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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 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: 000-53380

 

 

Xenith Bankshares, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia		80-0229922
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

One James Center 901 E. Cary Street, Suite 1700 Richmond, Virginia		23219
(Address of principal executive offices)		(Zip Code)

(804) 433-2200

(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 past 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 Common Stock, par value $1.00 per share, outstanding at November 2, 2015 was 12,988,622.

 

 

 

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TABLE OF CONTENTS

 

		Page
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements			3
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			35
Item 3 Quantitative and Qualitative Disclosures About Market Risk			56
Item 4 Controls and Procedures			56
PART II - OTHER INFORMATION
Item 1 Legal Proceedings			57
Item 1A Risk Factors			57
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			57
Item 6 Exhibits			58
SIGNATURES

 

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF SEPTEMBER 30, 2015 AND DECEMBER 31, 2014

 

(in thousands, except share data)		(Unaudited) September 30, 2015				December 31, 2014
Assets
Cash and cash equivalents
Cash and due from banks		$	22,550			$	34,666
Federal funds sold			4,199				4,533
Total cash and cash equivalents			26,749				39,199
Securities available for sale, at fair value			112,041				64,341
Securities held to maturity, at amortized cost (fair value: 2015 - $9,923; 2014 - $9,683)			9,272				9,279
Loans, net of allowance for loan and lease losses, 2015 - $7,064; 2014 - $6,247			753,466				744,626
Premises and equipment, net			7,672				8,010
Other real estate owned, net			932				1,140
Goodwill and other intangible assets, net			15,800				16,143
Accrued interest receivable			4,068				3,498
Deferred tax asset			6,731				6,343
Bank owned life insurance			19,466				14,106
Other assets			14,791				11,367
Total assets		$	970,988			$	918,052
Liabilities and Shareholders’ Equity
Deposits
Demand and money market		$	513,641			$	465,253
Savings			10,713				10,108
Time			300,169				297,550
Total deposits			824,523				772,911
Accrued interest payable			413				276
Borrowed funds			37,050				32,000
Supplemental executive retirement plan			2,242				2,295
Other liabilities			5,988				4,349
Total liabilities			870,216				811,831
Shareholders’ equity
Preferred stock, $1.00 par value, 25,000,000 shares authorized as of September 30, 2015 and December 31, 2014; no shares issued and outstanding as of September 30, 2015 and 8,381 ($1,000 liquidation value) shares issued and outstanding as of December 31, 2014			—				8,381
Common stock, $1.00 par value, 100,000,000 shares authorized as of September 30, 2015 and December 31, 2014; 12,989,222 shares issued and outstanding as of September 30, 2015 and 12,929,834 shares issued and outstanding as of December 31, 2014			12,989				12,930
Additional paid-in capital			86,482				86,016
Retained earnings (accumulated deficit)			2,070				(560	)
Accumulated other comprehensive loss, net of tax			(769	)			(546	)
Total shareholders’ equity			100,772				106,221
Total liabilities and shareholders’ equity		$	970,988			$	918,052

See notes to unaudited consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

(in thousands, except per share data)		September 30, 2015				September 30, 2014
Interest income
Interest and fees on loans		$	8,405			$	8,891
Interest on securities			707				422
Interest on federal funds sold and deposits in other banks			113				89
Total interest income			9,225				9,402
Interest expense
Interest on deposits			885				784
Interest on time certificates of $100,000 and over			454				412
Interest on federal funds purchased and borrowed funds			366				95
Total interest expense			1,705				1,291
Net interest income			7,520				8,111
Provision for loan and lease losses			343				1,560
Net interest income after provision for loan and lease losses			7,177				6,551
Noninterest income
Service charges on deposit accounts			155				157
Net loss on sale and write-down of other real estate owned			(95	)			—
(Loss) gain on sales of securities			(23	)			17
Bargain purchase gain			—				10
Loss on the write-down of equipment and other assets			—				(17	)
Increase in cash surrender value of bank owned life insurance			141				98
Other (loss) income			(74	)			92
Total noninterest income			104				357
Noninterest expense
Compensation and benefits			3,350				3,249
Occupancy			418				435
FDIC insurance			182				128
Bank franchise taxes			246				221
Technology and data processing			568				690
Communications			92				98
Insurance			93				74
Professional fees			313				257
Amortization of intangible assets			114				114
Guaranteed student loan servicing			109				152
Other			542				486
Total noninterest expense			6,027				5,904
Income before income tax			1,254				1,004
Income tax expense			326				347
Net income			928				657
Preferred stock dividend			—				(21	)
Net income available to common shareholders		$	928			$	636
Earnings per common share (basic and diluted):		$	0.07			$	0.05

See notes to unaudited consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

(in thousands, except per share data)		September 30, 2015				September 30, 2014
Interest income
Interest and fees on loans		$	24,773			$	21,073
Interest on securities			1,715				1,148
Interest on federal funds sold and deposits in other banks			331				223
Total interest income			26,819				22,444
Interest expense
Interest on deposits			2,538				1,776
Interest on time certificates of $100,000 and over			1,362				1,052
Interest on federal funds purchased and borrowed funds			796				291
Total interest expense			4,696				3,119
Net interest income			22,123				19,325
Provision for loan and lease losses			1,608				2,390
Net interest income after provision for loan and lease losses			20,515				16,935
Noninterest income
Service charges on deposit accounts			464				419
Net loss on sale and write-down of other real estate owned			(95	)			(39	)
Gain on sales of securities			58				39
Bargain purchase gain			—				42
Loss on the write-down of equipment and other assets			—				(17	)
Increase in cash surrender value of bank owned life insurance			360				258
Other income			141				236
Total noninterest income			928				938
Noninterest expense
Compensation and benefits			9,837				8,856
Occupancy			1,219				1,154
FDIC insurance			539				368
Bank franchise taxes			738				602
Technology and data processing			1,740				1,652
Communications			293				254
Insurance			279				218
Professional fees			925				1,165
Amortization of intangible assets			343				297
Guaranteed student loan servicing			336				476
Other			1,484				1,560
Total noninterest expense			17,733				16,602
Income before income tax			3,710				1,271
Income tax expense			1,038				564
Net income			2,672				707
Preferred stock dividend			(42	)			(63	)
Net income available to common shareholders		$	2,630			$	644
Earnings per common share (basic and diluted):		$	0.20			$	0.06

See notes to unaudited consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

		For the Three Months Ended September 30,
(in thousands)		2015				2014
Net income		$	928			$	657
Other comprehensive income, before taxes:
Securities available for sale:
Unrealized gain (loss) arising during the period			1,844				(332	)
Reclassification adjustment for losses (gains) included in net income			23				(17	)
Unrealized gain (loss) on available-for-sale securities			1,867				(349	)
Securities held to maturity:
Amortization of unrealized loss transferred from available for sale			13				13
Unrealized loss on held-to-maturity securities			13				13
Unrealized (loss) gain on derivative:
Unrealized (loss) gain arising during the period			(381	)			73
Reclassification adjustment for losses included in net income			37				37
Unrealized (loss) gain on derivative			(344	)			110
Other comprehensive income (loss), before taxes			1,536				(226	)
Income tax (expense) benefit related to other comprehensive income (loss)			(521	)			81
Comprehensive income		$	1,943			$	512

 

		For the Nine Months Ended September 30,
(in thousands)		2015				2014
Net income		$	2,672			$	707
Other comprehensive (loss) income, before taxes:
Securities available for sale:
Unrealized gain arising during the period			157				1,960
Reclassification adjustment for gains included in net income			(58	)			(39	)
Unrealized gain on available-for-sale securities			99				1,921
Securities held to maturity:
Unrealized loss transferred to held to maturity			—				(518	)
Amortization of unrealized loss transferred from available for sale			41				36
Unrealized loss on held-to-maturity securities			41				(482	)
Unrealized loss on derivative:
Unrealized loss arising during the period			(585	)			(275	)
Reclassification adjustment for losses included in net income			107				109
Unrealized loss on derivative			(478	)			(166	)
Other comprehensive (loss) income, before taxes			(338	)			1,273
Income tax benefit (expense) related to other comprehensive (loss) income			115				(429	)
Comprehensive income		$	2,449			$	1,551

See notes to unaudited consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

(in thousands)		September 30, 2015				September 30, 2014
Cash flows from operating activities
Net income		$	2,672			$	707
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan and lease losses			1,608				2,390
Depreciation and amortization			874				837
Net amortization of securities			659				301
Accretion of acquisition accounting adjustments			(1,237	)			(1,549	)
Deferred tax benefit			(273	)			(358	)
Gain on sales of securities			(58	)			(39	)
Share-based compensation expense			562				694
Bargain purchase gain			—				(42	)
Net loss on sale and write-down of other real estate owned			95				39
Loss on the write-down of equipment and other assets			3				17
Increase in cash surrender value of bank owned life insurance			(360	)			(258	)
Change in operating assets and liabilities:
Accrued interest receivable			(570	)			(1,494	)
Other assets			(3,425	)			(1,270	)
Accrued interest payable			137				34
Other liabilities			1,026				(99	)
Net cash provided by (used in) operating activities			1,713				(90	)
Cash flows from investing activities
Cash and cash equivalents acquired in bank acquisition			—				12,560
Proceeds from sales, maturities and calls of securities			19,920				9,137
Purchases of securities			(68,073	)			(5,359	)
Net increase in loans			(9,188	)			(132,999	)
Net decrease in other real estate owned			113				64
Purchases of bank owned life insurance			(5,000	)			—
Net purchase of premises and equipment			(197	)			(265	)
Sale of FRB and FHLB stock			2				126
Net cash used in investing activities			(62,423	)			(116,736	)
Cash flows from financing activities
Net increase in demand and savings deposits			48,993				45,567
Net increase in time deposits			2,675				50,793
Net increase in borrowed funds			5,050				12,000
Issuance of common stock, net of issuance costs			31				5,592
Repurchase of common stock			(66	)			(265	)
Redemption of preferred stock			(8,381	)			—
Preferred stock dividend			(42	)			(63	)
Net cash provided by financing activities			48,260				113,624
Net decrease in cash and cash equivalents			(12,450	)			(3,202	)
Cash and cash equivalents
Beginning of period			39,199				30,693
End of period		$	26,749			$	27,491
Supplementary disclosure of cash flow information
Cash payments for:
Interest		$	4,503			$	3,105
Income taxes		$	1,275			$	700
Transfer of loans to foreclosed assets		$	252			$	65
Transactions related to bank acquisition
Assets acquired		$	—			$	114,432
Liabilities assumed		$	—			$	103,900

See notes to unaudited consolidated financial statements.

 

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Xenith Bankshares, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

September 30, 2015

 

 

Note 1. Organization

Xenith Bankshares, Inc. (“Xenith Bankshares” or the “company”) is the bank holding company for Xenith Bank (the “Bank”), a Virginia-based institution headquartered in Richmond, Virginia. As of September 30, 2015, the company, through the Bank, operates eight full-service branches: one branch in Tysons Corner, Virginia, two branches in Richmond, Virginia, three branches in Suffolk, Virginia, and two branches in Gloucester, Virginia. Additionally, the Bank operates one loan production office in Newport News, Virginia.

In December 2009, First Bankshares, Inc. (“First Bankshares”), the bank holding company for SuffolkFirst Bank, and Xenith Corporation completed the merger of Xenith Corporation with and into First Bankshares (the “First Bankshares Merger”), with First Bankshares being the surviving entity in the First Bankshares Merger. At the effective time of the First Bankshares Merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the First Bankshares Merger, SuffolkFirst Bank changed its name to Xenith Bank. Although the First Bankshares Merger was structured as a merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes.

Effective on July 29, 2011, the Bank completed the acquisition of select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon Commercial Bank, a North Carolina banking corporation, and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the branch office.

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (the “FDIC”) acted as receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Acquisition agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

On June 30, 2014, the company completed the merger of Colonial Virginia Bank (“CVB”) with and into the Bank, with the Bank being the surviving bank (the “CVB Acquisition”). In connection with the CVB Acquisition, the company issued an aggregate of 1,618,186 shares of its common stock and paid $658 in cash to the former shareholders of CVB in exchange for their shares of CVB common stock.

Pursuant to the CVB Acquisition, the company acquired $114.4 million of assets, including $70.1 million in loans and assumed $103.9 million in liabilities, including $101.0 million of deposits. CVB operated two full-services branches in Gloucester, Virginia, and one loan production office in York County, Virginia. The CVB branches will continue doing business as Colonial Virginia Bank for an undetermined period of time. The loan production office has been relocated to Newport News, Virginia and operates as Xenith Bank.

In September 2014, the company issued and sold an aggregate of 880,000 shares of its common stock, $1.00 par value per share, at a price of $6.35 per share to third-party investors for an aggregate purchase price, net of stock issuance costs, of approximately $5.6 million.

On June 30, 2015, the company completed the redemption of all of the outstanding 8,381 shares of its senior non-cumulative perpetual preferred stock, Series A, that the company had issued and sold to the U.S. Treasury pursuant to the Small Business Lending Fund program (the “SBLF Preferred Stock”), at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends. There was no SBLF Preferred Stock outstanding as of September 30, 2015.

On June 26, 2015, the company issued and sold $8.5 million in aggregate principal amount of its 6.75% subordinated notes due 2025 (the “Subordinated Notes”). See Note 13 – Borrowings for more information on the Subordinated Notes. Substantially all of the net proceeds from the issuance and sale of the Subordinated Notes were used to fund the redemption of the company’s SBLF Preferred Stock.

Note 2. Basis of Presentation

The consolidated financial statements include the accounts of Xenith Bankshares and its wholly-owned subsidiary, Xenith Bank. All significant intercompany accounts have been eliminated.

In management’s opinion, the accompanying unaudited consolidated financial statements, which have been prepared in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim period reporting,

 

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and reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial position at September 30, 2015 and December 31, 2014, the results of operations and comprehensive income for the three and nine months ended September 30, 2015 and 2014, and the statements of cash flows for the nine months ended September 30, 2015 and 2014. The results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2015. The unaudited consolidated financial statements and accompanying notes should be read in conjunction with the company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2014.

All dollar amounts included in the tables in these notes are in thousands, except per share data, unless otherwise stated.

Note 3. Business Combination

The company has accounted for the CVB Acquisition under the acquisition method of accounting, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations,” whereby the acquired assets and assumed liabilities are recorded by the company at their estimated fair values as of the acquisition date, which was June 30, 2014.

In accordance with the framework established by FASB ASC Topic 820, “Fair Value Measurements and Disclosure” (“ASC 820”), the company used a fair value hierarchy to prioritize the information used to form assumptions and estimates in determining fair values. These fair value hierarchies are further discussed in Note 16 – Fair Value Measurements.

 

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The following table presents the allocation of the consideration paid to the estimated fair values of acquired assets and assumed liabilities in the CVB Acquisition as of the acquisition date. The allocation resulted in a bargain purchase gain of $42 thousand.

 

Fair value of assets acquired:
Cash and cash equivalents		$	12,560
Securities available for sale			17,439
Loans			70,051
Premises and equipment			3,338
Other real estate owned			1,186
Core deposit intangible			930
Accrued interest receivable			318
Deferred tax asset			1,898
Bank owned life insurance			4,054
Other assets			2,658
Total assets		$	114,432
Fair value of liabilities assumed:
Deposits		$	100,985
Accrued interest payable			39
Supplemental executive retirement plan			2,277
Other liabilities			599
Total liabilities		$	103,900
Net identifiable assets acquired		$	10,532
Consideration paid:
Company’s common shares issued			1,618,186
Purchase price per share (1)		$	6.40
Value of common stock issued			10,356
Estimated fair value of stock options			133
Cash in lieu of fractional shares			1
Total consideration paid		$	10,490
Bargain purchase gain		$	42

 

(1)	The value of the shares of common stock exchanged for shares of CVB common stock was based upon the closing price of the company’s common stock at June 27, 2014, the last trading day prior to the date of completion of the CVB Acquisition.

The following table presents the purchased performing and purchased impaired loans receivable at the date of the CVB Acquisition and the fair value adjustment recorded immediately following the acquisition:

 

		Purchased Performing				Purchased Impaired				Total
Contractual principal payments receivable		$	68,522			$	4,575			$	73,097
Fair value adjustment - credit and interest			(1,982	)			(1,064	)			(3,046	)
Fair value of acquired loans		$	66,540			$	3,511			$	70,051

 

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Note 4. Restrictions of Cash

To comply with regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement based on the weeks closest to September 30, 2015 and December 31, 2014 was $11.1 million and $9.4 million, respectively.

Note 5. Securities

The following tables present the amortized cost and fair value of securities as of the dates stated:

 

		September 30, 2015
						Gross Unrealized
		Amortized Cost				Gains				(Losses)				Fair Value
Securities available for sale:
Mortgage-backed securities - fixed rate		$	6,377			$	56			$	—			$	6,433
Commercial mortgage-backed securities - fixed rate			32,998				143				(60	)			33,081
Municipals - fixed rate
Tax exempt			54,188				281				(420	)			54,049
Taxable			10,058				158				(83	)			10,133
Collateralized mortgage obligations - fixed rate			8,275				120				(50	)			8,345
Total securities available for sale		$	111,896			$	758			$	(613	)		$	112,041
Securities held to maturity:
Municipals - fixed rate - taxable		$	9,272			$	651			$	—			$	9,923
Total securities held to maturity			9,272				651				—				9,923
Total securities		$	121,168			$	1,409			$	(613	)		$	121,964

 

		December 31, 2014
						Gross Unrealized
		Amortized Cost				Gains				(Losses)				Fair Value
Securities available for sale:
Mortgage-backed securities
Fixed rate		$	11,513			$	131			$	(101	)		$	11,543
Variable rate			4,136				106				(3	)			4,239
Municipals - fixed rate
Tax exempt			37,825				87				(165	)			37,747
Taxable			847				1				—				848
Collateralized mortgage obligations - fixed rate			9,974				55				(65	)			9,964
Total securities available for sale		$	64,295			$	380			$	(334	)		$	64,341
Securities held to maturity:
Municipals - fixed rate - taxable		$	9,279			$	404			$	—			$	9,683
Total securities held to maturity			9,279				404				—				9,683
Total securities		$	73,574			$	784			$	(334	)		$	74,024

As of September 30, 2015 and December 31, 2014, the company had securities with a fair value of $8.0 million and $8.7 million, respectively, pledged as collateral for public deposits.

 

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The following table presents the amortized cost and fair value of securities by contractual maturity as of the date stated:

 

		September 30, 2015
		Available for Sale								Held to Maturity
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Due within one year		$	—			$	—			$	—			$	—
Due after one year through five years			1,823				1,877				—				—
Due after five years through ten years			51,293				51,524				8,328				8,888
Due after ten years			58,780				58,640				944				1,035
Total securities		$	111,896			$	112,041			$	9,272			$	9,923

The following tables present fair values and the related unrealized losses in the company’s securities portfolio, with the information aggregated by investment category and by the length of time that individual securities have been in continuous unrealized loss positions as of the dates stated. The number of loss securities in each category is also noted.

 

		September 30, 2015
						Less than 12 months								More than 12 months								Total
		Number				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Securities available for sale:
Commercial mortgage-backed securities - fixed rate			4			$	10,163			$	(60	)		$	—			$	—			$	10,163			$	(60	)
Municipals - fixed rate
Tax exempt			23				35,026				(420	)			—				—				35,026				(420	)
Taxable			1				2,036				(83	)			—				—				2,036				(83	)
Collateralized mortgage obligations - fixed rate			2				—				—				3,168				(50	)			3,168				(50	)
Total securities available for sale			30			$	47,225			$	(563	)		$	3,168			$	(50	)		$	50,393			$	(613	)
Total securities			30			$	47,225			$	(563	)		$	3,168			$	(50	)		$	50,393			$	(613	)
		December 31, 2014
						Less than 12 months								More than 12 months								Total
		Number				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Securities available for sale:
Mortgage-backed securities
Fixed rate			3			$	—			$	—			$	8,682			$	(101	)		$	8,682			$	(101	)
Variable rate			1				2,789				(3	)			—				—				2,789				(3	)
Municipals - fixed rate
Tax exempt			11				19,353				(165	)			—				—				19,353				(165	)
Taxable			1				301				—				—				—				301				—
Collateralized mortgage obligations - fixed rate			2				—				—				3,767				(65	)			3,767				(65	)
Total securities available for sale			18			$	22,443			$	(168	)		$	12,449			$	(166	)		$	34,892			$	(334	)
Total securities			18			$	22,443			$	(168	)		$	12,449			$	(166	)		$	34,892			$	(334	)

All securities held as of September 30, 2015 were investment grade. The unrealized loss positions at September 30, 2015 were directly related to interest rate movements, and management believes there is minimal credit risk exposure in these investments. There is no intent to sell investments that were in an unrealized loss position at September 30, 2015, and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses. These investments were not considered to be other-than-temporarily impaired at September 30, 2015; therefore, no other-than-temporary impairment has been recognized in net income.

 

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Note 6. Loans

The following table presents the company’s composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total loans as of the dates stated:

 

		September 30, 2015								December 31, 2014
		Amount				Percent of Total				Amount				Percent of Total
Commercial and industrial		$	348,763				45.9	%		$	359,243				47.9	%
Commercial real estate			303,537				39.9	%			267,489				35.6	%
Residential real estate			36,089				4.7	%			40,859				5.4	%
Consumer			10,725				1.4	%			11,456				1.5	%
Guaranteed student loans			61,387				8.1	%			71,780				9.6	%
Overdrafts			29				0.0	%			46				0.0	%
Total loans			760,530				100.0	%			750,873				100.0	%
Allowance for loan and lease losses			(7,064	)							(6,247	)
Total loans, net of allowance		$	753,466							$	744,626

Loans, excluding guaranteed student loans, include unearned fees net of capitalized origination costs, of $338 thousand and $297 thousand, as of September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015, $250.4 million of loans were pledged to the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank as collateral for borrowing capacity.

As of September 30, 2015, the company had $61.4 million of guaranteed student loans, including premium and acquisition costs of $1.6 million and $896 thousand, respectively, which are amortized into interest income on the effective interest method. The guaranteed student loans were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, these loans are substantially guaranteed by a guarantee agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program (“FRLP”), pursuant to which borrowers under defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders. The student loans carry an approximate 98% federal government guarantee as to the payment of principal and accrued interest.

 

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The following tables present the company’s loans by regulatory risk ratings classification and by loan type as of the dates stated. As defined by the Federal Reserve and adopted by the company, “special mention” loans are defined as having potential weaknesses that deserve management’s close attention; “substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any; and “doubtful” loans have all the weaknesses inherent in substandard loans, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans not categorized as special mention, substandard or doubtful are classified as “pass.” The company’s risk ratings, which are assigned to loans, are embedded within these categories.

 

		September 30, 2015
		Pass				Special Mention				Substandard				Doubtful				Total Loans
Purchased credit-impaired loans:
Commercial and industrial		$	589			$	—			$	413			$	—			$	1,002
Commercial real estate			3,194				374				815				—				4,383
Residential real estate			218				—				626				—				844
Consumer			36				—				56				—				92
Total purchased credit-impaired loans			4,037				374				1,910				—				6,321
Originated and other purchased loans:
Commercial and industrial			342,715				2,361				2,685				—				347,761
Commercial real estate			291,574				786				6,794				—				299,154
Residential real estate			33,590				259				1,396				—				35,245
Consumer			10,455				26				152				—				10,633
Guaranteed student loans			61,387				—				—				—				61,387
Overdrafts			29				—				—				—				29
Total originated and other purchased loans			739,750				3,432				11,027				—				754,209
Total loans		$	743,787			$	3,806			$	12,937			$	—			$	760,530
		December 31, 2014
		Pass				Special Mention				Substandard				Doubtful				Total Loans
Purchased credit-impaired loans:
Commercial and industrial		$	462			$	150			$	524			$	—			$	1,136
Commercial real estate			3,636				—				2,648				—				6,284
Residential real estate			126				10				908				—				1,044
Consumer			158				—				56				—				214
Total purchased credit-impaired loans			4,382				160				4,136				—				8,678
Originated and other purchased loans:
Commercial and industrial			347,938				6,458				3,711				—				358,107
Commercial real estate			254,540				2,934				3,731				—				261,205
Residential real estate			37,818				765				1,232				—				39,815
Consumer			11,065				36				141				—				11,242
Guaranteed student loans			71,780				—				—				—				71,780
Overdrafts			46				—				—				—				46
Total originated and other purchased loans			723,187				10,193				8,815				—				742,195
Total loans		$	727,569			$	10,353			$	12,951			$	—			$	750,873

Allowance for Loan and Lease Losses

The allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “Contingencies,” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “Receivables.” A loan is impaired when, based on current information and events, it is probable that all amounts due (principal and interest) according to the contractual terms of the loan agreement will not be collected.

 

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The allowance for loan and lease losses is determined based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans that are originated by the company. In evaluating the loan portfolio, qualitative factors, such as general economic conditions, nationally and in the company’s target markets, are considered, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors and estimates may be subject to significant change. Increases to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in the consolidated statements of income. Loans or portions of loans deemed to be uncollectible are charged against the allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses.

The company’s allowance for loan and lease losses related to guaranteed student loans is based on historical and expected default rates for the loans applied to the portion of carrying value in these loans that is not subject to federal guarantee.

The following tables present the allowance for loan and lease loss activity, by loan category, for the dates stated:

 

		Three Months Ended September 30,
		2015				2014
Balance at beginning of period		$	6,849			$	6,016
Charge-offs:
Commercial and industrial			—				30
Commercial real estate			—				—
Residential real estate			—				136
Consumer			—				—
Guaranteed student loans			143				1,741
Overdrafts			2				6
Total charge-offs			145				1,913
Recoveries:
Commercial and industrial			—				2
Commercial real estate			—				—
Residential real estate			—				—
Consumer			—				—
Guaranteed student loans			—				—
Overdrafts			1				3
Total recoveries			1				5
Net charge-offs			144				1,908
Provision for loan and lease losses			343				1,560
Amount for unfunded commitments			16				(108	)
Other (1)			—				9
Balance at end of period		$	7,064			$	5,569

 

(1)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

 

 

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		Nine Months Ended September 30,
		2015				2014
Balance at beginning of period		$	6,247			$	5,305
Charge-offs:
Commercial and industrial			2				30
Commercial real estate			—				—
Residential real estate			54				171
Consumer			—				—
Guaranteed student loans			690				1,741
Overdrafts			7				20
Total charge-offs			753				1,962
Recoveries:
Commercial and industrial			1				3
Commercial real estate			81				4
Residential real estate			—				—
Consumer			1				—
Guaranteed student loans			—				—
Overdrafts			5				4
Total recoveries			88				11
Net charge-offs			665				1,951
Provision for loan and lease losses			1,608				2,390
Amount for unfunded commitments			(80	)			(118	)
Other (1)			(46	)			(57	)
Balance at end of period		$	7,064			$	5,569

 

(1)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

The company charges off the portion of its guaranteed student loans that are (1) not subject to federal government guarantee and (2) greater than 120 days past due and have a high probability of default. Probability of default is determined by recent loss migration analysis. Student loans greater than 120 days past due continue to accrue interest, with respect to the guaranteed portion, as interest receivable is guaranteed until a claim, if any, against the government guarantee is satisfied.

 

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The following tables present the allowance for loan and lease losses, with the amount independently and collectively evaluated for impairment, and loan balances, by loan type, as of the dates stated:

 

		September 30, 2015
		Total Amount				Individually Evaluated for Impairment				Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Purchased credit-impaired loans
Commercial and industrial		$	52			$	52			$	—
Commercial real estate			178				178				—
Residential real estate			79				79				—
Consumer			—				—				—
Total purchased credit-impaired loans			309				309				—
Originated and other purchased loans
Commercial and industrial			2,117				413				1,704
Commercial real estate			4,480				659				3,821
Residential real estate			87				11				76
Consumer			—				—				—
Guaranteed student loans			71				—				71
Total originated and other purchased loans			6,755				1,083				5,672
Total allowance for loan and lease losses		$	7,064			$	1,392			$	5,672
Loan balances applicable to:
Purchased credit-impaired loans
Commercial and industrial		$	1,002			$	977			$	25
Commercial real estate			4,383				2,649				1,734
Residential real estate			844				367				477
Consumer			92				—				92
Total purchased credit-impaired loans			6,321				3,993				2,328
Originated and other purchased loans
Commercial and industrial			347,761				2,378				345,383
Commercial real estate			299,154				6,023				293,131
Residential real estate			35,245				625				34,620
Consumer			10,662				516				10,146
Guaranteed student loans			61,387				—				61,387
Total originated and other purchased loans			754,209				9,542				744,667
Total loans		$	760,530			$	13,535			$	746,995

 

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		December 31, 2014
		Total Amount				Individually Evaluated for Impairment				Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Purchased credit-impaired loans
Commercial and industrial		$	34			$	34			$	—
Commercial real estate			182				182				—
Residential real estate			36				36				—
Consumer			—				—				—
Total purchased credit-impaired loans			252				252				—
Originated and other purchased loans
Commercial and industrial			2,174				326				1,848
Commercial real estate			3,577				123				3,454
Residential real estate			139				22				117
Consumer			—				—				—
Guaranteed student loans			105				—				105
Total originated and other purchased loans			5,995				471				5,524
Total allowance for loan and lease losses		$	6,247			$	723			$	5,524
Loan balances applicable to:
Purchased credit-impaired loans
Commercial and industrial		$	1,136			$	989			$	147
Commercial real estate			6,284				3,112				3,172
Residential real estate			1,044				554				490
Consumer			214				—				214
Total purchased credit-impaired loans			8,678				4,655				4,023
Originated and other purchased loans
Commercial and industrial			358,107				2,690				355,417
Commercial real estate			261,205				2,833				258,372
Residential real estate			39,815				384				39,431
Consumer			11,288				—				11,288
Guaranteed student loans			71,780				—				71,780
Total originated and other purchased loans			742,195				5,907				736,288
Total loans		$	750,873			$	10,562			$	740,311

 

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The following tables present the loans that were individually evaluated for impairment, by loan type, as of the dates stated. The tables present those loans with and without an allowance and various additional data, as of the dates stated:

 

		September 30, 2015
		Recorded Investment				Unpaid Principal Balance				Related Allowance
With no related allowance recorded:
Purchased credit-impaired loans
Commercial and industrial		$	302			$	1,451			$	—
Commercial real estate			388				525				—
Residential real estate			237				270				—
Consumer			—				—				—
Originated and other purchased loans
Commercial and industrial			1,252				1,274				—
Commercial real estate			3,339				3,915				—
Residential real estate			542				548				—
Consumer			516				579				—
With an allowance recorded:
Purchased credit-impaired loans
Commercial and industrial			675				668				52
Commercial real estate			2,261				2,376				178
Residential real estate			130				135				79
Consumer			—				—				—
Originated and other purchased loans
Commercial and industrial			1,126				1,126				413
Commercial real estate			2,684				2,692				659
Residential real estate			83				83				11
Consumer			—				—				—
Total loans individually evaluated for impairment		$	13,535			$	15,642			$	1,392

 

		December 31, 2014
		Recorded Investment				Unpaid Principal Balance				Related Allowance
With no related allowance recorded:
Purchased credit-impaired loans
Commercial and industrial		$	336			$	1,439			$	—
Commercial real estate			855				1,230				—
Residential real estate			181				216				—
Consumer			—				—				—
Originated and other purchased loans
Commercial and industrial			1,492				1,514				—
Commercial real estate			2,648				3,066				—
Residential real estate			173				173				—
Consumer			—				—				—
With an allowance recorded:
Purchased credit-impaired loans
Commercial and industrial			653				650				34
Commercial real estate			2,257				2,365				182
Residential real estate			373				405				36
Consumer			—				—				—
Originated and other purchased loans
Commercial and industrial			1,198				1,198				326
Commercial real estate			184				201				123
Residential real estate			212				212				22
Consumer			—				—				—
Total loans individually evaluated for impairment		$	10,562			$	12,669			$	723

 

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		Three Months Ended September 30,
		2015								2014
		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Purchased credit-impaired loans
Commercial and industrial		$	305			$	—			$	311			$	—
Commercial real estate			389				—				1,547				—
Residential real estate			239				—				323				—
Consumer			—				—				—				—
Originated and other purchased loans
Commercial and industrial			1,257				15				1,534				6
Commercial real estate			3,351				39				492				—
Residential real estate			542				4				175				—
Consumer			517				—				—				—
With an allowance recorded:
Purchased credit-impaired loans
Commercial and industrial			683				9				836				16
Commercial real estate			2,269				38				2,689				58
Residential real estate			164				—				—				—
Consumer			—				—				—				—
Originated and other purchased loans
Commercial and industrial			1,134				—				1,223				—
Commercial real estate			2,685				25				—				—
Residential real estate			83				—				215				—
Consumer			—				—				—				—
Total loans individually evaluated for impairment		$	13,618			$	130			$	9,345			$	80

 

		Nine Months Ended September 30,
		2015								2014
		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Purchased credit-impaired loans
Commercial and industrial		$	327			$	—			$	331			$	—
Commercial real estate			397				—				1,559				—
Residential real estate			245				—				322				—
Consumer			—				—				—				—
Originated and other purchased loans
Commercial and industrial			1,291				19				1,588				20
Commercial real estate			3,372				112				496				—
Residential real estate			549				12				179				—
Consumer			517				—				—				—
With an allowance recorded:
Purchased credit-impaired loans
Commercial and industrial			711				29				852				44
Commercial real estate			2,298				115				2,672				151
Residential real estate			178				—				—				—
Consumer			—				—				—				—
Originated and other purchased loans
Commercial and industrial			1,156				—				1,262				—
Commercial real estate			2,691				63				—				—
Residential real estate			85				—				217				—
Consumer			—				—				—				—
Total loans individually evaluated for impairment		$	13,817			$	350			$	9,478			$	215

 

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Acquired loans pursuant to a business combination are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any deterioration in credit quality subsequent to acquisition for these loans is reflected in the allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that all contractually required principal and interest payments will not be collected are accounted for under FASB ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). A portion of the loans acquired in the VBB Acquisition and the CVB Acquisition were deemed by management to be credit-impaired loans qualifying for accounting under ASC 310-30.

The remaining fair value adjustment on the VBB and CVB purchased credit-impaired loans, as of September 30, 2015, was $1.3 million and $560 thousand, respectively. The carrying value of the VBB and CVB purchased credit-impaired loans, as of September 30, 2015, was approximately $4.1 million and $2.0 million, respectively, which is net of any impairment charges recorded subsequent to acquisition.

For purchased credit-impaired loans, the excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and accreted into interest income over the remaining life of the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

In applying ASC 310-30 to acquired loans, the company must periodically estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including default rates, the amount and timing of prepayments and the liquidation value and timing of underlying collateral, in addition to other factors. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the initial accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The increased accretable yield is recognized in income over the remaining period of expected cash flows from the loan. Impairments and reversals of impairments are recorded in the provision for loan and lease losses in the consolidated statements of income and as a component of the allowance for loan and lease losses in the consolidated balance sheets.

The following table presents accretion activity related to acquired loans for the dates stated:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2015				2014				2015				2014
Balance at beginning of period		$	4,759			$	7,279			$	5,580			$	4,441
Additions			—				(4	)			—				3,046
Accretion (1)			(338	)			(1,252	)			(1,180	)			(1,530	)
Disposals (2)			(17	)			(51	)			(42	)			(51	)
Other (3)			—				—				46				66
Balance at end of period		$	4,404			$	5,972			$	4,404			$	5,972

 

(1)	Accretion amounts are reported in interest income.

(2)	Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2015 amount, $17 thousand relates to a loan reclassified as OREO.

(3)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

 

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The following tables present the age analysis of loans past due as of the dates stated:

 

		September 30, 2015
		Current				30-89 days Past Due				90+ days Past Due				Total Past Due				Total Loans
Purchased credit-impaired loans:
Commercial and industrial		$	588			$	76			$	338			$	414			$	1,002
Commercial real estate			4,192				10				181				191				4,383
Residential real estate			655				189				—				189				844
Consumer			81				—				11				11				92
Total purchased credit-impaired loans			5,516				275				530				805				6,321
Originated and other purchased loans:
Commercial and industrial			346,376				655				730				1,385				347,761
Commercial real estate			295,213				2,879				1,062				3,941				299,154
Residential real estate			34,509				253				483				736				35,245
Consumer			10,152				14				496				510				10,662
Guaranteed student loans			43,904				5,135				12,348				17,483				61,387
Total originated and other purchased loans			730,154				8,936				15,119				24,055				754,209
Total loans		$	735,670			$	9,211			$	15,649			$	24,860			$	760,530
		December 31, 2014
		Current				30-89 days Past Due				90+ days Past Due				Total Past Due				Total Loans
Purchased credit-impaired loans:
Commercial and industrial		$	696			$	222			$	218			$	440			$	1,136
Commercial real estate			5,567				629				88				717				6,284
Residential real estate			668				230				146				376				1,044
Consumer			203				—				11				11				214
Total purchased credit-impaired loans			7,134				1,081				463				1,544				8,678
Originated and other purchased loans:
Commercial and industrial			356,511				873				723				1,596				358,107
Commercial real estate			258,975				1,490				740				2,230				261,205
Residential real estate			38,891				702				222				924				39,815
Consumer			11,140				113				35				148				11,288
Guaranteed student loans			46,821				12,025				12,934				24,959				71,780
Total originated and other purchased loans			712,338				15,203				14,654				29,857				742,195
Total loans		$	719,472			$	16,284			$	15,117			$	31,401			$	750,873

Guaranteed student loans comprised $5.1 million of the total amounts that were past due 30-89 days and $12.3 million of the total amounts that were past due 90 days or greater as of September 30, 2015. These loans are nearly 98% guaranteed as to principal and accrued interest. Pursuant to the guarantee, the company may make a claim for payment on a loan after a period of 270 days during which no payment has been made on the loan.

The following table presents nonaccrual loans and other real estate owned (“OREO”) as of the dates stated. A loan is considered nonaccrual if it is 90 days or greater past due as to interest and principal or when collectability is in doubt, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of September 30,

 

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2015, there were no loans, other than guaranteed student loans, past due 90 days or greater for which interest was accruing. Accrued interest on the guaranteed portion of student loans is subject to the guarantee and is payable under the claim, if any, to the time the claim is satisfied.

 

		September 30, 2015				December 31, 2014
Purchased credit-impaired loans:
Commercial and industrial		$	405			$	463
Commercial real estate			435				2,105
Residential real estate			645				962
Consumer			7				8
Total purchased credit-impaired loans			1,492				3,538
Originated and other purchased loans:
Commercial and industrial			1,303				2,311
Commercial real estate			2,536				930
Residential real estate			1,401				594
Consumer			16				4
Total originated and other purchased loans			5,256				3,839
Total nonaccrual loans			6,748				7,377
Other real estate owned			932				1,140
Total nonperforming assets		$	7,680			$	8,517

In accordance with Accounting Standards Update (“ASU”) No. 2011-02, “Receivables: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” the company assesses all restructurings for potential identification as troubled debt restructurings (“TDR”). A modification of a loan’s terms constitutes a TDR, if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. Modifications of terms for loans that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal payments, regardless of the period of the modification.

For loans classified as TDRs, the company further evaluates the loans as performing or nonperforming. If at the time of restructure the loan is on accrual status, it will be classified as performing and will continue to be classified as performing as long as the borrower continues making payments in accordance with the restructured terms. A modified loan will be classified as nonaccrual, if the loan becomes 90 days delinquent, or when collectability is in doubt. TDRs originally considered nonaccrual will be classified as nonperforming, but may be classified as performing TDRs, if subsequent to restructure the loan experiences payment performance according to the restructured terms for a consecutive six-month period and other required conditions are met.

The following table presents performing and nonperforming loans identified as TDRs, by loan type, as of the dates stated:

 

		September 30, 2015				December 31, 2014
Performing TDRs:
Commercial and industrial		$	1,498			$	2,735
Commercial real estate			5,042				1,913
Residential real estate			443				87
Consumer			—				—
Total performing TDRs		$	6,983			$	4,735
Nonperforming TDRs:
Commercial and industrial		$	799			$	—
Commercial real estate			29				33
Residential real estate			118				265
Consumer			—				—
Total nonperforming TDRs		$	946			$	298
Total TDRs		$	7,929			$	5,033

 

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The following tables present loans classified as TDRs, including the type of modification, number of loans and loan type, as of the dates stated:

 

		September 30, 2015
		Number of Loans Modified				Rate Modification				Term Extension and/or Other Concessions				Total
Commercial and industrial			8			$	1,076			$	1,221			$	2,297
Commercial real estate			7				2,252				2,819				5,071
Residential real estate			5				220				341				561
Consumer			—				—				—				—
Total TDRs			20			$	3,548			$	4,381			$	7,929
		December 31, 2014
		Number of Loans Modified				Rate Modification				Term Extension and/or Other Concessions				Total
Commercial and industrial			8			$	1,149			$	1,586			$	2,735
Commercial real estate			5				—				1,946				1,946
Residential real estate			3				87				265				352
Consumer			—				—				—				—
Total TDRs			16			$	1,236			$	3,797			$	5,033

During the three months ended September 30, 2015, the company identified three loans as TDRs totaling $647 thousand, which are included in the tables above.

Note 7. Goodwill and Other Intangible Assets

The following table presents goodwill and other intangible assets, which are core deposit intangibles, as of the dates stated:

 

		September 30, 2015				December 31, 2014
Amortizable core deposit intangibles:
Gross carrying value		$	4,640			$	4,640
Accumulated amortization			(1,829	)			(1,486	)
Net core deposit intangibles			2,811				3,154
Goodwill			12,989				12,989
Total goodwill and other intangible assets, net		$	15,800			$	16,143

Note 8. Deposits

The following table presents a summary of deposit accounts as of the dates stated:

 

		September 30, 2015				December 31, 2014
Noninterest-bearing demand deposits		$	152,223			$	121,230
Interest-bearing:
Demand and money market deposits			361,418				344,023
Savings deposits			10,713				10,108
Time deposits of $100,000 or more			220,805				213,920
Other time deposits			79,364				83,630
Total deposits		$	824,523			$	772,911

 

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Note 9. Derivatives

Cash Flow Hedges

The company uses interest rate derivatives to manage its exposure to interest rate movements. The company is a party to two interest rate swap agreements designated as cash flow hedges in accordance with FASB ASC Topic 815, “Derivatives and Hedging.” Pursuant to these agreements, the company has minimized its exposure to interest rate movements by exchanging variable for fixed interest payments beginning September 28, 2015 without exchange of underlying notional amounts totaling $17.5 million. Prior to September 28, 2015, the company had an interest rate swap agreement whereby it exchanged variable for fixed interest payments related to a $20.0 million borrowing, without exchange of the underlying notional amount. The swap expired upon the maturity of the $20.0 million borrowing, which was September 28, 2015.

The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recorded in accumulated other comprehensive income (“AOCI”) and is subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. For the three months ended September 30, 2015 and 2014, the ineffective portion was insignificant. The amount reported in AOCI as of September 30, 2015 was a loss of $583 thousand, net of a tax benefit of $301 thousand. As of September 30, 2015 a liability of $903 thousand was recorded in other liabilities on the consolidated balance sheet related to these cash flow hedges.

Non-hedge Derivatives

Derivatives not designated as hedges are not speculative and result from a service the company provides to certain customers. The company executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the company executes with third parties, thus minimizing its net exposure from such transactions. These derivatives do not meet hedge accounting requirements; therefore, changes in the fair value of both the customer derivative and the offsetting derivative are recognized in earnings. As of September 30, 2015, $1.2 million was recorded in other assets and $1.2 million was recorded in other liabilities related to non-designated hedges. For the three months ended September 30, 2015 and 2014, $39 thousand of loss and $30 thousand of income, respectively, were recorded in net income related to non-designated hedges. For the nine months ended September 30, 2015 and 2014, $25 thousand and $68 thousand of income, respectively, were recorded in net income related to non-designated hedges.

The company has minimum collateral requirements with its counterparties for both cash flow hedges and non-hedge derivatives which contain provisions, whereby if the company fails to maintain its status as a well or an adequately capitalized institution, the company could be required to terminate or fully collateralize the derivative contract. Additionally, if the company defaults on any of its indebtedness, including default where repayment has not been accelerated by the lender, the company could also be in default on its derivative obligations. As of September 30, 2015, the valuation of these derivatives has surpassed the contractually specified minimum transfer amounts of $350 thousand, and $2.2 million has been pledged as collateral under the agreements. If the company is not in compliance with the terms of the derivative agreements, it could be required to settle its obligations under the agreements at termination value.

Note 10. Income Taxes

Net deferred tax assets as of September 30, 2015 and December 31, 2014 were $6.7 million and $6.3 million, respectively. The following table presents the statutory tax rate reconciled to the company’s effective tax rate for the dates stated:

 

		For the Nine Months Ended
		September 30, 2015								September 30, 2014
		Tax				Rate				Tax				Rate
Income tax expense at statutory rate		$	1,261				34.00	%		$	432				34.00	%
Meals and entertainment			7				0.20	%			10				0.80	%
Share-based compensation			31				0.83	%			52				4.13	%
Transaction-related expenses			—				0.00	%			147				11.60	%
Tax exempt income			(348	)			-9.37	%			(98	)			-7.68	%
Other			87				2.34	%			21				1.52	%
Income tax expense reported		$	1,038				28.00	%		$	564				44.37	%

 

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Note 11. Earnings per Common Share

The following tables summarize basic and diluted earnings per common share calculations for the periods stated. Weighted average shares outstanding for the calculation of basic earnings per share include vested restricted stock units. Excluded from the computation of diluted earnings per common share were 241,810 and 242,863 shares related to options, for the three and nine months ended September 30, 2015, respectively, because their inclusion in the calculation would be anti-dilutive. For the three and nine months ended September 30, 2014, 289,320 and 275,691 shares, respectively, related to options, were excluded from the calculation of diluted earnings per share as their inclusion would be anti-dilutive. The number of shares in the following tables is in thousands.

 

		For the Three Months Ended September 30,
		2015				2014
Net income		$	928			$	657
Preferred stock dividend			—				(21	)
Net income available to common shareholders		$	928			$	636
Weighted average shares outstanding, basic			13,143				12,124
Dilutive shares			201				187
Weighted average shares outstanding, diluted			13,344				12,311
Earnings per common share, basic		$	0.07			$	0.05
Earnings per common share, diluted		$	0.07			$	0.05
		For the Nine Months Ended September 30,
		2015				2014
Net income		$	2,672			$	707
Preferred stock dividend			(42	)			(63	)
Net income available to common shareholders		$	2,630			$	644
Weighted average shares outstanding, basic			13,119				11,037
Dilutive shares			187				146
Weighted average shares outstanding, diluted			13,306				11,183
Earnings per common share, basic		$	0.20			$	0.06
Earnings per common share, diluted		$	0.20			$	0.06

Note 12. Pension Plan

In connection with the CVB Acquisition, the company assumed the Colonial Virginia Bank Executive Retirement Plan (“SERP”). The SERP provides for the payment of supplemental retirement benefits to three former CVB executives. All benefits to the former CVB employees are fully vested and payments may begin six months following the employee’s termination, as defined by the SERP. As of September 30, 2015, two former CVB employees were receiving payments under the SERP. For the three and nine months ended September 30, 2015, the company paid $45 and $113 thousand, respectively, of benefits under the SERP. The company expects to pay $45 thousand to the former employees for the remainder of 2015. As of September 30, 2015, a $2.2 million liability was recorded on the company’s consolidated balance sheet related to the SERP. A discount rate of 4% was used in determining the SERP liability.

The company also has a grantor trust (rabbi trust) established as a source of funds to pay benefits under the SERP. As of September 30, 2015, $1.8 million in cash and investment securities, at fair value, was held in the rabbi trust and was recorded in other assets on the company’s consolidated balance sheet. The rabbi trust assets are subject to the general unsecured creditors of the company.

 

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Note 13. Borrowings

On June 26, 2015, the company issued and sold $8.5 million in aggregate principal amount of its 6.75% subordinated notes due 2025 pursuant to a Subordinated Note Purchase Agreement. The Subordinated Notes bear interest at an annual rate of 6.75%, which is payable quarterly in arrears on March 31, June 30, September 30 and December 31. The Subordinated Notes qualify as Tier 2 capital for the company. The Subordinated Notes may not be redeemed by the company prior to June 26, 2020, except in the event (i) the Subordinated Notes no longer qualify as Tier 2 Capital as a result of a change in interpretation or application of law or regulation, or (ii) of a “Tax Event” (as defined under the Subordinated Note Purchase Agreement). The Subordinated Notes are unsecured and subordinate and junior in right of payments to the company’s secured and general creditors. Additionally, the company is not permitted to declare or pay any dividend or make any distribution on its capital stock or any other of its equity securities of any kind, except for dividends payable solely in shares of the company’s common stock, if the total risk-based capital ratio, Tier 1 risk-based capital ratio, or leverage ratio of the company or the Bank, becomes less than 10.0%, 6.0% or 5.0%, respectively. For the three and nine months ended September 30, 2015, the effective interest rate, which includes the amortization of loan origination costs, on the Subordinated Notes was 7.13% and 7.11%, respectively.

On September 30, 2014, the company entered into an agreement with a national bank that provides for an unsecured senior term loan credit facility up to $15 million (the “Credit Agreement”). The company borrowed $12 million upon the closing of the Credit Agreement on September 30, 2014 and had the right to borrow up to an additional $3 million under a delayed-draw term loan commitment (“Delayed Draw Loan”), subject to customary conditions, on or before September 30, 2015. On September 24, 2015, the company entered into an amendment to the Credit Agreement (the “Amendment”) that amends certain provisions of the Credit Agreement. Among other things, the Amendment modified the Credit Agreement by (i) increasing the company’s right to borrow under the Delayed Draw Loan to up to an additional $5 million, subject to customary conditions, and (ii) extending the date by which the company may draw under the Delayed Draw Loan to September 30, 2016. Repayments under the term loans were monthly payments of accrued interest only for the first six months and then, beginning on March 31, 2015, the term loans are repayable in monthly installments of principal, based on a 10-year amortization schedule, plus accrued interest. Unless extended or earlier prepaid, the maturity date of all term loans made under the Credit Agreement is September 30, 2019, at which time all unpaid principal and interest will become due and payable in full. Borrowings under the Credit Agreement bear interest at the 30-day LIBOR in effect from time to time, plus 2.75% per annum, which was reduced from 30-day LIBOR in effect from time to time, plus 3.5% pursuant to the Amendment. The Credit Agreement is unsecured but the lender has the benefit of a negative pledge on all of the outstanding capital stock of the Bank. For the three and nine months ended September 30, 2015, the effective interest rate, which includes the amortization of loan origination costs, on the unsecured senior term loan was 4.00% and 3.98.%, respectively.

The Credit Agreement contains financial covenants that require (1) the company to be, and to cause the Bank to be, “well- capitalized” as defined in federal banking regulations, at all times, (2) the Bank’s total risk-based capital ratio to be at least equal to 11.5% as of the last day of each fiscal quarter, (3) the Bank’s ratio of nonperforming assets to tangible primary capital to be no more than 30% as of the last day of each fiscal quarter, (4) the Bank’s ratio of loan loss reserves, including loans discounts relating to acquired loans, to nonperforming loans to be at least equal to 70% at all times and (5) the company’s fixed charge coverage ratio, determined on a consolidated basis, to be at least 1.25 to 1.0 at the end of each fiscal quarter for the trailing four fiscal quarters. As of September 30, 2015, the company and the Bank, as applicable, were in compliance with these financial covenants.

Note 14. Senior Non-Cumulative Perpetual Preferred Stock

On June 30, 2015, the company completed the redemption of all of the outstanding 8,381 shares ($8.4 million) of the SBLF Preferred Stock. Substantially all of the net proceeds from the issuance and sale of the Subordinated Notes were used to fund the redemption. For the three months ended September 30, 2015 and 2014, the company’s dividend on the SBLF Preferred Stock was $0 and $21 thousand, respectively, and for the nine months ended September 30, 2015 and 2014, the company’s dividend on the SBLF Preferred Stock was $42 thousand and $63 thousand, respectively. The effective dividend rate was 1% for all periods for which a dividend was paid.

Note 15. Commitments and Contingencies

In the normal course of business, the Bank has commitments under credit agreements to lend to customers provided that there is no material violation of any condition established in the contracts. These commitments have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Additionally, the Bank issues letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

 

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The following table presents unfunded commitments outstanding as of the dates stated:

 

		September 30, 2015				December 31, 2014
Commercial lines of credit		$	176,849			$	127,363
Commercial real estate			56,758				63,950
Residential real estate			11,035				10,949
Consumer			3,915				2,936
Letters of credit			8,221				9,777
Total commitments		$	256,778			$	214,975

The Bank has a commitment to invest in a limited partnership that operates as a small business investment company. As of September 30, 2015, the Bank had invested $750 thousand; an additional $250 thousand will be funded at the request of the general partner of the partnership. Additionally, the Bank has a $1.0 million commitment to invest in a Virginia limited liability company, the purpose of which is to invest in low-income residential rental and/or historic properties.

In the third quarter of 2015, the company entered into a new agreement with its core processing servicer. This agreement replaced an existing agreement that was to expire in December 2016. The new agreement expires in December 2020, though is terminable with 180 days notice and payment of financial penalties. Minimum fees under the agreement over the remaining term are approximately $5.0 million.

Additionally, in the third quarter of 2015, the company entered into a new lease agreement for its loan production office. The lease agreement expires in July 2020. Future commitments under this agreement total $222 thousand.

Note 16. Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

ASC 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Under the guidance in ASC 820, the company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1		Quoted prices in active markets for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2		Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3		Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value to such assets or liabilities.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The company evaluates its hierarchy disclosures each quarter, and based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. An adjustment to the pricing method used within either Level 1 or Level 2 inputs could generate a fair value measurement that effectively falls in a lower level in the hierarchy. The company expects changes in classifications between levels will be rare.

Securities available for sale:

Available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, collateralized mortgage obligations, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

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Other real estate owned:

OREO is measured at the asset’s fair value less costs for disposal. The company estimates fair value at the asset’s liquidation value less disposal costs using management’s assumptions, which are based on current market analysis or recent appraisals. OREO is classified as nonrecurring Level 3.

Impaired loans:

The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of September 30, 2015, all of the impaired loans accounted for under ASC 310-30 were evaluated based on discounted cash flows or on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the company records the impaired loan as nonrecurring Level 2. When a current appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, or management evaluates fair value based on discounted cash flows, the company records the impaired loan as nonrecurring Level 3.

Derivatives:

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

Although the company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2015 and December 31, 2014, the company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

In conjunction with the FASB’s fair value measurement guidance, the company has elected to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Other assets:

Assets held in the company’s rabbi trust consist of cash and marketable securities. The carrying value for cash and cash equivalents approximates fair value. Securities include those traded on nationally recognized securities exchanges. Other assets are classified as recurring Level 1.

Cash, cash equivalents and accrued interest:

The carrying value for cash and cash equivalents and accrued interest approximates fair value.

The methodology for measuring the fair value of other financial assets and financial liabilities that are not recorded at fair value on a recurring or nonrecurring basis are discussed below.

Securities held to maturity:

Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, collateralized mortgage obligations, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

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Performing loans:

For variable-rate loans that re-price frequently and with no significant changes in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms.

Deposit liabilities:

The balance of demand, money market and savings deposits approximates the fair value payable on demand to the accountholder. The fair value of fixed-maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.

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 at the company’s current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of the senior term loan, for which interest rates reset quarterly or less, approximates its fair value. The fair value of the Subordinated Notes approximates their sales price.

Other commitments:

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

 

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As noted, certain assets and liabilities are measured at fair value on a recurring and nonrecurring basis. The following tables present assets measured at fair value on a recurring and nonrecurring basis as of the dates stated:

 

						Fair Value Measurements as of September 30, 2015 Using
		September 30, 2015 Balance				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale
Mortgage-backed securities - fixed rate		$	6,433			$	—				6,433				—
Commercial mortgage-backed securities - fixed rate			33,081				—				33,081				—
Municipals			64,182				—				64,182				—
Collateralized mortgage obligations			8,345				—				8,345				—
Cash flow hedge - liability			(903	)			—				(903	)			—
Interest rate derivative - asset			1,165				—				1,165				—
Interest rate derivative - liability			(1,230	)			—				(1,230	)			—
Other assets			1,829				1,829				—				—
Assets measured on a nonrecurring basis:
Impaired loans			13,535				—				—				13,535
Other real estate owned			932				—				—				932

 

						Fair Value Measurements as of December 31, 2014 Using
		December 31, 2014 Balance				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale
Mortgage-backed securities
Fixed rate		$	11,543			$	—			$	11,543			$	—
Variable rate			4,239				—				4,239				—
Municipals			38,595				9,021				29,574				—
Collateralized mortgage obligations			9,964				—				9,964				—
Cash flow hedge - liability			(423	)			—				(423	)			—
Interest rate derivative - asset			809				—				809				—
Interest rate derivative - liability			(852	)			—				(852	)			—
Other assets			2,030				2,030				—				—
Assets measured on a nonrecurring basis:
Impaired loans			10,562				—				—				10,562
Other real estate owned			1,140				—				—				1,140

Certain municipal securities in the amount of $9.0 million as of December 31, 2014 were classified as Level 1 at December 31, 2014 and subsequent to December 31, 2014, as Level 2. All of these securities were purchased in December 2014. The fair value of these securities at December 31, 2014 reflected the trade or purchase price and, therefore, were classified as Level 1. Subsequent to trade date, these securities are classified as Level 2.

 

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The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis, for which the company has utilized Level 3 inputs to determine fair value, as of the dates stated:

 

		Quantitative Information about Level 3 Fair Value Measurements
		Fair Value at September 30, 2015				Valuation Techniques		Unobservable Input		Range
Impaired Loans		$	13,535			Collateral value, market value of similar debt, enterprise value, liquidation value and/or discounted cash flows		Yield		0-29%
Other real estate owned (1)			932			Market analysis or recent appraisals		Disposal costs		N/A

 

(1)	The fair value of these assets is determined based on appraisal value or sales price less estimated disposal costs, if applicable, the range of which is not meaningful to disclose.

 

		Quantitative Information about Level 3 Fair Value Measurements
		Fair Value at December 31, 2014				Valuation Techniques		Unobservable Input		Range
Impaired Loans		$	10,562			Collateral value, market value of similar debt, enterprise value, liquidation value and/or discounted cash flows		Yield		0-29%
Other real estate owned (1)			1,140			Market analysis or recent appraisals		Disposal costs		N/A

 

(1)	The fair value of these assets is determined based on appraisal value or sales price less estimated disposal costs, if applicable, the range of which is not meaningful to disclose.

The following tables present the carrying amounts and approximate fair values of the company’s financial assets and liabilities as of the dates stated:

 

		September 30, 2015								Fair Value Measurements as of September 30, 2015 Using
		Carrying Amount				Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks		$	22,550			$	22,550			$	22,550			$	—			$	—
Federal funds sold			4,199				4,199				—				4,199				—
Securities available for sale			112,041				112,041				—				112,041				—
Securities held to maturity			9,272				9,923				—				9,923				—
Loans, net			753,466				756,241				—				—				756,241
Interest rate derivative			1,165				1,165				—				1,165				—
Accrued interest receivable			4,068				4,068				—				4,068				—
Other assets			1,829				1,829				1,829				—				—
Financial liabilities:
Cash flow hedge		$	903			$	903			$	—			$	903			$	—
Interest rate derivative			1,230				1,230				—				1,230				—
Borrowings			37,050				37,050				—				37,050				—
Deposits			824,523				827,900				—				827,900				—
Accrued interest payable			413				413				—				413				—

 

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		December 31, 2014								Fair Value Measurements as of December 31, 2014 Using
		Carrying Amount				Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks		$	34,666			$	34,666			$	34,666			$	—			$	—
Federal funds sold			4,533				4,533				—				4,533				—
Securities available for sale			64,341				64,341				9,021				55,320				—
Securities held to maturity			9,279				9,683				—				9,683				—
Loans, net			744,626				745,187				—				—				745,187
Interest rate derivative			809				809				—				809				—
Accrued interest receivable			3,498				3,498				—				3,498				—
Other assets			2,030				2,030				2,030				—				—
Financial liabilities:
Cash flow hedge		$	423			$	423			$	—			$	423			$	—
Interest rate derivative			852				852				—				852				—
Borrowings			32,000				32,000				—				32,000				—
Deposits			772,911				771,997				—				771,997				—
Accrued interest payable			276				276				—				276				—

Fair value estimates are made at a specific point in time and are based on relevant market information, as well as information about the financial instruments or other assets. These estimates do not reflect any premium or discount that could result from offering for sale the company’s entire holdings of a particular financial instrument at one time. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets, premises and equipment, and OREO. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Note 17. Recent Accounting Pronouncements

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.” The amendments in this ASU are intended to clarify the terms defining when an in substance repossession or foreclosure occurs, which determines when the receivable should be derecognized and the real estate property recognized. ASU 2014-04 became effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. The adoption of this standard did not have a significant impact on the company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” The amendments in this ASU modify the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. ASU 2014-09 requires that entities

 

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apply a specific method to recognize revenue reflecting the consideration expected from customers in exchange for the transfer of goods and services. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. Entities are also required to disclose significant judgments and changes in judgments for determining the satisfaction of performance obligations. Most revenue associated with financial instruments, including interest and loan origination fees, is outside the scope of the guidance. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017, with early adoption permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year. The company is evaluating the impact ASU 2014-09 will have on its consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU require that debt issuance costs be reported in the balance sheet as a direct deduction from the face amount of the related liability, consistent with the presentation of debt discounts. Further, the ASU requires the amortization of debt issuance costs to be reported as interest expense. Similarly, debt issuance costs and any discount or premium are considered in the aggregate when determining the effective interest rate on the debt. ASU 2015-03 is effective for fiscal years beginning after December 15, 2015, with early adoption permitted. The early adoption of this standard did not have a significant impact on the company’s consolidated financial statements.

Note 18. Share Repurchase Program

In July 2013, the company’s board of directors authorized a share repurchase program permitting the company to repurchase in the open market or otherwise up to 210,000 shares of the company’s outstanding stock. The authorization has no time limit. There is no guarantee as to the number of shares that will be repurchased by the company, and the company may discontinue the program at any time.

The company repurchased the following shares of common stock pursuant to the repurchase program for the periods stated. The repurchases were made using available cash resources and occurred in the open market.

 

		Three Months Ended September 30, 2015				Nine Months Ended September 30, 2015
Shares of common stock repurchased			10,600				10,600
Amount paid for common stock repurchased		$	67			$	67
Average price paid per common share		$	6.36			$	6.36

 

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

The following is management’s discussion and analysis of the company’s consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes in Part I, Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q (“Form 10-Q”) and Part II, Item 8, “Financial Statements and Supplementary Data” in the company’s Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”). The data presented as of September 30, 2015 and for the three and nine months ended September 30, 2015 and 2014 is derived from our unaudited interim financial statements and includes, in the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the data for such period. The data presented as of December 31, 2014 is derived from our audited financial statements as of and for the year ended December 31, 2014, which is included in the 2014 Form 10-K.

All references to “Xenith Bankshares,” “our company,” “the company,” “we,” “our” or “us” are to Xenith Bankshares, Inc. and its wholly-owned subsidiary, Xenith Bank, collectively. All references to “the Bank” are to Xenith Bank.

All dollar amounts included in the tables in this discussion and analysis are in thousands, except per share data. Columns and rows of amounts presented in tables may not total due to rounding.

BUSINESS OVERVIEW

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail clients, which we refer to as our target customers. We are geographically focused on the Greater Washington, DC, Richmond, Virginia, and the Greater Hampton Roads, Virginia metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its eight branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, three branches located in Suffolk, Virginia, and two branches located in Gloucester, Virginia. The Bank also has a loan production office in Newport News, Virginia. We acquired the three branches located in Suffolk in the 2009 merger of Xenith Corporation with and into First Bankshares, Inc., the parent company of its wholly-owned subsidiary, SuffolkFirst Bank. SuffolkFirst Bank opened the first branch in Suffolk, Virginia in 2003 under the name of SuffolkFirst Bank. We acquired the two branches in Gloucester and the loan production office in the acquisition of Colonial Virginia Bank (“CVB”) on June 30, 2014, which is further discussed below. The acquired CVB branches will continue doing business as Colonial Virginia Bank for an undetermined period of time. The loan production office operates as Xenith Bank. As of September 30, 2015, we had total assets of $971.0 million, total loans, net of our allowance for loan and lease losses, of $753.5 million, total deposits of $824.5 million, and shareholders’ equity of $100.8 million.

Our services and products consist primarily of taking deposits from, and making loans to, our target customers within our target markets. We provide a broad selection of commercial and retail banking products, including commercial and industrial loans, commercial and residential real estate loans, and select consumer loans. We also offer a wide range of checking, savings and treasury products, including remote deposit capture, automated clearing house transactions, debit cards, 24-hour ATM access, and Internet and mobile banking and bill pay service. We do not engage in any activities other than banking activities.

On June 26, 2015, we issued and sold $8.5 million in aggregate principal amount of our 6.75% subordinated notes due 2025 (the “Subordinated Notes”). The Subordinated Notes qualify as Tier 2 Capital for the company and are redeemable by us no earlier than June 26, 2020, except upon the occurrence of certain events, including their disqualification as Tier 2 Capital, as a result of a change in interpretation or application of law or regulation.

On June 30, 2015, we completed the redemption of all of the outstanding 8,381 shares of our senior non-cumulative perpetual preferred stock, Series A, that we had issued and sold to the U.S. Treasury pursuant to the Small Business Lending Fund program, at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends. Substantially all of the net proceeds from the issuance and sale of the Subordinated Notes were used to fund the redemption.

In September 2014, we issued and sold in a private placement an aggregate of 880,000 shares of our common stock, $1.00 par value per share, at a price of $6.35 per share to third-party investors for an aggregate purchase price, net of stock issuance costs, of approximately $5.6 million.

Also in September 2014, we entered into an agreement with a national bank that provides for an unsecured senior term loan credit facility up to $15 million (the “Credit Agreement”). We borrowed $12 million upon the closing of the Credit Agreement on September 30, 2014 and had the right to borrow up to an additional $3 million under a delayed-draw term loan commitment, subject to customary conditions, on or before September 30, 2015 (the “Delayed Draw Loan”). In September 2015, we entered into an amendment to the Credit Agreement (the “Amendment”) that, among other things, modified the Credit Agreement by (i) increasing our right to borrow under the Delayed Draw Loan to up to an additional $5 million, subject to customary conditions, and (ii) extending the date by which we may draw under the Delayed Draw Loan to September 30, 2016. Additionally, the Amendment lowered the interest rate on amounts borrowed under the Credit Agreement from 30-day LIBOR plus 3.5% to 30-day LIBOR plus 2.75%.

 

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We contributed a significant portion of the proceeds of both the September 2014 sale of our common stock and borrowings under the Credit Agreement to the Bank as equity. We retained the remainder of the proceeds to fund holding company obligations, including obligations under the Credit Agreement for a period of time.

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on liabilities used to fund those assets. Interest-earning assets include loans, securities, federal funds sold, and deposits held at other banks. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include service charges on deposit accounts, fees on treasury services, earnings from our investment in bank owned life insurance, gains on the sale of securities, and other miscellaneous income. Deposits, Federal Home Loan Bank (“FHLB”) borrowed funds, borrowed funds from other sources, and federal funds purchased are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. Measures of our performance include net interest margin, return on average assets (“ROAA”), return on average common equity (“ROAE”), ratio of average common equity to average assets, and efficiency ratio. Such measures are common performance indicators in the banking industry.

The following tables present selected financial performance measures, for the dates stated:

 

		Three Months Ended September 30,
		2015				2014
Net interest margin (1)			3.25	%			3.90	%
Return on average assets (2)			0.37	%			0.29	%
Return on average common equity (3)			3.72	%			2.86	%
Average common equity to average assets (4)			9.89	%			10.21	%
Efficiency ratio (5)			79	%			70	%
		Nine Months Ended September 30,
		2015				2014
Net interest margin (1)			3.27	%			3.59	%
Return on average assets (2)			0.36	%			0.12	%
Return on average common equity (3)			3.59	%			1.12	%
Average common equity to average assets (4)			10.12	%			10.95	%
Efficiency ratio (5)			77	%			82	%

 

(1)	Net interest margin is annualized net interest income divided by average interest-earning assets. Average interest-earning assets are presented within the average balances, income and expenses, yields, and rates table below.

(2)	ROAA is annualized net income divided by average total assets. Average total assets are presented within the average balances, income and expenses, yields, and rates table below.

(3)	ROAE is annualized net income divided by average shareholders’ equity less average preferred stock. Average shareholders’ equity is presented within the average balances, income and expenses, yields, and rates table below.

(4)

Average common equity to average assets is average common shareholders’ equity divided by average total assets. Average common shareholders’ equity is average total shareholders’ equity less preferred stock. Average total assets are presented within the average balances, income and expenses, yields, and rates table below.

(5)	Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

Acquisitions

On June 30, 2014, we completed the merger of CVB with and into the Bank, with the Bank being the surviving bank (the “CVB Acquisition”). In connection with CVB Acquisition, we issued an aggregate of 1,618,186 shares of our common stock and paid $658 in cash to the former shareholders of CVB in exchange for their shares of CVB common stock.

Pursuant to the CVB Acquisition, we acquired $114.4 million of assets, including $70.1 million in loans and assumed $103.9 million in liabilities, including $101.0 million of deposits.

 

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Industry Conditions

The national unemployment rate, seasonally adjusted, and as published by the Bureau of Labor Statistics, for September 2015 was reported at 5.1%, an improvement from 5.6% in December 2014. In the Fifth District of the Federal Reserve Bank (the “Fifth District”), which includes our target markets, the August 2015 (most recent) unemployment rate was 5.5%, unchanged from 5.5% at the end of 2014. More specifically, the unemployment rate in Virginia in August 2015 was 4.5%, an improvement from 4.8% from year-end 2014, based on data published by the Fifth District. Additionally, as published by the Fifth District, in the twelve months ended August 2015, all industry sectors in the Fifth District expanded.

The Federal Open Market Committee (the “FOMC”) stated in an October 28, 2015 release that economic growth has expanded moderately in recent months and labor market conditions held steady, though job gains had slowed. The FOMC stated household spending and business fixed investment have increased at solid rates in recent months, and the recovery in the housing sector has shown further improvement.

The FOMC reaffirmed its view that the current 0 to  ¹⁄₄% target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the FOMC stated, in determining whether to raise the target rate, it will assess progress (both realized and expected) toward its objectives of maximum employment and 2% inflation. The FOMC also stated that it will be appropriate to raise the target range when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term.

Low interest rates and intense competition have put pressure on net interest margins of banks, including the Bank. Banks with which we compete are offering aggressive terms and may be loosening credit underwriting standards. We have seen a particularly sharp increase in competition in the Richmond market over the last year, as new banks have entered this market. Though our commercial real estate business continues to show strong growth in both the Greater Washington and Richmond markets, our commercial and industrial lending business has grown at a slower pace. We anticipate intense competition in our markets until demand and supply are more balanced.

Outlook

In spite of industry and market conditions, we believe we are well positioned to effectively compete in our target markets. We believe we will benefit from (1) our team of skilled bankers, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team. We intend to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets, and by executing strategically advantageous combinations.

Intense competition for quality loans in this low interest rate environment requires that we remain firm in applying our established credit underwriting practices, providing exceptional customer service, and offering competitive treasury services products, as well as continually monitoring our expenses.

In our continuing evaluation of our business strategy, we believe that properly priced acquisitions can complement our organic growth. We may seek to acquire other financial institutions or branches or assets of those institutions. Although our principal acquisition focus will be to expand our presence in our target markets, we may also expand into new markets or related banking lines of business and related services and products. We evaluate potential acquisitions to determine what is in the best interest of our company and long-term strategy. Our goal in making these decisions is to maximize shareholder value.

Critical Accounting Policies

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with generally accepted accounting principles in the United States of America and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and the amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations.

We consider a policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe that our most critical accounting policy relates to the allowance for loan and lease losses, including our measurement of probable cash flows with respect to purchased credit-impaired loans accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”), which reflects our estimate of losses in the event of borrower default. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan and lease losses could be required, which could have a material adverse impact on our results of operations and financial condition. Further discussion of the estimates used in determining the

 

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allowance for loan and lease losses is contained in the discussion under “—Financial Condition—Allowance for Loan and Lease Losses” below and in measuring impairment for purchased credit-impaired loans is contained under “—Financial Condition—Allowance for Loan and Lease Losses—Acquired Loans” below.

Our critical accounting policies are discussed in detail in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and “Summary of Significant Accounting Policies” in the notes to the consolidated financial statements in our 2014 Form 10-K. Since December 31, 2014, there have been no changes in these policies that have had or could reasonably be expected to have a material effect on our results of operations or financial condition.

RESULTS OF OPERATIONS

Net Income

For the three months ended September 30, 2015, net income was $928 thousand compared to net income of $657 thousand for the three months ended September 30, 2014. Income before income tax expense was $1.3 million for the three months ended September 30, 2015 compared to income before income tax expense of $1.0 million for the same period in 2014. In the three months ended September 30, 2014, pretax income included $566 thousand of costs related to the CVB Acquisition.

For the nine months ended September 30, 2015, net income was $2.7 million compared to net income of $707 thousand for the nine months ended September 30, 2014. Income before income tax expense was $3.7 million for the nine months ended September 30, 2015 compared to $1.3 million for the same period in 2014. Pretax income in the nine months ended September 30, 2014 included $1.2 million of costs related to the CVB Acquisition and a $205 thousand loss from a fraudulent ACH transaction, of which $155 thousand was recovered through insurance in the fourth quarter of 2014.

The following tables present our net income and earnings per common share information for the periods stated:

 

		Three Months Ended September 30,
		2015				2014
Net income		$	928			$	657
Preferred stock dividend			—				(21	)
Net income available to common shareholders		$	928			$	636
Earnings per common share, basic and diluted		$	0.07			$	0.05
		Nine Months Ended September 30,
		2015				2014
Net income		$	2,672			$	707
Preferred stock dividend			(42	)			(63	)
Net income available to common shareholders		$	2,630			$	644
Earnings per common share, basic and diluted		$	0.20			$	0.06

Net Interest Income

For the three months ended September 30, 2015, net interest income was $7.5 million compared to $8.1 million for the three months ended September 30, 2014. Lower net interest income in the 2015 period was primarily due to greater accretion from acquired loans in the 2014 period (further discussed below), including a third quarter 2014 resolution of a loan acquired in our 2011 acquisition of Virginia Business Bank (“VBB”). Interest income from higher average balances of loans held for investment (which includes accretion) and investment securities and higher tax-equivalent yields on our investment portfolio were partially offset by both lower rates on loans held for investment, lower average balances of guaranteed student loans, and higher average balances and costs of borrowed funds. Average balances of loans held for investment, excluding guaranteed student loans (which decreased $28.8 million), increased $90.9 million for the three months ended September 30, 2015 from the same period of 2014, and this amount also excluding average balances from our participation in a warehouse lending program (which increased $19.0 million) increased $71.9 million. Higher tax-equivalent earnings on average balances of investments were a result of a re-positioning of our investment portfolio to a greater level of tax-exempt municipal securities with higher tax-equivalent yields and longer maturities. Higher average balances of borrowed funds in the 2015 period were primarily a result of the issuance of the Subordinated Notes in the second quarter of 2015 and the addition of the borrowing under the Credit Agreement late in the third quarter of 2014.

As presented in the table below, our net interest margin for the three months ended September 30, 2015 was 3.25%, a 65 basis point decrease from 3.90% for the three months ended September 30, 2014. The majority of this decline is attributable to lower

 

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accretion in the 2015 period compared to the 2014 period, primarily due to the third quarter 2014 resolution of an acquired loan. Excluding the effect of purchase accounting adjustments, net interest margin declined 19 basis points for the three months ended September 30, 2015 compared to the same period of 2014.

Average interest-earning assets increased $106.5 million, while related interest income decreased $177 thousand, for the three months ended September 30, 2015 compared to the same period of 2014. Average interest-bearing liabilities increased $78.5 million for the three months ended September 30, 2015 and related interest expense increased $414 thousand compared to the same period in 2014. Yields on interest-earning assets decreased 55 basis points to 3.97%, and costs of interest-bearing liabilities increased 14 basis points to 0.91%, when comparing the three months ended September 30, 2015 to the same period in 2014. Average interest-earning assets as a percentage of total assets were 93.1% for the three months ended September 30, 2015, an increase from 92.5% for the same period in 2014.

For the nine months ended September 30, 2015, net interest income was $22.1 million compared to $19.3 million for the nine months ended September 30, 2014. Higher net interest income was primarily due to higher average balances of loans held for investment and investment securities, and yields on our investment securities, partially offset by lower yields on loans held for investment, lower average balances of guaranteed student loans, and both higher average balances of our deposits and borrowed funds, and higher costs of these borrowings. Average balances of loans held for investment, excluding guaranteed student loans, increased $170.5 million for the nine months ended September 30, 2015 from the same period of 2014, and this amount also excluding average balances from our participation in a warehouse lending program increased $132.3 million. Accretion of discounts on acquired loans was lower in the nine months ended September 30, 2015 compared to the same period of 2014.

As presented in the table below, net interest margin for the nine months ended September 30, 2015 was 3.27%, a 32 basis point decrease from 3.59% for the same period in 2014. Net interest margin for the nine months ended September 30, 2015 was negatively affected by higher average balances of loans from our mortgage warehouse lending program, which have lower yields than other loan categories, higher average balances of cash, lower accretion in the 2015 period, and higher costs of borrowed funds.

Average interest-earning assets increased $193.8 million, and related interest income increased $4.4 million, for the nine months ended September 30, 2015 compared to the same period in 2014. Average interest-bearing liabilities increased $158.0 million, and related interest expense increased $1.6 million, for the nine months ended September 30, 2015 compared to the same period in 2014. Yields on interest-earning assets were 3.96% and 4.16% for the nine months ended September 30, 2015 and 2014, respectively. The costs of interest-bearing liabilities increased 13 basis points to 0.87% when comparing the nine months ended September 30, 2015 to the same period in 2014. Average interest-earning assets as a percentage of total assets was 93.1% for the nine months ended September 30, 2015 compared to 93.3% for the same period in 2014.

Our loan portfolios acquired in mergers and acquisitions, including the CVB Acquisition, were discounted to estimated fair value (for credit and interest rates) as of the acquisition dates. A portion of the discounts taken to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans or the period of expected cash flows from the loans. Amounts received in excess of the carrying value of loans accounted for on cost recovery are also accreted into interest income at the time of recovery. Loan discount accretion was $338 thousand for the three months ended September 30, 2015 compared to $1.3 million for the same period ended September 30, 2014. For the nine months ended September 30, 2015 and 2014, loan discount accretion was $1.2 million and $1.5 million, respectively.

The following tables present the effect of purchase accounting adjustments on our net interest margin for the periods stated:

 

		Three Months Ended September 30,
		2015				2014
Net interest margin			3.25	%			3.90	%
Purchase accounting adjustments impact (1)			0.15	%			0.61	%
Net interest margin excluding the impact of purchase accounting adjustments			3.10	%			3.29	%

 

		Nine Months Ended September 30,
		2015				2014
Net interest margin			3.27	%			3.59	%
Purchase accounting adjustments impact (1)			0.18	%			0.29	%
Net interest margin excluding the impact of purchase accounting adjustments			3.09	%			3.30	%

 

(1)	Purchase accounting adjustments include accretion of discounts on acquired loans and amortization of fair value adjustments on time deposits.

 

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The following tables provide an analysis of the effective yields and rates on average interest-earning assets and average interest-bearing liabilities as of and for the periods stated. The average balances and other statistical data used in this table were calculated using daily average balances. Tax-exempt income and yields are reported on a taxable-equivalent basis.

 

		Average Balances, Income and Expenses, Yields and Rates As of and For the Three Months Ended September 30,
																										2015 vs. 2014
		Average Balances (1)								Yield / Rate								Income / Expense (7)(8)(9)								Increase				Change due to (2)
		2015				2014				2015				2014				2015				2014				(Decrease)				Rate				Volume
Assets
Interest-earning assets:
Federal funds sold		$	15,266			$	20,202				0.33	%			0.26	%		$	13			$	13			$	—			$	3			$	(3	)
Interest-earning deposits			40,568				21,208				0.31	%			0.32	%			31				17				14				(1	)			15
Investments			118,041				87,995				3.01	%			2.24	%			887				493				394				197				197
Guaranteed student loans, gross			63,259				92,064				3.44	%			3.23	%			545				743				(198	)			48				(246	)
Loans held for investment, gross (3)			702,811				611,945				4.47	%			5.33	%			7,860				8,149				(289	)			(1,409	)			1,120
Total interest-earning assets			939,945				833,414				3.97	%			4.52	%			9,336				9,415				(79	)			(1,162	)			1,083
Allowance for loan and lease losses			(7,098	)			(6,357	)
Noninterest-earning assets:
Cash and due from banks			15,883				18,551
Premises and fixed assets			7,758				8,183
Other assets			53,493				46,746
Total noninterest-earning assets			77,134				73,480
Total assets		$	1,009,981			$	900,537
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Demand deposits		$	82,547			$	35,449				0.54	%			0.18	%		$	112			$	16			$	96			$	58			$	38
Savings and money market deposits			309,013				311,220				0.74	%			0.70	%			569				543				26				29				(3	)
Time deposits			317,876				303,114				0.83	%			0.84	%			658				637				21				(10	)			31
Federal funds purchased and borrowed funds			40,775				21,884				3.59	%			1.74	%			366				95				271				150				121
Total interest-bearing liabilities			750,211				671,667				0.91	%			0.77	%			1,705				1,291				414				227				187
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits			152,612				122,023
Other liabilities			7,270				6,513
Total noninterest-bearing liabilities			159,882				128,536
Shareholders’ equity			99,888				100,334
Total liabilities and shareholders’ equity		$	1,009,981			$	900,537
Interest rate spread (4)											3.06	%			3.75	%
Net interest income (5)																		$	7,631			$	8,124			$	(493	)		$	(1,389	)		$	896
Net interest margin (6)											3.25	%			3.90	%

 

(1)	Average balances are computed on a daily basis.

(2)	Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

 

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(3)	Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.

(4)	Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.

(5)	Net interest income is interest income less interest expense.

(6)	Net interest margin is net interest income divided by average interest-earning assets.

(7)	Tax-exempt interest income is stated on a taxable-equivalent basis.

(8)	Interest income from loans held for investment in 2015 and 2014 includes $338 thousand and $1,252 thousand, respectively, in accretion related to acquired loans.

(9)	Interest expense on time deposits in 2015 and 2014 includes a reduction of $19 thousand related to fair value adjustments recorded pursuant to the CVB Acquisition.

 

		Average Balances, Income and Expenses, Yields and Rates As of and For the Nine Months Ended September 30,
																										2015 vs. 2014
		Average Balances (1)								Yield / Rate								Income / Expense (7)(8)(9)								Increase				Change due to (2)
		2015				2014				2015				2014				2015				2014				(Decrease)				Rate				Volume
Assets
Interest-earning assets:
Federal funds sold		$	20,322			$	12,309				0.28	%			0.24	%		$	43			$	22			$	21			$	4			$	17
Interest-earning deposits			36,718				15,900				0.29	%			0.31	%			80				37				43				(2	)			45
Investments			98,572				77,761				3.01	%			2.29	%			2,225				1,333				892				481				411
Guaranteed student loans, gross			66,553				92,857				3.35	%			3.24	%			1,670				2,256				(586	)			72				(658	)
Loans held for investment, gross (3)			690,931				520,433				4.46	%			4.82	%			23,103				18,817				4,286				(1,499	)			5,785
Total interest-earning assets			913,096				719,260				3.96	%			4.16	%			27,121				22,465				4,656				(944	)			5,600
Allowance for loan and lease losses			(6,730	)			(5,784	)
Noninterest-earning assets:
Cash and due from banks			14,632				12,802
Premises and fixed assets			7,886				6,072
Other assets			51,397				38,969
Total noninterest-earning assets			73,915				57,843
Total assets		$	980,281			$	771,319
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Demand deposits		$	72,224			$	30,821				0.52	%			0.18	%		$	284			$	43			$	241			$	141			$	100
Savings and money market deposits			293,756				251,899				0.74	%			0.61	%			1,633				1,148				485				273				212
Time deposits			320,210				256,207				0.83	%			0.85	%			1,984				1,637				347				(49	)			396
Federal funds purchased and borrowed funds			35,345				24,642				3.00	%			1.58	%			796				291				505				340				165
Total interest-bearing liabilities			721,535				563,569				0.87	%			0.74	%			4,697				3,119				1,578				705				873
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits			146,684				110,521
Other liabilities			7,283				4,371
Total noninterest-bearing liabilities			153,967				114,892
Shareholders’ equity			104,779				92,858
Total liabilities and shareholders’ equity		$	980,281			$	771,319
Interest rate spread (4)											3.09	%			3.42	%
Net interest income (5)																		$	22,424			$	19,346			$	3,078			$	(1,649	)		$	4,727
Net interest margin (6)											3.27	%			3.59	%

 

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(1)	Average balances are computed on a daily basis.

(2)	Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

(3)	Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.

(4)	Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.

(5)	Net interest income is interest income less interest expense.

(6)	Net interest margin is net interest income divided by average interest-earning assets.

(7)	Tax-exempt interest income is stated on a taxable-equivalent basis.

(8)	Interest income from loans held for investment in 2015 and 2014 includes $1,180 thousand and $1,530 thousand, respectively, in accretion related to acquired loans.

(9)	Interest expense on time deposits in 2015 and 2014 includes a reduction of $57 thousand and $19 thousand, respectively, related to fair value adjustments recorded pursuant to the CVB Acquisition.

Provision for Loan and Lease Losses

For the three months ended September 30, 2015, our provision for loan and lease losses was $343 thousand compared to $1.6 million for the same period of 2014. For the nine months ended September 30, 2015, provision expense was $1.6 million compared to $2.4 million for the same period of 2014. Lower provision expense in both the three and nine months ended September 30, 2015 compared to the same periods of 2014 is primarily due to lower provision expense for the guaranteed student loan portfolio in the 2015 periods. In the second and third quarters of 2014, we increased provision expense due to higher expected losses as to unguaranteed balances and accelerated provision expense for unguaranteed balances greater than 120 days past due with a high probability of default.

Noninterest Income

For the three months ended September 30, 2015, noninterest income was $104 thousand compared to $357 thousand for the same period of 2014. Lower noninterest income in the 2015 period was primarily due to a write-down of an other real estate owned (“OREO”) property acquired as part of the CVB Acquisition, and a loss in value of both the rabbi trust assets and the company’s customer-related derivatives. We established a rabbi trust in connection with the CVB Acquisition as a source of funds to pay benefits under the assumed supplemental executive retirement plan (“SERP”). These items were partially offset by higher earnings from bank owned life insurance (“BOLI”), due to additional investment in the second quarter of 2015.

For the nine months ended September 30, 2015, noninterest income was $928 thousand compared to $938 thousand for the same period of 2014. Noninterest income in the nine months ended September 30, 2015 included higher service charges and fees on deposit accounts, higher gains on sales of securities, and higher earnings on BOLI when compared to the same period in 2014. These items were offset by the write-down of an OREO property, a loss in value of both the rabbi trust assets and customer-related derivatives. Additionally, noninterest income in the nine months ended September 30, 2014 included a bargain purchase gain of $42 thousand on the CVB Acquisition.

Noninterest Expense

For the three months ended September 30, 2015, noninterest expense was $6.0 million compared to $5.9 million in the same period in 2014. Noninterest expense in the 2014 period included $566 thousand of expenses, primarily professional fees and technology costs, related to the CVB Acquisition. Higher noninterest expense in the 2015 period was primarily due to higher compensation and benefits costs of $101 thousand and higher technology and data processing costs of $58 thousand (excluding merger-related costs in the 2014 period). Higher compensation and benefits were primarily the result of the addition of relationship managers and supporting personnel, the addition of regulatory compliance personnel, and management incentive charges recorded in the three months ended September 30, 2015, for which there were none recorded in the same 2014 period. Higher technology and data processing costs in the three months ended September 30, 2015 were primarily due to increased processing volumes added with the CVB Acquisition and with other growth, and costs incurred in connection with the renegotiation of the company’s core processing service contract.

For the nine months ended September 30, 2015, noninterest expense was $17.7 million, compared to $16.6 million for the same period of 2014. Noninterest expense in the 2014 period included $1.2 million of costs related to the CVB Acquisition, primarily recorded in professional fees and technology expenses, and the $205 thousand ACH fraud loss, discussed above. Higher noninterest expense in the 2015 period was primarily due to higher compensation and benefits of $981 thousand and higher technology and data processing costs of $394 thousand (excluding merger-related costs in the 2014 period). Higher expenses in both categories were primarily due to the above-mentioned items.

Income Taxes

For the three months ended September 30, 2015 income tax expense was $326 thousand (26% effective rate) compared to income tax expense of $347 thousand (35% effective rate) in the same period of 2014. For the nine months ended September 30, 2015

 

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and 2014, income tax expense was $1.0 million (28% effective rate) and $564 thousand (44% effective rate), respectively. The lower effective tax rates in the 2015 periods reflect the benefit of increased tax-exempt interest and increased balances of BOLI, the earnings from which are tax-exempt, while rates in the 2014 periods reflect the nondeductibility of certain merger-related transaction costs. Net deferred tax assets as of September 30, 2015 and December 31, 2014 were $6.7 million and $6.3 million, respectively.

BUSINESS COMBINATION

The CVB Acquisition was accounted for in accordance with FASB ASC Topic 805, “Business Combinations,” whereby the acquired assets and assumed liabilities are recorded by the company at their estimated fair values as of the acquisition date, which was June 30, 2014.

The following table presents the allocation of the consideration received to the estimated fair values of assets acquired and liabilities assumed in the CVB Acquisition as of the acquisition date. Our allocation resulted in a bargain purchase gain of $42 thousand.

 

Fair value of assets acquired:
Cash and cash equivalents		$	12,560
Securities available for sale			17,439
Loans			70,051
Premises and equipment			3,338
Other real estate owned			1,186
Core deposit intangible			930
Accrued interest receivable			318
Deferred tax asset			1,898
Bank owned life insurance			4,054
Other assets			2,658
Total assets		$	114,432
Fair value of liabilities assumed:
Deposits		$	100,985
Accrued interest payable			39
Supplemental executive retirement plan			2,277
Other liabilities			599
Total liabilities		$	103,900
Net identifiable assets acquired		$	10,532
Consideration paid:
Company’s common shares issued			1,618,186
Purchase price per share (1)		$	6.40
Value of common stock issued			10,356
Estimated fair value of stock options			133
Cash in lieu of fractional shares			1
Total consideration paid		$	10,490
Bargain purchase gain		$	42

 

(1)	The value of the shares of common stock exchanged for shares of CVB common stock was based upon the closing price of the company’s common stock at June 27, 2014, the last trading day prior to the date of completion of the CVB Acquisition.

 

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FINANCIAL CONDITION

Securities

The following tables present information about our securities portfolio as of the dates stated. Weighted average life calculations and weighted average yields are based on the current level of contractual maturities and expected prepayments as of the dates stated. Yields on tax-exempt securities are calculated on a taxable-equivalent yield basis.

 

		September 30, 2015
		Amortized Cost				Fair Value				Weighted Average Life in Years				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities - fixed rate		$	6,377			$	6,433				5.20				2.25	%
Commercial mortgage-backed securities - fixed rate			32,998				33,081				6.76				2.26	%
Municipals - fixed rate
Tax exempt			54,188				54,049				8.73				4.21	%
Taxable			10,058				10,133				6.73				2.89	%
Collateralized mortgage obligations - fixed rate			8,275				8,345				3.75				2.26	%
Total securities available for sale			111,896				112,041				7.39				3.26	%
Securities held to maturity:
Municipals - fixed rate			9,272				9,923				7.10				3.39	%
Total securities held to maturity			9,272				9,923				7.10				3.39	%
Total securities		$	121,168			$	121,964				7.31				3.27	%

 

		December 31, 2014
		Amortized Cost				Fair Value				Weighted Average Life in Years				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
Fixed rate		$	11,513			$	11,543				5.31				2.19	%
Variable rate			4,136				4,239				6.91				1.68	%
Municipals - fixed rate
Tax exempt			37,825				37,747				8.77				4.04	%
Taxable			847				848				4.34				1.83	%
Collateralized mortgage obligations - fixed rate			9,974				9,964				3.72				2.04	%
Total securities available for sale			64,295				64,341				7.19				3.21	%
Securities held to maturity:
Municipals - fixed rate			9,279				9,683				8.23				3.40	%
Total securities held to maturity			9,279				9,683				8.23				3.40	%
Total securities		$	73,574			$	74,024				7.24				3.24	%

Over the last several quarters, we have repositioned our investment portfolio to hold higher levels of municipal securities, which has increased both the weighted average life and weighted average yield of the portfolio.

 

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The following table presents a maturity analysis of our securities portfolio as of the date stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the date stated. Yields on tax-exempt securities are calculated on a taxable-equivalent yield basis.

 

		September 30, 2015
		Within 1 Year				Weighted Average Yield				After 1 Year Through 5 Years				Weighted Average Yield				After 5 Years Through 10 Years				Weighted Average Yield				After 10 Years				Weighted Average Yield				Total				Weighted Average Yield
Securities available for sale:
Mortgage-backed securities - fixed rate		$	—				—			$	1,021				2.44	%		$	5,412				2.21	%		$	—				—			$	6,433				2.25	%
Commercial mortgage-backed securities - fixed rate			—				—				—				—				33,081				2.26	%			—				—				33,081				2.26	%
Municipals - fixed rate
Taxable			—				—				856				1.84	%			9,277				2.99	%			—				—				10,133				2.89	%
Tax exempt			—				—				—				—				3,754				3.26	%			50,295				4.27	%			54,049				4.21	%
Collateralized mortgage obligations - fixed rate			—				—				—				—				—				—				8,345				2.26	%			8,345				2.26	%
Total securities available for sale		$	—							$	1,877							$	51,524							$	58,640							$	112,041				3.26	%
Securities held to maturity:
Municipals - fixed rate		$	—				—			$	—				—			$	8,888				3.31	%		$	1,035				4.10	%		$	9,923				3.39	%
Total securities held to maturity		$	—							$	—							$	8,888							$	1,035							$	9,923
Total securities		$	—				—			$	1,877				2.17	%		$	60,412				2.58	%		$	59,675				3.99	%		$	121,964				3.27	%

Loans

The following table presents our composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total loans as of the dates stated:

 

		September 30, 2015								December 31, 2014
		Amount				Percent of Total				Amount				Percent of Total
Commercial and industrial		$	348,763				45.9	%		$	359,243				47.9	%
Commercial real estate			303,537				39.9	%			267,489				35.6	%
Residential real estate			36,089				4.7	%			40,859				5.4	%
Consumer			10,725				1.4	%			11,456				1.5	%
Guaranteed student loans			61,387				8.1	%			71,780				9.6	%
Overdrafts			29				0.0	%			46				0.0	%
Total loans			760,530				100.0	%			750,873				100.0	%
Allowance for loan and lease losses			(7,064	)							(6,247	)
Total loans, net of allowance		$	753,466							$	744,626

Loans, net of allowance for loan and lease losses, increased $8.8 million to $753.5 million as of September 30, 2015 from $744.6 million as of December 31, 2014. As of September 30, 2015, loan balances from our participation in a mortgage warehouse lending program were $47.3 million compared to $60.0 million at December 31, 2014, while our portfolio of guaranteed student loans declined $10.4 million from December 31, 2014. We believe balances in our guaranteed student portfolio will continue to decline at this rate for the remainder of 2015. We do not intend to acquire additional loans in this asset class.

 

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The following tables provide the maturity analysis of our loans as of the dates stated based on whether loans are variable-rate or fixed-rate loans:

 

		September 30, 2015
						Variable Rate												Fixed Rate
		Within 1 year				1 to 5 years				After 5 years				Total variable > 1 year				1 to 5 years				After 5 years				Total fixed > 1 year				Total Maturities
Commercial and industrial (1)		$	159,865			$	108,641			$	23,293			$	131,934			$	40,547			$	14,709			$	55,256			$	347,055
Commercial real estate (2)			82,198				103,487				60,234				163,721				44,268				10,380				54,648				300,567
Residential real estate (3)			1,550				8,555				16,899				25,454				6,295				744				7,039				34,043
Consumer (4)			8,347				990				418				1,408				892				55				947				10,702
Guaranteed student loans			21				705				60,662				61,367				—				—				—				61,388
Overdrafts			29				—				—				—				—				—				—				29
Total loans		$	252,010			$	222,378			$	161,506			$	383,884			$	92,002			$	25,888			$	117,890			$	753,784

 

(1)	Excludes $903 thousand in nonaccrual fixed-rate loans and $805 thousand in nonaccrual variable-rate loans.

(2)	Excludes $2.1 million in nonaccrual fixed-rate loans and $862 thousand in nonaccrual variable-rate loans.

(3)	Excludes $309 thousand in nonaccrual fixed-rate loans and $1.7 million in nonaccrual variable-rate loans.

(4)	Excludes $4 thousand in nonaccrual fixed-rate loans and $19 thousand in nonaccrual variable-rate loans.

 

		December 31, 2014
						Variable Rate												Fixed Rate
		Within 1 year				1 to 5 years				After 5 years				Total variable > 1 year				1 to 5 years				After 5 years				Total fixed > 1 year				Total Maturities
Commercial and industrial (1)		$	180,100			$	104,694			$	15,187			$	119,881			$	47,184			$	9,302			$	56,486			$	356,467
Commercial real estate (2)			70,633				101,100				46,882				147,982				42,317				3,523				45,840				264,455
Residential real estate (3)			3,438				7,294				22,099				29,393				5,176				1,296				6,472				39,303
Consumer (4)			8,753				121				938				1,059				1,627				4				1,631				11,443
Guaranteed student loans			28				780				70,973				71,753				—				—				—				71,781
Overdrafts			46				—				—				—				—				—				—				46
Total loans		$	262,998			$	213,989			$	156,079			$	370,068			$	96,304			$	14,125			$	110,429			$	743,495

 

(1)	Excludes $1.4 million in nonaccrual fixed-rate loans and $1.4 million in nonaccrual variable-rate loans.

(2)	Excludes $1.8 million in nonaccrual fixed-rate loans and $1.3 million in nonaccrual variable-rate loans.

(3)	Excludes $167 thousand in nonaccrual fixed-rate loans and $1.4 million in nonaccrual variable-rate loans.

(4)	Excludes $4 thousand in nonaccrual fixed-rate loans and $8 thousand in nonaccrual variable-rate loans.

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies and guidelines designed to control both the types and amounts of risks we take and to minimize losses. Such policies and guidelines include loan underwriting parameters, loan-to-value parameters, credit monitoring guidelines, adherence to regulations, and other prudent credit practices.

Loans secured by real estate comprised 60.8% of our loan portfolio at September 30, 2015 and 57.5% at December 31, 2014. Commercial real estate (“CRE”) loans are secured by commercial properties. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt service coverage ratios as well. Residential real estate loans consist primarily of first and second lien loans, including home equity lines and credit loans, secured by residential real estate located primarily in our target markets, offered to select customers. These customers primarily include branch and private banking customers. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt-to-income ratios as well. The repayment of both residential and owner-occupied commercial real estate (“OORE”) loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment. We classify OORE loans as commercial and industrial (“C&I”), as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

 

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Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “Contingencies,” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “Receivables.”

We determine the allowance for loan and lease losses based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans that we originate in our portfolio. Qualitative factors include, but are not limited to, general economic conditions, nationally and in our target markets, and threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors are estimates and may be subject to significant change. Increases to our allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in our consolidated statements of income. Loans deemed to be uncollectible, in full or in part, are charged against our allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to our allowance for loan and lease losses.

In assessing the adequacy of our allowance for loan and lease losses as of the end of a reporting period, we also evaluate our loan risk ratings. Each loan is assigned two “risk ratings” at origination. One risk rating is based on our assessment of our borrower’s financial capacity and the other is based on the type of collateral and estimated loan to value. Our assigned risk ratings generally determine the quantitative factors used in the calculation of our allowance for loan and lease losses. In addition to our assessment of risk ratings, we also consider internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to our policies and procedures, and external observable data such as industry and general economic trends.

In evaluating loans accounted for under ASC 310-30, we periodically estimate the amount and timing of cash flows expected to be collected. Upon re-estimation, any deterioration in the timing and/or amount of cash flows results in an impairment charge, which is also reported in our provision for loan and lease losses and a component of our allowance for loan and lease losses. A subsequent improvement in the expected timing or amount of future cash flows for those loans could result in the reduction of the allowance for loan and lease losses and an increase in our net income.

In evaluating our acquired guaranteed student loans, our allowance for loan and lease losses is based on historical and expected default rates for these loans applied to the portion of carrying value of these loans that is not subject to federal guarantee.

Our allowance for loan and lease losses does not include amounts for loan losses on loans held pursuant to our participation in a mortgage warehouse lending program. Loans pursuant to this program are to mortgage originators that seek funding to facilitate the origination of residential mortgage loans for sale in the secondary market and are generally held for less than 30 days. We sub-participate in this lending program with a national bank (the participating bank), and neither the participating bank or we have experienced losses from this lending activity, since we began participating in this program.

Although we use various data and information sources to establish our allowance for loan and lease losses, future adjustments to our allowance for loan and lease losses may be necessary, if conditions, circumstances or events are substantially different from the assumptions used in making the assessments. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to recognize additions or reductions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.

The following tables present the allowance for loan and losses by loan type and the percent of loans in each category to total loans as of the dates stated:

 

		September 30, 2015								December 31, 2014
		Amount				Percent of loans in each category to total loans				Amount				Percent of loans in each category to total loans
Balance at end of period applicable to:
Commercial and industrial		$	2,169				45.9	%		$	2,208				47.9	%
Commercial real estate			4,658				39.9	%			3,759				35.6	%
Residential real estate			166				4.7	%			175				5.4	%
Consumer			—				1.4	%			—				1.5	%
Guaranteed student loans			71				8.1	%			105				9.6	%
Total allowance for loan and lease losses		$	7,064				100.0	%		$	6,247				100.0	%

 

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The following tables present the activity in the allowance for loan and lease losses for the dates stated:

 

		Three Months Ended September 30,
		2015				2014
Balance at beginning of period		$	6,849			$	6,016
Charge-offs:
Commercial and industrial			—				30
Commercial real estate			—				—
Residential real estate			—				136
Consumer			—				—
Guaranteed student loans			143				1,741
Overdrafts			2				6
Total charge-offs			145				1,913
Recoveries:
Commercial and industrial			—				2
Commercial real estate			—				—
Residential real estate			—				—
Consumer			—				—
Guaranteed student loans			—				—
Overdrafts			1				3
Total recoveries			1				5
Net charge-offs			144				1,908
Provision for loan and lease losses			343				1,560
Amount for unfunded commitments			16				(108	)
Other (1)			—				9
Balance at end of period		$	7,064			$	5,569

 

(1)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

 

		Nine Months Ended September 30,
		2015				2014
Balance at beginning of period		$	6,247			$	5,305
Charge-offs:
Commercial and industrial			2				30
Commercial real estate			—				—
Residential real estate			54				171
Consumer			—				—
Guaranteed student loans			690				1,741
Overdrafts			7				20
Total charge-offs			753				1,962
Recoveries:
Commercial and industrial			1				3
Commercial real estate			81				4
Residential real estate			—				—
Consumer			1				—
Guaranteed student loans			—				—
Overdrafts			5				4
Total recoveries			88				11
Net charge-offs			665				1,951
Provision for loan and lease losses			1,608				2,390
Amount for unfunded commitments			(80	)			(118	)
Other (1)			(46	)			(57	)
Balance at end of period		$	7,064			$	5,569

 

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(1)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

In the third quarter of 2014, we began charging off that portion of our guaranteed student loans that is (1) not subject to federal government guarantee and (2) greater than 120 days past due and has a high probability of default. Probability of default is determined by loss migration analysis. Loans greater than 120 days past due continue to accrue interest as interest receivable is guaranteed until a claim against the guarantee, if any, is satisfied. A claim can be made when a loan is past due 270 days, or earlier in certain circumstances.

Acquired Loans

Acquired loans are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in our allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC 310-30. We concluded that a portion of the loans acquired in our 2011 acquisition of substantially all the assets and assumption of certain liabilities of VBB and the CVB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

In applying ASC 310-30 to acquired loans, we must estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including estimated default rates and the amount and timing of prepayments, in addition to other factors. ASC 310-30 allows the purchaser to estimate cash flows on credit-impaired loans on a loan-by-loan basis or aggregate credit-impaired loans into one or more pools if the loans have common risk characteristics. We have estimated cash flows expected to be collected on a loan-by-loan basis.

The excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield. This amount is accreted into interest income over the period of expected cash flows from the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

The following table presents our accretion activity for the periods presented. We recorded a $3.0 million estimated fair value adjustment, for credit and interest rates, on the loans acquired in the CVB Acquisition.

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2015				2014				2015				2014
Balance at beginning of period		$	4,759			$	7,279			$	5,580			$	4,441
Additions			—				(4	)			—				3,046
Accretion (1)			(338	)			(1,252	)			(1,180	)			(1,530	)
Disposals (2)			(17	)			(51	)			(42	)			(51	)
Other (3)			—				—				46				66
Balance at end of period		$	4,404			$	5,972			$	4,404			$	5,972

 

(1)	Accretion amounts are reported in interest income.

(2)	Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2015 amount, $17 thousand relates to a loan reclassified as OREO.

(3)	Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

 

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Nonperforming Assets

It is our policy to discontinue the accrual of interest income on nonperforming loans. We consider a loan as nonperforming when it is 90 days or greater past due as to interest and principal or when collectability is in doubt, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of September 30, 2015, there were no loans, other than guaranteed student loans, 90 days or greater past due with respect to principal and interest for which interest was accruing. The federal guarantee on our guaranteed student loans covers both principal and interest accrued to the date a claim, if any, is paid under the guarantee.

As of September 30, 2015 and December 31, 2014, we had $932 thousand and $1.1 million, respectively, in OREO. OREO valuations are evaluated periodically, and any necessary valuation allowance to carry the asset at its fair value, less disposal costs, is recorded as a charge to net income. In the three and nine months ended September 30, 2015, we recorded a $101 thousand valuation allowance and charge to income for a property acquired in the CVB Acquisition to reflect its carrying value at estimated fair value.

The following table presents our nonperforming assets and various performance ratios for the periods and as of the dates stated:

 

		September 30, 2015				December 31, 2014
Nonaccrual loans		$	6,748			$	7,377
Other real estate owned			932				1,140
Total nonperforming assets		$	7,680			$	8,517
Nonperforming assets as a percentage of total loans			1.01	%			1.13	%
Nonperforming assets as a percentage of total assets			0.79	%			0.93	%
Net charge-offs as a percentage of average loans			0.09	%			0.33	%
Allowance for loan and lease losses as a percentage of total loans			0.93	%			0.83	%
Allowance for loan and lease losses to nonaccrual loans			104.70	%			84.68	%

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of September 30, 2015 totaled $824.5 million compared to deposits of $772.9 million at December 31, 2014. Demand deposits, including money market accounts, as of September 30, 2015, increased $48.4 million from balances at December 31, 2014, while time deposits increased $2.6 million over this period. As of September 30, 2015, $108.4 million of our deposits were in Insured Cash Sweep (“ICS”) accounts, Certificate of Deposit Account Registry Service (“CDARS”) accounts and brokered time deposits, which we collectively refer to as brokered deposits. As of December 31, 2014, $86.8 million of our deposits were brokered deposits.

The following table presents average balances and rates paid, by deposit category, as of the dates stated:

 

		September 30, 2015								December 31, 2014
		Amount				Rate				Amount				Rate
Noninterest-bearing demand deposits		$	146,684				—			$	114,796				—
Interest-bearing deposits:
Demand and money market			355,649				0.71	%			295,344				0.61	%
Savings accounts			10,331				0.29	%			8,357				0.25	%
Time deposits $100,000 or greater			238,193				0.76	%			196,137				0.75	%
Time deposits less than $100,000			82,017				1.01	%			70,866				1.14	%
Total interest-bearing deposits			686,190				0.76	%			570,704				0.72	%
Total average deposits		$	832,874				0.62	%		$	685,500				0.60	%

The following table presents maturities of large denomination time deposits (equal to or greater than $100,000) as of September 30, 2015:

 

		Within 3 Months				3-6 Months				6-12 Months				Over 12 Months				Total				Percent of Total Deposits
Time deposits		$	62,162			$	69,600			$	48,316			$	40,723			$	220,801				26.78	%

 

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Borrowings

We had one secured long-term borrowing with the FHLB in the amount of $20.0 million, which matured on September 28, 2015. This borrowing was modified in the fourth quarter of 2011, and in connection with that modification, we paid a fee of $533 thousand, which was recognized as interest expense over the contractual term. For the three and nine month period ended September 30, 2015, our effective interest rate on the $20.0 million FHLB borrowing, including the effect of the prepayment fee and cash flow hedge, discussed below, was 1.89% and 1.85%, respectively. Upon maturity of the $20.0 million borrowing on September 28, 2015, we entered into a $17.5 million borrowing with the FHLB, which matures December 28, 2015.

At the time we modified the $20.0 million long-term FHLB borrowing, we entered into a derivative (interest rate swap) whereby we paid fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without the exchange of the underlying notional amount. Our objective in using interest rate derivatives is to manage our exposure to interest rate movements. Upon the maturity of the $20.0 million FHLB borrowing, the associated interest rate swap expired. In connection with our $17.5 million FHLB borrowing, we have interest rate swaps whereby we pay fixed amounts to a counterparty and receive LIBOR-based variable payments on the full notional amount of this borrowing. The derivatives are designated as a cash flow hedges, whereby the effective portion of the hedge is recorded in accumulated other comprehensive income (loss). The amounts reported in accumulated other comprehensive income (loss) as of September 30, 2015 and 2014 related to these derivatives were unrealized losses of $583 thousand (net of tax benefit of $301 thousand) and $97 thousand (net of tax benefit of $50 thousand), respectively. The ineffective portion of the derivatives was insignificant for the three and nine months ended September 30, 2015.

We have an agreement with the counterparty to our cash flow hedge derivatives that contains a provision whereby if we fail to maintain our status as a well or an adequate capitalized institution, we could be required to terminate or fully collateralize the derivative contracts. Additionally, if we default on any of our indebtedness, including default where repayment has not been accelerated by the lender, we could also be in default on our derivative obligations. We have minimum collateral requirements with our counterparty and, as of September 30, 2015, $884 thousand had been pledged as collateral under the agreement for our cash flow derivatives, as the valuation of the derivatives had surpassed the contractually specified minimum transfer amount. If we are not in compliance with the terms of the derivative agreements, we could be required to settle obligations under the agreement at termination value. As of September 30, 2015, a hedge liability of $903 thousand was recorded in other liabilities on our consolidated balance sheet related to the cash flow hedge derivatives.

At September 30, 2015, $11.3 million was outstanding under the Credit Agreement. Term loans under the Credit Agreement were repayable in monthly payments of accrued interest only for the first six months and then, beginning on March 31, 2015, the term loans are repayable in monthly installments of principal, based on a 10-year amortization schedule, plus accrued interest. Unless extended or earlier prepaid, the maturity date of all term loans made under the Credit Agreement is September 30, 2019, at which time all unpaid principal, with accrued interest thereon, will become due and payable in full. All borrowings under the Credit Agreement bear interest at the 30-day LIBOR in effect from time to time, plus 2.75% per annum. The Credit Agreement is unsecured; however, there is a negative pledge on all of the outstanding capital stock of the Bank. We have the right to borrow up to an additional $5 million under the Credit Agreement on or before September 30, 2016. For the three and nine months ended September 30, 2015, the effective interest rate, which includes the amortization of loan origination costs, on borrowings under the senior term loan was 4.00% and 3.98%, respectively.

The Credit Agreement contains financial covenants that require: (1) the company to be and to cause the Bank to be “well-capitalized”, as defined in federal banking regulations, at all times, (2) the Bank’s total risk-based capital ratio to be at least equal to 11.5% as of the last day of each fiscal quarter, (3) the Bank’s ratio of nonperforming assets to tangible primary capital to be no more than 30% as of the last day of each fiscal quarter, (4) the Bank’s ratio of loan loss reserves, including loans discounts relating to acquired loans, to nonperforming loans to be at least equal to 70% at all times, and (5) the company’s fixed charge coverage ratio, determined on a consolidated basis, to be at least 1.25 to 1.0 at the end of each fiscal quarter for the trailing four fiscal quarters. As of September 30, 2015, the company and the Bank, as applicable, were in compliance with these financial covenants.

We contributed a significant portion of the proceeds under the Credit Agreement to the Bank as equity and retained the remainder of the proceeds to fund holding company obligations, including obligations under the Credit Agreement for a period of time.

On June 26, 2015, we issued and sold $8.5 million in aggregate principal amount of the Subordinated Notes. The Subordinated Notes may not be redeemed by the company prior to June 26, 2020, except in the event (i) the Subordinated Notes no longer qualify as Tier 2 Capital as a result of a change in interpretation or application of law or regulation, or (ii) of a “Tax Event” (as defined under the related note purchase agreement). The Subordinated Notes are unsecured and subordinate and junior in right of payments to the

 

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company’s secured and general creditors. Interest on the Subordinated Notes is payable quarterly in arrears on March 31, June 30, September 30 and December 31. Additionally, the company is not permitted to declare or pay any dividend or make any distribution on its capital stock or any other of its equity securities of any kind, except for dividends payable solely in shares of the company’s common stock, if the total risk-based capital ratio, Tier 1 risk-based capital ratio, or leverage ratio of the company or the Bank, becomes less than 10.0%, 6.0%, or 5.0%, respectively. For the three and nine months ended September 30, 2015, the effective interest rate, which includes the amortization of loan origination costs, on the Subordinated Notes was 7.13% and 7.11%, respectively.

LIQUIDITY AND CAPITAL RESOURCES

In the nine months ended September 30, 2015, cash and cash equivalents decreased $12.5 million compared to a decrease of $3.2 million for the same period in 2014. Net cash provided by operating activities was $1.7 million for the nine months ended September 30, 2015 compared to net cash used in operating activities of $90 thousand for the same period in 2014. The primary source of operating funds in the 2015 period was from net income, adjusted by our provision for loan and lease losses and accretion, offset by an increase in other assets, primarily an increase in amounts due from a participant bank. Net cash used in investing activities was $62.4 million for the nine months ended September 30, 2015 compared to net cash used in investing activities of $116.7 million for the same period in 2014. Cash used in investing activities in the 2015 period reflected net purchases of securities of $68.1 million and a net increase in loans held for investment of $9.2 million. Net cash provided by financing activities in the nine months ended September 30, 2015 was $48.3 million compared to $113.6 million for the same period of 2014. Cash provided by financing activities in both periods reflected a net increase in deposits. Additionally, the nine months ended September 30, 2015 included $8.4 million of cash used in the second quarter 2015 to fund the redemption of the preferred stock that we issued and sold to the U.S. Treasury pursuant to the Small Business Lending Fund Program.

Liquidity

Liquidity is the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate deposit withdrawals, payments of debt and operating expenses, fund increased loan demand, and to achieve stated objectives (including working capital requirements). These events may occur daily or in other short-term intervals in the normal operation of business. Historical trends may help management predict the amount of cash required. In assessing liquidity, management gives consideration to various factors, including stability of deposits, maturity of time deposits, quality, volume and maturity of assets, sources, repayments and costs of borrowings, concentrations of loans and deposits within certain businesses and industries, expected funding of loans and collection of deposits, and our overall financial condition and cash flows.

Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale portfolio. We have access to a credit line from our primary correspondent bank in the amount of $30.0 million. This line is for short-term liquidity needs, is subject to the prevailing federal funds interest rate, and can be terminated at any time.

We have six additional uncommitted lines of credit by national banks to borrow federal funds up to $88.0 million in total on an unsecured basis. One line for $10.0 million expires August 1, 2016 and one line for $15.0 million expires September 24, 2016. The remainder of the lines of credit can be cancelled at any time by the lender. As of September 30, 2015, there were no amounts outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate.

We have secured borrowing facilities with the FHLB and the Federal Reserve Bank (“FRB”). The total credit availability under the FHLB facility is equal to 30% of our total assets, which as of September 30, 2015 was $297.6 million, based on the most recent prior quarter-end. In addition, based on pledged collateral with the FHLB, we have a $50.8 million secured borrowing facility as of September 30, 2015. Under this facility, we have one non-amortizing term loan outstanding for $17.5 million. Credit availability under the FRB facility was $123.3 million as of September 30, 2015, which is also based on lendable collateral. Borrowings under this facility bear the prevailing current rate for primary credit. There were no amounts outstanding under this facility as of September 30, 2015. Pledged collateral (loans) for both the FHLB and FRB facilities was $250.4 million, as of September 30, 2015.

Additionally, we have $5.0 million of capacity under the Credit Agreement, which may be borrowed on or before September 30, 2016, subject to customary conditions. In management’s opinion, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs that may arise, within realistic limitations, for the foreseeable future.

Capital Adequacy

Capital management in a regulated financial services industry must properly balance return on equity to shareholders, while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Our capital management strategies have been developed to maintain our “well-capitalized” position.

We are subject to various regulatory capital requirements administered by federal and other bank regulators. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on us. Under capital adequacy guidelines and the regulatory framework for

 

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prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The rule establishing a new regulatory capital framework for smaller, less complex financial institutions became effective January 1, 2015 and will be phased in over the next five years. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee and certain changes required by the Dodd-Frank Act Wall Street Reform and Consumer Protection Act of 2010, and increases the minimum requirements for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

The following table presents capital and risk-weighted assets for the Bank and Xenith Bankshares as of the dates stated, including the new common equity Tier 1 capital ratio. Note that measures for the new ratio are not applicable prior to 2015.

 

		September 30, 2015								December 31, 2014
		Xenith Bank				Xenith Bankshares				Xenith Bank				Xenith Bankshares
Common equity Tier 1 capital		$	105,001				87,614				N/A				N/A
Tier 1 capital			105,001				87,614			$	94,980			$	86,016
Total risk-based capital			112,588				103,580				101,669				92,705
Risk-weighted assets			864,281				864,559				781,881				782,204

The following table presents capital ratios and minimum capital ratios required by our regulators for the Bank and Xenith Bankshares as of the dates stated, including the new common equity Tier 1 capital ratio. Note that the new ratio is not applicable prior to 2015.

 

		September 30, 2015								December 31, 2014
		Xenith Bank				Xenith Bankshares				Xenith Bank				Xenith Bankshares				Regulatory Minimum				Well Capitalized
Common equity Tier 1 capital ratio			12.15	%			10.13	%			N/A				N/A				4.50	%			> 6.50	%
Tier 1 leverage ratio			10.53	%			8.78	%			10.30	%			9.34	%			4.00	%			> 5.00	%
Tier 1 risk-based capital ratio			12.15	%			10.13	%			12.15	%			11.00	%			6.00	%			> 8.00	%
Total risk-based capital ratio			13.03	%			11.98	%			13.00	%			11.85	%			8.00	%			> 10.00	%

Interest Rate Sensitivity

Interest rate risk management is a central part of our overall asset-liability management process. A primary objective of interest rate risk management is to ensure the stability and quality of our primary earnings component, net interest income. This process involves monitoring the company’s balance sheet in order to determine the potential impact that changes in the interest rate environment may have on net interest income. Rate-sensitive assets and liabilities have interest rates that are subject to change within a specific time period, due to either maturity or contractual agreements that allow the instruments to reprice prior to maturity. Interest rate sensitivity management seeks to ensure that both assets and liabilities react to changes in interest rates within a similar time period, thereby minimizing the risk to net interest income. We use interest rate risk measurement tools (simulation models) to simulate the effect of interest rate movements on our net interest income and the economic value of our equity.

Net interest income simulation. Net interest income is affected by changes in the level of interest rates, the shape of the yield curve and the general market pressures affecting current market interest rates at the time of simulation. Many interest rate indices do not move uniformly, creating certain disunities between them. For example, the spread between a 30-day prime-based asset and a 30-day FHLB borrowing may not be uniform over time. The earnings simulation model projects changes in our net interest income caused by the effect of changes in interest rates on interest-earning assets and interest-bearing liabilities. Simulation results are measured as a percentage change in net interest income compared to the static-rate or “base case” scenario. The model uses our September 30, 2015 balance sheet, but considers decreases in asset and liability volumes based on prepayment assumptions as well as rate changes. Rate

 

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changes are modeled instantaneously, referred to as a “rate shock.” The model projects only “sensitivities” to interest income and expense and does not project changes in noninterest income, noninterest expense, provision for loan and lease losses or the impact of changing tax rates.

The following table summarizes the results of our earnings “rate shock” simulation model as of the dates stated:

 

		Annualized Hypothetical Percentage Change in Net Interest Income
Linear Change in Market Rate		September 30, 2015
Up 200 bps			15.74	%
Up 100			9.82	%
Base case - no change			0.00	%
Down 100			-0.75	%

Economic Value of Equity Simulation. Economic Value of Equity (“EVE”) represents the economic value of equity and is equal to the economic value of assets minus the economic value of liabilities, with adjustments made for off-balance sheet items. This simulation assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained increase or decrease in interest rates with no effect given to any actions management might take to counter the effect of that interest rate movement.

The following table summarizes the results of our EVE simulation model as of the dates stated:

 

		Hypothetical Percentage Change in EVE
Linear Change in Market Rate		September 30, 2015
Up 200 bps			46.40	%
Up 100			26.80	%
Base case - no change			0.00	%
Down 100			-38.30	%

Our balance sheet has been consistently “asset sensitive,” therefore should interest rates change, we expect our assets will reprice faster than our liabilities. An asset-sensitive balance sheet will result in an increase to net interest income in an increasing rate environment and a decrease in net interest income in a declining rate environment.

Commitments and Contingencies

In the normal course of business, we have commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the contracts. These commitments generally have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Additionally, we issue letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

These commitments represent outstanding off-balance sheet commitments. The following table presents unfunded loan commitments outstanding as of the dates stated:

 

		September 30, 2015				December 31, 2014
Commercial lines of credit		$	176,849			$	127,363
Commercial real estate			56,758				63,950
Residential real estate			11,035				10,949
Consumer			3,915				2,936
Letters of credit			8,221				9,777
Total commitments		$	256,778			$	214,975

 

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The Bank has a commitment to invest in a limited partnership that operates as a small business investment company. As of September 30, 2015, the Bank had invested $750 thousand; an additional $250 thousand will be funded at the request of the general partner of the partnership. Additionally, the Bank has a $1.0 million commitment to invest in a Virginia limited liability company, the purpose of which is to invest in low-income residential rental and/or historic properties.

In the third quarter of 2015, the company entered into a new agreement with its core processing servicer. This agreement replaced an existing agreement that was to expire in December 2016. The new agreement expires in December 2020, though is terminable with 180 days notice and payment of financial penalties. Minimum fees under the agreement over the remaining term are approximately $5.0 million.

Additionally, in the third quarter of 2015, the company entered into a new lease agreement for its loan production office. The lease agreement expires in July 2020. Future commitments under this agreement total $222 thousand.

CAUTIONARY NOTICE ABOUT FORWARD-LOOKING STATEMENTS

Certain statements included in this Form 10-Q are “forward-looking statements.” All statements other than statements of historical facts contained in this Form 10-Q, including statements regarding our plans, objectives and goals, future events or results, our competitive strengths and business strategies, and the trends in our industry are forward-looking statements. The words “believe,” “will,” “may,” “could,” “estimate,” “project,” “predict,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “appear,” “future,” “likely,” “probably,” “suggest,” “goal,” “potential” and similar expressions, as they relate to our company, are intended to identify forward-looking statements.

Forward-looking statements made in this Form 10-Q reflect beliefs, assumptions, and expectations of future events or results, taking into account the information currently available to us. These beliefs, assumptions, and expectations may change as a result of many possible events, circumstances or factors, not all of which are currently known to us. If a change occurs, our business, financial condition, liquidity, results of operations and prospects may vary materially from those expressed in, or implied by, the forward-looking statements. Accordingly, you should not place undue reliance on these forward-looking statements. You should carefully consider these matters, along with the risks discussed under “Risk Factors” in our 2014 Form 10-K and the following factors, which are not intended to be exhaustive, that may cause actual results to vary materially from our forward-looking statements:

 

•

general economic conditions nationally, regionally or in our target markets;

 

•

the efforts of government agencies to stabilize the equity and debt markets;

 

•

the adequacy of our allowance for loan and lease losses and the methodology for determining such allowance;

 

•

adverse changes in our loan portfolio and credit risk-related losses and expenses;

 

•

concentrations within our loan portfolio, including exposure to commercial real estate loans, and to our target markets;

 

•

our dependence on our target markets in and around Virginia;

 

•

reduced deposit flows and loan demand as well as increasing default rates;

 

•

changes in interest rates, reducing our margins or the volumes or values of the loans we make and the deposits and investments we hold;

 

•

our ability to generate sufficient taxable income to utilize our deferred tax assets, thus requiring a valuation allowance against this asset;

 

•

business conditions in the financial services industry, including competitive pressures among financial services companies, new service and product offerings by competitors, and similar factors;

 

•

the degree and nature of our competition, with the understanding that competitors may have greater financial resources and access to capital and may offer services that enable those competitors to compete more successfully than we can;

 

•

the regulatory environment, including evolving banking industry standards, changes in legislation or regulation;

 

•

our ability and willingness to pay dividends on our common stock in the future;

 

•

changes in accounting principles, policies and guidelines as well as estimates and assumptions used in the preparation of our financial statements;

 

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•

volatility of the market price of our common stock and capital markets generally;

 

•

changes in our competitive strengths or business or strategies;

 

•

the availability, terms and deployment of debt and equity capital;

 

•

our dependence upon key personnel whose continued service is not guaranteed, and our ability to identify, hire and retain highly qualified personnel in the future;

 

•

our ability to implement our business strategies successfully;

 

•

disruptions to customer and employee relationships and business operations caused by the CVB Acquisition;

 

•

our ability to maintain regulatory capital levels and adequate sources of funding and liquidity, which could be adversely affected by market conditions and changes in capital requirements made by regulators;

 

•

negative publicity and the impact on our reputation;

 

•

rapidly changing technology;

 

•

failures or breaches to our systems and network security, including “hacking,” “cyber fraud” or “identity theft” resulting in operating losses or litigation;

 

•

war or terrorist activities causing deterioration in the economy;

 

•

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and

 

•

the risks discussed in our public filings with the Securities and Exchange Commission (the “SEC”).

As a result of these factors, among others, the future events or results that are the subject of our beliefs, assumptions and expectations expressed in, or implied by, our forward-looking statements in this Form 10-Q may not be achieved in any specified time frame, or at all, which could be material. Accordingly and as noted above, you should not place undue reliance on these forward-looking statements. All subsequent written and oral forward-looking statements attributable to us or the persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Except as required by applicable law or regulations, we do not undertake, and specifically disclaim any obligation, to update or revise any forward-looking statement.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

Management evaluated, with the participation of the company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective as of the end of the period covered by this Form 10-Q to ensure that information required to be disclosed in the reports that the company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

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

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are not presently involved in any litigation, nor to our knowledge is any litigation threatened against us, that in management’s opinion would result in any material adverse effect on our financial position or results of operations or that is not expected to be covered by insurance.

Item 1A. Risk Factors

While we attempt to identify, manage and mitigate risks and uncertainties associated with our business to the extent practical under the circumstances, some level of risk and uncertainty will always be present. “Risk Factors” in our 2014 Form 10-K describes some of the risks and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our results of operations and our financial condition. We do not believe that there have been any material changes to the risk factors previously disclosed in the 2014 Form 10-K.

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

In July 2013, the company’s board of directors approved a share repurchase program under which the company may purchase in the open market or otherwise up to 210,000 shares of its outstanding common stock. There is no guarantee as to the number of shares that will be repurchased by the company, and the program can be discontinued at any time.

The following table presents monthly stock repurchases during the third quarter of 2015. All purchases were made using available cash resources and occurred in the open market.

 

Period		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Program				Maximum Number of Shares that May Yet Be Purchased Under the Program
July 1, 2015 - July 31, 2015			—			$	—				—				115,670
August 1, 2015 - August 31, 2015			—			$	—				—				115,670
September 1, 2015 - September 30, 2015			10,600			$	6.36				10,600				105,070
Total			10,600			$	6.36				10,600

 

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Item 6. Exhibits

 

Exhibit Number		Description
10.1		Amendment to Credit Agreement, effective as of September 24, 2015, between Xenith Bankshares, Inc. and Raymond James Bank, N.A. (incorporated herein by reference to Exhibit 10.1 to Current Report on Form 8-K filed September 29, 2015 (File No. 000-53380))
31.1		Certification of CEO pursuant to Rule 13a-14(a)
31.2		Certification of CFO pursuant to Rule 13a-14(a)
32.1		CEO Certification pursuant to 18 U.S.C. § 1350
32.2		CFO Certification pursuant to 18 U.S.C. § 1350
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

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SIGNATURES

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

 

				XENITH BANKSHARES, INC.
Date: November 9, 2015				/s/    T. GAYLON LAYFIELD, III
				T. Gaylon Layfield, III President and Chief Executive Officer (Principal Executive Officer)
Date: November 9, 2015				/s/    THOMAS. W. OSGOOD
				Thomas W. Osgood Executive Vice President, Chief Financial Officer, Chief Administrative Officer and Treasurer (Principal Financial Officer)