10-Q 1 d532369d10q.htm FORM 10-Q FORM 10-Q
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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 March 31, 2013

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 April 29, 2013 was 10,488,060.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  
PART I - FINANCIAL INFORMATION   

Item 1 Financial Statements

     1   

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

     21   

Item 3 Quantitative and Qualitative Disclosures About Market Risk

     37   

Item 4 Controls and Procedures

     37   
PART II - OTHER INFORMATION   

Item 1 Legal Proceedings

     37   

Item 1A Risk Factors

     37   

Item 6 Exhibits

     38   

SIGNATURES

  


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2013 AND DECEMBER 31, 2012

 

     (Unaudited)        
(in thousands, except share data)    March 31, 2013     December 31, 2012  

Assets

  

Cash and cash equivalents

    

Cash and due from banks

   $ 44,721     $ 9,457  

Federal funds sold

     7,548       2,906  
  

 

 

   

 

 

 

Total cash and cash equivalents

     52,269       12,363  

Securities available for sale, at fair value

     53,278       57,551  

Loans held for sale

     68,905       80,867  

Loans held for investment, net of allowance for loan and lease losses, 2013 - $5,099; 2012 - $4,875

     372,052       379,006  

Premises and equipment, net

     5,436       5,397  

Other real estate owned

     276       276  

Goodwill and other intangible assets, net

     15,898       15,989  

Accrued interest receivable

     1,514       1,606  

Deferred tax asset

     4,021       4,094  

Other assets

     6,204       6,057  
  

 

 

   

 

 

 

Total assets

   $ 579,853     $ 563,206  
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Deposits

    

Demand and money market

   $ 325,060     $ 317,526  

Savings

     4,528       4,069  

Time

     139,210       131,636  
  

 

 

   

 

 

 

Total deposits

     468,798       453,231  

Accrued interest payable

     224       232  

Borrowings

     20,000       20,000  

Other liabilities

     3,059       2,196  
  

 

 

   

 

 

 

Total liabilities

     492,081       475,659  
  

 

 

   

 

 

 

Shareholders’ equity

    

Preferred stock, $1.00 par value, $1,000 liquidation value, 25,000,000 shares authorized as of March 31, 2013 and December 31, 2012; 8,381 shares issued and outstanding as of March 31, 2013 and December 31, 2012

     8,381       8,381  

Common stock, $1.00 par value, 100,000,000 shares authorized as of March 31, 2013 and December 31, 2012; 10,488,060 shares issued and outstanding as of March 31, 2013 and December 31, 2012

     10,488       10,488  

Additional paid-in capital

     71,578       71,414  

Accumulated deficit

     (3,263     (3,660

Accumulated other comprehensive income, net of tax

     588       924  
  

 

 

   

 

 

 

Total shareholders’ equity

     87,772       87,547  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 579,853     $ 563,206  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012

(Unaudited)

 

(in thousands, except per share data)    March 31, 2013     March 31, 2012  

Interest income

    

Interest and fees on loans

   $ 5,860     $ 5,616  

Interest on securities

     250       436  

Interest on federal funds sold and deposits in other banks

     78       71  
  

 

 

   

 

 

 

Total interest income

     6,188       6,123  
  

 

 

   

 

 

 

Interest expense

    

Interest on deposits

     584       680  

Interest on time certificates of $100,000 and over

     263       285  

Interest on federal funds purchased and borrowed funds

     92       92  
  

 

 

   

 

 

 

Total interest expense

     939       1,057  
  

 

 

   

 

 

 

Net interest income

     5,249       5,066  

Provision for loan and lease losses

     411       360  
  

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     4,838       4,706  
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     94       59  

Net gain (loss) on sale and write-down of other real estate owned and other collateral

     346       (9

Gains on sales of securities

     159       219  

Other

     61       86  
  

 

 

   

 

 

 

Total noninterest income

     660       355  
  

 

 

   

 

 

 

Noninterest expense

    

Compensation and benefits

     2,958       2,831  

Occupancy

     364       389  

FDIC insurance

     99       90  

Bank franchise taxes

     197       150  

Technology

     387       416  

Communications

     61       72  

Insurance

     74       75  

Professional fees

     253       247  

Other real estate owned

     2       2  

Amortization of intangible assets

     91       91  

Other

     349       386  
  

 

 

   

 

 

 

Total noninterest expense

     4,835       4,749  
  

 

 

   

 

 

 

Income before income tax

     663       312  

Income tax expense

     245       —     
  

 

 

   

 

 

 

Net income

     418       312  
  

 

 

   

 

 

 

Preferred stock dividend

     (21     (21
  

 

 

   

 

 

 

Net income available to common shareholders

   $ 397     $ 291  
  

 

 

   

 

 

 

Earnings per common share (basic and diluted):

   $ 0.04     $ 0.03  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012

(Unaudited)

 

(in thousands)    March 31, 2013     March 31, 2012  

Net income

   $ 418     $ 312  

Other comprehensive loss, before taxes:

    

Unrealized loss on available-for-sale securities:

    

Unrealized (loss) gain arising during the year

     (381     204  

Reclassification adjustment for gains included in net income

     (159     (219
  

 

 

   

 

 

 

Unrealized loss on available-for-sale securities

     (540     (15
  

 

 

   

 

 

 

Unrealized gain (loss) on derivative:

    

Unrealized loss arising during the year

     (1     (74

Reclassification adjustment for losses included in net income

     32       20  
  

 

 

   

 

 

 

Unrealized gain (loss) on derivative

     31       (54
  

 

 

   

 

 

 

Other comprehensive loss, before taxes

     (509     (69
  

 

 

   

 

 

 

Income tax benefit related to other comprehensive income

     173       —     
  

 

 

   

 

 

 

Comprehensive income

   $ 82     $ 243  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012

(Unaudited)

 

(in thousands)    March 31, 2013     March 31, 2012  

Cash flows from operating activities

    

Net income

   $ 418     $ 312  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

    

Provision for loan and lease losses

     411       360  

Depreciation and amortization

     304       321  

Net amortization of securities

     180       181  

Accretion of acquisition accounting adjustments

     (502     (684

Deferred tax expense

     245       —     

Gains on sales of securities

     (159     (219

Share-based compensation expense

     164       61  

Net (gain) loss on sale and write-down of other real estate owned and other collateral

     (346     9  

Change in operating assets and liabilities:

    

Originations of loans held for sale

     (158,354     (41,757

Proceeds from sales of loans held for sale

     170,316       12,659  

Accrued interest receivable

     92       (53

Other assets

     (173     407  

Accrued interest payable

     (8     (62

Other liabilities

     868       119  
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     13,456       (28,346
  

 

 

   

 

 

 

Cash flows from investing activities

    

Proceeds from sales, maturities and calls of securities

     10,793       9,624  

Purchases of securities

     (7,081     (8,278

Net decrease (increase) in loans held for investment

     7,071       (2,722

Net proceeds from sale of other real estate owned and other collateral

     346       322  

Net purchase of premises and equipment

     (251     (105

Sale (purchase) of FRB and FHLB stock

     26       (138
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     10,904       (1,297
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in demand and savings deposits

     7,994       19,953  

Net increase (decrease) in time deposits

     7,573       (2,697

Preferred stock dividend

     (21     (21
  

 

 

   

 

 

 

Net cash provided by financing activities

     15,546       17,235  
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     39,906       (12,408

Cash and cash equivalents

    

Beginning of period

     12,363       55,795  
  

 

 

   

 

 

 

End of period

   $ 52,269     $ 43,387  
  

 

 

   

 

 

 

Supplementary disclosure of cash flow information

    

Cash payments for:

    

Interest

   $ 947     $ 1,118  
  

 

 

   

 

 

 

Income taxes

   $ 175     $ —     
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Xenith Bankshares, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

March 31, 2013

 

 

Note 1. Organization

General

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 March 31, 2013, the company, through the Bank, operates six full-service branches: one branch in Tysons Corner, Virginia, two branches in Richmond, Virginia, and three branches in Suffolk, Virginia.

Background

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 “merger”), with First Bankshares being the surviving entity in the merger. At the effective time of the 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 merger, SuffolkFirst Bank changed its name to Xenith Bank. Although the 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. Accordingly, the assets and liabilities of First Bankshares were recorded at their estimated fair values in the consolidated financial statements of Xenith Bankshares as of the date of the merger.

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 (the “Paragon Transaction”).

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.

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, and reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial positions at March 31, 2013 and December 31, 2012, the results of operations and comprehensive income for the three months ended March 31, 2013 and 2012, and the statements of cash flows for the three months ended March 31, 2013 and 2012. The results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2013. 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, 2012.

Certain amounts reported in prior periods’ financial statements have been reclassified to conform to the current presentation. Such reclassifications have no effect on previously reported total assets, liabilities, shareholders’ equity or net income.

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

Note 3. 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 for the weeks closest to March 31, 2013 and December 31, 2012 was $3.4 million and $3.1 million, respectively.

 

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Note 4. Securities

The following tables present the book value and fair value of available-for-sale securities as of the dates stated:

 

     March 31, 2013  
            Gross Unrealized        
     Book Value      Gains      (Losses)     Fair Value  

Mortgage-backed securities

          

- Fixed rate

   $ 36,039       $ 1,066       $ (21   $ 37,084   

- Variable rate

     6,002         121         (62     6,061   

Municipals

     1,048         —           (40     1,008   

Collateralized mortgage obligations

     9,046         140         (61     9,125   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 52,135       $ 1,327       $ (184   $ 53,278   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31, 2012  
            Gross Unrealized        
     Book Value      Gains      (Losses)     Fair Value  

Mortgage-backed securities

          

- Fixed rate

   $ 42,804       $ 1,436       $ —        $ 44,240   

- Variable rate

     2,038         143         —          2,181   

Municipals

     1,050         —           (50     1,000   

Collateralized mortgage obligations

     9,977         158         (5     10,130   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total securities available for sale

   $ 55,869       $ 1,737       $ (55   $ 57,551   
  

 

 

    

 

 

    

 

 

   

 

 

 

As of March 31, 2013 and December 31, 2012, the company had securities with a fair value of $7.5 million and $6.4 million, respectively, pledged as collateral for public deposits.

The following table presents the book value and fair value of available-for-sale securities by contractual maturity as of the date stated:

 

     March 31, 2013  
     Book Value      Fair Value  

Due within one year

   $ —         $ —     

Due after one year through five years

     —           —     

Due after five years through ten years

     15,556         15,945   

Due after ten years

     36,579         37,333   
  

 

 

    

 

 

 

Total securities available for sale

   $ 52,135       $ 53,278   
  

 

 

    

 

 

 

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.

 

     March 31, 2013  
            Less than 12 months     More than 12 months      Total  
     Number      Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Mortgage-backed securities

                   

- Fixed rate

     1       $ 3,016       $ (21   $ —         $ —         $ 3,016       $ (21

- Variable rate

     1         3,932         (62     —           —           3,932         (62

Municipals

     1         1,008         (40     —           —           1,008         (40

Collateralized mortgage obligations

     2         5,838         (61     —           —           5,838         (61
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

     5       $ 13,794       $ (184   $ —         $ —         $ 13,794       $ (184
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2012  
            Less than 12 months     More than 12 months      Total  
     Number      Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Municipals

     1       $ 1,000       $ (50   $ —         $ —         $ 1,000       $ (50

Collateralized mortgage obligations

     1         3,288         (5     —           —           3,288         (5
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

     2       $ 4,288       $ (55   $ —         $ —         $ 4,288       $ (55
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

All securities held as of March 31, 2013 were investment grade. The unrealized loss positions at March 31, 2013 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 March 31, 2013, 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 March 31, 2013; therefore, no impairment has been recognized.

Note 5. 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 held for investment as of the dates stated:

 

     March 31, 2013     December 31, 2012  
     Amount     Percent of
Total
    Amount     Percent of
Total
 

Commercial and industrial

   $ 196,696        52.16   $ 203,880        53.11

Commercial real estate

     152,532        40.44     150,796        39.28

Residential real estate

     23,203        6.15     24,291        6.33

Consumer

     4,720        1.25     4,914        1.28
  

 

 

   

 

 

   

 

 

   

 

 

 

Loans held for investment

   $ 377,151        100.00   $ 383,881        100.00

Allowance for loan and lease losses

     (5,099       (4,875  
  

 

 

     

 

 

   

Loans held for investment, net of allowance

     372,052          379,006     

Loans held for sale

     68,905          80,867     
  

 

 

     

 

 

   

Total loans

   $ 440,957        $ 459,873     
  

 

 

     

 

 

   

Loans held for investment included unearned fees, net of capitalized origination costs, of $90 thousand and $245 thousand, as of March 31, 2013 and December 31, 2012, respectively. As of March 31, 2013, $192.4 million of loans were pledged as collateral for borrowing capacity.

Loans Held for Sale

In the first quarter of 2012, the Bank entered into a sub-participation agreement with a commercial bank (the “participating bank”), whereby pursuant to the sub-participation agreement, the participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators and the participating bank deliver the loans to the investors. Typically, the Bank, together with the participating bank, purchase up to an aggregate of a 99% participation interest with the originators retaining the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

 

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Loans Held for Investment

The following table presents the company’s loans held for investment 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.”

 

     March 31, 2013  
     Pass      Special Mention      Substandard      Doubtful      Total Loans  

Commercial and industrial

   $ 188,684       $ 3,635       $ 4,377       $ —         $ 196,696   

Commercial real estate

     143,398         4,313         4,821         —           152,532   

Residential real estate

     22,163         75         965         —           23,203   

Consumer

     3,833         —           273         —           4,106   

Overdrafts

     614         —           —           —           614   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 358,692       $ 8,023       $ 10,436       $ —         $ 377,151   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     Pass      Special Mention      Substandard      Doubtful      Total Loans  

Commercial and industrial

   $ 196,004       $ 4,813       $ 3,063       $ —         $ 203,880   

Commercial real estate

     139,206         6,407         5,183         —           150,796   

Residential real estate

     23,282         87         922         —           24,291   

Consumer

     4,466         154         266         —           4,886   

Overdrafts

     28         —           —           —           28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 362,986       $ 11,461       $ 9,434       $ —         $ 383,881   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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.

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 as 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 operations and comprehensive income. 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.

 

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The following table presents the allowance for loan and lease loss activity, by loan category, as of the dates stated:

 

     For the Three Months Ended March 31,  
     2013     2012  

Balance at beginning of period

   $ 4,875      $ 4,280   

Charge-offs:

    

Commercial and industrial

     1        —     

Commercial real estate

     159        429   

Residential real estate

     —          —     

Consumer

     —          —     

Overdrafts

     1        3   
  

 

 

   

 

 

 

Total charge-offs

     161        432   
  

 

 

   

 

 

 

Recoveries:

    

Commercial and industrial

     —          —     

Commercial real estate

     —          3   

Residential real estate

     —          —     

Consumer

     —          —     

Overdrafts

     1        1   
  

 

 

   

 

 

 

Total recoveries

     1        4   
  

 

 

   

 

 

 

Net charge-offs

     160        428   
  

 

 

   

 

 

 

Provision for loan and lease losses

     411        360   

Less: Amount for unfunded commitments

     (27     (75
  

 

 

   

 

 

 

Balance at end of period

   $ 5,099      $ 4,137   
  

 

 

   

 

 

 

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:

 

     March 31, 2013  
     Total Amount      Individually Evaluated
for Impairment
     Collectively Evaluated
for Impairment
 

Allowance for loan losses applicable to:

        

Commercial and industrial

   $ 1,674       $ 406       $ 1,268   

Commercial real estate

     3,154         751         2,403   

Residential real estate

     252         32         220   

Consumer

     19         16         3   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 5,099       $ 1,205       $ 3,894   
  

 

 

    

 

 

    

 

 

 

Loan balances applicable to:

        

Commercial and industrial

   $ 196,696       $ 3,449       $ 193,247   

Commercial real estate

     152,532         8,087         144,445   

Residential real estate

     23,203         564         22,639   

Consumer

     4,720         59         4,661   
  

 

 

    

 

 

    

 

 

 

Total loans

   $ 377,151       $ 12,159       $ 364,992   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2012  
     Total Amount      Individually Evaluated
for Impairment
     Collectively Evaluated
for Impairment
 

Allowance for loan losses applicable to:

        

Commercial and industrial

   $ 1,523       $ 296       $ 1,227   

Commercial real estate

     3,086         782         2,304   

Residential real estate

     245         32         213   

Consumer

     21         16         5   
  

 

 

    

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 4,875       $ 1,126       $ 3,749   
  

 

 

    

 

 

    

 

 

 

Loan balances applicable to:

        

Commercial and industrial

   $ 203,880       $ 3,803       $ 200,077   

Commercial real estate

     150,796         8,590         142,206   

Residential real estate

     24,291         560         23,731   

Consumer

     4,914         72         4,842   
  

 

 

    

 

 

    

 

 

 

Total loans

   $ 383,881       $ 13,025       $ 370,856   
  

 

 

    

 

 

    

 

 

 

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:

 

     March 31, 2013  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Commercial and industrial

   $ 1,196       $ 2,251       $ —         $ 1,145       $ —     

Commercial real estate

     2,721         5,006         —           2,789         —     

Residential real estate

     120         140         —           120         3   

Consumer

     1         11         —           2         —     

With an allowance recorded:

              

Commercial and industrial

     2,253         2,298         406         2,242         11   

Commercial real estate

     5,368         6,237         751         5,147         70   

Residential real estate

     443         456         32         435         5   

Consumer

     57         45         16         44         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans individually evaluated for impairment

   $ 12,159       $ 16,444       $ 1,205       $ 11,924       $   90   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Commercial and industrial

   $ 1,202       $ 2,220       $ —         $ 1,178       $ 48   

Commercial real estate

     2,897         5,029         —           3,724         115   

Residential real estate

     120         140         —           121         11   

Consumer

     2         12         —           4         1   

With an allowance recorded:

              

Commercial and industrial

     2,601         2,680         296         2,665         116   

Commercial real estate

     5,693         6,663         782         5,613         343   

Residential real estate

     440         457         32         278         8   

Consumer

     70         60         16         77         5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans individually evaluated for impairment

   $ 13,025       $ 17,261       $ 1,126       $ 13,660       $ 647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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 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 were deemed by management to be credit-impaired loans qualifying for accounting under ASC 310-30.

As of July 29, 2011, the loans acquired in the Paragon Transaction and the VBB Acquisition were adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively. Of the $14.0 million discount recorded on the VBB Acquisition, $12.7 million related to $40.2 million of purchased credit-impaired loans. The remaining fair value adjustment on the purchased credit-impaired loans, as of March 31, 2013, was $6.4 million. The carrying value, as of March 31, 2013, of purchased impaired loans was approximately $15.8 million.

For acquired 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. As of March 31, 2013 and December 31, 2012, the company had $1.6 million and $1.2 million, respectively, of nonaccretable difference related to the credit-impaired loans acquired in the VBB Acquisition.

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 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 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.

During the first quarter of 2013, the company recorded a net impairment charge of $111 thousand due to deterioration in the timing and/or amount of cash flows of certain loans since the prior measurement date. This impairment amount is reported as a provision for loan and lease losses in the consolidated statements of operations and comprehensive income and a component of allowance for loan and lease losses. If upon remeasurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that exceed those previously determined, some portion of the impairment could be reversed.

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

 

     March 31, 2013     December 31, 2012  

Balance at beginning of period

   $ 8,133      $ 14,007   

Accretion (1)

     (502     (3,335

Disposals (2)

     —          (2,539
  

 

 

   

 

 

 

Balance at end of period

   $ 7,631      $ 8,133   
  

 

 

   

 

 

 

 

(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.

 

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The following table presents the age analysis of loans past due as of the dates stated:

 

     March 31, 2013  
     30-89 days
Past Due
     90+ days
Past Due
     Total
Past Due
 

Commercial and industrial

   $ 198       $ 2,102       $ 2,300   

Commercial real estate

     —           1,331         1,331   

Residential real estate

     33         395         428   

Consumer

     7         —           7   
  

 

 

    

 

 

    

 

 

 

Total

   $ 238       $ 3,828       $ 4,066   
  

 

 

    

 

 

    

 

 

 
     December 31, 2012  
     30-89 days
Past Due
     90+ days
Past Due
     Total
Past Due
 

Commercial and industrial

   $ 1,592       $ 1,657       $ 3,249   

Commercial real estate

     1,762         2,256         4,018   

Residential real estate

     —           74         74   

Consumer

     3         —           3   
  

 

 

    

 

 

    

 

 

 

Total

   $ 3,357       $ 3,987       $ 7,344   
  

 

 

    

 

 

    

 

 

 

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 March 31, 2013, there were no loans past due 90 days or greater for which interest was accruing.

 

     March 31, 2013      December 31, 2012  

Commercial and industrial

   $ 1,832       $ 1,847   

Commercial real estate

     2,983        3,148  

Residential real estate

     72        74  

Consumer

     —           —     
  

 

 

    

 

 

 

Total nonaccrual loans

   $ 4,887       $ 5,069   

Other real estate owned

     276         276   
  

 

 

    

 

 

 

Total nonperforming assets

   $ 5,163       $ 5,345   
  

 

 

    

 

 

 

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. 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.

 

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Table of Contents

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

 

     March 31, 2013      December 31, 2012  

Performing:

     

Commercial and industrial

   $ —         $ —     

Commercial real estate

     —           —     

Residential real estate

     —           123   

Consumer

     —           —     
  

 

 

    

 

 

 

Total performing TDRs

   $ —         $ 123   
  

 

 

    

 

 

 

Nonperforming:

     

Commercial and industrial

   $ 1,429       $ 1,439   

Commercial real estate

     401         411   

Residential real estate

     123         —     

Consumer

     —           —     
  

 

 

    

 

 

 

Total nonperforming TDRs

   $ 1,953       $ 1,850   
  

 

 

    

 

 

 

Total TDRs

   $ 1,953       $ 1,973   
  

 

 

    

 

 

 

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

 

     March 31, 2013  
     Number of Loans
Modified
     Rate Modification (1)      Term Extension and/or
Other Concessions
     Total  

Commercial and industrial

     3       $ 648       $ 781       $ 1,429   

Commercial real estate

     7         401         —           401   

Residential real estate

     1         —           123         123   

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total TDRs

     11       $ 1,049       $ 904       $ 1,953   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Restructured loans which had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

 

     December 31, 2012  
     Number of Loans
Modified
     Rate Modification (1)      Term Extension and/or
Other Concessions
     Total  

Commercial and industrial

     3       $ 657       $ 782       $ 1,439   

Commercial real estate

     7         411         —           411   

Residential real estate

     1         —           123         123   

Consumer

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total TDRs

     11       $ 1,068       $ 905       $ 1,973   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Restructured loans which had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

 

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Table of Contents

Note 6. Goodwill and Other Intangible Assets

The following table presents goodwill and other intangible assets as of the dates stated:

 

     March 31, 2013     December 31, 2012  

Amortizable core deposit intangibles:

    

Gross carrying value

   $ 3,710      $ 3,710   

Accumulated amortization

     (801     (710
  

 

 

   

 

 

 

Net core deposit intangibles

   $ 2,909      $ 3,000   
  

 

 

   

 

 

 

Unamortizable goodwill

   $ 12,989      $ 12,989   
  

 

 

   

 

 

 

Total goodwill and other intangible assets, net

   $ 15,898      $ 15,989   
  

 

 

   

 

 

 

The following table presents the estimated future amortization expense for core deposit intangibles:

 

Year

   Core Deposit Intangibles  

2013

   $ 274   

2014

     365   

2015

     365   

2016

     365   

2017

     365   

Thereafter

     1,175   
  

 

 

 

Total

   $ 2,909   
  

 

 

 

Note 7. Deposits

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

 

     March 31, 2013      December 31, 2012  

Noninterest-bearing demand deposits

   $ 75,877       $ 74,539   

Interest-bearing:

     

Demand and money market

     249,183         242,987   

Savings deposits

     4,528         4,069   

Time deposits of $100,000 or more

     79,750         72,870   

Other time deposits

     59,460         58,766   
  

 

 

    

 

 

 

Total deposits

   $ 468,798       $ 453,231   
  

 

 

    

 

 

 

Note 8. Derivatives

Cash Flow Hedges

The company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements. To accomplish this objective, the company is a party to an interest rate swap, whereby the company pays fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreements without exchange of the underlying notional amount. As of March 31, 2013, the company had one interest rate swap with a notional amount of $20 million that is designated as a cash flow hedge, in accordance with FASB ASC Topic 815, “Derivatives and Hedging.”

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 derivative is recognized directly in earnings. There was no ineffective portion of the derivative during this period. The amount reported in AOCI as of March 31, 2013 was a loss of

 

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$166 thousand, net of a tax benefit of $86 thousand. As of March 31, 2013, a liability of $252 thousand was recorded in other liabilities on the consolidated balance sheet related to this derivative. Additionally, the company has minimum collateral requirements with its counterparty, and as of March 31, 2013, $250 thousand has been pledged as collateral under the agreement, as the valuation of the derivative has surpassed the contractually specified minimum transfer amount of $250 thousand. If the company is not in compliance with the terms of the derivative agreement, it could be required to settle its obligations under the agreement at termination value.

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 a third party, thus minimizing its net exposure from such transactions. These derivatives do not meet the hedge accounting requirements; therefore, changes in the fair value of both the customer derivative and the offsetting derivative are recognized in earnings. As of March 31, 2013, $122 thousand was recorded in other assets and $135 thousand was recorded in other liabilities related to non-designated hedges. For the period ended March 31, 2013, $3 thousand was recognized in net income related to non-designated hedges. As of March 31, 2013, the company had $200 thousand pledged as collateral with respect to the non-hedge derivatives.

Note 9. Income Taxes

Net deferred tax assets as of March 31, 2013 and December 31, 2012 were $4.0 million and $4.1 million, respectively. For the three-month periods ended March 31, 2013 and 2012, income tax expense was $ $245 thousand and $0, respectively. For the period ended March 31, 2012, the company had a valuation allowance on the full amount of its net deferred tax asset. As of September 30, 2012, the company assessed the need for a valuation allowance, evaluating both positive and negative evidence. Based on the weight of available evidence as of September 30, 2012, the company believed it is more likely than not that its net deferred tax asset will be utilized in future periods; therefore, at September 30, 2012, the company reversed the full valuation allowance.

Note 10. Earnings per Common Share

The following table summarizes basic and diluted earnings per common share calculations for the periods stated:

 

     For the Periods Ended March 31,  
     2013     2012  

Net income

   $ 418      $ 312   

Preferred stock dividend

     (21     (21
  

 

 

   

 

 

 

Net income available to common shareholders

   $ 397      $ 291   
  

 

 

   

 

 

 

Weighted average shares outstanding, basic

     10,488        10,447   

Dilutive shares

     26        1   
  

 

 

   

 

 

 

Weighted average shares outstanding, diluted

     10,514        10,448   
  

 

 

   

 

 

 

Earnings per common share, basic

   $ 0.04      $ 0.03   
  

 

 

   

 

 

 

Earnings per common share, diluted

   $ 0.04      $ 0.03   
  

 

 

   

 

 

 

Note 11. Senior Non-Cumulative Perpetual Preferred Stock

On September 21, 2011, as part of the Small Business Lending Fund (“SBLF”) of the U.S. Department of Treasury (“U.S. Treasury”), the company sold 8,381 shares of non-cumulative perpetual preferred stock to the Secretary of the U.S. Treasury (the “SBLF Preferred Stock”) for a purchase price of $8.4 million. The SBLF Preferred Stock investment qualifies as Tier 1 capital. The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” (as defined in the SBLF Purchase Agreement) by the Bank. For the three-month periods ended March 31, 2013 and 2012, the company’s dividend was $21 thousand, representing an effective dividend rate of 1% for the periods.

Note 12. Commitment and Contingencies

In the normal course of business, the Bank has 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 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

 

15


Table of Contents

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.

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

 

     March 31, 2013      December 31, 2012  

Commercial lines of credit

   $ 70,269       $ 57,681   

Commercial real estate

     24,622         28,566   

Residential real estate

     6,952         7,130   

Consumer

     934         710   

Letters of credit

     3,451         2,308   

Loans held for sale

     37,095         25,133   
  

 

 

    

 

 

 

Total commitments

   $ 143,323       $ 121,528   
  

 

 

    

 

 

 

Note 13. 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.

FASB ASC Topic 820, “Fair Value Measurements and Disclosure” (“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, 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:

Other real estate owned 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. Other real estate owned is classified as a nonrecurring Level 3 valuation.

Impaired loans:

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. 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 March 31, 2013, substantially all of the impaired loans accounted for under ASC 310-30 were evaluated based on discounted cash flows. Other impaired loans were evaluated based 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 an 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, 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 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 March 31, 2013 and 2012, 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.

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.

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. The carrying value of loans held for sale approximates fair value.

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 long-term borrowings, for which interest rates reset quarterly or less, approximate their fair value.

 

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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.”

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 March 31, 2013 Using        
       March 31, 2013    
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

   $ 37,084      $ —           $ 37,084       $ —     

- Variable rate

     6,061        —             6,061         —     

Municipals

     1,008        —             1,008         —     

Collateralized mortgage obligations

     9,125        —             9,125         —     

Cash flow hedge

     (252     —             (252      —     

Interest rate derivative - asset

     122        —             122         —     

Interest rate derivative - liability

     (135     —             (135      —     

Assets measured on a nonrecurring basis:

            

Impaired loans

     12,282        —             —           12,282   

Other real estate owned

     276        —             —           276   

 

           Fair Value Measurements as of December 31, 2012 Using  
     December 31, 2012
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

   $ 44,240      $ —         $ 44,240      $ —     

- Variable rate

     2,181        —           2,181        —     

Municipals

     1,000        —           1,000        —     

Collateralized mortgage obligations

     10,130        —           10,130        —     

Cash flow hedge

     (283     —           (283     —     

Interest rate derivative - asset

     124        —           124        —     

Interest rate derivative - liability

     (140     —           (140     —     

Assets measured on a nonrecurring basis:

         

Impaired loans

     13,148        —           —          13,148   

Other real estate owned

     276        —           —          276   

 

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

 

       March 31, 2013            Fair Value Measurements as of March 31, 2013 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

   $ 44,721       $ 44,721       $ 44,721       $ —         $ —     

Federal funds sold

     7,548         7,548         —           7,548         —     

Securities available for sale

     53,278         53,278         —           53,278         —     

Loans held for sale

     68,905         68,905         —           68,905         —     

Loans held for investment, net

     372,052         371,741         —           —           371,741   

Interest rate derivative

     122         122         —           122         —     

Accrued interest receivable

     1,514         1,514         —           1,514         —     

Financial liabilities:

              

Cash flow hedge

   $ 252       $ 252       $ —         $ 252       $ —     

Interest rate derivative

     135         135         —           135         —     

Long-term borrowings

     20,000         20,000         —           20,000         —     

Deposits

     468,798         469,202         —           469,202         —     

Accrued interest payable

     224         224         —           224         —     

 

     December 31, 2012      Fair Value Measurements as of December 31, 2012 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

   $ 9,457       $ 9,457       $ 9,457       $ —         $ —     

Federal funds sold

     2,906         2,906         —           2,906         —     

Securities available for sale

     57,551         57,551         —           57,551         —     

Loans held for sale

     80,867         80,867         —           80,867         —     

Loans held for investment, net

     379,006         380,322         —           —           380,322   

Interest rate derivative

     124         124         —           124         —     

Accrued interest receivable

     1,606         1,606         —           1,606         —     

Financial liabilities:

              

Cash flow hedge

   $ 283       $ 283       $ —         $ 283       $ —     

Interest rate derivative

     140         140         —           140         —     

Long-term borrowings

     20,000         20,000         —           20,000         —     

Deposits

     453,231         453,813         —           453,813         —     

Accrued interest payable

     232         232         —           232         —     

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

 

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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 14. Accounting Pronouncements

In October 2012, the FASB issued ASU 2012-06, Business Combinations (Topic 805), “Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution.” The ASU specifies that when a reporting entity recognizes an indemnification asset as a result of a government-assisted acquisition of a financial institution and subsequently a change in the cash flows expected to be collected on the indemnification asset occurs, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification. Any amortization of changes in value should be limited to the contractual term of the indemnification agreement. This ASU became effective for fiscal years and interim periods within those years beginning on or after December 15, 2012. As the company does not have an indemnification asset, the adoption of this ASU had no effect on the company’s consolidated financial position or consolidated results of operations.

In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350), “Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this Update are intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. This ASU became effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The company does not anticipate any effect on its consolidated financial position or consolidated results of operations for the fiscal year ending December 31, 2013 as a result of adoption of this ASU.

 

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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, 2012 (“2012 Form 10-K”). The data presented as of March 31, 2013 and for the three-month periods ended March 31, 2013 and 2012 is derived from our unaudited interim financial statements and include, 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, 2012 is derived from our audited financial statements as of and for the year ended December 31, 2012, which is included in the 2012 Form 10-K.

All references to “Xenith Bankshares”, “our 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. 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 six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk in the merger of Xenith Corporation with and into First Bankshares Inc., the parent company of its wholly-owned subsidiary SuffolkFirst Bank. Prior to the merger, SuffolkFirst Bank opened the first branch in Suffolk, Virginia in 2003 under the name of SuffolkFirst Bank. All of the SuffolkFirst Bank branches now operate under the name Xenith Bank. As of March 31, 2013, we had total assets of $579.9 million, total loans, net of our allowance for loan and lease losses, of $441.0 million, total deposits of $468.8 million and shareholders’ equity of $87.8 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 banking and bill pay service. We do not engage in any activities other than banking activities.

During the first quarter of 2012, we began participating in a nationwide warehouse lending program with a commercial bank (the “participating bank”) by entering into a sub-participation agreement with the participating bank. The participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. Pursuant to the sub-participation agreement, the Bank purchases participations from the participating bank with respect to selected non-bank mortgage originators. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators and the participating bank deliver the loans to the investors. Substantially all of the loans are conforming loans. Typically, the Bank, together with the participating bank, purchases up to an aggregate of a 99% interest with the originators retaining the remaining 1% interest. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis. As of March 31, 2013, we had $68.9 million in loans held for sale.

Prior to the first quarter of 2013, in the preparation of our call report, we assigned a risk weighting of 50% to our participation interests, the weighting applicable to mortgage loans. The Office of the Comptroller of the Currency (the “OCC”) has stated its view that assets that do not qualify as “participating interests” should be assigned the 100% risk weighting associated with loans to mortgage companies that are secured by a pledge of mortgage loans as collateral. In March 2013, the Federal Financial Institutions Examination Council (the “FFIEC”) issued supplemental instructions for call reports. In these supplemental instructions, the FFIEC confirmed the view of the OCC stating for risk-based capital purposes, a loan to a mortgage originator secured by residential mortgages should be assigned a 100% risk weighting. The instructions published by the FFIEC did not change the balance sheet classification of such loans. As a result of the FFIEC’s supplemental instructions, in the first quarter of 2013, we assigned a risk weighting of 100% to our participation interests in loans to mortgage originators and continue to classify these loans as loans held for sale on our consolidated balance sheets.

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, available-for-sale securities and federal funds sold. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include

 

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service charges on deposit accounts, gains on the sale of securities and other assets, and other miscellaneous income. Deposits, Federal Home Loan Bank (“FHLB”) borrowed funds 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 equity (“ROAE”) and efficiency ratio. Such measures are common performance indicators in the banking industry.

The following table presents selected financial performance measures, as of the dates stated:

 

     For the Periods Ended March 31,  
     2013     2012  

Net interest margin (1)

     3.83     4.39

Return on average assets (2)

     0.29     0.26

Return on average common equity (3)

     2.10     1.73

Efficiency ratio (4)

     82     88

 

(1) Net interest margin is 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 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 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) Efficiency ratio is noninterest expenses divided by the sum of net interest income and noninterest income.

Merger of First Bankshares, Inc. and Xenith Corporation

First Bankshares, Inc. (“First Bankshares”) was incorporated in Virginia in 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002.

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares (the “merger”), with First Bankshares being the surviving entity in the merger. The merger was completed in accordance with the terms of an agreement of merger and related plan of merger, dated as of May 12, 2009, as amended. At the effective time of the 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 merger, SuffolkFirst Bank changed its name to Xenith Bank.

Acquisitions

Effective on July 29, 2011, the Bank acquired 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 (the “Paragon Transaction”).

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 (“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.

Industry Conditions

The economy showed signs of improvement in 2012 and first quarter 2013, with a slight decline in unemployment, an improvement in consumer confidence, and some stabilization in housing markets. The national unemployment rate, seasonally adjusted and as published by the Bureau of Labor Statistics for April 2013, was reported at 7.5%, a slight decline from 7.8% in December 2012. In the Fifth District of the Federal Reserve Bank (the “Fifth District”), based on data published by the Fifth District, which includes our target markets, the February 2013 unemployment rate was 7.5%, below the national unemployment rate of 7.7% in this period. More specifically, the unemployment rate in Virginia in February 2013 was 5.6%. In the 12 month period ended February 2013, all industry sectors in the Fifth District grew except for government, which showed a modest decline.

 

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The Federal Open Market Committee (the “FOMC”) stated in a May 1, 2013 release that economic activity has been expanding at a moderate pace, and although labor market conditions have shown some improvement, the unemployment rate remains elevated. The FOMC stated the housing sector continued to strengthen and business and household spending advanced.

The slow growth in business, high unemployment, and depressed real estate markets have taken a toll on banks. Since the beginning of 2009, the FDIC has closed over 450 failed banks. Georgia, Florida, California and Illinois account for over half of the failures. In Virginia, there have been four failures, the most recent failure being in 2011. One of the bank failures in Virginia was VBB, the assets and liabilities of which we acquired in July 2011. Besides the number of actual bank failures, the recession and weak recovery have taken a toll on many banks that are still operating. In our target markets alone, there are numerous banks that are undercapitalized, have high levels of criticized and nonperforming assets, and some are under written agreements with their regulators requiring that they address their short-comings.

The FOMC stated it expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time. In particular, the FOMC stated its goal “to keep the target range for the federal funds rate at 0 to  1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Low interest rates and intense competition, due to limited business investment, in addition to other factors, 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 anticipate intense competition in our target markets until the economy shows stronger signs of improvement.

Outlook

We believe we are well positioned to take advantage of competitive opportunities. We believe we will benefit from (1) our capital base, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team and board of directors. 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.

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 cautiously stepping down rates on our deposits and monitoring our expenses.

In our continuing evaluation of our business strategy, we believe 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. 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 (“GAAP”) 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, which reflects our estimate of losses in the event of borrower default. An additional accounting policy that we deem critical using these criteria is our measurement of probable cash flows with respect to acquired 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”). Yield and impairment for acquired credit-impaired loans is based on management’s estimate of future cash flows, which are re-estimated on a periodic basis. 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 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 acquired credit-impaired loans is contained under “—Financial Condition—Acquired Loans” below.

 

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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 2012 Form 10-K. Since December 31, 2012, there have been no changes in these policies that have had or could reasonably be expected to have a material impact on our results of operations or financial condition.

RESULTS OF OPERATIONS

Net Income

For the three months ended March 31, 2013, net income was $418 thousand, compared to net income of $312 thousand for the three months ended March 31, 2012. Net income before income tax expense was $663 thousand for the three months ended March 31, 2013 compared to $312 thousand for the 2012 period.

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

 

     For the Periods Ended March 31,  
     2013     2012  

Net income

   $ 418      $ 312   
  

 

 

   

 

 

 

Preferred stock dividend

     (21     (21
  

 

 

   

 

 

 

Net income available to common shareholders

   $ 397      $ 291   
  

 

 

   

 

 

 

Earnings per common share, basic and diluted

   $ 0.04      $ 0.03   
  

 

 

   

 

 

 

Net Interest Income

For the three months ended March 31, 2013, net interest income was $5.2 million compared to $5.1 million for the three months ended March 31, 2012. Higher net interest income was primarily due to higher average loan balances and lower deposit cost, partially offset by lower yields on average balances of loans held for investment. As presented in the table below, net interest margin for the three-month period ended March 31, 2013 was 3.83%, a 56 basis point decrease from 4.39% for the same period in 2012, partially due to lower accretion further discussed below. Higher average balances of loans held for sale from our participation in the mortgage warehouse lending program decreased our overall yield on interest-earning assets in the first quarter of 2013 compared to the first quarter of 2012; however, we believe participation in this program is an efficient use of our liquidity.

Average interest-earning assets and related interest income increased $87.7 million and $65 thousand, respectively, for the three-month period ended March 31, 2013 compared to the same period in 2012. Average interest-bearing liabilities increased $61.1 million, while related interest expense decreased $118 thousand for the three-month period ended March 31, 2013 compared to the same period in 2012. Yields on interest-earning assets decreased 80 basis points to 4.51%, and costs of interest-bearing liabilities decreased 30 basis points to 0.91%, when comparing the three-month period ended March 31, 2013 to the same period in 2012. Average interest-earning assets as a percentage of total assets were 95.1% for the three-month period ended March 31, 2013 slightly lower than 95.4% for the same period in 2012. The decrease in this percentage in the 2013 period was primarily due to the reversal of the valuation allowance on our net deferred tax asset, a noninterest-earning asset, in the third quarter of 2012.

Our loan portfolios acquired in the merger, the Paragon Transaction and VBB 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 for the three months ended March 31, 2013 and 2012 was $502 thousand and $684 thousand, respectively.

The following table presents the impact of purchase accounting adjustments on our net interest margin for the periods stated:

 

     For the Three Months Ended March 31,  
     2013     2012  

Net interest margin (1)

     3.83     4.39

Purchase accounting adjustments impact (2)

     0.37     0.56

Net interest margin excluding the impact of purchase accounting adjustments

     3.46     3.83

 

(1) Net interest margin is 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) Purchase accounting adjustments include accretion of discounts on acquired loans.

 

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The following table provides a detailed 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.

 

     Average Balances, Income and Expenses, Yields and Rates  
     As of and For the Three Months Ended March 31,  
                                           2013 vs. 2012  
     Average Balances (1)     Yield / Rate     Income / Expense (7)      Increase     Change due to (2)  
     2013     2012     2013     2012     2013      2012      (Decrease)     Rate     Volume  

Assets

                    

Interest-earning assets:

                    

Federal funds sold

   $ 4,484     $ 1,924       0.21     0.11   $ 2      $ 1      $ 1     $ (0   $ 1  

Investments / Interest-earning deposits (8)

     103,112       130,311       1.27     1.55     326        506        (180     (85     (95

Loans held for sale

     66,434       4,255       3.31     3.87     549        41        508       (7     515  

Loans held for investment, gross (3)

     374,752       324,596       5.67     6.87     5,311        5,575        (264     (1,055     791  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     548,782       461,086       4.51     5.31     6,188        6,123        65       (1,147     1,212  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Noninterest-earning assets:

                    

Cash and due from banks

     4,656       4,673                  

Premises and fixed assets

     5,412       6,018                  

Other assets (8)

     23,264       15,961                  

Allowance for loan and lease losses

     (5,064     (4,345                
  

 

 

   

 

 

                 

Total noninterest-earning assets

     28,268       22,307                  
  

 

 

   

 

 

                 

Total assets

   $ 577,050     $ 483,393                  
  

 

 

   

 

 

                 

Liabilities and Shareholders’ Equity

                    

Interest-bearing liabilities:

                    

Demand deposits

   $ 14,400     $ 12,210       0.24     0.31   $ 9      $ 9      $ 0     $ (2   $ 2  

Savings and money market deposits

     242,152       176,194       0.62     0.90     374        397        (23     (146     123  

Time deposits

     134,153       141,834       1.38     1.58     464        559        (95     (66     (29

Federal funds purchased and borrowed funds

     20,673       20,074       1.77     1.84     92        92        0       (4     4  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     411,378       350,312       0.91     1.21     939        1,057        (118     (218     99  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Noninterest-bearing liabilities:

                    

Noninterest-bearing demand deposits

     75,312       50,332                  

Other liabilities

     2,453       2,229                  
  

 

 

   

 

 

                 

Total noninterest-bearing liabilities

     77,765       52,561                  
  

 

 

   

 

 

                 

Shareholders’ equity

     87,907       80,520                  
  

 

 

   

 

 

                 

Total liabilities and shareholders’ equity

   $ 577,050     $ 483,393                  
  

 

 

   

 

 

                 

Interest rate spread (4)

         3.60     4.10            

Net interest income (5)

           $ 5,249      $ 5,066      $ 183     $ (929   $ 1,112  
          

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest margin (6)

         3.83     4.39            

 

(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. Only the interest collected on such loans has been included as income.
(4) Interest rate spread is the average yield on interest-earning assets less the average rate on 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) Interest income on loans in 2013 and 2012 includes $502 thousand and $684 thousand, respectively, in accretion related to acquired loans.
(8) Amounts in 2012 have been adjusted to include bank stock in investments/interest-earning deposits, which was previously reported in other assets.

 

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Table of Contents

Noninterest Income

For the three-month period ended March 31, 2013, noninterest income was $660 thousand compared to $355 thousand for the same period in 2012. In the 2013 period, noninterest income includes a gain of $346 thousand on the sale of collateral related to an impaired loan acquired in the VBB Acquisition.

Noninterest Expense

Noninterest expense increased $86 thousand to $4.8 million for the three months ended March 31, 2013 from the same period in 2012. Higher noninterest expenses were primarily due to higher compensation and benefit costs and bank franchise taxes. Higher compensation costs are due to the addition of relationship managers and various supporting positions, and bank franchise taxes, which are capital based, were higher due to greater capital levels.

Income Taxes

For the three-month periods ended March 31, 2013 and 2012, income tax expense was $245 thousand and $0, respectively. Net deferred tax assets as of March 31, 2013 and December 31, 2012 were $4.0 million and $4.1 million, respectively. For the period ended March 31, 2012, the company had a valuation allowance on the full amount of its net deferred tax asset. As of September 30, 2012, the company assessed the need for a valuation allowance, evaluating both positive and negative evidence. Based on the weight of available evidence as of September 30, 2012, we believed it is more likely than not that the net deferred tax asset will be utilized in future periods; therefore, at September 30, 2012, we reversed the full valuation allowance.

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.

 

     March 31, 2013  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 36,039       $ 37,084         2.70         2.13

- Variable rate

     6,002         6,061         7.89         1.89

Municipals

     1,048         1,008         9.00         2.80

Collateralized mortgage obligations

     9,046         9,125         2.42         1.76
  

 

 

    

 

 

       

Total securities available for sale

   $ 52,135       $ 53,278         3.37         2.05
  

 

 

    

 

 

       

 

     December 31, 2012  
     Book Value      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 42,804       $ 44,240         2.59         2.16

- Variable rate

     2,038         2,181         11.20         3.21

Municipals

     1,050         1,000         9.25         2.80

Collateralized mortgage obligations

     9,977         10,130         2.84         1.85
  

 

 

    

 

 

       

Total securities available for sale

   $ 55,869       $ 57,551         3.08         2.16
  

 

 

    

 

 

       

 

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Table of Contents

The following tables present a maturity analysis of our securities portfolio as of the dates stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the dates stated.

 

    March 31, 2013  
    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

  $ —          —        $ —          —        $ 15,945       1.73   $ 21,139       2.44   $ 37,084       2.13

- Variable rate

    —          —          —          —          —          —          6,061       1.89     6,061       1.89

Municipals

    —          —          —          —          —          —          1,008       2.80     1,008       2.80

Collateralized mortgage obligations

    —          —          —          —          —          —          9,125       1.76     9,125       1.76
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities available for sale

  $ —          —        $ —          —        $ 15,945       1.73   $ 37,333       2.19   $ 53,278       2.05
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following table presents the book value and fair value of securities for which the book value exceeded 10% of shareholders’ equity as of the date stated:

 

     March 31, 2013  
     Book Value      Fair Value      Book Value as a
Percentage of
Shareholders’ Equity
 

Mortgage-backed securities

        

- Federal National Mortgage Association

   $ 31,027       $ 31,876         35.3

- Federal Home Loan Mortgage Corporation

     11,015         11,269         12.5

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:

 

     March 31, 2013     December 31, 2012  
     Amount     Percent of
Total
    Amount     Percent of
Total
 

Commercial and industrial

   $ 196,696        52.16   $ 203,880        53.11

Commercial real estate

     152,532        40.44     150,796        39.28

Residential real estate

     23,203        6.15     24,291        6.33

Consumer

     4,720        1.25     4,914        1.28
  

 

 

   

 

 

   

 

 

   

 

 

 

Loans held for investment

   $ 377,151        100.00   $ 383,881        100.00

Allowance for loan and lease losses

     (5,099       (4,875  
  

 

 

     

 

 

   

Loans held for investment, net of allowance

     372,052          379,006     

Loans held for sale

     68,905          80,867     
  

 

 

     

 

 

   

Total loans

   $ 440,957        $ 459,873     
  

 

 

     

 

 

   

 

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Table of Contents

Loans held for sale

In the first quarter of 2012, we began participating in a nationwide warehouse lending program with a commercial bank (the “participating bank”), whereby pursuant to the sub-participation agreement, the participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis. As of March 31, 2013, we had $68.9 million in loans held for sale.

Loans held for investment

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

 

     March 31, 2013  
            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)

   $ 88,505       $ 65,422       $ 1,280       $ 66,702       $ 33,311       $ 6,347       $ 39,658       $ 194,865   

Commercial real estate (2)

     64,136         55,793         9,556         65,349         18,979         1,085         20,064         149,549   

Residential real estate (3)

     7,993         5,105         3,821         8,926         5,548         664         6,212         23,131   

Consumer

     2,965         661         18         679         457         6         463         4,107   

Overdrafts

     614         —           —           —           —           —           —           614   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 164,213       $ 126,981       $ 14,675       $ 141,656       $ 58,295       $ 8,102       $ 66,397       $ 372,266   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $1.1 million in nonaccrual fixed-rate loans and $781 thousand in nonaccrual variable-rate loans.
(2) Excludes $2.0 million in nonaccrual fixed-rate loans and $966 thousand in nonaccrual variable-rate loans.
(3) Excludes $39 thousand in nonaccrual fixed-rate loans and $33 thousand in nonaccrual variable-rate loans.

 

     December 31, 2012  
            Variable Rate      Fixed Rate         
                          Total                    Total         
     Within      1 to 5      After      variable      1 to 5      After      fixed      Total  
     1 year      years      5 years      > 1 year      years      5 years      > 1 year      Maturities  

Commercial and industrial (1)

   $ 94,697       $ 65,316       $ 1,313       $ 66,629       $ 35,305       $ 5,402       $ 40,707       $ 202,033   

Commercial real estate (2)

     58,309         62,117         9,988         72,105         16,443         791         17,234         147,648   

Residential real estate (3)

     8,515         5,740         3,473         9,213         5,736         753         6,489         24,217   

Consumer

     3,634         701         5         706         535         11         546         4,886   

Overdrafts

     28         —           —           —           —           —           —           28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 165,183       $ 133,874       $ 14,779       $ 148,653       $ 58,019       $ 6,957       $ 64,976       $ 378,812   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $1.1 million in nonaccrual fixed-rate loans and $781 thousand in nonaccrual variable-rate loans.
(2) Excludes $2.2 million in nonaccrual fixed-rate loans and $925 thousand in nonaccrual variable-rate loans.
(3) Excludes $39 thousand in nonaccrual fixed-rate loans and $35 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 61.9% of our loan portfolio at March 31, 2013, and 68.0% at December 31, 2012. Commercial real estate (“CRE”) loans are secured by business and commercial properties. Typically, our loan-to-value benchmark for these loans is at or below 80% at inception, with satisfactory debt service coverage ratios as well. Residential real estate loans consist

 

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Table of Contents

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. Typically, our loan-to-value benchmark for these loans is at or 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.

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized pursuant to FASB ASC Topic 450, “Contingencies,” and (2) a specific reserve component for individual loan impairment recognized and measured pursuant to FASB ASC Topic 310, “Receivables.” A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement.

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 as we originate in our portfolio. In evaluating our loan portfolio, we consider qualitative factors, such as general economic conditions, nationally and in our target markets, 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 our 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 operations and comprehensive income. Loans deemed to be uncollectible 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 our collateral. Our assigned risk ratings 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.

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 evaluating our acquired credit-impaired loans, we periodically estimate the timing and amount of cash flows expected to be collected. Upon re-estimation, any deterioration of in the timing and/or amount of cash flows results in an impairment charge, which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. If upon remeasurement in a future period, a loan for which we have taken an impairment charge is expected to have cash flows that exceed those determined in a prior period, some portion of the impairment charge could be reversed.

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 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 table presents the allowance for loan and losses by loan type and the percent of loans held for investment in each category to total loans as of the dates stated:

 

     March 31, 2013     December 31, 2012  
     Amount      Percent of loans in
each category to
total loans held for
investment
    Amount      Percent of loans in
each category to
total loans held for
investment
 

Balance at end of period applicable to:

          

Commercial and industrial

   $ 1,674         52.16   $ 1,523         53.11

Commercial real estate

     3,154         40.44     3,086         39.28

Residential real estate

     252         6.15     245         6.33

Consumer

     19         1.25     21         1.28
  

 

 

    

 

 

   

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 5,099         100.00   $ 4,875         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

 

29


Table of Contents

The following table presents the activity in the allowance for loan and lease losses for the dates stated:

 

     For the Three Months Ended March 31,  
     2013     2012  

Balance at beginning of period

   $ 4,875      $ 4,280   

Charge-offs:

    

Commercial and industrial

     1        —     

Commercial real estate

     159        429   

Residential real estate

     —          —     

Consumer

     —          —     

Overdrafts

     1        3   
  

 

 

   

 

 

 

Total charge-offs

     161        432   
  

 

 

   

 

 

 

Recoveries:

    

Commercial and industrial

     —          —     

Commercial real estate

     —          3   

Residential real estate

     —          —     

Consumer

     —          —     

Overdrafts

     1        1   
  

 

 

   

 

 

 

Total recoveries

     1        4   
  

 

 

   

 

 

 

Net charge-offs

     160        428   
  

 

 

   

 

 

 

Provision for loan and lease losses

     411        360   

Less: Amount for unfunded commitments

     (27     (75
  

 

 

   

 

 

 

Balance at end of period

   $ 5,099      $ 4,137   
  

 

 

   

 

 

 

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 the allowance for loan and lease losses.

Pursuant to the merger with First Bankshares, the acquired loans were adjusted to estimated fair value with a discount of $7.6 million. The loans acquired in the Paragon Transaction and the VBB Acquisition were also adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively.

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 ASC 310-30. We determined that a portion of the loans acquired in the VBB Acquisition were credit-impaired loans qualifying for accounting under ASC 310-30.

For acquired credit-impaired loans, 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 and accreted into interest income over the remaining life of the loan, or pool of loans, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected at acquisition, on an undiscounted basis, is referred to as the nonaccretable difference. As of March 31, 2013 and December 31, 2012, we had $1.6 million and $1.2 million, respectively, of nonaccretable difference related to the credit-impaired loans acquired in the VBB Acquisition.

In applying ASC 310-30 to acquired loans, we 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 our knowledge of the borrower’s financial condition at the time of measurement, historical payment activity and the estimated liquidation value 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 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.

 

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Our re-evaluation of expected cash flows in the first quarter of 2013 resulted in a net impairment charge of $111 thousand that is recorded in the provision for loan and lease losses in the consolidated statement of operations and in our allowance for loan and lease losses in our consolidated balance sheet.

The following table presents our accretion activity as of the dates stated. As of March 31, 2013, the remaining fair value discount related to the purchased credit-impaired loans was $6.4 million, and the remaining carrying value of these loans was approximately $15.8 million.

 

     March 31, 2013     December 31, 2012  

Balance at beginning of period

   $ 8,133      $ 14,007   

Accretion (1)

     (502     (3,335

Disposals (2)

     —          (2,539
  

 

 

   

 

 

 

Balance at end of period

   $ 7,631      $ 8,133   
  

 

 

   

 

 

 

 

(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.

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 March 31, 2013 and December 31, 2012, there were no loans 90 days or greater past due with respect to principal and interest for which interest was accruing.

As of March 31, 2013 and December 31, 2012, we had $276 thousand in other real estate owned (“OREO”) consisting primarily of commercial properties and undeveloped land. OREO valuations are evaluated periodically, and any necessary reserve to carry the asset at its fair value is recorded as a charge to net income.

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

 

     March 31, 2013     December 31, 2012  

Nonaccrual loans

   $ 4,887      $ 5,069   

Other real estate owned

     276        276   
  

 

 

   

 

 

 

Total nonperforming assets

   $ 5,163      $ 5,345   
  

 

 

   

 

 

 

Nonperforming assets as a percentage of total loans held for investment

     1.37     1.39

Nonperforming assets as a percentage of total assets

     0.89     0.95

Net charge-offs as a percentage of average loans held for investment (1)

     0.04     0.35

Allowance for loan and lease losses as a percentage of total loans held for investment

     1.35     1.27

Allowance for loan and lease losses to nonaccrual loans

     104.35     96.16

 

  (1) Ratio for March 31, 2013 is not annualized.

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of March 31, 2013 totaled $468.8 million compared to deposits of $453.2 million at December 31, 2012, an increase of $15.6 million, or 3%. Demand deposits, including money market accounts, increased $7.5 million, or 2%, over balances at December 31, 2012, while time deposits increased $7.6 million, or 6%. As of March 31, 2013 and December 31, 2012, $28.2 million and $28.5 million, respectively, of our deposits were in Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep accounts, which we refer to as brokered deposits.

 

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

 

     March 31, 2013     December 31, 2012  
     Amount      Rate     Amount      Rate  

Noninterest-bearing demand deposits

   $ 75,312         —        $ 61,889         —     

Interest-bearing deposits:

          

Demand and money market

     252,299         0.60     214,194         0.77

Savings accounts

     4,253         0.35     3,811         0.40

Time deposits $100,000 or greater (1)

     74,146         1.42     72,594         1.32

Time deposits less than $100,000

     58,793         1.37     61,321         1.54
  

 

 

      

 

 

    

Total interest-bearing deposits

     389,491         0.87     351,920         1.02
  

 

 

      

 

 

    

Total average deposits

   $ 464,803         0.73   $ 413,809         0.86
  

 

 

      

 

 

    

 

(1) The 2013 period rate reflects an adjustment related to prior periods which increased the rate by approximately 0.20%.

The following table presents maturities of large denomination time deposits (equal to or greater than $100,000) as of March 31, 2013:

 

     Within 3 Months      3-6 Months      6-12 Months (1)      Over 12
Months
     Total      Percent of Total
Deposits
 

Time deposits

   $ 3,501       $ 20,937       $ 14,405       $ 40,907       $ 79,750         17.01

 

(1) Includes CDARS deposits of $4.7 million.

Borrowings

The following table summarizes the period-end balance, highest month-end balance, average balance, and weighted average rate of short-term borrowings for each of the periods stated:

 

     March 31, 2013     December 31, 2012  
            Highest             Weighted            Highest             Weighted  
     Period-End      Month-End      Average      Average     Year-End      Month-End      Average      Average  
     Balance      Balance      Balance      Rate     Balance      Balance      Balance      Rate  

Federal funds purchased

   $ —         $ —         $ 228         0.31   $ —         $ —         $ 134         0.76

Other borrowings

     —           —           444         0.64     —           —           42         0.44
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

    

Total short-term borrowings

   $ —         $ —         $ 672         0.53   $ —         $ —         $ 176         0.69
  

 

 

    

 

 

    

 

 

      

 

 

    

 

 

    

 

 

    

We have one secured long-term borrowing with the FHLB in the amount of $20 million, which matures on September 28, 2015. The borrowing is a nonamortizing term loan and bears interest at a rate of 20 basis points over LIBOR, which resets quarterly. The borrowing was a modification of a then-existing borrowing, and in connection with the modification, we paid a fee of $533 thousand that is being recognized as interest expense over the remaining term of the borrowing.

At the time we modified the FHLB borrowing, we entered into a derivative (interest rate swap) whereby we pay 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, which is $20 million. Our objective in using interest rate derivatives is to manage our exposure to interest rate movements. The derivative is designated as a cash flow hedge, whereby the effective portion of the hedge is recorded in accumulated other comprehensive income. The amount reported in accumulated other comprehensive income as of March 31, 2013 was an unrealized loss of $166 thousand, net of a tax benefit of $86 thousand. As of March 31, 2013, there was no ineffective portion of the derivative.

We have an agreement with the counterparty to our derivative that contains a provision whereby if we fail to maintain our status as a well/an adequate capitalized institution, we could be required to terminate or fully collateralize the derivative contract. 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 March 31, 2013, $250 thousand had been pledged as collateral under the agreement, as the valuation of the derivative had surpassed the contractually specified minimum transfer amount of $250 thousand. If we are not in compliance with the terms of the derivative agreement, we could be required to settle obligations under the agreement at termination value.

 

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For the three-month period ended March 31, 2013, our effective interest rate on the $20 million FHLB borrowing, including the effect of the modification fee and cash flow hedge, was 1.83%. As of March 31, 2013, a hedge liability of $252 thousand was recorded in other liabilities on our consolidated balance sheet related to this derivative.

LIQUIDITY AND CAPITAL RESOURCES

In the three-month period ended March 31, 2013, cash and cash equivalents increased $39.9 million compared to a decrease of $12.4 million in the same period in 2012. Net cash provided by operating activities increased $41.8 million to $13.5 million for the three-month period ended March 31, 2013 compared to net cash used in operating activities of $28.3 million for the same period in 2012. The increase in net cash provided by operating activities in the three months ended March 31, 2013 was primarily due to proceeds from loans held for sale, as we funded fewer loans than we sold in the 2013 period, whereas in the 2012 period, we funded more loans than we sold. The decline in the 2013 period is due to seasonality in mortgage activity and cyclical refinancing activity. In the 2012 period, we began participating in this program, so originations were increasing. Net cash provided by investing activities was $10.9 million for the three-month period ended March 31, 2013 compared to net cash used in investing activities of $1.3 million for the same period in 2012. Cash provided by investing activities in the 2013 period reflects a decrease in loans held for investment of $7.1 million. Net cash provided by financing activities in the three-month period ended March 31, 2013 was $15.5 million compared to $17.2 million for the same period of 2012.

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 and 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 and costs of borrowings, concentrations of business and industry, competition, 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 $9.0 million. This line is for short-term liquidity needs, expires in March 2014, and is subject to the prevailing federal funds interest rate.

In addition, 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 March 31, 2013, was $168.7 million based on our December 31, 2012 balance sheet. Pledged collateral for this facility as of March 31, 2013 was $51.6 million. As discussed above, under this facility, we have one nonamortizing term loan outstanding for $20 million. Credit availability under the FRB facility was $91.4 million as of March 31, 2013, which is also based on pledged collateral. Borrowings under the FRB facility bear the prevailing current rate for primary credit. There were no amounts outstanding under the FRB facility as of March 31, 2013.

We also have three additional uncommitted lines of credit by national banks to borrow federal funds up to $28.0 million in total on an unsecured basis. One line for $5 million expires on June 30, 2013. The remainder of the lines of credit can be cancelled at any time. As of March 31, 2013, no amounts were outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate.

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 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 reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

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The following table presents Tier 1 and total risk-based capital and risk-weighted assets for the Bank and Xenith Bankshares as of the dates stated:

 

     March 31, 2013      December 31, 2012  
     Xenith Bank      Xenith
Bankshares
     Xenith Bank      Xenith
Bankshares
 

Tier 1 capital

   $ 67,519       $ 68,065       $ 68,820       $ 69,474   

Total risk-based capital

     72,865         73,411         73,916