10-K 1 a2015123110k.htm 10-K 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K
 
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2015
Commission File Number 001-32968
 
Hampton Roads Bankshares, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
Virginia
54-2053718
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
641 Lynnhaven Parkway Virginia Beach, Virginia
23452
(Address of principal executive offices)
(Zip Code)
 
(757) 217-1000
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, par value $0.01 per share   
The NASDAQ Global Select Market


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

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.  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        ¨    Accelerated filer        ¨
Non-accelerated filer        ¨    Smaller reporting company    x
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ No x
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter:  $71,288,408
 
The number of shares outstanding of the issuer's Common Stock as of March 17, 2016 was 171,325,712 shares, par value $0.01 per share.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
NONE

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HAMPTON ROADS BANKSHARES, INC.
 
 
 
 
 

Hampton Roads Bankshares, Inc.
Form 10-K Annual Report
For the Year Ended December 31, 2015
Table of Contents
 
Part I
 
 
Item 1
Business
Item 1A
Risk Factors
Item 1B
Unresolved Staff Comments
Item 2
Properties
Item 3
Legal Proceedings
Item 4
Mine Safety Disclosures
Part II
 
 
Item 5
Market for Registrant's Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities
Item 6
Selected Financial Data
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
Item 8
Financial Statements and Supplementary Data
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A
Controls and Procedures
Item 9B
Other Information
Part III
 
 
Item 10
Directors, Executive Officers, and Corporate Governance
Item 11
Executive Compensation
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Item 13
Certain Relationships and Related Transactions and Director Independence
Item 14
Principal Accounting Fees and Services
Part IV
 
 
Item 15
Exhibits and Financial Statement Schedules
 
Signatures
 
Exhibit Index


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HAMPTON ROADS BANKSHARES, INC.

PART 1

ITEM 1 - BUSINESS
 
Overview

Unless indicated otherwise, the terms “we,” “us,” or “our” refer to Hampton Roads Bankshares, Inc. and its consolidated subsidiaries.
Hampton Roads Bankshares, Inc. (the “Company”), a Virginia corporation, incorporated under the laws of the Commonwealth of Virginia on February 28, 2001, headquartered in Virginia Beach, Virginia, serves as a bank holding company for Bank of Hampton Roads (“BOHR” or "the Bank" or "our Bank" or "Bank"). 
BOHR is a Virginia state-chartered commercial bank, which engages in general community and commercial banking business. Currently, BOHR operates 17 full-service offices in the Hampton Roads region of southeastern Virginia, including six offices in the city of Chesapeake, three offices in the city of Norfolk, six offices in the city of Virginia Beach, one office in the city of Emporia, and one office in the city of Suffolk.  In addition, BOHR has 10 full-service offices located in Richmond, Virginia and the Northeastern and Research Triangle regions of North Carolina, which all do business as Gateway Bank. BOHR also operates 7 full-service offices and 3 loan production offices ("LPO") in the Virginia, Maryland, and Delaware portions of the Delmarva Peninsula, otherwise known as the Eastern Shore, and in Glen Burnie, Maryland, that do business as Shore Bank. Upon receiving federal and state regulatory approval, the Company merged its separately held bank subsidiary, Shore Bank ("Shore"), into BOHR on October 13, 2015.
Through Gateway Bank Mortgage, Inc. ("GBMI"), a wholly-owned operating subsidiary which owns 51% of DNJ Gateway Bank Mortgage, LLC ("DGBM"), BOHR provides mortgage banking services, including the origination and processing of mortgage loans for sale into the secondary market. Through its specialty finance unit, Shore Premier Finance ("SPF"), BOHR provides marine financing for U.S. Coast Guard documented vessels to customers throughout the United States. BOHR also has an investment in a Virginia title insurance agency that enables it to offer title insurance policies to its real estate loan customers, and also has several inactive wholly-owned operating subsidiaries: Harbour Asset Servicing, Inc., and Gateway Investment Services, Inc.
The Company also owns all of the common stock of Gateway Capital Statutory Trust I, Gateway Capital Statutory Trust II, Gateway Capital Statutory Trust III, and Gateway Capital Statutory Trust IV (collectively, the “Gateway Capital Trusts”).  The Gateway Capital Trusts are not consolidated as part of the Company’s consolidated financial statements.  However, the junior subordinated debentures issued by the Company to the Gateway Capital Trusts are included in other borrowings, and the Company’s equity interest in the Gateway Capital Trusts is included in other assets.
On February 10, 2016, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with Xenith Bankshares, Inc. (“Xenith”, "XBKS"), a Virginia corporation, the holding company for Xenith Bank. The Merger Agreement provides that Xenith will merge with and into the Company (the “Merger”), with the Company as the surviving corporation in the Merger. The transaction is expected to close in the third quarter of 2016. For a further discussion of the Merger, refer to Note 25, Subsequent Events, of the Notes to Consolidated Financial Statements.
Our principal executive office is located at 641 Lynnhaven Parkway, Virginia Beach, Virginia 23452 and our telephone number is (757) 217-1000.  The Company’s common stock, par value $0.01 per share (the “Common Stock”), trades on the NASDAQ Global Select Market under the symbol “HMPR.”  A significant portion of our outstanding Common Stock is owned by three institutional investors: Anchorage Capital Group, L.L.C. (“Anchorage”), CapGen Capital Group VI LP (“CapGen”), and The Carlyle Group, L.P. (“Carlyle”). Anchorage, CapGen, and Carlyle own 24.78%, 29.82%, and 24.78%, respectively, of the outstanding shares of our Common Stock as of December 31, 2015.


Business
 
Principal Products or Services
 
Hampton Roads Bankshares, Inc. engages in a general community and commercial banking business, targeting the banking needs of individuals and small- to medium-sized businesses in its primary service areas, which include the Hampton Roads region of southeastern Virginia, the Northeastern and Research Triangle regions of North Carolina, the Eastern Shore of Virginia, Maryland, and Delaware, the Baltimore region of Maryland, and Richmond, Virginia.  The Company’s primary products are traditional loan and deposit banking services. 

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We offer a broad range of interest-bearing and noninterest-bearing deposit accounts, including commercial and retail checking accounts, Negotiable Order of Withdrawal accounts, savings accounts, and individual retirement accounts as well as certificates of deposit with a range of maturity date options.  The primary sources of deposits are small- and medium-sized businesses and individuals within our target markets.  Additionally, we may obtain both national certificates of deposit and brokered certificates of deposit.
All deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the maximum allowed by law of $250,000.  We offer a range of commercial, real estate, and consumer loans.  Our loan portfolio is comprised of the following categories:  commercial and industrial, construction, real estate-commercial mortgage, real estate-residential mortgage, and installment.  Commercial and industrial loans are loans to businesses that are typically not collateralized by real estate.  Generally, the purpose of commercial and industrial loans is for the financing of accounts receivable, inventory, or equipment and machinery.  Construction loans are made to individuals and businesses for the purpose of construction of single family residential properties, multi-family properties, and commercial projects as well as the development of residential neighborhoods and commercial office parks.  Commercial mortgage loans are made for the purchase and re-financing of owner occupied commercial properties as well as non-owner occupied income producing properties.  Our residential mortgage portfolio includes first and junior lien mortgage loans, home equity lines of credit, and other term loans secured by first and junior lien mortgages.  Installment loans are made on a regular basis for personal, family, and general household purposes.  More specifically, we make automobile loans, marine loans, home improvement loans, loans for vacations, and debt consolidation loans. 
Our primary lending objective is to enhance customer relationships by meeting business and consumer needs in our market areas, while maintaining our standards of profitability and credit quality.  All lending decisions are based upon an evaluation of the financial strength and credit history of the borrower and the quality and value of the collateral securing the loan.  With few exceptions, personal guarantees are required on all loans.
The direct lending activities in which the Company engages carry the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Board of Governors of the Federal Reserve System (the "Federal Reserve") and general economic conditions, nationally and in the Company's primary market areas, have a significant impact on the Company's results of operations. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations to the Company in full, in a timely manner, resulting in decreased earnings or losses to the Company. To the extent the Company makes fixed rate loans, general increases in interest rates will tend to reduce the Company's spread as the interest rates the Company must pay for deposits may increase while interest income may be unchanged. Economic conditions may also adversely affect the value of property pledged as security for loans and the ability to liquidate that property to satisfy a loan if necessary.
The Company's goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures and modifying those policies on occasion to account for changing or emerging risks or changing market conditions, evaluating each borrower's business plan and financial condition during the underwriting process and periodically throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and maintaining sufficient collateral to mitigate economic loss in the event of liquidation. An allowance for loan losses has been established which consists of general, specific, and unallocated qualitative components. A risk rating system is employed to estimate loss exposure and provide a measuring system for setting general reserve allocations.  The general component relates to groups of homogeneous loans not designated for specific impairment analysis that are collectively evaluated for potential loss.  The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment.  The specific allowance for loan losses is based on a loan-by-loan analysis and varies between impaired loans largely due to the value of the loan’s underlying collateral.  An unallocated qualitative component is maintained to cover uncertainties that could affect management’s estimate of probable losses and considers internal portfolio management effectiveness and external macroeconomic factors. 
The composition of the Company's loan portfolio is weighted toward commercial real estate and real estate construction.  At December 31, 2015, commercial real estate and real estate construction represented 51.7% of the loan portfolio.  These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow, and general economic conditions. The Company typically requires a maximum loan-to-value ("LTV") of 80% or less and minimum cash flow debt service coverage at the time of origination of 1.25 to 1.0. Personal guarantees are required by policy, with a limited number of exceptions being granted due to mitigating factors.
The general terms and underwriting standards for each type of loan is incorporated into the Company's lending policies. These policies are analyzed periodically by management, and the policies are reviewed and approved by a designated subcommittee of the Board on an annual basis. The Company's loan policies and practices described in this report are subject to periodic change, and each guideline or standard is subject to waiver or exception in the case of any particular loan, with approval by the appropriate officer or committee, in accordance with the Company's loan policies. Policy standards are often stated in mandatory terms, such as "shall" or "must", but these provisions are subject to exception where appropriately mitigated. Policy requires that loan value

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not exceed a percentage of "market value" or "fair value" based upon appraisals or evaluations obtained in the ordinary course of the Company's underwriting practices.
Loans are secured primarily by duly recorded first deeds of trust. In some cases, the Company may accept a recorded second lien position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is required. Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Company. Guaranteed, fixed price construction contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.
Commercial land acquisition and construction loans are secured by real property where loan proceeds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are required to contribute equity into each project at levels determined by Loan Policy. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.  LTV ratios, with few exceptions, are maintained consistent with or below supervisory guidelines.
All construction draw requests must be presented in writing on American Institute of Architects documents and certified by the contractor, the borrower and the borrower's architect. Each draw request shall also include the borrower's soft cost breakdown certified by the borrower or it's Chief Financial Officer. Prior to an advance, the Company or its contractor inspects the project to determine that the work has been completed in order to justify the draw requisition.
Commercial permanent loans are secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. At the time of origination, the debt service coverage ratio is ordinarily at least 1.25 to 1.0.  As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.
Personal guarantees are generally received from the principals on commercial real estate loans, and only in instances where the loan-to-value is sufficiently low and the debt service is sufficiently high is consideration given to either limiting or not requiring personal recourse. Updated appraisals for real estate secured loans are obtained as necessary and appropriate to borrower financial condition, project status, loan terms, and market conditions.
The Company is also an active traditional commercial lender providing loans for a variety of purposes, including cash flow, equipment and accounts receivable financing. This loan category represents 15.1% of the Company's loan portfolio at December 31, 2015 and is generally priced at a variable or adjustable rate. Commercial loans must meet reasonable underwriting standards, including appropriate collateral, and cash flow necessary to support debt service.  Residential home mortgage loans, including home equity lines and loans, make up 22.7% of the loan portfolio. These credits represent both first and second liens on residential property almost exclusively located in the Company’s primary market areas. The remaining 10.5% of the loan portfolio consists of retail consumer installment loans. At December 31, 2015, approximately 90.8% of the consumer installment loan portfolio is comprised of marine loans either originated or acquired by SPF.
The risk of nonpayment (or deferred payment) of loans is inherent in commercial lending. The Company's marketing focus on small to medium-sized businesses may result in the assumption by the Company of certain lending risks that are different from those inherent in loans to larger companies. The policies and procedures of the Company dictate that all loan applications are to be carefully evaluated and attempt to minimize credit risk exposure by use of extensive loan application data, due diligence, and approval and monitoring procedures; however, there can be no assurance that such procedures can eliminate such lending risks.
We offer other banking-related specialized products and services to our customers, such as travelers’ checks, coin counters, wire services, online banking, and safe deposit box services. Additionally, we offer our commercial customers various cash management products including remote deposit. Remote Deposit Capture allows our customers to make check deposits conveniently from their office with a small desktop scanner for faster funds availability and to begin earning interest sooner. Our  merchant services offers a suite of payment processing solutions tailored to retailers and other specific industries allowing processing of all major credit cards 24 hours a day 365 days a year.  We issue letters of credit and standby letters of credit, most of which are related to real estate construction loans, for some of our commercial customers.  We also facilitate the use of back-to-back swaps to help us and our customers manage interest rate risk.  We have not engaged in any securitizations of loans.
Additional Services
In addition to its banking operations, the Company has two other reportable segments:  Mortgage and Corporate.  GBMI comprises our Mortgage segment and provides mortgage banking services such as originating and processing mortgage loans for sale to the secondary market.  Our Corporate segment includes the holding Company, and immaterial passive operating results from inactive subsidiary units. For financial information about our business segments, see Note 15, Business Segment Reporting, of the Notes to Consolidated Financial Statements.

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We offer telephone, internet, and mobile banking to our customers. These services allow both commercial and retail customers to access detailed account information and execute a wide variety of banking transactions, including balance transfers and bill payment, by means other than a traditional teller or automated teller machine (“ATM”). We believe these services are particularly attractive to our customers, as these services enable them to conduct their banking business and monitor their accounts at any time. Telephone, internet, and mobile banking assist us in attracting and retaining customers and encourage our existing customers to consider us for all of their banking and financial needs.
Throughout our markets, we have a network of thirty-eight ATMs, which are accessible by the customers of our subsidiary bank.  Our customers can also access ATMs not owned by the Bank.
Competition

The financial services industry in our market area remains highly competitive and is constantly evolving.  We experience strong competition from other financial services organizations, some of which are not subject to the same degree of regulation that is imposed on us.  Many of them have broader geographic markets and substantially greater resources, and therefore, can offer more diversified products and services. 
In our market areas, we compete with large national and regional financial institutions, savings banks, and other independent community banks, as well as credit unions, consumer finance companies, mortgage companies, and loan production offices.  Competition for deposits and loans is affected by factors such as interest rates and terms offered, the number and location of branches, types of products offered, and reputation of the institution.  We believe that the pricing and structure of our products, as well as our high quality service and community involvement, helps us remain competitive and contributes to our overall success in the markets we serve.
Market
 
Our primary service area is encompassed by the Virginia Beach – Norfolk – Newport News, VA-NC Metropolitan Statistical Area, the 32nd largest metropolitan area in the United States, with a population of approximately 1.8 million.  The Company’s market area includes the Hampton Roads region including the cities of Chesapeake, Norfolk, Virginia Beach, Portsmouth, and Suffolk, Virginia; the Northeastern and Research Triangle regions of North Carolina; the Eastern Shore of Virginia and Maryland; the Baltimore region of Maryland; Richmond, Virginia; Ocean City, Maryland; and Rehoboth Beach, Delaware.  The Hampton Roads region is recognized as the eighth largest metro area in the Southeast U.S. and the second largest between Atlanta and Washington D.C.  Six of the ten largest population centers in the U.S. are located within 750 miles of Hampton Roads.  This region has a diverse, well-rounded economy supported by a solid manufacturing base.  However, due to a substantial military presence, the U.S. government has a significant impact on the economy of our region. 
The U.S. Navy’s Atlantic Fleet is headquartered at the Norfolk Naval Base, which is the largest Navy base in the world.  Additionally, Portsmouth is the home of the Norfolk Naval Shipyard, which is the U.S. Navy’s largest ship repair yard, and the Portsmouth Naval Medical Center, the oldest continuously running hospital in the Navy medical system.  In Newport News, Newport News Shipbuilding, a division of Huntington Ingalls Industries, is the nation’s sole designer, builder, and refueler of nuclear-powered aircraft carriers and one of only two shipyards capable of designing and building nuclear-powered submarines.  The area is also home to the National Aeronautics and Space Administration / Langley Research Center in Hampton, the Colonial Williamsburg Foundation (hotels and museums), three marine terminals owned by the Virginia Port Authority (shipping), and the Anheuser-Busch Williamsburg Brewery (beverage).  Furthermore, the U.S. Army, Air Force, and Coast Guard each have a significant presence in the Greater Hampton Roads area with bases in the region.
Leading employers in the private sector include Stihl, Inc. (chain saws), Sumitomo Machinery Corporation of America (industrial motor drives), Canon Virginia, Inc. (copiers, laser printers, and supplies), Dollar Tree Stores, Inc. (retail), Norfolk Southern Corporation (transportation), and Mitsubishi Corporation (various manufacturing operations).
The Fifth District of the Federal Reserve System
According to the Federal Reserve Bank of Richmond’s February 2016 update of the Fifth District economy (which includes our major market areas of Virginia, North Carolina, and Maryland), general economic indicators show continued overall improvement. On a year-over-year basis, overall business conditions have stabilized; payroll employment has risen 1.9%, the unemployment rate has declined to 5.2%, real personal income has increased 4.4%, non-business bankruptcies have declined 5.4%, the house price index increased 3.4%, housing starts increased 9.6%, although residential building permits declined 1.2%.
Virginia Markets
On a year-over-year basis, total employment in Virginia in December 2015 expanded 1.6%, led by growth in construction (4.4%), professional and business services (3.7%), financial activities (3.3%), and leisure and hospitality (2.2%). The Virginia Beach-Norfolk MSA grew by 1.0%, which was a much slower pace compared to other regions in Virginia. The unemployment rate in Virginia declined to 4.2% in December 2015, down from 4.8% in December 2014. The unemployment rate in the Richmond MSA

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was 4.4% in December 2015, down from 5.0% in December 2014, and in the Virginia Beach-Norfolk MSA it was 4.7% in December 2015, down from 5.2% in December 2014. Real personal income grew 4.4% on a year-over-year basis, non-business bankruptcies in Virginia were down 2.7% in 2015 compared to 2014, and the share of mortgages with payments 90 or more days past due declined slightly from 1.8% in 2014 to 1.4% in 2015. Residential building permits declined 0.8% and housing starts grew 10.0%, on a year-over-year basis. According to CoreLogic Information Solutions, home values in Virginia appreciated 1.6% in 2015, with home values in the Richmond MSA growing 4.6% and in the Virginia Beach-Norfolk MSA growing 1.1%.
According to the Old Dominion University Economic Forecasting Project, the Hampton Roads economy is expected to grow at a slightly higher rate of 1.6% in 2016 compared to 1.1% in 2015, but will continue to be slower than the historical annual average of 3.1% and slower than that of the nation. The U.S Gross Domestic Product grew by 8.0% from 2010 to 2014; however the Hampton Roads Real Gross Regional Product grew by only 1.6% during the same period. The primary reason for the sluggish economy in Hampton Roads is attributable to the decline in U.S Department of Defense (DOD) spending. Between 2000 and 2012 DOD spending increased annually at a rate of 5.7% in the region, whereas, DOD spending in 2016 is expected to be 2.8% lower than its peak in 2012. The challenge for regional leaders in coming years will be to ensure Hampton Roads reduces its dependence on DOD spending to spur economic activity, and to focus more attention on attracting higher paying jobs, in more varied industry segments.
North Carolina Markets
North Carolina’s economy continues to improve, with solid employment growth, improving household conditions, and mostly positive housing market indicators. On a year-over-year basis, employment in North Carolina expanded 2.1% in 2015 - faster than the national increase of 1.9%. Employment grew in the Durham MSA by 2.1%, in Greensboro-High Point MSA by 2.9%, and in Raleigh-Cary MSA by 1.8%. However, North Carolina’s unemployment rate increased slightly to 5.6% in December 2015, up from 5.4% in December 2014. Real personal income grew 5.0% on a year-over-year basis, non-business bankruptcies in North Carolina were down 7.4% in 2015 compared to 2014, and the share of mortgages with payments 90 or more days past due declined from 2.2% in 2014 to 1.7% in 2015. Residential building permits grew 2.0% and housing starts grew 13.2%, on a year-over-year basis. According to CoreLogic Information Solutions, home values in North Carolina appreciated 4.9% in 2015.
Maryland Markets
Maryland’s economy showed signs of improvement, with strong employment growth and improving household conditions, although housing market indicators were somewhat mixed. On a year-over-year basis, employment in Maryland expanded 2.1% in 2015. Employment grew in the Salisbury MSA by 4.5% and in Baltimore-Towson MSA by 2.3%. Maryland’s unemployment rate decreased to 5.1% in December 2015, down from 5.5% in December 2014. Real personal income grew 4.1% on a year-over-year basis, non-business bankruptcies in Maryland were down 9.2% in 2015 compared to 2014, and the share of mortgages with payments 90 or more days past due declined from 3.1% in 2014 to 2.2% in 2015. Residential building permits grew 3.1% and housing starts grew 14.3%, on a year-over-year basis. According to CoreLogic Information Solutions, home values in Maryland appreciated a modest 1.1% in 2015.

Concentrations
 
The majority of our depositors are located and doing business in our targeted market areas, and we lend a substantial portion of our capital and deposits to individual and business borrowers in these market areas.  Any factors adversely affecting the economy of the Greater Hampton Roads area could, in turn, adversely affect our performance.  The Company has no significant concentrations to any one customer. 

Government Supervision and Regulation
 
General
 
As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended, and the examination and reporting requirements of the Federal Reserve.
 
Other federal and state laws govern the activities of our Bank, including the activities in which it may engage, the investments it may make, the aggregate amount of loans it may grant to one borrower, and the dividends it may declare and pay to us. Our banking subsidiary is also subject to various consumer and compliance laws. As a Virginia state-chartered bank, BOHR is primarily subject to regulation, supervision, and examination by the Bureau of Financial Institutions of the Virginia State Corporation Commission (“Bureau of Financial Institutions”).  

In addition, we are regulated and supervised by the Federal Reserve through the Federal Reserve Bank of Richmond (“FRB”).  We must furnish to the Federal Reserve quarterly and annual reports containing detailed financial statements and schedules.  All aspects of our operations, including reserves, loans, mortgages, capital, issuance of securities, payment of dividends, and establishment

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of branches are governed by these authorities.  These authorities are able to impose penalties, initiate civil and administrative actions, and take further steps to prevent us from engaging in unsafe or unsound practices.  In this regard, the Federal Reserve has adopted capital adequacy requirements. 
 
The following description summarizes the more significant federal and state laws applicable to us. To the extent that statutory or regulatory provisions are described, the description is qualified in its entirety by reference to that particular statutory or regulatory provision.

Bank Holding Company Act

Under the Bank Holding Company Act, we are subject to periodic examination by the Federal Reserve and required to file periodic reports regarding our operations and any additional information that the Federal Reserve may require. Our activities at the bank holding company level are limited to:

banking, managing, or controlling banks;
furnishing services to or performing services for our subsidiaries; and
engaging in other activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities.

Some of the activities that the Federal Reserve has determined by regulation to be closely related to the business of a bank holding company include making or servicing loans and specific types of leases, performing specific data processing services, and acting in some circumstances as a fiduciary, investment, or financial adviser.
 
With some limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: 
acquiring substantially all the assets of any bank and
acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares) or merging or consolidating with another bank holding company.
 
In addition, and subject to some exceptions, the Bank Holding Company Act and the Change in Bank Control Act (the “Acts”), together with their regulations, require Federal Reserve approval prior to any person or Company acquiring “control” of a bank holding company, which is generally deemed to occur if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Under the Acts, prior notice to the Federal Reserve is required if a person acquires 10% or more, but less than 25%, of any class of voting securities and if the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”) or no other person owns a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenging this rebuttable control presumption.  CapGen has received Federal Reserve approval as a bank holding company to “control” the Company and currently owns 29.78% of the outstanding Common Stock.  Our next two largest investors, Anchorage Carlyle each own 24.74% of the outstanding Common Stock, and are prohibited from owning 25% or more of the outstanding Common Stock of the Company.  None of our other investors currently owns 25% or more of the outstanding Common Stock of the Company.

Capital Requirements

The Federal Reserve approved a final rule regarding capital requirements under the Basel III framework on July 2, 2013.  The rule implemented in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Basel III requires bank holding companies and their bank subsidiaries to maintain more capital, with a greater emphasis on common equity.
 
The Basel III final capital framework, among other things, (i) introduced a new capital measure “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expands the scope of the adjustments as compared to existing regulations.
 

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When fully phased-in, Basel III requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5% plus a “capital conservation buffer” of 2.5%, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0% plus the capital conservation buffer, (iii) a minimum ratio of Total (Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0% plus the capital conservation buffer, and (iv) as a newly adopted international standard, a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).
 
Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) may face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
 
The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing assets, deferred tax assets related to temporary differences that could not be realized through net operating loss carrybacks, and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.  The Company does not have any recognized mortgage servicing assets or significant investments in non-consolidated entities; however it does have net deferred tax assets, net of valuation allowance, of approximately $92.4 million as of December 31, 2015.

The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories. Specifics changes to current rules impacting the Company’s determination of risk-weighted assets include, among other things:
 
Applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development and construction loans.
Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due.
Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (currently set at 0%). 
Providing for a risk weight, generally not less than 20% with certain exceptions, for securities lending transactions based on the risk weight category of the underlying collateral securing the transaction.

The new minimum capital requirements were effective January 1, 2015, whereas the capital conservation buffer and the deductions from common equity Tier 1 capital phase in between 2015 and 2019. 

The Basel III framework also changes the prompt corrective action capital requirements effective in 2015. After the change, an institution would be deemed to be:
(i) “well capitalized” if it has a total risk based capital ratio of 10.0% or more, a Tier 1 risk based capital ratio of 8.0% or more, a CET1 risk based capital ratio of 6.5% or more, and a leverage capital ratio of 5.0% or more,
(ii) “adequately capitalized” if it has a total risk based capital ratio of 8.0% or more, a Tier 1 risk based capital ratio of 6.0% or more, a CET1 risk based capital ratio of 4.5% or more, and a leverage capital ratio of 4.0% or more,
(iii) “undercapitalized” if it has a total risk based capital ratio of less than 8.0%, a Tier 1 risk based capital ratio of less than 6.0%, a CET1 risk based capital ratio of less than 4.5%, and a leverage capital ratio of less than 4.0%,
(iv) “significantly undercapitalized” if it has a total risk based capital ratio of less than 6.0%, a Tier 1 risk based capital ratio of less than 4.0%, a CET1 risk based capital ratio of less than 3.0%, and a leverage capital ratio of less than 3.0%, and
(v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is less than or equal to 2.0%. Tangible equity would be defined for this purpose as Tier 1 capital (common equity Tier 1 capital plus any additional Tier 1 capital elements) plus any outstanding perpetual preferred stock that is not already included in Tier 1 capital.

BOHR was “well capitalized” at December 31, 2015.  

The risk-based capital standards of the FDIC and the FRB explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure

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to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

Payment of Dividends

The Company is a legal entity separate and distinct from the Bank and its subsidiaries. Substantially all of our cash revenues will result from dividends paid to us by our Bank and interest earned on investments. Our Bank is subject to laws and regulations that limit the amount of dividends that they can pay. Under Virginia law, a bank may declare a dividend out of the bank’s net undivided profits, but not in excess of its accumulated retained earnings.  Additionally, our Bank may not declare a dividend, unless the dividend is approved by the Federal Reserve, if the total amount of all dividends, including the proposed dividend, declared by the bank in any calendar year exceeds the total of the bank’s retained net income of that year to date, combined with its retained net income of the two preceding years.  Federal Reserve regulations also provide that a bank may not declare a dividend in excess of its undivided profits without Federal Reserve approval.  Our Bank may not declare or pay any dividend if, after making the dividend, the bank would be “undercapitalized,” as defined in the banking regulations.

The Federal Reserve and the Bureau of Financial Institutions have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the Federal Reserve and the Bureau of Financial Institutions have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice.

In addition, we are subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Regulators have indicated that bank holding companies should generally pay dividends only if the organization’s net income attributable to Hampton Roads Bankshares, Inc. over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition.

Insurance of Accounts, Assessments, and Regulation by the FDIC

The deposits of our bank subsidiary are insured by the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance assessments of the Deposit Insurance Fund (“DIF”) of the FDIC.  Under the Dodd-Frank Act (refer to discussion below), a permanent increase in deposit insurance was authorized to $250,000.  The coverage limit is per depositor, per insured depository institution for each ownership category.

This system is intended to tie each bank’s deposit insurance assessments to the risk it poses to the FDIC’s DIF.  Under the risk-based assessment system, the FDIC evaluates each bank’s risk based on three primary factors:  (1) its supervisory rating, (2) its financial ratios, and (3) its long-term debt issuer rating, if applicable.  In addition to being influenced by the risk profile of the particular depository institution, FDIC premiums are also influenced by the size of the DIF in relation to total deposits in FDIC insured banks.  Rates vary between 2.5 and 45 basis points, depending on the insured institution’s Risk Category.  Initial base assessment rates range from 5-9 basis points for Risk Category I institutions to 35 basis points for Risk Category IV institutions.  In addition, premiums increase for institutions that rely on excessive amounts of brokered deposits to fund rapid growth, excluding Certificate of Deposit Account Registry Service (“CDARS”), and decrease for institutions’ unsecured debt.  After applying all possible adjustments, minimum and maximum total base assessment rates range from 2.5-9 basis points for Risk Category I institutions to 30-45 basis points for Risk Category IV institutions.  Either an increase in the Risk Category of our bank subsidiaries or adjustments to the base assessment rates could have a material adverse effect on our earnings.  As the DIF reserve ratio is replenished to certain thresholds in the future, these assessment rates may decrease without further action by the FDIC being required.  The FDIC also has authority to impose special assessments.
Assessments generally are based upon a depository institution’s average total consolidated assets minus the average tangible equity of the insured depository institution during the assessment period. Pursuant to the Dodd-Frank Act, the minimum deposit insurance fund ratio will increase from 1.15% to 1.35% by September 30, 2020, and the cost of the increase will be borne by depository institutions with assets of $10.0 billion or more.
The Dodd-Frank Act also provides the FDIC with discretion to determine whether to pay rebates to insured depository institutions when its deposit insurance reserves exceed certain thresholds. Previously, the FDIC was required to give rebates to depository institutions equal to the excess once the reserve ratio exceeded 1.50%, and was required to rebate 50% of the excess over 1.35% but not more than 1.50% of insured deposits. The FDIC adopted a final rule on February 7, 2011 that implemented these provisions of the Dodd-Frank Act. 
Further, all FDIC insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal Government established to recapitalize the predecessor to the

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DIF.  The FICO assessment rate, which is determined on a quarterly basis and computed on assets, was 0.0014% for the fourth quarter of 2015.  These assessments will continue until the FICO bonds mature in 2019. 
The FDIC is authorized to prohibit any insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the DIF. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. We are unaware of any existing circumstances that could result in the termination of any of our bank subsidiaries’ deposit insurance.

Dodd-Frank Act

On July 21, 2010, the Dodd-Frank Act, which significantly changes the regulation of financial institutions and the financial services industry, was signed into law.  The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  The Dodd-Frank Act requires a number of federal agencies to adopt a broad range of new rules and regulations and to prepare various studies and reports for Congress.  The federal agencies are given significant discretion in drafting these rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for some time.

The Dodd-Frank Act, among other things, limits interchange fees payable on debit card transactions, includes provisions that affect corporate governance and executive compensation at all publicly-traded companies, and allows financial institutions to pay interest on business checking accounts.

On December 10, 2013, five financial regulatory agencies, including the Federal Reserve, Commodity Futures Trading Commission, FDIC, Office of the Comptroller of the Currency, and the Securities and Exchange Commission, adopted final rules implementing a provision of the Dodd-Frank Act, commonly referred to as the Volcker Rule.  The final rules generally would prohibit banking entities from:
engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account;
owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as “covered funds”.

On January 14, 2014, the five financial regulatory agencies approved an adjustment to the final rule by allowing banks to keep certain collateralized debt obligations (“CDOs”) acquired by the bank before the Volcker Rule was finalized, if the CDO was established before May 2010 and is backed primarily by trust preferred securities issued by banks with less than $15 billion in assets established.  The final rules are effective April 1, 2014; however, the Federal Reserve has extended the conformance period until July 21, 2017.  As of December 31, 2015, our investment portfolio did not contain any securities subject to the Volcker Rule.

Consumer Financial Protection Bureau

The Dodd-Frank Act created a new, independent federal agency, the Consumer Financial Protection Bureau (“CFPB”) having broad rule-making, supervisory, and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10.0 billion or more in assets. Smaller institutions, including the Bank, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.


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In 2013, the CFPB adopted a rule, effective in January 2014, to implement certain sections of the Dodd-Frank Act requiring creditors to make a reasonable, good faith determination of a consumer’s ability to repay any closed-end consumer credit transaction secured by a 1-4 family dwelling.  The rule also establishes certain protections from liability under this requirement to ensure a borrower’s ability to repay for loans that meet the definition of “qualified mortgage.”  Loans that satisfy this “qualified mortgage” safe harbor will be presumed to have complied with the new ability-to-repay standard.  We have assessed our current lending practices and have determined that a large majority of mortgage loans that we originate are Government Sponsored Enterprise-eligible ("GSE-eligible") and are therefore qualified mortgages.  We have also determined that the Company’s lending policies comply with the requirement to consider certain underwriting factors under the ability-to-repay standard.

In November 2013, the CFPB issued a final rule amending Regulation Z (Truth in Lending Act or "TILA") and Regulation X (Real Estate Settlement Procedures Act or "RESPA") to integrate several mortgage loan disclosures. On July 21, 2015, the CFPB issued a final rule establishing October 3, 2015, as the new effective date for implementation of these new forms and the associated rules. The TILA-RESPA Integrated Disclosure Rule ("TRID", "TRID rule") consolidates four existing disclosures required under TILA and RESPA for closed-end credit transactions secured by real property, the appraisal notice required by the Equal Credit Opportunity Act, and the servicing notice required by RESPA into two forms: a Loan Estimate (LE) that must be delivered or placed in the mail no later than the third business day after receiving the consumer’s application, and a Closing Disclosure (CD) that must be provided to the consumer at least three business days prior to loan consummation.

The TRID rule applies to most closed-end consumer credit transactions secured by real property, but does not apply to: home equity lines of credit, reverse mortgages, or chattel-dwelling loans, such as loans secured by a mobile home or by a dwelling not attached to real property. The TRID rule applies to all lenders making mortgage loans, including community banks, unless the lender extended credit to a consumer 25 or fewer times including mortgage loans, or made five or fewer mortgage loans in the previous calendar year or current calendar year. Certain types of loans that are currently subject to TILA but not RESPA are subject to the TRID rule’s integrated disclosure requirements, including: construction-only loans; and loans secured by vacant land or by 25 or more acres. The new integrated disclosures must be provided by a creditor or mortgage broker that receives an application from a consumer for a closed-end credit transaction secured by real property on or after October 3, 2015.

On October 1, 2015, the CFPB and other financial regulators announced that during initial examinations for compliance with the TRID rule, examiners will evaluate an institution’s compliance management system and overall efforts to comply with the new requirements. Lenders will be expected to make good faith efforts to comply with the TRID rule's requirements in a timely manner. Specifically, examiners will consider: the lender’s implementation plan, including actions taken to update policies and procedures; its training of staff; and, its handling of early technical problems or other implementation challenges.

The TRID rule includes some new restrictions on certain activity prior to a consumer’s receipt of the LE. These restrictions took effect on October 3, 2015, regardless of whether an application has been received on that date. These activities include: imposing fees on a consumer before the consumer has received the loan estimate except for a bona fide and reasonable charge to obtain a consumer’s credit report; providing written estimates of terms or costs specific to consumers before they receive the LE without a written statement informing the consumer the terms and costs may change; and requiring submission of documents verifying information related to the consumer’s application before providing the LE.

Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 comprehensively revised the laws affecting corporate governance, accounting obligations, and corporate reporting for companies with equity or debt securities registered under the Exchange Act, as amended. In particular, the Sarbanes-Oxley Act of 2002 established (1) requirements for audit committees, including independence, expertise, and responsibilities; (2) certification responsibilities for the chief executive officer and chief financial officer with respect to the Company’s financial statements; (3) standards for auditors and regulation of audits; (4) increased disclosure and reporting obligations for reporting companies and their directors and executive officers; and (5) increased civil and criminal penalties for violation of the federal securities laws.

Bank Secrecy Act (“BSA”)
 
Under the BSA, a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving $10 thousand or more to the Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions that involve $5 thousand or more and which the financial institution knows, suspects, or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA, or has no lawful purpose.
 

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USA Patriot Act of 2001 (“Patriot Act”)
 
In October 2001, the Patriot Act was enacted in response to the terrorist attacks in New York, Pennsylvania, and Washington, D.C. that occurred on September 11, 2001.  The Patriot Act is intended to strengthen U.S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts.  The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.  The continuing and potential impact of the Patriot Act and related regulations and policies on financial institutions of all kinds is significant and wide-ranging.
 
Gramm-Leach-Bliley Act of 1999 (“GLBA”)
 
The GLBA covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms, and insurance companies. The following description summarizes some of its significant provisions.
 
The GLBA contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer credit reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are stricter than those contained in the act.
 
The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms.

Community Reinvestment Act of 1977 (“CRA”)
 
Under the CRA and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low- and moderate-income areas, consistent with safe and sound banking practice. The CRA requires the adoption by each institution of a CRA statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with the CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries.
 
The GLBA and federal bank regulators have made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual reports must be made to a bank’s primary federal regulator. A bank holding company or any of its subsidiaries will not be permitted to engage in new activities authorized under the GLBA if any bank subsidiary received less than a “satisfactory” rating in its latest CRA examination.  During our last CRA exam, our rating was “satisfactory.”
 
Monetary Policy
 
The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in United States government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against deposits held by federally insured banks, and quantitative easing. The Federal Reserve’s monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national and international economies and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of our bank subsidiaries, their subsidiaries, or any of our other subsidiaries.


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Transactions with Affiliates
 
Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any bank or entity that controls, is controlled by, or is under common control with such bank. Generally, Sections 23A and 23B (i) limit the extent to which the bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same as, or at least as favorable to those that, the bank has provided to a non-affiliate.
 
The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee, and similar other types of transactions. Section 23B applies to “covered transactions” as well as sales of assets and payments of money to an affiliate. These transactions must also be conducted on terms substantially the same as, or at least as favorable, to those that the bank has provided to non-affiliates.
 
The Dodd-Frank Act changed the definition of “covered transaction” in Sections 23A and 23B and limitations on asset purchases from insiders. With respect to the definition of “covered transaction,” the Dodd-Frank Act defines that term to include the acceptance of debt obligations issued by an affiliate as collateral for a bank’s loan or extension of credit to another person or Company. In addition, a “derivative transaction” with an affiliate is now deemed to be a “covered transaction” to the extent that such a transaction causes a bank or its subsidiary to have a credit exposure to the affiliate. A separate provision of the Dodd-Frank Act states that an insured depository institution may not “purchase an asset from or sell an asset to” a bank insider (or their related interests) unless (1) the transaction is conducted on market terms between the parties and (2) it has been approved in advance by the majority of the institution’s non-interested directors if the proposed transaction represents more than 10 percent of the capital stock and surplus of the insured institution. The Company believes it is in compliance with all aspects of Section 23A and 23B of the Federal Reserve Act.

Loans to Insiders
 
The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers, and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act and Regulation O, loans to a director, an executive officer, and to a principal shareholder of a bank as well as to entities controlled by any of the foregoing may not exceed, together with all other outstanding loans to such person and entities controlled by such person, the bank’s loan-to-one borrower limit. For this purpose, the bank’s loan-to-one borrower limit is 15% of the bank’s unimpaired capital and unimpaired surplus in the case of loans that are not fully secured and an additional 10% of the bank’s unimpaired capital and unimpaired surplus in the case of loans that are fully secured by readily marketable collateral having a market value at least equal to the amount of the loan.  Loans in the aggregate to insiders and their related interests as a class may not exceed the bank’s unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, and principal shareholders of a bank or bank holding company and to entities controlled by such persons, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. The Federal Reserve has prescribed the loan amount, which includes all other outstanding loans to such person as to which such prior board of director approval is required, as being the greater of $25 thousand or 5% of capital and surplus (up to $500 thousand). Section 22(h) requires that loans to directors, executive officers, and principal shareholders be made on terms and underwriting standards substantially the same as those offered in comparable transactions to other persons.  Violations of Section 22(h) of the Federal Reserve Act and Regulation O could subject the Company to civil penalties.  As of December 31, 2015, there were no loans to insiders and their related interests in the aggregate that exceeded the restrictions imposed by the Federal Reserve Act and related regulations.
 
Other Safety and Soundness Regulations    
 
There are significant obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event that the depository institution is insolvent or is in danger of becoming insolvent. These obligations and restrictions are not for the benefit of investors. Regulators may pursue an administrative action against any bank holding company or bank that violates the law, engages in an unsafe or unsound banking practice, or is about to engage in an unsafe or unsound banking practice. The administrative action could take the form of a "cease and desist" proceeding, a removal action against the responsible individuals or, in the case of a violation of law or unsafe and unsound banking practice, a civil monetary penalty action. A cease and desist order, in addition to prohibiting certain action, could also require that certain actions be undertaken. Under the Dodd-Frank Act and the policies of the Federal Reserve, we are required to serve as a source of

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financial strength to our subsidiary depository institutions and to commit resources to support the Bank in circumstances where we might not do so otherwise.

The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized, as defined by the law.  As of December 31, 2015, BOHR was “well capitalized.”  State banking regulators also have broad enforcement powers over the Bank, including the power to impose fines and other civil and criminal penalties and to appoint a conservator.

Consumer Laws Regarding Fair Lending
 
In addition to the CRA described above, other federal and state laws regulate various lending and consumer aspects of our business. Governmental agencies, including the United States Department of Housing and Urban Development, the Federal Trade Commission, and the United States Department of Justice, have become concerned that prospective borrowers may experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums of money, short of a full trial.

These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants but the practice had a discriminatory effect unless the practice could be justified as a business necessity.
 
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.

Future Regulatory Uncertainty
 
Because federal and state regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal and state regulation of financial institutions may change in the future and, as a result, impact our operations. As a result of the financial crisis, additional regulatory burden has been created, and we fully expect that the financial institution industry will remain heavily regulated going forward.
 
Recent Events

Xenith Merger
On February 10, 2016, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with Xenith Bankshares, Inc. (“Xenith”), a Virginia corporation, the holding company for Xenith Bank. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Xenith will merge with and into the Company (the “Merger”), with the Company as the surviving corporation in the Merger. Under the terms of the agreement, Xenith shareholders will receive 4.4 shares of Company common stock for each share of Xenith common stock. Based on the closing price of the Company’s common stock on February 10, 2016, the transaction was valued at approximately $107.2 million. Upon closing, the Company's shareholders and Xenith shareholders will own approximately 74% and 26%, respectively, of the stock in the combined company. The transaction is expected to close in the third quarter of 2016.

Immediately following the Merger, Xenith’s wholly owned subsidiary, Xenith Bank, a Virginia banking corporation, will merge with and into BOHR, pursuant to a separate merger agreement and related plan of merger in form and substance customary for similar Virginia bank mergers (the “Bank Merger”), with BOHR as the surviving entity in the Bank Merger.

Pursuant to the Merger Agreement, subject to the prior approval of the Company's shareholders, the Company will amend its Amended and Restated Articles of Incorporation to change its name to “Xenith Bankshares, Inc.” and will make conforming amendments to its bylaws. Immediately upon consummation of the Bank Merger, the Company, as the surviving corporation in the Merger and the sole shareholder of the surviving entity in the Bank Merger, will change the name of such surviving entity of

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the Bank Merger to “Xenith Bank.” The surviving corporation’s headquarters will be Xenith’s current headquarters in Richmond, Virginia.
The Merger Agreement provides that the Board of Directors of the surviving corporation (the “Surviving Corporation Board”) will consist of 13 members, eight of whom will be designated by the Company, and five of whom will be designated by Xenith, each of whom will be mutually agreeable to the Company and Xenith. In addition, the Chairman of the Surviving Corporation Board will be chosen from the directors designated by the Company, and each committee of the Surviving Corporation Board will include at least one director designated by Xenith.
The completion of the Merger is subject to customary conditions, including (1) approval of the Plan of Merger by Xenith's shareholders and by the Company's shareholders, (2) authorization for listing on the NASDAQ of the shares of HMPR Common Stock to be issued in the Merger, (3) the receipt of required regulatory approvals, including the approval of the Federal Reserve and the Bureau of Financial Institutions, including with respect to a contemplated distribution of cash to the surviving corporation from BOHR and Xenith Bank immediately prior to closing of the Merger, (4) effectiveness of the registration statement on Form S-4 for the HMPR Common Stock to be issued in the Merger, (5) the absence of any order, injunction or other legal restraint preventing the completion of the Merger or making the completion of the Merger illegal and (6) the receipt of a tax opinion to the effect that an “ownership change” as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), has not occurred with respect to the Company in the three years prior to and including closing of the Merger. Each party’s obligation to complete the Merger is also subject to certain additional customary conditions, including (1) subject to certain exceptions, the accuracy of the representations and warranties of the other party, (2) performance in all material respects by the other party of its obligations under the Merger Agreement, (3) receipt by such party of an opinion from its counsel to the effect that the Merger will qualify as a reorganization within the meaning of Section 368(a) of the Code and (4) the other party’s adjusted shareholders’ equity meeting certain minimum thresholds. The Merger Agreement provides certain termination rights for both the Company and Xenith and further provides that a termination fee of $4,000,000 will be payable by either the Company or Xenith, as applicable, upon termination of the Merger Agreement under certain circumstances.
The Merger Agreement was unanimously approved and adopted by the Board of Directors of each of the Company and Xenith.

Hampton Roads Bankshares, Inc., et al. v. Scott C. Harvard
On January 14, 2016, in the case of Hampton Roads Bankshares, Inc., et al. v. Scott C. Harvard (docket number: 150323), the Supreme Court of Virginia reversed and vacated the award of damages in favor of Harvard, in the matter of Scott C. Harvard v. Shore Bank et al (CL13-4525-00), the Circuit Court for the City of Norfolk, Virginia. Mr. Harvard had initiated the claim in June 2013 alleging that the Company and Shore Bank were contractually obligated to make certain severance payments to him following the termination of his employment in 2009. The Company asserted, and the Supreme Court of Virginia affirmed, that Mr. Harvard was not entitled to a “golden parachute” severance due to application of a regulation under the TARP program. See Item 3 Legal Proceedings for further discussion of this case.

Employees
 
As of December 31, 2015, we had 533 employees, of whom 506 were full-time.  None of our employees are represented by any collective bargaining agreements.
 
Available Information
 
We maintain the following internet websites: www.bankofhamptonroads.com, www.shorepremierfinance.com, and www.dnjmortgage.com. These websites contain a link to our filings with the U.S. Securities and Exchange Commission (“SEC”), including those on Form 10-K, Form 10-Q, and Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.  The reports are made available on these websites as soon as practicable following the filing of the reports with the SEC.  The information is free of charge and may be reviewed, downloaded, and printed from each website at any time.
 
Any material we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C.  20549.  You may obtain information on the operation of the SEC’s Public Reference Room by calling the SEC at 1-800-SEC-0330.  Copies of these materials may be obtained at prescribed rates from the SEC at such address.  These materials can also be inspected on the SEC’s website at www.sec.gov.


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ITEM 1A – RISK FACTORS
 
An investment in our Common Stock involves risks.  You should carefully consider the risks described below in conjunction with the other information in this Form 10-K, including our consolidated financial statements and related notes, before investing in our Common Stock.  In addition to the other information contained in this report, the following risks may affect us.  This Form 10-K contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions, and expectations.  Past results are not a reliable indicator of future results, and historical trends should not be used to anticipate results or trends in future periods. Many factors, including those described below, could cause actual results to differ materially from those discussed in forward-looking statements.
 
Risks Relating to our Business
 
Our success is largely dependent on attracting and retaining key management team members.
 
We are a customer-focused and relationship-driven organization. Future growth is expected to be driven in large part by the relationships maintained with customers. While we have assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers and/or attracting new talent in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on our business and may result in lower revenues or reduced earnings.

In September 2015, Douglas J. Glenn resigned as Chief Executive Officer, and we announced the appointment of Charles M. Johnston, Chairman of the Company's Board of Directors, to serve as the interim Chief Executive Officer of the Company while the Company conducts a search for Mr. Glenn's replacement. Any significant leadership change or executive management transition involves inherent risk, and we could experience disruptions in our executive management transition, or any executive management transition that may occur in the future, which could hinder our strategic planning, execution and future performance.
 
We are not paying dividends on our Common Stock currently and absent regulatory approval are prevented from doing so. The failure to resume paying dividends on our Common Stock may adversely affect the market price of our Common Stock.
 
We paid cash dividends on our Common Stock prior to the third quarter of 2009. During the third quarter of 2009, we suspended dividend payments. Absent permission from the Virginia State Corporation Commission, BOHR may pay dividends to us only to the extent of positive accumulated retained earnings. The retained deficit of BOHR, our principal banking subsidiary, was $362.3 million as of December 31, 2015. It is unlikely in the foreseeable future that we would be able to pay dividends if BOHR cannot pay dividends to us. As a result, there is no assurance if or when we will be able to resume paying cash dividends.

In addition, all dividends are declared and paid at the discretion of our Board of Directors and are dependent upon our liquidity, financial condition, results of operations, regulatory capital requirements, and such other factors as our Board of Directors may deem relevant. The ability of our banking subsidiary to pay dividends to us is also limited by obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to our banking subsidiary. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our Common Stock.

We incurred significant losses from 2009 to 2012.  While we returned to profitability in 2013 and continued to be profitable during 2014 and 2015, we can make no assurances that will continue.  An inability to improve our profitability could adversely affect our operations and our capital levels.
 
Since the beginning of the "Great Recession", many of our loan customers have operated in an economically challenging environment, however, the markets in which we operate have begun to experience generally more stable business conditions.  Generally, the levels of loan delinquencies and defaults have continued to decline over the last several years, although they continue to be higher than historical levels. Also during the last several years, our net interest income, before the provision for loan losses, has not grown due to a historically low interest rate environment.

Our net income attributable to Hampton Roads Bankshares, Inc. was $93.0 million, $9.3 million and $4.1 million for the years ended December 31, 2015, 2014, and 2013, respectively, but our net loss attributable to Hampton Roads Bankshares, Inc. for the year ended December 31, 2012 was $25.1 million.  There is no guarantee that we will be able to maintain this improvement in our net income. In addition to the risk that the broader economic conditions will stagnate or reverse their improvements, our mortgage banking earnings are particularly volatile due to their dependence upon the direction and level of mortgage interest rates.


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Our mortgage banking earnings are cyclical and 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 our results of operations.

Our mortgage banking earnings are dependent upon our ability to originate loans and sell them to investors. Loan production levels are sensitive to changes in the level of interest rates and changes in economic conditions. A significant portion of increases in our mortgage banking earnings over the last few years was due to historically low interest rate environment that resulted in a high volume of mortgage loan refinancing activity. During 2015, 34% of our mortgage loan production was related to refinancing activity. In December 2015, the Federal Reserve raised the target range for the federal funds rate to 0.25% to 0.50%. Should the Federal Reserve continue on a path of raising short term interest rates, there may be a negative impact to our production of mortgage loans. Loan production levels may also suffer if we experience 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 our mortgage originations and, consequently, could significantly reduce our income from mortgage banking activities. As a result, these conditions would also adversely affect our results of operations.

Economic, market, or operational developments may negatively impact our ability to maintain required capital levels or otherwise negatively impact our financial condition.
 
At December 31, 2015, BOHR was classified as “well capitalized” for regulatory capital purposes.  However, impairments to our loan or securities portfolio, declines in our earnings or a combination of these or other factors could change our capital position in a relatively short period of time.  If BOHR is unable to remain “well capitalized,” it will not be able to renew or accept brokered deposits without prior regulatory approval or offer interest rates on deposit accounts that are significantly higher than the average rates in its market area. As a result, it would be more difficult for us to attract new deposits as our existing brokered deposits mature and do not rollover and to retain or increase non-brokered deposits.  If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected.  In addition, any negative impact to our capital position may cause the Bank to have to pay higher insurance premiums to the FDIC, which will reduce our earnings.
 
Virginia law and the provisions of our Articles of Incorporation and Bylaws could deter or prevent takeover attempts by a potential purchaser of our Common Stock that would be willing to pay you a premium for your shares of our Common Stock.
 
Our Articles of Incorporation, as well as the Company’s Bylaws (the “Bylaws”), contain provisions that may be deemed to have the effect of discouraging or delaying uninvited attempts by third parties to gain control of the Company. These provisions include the ability of our board to set the price, term, and rights of, and to issue, one or more series of our preferred stock. Our Articles of Incorporation and Bylaws do not provide for the ability of stockholders to call special meetings.
 
Similarly, the Virginia Stock Corporation Act contains provisions designed to protect Virginia corporations and employees from the adverse effects of hostile corporate takeovers. These provisions reduce the possibility that a third party could affect a change in control without the support of our incumbent directors. These provisions may also strengthen the position of current management by restricting the ability of shareholders to change the composition of the board, to affect its policies generally, and to benefit from actions that are opposed by the current board.
 
Our ability to maintain adequate sources of funding and liquidity may be negatively impacted by the economic environment which may, among other things, impact our ability to resume the payment of dividends or satisfy our obligations.

The management of liquidity risk is critical to the management of our business and to our ability to service our customer base.  Our access to funding sources in amounts adequate to finance our activities on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general.  In managing our balance sheet, a primary source of funding is customer deposits. Our ability to continue to attract these deposits and other funding sources is subject to variability based upon a number of factors including volume and volatility in the securities markets and the relative interest rates that we are prepared to pay for these liabilities. Our potential inability to maintain adequate sources of funding may, among other things, impact our ability to resume the payment of dividends or satisfy our obligations.
 
An inability to raise funds through deposits, borrowings, the sale of investments or loans, the issuance of equity and debt securities, and other sources could have a substantial negative effect on our liquidity. Factors that could detrimentally impact our access to liquidity sources include operating losses; rising levels of non-performing assets; a decrease in the level of our business activity as a result of a downturn in the markets in which our loans or deposits are concentrated or as a result of a loss of confidence in us by our customers, lenders, and/or investors; or adverse regulatory action against us.  Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial industry.

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The availability and level of deposits and other funding sources, including borrowings and the issuance of equity and debt securities, is highly dependent upon the perception of the liquidity and creditworthiness of the financial institution, and such perception can change quickly in response to market conditions or circumstances unique to a particular company. Concerns about our financial condition or concerns about our credit exposure to other persons could adversely impact our sources of liquidity, financial position, regulatory capital ratios, results of operations, and our business prospects.

Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
 
We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions for deposits, loans, and other financial services that serve our market area.  A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services.  Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. While we believe we compete effectively with these other financial institutions serving our primary markets, we may face a competitive disadvantage to larger institutions.  If we have to raise interest rates paid on deposits or lower interest rates charged on loans to compete effectively, our net interest margin and income could be negatively affected. Failure to compete effectively to attract new clients or to retain existing clients may reduce or limit our margins and our market share and may adversely affect our results of operations, financial condition, growth, and the market price of our Common Stock.
 
Sales, or the perception that sales could occur, of large amounts of our Common Stock by our institutional investors may depress our stock price.
 
The market price of our Common Stock could drop if our existing shareholders decide to sell their shares.  As of December 31, 2015, Anchorage, CapGen, and Carlyle owned 24.78%, 29.82%, and 24.78%, respectively, of the outstanding shares of our Common Stock.  Pursuant to the various definitive investment agreements that we have entered into with these shareholders, the Company has an effective registration statement covering the resale of shares of our Common Stock by each of the shareholders listed above.  These shareholders could utilize this registration statement by reselling the shares of our Common Stock they currently hold.  If any of these shareholders sell large amounts of our Common Stock, or other investors perceive such sales to be imminent, the market price of our Common Stock could drop significantly.  In addition, at December 31, 2015, we have an estimated $295.9 million of tax net operating losses (“NOLs”) to be carried forward, and the ability to utilize our NOLs is subject to the rules of Section 382 of the Internal Revenue Code. Section 382 generally restricts the use of NOLs after an “ownership change.” An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation’s common stock or are otherwise treated as 5% shareholders under Section 382 and Treasury regulations promulgated thereunder because of an increase of their aggregate percentage ownership of that corporation’s stock by more than 50 percentage points over the lowest percentage of the stock owned by these shareholders over a rolling three-year period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carryforwards. This annual limitation is generally equal to the product of the value of the corporation’s stock on the date of the ownership change, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards. We do not believe that the 2012 capital raise caused an “ownership change” at the Company within the meaning of Section 382. However, the capital raise, in conjunction with prior recapitalization efforts, resulted in Anchorage, CapGen and Carlyle owning a substantial portion of our stock, which reduces our ability to engage in future acquisition activity involving entities of similar or greater size than the Company without undergoing an “ownership change.” Thus, any acquisition activity in which the Company may engage would require the Company to evaluate whether an “ownership change” would occur. Given the level of merger and acquisition activity in our market, we cannot ensure that our ability to use our NOLs to offset income will not become limited in the future. As a result, we could pay taxes earlier and in larger amounts than would be the case if our NOLs were available to reduce our federal income taxes without restriction.
 
The concentration of our loan portfolio continues to be in real estate – commercial mortgage, equity line lending, and construction, which may expose us to greater risk of loss.

Our business strategy centers, in part, on offering real estate - commercial mortgage and equity line loans secured by real estate in order to generate interest income.  These types of loans generally have higher yields due to an elevated risk profile compared to traditional one-to-four family residential mortgage loans.  At December 31, 2015 real estate – commercial mortgage and equity line lending totaled $648.5 million and $120.2 million, respectively.  These loan categories combined represented 49.9% of total

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loans.  Such loans increase our credit risk profile relative to other financial institutions that have lower concentrations of real estate - commercial mortgage and equity line loans.
 
Loans secured by real estate – commercial mortgage properties are generally for larger amounts than one-to-four family residential mortgage loans.  Payments on loans secured by these properties generally are dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties.  Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy.  While we seek to minimize these risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.
 
Equity line lending allows a customer to access an amount up to their line of credit for the term specified in their agreement.  At the expiration of the term of an equity line, a customer may have the entire principal balance outstanding as opposed to a one-to-four family residential mortgage loan where the principal is disbursed entirely at closing and amortizes throughout the term of the loan.  We cannot predict when and to what extent our customers will access their equity lines. Often, the equity line's security position is in a subordinate collateral position.  While we seek to minimize this risk in a variety of ways, including attempting to employ conservative underwriting criteria, there can be no assurance that these measures will protect against credit-related losses.
 
Our loan portfolio contains loans used to finance construction and land development.  Construction financing typically involves a higher degree of credit risk than financing on improved, owner-occupied real estate.  Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction, the marketability of the property, and the bid price and estimated cost (including interest) of construction.  If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment.  When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal.  Although our underwriting criteria were designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will have safeguarded against material delinquencies and losses to our operations.
 
At December 31, 2015 we had loans of $141.2 million or 9.2% of total loans outstanding to finance construction and land development.  Construction and land development loans are dependent on the successful completion of the projects they finance, however, in many cases such construction and development projects in our primary market areas are not being completed in a timely manner, if at all.  A portion of our residential and real estate – commercial mortgage lending is secured by vacant or unimproved land.  Loans secured by vacant or unimproved land are generally more risky than loans secured by improved property for one-to-four family residential mortgage loans. Since vacant or unimproved land is generally held by the borrower for investment purposes or future use, payments on loans secured by vacant or unimproved land will typically rank lower in priority to the borrower than a loan the borrower may have on their primary residence or business.  These loans are more susceptible to adverse conditions in the real estate market and local economy.
 
General economic conditions in the markets in which we do business may decline and may have a material adverse effect on our results of operations and financial condition.
 
The local economies where the Company does business are heavily reliant on military spending and may be adversely impacted by significant cuts to such spending that might result from recent Congressional budgetary enactments. Real estate values are affected by various factors in addition to local economic conditions, including, among other things, changes in general or regional economic conditions, government rules or policies, and natural disasters. With 82.0% of our loans concentrated in the regions of Hampton Roads, Richmond, the Eastern Shore of Virginia, and the Research Triangle and Northeast North Carolina regions, a decline in local economic conditions could adversely affect the value of the real estate collateral securing our loans. A decline in property values could diminish our ability to recover on defaulted loans by selling the real estate collateral, making it more likely that we would suffer additional losses on defaulted loans and/or foreclosed properties by requiring additions to our allowance for loan losses through increased provisions for loan losses. Also, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose real estate portfolios are more geographically diverse. While our policy is to obtain updated appraisals on a periodic basis, there are no assurances that we may be able to realize the amount indicated in the appraisal upon disposition of the underlying property. We take into account all available information in assessing the fair value of other real estate owned and repossessed assets, including pending offers, recent appraisals, and other indicators. However, differences may exist between our estimate of fair value and the amount we ultimately realize upon sale, and such differences could be material.


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We have had large numbers of problem loans. Although problem loans have declined significantly, there is no assurance that they will continue to do so.

Our non-performing assets ratio, defined as the ratio of loans 90 days past due and still accruing interest plus nonaccrual loans plus other real estate owned and repossessed assets to gross loans plus loans held for sale plus other real estate owned and repossessed assets was 2.98% and 2.95% at December 31, 2015 and December 31, 2014, respectively. On December 31, 2015, 0.33% of our loans was 30 to 89 days delinquent and treated as performing assets. The administration of non-performing loans is an important function in attempting to mitigate any future losses related to our non-performing assets.

The determination of the appropriate balance of our allowance for loan losses is merely an estimate of the inherent risk of loss in our existing loan portfolio and may prove to be incorrect.  If such estimate is proven to be materially incorrect and we are required to increase our allowance for loan losses, our results of operations, financial condition, and the market price of our Common Stock could be materially adversely affected. 
 
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to our expenses that represents management’s best estimate of probable losses within our existing portfolio of loans.  Our allowance for loan losses was $23.2 million at December 31, 2015, which represented 1.50% of our total loans, as compared to $27.1 million, or 1.90% of total loans, at December 31, 2014.  The level of the allowance reflects management’s estimates and judgments as to specific credit risks, evaluation of industry concentrations, loan loss experience, current loan portfolio quality, present economic, political, and regulatory conditions, and incurred but unidentified losses inherent in the current loan portfolio.  For further discussion on the impact continued weak economic conditions have on the collateral underlying our loan portfolio, see above section “General economic conditions in the markets in which we do business may decline and may have a material adverse effect on our results of operations and financial condition.” 
 
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses of loans.  Such agencies may require us to recognize additional losses based on their judgments about information available to them at the time of their examination.  Furthermore, certain proposed changes to GAAP, if implemented as proposed, may require us to increase our estimate for losses embedded in our loan portfolio, resulting in an adverse impact to our results of operations and level of regulatory capital.  Accordingly, the allowance for loan losses may not be adequate to cover loan losses or significant increases to the allowance for loan losses may be required in the future if economic conditions should worsen.  Any such increases in the allowance for loan losses may have a material adverse effect on our results of operations, financial condition, and the market price of our Common Stock.
 
Our profitability will be jeopardized if we are unable to successfully manage interest rate risk.
 
Our profitability depends in substantial part upon the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities.  These rates are normally in line with general market rates and rise and fall based on management’s view of our needs.  Changes in interest rates will affect our operating performance and financial condition in diverse ways including the prices of securities, loans and deposits, and the volume of loan originations in our mortgage banking business, and could result in decreases to our earnings. Our net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments.  This could, in turn, have a material adverse effect on the market price of our Common Stock.
 
We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability.

Deposit pricing pressures may result from competition as well as changes to the interest rate environment. There is intense competition for deposits. The competition has had an impact on interest rates paid to attract deposits as well as fees charged on deposit products. In addition to the competitive pressures from other depository institutions, we face heightened competition from non-depository financial products such as securities, other alternative investments, and technology-based savings vehicles. Furthermore, technology and other market changes have made it more convenient for bank customers to transfer funds for investing purposes. Bank customers also have greater access to deposit vehicles that facilitate spreading deposit balances among different depository institutions to maximize FDIC insurance coverage.

In addition to competitive forces, we also are at risk from market forces as they affect interest rates. It is not uncommon when interest rates transition from a low interest rate environment to a rising rate environment for deposit and other funding costs to rise in advance

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of yields on earning assets. In order to keep deposits required for funding purposes, it may be necessary to raise deposit rates without commensurate increases in asset pricing in the short term.
 
We face a variety of threats from technology-based frauds and scams.
 
Financial institutions are a prime target of criminal activities through various channels of information technology. We attempt to mitigate risk from such activities through policies, procedures, and preventative and detective measures. Although the Company devotes significant resources to maintain and regularly upgrade its systems and processes that are designed to protect the security of the Company’s computer systems, software, networks and other technology assets, as well as its intellectual property, and the confidentiality, integrity and availability of information belonging to the Company and its customers, the Company’s security measures do not provide absolute security.
In fact, many financial services institutions, retailers and other companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means.
Third parties with which the Company does business or that facilitate its business activities, including exchanges, clearinghouses, payment and ATM networks, financial intermediaries or vendors that provide services or technology solutions for the Company’s operations, could also be sources of operational and security risks to the Company, including with respect to breakdowns or failures of their systems, misconduct by their employees or cyber-attacks that could affect their ability to deliver a product or service to the Company or result in lost or compromised information of the Company or its customers.
While we maintain insurance coverage designed to provide a level of financial protection to our business risks posed by business interruption, fraud losses, business recovery expenses, and other potential losses or expenses that may be experienced from a significant event are not readily predictable and, therefore, could have an impact on our results of operations.

Our operations and customers might be affected by the occurrence of a natural disaster or other catastrophic event in our market area.
 
Because a substantial portion of our loans are with customers and businesses located in the central and coastal portions of Virginia, North Carolina, and Maryland, catastrophic events, including natural disasters such as hurricanes which have historically struck the east coast of the United States with some regularity, or terrorist attacks, could disrupt our operations. Any of these natural disasters or other catastrophic events could have a negative impact on our financial centers and customer base as well as collateral values and the strength of our loan portfolio. Any natural disaster or catastrophic event affecting us could have a material adverse impact on our operations and the market price of our Common Stock. 


Risks Relating to Market, Legislative, and Regulatory Events

Our business, financial condition, and results of operations are highly regulated and could be adversely affected by new or changed regulations and by the manner in which such regulations are applied by regulatory authorities.

Current economic conditions, particularly in the financial markets, have resulted in government regulatory agencies placing increased focus and scrutiny on the financial services industry.  The U.S. Government has intervened on an unprecedented scale, responding to what has been commonly referred to as the financial crisis.  Compliance with increased government regulation may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner.  The increased costs associated with anticipated regulatory and political scrutiny could adversely impact our results of operations.
 
New proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry.  Federal and state regulatory agencies also frequently adopt changes to their regulations and/or change the manner in which existing regulations are applied.  We cannot predict whether any pending or future legislation will be adopted or the substance and impact of any such new legislation on us.  Additional regulation could affect us in a substantial way and could have an adverse effect on our business, financial condition, and results of operations.
 

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Banking regulators have broad enforcement power, but regulations are meant to protect depositors and not investors.
 
We are subject to supervision by several governmental regulatory agencies. The regulators’ interpretation and application of relevant regulations are beyond our control, may change rapidly and unpredictably, and can be expected to influence our earnings and growth. In addition, if we do not comply with regulations that are applicable to us, we could be subject to regulatory penalties, which could have an adverse effect on our business, financial condition, and results of operations.

All such government regulations may limit our growth and the return to our investors by restricting activities such as the payment of dividends, mergers with, or acquisitions by, other institutions, investments, loans and interest rates, interest rates paid on deposits, the use of brokered deposits, and the creation of financial centers. Although these regulations impose costs on us, they are intended to protect depositors. The regulations to which we are subject may not always be in the best interests of investors.
 
The fiscal, monetary, and regulatory policies of the Federal Government and its agencies could have a material adverse effect on our results of operations.
 
The Federal Reserve regulates the supply of money and credit in the United States.  Its policies determine, in large part, the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect our net interest margin.  It also can materially decrease the value of financial assets we hold, such as debt securities.  Its policies also can adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. 

In addition, as a public company we are subject to securities laws and standards imposed by the Sarbanes-Oxley Act of 2002. Because we are a relatively small company, the costs of compliance are disproportionate compared with much larger organizations.  Continued growth of legal and regulatory compliance mandates could adversely affect our expenses, future results of operations, and the market price of our Common Stock.  In addition, the government and regulatory authorities have the power to impose rules or other requirements, including requirements that we are unable to anticipate, that could have an adverse impact on our results of operations and the market price of our Common Stock. 

Government legislation and regulation may adversely affect our business, financial condition, and results of operations.
 
On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the law mandates multiple studies, which could result in additional legislative or regulatory action.  The Dodd-Frank Act has and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes designed to improve supervision and oversight of and strengthen safety and soundness for the financial services sector.  Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next few years and will be subject to further rule-making and the discretion of applicable regulatory bodies.  Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rule-making and interpretation, we cannot predict the full effect of this legislation on our business, financial condition, or results of operations. The Dodd-Frank Act has indeed increased our operating costs of compliance and has increased the amount of capital we are required to maintain. For further discussion of these issues, see the “Government Supervision and Regulation” section found in Item 1 of this document.
 
The soundness of other financial institutions could adversely affect us.
 
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions.  Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships.  As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry, generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions.  Many of these transactions expose us to credit risk in the event of default of our counterparty or client.  In addition, our credit risk may be exacerbated when the collateral held by us cannot be liquidated at prices sufficient to recover the full amount of the financial instrument exposure due to us.  There is no assurance that any such losses would not materially and adversely affect our results of operations and the value of, or market for, our Common Stock.



23

HAMPTON ROADS BANKSHARES, INC.

Risks Related to the Merger

Completion of the Merger is subject to the satisfaction of numerous conditions, and the Merger may not be completed on the proposed terms, within the expected timeframe, or at all.

Each of our and Xenith’s obligation to consummate the Merger remains subject to a number of conditions, including, among others, the following, as further described in the Merger Agreement: (1) approval of the Merger by Xenith’s shareholders and our shareholders (2) authorization for listing on NASDAQ of the shares of our common stock to be issued in the Merger, (3) the receipt of required regulatory approvals, including with respect to distributions of cash to the surviving corporation from BOHR and/or Xenith Bank immediately prior to the closing (unless waived by the parties), (4) effectiveness of the registration statement the shares of our common stock to be issued in the Merger, (5) the absence of any order, injunction or other legal restraint preventing the completion of the Merger or making the completion of the Merger illegal, (6) the receipt of a tax opinion that an “ownership change” as defined in Section 382 of the Code has not occurred with respect to the Company in the three years prior to and including the closing of the Merger, (7) subject to the materiality standards provided in the Merger Agreement, the accuracy of the representations and warranties of the Company and Xenith in the Merger Agreement, (8) performance in all material respects by each of us and Xenith of its obligations under the Merger Agreement, (9) receipt by each of us and Xenith of an opinion from its counsel as to certain tax matters and (10) the adjusted shareholders’ equity of each of us and Xenith meeting certain minimum thresholds as provided in the Merger Agreement. There is no assurance that all of the conditions will be satisfied, or that the Merger will be completed on the proposed terms, within the expected timeframe, or at all. Any delay in completing the Merger could cause us not to realize some or all of the benefits that we expect to achieve if the Merger is successfully completed within its expected timeframe. Further, there can be no assurance that the conditions to the closing of the Merger will be satisfied or waived or that the Merger will be completed. See the risk factor entitled If the Merger is not completed, we will have incurred substantial expenses and committed substantial time and resources without realizing the expected benefits of the Merger below.

Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the Merger.

Before the Merger and the Bank Merger may be completed, we and Xenith must obtain approvals from the Federal Reserve Board and the Bureau of Financial Institutions, including with respect to contemplated distributions of cash to the surviving corporation from BOHR and/or Xenith Bank immediately prior to the closing (unless waived by the parties), and from any regulatory authority required to issue the Merger consideration to the shareholders of Xenith as contemplated by the Merger Agreement. Other approvals, waivers or consents from regulators may also be required. In determining whether to grant these approvals the regulators consider a variety of factors, including the regulatory standing of each party. An adverse development in either party’s regulatory standing or other factors could result in an inability to obtain approval or delay their receipt. These regulators may impose conditions on the completion of the Merger or the Bank Merger or require changes to the terms of the Merger or the Bank Merger. Such conditions or changes could have the effect of delaying or preventing completion of the Merger or the Bank Merger or imposing additional costs on or limiting the revenues of the combined company following the Merger and the Bank Merger, any of which might have an adverse effect on the combined company following the Merger. In addition, the contemplated distributions of cash to the surviving corporation from BOHR and/or Xenith Bank immediately prior to the closing may not be approved by the required regulatory authorities, or may be approved only in part and not in the full contemplated amount of $20 million.

Combining the two companies may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the Merger may not be realized.

We and Xenith have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine and integrate the businesses our company and Xenith in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the Merger. The loss of key employees could adversely affect our ability to successfully conduct our business, which could have an adverse effect on our financial results and the value of our common stock. If we experience difficulties with the integration process, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause us and/or Xenith to lose customers or cause customers to remove their accounts from us and/or Xenith and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on us during this transition period and for an undetermined period after completion of the Merger on the combined company. In addition, the actual cost savings of the

24

HAMPTON ROADS BANKSHARES, INC.

Merger could be less than anticipated, and we may be unable to realize or utilize our deferred tax assets within expected time frames or at all, or in the amounts currently anticipated following completion of the Merger.

Termination of the Merger Agreement, or failure to complete the Merger, could negatively impact our stock price and our future business and financial results.

If the Merger Agreement is terminated, there may be various consequences. For example, our businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. Additionally, if the Merger Agreement is terminated, the market price of our common stock could decline to the extent that the current market prices reflect a market assumption that the Merger will be completed. If the Merger Agreement is terminated under certain circumstances, we may be required to pay to Xenith a termination fee of $4 million.

We will be subject to business uncertainties and contractual restrictions while the Merger is pending.

Uncertainty about the effect of the Merger on employees and customers may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is completed, and could cause customers and others that deal with us to seek to change existing business relationships with us. Retention of certain employees by us may be challenging while the Merger is pending, as certain employees may experience uncertainty about their future roles. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with us, our business could be harmed. In addition, subject to certain exceptions, we have agreed to operate our business in the ordinary course prior to closing, and we have agreed to certain restrictive covenants.

If the Merger is not completed, we will have incurred substantial expenses and committed substantial time and resources without realizing the expected benefits of the Merger.

We have incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement, as well as the costs and expenses of filing, printing and mailing a joint proxy statement/prospectus and all filing and other fees paid to the SEC in connection with the Merger. Matters relating to the Merger (including integration planning) also will require substantial commitments of time and resources by our management, which would otherwise have been devoted to day-to-day operations and other potentially advantageous business opportunities or plans that may have been beneficial to us. If the Merger is not completed, we would have to recognize these expenses and would have committed substantial time and resources, without realizing the expected benefits of the Merger. In addition, failure to consummate the Merger also may result in negative reactions from the financial markets or from our customers, vendors and employees. If the Merger is not completed, these risks may materialize and could have a material adverse effect on our stock price, business and cash flows, financial condition and results of operations.

The combined company may not be able to realize our deferred income tax assets.

We have substantial deferred tax assets that can generally be utilized to offset our future taxable income and, under certain circumstances, the combined company after the consummation of the Merger. If we or the combined company were to undergo a change in ownership of more than 50% of its capital stock over a three year period as measured under Section 382 of the Code, the ability to utilize such deferred tax assets to offset future taxable income would be substantially limited. The annual limit would generally equal the product of the applicable long term tax exempt rate and the value of the relevant entity’s capital stock immediately before the ownership change. These changes of ownership rules generally focus on ownership changes involving stockholders owning directly or indirectly 5% or more of a company’s outstanding stock, including certain public groups of stockholders as set forth under Section 382, and those arising from new stock issuances and other equity transactions. The determination of whether an ownership change occurs is complex and not entirely within our or the combined company’s control. It is a condition to each party’s obligation to complete the Merger that we receive an accountant’s opinion that an “ownership change” as defined in Section 382 of the Code has not occurred with respect to the Company in the three years prior to and including the closing of the Merger.

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HAMPTON ROADS BANKSHARES, INC.

ITEM 1B – UNRESOLVED STAFF COMMENTS
 
Not applicable.
 

26

HAMPTON ROADS BANKSHARES, INC.

ITEM 2 - PROPERTIES
 
We own our executive office, which is located at 641 Lynnhaven Parkway, Virginia Beach, Virginia 23452.  As of December 31, 2015, we operated from the locations listed below. All of our properties are in good operating condition and are adequate for our present and anticipated future needs.

City, State
 
Address
 
Lease/Own
California, MD
 
23076 Three Notch Road (3)
 
Lease
Cape Charles, VA
 
22468 Lankford Highway (1)
 
Own
Chesapeake, VA
 
201 Volvo Parkway (1)
 
Own
Chesapeake, VA
 
852 N George Washington Highway (1)
 
Own
Chesapeake, VA
 
712 Liberty Street (1)
 
Own
Chesapeake, VA
 
4108 Portsmouth Boulevard (1)
 
Own
Chesapeake, VA
 
239 Battlefield Boulevard S (1)
 
Own
Chesapeake, VA
 
1500 Mount Pleasant Road (1)
 
Lease Land/Own Building
Chesapeake, VA
 
204 Carmichael Way (2)
 
Own
Chincoteague, VA
 
6350 Maddox Boulevard (1)
 
Own
Clayton, NC
 
336 East Main Street (3)
 
Lease
Clayton, NC
 
132 East Main Street (3)
 
Lease
Edenton, NC
 
322 S Broad Street (4)
 
Own
Elizabeth City, NC
 
112 Corporate Drive (2)
 
Own
Elizabeth City, NC
 
1145 North Road Street (1)
 
Lease Land/Own Building
Elizabeth City, NC
 
1404 West Ehringhaus Street (1)
 
Own
Emporia, VA
 
100 Dominion Drive (1)
 
Own
Exmore, VA
 
4071 Lankford Highway (1)
 
Own
Fayetteville, NC
 
2818 Raeford Road (3)
 
Lease
Fuquay Varina, NC
 
604 North Main Street (3)
 
Lease
Glen Burnie, MD
 
6958 Aviation Boulevard, Suite A1 (5)
 
Lease
Greenville, NC
 
605-A Lynndale Court (3)
 
Lease
Greenville, NC
 
3208 Charles Boulevard (3)
 
Lease
High Point, NC
 
4100 Mendenhall Oaks Parkway (3)
 
Lease
Kitty Hawk, NC
 
5406 North Croatan Highway (4)
 
Lease Land/Own Building
Moyock, NC
 
100 Moyock Commons Drive (1)
 
Own
New Bern, NC
 
134 Craven Street (3)
 
Lease
New Bern, NC
 
312 South Front Street, Suite 2 (3)
 
Lease
Norfolk, VA
 
539 West 21st Street (1)
 
Lease
Norfolk, VA
 
4037 East Little Creek Road (1)
 
Lease
Norfolk, VA
 
999 Waterside Drive, Suite 101(1)
 
Lease
Ocean City, MD
 
9748 Steven Decatur Highway (1)(5)
 
Lease
Onley, VA
 
25253 Lankford Highway (4)
 
Lease Land/Own Building
Onley, VA
 
25020 Shore Parkway (2)
 
Own
Plymouth, NC
 
433 US Highway 64 East (1)
 
Own
Pocomoke City, MD
 
103 Pocomoke Marketplace (1)
 
Lease
Raleigh, NC
 
2235 Gateway Access Point (4)
 
Own
Raleigh, NC
 
3041 Berks Way, Units 203 & 204 (3)
 
Lease
Rehoboth Beach, DE
 
19354B Coastal Highway (5)
 
Lease
Richmond, VA
 
5300 Patterson Avenue (1)
 
Own

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HAMPTON ROADS BANKSHARES, INC.

City, State
 
Address
 
Lease/Own
Richmond, VA
 
8209 West Broad Street (1)
 
Own
Richmond, VA
 
12090 West Broad Street (1)
 
Own
Salisbury, MD
 
1503 South Salisbury Boulevard (1)
 
Own
Southport, NC
 
727 N Howe Street (3)
 
Lease
Suffolk, VA
 
2825 Godwin Boulevard (4)
 
Own
Virginia Beach, VA
 
5472 Indian River Road (1)
 
Own
Virginia Beach, VA
 
1580 Laskin Road (4)
 
Lease Land/Own Building
Virginia Beach, VA
 
641 Lynnhaven Parkway (1)(2)
 
Own
Virginia Beach, VA
 
2098 Princess Anne Road (4)
 
Lease Land/Own Building
Virginia Beach, VA
 
3001 Shore Drive (1)
 
Lease
Virginia Beach, VA
 
281 Independence Boulevard (1)
 
Lease
Virginia Beach, VA
 
440 Viking Drive (3)
 
Lease
Wake Forest, NC
 
2627 Leighton Ridge Dr., Suite 103-C (3)
 
Lease
Wilmington, NC
 
901 Military Cutoff Road (3)
 
Own
Wilson, NC
 
2801 Nash Street (3)
 
Lease
 
 
(1) Banking services
 
 
 
 
(2) Operations center
 
 
 
 
(3) Mortgage services
 
 
 
 
(4) Banking and mortgage services
 
 
 
 
(5) LPO
 
 



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HAMPTON ROADS BANKSHARES, INC.


ITEM 3 - LEGAL PROCEEDINGS
 
In the ordinary course of operations, the Company may become a party to legal proceedings.  Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on our business, financial condition, cash flows, or results of operations.

In June 2013, Scott C. Harvard, the former President of Shore Bank, initiated a claim against the Company in the Circuit Court for the City of Norfolk, Virginia, captioned Scott C. Harvard v. Shore Bank et al (CL13-4525-000). Mr. Harvard alleged that the Company and Shore Bank were contractually obligated to make certain severance payments to him following the termination of his employment in 2009. The Company asserted that Mr. Harvard was not entitled to a "golden parachute" severance due to application of a regulation under the TARP program and furthermore, that based upon the legally distinct entity from which Harvard derived his compensation, Shore Bank did not owe Harvard severance compensation. On November 21, 2014, the Circuit Court ruled that Mr. Harvard was entitled to $655,495.43 in severance pay, plus interest from May 20, 2014, and $155,000 in attorney's fees, plus additional fees incurred since July 15, 2014. The Company appealed this decision and, on January 14, 2016, the Supreme Court of Virginia reversed and vacated the Circuit Court's award of damages.

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HAMPTON ROADS BANKSHARES, INC.


ITEM 4 - MINE SAFETY DISCLOSURES
 
None.
 

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HAMPTON ROADS BANKSHARES, INC.

PART II

ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Price of Common Stock and Dividend Payments
 
Market Information
 
Our Common Stock trades on the NASDAQ Global Select Market under the symbol "HMPR".
 
The following table sets forth for the periods indicated the high and low prices per share of our Common Stock as reported on the NASDAQ Global Select Market along with the quarterly cash dividends per share declared.  Per share prices do not include adjustments for markups, markdowns, or commissions.
 
Sales Price
 
Cash Dividend Declared
 
High
 
Low
 
2015
 
 
 
 
 
First Quarter
$
1.98

 
$
1.58

 
$

Second Quarter
2.10

 
1.75

 

Third Quarter
2.54

 
1.71

 

Fourth Quarter
2.05

 
1.78

 

 
 
 
 
 
 
2014
 
 
 
 
 
First Quarter
$
1.92

 
$
1.43

 
$

Second Quarter
1.76

 
1.57

 

Third Quarter
1.85

 
1.48

 

Fourth Quarter
1.80

 
1.48

 

 
Number of Shareholders of Record
 
As of March 17, 2016, we had 171,325,712 shares of Common Stock outstanding, which were held by 2,864 shareholders of record.

Dividend Policy
 
On July 30, 2009, the Board of Directors voted to suspend the quarterly dividend on Common Stock of the Company in order to preserve capital and liquidity.  Our ability to distribute cash dividends in the future may be limited by negative regulatory restrictions and the need to maintain sufficient consolidated capital.  In addition, the retained deficit of BOHR, our principal banking subsidiary, was $362.3 million as of December 31, 2015.  Absent permission from the Virginia State Corporation Commission, BOHR may pay dividends to us only to the extent of positive accumulated retained earnings.  It is unlikely in the foreseeable future that we would be able to pay dividends if BOHR cannot pay dividends to us.  Although we can seek to obtain a waiver of this prohibition, our regulators may choose not to grant such a waiver, and we would not expect to be granted a waiver or be released from this obligation until our financial performance and retained earnings improve significantly.  As a result, there is no assurance if or when we will be able to resume paying cash dividends.

Recent Sales of Unregistered Securities
 
Not applicable.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
The Company announced an open ended program on August 13, 2003 by which management was authorized to repurchase an unlimited number of the Company’s shares of Common Stock in the open market and through privately negotiated transactions.  During 2015 the Company did not purchase any shares of its Common Stock.

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HAMPTON ROADS BANKSHARES, INC.

ITEM 6 - SELECTED FINANCIAL DATA
 
Not applicable.
 
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Executive Overview
The following commentary provides information about the major components of our results of operations, financial condition, liquidity, and capital resources.  This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements.
Hampton Roads Bankshares, Inc. (the “Company”) is a bank holding company headquartered in Virginia Beach, Virginia. The Company’s primary subsidiary is Bank of Hampton Roads (“BOHR” or "the Bank" or "our Bank" or "Bank"). The Bank engages in general community and commercial banking business, targeting the needs of individuals and small- to medium-sized businesses in our primary service areas. Currently, BOHR operates 17 full-service offices in the Hampton Roads region of southeastern Virginia, 10 full-service offices throughout Richmond, Virginia and the Northeastern and Research Triangle regions of North Carolina that do business as Gateway Bank (“Gateway”), and 7 full-service offices on the Eastern Shore of Virginia and Maryland and 3 loan production offices in Maryland and Delaware, all of which do business as Shore Bank. Through various divisions, BOHR also offers mortgage banking and marine financing. Our largest investor shareholders include Anchorage Capital Group, L.L.C. (“Anchorage”), CapGen Capital Group VI LP (“CapGen”), and The Carlyle Group, L.P. (“Carlyle”). Anchorage, CapGen, and Carlyle own 24.78%, 29.82%, and 24.78%, respectively, of the outstanding shares of our Common Stock as of December 31, 2015
Our primary source of revenue is net interest income earned by our bank subsidiary. Net interest income represents interest and fees earned from lending and investment activities less the interest paid on deposits and borrowings. Net interest income may be impacted by variations in the volume and mix of interest-earning assets and interest-bearing liabilities, changes in the yields earned and the rates paid, level of non-performing assets, and the level of noninterest-bearing liabilities available to support earning assets. In addition to net interest income, noninterest income is another important source of revenue. Noninterest income is derived primarily from service charges on deposits and mortgage banking revenue. Other significant factors that impact net income attributable to Hampton Roads Bankshares, Inc. are the provision for loan losses, and noninterest expense.
The direct lending activities in which the Company engages carry the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Board of Governors of the Federal Reserve System (the "Federal Reserve") and general economic conditions, nationally and in the Company's primary market areas, have a significant impact on the Company's results of operations. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations to the Company in full, in a timely manner, resulting in decreased earnings or losses to the Company. Regarding net interest margin, the Company makes fixed rate loans, whereby general increases in interest rates will tend to reduce the Company's spread as the interest rates the Company must pay for deposits may increase while interest income may be unchanged. Economic conditions may also adversely affect the value of property pledged as security for loans and the ability to liquidate that property to satisfy a loan if necessary.
The Company's goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures and modifying those policies on occasion to account for changing or emerging risks or changing market conditions, evaluating each borrower's business plan and financial condition during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and maintaining sufficient collateral to mitigate economic loss in the event of liquidation. An allowance for loan losses has been established which consists of general, specific, and unallocated qualitative components.
A risk rating system is employed to estimate loss exposure and provide a measuring system for setting general reserve allocations. The general component relates to groups of homogeneous loans not designated for specific impairment analysis and are collectively evaluated for potential loss. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. The specific allowance for loan losses is based on a loan-by-loan analysis and varies between impaired loans largely due to the value of the loan’s underlying collateral. An unallocated qualitative component is maintained to cover uncertainties that could affect management’s estimate of probable losses and considers internal portfolio management effectiveness and external macroeconomic factors.
The composition of the Company's loan portfolio is weighted toward commercial real estate and real estate construction.  At December 31, 2015, commercial real estate and real estate construction represented 51.7% of the loan portfolio.  These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow, and general economic conditions. The Company typically requires a maximum LTV of 80% or less and minimum cash flow

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HAMPTON ROADS BANKSHARES, INC.

debt service coverage at the time of origination of 1.25 to 1.0. Personal guarantees are required by policy, with a limited number of exceptions being granted due to mitigating factors.
The general terms and underwriting standards for each type of loan is incorporated into the Company's lending policies. These policies are analyzed periodically by management, and the policies are reviewed and approved by a designated subcommittee of the Board on an annual basis. The Company's loan policies and practices described in this report are subject to periodic change, and each guideline or standard is subject to waiver or exception in the case of any particular loan, with approval by the appropriate officer or committee, in accordance with the Company's loan policies. Policy standards are often stated in mandatory terms, such as "shall" or "must", but these provisions are subject to exception where appropriately mitigated. Policy requires that loan value not exceed a percentage of "market value" or "fair value" based upon appraisals or evaluations obtained in the ordinary course of the Company's underwriting practices.
Loans are secured primarily by duly recorded first deeds of trust. In some cases, the Company may accept a recorded second lien position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is required. Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Company. Guaranteed, fixed price construction contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.
Commercial land acquisition and construction loans are secured by real property where loan proceeds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are required to contribute equity into each project at levels determined by Loan Policy. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.  LTV ratios, with few exceptions, are maintained consistent with or below supervisory guidelines.
All construction draw requests must be presented in writing on American Institute of Architects documents and certified by the contractor, the borrower and the borrower's architect. Each draw request shall also include the borrower's soft cost breakdown certified by the borrower or it's Chief Financial Officer. Prior to an advance, the Company or its contractor inspects the project to determine that the work has been completed in order to justify the draw requisition.
Commercial permanent loans are secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. At the time of origination, the debt service coverage ratio is ordinarily at least 1.25 to 1.0.  As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.
Personal guarantees are generally received from the principals on commercial real estate loans, and only in instances where the loan-to-value is sufficiently low and the debt service is sufficiently high is consideration given to either limiting or not requiring personal recourse. Updated appraisals for real estate secured loans are obtained as necessary and appropriate to borrower financial condition, project status, loan terms, and market conditions.
The Company is also an active traditional commercial lender providing loans for a variety of purposes, including cash flow, equipment and accounts receivable financing. This loan category represents 15.1% of the Company's loan portfolio at December 31, 2015 and is generally priced at a variable or adjustable rate. Commercial loans must meet reasonable underwriting standards, including appropriate collateral, and cash flow necessary to support debt service.  Residential home mortgage loans, including home equity lines and loans, make up 22.7% of the loan portfolio. These credits represent both first and second liens on residential property almost exclusively located in the Company’s primary market areas. At December 31, 2015 the remaining 10.5% of the loan portfolio consists of retail consumer installment loans. At December 31, 2015, approximately 90.8% of the consumer installment loan portfolio is comprised of marine loans either originated or acquired by Shore Premier Finance ("SPF"), the Company's lending unit that specializes in marine financing for U.S. Coast Guard documented vessels to customers throughout the United States.
The risk of nonpayment (or deferred payment) of loans is inherent in commercial lending. The Company's marketing focus on small to medium-sized businesses may result in the assumption by the Company of certain lending risks that are different from those inherent in loans to larger companies. The policies and procedures of the Company dictate that all loan applications are to be carefully evaluated and attempt to minimize credit risk exposure by use of extensive loan application data, due diligence, and approval and monitoring procedures; however, there can be no assurance that such procedures can eliminate such lending risks.
 
Material Trends and Uncertainties
Since the beginning of the "Great Recession", many of our loan customers have operated in an economically challenging business environment; however, the markets in which we operate have begun to experience generally more stable business conditions. According to the Old Dominion University Economic Forecasting Project, the economy of the Company's largest market in which it does business, the Hampton Roads region of Virginia, is expected to grow at a slightly higher rate of 1.6% in 2016 compared to

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HAMPTON ROADS BANKSHARES, INC.

1.1% in 2015, but will continue to be slower than the historical annual average of 3.1% and slower than that of the nation. The U.S Gross Domestic Product grew by 8.0% from 2010 to 2014; however the Hampton Roads Real Gross Regional Product grew by only 1.6% during the same period. The primary reason for the sluggish economy in Hampton Roads is attributable to the decline in U.S Department of Defense ("DOD") spending. Between 2000 and 2012 DOD spending increased annually at a rate of 5.7% in the region, whereas, DOD spending in 2016 is expected to be 2.8% lower than its peak in 2012. The challenge for regional leaders in coming years will be to ensure Hampton Roads reduces its dependence on DOD spending to spur economic activity, and to focus more attention on attracting higher paying jobs, in more varied industry segments.

During the last several years, our net interest income, before the provision for loan losses, has not grown primarily due to a historically low interest rate environment. Although we cannot predict with any level of accuracy where interest rates are headed, based on the fact that core inflation is forecasted to remain below the Federal Reserve's target levels, combined with downward pressure on growth prospects for the U.S. economy, our expectations are that for 2016, we will continue to experience a low interest rate environment. Generally, the levels of loan delinquencies and defaults have continued to decline over the last several years, although they continue to be higher than pre-"Great Recession" levels.

On February 10, 2016, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with Xenith Bankshares, Inc. (“Xenith”), a Virginia corporation, the holding company for Xenith Bank. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Xenith will merge with and into the Company (the “Merger”), with the Company as the surviving corporation in the Merger. Under the terms of the agreement, Xenith shareholders will receive 4.4 shares of Company common stock for each share of Xenith common stock. Based on the closing price of the Company’s common stock on February 10, 2016, the transaction was valued at approximately $107.2 million. Upon closing, the Company's shareholders and Xenith shareholders will own approximately 74% and 26%, respectively, of the stock in the combined company. The transaction is expected to close in the third quarter of 2016.

The Company’s management has concluded that, as of December 31, 2015, it is more likely than not that the Company will partially realize its net deferred tax asset (“DTA”). At December 31, 2015, the Company’s net DTA was $152.8 million predominantly comprised of $103.6 million, which is the tax effect of an estimated $295.9 million of tax net operating losses (“NOLs”) to be carried forward, and $38.1 million, which is the tax effect of net future deductible amounts attributable to the allowance for loan losses (“the ALLL”). A schedule of estimated deferred taxes as of December 31, 2015, and a further discussion of the partial release of the valuation allowance against the deferred tax assets is included in Note 20 Income Taxes of the Notes to Consolidated Financial Statements.
Overview
The Company has reported net income for the last three consecutive fiscal years, compared to reporting net operating losses for 2010 to 2012, primarily resulting from improved general economic conditions and credit performance of the Company’s loan portfolio.  There is no guarantee that we will be able to maintain this improvement in our net income. In addition to the risk that the broader economic conditions will stagnate or reverse their improvements, our mortgage banking earnings are particularly volatile due to their dependence upon the direction and level of mortgage interest rates.  As of December 31, 2015, the Company exceeded the regulatory capital minimums and BOHR was considered “well capitalized” under the Basel III risk-based capital framework.
The following is a summary of our financial condition as of December 31, 2015 and our financial performance for the year then ended.
Assets were $2.1 billion at December 31, 2015.  Total assets increased by $77.3 million or 3.9% from December 31, 2014.  The increase in assets was primarily associated with a $92.1 million increase in net deferred tax assets, net of valuation allowance resulting from a partial release of the valuation allowance. Other significant changes in assets resulted from a shift out of overnight funds sold and due from FRB and investment securities available for sale in order to fund growth in loans held for sale and loans.
Loans held for sale increased $34.4 million or 155.7% due to a favorable interest rate environment driving significant growth in our mortgage subsidiary unit.
Gross loans increased by $118.6 million or 8.3% primarily driven by a $104.7 million marine loan portfolio purchase. 
Impaired loans increased by $17.0 million, or 34.8% during 2015 to $65.9 million at December 31, 2015, compared to $48.9 million at December 31, 2014, primarily as a result of the Company moving its largest substandard relationship into nonaccrual commercial loans.
Allowance for loan losses at December 31, 2015 decreased 14.3% to $23.2 million from $27.1 million at December 31, 2014 as net charge-offs of previously identified impaired loans exceeded additional provisions for loan losses.

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HAMPTON ROADS BANKSHARES, INC.

Premises and equipment, net declined $11.3 million or 17.7% as the Company identified underutilized assets, and transferred them to other real estate owned and repossessed assets, net of valuation allowance, incurring a $4.3 million impairment of premises and equipment charge included in noninterest expense.
Deposits at December 31, 2015 increased $123.8 million or 7.8% from December 31, 2014, as the Company has made a concerted effort throughout the year to attract deposits to fund loan growth and payoff maturing Federal Home Loan Bank borrowings.
Net income attributable to Hampton Roads Bankshares, Inc. for 2015 was $93.0 million, as compared with net income of $9.3 and $4.1 million for 2014 and 2013, respectively. The largest driver of this significant increase in net income was the recognition of $92.5 million in deferred tax benefit, resulting from the partial release of the valuation allowance against net deferred tax assets.
Net interest income increased $1.6 million in 2015 as compared to 2014, as the Company shifted its balance sheet asset mix away from lower yielding assets into loans.
Provision for loan losses increased to $600 thousand in 2015 compared to $218 thousand in 2014 mainly due to the overall growth in the loan portfolio.
Noninterest income for 2015 was $31.6 million, compared to $26.8 million and $31.3 million for 2014 and 2013, respectively. Mortgage banking revenue was the main driver for the increase in 2015 over 2014, due in part to a favorable mortgage interest rate environment. Offsetting these increases was a decline in income from bank-owned life insurance in 2015 compared to 2014 due to death benefits received in 2014.
Noninterest expense for 2015 was $90.3 million, compared to $76.8 million and $88.2 million for 2014 and 2013, respectively. Primary drivers of this increase in 2015 over 2014 was due to salaries and employee benefits resulting from subsidiary expansion, mortgage-related commissions, one-time separation costs, increased share-based compensation, impairment of premises and equipment related to underutilized assets, and impairment of other real estate owned and repossessed assets.
The Company's return on average assets ratio (ROAA) was 4.64%, 0.47%, and 0.20% for the years ended December 31, 2015, 2014, and 2013, respectively, and its return on average equity ratio (ROAE) was 45.42%, 4.81%, and 2.22% for the years ended December 31, 2015, 2014, and 2013, respectively.
Our effective current tax rate was 6.2% for 2015 compared to 0.06% and 1.6% for 2014 and 2013, respectively.  These taxes related to state income taxes owed.  The major driver of the increase in the effective tax rate from 2014 to 2015 was due to the increased earnings in our mortgage division. These rates differ from the statutory rate due primarily to the partial valuation allowance against the Company’s deferred tax assets.
Critical Accounting Policies
U.S. generally accepted accounting principles (“GAAP”) are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters. Management must use assumptions, judgments, and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex assumptions, judgments, and estimates.  Our assumptions, judgments, and estimates may be incorrect, and changes in such assumptions, judgments, and estimates may have a material impact on the consolidated financial statements.  Actual results, in fact, could differ materially from those estimates.  We consider our policies on allowance for loan losses, the valuation of deferred taxes, and the valuation of other real estate owned to be critical accounting policies.
Allowance for Loan Losses 
The purpose of the allowance for loan losses is to provide for potential losses inherent in our loan portfolio.  Management considers numerous factors in determining the allowance for loan losses, including historical loan loss experience, the size and composition of the portfolio, directionality and velocity of periodic change, and the estimated value of collateral and guarantees securing the loans.  
Management regularly reviews the loan portfolio to determine whether adjustments are necessary to maintain an allowance for loan losses sufficient to absorb losses.  Our review takes into consideration changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and review of current economic conditions that may affect the borrower’s ability to repay.  Some of the tools used in the credit review process to identify potential problem loans include past due reports, collateral valuations (primarily from third parties), cash flow analysis of borrowers, and risk ratings of loans.  In addition to the review of credit quality through ongoing credit review processes, we perform a comprehensive allowance analysis for our loan portfolio at least quarterly. 
The allowance consists of specific, general, and unallocated qualitative components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment.  The specific allowance for loan losses necessary

35

HAMPTON ROADS BANKSHARES, INC.

for these loans is based on a loan-by-loan analysis and varies between impaired loans largely due to the value of the loan’s underlying collateral. The majority of the Company’s impaired loans are considered collateral-dependent.
The general component relates to groups of homogeneous loans collectively evaluated for the appropriate level of reserve.  The general component is based on historical loss experience adjusted for qualitative factors where considered necessary and appropriate.  To arrive at the general component, the loan portfolio is grouped by loan type.  Each loan type is further subdivided by risk level as determined in our loan grading process.  A weighted average historical loss rate is computed for each group of loans over the trailing forty-eight months with higher weightings assigned to the most recent months. In accordance with policy, management increased the lookback period for historical losses by one additional quarter in each of the four quarters of 2015.  The loss reserve model now uses sixteen quarters of weighted net charge-off data, anchored from the fourth quarter of 2011, to arrive at a historical loss rate for each loan category in the general reserve pool.  The lookback period will be extended by one quarter with each successive quarter until the lookback period equals sixty months.  At that time, the loss history and economic cycle will be examined to determine the appropriateness of the lookback period.
In addition, an adjustment factor may be applied.  The adjustment factor, which may be favorable or unfavorable, represents management’s judgment that inherent losses in a given group of loans are different from historical loss rates due to environmental factors unique to that specific group of loans.  These factors may relate to growth rate factors within the particular loan group; whether the recent loss history for a particular group of loans differs from its historical loss rate; the amount of loans in a particular group that have recently been designated as impaired and that may be indicative of future trends for this group; reported or observed difficulties that other banks are having with loans in the particular group; changes in the experience, ability, and depth of lending personnel; changes in the nature and volume of the loan portfolio and in the terms of loans; and changes in the volume and severity of past due loans, nonaccrual loans, and adversely classified loans.  
The sum of the historical loss rate and the adjustment factor comprise the estimated annual loss rate.  To adjust for risk levels, a loss allocation factor is estimated based on the segmented risk levels for the loan group and is keyed off of a pass credit rating.  The loss allocation factor is applied to the estimated annual loss rate to determine the expected annual loss amount. Within the Company’s loss reserve model, the concept of “years to impairment” is used; Years to impairment (also known as the 'loss emergence period") is defined by the Company as the average period of time from the point at which a potential loss is incurred (marked by a downgrade from a pass risk grade, typically to Special Mention) to the point at which the loss is confirmed, through the identification of the loss (i.e., loan default, resulting in ASC 310 reserve). In addition to the calculated loss emergence period, it is acknowledged that some additional pre-emergence period likely exists but is unobservable. Because of the Company’s strong internal loan and relationship review processes and regular collection of updated borrower financial information, a small pre-emergence period of one-quarter year is added to the calculated loss emergence period by loan type. The move out of a passing grade (risk rating 1-5) and into Special Mention (risk rating 6) is determined to be an indicator that a loss trigger event may have occurred or may occur in the foreseeable future and the loan is beginning to demonstrate initial signs of deterioration.
Special mention loans are not considered impaired (management believes the Company will collect all contractual principal and interest as it comes due) and are performing satisfactorily, but are showing signs of potential weaknesses that may, if not corrected by the borrower, weaken further and possibly inadequately protect the Company’s position at some future date. The Company instituted in 2014 a new “pass/watch” risk grade for loans that do not provide acceptable credit metrics based upon analysis of financial statements but for which there is a strong mitigating factor such as satisfactory payment history. The “pass/watch” grade is considered a pass grade category and is now designated as Risk Grade 5. If the loan continues to deteriorate, it would be subsequently downgraded to substandard (risk rating 7), doubtful (risk rating 8), and then loss (risk rating 9). Such impaired loans are removed from the general reserve category and placed into the specific reserve category (although loans may be assigned a specific reserve of zero, depending on the fair value of the underlying collateral if determined to be collateral dependent); losses are then confirmed by the note’s default, subsequent impairment, and charge-off.
An unallocated qualitative component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated qualitative 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 and represents inherent losses that may not otherwise be captured in the specific or general components or attributable to specific types of loans within the portfolio.  The unallocated qualitative reserve is comprised of internal and external components. The Company now employs an anchoring analysis tied to a defined proxy to determine the maximum allowable amount of unallocated qualitative internal and external reserves as a percentage of total loans.  The maximum unallocated qualitative reserves are based upon the variance between the Company’s quarterly general reserves to total loans and its peak peer bank quarterly charge-off rates over the past ten years, approximating a full credit cycle.  As the Company’s historical credit losses decline and general reserves move lower, the unallocated qualitative reserve will increase.  As losses grow in a future weak economic cycle, unallocated qualitative reserves will come down as general reserves increase once more.
As a part of the unallocated qualitative reserve, we apply an economic factor to recognize external forces over which management has no control and to estimate inherent losses that may otherwise be omitted from the allowance calculation.  The factors used in

36

HAMPTON ROADS BANKSHARES, INC.

this calculation include published data for the gross domestic product growth rate, interest rate levels as measured by the prime rate, changes in regional real estate indices, and regional unemployment statistics.  The Company also performs a self-diagnostic assessment to evaluate internal controls over the management of the credit process to derive an internal component to the unallocated qualitative portion of the allowance which is added to the aforementioned macroeconomic factors. The factors used in this calculation include loan approval authority changes, the number of extensions and interest only loans within the portfolio, the ability to gather updated financial information from borrowers, loan type concentration, risk grade accuracy, and asset quality metrics.
Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are adequate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment.  Credit losses are also impacted by real estate values.  
To the extent possible, we use updated third party appraisals to assist us in determining the estimated fair value of our collateral dependent impaired loans.  While we believe our appraisal practices are consistent with industry norms, there can be no assurance that the fair values we estimate in determining how much impairment (if any) to recognize on our collateral dependent impaired loan portfolio will be realized in an actual sale of the property to a third party.  Additional provisions for such losses, if necessary, would negatively impact earnings.  As a result, our earnings could be adversely affected if our estimate of an adequate allowance is inaccurate by even a small amount. Ultimately, the allowance for loan losses is an estimate based upon the data in hand at a particular time and that estimate involves some amount of judgment regarding that data.
Valuation of Deferred Taxes
Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  Deferred tax assets, including tax loss and credit carryforwards, and deferred tax liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  Deferred income tax expense (benefit) represents the change during the period in the deferred tax assets and deferred tax liabilities.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  As of December 31, 2015, we have recorded a partial valuation allowance of $60.7 million on our net deferred tax assets of $152.8 million.  Our determination of the amount of the partial valuation allowance on our net deferred tax assets was based on the portion of NOLs that we believe are not more likely than not of being realized due to the Company's inability to generate sufficient taxable income in future years.
Internal Revenue Code Section 382 (“Section 382”) limitations related to the capital raised and resulting change in control for tax purposes during the third and fourth quarters of 2010 add further uncertainty as to the realizability of the deferred tax assets in future periods.  In addition, the ability to utilize our NOLs is subject to the rules of Section 382 of the Internal Revenue Code. Section 382 generally restricts the use of NOLs after an “ownership change.” An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation’s common stock or are otherwise treated as 5% shareholders under Section 382 and Treasury regulations promulgated thereunder because of an increase of their aggregate percentage ownership of that corporation’s stock by more than 50 percentage points over the lowest percentage of the stock owned by these shareholders over a rolling three-year period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of taxable income a corporation may offset with NOL carryforwards. This annual limitation is generally equal to the product of the value of the corporation’s stock on the date of the ownership change, multiplied by the long-term tax-exempt rate published monthly by the Internal Revenue Service. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards. We do not believe that the 2012 capital raise caused an “ownership change” at the Company within the meaning of Section 382. However, the capital raise, in conjunction with prior recapitalization efforts, resulted in Anchorage, CapGen and Carlyle owning a substantial portion of our stock, which reduces our ability to engage in future acquisition activity involving entities of similar or greater size than the Company without undergoing an “ownership change.” As noted in Part I, Recent Events, on February 10, 2016, the Company announced that it had entered into a Merger Agreement with Xenith. We believe that the Merger will not be subject to the limitations of Section 382, and should enhance our ability to generate additional future taxable income such that more of our NOLs will be realized.
A schedule of estimated deferred taxes as of December 31, 2015, and a further discussion of the partial release of the valuation allowance against the deferred tax assets is included in Note 20 Income Taxes of the Notes to Consolidated Financial Statements.
Valuation of Other Real Estate Owned
Other real estate owned and repossessed assets include real estate acquired in the settlement of loans and other repossessed collateral and is initially recorded at the lower of the recorded loan balance or estimated fair value less estimated disposal costs.  Although by policy, each property in other real estate owned is to receive an updated appraisal on an annual basis, we cannot be certain that the most recent appraisal represents current market conditions.  Similar to the discussion above under Allowance for Loan Losses, there

37

HAMPTON ROADS BANKSHARES, INC.

can be no assurance that the fair values we estimate in determining how much impairment (if any) to recognize on our foreclosed real estate portfolio will be realized in an actual sale of the property to a third party.
At foreclosure, any excess of the loan balance over fair value is charged to the allowance for loan losses.  Such carrying value is periodically reevaluated and written down if there is an indicated subsequent decline in fair value.  Costs to bring a property to salable condition are capitalized up to the fair value of the property while costs to maintain a property in salable condition are expensed as incurred.  Gains and losses on sales of other real estate owned upon disposition and write-downs of other real estate owned during the holding period are recognized in noninterest expense.
Analysis of Results of Operations
Net income attributable to Hampton Roads Bankshares, Inc. for 2015 was $93.0 million, as compared with net income of $9.3 and $4.1 million for 2014 and 2013, respectively.
Net Interest Income and Net Interest Margin
Net interest income, a major component of our earnings, is the difference between the income generated by interest-earning assets and the cost of interest-bearing liabilities.  Net interest margin, which is calculated by expressing net interest income as a percentage of average interest-earning assets, is an indicator of effectiveness in generating income from earning assets.
Interest-earning assets consist of loans, investment securities, overnight funds sold and due from FRB, and interest-bearing deposits in other banks. Interest-bearing liabilities consist of deposit accounts and borrowings. Net interest income and net interest margin may be significantly impacted by the market interest rates (rate); the mix, duration, and volume of interest-earning assets and interest-bearing liabilities (volume); changes in the yields earned and rates paid; and the level of noninterest-bearing liabilities available to support interest-earning assets.
Our management team strives to maximize net interest income through prudent balance sheet administration and by maintaining appropriate risk levels as determined by our Asset / Liability Committee (“ALCO”) and the Board of Directors.

38

HAMPTON ROADS BANKSHARES, INC.

Table 1 presents the average interest-earning assets and average interest-bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin for the indicated periods.
Table 1:  Average Balance Sheet and Net Interest Margin Analysis
 
2015

2014

2013
(in thousands, except average yield/rate data)
Average Balance

Interest Income/Expense

Average Yield/Rate

Average Balance

Interest Income/Expense

Average Yield/Rate

Average Balance

Interest Income/Expense

Average Yield/Rate
Assets:
 

 

 

 

 

 

 

 

 
Loans
$
1,565,821


$
68,123


4.35
%

$
1,396,443


$
63,132


4.52
%

$
1,437,967


$
68,954


4.80
%
Investment securities
233,259


6,267


2.69


342,996


9,018


2.63


308,161


7,710


2.50

Overnight funds sold
 

 

 

 

 

 

 

 

 
and due from FRB
73,389


157


0.21


90,177


193


0.21


103,852


238


0.23

Interest-bearing deposits
 

 

 

 

 

 

 

 

 
in other banks
1,230


1


0.06


845






712


1


0.14

Total interest-earning assets
1,873,699


74,548


3.98


1,830,461


72,343


3.95


1,850,692


76,903


4.16

Noninterest-earning assets
131,536


 

 

143,419


 

 

156,101


 

 
Total assets
$
2,005,235


 

 

$
1,973,880


 

 

$
2,006,793


 

 
Liabilities and Shareholders' Equity:
 

 

 

 

 

 

 

 

 
Interest-bearing liabilities
 

 

 

 

 

 

 

 

 
Interest-bearing demand deposits
$
640,048


$
2,775


0.43
%

$
616,215


$
2,667


0.43
%

$
570,390


$
2,156


0.38
%
Savings deposits
59,778


54


0.09


57,987


31


0.05


64,754


36


0.06

Time deposits
675,091


7,709


1.14


625,532


6,563


1.05


683,870


7,155


1.05

Total interest-bearing deposits
1,374,917


10,538


0.77


1,299,734


9,261


0.71


1,319,014


9,347


0.71

Borrowings
107,815


2,395


2.22


206,832


3,037


1.47


231,012


4,055


1.76

Total interest-bearing liabilities
1,482,732


12,933


0.87


1,506,566


12,298


0.82


1,550,026


13,402


0.86

Noninterest-bearing liabilities
 

 

 

 

 

 

 

 

 
Demand deposits
300,289


 

 

256,652


 

 

256,413


 

 
Other liabilities
17,568


 

 

16,526


 

 

16,368


 

 
Total noninterest-bearing liabilities
317,857


 

 

273,178


 

 

272,781


 

 
Total liabilities
1,800,589


 

 

1,779,744


 

 

1,822,807


 

 
Shareholders' equity
204,646


 

 

194,136


 

 

183,986


 

 
Total liabilities and shareholders' equity
$
2,005,235


 

 

$
1,973,880


 

 

$
2,006,793


 

 
Net interest income
 

$
61,615


 

 

$
60,045


 

 

$
63,501


 
Net interest spread
 

 

3.10
%

 

 

3.13
%

 

 

3.30
%
Net interest margin
 

 

3.29
%

 

 

3.28
%

 

 

3.43
%
Note:  Interest income from loans includes fees of $1,325 in 2015, $1,478 in 2014, and $1,917 in 2013.

 

 

39

HAMPTON ROADS BANKSHARES, INC.

Table 2 below shows the variance in interest income and expense caused by differences in average balances and rates.
Table 2:  Effect of Changes in Rate and Volume on Net Interest Income
 
2015 Compared to 2014
 
2014 Compared to 2013
 
Interest
Income/
Expense
Variance
 
 
 
 
 
Interest
Income/
Expense
Variance
 
 
 
 
 
 
Variance
Attributable to
 
 
Variance
Attributable to
 
 
 
 
(in thousands)
 
Rate
 
Volume
 
 
Rate
 
Volume
Interest-Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
Loans
$
4,991

 
$
(2,666
)
 
$
7,657

 
$
(5,822
)
 
$
(3,831
)
 
$
(1,991
)
Investment securities
(2,751
)
 
134

 
(2,885
)
 
1,308

 
436

 
872

Overnight funds sold
 
 
 
 
 
 
 
 
 
 
 
and due from FRB
(36
)
 

 
(36
)
 
(45
)
 
(14
)
 
(31
)
Interest-bearing deposits
 
 
 
 
 
 
 
 
 
 
 
in other banks
1

 
1

 

 
(1
)
 
(1
)
 

Total interest-earning assets
2,205

 
(2,531
)
 
4,736

 
(4,560
)
 
(3,410
)
 
(1,150
)
Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deposits
1,277

 
653

 
624

 
(86
)
 
51

 
(137
)
Borrowings
(642
)
 
812

 
(1,454
)
 
(1,018
)
 
(594
)
 
(424
)
Total interest-
 
 
 
 
 
 
 
 
 
 
 
bearing liabilities
635

 
1,465

 
(830
)
 
(1,104
)
 
(543
)
 
(561
)
Net interest income
$
1,570

 
$
(3,996
)
 
$
5,566

 
$
(3,456
)
 
$
(2,867
)
 
$
(589
)
 
 
 
 
 
 
 
 
 
 
 
 
Note:  The change in interest due to both rate and volume has been allocated to variance attributable to rate and variance attributable to volume in proportion to the relationship for the absolute amount of change in each.
 
Interest income on interest-earning assets increased in 2015 compared to 2014 predominantly as a result of a shift into loans away from lower yielding investment securities and overnight funds sold and due from FRB.
Interest expense on interest-bearing liabilities increased in 2015 compared to 2014 mainly due to two factors: the Company strategically offered higher rates on certain deposit products in order to attract additional deposits; and as FHLB advances matured, the mix of borrowings was more heavily weighted towards trust preferred securities, which have a higher effective interest rate compared to the FHLB instruments.
Noninterest Income
Noninterest income comprised 29.8% of total revenue in 2015, 27.0% in 2014 and 28.9% in 2013.  We define total revenue as the sum of interest income and noninterest income. The primary cause of this increase in noninterest income as a percentage of total revenue was an increase in mortgage banking revenue, offset by a decline in income from bank-owned life insurance. Table 3 provides a summary of noninterest income for the years ended December 31, 2015, 2014, and 2013
Table 3:  Noninterest Income
 
 

 

 

2015 Compared to 2014

2014 Compared to 2013
(in thousands, except for percentages)
2015

2014

2013

$

%

$

%
Mortgage banking revenue
$
19,969


$
11,389


$
15,832


$
8,580


75.3
 %

$
(4,443
)

(28.1
)%
Service charges on deposit accounts
4,989


4,703


5,014


286


6.1


(311
)

(6.2
)
Income from bank-owned life insurance
1,245


4,110


3,312


(2,865
)

(69.7
)

798


24.1

Gain on sale of investment securities available for sale
238


306


781


(68
)

(22.2
)

(475
)

(60.8
)
Visa check card income
2,652


2,635


2,556


17


0.6


79


3.1

Other
2,543


3,650


3,820


(1,107
)

(30.3
)

(170
)

(4.5
)
Total noninterest income
$
31,636


$
26,793


$
31,315


$
4,843


18.1
 %

$
(4,522
)

(14.4
)%

40

HAMPTON ROADS BANKSHARES, INC.

Mortgage banking revenue increased in 2015 compared to 2014 in part due to favorable market interest rates driving an increased demand for mortgage financing. The strong refinancing activity experienced earlier in 2015 was supplemented by an increased demand for purchase financing. Income from bank-owned life insurance declined due to death benefits received in excess of cash surrender value in 2014, which were nonrecurring in 2015. The decline in other noninterest income is mainly driven by one-time loan monitoring fees related to the marine financing portfolio that benefited 2014, a decline in rental income related to the decrease in other real estate owned and repossessed assets, and other nonrecurring miscellaneous income.
Noninterest Expense
Noninterest expense represents our operating and overhead expenses.  The efficiency ratio, calculated by dividing noninterest expense by the sum of net interest income and noninterest income excluding securities gains was 97.0% in 2015 compared to 88.8% in 2014 and 93.7% in 2013. Table 4 provides a summary of noninterest expense for the years ended December 31, 2015, 2014, and 2013. 
Table 4:  Noninterest Expense
 
 

 

 

2015 Compared to 2014

2014 Compared to 2013
(in thousands, except for percentages)
2015

2014

2013

$

%

$

%
Salaries and employee benefits
$
46,327


$
38,930


$
41,223


$
7,397


19.0
 %

$
(2,293
)

(5.6
)%
Professional and consultant fees
3,798


6,108


5,786


(2,310
)

(37.8
)

322


5.6

Occupancy
7,085


6,476


9,092


609


9.4


(2,616
)

(28.8
)
FDIC insurance
1,765


2,366


4,762


(601
)

(25.4
)

(2,396
)

(50.3
)
Data processing
5,548


4,610


4,198


938


20.3


412


9.8

Problem loan and repossessed asset costs
1,486


1,788


2,429


(302
)

(16.9
)

(641
)

(26.4
)
Impairments and gains and losses on sales of other real estate owned and repossessed assets, net
5,140


2,045


3,558


3,095


151.3


(1,513
)

(42.5
)
Impairments and gains and losses on sales of premises and equipment, net
4,348


112


2,245


4,236


3,782.1


(2,133
)

(95.0
)
Equipment
1,392


1,726


1,730


(334
)

(19.4
)

(4
)

(0.2
)
Directors' and regional board fees
1,183


1,591


1,493


(408
)

(25.6
)

98


6.6

Advertising and marketing
1,556


1,513


1,431


43


2.8


82


5.7

Other
10,639


9,549


10,204


1,090


11.4


(655
)

(6.4
)
Total noninterest expense
$
90,267


$
76,814


$
88,151


$
13,453


17.5
 %

$
(11,337
)

(12.9
)%
The increase in salaries and employee benefits in 2015 compared to 2014 was mainly driven by subsidiary expansions, growth in commission expense in the mortgage division, increased share-based compensation due to the TARP-related clawback that occurred in 2014, and one-time separation costs in 2015. As the Company's credit profile improves and legacy legal issues are resolved, professional and consultant fees have declined. FDIC insurance expense has declined, as our assessment rates have decreased due to the Company’s improved risk profile. Data processing expenses increased primarily due to the Company outsourcing the processing and printing of customer statements, as well as fees incurred that were related to revenue enhancement initiatives.

Problem loan and repossessed asset costs declined due to the overall decrease in other real estate owned and repossessed assets, and lower levels of classified loans. Impairments and gains and losses on sales of other real estate owned and repossessed assets, net increased in 2015 due to increased write-downs recorded as the fair value of certain properties declined. Impairment and gains and losses on sales of premises and equipment increased as the Company identified underutilized assets, wrote the assets down to fair value, and transferred them to other real estate owned and repossessed assets, net of valuation allowance. Management decided that these assets no longer fit its overall strategy and to ensure an efficient disposition of these assets, decided to write them down to fair value, less an estimated cost to sell the assets. Other noninterest expense increased due to higher bank franchise tax related to capital growth, higher online banking fees as more customers shift their banking online, and higher loan-related expenses due to loan portfolio growth.


41

HAMPTON ROADS BANKSHARES, INC.

Analysis of Financial Condition
Assets were $2.1 billion at December 31, 2015.  Total assets increased by $77.3 million or 3.9% from December 31, 2014. The increase in assets was primarily associated with a $92.1 million increase in net deferred tax assets, net of valuation allowance resulting from a partial release of the valuation allowance. Other significant changes in assets resulted from a shift out of overnight funds sold and due from FRB and investment securities available for sale in order to fund growth in loans held for sale and loans.
Cash and Cash Equivalents
Cash and cash equivalents includes cash and due from banks, interest-bearing deposits in other banks, and overnight funds sold and due from FRB.  Cash and cash equivalents are used for daily cash management purposes, management of short-term interest rate opportunities, and liquidity.  Cash and cash equivalents as of December 31, 2015 were $63.7 million compared to $103.6 million at December 31, 2014.
Investment Securities
Our investment portfolio at December 31, 2015 consisted primarily of U.S. agency, mortgage-backed securities (“MBS”), and asset-backed securities ("ABS").
The Company performs due diligence of each security on a pre- and post-purchase basis to evaluate the underlying collateral and invests in the investment grade tranches of securitizations. However, should defaults or loss severities exceed the credit enhancement in the structure, payment of principal or interest may be impacted. The Company currently does not own any collateralized loan obligation securities that would require divestiture under the Volcker Rule of the Dodd-Frank Act. The Volcker Rule generally prohibits banking entities from engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account; and from owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as “covered funds”.
Our available for sale securities are reported at fair value and are used primarily for liquidity, pledging, earnings, and asset / liability management purposes and are reviewed quarterly for possible impairment.  Due to portfolio activity, the fair value of our available for sale investment securities at December 31, 2015 decreased $104.0 million or 34.4% to $198.2 million compared to $302.2 million at December 31, 2014. The proceeds from investment security sales partially funded the loan portfolio growth.
Table 5 displays the contractual maturities and weighted average yields of investment securities at December 31, 2015.  Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  In addition, the effective life or duration of MBS and ABS is also less than the contractual maturity since these securities pay principal and interest monthly.
Table 5:  Investment Maturities and Yields
(in thousands, except weighted average yield data)
Amortized Cost
 
Estimated Fair Value
 
Weighted Average Yield
U.S. agency securities:
 
 
 
 
 
After 1 year but within 5 years
1,259

 
1,313

 
4.11

After 5 years but within 10 years
1,518

 
1,586

 
4.24

Over 10 years
9,788

 
10,173

 
3.52

Total U.S. agency securities
12,565

 
13,072

 
3.67

Corporate bonds:
 
 
 
 
 

After 1 year but within 5 years
994

 
991

 
2.17

After 5 years but within 10 years
11,000

 
10,199

 
2.00

Total corporate debt securities
11,994

 
11,190

 
2.02

Mortgage-backed securities:
 
 
 
 
 

Agency
147,980

 
149,199

 
2.42

Total mortgage-backed securities
147,980

 
149,199

 
2.42

Asset-backed securities:
 
 
 
 
 

After 5 years but within 10 years
9,756

 
9,534

 
2.27

Over 10 years
14,031

 
13,758

 
2.86

Total asset-backed securities
23,787

 
23,292

 
2.62

Equity securities
970

 
1,421

 

Total investment securities available for sale
$
197,296

 
$
198,174

 
2.53
%


42

HAMPTON ROADS BANKSHARES, INC.

Table 6 provides information regarding the composition of our securities portfolio showing selected yields.  For more information on investment securities, refer to Note 5, Investment Securities, of the Notes to Consolidated Financial Statements.
Table 6:  Composition of Securities Portfolio
 
December 31,
 
2015
 
2014
 
2013
(in thousands, except
Amortized
 
Estimated
 
Weighted Average
 
Amortized
 
Estimated
 
Weighted Average
 
Amortized
 
Estimated
 
Weighted Average
weighted average yield data)
Cost
 
Fair Value
 
Yield
 
Cost
 
Fair Value
 
Yield
 
Cost
 
Fair Value
 
Yield
Securities available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency
$
12,565

 
$
13,072

 
3.67
%
 
$
17,042

 
$
17,653

 
3.85
%
 
$
21,500

 
$
21,998

 
3.82
%
State and municipal

 

 

 

 

 

 
525

 
537

 
4.95

Corporate
11,994

 
11,190

 
2.02

 
15,080

 
14,560

 
2.02

 
17,212

 
17,542

 
2.65

Mortgage-backed -
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
147,980

 
149,199

 
2.42

 
212,650

 
215,428

 
2.40

 
227,662

 
225,845

 
2.68

Non-agency

 

 

 

 

 

 
8,150

 
8,180

 
2.10

Asset-backed
23,787

 
23,292

 
2.62

 
54,345

 
53,197

 
2.68

 
50,330

 
49,871

 
2.27

Equity
970

 
1,421

 

 
970

 
1,383

 

 
970

 
1,511

 

Total securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
available for sale
$
197,296

 
$
198,174

 
2.53
%
 
$
300,087

 
$
302,221

 
2.52
%
 
$
326,349

 
$
325,484

 
2.68
%
Loans
As a holding company of a community bank, we have a primary objective of meeting the business and consumer credit needs within our markets where standards of profitability, client relationships, and credit quality intersect. Our loan portfolio is comprised of commercial and industrial, construction, real estate-commercial mortgage, real estate-residential mortgage, and installment loans. Lending decisions are based upon evaluation of the financial strength and credit history of the borrower and the quality and value of the collateral securing the loan. Personal guarantees are required on most loans; however, prudent exceptions are made on occasion based upon the financial viability of the borrowing entity or the underlying project that is being financed.
As shown in Table 7, the overall loan portfolio increased $118.6 million or 8.3% to $1.5 billion at December 31, 2015.
Table 7:  Loans by Classification
 
 
December 31,
 
 
2015
 
2014
 
2013
 
2012
 
2011
(in thousands, except for percentages)
 
Balance
 
%
 
Balance
 
%
 
Balance
 
%
 
Balance
 
%
 
Balance
 
%
Loan Classification:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
$
233,319

 
15.1
 %
 
$
219,029

 
15.4
 %
 
$
225,492

 
16.3
 %
 
$
267,080

 
18.7
 %
 
$
256,058

 
17.0
%
Construction
 
141,208

 
9.2

 
136,955

 
9.6

 
158,473

 
11.4

 
206,391

 
14.4

 
284,984

 
18.9

Real Estate -
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial mortgage
 
655,895

 
42.5

 
639,163

 
44.9

 
590,475

 
42.6

 
530,042

 
37.0

 
522,052

 
34.7

Residential mortgage
 
349,758

 
22.7

 
354,017

 
24.9

 
354,035

 
25.6

 
372,591

 
26.0

 
414,957

 
27.6

Installment
 
161,918

 
10.5

 
74,821

 
5.3

 
57,623

 
4.2

 
56,302

 
3.9

 
26,525

 
1.8

Deferred loan fees and related costs
 
(596
)
 

 
(1,050
)
 
(0.1
)
 
(1,567
)
 
(0.1
)
 
(131
)
 

 
157

 

Total loans
 
$
1,541,502

 
100.0
 %
 
$
1,422,935

 
100.0
 %
 
$
1,384,531

 
100.0
 %
 
$
1,432,275

 
100.0
 %
 
$
1,504,733

 
100.0
%
This growth in 2015 was primarily driven by a $104.7 million marine loan portfolio purchase, arranged by the Shore Premier Finance marine lending unit, of which $75.3 million were installment loans and $29.4 million were commercial and industrial loans. It is the intent of the Company to continue to grow the loan portfolio in all the markets we serve.
Credit concentrations are measured against internal and prudential regulatory guidelines. Additionally, our business practices and internal guidelines and underwriting standards will continue to be followed in making lending decisions in order to manage exposure to credit-related losses.

43

HAMPTON ROADS BANKSHARES, INC.

Table 8 indicates our loans by geographic area as of December 31, 2015.  The Other geographic location represents both marine dealer floor plan loans and consumer marine loans located in multiple states outside our core markets.
Table 8:  Loans by Geographic Location
 
Commercial
& Industrial
 
 
 
Real Estate
 
 
 
 
(in thousands)
 
Construction
 
Commercial Mortgage
 
Residential Mortgage
 
Installment
 
Total
Hampton Roads VA
$
137,753

 
$
75,863

 
$
338,622

 
$
86,222

 
$
6,965

 
$
645,425

Eastern Shore MD/VA
15,063

 
12,309

 
79,628

 
84,604

 
2,709

 
194,313

Delaware
1,838

 
5,885

 
28,798

 
10,745

 

 
47,266

Baltimore MD
1,769

 

 
44,040

 
2,565

 
12

 
48,386

Richmond VA
13,497

 
11,955

 
80,114

 
30,794

 
494

 
136,854

Northeast NC
25,287

 
14,452

 
42,583

 
42,428

 
4,430

 
129,180

Triangle NC
348

 
12,039

 
9,801

 
69,279

 
86

 
91,553

Outer Banks NC
3,360

 
8,408

 
26,979

 
23,013

 
249

 
62,009

Wilmington NC

 
297

 
5,330

 
108

 

 
5,735

Other
34,404

 

 

 

 
146,973

 
181,377

Total loans
$
233,319

 
$
141,208

 
$
655,895

 
$
349,758

 
$
161,918

 
$
1,542,098

Note:  This table does not include deferred loan fees of $596 thousand.
 
 
 
 
 
 
 Table 9 sets forth the maturity periods of our loan portfolio as of December 31, 2015
Table 9:  Loan Maturities Schedule
 
Commercial
& Industrial

 

Real Estate

 

 
(in thousands)

Construction

Commercial Mortgage

Residential Mortgage

Installment

Total
Variable Rate:
 

 

 

 

 

 
Within 1 year
$
85,862


$
44,174


$
10,492


$
6,939


$
935


$
148,402

1 to 5 years
25,935


24,765


50,511


23,987


4,950


130,148