shares of the Company’s common stock at an initial exercise price of $9.63 per share. If not exercised, the Warrant expires after ten years. On October 21, 2013, the Treasury sold all 24,000 shares of Series A Preferred Stock that were held by Treasury to private investors. Capital stock transactions by the Company subsequent to the Warrant’s issuance adjusted the Warrant’s exercise price per share to $9.374 and increased the number of shares that may be acquired upon exercise to 384,041.19 shares.

 

On May 13, 2015, the Company repurchased from the Treasury the Warrant for an aggregate repurchase price of $115 thousand, based on the fair value of the Warrant as agreed upon by the Company and the Treasury. Following the repurchase of the Warrant, the Treasury has no remaining equity investment in the Company. Additionally, on June 15, 2015, the Company redeemed the remaining $9.0 million of its Series A Preferred Stock.

 

Accounting for the issuance of the Series A Preferred Stock included entries to the equity portion of the Company’s consolidated balance sheet to recognize the Series A Preferred Stock at the full amount of the issuance, the warrant and discount on the Series A Preferred Stock at values calculated by discounting the future cash flows by a prevailing interest rate that a similar security would receive in the current market environment. At the time of issuance, that discount rate was determined to be 12%. The fair value of the warrant of $950 thousand was calculated using the Black-Scholes model with inputs of 7 year volatility, average rate of quarterly dividends, 7 year Treasury strip rate and the exercise price of $9.63 per share exercisable for up to 10 years. The present value of the Series A Preferred Stock using a 12% discount rate was $14.4 million. The Series A Preferred Stock discount determined by the allocation of discount to the warrant was accreted quarterly over a 5 year period on a constant effective yield method at a rate of approximately 6.4%. Allocation of the Series A Preferred Stock discount and the warrant as of January 9, 2009 is provided in the tables below:

 

		2009
Warrant Value
Series A Preferred Stock		$	24,000,000
Price		$	9.63
Warrant - shares			373,832
Value per warrant		$	2.54
Fair value of warrant		$	949,533

 

  

NPV of Series A Preferred Stock
@ 12% discount rate		(dollars in thousands)
						Relative				Relative
		Fair Value				Value %				Value
$24 million 1/09/2009
NPV of Series A Preferred Stock (12% discount rate)		$	14,446				93.8	%		$	22,519
Fair value of warrant			950				6.2	%			1,481
		$	15,396				100.0	%		$	24,000

 

From February 2011 to May 2014, the Company deferred its regularly scheduled dividend payments on its Series A Preferred Stock. Deferral of dividends on the Series A Preferred Stock did not constitute an event of default.  Dividends on the Series A Preferred Stock were, however, cumulative, and the Company had accumulated the dividends in accordance with the terms of the Series A Preferred Stock and U.S. GAAP and reflected the accumulated dividends as a portion of the effective dividend on Series A Preferred Stock on the consolidated statements of income.  On August 15, 2014, the Company paid $5.5 million of current and all deferred but accumulated dividends on its Series A Preferred Stock.

 

In connection with its private placements, on June 12, 2013, the Company issued 5,240,192 shares of its Series B Preferred Stock for a gross purchase price of $23.8 million, or $4.55 per share. The Series B Preferred Stock has no maturity date. The holders of Series B Preferred Stock are entitled to receive dividends if, as and when declared by the Company’s Board of Directors, in an identical form of consideration and at the same time, as those dividends or distributions that would have been payable on the number of whole shares of the Company’s common stock that such shares of Series B Preferred Stock would be convertible into upon satisfaction of certain conditions. The Company will not pay any dividends with respect to its common stock unless an equivalent dividend also is paid to the holders of Series B Preferred Stock. The Series B Preferred Stock ranks junior with regard to dividends to any class or series of capital stock of the Company the terms of which expressly provide that such class or series will rank senior to the common stock or the Series B Preferred Stock as to dividend rights and/or as to rights on liquidation, dissolution or winding up of the Company.

 

Note 13. Junior and Senior Subordinated Debt

 

On September 17, 2003, $10 million of trust preferred securities were placed through EVB Statutory Trust I in a pooled underwriting totaling approximately $650 million. The trust issuer has invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures (“Junior Subordinated Debt”) issued by the Parent. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the 3-month LIBOR plus 2.95%. As of June 30, 2015 and December 31, 2014, the interest rate was 3.23% and 3.21%, respectively. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities have a mandatory redemption date of September 17, 2033, and became subject to varying call provisions beginning September 17, 2008. The Parent has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the Junior Subordinated Debt and other related documents. The Parent’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Parent.

 

The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. At June 30, 2015 and December 31, 2014, all of the trust preferred securities qualified as Tier 1 capital.

 

Subject to certain exceptions and limitations, the Company is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debt relating to its trust preferred securities. If the Company defers interest payments on the Junior Subordinated Debt for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.

 

From June 2011 to March 2014, the Company deferred its regularly scheduled interest payments on its outstanding Junior Subordinated Debt relating to its trust preferred securities due to prohibitions on such payments under provisions of regulatory agreements with the Company’s and the Bank’s federal and state banking regulators. On June 17, 2014, the Company paid all current and deferred interest on these outstanding Junior Subordinated Debt, and the Company has not deferred any subsequent interest payments through June 30, 2015.

 

  

On April 22, 2015, the Company entered in a Senior Subordinated Note Purchase Agreement with certain institutional accredited investors pursuant to which the Company sold $20.0 million in aggregate principal amount of its 6.50% Fixed-to-Floating Rate Subordinated Notes due 2025 ("Senior Subordinated Debt") to the investors at a price equal to 100% of the aggregate principal amount of the Senior Subordinated Debt. The Senior Subordinated Debt bears interest at an annual rate of 6.50%, payable semi-annually in arrears on May 1 and November 1 of each year ending on May 1, 2020. From and including May 1, 2020 to, but excluding, the maturity date, the Senior Subordinated Debt will bear interest at an annual rate, reset quarterly, equal to LIBOR determined on the determination date of the applicable interest period plus 502 basis points, payable quarterly in arrears on February 1, May 1, August 1 and November 1 of each year, beginning on August 1, 2020. The Company may, at its option, redeem, in whole or in part, the Senior Subordinated Debt as early as May 1, 2020, and any partial redemption would be made pro rata among all of the holders. At June 30, 2015, all of the Senior Subordinated Debt qualified as Tier 2 capital. At June 30, 2015, the remaining unamortized debt issuance costs related to the Senior Subordinated Debt totaled $860 thousand.

 

Note 14. Capital Requirements

 

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

 

In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and a revised framework for calculating risk-weighted assets (the “Basel III Capital Rules”). The Basel III Capital Rules were effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain portions of the new rules). For a summary of these final rules, see Part I, Item 1 “Business” under the heading “Regulation and Supervision – Capital Requirements” included in the 2014 Form 10-K.

 

 

As of June 30, 2015, the most recent notification from the Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, common equity Tier 1 (“CET1”) risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank’s category. The capital ratios of the Company and the Bank as of June 30, 2015 and December 31, 2014, presented with related minimum regulatory guidelines, is as follows:

 

										Minimum To Be
As of June 30, 2015										Well-Capitalized
						Minimum				Under Prompt
						Capital				Corrective Action
		Actual Capital				Requirements				Provisions
CET1 to risk weighted assets:
Company			9.59	%			4.50	%			N/A
Bank			12.53	%			4.50	%			6.50	%
Tier 1 capital to risk weighted assets:
Company			12.58	%			6.00	%			N/A
Bank			12.53	%			6.00	%			8.00	%
Total capital to risk weighted assets:
Company			16.12	%			8.00	%			N/A
Bank			13.78	%			8.00	%			10.00	%
Tier 1 capital to average assets:
Company			9.44	%			4.00	%			N/A
Bank			9.39	%			4.00	%			5.00	%

 

										Minimum to be
As of December 31, 2014										Well-Capitalized
						Minimum				Under Prompt
						Capital				Corrective Action
		Actual Capital				Requirements				Provisions
Tier 1 capital to risk weighted assets:
Company			14.06	%			4.00	%			N/A
Bank			12.28	%			4.00	%			6.00	%
Total capital to risk weighted assets:
Company			15.31	%			8.00	%			N/A
Bank			13.53	%			8.00	%			10.00	%
Tier 1 capital to average assets:
Company			10.76	%			4.00	%			N/A
Bank			9.40	%			4.00	%			5.00	%

  

  

Note 15. Low Income Housing Tax Credits

 

The Company has invested in four separate housing equity funds at June 30, 2015. The general purpose of these funds is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, deliver Federal Low Income Housing Credits to investors, allocate tax losses and other possible tax benefits to investors, and to preserve and protect project assets. The investments in these funds were recorded as other assets on the consolidated balance sheets and were $3.0 million and $2.2 million at June 30, 2015 and December 31, 2014, respectively. These investments and related tax benefits have expected terms through 2032, with the majority maturing by 2027. Tax credits and other tax benefits recognized related to these investments during the six months ended June 30, 2015 and 2014 were $238 thousand and $191 thousand, respectively. Total projected tax credits to be received for 2015 are $366 thousand, which is based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds totaled $1.0 million and $35 thousand at June 30, 2015 and December 31, 2014, respectively, and are included in other liabilities on the consolidated balance sheets.

 

Note 16. Accumulated Other Comprehensive Loss

 

The changes in accumulated other comprehensive loss for the six months ended June 30, 2015 and 2014 are summarized as follows:

 

(dollars in thousands)		Unrealized Securities Gains (Losses)				Adjustments Related to Pension Plan				Accumulated Other Comprehensive Loss
Balance at December 31, 2014		$	(1,954	)		$	(2,112	)		$	(4,066	)
Other comprehensive (loss) before reclassification and amortization			(597	)			-				(597	)
Reclassification adjustment for gains included in net income			(34	)			-				(34	)
Net amortization of unrealized losses on securities transferred from available for sale to held to maturity			64				-				64
Net current period other comprehensive (loss)			(567	)			-				(567	)
Balance at June 30, 2015		$	(2,521	)		$	(2,112	)		$	(4,633	)
Balance at December 31, 2013		$	(8,396	)		$	(472	)		$	(8,868	)
Other comprehensive income before reclassification and amortization			4,364				-				4,364
Reclassification adjustment for gains included in net income			(323	)			-				(323	)
Net amortization of unrealized losses on securities transferred from available for sale to held to maturity			80				-				80
Net current period other comprehensive income			4,121				-				4,121
Balance at June 30, 2014		$	(4,275	)		$	(472	)		$	(4,747	)

 

Reclassifications of gains on securities available for sale are reported in the consolidated statements of income as “Gain on sale of available for sale securities, net” with the corresponding income tax effect being reflected as a component of income tax expense. Amortization of unrealized losses on securities transferred from available for sale to held to maturity is included in interest income on investments (taxable or non-taxable, as appropriate) in the Company’s consolidated statements of income.

 

  

During the three and six months ended June 30, 2015 and 2014, the Company reported gains on the sale of available for sale securities and amortization of unrealized losses on securities transferred from available for sale to held to maturity as shown in the following table:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(dollars in thousands)		2015				2014				2015				2014
Gains on sale of available for sale securities		$	26			$	109			$	51			$	489
Less: tax effect			(8	)			(37	)			(17	)			(166	)
Net gains on the sale of available for sale securities		$	18			$	72			$	34			$	323
Amortization of unrealized losses on securities transferred from available for sale to held to maturity		$	(57	)		$	(78	)		$	(97	)		$	(121	)
Less: tax effect			19				26				33				41
Net amortization of unrealized losses on securities transferred from available for sale to held to maturity		$	(38	)		$	(52	)		$	(64	)		$	(80	)

 

  

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

 

We present management’s discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations. This discussion provides information about the major components of our results of operations, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements presented elsewhere in this report and the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in the 2014 Form 10-K. Operating results include those of all our operating entities combined for all periods presented.

 

Internet Access to Corporate Documents

 

Information about the Company can be found on the Company’s investor relations website at http://www.evb.org. The Company posts its annual reports, quarterly reports, current reports, definitive proxy materials and any amendments to those documents as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. All such filings are available at no charge. The information on the Company’s website is not, and shall not be deemed to be, a part of this Quarterly Report on Form 10-Q or incorporated into any other filings the Company makes with the SEC.

 

Forward Looking Statements

 

Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute “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 (the “Exchange Act”), as amended. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Exchange Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, income or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or Board of Directors, including those relating to products or services, the performance or disposition of portions of the Company’s asset portfolio, future changes to the Bank’s branch network and the payment of dividends; (iii) statements of future financial performance and economic conditions; (iv) statements regarding the adequacy of the allowance for loan losses; (v) statements regarding the effect of future sales of investment securities or foreclosed properties; (vi) statements regarding the Company’s liquidity; (vii) statements of management’s expectations regarding future trends in interest rates, real estate values, and economic conditions generally and in the Company’s markets; (viii) statements regarding future asset quality, including expected levels of charge-offs; (ix) statements regarding potential changes to laws, regulations or administrative guidance; (x) statements regarding strategic initiatives of the Company or the Bank and the results of these initiatives; and (xi) statements of assumptions underlying such statements. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

 

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

 

q

factors that adversely affect our strategic and business initiatives, including, without limitation, changes in the economic or business conditions in the Company’s markets;

q

our ability and efforts to assess, manage and improve our asset quality;

q

the strength of the economy in our target market area, as well as general economic, market, political, or business factors;

q

changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries or in the repayment ability of individual borrowers or issuers;

q

concentrations in segments of the loan portfolio or declines in real estate values in the Company’s markets;

q

the effects of our adjustments to the composition of our investment portfolio;

q

the strength of the Company’s counterparties;

q

an insufficient allowance for loan losses;

q

our ability to meet the capital requirements of our regulatory agencies;

q

changes in laws, regulations and the policies of federal or state regulators and agencies, the implementation of the Basel III capital framework and for calculating risk-weighted assets;

q

changes in the interest rates affecting our deposits and loans;

 

 

q

the loss of any of our key employees;

q

failure, interruption or breach of any of the Company’s communication or information systems, including those provided by external vendors;

q

our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;

q

future mergers or acquisitions, if any;

q

changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services;

q

our ability to maintain internal control over financial reporting;

q

our ability to realize our deferred tax assets, including in the event we experience an ownership change as defined by Section 382 of the Code;

q

our ability to raise capital as needed by our business;

q

our reliance on secondary sources, such as FHLB advances, sales of securities and loans and federal funds lines of credit from correspondent banks to meet our liquidity needs; and

q

other circumstances, many of which are beyond our control.

 

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions and projections within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance, actions or achievements of the Company will not differ materially from any future results, performance, actions or achievements expressed or implied by such forward-looking statements. Readers should not place undue reliance on such statements, which speak only as of the date of this report. The Company does not undertake any steps to update any forward-looking statement that may be made from time to time by it or on its behalf. For additional information on risk factors that could affect the Company’s forward-looking statements, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 and other reports filed with the SEC.

 

Critical Accounting Policies

 

The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.

 

Allowance for Loan Losses

 

The Company establishes the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. For more information see the section titled “Asset Quality” within this Item 2.

 

Impairment of Loans

 

The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due, according to the contractual terms of the loan agreement. The Company does not consider a loan impaired during a period of insignificant payment shortfalls if we expect the ultimate collection of all amounts due. Impairment is measured on a loan by loan basis for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans, representing consumer, one to four family residential first and seconds and home equity lines, are collectively evaluated for impairment. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are also considered impaired loans. A TDR occurs when the Company, for economic or legal reasons related to the borrower’s financial condition, grants a concession (including, without limitation, rate reductions to below-market rates, payment deferrals, forbearance and, in some cases, forgiveness of principal or interest) to the borrower that it would not otherwise consider. For more information see the section titled “Asset Quality” within Item 2.

 

 

Loans Acquired in a Business Combination

 

The Company accounts for loans acquired in a business combination, such as the Company’s acquisition of VCB, in accordance with the FASB ASC Topic 805, “Business Combinations.” Accordingly, acquired loans are segregated between PCI loans and purchased performing loans and are recorded at estimated fair value on the date of acquisition without the carryover of the related allowance for loan losses.

 

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. When determining fair market value, PCI loans were aggregated into pools of loans based on common characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The Company estimates the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded as a provision for loan losses. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income. Loans not designated PCI loans as of the acquisition date are designated purchased performing loans. The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing or PCI loans. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition.

 

Impairment of 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) the Company intends to sell the security or (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery, the Company 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 the Company’s ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

 

Other Real Estate Owned

 

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at estimated fair market value of the property, less estimated disposal costs, if any. Any excess of cost over the estimated fair market value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings.

 

 

Goodwill

 

With the adoption of ASU 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, it determines that it is more likely than not that the fair value of goodwill is less than its carrying amount. If the likelihood of impairment is more than 50 percent, the Company must perform a test for impairment and we may be required to record impairment charges. In assessing the recoverability of the Company’s goodwill, the Company must make assumptions in order to determine the fair value of the respective assets. Major assumptions used in the impairment analysis were discounted cash flows, merger and acquisition transaction values (including as compared to tangible book value), and stock market capitalization. The Company chose to bypass the preliminary assessment of qualitative impairment factors and completed its annual goodwill impairment test during the fourth quarter of 2014 through the use of an independent third party specialist and determined there was no impairment to be recognized in 2014. If the underlying estimates and related assumptions change in the future, the Company may be required to record impairment charges.

 

Retirement Plan

 

The Company has historically maintained a defined benefit pension plan. Effective January 28, 2008, the Company took action to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended on February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participant’s account will be credited with an “interest” credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.

 

Accounting for Income Taxes

 

Determining the Company’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Company’s tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

 

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized.  “More likely than not” is defined as greater than a 50% chance.  Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed. For more information, see Item 1. “Financial Statements,” under the heading “Note 5. Deferred Income Taxes” in this Quarterly Report on Form 10-Q and Item 8. “Financial Statements and Supplementary Data,” under the headings “Note 1. Summary of Significant Accounting Policies” and “Note 11. Income Taxes” in the 2014 Form 10-K.

 

For further information concerning accounting policies, refer to Item 8. “Financial Statements and Supplementary Data,” under the heading “Note 1. Summary of Significant Accounting Policies” in the 2014 Form 10-K.

 

Business Overview

 

The Company provides a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level, so they can provide timely lending decisions and respond promptly to customer inquiries. Having been in many of our markets for over 100 years, we have established relationships with and an understanding of our customers. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.

 

 

The Company is committed to delivering strong, long-term earnings using a prudent allocation of capital, in business lines where we have demonstrated the ability to compete successfully. During the first six months of 2015, the national and local economies continued to show measured signs of recovery with the main challenges continuing to be persistent unemployment above historical levels and uneven economic growth. Macro-economic and political issues continue to temper the global economic outlook and, as such, the Company remains cautiously optimistic regarding the limited signs of improvement seen in our local markets. Despite this, the Company believes that our local markets are poised for stronger growth in the coming months and years than the economic recovery has provided in our markets in recent periods.

 

Since 2013 the Company has completed strategic initiatives that have significantly improved the Company’s financial condition. These initiatives represent significant progress toward the Company’s long-term goal of growing a more robust community banking business, and will provide the platform for continued growth and success in future periods. These initiatives include:

 

·

Raising in 2013 an aggregate of $50.0 million of gross proceeds from sales of the Company’s common stock and Series B Preferred Stock in private placements to certain institutional investors ($45.0 million in gross proceeds) and a rights offering to existing shareholders ($5.0 million in gross proceeds) (collectively, the “2013 Capital Initiative”);

·

Using a portion of the proceeds from the 2013 Capital Initiative to prepay long-term, higher-rate FHLB advances and to accelerate the disposition of adversely classified assets;

·

Paying all current and previously deferred interest and all current and previously deferred, but accumulated, dividends on the Company’s Junior Subordinated Debt and Series A Preferred Stock, respectively;

·

Redeeming all of the Company’s Series A Preferred Stock, which eliminated one of the Company’s most expensive sources of capital;

·

Acquiring VCB effective November 14, 2014, thus adding three branches to the Bank’s branch network and an aggregate of $128.9 million of assets to the Company’s balance sheet. All former VCB branches have been fully integrated into the Bank’s branch network and operate as branches of the Bank, expanding the Bank’s branch network into the Virginia cities of Hampton, Newport News and Williamsburg;

·

Opening a loan production office in Chesterfield County, Virginia to increase the Bank’s presence in the Richmond metropolitan area;

·

Declaring dividends to holders of both the Company’s common stock and Series B Preferred Stock of $0.01 as of March 6, 2015 and May 8, 2015, which were paid on March 20, 2015 and May 22, 2015, respectively; and

·

Raising in the second quarter of 2015 an aggregate of $20.0 million in gross proceeds from sales of Senior Subordinated Debt in private placements to certain institutional investors. A portion of these proceeds were used to redeem the remainder of the Company’s Series A Preferred Stock and to repurchase the Warrant that was issued to the Treasury through the Capital Purchase Program.

 

The Company expects to recognize the continued benefits of these initiatives during the remainder of 2015, including through lower interest expense related to the extinguished FHLB advances, elimination of the Series A Preferred Stock Dividend as of June 15, 2015, additional interest income and cost savings related to the acquisition of VCB and positive contributions to the Company’s loan portfolio generated by the three branches acquired from VCB and the Chesterfield County, Virginia loan production office. During the remainder of 2015 the Company also plans to continue its focus on developing online and mobile banking options and offering these products and services to the Bank’s customers.

 

While the Company has largely worked through the economic challenges of the past few years and believes that it is positioned for future success, in significant part due to the successful execution of the strategic initiatives summarized above, the Company will continue to evaluate business development and other strategic initiatives and opportunities it identifies during 2015. These opportunities and initiatives could include opportunities to grow the Company’s business or strengthen the Bank’s branch network in existing or new markets. Also, during the first half of 2015, the Company engaged an independent consultant to conduct a comprehensive assessment of its operations. This assessment identified operating efficiencies and revenue enhancement opportunities. Throughout the balance of 2015 and forward, we plan to evaluate and implement strategies that we believe will improve our performance and profitability and will increase the value of our company.

 

 

Summary of Second Quarter 2015 and Year to Date Operating Results and Financial Condition

 

Table 1: Performance Summary

 

		Three Months Ended June 30,
(dollars in thousands, except per share data)		2015				2014
Net income (1)		$	1,507			$	1,655
Net income available to common shareholders (1)		$	1,341			$	1,114
Basic net income per common share		$	0.07			$	0.06
Diluted net income per common share		$	0.07			$	0.06
Return on average assets (annualized)			0.45	%			0.43	%
Return on average common shareholders' equity (annualized)			5.29	%			4.76	%
Net interest margin (tax equivalent basis) (2)			3.93	%			3.82	%

 

		Six Months Ended June 30,
(dollars in thousands, except per share data)		2015				2014
Net income (1)		$	3,116			$	3,651
Net income available to common shareholders (1)		$	2,730			$	2,592
Basic net income per common share		$	0.15			$	0.15
Diluted net income per common share		$	0.15			$	0.15
Return on average assets (annualized)			0.46	%			0.50	%
Return on average common shareholders' equity (annualized)			5.46	%			5.68	%
Net interest margin (tax equivalent basis) (2)			3.97	%			3.88	%

 

(1) The difference between net income and net income available to common shareholders is the effective dividend to holders of the Company’s Series A Preferred Stock. The Company redeemed the remaining shares of Series A Preferred Stock during the second quarter of 2015.

(2) For more information on the calculation of net interest margin on a tax equivalent basis, see the average balance sheet and net interest margin analysis for the three and six months ended June 30, 2015 and 2014 contained in "Results of Operations" in this Item 2.

 

For the three months ended June 30, 2015, the following were significant factors in the Company’s reported results:

 

·

Increase in net interest income of $1.5 million from the same period in 2014, principally due to a $1.8 million increase in interest and fees on loans driven primarily by loans acquired through the acquisition of VCB, partially offset by a decrease in interest income on investment securities and an increase in interest expense associated with the issuance of $20.0 million in Senior Subordinated Debt during the second quarter of 2015;

·

Net interest margin (tax equivalent basis) increased 11 basis points to 3.93% during the second quarter of 2015 as compared to 3.82% for the same period in 2014;

·

Increase in salaries and employee benefits of $775 thousand from the same period in 2014, primarily due to increased staff levels and support positions associated with the addition of three branches through the acquisition of VCB;

·

Operating results were impacted by accounting adjustments which were recorded in relation to the VCB acquisition. As a result, yields on acquired loans increased and were partially offset by amortization of the core deposit intangible and the fair value adjustment for time deposits. The net accretion attributable to these adjustments was $224 thousand;

·

No provision for loan losses was recorded during the second quarter of 2015 or 2014. Net charge-offs increased to $371 thousand for the second quarter of 2015 from $288 thousand in the same period of 2014;

·

Consultant fees increased $267 thousand during the second quarter of 2015 as compared to the same period in 2014 and were driven primarily by the Company’s engagement of an independent consultant to conduct a comprehensive assessment of its operations;

·

Other operating expenses increased $491 thousand during the second quarter of 2015 as compared to the same period in 2014 and were driven primarily by increased costs associated with outsourcing of the Bank’s core information technology processing; and

 

 

·

Decrease in the effective dividend on preferred stock of $375 thousand from the same period in 2014. This was due to the redemption of the Company’s Series A Preferred Stock (10,000, 5,000 and 9,000 shares on October 15, 2014, January 15, 2015 and June 15, 2015, respectively).

 

For the six months ended June 30, 2015, the following were significant factors in the Company’s reported results:

 

·

Increase in net interest income of $2.8 million from the same period in 2014, principally due to a $3.5 million increase in interest and fees on loans driven primarily by loans acquired through the acquisition of VCB, partially offset by a decrease in interest income on investment securities and an increase in interest expense associated with the issuance of $20.0 million in Senior Subordinated Debt;

·

Increase in net interest margin (tax equivalent basis) of 9 basis points to 3.97% for the six months ended June 30, 2015 as compared to 3.88% for the six months ended June 30, 2014;

·

The net accretion attributable to accounting adjustments related to the VCB acquisition was $402 thousand;

·

No provision for loan losses was recorded during the six months ended June 30, 2015 compared to $250 thousand for the same period in 2014. Net charge-offs increased to $734 thousand for the six months ended June 30, 2015 from $399 thousand in the same period of 2014;

·

Nonperforming assets at June 30, 2015 decreased $1.5 million from June 30, 2014, primarily due to a $2.5 million decline in nonaccrual loans which was partially offset by a $743 thousand increase in other real estate owned;

·

Expenses related to FDIC insurance premiums declined to $426 thousand as compared to $637 thousand for the same period in 2014. The Company faced lower FDIC insurance assessment rates following termination of its memorandum of understanding with its federal and state banking regulators (the “MOU”), which was partially offset by higher average asset balances due to the VCB acquisition;

·

Consultant fees increased $329 thousand for the six months ended June 30, 2015 as compared to the same period in 2014 and were driven primarily by the Company’s engagement of an independent consultant to conduct a comprehensive assessment of its operations;

·

Other operating expenses increased $965 thousand for the six months ended June 30, 2015 as compared to the same period in 2014 and were driven primarily by increased costs associated with outsourcing of the Bank’s core information technology processing; and

·

Decrease in the effective dividend on preferred stock of $673 thousand from the same period in 2014. This was due to the redemption of the Company’s Series A Preferred Stock (10,000, 5,000 and 9,000 shares on October 15, 2014, January 15, 2015 and June 15, 2015, respectively).

 

Results of Operations

 

Net Interest Income and Net Interest Margin

 

Net interest income, the fundamental source of the Company’s earnings, is defined as the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and investment securities, while deposits, short-term borrowings, Junior Subordinated Debt and Senior Subordinated Debt represent the major portion of interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operations and the yield of our interest earning assets compared to our cost of funding these assets.

 

Net interest margin is calculated by expressing tax-equivalent net interest income as a percentage of average interest earning assets, and represents the Company’s net yield on its earning assets. Net interest margin is an indicator of the Company’s effectiveness in generating income from its earning assets. The net interest margin is affected by the structure of the balance sheet as well as by competitive pressures, Federal Reserve policies and the economy. The spread that can be earned between interest earning assets and interest-bearing liabilities is also dependent to a large extent on the slope of the yield curve, which in recent periods has been significantly impacted by initiatives of the Federal Reserve intended to lower long-term interest rates.

 

Table 2 presents the average balances of assets and liabilities, the average yields earned on such assets (on a tax equivalent basis) and rates paid on such liabilities, and the net interest margin for the three and six months ended June 30, 2015 and 2014.

 

 

Table 2: Average Balance Sheet and Net Interest Margin Analysis

(dollars in thousands)

 

		Three Months Ended June 30,
		2015												2014
		Average				Income/				Yield/				Average				Income/				Yield/
		Balance				Expense				Rate (1)				Balance				Expense				Rate (1)
Assets:
Securities
Taxable		$	221,747			$	1,185				2.14	%		$	236,634			$	1,338				2.27	%
Restricted securities			7,198				96				5.35	%			6,779				89				5.27	%
Tax exempt (2)			38,794				385				3.99	%			29,521				294				3.99	%
Total securities			267,739				1,666				2.50	%			272,934				1,721				2.53	%
Interest bearing deposits in other banks			6,886				4				0.23	%			5,097				4				0.31	%
Federal funds sold			188				-				0.00	%			121				-				0.00	%
Loans, net of unearned income (3)			819,061				10,382				5.08	%			685,491				8,562				5.01	%
Total earning assets			1,093,874				12,052				4.42	%			963,643				10,287				4.28	%
Less allowance for loan losses			(12,524	)											(14,898	)
Total non-earning assets			113,370												98,403
Total assets		$	1,194,720											$	1,047,148
Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking		$	289,473			$	269				0.37	%		$	259,279			$	233				0.36	%
Savings			92,733				31				0.13	%			89,334				30				0.13	%
Money market savings			163,105				190				0.47	%			113,929				116				0.41	%
Large dollar certificates of deposit (4)			107,358				173				0.65	%			99,525				307				1.24	%
Other certificates of deposit			126,341				271				0.86	%			124,096				292				0.94	%
Total interest-bearing deposits			779,010				934				0.48	%			686,163				978				0.57	%
Federal funds purchased and repurchase agreements			8,275				13				0.63	%			3,274				5				0.61	%
Short-term borrowings			72,526				37				0.20	%			68,547				36				0.21	%
Junior subordinated debt			10,310				81				3.15	%			10,310				88				3.42	%
Senior subordinated debt			15,034				264				7.04	%			-				-				0.00	%
Total interest-bearing liabilities			885,155				1,329				0.60	%			768,294				1,107				0.58	%
Noninterest-bearing liabilities
Demand deposits			171,957												134,605
Other liabilities			6,947												4,801
Total liabilities			1,064,059												907,700
Shareholders' equity			130,661												139,448
Total liabilities and shareholders' equity		$	1,194,720											$	1,047,148
Net interest income (2)						$	10,723											$	9,180
Interest rate spread (2)(5)											3.82	%											3.70	%
Interest expense as a percent of average earning assets											0.49	%											0.46	%
Net interest margin (2)(6)											3.93	%											3.82	%

 

Notes:

(1) Yields are annualized and based on average daily balances.

(2) Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $117 adjustment for 2015 and a $90 adjustment in 2014.

(3) Nonaccrual loans have been included in the computations of average loan balances.

(4) Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.

(5) Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(6) Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

 

 

 

(dollars in thousands)
		Six Months Ended June 30,
		2015												2014
		Average				Income/				Yield/				Average				Income/				Yield/
		Balance				Expense				Rate (1)				Balance				Expense				Rate (1)
Assets:
Securities
Taxable		$	217,733			$	2,387				2.21	%		$	238,849			$	2,845				2.40	%
Restricted securities			7,490				204				5.49	%			7,006				191				5.50	%
Tax exempt (2)			38,504				760				3.98	%			29,893				600				4.05	%
Total securities			263,727				3,351				2.56	%			275,748				3,636				2.66	%
Interest bearing deposits in other banks			6,926				8				0.23	%			6,288				8				0.26	%
Federal funds sold			232				-				0.00	%			132				-				0.00	%
Loans, net of unearned income (3)			818,059				20,573				5.07	%			681,821				17,112				5.06	%
Total earning assets			1,088,944				23,932				4.43	%			963,989				20,756				4.34	%
Less allowance for loan losses			(12,714	)											(14,842	)
Total non-earning assets			113,530												98,946
Total assets		$	1,189,760											$	1,048,093
Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking		$	285,428			$	523				0.37	%		$	258,234			$	461				0.36	%
Savings			92,033				60				0.13	%			89,757				60				0.13	%
Money market savings			164,421				385				0.47	%			116,494				241				0.42	%
Large dollar certificates of deposit (4)			108,536				466				0.87	%			100,143				608				1.22	%
Other certificates of deposit			129,347				551				0.86	%			124,591				595				0.96	%
Total interest-bearing deposits			779,765				1,985				0.51	%			689,219				1,965				0.57	%
Federal funds purchased and repurchase agreements			10,055				31				0.62	%			3,329				10				0.61	%
Short-term borrowings			77,453				79				0.21	%			70,754				71				0.20	%
Junior subordinated debt			10,310				161				3.15	%			10,310				176				3.44	%
Senior subordianted debt			7,558				264				7.04	%			-				-				0.00	%
Total interest-bearing liabilities			885,141				2,520				0.57	%			773,612				2,222				0.58	%
Noninterest-bearing liabilities
Demand deposits			166,823												132,074
Other liabilities			6,796												4,745
Total liabilities			1,058,760												910,431
Shareholders' equity			131,000												137,662
Total liabilities and shareholders' equity		$	1,189,760											$	1,048,093
Net interest income (2)						$	21,412											$	18,534
Interest rate spread (2)(5)											3.86	%											3.76	%
Interest expense as a percent of average earning assets											0.47	%											0.46	%
Net interest margin (2)(6)											3.97	%											3.88	%

 

Notes:

(1) Yields are annualized and based on average daily balances.

(2) Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $232 adjustment for 2015 and a $183 adjustment in 2014.

(3) Nonaccrual loans have been included in the computations of average loan balances.

(4) Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.

(5) Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(6) Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

 

 

Interest Income and Expense

 

Net interest income and net interest margin

 

Net interest income in the second quarter of 2015 increased $1.5 million, or 16.7%, when compared to the second quarter of 2014. Net interest income for the six months ended June 30, 2015 increased $2.8 million, or 15.4%, as compared to the first half of 2014. The Company's net interest margin increased to 3.93% and 3.97% for the three and six months ended June 30, 2015, representing 11 and 9 basis point increases, respectively, over the Company's net interest margins for the three and six months ended June 30, 2014. The most significant factors impacting net interest income during these periods were as follows:

 

Positive Impacts:

·

Average loan balances increased primarily due to the acquisition of VCB; and

·

Average rates paid on total interest-bearing deposits decreased for the three and six months ended June 30, 2015. However, higher average interest-bearing deposit balances during the first half of 2015 over the comparable 2014 period, due to interest-bearing deposits added from the VCB acquisition, offset the favorable impacts of the lower rates paid on interest-bearing deposits and drove a slight increase in interest expense attributable to the Company’s deposit portfolio.

 

Negative Impacts:

·

Decreases in the average balances of and average rates earned on total investment securities for both the three and six months ended June 30, 2015; and

·

Private placement of $20.0 million of Senior Subordinated Debt resulting in increases to total average interest-bearing liabilities and related interest expense. The issuance of the Senior Subordinated Debt was the primary driver of the 7 basis point decline in the Company’s net interest margin from the first quarter of 2015 to the second quarter of 2015.

 

Total interest and dividend income

 

Total interest and dividend income increased 17.0% and 15.2% for the three and six months ended June 30, 2015, respectively, as compared to the same periods in 2014. The increase in total interest and dividend income during the three and six months ended June 30, 2015 was primarily driven by an increase in average loan balances and slight increases in average loan yields, and partially offset by a decrease in average investment securities balances and declines in investment securities yields.

 

Loans

 

Average loan balances increased for the three and six month periods ended June 30, 2015, as compared to the same periods in 2014, due primarily to the acquisition of VCB loans totaling $101.5 million as of November 14, 2014, net of fair value adjustments, the purchase of $11.3 million in performing one-to-four family residential mortgage loans and government guaranteed loans in June 2015, organic loan growth, the opening of a new loan production office in Chesterfield County, Virginia in the second quarter of 2014 and the origination of a line of credit to fund loan originations through Southern Trust Mortgage, LLC (balance of $12.3 million as of June 30, 2015) in the second quarter of 2014.  Despite a 3% increase in loans during the current period, loan growth came in lower than our expectations.  Loan growth in the Company’s rural markets, primarily on the consumer side, remains weak while competition for commercial loans, especially in the Richmond and Tidewater markets, has been and we expect will continue to be intense given the historically low rate environment.  The Company’s average loan balances increased $133.6 million for the three months ended June 30, 2015 and increased $136.2 million for the six months ended June 30, 2015, as compared to average loan balances for the same periods in 2014.  Total average loans were 74.9% of total average interest-earning assets for the three months ended June 30, 2015, compared to 71.1% for the three months ended June 30, 2014.  Total average loans were 75.1% of total average interest-earning assets for the six months ended June 30, 2015, compared to 70.7% for the six months ended June 30, 3014.

 

Investment securities

 

Average investment securities balances declined 1.9% and 4.4% for the three and six month periods ended June 30, 2015, respectively, as compared to the same periods in 2014. These declines were the result of the Company moving towards its long term target of the investment securities portfolio comprising 20% of the Company’s total assets, the lack of investment opportunities with acceptable risk-adjusted rates of return and liquidity needs to support the Company’s operations and strategic initiatives. The yields on investment securities decreased 3 and 10 basis points for the three and six months ended June 30, 2015, respectively, as compared to the same periods in 2014, driven by lower interest rates and sales/calls of higher yielding municipal securities since the first and second quarters of 2014.

 

 

Interest-bearing deposits

 

Average total interest-bearing deposit balances increased for the three and six month periods ended June 30, 2015, as compared to the same periods in 2014, primarily due to the acquisition of VCB’s interest-bearing deposit liabilities, which totaled $85.6 million as of November 14, 2014.

 

Borrowings

 

Average total borrowings increased for the three and six month periods ended June 30, 2015, as compared to the same periods in 2014, primarily due to the issuance of $20.0 million in Senior Subordinated Debt in April 2015, the assumption of $8.7 million in short-term FHLB advances as a result of the VCB acquisition and increased repurchase agreement balances related to a significant customer deposit relationship.

 

Noninterest Income

 

Noninterest income is comprised of all sources of income other than interest and dividend income on our earning assets. Significant revenue items include fees collected on certain deposit account transactions, debit and credit card fees, fees from other general services, earnings from other investments we own in part or in full, gains or losses from investments, and gains or losses on sales of investment securities, loans, and fixed assets.

 

The following tables depict the components of noninterest income for the three and six months ended June 30, 2015 and 2014:

 

Table 3: Noninterest Income
		Three Months Ended June 30,
(dollars in thousands)		2015				2014				Change $				Change %
Service charges and fees on deposit accounts		$	673			$	837			$	(164	)			-19.6	%
Debit/credit card fees			442				378				64				16.9	%
Gain on sale of available for sale securities, net			26				109				(83	)			-76.1	%
(Loss) on sale of bank premises and equipment			(30	)			-				(30	)			-100.0	%
Other operating income			421				315				106				33.7	%
Total noninterest income		$	1,532			$	1,639			$	(107	)			-6.5	%

 

		Six Months Ended June 30,
(dollars in thousands)		2015				2014				Change $				Change %
Service charges and fees on deposit accounts		$	1,336			$	1,659			$	(323	)			-19.5	%
Debit/credit card fees			805				687				118				17.2	%
Gain on sale of available for sale securities, net			51				489				(438	)			-89.6	%
(Loss) gain on sale of bank premises and equipment			(27	)			5				(32	)			-640.0	%
Other operating income			886				691				195				28.2	%
Total noninterest income		$	3,051			$	3,531			$	(480	)			-13.6	%

 

Key changes in the components of noninterest income for the three and six months ended June 30, 2015, as compared to the same periods in 2014, are discussed below:

 

·

Service charges and fees on deposit accounts declined due to decreases in service charge and overdraft fees on checking accounts;

·

Debit/credit card fees increased primarily due to an increase in debit card fees driven by the acquisition of VCB and a higher utilization rate of debit cards by the Company’s customer base;

 

 

·

Gain on sale of available for sale securities, net decreased for the second quarter of 2015 compared to the same period of 2014 primarily as a result of the Company adjusting the composition of the investment securities portfolio as part of the Company’s overall asset/liability management strategy. Additionally, gains decreased during the first six months of 2015 primarily due to the sale of a portion of its previously impaired agency preferred securities (FNMA & FHLMC) during the first quarter of 2014, and because the Company did not generate comparable gains during 2015;

·

(Loss) gain on sale of bank premises and equipment was primarily due to the sale of the Bank’s former Heathsville branch building as operations were relocated to a new facility, with no similar losses occurring during 2014; and

·

Other operating income increased primarily due to higher earnings from the Bank’s subsidiaries, its investment in Bankers Insurance, LLC and bank owned life insurance policies, partially offset by higher losses from the Bank’s investments in Housing Equity Funds. Additionally, other operating income includes earnings from the Bank’s investments in Southern Trust Mortgage, LLC (acquired 4.9% ownership on May 15, 2014) and Bankers Title, LLC (acquired 6.0% ownership on October 1, 2014).

 

Noninterest Expense

 

Noninterest expense includes all expenses with the exception of those paid for interest on borrowings and deposits. Significant expense items included in this component are salaries and employee benefits, occupancy and equipment expenses and other operating expenses.

 

The following tables depict the components of noninterest expense for the three and six months ended June 30, 2015 and 2014:

 

Table 4: Noninterest Expense
		Three Months Ended June 30,
(dollars in thousands)		2015				2014				Change $				Change %
Salaries and employee benefits		$	5,523			$	4,748			$	775				16.3	%
Occupancy and equipment expenses			1,392				1,267				125				9.9	%
Telephone			210				211				(1	)			-0.5	%
FDIC expense			254				305				(51	)			-16.7	%
Consultant fees			546				279				267				95.7	%
Collection, repossession and other real estate owned			126				89				37				41.6	%
Marketing and advertising			347				270				77				28.5	%
(Gain) loss on sale of other real estate owned			(6	)			28				(34	)			-121.4	%
Impairment losses on other real estate owned			-				6				(6	)			-100.0	%
Other operating expenses			1,807				1,316				491				37.3	%
Total noninterest expenses		$	10,199			$	8,519			$	1,680				19.7	%

 

		Six Months Ended June 30,
(dollars in thousands)		2015				2014				Change $				Change %
Salaries and employee benefits		$	11,113			$	9,334			$	1,779				19.1	%
Occupancy and equipment expenses			2,913				2,586				327				12.6	%
Telephone			407				422				(15	)			-3.6	%
FDIC expense			426				637				(211	)			-33.1	%
Consultant fees			951				622				329				52.9	%
Collection, repossession and other real estate owned			215				156				59				37.8	%
Marketing and advertising			668				437				231				52.9	%
Loss on sale of other real estate owned			26				15				11				73.3	%
Impairment losses on other real estate owned			5				11				(6	)			-54.5	%
Other operating expenses			3,442				2,477				965				39.0	%
Total noninterest expenses		$	20,166			$	16,697			$	3,469				20.8	%

 

 

Key changes in the components of noninterest expense for the three and six months ended June 30, 2015, as compared to the same periods in 2014, are discussed below:

 

·

Salaries and employee benefits increased due to annual merit salary increases, increased restricted stock compensation expense, increased bonuses, commissions and other incentive compensation and valuation adjustments related to pension plan liabilities, partially offset by an increase in deferred compensation on loan originations and reduced expense related to paid time off accrual adjustments for the six month period. Additionally, the Bank incurred higher personnel costs associated with increased staff levels and support positions due to the addition of three branches through the acquisition of VCB;

·

Occupancy and equipment expenses increased primarily due to depreciation expense associated with certain acquired VCB assets and increased rent, building repairs and maintenance and real estate tax expenses related to the acquired VCB branch locations;

·

FDIC expense decreased due to lower base insurance assessment rates resulting from the improvement in the Bank’s overall composite rating in connection with the termination of the MOU in March 2014;

·

Consultant fees increased due to the Company’s engagement of an independent consultant to conduct a comprehensive assessment of its operations;

·

Collection, repossession and other real estate owned expenses increased due to increases in carrying balances of and costs associated with other real estate owned and classified assets;

·

Marketing and advertising expenses increased due to the timing of campaigns and costs associated with the acquisition of VCB; and

·

Other operating expenses increased primarily due to elevated costs associated with outsourcing of the Bank’s core information technology processing. Other operating expenses also increased due to higher franchise taxes, education and training, dues and subscriptions, legal expenses and core deposit intangible amortization expense.

 

Income Taxes

 

The Company recorded income tax expense of $432 thousand for the three months ended June 30, 2015, as compared to $555 thousand for the same period of 2014, reflecting a $123 thousand decrease in income tax expense. The Company recorded income tax expense of $949 thousand for the six months ended June 30, 2015, as compared to $1.3 million for the same period of 2014, reflecting a $335 thousand decrease in income tax expense.

 

The decrease in income tax expense from the second quarter and first six months of 2014 to the same periods of 2015 was primarily the result of the Company’s pretax income decreasing by $271 thousand and $870 thousand, respectively for the three and six months ended June 30, 2015 as compared to the same periods of 2014.

 

The effective tax rate for the three and six months ended June 30, 2015 was 22.3% and 23.3%, respectively, as compared to 25.1% and 26.0%, respectively for the same periods in 2014. The decrease in the effective tax rate from the second quarter and first six months of 2014 to the same periods in 2015 is primarily related to increased tax-exempt interest income on the investment portfolio and tax-exempt bank owned life insurance income as a percentage of pre-tax income.

 

Asset Quality

 

Provision and Allowance for Loan Losses

 

The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as probable credit losses inherent in the loan portfolio, and is based on periodic evaluations of the collectability and historical loss experience of loans. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio.

 

Actual credit losses are deducted from the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent. Subsequent recoveries, if any, are credited to the allowance for loan losses.

 

 

The allowance for loan losses is comprised of a specific allowance for identified problem loans and a general allowance representing estimations done pursuant to either FASB ASC Topic 450 “Accounting for Contingencies”, or FASB ASC Topic 310 “Accounting by Creditors for Impairment of a Loan.” The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when deemed appropriate. The general component covers non-classified or performing loans and those loans classified as substandard, doubtful or loss that are not impaired. The general component is based on migration analysis adjusted for qualitative factors, such as economic conditions, interest rates and unemployment rates. The Company uses a risk grading system for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans. Loans are graded on a scale from 1 to 9. Non-impaired real estate and commercial loans are assigned an allowance factor which increases with the severity of risk grading. A general description of the characteristics of the risk grades is as follows:

 

Pass Grades

·

Risk Grade 1 loans have little or no risk and are generally secured by cash or cash equivalents;

·

Risk Grade 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;

·

Risk Grade 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;

·

Risk Grade 4 loans are satisfactory loans with borrowers not as strong as risk grade 3 loans but may exhibit a higher degree of financial risk based on the type of business supporting the loan; and

·

Risk Grade 5 loans are loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay.

 

Special Mention

·

Risk Grade 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position.

 

Classified Grades

·

Risk Grade 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged. These have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;

·

Risk Grade 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and

·

Risk Grade 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as a bank asset is not warranted.

 

The Company uses a past due grading system for consumer loans, including one to four family residential first and seconds and home equity lines. The past due status of a loan is based on the contractual due date of the most delinquent payment due. The past due grading of consumer loans is based on the following categories: current, 1-29 days past due, 30-59 days past due, 60-89 days past due and over 90 days past due. The consumer loans are segregated between performing and nonperforming loans. Performing loans are those that have made timely payments in accordance with the terms of the loan agreement and are not past due 90 days or more. Nonperforming loans are those that do not accrue interest, are greater than 90 days past due and accruing interest or considered impaired. Non-impaired consumer loans are assigned an allowance factor which increases with the severity of past due status. This component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

 

The Company's ALL Committee is responsible for assessing the overall appropriateness of the allowance for loan losses and monitoring the Company's allowance for loan losses methodology, particularly in the context of current economic conditions and a rapidly changing regulatory environment.  The ALL Committee reviews at least annually the Company's allowance for loan losses methodology.

 

The allocation methodology applied by the Company includes management’s ongoing review and grading of the loan portfolio into criticized loan categories (defined as specific loans warranting either specific allocation, or a classified status of substandard, doubtful or loss). The allocation methodology focuses on evaluation of several factors, including but not limited to: evaluation of facts and issues related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of migration analysis and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of classified loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the portfolio. In determining the allowance for loan losses, the Company considers its portfolio segments and loan classes to be the same.

 

 

Management believes that the level of the allowance for loan losses is appropriate in light of the credit quality and anticipated risk of loss in the loan portfolio. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses through increased provisions for loan losses or may require that certain loan balances be charged-off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examinations.

 

 

The following table presents the Company’s loan loss experience for the periods indicated:

 

Table 5: Allowance for Loan Losses
		Six Months Ended June 30,
(dollars in thousands)		2015				2014
Average loans outstanding*		$	818,059			$	681,821
Allowance for loan losses, January 1		$	13,021			$	14,767
Charge-offs:
Commercial, industrial and agricultural			(80	)			(290	)
Real estate - one to four family residential:
Closed end first and seconds			(332	)			(304	)
Home equity lines			(137	)			(54	)
Real estate - construction:
One to four family residential			(102	)			-
Real estate - non-farm, non-residential:
Owner occupied			(139	)			-
Consumer			(7	)			(86	)
Other			(24	)			(26	)
Total loans charged-off			(821	)			(760	)
Recoveries:
Commercial, industrial and agricultural			21				30
Real estate - one to four family residential:
Closed end first and seconds			13				211
Home equity lines			5				13
Real estate - construction:
One to four family residential			1				6
Other construction, land development and other land			-				2
Real estate - non-farm, non-residential:
Owner occupied			1				27
Non-owner occupied			-				3
Consumer			34				55
Other			12				14
Total recoveries			87				361
Net charge-offs			(734	)			(399	)
Provision for loan losses			-				250
Allowance for loan losses, June 30		$	12,287			$	14,618
Ratios:
Ratio of allowance for loan losses to total loans outstanding, end of period			1.46	%			2.09	%
Ratio of annualized net charge-offs to average loans outstanding during the period			0.18	%			0.12	%

*Net of unearned income and includes nonaccrual loans.

 

 

No provision for loan losses was recorded for the three and six months ended June 30, 2015 compared to $0 and $250 thousand, respectively for the same periods in 2014.  The allowance for loan losses totaled $12.3 million at June 30, 2015, representing a decline of $734 thousand from December 31, 2014 and a decline of $2.3 million from June 30, 2014.  The decline in the allowance for loan losses from December 31, 2014 was primarily due to measured improvements in the economic and financial conditions in the Company’s markets, improvements in the Company’s asset quality and charge-offs of loans for which the Company had specifically reserved.  Impaired loans increased approximately $1.3 million from December 31, 2014, primarily due to the deteriorating financial condition of two large commercial borrowers.  As appropriate, the Company applied specific reserves against these impaired loans recorded prior to December 31, 2014.  The decline in the allowance for loan losses from June 30, 2014 was due to improvements in economic and financial market conditions, both nationally and in the Company’s markets, that improved the general allowance for loan losses and improvements in the Company’s asset quality.  Additionally, due to purchase accounting related to the Company’s acquisition of VCB, the Company recorded loans acquired from VCB at fair value at the effective time of the acquisition, and any allowance for loan losses previously established by VCB was not recorded on the Company’s financial statements.  Net charge-offs for the six months ended June 30, 2015 were $734 thousand, compared to $399 thousand for the same period of 2014.  This represents, on an annualized basis, 0.18% of average loans outstanding for the six months ended June 30, 2015 and 0.12% of average loans outstanding for the same period of 2014. 

 

The allowance for loan losses at June 30, 2015 was $12.3 million, compared with $13.0 million at December 31, 2014. This represented 1.46% of period end loans at June 30, 2015, compared with 1.59% of year end loans at December 31, 2014.

 

The following table shows the allocation of the allowance for loan losses at the dates indicated. Notwithstanding these allocations, the entire allowance for loan losses is available to absorb charge-offs in any category of loan.

 

Table 6: Allocation of Allowance for Loan Losses
		At June 30,								At December 31,
		2015								2014
(dollars in thousands)		Allowance				Percent				Allowance				Percent
Commercial, industrial and agricultural		$	1,619				10.21	%		$	1,168				10.37	%
Real estate - one to four family residential:
Closed end first and seconds			1,699				28.91	%			1,884				28.86	%
Home equity lines			2,013				13.20	%			1,678				13.42	%
Real estate - multifamily residential			102				3.54	%			89				3.07	%
Real estate - construction:
One to four family residential			257				2.27	%			235				2.40	%
Other construction, land development and other land			2,590				4.36	%			2,670				4.34	%
Real estate - farmland			79				1.26	%			144				1.15	%
Real estate - non-farm, non-residential:
Owner occupied			1,838				20.09	%			2,416				19.22	%
Non-owner occupied			1,168				11.81	%			1,908				12.77	%
Consumer			257				1.72	%			305				1.94	%
Other			665				2.63	%			524				2.46	%
Total allowance for loan losses		$	12,287				100.00	%		$	13,021				100.00	%

 

(Percent is portfolio loans in category divided by total loans)

 

Tabular presentations of commercial loans by credit quality indicator and consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at June 30, 2015 and December 31, 2014 can be found under Item 1. “Financial Statements,” under the heading “Note 4. Loan Portfolio.”

 

 

 

Nonperforming Assets

 

The past due status of a loan is based on the contractual due date of the most delinquent payment due. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans greater than 90 days past due may remain on an accrual status if management determines it has adequate collateral to cover the principal and interest. If a loan or a portion of a loan is adversely classified, or is partially charged off, the loan is generally classified as nonaccrual. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on a nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. As of June 30, 2015, management is not aware of any potential problem loans to place immediately on nonaccrual status.

 

When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, and the amortization of related deferred loan fees or costs is suspended. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. These policies are applied consistently across our loan portfolio.

 

A loan (including a TDR) may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

 

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at estimated fair market value of the property, less estimated disposal costs, if any. Cost includes loan principal and accrued interest. Any excess of cost over the estimated fair market value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings. Development and improvement costs relating to property are capitalized. Net operating income or expenses of such properties are included in collection, repossession and other real estate owned expenses.

 

The following table presents information concerning nonperforming assets as of and for the six months ended June 30, 2015 and the year ended December 31, 2014:

 

Table 7:  Nonperforming Assets

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Nonaccrual loans*		$	7,263			$	6,622			$	641				9.7	%
Loans past due 90 days and accruing interest			240				53				187				352.8	%
Total nonperforming loans		$	7,503			$	6,675			$	828				12.4	%
Other real estate owned			1,344				1,838				(494	)			-26.9	%
Total nonperforming assets		$	8,847			$	8,513			$	334				3.9	%
Nonperforming assets to total loans and   other real estate owned			1.05	%			1.04	%
Allowance for loan losses to nonaccrual loans			169.17	%			196.63	%
Annualized net charge-offs to average loans for the period			0.18	%			0.28	%
Allowance for loan losses to period end loans			1.46	%			1.59	%

 

* Includes $2.3 million and $3.4 million in nonaccrual TDRs at June 30, 2015 and December 31, 2014, respectively.

 

   

The following table presents the change in the OREO balance for the six months ended June 30, 2015 and 2014:

 

Table 8: OREO Changes

 

		June 30,
(dollars in thousands)		2015				2014				Change $				Change %
Balance at the beginning of period, gross		$	1,914			$	1,054			$	860				81.6	%
Transfers from loans			1,084				289				795				275.1	%
Capitalized costs			1				-				1				100.0	%
Sales proceeds			(1,548	)			(462	)			(1,086	)			-235.1	%
Previously recognized impairment losses on disposition			(78	)			(157	)			79				50.3	%
Loss on disposition			(26	)			(15	)			(11	)			-73.3	%
Balance at the end of period, gross			1,347				709				638				90.0	%
Less valuation allowance			(3	)			(108	)			105				97.2	%
Balance at the end of period, net		$	1,344			$	601			$	743				123.6	%

 

The following table presents the change in the valuation allowance for OREO for the six months ended June 30, 2015 and 2014:

 

Table 9: OREO Valuation Allowance Changes

 

		June 30,
(dollars in thousands)		2015				2014
Balance at the beginning of period		$	76			$	254
Valuation allowance			5				11
Charge-offs			(78	)			(157	)
Balance at the end of period		$	3			$	108

 

Nonperforming assets were $8.8 million or 1.05% of total loans and other real estate owned at June 30, 2015 compared to $8.5 million or 1.04% at December 31, 2014. The sluggish economic recovery and continuing asset quality issues in the Company’s loan portfolio have prompted the Company to maintain the heightened level of the allowance for loan losses as compared to pre-2009 levels, which is 169.17% of nonaccrual loans at June 30, 2015, compared to 196.63% at December 31, 2014. Nonperforming loans increased $828 thousand or 12.4% during the six months ended June 30, 2015 to $7.5 million, primarily due to increases in nonaccrual loans.

 

Nonaccrual loans were $7.3 million at June 30, 2015, an increase of approximately $641 thousand or 9.7% from $6.6 million at December 31, 2014. Of the current $7.3 million in nonaccrual loans, $6.9 million or 94.4% is secured by real estate in our market area. Of these real estate secured loans, $5.4 million are one to four family residential real estate, $1.3 million are commercial properties and $190 thousand are real estate construction. Nonaccrual loans decreased $677 thousand during the second quarter of 2015 primarily due to the foreclosure of a large commercial property that was transferred to other real estate owned. Subsequent to June 30, 2015, this foreclosed property was sold for gross proceeds of approximately $825 thousand.

 

Other real estate owned, net of valuation allowance at June 30, 2015 was $1.3 million, a decrease of approximately $494 thousand or 26.9% from December 31, 2014. The balance of other real estate owned at June 30, 2015 was comprised of five properties of which $92 thousand are real estate construction properties and $1.3 million are commercial properties. During the six months ended June 30, 2015, new foreclosures included seven properties totaling $1.1 million transferred from loans, including one commercial property during the second quarter of 2015 totaling $700 thousand. Sales of twelve other real estate owned properties for the six months ended June 30, 3015 resulted in a net loss of $26 thousand. The remaining properties are being actively marketed and the Company does not anticipate any material losses associated with these properties. The Company recorded losses of $5 thousand in its consolidated statements of income for the six months ended June 30, 2015, due to valuation adjustments on other real estate owned properties as compared to $11 thousand for the same period of 2014. Asset quality continues to be a top priority for the Company. The Company continues to allocate significant resources to the expedient disposition and collection of nonperforming and other lower quality assets.

  

 

As discussed earlier in this Item 2, the Company measures impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are considered impaired loans. TDRs occur when we agree to modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions can be temporary and are made in an attempt to avoid foreclosure and with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include, without limitation, rate reductions to below market rates, payment deferrals, forbearance, and, in some cases, forgiveness of principal or interest.

 

A tabular presentation of loans individually evaluated for impairment by class of loans at June 30, 2015 and December 31, 2014 can be found under Item 1. “Financial Statements,” under the heading “Note 4. Loan Portfolio.”

 

At June 30, 2015, the balance of impaired loans was $37.7 million, for which there were specific valuation allowances of $4.6 million. At December 31, 2014, the balance of impaired loans was $36.4 million, for which there were specific valuation allowances of $5.3 million. The average balance of impaired loans was $37.4 million for the six months ended June 30, 2015, compared to $40.0 million for the year ended December 31, 2014. Impaired loans increased by approximately $1.3 million from December 31, 2014 to June 30, 2015, primarily due to the deteriorating financial condition of two large commercial relationships. As appropriate, the Company applied specific reserves against these impaired loans. The Company’s balance of impaired loans remains elevated over historical levels as a result of the continued challenging economic conditions which have significantly increased unemployment, reduced profitability of local businesses, and reduced the ability of many of our customers to keep their loans current.

 

The following table presents the balances of TDRs at June 30, 2015 and December 31, 2014:

 

Table 10: Troubled Debt Restructurings (TDRs)

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Performing TDRs		$	14,843			$	15,223			$	(380	)			-2.5	%
Nonperforming TDRs*			2,252				3,438				(1,186	)			-34.5	%
Total TDRs		$	17,095			$	18,661			$	(1,566	)			-8.4	%

 

* Included in nonaccrual loans in Table 7: Nonperforming Assets.

 

At the time of a TDR, the loan is placed on nonaccrual status. A loan (including a TDR) may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

 

  

Financial Condition

 

Summary

 

At June 30, 2015, the Company had total assets of $1.22 billion, an increase of approximately $37.2 million or 3.1% from $1.18 billion at December 31, 2014. The increase in total assets was principally the result of increases in loans and investment securities principally funded by short term borrowings, the Company’s issuance of Senior Subordinated Debt during the second quarter of 2015, and continued deposit growth. Major categories and changes in our balance sheet are as detailed in the following schedule.

 

Table 11: Balance Sheet Changes

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Total assets		$	1,219,191			$	1,181,972			$	37,219				3.1	%
Cash and short-term investments			14,416				14,024				392				2.8	%
Interest bearing deposits with banks			6,467				5,272				1,195				22.7	%
Securities available for sale, at fair value			227,932				214,011				13,921				6.5	%
Securities held to maturity, at carrying value			30,671				32,163				(1,492	)			-4.6	%
Restricted securities, at cost			8,118				7,533				585				7.8	%
Total loans			840,710				820,569				20,141				2.5	%
Deferred income taxes, net			16,937				17,529				(592	)			-3.4	%
Other real estate owned, net			1,344				1,838				(494	)			-26.9	%
Bank owned life insurance			24,786				24,463				323				1.3	%
Total deposits			957,222				939,254				17,968				1.9	%
Total borrowings			132,544				102,013				30,531				29.9	%
Total shareholders' equity			121,909				134,274				(12,365	)			-9.2	%

 

Investment Securities

 

The investment portfolio plays a primary role in the management of the Company’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements, such as those related to secure public deposits, balances with the Reserve Bank and repurchase agreements. The investment portfolio consists of held to maturity and available for sale securities. We classify securities as available for sale or held to maturity based on our investment strategy and management’s assessment of our intent and ability to hold the securities until maturity. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold the investment securities to maturity, they are classified as investment securities held to maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Investment securities which the Company may not hold to maturity are classified as investment securities available for sale, as management has the intent and ability to hold such investment securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors and are carried at estimated fair value.

 

 

Table 12: Investment Securities

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Available for Sale (at Fair Value):
Obligations of U.S. Government agencies		$	13,081			$	14,569			$	(1,488	)			-10.2	%
SBA Pool securities			71,007				74,799				(3,792	)			-5.1	%
Agency residential mortgage-backed securities			19,400				28,629				(9,229	)			-32.2	%
Agency commercial mortgage-backed securities			6,487				-				6,487				100.0	%
Agency CMO securities			53,154				39,215				13,939				35.5	%
Non agency CMO securities			704				828				(124	)			-15.0	%
State and political subdivisions			64,090				55,926				8,164				14.6	%
FNMA and FHLMC preferred stock			9				45				(36	)			-80.0	%
Total		$	227,932			$	214,011			$	13,921				6.5	%

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Held to Maturity (at Carrying Value):
Agency CMO securities		$	11,743			$	11,993			$	(250	)			-2.1	%
State and political subdivisions			18,928				20,170				(1,242	)			-6.2	%
Total		$	30,671			$	32,163			$	(1,492	)			-4.6	%

 

Total investment securities were $258.6 million at June 30, 2015, reflecting an increase of $12.4 million or 5.0% from $246.2 million at December 31, 2014. The increase in the investment portfolio during the first six months of 2015 was the result of investing excess liquidity that resulted from increases in total deposits and borrowings.

 

During the first six months of 2015, the Company primarily invested in Agency commercial mortgage-backed securities, Agency CMO securities and securities issued by State and political subdivisions. The Company decreased its investments in Agency residential mortgage-backed securities while increasing its investments in Agency commercial mortgage-backed securities and Agency CMO securities in an effort to enhance the portfolio’s overall structure and provide more consistent cash flows and reinvestment opportunities. The increased investment in securities issued by State and political subdivisions was due to the related tax benefits and the higher yield offered by these securities. In addition, the Company decreased its investments in SBA Pool securities in order to diversify its securities portfolio and target investments with a higher risk-adjusted rate of return. As part of our overall asset/liability management strategy, we are targeting our investment portfolio to be approximately 20% of our total assets. As of June 30, 2015 and December 31, 2014, our investment portfolio was 21.2% and 20.8%, respectively, of total assets.

 

The available for sale portfolio had an unrealized (loss), net of tax benefit, of ($2.1) million at June 30, 2015 compared with an unrealized (loss), net of tax benefit, of ($1.5) million at December 31, 2014. These unrealized (losses) as of June 30, 2015 are principally due to financial market conditions for these types of investments, particularly changes in interest rates, which increased during the first six months of 2015 causing bond prices to decrease and thereby increased the amount of unrealized losses at June 30, 2015.

 

  

Loans

 

The Company offers an array of lending and credit services to customers including mortgage, commercial and consumer loans. A substantial portion of the loan portfolio is represented by commercial and residential mortgage loans in our market area. The ability of our debtors to honor their contracts is dependent upon the real estate and general economic conditions in our market area. The loan portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. Total loans were $840.7 million at June 30, 2015, an increase of approximately $20.1 million, or 2.5%, from $820.6 million at December 31, 2014. The following table presents the composition of the Company’s loan portfolio at the dates indicated.

 

Table 13: Loan Portfolio

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Commercial, industrial and agricultural		$	85,845			$	85,119			$	726				0.9	%
Real estate - one to four family residential:
Closed end first and seconds			243,072				236,761				6,311				2.7	%
Home equity lines			111,007				110,100				907				0.8	%
Total real estate - one to four family residential			354,079				346,861				7,218				2.1	%
Real estate - multifamily residential			29,802				25,157				4,645				18.5	%
Real estate - construction:
One to four family residential			19,091				19,698				(607	)			-3.1	%
Other construction, land development and other land			36,620				35,591				1,029				2.9	%
Total real estate - construction			55,711				55,289				422				0.8	%
Real estate - farmland			10,553				9,471				1,082				11.4	%
Real estate - non-farm, non-residential:
Owner occupied			168,861				157,745				11,116				7.0	%
Non-owner occupied			99,287				104,827				(5,540	)			-5.3	%
Total real estate - non-farm, non-residential			268,148				262,572				5,576				2.1	%
Consumer			14,443				15,919				(1,476	)			-9.3	%
Other			22,129				20,181				1,948				9.7	%
Total loans		$	840,710			$	820,569			$	20,141				2.5	%

 

Total loans increased 2.5% during the first six months of 2015.  Loan growth in the Company’s rural markets, primarily on the consumer side, remained weak while competition for commercial loans, especially in the Richmond and Tidewater markets, has been and is expected to continue to be intense given the historically low rate environment.

 

Deposits

 

The Company’s predominant source of funds is depository accounts. The Company’s deposit base, which is provided by individuals and businesses located within the communities served, is comprised of demand deposits, savings and money market accounts, and time deposits. The Company augments its deposit base through conservative use of brokered deposits, including through the Certificate of Deposit Account Registry Service program (“CDARS”). The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios.

 

  

Total deposits were $957.2 million as of June 30, 2015, an increase of approximately $18.0 million or 1.9% from $939.3 million as of December 31, 2014. The following table presents the composition of the Company’s deposits at the dates indicated.

 

Table 14: Deposits

 

		June 30,				December 31,
(dollars in thousands)		2015				2014				Change $				Change %
Noninterest-bearing demand deposits		$	178,844			$	162,328			$	16,516				10.2	%
Interest-bearing deposits:
Checking			293,202				277,937				15,265				5.5	%
Savings deposits			91,959				89,849				2,110				2.3	%
Money market savings			162,554				162,794				(240	)			-0.1	%
Time deposits $100 and over			105,418				136,977				(31,559	)			-23.0	%
Other time deposits			125,245				109,369				15,876				14.5	%
Total interest-bearing deposits			778,378				776,926				1,452				0.2	%
Total deposits		$	957,222			$	939,254			$	17,968				1.9	%

 

During the first six months of 2015, the Company’s deposits increased due to customer growth and cyclical increases in deposit balances, partially offset by a decline in brokered certificates of deposit. Additionally, the Company believes the increase in our noninterest-bearing demand deposits as well as our lower cost non-maturity interest-bearing deposits is the result of customers seeking the liquidity and safety of deposit accounts in light of continuing economic uncertainty in general. At June 30, 2015 and December 31, 2014, the Company had $35.5 million and $55.7 million in brokered certificates of deposits, respectively. The interest rates paid on these deposits are consistent, if not lower, than the market rates offered in our local area. Amounts included in these brokered certificates of deposits also include deposits under the CDARS program.

 

Borrowings

 

The Company’s ability to borrow funds through non-deposit sources provides additional flexibility in meeting the liquidity needs of customers while enhancing its cost of funds structure. Total borrowings were $132.5 million at June 30, 2015, an increase of approximately $30.5 million or 29.9% from $102.0 million at December 31, 2014. The increase in borrowings was primarily driven by the issuance of $20.0 million in Senior Subordinated Debt on April 22, 2015 and a $17.8 million increase in short-term borrowings. Borrowings increased as the Company funded loan growth, purchased additional investment securities and redeemed the remaining $14.0 million of its Series A Preferred Stock during the first six months of 2015. The Company will continue to consider lower cost, short-term borrowings as a favorable funding option and may use these funding sources in connection with executing the Company’s strategic initiatives during the remainder of 2015.

 

Off-Balance Sheet Arrangements

 

As of June 30, 2015, there have been no material changes to the off-balance sheet arrangements disclosed in the Company’s 2014 Form 10-K.

 

Contractual Obligations

 

As of June 30, 2015, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s 2014 Form 10-K.

 

 

 

Liquidity

 

Liquidity represents an institution’s ability to meet present and future financial obligations, including through the sale of existing assets or the acquisition of additional funds through short-term borrowings. Our liquidity is provided from cash and due from banks, interest bearing deposits with other banks, federal funds sold, repayments from loans, sales of loans, increases in deposits, lines of credit from the FHLB and three correspondent banks, sales of investments, interest and dividend payments received from investments and maturing investments. We also use other short and long-term borrowings to provide additional liquidity when available on terms favorable to the Company, including entering into repurchase agreements with customers and issuing subordinated debt and notes. Our ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in our markets and available borrowing capacity under certain of our borrowing sources. Depending on our liquidity levels, our capital position, conditions in the capital markets and other factors, we may from time to time consider the issuance of debt, equity or other securities, or other possible capital market transactions, the proceeds of which could provide additional liquidity for operations.

 

As a result of our management of liquid assets and our ability to generate liquidity through liability funding, we believe that we maintain overall liquidity to satisfy our depositors’ requirements and to meet customers’ credit needs. We also take into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit.

 

We monitor and plan our liquidity position for future periods. Liquidity strategies are implemented and monitored by our Asset/Liability Committee.

 

Cash, cash equivalents and federal funds sold totaled $20.9 million as of June 30, 2015 compared to $19.6 million as of December 31, 2014. At June 30, 2015, cash, cash equivalents, federal funds sold and unpledged securities available for sale were $207.1 million or 18.7% of total assets, compared to $179.9 million or 15.2% of total assets at December 31, 2014.

 

As disclosed in the Company’s consolidated statements of cash flows, net cash provided by operating activities was $5.5 million, net cash used in investing activities was $37.6 million and net cash provided by financing activities was $33.4 million for the six months ended June 30, 2015. Combined, this contributed to a $1.3 million increase in cash and cash equivalents for the six months ended June 30, 2015.

 

The Company maintains access to short-term funding sources as well, including federal funds lines of credit with three correspondent banks up to $40.0 million and the ability to borrow from the FHLB up to $225.3 million. The Company has no reason to believe these arrangements will not be renewed at maturity. Additional loans and securities are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value.

 

Certificates of deposit of $100,000 or more, maturing in one year or less, totaled $71.3 million at June 30, 2015. Certificates of deposit of $100,000 or more, maturing in more than one year, totaled $59.3 million at June 30, 2015.

 

As of June 30, 2015, and other than referenced in this Quarterly Report on Form 10-Q, the Company was not aware of any other known trends, events or risks that have or are reasonably likely to have a material impact on our liquidity. As of June 30, 2015, the Company has no material commitments or long-term debt for capital expenditures.

 

Capital Resources

 

The assessment of capital adequacy depends on such factors as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The Company regularly reviews the adequacy of the Company’s capital. The Company maintains a capital structure that it believes will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

 

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

 

In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and a revised framework for calculating risk-weighted assets. The Basel III Capital Rules were effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain portions of the new rules). For a summary of these final rules, see Part I, Item 1 under the heading “Regulation and Supervision – Capital Requirements” included in the 2014 Form 10-K.

 

Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios of total, common equity Tier 1 (or CET1) and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of June 30, 2015, the Bank meets all capital adequacy requirements to which it is subject.

 

As of June 30, 2015, the Bank was categorized as “well capitalized,” the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, CET1 risked-based, Tier 1 risk-based, and Tier 1 leverage ratios. The Company’s and the Bank’s actual capital ratios as of June 30, 2015 and December 31, 2014 are presented under Item 1. “Financial Statements,” under the heading “Note 14. Capital Requirements.”

 

Cash Dividends

 

The Bank, as a Virginia banking corporation, may pay dividends only out of retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the bank. Regulatory agencies place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. For the six months ended June 30, 2015 and 2014, no cash dividends have been paid from the Bank to the Company.

 

The Company’s Board of Directors determines whether to declare dividends and the amount of any dividends declared. Such determinations by the Board take into account the Company’s financial condition, results of operations and other relevant factors, including any relevant regulatory restrictions.

 

For the six months ended June 30, 2015, the Company paid $0.02 of cash dividends to common shareholders and the holders of the Company’s Series B Preferred Stock, as compared to paying no cash dividends in the same period of 2014.

 

From February 2011 to May 2014, the Company deferred dividend payments on its Series A Preferred Stock. On August 15, 2014, the Company paid dividends of $5.5 million, including both current and accumulated but unpaid dividends on its Series A Preferred Stock, and has paid all subsequent dividends on the Series A Preferred Stock as due pursuant to the terms of the Series A Preferred Stock. The Company redeemed the final $14.0 million of the Series A Preferred Stock during the first half of 2015.

 

Effects of Inflation

 

The effect of changing prices on financial institutions is typically different from other industries as the Company’s assets and liabilities are monetary in nature. The primary effect of inflation on the Company’s operations is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are significantly impacted by changes in the inflation rate, they do not necessarily change at the same time or in the same magnitude as the inflation rate. For additional information, see the Company’s 2014 10-K in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Impact of Inflation and Changing Prices.”

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

There have been no significant changes from the quantitative and qualitative disclosures made in the Company’s 2014 Form 10-K.

 

Item 4. Controls and Procedures

 

The Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2015 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

 

 

Management of the Company is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There were no changes in the Company’s internal control over financial reporting during the Company’s quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

In the ordinary course of operations, the Company and its subsidiaries may become a party to legal proceedings, or property of the Company or its subsidiaries may become subject to legal proceedings. As of June 30, 2015 and based on information currently available, there are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

 

Item 1A. Risk Factors

 

There have been no material changes in the risk factors faced by the Company from those disclosed under Part I, Item 1A. “Risk Factors” in the Company’s 2014 Form 10-K. These risk factors could materially affect our business, financial condition or future results.  Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations.

 

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

 

In January 2001, the Company announced a stock repurchase program by which management was authorized to repurchase up to 300,000 shares of the Company’s common stock. This plan was amended in 2003 and the number of shares by which management is authorized to repurchase is up to 5% of the outstanding shares of the Company’s common stock on January 1 of each year. There is no stated expiration date for the program. During the six months ended June 30, 2015, the Company did not repurchase any shares of its common stock under the program.

 

There were no repurchases of the Company’s common stock during the three months ended June 30, 2015.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

None.

 

Item 5. Other Information

 

None.

 

  

Item 6. Exhibits

 

2.1	Agreement and Plan of Reorganization, dated as of May 29, 2014 by and among Eastern Virginia Bankshares, Inc., EVB and Virginia Company Bank (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed May 30, 2014).
3.1	Amended and Restated Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective December 29, 2008 (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed March 10, 2009).
3.1.1	Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective January 6, 2009 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed January 13, 2009).
3.1.2	Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective June 10, 2013 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed June 14, 2013).
3.2	Bylaws of Eastern Virginia Bankshares, Inc., as amended June 4, 2013 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed June 14, 2013).
4.3	Indenture, dated April 22, 2015, by and between Eastern Virginia Bankshares, Inc. and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed April 24, 2015).
4.4	Forms of 6.50% Subordinated Note due 2025 (included as Exhibit A-1 and Exhibit A-2 in Exhibit 4.3 filed with, and incorporated herein by reference to, the Company’s Current Report on Form 8-K filed April 24, 2015).
10.26	Subordinated Note Purchase Agreement, dated April 22, 2015, by and among Eastern Virginia Bankshares, Inc. and the purchasers identified therein (incorporated by reference to Exhibit 10.26 to the Company’s Current Report on Form 8-K filed April 24, 2015).
10.27	Registration Rights Agreement, dated April 22, 2015, by and among Eastern Virginia Bankshares, Inc. and the purchasers identified therein (incorporated by reference to Exhibit 10.27 to the Company’s Current Report on Form 8-K filed April 24, 2015).
31.1	Rule 13a-14(a) Certification of Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of Chief Financial Officer.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101	The following materials from Eastern Virginia Bankshares, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive (Loss) Income (unaudited), (iv) Consolidated Statements of Shareholders’ Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to the Interim Consolidated Financial Statements (unaudited).

 

  

SIGNATURES

 

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

 

Eastern Virginia Bankshares, Inc.

(Registrant)

 

Date:    August 14, 2015		/s/ Joe A. Shearin
		Joe A. Shearin
		President and Chief Executive Officer
		(Principal Executive Officer)
Date:    August 14, 2015		/s/ J. Adam Sothen
		J. Adam Sothen
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)