10-K 1 v402863_10k.htm FORM 10K

 

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, 2014

 

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

 

Commission file number: 0-20293

 

 

 

UNION 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  x    No  ¨

 

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 x Accelerated filer ¨
       
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, 2014 was approximately $1,151,422,323 based on the closing share price on that date of $25.65 per share.

 

The number of shares of common stock outstanding as of February 20, 2015 was 45,054,738.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2015 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 
 

 

UNION 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 25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 57
Item 8. Financial Statements and Supplementary Data 58
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 129
Item 9A. Controls and Procedures 129
Item 9B. Other Information 129
     
  PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 130
Item 11. Executive Compensation 131
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 131
Item 13. Certain Relationships and Related Transactions, and Director Independence 132
Item 14. Principal Accounting Fees and Services 132
     
  PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 132
  Signatures 135

  

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 or the Subsidiary Bank Union Bank & Trust
BHCA Bank Holding Company Act of 1956
CDARS Certificates of Deposit Account Registry Service
CFPB Consumer Financial Protection Bureau
bps Basis points
the Company Union Bankshares Corporation, formerly known as Union First Market Bank
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, FSB
FRB or Federal Reserve Board of Governors of the Federal Reserve System
FTE Fully taxable equivalent
GAAP Accounting principles generally accepted in the United States
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
PCI Purchased credit impaired
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, LLC
UISI Union Investment Services, Inc.
UMG Union Mortgage Group, Inc.
VFG Virginia Financial Group, Inc.

 

 
 

 

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 subsidiary Union Bank & Trust and three non-bank financial services affiliates. The Company’s bank subsidiary and non-bank financial services affiliates are:

  

Community Bank
Union Bank & Trust Richmond, Virginia
   
Financial Services Affiliates
Union Mortgage Group, Inc. Glen Allen, Virginia
Union Investment Services, Inc. Richmond, Virginia
Union Insurance Group, LLC Richmond, Virginia

 

Effective April 25, 2014, the Company changed its corporate name from “Union First Market Bankshares Corporation” to “Union Bankshares Corporation.” The name change was approved at the Company’s annual meeting of shareholders held April 22, 2014. Effective February 16, 2015, the Company changed its subsidiary bank’s name from “Union First Market Bank” to “Union Bank & Trust.”

 

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 Bank & Trust were among the oldest in Virginia at the time they were acquired.

 

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The table below indicates the year each community bank was formed, acquired by the Company and merged into what is now Union Bank & Trust.

 

    Formed   Acquired   Merged
Union Bank & 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   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 operated StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014 at which time StellarOne Bank was merged with and into the 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. As of December 31, 2014, the Subsidiary Bank operates 131 locations in the counties of Albemarle, Augusta, Bedford, 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 Buena Vista, Charlottesville, Colonial Heights, Covington, Fredericksburg, Harrisonburg, Lynchburg, Newport News, Radford, Richmond, Roanoke, Salem, Staunton, Virginia Beach, and Waynesboro.

 

The Subsidiary Bank is a full service community bank 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 Bank issues 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 Bank also offers internet banking services and online bill payment for all customers, whether retail or commercial. The Subsidiary Bank also offers private banking and trust services to individuals and corporations through its Wealth Management Group, a division of the Subsidiary Bank.

  

UISI has provided securities, brokerage, and investment advisory services since its formation in February 1993. UISI gained 9 locations and opened 1 in connection with the StellarOne acquisition. It now has 19 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, 2014, UMG has offices in Virginia (16), Maryland (1), North Carolina (1), 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 with servicing released.

 

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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, “Segment Information – Community Bank Segment” and “Segment Information – 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 expected 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.

 

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 shares of common stock. The Company operated StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank was merged with and into the Bank. As part of the acquisition plan and cost control efforts, the Company consolidated 13 overlapping bank branches into nearby locations during 2014.

 

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 & Trust Company (former name of Union Bank & Trust) in March 2010 and the combined bank began to operate under the name Union First Market Bank.

 

The Bank currently operates in-store bank branches in 27 MARTIN’S Food Markets, one Fas Mart location, and one Walmart location. A significant majority of branches in the MARTIN’s Food Markets stores were acquired in connection with the Company’s acquisition of FMB.

 

Excluding the StellarOne acquisition, the Company’s new construction expansion during the last five years consisted of opening two new bank branches in Virginia:

 

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

 

Berea Marketplace, Union Bank & Trust branch located in Stafford County, Virginia (March 2011)

 

EMPLOYEES

 

As of December 31, 2014, the Company had approximately 1,471 full-time equivalent employees, including executive officers, loan and other banking officers, branch personnel, and operations and other support personnel. Of this total, 129 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.

 

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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, they 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 3.38% of total bank deposits as of June 30, 2014.

 

ECONOMY

 

The economies in the Company’s market areas are widely diverse and include local and federal government, military, agriculture, and manufacturing. Although the Company believes Virginia has weathered the recession better than most other states over the last several years, continued weakness in employment, a protracted low interest rate environment, and the burden of regulatory requirements enacted in response to the recent financial crisis made for a challenging 2014 for the Company and for community banks in general. Virginia’s housing industry and unemployment indicators were mixed in 2014 compared to the rest of the country, as the effect of federal sequestration and spending cuts dampened economic growth and employment in defense-related professional and business services sectors. Job growth also remained sluggish for the state’s businesses that were dependent on consumer spending. Progress in the near future for the state’s employment and the housing industry is uncertain given the prospect for higher long-term interest rates. Despite this uncertainty, Virginia ranked third in Forbes’ 2014 list of the Best States for Business, and ranked first in the regulatory category because of its strong incentive offerings and business-friendly government policies. The Company’s management continues to consider future economic events and their impact on the Company’s performance while focusing attention on managing nonperforming assets and controlling costs, and working with borrowers to mitigate and protect against risk of loss.

 

SUPERVISION AND REGULATION

 

The Company and the Subsidiary Bank are extensively 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 Bank. 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.

 

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 and 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 Federal Reserve. 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 Bank 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 Bank 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 Bank. 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.

 

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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. The permitted activities of a bank holding company are 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 financial 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 Bank – Community Reinvestment Act.”

 

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.

 

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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 Bank, 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.

 

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 Bank – 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 Bank, and such loans may be repaid from dividends paid by the Subsidiary Bank 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 Bank. There are various legal limitations applicable to the payment of dividends by the Subsidiary Bank to the Company and to the payment of dividends by the Company to its shareholders. The Subsidiary Bank is 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 Bank 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 Bank or the Company from engaging in an unsafe or unsound practice in conducting its respective business. The payment of dividends, depending on the financial condition of the Subsidiary Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice.

 

Under the FDIA, insured depository institutions such as the Subsidiary Bank, 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 Bank’s current financial condition, the Company does not expect that this provision will have any impact on its ability to receive dividends from the Subsidiary Bank. The Company’s non-bank subsidiaries pay dividends to the Company periodically on a non-regulated basis.

 

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In addition to dividends it receives from the Subsidiary Bank, 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 Bank

 

General. The Subsidiary Bank is 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.”

 

2014 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. 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 risk-based capital requirements of the Federal Reserve that were effective through December 31, 2014, the Company and the Subsidiary Bank were required to maintain a minimum ratio of total capital (which was 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, were 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 was required to be “Tier 1 capital,” which consisted 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”) consisted 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 12.77% and 13.40%, respectively, as of December 31, 2014, thus exceeding the minimum requirements. The Tier 1 and total capital to risk-weighted asset ratios of the Subsidiary Bank were 12.37% and 13.00%, respectively, as of December 31, 2014, also exceeding the minimum requirements.

 

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”) that was effective through December 31, 2014. The guidelines required a minimum Tier 1 leverage ratio of 3.0% for financial holding companies and banking organizations with the highest supervisory rating. All other banking organizations were required to maintain a minimum Tier 1 leverage ratio of 4.0% unless a different minimum was specified by an appropriate regulatory authority. In addition, for a depository institution to have been considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 leverage ratio must have been at least 5.0%. Under the guidelines, banking organizations that experienced internal growth or made acquisitions were expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve did not advise the Company or the Subsidiary Bank of any specific minimum leverage ratio applicable to either entity. As of December 31, 2014, the Tier 1 leverage ratios of the Company and the Subsidiary Bank were 10.63% and 10.30%, respectively, well above the minimum requirements.

 

New Capital Requirements. On June 7, 2012, the Federal Reserve issued a series of proposed rules that intended to 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.

 

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Effective January 1, 2015, the final rules require the Company and the Subsidiary Bank 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 prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). 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 Bank 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 2.5% 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 2.5% 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 by the same amount 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 Bank, the Federal Reserve’s final 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 prior ratio of 6.0%); and (iii) eliminating the 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. These new thresholds were effective for the Subsidiary Bank as of January 1, 2015. The minimum total capital to risk-weighted assets ratio (10.0%) and minimum leverage ratio (5.0%) for well-capitalized status were unchanged by the final rules.

 

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, 2014, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

Deposit Insurance. The deposits of the Subsidiary Bank 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.

 

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 2014 and 2013, the Company paid only the base assessment rate for “well capitalized” institutions, which totaled $5.1 million and $2.8 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.

 

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Transactions with Affiliates. Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Subsidiary Bank 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 Bank 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 Subsidiary Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Subsidiary Bank 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 Bank’s unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Subsidiary Bank is 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 Bank met the definition of being “well capitalized” as of December 31, 2014.

 

As described above in “The Subsidiary Bank – 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 Bank is 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 Bank receives 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 Bank received a “satisfactory” CRA rating in its most recent examination.

 

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.

 

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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 Bank. The final rules were effective April 1, 2014, with full compliance being phased in over a period which will end on July 21, 2016. The Company has evaluated the implications of the final rules on its investments and does not expect any material financial implications at this time.

 

Under 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 final 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. The regulators solicited comments on the interim final 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 final rule and, therefore, will not be required to divest any of such investments or change their accounting treatment. The Company is continuously reviewing its investments to ensure compliance as the various provisions of the Volcker Rule regulations become effective.

 

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 intended to be in compliance with the ability-to-pay requirements.

 

Consumer Laws and Regulations. The Subsidiary Bank is 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 Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations.

 

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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 Bank, 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, 2014, the Company and the Subsidiary Bank 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 http://www.sec.gov.

 

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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 economies in the Company’s market areas improved during 2014, though growth remained sluggish. 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 2014, there can be no assurance that this improvement will continue.

 

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.

 

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. 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.

 

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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 Bank is 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 mortgage revenue is cyclical and is sensitive to the level of interest rates, changes in economic conditions, decreased economic activity, and slowdowns in the housing market, any of which could adversely impact the Company’s profits.

 

The success of the Company’s mortgage business is dependent upon its ability to originate loans and sell them to investors at or near current volumes. Loan production levels are sensitive to changes in the level of interest rates and changes in economic conditions. Loan production levels may suffer if the Company experiences a slowdown in the local housing market or tightening credit conditions. Any sustained period of decreased activity caused by fewer refinancing transactions, higher interest rates, housing price pressure or loan underwriting restrictions would adversely affect the Company’s mortgage originations and, consequently, could significantly reduce its income from mortgage activities. As a result, these conditions would also adversely affect the Company’s results of operations.

 

Deteriorating economic conditions may also cause home buyers to default on their mortgages. In certain cases where the Company has originated loans and sold them to investors, the Company may be required to repurchase loans or provide a financial settlement to investors if it is proven that the borrower failed to provide full and accurate information on, or related to, their loan application, if appraisals for such properties have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor. Such repurchases or settlements would adversely affect the Company’s results of operations.

 

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.

 

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

 

The Bank 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 Bank’s loans are secured by real estate (both residential and commercial) in the Bank’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 negatively affect the Bank. Risks of loan defaults and foreclosures are unavoidable in the banking industry; the Bank tries to limit its exposure to these risks by monitoring extensions of credit carefully. The Bank 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 Bank 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 Bank’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 Bank’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 Bank’s financial condition.

 

The Bank’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 Bank’s results of operations.

 

The Bank’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 Bank’s financial condition.

 

Although most of the Bank’s construction and development loans are secured by real estate, the Bank 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. If the Bank 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 Bank’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 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 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.

 

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.

 

- 15 -
 

 

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 its 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 $293.5 million at December 31, 2014, which included goodwill recorded with the Company’s acquisition of StellarOne.

 

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 its business. Furthermore, as cyber threats continue to evolve and increase, the Company may be required to expend significant additional resources to modify or enhance its protective measures, or to investigate and remediate any identified information security vulnerabilities.

 

- 16 -
 

 

The operational functions of business counterparties over which the Company may have limited or no control may experience disruptions that could adversely impact the Company.

 

Multiple major U.S. retailers have recently experienced data systems incursions reportedly resulting in the thefts of credit and debit card information, online account information, and other financial data of tens of millions of the retailers’ customers. Retailer incursions affect cards issued and deposit accounts maintained by many banks, including the Subsidiary Bank. Although neither the Company’s nor the Subsidiary Bank’s systems are breached in retailer incursions, these events can cause the Subsidiary Bank to reissue a significant number of cards and take other costly steps to avoid significant theft loss to the Subsidiary Bank and its customers. In some cases, the Subsidiary Bank may be required to reimburse customers for the losses they incur. Other possible points of intrusion or disruption not within the Company’s nor the Subsidiary Bank’s control include internet service providers, electronic mail portal providers, social media portals, distant-server (“cloud”) service providers, electronic data security providers, telecommunications companies, and smart phone manufacturers.

 

Current and proposed regulation addressing consumer privacy and data use and security could increase the Company’s costs and impact its reputation.

 

The Company is subject to a number of laws concerning consumer privacy and data use and security, including information safeguard rules under the Gramm-Leach-Bliley Act. These rules require that financial institutions develop, implement, and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities, and the sensitivity of any customer information at issue. The United States has experienced a heightened legislative and regulatory focus on privacy and data security, including requiring consumer notification in the event of a data breach. In addition, most states have enacted security breach legislation requiring varying levels of consumer notification in the event of certain types of security breaches. New regulations in these areas may increase compliance costs, which could negatively impact earnings. In addition, failure to comply with the privacy and data use and security laws and regulations to which the Company is subject, including by reason of inadvertent disclosure of confidential information, could result in fines, sanctions, penalties, or other adverse consequences and loss of consumer confidence, which could materially adversely affect our results of operations, overall business, and reputation.

 

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 include higher capital requirements, and could include increased insurance premiums, increased compliance costs, reductions of noninterest 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.

 

- 17 -
 

 

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 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 the Company’s 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 is 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 Bank 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. These stricter capital requirements will be phased-in over a four-year period, which began on January 1, 2015, until they are fully-implemented on January 1, 2019. See “Business − Supervision and Regulation − New Capital Requirements” for further information about the requirements. If the Company and the Subsidiary Bank fail to meet these minimum capital guidelines and/or other regulatory requirements, the Company’s financial condition would be materially and adversely affected.

 

Recent 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 rule also contains additional 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 Bank relies 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 Bank is forced to foreclose upon such loans.

 

A significant portion of the Subsidiary Bank’s loan portfolio consists of loans secured by real estate. The Subsidiary Bank relies 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 Bank may not be able to recover the outstanding balance of the loan.  

 

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

 

Third parties provide key components of the Company’s (and the Subsidiary Bank’s) 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.

 

- 18 -
 

 

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.

 

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 Bank 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.

 

- 19 -
 

 

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.

 

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 Bank 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 Bank 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, the Company cannot predict the effect, if any, that future sales of the its 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 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 expected 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, 2014.

 

ITEM 2. - PROPERTIES.

 

The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. The Company’s corporate headquarters is located at 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, 2014, the Bank operated 131 branches throughout Virginia. All of the offices of UMG are leased, either from a third party or as a result of being within a Bank branch. The vast majority of the offices of UISI are located within Bank branch properties. The Company’s operations center is in Ruther Glen, Virginia. See the Note 1 “Summary of Significant Accounting Policies” and Note 5 “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, 2014, with (1) the Total Return Index for the NASDAQ Composite and (2) the Total Return Index for NASDAQ Bank. This comparison assumes $100 was invested on December 31, 2009 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 Bankshares Corporation

 

 

   Period Ending 
Index  12/31/09   12/31/10   12/31/11   12/31/12   12/31/13   12/31/14 
Union Bankshares Corporation   100.00    121.52    111.87    136.21    219.89    218.59 
NASDAQ Composite   100.00    118.15    117.22    138.02    193.47    222.16 
NASDAQ Bank   100.00    114.16    102.17    121.26    171.86    180.31 

 

Source: SNL Financial Corporation LC, Charlottesville, VA (2015)

 

- 22 -
 

 

Information on Common Stock, Market Prices and Dividends

 

The Company’s common stock is listed on the NASDAQ Global Select Market and is traded under the symbol “UBSH.” There were 45,162,853 shares of the Company’s common stock outstanding at the close of business on December 31, 2014, which were held by 4,680 shareholders of record. The closing price of the Company’s common stock on December 31, 2014 was $24.08 per share compared to $24.81 on December 31, 2013.

 

The following table summarizes the high and low sales prices and dividends declared for quarterly periods during the years ended December 31, 2014 and 2013.

 

                   Dividends 
   Sales Prices   Declared 
   2014   2013   2014   2013 
   High   Low   High   Low         
First Quarter  $26.72   $22.57   $20.25   $15.87   $0.14   $0.13 
Second Quarter   26.42    23.86    21.40    18.01   $0.14   $0.13 
Third Quarter   26.23    21.86    23.54    20.48   $0.15   $0.14 
Fourth Quarter   24.99    20.78    26.29    22.99   $0.15   $0.14 
                       $0.58   $0.54 

 

Regulatory restrictions on the ability of the Bank to transfer funds to the Company at December 31, 2014 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 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.

 

The following information describes the Company’s common stock repurchases for the year ended December 31, 2014:

 

Period  Total number of
shares
purchased (1)
   Average price
paid per share
($)
   Total number of
shares purchased as
part of publicly
announced plan
   Approximate value
of shares that may
yet be purchased
under the plan ($)
 
February 26 - February 28, 2014   206,886    25.01    206,886    59,826,000 
March 1 - March 31, 2014   303,629    25.62    303,629    52,047,000 
April 1 - April 30, 2014   390,818    25.14    390,818    42,222,000 
May 1 - May 30, 2014   251,642    24.93    251,642    35,948,000 
June 1 - June 30, 2014   189,100    25.47    189,100    31,131,000 
July 1 - July 31, 2014   242,350    25.06    242,350    25,058,000 
August 1 - August 31, 2014   62,600    23.95    62,600    23,559,000 
September 1 - September 30, 2014   84,000    23.65    84,000    21,572,000 
October 1 - October 31, 2014   65,739    22.94    65,739    20,064,000 
November 1 - November 30, 2014   195,000    22.89    195,000    15,601,000 
December 1 - December 31, 2014   133,500    23.53    133,500    12,460,000 
   Total   2,125,264    24.72    2,125,264    12,460,000 

 

(1)On January 31, 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. The Company intends to continue to repurchase shares under this program.

 

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Director Stock Retainer

 

Beginning in the third quarter of 2014, non-employee members of the Company’s Board of Directors may elect to receive, on a quarterly basis, either cash or Company common stock in lieu of an annual stock retainer for services as a director. During the third and fourth quarter of 2014, certain shares were issued to non-employee directors of the Company’s Board of Directors and the boards of certain affiliates of the Company from authorized but unissued shares of the Company’s common stock as compensation to such directors for their services to the applicable board. Such shares are considered exempt from registration as they were issued pursuant to Section 4(a)(2) of the Securities Act of 1933. The shares were also issued in a transaction that meets the requirements of Rule 16b-3(d) of the Exchange Act.

 

In 2014, the Company issued the following stock retainer awards including shares exempt from registration as set forth above:

 

   Issue Date  Total number
of shares
issued
   Price per
share ($)
   Valuation
($)
 
Union Bankshares Corporation Board of Directors (1)                  
  July 31, 2014   10,580    24.22    256,248 
   September 3, 2014   4,483    23.70    106,247 
   December 4, 2014   4,224    23.68    100,024 
Bank and UMG Boards of Directors (2)                  
   December 1, 2014   10,770    23.30    250,938 
      Total   30,057         713,457 

 

(1)The price per share is based on the per share closing sale price of the Company’s common stock on the date prior to the issue date.

 

(2)The price per share is based on the five-day moving average closing sale price of the Company’s common stock on the date prior to the issue date.

 

For the year ended December 31, 2014 the aggregate amount of Director services received by the company for the stock issuances was $713,457.

  

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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):

 

   2014   2013   2012   2011   2010 
Results of Operations (1)                         
Interest and dividend income  $274,945   $172,127   $181,863   $189,073   $189,821 
Interest expense   19,927    20,501    27,508    32,713    38,245 
Net interest income   255,018    151,626    154,355    156,360    151,576 
Provision for loan losses   7,800    6,056    12,200    16,800    24,368 
Net interest income after provision for loan losses   247,218    145,570    142,155    139,560    127,208 
Noninterest income   61,287    38,728    41,068    32,964    34,217 
Noninterest expenses   238,552    137,289    133,479    130,815    129,920 
Income before income taxes   69,953    47,009    49,744    41,709    31,505 
Income tax expense   17,362    12,513    14,333    11,264    8,583 
Net income  $52,591   $34,496   $35,411   $30,445   $22,922 
                          
Financial Condition                         
Assets  $7,359,171   $4,176,571   $4,095,865   $3,907,087   $3,837,247 
Loans, net of unearned income   5,345,996    3,039,368    2,966,847    2,818,583    2,837,253 
Deposits   5,638,770    3,236,842    3,297,767    3,175,105    3,070,059 
Stockholders' equity   978,025    438,239    435,863    421,639    428,085 
                          
Ratios                         
Return on average assets (1)   0.73%   0.85%   0.89%   0.79%   0.61%
Return on average equity (1)   5.34%   7.91%   8.13%   6.90%   5.50%
Return on average tangible common equity (1)   8.08%   9.51%   9.89%   9.34%   7.68%
Efficiency ratio (FTE) (1)   73.53%   70.19%   66.86%   67.55%   68.19%
Efficiency ratio - community bank segment (FTE) (1)   70.92%   65.81%   65.88%   66.84%   68.59%
Efficiency ratio - mortgage bank segment (FTE)   148.71%   130.58%   77.66%   79.20%   64.22%
Common equity to total assets   13.29%   10.49%   10.64%   10.79%   10.26%
Tangible common equity / tangible assets   9.28%   8.94%   8.97%   8.91%   8.22%
                          
Asset Quality                         
Allowance for loan losses  $32,384   $30,135   $34,916   $39,470   $38,406 
Nonaccrual loans  $19,255   $15,035   $26,206   $44,834   $61,716 
Other real estate owned  $28,118   $34,116   $32,834   $32,263   $36,122 
ALL / total outstanding loans   0.61%   0.99%   1.18%   1.40%   1.35%
ALL / total outstanding loans, adjusted for acquisition accounting (1)   1.08%   1.10%   1.35%   1.71%   1.82%
ALL / nonperforming loans   168.19%   200.43%   133.24%   88.04%   62.23%
NPAs / total outstanding loans   0.89%   1.62%   1.99%   2.74%   3.45%
Net charge-offs / total outstanding loans   0.10%   0.36%   0.56%   0.56%   0.58%
Provision / total outstanding loans   0.15%   0.20%   0.41%   0.60%   0.86%
                          
Per Share Data                         
Earnings per share, basic (1)  $1.14   $1.38   $1.37   $1.07   $0.83 
Earnings per share, diluted (1)   1.14    1.38    1.37    1.07    0.83 
Cash dividends paid   0.58    0.54    0.37    0.28    0.25 
Market value per share   24.08    24.81    15.77    13.29    14.78 
Book value per common share   21.75    17.56    17.30    16.17    15.16 
Price to earnings ratio, diluted   21.12    17.98    11.51    12.42    17.81 
Price to book value ratio   1.11    1.41    0.91    0.82    0.98 
Dividend payout ratio   50.88%   39.13%   27.01%   26.17%   30.12%
Weighted average shares outstanding, basic   46,036,023    24,975,077    25,872,316    25,981,222    25,222,565 
Weighted average shares outstanding, diluted   46,130,895    25,030,711    25,900,863    26,009,839    25,268,216 

 

(1) The metrics presented here are presented on a GAAP basis; however, there are related supplemental non-GAAP performance measures that 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.  Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", section "Non GAAP Measures" for operating metrics, which exclude acquisition-related costs, including operating earnings, return on average assets, return on average equity, return on average tangible common equity, efficiency ratio, and earnings per share for the years ended December 31, 2014, 2013, and 2012 only.                                        

 

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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 Loan Review 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.

 

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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 charges 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.

 

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, 2014, there were no material amounts considered unallocated as part of the allowance for loan losses.

 

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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.

 

Business Combinations and Acquired Loans

 

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 Company’s Consolidated Statements of Income classified within the noninterest expense caption.

 

Loans acquired in a business combination are recorded at fair value on the date of the acquisition. Loans acquired with deteriorated credit quality are accounted for in accordance with ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality, and are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are not considered to be impaired unless they deteriorate further subsequent to the acquisition. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with ASC 310-20, Receivables – Nonrefundable Fees and Other Costs, where the discount is accreted through earnings based on estimated cash flows over the estimate life of the loan.

 

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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. Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selected April 30, 2014 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives, which range from 4 to 14 years, to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Company’s Consolidated Balance Sheets.

 

Long-lived assets, including purchased intangible assets subject to amortization, such as the core deposit intangible asset, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. Management concluded that no circumstances indicating an impairment of these assets existed as of the balance sheet date.

 

The Company performed its annual impairment testing on April 30 and determined that there was no impairment to its goodwill or intangible assets. Subsequently, the Company determined that an additional evaluation was necessary at year-end due to potential indicators based on the net losses recorded at the mortgage company during 2014. Based on this additional testing, the Company confirmed that no impairment charges to date for goodwill or intangible assets were necessary. If the Company’s mortgage segment does not show improvement in subsequent periods, the Company may be required to perform a step two impairment analysis.

 

RESULTS OF OPERATIONS

 

Executive Overview

 

·The Company reported net income of $52.6 million and earnings per share of $1.14 for its year ended December 31, 2014. Excluding after-tax acquisition-related costs of $13.7 million, operating earnings(1) for the year were $66.3 million and operating earnings per share(1) was $1.44. The annual results represent an increase of $29.8 million, or 81.5%, in operating earnings and a decrease of $0.02 per share, or 1.4%, from 2013 levels. The 2014 financial results include the full-year financial results of StellarOne, which the Company acquired on January 1, 2014.

·The Company’s community banking segment reported operating earnings of $69.8 million for the year ended December 31, 2014, an increase of $30.6 million from the prior year, and operating earnings per share of $1.52, a decrease of $0.05 per share from the prior year. The Company’s mortgage segment reported a net loss of $3.5 million, an increased loss of $839,000, from a net loss of $2.7 million in the prior year.

·The Company experienced continued improvement in asset quality. Nonperforming assets, net charge-offs, and loans past due 90 days or more and still accruing interest as a percentage of total loans outstanding, declined from December 31, 2013.

·On January 31, 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. As of December 31, 2014, approximately 2.1 million shares of common stock had been repurchased, with approximately $12.5 million remaining available under the repurchase program.

·The Company successfully integrated StellarOne, achieving cost savings targets and experiencing lower than expected customer attrition.

·Average loans increased approximately $2.2 billion from December 31, 2013 and average deposits increased approximately $2.4 billion, primarily due to the acquisition of StellarOne.

·Cash dividends per common share increased from $0.54 per common share during 2013 to $0.58 during 2014.

 

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

 

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Net Income

 

2014 compared to 2013 

Net income for the year ended December 31, 2014 increased $18.1 million, or 52.4%, from $34.5 million to $52.6 million and represented earnings per share of $1.14 compared to $1.38 for the prior year. The $18.1 million increase in net income included the full-year impact of the StellarOne acquisition. Net interest income increased $103.4 million from 2013, largely a result of an increase of $2.7 billion in average interest-earning assets and $2.1 billion in average interest-bearing liabilities resulting from the StellarOne acquisition. The provision for loan losses increased $1.7 million from $6.1 million in 2013 to $7.8 million in 2014 due to increases in specific reserves on impaired loans and loan growth in the fourth quarter of 2014.

 

Noninterest income increased $22.6 million from $38.7 million in 2013 to $61.3 million in 2014. The majority of the increase was driven by customer-related noninterest income (services charges on deposit accounts, debit card and ATM interchange income, and income from fiduciary and asset management services) and is primarily due to the acquisition of StellarOne. Additionally, income related to bank owned life insurance policies increased $2.3 million and gains on sale of securities increased $1.7 million from 2013. Offsetting these increases, gains on sales of mortgage loans, net of commissions, declined $2.2 million, a result of a decline in origination volume of $264.0 million, or 28.0%, to $677.4 million from $941.4 million during the prior year. The significant decline in origination volume was primarily driven by lower refinance volume as well as lower purchased volume.

 

Noninterest expense increased $101.3 million, or 73.8%, from $137.3 in 2013 to $238.6 million in 2014, and included the full-year impact of the StellarOne acquisition. Salaries and benefits expenses increased $37.4 million driven by the net addition of approximately 450 branch and management personnel; acquisition-related expenses increased $18.2 million from $2.1 million during 2013; occupancy expenses increased $8.6 million driven by the added rent expense and depreciation on acquired branches; OREO and credit-related expenses increased $5.3 million driven by a $6.2 million valuation adjustment recorded in the third quarter of 2014. Amortization expense increased $6.0 million due to purchase accounting amortization on acquired deposits. Other increases included higher telephone, technology, and data processing costs of $6.9 million related to additional personnel and transaction processing, higher FDIC and liability insurance costs of $3.0 million, and higher marketing and advertising expense of $2.1 million related to public relations and brand awareness campaigns of the combined banks after the StellarOne integration.

 

Excluding after-tax acquisition-related expenses of $13.7 million and $2.0 million for the years ended December 31, 2014 and 2013, respectively, operating earnings were $66.3 million and $36.5 million. Operating earnings per share was $1.44 for the year ended December 31, 2014 compared to $1.46 for the year ended December 31, 2013. Return on average tangible common equity for the year ended December 31, 2014 was 8.08% compared to 9.51% for the prior year, while return on average assets was 0.73% compared to 0.85% for the prior year. Operating return on average tangible common equity (which excludes after-tax acquisition-related expenses) for the year ended December 31, 2014 was 10.19% compared to 10.07% for the prior year, while operating return on average assets was 0.91% compared to 0.90% for the prior year.

 

2013 compared to 2012 

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 2012. The $915,000 decrease in net income was principally a result of a decrease in net interest income 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 StellarOne merger-related expenses. These items were partially offset by a $6.1 million decrease in provision for loan losses due to continued improvement in asset quality.

 

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 compared to $35.4 million and $1.37 for 2012. Return on average equity for the year ended December 31, 2013 was 7.91% compared to 8.13% for 2012, while return on average assets was 0.85% compared to 0.89% for 2012; operating return on average equity for the year ended December 31, 2013 was 8.38% compared to 8.13% for 2012 while operating return on average assets was 0.90% compared to 0.89% for 2012.

 

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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 several 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 partially offset by the re-pricing 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 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     
   December 31,     
   2014   2013   Change 
   (Dollars in thousands) 
Average interest-earning assets  $6,437,681   $3,716,849   $2,720,832 
Interest income (FTE)  $283,072   $177,383   $105,689 
Yield on interest-earning assets   4.40%   4.77%   (37)bps
Average interest-bearing liabilities  $5,047,550   $2,914,139   $2,133,411 
Interest expense  $19,927   $20,501   $(574)
Cost of interest-bearing liabilities   0.39%   0.70%   (31)bps
Cost of funds   0.31%   0.55%   (24)bps
Net Interest Income (FTE)  $263,145   $156,882   $106,263 
Net Interest Margin (FTE)   4.09%   4.22%   (13)bps
Core Net Interest Margin (FTE) (1)   3.93%   4.18%   (25)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, 2014, tax-equivalent net interest income was $263.1 million, an increase of $106.3 million, or 67.7%, when compared to the prior year, a result of a $2.7 billion increase in average interest-earning assets and a $2.1 billion increase in average interest-bearing liabilities from the impact of the StellarOne acquisition. The tax-equivalent net interest margin decreased by 13 basis points to 4.09% from 4.22% in the prior year. Core tax-equivalent net interest margin (which excludes the 16 basis points impact of acquisition accounting accretion) decreased by 25 basis points. The decline in the core net interest margin was principally due to a decrease in interest-earning asset yields (-33 basis points), outpacing the decline in cost of funds (+8 basis points). The decline in interest-earning asset yields was primarily driven by reinvestment of excess cash flows at lower rates during the year and lower loan yields, as new and renewed loans were originated and re-priced at lower rates. In addition, the declines in net interest margin and earning asset yields in 2014 were driven by the impact of the StellarOne acquisition in the current year as StellarOne’s net interest margin and earning asset yields were lower than that of the Company’s prior to acquisition.

 

- 31 -
 

 

   For the Year Ended     
   December 31,     
   2013   2012   Change 
   (Dollars in thousands) 
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 2012. The tax-equivalent net interest margin decreased by 12 basis points to 4.22% from 4.34% in 2012. 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). The decline in interest-earning asset yields was primarily driven by reinvestment of excess cash flows at lower rates during 2013 and lower loan yields, as new and renewed loans were originated and re-priced at lower rates.

  

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The following table shows interest income on interest-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, 
   2014   2013   2012 
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
 
   (Dollars in thousands) 
Assets:                                             
Securities:                                             
Taxable  $722,600   $15,226    2.11%  $391,804   $8,202    2.09%  $462,996   $11,912    2.57%
Tax-exempt   402,402    20,451    5.08%   223,054    12,862    5.77%   179,977    11,155    6.20%
Total securities (2)   1,125,002    35,677    3.17%   614,858    21,064    3.43%   642,973    23,067    3.59%
Loans, net (3) (4)   5,235,471    245,529    4.69%   2,985,733    152,868    5.12%   2,875,916    159,682    5.55%
Loans held for sale   46,917    1,805    3.85%   105,450    3,433    3.26%   104,632    3,273    3.13%
Federal funds sold   694    1    0.19%   421    1    0.22%   365    1    0.24%
Money market investments   1    -    0.00%   1    -    0.00%   -    -    0.00%
Interest-bearing deposits in other banks   29,596    60    0.20%   10,386    17    0.17%   25,979    62    0.24%
Total earning assets   6,437,681   $283,072    4.40%   3,716,849   $177,383    4.77%   3,649,865   $186,085    5.10%
Allowance for loan losses   (31,288)             (34,533)             (40,460)          
Total non-earning assets   844,629              369,752              365,820           
Total assets  $7,251,022             $4,052,068             $3,975,225           
                                              
Liabilities and Stockholders' Equity:                                             
Interest-bearing deposits:                                             
Transaction and money market accounts  $2,568,425   $4,714    0.18%  $1,403,721   $2,696    0.19%  $1,328,958   $3,769    0.28%
Regular savings   552,756    1,063    0.19%   226,343    680    0.30%   197,228    662    0.34%
Time deposits (5)   1,390,308    5,257    0.38%   961,359    10,721    1.12%   1,099,252    15,015    1.37%
Total interest-bearing deposits   4,511,489    11,034    0.24%   2,591,423    14,097    0.54%   2,625,438    19,446    0.74%
Other borrowings (6)   536,061    8,893    1.66%   322,716    6,404    1.98%   296,935    8,062    2.72%
Total interest-bearing liabilities   5,047,550   $19,927    0.39%   2,914,139   $20,501    0.70%   2,922,373   $27,508    0.94%
                                              
Noninterest-bearing liabilities:                                             
Demand deposits   1,164,032              664,203              577,740           
Other liabilities   54,857              37,662              39,338           
Total liabilities   6,266,439              3,616,004              3,539,451           
Stockholders' equity   984,583              436,064              435,774           
Total liabilities and stockholders' equity  $7,251,022             $4,052,068             $3,975,225           
                                              
Net interest income       $263,145             $156,882             $158,577      
                                              
Interest rate spread (7)             4.01%             4.07%             4.16%
Interest expense as a percent of average earning assets           0.31            0.55                0.76 %
Net interest margin (8)             4.09%             4.22%             4.34%

 

(1) Rates and yields are annualized and calculated from actual, not rounded amounts in thousands, which appear above.
(2) Interest income on securities includes $0, $15,000, and $201,000 for the years ended December 31, 2014, 2013, and 2012, respectively, in accretion of the fair market value adjustments.
(3) Nonaccrual loans are included in average loans outstanding.
(4) Interest income on loans includes $586,000, $2.1 million, and $3.7 million for the years ended December 31, 2014, 2013, and 2012, respectively, in accretion of the fair market value adjustments related to acquisitions.
(5) Interest expense on certificates of deposits includes $8.9 million, $7,000, and $233,000 for the years ended December 31, 2014, 2013, and 2012, respectively, in accretion of the fair market value adjustments related to acquisitions.
(6) Interest expense on borrowings includes $550,000, $489,000, and $489,000 for the years ended December 31, 2014, 2013, and 2012, respectively 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 3.93%, 4.18%, and 4.24% for the years ended December 31, 2014, 2013, and 2012, respectively.

 

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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 interest-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):

 

   2014 vs. 2013   2013 vs. 2012 
   Increase (Decrease) Due to Change in:   Increase (Decrease) Due to Change in: 
   Volume   Rate   Total   Volume   Rate   Total 
Earning Assets:                              
Securities:                              
Taxable  $6,947   $77   $7,024   $(1,675)  $(2,035)  $(3,710)
Tax-exempt   9,281    (1,692)   7,589    2,523    (816)   1,707 
Total securities   16,228    (1,615)   14,613    848    (2,851)   (2,003)
Loans, net   106,471    (13,810)   92,661    5,908    (12,722)   (6,814)
Loans held for sale   (2,165)   537    (1,628)   25    135    160 
Interest-bearing deposits in other banks   40    3    43    (31)   (14)   (45)
Total earning assets  $120,574   $(14,885)  $105,689   $6,750   $(15,452)  $(8,702)
                               
Interest-Bearing Liabilities:                              
Interest-bearing deposits:                              
Transaction and money market accounts  $2,191   $(173)  $2,018   $162   $(1,235)  $(1,073)
Regular savings   700    (317)   383    97    (79)   18 
Time deposits   3,500    (8,964)   (5,464)   (1,766)   (2,528)   (4,294)
Total interest-bearing deposits   6,391    (9,454)   (3,063)   (1,507)   (3,842)   (5,349)
Other borrowings   3,660    (1,171)   2,489    662    (2,320)   (1,658)
Total interest-bearing liabilities   10,051    (10,625)   (574)   (845)   (6,162)   (7,007)
                               
Change in net interest income  $110,523   $(4,260)  $106,263   $7,595   $(9,290)  $(1,695)

 

The Company’s fully taxable equivalent net interest margin includes the impact of acquisition accounting fair value adjustments. The 2014 and remaining estimated discount/premium and net accretion impact are reflected in the following table (dollars in thousands):

 

   Accretion   Amortization     
   Loan   Certificates
of Deposit
   Borrowings   Total 
                 
For the year ended December 31, 2014  $586   $8,914   $550   $10,050 
For the years ending:                    
2015   1,792    1,843    175    3,810 
2016   2,525    -    271    2,796 
2017   2,898    -    170    3,068 
2018   2,594    -    (143)   2,451 
2019   2,035    -    (286)   1,749 
Thereafter   12,473    -    (5,923)   6,550 

 

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Noninterest Income

 

   For the Year Ended     
   December 31,   Change 
   2014   2013   $   % 
   (Dollars in thousands) 
Noninterest income:                    
Service charges on deposit accounts  $17,721   $9,492   $8,229    86.7%
Other service charges, commissions and fees   14,983    8,607    6,376    74.1%
Fiduciary and asset management fees   9,036    5,183    3,853    74.3%
Gains on sales of mortgage loans, net of commissions   9,707    11,900    (2,193)   -18.4%
Gains on securities transactions, net   1,695    21    1,674    NM 
Losses on bank premises, net   (184)   (340)   156    -45.9%
Bank owned life insurance income   4,648    2,311    2,337    101.1%
Other operating income   3,681    1,554    2,127    136.9%
Total noninterest income  $61,287   $38,728   $22,559    58.2%
                     
Mortgage segment operations  $(10,091)  $(11,906)  $1,815    -15.2%
Intercompany eliminations   682    670    12    1.8%
Community Bank segment  $51,878   $27,492   $24,386    88.7%
                     

  NM - Not Meaningful

             

 

For the year ended December 31, 2014, noninterest income increased $22.6 million, or 58.2%, to $61.3 million, from $38.7 million a year ago, largely a result of the StellarOne acquisition. Excluding mortgage segment operations, noninterest income increased $24.4 million, or 88.7%, from last year. Service charges on deposit accounts and other account service charges and fees increased $14.6 million due to higher volume in all product and service lines, a result of the addition of StellarOne’s deposit accounts. Fiduciary and asset management fees increased $3.9 million, a result of the contribution of the StellarOne’s wealth management and trust operations. Gains on sales of mortgage loans, net of commissions, decreased $2.2 million driven by lower loan origination volume and lower gain on sale margins in 2014. Mortgage loan originations decreased by $264.0 million, or 28.0%, to $677.4 million in 2014 compared to $941.4 million in 2013. Of the loan originations in 2014, 29.9% were refinances compared to 38.9% in 2013.

 

   For the Year Ended     
   December 31,   Change 
   2013   2012   $   % 
   (Dollars in thousands) 
Noninterest income:                    
Service charges on deposit accounts  $9,492   $9,033   $459    5.1%
Other service charges, commissions and fees   8,607    7,890    717    9.1%
Fiduciary and asset management fees   5,183    4,324    859    19.9%
Gains on sales of mortgage loans, net of commissions   11,900    16,651    (4,751)   -28.5%
Gains on securities transactions, net   21    190    (169)   NM 
(Losses) gains on bank premises, net   (340)   2    (342)   NM 
Bank owned life insurance income   2,311    1,950    361    18.5%
Other operating income   1,554    1,028    526    51.2%
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              

 

- 35 -
 

 

For the year ended December 31, 2013, noninterest income decreased $2.4 million, or 5.7%, to $38.7 million, from $41.1 million in 2012. Excluding mortgage segment operations, noninterest income increased $2.6 million, or 10.5%, from 2012. 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 $717,000 due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other income increases were related to increased income on bank owned life insurance of $361,000, fiduciary and asset management fees of $859,000, and other operating income of $526,000, which was primarily related to other insurance-related revenues. Conversely, gains on bank premises decreased $342,000 as the Company recorded a loss in 2013 on the closure of bank premises coupled with net gains in 2012 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 2013, 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.

 

Noninterest expense

 

   For the Year Ended         
   December 31,   Change 
   2014   2013   $   % 
   (Dollars in thousands) 
Noninterest expense:                    
Salaries and benefits  $107,804   $70,369   $37,435    53.2%
Occupancy expenses   20,136    11,543    8,593    74.4%
Furniture and equipment expenses   11,872    6,884    4,988    72.5%
OREO and credit-related expenses (1)   10,164    4,880    5,284    108.3%
Acquisition-related expenses   20,345    2,132    18,213    854.3%
Other operating expenses   68,231    41,481    26,750    64.5%
Total noninterest expense  $238,552   $137,289   $101,263    73.8%
                     
Mortgage segment operations  $(16,587)  $(17,703)  $1,116    -6.3%
Intercompany eliminations   682    670    12    1.8%
Community Bank segment  $222,647   $120,256   $102,391    85.1%
  
  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, 2014, noninterest expense increased $101.3 million, or 73.8%, to $238.6 million, from $137.3 million a year ago, largely a result of the StellarOne acquisition. Excluding acquisition-related costs of $2.1 million and $20.3 million incurred in 2013 and 2014, respectively, noninterest expense increased $83.1 million, or 61.5%, compared to 2013. Salaries and benefits expense increased $37.4 million due to the net addition of approximately 450 employees associated with the acquisition. Occupancy expenses increased $8.6 million in 2014, a result of additional rent, utilities, and depreciation on acquired branches and service centers, partially offset by cost savings associated with the closure of 13 overlapping bank branches into nearby locations.  Furniture and equipment expenses increased $5.0 million due to additional acquisition-related depreciation expense and equipment maintenance. OREO and credit-related expenses increased $5.3 million mainly related to valuation adjustments of $6.2 million recorded on OREO property in third quarter of 2014, as the Company’s management shifted its strategy to more aggressively market OREO properties in inactive rural markets that have continued to struggle coming out of the economic downturn and for which transaction volume for comparable sales has been slow or nonexistent. The higher valuation adjustments were partially offset by gains on sales of property. Other operating expenses, including amortization on the acquired core deposit portfolio, communication and technology expenses for additional internet, telephone, and data processing services for the combined companies, additional marketing expenses related to building brand awareness of the combined companies, and additional FDIC insurance expenses increased $26.8 million, due to the acquisition of StellarOne.

 

- 36 -
 

 

   For the Year Ended         
   December 31,   Change 
   2013   2012   $   % 
   (Dollars in thousands) 
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 in 2012. 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 2013 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 2013. 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.

 

SEGMENT INFORMATION

 

Community Bank Segment

 

2014 compared to 2013

For the year ended December 31, 2014, which included the full-year impact of the StellarOne acquisition, the community bank’s net income increased $18.9 million, or 51.0%, to $56.1 million when compared to the prior year. Excluding after-tax acquisition-related costs of $13.7 million and $2.0 million in 2014 and 2013, respectively, net income increased $30.6 million, or 78.1%. Net interest income increased $104.0 million from 2013, largely a result of an increase of $2.7 billion in average interest-earning assets and $2.1 billion in average interest-bearing liabilities resulting from the StellarOne acquisition. The provision for loan losses increased $1.7 million from $6.1 million in 2013 to $7.8 million in 2014 due to increases in specific reserves on impaired loans and loan growth in the fourth quarter of 2014.

 

Noninterest income increased $24.4 million from $27.5 million in 2013 to $51.9 million in 2014. The majority of the increase was driven by customer-related noninterest income (services charges on deposit accounts, debit card and ATM interchange income, and income from fiduciary and asset management services) and is primarily due to the acquisition of StellarOne. Additionally, income related to bank owned life insurance policies increased $2.3 million and gains of sale of securities increased $1.7 million from the prior year.

 

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Noninterest expense increased $102.4 million, or 85.1%, from $120.2 in 2013 to $222.6 million in 2014, and included the full-year impact of the StellarOne acquisition. Excluding current and prior year acquisition-related costs of $20.3 million and $2.1 million, respectively, noninterest expense increased $84.2 million, or 71.3% compared to 2013. Salaries and benefits expenses increased $37.5 million driven by the net addition of 492 branch and management personnel; occupancy expenses increased $8.8 million driven by the added rent expense and depreciation on acquired branches; OREO and credit-related expenses increased $5.3 million driven by a $6.2 million valuation adjustment taken in the third quarter. Amortization expense increased $6.0 million due to purchase accounting amortization on acquired deposits. Other increases included higher telephone, technology, and data processing costs of $6.7 million related to additional personnel and transaction processing, higher FDIC and liability insurance costs of $3.0 million, and higher marketing and advertising expense of $2.2 million related to public relations and brand awareness of the combined banks after the StellarOne integration.

 

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 2012; 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 2012 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 2012 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 $718,000 due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other income increased $2.0 million related to increased income on bank owned life insurance of $361,000, fiduciary and asset management fees of $859,000, and other operating income of $732,000, primarily related to 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 2013 compared to gains in 2012, and lower net gains on securities of $169,000.

 

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 2012. 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.

 

Mortgage Segment

 

2014 compared to 2013

For the year ended December 31, 2014, the mortgage segment reported a net loss of $3.5 million compared to a loss of $2.7 million for the prior year, representing an increased loss of $839,000, or 31.6%. Noninterest income declined $1.8 million during the year due to lower gains on sales of mortgage loans, net of commissions, driven by a decline in origination volume of $264.0 million, or 28.0%, to $677.4 million from $941.4 million during 2013. The significant decline in origination volume was primarily driven by lower refinance volume as well as lower purchased volume. Of the loan originations in the current year, 29.9% were refinances compared to 38.9% in 2013.

 

Noninterest expenses decreased $1.1 million, or 6.2%, from $17.7 million in 2013 to $16.6 million, primarily related to declines in professional fees, occupancy expense, and lower loan related fees due to lower origination volume. Included in noninterest expense is approximately $350,000 of nonrecurring costs related to severance and lease terminations, as the Company continues to streamline the mortgage segment’s processes and cost structure to align with the overall lower mortgage origination levels. 

 

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 2012, 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 2012. 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. 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.

 

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Expenses increased by $3.7 million, or 26.7%, over 2012 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 2013 to enhance the mortgage segment’s operating capabilities, and severance related to the relocation of the mortgage segment’s headquarters to Richmond, Virginia. 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.

 

INCOME TAXES

 

The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

 

In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of temporary differences, projected future taxable income, and tax planning strategies. Management continues to believe that it is not likely that the Company will realize its deferred tax asset related to net operating losses generated at the state level and accordingly has established a valuation allowance. The Company’s bank subsidiary is not subject to a state income tax in its primary place of business (Virginia). The Company’s other subsidiaries are subject to state income taxes and have generated losses for state income tax purposes which the Company is currently unable to utilize. State net operating loss carryovers will begin to expire after 2026.

 

The effective tax rate for the years ended December 31, 2014, 2013, and 2012 was 24.8%, 26.6%, and 28.8%, respectively. The decline in the effective tax rate is primarily related to tax-exempt interest income on the investment portfolio and tax-exempt bank-owned life insurance income being a larger percentage of pre-tax income during 2014 due to elevated merger-related costs included in pre-tax income.

 

BALANCE SHEET

 

At December 31, 2014, total assets were $7.4 billion, an increase of $3.2 billion from December 31, 2013, reflecting the impact of the January 1, 2014 StellarOne acquisition. The fair value of total assets acquired equaled $3.0 billion.

 

·Total cash and cash equivalents were $133.3 million at December 31, 2014, an increase of $60.2 million from December 31, 2013. The fair value of cash acquired was $50.0 million. As a percentage of total assets, cash and cash equivalents remained fairly constant at 1.8% and 1.7% for the years ending December 31, 2014 and 2013, respectively.

·Investment in securities increased $424.8 million, or 62.7%, from $677.3 million at December 31, 2013 to $1.1 billion at December 31, 2014. The fair value of investment in securities acquired was $460.9 million.

·Mortgage loans held for sale were $42.5 million, a decrease of $10.7 million from December 31, 2013, a result of lower origination volume.

·Loans net of unearned income were $5.3 billion at December 31, 2014, an increase of $2.3 billion, or 75.9%, from December 31, 2013. Gross loans acquired equaled $2.283 billion with a fair value of $2.239 billion. Average loans outstanding increased $2.2 billion, or 75.3%, from December 31, 2013.

·Total goodwill arising from the acquisition of StellarOne equaled $234.1 million.

  

At December 31, 2014, total liabilities were $6.4 billion, an increase of $2.6 billion from December 31, 2013, reflecting the impact of the January 1, 2014 StellarOne acquisition. The fair value of total liabilities assumed equaled $2.6 billion.

 

·Total deposits at December 31, 2014 were $5.6 billion, an increase of $2.4 billion, or 74.2%, when compared to December 31, 2013. Total deposits assumed equaled $2.469 billion with a fair value of $2.480 billion.

·Net other short-term borrowings were $343.0 million, an increase of $131.5 million from December 31, 2013. The fair value of short-term borrowings assumed was $49.2 million. The majority of the increase from December 31, 2013 relates to advances from the FHLB.

·Long-term borrowings were $299.5 million at December 31, 2014, an increase of $100.2 million from December 31, 2013. The fair value of long-term borrowings assumed was $98.7 million.

 

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On January 31, 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. For the year ended December 31, 2014, approximately 2.1 million shares of common stock have been repurchased and approximately $12.5 million remains available under the repurchase program.

 

Securities

 

At December 31, 2014, the Company had total investments in the amount of $1.2 billion, or 15.7% of total assets, as compared to $703.4 million, or 16.8% of total assets, at December 31, 2013. 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.

 

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):

  

   2014   2013 
U.S. government and agency securities  $8,454   $2,153 
Obligations of states and political subdivisions   445,647    254,830 
Corporate and other bonds   78,680    9,434 
Mortgage-backed securities   559,329    407,362 
Other securities   10,004    3,569 
Total securities available for sale, at fair value   1,102,114    677,348 
           
Federal Reserve Bank stock   23,834    6,734 
Federal Home Loan Bank stock   31,020    19,302 
Total restricted stock   54,854    26,036 
Total investments  $1,156,968   $703,384 

 

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. During the quarter ended June 30, 2014, the trust preferred security was called at a premium.  As a result, the Company recognized a gain on the call of the previously written down security of $400,000 in the second quarter of 2014. No OTTI was recognized in 2012, 2013, or 2014. 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.

 

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The following table summarizes the contractual maturity of securities available for sale at fair value and their weighted average yields as of December 31, 2014 (dollars in thousands):

  

   1 Year or Less   1 - 5 Years   5 - 10 Years   Over 10 Years   Total 
U.S. government and agency securities:                         
Amortized cost  $1,214   $-   $7,080   $19   $8,313 
Fair value   1,237    -    7,055    162    8,454 
Weighted average yield (1)   2.87    -    1.99    -    2.12 
                          
Mortgage backed securities:                         
Amortized cost   97    18,277    143,771    388,571    550,716 
Fair value   103    18,661    145,868    394,697    559,329 
Weighted average yield (1)   4.60    2.36    1.77    1.90    1.88 
                          
Obligations of states and political subdivisions:                         
Amortized cost   6,224    23,176    129,462    268,621    427,483 
Fair value   6,247    24,316    134,463    280,621    445,647 
Weighted average yield (1)   1.95    4.06    4.71    4.92    4.77 
                          
Corporate bonds and other securities:                         
Amortized cost   11,810    92    26,587    50,234    88,723 
Fair value   11,847    93    26,658    50,086    88,684 
Weighted average yield (1)   2.00    4.51    2.80    1.89    2.18 
                          
Total securities available for sale:                         
Amortized cost   19,345    41,545    306,900    707,445    1,075,235 
Fair value   19,434    43,070    314,044    725,566    1,102,114 
Weighted average yield (1)   2.05    3.32    3.10    3.04    3.05 
                          
(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis.      

 

As of December 31, 2014, the Company maintained a diversified municipal bond portfolio with approximately 75% of its holdings in general obligation issues and the remainder backed by revenue bonds. Issuances within the Commonwealth of Virginia and the State of Washington both represented 10% and issuances within the State of Texas represented 15% of the municipal portfolio; no other state had a concentration above 10%. Approximately 95% of municipal holdings are considered investment grade by Moody’s or Standard & Poor’s rating services. 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.

 

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Loan Portfolio

 

Loans, net of unearned income, were $5.3 billion and $3.0 billion at December 31, 2014 and 2013, respectively. Loans secured by real estate continue to represent the Company’s largest category, comprising 84.9% of the total loan portfolio at December 31, 2014.

 

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):

  

   2014   2013   2012   2011   2010 
Loans secured by real estate:                                                  
Residential 1-4 family   $925,371    17.3%   $475,688    15.7%   $472,985    15.9%   $447,544    15.9%  $431,614    15.2%
Commercial   2,051,943    38.3%   1,094,451    36.0%   1,044,396    35.2%   985,934    34.9%   924,548    32.6%
Construction, land development and other land loans   656,418    12.3%   470,684    15.5%   470,638    15.9%   444,739    15.8%   489,601    17.3%
Second mortgages   57,650    1.1%   34,891    1.1%   39,925    1.3%   55,630    2.0%   64,534    2.3%
Equity lines of credit   523,808    9.8%   302,965    10.0%   307,668    10.4%   304,320    10.8%   305,741    10.8%
Multifamily   297,289    5.6%   146,433    4.8%   140,038    4.7%   108,260    3.8%   91,397    3.2%
Farm land   26,043    0.5%   20,769    0.7%   22,776    0.8%   26,962    1.0%   26,787    0.9%
Total real estate loans   4,538,522    84.9%   2,545,881    83.8%   2,498,426    84.2%   2,373,389    84.2%   2,334,222    82.3%
                                                   
Commercial Loans   374,080    7.0%   194,809    6.4%   186,528    6.3%   169,695    6.0%   180,840    6.4%
                                                   
Consumer installment loans                                                  
Personal   333,126    6.2%   238,368    7.8%   222,812    7.5%   241,753    8.6%   277,184    9.8%
Credit cards   24,225    0.5%   23,211    0.8%   21,968    0.7%   19,006    0.7%   19,308    0.6%
Total consumer installment loans   357,351    6.7%   261,579    8.6%   244,780    8.2%   260,759    9.3%   296,492    10.4%
                                                   
All other loans   76,043    1.4%   37,099    1.2%   37,113    1.3%   14,740    0.5%   25,699    0.9%
Gross loans   $5,345,996    100.0%  $3,039,368    100.0%   $2,966,847   100.0%   $2,818,583    100.0%   $2,837,253    100.0%

  

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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, 2014 (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  $925,371   $77,832   $348,961   $22,688   $326,273   $498,578   $279,880   $218,698 
Commercial   2,051,943    193,880    647,796    226,045    421,751    1,210,267    972,972    237,295 
Construction, land development and other land loans   656,418    410,920    164,070    145,009    19,061    81,428    70,598    10,830 
Second mortgages   57,650    6,449    9,716    3,676    6,040    41,485    17,051    24,434 
Equity lines of credit   523,808    35,765    487,046    68,415    418,631    997    918    79 
Multifamily   297,289    35,991    85,012    34,465    50,547    176,286    145,545    30,741 
Farm land   26,043    9,651    7,890    3,179    4,711    8,502    7,704    798 
Total real estate loans   4,538,522    770,488    1,750,491    503,477    1,247,014    2,017,543    1,494,668    522,875 
                                         
Commercial Loans   374,080    129,591    98,605    93,572    5,033    145,884    123,169    22,715 
                                         
Consumer installment loans                                        
Personal   333,126    61,463    1,791    1,584    207    269,872    182,982    86,890 
Credit cards   24,225    24,225    -    -    -    -    -    - 
Total consumer installment loans   357,351    85,688    1,791    1,584    207    269,872    182,982    86,890 
                                         
All other loans   76,043    11,417    17,627    4,737    12,890    46,999    15,703    31,296 
Gross loans  $5,345,996   $997,184   $1,868,514   $603,370   $1,265,144   $2,480,298   $1,816,522   $663,776 

  

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, 2014, 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

 

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.

 

During 2014, the Company continued to see improvement in asset quality with reduced levels of nonperforming assets, OREO balances, and net charge-offs from the prior year. The decline in OREO balances has been mostly attributable to sales of closed bank premises and foreclosed commercial real estate property. The provision increased from the prior year primarily driven by an increase in loan balances and increased reserves for impaired loans. Both the allowance for loan losses to total loans ratio and allowance for loan losses to total loans ratio, adjusted for acquisition accounting, were down from the prior year. 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.

 

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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, 2014 was $26.8 million, a decrease of $15.0 million, or 35.9%, from $41.8 million at December 31, 2013. Of the $26.8 million of TDRs at December 31, 2014, $22.8 million, or 85.1%, were considered performing while the remaining $4.0 million were considered nonperforming. 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. The decline in the TDR balance from the prior year is attributable to $9.0 million being removed from TDR status, $5.1 million in net payments, and $3.1 million in charge-offs, partially offset by $1.4 million in additions and $849,000 in acquired TDRs. The TDRs acquired in the StellarOne acquisition were related to loans with a revolving feature and, therefore, excluded from being classified as PCI in accordance with ASC 310-30. Loans removed from TDR status represent restructured loans with a market rate of interest at the time of the restructuring. These loans have performed in accordance with their modified terms for twelve consecutive months and were no longer considered impaired based on a current evaluation by Special Asset Loan Committee. Loans removed from TDR status are collectively evaluated for impairment; 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. 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 re-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.

 

Nonperforming Assets

 

At December 31, 2014, nonperforming assets totaled $47.4 million, a decrease of $1.8 million, or 3.6%, from December 31, 2013. In addition, NPAs as a percentage of total outstanding loans declined 73 basis points to 0.89% from 1.62% at the end of the prior year. All metrics discussed below exclude PCI loans, which aggregated $105.8 million (net of fair value mark) at December 31, 2014.

 

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):

 

   2014   2013   2012   2011   2010 
Nonaccrual loans, excluding PCI loans  $19,255   $15,035   $26,206   $44,834   $61,716 
Foreclosed properties   23,058    34,116    32,834    31,243    35,102 
Former bank premises   5,060    -    -    1,020    1,020 
Total nonperforming assets   47,373    49,151    59,040    77,097    97,838 
Loans past due 90 days and accruing interest   10,047    6,746    8,843    19,911    15,332 
Total nonperforming assets and loans past due 90 days and accruing interest  $57,420   $55,897   $67,883   $97,008   $113,170 
                          
Performing Restructurings  $22,829   $34,520   $51,468   $98,834   $13,086 
                          
Balances                         
Allowance for loan losses  $32,384   $30,135   $34,916   $39,470   $38,406 
Average loans, net of unearned income   5,235,471    2,985,733    2,875,916    2,818,022    2,750,756 
Loans, net of unearned income   5,345,996    3,039,368    2,966,847    2,818,583    2,837,253 
                          
Ratios                         
NPAs to total loans   0.89%   1.62%   1.99%   2.74%   3.45%
NPAs & loans 90 days past due to total loans   1.07%   1.84%   2.29%   3.44%   3.99%
NPAs to total loans & OREO   0.88%   1.60%   1.97%   2.70%   3.40%
NPAs & loans 90 days past due to total loans & OREO   1.07%   1.82%   2.26%   3.40%   3.94%
ALL to nonaccrual loans   168.18%   200.43%   133.24%   88.04%   62.23%
ALL to nonaccrual loans & loans 90 days past due   110.52%   138.35%   99.62%   60.96%   49.85%

 

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Nonperforming assets at December 31, 2014 included $19.3 million in nonaccrual loans (excluding PCI loans), a net increase of $4.2 million, or 28.1%, from the prior year. Nonaccrual loans as a percentage of total outstanding loans declined 13 basis points to 0.36% from 0.49% at the end of the prior year. The following table shows the activity in nonaccrual loans for the years ended December 31, (dollars in thousands):

 

   2014   2013   2012   2011   2010 
Beginning Balance  $15,035   $26,206   $44,834   $61,716   $22,348 
Net customer payments   (8,053)   (12,393)   (13,624)   (18,661)   (8,985)
Additions   20,961    16,725    10,265    19,905    75,099 
Charge-offs   (2,732)   (8,743)   (8,510)   (8,716)   (10,005)
Loans returning to accruing status   (3,492)   (2,718)   (3,455)   (3,607)   (1,017)
Transfers to OREO   (2,464)   (4,042)   (3,304)   (5,803)   (15,724)
Ending Balance  $19,255   $15,035   $26,206   $44,834   $61,716 

 

The following table presents the composition of nonaccrual loans (excluding PCI 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):

 

   2014   2013   2012   2011   2010 
Raw Land and Lots  $2,359   $2,560   $8,760   $13,322   $22,546 
Commercial Construction   968    1,596    5,781    10,276    11,410 
Commercial Real Estate   6,962    2,212    3,018    7,993    10,157 
Single Family Investment Real Estate   2,070    1,689    3,420    5,048    10,226 
Commercial and Industrial   3,286    3,848    2,036    5,297    4,797 
Other Commercial   74    126    193    238    458 
Consumer   3,536    3,004    2,998    2,660    2,122 
Total  $19,255   $15,035   $26,206   $44,834   $61,716 
                          
Coverage Ratio   168.18%   200.43%   133.24%   88.04%   62.23%

 

Nonperforming assets at December 31, 2014 also included $28.1 million in OREO, a decrease of $6.0 million, or 17.6%, from the prior year. The following table shows the activity in OREO for the years ended December 31, (dollars in thousands):

 

   2014   2013   2012   2011   2010 
Beginning Balance  $34,116   $32,834   $32,263   $36,122   $22,509 
Additions   20,872    9,542    14,274    11,625    24,792 
Capitalized Improvements   686    561    381    528    404 
Valuation Adjustments   (7,646)   (791)   (301)   (707)   (43)
Proceeds from sales   (21,291)   (7,569)   (13,152)   (14,240)   (11,747)
Gains (losses) from sales   1,381    (461)   (631)   (1,065)   207 
Ending Balance  $28,118   $34,116   $32,834   $32,263   $36,122 

 

Of the $20.9 million in additions to OREO in 2014, $4.3 million were acquired foreclosed property from StellarOne and $10.9 million related to bank premises no longer used in operations related to the StellarOne acquisition. During 2014, the majority of sales of OREO were primarily related to closed bank premises and commercial real estate. OREO is evaluated for impairment at least quarterly by the Company’s Special Asset Loan Committee and any necessary write downs to fair values are recorded as impairment and included as a component of noninterest expense. During the third quarter of 2014, the Company reevaluated its OREO sales strategies in light of limited progress in selling properties in inactive rural markets that have continued to struggle coming out of the economic downturn and for which transaction volume for comparable sales has been slow or nonexistent. With the shift in strategy to more aggressively market this OREO, the Company obtained appraisals that reflect the newly determined highest and best use of the underlying assets. As a result, the Company recorded valuation adjustments of $6.2 million during the third quarter of 2014. These valuation adjustments will allow the Company to be more aggressive in disposing of long-held OREO properties and reducing the ongoing expenses associated with managing these properties. Valuation adjustments for the full year ended December 31, 2014 totaled $7.6 million.

 

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

 

   2014   2013   2012   2011   2010 
Land  $8,726   $10,310   $8,657   $6,327   $7,689 
Land Development   7,162    10,904    10,886    11,309    11,233 
Residential Real Estate   5,736    7,379    7,939    11,024    13,402 
Commercial Real Estate   1,434    5,523    5,352    2,583    2,778 
Former Bank Premises (1)   5,060    -    -    1,020    1,020 
Total  $28,118   $34,116   $32,834   $32,263   $36,122 
(1) Includes closed branch property and land previously held for branch sites.      

 

Past Due Loans

 

At December 31, 2014, total accruing past due loans, excluding PCI loans, were $48.1 million, or 0.90% of total loans, an increase from $26.5 million, or 0.87% of total loans, a year ago. At December 31, 2014, loans past due 90 days or more and accruing interest totaled $10.0 million, or 0.19% of total loans, compared to $6.7 million, or 0.22%, at December 31, 2013.

 

Charge-offs

 

For the year ended December 31, 2014, net charge-offs of loans were $5.6 million, or 0.10%, compared to $10.8 million, or 0.36%, for the prior year. The higher level of charge-offs in 2013 mainly related to loans that were previously considered impaired and specifically reserved for in prior periods.

 

Provision

 

The provision for loan losses for the year ended December 31, 2014 was $7.8 million, an increase of $1.7 million, or 28.8%, from the prior year. The increase in provision for loan losses for the current year compared to the prior year was driven by an increase in loan balances and increased reserves for impaired loans.

 

Allowance for Loan Losses

 

The allowance for loan losses increased $2.3 million from December 31, 2013 to $32.4 million at December 31, 2014. The ALL as a percentage of the total loan portfolio, adjusted for acquisition accounting (non-GAAP), was 1.08% at December 31, 2014, a decrease from 1.10% at December 31, 2013. The allowance for loan losses as a percentage of the total loan portfolio, unadjusted for acquisition accounting, was 0.61% at December 31, 2014, compared to 0.99% at December 31, 2013. The decrease in the allowance ratios was primarily attributable to improving credit quality metrics (as a percentage of total loans) and the acquisition of StellarOne. In acquisition accounting, there is no carryover of previously established allowance for loan losses.

  

The nonaccrual loan coverage ratio was 168.2% at December 31, 2014, compared to 200.4% at December 31, 2013. 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.

 

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

 

   2014   2013   2012   2011   2010 
Balance, beginning of year  $30,135   $34,916   $39,470   $38,406   $30,484 
Loans charged-off:                         
Commercial   1,557    3,080    1,439    2,183    2,205 
Real estate   5,855    8,596    14,127    12,669    12,581 
Consumer   1,608    1,942    2,899    3,014    3,763 
Total loans charged-off   9,020    13,618    18,465    17,866    18,549 
Recoveries:                         
Commercial   316    746    207    413    551 
Real estate   2,314    1,125    465    571    628 
Consumer   839    910    1,039    1,146    924 
Total recoveries   3,469    2,781    1,711    2,130    2,103 
Net charge-offs   5,551    10,837    16,754    15,736    16,446 
Provision for loan losses   7,800    6,056    12,200    16,800    24,368 
Balance, end of year  $32,384   $30,135   $34,916   $39,470   $38,406 
                          
ALL to loans   0.61%   0.99%   1.18%   1.40%   1.35%
ALL to loans, adjusted for acquisition accounting (Non-GAAP)   1.08%   1.10%   1.35%   1.71%   1.82%
Net charge-offs to total loans   0.10%   0.36%   0.56%   0.56%   0.58%
Provision to total loans   0.15%   0.20%   0.41%   0.60%   0.86%

 

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):

 

   2014   2013   2012   2011   2010 
   $   %(1)   $   %(1)   $   %(1)   $   %(1)   $   %(1) 
Commercial  $2,266    7.0%  $1,932    6.4%  $2,195    6.3%  $2,376    6.0%  $2,448    6.4%
Real estate   27,493    84.9%   25,242    83.8%   29,403    84.2%   33,236    84.2%   31,597    82.3%
Consumer   2,625    8.1%   2,961    9.8%   3,318    9.5%   3,858    9.8%   4,361    11.3%
Total  $32,384    100.0%  $30,135    100.0%  $34,916    100.0%  $39,470    100.0%  $38,406    100.0%

 

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

 

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Deposits

 

As of December 31, 2014, total deposits were $5.6 billion, an increase of $2.4 billion, or 74.2%, compared to December 31, 2013, due to the addition of the deposit accounts acquired through the StellarOne acquisition. Total interest-bearing deposits consist of NOW, money market, savings, and time deposit account balances. Total time deposit balances of $1.3 billion accounted for 29.2% of total interest-bearing deposits at December 31, 2014. The Company continues to experience a shift from time deposits into lower cost transaction accounts, particularly in NOW 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.

 

The following table presents the deposit balances by major category as of December 31:

 

   2014   2013 
Deposits:  Amount   % of total
deposits
   Amount   % of total
deposits
 
Non-interest bearing  $1,199,378    21.3%  $691,674    21.4%
NOW accounts   1,332,029    23.6%   498,068    15.4%
Money market accounts   1,261,520    22.4%   940,215    29.0%
Savings accounts   548,526    9.7%   235,034    7.3%
Time deposits of $100,000 and over   550,842    9.8%   427,597    13.2%
Other time deposits   746,475    13.2%   444,254    13.7%
Total Deposits  $5,638,770    100.0%  $3,236,842    100.0%

 

The Company 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, 2014 and 2013, there were $0 and $13.7 million, respectively, of purchased certificates of deposits and included in certificates of deposit on the Company’s Consolidated Balance Sheet. Maturities of time deposits as of December 31, 2014 are as follows (dollars in thousands):

  

   Within 3
Months
   3 - 12
Months
   Over 12
Months
   Total 
Maturities of time deposits of $100,000 and over  $72,561   $190,952   $287,329   $550,842 
Maturities of other time deposits   103,282    295,545    347,648    746,475 
Total time deposits  $175,843   $486,497   $634,977   $1,297,317 

 

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.

 

As in effect at December 31, 2014, the FRB and the FDIC 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, principally consisting of 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 at December 31, 2014.

 

Prior to the StellarOne acquisition and 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. In connection with the

 

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StellarOne acquisition, the Company acquired $32.0 million in trust preferred securities issued by StellarOne’s finance subsidiaries. These trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

 

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

 

   2014   2013   2012 
Tier 1 Capital:               
Common Stock - par value  $59,795   $33,020   $33,510 
Surplus   643,443    170,770    176,635 
Retained Earnings   262,532    236,639    215,634 
Total Equity   965,770    440,429    425,779 
Plus: qualifying trust preferred capital notes   90,500    58,500    58,500 
Less: disallowed intangibles   325,277    71,380    75,211 
Plus: goodwill deferred tax liability   4,618    940    810 
Total Tier 1 Capital  $735,611   $428,489   $409,878 
                
Tier 2 Capital:               
Net unrealized gain/loss on equity securities  $76   $191   $128 
Subordinated debt   3,370    6,544    9,522 
Allowance for loan losses   32,384    30,135    34,916 
Total Tier 2 Capital  $35,830   $36,870   $44,566 
Total risk-based capital  $771,441   $465,359   $454,444 
                
Risk-weighted assets  $5,758,599   $3,284,430   $3,119,063 
                
Capital ratios:               
Tier 1 risk-based capital ratio   12.77%   13.05%   13.14%
Total risk-based capital ratio   13.40%   14.17%   14.57%
Leverage ratio (Tier 1 capital to average adjusted assets)   10.63%   10.70%   10.52%
Common equity to total assets   13.29%   10.49%   10.64%
Tangible common equity to tangible assets   9.28%   8.94%   8.97%

 

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. Effective January 1, 2015, the final rules require the Company and the Subsidiary Bank 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 prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). 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 Bank 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 2.5% 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 2.5% 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 by the same amount 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.

 

Had the new minimum capital ratios described above been effective as of December 31, 2014, based on management’s interpretation and understanding of the new rules, the Company and the Bank would have remained “well capitalized” as of such date.

 

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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 Company’s Consolidated Balance Sheets. 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 9 “Commitments and Contingencies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

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.

 

UMG, a wholly owned subsidiary of the Bank, uses rate lock commitments and best efforts contracts during the origination process and for loans held for sale. These best efforts contracts are designed to mitigate UMG’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):

 

   2014   2013 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $1,601,287   $891,680 
Standby letters of credit   117,988    48,107 
Mortgage loan rate lock commitments   49,552    54,834 
Total commitments with off-balance sheet risk  $1,768,827   $994,621 
Commitments with balance sheet risk:          
Loans held for sale  $42,519   $53,185 
Total other commitments  $1,811,346   $1,047,806 
           
(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, 2014 (dollars in thousands):

 

   Total   Less than 1
year
   1-3 years   4-5 years   More than 5
years
 
Long-term debt  $206,241   $-   $77,500   $10,000   $118,741 
Trust preferred capital notes   93,301    -    -    -    93,301 
Operating leases   45,326    7,711    13,621    11,466    12,528 
Other short-term borrowings   343,000    343,000    -    -    - 
Repurchase agreements   44,393    44,393    -    -    - 
Total contractual obligations  $732,261   $395,104   $91,121   $21,466   $224,570 

 

For more information pertaining to the previous table, reference Note 5 “Bank Premise and Equipment” and Note 8 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of the Form 10-K.

 

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MARKET RISK

 

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.

 

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. These assumptions may not materialize and unanticipated events and circumstances may occur. The model also does not take into account any future actions of management to mitigate the impact of interest rate changes. 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.

 

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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, 2014 (dollars in thousands):

 

   Change In Net Interest Income 
   2014   2013 
   %   $   %   $ 
Change in Yield Curve:                    
+300 basis points   4.72    12,439    (2.01)   (3,274)
+200 basis points   3.30    8,689    (1.16)   (1,896)
+100 basis points   1.38    3,635    (0.86)   (1,405)
Most likely rate scenario   -    -    -    - 
-100 basis points   (1.66)   (4,378)   (1.91)   (3,118)
-200 basis points   (4.33)   (11,406)   (5.85)   (9,546)
-300 basis points   (4.59)   (12,087)   (7.34)   (11,980)

 

Asset sensitivity indicates that in a rising interest rate environment the Company's net interest income would increase and in decreasing interest rate environment the Company's net interest income would decrease. Liability sensitivity indicates that in a rising interest rate environment the Company's net interest income would decrease and in a decreasing interest rate environment the Company's net interest income would increase.

 

During 2014, the Company became asset sensitive when compared to 2013 due to changes in the composition of the balance sheet, primarily due to the acquisition of StellarOne which was asset sensitive. In becoming “asset sensitive”, the Company expects net interest income to increase as market rates increase. In the decreasing interest rate environments the Company shows a decline in net interest income as interest earning assets re-price lower and interest bearing deposits remain at or near their floors. It should be noted that although net interest income simulation results are presented through the down 300 basis points interest rate environments, the Company does not believe the down 200 and 300 basis point scenarios are plausible given the current level of interest rates.

 

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.

 

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, 2014 (dollars in thousands):

 

   Change In Economic Value of Equity 
   2014   2013 
   %   $   %   $ 
Change in Yield Curve:                    
+300 basis points   (1.23)   (15,859)   (11.84)   (75,364)
+200 basis points   0.26    3,402    (7.28)   (46,371)
+100 basis points   0.80    10,300    (3.30)   (21,002)
Most likely rate scenario   -    -    -    - 
-100 basis points   (3.20)   (41,243)   0.35    2,217 
-200 basis points   (8.16)   (105,144)   (2.48)   (15,794)
-300 basis points   (7.29)   (93,942)   (2.84)   (18,103)

  

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As of December 31, 2014, the Company’s economic value of equity model projects that a sudden increase in market interest rates would result in a small change in the Company’s estimated economic value of equity. The Company has become less sensitive to market interest rate increases while becoming more sensitive to market interest rate declines as of December 31, 2014 compared to December 31, 2013. 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, 2014, cash and cash equivalents, restricted stock, and securities classified as available for sale comprised 17.5% of total assets, compared to 18.6% at December 31, 2013. 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 $150.0 million as of December 31, 2014. As of December 31, 2014, there were no borrowings 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 $44.4 million as of December 31, 2014 compared to $52.5 million as of December 31, 2013. In addition, the Company has an unsecured line of credit with a correspondent bank for up to $25.0 million. There was $8.0 million outstanding under this line at December 31, 2014 compared to zero outstanding at December 31, 2013. Lastly, the Company had a collateral dependent line of credit with the FHLB for up to $1.4 billion. Based on the underlying collateralized loans, the Company has $742.0 million available as of December 31, 2014. There was approximately $548.2 million outstanding under this line at December 31, 2014 compared to $320.0 million as of December 31, 2013.

 

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, 2014, there were no borrowed funds included in certificates of deposit on the Company’s Consolidated Balance Sheets.

 

As of December 31, 2014, the liquid assets that mature within one year totaled $1.8 billion, or 27.4% of total earning assets. As of December 31, 2014, approximately $1.6 billion, or 29.6% of total loans, are scheduled to mature within one year based on contractual maturity, adjusted for expected prepayments.

 

Impact of Inflation and Changing Prices

 

The Company’s financial statements included in Item 8 below have been prepared in accordance with GAAP, which requires the financial position and operating results to be measured principally in terms of historic dollars without considering the change in the relative purchasing power of money over time due to inflation. Inflation affects the Company’s results of operations mainly through increased operating costs, but since nearly all the Company’s assets and liabilities of the Company are monetary in nature, changes in interest rates affect the financial condition of the Company to a greater degree than changes in the rate of inflation. Although interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. The Company’s management reviews pricing of its products and services, in light of current and expected costs due to inflation, to mitigate the inflationary impact on financial performance.

 

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NON-GAAP MEASURES

 

In reporting the results of December 31, 2014, 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.

 

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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):

  

<
   2014   2013   2012 
Operating Earnings               
Net Income (GAAP)  $52,591   $34,496   $35,411 
Plus: Merger and conversion related expense, after tax   13,724    2,042    - 
Net operating earnings (loss) (non-GAAP)  $66,315   $36,538   $35,411 
Operating earnings per share - Basic  $1.44   $1.46   $1.37 
Operating earnings per share - Diluted   1.44    1.46    1.37 
Operating ROA   0.91%   0.90%   0.89%
Operating ROE   6.74%   8.38%   8.13%
Operating ROTCE   10.19%   10.07%   9.89%
                
Community Bank Segment Operating Earnings               
Net Income (GAAP)  $56,089   $37,155   $32,866 
Plus: Merger and conversion related expense, after tax   13,724    2,042    - 
Net operating earnings (loss) (non-GAAP)  $69,813   $39,197   $32,866 
Operating earnings per share - Basic  $1.52   $1.57   $1.27 
Operating earnings per share - Diluted   1.52    1.57    1.27 
Operating ROA   0.96%   0.97%   0.83%
Operating ROE   7.14%   9.18%   7.67%
Operating ROTCE   10.84%   11.08%   9.37%
                
Operating Efficiency Ratio FTE               
Net Interest Income (GAAP)  $255,018   $151,626   $154,355 
FTE adjustment   8,127    5,256    4,222 
Net Interest Income (FTE)  $263,145   $156,882   $158,577 
Noninterest Income (GAAP)   61,287    38,728    41,068 
Noninterest Expense (GAAP)  $238,552   $137,289   $133,479 
Merger and conversion related expense   20,345    2,132    - 
Noninterest Expense (Non-GAAP)  $218,207   $135,157   $133,479 
Operating Efficiency Ratio FTE (non-GAAP)   67.26%   69.10%   66.86%
                
Community Bank Segment Operating Efficiency Ratio FTE               
Net Interest Income (GAAP)  $253,956   $149,975   $153,024 
FTE adjustment   8,126    5,256    4,223 
Net Interest Income (FTE)  $262,082   $155,231   $157,247 
Noninterest Income (GAAP)   51,878    27,492    24,876 
Noninterest Expense (GAAP)  $222,647   $120,256   $119,976 
Merger and conversion related expense   20,345    2,132    - 
Noninterest Expense (Non-GAAP)  $202,302   $118,124   $119,976 
Operating Efficiency Ratio FTE (non-GAAP)   64.44%   64.65%   65.88%
                
Tangible Common Equity