10-Q 1 f10qvalley.htm f10qvalley.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2012

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

For the transition period from _____________________________to_____________________________________

Commission File Number:  000-28342

VALLEY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
VIRGINIA
54-1702380
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
   
36 Church Avenue, S.W.
 
Roanoke, Virginia
24011
(Address of principal executive offices)
(Zip Code)
(540) 342-2265
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yesx  Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 o

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


 
 

 


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

At November 14, 2012, 4,742,295 shares of common stock, no par value, of the registrant were outstanding.
 



 
 

 

VALLEY FINANCIAL CORPORATION
FORM 10-Q
September 30, 2012

TABLE OF CONTENTS
   
   
PART I – FINANCIAL INFORMATION
 
Item 1.  Financial Statements
 
Consolidated Balance Sheets
5
Consolidated Statements of Income
6
Consolidated Statements of Comprehensive Income
7
Consolidated Statements of Cash Flows
8
Notes to Consolidated Financial Statements
9
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
39
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
46
Item 4.  Controls and Procedures
46
PART II.  OTHER INFORMATION
 
Item 1.  Legal Proceedings
47
Item 1A.  Risk Factors
47
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
47
Item 3.  Defaults Upon Senior Securities
47
Item 4.  Mine Safety Disclosures
47
Item 5.  Other Information
47
Item 6.  Exhibits
49
SIGNATURES
50
EXHIBIT INDEX
 



 
3

 

Forward-Looking and Cautionary Statements
The Private Securities Litigation Reform Act of 1995 (the “1995 Act”) provides a safe harbor for forward-looking statements made by or on our behalf.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared.
This report includes forward-looking statements within the meaning of the 1995 Act. These statements are included throughout this report and relate to, among other things, projections of revenues, earnings, earnings per share, cash flows, capital expenditures, or other financial items, expectations regarding acquisitions, discussions of estimated future revenue enhancements, potential dispositions, and changes in interest rates. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. The words “believe”, “anticipate”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, and similar terms and phrases identify forward-looking statements in this report.
Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. Our operations involve risks and uncertainties, many of which are outside of our control, and any one of which, or a combination of which, could materially affect our results of operations and whether the forward-looking statements ultimately prove to be correct.  Actual results and trends in the future may differ materially from those suggested or implied by the forward-looking statements depending on a number of factors. Factors that may cause actual results to differ materially from those expected include the following:
 
 
 
General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances;
 
 
 
General decline in the residential real estate construction and finance market;
 
 
 
Decline in market value of real estate in the Company’s markets;
 
 
 
Changes in interest rates could reduce net interest income and/or the borrower’s ability to repay loans;
 
 
 
Competitive pressures among financial institutions may reduce yields and profitability;
       
 
 
Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses that the Company is engaged in;
       
 
 
Increased regulatory supervision could limit our ability to grow and could require considerable time and attention of our management and board of directors;
       
 
 
New products developed or new methods of delivering products could result in a reduction in business and income for the Company;
 
 
 
The Company’s ability to continue to improve operating efficiencies;
 
 
 
Natural events and acts of God such as earthquakes, fires and floods;
 
 
 
Loss or retirement of key executives; and
       
 
 
Adverse changes may occur in the securities market.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein.  We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.

 
4

 

VALLEY FINANCIAL CORPORATION
 
Consolidated Balance Sheets
 
(In 000s, except share data)
 
   
(Unaudited)
   
(Audited)
 
Assets
 
September 30, 2012
   
December 31, 2011
 
Cash and due from banks
  $ 9,262     $ 8,428  
Interest bearing deposits
    12,872       22,296  
Total cash and cash equivalents
    22,134       30,724  
                 
Securities available for sale
    142,867       160,465  
Securities held to maturity (fair value 9/30/12: $28,014; 12/31/11: $29,723)
    26,475       28,770  
Loans, net of allowance for loan losses, 9/30/12: $8,548; 12/31/11: $9,650)
    533,420       498,936  
Foreclosed assets
    22,151       17,040  
Premises and equipment, net
    7,950       7,491  
Bank owned life insurance
    17,541       16,565  
Accrued interest receivable
    2,518       2,401  
Other assets
    10,236       11,112  
Total assets
  $ 785,292     $ 773,504  
                 
Liabilities and Shareholders' Equity
               
Liabilities:
               
Non-interest bearing deposits
  $ 18,004     $ 17,903  
Interest bearing deposits
    599,543       612,805  
Total deposits
    617,547       630,708  
                 
Federal funds purchased and securities sold under agreements to repurchase
    22,022       18,646  
FHLB borrowings
    58,000       43,000  
Junior subordinated debentures
    16,496       16,496  
Accrued interest payable
    437       533  
Other liabilities
    4,614       4,008  
Total liabilities
    719,116       713,391  
                 
Shareholders' equity:
               
Preferred stock, no par value; 10,000,000 shares authorized; 16,019 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
    15,794       15,661  
Common stock, no par value; 10,000,000 shares authorized; 4,742,295 shares issued and outstanding at September 30, 2012 and 4,711,123 shares issued and outstanding at December 31, 2011
    23,845       23,654  
Retained earnings
    24,457       20,131  
Accumulated other comprehensive income
    2,080       667  
Total shareholders' equity
    66,176       60,113  
Total liabilities and shareholders' equity
  $ 785,292     $ 773,504  
See accompanying notes to consolidated financial statements
         


 
5

 
VALLEY FINANCIAL CORPORATION
 
Consolidated Income Statements
 
(In 000s, except share and per share data)
 
                         
   
Three Months Ended (Unaudited)
   
Nine Months Ended (Unaudited)
 
   
9/30/2012
   
9/30/2011
   
9/30/2012
   
9/30/2011
 
Interest income
                       
Interest and fees on loans
  $ 6,935     $ 6,913     $ 20,415     $ 20,960  
Interest on securities - taxable
    833       1,128       3,040       3,380  
Interest on securities - nontaxable
    131       134       396       447  
Interest on deposits in banks
    4       21       30       66  
Total interest income
    7,903       8,196       23,881       24,853  
Interest expense
                               
Interest on deposits
    984       1,541       3,342       5,015  
Interest on borrowings
    455       492       1,353       1,474  
Total interest expense
    1,439       2,033       4,695       6,489  
Net interest income
    6,464       6,163       19,186       18,364  
Provision for loan losses
    -       164       (53 )     425  
Net interest income after provision for loan losses
    6,464       5,999       19,239       17,939  
Noninterest income
                               
Service charges on deposit accounts
    437       360       1,163       1,049  
Mortgage fee income
    159       67       464       175  
Brokerage fee income, net
    183       188       655       339  
Realized gain on sale of securities
    118       541       158       1,017  
Other  income
    292       217       771       608  
Total noninterest income
    1,189       1,373       3,211       3,188  
Noninterest expense
                               
Compensation expense
    2,716       2,459       7,955       6,987  
Occupancy and equipment expense
    405       370       1,175       1,170  
Data processing expense
    305       256       889       786  
Insurance expense
    233       445       850       2,024  
Professional fees
    290       415       750       1,265  
Foreclosed asset expense, net
    475       579       917       1,194  
Other operating expense
    790       818       2,390       2,388  
Total noninterest expense
    5,214       5,342       14,926       15,814  
Income before income taxes
    2,439       2,030       7,524       5,313  
Income tax expense
    742       460       2,299       1,426  
Net income
  $ 1,697     $ 1,570     $ 5,225     $ 3,887  
Preferred dividends and accretion of discounts on warrants
    245       242       734       726  
Net income available to common shareholders
  $ 1,452     $ 1,328     $ 4,491     $ 3,161  
Earnings per share
                               
Basic earnings per common share
  $ 0.31     $ 0.28     $ 0.95     $ 0.67  
Diluted earnings per common share
  $ 0.30     $ 0.28     $ 0.93     $ 0.67  
Weighted average common shares outstanding
    4,742,295       4,697,256       4,737,998       4,694,299  
Diluted average common shares outstanding
    4,871,077       4,735,658       4,829,638       4,725,967  
Dividends declared per common share
  $ 0.04     $ -     $ 0.04     $ -  
See accompanying notes to consolidated financial statements
                         



 
6

 

VALLEY FINANCIAL CORPORATION
 
Consolidated Statements of Comprehensive Income
 
(In 000s)
 
                         
                         
 
Three Months Ended (Unaudited)
   
Nine Months Ended (Unaudited)
 
   
9/30/2012
   
9/30/2011
   
9/30/2012
   
9/30/2011
 
Net Income
  $ 1,697     $ 1,570     $ 5,225     $ 3,887  
Other comprehensive income ("OCI"):
                               
Unrealized gains on securities:
                               
Unrealized holding gains arising during period
    1,066       766       2,310       3,912  
Tax related to unrealized gains
    (362 )     (260 )     (785 )     (1,330 )
Reclassification adjustment for gains included in net income
    (118 )     (541 )     (158 )     (1,017 )
Tax related to realized gains
    40       184       54       346  
Holding gains on securities transferred to HTM from AFS:
                               
Holding gains transferred into OCI during period
    -       -       -       118  
Holding gains amortized during period
    (2 )     (2 )     (10 )     (3 )
Tax related to amortized holding gains
    1       -       3       -  
Total other comprehensive income
    625       147       1,414       2,026  
Total comprehensive income
  $ 2,322     $ 1,717     $ 6,639     $ 5,913  
                                 
See accompanying notes to consolidated financial statements
                         


 
7

 

VALLEY FINANCIAL CORPORATION
 
Consolidated Statements of Cash Flows
 
(In 000s)
 
   
Nine Months Ended (Unaudited)
 
   
9/30/2012
   
9/30/2011
 
Cash flows from operating activities
           
Net income
  $ 5,225     $ 3,887  
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
               
Provision for loan losses
    (53 )     425  
Depreciation and amortization of bank premises, equipment and software
    519       546  
Net amortization of bond premiums/discounts
    1,930       1,215  
Stock compensation expense
    188       189  
Net gains on sale of securities
    (158 )     (1,017 )
Net losses and impairment writedowns on foreclosed assets and premises
    391       963  
Increase in value of life insurance contracts
    (477 )     (433 )
Decrease in other assets
    841       4,095  
Increase in other liabilities
    344       1,157  
Net cash and cash equivalents provided by operating activities
    8,750       11,027  
Cash flows from investing activities
               
Purchases of bank premises, equipment and software
    (966 )     (316 )
Purchases of securities available-for-sale
    (85,946 )     (104,704 )
Purchases of securities held-to-maturity
    -       (2,771 )
Proceeds from maturities, calls, and paydowns of securities available-for-sale
    103,266       82,295  
Proceeds from maturities, calls, and paydowns of securities held-to-maturity
    2,214       3,410  
Proceeds from sale of foreclosed assets
    302       2,447  
Purchases of bank owned life insurance
    (500 )     (1,500 )
Capitalized costs related to foreclosed assets
    (1,058 )     (1,280 )
(Increase) decrease in loans, net
    (39,270 )     27,511  
Net cash and cash equivalents provided by / (used in) investing activities
    (21,958 )     5,092  
Cash flows from financing activities
               
Increase in non-interest bearing deposits
    101       2,517  
Decrease in interest bearing deposits
    (13,262 )     (22,432 )
Proceeds from borrowings
    25,000       17,500  
Principal repayments of borrowings
    (10,000 )     (15,000 )
Increase (decrease) in securities sold under agreements to repurchase
    3,376       (2,701 )
Net proceeds from issuance of common stock
    3       -  
Cash dividends paid
    (600 )     (1,201 )
Net cash and cash equivalents provided by / (used in) financing activities
    4,618       (21,317 )
Net increase in cash and cash equivalents
    (8,590 )     (5,198 )
                 
Cash and cash equivalents at beginning of period
    30,724       24,312  
Cash and cash equivalents at end of period
  $ 22,134     $ 19,114  
Supplemental disclosure of cash flow information
               
        Cash paid during the period for interest
  $ 4,791     $ 6,991  
        Cash paid during the period for income taxes
  $ 2,105     $ 936  
Noncash financing and investing activities
               
        Transfer of loans to foreclosed property
  $ 4,746     $ 3,491  
See accompanying notes to consolidated financial statements.
               


 
8

 
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)
 
Note 1.  Organization and Summary of Significant Accounting Policies

Valley Financial Corporation (the "Company") was incorporated under the laws of the Commonwealth of Virginia on March 15, 1994, primarily to serve as a holding company for Valley Bank (the "Bank"), which opened for business on May 15, 1995. The Company's fiscal year end is December 31.

The consolidated financial statements of the Company conform to generally accepted accounting principles and to general banking industry practices. The interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments of a normal recurring nature which are necessary for a fair presentation of the consolidated financial statements herein have been included. The consolidated financial statements herein should be read in conjunction with the Company's 2011 Annual Report on Form 10-K.

Interim financial performance is not necessarily indicative of performance for the full year.

The Company reports its activities as a single business segment.

Use of Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Subsequent Events
In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure.

Recent and Future Accounting Considerations

None.

Note 2.  Securities

The carrying values, unrealized gains, unrealized losses, and approximate fair values of available-for-sale and held-to-maturity investment securities at September 30, 2012 are shown in the tables below. As of  September 30, 2012, investments (including both available-for-sale and held-to-maturity) and restricted equity securities with amortized costs and fair values of $55,926 and $58,098 respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as required or permitted by law.

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale (“AFS”) as of  September 30, 2012 and December 31, 2011 were as follows:


 
9

 
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


   
Amortized
   
Unrealized
   
Unrealized
       
September 30, 2012
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 7,686     $ 150     $ -     $ 7,836  
Government-sponsored enterprises *
    23,658       191       (7 )     23,842  
Mortgage-backed securities
    74,041       2,065       -       76,106  
Collateralized mortgage obligations
    11,980       145       (10 )     12,115  
States and political subdivisions
    22,510       540       (82 )     22,968  
    $ 139,875     $ 3,091     $ (99 )   $ 142,867  

December 31, 2011
                       
U.S. Government and federal agency
  $ 2,770     $ 2     $ -     $ 2,772  
Government-sponsored enterprises *
    38,748       131       (37 )     38,842  
Mortgage-backed securities
    98,836       836       (182 )     99,490  
Collateralized mortgage obligations
    15,280       125       (15 )     15,390  
States and political subdivisions
    3,990       -       (19 )     3,971  
    $ 159,624     $ 1,094     $ (253 )   $ 160,465  

* Such as FNMA, FHLMC and FHLB.

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity (“HTM”) as of September 30, 2012 and December 31, 2011 were as follows:


   
Amortized
   
Unrealized
   
Unrealized
       
September 30, 2012
 
Cost
   
Gains
   
Losses
   
Fair Values
 
U.S. Government and federal agency
  $ 8,260     $ 344     $ -     $ 8,604  
Mortgage-backed securities
    250       20       -       270  
Collateralized mortgage obligations
    1,824       99       -       1,923  
States and political subdivisions
    16,141       1,076       -       17,217  
    $ 26,475     $ 1,539     $ -     $ 28,014  
 
 
December 31, 2011
                       
U.S. Government and federal agency
  $ 8,981     $ 160     $ -     $ 9,141  
Mortgage-backed securities
    346       25       -       371  
Collateralized mortgage obligations
    2,555       126       -       2,681  
States and political subdivisions
    16,888       653       (11 )     17,530  
    $ 28,770     $ 964     $ (11 )   $ 29,723  

The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $1,684 and $1,772, respectively, as of September 30, 2012.  The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $2,358 and $2,472, respectively, as of December 31, 2011.

 
10

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)



The following tables present the maturity ranges of securities available-for-sale and held-to-maturity as of  September 30, 2012 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.

Investment Portfolio Maturity Distribution
 
                                     
   
Available-for-Sale
   
Held-to-Maturity
 
   
Amortized
   
Fair
         
Amortized
   
Fair
       
In thousands
 
Costs
   
Value
   
Yield
   
Costs
   
Value
   
Yield
 
U.S. Government and federal agency:
                                   
Less than one year
  $ 200       200       1.37 %   $ -     $ -       -  
After five but within ten years
    3,044       3,051       2.13 %     4,482       4,656       3.43 %
After ten years
    4,442       4,585       2.76 %     3,778       3,948       3.21 %
Government-sponsored enterprises:
                                               
After one but within five years
    2,584       2,680       1.77 %     -       -       -  
After five but within ten years
    14,574       14,647       1.85 %     -       -       -  
After ten years
    6,500       6,515       3.58 %     -       -       -  
Obligations of states and subdivisions:
                                               
After one but within five years
    5,447       5,442       1.83 %     599       616       3.90 %
After five but within ten years
    4,583       4,570       2.13 %     4,841       5,182       4.16 %
After ten years
    12,480       12,956       3.83 %     10,701       11,419       4.35 %
Mortgage-backed securities
    74,041       76,106       2.29 %     250       270       4.66 %
Collateralized mortgage obligations
    11,980       12,115       1.90 %     1,824       1,923       5.57 %
Total
  $ 139,875     $ 142,867             $ 26,475     $ 28,014          
                                                 
Total Securities by Maturity Period
                                               
Less than one year
  $ 200     $ 200             $ -     $ -          
After one but within five years
    8,031       8,122               599       616          
After five but within ten years
    22,201       22,268               9,323       9,838          
After ten years
    23,422       24,056               14,479       15,367          
Mortgage-backed securities*
    74,041       76,106               250       270          
Collateralized mortgage obligations*
    11,980       12,115               1,824       1,923          
Total by Maturity Period
  $ 139,875     $ 142,867             $ 26,475     $ 28,014          

*  Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms due to early repayments of principal.

 
11

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


The following tables detail unrealized losses and related fair values in the Bank’s available-for-sale and held-to-maturity investment securities portfolios.  This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2012 and December 31, 2011, respectively.


Temporarily Impaired Securities in AFS Portfolio
 
                                     
In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
September 30, 2012
 
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
Government-sponsored enterprises
  $ 2,493     $ (7 )   $ -     $ -     $ 2,493     $ (7 )
Collateralized mortgage obligations
    3,442       (10 )     -       -       3,442       (10 )
States and political subdivisions
    10,327       (82 )     -       -       10,327       (82 )
    $ 16,262     $ (99 )   $ -     $ -     $ 16,262     $ (99 )

                                     
December 31, 2011
                                   
Government-sponsored enterprises
  $ 10,558     $ (30 )   $ 2,993     $ (7 )   $ 13,551     $ (37 )
Mortgage-backed securities
    42,828       (182 )     -       -       42,828       (182 )
Collateralized mortgage obligations
    6,884       (14 )     16       (1 )     6,900       (15 )
States and political subdivisions
    3,971       (19 )     -       -       3,971       (19 )
    $ 64,241     $ (245 )   $ 3,009     $ (8 )   $ 67,250     $ (253 )

There were no securities with unrealized losses in the HTM portfolio at September 30, 2012.

Temporarily Impaired Securities in HTM Portfolio
 
                                     
In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
December 31, 2011
 
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
States and political subdivisions
  $ 1,005     $ (11 )   $ -     $ -     $ 1,005     $ (11 )
    $ 1,005     $ (11 )   $ -     $ -     $ 1,005     $ (11 )

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At September 30, 2012, there are no securities in the portfolio with unrealized losses for a period greater than 12 months.

Note 3.  Loans and Allowance for Loan and Lease Losses

The major components of loans in the consolidated balance sheets at September 30, 2012 and December 31, 2011 are as follows:

 
12

 

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


In thousands
 
9/30/2012
   
12/31/2011
 
Commercial
  $ 90,997     $ 87,711  
Real estate:
               
Commercial real estate
    263,242       257,578  
Construction real estate
    46,478       36,081  
Residential real estate
    136,245       122,450  
Consumer
    4,648       4,314  
Deferred loan fees, net
    358       452  
Gross loans
    541,968       508,586  
                 
Allowance for loan losses
    (8,548 )     (9,650 )
Net loans
  $ 533,420     $ 498,936  

Substantially all one-four family residential and commercial real estate loans collateralize the line of credit available from the Federal Home Loan Bank and substantially all commercial and construction loans collateralize the line of credit with the Federal Reserve Bank of Richmond Discount Window.  The aggregate amount of deposit overdrafts that have been reclassified as loans and included in the consumer category in the above table as of September 30, 2012 and December 31, 2011 was $388 and $74, respectively.

Loan Origination.  The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a periodic basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate market or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus income producing loans. At September 30, 2012, approximately 44% of the

 
13

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties and 49% was secured by income-producing properties.

With respect to construction and development loans that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by recurring on-site inspections during the construction phase and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential real estate loans are secured by deeds of trust on 1-4 family residential properties.  The Bank also serves as a broker for residential real estate loans placed in the secondary market.  There are occasions when a borrower or the real estate does not qualify under secondary market criteria, but the loan request represents a reasonable credit risk.  On these occasions, if the loan meets the Bank’s internal underwriting criteria, the loan will be closed and placed in the Company’s portfolio.  Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of collateral.

The Company routinely makes consumer loans, both secured and unsecured, for financing automobiles, home improvements, education, and personal investments.  The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit decision.  Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property.  Negative changes in a
customer’s financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk.  In addition, deterioration in collateral value can add risk to consumer loans.

Risk Management. It is the Company’s policy that loan portfolio credit risk shall be continually evaluated and categorized on a consistent basis.  The Board of Directors recognizes that commercial, commercial real estate and construction lending involve varying degrees of risk, which must be identified, managed, and monitored through established risk rating procedures.  Management’s ability to accurately segment the loan portfolio by the various degrees of risk enables the Bank to achieve the following objectives:

1. 
Assess the adequacy of the Allowance for Loan and Lease Losses;
2. 
Identify and track high risk situations and ensure appropriate risk management;
3. 
Conduct portfolio risk analysis and make informed portfolio planning and strategic decisions; and
4.
Provide risk profile information to management, regulators and independent accountants as requested in a timely manner.

There are three levels of accountability in the risk rating process:
1.
Risk Identification -  The primary responsibility for risk identification lies with the account officer.  It is the account officer's responsibility for the initial and ongoing risk rating of all notes and commitments in his or her portfolio.  The account officer is the one individual who is closest to the credit relationship and is in the best position to identify changing risks.  Account officers are required to continually review the risk ratings for their credit relationships and make timely adjustments, up or down, at the time the circumstances warrant a change.  Account officers are responsible for ensuring that accurate and timely risk ratings are maintained at all times.   Account officers are allowed a maximum 30-day period to assess current financial information (e.g. prepare credit analysis) which may influence the current risk rating. Account officers are required to review the risk ratings of loans assigned to their portfolios on a monthly basis and to certify to the accuracy of the ratings.  Certifications are submitted to the Chief Credit Officer and Chief Lending Officer for review.  All risk rating changes (upgrades and downgrades) must be approved by the Chief Credit Officer prior to submission for input into the Commercial Loan System.

 
14

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


2.
Risk Supervision -  In addition to the account officer’s process of assigning and managing risk ratings, the Chief Credit Officer is responsible for periodically reviewing the risk rating process employed by the account officers.  Through credit administration, the Chief Credit Officer manages the credit process which, among other things, includes maintaining and managing the risk identification process.  The Chief Credit Officer is responsible for the accuracy and timeliness of account officer risk ratings and has the authority to override account officer risk ratings and initiate rating changes, if warranted.  Upgrades from a criticized or classified category to a pass category or upgrades within the criticized/classified categories require the approval of the Senior Loan Committee or Directors’ Loan Committee based upon aggregate exposure. Upgrades must be reported to the Directors' Loan Committee and Board of Directors at their next scheduled meetings.
3.
Risk Monitoring - Valley Bank has a loan review program to provide an independent validation of portfolio quality. This independent review is intended to assess adherence to underwriting guidelines, proper credit analysis and documentation.  In addition, the loan review process is required to test the integrity, accuracy, and timeliness of account officer risk ratings and to test the effectiveness of the credit administration function's controls over the risk identification process.  Portfolio quality and risk rating accuracy are evaluated during regularly scheduled portfolio reviews.  Risk Management is required to report all loan review findings to the quarterly joint meeting of the Audit Committee and Directors’ Loan Committee.

Related party loans.  In the ordinary course of business, the Company has granted loans to certain directors, executive officers, significant shareholders and their affiliates (collectively referred to as “related parties”). These loans were made on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other unaffiliated persons, and do not involve more than normal credit risk or present other unfavorable features.
 
Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following schedule is an aging of past due loans receivable by portfolio segment as of September 30, 2012 and December 31, 2011:
 

 
15

 

VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


                                           
In thousands
 
30 - 59 Days Past Due
   
60 - 89 Days Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
   
Current
   
Total Loans
   
Recorded Investment > 90 Days, Accruing
 
September 30, 2012
                                         
Commercial
  $ 176     $ 586     $ 557     $ 1,319     $ 89,678     $ 90,997     $ -  
Commercial real estate
                                                       
Owner occupied
    865       1,223       884       2,972       112,116       115,088       476  
Income producing
    -       -       -       -       129,584       129,584       -  
Multifamily
    -       -       -       -       18,570       18,570       -  
Construction real estate
                                                       
1 - 4 Family
    -       -       289       289       23,175       23,464       -  
Other
    -       -       4,674       4,674       16,808       21,482       -  
Farmland
    -       -       -       -       1,532       1,532       -  
Residential real estate
                                                       
Equity Lines
    124       -       400       524       29,227       29,751       400  
1 - 4 Family
    811       981       676       2,468       96,706       99,174       -  
Junior Liens
    -       88       -       88       7,232       7,320       -  
Consumer
                                                       
Credit Cards
    23       3       -       26       1,529       1,555       -  
Other
    -       1       3       4       3,089       3,093       -  
Deferred loan fees, net
    -       -       -       -       358       358       -  
Total
  $ 1,999     $ 2,882     $ 7,483     $ 12,364     $ 529,604     $ 541,968     $ 876  
                                                         

                                           
December 31, 2011
                                         
Commercial
  $ 93     $ 813     $ 1,957     $ 2,863     $ 84,848     $ 87,711     $ -  
Commercial real estate
                                                       
Owner occupied
    1,265       495       1,012       2,772       110,697       113,469       -  
Income producing
    -       -       808       808       129,333       130,141       -  
Multifamily
    -       -       -       -       13,968       13,968       -  
Construction real estate
                                                       
1 - 4 Family
    -       -       -       -       11,171       11,171       -  
Other
    -       569       3,713       4,282       19,266       23,548       -  
Farmland
    -       -       -       -       1,362       1,362       -  
Residential real estate
                                                       
Equity Lines
    164       -       -       164       30,241       30,405       -  
1 - 4 Family
    775       -       93       868       86,284       87,152       -  
Junior Liens
    1       -       -       1       4,892       4,893       -  
Consumer
                                                       
Credit Cards
    10       -       -       10       1,345       1,355       -  
Other
    15       -       -       15       2,944       2,959       4  
Deferred loan fees, net
    -       -       -       -       452       452       -  
Total
  $ 2,323     $ 1,877     $ 7,583     $ 11,783     $ 496,803     $ 508,586     $ 4  

 
16

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)


Nonaccrual Loans.  Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Loans will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of collection.  In this case, the loan will continue to accrue interest despite its past due status.  When interest accrual is discontinued, all unpaid accrued interest is reversed and any subsequent payments received are applied to the outstanding principal balance. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  The following is a schedule of loans receivable, by portfolio segment, on nonaccrual status as of September 30, 2012 and December 31, 2011:
 
In thousands
 
September 30, 2012
   
December 31, 2011
 
Commercial
  $ 1,249     $ 2,183  
Commercial real estate
               
Owner occupied
    408       1,013  
Income producing
    -       808  
Construction real estate
               
1 - 4 Family
    290       471  
Other
    4,674       3,713  
Residential real estate
               
Equity Lines
    62       64  
1 - 4 Family
    1,815       334  
Junior Liens
    46       49  
Consumer
               
Other
    3       3  
Total
  $ 8,547     $ 8,638  
 
 
Had nonaccrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income in the amount of $253 during the nine-months ended September 30, 2012; $550 during the year ended December 31, 2011, and $437 during the nine-months ended September 30, 2011.  There were seven restructured loans totaling $3,324 at September 30, 2012 and there were twelve restructured loans totaling $2,305 at December 31, 2011.

Impaired Loans.  Impaired loans are identified by the Company as loans in which it is determined to be probable that the borrower will not make interest and principal payments according to the contract terms of the loan.  In determining impaired loans, our credit administration department reviews past-due loans, examiner classifications, Bank classifications, and a selection of other loans to provide evidence as to whether the loan is impaired.  All loans rated as substandard are evaluated for impairment by the Bank’s Allowances for Loan and Lease Losses (“ALLL”) Committee.  Once classified as impaired, the ALLL Committee individually evaluates the total loan relationship, including a detailed collateral analysis, to determine the reserve appropriate for each one.  Any potential loss exposure identified in the collateral analysis is set aside as a specific reserve (valuation allowance) in the allowance for loan and lease losses.  If the impaired loan is subsequently resolved and it is determined the reserve is no longer required, the specific reserve will be taken back into income during the period the determination is made.  Impaired loans, or portions thereof, are charged off

 
17

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)



when deemed uncollectible.  Impaired loans as of September 30, 2012 and December 31, 2011 are set forth in the following table:
                               
                               
In thousands
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
September 30, 2012
                             
With no related allowance:
                             
Commercial
  $ 2,064     $ 2,267     $ -     $ 2,485     $ 60  
Commercial real estate
                                       
Owner occupied
    10,680       10,680       -       12,217       575  
Income producing
    4,641       4,641       -       2,453       106  
Multifamily
    -       -       -       -       -  
Construction real estate
                                       
1 - 4 Family
    1,294       1,294       -       1,503       50  
Other
    1,710       3,695       -       2,520       51  
Farmland
    -       -       -       -       -  
Residential real estate
                                       
Equity Lines
    861       864       -       883       25  
1 - 4 Family
    5,817       6,022       -       5,492       191  
Junior Liens
    104       104       -       104       4  
Consumer
                                       
Credit Cards
    -       -       -       -       -  
Other
    28       28       -       32       1  
Total loans with no allowance
  $ 27,199     $ 29,595     $ -     $ 27,689     $ 1,063  
                                         
With an allowance recorded:
                                       
Commercial
    297       308       112       315       1  
Construction real estate
                                       
1 - 4 Family
    289       321       217       402       -  
Other
    3,769       9,341       1,708       9,341       25  
Farmland
    180       180       4       183       10  
Residential real estate
                                       
1 - 4 Family
    1,977       1,984       152       1,992       57  
Junior Liens
    46       49       17       49       -  
Total loans with an allowance
  $ 6,558     $ 12,183     $ 2,210     $ 12,282     $ 93  
                                         
Total:
                                       
Commercial
    2,361       2,575       112       2,800       61  
Commercial real estate
    15,321       15,321       -       14,670       681  
Construction real estate
    7,242       14,831       1,929       13,949       136  
Residential real estate
    8,805       9,023       169       8,520       277  
Consumer
    28       28       -       32       1  
Totals
  $ 33,757     $ 41,778     $ 2,210     $ 39,971     $ 1,156  

 
18

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2012 (Unaudited)
(In thousands, except share and per share data)



In thousands
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance