10-K 1 v370796_10k.htm FORM 10-K

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

  

 

 

FORM 10-K

 

 

 

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

 

For the fiscal year ended December 31, 2013

 

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

 

Commission file number: 0-20293

 

 

  

UNION FIRST MARKET BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

   

VIRGINIA 54-1598552

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

1051 East Cary Street, Suite 1200, Richmond, Virginia 23219

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code is (804) 633-5031

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class  Name of exchange on which registered 
Common Stock, par value $1.33 per share The NASDAQ Global Select Market

 

Securities registered pursuant to Section 12(g) of the Act: None

  

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 29.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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. (Check one):

 

Large accelerated filer ¨ Accelerated filer x
       
Non-accelerated filer ¨ Smaller reporting company ¨

 

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

  

The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2013 was approximately $494,929,402 based on the closing share price on that date of $20.59 per share.

 

The number of shares of common stock outstanding as of March 4, 2014 was 46,858,764.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2014 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

 

 

 
 

  

UNION FIRST MARKET BANKSHARES CORPORATION

FORM 10-K

INDEX

 

ITEM   PAGE
  PART I  
Item 1. Business 2
Item 1A. Risk Factors 13
Item 1B. Unresolved Staff Comments 21
Item 2. Properties 21
Item 3. Legal Proceedings 21
Item 4. Mine Safety Disclosures 21
     
  PART II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 22
Item 6. Selected Financial Data 24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 54
Item 8. Financial Statements and Supplementary Data 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 117
Item 9A. Controls and Procedures 117
Item 9B. Other Information 117
     
  PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 118
Item 11. Executive Compensation 119
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 119
Item 13. Certain Relationships and Related Transactions, and Director Independence 120
Item 14. Principal Accounting Fees and Services 120
     
  PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 120

 

ii
 

  

Glossary of Acronyms

 

ALCO Asset Liability Committee
ALL Allowance for loan losses
ASC Accounting Standards Codification
ASU Accounting Standards Update
ATM Automated teller machine
the Bank Union First Market Bank
the Subsidiary Banks Union First Market Bank and StellarOne Bank
BHCA Bank Holding Company Act of 1956
CDARS Certificates of Deposit Account Registry Service
CFPB Consumer Financial Protection Bureau
the Company Union First Market Bankshares Corporation
COSO Committee of Sponsoring Organizations
CRA Community Reinvestment Act of 1977
DIF Deposit Insurance Fund
Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
EPS Earnings per share
ESOP Employee Stock Ownership Plan
Exchange Act Securities Exchange Act of 1934
FASB Financial Accounting Standards Board
Federal Reserve Bank Federal Reserve Bank of Richmond
FDIA Federal Deposit Insurance Act
FDIC Federal Deposit Insurance Corporation
FDICIA Federal Deposit Insurance Corporation Improvement Act
FHLB Federal Home Loan Bank of Atlanta
FICO Financing Corporation
FMB First Market Bank
FRB or Federal Reserve Board of Governors of the Federal Reserve System
HELOC Home equity line of credit
LIBOR London Interbank Offered Rate
NPA Nonperforming assets
OREO Other real estate owned
OTTI Other than temporary impairment
PCA Prompt Corrective Action
SCC Virginia State Corporation Commission
SEC Securities and Exchange Commission
StellarOne StellarOne Corporation
TDR Troubled debt restructuring
Treasury U.S. Department of the Treasury
UIG Union Insurance Group, LCC
UISI Union Investment Services, Inc.
UMG Union Mortgage Group, Inc.
GAAP Accounting principles generally accepted in the United States

 

 
 

  

FORWARD-LOOKING STATEMENTS

 

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations, or beliefs about future events or results or otherwise and are not statements of historical fact.  Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate,” “intend,” “will,” or words of similar meaning or other statements concerning opinions or judgment of the Company and its management about future events.  Although the Company believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance, or achievements of the Company will not differ materially from any future results, performance, or achievements expressed or implied by such forward-looking statements.  Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic and bank industry conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, stock and bond markets, accounting standards or interpretations of existing standards, mergers and acquisitions, technology, and consumer spending and savings habits.  More information is available on the Company’s website, http://investors.bankatunion.com and on the SEC’s website, www.sec.gov. The information on the Company’s website is not a part of this Form 10-K. The Company does not intend or assume any obligation to update or revise any forward-looking statements that may be made from time to time by or on behalf of the Company.

 

PART I

 

ITEM 1. - BUSINESS.

 

GENERAL

 

The Company is a financial holding company and a bank holding company organized under Virginia law and registered under the BHCA. The Company, headquartered in Richmond, Virginia is committed to the delivery of financial services through its community bank subsidiaries Union First Market Bank and StellarOne Bank and three non-bank financial services affiliates. The Company’s bank subsidiaries and non-bank financial services affiliates are:

 

Community Bank
Union First Market Bank Richmond, Virginia
StellarOne Bank Charlottesville, Virginia
 
Financial Services Affiliates
Union Mortgage Group, Inc. Glen Allen, Virginia
Union Investment Services, Inc. Ashland, Virginia
Union Insurance Group, LLC Richmond, Virginia

 

History

 

The Company was formed in connection with the July 1993 merger of Northern Neck Bankshares Corporation and Union Bancorp, Inc. Although the Company was formed in 1993, certain of the community banks that were acquired and ultimately merged to form what is now Union First Market Bank were among the oldest in Virginia.

 

- 2 -
 

 

The table below indicates the year each community bank was formed, acquired by the Company and merged into what is now Union First Market Bank (except StellarOne Bank).

 

    Formed     Acquired     Merged  
Union Bank and Trust Company   1902   n/a   2010
Northern Neck State Bank   1909   1993   2010
King George State Bank   1974   1996   1999
Rappahannock National Bank   1902   1998   2010
Bay Community Bank   1999   de novo bank   2008
Guaranty Bank   1981   2004   2004
Prosperity Bank & Trust Company   1986   2006   2008
First Market Bank, FSB   2000   2010   2010
StellarOne Bank   1900   2014  

 

On January 1, 2014, the Company acquired StellarOne, a bank holding company based in Charlottesville, Virginia, in an all stock transaction pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of June 9, 2013, between the Company and StellarOne, and a related Plan of Merger (together, the “StellarOne Merger Agreement”). As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into Union First Market Bank.

 

The Company’s operations center is located in Ruther Glen, Virginia.

 

The Company elected to be treated as a financial holding company by the Federal Reserve in September 2013.

 

Product Offerings and Market Distribution

 

The Company is the largest community banking organization headquartered in Virginia in terms of asset size, and provides full service banking and other financial services to the Northern, Central, Rappahannock, Roanoke Valley, Shenandoah, Tidewater, and Northern Neck regions of Virginia. The Subsidiary Banks operate 144 locations in the counties of Albemarle, Augusta, Bedford, Buena Vista, Caroline, Chesterfield, Culpeper, Essex, Fairfax, Fauquier, Floyd, Fluvanna, Franklin, Frederick, Giles, Hanover, Henrico, James City, King George, King William, Lancaster, Loudoun, Madison, Montgomery, Nelson, Northumberland, Orange, Pulaski, Rappahannock, Richmond, Roanoke, Rockbridge, Rockingham, Spotsylvania, Stafford, Warren, Westmoreland, Wythe, and York, and the independent cities of Bedford, Charlottesville, Colonial Heights, Covington, Fredericksburg, Harrisonburg, Lynchburg, Newport News, Radford, Richmond, Roanoke, Salem, Staunton, Virginia Beach, and Waynesboro.

 

The Subsidiary Banks are full service community banks offering consumers and businesses a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, as well as loans for commercial, industrial, residential mortgage and consumer purposes. The Subsidiary Banks issue credit cards and delivers ATM services through the use of reciprocally shared ATMs in the major ATM networks as well as remote ATMs for the convenience of customers and other consumers. The Subsidiary Banks also offer internet banking services and online bill payment for all customers, whether retail or commercial. The Subsidiary Banks also offer private banking and trust services to individuals and corporations through a Wealth Management Group.

 

- 3 -
 

 

UISI has provided securities, brokerage and investment advisory services since its formation in February 1993. UISI has 9 offices within the Bank’s trade area and is a full service investment company handling all aspects of wealth management including stocks, bonds, annuities, mutual funds and financial planning. Securities are offered through a third party contractual arrangement with Raymond James Financial Services, Inc., an independent broker dealer.

 

As of December 31, 2013, UMG has offices in Virginia (13), Maryland (3), North Carolina (6), and South Carolina (1). UMG is also licensed to do business in selected states throughout the Mid-Atlantic and Southeast, as well as Washington, D.C.  It provides a variety of mortgage products to customers in those areas. The mortgage loans originated by UMG generally are sold in the secondary market through purchase agreements with institutional investors.

 

UIG, an insurance agency, is owned by the Bank and UMG. This agency operates in a joint venture with Bankers Insurance, LLC, a large insurance agency owned by community banks across Virginia and managed by the Virginia Bankers Association. UIG generates revenue through sales of various insurance products, including long term care insurance and business owner policies.

 

SEGMENTS

 

The Company has two reportable segments: its traditional full service community banking business and its mortgage loan origination business. For more financial data and other information about each of the Company’s operating segments, refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, “Community Bank Segment” and “Mortgage Segment,” and to Note 17 “Segment Reporting Disclosures” in the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

EXPANSION AND STRATEGIC ACQUISITIONS

 

The Company expands its market area and increases its market share through organic growth (internal growth and de novo expansion) and strategic acquisitions. Strategic acquisitions by the Company to date have included whole bank acquisitions, branch and deposit acquisitions, and purchases of existing branches from other banks. The Company generally considers acquisitions of companies in strong growth markets or with unique products or services that will benefit the entire organization. Targeted acquisitions are priced to be economically feasible with minimal short-term drag to achieve positive long-term benefits. These acquisitions may be paid for in the form of cash, stock, debt, or a combination thereof. The amount and type of consideration and deal charges paid could have a short-term dilutive effect on the Company’s earnings per share or book value. However, cost savings and revenue enhancements in such transactions are anticipated to provide long-term economic benefit to the Company.

 

The Company’s new construction expansion during the last three years consists of opening two new bank branches in Virginia:

 

Three James Center, Union First Market Bank branch located in the city of Richmond, Virginia (November 2011)

 

Berea Marketplace, Union First Market Bank branch located in Stafford County, Virginia (March 2011)

 

On January 1, 2014, the Company acquired StellarOne in an all stock transaction pursuant to the terms and conditions of the StellarOne Merger Agreement. Pursuant to the StellarOne Merger Agreement, StellarOne’s common shareholders received 0.9739 shares of the Company’s common stock in exchange for each share of StellarOne’s common stock, resulting in the Company issuing 22,147,874 common shares. As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into the Bank. Further information about the StellarOne acquisition can be found in Note 20 “Subsequent Events”. As part of the acquisition plan and cost control efforts, the Company has decided to consolidate 13 overlapping bank branches into nearby locations during 2014.  In all cases, customers will be able to use branches within close proximity or continue to use the Subsidiary Banks’ other delivery channels including internet and mobile banking.

 

In June 2011, the Bank opened seven in-store bank branches in MARTIN’S Food Markets located in Harrisonburg, Waynesboro, Staunton, Winchester (2), Culpeper, and Stephens City, Virginia. The Bank currently operates in-store bank branches in 28 MARTIN’S Food Markets through its acquisition of FMB primarily in the Richmond area market.

 

In May 2011, the Company acquired deposits of approximately $48.9 million and loans of approximately $70.8 million at book value through the acquisition of the Harrisonburg, Virginia branch of NewBridge Bank. The Bank retained the commercial loan operation team from the branch and all employees of the branch. The transaction also included the purchase of a real estate parcel/future branch site in Waynesboro, Virginia.

 

- 4 -
 

  

On February 1, 2010, the Company acquired First Market Bank, FSB, a privately held federally chartered savings bank based in Richmond, Virginia, in an all stock transaction. Upon the acquisition, FMB became a state chartered commercial bank subsidiary of the Company until it merged with Union Bank and Trust Company in March 2010 and the combined bank began to operate under the name Union First Market Bank.

 

During 2011 and 2012, the Bank conducted a performance and opportunity analysis of its branch network.  As a result, the Company decided to consolidate bank branches into nearby locations during 2012.  The Company closed eight branches located in Charlottesville, Mechanicsville, Port Royal, Fredericksburg, Williamsburg, Northumberland County, and two located in Fairfax County. In all cases, customers could use branches within close proximity or continue to use the Bank’s other delivery channels including internet and mobile banking.

 

EMPLOYEES

 

As of December 31, 2013, the Company had approximately 1,025 full-time equivalent employees, including executive officers, loan and other banking officers, branch personnel, operations, and other support personnel. Of this total, 175 were mortgage segment personnel. None of the Company’s employees are represented by a union or covered under a collective bargaining agreement. The Company provides employees with a comprehensive employee benefit program which includes the following: group life, health and dental insurance, paid time off, educational opportunities, a cash incentive plan, a stock purchase plan, stock incentive plans, deferred compensation plans for officers and key employees, an ESOP and a 401(k) plan with employer match.

 

COMPETITION

 

The financial services industry remains highly competitive and is constantly evolving. The Company experiences strong competition in all aspects of its business. In its market areas, the Company competes with large national and regional financial institutions, credit unions, other independent community banks, as well as consumer finance companies, mortgage companies, loan production offices, mutual funds and life insurance companies. Competition for deposits and loans is affected by various factors including interest rates offered, the number and location of branches and types of products offered, and the reputation of the institution. Credit unions increasingly have been allowed to expand their membership definitions and, because they enjoy a favorable tax status, have been able to offer more attractive loan and deposit pricing. The Company’s non-bank affiliates also operate in highly competitive environments. The Company believes its community bank framework and philosophy provide a competitive advantage, particularly with regard to larger national and regional institutions, allowing the Company to compete effectively. The Company’s community bank segment generally has strong market shares within the markets it serves. The Company’s deposit market share in Virginia was 1.96% of total bank deposits as of June 30, 2013.

 

ECONOMY

 

The economy in the Company’s footprint showed some signs of improvement during 2013, though growth remains sluggish and unemployment continues to be elevated by historical standards. Interest rates steepened somewhat, but continue to be low relative to historical rates. Housing starts and sales improved in 2013; however, higher long term interest rates may suppress continued progress in the housing market. The continued weakness in employment, continued low rates, and the burden of regulatory requirements enacted in response to the most recent financial crisis made for a challenging 2013 for the Company and for community banks in general. The effects of federal sequestration and spending cuts on Virginia’s economy remain uncertain and could have significant consequences, as approximately 30% of Virginia’s economy is tied to the federal government and the state is the leader in Department of Defense contracts. Despite this uncertainty, Virginia topped Forbes’ 2013 list of the Best States for Business. In response to the continued slow economic recovery during 2013, the Company’s management focused significant attention on managing nonperforming assets and controlling costs, while working with borrowers to mitigate and protect against risk of loss.

 

SUPERVISION AND REGULATION

 

The Company and its bank subsidiaries are extensively and increasingly regulated under both federal and state laws. The following description briefly addresses certain historic and current provisions of federal and state laws and certain regulations, proposed regulations, and the potential impacts on the Company and the Subsidiary Banks. To the extent statutory or regulatory provisions or proposals are described in this report, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.

 

- 5 -
 

  

Regulatory Reform – The Dodd-Frank Act

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act significantly restructured the financial regulatory regime in the United States and has a broad impact on the financial services industry. The Dodd-Frank Act provides for new and stronger capital standards that, among other things, eliminate the treatment of trust preferred securities as Tier 1 capital. Existing trust preferred securities are grandfathered for banking entities with less than $15 billion of assets, such as the Company. The Dodd-Frank Act also permanently raises deposit insurance levels to $250,000. Pursuant to modifications under the Dodd-Frank Act, deposit insurance assessments are now calculated based on an insured depository institution’s assets rather than its insured deposits and the minimum reserve ratio of the Deposit Insurance Fund of the FDIC was raised to 1.35%. The Dodd-Frank Act also established the CFPB as an independent bureau of the Board of Governors of the FRB. The CFPB has the exclusive authority to prescribe rules governing the provision of consumer financial products and services, which in the case of the Subsidiary Banks will be enforced by the Federal Reserve.

 

Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, certain of the act’s requirements have yet to be implemented. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the federal bank regulatory agencies in the future, the full extent of the impact such requirements will have on the operations of the Company and the Subsidiary Banks is unclear. The changes resulting from the Dodd-Frank Act may affect the profitability of business activities, require changes to certain business practices, impose more stringent regulatory requirements or otherwise adversely affect the business and financial condition of the Company and the Subsidiary Banks. These changes may also require the Company to invest significant management attention and resources to evaluate and make necessary changes to comply with new statutory and regulatory requirements.

 

The Company

 

General. As a financial holding company and a bank holding company registered under the BHCA, the Company is subject to supervision, regulation, and examination by the Federal Reserve. The Company elected to be treated as financial holding company by the Federal Reserve in September 2013. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation, and examination by the SCC.

 

Permitted Activities. A bank holding company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies, such as the Company, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve), without prior approval of the Federal Reserve. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.

 

To maintain financial holding company status, a financial holding company and all of its depository institution subsidiaries must be “well capitalized” and “well managed.” A depository institution subsidiary is considered to be “well capitalized” if it satisfies the requirements for this status under applicable Federal Reserve capital requirements. A depository institution subsidiary is considered “well managed” if it received a composite rating and management rating of at least “satisfactory” in its most recent examination. A financial holding company’s status will also depend upon it maintaining its status as “well capitalized” and “well managed” under applicable Federal Reserve regulations. If a financial holding company ceases to meet these capital and management requirements, the Federal Reserve’s regulations provide that the financial holding company must enter into an agreement with the Federal Reserve to comply with all applicable capital and management requirements. Until the financial holding company returns to compliance, the Federal Reserve may impose limitations or conditions on the conduct of its activities, and the company may not commence any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the Federal Reserve. If the company does not return to compliance within 180 days, the Federal Reserve may require divestiture of the holding company’s depository institutions.

 

In order for a financial holding company to commence any new activity permitted by the BHCA or to acquire a company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. See below under “The Subsidiary Banks – Community Reinvestment Act.”

 

- 6 -
 

  

Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

 

Banking Acquisitions; Changes in Control. The BHCA requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the CRA and its compliance with fair housing and other consumer protection laws.

 

Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company’s acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the SEC under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock is registered under Section 12 of the Exchange Act.

 

In addition, Virginia law requires the prior approval of the SCC for (i) the acquisition of more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

 

Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Subsidiary Banks, including times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the FDICIA, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

 

Under the FDIA, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

 

- 7 -
 

  

Capital Requirements. The Federal Reserve imposes certain capital requirements on bank holding companies under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “The Subsidiary Banks – Capital Requirements”. Subject to its capital requirements and certain other restrictions, the Company is able to borrow money to make a capital contribution to the Subsidiary Banks, and such loans may be repaid from dividends paid by the Subsidiary Banks to the Company.

 

Limits on Dividends and Other Payments. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Subsidiary Banks. There are various legal limitations applicable to the payment of dividends by the Subsidiary Banks to the Company and to the payment of dividends by the Company to its shareholders. The Subsidiary Banks are subject to various statutory restrictions on its ability to pay dividends to the Company. Under current regulations, prior approval from the Federal Reserve is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. The payment of dividends by the Subsidiary Banks or the Company may be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Subsidiary Banks or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Subsidiary Banks, or the Company, could be deemed to constitute such an unsafe or unsound practice.

 

Under the FDIA, insured depository institutions such as the Subsidiary Banks, are prohibited from making capital distributions, including the payment of dividends, if, after making such distributions, the institution would become “undercapitalized” (as such term is used in the statute). Based on the Subsidiary Banks’ current financial condition, the Company does not expect this provision will have any impact on its ability to receive dividends from the Subsidiary Banks. The Company’s non-bank subsidiaries pay dividends to the Company periodically on a non-regulated basis.

 

In addition to dividends it receives from the Subsidiary Banks, the Company receives management fees from its affiliated companies for expenses incurred related to external financial reporting and audit fees, investor relations expenses, board of directors fees, and legal fees related to corporate actions. These fees are charged to each subsidiary based upon various specific allocation methods measuring the estimated usage of such services by that subsidiary. The fees are eliminated from the financial statements in the consolidation process.

 

The Subsidiary Banks

 

General. The Subsidiary Banks are supervised and regularly examined by the Federal Reserve and the SCC. The various laws and regulations administered by the bank regulatory agencies affect corporate practices, such as the payment of dividends, incurrence of debt, and acquisition of financial institutions and other companies; they also affect business practices, such as the payment of interest on deposits, the charging of interest on loans, types of business conducted, and location of offices. Certain of these law and regulations are referenced above under “The Company.”

 

Current Capital Requirements. The Federal Reserve and the other federal banking agencies have issued risk-based and leverage capital guidelines applicable to U.S. banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the current risk-based capital requirements of the Federal Reserve, the Company and the Subsidiary Banks are required to maintain a minimum ratio of total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 8.0%. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 1,250%, assigned by the capital regulation based on the risks believed inherent in the type of asset. At least half of the total capital is required to be “Tier 1 capital,” which consists principally of common and certain qualifying preferred shareholders’ equity (including grandfathered trust preferred securities), less certain intangibles and other adjustments. The remainder (“Tier 2 capital”) consists of cumulative preferred stock, long-term perpetual preferred stock, a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments), and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company were 13.05% and 14.17%, respectively, as of December 31, 2013, thus exceeding the minimum requirements. The Tier 1 and total capital to risk-weighted asset ratios of the Bank were 12.43% and 13.56%, respectively, as of December 31, 2013, also exceeding the minimum requirements.

 

- 8 -
 

  

Each of the federal bank regulatory agencies also has established a minimum leverage capital ratio of Tier 1 capital to average adjusted assets (“Tier 1 leverage ratio”). The guidelines provide for a minimum Tier 1 leverage ratio of 3.0% for financial holding companies and banking organizations that have the highest supervisory rating. All other banking organizations are required to maintain a minimum Tier 1 leverage ratio of 4.0% unless a different minimum is specified by an appropriate regulatory authority. In addition, for a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 leverage ratio must be at least 5.0%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve has not advised the Company or the Subsidiary Banks of any specific minimum leverage ratio applicable to either entity. As of December 31, 2013, the Tier 1 leverage ratios of the Company and the Bank were 10.70% and 10.19%, respectively, well above the minimum requirements.

 

New Capital Requirements. On June 7, 2012, the Federal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. On July 2, 2013, the Federal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations.

 

Effective January 1, 2015, the final rules require the Company and the Subsidiary Banks to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the current requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from current requirement); and (iv) a leverage ratio of 4.0% of total assets. These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the Company and the Subsidiary Banks to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.

 

The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

 

With respect to the Subsidiary Banks, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the current 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized.

 

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

 

If the new minimum capital ratios described above had been effective as of December 31, 2013, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

Deposit Insurance. Substantially all of the deposits of the Subsidiary Banks are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act.

 

- 9 -
 

  

The FDIA, as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution’s assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits. In 2013 and 2012, the Company paid only the base assessment rate for “well capitalized” institutions, which totaled $2.8 million and $2.1 million, respectively, in regular deposit insurance assessments.

 

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately one basis point of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the FICO bonds mature in 2017 through 2019.

 

Transactions with Affiliates. Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Subsidiary Banks to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Subsidiary Banks and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Subsidiary Banks generally may not purchase securities issued or underwritten by affiliates.

 

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (“10% Shareholders”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Subsidiary Banks’ unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Subsidiary Banks are permitted to extend credit to executive officers.

 

Prompt Corrective Action. Federal banking regulators are authorized and, under certain circumstances, required to take certain actions against banks that fail to meet their capital requirements. The federal bank regulatory agencies have additional enforcement authority with respect to undercapitalized depository institutions. “Well capitalized” institutions may generally operate without supervisory restriction. With respect to “adequately capitalized” institutions, such banks cannot normally pay dividends or make any capital contributions that would leave it undercapitalized, they cannot pay a management fee to a controlling person if, after paying the fee, it would be undercapitalized, and they cannot accept, renew or roll over any brokered deposit unless the bank has applied for and been granted a waiver by the FDIC.

 

Immediately upon becoming “undercapitalized,” a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. The Subsidiary Banks meet the definition of being “well capitalized” as of December 31, 2013.

 

- 10 -
 

  

As described above in “The Subsidiary Banks – New Capital Requirements,” the new capital requirement rules issued by the Federal Reserve incorporate new requirements into the prompt corrective action framework.

 

Community Reinvestment Act. The Subsidiary Banks are subject to the requirements of the CRA. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities, including low and moderate income neighborhoods. If the Subsidiary Banks receive a rating from the Federal Reserve of less than “satisfactory” under the CRA, restrictions on operating activities would be imposed. In addition, in order for a financial holding company, like the Company, to commence any new activity permitted by the BHCA, or to acquire any company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. The Subsidiary Banks currently have a “satisfactory” CRA rating.

 

Privacy Legislation. Several recent laws, including amendments to the Dodd-Frank Act, and related regulations issued by the federal bank regulatory agencies, provide new protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

 

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (“Patriot Act”) was enacted in response to the September 11, 2001 terrorist attacks in New York, Pennsylvania, and Northern Virginia. The Patriot Act is intended to strengthen U. S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism. The continuing impact on financial institutions of the Patriot Act and related regulations and policies is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities to identify persons who may be involved in terrorism or money laundering.

 

Volcker Rule. The Dodd-Frank Act prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances, and prohibits them from owning equity interests in excess of 3% of Tier 1 capital in private equity and hedge funds (known as the “Volcker Rule”). On December 10, 2013, the federal bank regulatory agencies adopted final rules implementing the Volcker Rule. These final rules prohibit banking entities from (i) engaging in short-term proprietary trading for their own accounts, and (ii) having certain ownership interests in and relationships with hedge funds or private equity funds. The final rules are intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The final rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Although the final rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and the Subsidiary Banks. The final rules are effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. The Company has evaluated the implications of the final rules on its investments and does not expect any material financial implications.

 

Under the final rules implementing the Volcker Rule, banking entities would have been prohibited from owning certain collateralized debt obligations (“CDOs”) backed by trust preferred securities (“TruPS”) as of July 21, 2015, which could have forced banking entities to recognize unrealized market losses based on the inability to hold any such investments to maturity. However, on January 14, 2014, the federal bank regulatory agencies issued an interim rule, effective April 1, 2014, exempting TruPS CDOs from the Volcker Rule if (i) the CDO was established prior to May 19, 2010, (ii) the banking entity reasonably believes that the offering proceeds of the CDO were used to invest primarily in TruPS issued by banks with less than $15 billion in assets, and (iii) the banking entity acquired the CDO on or before December 10, 2013. However, regulators are soliciting comments to the Interim Rule, and this exemption could change prior to its effective date. The Company currently does not have any impermissible holdings of TruPS CDOs under the interim rule, and therefore, will not be required to divest of any such investments or change the accounting treatment.

 

- 11 -
 

  

Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring creditors to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Creditors are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the creditor to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the creditor can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance. To meet the mortgage credit needs of a broader customer base, the Company is predominantly an originator of mortgages that are in compliance with the Ability-to-Pay rules.

 

Consumer Laws and Regulations. The Subsidiary Banks are also subject to certain consumer laws and regulations issued thereunder that are designed to protect consumers in transactions with banks. These laws include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, Real Estate Settlement Procedures Act, Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Fair Housing Act and the Servicemembers Civil Relief Act, among others. The laws and related regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The Subsidiary Banks must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations.

 

Incentive Compensation. In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution’s board of directors.

 

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company and the Subsidiary Banks, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2013, the Company and the Subsidiary Banks have not been made aware of any instances of non-compliance with the final guidance.

 

Effect of Governmental Monetary Policies

 

The Company’s operations are affected not only by general economic conditions but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future.

 

Filings with the SEC

 

The Company files annual, quarterly, and other reports under the Exchange Act with the SEC. These reports and this Form 10-K are posted and available at no cost on the Company’s investor relations website, http://investors.bankatunion.com, as soon as reasonably practicable after the Company files such documents with the SEC. The information contained on the Company’s website is not a part of this Form 10-K. The Company’s filings are also available through the SEC’s website at www.sec.gov.

 

- 12 -
 

  

ITEM 1A. - RISK FACTORS

 

An investment in the Company’s securities involves risks. In addition to the other information set forth in this report, investors in the Company’s securities should carefully consider the factors discussed below. These factors could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations and capital position, and could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this report, in which case the trading price of the Company’s securities could decline.

 

Risks Related To The Company’s Business

 

The Company’s business may be adversely affected by conditions in the financial markets and economic conditions generally.

 

The community banking industry is directly affected by national, regional, and local economic conditions. The economy in the Company’s footprint showed some signs of improvement during 2013, though growth remains sluggish and unemployment continues to be elevated. The effects of federal sequestration and spending cuts on Virginia’s economy remain uncertain and could have significant consequences. Management allocates significant resources to mitigate and respond to risks associated with the current economic conditions, however, such conditions cannot be predicted or controlled. Therefore, such conditions, including a reduction in federal government spending, a flatter yield curve and extended low interest rates, could adversely affect the credit quality of the Company’s loans, and/or the Company’s results of operations and financial condition. The Company’s financial performance is dependent on the business environment in the markets where the Company operates, in particular, the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers. In addition, the Company holds securities which can be significantly affected by various factors including credit ratings assigned by third parties, and an adverse credit rating in securities held by the Company could result in a reduction of the fair value of its securities portfolio and have an adverse impact on its financial condition. While general economic conditions in Virginia and the U.S. continued to improve in 2013, there can be no assurance that this improvement will continue.

 

Combining the Company and StellarOne may be more difficult, costly or time-consuming than expected, and the anticipated benefits and cost savings of the merger may not be realized.

 

The Company and StellarOne operated independently until the completion of the merger in January 2014. The success of the merger will depend, in part, on the Company’s ability to realize the anticipated benefits and cost savings from combining and integrating the businesses of the Company and StellarOne and to do so in a manner that permits growth opportunities and cost savings to be realized without materially disrupting existing customer relationships or decreasing revenues due to loss of customers. The integration process in the merger could result in the loss of key employees, the disruption of ongoing business, inconsistencies in standards, controls, procedures and policies that affect adversely the combined company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits and cost savings of the merger. The loss of key employees or delays or other problems in implementing planned system conversions could adversely affect the Company’s ability to successfully conduct its business, which could have an adverse effect on the Company’s financial results and the value of its common stock. If the Company experiences difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause the Company to lose customers or cause customers to remove their accounts from the Company’s subsidiary banks and move their business to competing financial institutions. These integration matters could have an adverse effect on the Company. If the Company is not able to achieve its business objectives in the merger, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.

 

The inability of the Company to successfully manage its growth or implement its growth strategy may adversely affect the Company’s results of operations and financial conditions.

 

The Company may not be able to successfully implement its growth strategy if it is unable to identify attractive markets, locations, or opportunities to expand in the future. In addition, the ability to manage growth successfully depends on whether the Company can maintain adequate capital levels, maintain cost controls, effectively manage asset quality, and successfully integrate any businesses acquired into the organization.

 

- 13 -
 

  

As the Company continues to implement its growth strategy by opening new branches or acquiring branches or banks, it expects to incur increased personnel, occupancy, and other operating expenses. In the case of new branches, the Company must absorb those higher expenses while it begins to generate new deposits; there is also further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, the Company’s plans to expand could depress earnings in the short run, even if it efficiently executes a branching strategy leading to long-term financial benefits.

 

Difficulties in combining the operations of acquired entities with the Company’s own operations may prevent the Company from achieving the expected benefits from acquisitions.

 

The Company may not be able to achieve fully the strategic objectives and operating efficiencies expected in an acquisition, including the Company’s recent acquisition of StellarOne. Inherent uncertainties exist in integrating the operations of an acquired entity. In addition, the markets and industries in which the Company and its potential acquisition targets operate are highly competitive. The Company may lose customers or the customers of acquired entities as a result of an acquisition; the Company may lose key personnel, either from the acquired entity or from itself; and the Company may not be able to control the incremental increase in noninterest expense arising from an acquisition in a manner that improves its overall operating efficiencies. These factors could contribute to the Company’s not achieving the expected benefits from its acquisitions within desired time frames, if at all. Future business acquisitions could be material to the Company and it may issue additional shares of common stock to pay for those acquisitions, which would dilute current shareholders’ ownership interests. Acquisitions also could require the Company to use substantial cash or other liquid assets or to incur debt; the Company could therefore become more susceptible to economic downturns and competitive pressures.

 

Changes in interest rates could adversely affect the Company’s income and cash flows.

 

The Company’s income and cash flows depend to a great extent on the difference between the interest rates earned on interest-earning assets, such as loans and investment securities, and the interest rates paid on interest-bearing liabilities, such as deposits and borrowings. These rates are highly sensitive to many factors beyond the Company’s control, including general economic conditions and the policies of the Federal Reserve and other governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the prepayment of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if the Company does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates. In addition, the Company’s ability to reflect such interest rate changes in pricing its products is influenced by competitive pressures. Fluctuations in these areas may adversely affect the Company and its shareholders. The Subsidiary Banks are often at a competitive disadvantage in managing its costs of funds compared to the large regional, super-regional, or national banks that have access to the national and international capital markets.

 

The Company generally seeks to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that it may reasonably maintain its net interest margin; however, interest rate fluctuations, loan prepayments, loan production, deposit flows, and competitive pressures are constantly changing and influence the ability to maintain a neutral position. Generally, the Company’s earnings will be more sensitive to fluctuations in interest rates depending upon the variance in volume of assets and liabilities that mature and re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of changes in interest rates, shape and slope of the yield curve, and whether the Company is more asset sensitive or liability sensitive. Accordingly, the Company may not be successful in maintaining a neutral position and, as a result, the Company’s net interest margin may be affected.

 

The Company’s allowance for loan losses may prove to be insufficient to absorb losses in its loan portfolio.

 

Like all financial institutions, the Company maintains an allowance for loan losses to provide for loans that its borrowers may not repay in their entirety. The Company believes that it maintains an allowance for loan losses at a level adequate to absorb probable losses inherent in the loan portfolio as of the corresponding balance sheet date and in compliance with applicable accounting and regulatory guidance. However, the allowance for loan losses may not be sufficient to cover actual loan losses and future provisions for loan losses could materially and adversely affect the Company’s operating results. Accounting measurements related to impairment and the loan loss allowance require significant estimates that are subject to uncertainty and changes relating to new information and changing circumstances. The significant uncertainties surrounding the ability of the Company’s borrowers to execute their business models successfully through changing economic environments, competitive challenges, and other factors complicate the Company’s estimates of the risk of loss and amount of loss on any loan. Because of the degree of uncertainty and susceptibility of these factors to change, the actual losses may vary from current estimates. The Company expects fluctuations in the loan loss provisions due to the uncertain economic conditions.

 

The Company’s banking regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require the Company to increase its allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease the allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such required additional provisions for loan losses or charge-offs could have a material adverse effect on the Company’s financial condition and results of operations.

 

- 14 -
 

  

The Company’s concentration in loans secured by real estate may adversely affect earnings due to changes in the real estate markets.

 

The Company offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer, and other loans. Many of the Company’s loans are secured by real estate (both residential and commercial) in the Company’s market areas. A major change in the real estate markets, resulting in deterioration in the value of this collateral, or in the local or national economy, could adversely affect borrowers’ ability to pay these loans, which in turn could affect the Company. Risks of loan defaults and foreclosures are unavoidable in the banking industry; the Company tries to limit its exposure to these risks by monitoring extensions of credit carefully. The Company cannot fully eliminate credit risk; thus, credit losses will occur in the future. Additionally, changes in the real estate market also affect the value of foreclosed assets and, therefore, additional losses may occur when management determines it is appropriate to sell the assets.

 

The Company has a significant concentration of credit exposure in commercial real estate, and loans with this type of collateral are viewed as having more risk of default.

 

The Company’s commercial real estate portfolio consists primarily of owner-operated properties and other commercial properties. These types of loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because the Company’s loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in the percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on the Company’s financial condition.

 

The Company’s banking regulators generally give commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures, which could have a material adverse effect on the Company’s results of operations.

 

The Company’s loan portfolio contains construction and development loans, and a decline in real estate values and economic conditions would adversely affect the value of the collateral securing the loans and have an adverse effect on the Company’s financial condition.

 

Although most of the Company’s construction and development loans are secured by real estate, the Company believes that, in the case of the majority of these loans, the real estate collateral by itself may not be a sufficient source for repayment of the loan if real estate values decline and there is a downturn in the local and national economies. If the Company is required to liquidate the collateral securing a construction and development loan to satisfy the debt, its earnings and capital may be adversely affected. A period of reduced real estate values may continue for some time, resulting in potential adverse effects on the Company’s earnings and capital.

 

The Company’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses.

 

The Company assumes credit risk by virtue of making loans and leases and extending loan commitments and letters of credit. The Company manages credit risk through a program of underwriting standards, the review of certain credit decisions and a continuous quality assessment process of credit already extended. The Company’s exposure to credit risk is managed through the use of consistent underwriting standards that emphasize local lending while avoiding highly leveraged transactions as well as excessive industry and other concentrations. The Company’s credit administration function employs risk management techniques to help ensure that problem loans and leases are promptly identified. While these procedures are designed to provide the Company with the information needed to implement policy adjustments where necessary and to take appropriate corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.

 

- 15 -
 

  

The Company’s focus on lending to small to mid-sized community-based businesses may increase its credit risk.

 

Most of the Company’s commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which the Company operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have experienced a complete business or economic cycle. Any deterioration of the borrowers’ businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on the Company’s financial condition and results of operations.

 

Nonperforming assets take significant time to resolve and adversely affect the Company’s results of operations and financial condition.

 

The Company’s nonperforming assets adversely affect its net income in various ways. The Company does not record interest income on nonaccrual loans, which adversely affects its income and increases loan administration costs. When the Company receives collateral through foreclosures and similar proceedings, it is required to mark the related loan to the then fair market value of the collateral less estimated selling costs, which may result in a loss. An increase in the level of nonperforming assets also increases the Company’s risk profile and may affect the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques such as workouts, restructurings, and loan sales to manage problem assets. Increases in or negative adjustments in the value of these problem assets, the underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s business, results of operations, and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and staff, which can be detrimental to the performance of their other responsibilities, including origination of new loans. There can be no assurance that the Company will avoid further increases in nonperforming loans in the future.

 

The Company faces substantial competition that could adversely affect the Company’s growth and/or operating results.

 

The Company operates in a competitive market for financial services and faces intense competition from other financial institutions both in making loans and attracting deposits which can greatly affect pricing for our products and services. The Company’s primary competitors include community, regional, and national banks as well as credit unions and mortgage companies. Many of these financial institutions have been in business for many years, are significantly larger, have established customer bases and have greater financial resources and higher lending limits. In addition, credit unions are exempt from corporate income taxes, providing a significant competitive pricing advantage. Accordingly, some of the Company’s competitors in its market have the ability to offer products and services that it is unable to offer or to offer at more competitive rates.

 

The carrying value of goodwill may be adversely affected.

 

When the Company completes an acquisition, often times, goodwill is recorded on the date of acquisition as an asset. Current accounting guidance requires goodwill to be tested for impairment; the Company performs such impairment analysis at least annually. A significant adverse change in expected future cash flows or sustained adverse change in the Company’s common stock could require the asset to become impaired. If impaired, the Company would incur a charge to earnings that would have a significant impact on the results of operations. The Company’s carrying value of goodwill was approximately $59.4 million at December 31, 2013.

 

The Company’s exposure to operational, technological, and organizational risk may adversely affect the Company.

 

Similar to other financial institutions, the Company is exposed to many types of operational and technological risk, including reputation, legal, and compliance risk. The Company’s ability to grow and compete is dependent on its ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while it expands and integrates acquired businesses. Operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or persons outside of the Company, and exposure to external events. The Company is dependent on its operational infrastructure to help manage these risks. From time to time, it may need to change or upgrade its technology infrastructure. The Company may experience disruption, and it may face additional exposure to these risks during the course of making such changes. As the Company acquires other financial institutions, it faces additional challenges when integrating different operational platforms. Such integration efforts may be more disruptive to the business and/or more costly than anticipated.

 

The Company’s operations may be adversely affected by cyber security risks.

 

In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to operations and the Company’s business strategy. The Company has invested in accepted technologies, and continually reviews processes and practices that are designed to protect its networks, computers and data from damage or unauthorized access. Despite these security measures, the Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to the Company’s reputation, which could adversely affect our business.

 

- 16 -
 

  

The Company’s dependency on its management team and the unexpected loss of any of those personnel could adversely affect operations.

 

The Company is a customer-focused and relationship-driven organization. Future growth is expected to be driven in large part by the relationships maintained with customers. While the Company has assembled an experienced management team, is building the depth of that team, and has management development plans in place, the unexpected loss of key employees could have a material adverse effect on the Company’s business and may result in lower revenues or greater expenses.

 

Legislative or regulatory changes or actions, or significant litigation, could adversely affect the Company or the businesses in which the Company is engaged.

 

The Company is subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of its operations. Laws and regulations change from time to time and are primarily intended for the protection of consumers, depositors, and the FDIC’s DIF. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively affect the Company or its ability to increase the value of its business. Such changes could include higher capital requirements, increased insurance premiums, increased compliance costs, reductions of non-interest income, and limitations on services that can be provided. Actions by regulatory agencies or significant litigation against the Company could cause it to devote significant time and resources to defend itself and may lead to liability or penalties that materially affect the Company and its shareholders. Future changes in the laws or regulations or their interpretations or enforcement could be materially adverse to the Company and its shareholders.

 

The Dodd-Frank Act substantially changes the regulation of the financial services industry and it could have a material adverse effect upon the Company.

 

The Dodd-Frank Act provides wide-ranging changes in the way banks and financial services firms generally are regulated and affects the way the Company and its customers and counterparties do business with each other. Among other things, it requires increased capital and regulatory oversight for banks and their holding companies, changes the deposit insurance assessment system, changes responsibilities among regulators, establishes the new CFPB, and makes various changes in the securities laws and corporate governance that affect public companies, including the Company. The Dodd-Frank Act also requires numerous studies and regulations related to its implementation. The Company is continually evaluating the effects of the Dodd-Frank Act, together with implementing the regulations that have been proposed and adopted. The ultimate effects of the Dodd-Frank Act and the resulting rulemaking cannot be predicted at this time, but it has increased our operating and compliance costs in the short-term, and it could have a material adverse effect on the Company’s results of operation and financial condition.

 

The Company will be subject to more stringent capital and liquidity requirements as a result of the Basel III regulatory capital reforms and the Dodd-Frank Act, the short-term and long-term impact of which is uncertain.

 

The Company and the Subsidiary Banks are each subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital which each must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. Under the Dodd-Frank Act, the federal banking agencies have established stricter capital requirements and leverage limits for banks and bank holding companies that are based on the Basel III regulatory capital reforms. If the Company and the Subsidiary Banks fail to meet these minimum capital guidelines and/or other regulatory requirements, the Company’s financial condition would be materially and adversely affected.

 

- 17 -
 

  

New regulations issued by the CFPB could adversely impact the Company’s earnings.

 

The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule effective January 10, 2014, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms, or to originate “qualified mortgages” that meet specific requirements with respect to terms, pricing and fees. The new rule also contains new disclosure requirements at mortgage loan origination and in monthly statements. These requirements could limit the Company’s ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact the Company’s profitability.

 

The Subsidiary Banks rely upon independent appraisals to determine the value of the real estate which secures a significant portion of its loans, and the values indicated by such appraisals may not be realizable if the Subsidiary Banks are forced to foreclose upon such loans.

 

A significant portion of the Subsidiary Banks’ loan portfolio consists of loans secured by real estate. The Subsidiary Banks rely upon independent appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment that adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the Subsidiary Bank’s loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Subsidiary Banks may not be able to recover the outstanding balance of the loan.  

 

The Company and the Subsidiary Banks rely on other companies to provide key components of its business infrastructure.

 

Third parties provide key components of the Company’s (and the Subsidiary Banks’) business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections and network access. While the Company has selected these third party vendors carefully, it does not control their actions. Any problem caused by these third parties, including poor performance of services, failure to provide services, disruptions in communication services provided by a vendor and failure to handle current or higher volumes, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business, and may harm its reputation. Financial or operational difficulties of a third party vendor could also hurt the Company’s operations if those difficulties affect the vendor’s ability to serve the Company. Replacing these third party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to the Company’s business operations.

 

The Company depends on the accuracy and completeness of information about clients and counterparties, and its financial condition could be adversely affected if it relies on misleading information.

 

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, the Company may rely on information furnished to it by or on behalf of clients and counterparties, including financial statements and other financial information, which the Company does not independently verify. The Company also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, the Company may assume that a customer’s audited financial statements conform to GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. The Company’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or are materially misleading.

 

Changes in accounting standards could impact reported earnings.

 

The authorities that promulgate accounting standards, including the FASB, SEC, and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also require the Company to incur additional personnel or technology costs.

 

- 18 -
 

  

Failure to maintain effective systems of internal and disclosure control could have a material adverse effect on the Company’s results of operation and financial condition.

 

Effective internal and disclosure controls are necessary for the Company to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If the Company cannot provide reliable financial reports or prevent fraud, its reputation and operating results would be harmed. As part of the Company’s ongoing monitoring of internal control, it may discover material weaknesses or significant deficiencies in its internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

The Company has in the past discovered, and may in the future discover, areas of its internal controls that need improvement. Even so, the Company is continuing to work to improve its internal controls. The Company cannot be certain that these measures will ensure that it implements and maintains adequate controls over its financial processes and reporting in the future. Any failure to maintain effective controls or to timely implement any necessary improvement of the Company’s internal and disclosure controls could, among other things, result in losses from fraud or error, harm the Company’s reputation or cause investors to lose confidence in the Company’s reported financial information, all of which could have a material adverse effect on the Company’s results of operation and financial condition.

 

Limited availability of financing or inability to raise capital could adversely impact the Company.

 

The amount, type, source, and cost of the Company’s funding directly impacts the ability to grow assets. The ability to raise funds through deposits, borrowings, and other sources could become more difficult, more expensive, or altogether unavailable. A number of factors could make such financing more difficult, more expensive or unavailable including: the financial condition of the Company at any given time; rate disruptions in the capital markets; the reputation for soundness and security of the financial services industry as a whole; and, competition for funding from other banks or similar financial service companies, some of which could be substantially larger or be more favorably rated.

 

Consumers may increasingly decide not to use the Subsidiary Banks to complete their financial transactions, which would have a material adverse impact on the Company’s financial condition and operations.

 

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

 

The Company is subject to claims and litigation pertaining to fiduciary responsibility.

 

From time to time, customers make claims and take legal action pertaining to the performance of the Company’s fiduciary responsibilities. Whether customer claims and legal action related to the performance of the Company’s fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

 

The Company is a defendant in a variety of litigation and other actions, which may have a material adverse effect on its financial condition and results of operation.

 

The Company may be involved from time to time in a variety of litigation arising out of its business. The Company’s insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm the Company’s reputation. Should the ultimate judgments or settlements in any litigation exceed the Company’s insurance coverage, they could have a material adverse effect on the Company’s financial condition and results of operation for any period. In addition, the Company may not be able to obtain appropriate types or levels of insurance in the future, nor may the Company be able to obtain adequate replacement policies with acceptable terms, if at all.

 

- 19 -
 

  

On November 20, 2013, the Company entered into a memorandum of understanding (the “Memorandum”) with plaintiffs regarding the settlement of certain litigation in response to the announcement of the StellarOne Merger Agreement. As described in the joint proxy statement/prospectus of Union and StellarOne dated October 22, 2013, on June 14, 2013, Jaclyn Crescente, individually and purportedly on behalf of all other StellarOne shareholders, filed a class action complaint against StellarOne, its current directors, StellarOne Bank (the “StellarOne Defendants”) and the Company, in the U.S. District Court for the Western District of Virginia, Charlottesville Division (the “Court”) (Case No. 3:13-cv-00021-NKM). The complaint alleges that the StellarOne directors breached their fiduciary duties by approving the merger with the Company, and that the Company aided and abetted in such breaches of duty. The complaint seeks, among other things, an order enjoining the defendants from proceeding with or consummating the merger, as well as other equitable relief and/or money damages in the event that the transaction is completed. Under the terms of the Memorandum, the Company, the StellarOne Defendants and the plaintiffs have agreed to settle the lawsuit and release the defendants from all claims made by the plaintiffs relating to the merger, subject to approval by the Court. If the Court approves the settlement contemplated by the Memorandum, the lawsuit will be dismissed with prejudice. The parties to the Memorandum have agreed that final resolution by the Court of any fee petition will not be a precondition to the dismissal of the lawsuit. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Court will approve the settlement, even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the Memorandum may be terminated.

 

Risks Related To The Company’s Securities

 

The Company’s ability to pay dividends depends upon the results of operations of its subsidiaries.

 

The Company is a financial holding company and a bank holding company that conducts substantially all of its operations through the Subsidiary Banks and other subsidiaries. As a result, the Company’s ability to make dividend payments on its common stock depends primarily on certain federal regulatory considerations and the receipt of dividends and other distributions from its subsidiaries. There are various regulatory restrictions on the ability of the Subsidiary Banks to pay dividends or make other payments to the Company. Although the Company has historically paid a cash dividend to the holders of its common stock, holders of the common stock are not entitled to receive dividends, and regulatory or economic factors may cause the Company’s board of directors to consider, among other things, the reduction of dividends paid on the Company’s common stock.

 

While the Company’s common stock is currently traded on the NASDAQ Global Select Market, it has less liquidity than stocks for larger companies quoted on a national securities exchange.

 

The trading volume in the Company’s common stock on the NASDAQ Global Select Market has been relatively low when compared with larger companies listed on the NASDAQ Global Select Market or other stock exchanges. There is no assurance that a more active and liquid trading market for the common stock will exist in the future. Consequently, shareholders may not be able to sell a substantial number of shares for the same price at which shareholders could sell a smaller number of shares. In addition, we cannot predict the effect, if any, that future sales of the Company’s common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of the common stock. Sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, could cause the price of the Company’s common stock to decline, or reduce the Company’s ability to raise capital through future sales of common stock.

 

Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.

 

The Company is not restricted from issuing additional shares of common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, shares of common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, including in connection with acquisitions by the Company, could materially adversely affect the market price of the shares of the common stock and could be dilutive to shareholders. Because the Company’s decision to issue common stock in the future will depend on market conditions and other factors, it cannot predict or estimate the amount, timing, or nature of possible future issuances of its common stock. Accordingly, the Company’s shareholders bear the risk that future issuances will reduce the market price of the common stock and dilute their stock holdings in the Company.

 

- 20 -
 

  

The Company’s governing documents and Virginia law contain anti-takeover provisions that could negatively affect its shareholders.

 

The Company’s Articles of Incorporation and Bylaws and the Virginia Stock Corporation Act contain certain provisions designed to enhance the ability of the Company’s board of directors to deal with attempts to acquire control of the Company. These provisions and the ability to set the voting rights, preferences, and other terms of any series of preferred stock that may be issued, may be deemed to have an anti-takeover effect and may discourage takeovers (which certain shareholders may deem to be in their best interest). To the extent that such takeover attempts are discouraged, temporary fluctuations in the market price of the Company’s common stock resulting from actual or rumored takeover attempts may be inhibited. These provisions also could discourage or make more difficult a merger, tender offer, or proxy contest, even though such transactions may be favorable to the interests of shareholders, and could potentially adversely affect the market price of the Company’s common stock.

 

The current economic conditions may cause volatility in the Company’s common stock value.

 

In the current economic environment, the value of publicly traded stocks in the financial services sector has been volatile. However, even in a more stable economic environment the value of the Company’s common stock can be affected by a variety of factors such as excepted results of operations, actual results of operations, actions taken by shareholders, news or expectations based on the performance of others in the financial services industry, and expected impacts of a changing regulatory environment. These factors not only impact the value of the Company’s common stock but could also affect the liquidity of the stock given the Company’s size, geographical footprint, and industry.

 

ITEM 1B. - UNRESOLVED STAFF COMMENTS.

 

The Company does not have any unresolved staff comments to report for the year ended December 31, 2013.

 

ITEM 2. - PROPERTIES.

 

The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Effective October 31, 2011, the corporate headquarters was relocated from 111 Virginia Street, Suite 200, Richmond, Virginia to 1051 East Cary Street, Suite 1200, Richmond, Virginia. The Company’s subsidiaries own or lease various other offices in the counties and cities in which they operate. At December 31, 2013, the Bank operated 90 branches throughout Virginia. All of the offices of UMG are leased, either through a third party or within a Bank branch. The vast majority of the offices of UISI are located within the retail branch properties. The Company’s operations center is in Ruther Glen, Virginia. See the Note 1 “Summary of Significant Accounting Policies” and Note 4 “Bank Premises and Equipment” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K for information with respect to the amounts at which Bank premises and equipment are carried and commitments under long-term leases.

 

ITEM 3. - LEGAL PROCEEDINGS.

 

In the ordinary course of its operations, the Company and its subsidiaries are parties to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or the financial condition or results of operations of the Company.

 

ITEM 4. - MINE SAFETY DISCLOSURES.

 

None.

 

- 21 -
 

  

PART II

 

ITEM 5. - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

The following performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Exchange Act, except to the extent the Company specifically incorporates the performance graph by reference therein.

 

Five-Year Stock Performance Graph

 

The following chart compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2013, with (1) the Total Return Index for the NASDAQ Stock Market and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100 was invested on December 31, 2008 in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends.

 

Union First Market Bankshares Corporation

 

 

       Period Ending 
Index  12/31/08   12/31/09   12/31/10   12/31/11   12/31/12   12/31/13 
Union First Market Bankshares Corporation   100.00    51.04    62.02    57.10    69.52    112.23 
NASDAQ Composite   100.00    145.36    171.74    170.38    200.63    281.22 
NASDAQ Bank   100.00    83.70    95.55    85.52    101.50    143.84 

 

Source: SNL Financial Corporation LC, Charlottesville, VA (2014)

 

- 22 -
 

  

Information on Common Stock, Market Prices and Dividends

 

There were 24,976,434 shares of the Company’s common stock outstanding at the close of business on December 31, 2013, which were held by 2,378 shareholders of record. The closing price of the Company’s common stock on December 31, 2013 was $24.81 per share compared to $15.77 on December 31, 2012.

 

The following table summarizes the high and low sales prices and dividends declared for quarterly periods during the years ended December 31, 2013 and 2012.

 

                   Dividends 
   Sales Prices   Declared 
   2013   2012   2013   2012 
   High   Low   High   Low         
First Quarter  $20.25   $15.87   $14.93   $13.00   $0.13   $0.07 
Second Quarter   21.40    18.01    14.75    13.08   $0.13   $0.08 
Third Quarter   23.54    20.48    15.81    14.31   $0.14   $0.10 
Fourth Quarter   26.29    22.99    16.29    14.23   $0.14   $0.12 
                       $0.54   $0.37 

 

Regulatory restrictions on the ability of the Bank to transfer funds to the Company at December 31, 2013 are set forth in Note 19, “Parent Company Financial Information,” contained in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K. A discussion of certain limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends on its common stock, is set forth in Part I., Item 1 - Business, of this Form 10-K under the headings “Supervision and Regulation – The Company - Limits on Dividends and Other Payments.”

 

It is anticipated that dividends will continue to be paid on a quarterly basis. In making its decision on the payment of dividends on the Company’s common stock, the Board of Directors considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and other factors.

 

Stock Repurchase Program

In December 2011, the Company was authorized to repurchase up to 350,000 shares of its common stock in the open market or in private transactions. No shares were repurchased during 2011.

 

In February 2012, the Company was authorized to enter into a stock purchase agreement with James E. Ukrop, then a member of the Company’s Board of Directors, and a trust related to Mr. Ukrop. Pursuant to the agreement, the Company repurchased 335,649 shares of its common stock for an aggregate purchase price of $4,363,437, or $13.00 per share. The repurchase was funded with cash on hand. The Company transferred 115,384 of the repurchased shares to its ESOP for $13.00 per share. The remaining 220,265 shares were retired. On February 6, 2012, the Company filed a Current Report on Form 8-K with respect to the agreement and repurchase.

 

In December 2012, the Company was authorized to repurchase up to 750,000 shares of the Company’s common stock on the open market or in private transactions. Subsequently, in December 2012, the Company entered into an agreement to purchase 750,000 shares of its common stock from Markel Corporation, the Company’s largest shareholder at that time, for an aggregate purchase price of $11,580,000, or $15.44 per share. Steven A. Markel was a director of the Company and Vice Chairman of Markel Corporation at that time. The repurchase was funded with cash on hand and the Company retired the shares. On December 12 and 21, 2012, the Company filed Current Reports on Form 8-K with respect to the authorization and repurchase.

 

In March 2013, the Company entered into an agreement to purchase 500,000 shares of its common stock from Markel Corporation, at that time the Company’s largest shareholder, for an aggregate purchase price of $9,500,000, or $19.00 per share. Steven A. Markel was a director of the Company and Vice Chairman of Markel Corporation at that time. The repurchase was funded with cash on hand and the shares were retired. The Company’s authorization to repurchase an additional 250,000 shares under its current repurchase program authorization expired December 31, 2013.

 

On January 30, 2014, the Company received authorization from its Board of Directors to purchase up to $65.0 million of the Company’s common stock on the open market or in privately negotiated transactions. The repurchase program is authorized through December 31, 2015.

 

- 23 -
 

  

ITEM 6. – SELECTED FINANCIAL DATA.

 

The following table sets forth selected financial data for the Company over each of the past five years ended December 31, (dollars in thousands, except per share amounts):

 

   2013   2012   2011   2010   2009 
Results of Operations (1)                         
Interest and dividend income  $172,127   $181,863   $189,073   $189,821   $128,587 
Interest expense   20,501    27,508    32,713    38,245    48,771 
Net interest income   151,626    154,355    156,360    151,576    79,816 
Provision for loan losses   6,056    12,200    16,800    24,368    18,246 
Net interest income after provision for loan losses   145,570    142,155    139,560    127,208    61,570 
Noninterest income   38,728    41,068    32,964    34,217    23,442 
Noninterest expenses   137,289    133,479    130,815    129,920    75,762 
Income before income taxes   47,009    49,744    41,709    31,505    9,250 
Income tax expense   12,513    14,333    11,264    8,583    890 
Net income  $34,496   $35,411   $30,445   $22,922   $8,360 
                          
Financial Condition                         
Assets  $4,176,571   $4,095,865   $3,907,087   $3,837,247   $2,587,272 
Loans, net of unearned income   3,039,368    2,966,847    2,818,583    2,837,253    1,874,224 
Deposits   3,236,842    3,297,767    3,175,105    3,070,059    1,916,364 
Stockholders' equity   438,239    435,863    421,639    428,085    282,088 
                          
Ratios                         
Return on average assets (1)   0.85%   0.89%   0.79%   0.61%   0.32%
Return on average equity (1)   7.91%   8.13%   6.90%   5.50%   2.90%
Efficiency ratio (FTE) (1)   70.19%   66.86%   67.55%   68.19%   70.81%
Efficiency ratio - community bank segment (FTE) (1)   65.81%   65.88%   66.84%   68.59%   71.72%
Efficiency ratio - mortgage bank segment (FTE)   130.58%   77.66%   79.20%   64.22%   63.41%
Common equity to total assets   10.49%   10.64%   10.79%   10.26%   10.90%
Tangible common equity / tangible assets   8.94%   8.97%   8.91%   8.22%   8.64%
                          
Asset Quality                         
Allowance for loan losses  $30,135   $34,916   $39,470   $38,406   $30,484 
Nonaccrual loans  $15,035   $26,206   $44,834   $61,716   $22,348 
Other real estate owned  $34,116   $32,834   $32,263   $36,122   $22,509 
ALL / total outstanding loans   0.99%   1.18%   1.40%   1.35%   1.63%
ALL / total outstanding loans, adjusted for acquisition accounting (1)   1.10%   1.35%   1.71%   1.82%   N/A 
ALL / nonperforming loans   200.43%   133.24%   88.04%   62.23%   136.41%
NPAs / total outstanding loans   1.62%   1.99%   2.74%   3.45%   2.39%
Net charge-offs / total outstanding loans   0.36%   0.56%   0.56%   0.58%   0.71%
Provision / total outstanding loans   0.20%   0.41%   0.60%   0.86%   0.97%
                          
Per Share Data                         
Earnings per share, basic (1)  $1.38   $1.37   $1.07   $0.83   $0.19 
Earnings per share, diluted (1)   1.38    1.37    1.07    0.83    0.19 
Cash dividends paid   0.54    0.37    0.28    0.25    0.30 
Market value per share   24.81    15.77    13.29    14.78    12.39 
Book value per common share   17.56    17.30    16.17    15.16    15.34 
Price to earnings ratio, diluted   17.98    11.51    12.42    17.81    65.21 
Price to book value ratio   1.41    0.91    0.82    0.98    0.81 
Dividend payout ratio   39.13%   27.01%   26.17%   30.12%   157.89%
Weighted average shares outstanding, basic   24,975,077    25,872,316    25,981,222    25,222,565    15,160,619 
Weighted average shares outstanding, diluted   25,030,711    25,900,863    26,009,839    25,268,216    15,201,993 

 

(1) Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", section "Non GAAP Measures" for supplemental performance measures which the Company believes may be useful to investors as they exclude non-operating adjustments resulting from acquisitions and allow investors to see the combined economic results of the organization. These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be viewed as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. Operating metrics, which exclude acquisition-related costs, including operating earnings, return on average assets, return on average equity, efficiency ratio, and earnings per share are shown for the years ended December 31, 2013, 2012, and 2011 only.

 

- 24 -
 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company and its subsidiaries. This discussion and analysis should be read in conjunction with the “Consolidated Financial Statements” and the “Notes to the Consolidated Financial Statements” presented in Item 8 “Financial Statements and Supplementary Data” contained in this Form 10-K.

 

CRITICAL ACCOUNTING POLICIES

 

General

 

The accounting and reporting policies of the Company and its subsidiaries are in accordance with GAAP and conform to general practices within the banking industry. The Company’s 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 amounts reported for revenues, expenses, and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

 

The more critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses, mergers and acquisitions, and goodwill and intangible assets. The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in Note 1 “Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments.

 

Allowance for Loan Losses

 

The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectability of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make adjustments to the allowance based on their judgments about information available to them at the time of their examination.

 

The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. The credit reviews consist of reviews by its Internal Audit group and reviews performed by an independent third party. Upon origination, each commercial loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company’s primary credit quality indicator. Consumer loans are generally not risk rated; the primary credit quality indicator for this portfolio segment is delinquency status. The Company has various committees that review and ensure that the allowance for loan losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

 

The Company’s ALL consists of specific, general, and unallocated components.

 

Specific Reserve Component - The specific reserve component relates to impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Upon being identified as impaired, for loans not considered to be collateral dependent, an allowance is established when the discounted cash flows of the impaired loan are lower than the carrying value of that loan. Nonaccrual loans under $100,000 and other impaired loans under $500,000 are aggregated based on similar risk characteristics. The level of credit impairment within the pool(s) is determined based on historical loss factors for loans with similar risk characteristics, taking into consideration environmental factors specifically related to the underlying pool. The impairment of collateral dependent loans is measured based on the fair value of the underlying collateral (based on independent appraisals), less selling costs, compared to the carrying value of the loan. If the Company determines that the value of an impaired collateral dependent loan is less than the recorded investment in the loan, it either recognizes an impairment reserve as a specific component to be provided for in the allowance for loan losses or charge-off the deficiency if it is determined that such amount represents a confirmed loss. Typically, a loss is confirmed when the Company is moving towards foreclosure (or final disposition) of the underlying collateral, the collateral deficiency has not improved for two consecutive quarters, or when there is a payment default of 180 days, whichever occurs first.

 

- 25 -
 

  

The Company obtains independent appraisals from a pre-approved list of independent, third party appraisal firms located in the market in which the collateral is located. The Company’s approved appraiser list is continuously maintained to ensure the list only includes such appraisers that have the experience, reputation, character, and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is currently licensed in the state in which the property is located, experienced in the appraisal of properties similar to the property being appraised, has knowledge of current real estate market conditions and financing trends, and is reputable. The Company’s internal Real Estate Valuation Group, which reports to the Risk and Compliance Group, performs either a technical or administrative review of all appraisals obtained. A technical review will ensure the overall quality of the appraisal, while an administrative review ensures that all of the required components of an appraisal are present. Generally, independent appraisals are updated every 12 to 24 months or as necessary. The Company’s impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Adjustments to appraisals generally include discounts for continued market deterioration subsequent to the appraisal date. Any adjustments from the appraised value to carrying value are documented in the impairment analysis, which is reviewed and approved by senior credit administration officers and the Special Assets Loan Committee. External appraisals are the primary source to value collateral dependent loans; however, the Company may also utilize values obtained through broker price opinions or other valuations sources. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed, and approved on a quarterly basis at or near the end of each reporting period.

 

General Reserve Component - The general reserve component covers non-impaired loans and is derived from an estimate of credit losses adjusted for various environmental factors applicable to both commercial and consumer loan segments. The estimate of credit losses is a function of the product of net charge-off historical loss experience to the loan balance of the loan portfolio averaged during the preceding twelve quarters, as management has determined this to adequately reflect the losses inherent in the loan portfolio. The environmental factors consist of national, local, and portfolio characteristics and are applied to both the commercial and consumer segments. The following table shows the types of environmental factors management considers:

 

ENVIRONMENTAL FACTORS
Portfolio   National   Local
Experience and ability of lending team   Interest rates   Level of economic activity
Depth of lending team   Inflation   Unemployment
Pace of loan growth   Unemployment   Competition
Franchise expansion   Gross domestic product   Military/government impact
Execution of loan risk rating process   General market risk and other concerns    
Degree of oversight / underwriting standards   Legislative and regulatory environment    
Value of real estate serving as collateral        
Delinquency levels in portfolio        
Charge-off levels in portfolio        
Credit concentrations / nature and volume  of the portfolio        

 

Unallocated Component – This component may be used to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Together, the specific, general, and any unallocated allowance for loan loss represents management’s estimate of losses inherent in the current loan portfolio. Though provisions for loan losses may be based on specific loans, the entire allowance for loan losses is available for any loan management deems necessary to charge-off. At December 31, 2013, there were no material amounts considered unallocated as part of the allowance for loan losses.

 

- 26 -
 

  

Impaired Loans

 

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

 

For the consumer loan portfolio segment, large groups of smaller balance homogeneous loans are collectively evaluated for impairment. This evaluation subjects each of the Company’s homogenous pools to a historical loss factor derived from net charge-offs experienced over the preceding twelve quarters. The Company applies payments received on impaired loans to principal and interest based on the contractual terms until they are placed on nonaccrual status. All payments received are then applied to reduce the principal balance and recognition of interest income is terminated.

 

Mergers and Acquisitions

 

The Company’s merger and acquisition strategy focuses on high-growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance, and good asset quality, among other factors.

 

Business combinations are accounted for under ASC 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will continue to rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions. If they are necessary to implement its plan to exit an activity of an acquiree, costs that the Company expects, but is not obligated, to incur in the future are not liabilities at the acquisition date, nor are costs to terminate the employment of or relocate an acquiree’s employees. The Company does not recognize these costs as part of applying the acquisition method. Instead, the Company recognizes these costs as expenses in its post-combination financial statements in accordance with other applicable GAAP.

 

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of acquisition-related costs to the Company include systems conversions, integration planning consultants, and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. These acquisition-related costs are included within the Consolidated Statements of Income classified within the noninterest expense caption.

 

Goodwill and Intangible Assets

 

The Company follows ASC 350, Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of this guidance discontinued the amortization of goodwill and intangible assets with indefinite lives but require an impairment review at least annually and more frequently if certain impairment indicators are evident.

 

- 27 -
 

  

RESULTS OF OPERATIONS

 

Executive Overview

 

·The Company reported net income of $34.5 million and earnings per share of $1.38 for its year ended December 31, 2013. Excluding after-tax acquisition-related costs of $2.0 million, operating earnings(1) for the year were $36.5 million and operating earnings per share(1) were $1.46. The annual results represent an increase of $1.1 million, or 3.2%, in operating earnings and $0.09 per share, or 6.6%, from 2012 levels. The year to date financial results do not include the financial results of StellarOne, which the Company acquired on January 1, 2014, and are prior to the effective date of the merger with StellarOne.
·The Company’s community banking segment reported operating earnings of $39.2 million (or $1.57 per share), an increase of $6.3 million (or $0.30 per share) from the prior year. The Company’s mortgage segment reported a net loss of $2.7 million, a decrease of $5.2 million, from net income of $2.5 million in the prior year.
·The Company experienced continued improvement in asset quality with reduced levels of impaired loans, troubled debt restructurings, past due loans, and nonperforming assets, which were at their lowest levels since the fourth quarter of 2009.
·Net charge-offs and the loan loss provision, as well as their respective ratios of net charge-offs to total loans and provision to total loans decreased from the prior year. The allowance to nonperforming loans coverage ratio was at the highest level since the first quarter of 2008.
·Average loans outstanding increased $109.8 million, or 3.8%, in 2013 over 2012.

 

(1)For a reconciliation of the non-GAAP measures operating earnings, ROA, ROE, EPS, and efficiency ratio, see “NON-GAAP MEASURES” included in this Item 7.

 

Net Income

 

Net income for the year ended December 31, 2013 decreased $915,000, or 2.6%, from $35.4 million to $34.5 million and represented earnings per share of $1.38 compared to $1.37 for the prior year. Excluding after-tax acquisition-related expenses of $2.0 million, operating earnings for 2013 were $36.5 million and operating earnings per share was $1.46. Return on average equity for the year ended December 31, 2013 was 7.91% compared to 8.13% for the prior year while return on average assets was 0.85% compared to 0.89% for the prior year; operating return on average equity for the year ended December 31, 2013 was 8.38% compared to 8.13% for the prior year while operating return on average assets was 0.90% compared to 0.89% for the prior year.

 

The $915,000 decrease in net income was principally a result of a decrease in net interest margin of $2.7 million related to a decline in the yield on interest-earning assets that outpaced the reduction in the cost of funds, a decrease in noninterest income of $2.4 million largely due to lower gains on sales of mortgage loans, net of commission expenses, of $4.8 million, and higher noninterest expenses of $3.8 million primarily driven by salary and benefits expenses and costs related to the StellarOne merger. These items were partially offset by a $6.1 million decrease in provision for loan losses due to continued improvement in asset quality.

 

Net income for the year ended December 31, 2012 increased $5.0 million, or 16.3%, from 2011. Net income available to common shareholders increased $7.6 million, or 27.5%, from 2011, which included preferred dividends and discount accretion on preferred stock of $2.7 million. Return on average equity for the year ended December 31, 2012 was 8.13% compared to 6.90% for 2011 while return on average assets was 0.89% compared to 0.79% for 2011. Earnings per share was $1.37, an increase of $0.30, or 28.0%, from $1.07 for the year ended December 31, 2011. Earnings per share included preferred dividends and discount accretion on preferred stock of $2.7 million, or $0.10 per share, in 2011.

 

The $5.0 million increase in net income was principally a result of higher net gains on sales of mortgage loans driven by higher origination volumes, lower provision for loan losses, reductions in FDIC insurance expense due to changes in the assessment base and rate, lower core deposit intangible amortization expense, and an increase in account service charges and net debit and credit card interchange fees. Partially offsetting these results were higher salaries and benefits related to the addition of mortgage loan originators and support personnel in 2012 and lower net interest income driven by reductions in interest income on interest-earning assets that outpaced the impact of lower costs on interest-bearing liabilities.

 

- 28 -
 

  

Net Interest Income

 

Net interest income, which represents the principal source of revenue for the Company, is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of average earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income, the net interest margin, and net income.

 

The decline in the general level of interest rates over the last five years has placed downward pressure on the Company’s earning asset yields and related interest income. The decline in earning asset yields, however, has been offset principally by the repricing of money market deposit accounts and certificates of deposits and lower borrowing costs. The Company believes that its net interest margin will continue to decline modestly over the next several quarters as decreases in earning asset yields are projected to outpace declines in rates paid on interest-bearing liabilities.

 

The following table shows interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   Change 
             
Average interest-earning assets  $3,716,849   $3,649,865   $66,984 
Interest income (FTE)  $177,383   $186,085   $(8,702)
Yield on interest-earning assets   4.77%   5.10%   (33)bps
Average interest-bearing liabilities  $2,914,139   $2,922,373   $(8,234)
Interest expense  $20,501   $27,508   $(7,007)
Cost of interest-bearing liabilities   0.70%   0.94%   (24)bps
Cost of funds   0.55%   0.76%   (21)bps
Net Interest Income (FTE)  $156,882   $158,577   $(1,695)
Net Interest Margin (FTE)   4.22%   4.34%   (12)bps
Core Net Interest Margin (FTE) (1)   4.18%   4.24%   (6)bps

 

(1) Core net interest margin (FTE) excludes the impact of acquisition accounting accretion and amortization adjustments in net interest income.

 

For the year ended December 31, 2013, tax-equivalent net interest income was $156.9 million, a decrease of $1.7 million, or 1.1%, when compared to the same period last year. The tax-equivalent net interest margin decreased by 12 basis points to 4.22% from 4.34% in the prior year. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets (-6 bps) and a decline in the yield on interest-earning assets that outpaced the reduction in the cost of funds (-6 bps). Lower interest-earning asset income was principally due to lower yields on loans as new loans and renewed loans were originated and repriced at lower rates and declining investment securities yields driven by cash flows from securities investments reinvested at lower yields.

 

- 29 -
 

  

   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   Change 
             
Average interest-earning assets  $3,649,865   $3,523,330   $126,535 
Interest income (FTE)  $186,085   $193,399   $(7,314)
Yield on interest-earning assets   5.10%   5.50%   (40)bps
Average interest-bearing liabilities  $2,922,373   $2,875,242   $47,131 
Interest expense  $27,508   $32,713   $(5,205)
Cost of interest-bearing liabilities   0.94%   1.14%   (20)bps
Cost of funds   0.76%   0.93%   (17)bps
Net Interest Income (FTE)  $158,577   $160,686   $(2,109)
Net Interest Margin (FTE)   4.34%   4.57%   (23)bps
Core Net Interest Margin (FTE) (1)   4.24%   4.37%   (13)bps

 

(1) Core net interest margin (FTE) excludes the impact of acquisition accounting accretion and amortization adjustments in net interest income.

 

For the year ended December 31, 2012, tax-equivalent net interest income was $158.6 million, a decrease of $2.1 million, or 1.3%, when compared to the same period in 2011. The tax-equivalent net interest margin decreased by 23 basis points to 4.34% from 4.57% in 2011. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets (-10 bps) and a decline in the yield on interest-earning assets that outpaced the reduction in the cost of interest-bearing liabilities (-13 bps). Lower interest-earning asset income was principally due to lower yields on loans and investment securities as new loans and renewed loans were originated and repriced at lower rates, faster prepayments on mortgage backed securities, and cash flows from securities investments reinvested at lower yields. The reduction in the cost of interest-bearing liabilities was primarily driven by a shift in the mix of the Company’s deposit accounts as customers moved from certificates of deposits to transaction and money market accounts. During the third quarter of 2012, the Company modified its fixed rate convertible FHLB advances to floating rate advances, which resulted in reducing the Company’s FHLB borrowing costs. The modification of the FHLB advances lowered the 2012 cost of interest-bearing liabilities by 3 bps subsequent to executing the modification during the third quarter of 2012.

 

- 30 -
 

  

The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the years indicated (dollars in thousands):

 

AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES (TAXABLE EQUIVALENT BASIS)

 

   For the Year Ended December 31, 
   2013   2012   2011 
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
 
Assets:                                             
Securities:                                             
Taxable  $391,804   $8,202    2.09%  $462,996   $11,912    2.57%  $427,443   $13,387    3.13%
Tax-exempt   223,054    12,862    5.77%   179,977    11,155    6.20%   167,818    10,897    6.49%
Total securities (2)   614,858    21,064    3.43%   642,973    23,067    3.59%   595,261    24,284    4.08%
Loans, net (3) (4)   2,985,733    152,868    5.12%   2,875,916    159,682    5.55%   2,818,022    166,869    5.92%
Loans held for sale   105,450    3,433    3.26%   104,632    3,273    3.13%   53,463    2,122    3.97%
Federal funds sold   421    1    0.22%   365    1    0.24%   351    1    0.24%
Money market investments   1    -    0.00%   -    -    0.00%   96    -    0.00%
Interest-bearing deposits in other banks   10,386    17    0.17%   25,979    62    0.24%   56,137    123    0.24%
Other interest-bearing deposits   -    -    0.00%   -    -    0.00%   -    -    0.00%
Total earning assets   3,716,849    177,383    4.77%   3,649,865    186,085    5.10%   3,523,330    193,399    5.50%
Allowance for loan losses   (34,533)             (40,460)             (40,105)          
Total non-earning assets   369,752              365,820              378,403           
Total assets  $4,052,068             $3,975,225             $3,861,628           
                                              
Liabilities and Stockholders' Equity:                                             
Interest-bearing deposits:                                             
Checking  $461,594    351    0.08%  $419,550    445    0.11%  $385,715    621    0.16%
Money market savings   942,127    2,345    0.25%   909,408    3,324    0.37%   849,676    5,429    0.64%
Regular savings   226,343    680    0.30%   197,228    662    0.34%   172,627    638    0.37%
Time deposits: (5)                                             
$100,000 and over   473,244    5,751    1.22%   540,501    7,957    1.47%   573,276    9,045    1.58%
Under $100,000   488,115    4,970    1.02%   558,751    7,058    1.26%   604,172    8,613    1.43%
Total interest-bearing deposits   2,591,423    14,097    0.54%   2,625,438    19,446    0.74%   2,585,466    24,346    0.94%
Other borrowings (6)   322,716    6,404    1.98%   296,935    8,062    2.72%   289,776    8,367    2.89%
Total interest-bearing liabilities   2,914,139    20,501    0.70%   2,922,373    27,508    0.94%   2,875,242    32,713    1.14%
                                              
Noninterest-bearing liabilities:                                             
Demand deposits   664,203              577,740              513,352           
Other liabilities   37,662              39,338              31,994           
Total liabilities   3,616,004              3,539,451              3,420,588           
Stockholders' equity   436,064              435,774              441,040           
Total liabilities and stockholders' equity  $4,052,068             $3,975,225             $3,861,628           
                                              
Net interest income       $156,882             $158,577             $160,686      
                                              
Interest rate spread (7)             4.07%             4.16%             4.36%
Interest expense as a percent of average earning assets             0.55%             0.76 %             0.93%
Net interest margin (8)             4.22%             4.34%             4.57%

 

(1) Rates and yields are annualized and calculated from actual, not rounded amounts in thousands, which appear above.

(2) Interest income on securities includes $15 thousand, $201 thousand, and $387 thousand for the year ended December 31, 2013, 2012, and 2011 in accretion of the fair market value adjustments.

(3) Nonaccrual loans are included in average loans outstanding.

(4) Interest income on loans includes $2.1 million, $3.7 million, and $6.2 million for the year ended December 31, 2013, 2012, and 2011 in accretion of the fair market value adjustments related to the acquisitions.

(5) Interest expense on certificates of deposits includes $7 thousand, $233 thousand, and $886 thousand for the year ended December 31, 2013, 2012 and 2011 in accretion of the fair market value adjustments related to the acquisitions.

(6) Interest expense on borrowings includes $489 thousand for the year ended December 31, 2013, 2012, and 2011 in amortization of the fair market value adjustments related to acquisitions.

(7) Income and yields are reported on a taxable equivalent basis using the statutory federal corporate tax rate of 35%.

(8) Core net interest margin excludes purchase accounting adjustments and was 4.18%, 4.24%, and 4.37% for the year ended December 31, 2013, 2012 and 2011.

 

- 31 -
 

 

The Volume Rate Analysis table below presents changes in interest income and interest expense and distinguishes between the changes related to increases or decreases in average outstanding balances of earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Changes attributable to both volume and rate have been allocated proportionally. Results, on a taxable equivalent basis, are as follows in this Volume Rate Analysis table for the years ended December 31, (dollars in thousands):

 

   2013 vs. 2012   2012 vs. 2011 
   Increase (Decrease) Due to Change in:   Increase (Decrease) Due to Change in: 
   Volume   Rate   Total   Volume   Rate   Total 
Earning Assets:                              
Securities:                              
Taxable  $(1,675)  $(2,035)  $(3,710)  $1,050   $(2,525)  $(1,475)
Tax-exempt   2,523    (816)   1,707    768    (510)   258 
Total securities   848    (2,851)   (2,003)   1,818    (3,035)   (1,217)
Loans, net   5,908    (12,722)   (6,814)   3,375    (10,562)   (7,187)
Loans held for sale   25    135    160    1,678    (527)   1,151 
Interest-bearing deposits in other banks   (31)   (14)   (45)   (62)   1    (61)
Total earning assets  $6,750   $(15,452)  $(8,702)  $6,809   $(14,123)  $(7,314)
                               
Interest-Bearing Liabilities:                              
Interest-bearing deposits:                              
Checking  $42   $(136)  $(94)  $50   $(226)  $(176)
Money market savings   120    (1,099)   (979)   358    (2,463)   (2,105)
Regular savings   97    (79)   18    88    (64)   24 
Certificates of deposit:                              
$100,000 and over   (932)   (1,274)   (2,206)   (501)   (587)   (1,088)
Under $100,000   (834)   (1,254)   (2,088)   (619)   (936)   (1,555)
Total interest-bearing deposits   (1,507)   (3,842)   (5,349)   (624)   (4,276)   (4,900)
Other borrowings   662    (2,320)   (1,658)   203    (508)   (305)
Total interest-bearing liabilities   (845)   (6,162)   (7,007)   (421)   (4,784)   (5,205)
                               
Change in net interest income  $7,595   $(9,290)  $(1,695)  $7,230   $(9,339)  $(2,109)

 

The Company’s fully taxable equivalent net interest margin includes the impact of acquisition accounting fair value adjustments. The 2013 and remaining estimated discount/premium and net accretion impact are reflected in the following table (dollars in thousands):

 

   Loan
Accretion
   Certificates of
Deposit
   Investment
Securities
   Borrowings   Total 
                     
For the year ended December 31, 2013  $2,065   $7   $15   $(489)  $1,598 
For the years ending:                         
2014   1,459    4    -    (489)   974 
2015   1,002    -    -    (489)   513 
2016   557    -    -    (163)   394 
2017   172    -    -    -    172 
2018   19    -    -    -    19 
Thereafter   132    -    -    -    132 

 

- 32 -
 

  

Noninterest Income

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   $   % 
Noninterest income:                    
Service charges on deposit accounts  $9,492   $9,033   $459    5.1%
Other service charges, commissions and fees   12,309    10,898    1,411    12.9%
Gains on securities transactions   21    190    (169)   NM 
Gains on sales of mortgage loans, net of commissions   11,900    16,651    (4,751)   -28.5%
(Losses) gains on bank premises   (340)   2    (342)   NM 
Other operating income   5,346    4,294    1,052    24.5%
Total noninterest income  $38,728   $41,068   $(2,340)   -5.7%
                     
Mortgage segment operations  $(11,906)  $(16,660)  $4,754    -28.5%
Intercompany eliminations   670    468    202    43.2%
Community Bank segment  $27,492   $24,876   $2,616    10.5%

 

NM - Not Meaningful

 

For the year ended December 31, 2013, noninterest income decreased $2.4 million, or 5.7%, to $38.7 million, from $41.1 million a year ago. Excluding mortgage segment operations, noninterest income increased $2.6 million, or 10.5%, from last year. Service charges on deposit accounts increased $459,000 primarily related to higher overdraft and returned check fees as well as service charges on savings accounts. Other account service charges and fees increased $1.4 million due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other operating income increased $1.1 million primarily related to increased income on bank owned life insurance, trust income, and other insurance-related revenues. Conversely, gains on bank premises decreased $342,000 as the Company recorded a loss in the current year on the closure of bank premises coupled with net gains in the prior year related to sale of bank premises. Gains on sales of mortgage loans, net of commissions, decreased $4.8 million driven by lower loan origination volume and lower gain on sale margins in 2013. Mortgage loan originations decreased by $154.8 million, or 14.1%, to $941.4 million in 2013 compared to $1.1 billion in 2012. Of the loan originations in the current year, 38.9% were refinances compared to 54.3% in 2012. Lower gain on sale margins were also partly due to reductions resulting from valuation reserves of $363,000 related to aged mortgage loans held-for-sale as well as a non-recurring charge of $966,000 for contractual indemnifications related to prior period errors in mortgage insurance premium calculations in certain mortgage loans.

 

   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   $   % 
Noninterest income:                    
Service charges on deposit accounts  $9,033   $8,826   $207    2.3%
Other service charges, commissions and fees   10,898    9,736    1,162    11.9%
Gains on securities transactions   190    913    (723)   NM 
Other-than-temporary impairment losses   -    (400)   400    -100.0%
Gains on sales of mortgage loans, net of commissions   16,651    11,052    5,599    50.7%
(Losses) gains on bank premises   2    (996)   998    NM 
Other operating income   4,294    3,833    461    12.0%
Total noninterest income  $41,068   $32,964   $8,104    24.6%
                     
Mortgage segment operations  $(16,660)  $(11,050)  $(5,610)   50.8%
Intercompany eliminations   468    468    -    0.0%
Community Bank segment  $24,876   $22,382   $2,494    11.1%

 

NM - Not Meaningful

 

- 33 -
 

  

For the year ended December 31, 2012, noninterest income increased $8.1 million, or 24.6%, to $41.1 million, from $33.0 million in 2011. Gains on sales of mortgage loans, net of commissions, increased $5.6 million driven by an increase in loan origination volume, a result of additional loan originators hired in 2012 and historically low interest rates. Service charges on deposit accounts and other account fees increased $1.4 million primarily related to higher net interchange fee income, higher brokerage commissions, and higher ATM fee income. In addition, gains on bank premises increased $998,000 as the Company sold a former branch building and recorded a loss on the sale of $626,000 during 2011. Gains on securities transactions decreased $723,000 as a result of a gain on the sale of municipal securities in the prior year. Also, other-than-temporary losses of $400,000 related to a single issuer trust preferred security was recorded in the prior year. Excluding mortgage segment operations, noninterest income increased $2.5 million, or 11.1%, from the same period a year ago.

 

Noninterest expense

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   $   % 
Noninterest expense:                    
Salaries and benefits  $70,369   $68,648   $1,721    2.5%
Occupancy expenses   11,543    12,150    (607)   -5.0%
Furniture and equipment expenses   6,884    7,251    (367)   -5.1%
OREO and credit-related expenses (1)   4,880    4,639    241    5.2%
Acquisition-related expenses   2,132    -    2,132    NM 
Other operating expenses   41,481    40,791    690    1.7%
Total noninterest expense  $137,289   $133,479   $3,810    2.9%
                     
Mortgage segment operations  $(17,703)  $(13,971)  $(3,732)   26.7%
Intercompany eliminations   670    468    202    43.2%
Community Bank segment  $120,256   $119,976   $280    0.2%

 

NM - Not Meaningful

 

(1) OREO related costs include foreclosure related expenses, gains/losses on the sale of OREO, valuation reserves, and asset resolution related legal expenses.

 

For the year ended December 31, 2013, noninterest expense increased $3.8 million, or 2.9%, to $137.3 million, from $133.5 million a year ago. Excluding mortgage segment operations and acquisition-related costs of $2.1 million incurred in 2013, noninterest expense declined $1.8 million, or 1.5%, compared to 2012. Salaries and benefits expense increased $1.7 million due to costs associated with strategic investments in mortgage segment personnel in 2012 and 2013 and severance expense recorded in the current year related to the relocation of Union Mortgage Group, Inc.’s headquarters to Glen Allen, Virginia. Occupancy expenses decreased $607,000 and furniture and equipment expenses declined $367,000, primarily due to branch closures in 2012. OREO and credit-related expenses increased $241,000, or 5.2%, mainly related to valuation adjustments on OREO property in the current year. Other operating expenses increased $690,000, or 1.7%, due to increases in legal and litigation-related expenses of $1.2 million and FDIC insurance expenses of $672,000, partially offset by lower amortization expenses of $1.5 million.

 

- 34 -
 

  

   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   $   % 
Noninterest expense:                    
Salaries and benefits  $68,648   $62,865   $5,783    9.2%
Occupancy expenses   12,150    11,104    1,046    9.4%
Furniture and equipment expenses   7,251    6,920    331    4.8%
OREO and credit-related expenses (1)   4,639    5,668    (1,029)   -18.2%
Acquisition-related expenses   -    426    (426)   -100.0%
Other operating expenses   40,791    43,832    (3,041)   -6.9%
Total noninterest expense  $133,479   $130,815   $2,664    2.0%
                     
Mortgage segment operations  $(13,971)  $(9,793)  $(4,178)   42.7%
Intercompany eliminations   468    468    -    0.0%
Community Bank segment  $119,976   $121,490   $(1,514)   -1.2%

 

NM - Not Meaningful

 

(1) OREO related costs include foreclosure related expenses, gains/losses on the sale of OREO, valuation reserves, and asset resolution related legal expenses.

 

For the year ending December 31, 2012, noninterest expense increased $2.7 million, or 2.0%, to $133.5 million, from $130.8 million during 2011. Salaries and benefits expense increased $5.8 million due to the addition of mortgage loan originators and support personnel hired in 2012, group insurance cost increases, and severance expense recorded in the current year. Occupancy costs increased $1.0 million primarily due to the addition of mortgage offices in the first quarter of 2012 and increases in bank branch lease costs. Furniture and equipment expense increased $331,000, primarily related to equipment maintenance contracts and software amortization. Partially offsetting these increases were other operating expenses which decreased $3.5 million, or 7.8%, primarily due to reductions in FDIC insurance expense of $2.6 million resulting from changes in the assessment base and rate as well as lower core deposit intangible amortization expense of $1.2 million. OREO and related costs decreased $1.0 million, or 18.2%, during 2012 due to lower valuation adjustments and losses on sales of OREO and declines in problem loan legal fees as asset quality improved. Excluding mortgage segment operations, noninterest expense decreased $1.5 million, or 1.2%, compared to the same period in 2011.

 

SEGMENT INFORMATION

 

Community Bank Segment

 

2013 compared to 2012

For the year ended December 31, 2013, the community bank segment’s net income increased $4.3 million, or 13.0%, to $37.2 million when compared to the prior year; excluding after-tax acquisition-related costs of $2.0 million in 2013, net income increased $6.3 million, or 19.3%. Net interest income decreased $3.0 million, or 2.0%, to $150.0 million when compared to the prior year due to declines in the net interest margin partially offset by loan growth. In addition, the Company’s provision for loan losses was $6.1 million lower than the prior year due to continued improvement in asset quality.

 

Noninterest income increased $2.6 million, or 10.5%, to $27.5 million from $24.9 million last year. Service charges on deposit accounts increased $459,000 primarily related to higher overdraft and returned check fees as well as service charges on savings accounts. Other account service charges and fees increased $1.4 million due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other operating income increased $1.3 million primarily related to increased income on bank owned life insurance, trust income, and other insurance-related revenues. Partially offsetting these increases were decreases in gains on sale of bank premises of $342,000, as a loss was recognized in the current year compared to gains in 2012, and lower net gains on securities of $169,000.

 

- 35 -
 

  

Noninterest expense increased $280,000, or 0.2%, to $120.3 million in 2013 from $120.0 million in 2012. Excluding acquisition-related costs of $2.1 million in 2013, noninterest expense decreased $1.8 million, or 1.5%, from the prior year. Salaries and benefits declined $475,000 related to lower equity based compensation expense. Occupancy expenses and furniture and equipment expenses declined $1.2 million and $367,000, respectively, largely due to branch closures that occurred in 2012.

 

2012 compared to 2011

 

The community bank’s net income for the year ended December 31, 2012 increased $4.1 million, or 14.0%, to $32.9 million compared to $28.8 million for the year ended December 31, 2011 principally a result of lower provision for loan losses, a reduction in FDIC insurance due to change in base assessment and rate, lower amortization on the acquired deposit portfolio, and an increase in account service charges and fees. Partially offsetting these results were higher salaries and benefits costs and lower net interest income primarily due to reductions in interest-earning assets interest income outpacing lower costs on interest-bearing liabilities. Net interest income decreased $2.0 million, or 1.3%, when compared to the same period in 2011. The tax-equivalent net interest margin decreased by 23 basis points to 4.34% from 4.57% in 2011. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets and a decline in income from interest-earning assets outpacing lower costs on interest-bearing liabilities. Lower interest-earning asset income was principally due to lower yields on loans and investment securities as new loans and renewed loans were originated and repriced at lower rates, faster prepayments on mortgage backed securities, and cash flows from securities investments were reinvested at lower yields.

 

Noninterest income increased $2.5 million, or 11.2%, to $24.9 million from $22.4 million during 2011. Service charges on deposit accounts and other account fees increased $1.4 million primarily related to higher net interchange fee income, higher brokerage commissions, and higher ATM fee income. In addition, gains on bank premises increased $992,000 as the Company sold a former branch building and recorded a loss on the sale of $626,000 during 2011. Gains on securities transactions decreased $723,000 as a result of a gain on the sale of municipal securities in 2011. Also, an other-than-temporary loss of $400,000 related to a single issuer trust preferred security was recorded in 2011.

 

Noninterest expense decreased $1.5 million, or 1.2%, to $120.0 million, from $121.5 million during 2011. Salaries and benefits expense increased $2.8 million due to group insurance cost increases and severance payments to affected employees in addition to general salary increases, resulting from merit increases and additional personnel. Occupancy costs increased $747,000 primarily due to bank branch rent increases. Partially offsetting these cost increases were other operating expenses which decreased $5.2 million, or 11.0%. Included in the reduction of other operating expenses was a $2.6 million reduction in FDIC insurance due to change in base assessment and rate, lower core deposit intangible amortization of $1.2 million, and a decrease in conversion costs related to acquisition activity during 2011.

 

Mortgage Segment

 

2013 compared to 2012

 

For the year ended December 31, 2013, the mortgage segment incurred a net loss of $2.7 million compared to net income of $2.5 million during the prior year, representing a decline of $5.2 million. Mortgage loan originations decreased by $154.8 million, or 14.1%, to $941.4 million from $1.1 billion during the prior year. Loan origination volume, particularly refinance volume, is highly sensitive to changes in interest rates, and was negatively affected by the higher interest rate environment in the second half of 2013 compared to the lower interest rate environment for the full year 2012. As a result, of the loan originations in the current year, 38.9% were refinances compared to 54.3% in 2012. 

 

Related to the decline in origination volume, gains on sales of mortgage loans, net of commission expenses, decreased 28.5%, or $4.8 million. The decrease included reductions from valuation reserves of $363,000 related to aged mortgage loans held-for-sale and the non-recurring $966,000 charge for indemnification claims previously discussed. Excluding this accrual, net gains on sales of loans decreased $3.8 million, or 22.7%, driven by the 14.1% drop in mortgage loan originations and lower margins. The year to year comparative decline in net income was affected not only by the impact of the rising interest rate environment, but also the full year impact of the additional mortgage loan officers in 2013, added in the first half of 2012.

 

Expenses increased by $3.7 million, or 26.7%, over last year primarily due to increases in salary and benefit expenses of $2.2 million related to the addition of personnel to support mortgage loan originators in 2012, investments made in the current year to enhance the mortgage segment’s operating capabilities, and severance related to the relocation of the mortgage segment’s headquarters to Richmond. In addition, increases in expenses included higher rent expense of $563,000 related to annual rent increases, lease termination costs, and the headquarters relocation, loan-related expenses of $236,000, primarily related to appraisal and credit reporting expenses, and professional fees of $200,000.

 

- 36 -
 

 

2012 compared to 2011

For the year ended December 31, 2012, the mortgage segment net income increased $933,000, or 57.8%, from $1.6 million in 2011 to $2.5 million.  In early 2012, the Company significantly increased its mortgage loan production capacity by hiring additional loan originators and support personnel who were formerly employed by a national mortgage company that exited the mortgage origination business. Originations increased by $436.8 million, or 66.2%, to $1.1 billion from $659.4 million in 2011 due to the addition of mortgage loan originators and the historically low interest rate environment.  Gains on sales of loans, net of commission expenses, increased $5.6 million, or 50.7%, while salary and benefit expenses increased $3.0 million, or 55.4%, primarily due to the addition of mortgage loan originators and support personnel in early 2012.  Refinanced loans represented 54.3% of originations during the year compared to 37.4% during 2011.

 

BALANCE SHEET

 

At December 31, 2013, total assets were $4.2 billion, an increase of $80.7 million from December 31, 2012. Total cash and cash equivalents were $73.0 million at December 31, 2013, a decrease of $9.9 million from the same period last year. Investment in securities increased $91.9 million, or 15.7%, from $585.4 million at December 31, 2012 to $677.3 million at December 31, 2013. Mortgage loans held for sale were $53.2 million, a decrease of $114.5 million from December 31, 2012.

 

At December 31, 2013, loans (net of unearned income) were $3.0 billion, an increase of $72.5 million, or 2.4%, from December 31, 2012. Average loans outstanding increased $109.8 million, or 3.8%, from December 31, 2012.

 

As of December 31, 2013, total deposits were $3.2 billion, a decrease of $60.9 million, or 1.8%, when compared to December 31, 2012. The decline of year over year deposit totals was driven by decreases in time deposits of $160.9 million, partially offset by an increase of lower cost demand deposit levels of $45.8 million and an increase of NOW accounts of $43.9 million.

 

As of December 31, 2013, net short term borrowings increased $131.7 million, or 99.6% from December 31, 2012, primarily related to securities purchases (primarily mortgage backed and tax-free municipals) in the fourth quarter of 2013 in anticipation of the StellarOne merger. During the third quarter of 2012, the Company modified its fixed rate convertible FHLB advances to floating rate advances, which resulted in reducing the Company’s FHLB borrowing costs. In connection with this modification, the Company incurred a prepayment penalty of $19.6 million which is being amortized, as a component of interest expense on borrowing, over the life of the advances. The prepayment amount is reported as a component of long-term borrowings in the Company’s Consolidated Balance Sheet.

 

During the first quarter of 2013, the Company entered into an agreement to purchase 500,000 shares of its common stock from Markel Corporation, then the Company’s largest shareholder, for an aggregate purchase price of $9,500,000, or $19.00 per share. The repurchase was funded with cash on hand and the shares were retired. During the remainder of 2013, the Company did not repurchase any shares. The Company’s authorization to repurchase an additional 250,000 shares under its 2013 repurchase program authorization expired December 31, 2013.

 

On January 30, 2014, the Company’s Board of Directors authorized a share repurchase program to purchase up to $65.0 million worth of the Company’s common stock on the open market or in privately negotiated transactions. The repurchase program is authorized through December 31, 2015.

 

Securities

At December 31, 2013, the Company had total investments, in the amount of $703.4 million, or 16.8% of total assets, as compared to $606.1 million, or 14.8% of total assets, at December 31, 2012. The Company seeks to diversify its portfolio to minimize risk. It focuses on purchasing mortgage-backed securities for cash flow and reinvestment opportunities and securities issued by states and political subdivisions due to the tax benefits and the higher yield offered from these securities. All of the Company’s mortgage-backed securities are investment grade. The investment portfolio has a high percentage of municipals and mortgage-backed securities; therefore a higher taxable equivalent yield exists on the portfolio compared to its peers. The Company does not engage in structured derivative or hedging activities within the investment portfolio.

 

- 37 -
 

  

The table below sets forth a summary of the securities available for sale and restricted stock, at fair value for the following periods (dollars in thousands):

 

   2013   2012 
U.S. government and agency securities  $2,153   $2,849 
Obligations of states and political subdivisions   254,830    229,778 
Corporate and other bonds   9,434    7,212 
Mortgage-backed securities   407,362    342,174 
Other securities   3,569    3,369 
Total securities available for sale, at fair value   677,348    585,382 
           
Federal Reserve Bank stock   6,734    6,754 
Federal Home Loan Bank stock   19,302    13,933 
Total restricted stock   26,036    20,687 
Total investments  $703,384   $606,069 

 

During each quarter and at year end, the Company conducts an assessment of the securities portfolio for OTTI consideration. The Company determined that a single issuer trust preferred security incurred credit-related OTTI of $400,000 during the year ended December 31, 2011; there is no remaining unrealized loss for this issue as of December 31, 2013. No OTTI was recognized in 2012 or 2013. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes, and credit risk changes, to determine whether adjustments are needed. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

- 38 -
 

  

The following table summarizes the contractual maturity of securities available for sale at fair value and their weighted average yields as of December 31, 2013 (dollars in thousands):

 

   1 Year or Less   1 - 5 Years   5 - 10 Years   Over 10 Years
and Equity
Securities
   Total 
U.S. government and agency securities:                         
Amortized cost  $-   $1,594   $-   $60   $1,654 
Fair value   -    1,628    -    525    2,153 
Weighted average yield (1)   -    2.78    -    -    2.67 
                          
Mortgage backed securities:                         
Amortized cost   209    11,839    67,865    325,476    405,389 
Fair value   211    12,248    68,704    326,199    407,362 
Weighted average yield (1)   4.21    2.96    2.08    2.02    2.06 
                          
Obligations of states and political subdivisions:                         
Amortized cost   2,965    7,463    48,870    196,037    255,335 
Fair value   3,016    7,817    50,565    193,432    254,830 
Weighted average yield (1)   6.96    6.32    6.19    5.29    5.51 
                          
Corporate bonds and other securities:                         
Amortized cost   3,617    770    -    8,709    13,096 
Fair value   3,569    804    -    8,630    13,003 
Weighted average yield (1)   1.99    4.99    -    4.90    4.10 
                          
Total securities available for sale:                         
Amortized cost   6,791    21,666    116,735    530,282    675,474 
Fair value   6,796    22,497    119,269    528,786    677,348 
Weighted average yield (1)   4.23    4.17    3.80    3.28    3.41 

 

(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis.

 

As of December 31, 2013, the Company maintained a diversified municipal bond portfolio with approximately 70% of its holdings in general obligation issues and the remainder backed by revenue bonds. Issuances within the Commonwealth of Virginia represented 11% and issuances within the State of Texas represented 22% of the municipal portfolio; no other state had a concentration above 10%. Approximately 92% of municipal holdings are considered investment grade by Moody’s or Standard & Poor’s. The non-investment grade securities are principally insured Texas municipalities with no underlying rating. When purchasing municipal securities, the Company focuses on strong underlying ratings for general obligation issuers or bonds backed by essential service revenues.

 

- 39 -
 

  

Loan Portfolio

Loans, net of unearned income, were $3.0 billion at both December 31, 2013 and 2012. Loans secured by real estate continue to represent the Company’s largest category, comprising 83.8% of the total loan portfolio at December 31, 2013.

 

The following table presents the Company’s composition of loans, net of unearned income, in dollar amounts and as a percentage of total gross loans as of December 31, (dollars in thousands):

 

   2013   2012   2011   2010   2009 
Loans secured by real estate:                                                  
Residential 1-4 family  475,688    15.7%  472,985   15.9%  447,544    15.9%  431,614    15.2%  349,277    18.6%
Commercial   1,094,451    36.0%   1,044,396    35.2%   985,934    34.9%   924,548    32.6%   596,773    31.9%
Construction, land development and other land loans   470,684    15.5%   470,638    15.9%   444,739    15.8%   489,601    17.3%   307,726    16.4%
Second mortgages   34,891    1.1%   39,925    1.3%   55,630    2.0%   64,534    2.3%   34,942    1.9%
Equity lines of credit   302,965    10.0%   307,668    10.4%   304,320    10.8%   305,741    10.8%   182,449    9.7%
Multifamily   146,433    4.8%   140,038    4.7%   108,260    3.8%   91,397    3.2%   46,581    2.5%
Farm land   20,769    0.7%   22,776    0.8%   26,962    1.0%   26,787    0.9%   26,191    1.4%
Total real estate loans   2,545,881    83.8%   2,498,426    84.2%   2,373,389    84.2%   2,334,222    82.3%   1,543,939    82.4%
                                                   
Commercial Loans   194,809    6.4%   186,528    6.3%   169,695    6.0%   180,840    6.4%   126,157    6.8%
                                                   
Consumer installment loans                                                  
Personal   238,368    7.8%   222,812    7.5%   241,753    8.6%   277,184    9.8%   148,811    7.9%
Credit cards   23,211    0.8%   21,968    0.7%   19,006    0.7%   19,308    0.6%   17,743    0.9%
Total consumer installment loans   261,579    8.6%   244,780    8.2%   260,759    9.3%   296,492    10.4%   166,554    8.8%
                                                   
All other loans   37,099    1.2%   37,113    1.3%   14,740    0.5%   25,699    0.9%   37,574    2.0%
Gross loans  $3,039,368    100.0%  $ 2,966,847    100.0%  $ 2,818,583    100.0%  $ 2,837,253    100.0%  $ 1,874,224    100.0%

 

- 40 -
 

  

The following table presents the remaining maturities, based on contractual maturity, by loan type and by rate type (variable or fixed), as of December 31, 2013 (dollars in thousands):

 

           Variable Rate   Fixed Rate 
   Total Maturities   Less than 1
year
   Total   1-5 years   More than 5
years
   Total   1-5 years   More than
5 years
 
Loans secured by real estate:                                        
Residential 1-4 family  $475,688   $66,151   $73,136   $19,788   $53,348   $336,401   $204,244   $132,157 
Commercial   1,094,451    169,626    95,457    88,130    7,327    829,368    556,863    272,505 
Construction, land development and other land loans   470,684    318,623    8,572    5,292    3,280    143,489    120,737    22,752 
Second mortgages   34,891    3,401    2,678    2,089    589    28,812    14,231    14,581 
Equity lines of credit   302,965    194,977    43    -    43    107,945    17,695    90,250 
Multifamily   146,433    18,490    23,644    23,644    -    104,299    83,746    20,553 
Farm land   20,769    13,903    493    454    39    6,373    5,888    485 
Total real estate loans   2,545,881    785,171    204,023    139,397    64,626    1,556,687    1,003,404    553,283 
                                         
Commercial Loans   194,809    82,806    137    137    -    111,866    89,840    22,026 
                                         
Consumer installment loans                                        
Personal   238,368    7,326    -    -    -    231,042    105,715    125,327 
Credit cards   23,211    23,211    -    -    -    -    -    - 
Total consumer installment loans   261,579    30,537    -    -    -    231,042    105,715    125,327 
                                         
All other loans   37,099    7,171    3,228    3,228    -    26,700    3,720    22,980 
Gross loans  $3,039,368   $905,685   $207,388   $142,762   $64,626   $1,926,295   $1,202,679   $723,616 

 

While the current economic environment is challenging, the Company remains committed to originating soundly underwritten loans to qualifying borrowers within its markets. The Company is focused on providing community-based financial services and discourages the origination of portfolio loans outside of its principal trade areas. As reflected in the loan table, at December 31, 2013, the largest component of the Company’s loan portfolio consisted of real estate loans, concentrated in commercial, construction, and residential 1-4 family. The risks attributable to these concentrations are mitigated by the Company’s credit underwriting and monitoring processes, including oversight by a centralized credit administration function and credit policy and risk management committee, as well as seasoned bankers focusing their lending to borrowers with proven track records in markets with which the Company is familiar. UMG serves as a mortgage brokerage operation, selling the majority of its loan production in the secondary market or selling loans to meet the Bank’s current asset/liability management needs.

 

Asset Quality

 

Overview

During 2013, the Company continued to see improvement in asset quality with reduced levels of impaired loans, troubled debt restructurings, past due loans, and nonperforming assets, which were at their lowest levels since the fourth quarter of 2009. Net charge-offs and the loan loss provision, as well as their respective ratios of net charge-offs to total loans and provision to total loans, also decreased from the prior year. The allowance to nonperforming loans coverage ratio was at the highest level since the first quarter of 2008. The magnitude of any change in the real estate market and its impact on the Company is still largely dependent upon continued recovery of residential housing and commercial real estate and the pace at which the local economies in the Company’s operating markets improve.

 

The Company’s continued proactive efforts to effectively manage its loan portfolio have contributed to the improvement in asset quality. Efforts include identifying existing problem credits as well as generating new business relationships. Through early identification and diligent monitoring of specific problem credits where the uncertainty has been realized, or conversely, has been reduced or eliminated, the Company’s management has been able to quantify the credit risk in its loan portfolio, adjust collateral dependent credits to appropriate reserve levels, and further identify those credits not recoverable. The Company continues to refrain from originating or purchasing loans from foreign entities or loans classified by regulators as highly leveraged transactions. The Company’s loan portfolio generally does not include exposure to option adjustable rate mortgage products, high loan-to-value ratio mortgages, interest only mortgage loans, subprime mortgage loans or mortgage loans with initial teaser rates, which are all considered higher risk instruments.

 

- 41 -
 

  

Troubled Debt Restructurings

A modification of a loan’s terms constitutes a TDR if the creditor grants a concession that it would not otherwise consider to the borrower for economic or legal reasons related to the borrower’s financial difficulties. The Company generally does not provide concession on interest rates, with the primary concession being an extension of the term of the loan from the original maturity date. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. The Company reviews previously restructured loans quarterly in order to determine whether any has performed, subsequent to the restructure, at a level that would allow for it to be removed from TDR status. The Company generally would consider a change in this classification if the loan has performed under the restructured terms for a consecutive twelve month period.

 

The total recorded investment in TDRs as of December 31, 2013 was $41.8 million, a decrease of $21.7 million, or 34.2%, from $63.5 million at December 31, 2012. The decline in the TDR balance from the prior year is attributable to $13.6 million being removed from TDR status, $11.6 million in net payments, $2.4 million in transfers to OREO, and $1.9 million in charge-offs, partially offset by additions of $7.8 million. Loans removed from TDR status represent restructured loans with a market rate of interest at the time of the restructuring, which were performing in accordance with their modified terms for a consecutive twelve month period and that were no longer considered impaired. Loans removed from TDR status are collectively evaluated for impairment and due to the significant improvement in the expected future cash flows, these loans are grouped based on their primary risk characteristics, typically using the Company’s internal risk rating system as its primary credit quality indicator, and impairment is measured based on historical loss experience taking into consideration environmental factors. The significant majority of these loans have been subject to new credit decisions due to the improvement in the expected future cash flows, the financial condition of the borrower, and other factors considered during underwriting. The TDR activity during the quarter did not have a material impact on the Company’s allowance for loan losses, financial condition, or results of operations.

 

Of the $41.8 million of TDRs at December 31, 2013, $34.5 million, or 82.5%, were considered performing while the remaining $7.3 million were considered nonperforming. Of the $63.5 million of TDRs at December 31, 2012, $51.5 million, or 81.1%, were considered performing while the remaining $12.0 million were considered nonperforming.

 

Nonperforming Assets

At December 31, 2013, nonperforming assets totaled $49.2 million, a decrease of $9.8 million, or 16.6%, from December 31, 2012. In addition, NPAs as a percentage of total outstanding loans declined 37 basis points to 1.62% from 1.99% at the end of the prior year.

 

The following table shows a summary of assets quality balances and related ratios as of and for the years ended December 31, (dollars in thousands):

 

   2013   2012   2011   2010   2009 
Nonaccrual loans (excluding purchased impaired)  $15,035   $26,206   $44,834   $61,716   $22,348 
Foreclosed properties   34,116    32,834    31,243    35,102    21,489 
Real estate investment   -    -    1,020    1,020    1,020 
Total nonperforming assets   49,151    59,040    77,097    97,838    44,857 
Loans past due 90 days and accruing interest   6,746    8,843    19,911    15,332    7,296 
Total nonperforming assets and Loans past due 90 days and accruing interest  $55,897   $67,883   $97,008   $113,170   $52,153 
                          
Performing Restructurings  $34,520   $51,468   $98,834   $13,086   $- 
                          
NPAs to total loans   1.62%   1.99%   2.74%   3.45%   2.39%
NPAs & loans 90 days past due to total loans   1.84%   2.29%   3.44%   3.99%   2.78%
NPAs to total loans & OREO   1.60%   1.97%   2.70%   3.40%   2.36%
NPAs & loans 90 days past due to total loans & OREO   1.82%   2.26%   3.40%   3.94%   2.75%
ALLL to nonaccrual loans   200.43%   133.24%   88.04%   62.23%   136.41%
ALLL to nonaccrual loans & loans 90 days past due   138.35%   99.62%   60.96%   49.85%   102.83%

 

- 42 -
 

  

Nonperforming assets at December 31, 2013 included $15.0 million in nonaccrual loans (excluding purchased impaired loans), a net decrease of $11.2 million, or 42.7%, from the prior year. The following table shows the activity in nonaccrual loans for the years ended December 31, (dollars in thousands):

  

                 
   2013   2012   2011   2010 
Beginning Balance  $26,206   $44,834   $61,716   $22,348 
Net customer payments   (12,393)   (13,624)   (18,661)   (8,985)
Additions   16,725    10,265    19,905    75,099 
Charge-offs   (8,743)   (8,510)   (8,716)   (10,005)
Loans returning to accruing status   (2,718)   (3,455)   (3,607)   (1,017)
Transfers to OREO   (4,042)   (3,304)   (5,803)   (15,724)
Ending Balance  $15,035   $26,206   $44,834   $61,716 

 

The additions during the year were primarily related to commercial and industrial loans and mortgages. The reductions in nonaccrual loans during the year were primarily related to the commercial loan portfolio, particularly commercial construction and raw land loans.

 

The following table presents the composition of nonaccrual loans (excluding purchased impaired loans) and the coverage ratio, which is the allowance for loan losses expressed as a percentage of nonaccrual loans, at the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
Raw Land and Lots  $2,560   $8,760   $13,322   $22,546 
Commercial Construction   1,596    5,781    10,276    11,410 
Commercial Real Estate   2,212    3,018    7,993    10,157 
Single Family Investment Real Estate   1,689    3,420    5,048    10,226 
Commercial and Industrial   3,848    2,036    5,297    4,797 
Other Commercial   126    193    238    458 
Consumer   3,004    2,998    2,660    2,122 
Total  $15,035   $26,206   $44,834   $61,716 
                     
Coverage Ratio   200.43%   133.24%   88.04%   62.23%

 

Nonperforming assets at December 31, 2013 also included $34.1 million in OREO, an increase of $1.3 million, or 4.0%, from the prior year. The following table shows the activity in OREO for the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
Beginning Balance  $32,834   $32,263   $36,122   $22,509 
Additions   9,542    14,275    11,625    24,792 
Capitalized Improvements   561    380    528    404 
Valuation Adjustments   (791)   (301)   (707)   (43)
Proceeds from sales   (7,569)   (13,152)   (14,240)   (11,747)
Gains (losses) from sales   (461)   (631)   (1,065)   207 
Ending Balance  $34,116   $32,834   $32,263   $36,122 

 

During the year ended December 31, 2013, the additions to OREO were principally related to residential real estate and raw land; sales from OREO were principally related to residential real estate.

 

- 43 -
 

  

The following table presents the composition of the OREO portfolio at the years ended December 31, (dollars in thousands):

 

   2013   2012   2011   2010 
Land  $10,310   $8,657   $6,327   $7,689 
Land Development   10,904    10,886    11,309    11,233 
Residential Real Estate   7,379    7,939    11,024    13,402 
Commercial Real Estate   5,523    5,352    2,583    2,778 
Former Bank Premises (1)   -    -    1,020    1,020 
Total  $34,116   $32,834   $32,263   $36,122 

(1) Includes closed branch property and land previously held for branch sites.

 

Included in land development is $9.3 million related to a residential community in the Northern Neck region of Virginia, which includes developed residential lots, a golf course, and undeveloped land. Foreclosed properties were adjusted to their fair values at the time of each foreclosure and any losses were taken as loan charge-offs against the allowance for loan losses at that time. OREO asset balances are also evaluated at least quarterly by the subsidiary bank’s Special Asset Loan Committee and any necessary write downs to fair values are recorded as impairment.

 

Past Due Loans

At December 31, 2013, total accruing past due loans were $26.5 million, or 0.87% of total loans, a decrease from $32.4 million, or 1.09% of total loans, a year ago. This net decrease of $5.9 million, or 18.2%, is a result of management’s diligence in handling problem loans and an improving economy.

 

Charge-offs and delinquencies

For the year ended December 31, 2013, net charge-offs of loans were $10.8 million, or 0.36%, compared to $16.8 million, or 0.56%, last year. Of the $10.8 million in net charge-offs, approximately $8.8 million, or 81%, related to impaired loans specifically reserved for in the prior periods. Net charge-offs in the current year included commercial loans of $7.0 million and consumer loans of $3.8 million.

 

Provision

The provision for loan losses for the year ended December 31, 2013 was $6.1 million, a decrease of $6.1 million, or 50.0%, from the prior year. The lower provision for loan losses compared to last year is driven by improving asset quality and the impact of overall lower historical charge-off factors. The provision to loans ratio for the year ended December 31, 2013 was 0.20% compared to 0.41% for the prior year.

 

Allowance for Loan Losses

The allowance for loan losses as a percentage of the total loan portfolio, adjusted for acquisition accounting (non-GAAP), was 1.10% at December 31, 2013, a decrease from 1.35% a year ago. In acquisition accounting, there is no carryover of previously established allowance for loan losses. The allowance for loan losses as a percentage of the total loan portfolio was 0.99% at December 31, 2013, a decrease from 1.18% at December 31, 2012. The decrease in the allowance and related ratios was primarily attributable to the charge-off of impaired loans specifically reserved for in prior periods and improving credit quality metrics.

 

Impaired loans have declined from $155.4 million at December 31, 2012 to $112.6 million at December 31, 2013. The nonaccrual loan coverage ratio also improved, as it increased to 200.4% at December 31, 2013 from 133.2% at December 31, 2012. The rise in the coverage ratio, which is at the highest level since the first quarter of 2008, illustrates that management’s proactive diligence in working through problem credits is having a significant impact on asset quality. The current level of the allowance for loan losses reflects specific reserves related to nonperforming loans, current risk ratings on loans, net charge-off activity, loan growth, delinquency trends, and other credit risk factors that the Company considers important in assessing the adequacy of the allowance for loan losses.

 

- 44 -
 

  

The following table summarizes activity in the allowance for loan losses during the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010   2009 
Balance, beginning of year  $34,916   $39,470   $38,406   $30,484   $25,496 
Loans charged-off:                         
Commercial   3,080    1,439    2,183    2,205    2,039 
Real estate   8,596    14,127    12,669    12,581    8,702 
Consumer   1,942    2,899    3,014    3,763    3,667 
Total loans charged-off   13,618    18,465    17,866    18,549    14,408 
Recoveries:                         
Commercial   746    207    413    551    71 
Real estate   1,125    465    571    628    807 
Consumer   910    1,039    1,146    924    272 
Total recoveries   2,781    1,711    2,130    2,103    1,150 
Net charge-offs   10,837    16,754    15,736    16,446    13,258 
Provision for loan losses   6,056    12,200    16,800    24,368    18,246 
Balance, end of year  $30,135   $34,916   $39,470   $38,406   $30,484 
                          
ALL to loans   0.99%   1.18%   1.40%   1.35%   1.63%
ALL to loans, adjusted for acquisition accounting (Non-GAAP)   1.10%   1.35%   1.71%   1.82%   N/A 
Net charge-offs to total loans   0.36%   0.56%   0.56%   0.58%   0.71%
Provision to total loans   0.20%   0.41%   0.60%   0.86%   0.97%

 

The following table shows both an allocation of the allowance for loan losses among loan categories based upon the loan portfolio’s composition and the ratio of the related outstanding loan balances to total loans as of December 31, (dollars in thousands):

  

   2013   2012   2011   2010   2009 
   $   % (1)   $   % (1)   $   % (1)   $   % (1)   $   % (1) 
Commercial  $1,932    6.4%  $2,195    6.3%  $2,376    6.0%  $2,448    6.4%  $2,052    6.7%
Real estate   25,242    83.8%   29,403    84.2%   33,236    84.2%   31,597    82.3%   25,112    82.4%
Consumer   2,961    9.8%   3,318    9.5%   3,858    9.8%   4,361    11.3%   3,320    10.9%
Total  $30,135    100.0%  $34,916    100.0%  $39,470    100.0%  $38,406    100.0%  $30,484    100.0%

 

(1) The percent represents the loan balance divided by total loans.

 

Deposits

As of December 31, 2013, total deposits were $3.2 billion, down $60.9 million, or 1.8%, from December 31, 2012. Total interest-bearing deposits consist of NOW, money market, savings, and time deposit account balances. Total time deposit balances of $871.9 million accounted for 34.3% of total interest-bearing deposits at December 31, 2013. The Company continues to experience a shift from time deposits into lower cost transaction (demand deposits, NOW, money market, and savings) accounts. This shift is driven by the Company’s focus on acquiring low cost deposits and customer preference for liquidity in a historically low interest rate environment.

 

- 45 -
 

  

The community bank segment may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. The Company utilizes this funding source when rates are more favorable than other funding sources. As of December 31, 2013 and 2012, there were $13.7 million and $10.2 million, respectively, purchased and included in certificates of deposit on the Company’s Consolidated Balance Sheet. Maturities of time deposits as of December 31, 2013 are as follows (dollars in thousands):

  

   Within 3
Months
   3 - 12
Months
   Over 12
Months
   Total   Percent Of
Total
Deposits
 
Maturities of time deposits of $100,000 and over  $102,186   $169,565   $155,846   $427,597    13.21%
Maturities of other time deposits   71,496    218,350    154,408    444,254    13.72%
Total time deposits  $173,682   $387,915   $310,254   $871,851    26.93%

 

Capital Resources

 

Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders.

 

The FRB and the FDIC have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of principally common equity, retained earnings and a limited amount of perpetual preferred stock, less certain intangible items. The table below shows the Company exceeded the definition of “well capitalized” for regulatory purposes.

 

In connection with two bank acquisitions, prior to 2006, the Company issued trust preferred capital notes to fund the cash portion of those acquisitions, collectively totaling $58.5 million. The trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

 

- 46 -
 

  

The following table summarizes the Company’s regulatory capital and related ratios over the past three years ended December 31, (dollars in thousands):

 

   2013   2012   2011 
Tier 1 Capital:               
Common Stock - par value  $33,020   $33,510   $34,672 
Surplus   170,770    176,635    187,493 
Retained Earnings   236,639    215,634    189,824 
Total Equity   440,429    425,779    411,989 
Plus: qualifying trust preferred capital notes   58,500    58,500    58,500 
Less: disallowed intangibles   71,380    75,211    80,547 
Plus: goodwill deferred tax liability   940    810    681 
Total Tier 1 Capital  $428,489   $409,878   $390,623 
                
Tier 2 Capital:               
Net unrealized gain/loss on equity securities  $191   $128   $83 
Subordinated debt   6,544    9,522    12,305 
Allowance for loan losses   30,135    34,916    38,007 
Total Tier 2 Capital  $36,870   $44,566   $50,395 
Total risk-based capital  $465,359   $454,444   $441,018 
                
Risk-weighted assets  $3,284,430   $3,119,063   $3,039,099 
                
Capital ratios:               
Tier 1 risk-based capital ratio   13.05%   13.14%   12.85%
Total risk-based capital ratio   14.17%   14.57%   14.51%
Leverage ratio (Tier 1 capital to average adjusted assets)   10.70%   10.52%   10.34%
Common equity to total assets   10.49%   10.64%   10.79%
Tangible common equity to tangible assets   8.94%   8.97%   8.91%

 

In July 2013, the FRB issued revised final rules that make technical changes to its market risk capital rules to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules require the Company to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the current requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets.

 

If the new minimum capital ratios described above had been effective as of December 31, 2013, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

Commitments and off-balance sheet obligations

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments. For more information pertaining to these commitments, reference Note 8 “Commitments and Contingencies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

- 47 -
 

  

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk.

 

At December 31, 2013, UMG had rate lock commitments to originate mortgage loans amounting to $54.8 million and loans held for sale of $53.2 million. UMG has entered into corresponding commitments on a best-efforts basis to sell loans on a servicing-released basis totaling approximately $108.0 million. These commitments to sell loans are designed to reduce the mortgage company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

 

The following table represents the Company’s other commitments with balance sheet or off-balance sheet risk as of December 31, (dollars in thousands):

  

   2013   2012 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $891,680   $844,766 
Standby letters of credit   48,107    45,536 
Mortgage loan rate lock commitments   54,834    133,326 
Total commitments with off-balance sheet risk  $994,621   $1,023,628 
Commitments with balance sheet risk:          
Loans held for sale  $53,185   $167,698 
Total other commitments  $1,047,806   $1,191,326 
           
(1) Includes unfunded overdraft protection.          

 

The following table presents the Company’s contractual obligations and scheduled payment amounts due at the various intervals over the next five years and beyond as of December 31, 2013 (dollars in thousands):

 

   Total   Less than 1
year
   1-3 years   4-5 years   More than 5
years
 
Long-term debt  $139,049   $-   $16,359   $-   $122,690 
Trust preferred capital notes   60,310    -    -    -    60,310 
Operating leases   32,781    5,380    9,217    7,774    10,410 
Other short-term borrowings   211,500    211,500    -    -    - 
Repurchase agreements   52,455    52,455    -    -    - 
Total contractual obligations  $496,095   $269,335   $25,576   $7,774   $193,410 

 

For more information pertaining to the previous table, reference Note 4 “Bank Premise and Equipment” and Note 7 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of the Form 10-K.

 

Interest Sensitivity

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. The Company’s market risk is composed primarily of interest rate risk. The ALCO of the Company is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to this risk. The Company’s Board of Directors reviews and approves the guidelines established by ALCO.

 

- 48 -
 

  

Interest rate risk is monitored through the use of three complementary modeling tools: static gap analysis, earnings simulation modeling, and economic value simulation (net present value estimation). Each of these models measures changes in a variety of interest rate scenarios. While each of the interest rate risk models has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap, which measures aggregate re-pricing values, is less utilized because it does not effectively measure the options risk impact on the Company and is not addressed here. Earnings simulation and economic value models, which more effectively measure the cash flow and optionality impacts, are utilized by management on a regular basis and are explained below.

 

The Company determines the overall magnitude of interest sensitivity risk and then formulates policies and practices governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management’s expectations regarding future interest rate movements, the states of the national, regional and local economies, and other financial and business risk factors. The Company uses computer simulation modeling to measure and monitor the effect of various interest rate scenarios and business strategies on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.

 

Earnings Simulation Analysis

 

Management uses simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analyses, such as the static gap analysis discussed above.

 

Assumptions used in the model are derived from historical trends and management’s outlook and include loan and deposit growth rates and projected yields and rates. Such assumptions are monitored by management and periodically adjusted as appropriate. All maturities, calls, and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage-backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are reflected in the different rate scenarios.

 

The Company uses its simulation model to estimate earnings in rate environments where rates are instantaneously shocked up or down around a “most likely” rate scenario, based on implied forward rates. The analysis assesses the impact on net interest income over a 12 month time horizon after an immediate increase or “shock” in rates, of 100 basis points up to 300 basis points. The shock down 200 or 300 basis points analysis is not as meaningful as interest rates across most of the yield curve are at historic lows and cannot decrease another 200 or 300 basis points. The model, under all scenarios, does not drop the index below zero.

 

 The following table represents the interest rate sensitivity on net interest income for the Company across the rate paths modeled for balances ended December 31, 2013 (dollars in thousands):

 

   Change In Net Interest Income 
   %   $ 
Change in Yield Curve:          
+300 basis points   (2.01)   (3,274)
+200 basis points   (1.16)   (1,896)
+100 basis points   (0.86)   (1,405)
Most likely rate scenario   -    - 
-100 basis points   (1.91)   (3,118)
-200 basis points   (5.85)   (9,546)
-300 basis points   (7.34)   (11,980)

 

Economic Value Simulation

 

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The economic value simulation uses instantaneous rate shocks to the balance sheet.

 

- 49 -
 

  

The following chart reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the period ended December 31, 2013 (dollars in thousands):

 

   Change In Economic Value of Equity 
   %   $ 
Change in Yield Curve:          
+300 basis points   (11.84)   (75,364)
+200 basis points   (7.28)   (46,371)
+100 basis points   (3.30)   (21,002)
Most likely rate scenario   -    - 
-100 basis points   0.35    2,217 
-200 basis points   (2.48)   (15,794)
-300 basis points   (2.84)   (18,103)

 

The shock down 200 or 300 basis points analysis is not as meaningful since interest rates across most of the yield curve are at historic lows and cannot decrease another 200 or 300 basis points.  While management considers this scenario highly unlikely, the natural floor increases the Company’s sensitivity in rates down scenarios.

 

Liquidity

 

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, money market investments, federal funds sold, securities available for sale, loans held for sale, and loans maturing or re-pricing within one year. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary through federal funds lines with several correspondent banks, a line of credit with the FHLB, the purchase of brokered certificates of deposit, and a corporate line of credit with a large correspondent bank. Management considers the Company’s overall liquidity to be sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

 

At December 31, 2013, cash and cash equivalents, restricted stock, and securities classified as available for sale comprised 18.6% of total assets, compared to 16.8% at December 31, 2012. Asset liquidity is also provided by managing loan and securities maturities and cash flows.

 

Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary. The community bank segment maintains federal funds lines with several regional banks totaling $125.0 million as of December 31, 2013. As of December 31, 2013, there were $31.5 million outstanding on these federal funds lines. The Company had outstanding borrowings pursuant to securities sold under agreements to repurchase transactions with a maturity of one day of $52.5 million as of December 31, 2013 compared to $54.3 million as of December 31, 2012. Lastly, the Company had a collateral dependent line of credit with the FHLB for up to $805.2 million. Based on the underlying collateralized loans, the Company has $635.2 million available as of December 31, 2013. There was approximately $320.0 million outstanding under this line at December 31, 2013 compared to $494.0 million as of December 31, 2012.

 

The community bank segment may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. The Bank utilizes this funding source when rates are more favorable than other funding sources. As of December 31, 2013, there were $13.7 million purchased and included in certificates of deposit on the Consolidated Balance Sheet.

 

As of December 31, 2013, the liquid assets that mature within one year totaled $1.2 billion, or 30.3%, of total earning assets. As of December 31, 2013, approximately $976.0 million, or 32.1%, of total loans are scheduled to mature within one year based on contractual maturity, adjusted for expected prepayments.

 

- 50 -
 

  

NON-GAAP MEASURES

 

In reporting the results of December 31, 2013, the Company has provided supplemental performance measures on an operating or tangible basis. Operating measures exclude acquisition costs unrelated to the Company’s normal operations. The Company believes these measures are useful to investors as they exclude non-operating adjustments resulting from acquisition activity and allow investors to see the combined economic results of the organization. Tangible common equity is used in the calculation of certain capital and per share ratios. The Company believes tangible common equity and the related ratios are meaningful measures of capital adequacy because they provide a meaningful base for period-to-period and company-to-company comparisons, which the Company believes will assist investors in assessing the capital of the Company and its ability to absorb potential losses.

 

These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be viewed as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies.

 

- 51 -
 

  

The following table reconciles these non-GAAP measures from their respective GAAP basis measures for the years ended December 31, (dollars in thousands, except per share amounts):

  

   2013   2012   2011 
             
Operating Earnings               
Net Income (GAAP)  $34,496   $35,411   $30,445 
Plus: Merger and conversion related expense, after tax   2,042    -    277 
Net operating earnings (loss) (non-GAAP)  $36,538   $35,411   $30,722 
                
Operating earnings per share - Basic  $1.46   $1.37   $1.18 
Operating earnings per share - Diluted   1.46    1.37    1.18 
                
Operating ROA   0.90%   0.89%   0.80%
Operating ROE   8.38%   8.13%   6.97%
Operating ROTCE   10.07%   9.89%   9.42%
                
Community Bank Segment Operating Earnings               
Net Income (GAAP)  $37,155   $32,866   $28,833 
Plus: Merger and conversion related expense, after tax   2,042    -    277 
Net operating earnings (loss) (non-GAAP)  $39,197   $32,866   $29,110 
                
Operating earnings per share - Basic  $1.57   $1.27   $1.12 
Operating earnings per share - Diluted   1.57    1.27    1.12 
                
Operating ROA   0.97%   0.83%   0.75%
Operating ROE   9.18%   7.67%   6.68%
Operating ROTCE   11.08%   9.37%   9.07%
                
Operating Efficiency Ratio FTE               
Net Interest Income (GAAP)  $151,626   $154,355   $156,360 
FTE adjustment   5,256    4,222    4,326 
Net Interest Income (FTE)   156,882    158,577    160,686 
Noninterest Income (GAAP)   38,728    41,068    32,964 
Noninterest Expense (GAAP)  $137,289   $133,479   $130,815 
Merger and conversion related expense   2,132    -    426 
Noninterest Expense (non-GAAP)  $135,157   $133,479   $130,389 
                
Operating Efficiency Ratio FTE (non-GAAP)   69.10%   66.86%   67.33%
                
Community Bank Segment Operating Efficiency Ratio FTE          
Net Interest Income (GAAP)  $149,975   $153,024   $155,045 
FTE adjustment   5,256    4,223    4,325 
Net Interest Income (FTE)   155,231    157,247    159,370 
Noninterest Income (GAAP)   27,492    24,876    22,382 
Noninterest Expense (GAAP)  $120,256   $119,976   $121,490 
Merger and conversion related expense   2,132    -    426 
Noninterest Expense (non-GAAP)  $118,124   $119,976   $121,064 
                
Operating Efficiency Ratio FTE (non-GAAP)   64.65%   65.88%   66.61%
                
Tangible Common Equity               
Ending equity  $438,239   $435,863   $421,639 
Less: Ending trademark intangible   -    33    433 
Less: Ending goodwill   59,400    59,400    59,400 
Less: Ending core deposit intangibles   11,980    15,778    20,714 
Ending tangible common equity  $366,859   $360,652   $341,092 
                
Average equity  $436,064   $435,774   $441,040 
Less: Average trademark intangible   1    231    631 
Less: Average goodwill   59,400    59,400    58,494 
Less: Average core deposit intangibles   13,804    18,159    23,654 
Less: Average preferred equity   -    -    32,171 
Average tangible common equity  $362,859   $357,984   $326,090 

 

- 52 -
 

  

The allowance for loan losses, adjusted for acquisition accounting (non-GAAP) ratio includes an adjustment for the credit mark on purchased performing loans. The purchased performing loans are reported net of the related credit mark in loans, net of unearned income, on the Company’s Consolidated Balance Sheet; therefore, the credit mark is added back to the balance to represent the total loan portfolio. The adjusted allowance for loan losses, including the credit mark, represents the total reserve on the Company’s loan portfolio. GAAP requires the acquired allowance for loan losses not be carried over in an acquisition or merger. The Company believes the presentation of the allowance for loan losses, adjusted for acquisition accounting ratio is useful to investors because the acquired loans were purchased at a market discount with no allowance for loan losses carried over to the Company and the credit mark on the purchased performing loans represents the allowance associated with those purchased loans. The Company believes that this measure is a better reflection of the reserves on the Company’s loan portfolio. The following table shows the allowance for loan losses as a percentage of the total loan portfolio, adjusted for acquisition accounting, at December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
                 
Allowance for loan losses  $30,135   $34,916   $39,470   $38,406 
Remaining credit mark on purchased loans   3,341    5,350    9,010    13,589 
Adjusted allowance for loan losses  $33,476   $40,266   $48,480   $51,995 
                     
Loans, net of unearned income  $3,039,368   $2,966,847   $2,818,583   $2,837,253 
Remaining credit mark on purchased loans   3,341    5,350    9,010    13,589 
Adjusted loans, net of unearned income  $3,042,709   $2,972,197   $2,827,593   $2,850,842 
                     
ALL / gross loans, adjusted for acquisition accounting   1.10%   1.35%   1.71%   1.82%

 

- 53 -
 

  

QUARTERLY RESULTS

 

The following table presents the Company’s quarterly performance, as previously filed, for the years ended December 31, 2013 and 2012 (dollars in thousands, except per share amounts):

  

   Quarter 
   First   Second   Third   Fourth 
For the Year 2013                    
Interest and dividend income  $43,285   $42,686   $42,841   $43,315 
Interest expense   5,532    5,283    4,983    4,702 
Net interest income   37,753    37,403    37,858    38,613 
Provision for loan losses   2,050    1,000    1,800    1,206 
Net interest income after provision for loan losses   35,703    36,403    36,058    37,407 
Noninterest income   9,835    11,299    9,216    8,379 
Noninterest expenses   33,501    34,283    34,132    35,375 
Income before income taxes   12,037    13,419    11,142    10,411 
Income tax expense   3,054    3,956    3,196    2,306 
Net income  $8,983   $9,463   $7,946   $8,105 
                     
Earnings per share, basic  $0.36   $0.38   $0.32   $0.32 
Earnings per share, diluted  $0.36   $0.38   $0.32   $0.32 
                     
For the Year 2012                    
Interest and dividend income  $45,874   $45,302   $45,503   $45,183 
Interest expense   7,527    7,215    6,741    6,023 
Net interest income   38,347    38,087    38,762    39,160 
Provision for loan losses   3,500    3,000    2,400    3,300 
Net interest income after provision for loan losses   34,847    35,087    36,362    35,860 
Noninterest income   8,477    10,253    10,502    11,835 
Noninterest expenses   32,268    33,607    33,268    34,336 
Income before income taxes   11,056    11,733    13,596    13,359 
Income tax expense (benefit)   3,133    3,313    3,970    3,917 
Net income  $7,923   $8,420   $9,626   $9,442 
                     
Earnings per share, basic  $0.31   $0.32   $0.37   $0.37 
Earnings per share, diluted  $0.31   $0.32   $0.37   $0.37 

 

ITEM 7A. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

This information is incorporated herein by reference from Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.

 

- 54 -
 

  

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Union First Market Bankshares Corporation

Richmond, Virginia

 

We have audited the accompanying consolidated balance sheets of Union First Market Bankshares Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Union First Market Bankshares Corporation and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Union First Market Bankshares Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, and our report dated March 11, 2014 expressed an unqualified opinion on the effectiveness of Union First Market Bankshares Corporation and subsidiaries’ internal control over financial reporting.

 

/s/ Yount, Hyde & Barbour, P.C.

 

Winchester, Virginia

March 11, 2014

 

- 55 -
 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Union First Market Bankshares Corporation

Richmond, Virginia

 

We have audited Union First Market Bankshares and subsidiaries' internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Union First Market Bankshares Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.