10-K 1 singlesourcekdocumentq4.htm 10-K single source K document Q4
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 _______________________________________________
FORM 10-K
 _______________________________________________
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
Commission File No. 001-34565
 _______________________________________________
MONARCH FINANCIAL HOLDINGS, INC.
[EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER]
Virginia
 
20-4985388
(State or other jurisdiction of incorporation)
 
(I.R.S. Employer Identification Number)
 
 
 
1435 Crossways Blvd., Chesapeake, Virginia
 
23320
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (757) 389-5111
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $5.00 par value
 
The Nasdaq Stock Market, LLC
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  þ
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  þ
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  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    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.  ¨
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 “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
¨
  
Accelerated filer
 
þ
 
 
 
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2013 was approximately $112,724,000.
The number of shares of common stock outstanding as of March 10, 2014 was 10,589,059.
_______________________________________________
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement relating to its 2013 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.
 




MONARCH FINANCIAL HOLDINGS, INC.
FORM 10-K
INDEX
 
Part I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
Part II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
Part III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
Part IV
 
Item 15.
 


2

PART I
 
Item 1.
Business.
Monarch Financial Holdings, Inc. (sometimes referred to herein as the “Company” or “Monarch”) is a Virginia-chartered bank holding company headquartered in Chesapeake, Virginia engaged in commercial and retail banking, investment and insurance sales, and mortgage origination and brokerage. We conduct our operations through our wholly-owned subsidiary, Monarch Bank (sometimes referred to herein as the “Bank”), and its two wholly-owned subsidiaries, Monarch Investment, LLC and Monarch Capital, LLC. We also do business in some markets as OBX Bank, Monarch Bank Private Wealth, Monarch Mortgage and under various names via joint ventures with other partners.
Monarch was created on June 1, 2006 through a reorganization plan, under the laws of the Commonwealth of Virginia, in which Monarch Bank became its wholly-owned subsidiary. Monarch Bank was incorporated on May 1, 1998 and opened for business on April 14, 1999 as a Virginia-chartered bank and a member of the Federal Reserve banking system. The Company has grown through de novo expansion, acquisition and the hiring of seasoned banking professionals in our target markets. While Monarch has grown rapidly in recent years, the Company strategy has been to do so profitably and without compromising asset quality.
Monarch Bank serves the needs of local businesses, professionals, corporate executives and individuals in the Hampton Roads area of Southeastern Virginia and the Outer Banks region of Northeastern North Carolina. We operate eleven banking offices, one commercial lending office and eleven residential mortgage offices in the cities of Chesapeake, Norfolk, Newport News, Williamsburg and Virginia Beach, Virginia. We have two full-service banking offices operating under the name “OBX Bank” and two residential mortgage offices operating under the name of “OBX Bank Mortgage” in the Outer Banks region of Northeastern North Carolina in the towns of Kitty Hawk and Nags Head. We also operate thirty-three additional residential mortgage offices outside of our primary banking market area.
We utilize a “Market President” approach to deliver products and services in each of our primary banking markets. We hire experienced bankers to serve in these leadership roles, and each Market President is responsible for building a strong team of bankers in their respective markets, developing and managing an advisory board of directors, managing sales and service delivery, and integrating our other lines of business in their communities. We believe this approach allows us to expand into new markets with fewer banking office locations and achieve profitability earlier than by utilizing the traditional banking model of opening a banking office and then looking for bankers to staff the location.
Our current capitalization enables us to provide loans in amounts responsive to the credit needs of a large portion of our targeted market. Our board of directors believes our capitalization supports current growth in loans and deposits.
Banking
Monarch operates in several integrated lines of business. Our Business Banking Group has been a core line of business since we opened. This group supports our business/commercial clients and offers both secured and unsecured commercial loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and the purchase of equipment and machinery, as well as loans secured by commercial real estate. This group also originates business deposits and related services. We have Business Banking groups in Chesapeake, Norfolk, Newport News, Suffolk, Williamsburg,Virginia Beach and the Outer Banks, each led by a Market President.
Our Real Estate Finance Group has been a core line of business since we opened. This group provides the delivery of residential real estate construction, acquisition and development loans, with the majority of its focus in the 1-4 family residential markets of Hampton Roads and Northeastern North Carolina. This group supports this type of banking in all of our markets.
Monarch has a Commercial Real Estate Finance Group specializing in underwriting commercial real estate loans, which are either financed for our balance sheet or brokered to other investors. Non-owner occupied income producing real estate loans require a specialized approach to underwriting, structuring, and pricing. We formed this group to ensure proper risk management and customer relationships are retained with those clients that expect an experienced and well equipped banking platform. Our Commercial Real Estate Finance Group supports this type of banking in all our markets.

Our Private Wealth Group recently completed its first full year of operation and specializes in serving the needs of high net worth individuals. In addition to private banking and financial planning, the Bank's affiliation with Raymond James Financial Services, Inc. allows us to offer comprehensive investment and trust services.

3

Our Private Banking / Cash Management Group supports our deposit gathering and service operations, along with the delivery of consumer lending. Our dedicated cash management specialists focus on the acquisition, support and delivery of deposit products and services to our business banking clients. They deliver cash management services for small and moderate size businesses in all our markets. We offer a full range of deposit services including checking accounts, savings accounts and time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. Consumer loans include home equity lines of credit, professional lines of credit, secured and unsecured loans for financing automobiles, home improvements, education and personal investments.
Monarch offers other services which include insurance sales, safe deposit boxes, check and bankcard services, online banking services, direct deposit of payroll and social security checks and automatic drafts for various accounts. We offer our clients access to their accounts and our banking services utilizing traditional in-office transactions as well as internet banking, mobile banking, remote deposit capture, online cash management, and through more than 50 automated teller machines (ATMs) located throughout South Hampton Roads and Northeastern North Carolina.
Monarch Investment, LLC, a wholly-owned subsidiary of Monarch Bank, offers investment advisory services through licensed investment advisors and its agreement with Raymond James Financial Services, Inc. Monarch Investment, LLC also has ownership interests in several subsidiaries. Monarch Investment owns a minority interest in Bankers Insurance, LLC, a joint venture with the Virginia Bankers’ Association and many other community banks in Virginia. This insurance agency offers a full line of commercial and personal lines of insurance to the general public and to our clients.
Mortgage Banking
Monarch Mortgage, a division of Monarch Bank, was formed in May 2007 when we hired a group of approximately 70 experienced mortgage professionals to staff the division. At that time our employment of these individuals increased the size of our mortgage group from approximately 10 to approximately 80 mortgage professionals. Monarch Mortgage is a retail residential mortgage lender with offices in Virginia, Maryland, North Carolina and South Carolina. We sell 99% of the mortgages we originate on a loan by loan basis to a large number of national banks, mortgage companies, and directly to certain governmental agencies. By maintaining correspondent and broker relationships with a number of companies, and by monitoring the financial condition of those companies, we feel we can limit the risk of our correspondents not purchasing loans we originate. We originate and sell primarily long-term fixed rate mortgage loans, both conventional and for government programs such as FHA, VA, and the Virginia Housing and Development Authority. A small portion of our loan clients select shorter term, variable rate loans. We do not securitize pools of loans.
Mortgage originations and sales have become a material source of revenue for the Company since the formation of Monarch Mortgage in 2007, The division stabilized in 2013 after significant growth in 2008 through 2012, due to a low interest rate environment coupled with government stimulus to the mortgage marketplace. We manage the majority of our interest rate risk by locking in the interest rate for each mortgage loan with our correspondents and borrowers at the same time. When markets are favorable, a small portion of our mortgage loans may be included in a mandatory delivery program which utilizes pairing of agency securities with pool of loans to manage interest rate risk. We do not currently have any loans in a mandatory delivery program.

As a mortgage lender, Monarch Mortgage underwrites mortgage loans for our clients to be sold in the secondary market or booked on our balance sheet. Monarch Mortgage currently has offices with locations in Alexandria, Chesapeake, Fairfax, Fredericksburg, Midlothian, Newport News, Norfolk, Oakton, Richmond, Virginia Beach and Woodbridge, Virginia; Annapolis, Crofton, Dunkirk, Frederick, Greenbelt, Rockville, Towson and Waldorf, Maryland; Carolina Beach, Elizabeth City, Indian Trail, Kitty Hawk, Mint Hill, Mooresville, Southport Wake Forest and Wilmington, North Carolina; and Greenwood, South Carolina. Monarch Mortgage originates and sells loans under two different financial models. All the offices in Maryland, and the majority of the offices in Northern Virginia, North Carolina and South Carolina, operate as fee-based offices, with each office paying a per loan processing fee along with a percentage of net income to Monarch Mortgage, with the remaining net income or loss of each office the responsibility of each office’s manager or management team. The fee-based office model allows Monarch Mortgage to attract quality entrepreneurial leaders focused on their bottom line. The loan fees from these operations lower the cost basis and break-even volume for the Virginia operations while reducing the downside risk of startup and operating losses. The remaining Virginia and OBX Bank mortgage offices are traditional operations with the profits and losses accruing to Monarch Mortgage.
Monarch Capital, LLC, a wholly-owned subsidiary of Monarch Bank formed in 2004, provides commercial mortgage brokerage services in the placement of primarily long-term fixed-rate debt for the commercial, hospitality, and multi-family housing markets.


4

Monarch Investment, LLC also delivers mortgages and mortgage related services through other subsidiaries or investments as follows:
•
Coastal Home Mortgage, LLC became a subsidiary of Monarch Investment, LLC in July 2007 when a majority ownership interest in the company was purchased from another bank. Monarch Investment, LLC owns 50.1% of this joint venture with four unaffiliated individuals involved with residential construction in Hampton Roads. Its primary mission is to provide residential mortgage loan services for the builder’s end product.
•
Real Estate Security Agency, LLC was formed in October 2007 to offer title insurance services to clients of Monarch Mortgage and Monarch Bank. This agency offers residential and commercial title insurance to our clients. Monarch Investment, LLC, owns 75% of this company with 25% owned by an unaffiliated party, TitleVentures, LLC.
•
Regional Home Mortgage, LLC was formed in March 2010 and is 51% owned by Monarch Investment, LLC. This is a joint venture with a residential real estate brokerage firm in Hampton Roads, Virginia. Its primary mission is to provide residential mortgage loan services for their clients and other consumers.
•
Monarch Home Funding, LLC was formed in September 2010 and is 51% owned by Monarch Investment, LLC. This is a joint venture with a local real estate marketing and sales company. Its primary mission is to provide residential mortgage loan services for the company’s clients and other consumers.
Employees
As of February 15, 2014, the Company and its subsidiaries had six hundred, fourteen (614) full-time and twenty (20) part-time employees. None of our employees are represented by any collective bargaining agreements, and relations with employees are considered excellent.
Commercial and Other Banking Lending Activities
Credit Policies
The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. In an effort to manage the risk, our loan policy gives loan amount approval limits to individual loan officers based on their position and level of experience and to our loan committees based on the size of the lending relationship. The risk associated with real estate and construction loans, commercial loans and consumer loans varies, based on market employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction.
We have written policies and procedures to help manage credit risk. We utilize an outside third party loan review process that includes annual portfolio reviews to establish loss exposure and to ascertain compliance with our loan policy.
We use a management loan committee and a directors’ loan committee to approve loans. The management loan committee is comprised of members of management, and the directors’ loan committee is composed of six directors, of which four are independent directors. Both committees approve new, renewed and or modified loans that exceed officer loan authorities. The directors’ loan committee also reviews any changes to our lending policies, which are then approved by our board of directors.

Construction and Development Lending
We make construction loans, primarily residential, and land acquisition and development loans. The construction loans are secured by residential houses under construction and the underlying land for which the loan was obtained. The average life of a construction loan is typically less than 12 months. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction lending is attributable to the fact that loan funds are advanced upon the security of the land or home under construction, which value is estimated prior to the completion of construction. Therefore, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To mitigate the risks associated with construction lending, we generally limit loan amounts to 75% to 85% of appraised value, in addition to analyzing the creditworthiness of our borrowers. We also obtain a first lien on the property as security for our construction loans and typically require personal guarantees from the borrower’s principal owners.

5

Commercial Real Estate Lending
Commercial real estate loans are secured by various types of commercial real estate in our market area, including multi-family residential buildings, commercial buildings and offices, shopping centers and churches. Commercial real estate lending entails significant additional risks, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios and the borrower’s creditworthiness, cash flow, prior credit history and reputation. We also evaluate the location of the property and typically require personal guarantees or endorsements of the borrower’s principal owners.
Business Lending
Business loans generally have a higher degree of risk than residential mortgage loans but typically have higher yields. To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of our business borrowers. Business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for business loans may depreciate over time and generally cannot be appraised with as much precision as other forms of collateral.
Consumer Lending
We offer various consumer loans, including personal loans and lines of credit, investment margin loans, automobile loans, deposit account loans, installment and demand loans, and home equity lines of credit and loans. Such loans are generally made to clients with whom we have a pre-existing relationship. We currently originate all of our consumer loans in our geographic market area.
The underwriting standards employed by us for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount. For home equity lines of credit and loans, our primary consumer loan category, we require title insurance, hazard insurance and, if required, flood insurance.
Mortgage Banking Lending Activities
Through our mortgage division Monarch Mortgage, for our own portfolio, we offer mortgages and construction loans to individual borrowers. Mortgages typically have initial resets in five years or less and are structured for a potential later sale on the secondary market. Our construction permanent loan program offers individual clients, typically working with a custom builder, a residential construction loan with the ability to sell the loan on the secondary market once complete through Monarch Mortgage. All other residential mortgage loans originated by Monarch Mortgage are sold to investors on the secondary market.

Competition
Commercial and Other Banking
The banking business is highly competitive. We encounter strong competition from a variety of bank and non-bank financial service providers. These competitors include commercial banks, savings banks, credit unions, consumer finance companies, brokerage firms, money market mutual funds, mortgage banks, leasing, and finance companies. In addition, the delivery of financial services has changed significantly with the telephone, ATM, personal computer, mobile smart phones, tablets and the internet being used to access information and perform banking transactions.
Competition in our target market area for loans to businesses, professionals and consumers is very strong. Many of our competitors have substantially greater resources and lending limits and offer certain services, such as extensive and established banking office networks and other services, that we cannot provide. Moreover, larger institutions operating in the South Hampton Roads have access to borrowed funds at a lower costs. Several community banks are headquartered in our trade market areas. Several regional and super-regional banks, as well as a number of large credit unions, also have offices in our market area. Competition among institutions for deposits in the area remains strong.

6

Factors affecting the competition for bank loans and deposits are interest rates and terms offered, number and location of banking offices and types of products offered, as well as the reputation of the institution. The advantages we have over our competition include experienced and dedicated employees, our Market President structure, long-term customer relationships, strong historical financial performance, a commitment to excellent customer service, experienced management and directors, and the support and involvement in the communities that we serve. We focus on providing products and services to individuals, professionals, and small to medium-sized businesses within our communities. According to FDIC deposit data as of June 30, 2013, Monarch Bank was ranked 6th in deposit market share with 3.64% of the $22 billion in deposits in the Greater Hampton Roads market. OBX Bank was ranked 4th in deposit market share with 11.04% of the $2.3 billion in deposits in the Outer Banks market. The top five banks in our markets together control 81% of the total deposits in the Greater Hampton Roads market and the top three banks together control 76% of the total deposits in the Outer Banks, providing us with ample opportunity to continue to grow our market share.
Mortgage Banking
Factors affecting competition for our mortgage banking operations are our status as a mortgage lender as opposed to being a mortgage broker, the number and location of mortgage offices and types of loan programs offered, as well as the reputation of Monarch and our mortgage loan officers. Our advantages over the competition include experienced and dedicated employees, long-term customer and referral relationships, local and experienced underwriting, a commitment to excellent customer service, experienced management, and the support and involvement in the communities that we serve. We focus on residential mortgage loan origination and placement in the secondary market.
Supervision and Regulation
General
As a financial holding company, we are 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 subsidiary, Monarch Bank, including the activities in which it may engage, the investments that it makes, the aggregate amount of loans that it may grant to one borrower, the amount of capital it must retain, and the dividends it may declare and pay to us. Monarch Bank is also subject to various consumer and compliance laws. As a state-chartered bank, Monarch Bank is primarily subject to regulation, supervision and examination by the Bureau of Financial Institutions of the Virginia State Corporation Commission and the Federal Reserve Bank of Richmond. Monarch Bank also is subject to regulation, supervision and examination by the FDIC.
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
To acquire the shares of Monarch Bank and thereby become a bank holding company within the meaning of the Bank Holding Company Act, we were required to obtain approval from, and register as a bank holding company, with the Federal Reserve, and are subject to ongoing regulation, supervision and examination by the Federal Reserve. As a condition to its approval, the Federal Reserve required that we obtain approval of the Federal Reserve Bank of Richmond prior to incurring any indebtedness. We are required to file with the Federal Reserve periodic and annual reports and other information concerning our business operations and those of our subsidiaries. In addition, the Bank Holding Company Act requires a bank holding company to obtain Federal Reserve approval before it acquires, directly or indirectly, ownership or control of any voting shares of a second or subsequent bank if, after such acquisition, it would own or control more than 5% of such shares, unless it already owns or controls a majority of such voting shares. Federal Reserve approval must also be obtained before a bank holding company acquires all or substantially all of the assets of another bank or merges or consolidates with another bank holding company. Any acquisition by a bank holding company of more than 5% of the voting shares, or of all or substantially all of the assets, of a bank located in another state may not be approved by the Federal Reserve unless such acquisition is specifically authorized by the laws of that second state.
A bank holding company is prohibited under the Bank Holding Company Act, with limited exceptions, from acquiring or obtaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank, or from engaging in any activities other than those of banking or of managing or controlling banks or furnishing services to or performing services for its subsidiaries. An exception to these prohibitions permits a bank holding company to engage in, or acquire an interest in a company which engages in, activities which the Federal Reserve, after due notice and opportunity for hearing, by regulation or order, has determined is so closely related to banking or of managing or controlling banks as to be a

7

proper incident thereto. A number of such activities have been determined by the Federal Reserve to be permissible, including servicing loans, performing certain data processing services, and acting as a fiduciary, investment or financial adviser.
A bank holding company may not, without providing notice to the Federal Reserve, purchase or redeem its own stock if the gross consideration to be paid, when added to the net consideration paid by the company for all purchases or redemptions by the company of its equity securities within the preceding 12 months, will equal 10% or more of the company’s consolidated net worth, unless it meets the requirements of a well capitalized and well managed organization.
Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law in July 2010, incorporating numerous financial institution regulatory reforms. Some of these reforms have been implemented, but many reforms will be implemented in 2014 and beyond through regulations to be adopted by various federal banking and securities regulatory agencies. The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions. Many of its provisions do not directly impact community-based institutions like the Bank. For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of the Bank’s operations. Provisions that impact the Bank include the following:
•
FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity. In addition, it increases the minimum size of the Deposit Insurance Fund (“DIF”) and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
•
Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance.
•
Interest on Demand Deposits. The Dodd- Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits, including business transaction and other accounts.
•
Interchange Fees. The Federal Reserve set a cap on debit card interchange fees charged to retailers. While banks with less than $10 billion in assets, such as the Bank, are exempted from this measure, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers.
•
Consumer Financial Protection Bureau. The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
•
Mortgage Lending. New requirements are imposed on mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
•
Holding Company Capital Levels. Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks. In addition, all trust preferred securities issued after May 19, 2010 will be counted as Tier 2 capital.
•
De Novo Interstate Branching. National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
•
Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
•
Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

8

•
Corporate Governance. The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.
Many aspects of the Dodd-Frank Act are subject to rule-making and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted.
Regarding Capital Requirements
The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements. Under the Collins Amendment to the Dodd-Frank Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis. These minimum requirements can’t be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions. The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets. Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013. Accordingly, our trust preferred securities will continue to qualify as Tier 1 capital.
Regarding transactions with insiders
The Dodd-Frank Act also provides that banks may not “purchase an asset from, or sell an asset to” a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the bank, it has been approved in advance by a majority of the bank’s non-interested directors.
Regarding debit card interchange fees
One provision of the Financial Reform Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. In June 2011, the Federal Reserve issued a final rule capping the fee at a level below the average that banks were currently charging. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, our debit card revenue could be adversely impacted.
Monarch Bank
The Federal Reserve and the Virginia Bureau of Financial Institutions regulate and monitor all significant aspects of Monarch Bank’s operations. The Federal Reserve requires quarterly reports on our financial condition, and both federal and state regulators conduct periodic examinations of us. The cost of complying with these regulations and reporting requirements can be significant. In addition, some of these regulations, such as the ability to pay dividends, impact investors directly.
For member banks like Monarch Bank, the Federal Reserve has the authority to prevent the continuance or development of unsound and unsafe banking practices and to approve conversions, mergers and consolidations. Obtaining regulatory approval of these transactions can be expensive, time consuming, and ultimately may not be successful. The opening of any additional banking offices by us requires prior regulatory approval, which takes into account a number of factors, including, among others, adequate capital to support additional expansion and a finding that public interest will be served by such expansion. While we plan to seek regulatory approval to establish additional banking offices, there can be no assurance when, or if, we will be permitted to so expand.
As a member of the Federal Reserve, we are also required to comply with rules that restrict preferential loans by us to “insiders,” require us to keep information on loans to principal stockholders and executive officers, and prohibit certain director and officer interlocks between financial institutions. Our loan operations, particularly for consumer and residential real estate loans, are also subject to numerous legal requirements, as are our deposit activities. In addition to regulatory compliance costs, these laws may create the risk of liability to us for noncompliance.




9

Dividends
The Company is a legal entity, separate and distinct from the Bank. A significant portion of the revenues of the Company result from the dividends paid to it by the Bank. The amount of cash dividends we are permitted to pay will depend upon our earnings and capital position and is limited by federal and state law, regulations and policies applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. Virginia law imposes restrictions on the ability of all banks chartered under Virginia law to pay dividends. Under Virginia law, no dividend may be declared or paid that would impair a bank’s paid-in capital, and payments must be paid from retained earnings. Virginia banking regulators and the Federal Reserve have the general authority to limit dividends paid by the Bank or the Company if such payments are deemed to constitute an unsafe and unsound practice.
Under current supervisory practice, prior approval of the Federal Reserve is required if cash dividends of the Bank declared in any given year exceed the total of the Bank's net profits for such year, plus retained net profits for the preceding two years. In addition, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting current losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of all loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Federal law further provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements. The Federal Reserve also has issued guidelines that bank holding companies should inform and consult with the Federal Reserve in advance of declaring or paying a dividend that exceeds earnings, for the period for which the dividend is being paid.
Federal Deposit Insurance Corporation
Our deposits are insured by the Deposit Insurance Fund ("DIF"), as administered by the FDIC, to the maximum amount permitted by law. On November 17, 2009 the FDIC had amended it regulations requiring all insured institutions, including Monarch Bank, to prepay their FDIC premiums for the fourth quarter of 2009 and estimates 2010 through 2012. The prepaid assessments for these periods were collected on December 31, 2010. This represented a charge of approximately $3.5 million. At December 31, 2012, approximately $1.0 million of this prepayment remained. In July 2013, the remaining prepaid balance were returned to insured institutions. Approximately $831 thousand of this prepayment was refunded to the Bank.
The FDIC is required to maintain a designated minimum ratio of the DIF to insured deposits in the United States. The Dodd Frank Act requires the FDIC to assess insured depository institutions to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. The FDIC has adopted new regulations that establish a long-term target DIF ratio of greater than two percent. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole.
Pursuant to the Dodd Frank Act, FDIC insurance coverage limits were permanently increased from $100,000 to $250,000 per customer. The Dodd Frank Act also changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution’s domestic deposits to its total assets minus tangible equity. The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to regulatory capital levels of the institution and other factors, including supervisory evaluations. On February 7, 2011, the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Dodd Frank Act. The new regulation was effective April 1, 2011 and was reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the regulations, our annual deposit insurance assessments are lower than before the regulation. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.

Capital Requirements

Each of the FDIC and the Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, we and our bank subsidiary are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of “Tier 1 Capital,” which is defined as common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles. The remainder may consist of “Tier 2 Capital”, which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance and pretax net unrealized holding gains on certain equity securities. In addition, each of the federal

10

banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization's overall safety and soundness. In summary, the capital measures used by the federal banking regulators are:

•
Total Risk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital (which includes common shareholders' equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments) and Tier 2 Capital (which includes preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25 percent of risk-weighted assets and other adjustments) as a percentage of total risk-weighted assets;

•
Tier 1 Risk-Based Capital ratio (Tier 1 capital divided by total risk-weighted assets); and

•
the Leverage ratio (Tier 1 capital divided by adjusted average total assets).

Under these regulations, a bank will be:

•
“well capitalized” if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier 1 Risk-Based Capital ratio of 6% or greater, a Leverage ratio of 5% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure;

•
“adequately capitalized” if it has a Total Risk-Based Capital ratio of 8% or greater, a Tier 1 Risk-Based Capital ratio of 4% or greater, and a Leverage ratio of 4% or greater (or 3% in certain circumstances) and is not well capitalized;

•
“undercapitalized” if it has a Total Risk-Based Capital ratio of less than 8%, a Tier 1 Risk-Based Capital ratio of less than 4% (or 3% in certain circumstances), or a Leverage ratio of less than 4% (or 3% in certain circumstances);

•
“significantly undercapitalized” if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1 Risk-Based Capital ratio of less than 3%, or a Leverage ratio of less than 3%; or

•
“critically undercapitalized” if its tangible equity is equal to or less than 2% of tangible assets.

The risk-based capital standards of each of the FDIC and the Federal Reserve Board 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 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.

The FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan acceptable to the FDIC. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any financial holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers. We are considered “well-capitalized” at December 31, 2013 and, in addition, our bank subsidiary maintained sufficient capital to remain in compliance with capital requirements and is considered “well-capitalized” at December 31, 2013.

Basel III

In June 2012, the Federal Reserve, the FDIC and the OCC jointly issued proposed rules that would revise the risk-based and leverage capital requirements and the method for calculating risk-weighted assets to be consistent with the agreements reached by the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and certain provisions of the Dodd-Frank Act. The proposed rules would apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (“banking organizations”). In June 2013, final rules were issued under Basel III which are scheduled to begin transitioning capital requirements January 1, 2015.


11

Among other things, the final rules establish a new common equity tier 1 (“CET1”) minimum capital requirement and a “capital conservation buffer”. These rules also raise minimum risk-based capital requirements. Basel III establishes a CET1 to risk-weighted assets of 4.5%, and a capital conservation buffer of an additional 2.5%, raising the target CET1 to risk-weighted assets ratio to 7%. It increases banks minimum ratio of Tier 1 capital to risk weighted assets to 6.0%, plus the capital conservation buffer effectively resulting in a minimum Tier 1 capital ratio of 8.5%. Basel III increases the minimum total capital ratio to 8.0% plus the capital conservation buffer, increasing the minimum total capital ratio to 10.5%. Institutions that do not maintain the required capital buffer would be subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management.

The final rules also introduce a new category for risk-weighted assets, with a higher risk weighting. This new category "high volatility commercial real estate" is risk weighted 150% and applies to certain commercial real estate facilities that finance the acquisition, development or construction of real property (excluding 1-4 family residential properties), unless the financing meets certain specified guidelines.
Affiliate Transactions and Branching
The Federal Reserve Act restricts loans, investments, asset purchases and other transactions between banks and their affiliates; including placing collateral requirements and requiring that those transactions are on terms and under conditions substantially the same as those prevailing at the time for comparable transactions with non-affiliates. Subject to receipt of required regulatory approvals, we may acquire banking offices without geographic restriction in Virginia, and we may acquire banking offices or banks or merge across state lines in most cases.

Community Reinvestment Act
The Community Reinvestment Act of 1977 requires that federal banking regulators evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a banking office or facility. We received a “Satisfactory” CRA rating in our latest CRA examination.
Other Regulations
We are subject to a variety of other regulations. State and federal laws restrict interest rates on loans, potentially affecting our income. The Truth in Lending Act and the Home Mortgage Disclosure Act impose information requirements on us in making loans. The Equal Credit Opportunity Act prohibits discrimination in lending on the basis of race, creed, or other prohibited factors. The Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act govern the use and release of information to credit reporting agencies. The Truth in Savings Act requires disclosure of yields and costs of deposits and deposit accounts. The Secure and Fair Enforcement for Mortgage Licensing Act requires that mortgage loan originators employed by “Agency-regulated” institutions be registered with the National Mortgage Licensing System and Registry. Other acts govern confidentiality of consumer financial records, automatic deposits and withdrawals, check settlement, endorsement and presentment, and disclosure of cash transactions exceeding $10 thousand to the Internal Revenue Service.
USA PATRIOT Act of 2001
In October 2001, the USA PATRIOT Act was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C., which occurred on September 11, 2001. The USA PATRIOT Act is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the USA PATRIOT Act on financial institutions of all kinds is significant and wide ranging. The USA 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.

Governmental Monetary Policies
Our earnings and growth are affected not only by general economic conditions, but also by the monetary policies of various governmental regulatory authorities, particularly the Federal Reserve. The Federal Reserve’s Open Market Committee implements national monetary policy, control of the discount rate and establishment of reserve requirements against both member and nonmember financial institutions’ deposits. These actions have a significant effect on the overall growth and distribution of loans, investments and deposits, as well as the rates earned on loans, or paid on deposits.

12

Our management is unable to predict the effect of possible changes in monetary policies upon our future operating results.
Access to Filings
We make available all periodic and current reports, free of charge, on our website as soon as reasonably practicable after such material is electronically filed with, or furnished to the Securities and Exchange Commission (SEC). Monarch’s website address is www.monarchbank.com. After accessing the Website, the filings are available upon selecting the About Monarch & Investor Documents menu items. The contents of the website are not incorporated into this report or into Monarch’s other filings with the SEC.
The public may read and copy any materials Monarch Financial Holdings, Inc., files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. In addition the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at its website (http://www.sec.gov).
Item 1A.
Risk Factors.
An investment in our common stock involves risk, and you should not invest in our common stock unless you can afford to lose some or all of your investment. You should carefully read the risks described below before you decide to buy any of our common stock. Our business, prospects, financial condition and results of operations could be harmed by any of the following risks.
Risks Relating to Our Business
Changes in interest rates may impact our net interest margin and profitability.
Our profitability depends in substantial part on our net interest margin, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest margin depends on many factors that are partly or completely outside of our control, including competition, monetary and fiscal policies, and economic conditions generally. Our net interest margin is impacted when the Federal Reserve increases or decreases interest rates, due to our loan and deposit maturities and structure. We anticipate that our profitability will continue to hold in the current rate environment by our ability to control the costs of deposits and other borrowings which are used to fund loans. We try to minimize our exposure to interest rate risk, but we are unable to completely eliminate this risk.
Changes in our delivery method for loans held for sale may impact profitability.
We manage the majority of our interest rate risk by locking in the interest rate for each mortgage loan with our correspondents (investors) and borrowers at the same time, which is a “best efforts” delivery system. From time to time we may modify the delivery system on a small portion of our mortgage loans to incorporate a “mandatory delivery” process. Under the mandatory delivery system the interest rate risk associated with a rate lock on a mortgage loan shifts from the investor back to our Company. Therefore, to the extent we adopt the mandatory delivery system our interest income could be adversely impacted if mortgage rates were to become volatile. There were no mandatory delivery commitments at year end.
Our profitability depends significantly on economic conditions in our market area.
Our success depends to a large degree on the general economic conditions in Greater Hampton Roads, Virginia. In recent years our market experienced a downturn in which we saw falling home prices, rising foreclosures, reduced economic activity, increased unemployment and an increased level of commercial and consumer delinquencies. The economic climate has created diminished cash flows for many of our borrowers, and at times left some borrowers unable to properly service their loan obligations. The rise in unemployment has also affected the ability of consumers to properly service their debt obligations. Although the economy in our area and across the nation has shown gradual improvement, the impact of the sequestration could reduce, or reverse, that improvement. If economic conditions in our market deteriorate further, we could experience any of the following consequences, each of which could further adversely affect our business:
•
demand for our products and services could decline;
•
loan delinquencies may increase; and
•
problem assets and foreclosures may increase.
We could experience further adverse consequences in the event of a prolonged economic downturn in our market due to our exposure to commercial loans across various lines of business. A prolonged economic downturn could impact collateral

13

values or cash flows of the borrowing businesses, and as a result our primary source of repayment could be insufficient to service the debt. In addition, adverse consequences to us in the event of a prolonged economic downturn in our market could be compounded by the fact that many of our commercial and real estate loans are secured by real estate located in our market area. A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets.
Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation. Adverse changes in economic conditions in our market would likely impair our ability to collect loans and could otherwise have a negative effect on our financial condition.
If we experience greater loan losses than anticipated, it will have an adverse effect on our net income and our ability to fund our growth strategy.
While the risk of nonpayment of loans is inherent in banking, if we experience greater nonpayment levels than we anticipate, our earnings and overall financial condition, as well as the value of our Common Stock, could be adversely affected. We cannot absolutely assure you that our monitoring, procedures and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses. In addition, as a result of the growth in our loan portfolio, loan losses may be greater than management’s estimates of the appropriate level for the allowance. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our stockholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect our profitability. Any loan losses will reduce the loan loss allowance. A reduction in the loan loss allowance will be restored by an increase in our provision for loan losses. This would reduce our earnings, which could have an adverse effect on our stock price.
Our profitability depends on our ability to manage our balance sheet to minimize the effects of interest rate fluctuation on our net interest margin.
Our results of operations depend on the stability of our net interest margin, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy and geo-political stability, are not predictable or controllable. In addition, the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits are heavily influenced by competitive factors. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.
Our long-term goal is to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that we may reasonably predict our net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings will be more sensitive to fluctuations in interest rates the greater the variance in the volume of assets and liabilities that mature or re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether we are more asset sensitive or liability sensitive. Accordingly, we may not be successful in maintaining this neutral position and, as a result, our net interest margin may suffer, which will negatively impact our earnings. Based on our asset and liability position at December 31, 2013, a rise or decline in interest rates would have limited impact on our net interest income in the short term.
We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel.
We are a client-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our clients by our executive and senior lending officers. We have entered into an employment agreement with Mr. Schwartz, Chief Executive Officer of the Company, E. Neal Crawford, Jr., President of the Company, and William T. Morrison, Executive Vice President and Chief Executive Officer of Monarch Mortgage. The existence of such agreements, however, does not necessarily ensure that we will be able to continue to retain their services. Several other members of management currently have employment agreements to retain their services. The unexpected loss of key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings.

14

Also, our anticipated growth and success, in large part, will be due to the services provided by our mortgage banking officers and the employees of our residential mortgage division. The loss of services of one or more of these persons could have a material adverse effect on our operations, and our business could suffer. With the exception of Mr. Morrison, our mortgage loan originators are not a party to any employment agreement with us, and they could terminate their employment with us at any time and for any reason.
The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new client relationships as well as new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing clients if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. The market for these people is competitive, and we cannot assure you that we will be successful in attracting, hiring, motivating or retaining them.
Revenue from our mortgage banking operations are sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market, higher interest rates or new legislation and may adversely impact our profits.
Our mortgage banking division, Monarch Mortgage, has provided a significant portion of our consolidated revenue and maintaining our revenue stream in this segment is dependent upon our ability to originate loans and sell them to investors. Mortgage loan production levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates. Generally, any sustained period of decreased economic activity or higher interest rates could adversely affect Monarch Mortgage’s mortgage originations and, consequently, reduce its income from mortgage lending activities. A significant portion of recent increases in our mortgage banking earnings is due to the recent historically low interest rate environment that resulted in a high volume of mortgage loan refinancing activity. As the interest rate environment returns to more typical levels, mortgage loan refinancing activity has significantly reduced. In addition, new legislation could adversely affect its operations.
Deteriorating economic conditions may also cause home buyers to default on their mortgages. In addition, if it is proven a borrower failed to provide full and accurate information on or related to their loan application or that appraisals have not been acceptable or the loan was not underwritten in accordance with the loan program specified by the loan investor, Monarch may be required to repurchase the loan or provide financial settlement to the investor. Such repurchases or settlements would also adversely affect our net income.
Periods of rising interest rates will adversely affect our income from our mortgage division.
In periods of rising interest rates, consumer demand for new mortgages and re-financings decreases which in turn, adversely impacts our mortgage banking division. Because interest rates depend on factors outside of our control, we cannot eliminate the interest rate risk associated with our mortgage operations.
We are subject to more stringent capital requirements, which could adversely affect our results of operations and future growth.
In June 2013, federal regulators issued final rules that revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. Many of these proposals are applicable to us when effective, and will add and change the definitions of “capital” for regulatory purposes, the types and minimum levels of capital required under the prompt corrective action rules and for other regulatory purposes, and the right-weighting of various assets. These changes in capital requirements could adversely affect our results of operations and future growth opportunities.
Proposed and final regulations could restrict our ability to originate loans.
The CFPB has issued a rule designed to clarify how lenders can avoid legal liability under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this definition of “qualified mortgage” will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:
•
excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);
•
interest-only payments;
•
negative-amortization; and
•
terms longer than 30 years. 


15

Also, to qualify as a “qualified mortgage,” a borrower’s total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages and similar rules could limit our ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and time-consuming to make these loans, which could limit our growth or profitability.
Mortgage Servicing Rules may impact profitability on our loans held for sale.
Newly issued regulatory rules related to the servicing of mortgages require that we outsource the servicing of our loans held for sale for the time period between the loan closing and delivery to the investor, thereby potentially increasing our costs.
Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. As of December 31, 2013, $590.1 million, or 82.8% of our loans held for investment were secured by real estate (both residential and commercial). A major change in the real estate market, such as deterioration in the value of this collateral, or in the local or national economy, could adversely affect our clients’ ability to pay these loans, which in turn could negatively impact us. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.
We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition.
A key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:
•
open new banking offices;
•
attract deposits to those locations; and
•
identify attractive loan and investment opportunities.
We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand in the future. Our ability to manage our growth successfully also will depend on whether we can maintain capital levels adequate to support our growth; maintain cost controls and asset quality and successfully integrate any new banking offices into our organization.
As we continue to implement our growth strategy by opening new banking and mortgage offices, we expect to incur construction costs and increased personnel, occupancy and other operating expenses. We generally must absorb those higher expenses while we continue to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to grow could depress our earnings in the short run, even if we efficiently execute this growth.

The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be affected adversely by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. 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 realized upon or is liquidated at prices insufficient 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.
Recent legislative regulatory initiatives to address difficult market and economic conditions could adversely affect us.
Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws,

16

regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations.
The recent repeal of federal prohibitions on payment of interest on demand deposits could increase our interest expense.
All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts to businesses were repealed as part of the Dodd-Frank Act. As a result, financial institutions can now offer interest on demand deposits to compete for clients. Our interest expense may increase and our net interest margin may decrease if we begin paying interest on demand deposits to attract additional clients or to maintain current clients, which could have a material adverse effect on our business, financial condition and results of operations.
Our directors and executive officers own our common stock, and their interests may conflict with those of our other shareholders.
As of March 1, 2014, our directors and executive officers beneficially owned approximately 1,017,838 shares or 9.6% of our common stock. Accordingly, such persons will be in a position to exercise substantial influence over our affairs and may impede the acquisition of control by a third party. We cannot assure investors that the interests of our directors and executive officers will always align precisely with the interests of the holders of our common stock.
Our future success will depend on our ability to compete effectively in the highly competitive financial services industry.
The banking business is highly competitive, and we face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive financial services environment. Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered banks, national banks and federal savings institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. Some of these competitors are subject to similar regulation but have the advantages of larger established client bases, higher lending limits, extensive banking office networks, numerous ATMs, greater advertising-marketing budgets and other factors.

Competition in our target market area for loans to businesses, professionals and consumers is very strong. Most of our competitors have substantially greater resources and lending limits than us and offer certain services, such as extensive and established banking office networks and trust services that we cannot provide. Moreover, larger institutions operating in South Hampton Roads have access to borrowed funds at a lower cost than is available to us. Several community banks are headquartered in our trade areas. Several regional and super-regional banks, as well as a number of large credit unions, also have banking offices in our market area. Competition among institutions for checking and saving deposits in the area is intense.
Our legal lending limit may limit our growth.
We are limited in the amount we can lend to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of the unimpaired capital and surplus, of Monarch Bank, to any one borrower. As of December 31, 2013, we were allowed to lend approximately $17.4 million to any one borrower and maintained an in-house limit of $14.0 million to any one borrower. This amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We can accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not efficient or always available. We may not be able to attract or maintain clients seeking larger loans or may not be able to sell participations in such loans on terms we consider favorable.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting

17

the loans and performance of our clients relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed our current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more affected by changes in estimates, and by losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material and adverse impact on our financial performance. Because of our growth strategy, we expect that our earnings will be negatively impacted by loan growth, which requires additions to our allowance for loan losses. Consistent with our loan loss reserve methodology, we expect to make additions to our loan loss reserve levels as a result of our growth strategy, which may affect our short-term earnings.
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
The Company’s information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct its business. In addition, as part of our business, we collect, process and retain sensitive and confidential client information. Our facilities and systems, and those of our third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors, or other similar events. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our client relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of client business, subject the Company and the Bank to regulatory scrutiny, or expose the Company and the Bank to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Our ability to operate profitably may depend on our ability to implement various technologies into our operations.
The market for financial services, including banking services and consumer finance services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. If we are not able to afford such technologies, properly or timely anticipate or implement such technologies, or properly train our staff to use such technologies, our business, financial condition or operating results could be adversely affected.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our Common Stock.
Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at new banking locations as well as investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.

Continued growth may require raising additional capital which may dilute current stockholders’ ownership percentage.
In order to meet applicable regulatory capital requirements, we may, from time to time, need to raise additional capital to support continued growth. If selling our equity securities raises additional funds, the relative ownership interests of our existing stockholders would likely be diluted.
Regulatory Risks
Our need to comply with extensive and complex government regulation could have an adverse effect on our business.
The banking industry is subject to extensive regulation by state and federal banking authorities. Many of the banking regulations we are governed by are intended to protect depositors, the public or the insurance funds maintained by the FDIC, not stockholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and

18

many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in general, and us specifically, at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to reduce losses or operate profitably.
In addition, because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future nor the impact those changes may have on our operations. We fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.
Compliance with the Recently Enacted Dodd-Frank Act Will Increase Our Regulatory Compliance Burdens, and May Increase Our Operating Costs and/or Adversely Impact Our Earnings and/or Capital Ratios.
On July 21, 2010, President Obama signed the Dodd-Frank Act, which represented a significant overhaul of many aspects of the regulation of the financial services industry. Among other things, the Dodd-Frank Act created a new federal Consumer Financial Protection Bureau (“CFPB”), tightened capital standards, imposed clearing and margining requirements on many derivatives activities, and generally increased oversight and regulation of financial institutions and financial activities.
In addition to the self-implementing provisions of the statute, the Dodd-Frank Act calls for over 200 administrative rulemakings by numerous federal agencies to implement various parts of the legislation. While some rules have been finalized and/or issued in proposed form, many have yet to be proposed. It not possible at this time to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings and/or capital.
The Dodd-Frank Act and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and/or our ability to conduct business.
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 and bylaws contain provisions that may be deemed to have the effect of discouraging or delaying uninvited attempts by third parties to gain control of us. These provisions include the division of our board of directors into classes with staggered terms, the ability of our board of directors to set the price, term and rights of, and to issue, one or more series of our preferred stock and the ability of our board of directors, in evaluating a proposed business combination or other fundamental change transaction, to consider the effect of the business combination on us and our stockholders, employees, customers and the communities which we serve. 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 stockholders to change the composition of the board of directors, to affect its policies generally and to benefit from actions which are opposed by the current board of directors.

Item 1B.
Unresolved Staff Comments.
Not applicable

19

Item 2.
Properties.
The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. The Company’s corporate headquarters is located at 1435 Crossways Blvd., Chesapeake, VA. This location also houses, Monarch Capital, LLC and Monarch Investments, LLC. The main banking center is located at 750 Volvo Parkway, Chesapeake, VA. Eight additional banking centers are located throughout SE Virginia and two additional banking centers are located in NE North Carolina. The Company’s mortgage operation headquarters is located at 1635 Laskin Road, Virginia Beach, VA. Additionally, thirty three residential mortgage offices are located throughout Virginia, North Carolina, South Carolina and Maryland. Subsidiaries of Monarch Investment, LLC including; Coastal Home Mortgage, Real Estate Security Agency, Regional Home Mortgage and Monarch Home Funding all have offices in Virginia Beach VA, additionally Regional Home Mortgage has a second location in Chesapeake, VA. See the Note 1 “Summary of Significant Accounting Policies” and Note 6 “Property and Equipment” contained in Item 8 of this Form 10-K for information with respect to the amounts at which Bank premises and equipment are carried and commitments under long-term leases. We believe our facilities are in good operating condition, suitable and adequate for our operational needs and are adequately insured.

Item 3.
Legal Proceedings.
There are no material legal proceedings pending against the Company. In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings are, to management’s knowledge, threatened against us.
 
Item 4.
Mine Safety Disclosure – None.


20

PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our Common Stock is listed on the NASDAQ Capital Market under the symbol MNRK. As of March 5, 2014 there were approximately 2,729 known record holders of Common Stock.
The table below presents the high and low sales prices for our Common Stock for the past two years. Market values are shown per share and are based on the shares outstanding, on a split adjusted basis, for 2013 and 2012.
 
Market Price for
2013
Common Stock
High
 
Low
4th Quarter
$
12.53

 
$
10.94

3rd Quarter
13.35

 
10.02

2nd Quarter
11.93

 
9.55

1st Quarter
11.40

 
8.20

 
Market Price for
2012
Common Stock
High
 
Low
4th Quarter
$
8.94

 
$
7.85

3rd Quarter
8.29

 
7.60

2nd Quarter
8.54

 
6.88

1st Quarter
7.50

 
6.18

Dividend Policy
We paid our first common stock dividend in 2010 and began paying quarterly cash dividends in the first quarter of 2012. In 2011 we paid semi-annual cash dividends. The table below summarizes our common stock dividends for 2013, 2012 and 2011.
Common Stock Dividends
Payment Date
 
Per Share Dividend
 
Total Dividend
November 30, 2013
 
$
0.07

 
$
733,448

August 30, 2013
 
$
0.06

 
$
628,325

May 31, 2013
 
$
0.06

 
$
624,443

February 28, 2013
 
$
0.05

 
$
453,880

Total 2013
 
$
0.24

 
$
2,440,096

 
 
 
 
 
November 30, 2012
 
$
0.05

 
$
332,754

August 31, 2012
 
$
0.05

 
$
302,161

May 31, 2012
 
$
0.05

 
$
299,174

February 28, 2012
 
$
0.04

 
$
240,000

Total 2012
 
$
0.19

 
$
1,174,089

 
 
 
 
 
November 30, 2011
 
$
0.08

 
$
475,531

June 22, 2011
 
$
0.08

 
$
477,227

Total 2011
 
$
0.16

 
$
952,758

On December 7, 2012, Monarch paid a 6 for 5 or 20% common stock dividend to shareholders of record on November 9, 2012. Cash was paid in lieu of fractional shares. This split resulted in an additional 1,330,633 shares being issued to shareholders.

21

We are subject to certain restrictions imposed by the reserve and capital requirements of Federal and Virginia banking statutes and regulations. See Item 1. Business – Supervision and Regulation – Dividends. Prior to the Company's forced conversion of our 7.80% Series B Noncumulative Convertible Perpetual Preferred Stock ("Series B Preferred") on March 8, 2013, holders of these shares had a priority on the receipt of dividends relative to the holders of our Common Stock. The final determination of the timing, amount and payment of dividends is at the discretion of our board of directors and is dependent upon our and our subsidiaries’ earnings, principally Monarch Bank, our financial condition and other factors, including general economic conditions and applicable governmental regulations and policies. Thus, there can be no assurance of when, and if, we will continue to pay cash dividends on our Common shares.
In June 2012, holders of our Series B Preferred began exercising their option to convert their shares to Common Stock. Per Section VIII of the Company Articles of Incorporation, Series B Preferred shareholders could convert their shares to Common Stock at any time. In addition, the Company could force conversion of Series B Preferred to Common Stock if our Common Stock traded for 20 out of 30 consecutive trading days at 130% of the conversion price of $6.67, or $8.67. On March 8, 2013, having met the conditions for forced conversion, the Company force converted all remaining outstanding shares of Series B Preferred stock.
The table below summarizes the conversion activity.
Series B Noncumulative Convertible Perpetual Preferred Stock
Converted to Common Stock
 
 
(a)
 
(b)
 
(c)
 
(d)
Period
 
Total Number of Shares of Preferred Stock Converted to Common Stock
 
Total Number of Shares of Common Stock After Conversion
 
Total Number of Preferred Shares Remaining to Convert
 
Maximum Number of Post Conversion Whole Shares Remaining That May Yet Be Converted
2013
 
 
 
 
 
 
 
 
March 1, 2013 - March 8, 2013
 
271,020

 
1,016,312

 
—

 
—

February 1, 2013 - February 28, 2013
 
172,074

 
645,264

 
271,020

 
1,016,325

January 1, 2013 - January 31, 2013
 
38,029

 
142,608

 
443,094

 
1,661,602

2012
 
 
 
 
 
 
 
 
December 1, 2012 - December 31, 2012
 
6,966

 
26,121

 
481,123

 
1,804,211

November 1, 2012 - November 30, 2012
 
147,456

 
552,950

 
488,089

 
1,830,333

October 1, 2012 - October 31, 2012
 
153,355

 
575,071

 
635,545

 
2,383,293

June 1, 2012 - June 30, 2012
 
11,100

 
41,623

 
788,900

 
2,958,375




22

Item 6.
Selected Financial Data.
The following consolidated summary sets forth our selected financial data for the periods and at the dates indicated. The selected financial data have been derived from our audited financial statements for each of the five years that ended December 31, 2013, 2012, 2011, 2010 and 2009.
 
 
At or For the Years Ended December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(in thousands, except ratios, shares and per share amounts)
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Assets
$
1,016,701

 
$
1,215,578

 
$
908,787

 
$
825,583

 
$
689,569

Loans held for sale (HFS)
99,718

 
419,075

 
211,555

 
175,388

 
78,998

Loans held for investment (HFI), net of unearned income
712,671

 
661,094

 
607,612

 
558,868

 
537,700

Deposits
893,118

 
901,782

 
740,092

 
705,662

 
540,039

Total common stockholders’ equity
97,518

 
75,314

 
56,230

 
51,568

 
47,908

Total stockholders’ equity
97,518

 
87,342

 
76,230

 
71,568

 
67,908

Average shares outstanding, basic (1)
10,167,156

 
7,400,443

 
7,147,290

 
6,858,638

 
6,793,540

Average shares outstanding, diluted (1)
10,299,471

 
10,271,874

 
10,165,105

 
7,003,556

 
6,941,510

Results of Operations:
 
 
 
 
 
 
 
 
 
Interest Income
$
44,348

 
$
46,468

 
$
40,420

 
$
39,273

 
$
32,518

Interest Expense
4,786

 
5,916

 
6,797

 
8,798

 
10,421

Net Interest Income
39,562

 
40,552

 
33,623

 
30,475

 
22,097

Provision for loan losses
—

 
4,831

 
6,320

 
8,639

 
5,184

Net interest income after provision for loan losses
39,562

 
35,721

 
27,303

 
21,836

 
16,913

Non-interest income
69,882

 
89,761

 
54,746

 
53,400

 
35,676

Non-interest expenses
90,911

 
104,256

 
71,044

 
65,480

 
45,076

Income before income taxes
18,533

 
21,226

 
11,005

 
9,756

 
7,513

Income tax expense
6,386

 
7,427

 
3,419

 
3,544

 
2,453

Net income
12,147

 
13,799

 
7,586

 
6,212

 
5,060

Net income attributable to non-controlling interests
(1,056
)
 
(975
)
 
(460
)
 
(263
)
 
(204
)
Net income attributable to Monarch Financial Holdings, Inc.
11,091

 
12,825

 
7,126

 
5,949

 
4,856

Accretion of discount
—

 
—

 
—

 
—

 
219

Dividends on preferred stock
—

 
1,402

 
1,560

 
1,560

 
844

Net income available to common stockholders
11,091

 
11,422

 
5,566

 
4,389

 
3,793

Per Common Share Data:
 
 
 
 
 
 
 
 
 
Net income, basic
$
1.09

 
$
1.54

 
$
0.78

 
$
0.64

 
$
0.55

Net income, diluted
1.08

 
1.25

 
0.70

 
0.62

 
0.55

Book value at period end
9.29

 
8.80

 
7.81

 
7.20

 
6.80

Tangible book value at period end
9.20

 
8.68

 
7.64

 
7.00

 
6.58

Asset Quality Ratios:
 
 
 
 
 
 
 
 
 
Non-performing assets to total assets (5)
0.25
%
 
0.29
%
 
0.84
%
 
1.30
%
 
1.40
%
Non-performing loans to period end loans (HFI) (5)
0.31
%
 
0.54
%
 
0.71
%
 
1.61
%
 
1.40
%
Net Charge-offs (recoveries) to average loans
1.25
%
 
0.62
%
 
0.93
%
 
1.61
%
 
0.76
%
Allowance for loan losses to period-end loans (HFI)
1.27
%
 
1.65
%
 
1.63
%
 
1.62
%
 
1.73
%
Allowance for loan losses to nonperforming loans (5)
409.63
%
 
307.15
%
 
231.36
%
 
100.19
%
 
123.15
%
Selected Ratios :
 
 
 
 
 
 
 
 
 
Return on average assets
1.07
%
 
1.26
%
 
0.89
%
 
0.76
%
 
0.75
%
Return on average equity
11.97
%
 
15.84
%
 
9.66
%
 
8.59
%
 
7.55
%
Efficiency ratio (2)
82.78
%
 
79.80
%
 
80.20
%
 
77.90
%
 
77.70
%
Non-interest income to operating revenue (3)
63.85
%
 
68.88
%
 
61.95
%
 
63.71
%
 
61.72
%
Net interest margin (tax adjusted) (4)
4.13
%
 
4.29
%
 
4.51
%
 
4.22
%
 
3.64
%
Equity to assets
9.59
%
 
7.19
%
 
8.39
%
 
8.67
%
 
9.85
%
Tier 1 risk-based capital ratio
12.82
%
 
10.85
%
 
11.17
%
 
11.74
%
 
12.97
%
Total risk-based capital ratio
13.91
%
 
12.05
%
 
12.42
%
 
12.99
%
 
14.23
%

(1)
Amounts have been adjusted to reflect all Common Stock splits and dividends as of December 31, 2013. In 2012 and 2011 diluted shares assumes the conversion of our non-cumulative perpetual preferred shares to common stock. Prior years do not include this assumption.
(2)
The efficiency ratio is a key performance indicator of the Company’s industry. We monitor this ratio in tandem with other key indicators for signals of potential trends that should be considered when making decisions regarding strategies related to such areas as asset liability management, business line development, and growth and expansion planning. The ratio is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income, net of any securities gains or losses. It is a measure of the relationship between operating expenses to earnings. See “Critical Accounting Policies” on page 48 for additional information.
(3)
Operating revenue is defined as net interest income plus non-interest income.
(4)
Net interest margin is calculated as net interest income divided by total average earning assets and reported on a tax equivalent basis at a rate of 35% in 2013 and 2012 and 34% for the remaining years presented.
(5)
For the purpose of these ratios, we have excluded performing restructured loans from the calculation. For more information please refer to Table 13- Nonperforming Assets included in Item 7. of this Form 10-K.

Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Risks and Cautionary Statement Concerning Forward Looking Statement.
The Private Securities Litigation Reform Act of 1995 (the “1995 Act”) provides a safe harbor for forward-looking statements made by or on our behalf. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared.
This report includes and incorporates by reference forward-looking statements within the meaning of the 1995 Act. These statements are included throughout this report, and in the documents incorporated by reference in this report, and relate to, among other things, projections of revenues, earnings, earnings per share, cash flows, capital expenditures, or other financial items, expectations regarding acquisitions, discussions of estimated future revenue enhancements, potential dispositions, and changes in interest rates. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. The words “believe”, “anticipate”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, and similar terms and phrases identify forward-looking statements in this report and in the documents incorporated by reference in this report.
Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. Our operations involve risks and uncertainties, many of which are outside of our control, and any one of which, or a combination of which, could materially affect our results of operations and whether the forward-looking statements ultimately prove to be correct.
Actual results and trends in the future may differ materially from those suggested or implied by the forward-looking statements depending on a number of factors. Factors that may cause actual results to differ materially from those expected include the following:
•
changes in interest rates;
•
changes in economic conditions in our market area;
•
greater loan losses than anticipated;
•
the effect on us and our industry of difficult market conditions, unprecedented volatility and the soundness of other financial institutions;
•
the effect of legislative regulatory initiatives;
•
our ability to compete effectively in the highly competitive financial services industry;
•
the effect of our concentration in loans secured by real estate;
•
the adequacy of our allowance for loan losses;
•
our ability to obtain additional capital in the future on terms that are favorable;

23

•
our expansion and technology initiatives;
•
our reliance on third parties for key services;
•
other factors described under “Risk Factors” above.
Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements.

OVERVIEW
The purpose of this discussion is to provide information about the major components of our results of operations and financial condition, liquidity and capital resources. The discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes to assist in the evaluation of our 2013 performance.
We generate a significant amount of our income from the net interest income earned by Monarch Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. Monarch Bank’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses.
We also generate income from non-interest sources. Non-interest income sources include bank related service charges, fee income from residential mortgage sales, fee income from title insurance, fee income from the sale of investment and insurance services, income from bank owned life insurance (“BOLI”) policies, as well as gains or losses from the sale of investment securities.
ANALYSIS OF OPERATING RESULTS
NET INCOME
Our consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, after all significant inter-company transactions have been eliminated. Net income attributable to our non-controlling interests of $1,056,385, $974,637 and $459,753, respectively, are deducted for the years ended December 31, 2013, 2012 and 2011, after the income tax provision, to arrive at net income attributable to Monarch Financial Holdings, Inc. The ensuing references and ratios are related to net income attributable to Monarch Financial Holdings, Inc., (hereon referred to as “net income”) after net income attributable to non-controlling interest has been deducted.
 
 
2013
 
2012
 
2011
Income before taxes
$
18,533,432

 
$
21,226,291

 
$
11,004,057

Income tax provision
(6,386,040
)
 
(7,426,785
)
 
(3,418,692
)
Net income
12,147,392

 
13,799,506

 
7,585,365

Less: Net income attributable to non-controlling interest
(1,056,385
)
 
(974,637
)
 
(459,753
)
Net income attributable to Monarch Financial Holdings, Inc.
$
11,091,007

 
$
12,824,869

 
$
7,125,612

We reported net income for December 31, 2013 of $11,091,007, compared to $12,824,869 for December 31, 2012 and $7,125,612 for December 31, 2011. Our basic earnings per share were $1.09, $1.54 and $0.78 for the years ended December 31, 2013, 2012 and 2011, respectively. Diluted earnings per share were $1.08 for December 31, 2013, $1.25 for December 31, 2012, and $0.70 for December 31, 2011.
Two important and commonly used measures of profitability are return on assets (net income as a percentage of average total assets) and return on stockholders’ equity (net income as a percentage of average stockholders’ equity). Our returns on average assets were 1.07%, 1.26% and 0.89% for the years ended December 31, 2013, 2012 and 2011, respectively. The returns on average stockholders’ equity were 11.97%, 15.84% and 9.66% for the same time periods.
Net income for the year ended December 31, 2013 was $11,091,007, a decrease of $1,733,862, or 13.5% when compared to one year prior. December 31, 2012 was $12,824,869, an increase of 80.0% compared to 2011. This primary source of fluctuation in income was related to mortgage banking income, which is included in non-interest income. Changes in net interest income and non-interest expense also impacted income results. Net income available to common stockholders, which

24

is net of preferred stock dividends of $0 in 2013, $1,402,532 in 2012 and $1,560,000 in 2011, was $11,091,007 at December 31, 2013, $11,422,337 at December 31, 2012, and $5,565,612 in 2011.
Net interest income declined $990 thousand, or 2.4% to $39.6 million, in 2013. Net interest income had increased $6.9 million, or 20.6% to $40.6 million, in 2012 compared to 2011. This shift in income levels is primarily volume driven. Our loans held for sale portfolio had declined $319.4 million at year end 2013 to $99.7 million, compared to a record high of $419.1 million in 2012. With this decline, interest earned on these loans also declined $4.2 million. This decline was partially offset by income earned on our growing loans held for investment portfolio and savings on interest expense due to lower volume and rates. Loans held for investment grew $51.6 million in 2013 while interest bearing liabilities declined $223 million. On average, our loans held for sale portfolio declined $117.8 million, while our loans held for investment portfolio increased $68.5 million and our interest bearing liabilities declined $51.2 million. The combined yield on our loan portfolios increased 1 basis point to 5.02%. Liability costs declined 10 basis points, year over year.
In 2012, earning asset growth coupled with lower cost liabilities was the source of the increase in net interest income. Loans held for sale increased $207.5 million and loans held for investment grew $53.5 million, year over year. Average outstanding loans held for sale increased $177.2 million and average loans held for investment increased $37.0 million. The combined yield on these loans declined 67 basis points. Interest bearing deposits increased $105.4 million, year over year, and average outstanding interest bearing deposits increased $112.8 million. The overall costs associated with deposits declined 34 basis points. Total borrowings increased $128.4 million, year over year, while average outstanding borrowings only increased $36.6 million, and the cost of borrowing declined 168 basis points.

Non-interest income declined $19.9 million to $69.9 million in 2013 compared to $89.8 million in 2012. In 2012 non-interest income had increased $35.0 million from $54.7 in 2011. Our primary source of non-interest income is mortgage banking income, which declined $20.7 million to $65.7 million in 2013 after increasing $34.9 million in 2012 from $51.4 million. Production by our mortgage division, operating under the name of Monarch Mortgage declined in 2013 after delivering record production in 2012. Other non-interest income increased $787 thousand in 2013 compared to 2012, and $164 thousand in 2012 compared to 2011. Included in other non-interest income in 2011 were non-recurring net proceeds from bank owned life insurance (BOLI) totaling $421 thousand.
Non-interest expense declined $13.3 million to $90.9 million in 2013, after increasing $33.2 million to $104.3 million in 2012, compared to $71.0 million in 2011. In 2013, the source of the decrease was the same as the source of the increase in 2012; salaries and benefits, commissions and loan expense related primarily to mortgage production.
Our provision for loan losses was $0 in 2013, compared to $4.8 million in 2012, and $6.3 million in 2011. At the same time net charge offs were $1.8 million, a decrease of $2.1 million or 53.8% from 2012. Net charge offs were $3.9 million in 2012, a decrease of $1.5 million or 27.8% compared to $5.4 million in 2011. Our allowance for loan losses declined $1.8 million in 2013 compared to an increase of $980 thousand in 2012. Through use of the provision, management seeks to provide for future losses inherent in the existing portfolio. This is achieved by utilizing various metrics including but not limited to loss history, economic conditions and industry trends. Provision and allowance management requires a great deal of judgment and is a primary focus of our team.
The net effect on 2013 pre-tax and pre-non-controlling interest income was a decrease of $2,692,859, or 12.69% to $18,533,432 compared to an increase in 2012 of 92.9%, or $10,222,234, to $21,226,291. Pre-tax and pre-non-controlling interest income was $11,004,057 in 2011.
NET INTEREST INCOME
Net interest income, which is the excess of interest income over interest expense, is a significant source of revenue. Net interest income is influenced by a number of factors, including the volume of interest-earning assets and interest-bearing liabilities, the mix of interest-earning assets and interest-bearing liabilities, the interest rates earned on earning assets and the interest rates paid to obtain funding to support the assets.
Net interest income was $39,561,979 for the year ended December 31, 2013 and $40,552,232 for the year ended December 31, 2012. This represents a decrease of $990,253 or 2.4% compared to 2012. At December 31, 2012 net interest income had increased 20.6% or $6,929,360 over 2011 when net interest income was $33,622,872.
Rates, though stable, have remained at historically low levels over the past five years. Although 2013 continued to show measured signs of economic recovery that began in 2012, we have been at, or near, the bottom of an economic downturn that began in the later months of 2007. At the time the Federal Reserve Open Market Committee ("FOMC"), which sets the federal funds rate, began to decrease the federal funds target. It did this in an effort to stabilize the economy and head-off a recession. Between September 2007 and December 2008 the FOMC decreased the target funds rate a total of 500 basis points which

25

resulted in the current, historically low, federal funds rate of 0.25%. During this same period, Wall Street Journal Prime (“WSJP”), which moves in tandem with the federal funds target rate, has held at 3.25%. Repeated comments by the FOMC indicate that they intend to maintain this low rate environment until, at least, mid-2015 or beyond. In addition to setting the target funds rate, the FOMC utilizes other tools to shape monetary policy. It uses the federal funds rate to manage short term interest, but it can also influence long term rates. Over the past few years, through the systematic purchase of longer term treasury bonds and mortgage-backed securities, the FOMC has kept the money supply flowing and long term interest rates artificially low, in an effort to encourage banks to lend and businesses to borrow. As the FOMC escalated its purchases in long term mortgage-backed securities in 2012, it had a significant impact on the long term mortgage market in the form of a refinance boom. In mid-2013 the FOMC added language to their meeting minutes and press releases indicating they would begin to curtail their long term mortgage-backed and treasury purchases. With this announcement, long term mortgage rates increased and had an immediate impact on the mortgage industry. The refinance boom ceased and the number of new home buyers, dropped dramatically due to a form of "sticker shock" in response to the new, but not significantly higher, rates now available.
We continued the work begun in 2011 of reshaping our balance sheet in preparation for future increases in rates. Our focus has been on building non-maturity core deposits to support our loans held for investment portfolio. A portion of these deposits also support a base level of our loans held for sale portfolio. We define core deposits as non-brokered, in-market deposits. Demand deposits grew $6.9 million, or 2.7% in 2013 and $80.7 million, or 46.2% in 2012. Money market accounts grew $38.6 million, or 11.5% in 2013 and $66.1 million, or 24.5% in 2012. We also utilized short term non-core brokered funds and borrowings at the Federal Home Loan Bank ("FHLB") to meet the volume demands of our loans held for sale portfolio. This utilization resulted in dramatic increases in both areas in 2012 in response to the long-term strategies of the FOMC and produced equally dramatic reductions in 2013 with changes to those strategies.
As stated previously, in 2012 historically low mortgage rates lead to high refinance production which all but dried up in 2013. In addition purchase money production, which was also strong in 2012 showed a slight decline in 2013. In the third quarter of 2012 the high volume of refinance business coupled with increased purchase money volume led to a slowdown in investor processing. Due to the sheer volume of mortgages being processed, investors began pushing back or delaying the purchase of loans, even though their commitments were in place. Therefore growth in our loans held for sale portfolio was a function of both production levels and timing. In 2013, the problems noted in 2012 with regard to delivery of loans held for sale to investors, as well as investor push back, ended and our delivery time declined to pre-2012 levels. At December 31, 2013 our loans held for sale had declined $319.4 million, or 76.2% to $99.7 million. On average, our loans held for sale declined $117.8 million, or 38.4% to $188.7 million. At December 31, 2012 our loans held for sale had increased $207.5 million, or 98.1% to $419.1 million over year end 2011. On average, our loans held for sale portfolio increased $177.2 million, or 137.0% to $306.5 million. Interest income from our loans held for sale decreased $4.2 million, or 37.6% in 2013 after increasing $5.8 million, or 107.6% in 2012 to $11.3 million.
During 2013 we continued our 2012 loans held for investment strategy of supporting our existing client base, promoting disciplined growth with regard to new clients, and promoting short term fixed rate loan pricing where possible. Growth has been slow but steady as many borrowers are reluctant to enter the market, despite low rates. There is strong competition for high quality credits. Our outstanding loans held for investment increased $51.6 million, or 7.8% in 2013 compared to $53.5 million or 8.8% in 2012. Interest income from loans held for investment increased $1.9 million or 5.4% in 2013, after only increasing $175 thousand or 0.5% in 2012.

Total interest income was $44,348,437 in 2013 compared to $46,468,465 in 2012 and $40,419,327 in 2011. Earning asset yield declined 29 basis points to 4.62% compared to 4.91% in 2012. Earning asset yield declined 50 basis points to 4.91% in 2012 compared to 5.41% in the prior year. Loan yield is the result of both the interest rate and any fees collected on a loan. Interest and fees on loans are the largest component of our interest income. Interest and fees on loans held for investment decreased 29 basis points in 2013 to a blended yield of 5.39%, and 34 basis points in 2012 to a blended yield of 5.68% compared to 6.02% in 2011. The yield on our loans held for sale, which is driven by FOMC monetary policy, increased 5 basis points to 3.72% after declining 52 basis points in 2012 to 3.67%, compared to 4.19% in 2011. The combined yield of our loan portfolios increased 1 basis point to 5.02% in 2013 compared to 2012. Volume fluctuations coupled with the changes in yield discussed previously resulted in a decrease in the combined loan portfolios of 67 basis points to 5.01% in 2012 from 5.68% in 2011.
In 2013 the yield on our securities portfolio declined 81 basis points to 1.35% after increasing 64 basis points to 2.16% in 2012 from 1.52% in 2011. Security purchases in the form of callable and non-callable agencies totaled $38.6 million in 2013. Maturities and calls totaled $3.9 million for the same period. The 2013 decline in yield is a function of low rates coupled with purchase volume relative to the size of the portfolio. During 2012, $4.8 million of the $9.2 million in outstanding securities at December 31, 2011 either matured or were subject to rate call. Securities totaling $10.2 million were purchased in 2012. The

26

year over year increase in yield is related to one low yielding non-callable agency security in 2011. At the instrument level, the overall yield of our outstanding securities portfolio at December 31, 2012 was lower than year end 2011.
Our restricted stock and deposits in other banks yield decreased 73 basis points to 0.62% due to the high level of low yielding federal funds included in this line item. However, the high volume of funds in this category produced an additional $216 thousand in income in 2013. In 2012 this line item increased 63 basis points or $20 thousand. We have restricted stock with FHLB, the Federal Reserve and Community Bankers Bank which earn dividends. The yield on our bank owned life insurance (BOLI) increased 7 basis points to 4.94% in 2013 after declining 80 basis points to 4.87% in 2012 compared to 5.67% in 2011.
Total interest expense declined $1,129,775, or 19.1% to $4,786,458, in 2013 compared to a decline of $880,222, or 13.0% to $5,916,233, for the year ended December 31, 2012 from $6,796,455. Interest cost declined 10 basis points to 0.68% in 2013. In 2012 interest cost declined 34 basis points from 1.12% in 2011 to 0.78%. Interest bearing deposits, the largest component of interest expense, declined 12 basis points in 2013 to 0.59% compare to a decline of 34 basis points to 0.71% in 2012, from 1.05% in 2011. During both 2013 and 2012, we adjusted the pricing of our products while remaining market competitive. The rate on our money market accounts declined 17 basis points to 0.42% in 2013, and 20 basis points to 0.59% in 2012. The blended yield on our time deposit or Certificate of Deposit ("CD") rate increased 3 basis points to 0.92% in 2013 after declining 61 basis points to 0.89% in 2012.
Our borrowing cost increased 48 basis points in 2013 to 2.25% after decreasing 168 basis points in 2012 to 1.77%. This fluctuation is due to changes in the level of low cost borrowing relative to total borrowing. We have a borrowing for $1.2 million with FHLB that bears a rate of 4.96%. In 2013, as in 2011, we borrowed less on average, so this relatively high rate had a greater impact on yield. In 2012 we secured a $5.0 million holding company line of credit from PNC bank with a variable rate of 6 month London Interbank Offered Rate ("LIBOR") plus 200 basis points. In 2013, we repaid this line. In addition, we paid down our FHLB lines. At December 31, 2013 the borrowings on our FHLB line totaled $1.2 million as compared $194.3 million at December 31, 2012 and $70.9 million at December 31, 2011.
Additional analysis with regard to interest income will reference the following tables. For discussion purposes, our “net interest income analysis” and our “changes in net interest income (rate/volume analysis)” tables are adjusted to include tax equivalent income on BOLI and tax exempt municipal securities that is not in compliance with Generally Accepted Accounting Principles (GAAP). The following table is a reconciliation of our income statement presentation to these tables.
RECONCILIATION OF NET INTEREST INCOME TO TAX EQUIVALENT NET INTEREST INCOME
 
 
Year Ended December 31,
 
2013
 
2012
 
2011
Non-GAAP
 
 
 
 
 
Interest income
 
 
 
 
 
Total interest income
$
44,348,437

 
$
46,468,465

 
$
40,419,327

Bank owned life insurance
236,377

 
226,893

 
269,263

Tax equivalent adjustment (1)
 
 
 
 
 
Bank owned life insurance
127,280

 
116,884

 
138,711

Municipal securities
21,020

 
20,125

 
13,300

Adjusted income on earning assets
44,733,114

 
46,832,367

 
40,840,601

Interest expense
 
 
 
 
 
Total interest expense
4,786,458

 
5,916,233

 
6,796,455

Net interest income-adjusted
$
39,946,656

 
$
40,916,134

 
$
34,044,146


(1) A tax rate of 35% for 2013 and 2012, and 34% for 2011, was used in adjusting interest on BOLI, tax-exempt securities and loans to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by the net interest margin.
Table 1 depicts interest income on average earning assets and related yields, as well as, interest expense on average interest-bearing liabilities and related rates paid for the periods indicated.

27

Our net yield on earning assets or net interest margin, which is calculated by dividing net interest income by average earning assets, was 4.13% in 2013, and 4.29% in 2012 compared to 4.51% in 2011. Our earning asset yield was 4.62% in 2013, a decrease of 29 basis points from 4.91% in 2012, which was a decrease of 50 basis points from 5.41% in 2011. During the same periods liability costs declined 10 basis points to 0.68% in 2013, 34 basis points to 0.78% in 2012 from 1.12% in 2011. Our interest rate spread, which is the difference between the average yield on earning assets and the average cost on interest bearing liabilities, was 3.94% in 2013 compared to 4.13% in 2012 and 4.29% in 2011. The result of these changes is a 16 basis point decrease in margin for 2013 compared to 2012, and a 22 basis point decrease in margin for 2012 compared to 2011.

28

Table 1 - NET INTEREST INCOME ANALYSIS
(in thousands)
The following is an analysis of net interest income, on a taxable equivalent basis.  
 
2013
 
2012
 
2011
 
Average
Balance
 
Income/
Expense
 
Yield/
Rate
 
Average
Balance
 
Income/
Expense
 
Yield/
Rate
 
Average
Balance
 
Income/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
113,971

 
$
5,913

 
5.19
%
 
$
86,776

 
$
5,041

 
5.81
%
 
$
90,026

 
$
5,791

 
6.43
%
Real estate
563,464

 
30,471

 
5.41
%
 
521,307

 
29,456

 
5.65
%
 
481,486

 
28,520

 
5.92
%
Consumer
2,848

 
261

 
9.16
%
 
3,671

 
278

 
7.57
%
 
3,292

 
289

 
8.78
%
Loans held for sale
188,696

 
7,021

 
3.72
%
 
306,497

 
11,257

 
3.67
%
 
129,279

 
5,420

 
4.19
%
Total loans
868,979

 
43,666

 
5.02
%
 
918,251

 
46,032

 
5.01
%
 
704,083

 
40,020

 
5.68
%
Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal agencies
14,860

 
126

 
0.85
%
 
6,254

 
88

 
1.41
%
 
11,385

 
124

 
1.09
%
Mortgage-backed
1,729

 
33

 
1.91
%
 
1,896

 
39

 
2.06
%
 
377

 
12

 
3.18
%
Municipals
1,769

 
83

 
4.69
%
 
1,510

 
72

 
4.77
%
 
630

 
39

 
6
%
Other securities
226

 
9

 
3.98
%
 
509

 
21

 
4.13
%
 
500

 
21

 
4.20
%
Total securities
18,584

 
251

 
1.35
%
 
10,169

 
220

 
2.16
%
 
12,892

 
196

 
1.52
%
Restricted stock and deposits in other banks
73,201

 
453

 
0.62
%
 
17,594

 
236

 
1.34
%
 
30,588

 
216

 
0.71
%
Bank owned life insurance
7,347

 
363

 
4.94
%
 
7,068

 
344

 
4.87
%
 
7,191

 
408

 
5.67
%
Total interest-earning assets
968,111

 
$
44,733

 
4.62
%
 
953,082

 
$
46,832

 
4.91
%
 
754,754

 
$
40,840

 
5.41
%
Less: Allowance for loan losses
(10,956
)
 
 
 
 
 
(10,414
)
 
 
 
 
 
(9,374
)
 
 
 
 
Other non-earning assets
78,455

 
 
 
 
 
79,148

 
 
 
 
 
59,462

 
 
 
 
Total assets
$
1,035,610

 
 
 
 
 
$
1,021,816

 
 
 
 
 
$
804,842

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand
$
49,284

 
92

 
0.19
%
 
$
40,764

 
86

 
0.21
%
 
$
30,792

 
82

 
0.27
%
Money market
347,734

 
1,470

 
0.42
%
 
302,750

 
1,776

 
0.59
%
 
295,187

 
2,337

 
0.79
%
Savings
22,346

 
91

 
0.41
%
 
19,765

 
88

 
0.45
%
 
19,803

 
100

 
0.50
%
Time
249,071

 
2,283

 
0.92
%
 
340,188

 
3,012

 
0.89
%
 
244,851

 
3,679

 
1.50
%
Total deposits
668,435

 
3,936

 
0.59
%
 
703,467

 
4,962

 
0.71
%
 
590,633

 
6,198

 
1.05
%
Other borrowings
37,756

 
851

 
2.25
%
 
53,964

 
954

 
1.77
%
 
17,329

 
598

 
3.45
%
Total interest-bearing liabilities
706,191

 
$
4,787

 
0.68
%
 
757,431

 
$
5,916

 
0.78
%
 
607,962

 
$
6,796

 
1.12
%
Demand deposits
210,325

 
 
 
 
 
161,866

 
 
 
 
 
113,829

 
 
 
 
Other liabilities
26,458

 
 
 
 
 
21,555

 
 
 
 
 
9,296

 
 
 
 
Stockholders’ equity
92,636

 
 
 
 
 
80,984

 
 
 
 
 
73,755

 
 
 
 
Total liabilities and Stockholders’ equity
$
1,035,610

 
 
 
 
 
$
1,021,836

 
 
 
 
 
$
804,842

 
 
 
 
Interest rate spread
 
 
 
 
3.94
%
 
 
 
 
 
4.13
%
 
 
 
 
 
4.29
%
Net yield on earning assets
 
 
 
 
4.13
%
 
 
 
 
 
4.29
%
 
 
 
 
 
4.51
%
Reconciliation to GAAP
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income tax equivalent
 
 
$
39,946

 
 
 
 
 
 
 
 
 
 
 


 
 
Less: Taxable equivalent adjustment - municipals
 
 
21

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less: Taxable equivalent adjustment - BOLI
 
 
127

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less: BOLI interest income
 
 
236

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
39,562

 
 
 
 
 
 
 
 
 
 
 
 
 
 

29


Table 2 presents changes in net interest income in a rate/volume analysis format. The goal of a rate/volume analysis is to compare two or more earning periods to determine whether the difference between the results of those periods is due to changes in rate, or volume, or some combination of the two. This is achieved through a “what if” analysis. We calculate what the potential income would have been in the new period if the prior period rate had remained unchanged, and compare that result to what the potential income would have been in the prior period if the current rates were in effect. Through the analysis of these income potentials, we are able to determine how much of the dollar change between periods is due to the impact of differing rates and how much is volume driven. Net interest income has been adjusted to include income from BOLI and the tax effect of tax exempt municipal securities.
Net interest income declined $970 thousand in 2013 when compared to 2012. This decline was rate driven, with the impact of a $1.7 million loss in earnings power due to lower rates partially offset by $712 thousand in additional income due to volume. The decline in yield on our earning assets was $1.9 million while the decline in loan volume driven by our loans held for sale portfolio outpaced other asset growth for an additional income loss of $182 thousand. Lower deposit and borrowing expenses driven by both rate and volume provided a savings of $1.1 million.
Our net interest income in 2012 increased $6.9 million when compared to 2011, $6.6 million of this increase was due to changes in volume and $275 thousand was due to changes in rates. Earning asset growth provided $8.6 million due to volume driven earnings, $2.6 million of which was absorbed by increased volume in liabilities. Changes in rates had minimal impact as savings in liability costs of $2.9 million were offset by reduced earning asset potential of $2.6 million.

Table 2 - CHANGES IN NET INTEREST INCOME (RATE/VOLUME ANALYSIS)
(in thousands)
 
 
2013 vs 2012
 
Interest
Increase
(Decrease)
 
Change
Attributable to
 
Rate
 
Volume
Interest income
 
 
 
 
 
Loans held for investment:
 
 
 
 
 
Commercial
872

 
(582
)
 
1,454

Real estate
1,015

 
(1,300
)
 
2,315

Consumer
(17
)
 
52

 
(69
)
Loans held for sale
(4,236
)
 
145

 
(4,381
)
Total loans
(2,366
)
 
(1,685
)
 
(681
)
Securities:
 
 
 
 
 
Federal agencies
38

 
(46
)
 
84

Mortgage-backed
(6
)
 
(3
)
 
(3
)
Municipals
11

 
(1
)
 
12

Other securities
(12
)
 
(1
)
 
(11
)
Total securities
31

 
(51
)
 
82

Restricted stock and deposits in other banks
217

 
(186
)
 
403

Bank owned life insurance
19

 
5

 
14

Total interest income
(2,099
)
 
(1,917
)
 
(182
)
Interest expense
 
 
 
 
 
Deposits:
 
 
 
 
 
Demand
6

 
(11
)
 
17

Money market
(306
)
 
(544
)
 
238

Savings
3

 
(8
)
 
11

Time
(729
)
 
103

 
(832
)
Total deposits
(1,026
)
 
(460
)
 
(566
)
Other borrowings
(103
)
 
225

 
(328
)
Total interest expense
(1,129
)
 
(235
)
 
(894
)
Net interest income
(970
)
 
(1,682
)
 
712


30

 
2012 vs 2011
 
Interest
Increase
(Decrease)
 
Change
Attributable to
 
Rate
 
Volume
Interest income
 
 
 
 
 
Loans held for investment:
 
 
 
 
 
Commercial
(750
)
 
(546
)
 
(204
)
Real estate
936

 
(1,353
)
 
2,289

Consumer
(11
)
 
(42
)
 
31

Loans held for sale
5,837

 
(748
)
 
6,585

Total loans
6,012

 
(2,689
)
 
8,701

Securities:
 
 
 
 
 
Federal agencies
(36
)
 
30

 
(66
)
Mortgage-backed
27

 
(6
)
 
33

Municipals
33

 
(11
)
 
44

Other securities
—

 
—

 
—

Total securities
24

 
13

 
11

Restricted stock and deposits in other banks
20

 
138

 
(118
)
Bank owned life insurance
(64
)
 
(57
)
 
(7
)
Total interest income
5,992

 
(2,595
)
 
8,587

Interest expense
 
 
 
 
 
Deposits:
 
 
 
 
 
Demand
4

 
(19
)
 
23

Money market
(561
)
 
(619
)
 
58

Savings
(12
)
 
(12
)
 
—

Time
(667
)
 
(1,813
)
 
1,146

Total deposits
(1,236
)
 
(2,463
)
 
1,227

Other borrowings
356

 
(407
)
 
763

Total interest expense
(880
)
 
(2,870
)
 
1,990

Net interest income
6,872

 
275

 
6,597


MARKET RISK MANAGEMENT
We spend a great deal of time focusing on the management of the balance sheet to maximize net interest income. Our primary component of market risk is interest rate volatility, and our primary objectives for managing interest rate volatility are to identify opportunities to maximize net interest income while ensuring adequate liquidity and carefully managing interest rate risk. The Asset/Liability Management Committee (“ALCO”), which is composed of executive officers, is responsible for:
•
Monitoring corporate financial performance;
•
Meeting liquidity requirements;
•
Establishing interest rate parameters, indices, and terms for loan and deposit products;
•
Assessing and evaluating the competitive rate environment;
•
Monitoring and measuring interest rate risk;
•
Reporting our performance results to our Board.
Interest rate risk refers to the exposure of our earnings and market value of portfolio equity (“MVE”) to changes in interest rates. The magnitude of the change in earnings and MVE resulting from interest rate changes is impacted by the time remaining to maturity on fixed-rate obligations, the contractual ability to adjust rates prior to maturity, competition, and the general level of interest rates and customer actions.

There are several common sources of interest rate risk that must be effectively managed to limit impact on our earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and

31

liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.
In determining the appropriate level of interest rate risk, ALCO reviews the changes in net interest income and MVE given various changes in interest rates. We also consider the most likely interest rate scenarios, local economics, liquidity needs, business strategies, and other factors in determining the appropriate levels of interest rate risk. To effectively measure and manage interest rate risk, simulation analysis is used to determine the impact on net interest income and MVE from changes in interest rates.
Interest rate sensitivity analysis presents the amount of assets and liabilities that are estimated to reprice through specified periods if there are no changes in balance sheet mix. The interest rate sensitivity analysis in Table 3 reflects our assets and liabilities on December 31, 2013 that will either be repriced in accordance with market rates, mature or are estimated to mature early or prepay within the periods indicated. Non-maturity deposits are treated as repricing immediately. This is a one-day position that is continually changing and is not necessarily indicative of our position at any other time.
Table 3 - INTEREST RATE SENSITIVITY ANALYSIS
(in thousands)
 
 
December 31, 2013
 
3 Months
or Less
 
> 3 Months
to 1 Year
 
> 1 Year
to 3 Years
 
> 3 Years
to 5 Years
 
> 5 Years
 
Total
Interest sensitive assets:
 
 
 
 
 
 
 
 
 
 
 
Interest bearing deposits and Federal funds sold
$
74,940

 
$
5,750

 
$
4,250

 
$
1,000

 
$
—

 
$
85,940

Securities
30,000

 
500

 
3,985

 
9,444

 
4,893

 
48,822

Loans held for sale
99,718

 
—

 
—

 
—

 
—

 
99,718

Loans held for investment
361,081

 
96,435

 
104,709

 
126,384

 
24,062

 
712,671

Restricted equity securities
1,515

 
2,034

 
—

 
—

 
134

 
3,683

Bank Owned Life Insurance
—

 
—

 
—

 
—

 
7,409

 
7,409

Total interest sensitive assets
567,254

 
104,719

 
112,944

 
136,828

 
36,498

 
958,243

Interest sensitive liabilities:
 
 
 
 
 
 
 
 
 
 
 
NOW and savings deposits
77,665

 
—

 
—

 
—

 
—

 
77,665

Money market deposits
374,461

 
—

 
—

 
—

 
—

 
374,461

Time deposits
77,107

 
91,106

 
58,291

 
7,596

 
—

 
234,100

Other borrowings
25

 
75

 
1,075

 
10,000

 
—

 
11,175

Total interest sensitive liabilities
529,258

 
91,181

 
59,366

 
17,596

 
—

 
697,401

Interest sensitivity gap
$
37,996

 
$
13,538

 
$
53,578

 
$
119,232

 
$
36,498

 
$
260,842

Cumulative interest sensitivity gap
$
37,996

 
$
51,534

 
$
105,112

 
$
224,344

 
$
260,842

 
 
Percentage cumulative gap to total interest sensitive assets
4.0
%
 
5.4
%
 
11.0
%
 
23.4
%
 
27.2
%
 
 
As illustrated in Table 3, we are asset sensitive despite the large balances in our non-maturity deposits. As stated previously, this is a model of a one-day position. Because of their limited term before being delivered to investors, loans held for sale are treated as though it were a single duration asset, as opposed to a constantly renewing asset. Being asset sensitive means assets will reprice more quickly than deposits. This is an optimal position to be in when poised for rising rates.
In recognition of the fact that all modeling tools have some form of limitation, ALCO utilizes a more sophisticated interest rate risk measurement tool. Simulation analysis is used to subject the current repricing conditions to rising interest rates in increments of 1%, 2%, 3% and 4% and falling interest rates in decrements of 1% and 2% to determine how net interest income changes for the next twelve and twenty-four months, with flat growth, under two rate assumptions. The assumptions are “shocked”, in a scenario that assumes the entire rate change has occurred in a single month, and “ramped”, in a scenario that assumes rate changes have occurred equally throughout the analysis period. ALCO also applies a “shocked” and “ramped” assumption when measuring the effects of changes in interest rates over a twelve month period on MVE by discounting future cash flows of interest bearing deposits and loans using new rates at which deposits and loans would be made to similar depositors and borrowers. Market value changes in the investment portfolio are estimated by discounting future cash flows and using duration analysis. Loan and investment security prepayments are estimated using current market information. Tables 4

32

and 4A show the estimated impact of changes in interest rates up 1%, 2%, 3% and 4% and down 1% and 2%, on net interest income and on MVE as of December 31, 2013 (in thousands).
Change in Net Interest Income
Shocked Assumption Results: The projected change in net interest income due to changes in interest rates in both the twelve and twenty-four month projection at December 31, 2013, were outside of compliance with our internally established guidelines for increases of 1%, 2%, 3% and 4%, but were compliant for decreases of 1% and 2%. The internal guidelines are set by management and approved by our Board. These guidelines have been established to assist the Company in monitoring potential sensitivity to interest rate risk, but a non-compliant result is not an indication of excessive risk. It is merely an indicator that closer monitoring by management may be necessary.
Ramped Assumption Results: The projected change in net interest income due to changes in interest rates in the twelve month projection at December 31, 2013, were in compliance with our established internal guidelines at all rate increments. In the twenty-four month projection, the degree of change in net interest income due to changes in interest rates were outside of compliance for increases of 1%, 2%, 3% and 4%. The projections were in compliance with our established internal guidelines for decreases of 1% and 2%.
In all except the twelve month ramped scenario, the projected increase in income is higher than established internal guidelines. These results further support the results from Table 3 which indicated we are asset sensitive. However, these results should not be treated as a projection of our actual income when rates begin to rise. As stated previously, all models have limitations. This model makes two basic assumptions based on the source data being a snapshot of a single date, December 31, 2013. The first is: as rates move up or down asset and liability levels would remain constant and the second is: all assets and liabilities will reprice, at or close to, the same time. Actual asset and liability levels change daily with new loans, loan payoffs, new deposits, withdrawals, etc... occurring at regular intervals. With each addition, loan rates offered may vary from those in the model based on the financial strength of the borrower. Deposits may be added or withdrawn to types different from those projected in the model. The models assumption of either a smooth rate transition over the time periods indicated or an immediate change may differ from actual changes with regard to timing and velocity.
Market Value of Equity
Under both the “shocked” and “ramped” assumptions changes in the market value of equity for increases of 1%, 2%, 3%, and 4% were in compliance with our established internal guidelines. However for decreases of both 1% and 2% the results were not within our internal guidelines. These projected changes in the MVE model are based on flat growth assumptions and no changes in the mix of assets or liabilities.
All model results indicate we are well positioned for potential rate increases. These models support the actions management has taken with regard to the length of maturities in our portfolio and the products we offer. We will continue to analyze our portfolio and modify our actions as needed to support Company growth in the future.

Table 4 - CHANGE IN NET INTEREST INCOME
 
SHOCKED
Change in Interest Rates(1)
12 Months
Changes in
Net Interest Income(2)
 
24 Months
Changes in
Net Interest Income(2)
Amount
 
Percent
 
Amount
 
Percent
Up 4%
$
9,834

 
26.83
%
 
$
22,381

 
30.49
%
Up 3%
7,117

 
19.42

 
16,171

 
22.03

Up 2%
4,407

 
12.02

 
9,970

 
13.58

Up 1%
1,866

 
5.09

 
4,090

 
5.57

Down 1%
(411
)
 
(1.12
)
 
(749
)
 
(1.02
)
Down 2%
(2,380
)
 
(6.49
)
 
(5,192
)
 
(7.07
)
 

33

RAMPED
Change in Interest Rates(1)
12 Months
Changes in
Net Interest Income(2)
 
24 Months
Changes in
Net Interest Income(2)
Amount
 
Percent
 
Amount
 
Percent
Up 4%
$
4,714

 
12.86
%
 
$
17,084

 
23.27
%
Up 3%
4,430

 
12.09

 
13,472

 
18.35

Up 2%
3,333

 
9.09

 
8,935

 
12.17

Up 1%
1,668

 
4.55

 
3,905

 
5.32

Down 1%
(366
)
 
(0.99
)
 
(702
)
 
(0.96
)
Down 2%
(1,650
)
 
(4.50
)
 
(4,451
)
 
(6.06
)
 
 
 
 
 
 
 
 

(1)
Our simulation model makes assumptions including the slope and timing of rate increases, the rates that drive certain financial instruments, prepayment assumptions, etc.
(2)
Represents the difference between estimated net interest income for the next 12 and 24 months in the current rate environment.
Table 4A - CHANGE IN MARKET VALUE OF PORTFOLIO EQUITY
 
 
SHOCKED
 
RAMPED
Change in Interest Rates(1)
Changes in Market Value
of Portfolio Equity(2)
 
Changes in Market Value
of Portfolio Equity(2)
Amount
 
Percent
 
Amount
 
Percent
Up 4%
$
20,437

 
10.92
%
 
$
24,671

 
13.18
%
Up 3%
15,104

 
8.07

 
17,615

 
9.41

Up 2%
12,153

 
6.49

 
13,094

 
7.00

Up 1%
7,220

 
3.86

 
7,385

 
3.95

Down 1%
(12,762
)
 
(6.82
)
 
(12,931
)
 
(6.91
)
Down 2%
(49,776
)
 
(26.59
)
 
(49,986
)
 
(26.70
)
(1)
Our simulation model makes assumptions including the slope and timing of rate increases, the rates that drive certain financial instruments, prepayment assumptions, etc.
(2)
Represents the difference between market value of portfolio equity in the current interest rate environment.


34

NON-INTEREST INCOME
Non-interest income declined $19,878,535 or 22.1% in 2013 when compared to 2012. Non-interest income for 2012 was $35,015,368 or 63.9% higher than 2011. The following table lists the major components of non-interest income for December 31, 2013, 2012 and 2011.
 
 
December 31,
 
2013
 
2012
 
2011
Mortgage banking income
$
65,672,402

 
$
86,337,921

 
$
51,362,464

Service charges and fees
1,941,926

 
1,830,018

 
1,630,416

Title company income
789,253

 
814,487

 
618,114

Proceeds from bank owned life insurance
—

 
—

 
421,010

Bank owned life insurance income
236,377

 
226,893

 
269,263

Investment and insurance commissions
1,053,429

 
172,667

 
250,461

Gain on sale of assets, net
58,460

 
5,539

 
37,223

Gain on sale of securities, net
—

 
920

 
3,107

Other
130,424

 
372,361

 
153,380

 
$
69,882,271

 
$
89,760,806

 
$
54,745,438

Mortgage banking income represents fees from originating and selling residential mortgage loans as well as commercial mortgages through Monarch Mortgage and our subsidiary, Monarch Capital, LLC. Monarch Mortgage, our residential mortgage division, was reorganized and expanded in June 2007. Lower production in 2013 compared to 2012 resulted in a $20.7 million decline in mortgage banking income. 2012 was a record year for production when rates were at an historical low that spurred a refinance boom coupled with higher purchase money activity. As discussed above, rates have increased in the past year beginning in June 2013 and much of the refinance activity has ended. Monarch Mortgage originated a total dollar volume of $1,977,423,402 in 2013, compared to $2,703,490,436 in 2012 and $1,648,847,556 in 2011. The total number of loans closed was 7,201 in 2013, 9,940 in 2012 and 6,801 in 2011. By dollar volume, purchase money mortgages represented 63% of loans closed in 2013 compared to 42% for the two previous years.
Service charges increased 6.1% in 2013 or $112 thousand due to growth in our non-interest bearing deposits, increases in credit card volume and automated teller machine usage. In 2012 service charges increased 12.2% or $200 thousand over 2011 due to growth in deposits. Service charges include overdraft and non-sufficient funds fees, automated teller machine transaction fees, non-recurring loan fees and credit card fees. Service charge pricing on deposit accounts and loan fees are typically reevaluated annually to reflect current costs and competition.
Title income declined $25 thousand due to lower loan closing activities in 2013. In 2012 title income had increased $196 thousand, or 31.8% with the increased levels of loan closings during the year. Title income was generated through Real Estate Security Agency, LLC, a subsidiary of Monarch Investment, LLC, which owns 75% of the company.
In October 2005 we purchased $6,000,000 in BOLI that has resulted in income in each of the three years presented. Income from BOLI is not subject to tax. The tax-effective income earnings from BOLI are $363,657 in 2013, $343,777 in 2012 and $407,974 in 2011. During the third quarter of 2011, we received proceeds from bank owned life insurance ("BOLI") of $1,077,632 which resulted in a $656,622 reduction in the value of our BOLI asset. The remaining $421,010 in proceeds was tax-exempt non-interest income. The majority of this income was paid out in death benefits. The tax-effective income from these proceeds was $637,892.
In August 2012, Monarch introduced a new division to meet the needs of high net worth individuals, Monarch Bank Private Wealth ("MBPW"). In addition, Monarch formed an affiliation with Raymond James Financial Services, Inc., to enable MBPW to offer their clientele financial planning, trust and investment services. We also continue to offer investment services, through our investment division, Monarch Investment. With a full year of MBPW operations, investment and insurance commissions increased $881 thousand in 2013. Production had decreased $78 thousand in 2012 compared to 2011.
In 2013 we sold two autos for a net gain of $21,904 and a parcel of land which had been carried in other assets at a gain of $36,556. In 2012 we sold five autos and four pieces of equipment for a net gain of $5,539. In 2011 we sold two autos and a piece of equipment for a net gain of $37,223. There were no security gains in 2013, compared to one security gain of $920 in 2012 related to an agency call and one security gain of $3,107 recorded in 2011 on the sale of a mortgage-backed security. There were no security losses in any period.

35

Other income represents a variety of nominal recurring and non-recurring activities and transactions that have occurred throughout the years presented.

NON-INTEREST EXPENSE
Non-interest expense was $90,910,818 in 2013, a 12.8% decrease from $104,255,614 for 2012. Non-interest expense in 2012 had increased $33,211,248 or 46.7% compared to $71,044,366 in 2011. The following table lists the major components of non-interest expense for December 31, 2013, 2012 and 2011.
 
 
Year Ended December 31,
 
2013
 
2012
 
2011
Commissions
$
28,344,347

 
$
46,572,529

 
$
25,093,001

Salaries and employee benefits
34,112,834

 
29,868,159

 
23,236,123

Loan origination expenses
7,891,835

 
8,487,520

 
6,456,864

Occupancy expenses
5,408,567

 
4,683,224

 
3,929,058

Furniture and equipment expense
3,041,345

 
2,406,533

 
1,982,600

Marketing expense
2,873,259

 
2,412,674

 
1,541,689

Data processing services
1,696,535

 
1,525,401

 
1,197,085

Professional fees
1,053,499

 
1,100,039

 
990,056

Telephone
1,184,894

 
964,777

 
812,403

Stationary and supplies
687,971

 
759,891

 
722,155

FDIC insurance
567,819

 
698,857

 
751,214

Postage and delivery
632,065

 
634,036

 
479,733

Franchise Tax
749,705

 
577,769

 
565,543

Travel
452,143

 
395,854

 
244,376

ATM expense
293,468

 
286,554

 
239,414

Insurance
202,776

 
189,010

 
154,175

Amortization of intangible assets
178,572

 
178,572

 
178,572

Title
106,853

 
110,970

 
86,900

Valuation adjustments on other real estate
—

 
592,575

 
574,192

Other real estate expense
7,098

 
72,080

 
324,051

Rental income, other real estate
—

 
(10,030
)
 
—

Loss (income) on sale of other real estate
3,020

 
(151,956
)
 
(49,720
)
Other
1,422,213

 
1,900,576

 
1,534,882

 
$
90,910,818

 
$
104,255,614

 
$
71,044,366

Commissions, which are variable in nature, were the primary source of decrease in non-interest expense in 2013 and the primary source of increase in 2012. Mortgage banking is a commission based industry with the majority of employee income tied to production levels. The decline in production in 2013 resulted in a 39.1% or $18.2 million decrease in commissions compared to 2012, when record production levels increased this expense 85.6%, or $21.5 million. Employee levels stabilized at the end of 2012, so in 2013 a full year's salaries and benefits are recorded. These benefits included social security taxes, Medicare taxes and 401k retirement match up to 3% of the employee's salary. In addition the Company pays a portion of health care expenses for both its employees and their families. At December 31, 2013, we employed a total of 664 full and part-time employees compared to 665 at year-end 2012 and 557 at year-end 2011. In addition, higher compensation related benefits such as social security tax and Medicare tax expenses have contributed to the increase.
Loan expense declined 7% in 2013 compared to 2012. Despite a greater decline in production in 2013, the overall costs associated with mortgage lending has grown due to increased regulation and compliance. Included in loan expense are costs associated with underwriting and processing mortgage loans. Additionally, expense related to the shipping of mortgage loan packages to secondary market investors impacts postage. The telephone is a critical communication tool for the banking industry as a whole and our mortgage lenders in particular. Our bank and mortgage lenders spend a great deal of time out of the office meeting with clients and prospects. This expense has grown with our banking and mortgage operations.


36

The Company continues to reposition and expand operations to better serve clients. We opened a mortgage and commercial lending office in Newport News in January 2013. In March 2013, we relocated our Monarch Mortgage headquarters, Virginia Beach commercial lending and Oceanfront banking office. In 2012 the Company launched our MBPW division with the opening of an office in Williamsburg. We also opened our Suffolk office in 2012. Our mortgage operations continue to expand to new markets as well. These additions and improvements have contributed to the increases in both occupancy and furniture and equipment expense in 2013 and 2012.
Monarch has focused on marketing our company brand and gaining exposure in the communities we serve through advertising, community activities and sponsorships. These activities included, media advertisement, higher visibility sponsorships, greater community involvement, and a third year of our “Top Flight” award aimed at recognizing small businesses in the community that have demonstrated a strong performance in a number of key areas.
Technology is critical to our success as a company. Changes and innovations in technology are rapidly finding their way to the banking industry and in 2013 Monarch continued its commitment to focus on providing our clients with secure, leading edge technology and service. With this ongoing commitment, the expenses related to upgrades and technology conversions of our systems have resulted in increased data processing costs.
Professional fees which include legal, accounting, and consulting expenses declined in 2013. Fewer problem loans have resulted in lower legal fees in 2013. Professional fees had increased in 2012 due to loan portfolio management, company growth and increased and changing regulatory issues which required consultation from experts specializing in those areas.
Four line items related to other real estate are included in non-interest expense: valuation adjustments for property held in other real estate, other real estate expense, income or loss on sale of other real estate and rental income on other real estate. In 2013, only two of those line items applied, other real estate expense and loss on sale of other real estate. At the end of 2012, there were no properties in other real estate. However, early in 2013 one property was moved to other real estate and subsequently sold. A second property was moved into other real estate at the end of 2013 and was in the account at year end. At the beginning of 2012 there were six properties in other real estate. Three properties were moved into other real estate during 2012 and all nine properties were sold. As stated previously, there were no properties in other real estate at December 31, 2012. At the beginning of 2011 there were five properties in other real estate. During the year, fifteen additional properties were moved into other real estate and fourteen properties were sold. There was one property sold at a loss of $3,020 in 2013, nine properties sold at a net gain of $151,956 in 2012 and fourteen properties sold at a net gain of $49,720 in 2011. There were no properties written down in 2013. Based on additional market information and property evaluations, three properties were written down $592,575 in 2012 and five properties were written down $574,192 in 2011, after being moved into other real estate. Maintenance and selling costs associated with other real estate were $7,098 in 2013, $72,080 in 2012 and $324,051 in 2011. One property in other real estate in 2012 was leased a portion of the year for $10,030 in rental income.
We continue to focus on controlling overhead expenses in relation to income growth. Our efficiency ratio, a productivity measure used to determine how well non-interest expense is managed, was 82.8% in 2013, 79.8% in 2012 and 80.2% in 2011. Our “Bank only” efficiency ratio was 60.4% in 2013, 53.6% in 2012 and 54.5% in 2011. A lower efficiency ratio indicates more favorable expense efficiency. The efficiency ratio is calculated by dividing non-interest expense by the sum of taxable equivalent net interest income and non-interest income. Increased regulatory burden and expenses associated with our non-interest income lines of business have negatively impacted this ratio and the value it provides to investors.

The dollar and percentage change of listed expenses is provided below.
 

37

 
Year Ended December 31,
 
2013 vs. 2012
 
2012 vs. 2011
 
Dollars
 
Percentage
 
Dollars
 
Percentage
Salaries and employee benefits
$
4,244,675

 
14.2
 %
 
$
6,632,036

 
28.5
 %
Occupancy expenses
725,343

 
15.5
 %
 
754,166

 
19.2
 %
Furniture and equipment expense
634,812

 
26.4
 %
 
423,933

 
21.4
 %
Marketing expense
460,585

 
19.1
 %
 
870,985

 
56.5
 %
Telephone
220,117

 
22.8
 %
 
152,374

 
18.8
 %
Franchise Tax
171,936

 
29.8
 %
 
12,226

 
2.2
 %
Data processing services
171,134

 
11.2
 %
 
328,316

 
27.4
 %
Loss (income) on sale of other real estate
154,976

 
(102.0
)%
 
(102,236
)
 
205.6
 %
Travel
56,289

 
14.2
 %
 
151,478

 
62.0
 %
Insurance
13,766

 
7.3
 %
 
34,835

 
22.6
 %
Rental income, other real estate
10,030

 
(100.0
)%
 
(10,030
)
 
100.0
 %
ATM expense
6,914

 
2.4
 %
 
47,140

 
19.7
 %
Postage and delivery
(1,971
)
 
(0.3
)%
 
154,303

 
32.2
 %
Title
(4,117
)
 
(3.7
)%
 
24,070

 
27.7
 %
Professional fees
(46,540
)
 
(4.2
)%
 
109,983

 
11.1
 %
Other real estate expense
(64,982
)
 
(90.2
)%
 
(251,971
)
 
(77.8
)%
Stationary and supplies
(71,920
)
 
(9.5
)%
 
37,736

 
5.2
 %
FDIC insurance
(131,038
)
 
(18.8
)%
 
(52,357
)
 
100.0
 %
Other
(478,363
)
 
(25.2
)%
 
365,694

 
23.8
 %
Valuation adjustments on other real estate
(592,575
)
 
(100.0
)%
 
18,383

 
3.2
 %
Loan origination expenses
(595,685
)
 
(7.0
)%
 
2,030,656

 
31.4
 %
Commissions
(18,228,182
)
 
(39.1
)%
 
21,479,528

 
85.6
 %
INCOME TAXES
In 2013 we recognized $5,898,468 in federal income tax expense compared to federal income tax expense of $6,973,382 in 2012. The resulting effective tax rate was 32.3% in 2013 compared to 33.3% in 2012. We pay state taxes related to Monarch Mortgage in Maryland, North Carolina and South Carolina. The following table provides detail of state taxes and income not subject to federal tax. In 2011, a deferred tax adjustment related to a change in our statutory tax rate from 34% to 35% on earnings in excess of $10.0 million resulted in a reduction in federal tax recognition.
Income Tax Summary
 
Year Ended December 31,
 
2013
 
2012
 
2011
Income tax provision
$
6,386,040

 
$
7,426,785

 
$
3,418,692

Less: state tax provision
487,572

 
453,403

 
344,140

Federal tax provision
$
5,898,468

 
$
6,973,382

 
$
3,074,552

 
 
 
 
 
 
Net income
$
18,533,432

 
$
21,226,291

 
$
11,004,057

Federal tax free income:
 
 
 
 
 
Bank owned life insurance
236,377

 
226,893

 
269,263

Municipal securities
39,037

 
39,066

 
25,818

Life insurance proceeds
—

 
—

 
421,010

Federal taxable income
$
18,258,018

 
$
20,960,332

 
$
10,287,966

 
 
 
 
 
 
Effective federal tax rate
32.3
%
 
33.3
%
 
29.9
%

38


SEGMENT REPORTING
Our reportable segments include community banking and retail mortgage banking services. Community banking involves making loans to and generating deposits from individuals and businesses in the markets where we have offices. Our mortgage banking services consist of originating residential loans and subsequently selling them to investors. Our mortgage banking segment is a strategic business unit that is managed separately from the community banking segment because the mortgage banking services segment appeals to different markets and, accordingly, requires different technology and marketing strategies. We do not have other reportable operating segments. For discussion of our segment accounting policies, see Note 1 to our Consolidated Financial Statements (included in Item 8. of this Form-K). The assets and liabilities and operating results of one of our other wholly owned subsidiaries, Monarch Capital, LLC, is included in the mortgage banking segment. Monarch Capital, LLC, provides commercial mortgage brokerage services.
Funding for retail mortgage banking services' loans held for sale (LHFS) portfolio is provided by community banking services. The outstanding LHFS balance and related interest earned for the bank's interim holding period of these loans is recorded in the community banking segment. This interim interest income was $7,021,186 in 2013, $11,257,408 in 2012 and $5,419,426 in 2011.
Segment information for the years 2013, 2012 and 2011 is shown in the following table. The “Other” column includes corporate related items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments and inter-company eliminations.
Selected Financial Information
 
 
Commercial and
Other Banking
 
Mortgage
Banking
Operations
 
Inter-segment
Eliminations
 
Total
Year Ended December 31, 2013
 
 
 
 
 
 
 
Interest income
$
43,518,266

 
$
830,171

 
$
—

 
$
44,348,437

Interest expense
(4,786,458
)
 
—

 
—

 
(4,786,458
)
Net interest income
38,731,808

 
830,171

 
—

 
39,561,979

Provision expense
—

 
—

 
—

 
—

Net interest income after provision for loan losses
38,731,808

 
830,171

 
—

 
39,561,979

Non-interest income
5,274,634

 
65,672,402

 
(1,064,765
)
 
69,882,271

Non-interest expenses
(28,886,930
)
 
(63,088,653
)
 
1,064,765

 
(90,910,818
)
Net income before income taxes and non-controlling interest
15,119,512

 
3,413,920

 
—

 
18,533,432

Income tax provision
(5,209,710
)
 
(1,176,330
)
 
—

 
(6,386,040
)
Less: Net income attributable to non-controlling interests
(47,305
)
 
(1,009,080
)
 
—

 
(1,056,385
)
Net income attributable to Monarch Financial Holdings, Inc.
$
9,862,497

 
$
1,228,510

 
$
—

 
$
11,091,007

 
 
 
 
 
 
 
 
Year Ended December 31, 2012
 
 
 
 
 
 
 
Interest income
$
45,593,745

 
$
874,720

 
$
—

 
$
46,468,465

Interest expense
(5,916,233
)
 
—

 
—

 
(5,916,233
)
Net interest income
39,677,512

 
874,720

 
—

 
40,552,232

Provision expense
(4,831,133
)
 
—

 
—

 
(4,831,133
)
Net interest income after provision for loan losses
34,846,379

 
874,720

 
—

 
35,721,099

Non-interest income
5,222,612

 
86,056,021

 
(1,517,827
)
 
89,760,806

Non-interest expenses
(24,168,712
)
 
(81,604,729
)
 
1,517,827

 
(104,255,614
)
Net income before income taxes and non-controlling interest
15,900,279

 
5,326,012

 
—

 
21,226,291

Income tax provision
(5,563,287
)
 
(1,863,498
)
 
—

 
(7,426,785
)
Less: Net income attributable to non-controlling interests
(72,207
)
 
(902,430
)
 
—

 
(974,637
)
Net income attributable to Monarch Financial Holdings, Inc.
$
10,264,785

 
$
2,560,084

 
$
—

 
$
12,824,869


39

 
Commercial and
Other Banking
 
Mortgage
Banking
Operations
 
Inter-segment
Eliminations
 
Total
Year Ended December 31, 2011
 
 
 
 
 
 
 
Interest income
$
39,693,522

 
$
725,805

 
$
—

 
$
40,419,327

Interest expense
(6,796,455
)
 
—

 
—

 
(6,796,455
)
Net interest income
32,897,067

 
725,805

 
—

 
33,622,872

Provision expense
(6,319,887
)
 
—

 
—

 
(6,319,887
)
Net interest income after provision for loan losses
26,577,180

 
725,805

 
—

 
27,302,985

Non-interest income
4,275,449

 
51,018,091

 
(548,102
)
 
54,745,438

Non-interest expenses
(21,026,211
)
 
(50,566,257
)
 
548,102

 
(71,044,366
)
Net income before income taxes and non-controlling interest
9,826,418

 
1,177,639

 
—

 
11,004,057

Income tax provision
(3,052,828
)
 
(365,864
)
 
—

 
(3,418,692
)
Less: Net income attributable to non-controlling interests
(51,542
)
 
(408,211
)
 
—

 
(459,753
)
Net income attributable to Monarch Financial Holdings, Inc.
$
6,722,048

 
$
403,564

 
$
—

 
$
7,125,612

Segment Assets
 
 
 
 
 
 
 
2013
$
1,015,770,066

 
$
11,991,775

 
$
(11,061,181
)
 
$
1,016,700,660

2012 (1)
$
1,212,171,772

 
$
25,725,118

 
$
(22,318,737
)
 
$
1,215,578,153

(1) 2012 has been restated to be consistent with 2013 presentation of segment assets. In 2013, assets and liabilities which were grossed up on the mortgage banking balance sheet in prior years are combined, reducing both the mortgage banking operation segment assets and the inter-segment eliminations.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
GENERAL
Total assets were $1,016.7 million at December 31, 2013, a decrease of $198.9 million, or 16.4% compared to $1,215.6 million at year-end 2012. This decline is attributable to a $319.4 million, or 76.2% decrease in our loans held for sale portfolio which was $99.7 million at year end. Cash and due from banks declined $20.9 million, or 52.4% to $19.0 million, while restricted equity securities decreased $8.7 million, or 70.2% to $3.7 million. As a partial offset to these declines, growth was noted in several areas. Loans held for investment grew $51.6 million or 7.8% to $712.7 million, and federal funds sold increased $38.2 million, or 242.9% to $54.0 million. Interest bearing bank balances also increased $29.9 million to $32.0 million while investment securities grew $34.2 million to $48.8 million. Property and equipment increased $3.4 million to $28.9 million. Other real estate increased to $302.0 thousand from $0 at December 31, 2012. Other assets declined $9.4 million to $18.5 million at December 31, 2013.
Total liabilities decreased $207.7 million, or 18.4% to $919.0 million at December 31, 2013, compared to $1,126.6 million at December 31, 2012. Total deposits were $893.1 million at year end 2013, a decrease of 1.0% or $8.7 million when compared to $901.8 million at December 31, 2012. Total borrowings declined $198.1 million to $11.2 million at December 31, 2013. Total stockholders’ equity was $97.7 million at December 31, 2013, compared to $88.9 million at December 31, 2012, an increase of $8.8 million or 9.9%.

SECURITIES
Our securities portfolio consists primarily of securities for which an active market exists. Our policy is to invest mainly in securities of the U. S. Government and its agencies and in other high grade fixed income securities to minimize credit risk. Our securities portfolio plays a limited role in the management of interest rate sensitivity and generates additional interest income. In addition, our portfolio serves as a source of liquidity and is used to meet collateral requirements for municipal deposits.
All of the securities in our portfolio are classified, available-for-sale. These securities are carried at estimated fair value and may be sold in response to changes in market interest rates, changes in securities’ prepayment risk, increases in loan demand, general liquidity needs, and other similar factors.



40



Table 5 - SECURITIES PORTFOLIO
(in thousands)
 
 
As of December 31,
 
2013
 
2012
Securities available-for-sale, at fair value:
 
 
 
U.S. government agency obligations
$
45,346

 
$
10,574

Residential mortgage-backed securities
1,567

 
2,032

Municipal securities
1,909

 
1,522

Corporate debt securities
—

 
506

Total Securities Portfolio
$
48,822

 
$
14,634

The amortized cost and estimated fair value of securities, all of which are classified as available for sale, at December 31, 2013, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

Table 6 - ESTIMATED MATURITIES OF SECURITIES AS OF PERIOD INDICATED
(in thousands)
 
 
December 31, 2013
 
1 Year
or Less
 
1 to 5
Years
 
5 to 10
Years
 
Over 10
Years
 
Total
 
 
 
(Dollars In thousands)
 
 
US agency securities:
 
 
 
 
 
 
 
 
 
Amortized cost
$
35,538

 
$
10,004

 
$
—

 
$
—

 
$
45,542

Fair value
$
35,492

 
$
9,854

 
$
—

 
$
—

 
$
45,346

Weighted average yield
0.25
%
 
0.85
%
 
—

 
—

 
0.38
%
Residential mortgage backed securities:
 
 
 
 
 
 
 
 
 
Amortized cost
$
—

 
$
—

 
$
—

 
$
1,573

 
$
1,573

Fair value
$
—

 
$
—

 
$
—

 
$
1,567

 
$
1,567

Weighted average yield
—

 
—

 
—

 
1.90
%
 
1.90
%
Municipal securities:
 
 
 
 
 
 
 
 
 
Amortized cost
$
—

 
$
502

 
$
1,410

 
$
—

 
$
1,912

Fair value
$
—

 
$
501

 
$
1,408

 
$
—

 
$
1,909

Weighted average yield
—

 
3.36
%
 
3.22
%
 
—

 
3.26
%
Corporate debt securities:
 
 
 
 
 
 
 
 
 
Amortized cost
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Fair value
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Weighted average yield
—

 
—

 
—

 
—

 
—

Total securities:
 
 
 
 
 
 
 
 
 
Amortized cost
$
35,538

 
$
10,506

 
$
1,410

 
$
1,573

 
$
49,027

Fair value
$
35,492

 
$
10,355

 
$
1,408

 
$
1,567

 
$
48,822

Weighted average yield
2.14
%
 
0.91
%
 
2.44
%
 
1.87
%
 
0.54
%
Total investment securities were $48.8 million at December 31, 2013, compared to $14.6 million in 2012. At year end, neither the aggregate book value nor the aggregate market value of the securities of any issuer exceeded ten percent of our

41

stockholders’ equity. Additional information on our investment securities portfolio is in Note 2 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).
As of December 31, 2013, there was a net unrealized loss of $205,607 related to the available-for-sale investment portfolio compared to a net unrealized gain of $208,858 at year end 2012. Note 2 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K) provides details of the amortized cost, unrealized gains and losses, and estimated fair value of each category of the investment portfolio as of December 31, 2013 and 2012.

LOAN PORTFOLIO
Our lending activities are our principal source of income. Loans held for investment, net of unearned income, increased $51,577,305 or 7.8% during 2013. Loans held for sale, loans originated for the secondary market by Monarch Mortgage that have closed but not funded with our investors, decreased 76.2% or $319,357,304 to $99,781,785 on December 31, 2013 compared to $419,075,089 on December 31, 2012. This decrease was due to an increase in mortgage rates which put an end to the refinance boom that occurred late in 2012 and slowed purchase money activity related to new home buying. Discussions below exclude loans held for sale.
Our loan portfolio is divided into three loan types; commercial, real estate, and consumer. The commercial loan type represents 16.8%, the real estate loan type represents 82.8%, and the consumer loan type represents 0.4% of our loan portfolio.
Commercial loans increased $27.6 million or 30.0% in 2013 to $119.5 million. Commercial loan yield is 5.19% in 2013 compared to 5.81% in 2012 and 6.43% in 2011. Commercial loans are highly sought after in the current banking environment. Competition from the standpoint of both pricing and term is considerable while the number of opportunities available in the market are limited.
Real estate secured loans, increased $24.0 million to $590.1 million in 2013 compared to 2012. The blended yield on this was 5.41% in 2013 compared to 5.65% in 2012 and 5.92% in 2011. Margin compression has not been as significant in the loan type because our competitors have been slower to re-enter this market. The real estate secured type is further divided into classes based on loan purpose and includes construction, 1-4 family residential properties, home equity lines, multifamily and real estate secured commercial loans. Monarch continued to make real estate secured loans throughout the recent economic downturn, which was counter to many of our competitors. Despite the decline in the real estate market, there remains a number of financially sound companies and individuals with projects and borrowing needs that have allowed us to grow certain classes of the real estate secured portfolio, while maintaining strong credit quality. Commercial real estate loans are by far the largest class of loans in our loans held for investment portfolio, at 35.1% of total loans. This class represents 42.4% of total real estate secured loans and increased $22.4 million or 9.8%, to $250.1 million in 2013. Owner occupied commercial real estate loans comprise 40.3% of that total. Multifamily real estate loans represent 4.6% of total real estate secured loans and increased $7.3 million in 2013 to $27.4 million. Real estate construction increased marginally in 2013. It is the second largest class of loans, at 21.8% of total loans held for investment and 26.4% of real estate loans, or $155.4 million. 1-4 family residential loans represent 15.2% of this segment and declined 2.9%, or $2.6 million in 2013 to $90.0 million. Home equity lines declined 6.0% or $4.3 million in 2013 to $67.3 million. Home equity lines have been trending downward since 2008.
Consumer loans, which comprise less than 1.0% of our loans held for investment, declined marginally in 2013. The yield on consumer and installment loans has increased to 9.16% in 2013 from 7.57% in 2012 and 8.78% in 2011.
We consider our overall loan portfolio diversified as it consists of 16.8% in commercial loans, 21.8% in construction loans, 12.6% in loans secured by 1-4 family residential properties, 9.4% in home equity lines, 14.1% in owner occupied commercial loans secured by real estate, 21.0% non-owner occupied commercial loans secured by real estate, 3.8% in multifamily loans and less than 1% in consumer loans as of December 31, 2013, as detailed in Table 7 (in thousands) classified by type.
Interest income on consumer, commercial, and real estate mortgage loans is computed on the principal balance outstanding. Most variable rate loans carry an interest rate tied to the Wall Street Journal Prime Rate, as published in the Wall Street Journal. Note 4 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K) provides a schedule of loans by type and other information. We do not participate in highly leveraged lending transactions, as defined by the regulators, and there are no loans of this nature recorded in the loan portfolio. We do not have foreign loans in our portfolio. At December 31, 2013, we had two loan concentrations (loans to borrowers engaged in similar activities) which exceeded 10% of total loans in two areas. These areas of concentration are to borrowers who are principally engaged in the acquisition, development and construction of 1-4 single family homes and developments and to residential home owners with equity lines.


42




Table 7 - LOANS
(in thousands)
 
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Commercial
$
119,533

 
$
91,889

 
$
81,130

 
$
86,560

 
$
71,414

Real estate
 
 
 
 
 
 
 
 
 
Construction
155,429

 
154,213

 
139,313

 
119,958

 
131,210

Residential (1-4 family)
89,973

 
92,606

 
85,731

 
84,826

 
87,749

Home equity lines
67,310

 
71,635

 
74,706

 
80,823

 
81,168

Multifamily
27,356

 
20,021

 
26,780

 
20,975

 
16,126

Commercial
250,065

 
227,621

 
196,370

 
162,750

 
146,831

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
2,931

 
3,054

 
3,532

 
2,918

 
3,142

Overdraft protection loans
74

 
55

 
50

 
58

 
60

Loans - net of unearned income (1)
$
712,671

 
$
661,094

 
$
607,612

 
$
558,868

 
$
537,700

(1)
Loans - net of unearned income include deferred loan fees. These fees were $175 thousand in 2013, $82 thousand in 2012 and $10 thousand in 2011.

Table 8 - LOAN MATURITIES
(in thousands)
 
 
December 31, 2013
 
Due within
one year
 
Due after one year
but within five
years
 
Due after
five years
 
Total (1)
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
Commercial
$
65,000

 
4.82
%
 
$
46,922

 
5.26
%
 
$
7,610

 
5.16
%
 
$
119,532

 
5.01
%
Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
129,150

 
5.48
%
 
26,279

 
5.40
%
 
—

 
—
%
 
155,429

 
5.47
%
Residential (1-4 family)
39,713

 
5.86
%
 
31,785

 
5.62
%
 
18,475

 
4.70
%
 
89,973

 
5.54
%
Home equity lines
353

 
5.79
%
 
1,061

 
5.66
%
 
65,896

 
3.38
%
 
67,310

 
3.42
%
Multifamily
9,066

 
5.89
%
 
18,290

 
5.41
%
 
—

 
—
%
 
27,356

 
5.57
%
Commercial
87,902

 
5.62
%
 
137,267

 
5.32
%
 
24,896

 
4.61
%
 
250,065

 
5.35
%
Consumers
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer and installment loans
926

 
5.81
%
 
1,901

 
11.89
%
 
104

 
13.68
%
 
2,931

 
9.76
%
Overdraft protection loans
27

 
20.58
%
 
24

 
20.31
%
 
24

 
20.26
%
 
75

 
20.39
%
 
$
332,137

 
5.45
%
 
$
263,529

 
5.41
%
 
$
117,005

 
3.97
%
 
$
712,671

 
5.19
%
Fixed rate loans due
 
 
 
 
$
233,078

 
 
 
$
26,570

 
 
 
$
259,648

 
 
Variable rate loans due
 
 
 
 
30,451

 
 
 
90,435

 
 
 
120,886

 
 
 
 
 
 
 
$
263,529

 
 
 
$
117,005

 
 
 
$
380,534

 
 
(1)
Total loans include unearned income in the form of deferred loan fees. These fees were $175 thousand in 2013, $82 thousand in 2012 and $10 thousand in 2011.
ALLOWANCE AND PROVISION FOR LOAN LOSSES

43

We have certain lending policies and procedures in place that are designed to balance loan growth and income with an acceptable level of risk, which management reviews and approves on a regular basis. Our review process is supported by a series of reports related to loan production, loan quality, credit concentrations, policy exceptions, loan delinquencies and non-performing and potential problem loans. We also utilize diversification in our loan portfolio as a means of managing risk.
Our allowance for loan losses is to provide for losses inherent in the loan portfolio. Management is responsible for determining the level of the allowance for loan losses, subject to review by our Board of Directors. Among other factors, we consider on a monthly basis our historical loss experience, the size and composition of our loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits including impaired loans, our risk-rating-based loan “watch list”, and local and national economic conditions. The economy of our trade area is well diversified. There are additional risks of future loan losses that cannot be precisely quantified or attributed to particular loans or classes of loans. Since those factors include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate.
To determine the total allowance for loan losses, we estimate the reserves needed for each segment of the portfolio, including loans analyzed on both, a pooled basis and individually. Our allowance for loan losses consists of amounts applicable to the following loan types: (i) the commercial loan portfolio; (ii) the real estate loan portfolio; (iii) the consumer loan portfolio. In addition, loans within these portfolios are evaluated as a group or on an individual or relationship basis and assigned a risk grade based on the underlying characteristics. In 2013, we changed the methodology for evaluating pooled loans from an overall profile by risk grade to a historical loss rate by loan class within loan type, which is a more detailed approach, then applied other known inherent risks and quantitative techniques which management has determined fit the characteristics of that type. Prior to 2013 loans were first modeled using the risk rating, historical experience, then other known inherent risks and quantitative techniques which management has determined fit the characteristics of that type, were applied.
The commercial loan portfolio includes commercial and industrial loans which are usually secured by the assets being financed or other business assets such as accounts receivable or inventory and normally incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business.
The real estate loan portfolio includes all loans secured by real estate. This type is further broken down into the following classes: construction loans, residential 1-4 family loans, home equity lines, multifamily loans, and commercial real estate loans. Construction and multifamily loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. Residential 1-4 family and home equity loan originations utilize analytics to supplement the underwriting process. Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.

Commercial and real estate portfolio loans are evaluated on an individual or relationship basis and assigned a risk grade at the time the loan is made. Additionally, we perform periodic reviews of the loan or relationship to determine if there have been any changes in the original underwriting which would change the risk grade and/or impact the borrower’s ability to repay the loan.
The consumer loan portfolio includes consumer and installment loans and overdraft protection loans. These loans, which are in relatively small loan amounts, are spread across many individual borrowers. We utilize analytics to supplement general underwriting. Loans within the consumer type are assigned risk grades and evaluated as a pool, unless specifically identified through delinquency or other signs of credit deterioration, at which time the identified loan is individually evaluated. Additionally, loans that have been specifically identified as a credit risk due to circumstances that may affect the ability of the borrower to repay interest and/or principal are analyzed on an individual basis. Adverse circumstances may include loss of repayment source, deterioration in the estimated value of collateral, elevated trends of delinquencies, and charge-offs.
We evaluate the adequacy of the allowance for loan losses monthly in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. From time to time, events or economic factors may affect the loan portfolio, causing management to provide additional amounts to or release balances from the allowance for loan losses. Our allowance for loan losses is sensitive to risk ratings assigned to individually evaluated loans, economic assumptions, and delinquency trends driving statistically modeled reserves.
There are nine numerical risk grades that can be assigned to loans:
 

44

“Pass”
  
“Watch List”
1 Minimal
  
6 Special mention
2 Modest
  
7 Substandard
3 Average
  
8 Doubtful
4 Acceptable
  
9 Loss
5 Acceptable with care
  
 

The following table delineates, in thousands, our loan portfolio by class and “pass” and “watch list” risk grade for the years ended December 31, 2013 and 2012.
Table 9 - LOANS BY RISK GRADE
(in thousands)
 
 
2013
 
Pass
 
Watch list
 
Total
Commercial
$
112,513

 
$
6,855

 
$
119,368

Real estate
 
 
 
 
 
Construction
147,478

 
8,073

 
155,551

Residential (1-4 family)
80,560

 
9,286

 
89,846

Home equity lines
65,791

 
1,386

 
67,177

Multifamily
26,079

 
1,314

 
27,393

Commercial
242,168

 
8,011

 
250,179

Real estate subtotal
562,076

 
28,070

 
590,146

Consumers
 
 
 
 
 
Consumer and installment loans
2,823

 
88

 
2,911

Overdraft protection loans
71

 
—

 
71

Loans to individuals subtotal
2,894

 
88

 
2,982

Total gross loans
$
677,483

 
$
35,013

 
$
712,496

Unamortized loan costs, net of deferred fees
 
 
 
 
175

Total net loans
 
 
 
 
$
712,671

 
 
 
 
 
 
 
2012
 
Pass
 
Watch list
 
Total
 
$
87,323

 
$
4,481

 
$
91,804

Commercial
 
 
 
 
 
Real estate
139,899

 
14,398

 
154,297

Construction
83,634

 
8,863

 
92,497

Residential (1-4 family)
69,908

 
1,583

 
71,491

Home equity lines
17,764

 
2,269

 
20,033

Multifamily
220,154

 
7,660

 
227,814

Commercial
531,359

 
34,773

 
566,132

Real estate subtotal
 
 
 
 
 
Consumers
 
 
 
 
 
Consumer and installment loans
2,884

 
142

 
3,026

Overdraft protection loans
50

 
—

 
50

Loans to individuals subtotal
2,934

 
142

 
3,076

Total gross loans
$
621,616

 
$
39,396

 
$
661,012

Unamortized loan costs, net of deferred fees
 
 
 
 
82

Total net loans
 
 
 
 
$
661,094

A loan risk graded a loss is charged-off when identified and a loan risk graded as doubtful is classified as a nonaccrual loan. At December 31, 2013 we did not have any loans risk graded as a loss or as doubtful. We do not have any potential problem loans which have not been evaluated and disclosed at December 31, 2013. Loans identified as special mention and substandard may or may not be classified as nonaccrual, based on current performance. “Watch list” loans are evaluated on an individual or relationship basis to determine if any, or all, of our loans to the borrower are at risk. We evaluate the collectability of both principal and interest when assessing the need for a loss accrual. For additional discussion on this evaluation refer to Note 1 and Note 4 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).

45

Beginning with the quarter ended March 31, 2013, we changed the methodology for evaluating additional risk inherent in our satisfactory risk grade groups which should be included in our allowance for loan losses. Under the new methodology, loans within this group are evaluated on a pool basis by loan segment which is further delineated by purpose. Each segment is assigned an expected loss factor which is based on a four-year moving average “look-back” at our historical losses for that particular segment. We believe this change in methodology provides a more accurate evaluation of the potential risk in our portfolio because the additional delineation by purpose establishes a stronger focus on areas of weakness and strength within the portfolio.
This change in methodology for evaluating additional risk inherent in our satisfactory risk groups is applied to December 31, 2013. However, at December 31, 2012 pass loans were evaluated for loss based on risk rating. Loans with a risk rating of modest to acceptable with care were assigned an expected loss factor based on their lower risk profiles. The loss factor, which was multiplied by the outstanding principal within each risk grade to arrive at an overall loss estimate, was based on a three-year moving average “look-back” at our historical losses, adjusted for environmental risk factors described below. We believe a four year average is more indicative of the loss currently remaining in our loan portfolio. Any unallocated portion of the allowance for loan losses reflects management’s attempt to ensure that the overall reserve appropriately reflects a margin for the imprecision necessarily inherent in estimates of credit losses.

The allowance is subject to regulatory examinations and determination as to adequacy. This examination may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies.
In 2013, we expensed $0 in provision for loan losses compared to $4,831,133 in 2012 and $6,319,887 in 2011. Based on the current economic environment and the composition of our loan portfolio, the level of our charged-off loans combined with our peer bank loss experience, we considered this provision to be a prudent allocation of funds for our loan loss allowance.
Loans charged off during 2013 totaled $3,222,495 compared to $4,342,790 in 2012 and recoveries totaled $1,373,864 and $491,657 in 2013 and 2012, respectively. The ratio of net charge-offs to average outstanding loans was 0.27% in 2013 compared to 0.62% in 2012.
In 2013, approximately $2.5 million in loans charged off were related to failed business activities, $685 thousand were related to residential properties, with the remaining $23 thousand related to consumer losses. In 2012, approximately $1.6 million in loans charged off were related to failed real estate projects, approximately $2.1 million in loans charged off were related to failed business activities, and the remaining $648 thousand in charge offs were related to residential properties. In both 2013 and 2012, the charge-off activities are related to singular events and are not indicative of any trends.
Table 10 presents our loan loss and recovery experience (in thousands) for the past five years.
The allowance for loan losses totaled $9,061,369 at December 31, 2013 a decrease of $1,848,631 or 16.9% over December 31, 2012. The ratio of the allowance to loans, less unearned income, was 1.27% at December 31, 2013 and 1.65% at December 31, 2012. We believe that the allowance for loan losses is adequate to absorb any inherent losses on existing loans in our loan portfolio at December 31, 2013. The allowance to loans ratio is supported by the level of non-performing loans, the seasoning of the loan portfolio, and the experience of the lending staff in the market. See Note 4 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K) for more information concerning our loan loss and recovery experience.


46

Table 10 - LOAN LOSS ALLOWANCE AND LOSS EXPERIENCE
(in thousands)
 
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Balance at beginning of period
$
10,910

 
$
9,930

 
$
9,037

 
$
9,300

 
$
8,046

Charge-offs:
 
 
 
 
 
 
 
 
 
Commercial
(2,468
)
 
(835
)
 
(907
)
 
(304
)
 
(524
)
Real estate
 
 
 
 
 
 
 
 
 
Construction
—

 
(533
)
 
(799
)
 
(3,903
)
 
(1,232
)
Residential (1-4 family)
(149
)
 
(2,239
)
 
(983
)
 
(1,843
)
 
(1,106
)
Home equity Lines
(582
)
 
(602
)
 
(3,158
)
 
(2,887
)
 
(1,077
)
Multifamily
—

 
—

 
—

 
—

 
—

Commercial
—

 
(134
)
 
(276
)
 
(195
)
 
(51
)
Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
(23
)
 
—

 
(1
)
 
(38
)
 
(28
)
Overdraft protection loans
(1
)
 
—

 
(2
)
 
(1
)
 
(4
)
 
(3,223
)
 
(4,343
)
 
(6,126
)
 
(9,171
)
 
(4,022
)
Recoveries:
 
 
 
 
 
 
 
 
 
Commercial
176

 
67

 
55

 
74

 
14

Real estate
 
 
 
 
 
 
 
 
 
Construction
1,040

 
151

 
65

 
11

 
2

Residential (1-4 family)
40

 
197

 
197

 
10

 
32

Home equity Lines
98

 
74

 
367

 
142

 
24

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
20

 
—

 
—

 
30

 
3

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
—

 
2

 
13

 
1

 
16

Overdraft protection loans
—

 
1

 
2

 
1

 
1

 
1,374

 
492

 
699

 
269

 
92

Net charge-offs
(1,849
)
 
(3,851
)
 
(5,427
)
 
(8,902
)
 
(3,930
)
Provision for loan losses
—

 
4,831

 
6,320

 
8,639

 
5,184

Balance at end of period
$
9,061

 
$
10,910

 
$
9,930

 
$
9,037

 
$
9,300

Percent of net charge-offs to average total loans outstanding during the period
0.27
%
 
0.62
%
 
0.93
%
 
1.61
%
 
0.76
%

47

TABLE 11 - ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
For the Years Ended December 31, 2013, 2012 and 2011
(in thousands)
 
Commercial
 
Real Estate
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial
2013
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,750

 
$
2,360

 
$
1,545

 
$
1,402

 
$
291

 
$
2,882

Charge-offs
(2,468
)
 
—

 
(149
)
 
(582
)
 
—

 
—

Recoveries
176

 
1,040

 
40

 
98

 
—

 
20

Provision
1,761

 
(1,422
)
 
249

 
1,215

 
(231
)
 
(1,597
)
Ending balance
$
1,219

 
$
1,978

 
$
1,685

 
$
2,133

 
$
60

 
$
1,305

 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
713

 
$
736

 
$
274

 
$
510

 
$
—

 
$
616

Collectively evaluated for impairment
$
506

 
$
1,242

 
$
1,411

 
$
1,623

 
$
60

 
$
689

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
119,368

 
$
155,551

 
$
89,846

 
$
67,177

 
$
27,393

 
$
250,179

Ending balance: individually evaluated for impairment
$
6,842

 
$
7,095

 
$
5,956

 
$
1,386

 
$
308

 
$
5,716

Ending balance: collectively evaluated for impairment
$
112,526

 
$
148,456

 
$
83,890

 
$
65,791

 
$
27,085

 
$
244,463

 
Consumers
 
Unallocated
 
Total
 
 
 
 
 
Consumer and
Installment loans
 
Overdraft
Protection
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
56

 
$
1

 
$
623

 
$
10,910

 
 
 
 
Charge-offs
(23
)
 
(1
)
 
—

 
(3,223
)
 
 
 
 
Recoveries
—

 
—

 
—

 
1,374

 
 
 
 
Provision
66

 
1

 
(42
)
 
—

 
 
 
 
Ending balance
$
99

 
$
1

 
$
581

 
$
9,061

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
84

 
$
—

 
$
—

 
$
2,933

 
 
 
 
Collectively evaluated for impairment
$
15

 
$
1

 
$
581

 
$
6,128

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,911

 
$
71

 
$
—

 
$
712,496

 
 
 
 
Ending balance: individually evaluated for impairment
$
88

 
$
—

 
$
—

 
$
27,391

 
 
 
 
Ending balance: collectively evaluated for impairment
$
2,823

 
$
71

 
$
—

 
$
685,105

 
 
 
 

 

48

 
Commercial
 
Real Estate
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial
2012
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,946

 
$
1,426

 
$
2,733

 
$
1,070

 
$
346

 
$
2,224

Charge-offs
(835
)
 
(533
)
 
(2,239
)
 
(602
)
 
—

 
(134
)
Recoveries
67

 
151

 
197

 
74

 
—

 
—

Provision
572

 
1,316

 
854

 
860

 
(55
)
 
792

Ending balance
$
1,750

 
$
2,360

 
$
1,545

 
$
1,402

 
$
291

 
$
2,882

 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
815

 
$
740

 
$
635

 
$
626

 
$
113

 
$
513

Collectively evaluated for impairment
$
935

 
$
1,620

 
$
910

 
$
776

 
$
178

 
$
2,369

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
91,804

 
$
154,297

 
$
92,497

 
$
71,491

 
$
20,033

 
$
227,814

Ending balance: individually evaluated for impairment
$
2,873

 
$
9,173

 
$
5,615

 
$
1,498

 
$
2,218

 
$
5,985

Ending balance: collectively evaluated for impairment
$
88,931

 
$
145,124

 
$
86,882

 
$
69,993

 
$
17,815

 
$
221,829

 
Consumers
 
Unallocated
 
Total
 
 
 
 
 
Consumer and
Installment loans
 
Overdraft
Protection
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
28

 
$
4

 
$
153

 
$
9,930

 
 
 
 
Charge-offs
—

 
—

 
—

 
(4,343
)
 
 
 
 
Recoveries
2

 
1

 
—

 
492

 
 
 
 
Provision
26

 
(4
)
 
470

 
4,831

 
 
 
 
Ending balance
$
56

 
$
1

 
$
623

 
$
10,910

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
25

 
$
—

 
$
—

 
$
3,467

 
 
 
 
Collectively evaluated for impairment
$
31

 
$
1

 
$
623

 
$
7,443

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
3,026

 
$
50

 
$
—

 
$
661,012

 
 
 
 
Ending balance: individually evaluated for impairment
$
142

 
$
—

 
$
—

 
$
27,504

 
 
 
 
Ending balance: collectively evaluated for impairment
$
2,884

 
$
50

 
$
—

 
$
633,508

 
 
 
 

49

 
Commercial
 
Real Estate
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial
2011
 
 
 
 
 
 
 
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
919

 
$
1,932

 
$
2,114

 
$
2,443

 
$
147

 
$
1,308

Charge-offs
(907
)
 
(799
)
 
(983
)
 
(3,158
)
 
—

 
(276
)
Recoveries
55

 
65

 
196

 
367

 
—

 
—

Provision
1,879

 
228

 
1,406

 
1,418

 
199

 
1,192

Ending balance
$
1,946

 
$
1,426

 
$
2,733

 
$
1,070

 
$
346

 
$
2,224

 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,307

 
$
307

 
$
2,074

 
$
393

 
$
132

 
$
570

Collectively evaluated for impairment
$
639

 
$
1,119

 
$
659

 
$
677

 
$
214

 
$
1,654

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
81,210

 
$
139,255

 
$
85,750

 
$
74,871

 
$
26,711

 
$
196,199

Ending balance: individually evaluated for impairment
$
6,632

 
$
14,012

 
$
9,250

 
$
1,947

 
$
2,303

 
$
7,829

Ending balance: collectively evaluated for impairment
$
74,578

 
$
125,243

 
$
76,500

 
$
72,924

 
$
24,408

 
$
188,370

 
Consumers
 
Unallocated
 
Total
 
 
 
 
 
Consumer and
Installment loans
 
Overdraft
Protection
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
85

 
$
—

 
$
89

 
$
9,037

 
 
 
 
Charge-offs
(1
)
 
(2
)
 
—

 
(6,126
)
 
 
 
 
Recoveries
13

 
3

 
—

 
699

 
 
 
 
Provision
(69
)
 
3

 
64

 
6,320

 
 
 
 
Ending balance
$
28

 
$
4

 
$
153

 
$
9,930

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
—

 
$
—

 
$
—

 
$
4,783

 
 
 
 
Collectively evaluated for impairment
$
28

 
$
4

 
$
153

 
$
5,147

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
3,548

 
$
58

 
$
—

 
$
607,602

 
 
 
 
Ending balance: individually evaluated for impairment
$
20

 
$
—

 
$
—

 
$
41,993

 
 
 
 
Ending balance: collectively evaluated for impairment
$
3,528

 
$
58

 
$
—

 
$
565,609

 
 
 
 



50

Table 12 provides a breakdown of the allowance for loan losses by segment with the relative percentage of that allowance to the segment it represents.
TABLE 12 - Allocation of the Allowance for Loan Losses
 
 
Years Ended December 31,
 
2013
 
2012
 
Amount

 
Percentage of loans
in each category
to total loans

 
Amount

 
Percentage of loans
in each category
to total loans

Commercial
$
1,219,255

 
16.8
%
 
$
1,749,641

 
13.9
%
Real estate
 
 
 
 
 
 
 
Construction
1,978,320

 
21.8
%
 
2,360,707

 
23.3
%
Residential (1-4 family)
1,685,502

 
12.6
%
 
1,545,315

 
14.0
%
Home equity lines
2,132,916

 
9.4
%
 
1,402,448

 
10.8
%
Multifamily
59,586

 
3.9
%
 
290,532

 
3.0
%
Commercial
1,305,131

 
35.1
%
 
2,882,398

 
34.5
%
Consumers
 
 
 
 
 
 
 
Consumer and installment loans
99,271

 
0.4
%
 
55,192

 
0.5
%
Overdraft protection loans
688

 
—
%
 
501

 
—
%
Unallocated
580,700

 
 
 
623,266

 
 
 
$
9,061,369

 
100.0
%
 
$
10,910,000

 
100.0
%
Total loans held for investment outstanding *
$
712,671,467

 
 
 
$
661,094,162

 
 
Ratio of allowance for loan losses to total loans held for investment
1.27
%
 
 
 
1.65
%
 
 
*
Total loans held for investment outstanding includes unamortized loan costs, net of deferred fees of $174,976 at December 31, 2013 and $82,470 at December 31, 2012.

ASSET QUALITY AND NON-PERFORMING LOANS
We identify specific credit exposures through periodic analysis of our loan portfolio and monitor general exposures from economic trends, market values and other external factors. We maintain an allowance for loan losses, which is available to absorb losses inherent in the loan portfolio. The allowance is increased by the provision for losses and by recoveries from losses. Charged-off loan balances are subtracted from the allowance. The adequacy of the allowance for loan losses is determined on a monthly basis. Various factors as defined in the previous section “Allowance and Provision for Loan Losses” are considered in determining the adequacy of the allowance. Loans are generally placed on non-accrual status after they are past due for 90 days.
Non-performing loans include loans on which interest is no longer accrued, accruing loans that are contractually past due 90 days or more as to principal and interest payments, and loans classified as troubled debt restructurings, and these are detailed in Table 13. Based on this definition total non-performing loans as a percentage of total loans were 1.0% and 0.55% at December 31, 2013 and December 31, 2012, respectively. However, at December 31, 2013 all of our troubled debt restructure loans were performing. Excluding performing troubled debt restructure this percentage declines to 0.31% in 2013 and 0.32% in 2012.
There were ten loans totaling $1,740,070 in non-accrual status at December 31, 2013 and sixteen loans totaling $3,399,589 in non-accrual status at December 31, 2012. All of these loans have been identified as impaired according to Accounting Standards Codification 310, Receivables. A loan is considered impaired if it is probable that the lender will be unable to collect all amounts due under the contractual terms of the loan agreement. We have provided specific reserves for these non-accrual loans in our allowance for loan loss of $144,903 at December 31, 2013, and $1,070,253 in 2012. We recognized interest income on these loans of $9,499 and $211,628 in 2013 and 2012, respectively. Our average recorded investment in non-performing loans was $2,081,959 in 2013 and $5,559,759 in 2012.
There was one loan totaling $472,052 on accrual status and past due 90 days or more at December 31, 2013 and one loan for $152,880 at December 31, 2012. There was one asset in other real estate totaling $301,963 at December 31, 2013 and no assets in other real estate held due to loan foreclosures at December 31, 2012.
 

51

Table 13 - NONPERFORMING ASSETS
Amounts are in thousands, except ratios.
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Non-accruing loans:
 
 
 
 
 
 
 
 
 
Commercial
$
—

 
$
—

 
$
1,022

 
$
1,393

 
$
197

Real estate
 
 
 
 
 
 
 
 
 
Construction
358

 
1,028

 
129

 
1,758

 
4,666

Residential (1-4 family)
826

 
931

 
1,224

 
3,496

 
2,132

Home equity Lines
552

 
586

 
857

 
757

 
354

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
—

 
95

 
229

 
179

 
—

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
4

 
142

 
20

 
—

 
—

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Total non-accruing loans
1,740

 
2,782

 
3,481

 
7,583

 
7,349

Loans past due 90 days and accruing interest:
 
 
 
 
 
 
 
 
 
Commercial
—

 
—

 
39

 
271

 
—

Real estate
 
 
 
 
 
 
 
 
 
Construction
—

 
—

 
—

 
241

 
—

Residential (1-4 family)
472

 
—

 
139

 
418

 
—

Home equity Lines
—

 
—

 
—

 
180

 
—

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
—

 
153

 
—

 
—

 
203

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
—

 
—

 
—

 
21

 
—

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Total past due loans
472

 
153

 
178

 
1,131

 
203

Restructured loans - non-accruing
 
 
 
 
 
 
 
 
 
Commercial
—

 
617

 
633

 
182

 
—

Real estate
 
 
 
 
 
 
 
 
 
Construction
—

 
—

 
—

 
—

 
—

Residential (1-4 family)
—

 
—

 
—

 
125

 
—

Home equity Lines
—

 
—

 
—

 
—

 
—

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
—

 
—

 
—

 
—

 
—

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
—

 
—

 
—

 
—

 
—

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Total restructured loans past due
—

 
617

 
633

 
307

 
—

Foreclosed property
302

 
—

 
3,369

 
1,745

 
2,116

Total non-accruing nonperforming assets
$
2,514

 
$
3,552

 
$
7,661

 
$
10,766

 
$
9,668

Restructured loans - accruing
 
 
 
 
 
 
 
 
 
Commercial
—

 
—

 
—

 
—

 
—

Real estate
 
 
 
 
 
 
 
 
 
Construction
—

 
—

 
—

 
—

 
—

Residential (1-4 family)
263

 
84

 
103

 
—

 
—

Home equity Lines
—

 
—

 
—

 
—

 
—

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
4,569

 
1,404

 
1,588

 
—

 
—

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
84

 
—

 
—

 
—

 
—

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Accruing restructured loans carried in nonperforming assets
$
4,916

 
$
1,488

 
$
1,691

 
$
—

 
$
—

Total nonperforming assets
$
7,430

 
$
5,040

 
$
9,352

 
$
10,766

 
$
9,668

 
 
 
 
 
 
 
 
 
 



52

 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Asset Quality Ratios:
 
 
 
 
 
 
 
 
 
Allowance for loan losses to period-end loans
1.27
%
 
1.65
%
 
1.63
%
 
1.62
%
 
1.73
%
Allowance for loan losses to non-accruing nonperforming loans
409.63
%
 
307.15
%
 
231.36
%
 
100.19
%
 
123.15
%
Non-accruing nonperforming assets to total assets
0.25
%
 
0.29
%
 
0.84
%
 
1.30
%
 
1.40
%
Nonperforming assets to total assets
0.73
%
 
0.41
%
 
1.03
%
 
1.30
%
 
1.40
%
 
 
 
 
 
 
 
 
 
 

There were five restructured loans at December 31, 2013 with an investment amount of $4,716,299 and a valuation allowance of $0, for a net value of $4,716,299. We have provided specific reserves in our allowance for loan loss of $313,792 for these loans. All restructured loans were accruing at December 31, 2013. There were three restructured loans at December 31, 2012 with an investment amount of $2,105,045 and a valuation allowance of $0, for a net value of $2,105,045. Two restructured loans totaling $1,487,651 were accruing as of December 31, 2012.

Table 14 - NON-PERFORMING LOANS
(in thousands)
 
 
Non-Performing Loan Balances
 
Loan Loss Provision  for
Non-Performing Loans
  
Loans 90
Days Past
Due  And
Still Accruing
 
Nonaccrual
Loans
 
 Accruing Restructured
Loans
 
Total
Non-Performing
Loans
 
Loan
Loss
Provision
Provided
 
Loan
Balance
With
Loan Loss
Provision
 
Loan
Balance
Without
Loan Loss
Provision
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
—

 
358

 
—

 
358

 
134

 
358

 
—

Residential (1-4 family)
472

 
826

 
263

 
1,561

 
10

 
226

 
1,335

Home equity lines
—

 
552

 
—

 
552

 
—

 
—

 
552

Multifamily
—

 
—

 
—

 
—

 
—

 
—

 
—

Commercial
—

 
—

 
4,569

 
4,569

 
230

 
3,200

 
1,369

Consumers
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer and installment loans
—

 
4

 
84

 
88

 
84

 
84

 
4

Overdraft protection loans
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
$
472

 
$
1,740

 
$
4,916

 
$
7,128

 
$
458

 
$
3,868

 
$
3,260

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
—

 
$
617

 
$
—

 
$
617

 
$
503

 
$
617

 
$
—

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
—

 
1,028

 
—

 
1,028

 
220

 
829

 
199

Residential (1-4 family)
—

 
931

 
84

 
1,015

 
342

 
779

 
236

Home equity lines
—

 
586

 
—

 
586

 
—

 
—

 
586

Multifamily
—

 
—

 
—

 
—

 
—

 
—

 
—

Commercial
153

 
95

 
1,404

 
248

 
5

 
95

 
153

Consumers
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer and installment loans
—

 
142

 
—

 
142

 
—

 
—

 
142

Overdraft protection loans
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
$
153

 
$
3,399

 
$
1,488

 
$
3,636

 
$
1,070

 
$
2,320

 
$
1,316


53

Table 15 - NON-PERFORMING ASSETS
(in thousands) 
 
Total
Non-Performing
Loans
 
Other
Real Estate
Owned
 
Total
December 31, 2013
 
 
 
 
 
Commercial
$
—

 
$
—

 
$
—

Real estate
 
 
 
 
 
Construction
358

 
—

 
358

Residential (1-4 family)
1,561

 
302

 
1,863

Home equity lines
552

 
—

 
552

Multifamily
—

 
—

 
—

Commercial
4,569

 
—

 
4,569

Consumers
 
 
 
 
 
Consumer and installment loans
88

 
—

 
88

Overdraft protection loans
—

 
—

 
—

Total
$
7,128

 
$
302

 
$
7,430

December 31, 2012
 
 
 
 
 
Commercial
$
617

 
$
—

 
$
617

Real estate
 
 
 
 
 
Construction
1,028

 
—

 
1,028

Residential (1-4 family)
1,015

 
—

 
1,015

Home equity lines
586

 
—

 
586

Multifamily
—

 
—

 
—

Commercial
248

 
—

 
248

Consumers
 
 
 
 
 
Consumer and installment loans
142

 
—

 
142

Overdraft protection loans
—

 
—

 
—

Total
$
3,636

 
$
—

 
$
3,636

 

DEPOSITS
Our major source of funds and liquidity is our deposit base. Deposits provide funding for our investment in loans and securities. Our primary objective is to increase core deposits as a means to fund asset growth at a lower cost. Interest paid for deposits must be managed carefully to control the level of interest expense. We offer individuals and small-to-medium sized businesses a variety of deposit accounts, including checking, savings, money market, and certificates of deposit.
Table 16 presents the average balances of deposits and the average rates paid on those deposits for the past two years (in thousands).
Table 16 - AVERAGE DEPOSITS
(in thousands) 
 
2013
 
2012
 
Average
Balance
 
Average
Rate
 
Average
Balance
 
Average
Rate
Demand deposits non-interest bearing
$
210,325

 
—
%
 
$
161,866

 
—
%
Demand accounts interest bearing
49,284

 
0.19
%
 
40,764

 
0.21
%
Money market accounts
347,734

 
0.42
%
 
302,750

 
0.59
%
Savings accounts
22,346

 
0.41
%
 
19,765

 
0.45
%
Time deposits
249,071

 
0.92
%
 
340,188

 
0.89
%
 
$
878,760

 
0.45
%
 
$
865,333

 
0.57
%

54

Table 17 presents the ending balances of deposits, dollar and percentage change on those deposits for the past two years (in thousands).

Table 17 - ENDING DEPOSITS
(in thousands)
 
 
 
 
 
Change
 
2013
 
2012
 
Dollar
Percent
Demand deposits non-interest bearing
$
206,891

 
$
190,120

 
$
16,771

8.8
 %
Demand accounts interest bearing
55,528

 
65,369

 
(9,841
)
(15.1
)%
Money market accounts
374,462

 
335,899

 
38,563

11.5
 %
Savings accounts
22,137

 
22,127

 
10

—
 %
Time deposits
234,100

 
288,267

 
(54,167
)
(18.8
)%
 
$
893,118

 
$
901,782

 
$
(8,664
)
(1.0
)%
We are continually evaluating the mix of our deposit base (time deposits versus demand, money market and savings) in relation to our funding needs and current market conditions. Demand deposit products are an area of focus due to their low cost. Provisions of the Dodd-Frank Act provided separate unlimited Federal Deposit Insurance coverage for non-interest bearing demand and interest on Lawyer Trust Accounts (IOLTAs) until December 31, 2012. This coverage expired December 31, 2012.
Non-interest bearing demand deposits increased an average of $48.5 million or 29.9% in 2013 and $16.8 million or 8.8% an annual basis. The majority of our non-interest bearing demand accounts are commercial, small business and attorney escrow accounts. Commercial accounts have increased an average of $33.9 million in the past year and small business checking increased an average of $10.6 million. On an annual basis commercial accounts increased $7.3 million and small business accounts have increased $1.0 million. The variation between the trending of average and ending balances in our demand accounts indicates higher balances were maintained throughout the year, but declined at year end. This is consistent with commercial banking activities, which tend to build throughout the year and pay out bonuses and production related incentives at year end. Monarch began focusing on growing low cost demand and Now accounts several years ago. This focus has taken the form of developing a well trained, dedicated cash management team with a goal of providing high quality service and cost effective products to our commercial and small business clients, thereby growing business deposits and also obtaining their personal banking accounts in the process. NOW accounts grew $8.5 million on average but declined $9.8 million year over year in 2013. The majority of the activity in NOW accounts was in personal accounts.
On average, savings account balances increased $2.6 million but were flat year over year. This is a change from recent years in which there has been a declining trend in these balances. Savings accounts are typically utilized by individuals with limited savings capacity or with specific short term goals, looking for a place to set aside funds but who are not particularly interest rate sensitive.
Money market accounts have increased an average $44.9 million or 14.8% and $38.6 million or 11.5%, on an annual basis in 2013. Our money market portfolio consists of both core and non-core accounts. Core money market accounts, which are in market individual client accounts, increased an average $26.7 million, and $38.3 million annually, in 2013. Our core money market account is a multi-tiered product offering better rates than savings accounts but at higher deposit levels. It is a highly competitive product that offers more flexibility than time deposits with the benefit of rates comparable with short term time deposits. Non-core money market account balances, which is two brokered money market accounts, increased on average $18.2 million in 2013 compared to 2012, but was relatively flat on an annual basis. The balance and interest rate in the non-core money market account is controlled through contract. In 2012 we began reducing the rates on our core money market accounts to control growth. We continued that trend in 2013. However, our rates remain highly competitive, as is evidenced by the continued growth in our core money market accounts.
Certificates of deposit of $100,000 or more are detailed in Table 18. More information on deposits is contained in Note 9 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).


55

Certificates of deposit as of December 31, 2013 and 2012 in amounts of $100,000 and over were classified by maturity as follows:
Table 18 - CERTIFICATES OF DEPOSITS $100,000 AND OVER
(in thousands)
 
 
December 31,
 
2013
 
2012
 
Combined
 
Core
 
Brokered
 
Combined
 
Core
 
Brokered
3 months or less
$
66,379

 
$
23,165

 
$
43,214

 
$
59,361

 
$
18,025

 
$
41,336

Over 3 through 6 months
24,185

 
19,251

 
4,934

 
29,309

 
9,158

 
20,151

Over 6 through 12 months
37,992

 
30,039

 
7,953

 
62,983

 
30,801

 
32,182

Over 12 months
46,204

 
38,977

 
7,227

 
53,494

 
48,814

 
4,680

 
$
174,760

 
$
111,432

 
$
63,328

 
$
205,147

 
$
106,798

 
$
98,349

At December 31, 2013 our brokered time deposits to total deposits was 7.1% compared to 10.9% at December 31, 2012. Although brokered deposits are purchased in large denomination transactions, the source of these deposits is in denominations of less than $250,000, providing us with a balance of stability and flexibility. Brokered deposits include Certificate of Deposit Account Registry Service (“CDARS”) deposits used by municipalities and other depositors to ensure full FDIC insurance protection. We had $19.4 million in municipal deposits in CDARS at December 31, 2013 and $18.0 million one year prior. We use our brokered time deposits primarily to fund our loans held for sale portfolio which declined sharply in 2013. CDARS offers short term CD products called One-way Buys, which allow participants to bid weekly for available deposits at specified terms. At both December 31, 2013 and 2012 two of our brokered deposits totaling $35.0 million were in the form of CDARS One-way Buys with remaining terms of between 5 and 26 days. These deposits work well for Monarch because of their weekly availability, coupled with their short term, which allows us to more closely mirror the funding needs of our loans held for sale. In 2010 a provision of the Dodd-Frank Act permanently increased the level of Federal Deposit Insurance on all deposits to $250,000. As of December 31, 2012, our non-brokered deposits in excess of $250,000 totaled $21.2 million as compared to $17.1 million one year prior.
LIQUIDITY
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale of existing assets or the acquisition of additional funds through short-term borrowings. Our liquidity is provided from cash and amounts due from banks, federal funds sold, interest-bearing deposits in other banks, repayments from loans, increases in deposits, lines of credit from the Federal Home Loan Bank and five correspondent banks, and maturing investments. As a result of our management of liquid assets, and our ability to generate liquidity through liability funding, we believe that we maintain overall liquidity sufficient to satisfy our depositors’ requirements and to meet clients’ credit needs. We also take into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit.
We monitor and plan our liquidity position for future periods. Liquidity strategies are implemented and monitored by our Asset/Liability Committee (“ALCO”). Daily and monthly liquidity positions are also monitored.
Cash, cash equivalents and federal funds sold totaled $104.9 million as of December 31, 2013, an increase of $47.1 million from the year ended December 31, 2012. At December 31, 2013, cash, securities classified as available for sale and federal funds sold were $121.8 million or 12.8% of total earning assets, compared to $72.4 million or 6.4% of total earning assets at December 31, 2012.
We are members of the Promontory Network and have access to a program through their Certificate of Deposit Account Registry Service® (“CDARS”) to use their CDARS One Way BuySM to purchase cost-effective funding without collateralization (and in lieu of generating funds through “traditional” brokered CDs or the Federal Home Loan Bank). These funds are accessed through a weekly auction. The auction typically takes place on Wednesdays, with next day settlement. There are seven maturities available ranging from 4 weeks to 5 years. If we are allotted funds in the auction, we incur no transaction fees or commissions. Although the process to compete for these deposits is different from the process for traditional brokered CDs, they are still considered brokered for regulatory purposes. These funds, which are included in our Jumbo CDs, are subject to discretionary limitations on volume that we normally would impose on traditional brokered deposits. Based on our “well capitalized” status, we are able to draw up to 30% of assets or $305.0 million from this program at December 31, 2013. We had $38.4 million on our balance sheet from this program at December 31, 2013 and $81.5 million at December 31, 2012.

56


We have additional sources of liquidity available to us including the capacity to borrow additional funds through several established arrangements. Further information on Borrowings is contained in Note 10 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).
In the course of operations, due to fluctuations in loan and deposit levels, we occasionally find it necessary to purchase federal funds on a short-term basis. We maintain unsecured federal funds line arrangements with five other banks, which allow us to purchase funds totaling $61,000,000. These lines mature and reprice daily. There were no federal funds purchased at December 31, 2013 or December 31, 2012.
We also have access to the Federal Reserve Bank of Richmond’s discount window should a liquidity crisis occur. We have not used this facility in the past and consider it a backup source of funds.
We are a member of the Federal Home Loan Bank of Atlanta (“FHLB”) and as such, may borrow funds under a line of credit based on criteria established by the FHLB. This line of credit would allow us to borrow up to 30% of assets, or approximately $304.0 million, if collateralized, as of December 31, 2013. We currently pledge loans and investment securities to secure this line. Blanket liens pledged on certain designated loan portfolios amounted to $129.4 million at December 31, 2013 and $85.6 million at December 31, 2012. Additionally, investment securities with carrying values of $126 thousand at December 31, 2013 and $171 thousand at December 31, 2012 were pledged to secure any borrowings. Based on pledged collateral we had a line of $97.8 million at December 31, 2013. This line is reduced by $8.0 million, which has been pledged as collateral for public deposits. Should we ever desire to increase the line of credit beyond the 30% limit, the FHLB would allow borrowings of up to 40% of total assets once we met specific eligibility criteria.
In 2009, we negotiated an additional line of credit with FHLB that was secured by specific loans held for sale (“LHFS”). We pledge these loans, which have been sold to FHLB approved investors, as collateral. In return, we are allowed to borrow up to 92% of these loans for up to 120 days. Blanket liens pledged on specifically designated loans held for sale amounted to $50.8 million. Based on pledged collateral we had a line of $46.8 million at December 31, 2013. This line of credit product was discontinued at year end December 31, 2013.
We had $1,175,485 of FHLB borrowings outstanding on our primary line and $0 outstanding on our LHFS line on December 31, 2013. We had $1,275,462 outstanding on our primary line and $193,023,061outstanding on our LHFS line as of December 31, 2012. We had $1,175,485 in a fixed-term advance contract outstanding on December 31, 2013. This advance, which was used to match-fund several amortizing longer-term fixed-rate loans, matures on September 28, 2015 and bears interest of 4.96% at December 31, 2013.
Advances on the LHFS line are re-priced daily. We did not have any advances outstanding at December 31, 2013 and one advance outstanding on December 31, 2012 in the amount of $193,023,061 maturing May 17, 2013.
In June 2012, we obtained a short term, holding company line of credit from PNC Bank of Pittsburgh, PA in the amount of $5.0 million which we repaid in full at the maturity date of June 7, 2013. The line of credit was renewed for six months, maturing on December 7, 2013. However, we did not utilize this renewal and we did not renew the line with the December 7, 2013 maturity. At December 31, 2012 we had $5.0 million outstanding on the line, scheduled to mature on June 7, 2013.
CAPITAL RESOURCES
We review the adequacy of our capital on an ongoing basis with reference to the size, composition, and quality of our resources and consistent with regulatory requirements and industry standards. We seek to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.
In November 2009, we raised a net of $18.4 million in capital through the sale of 800,000 shares of $5 par value, 7.80% Series B noncumulative convertible perpetual preferred stock, in a public offering. The stock carried a conversion feature for the stock holder for 3.75 shares of our Common Stock, which reflected a post split conversion price of $6.67 per share of Common Stock, subject to certain adjustments. The stock also carried a conversion feature for the Company that allowed us to exercise our conversion right if, for 20 trading days within any period of 30 consecutive trading days, the closing price of our Common Stock exceeded 130% of the then applicable conversion price of the Series B preferred stock. In June 2012, holders of our Series B noncumulative convertible perpetual preferred stock began converting their shares to common stock. At December 31, 2012, 481,123 shares remained outstanding. In March 2013, after meeting the forced conversion parameters, we forced the conversion of the remaining shares of Series B preferred stock to common stock. For further information on the Company's conversion activity with regard to our Series B noncumulative convertible perpetual preferred stock see Note 13 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).

57

In December 2008, we were approved for and received $14.7 million from the U.S. Treasury Department under the TARP Capital Purchase Program. Under this program we issued 14,700 shares of Series A, $1,000 liquidation value, cumulative perpetual preferred stock. This stock carried a 5% dividend for each of the first 5 years of the investment, and 9% thereafter, and certain warrants on our common stock. In December 2009, we repurchased all of our Series A cumulative perpetual preferred stock from the U.S. Treasury Department. In early 2010 we repurchased the remaining warrants outstanding.
In June 2008, we raised $6.8 million net in capital through the sale of 928,932 shares of our common stock in two private placements. Selling shareholders were accredited investors and included certain qualifying insiders. These insiders were members of our board of directors and senior management whose purchases were made in accordance with Nasdaq Capital Market guidelines.
On July 5, 2006, we issued Trust Preferred Subordinated Notes in the amount of $10,000,000 through a private transaction. These notes, which are non-dilutive to common stock, may be included in Tier I capital for regulatory capital determination purposes. The notes have a LIBOR-indexed rate which adjusts, and is payable, quarterly. The rate on the notes at December 31, 2012 was 1.91%. In September 2009, we entered into an interest rate swap arrangement with PNC Bank of Pittsburgh to fix this rate at 4.86% for five years. The Trust Preferred Subordinated Notes may be redeemed at par beginning on September 30, 2011. This capital was used for general corporate purposes to support the continued growth.
On April 11, 2005, we announced an offering of a minimum of 497,880 shares and a maximum of 891,000 shares of common stock at a pre-established price of $7.32 per share. The offering ran until May 31, 2005 with the full 891,000 shares sold. This capital was used for general corporate purposes to support the continued growth.
The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Bank adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. At December 31, 2013, the required minimum ratio of qualifying total capital to risk-weighted assets was 8%, of which 4% must be tier-one capital. Tier-one capital includes stockholders’ equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. At December 31, 2013, our total risk-based capital ratio was 13.91%, which is well above the regulatory minimum of 8% and the well capitalized minimum of 10%.
In July 2013, the Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Bank announced the final rules for implementing the principles of the BASEL III Accords. These rules impact the capital standards listed previously. Specifically, beginning January 2015, in addition to existing capital measurements, a new common equity Tier-one capital requirement of 4.5% will be introduced. At the same time the minimum Tier-one capital ratio will increase from 4% to 6%. A capital conservation buffer, which will be added to the new minimum common equity Tier-one ratio, the minimum Tier-one capital ratio and the minimum total capital ratio, will be phased in beginning January 2016 at a rate of 0.625% per year until reaching 2.5% in 2019. Failure to meet the minimum standards plus the capital conservation buffer will limit a bank's ability to make capital distributions and discretionary bonus payments.
Monarch should not be impacted by the increased capital requirements because current ratios are well above the minimums established by BASEL III. The table below lists our capital results for December 31, 2013 and 2012.




58

Table 19 - REGULATORY CAPITAL
(Dollars in Thousands)
 
 
Actual
 
For Capital
Adequacy
Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Action
 
Amounts
 
Ratio
 
Amounts
 
Ratio
 
Amounts
 
Ratio
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Total Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
116,120

 
13.91
%
 
$
66,783

 
8.00
%
 
N/A

 
N/A

Bank
$
116,340

 
13.95
%
 
$
66,718

 
8.00
%
 
$
83,397

 
10.00
%
(Total Risk-Based Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,059

 
12.82
%
 
$
33,391

 
4.00
%
 
N/A

 
N/A

Bank
$
107,279

 
12.86
%
 
$
33,359

 
4.00
%
 
$
50,038

 
6.00
%
(Tier 1 Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,059

 
10.81
%
 
$
39,600

 
4.00
%
 
N/A

 
N/A

Bank
$
107,279

 
10.84
%
 
$
39,600

 
4.00
%
 
$
49,501

 
5.00
%
(Tier 1 Capital to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Total Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,138

 
12.05
%
 
$
71,154

 
8.00
%
 
N/A

 
N/A

Bank
$
113,179

 
12.73
%
 
$
71,119

 
8.00
%
 
$
88,899

 
10.00
%
(Total Risk-Based Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
96,484

 
10.85
%
 
$
35,557

 
4.00
%
 
N/A

 
N/A

Bank
$
102,525

 
11.53
%
 
$
35,559

 
4.00
%
 
$
53,339

 
6.00
%
(Tier 1 Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
96,484

 
8.29
%
 
$
46,535

 
4.00
%
 
N/A

 
N/A

Bank
$
102,525

 
8.81
%
 
$
46,535

 
4.00
%
 
$
58,169

 
5.00
%
(Tier 1 Capital to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
OFF-BALANCE SHEET TRANSACTIONS
We enter into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. Our off-balance sheet transactions recognized as of December 31, 2013 were a letter of credit to secure public funds, commitments to extent credit and standby letters of credit.
Our letter of credit to secure public funds was from the Federal Home Loan Bank, and was for $8.0 million at December 31, 2013 and 2012.
Commitments to extend credit and unfunded commitments under existing lines of credit amounted to $237.9 million at December 31, 2013 and $213.2 million at December 31, 2012, which represent legally binding agreements to lend to clients with fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being funded, the total commitment amounts do not necessarily represent future liquidity requirements.
Standby letters of credit are conditional commitments we issue guaranteeing the performance of a client to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. At December 31, 2013 and December 31, 2012, we had $19.9 million and $19.3 million respectively, in outstanding standby letters of credit. We do not have any off-balance sheet subsidiaries or special purpose entities. There were no commitments to purchase securities at December 31, 2013 or 2012.
We and our subsidiaries have thirty-seven non-cancellable leases for premises. Further information on lease commitments is contained in Note 6 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).



59

CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those applications of accounting principles or practices that require considerable judgment, estimation, or sensitivity analysis by management. In the financial service industry, examples, though not an all inclusive list, of disclosures that may fall within this definition are the determination of the adequacy of the allowance for loan losses, valuation of mortgage servicing rights, valuation of derivatives or securities without a readily determinable market value, and the valuation of the fair value of intangibles and goodwill. Except for the determination of the adequacy of the allowance for loan losses, derivative financial instrument estimations and fair value estimations related to foreclosed real estate, we do not believe there are other practices or policies that require significant sensitivity analysis, judgments, or estimations.
Our financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Our critical accounting policies are listed below. A summary of our significant accounting policies is set forth in Note 1 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).
Allowance for Loan Losses
Our allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on GAAP guidance which requires that losses be accrued when they have a probability of occurring and are estimable and that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses along with various economic factors and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur may be mitigated. The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified loans. Historical loss information, expected cash flows and fair value of collateral are used to estimate these losses. The unallocated allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. The use of these values is inherently subjective, and our actual losses could be greater or less than the estimates.
Derivative Financial Instruments
We use derivatives to manage risks related to interest rate movements. Interest rate swap contracts designated and qualifying as cash flow hedges are reported at fair value. The gain or loss on the effective portion of the hedge initially is included as a component of other comprehensive income and is subsequently reclassified into earnings when interest on the related debt is paid. We document our risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Our interest rate risk management strategy is to stabilize cash flow requirements by maintaining interest rate swap contracts to convert variable-rate debt to a fixed rate and vice versa. We do not hold or issue derivative financial instruments for trading purposes.
Periodically, we participate in a “mandatory” delivery program for mortgage loans. Under the mandatory delivery system, loans with interest rate locks are paired with the sale of a notional security bearing similar attributes. Interim income or loss on the pairing of the loans and securities is recorded in mortgage banking income on our income statement. In addition, at the time the loan is delivered to an investor, matched securities are repurchased and a gain or loss on the pairing is recorded in mortgage banking income on our income statement. Management has elected to limit our exposure to this form of delivery to $50 million in outstanding loans. We were not participating in the mandatory delivery program at December 31, 2013.

Fair Value Measurements
Under GAAP we are permitted to choose to measure many financial instruments and certain other items at fair value. The estimation of fair value is significant to certain assets, including loans held-for-sale, available-for-sale securities, and foreclosed real estate owned. These assets are recorded at fair value or lower of cost or fair value, as applicable. The fair values of loans held-for-sale are based on commitments from investors. The fair values of available-for-sale securities are based on published market or dealer quotes for similar securities. The fair values of rate lock commitments are based on net fees currently charged

60

to enter into similar agreements. The fair value of foreclosed real estate owned is estimated based on our evaluation of fair value of similar properties.
Fair values can be volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, and market conditions, among others. Since these factors can change significantly and rapidly, fair values are difficult to predict and subject to material changes that could impact our financial condition and results of operation.
IMPACT OF INFLATION AND CHANGING PRICES
The majority of assets and liabilities of a financial institution are monetary in nature and therefore differ greatly from most industrial companies that have significant investments in fixed assets. The primary effects of inflation on our balance sheet are minimal, meaning that there are no substantial increases or decreases in net purchasing power over time. The most significant effect of inflation is on other expenses that tend to rise during periods of general inflation. In management's opinion, the most significant impact on financial results is changes in interest rates and the Company's ability to react to those changes. As discussed previously, management is attempting to measure, monitor and control interest rate risk.
IMPACT OF PROSPECTIVE ACCOUNTING STANDARDS
For discussion regarding the impact of new accounting standards, refer to Recent Accounting Pronouncements in Note 1 to our Consolidated Financial Statements (included in Item 8. of this Form 10-K).
 

SELECTED QUARTERLY FINANCIAL DATA
The following table presents unaudited selected quarterly financial data for 2013 and 2012.
Selected Quarterly Financial Data - Unaudited
 
For the Quarter Ended
Earnings (in thousands)
December 31, 2013
September 30, 2013
June 30, 2013
March 31, 2013
Interest income
$
10,677

$
10,842

$
10,976

$
11,854

Interest expense
(1,044
)
(1,121
)
(1,184
)
(1,438
)
Net interest income
9,633

9,721

9,792

10,416

Provision for loan losses
—

—

—

—

Non-interest income
14,352

16,675

21,674

17,181

Non-interest expense
(20,562
)
(22,315
)
(26,173
)
(21,861
)
Pre-tax net income
3,423

4,081

5,293

5,736

Minority interest in net income
(87
)
(256
)
(428
)
(285
)
Income taxes
(1,179
)
(1,416
)
(1,798
)
(1,993
)
Net income
2,157

2,409

3,067

3,458

Preferred stock dividend
—

—

—

—

Net income available to common stockholders
$
2,157

$
2,409

$
3,067

$
3,458

Per Common Share
 
 
 
 
Earnings per share - basic
$
0.21

$
0.23

$
0.29

$
0.37

Earnings per share - diluted
0.20

0.23

0.29

0.33

Common stock - per share dividends
0.07

0.06

0.06

0.05

Average basic shares outstanding
10,486,056

10,464,992

10,401,992

9,300,760

Average diluted shares outstanding
10,535,313

10,519,472

10,483,420

10,451,897


61

 
For the Quarter Ended
Earnings (in thousands)
December 31, 2012
September 30, 2012
June 30, 2012
March 31, 2012
Interest income
$
12,691

$
11,820

$
10,983

$
10,975

Interest expense
(1,591
)
(1,430
)
(1,428
)
(1,467
)
Net interest income
11,100

10,390

9,555

9,508

Provision for loan losses
(517
)
(899
)
(1,484
)
(1,931
)
Non-interest income
24,880

26,561

20,924

17,396

Non-interest expense
(29,058
)
(29,810
)
(24,506
)
(20,882
)
Pre-tax net income
6,405

6,242

4,489

4,091

Minority interest in net income
(298
)
(368
)
(156
)
(153
)
Income taxes
(2,338
)
(2,111
)
(1,556
)
(1,422
)
Net income
3,769

3,763

2,777

2,516

Preferred stock dividend
(237
)
(386
)
(390
)
(390
)
Net income available to common stockholders
$
3,532

$
3,377

$
2,387

$
2,126

Per Common Share
 
 
 
 
Earnings per share - basic
$
0.44

$
0.47

$
0.33

$
0.30

Earnings per share - diluted
0.37

0.37

0.27

0.25

Common stock - per share dividends
0.05

0.05

0.05

0.04

Average basic shares outstanding
7,980,259

7,251,870

7,188,270

7,177,786

Average diluted shares outstanding
10,315,360

10,255,285

10,225,182

10,203,781


Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of our asset/liability management process, which is governed by policies established by our board of directors that are reviewed and approved annually. Our board of directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Management Committee (“ALCO”). In this capacity, this committee develops guidelines and strategies that govern our asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with our financial instruments also change, affecting net interest income, the primary component of our earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While this committee routinely monitors simulated net interest income sensitivity over a rolling 12 and 24 month horizon, it also employs additional tools to monitor potential longer-term interest rate risk.

The results of this simulation model are presented in tables 4 and 4a included in Item 7. of this Form 10-K. This model assumes flat growth and captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on our balance sheet. The simulation model is prepared and updated four times each year. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum internal tolerance level for net interest income exposure over a one and two year horizon given a 400, 300, 200 and 100 basis point (bp) upward shift or a 100, or 200 basis point downward shift in interest rates. The model does simulations using two assumptions; a sudden or “shocked” one month parallel and pro rata shift in rates and a “ramped” parallel and pro rata shift in rates over a 12 month and 24 month period for changes in net interest income and for 12 months for Market value of Portfolio Equity Sensitivity.
All of the ramped 12 month period results in the net interest income simulation met the approved internal limits of our Asset Liability Management Policy. However, with the exception of the downward shift of 100 and 200 bp in the remaining twelve and twenty-four shocked and the twenty-four month ramped assumptions, scenario results were outside of approved internal limits, with Company earnings increasing more than guidelines recommend. The results of changes in Market Value of

62

Portfolio Equity Sensitivity indicate that downward shifts of 200 basis points under both assumptions would yield results that were not within the approved internal policy limits. We continue to focus our efforts on complying with approved limits.
The model assumes flat growth and is a “snapshot” approach that attempts to capture how the assets and liabilities that are on our balance sheet at a specific point in time, which in this case is December 31, 2013, would perform under changing rate scenarios. This approach only focuses on management’s decisions about the pricing, structure and duration of assets and liabilities to that point, filtering out the impact of future decisions but cannot capture the impact of shifts in volume and product. In spite of this flaw in the flat growth model the overall simulation is beneficial because it allows management to evaluate current strategies and determine if changes need to be made in the future with regard to those strategies.
The potential impact of rising rates on net interest income and equity is a primary concern for most members of the banking industry today, because rates have remained at historic lows long enough for assets and liabilities to re-price to the low levels creating a potential for liability sensitivity. Borrowers want to “lock in” loan rates for a longer period when rates are low because it decreases their costs. At the same time, depositors want to keep time deposits and similar savings products short so that they are not locked in to lower earnings when rates rise. This combination, if allowed to occur would create liability sensitivity, resulting in margin compression when rates rise because rates on deposits and borrowings would increase at a faster pace than rates on loans and other earning assets. Monarch has attempted to balance the desires of our clients with the realities of positioning the Bank for protection from margin compression in the future. Based on model results, Monarch’s balance sheet appears to be asset sensitive and adequately positioned to avoid margin compression when rates begin to rise.
The preceding sensitivity analysis does not represent a Bank forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels including yield curve shape, asset and liability growth, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flow. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on clients with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that our ALCO Committee might take in response to or in anticipation of changes in interest rates.
 

63

Item 8.
Financial Statements and Supplementary Data.

MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management regularly monitors its internal control over financial reporting and takes appropriate action to correct any deficiencies that may be identified.
Management assessed the effectiveness of our internal controls over financial reporting as of December 31, 2013. This assessment was based on criteria established in Internal Controls – Integrated Framework issued by the Commission of Sponsoring Organizations of the Treadway Commission in 1992. Based on this assessment, management concluded that the Company's internal internal control over financial reporting as of December 31, 2013 was effective.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, because of changes in conditions, internal control effectiveness may vary over time.
Yount, Hyde & Barbour, P.C., an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2013, as stated in their report which is included in this annual report on Form 10-K.
 
/s/    BRAD E. SCHWARTZ        
 
Brad E. Schwartz
 
Chief Executive Officer
 
 
 
/s/    LYNETTE P. HARRIS        
 
Lynette P. Harris
 
Executive Vice President and Chief Financial Officer
 
March 13, 2014

64


Certified Public Accountants and Consultants

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
Monarch Financial Holdings, Inc.
Chesapeake, Virginia

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

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

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

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Monarch Financial Holdings, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, and our report dated March 13, 2014 expressed an unqualified opinion on the effectiveness of Monarch Financial Holdings, Inc. and subsidiaries’ internal control over financial reporting.

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

Winchester, Virginia
March 13, 2014

65

Certified Public Accountants and Consultants

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Monarch Financial Holdings, Inc.
Chesapeake, Virginia

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

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

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Monarch Financial Holdings, Inc. and subsidiaries’ maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2013 of Monarch Financial Holdings, Inc. and subsidiaries and our report dated March 13, 2014 expressed an unqualified opinion.

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

Winchester , Virginia
March 13, 2014


66


MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CONDITION
 
December 31,
 
2013
 
2012
ASSETS:
 
 
 
Cash and due from banks
$
18,971,268

 
$
39,887,983

Interest bearing bank balances
31,955,092

 
2,142,896

Federal funds sold
53,984,962

 
15,743,699

Total cash and cash equivalents
104,911,322

 
57,774,578

Investment securities available-for-sale, at fair value
48,821,760

 
14,633,733

Loans held for sale
99,717,785

 
419,075,089

Loans held for investment, net of unearned income
712,671,467

 
661,094,162

Less: allowance for loan losses
(9,061,369
)
 
(10,910,000
)
Loans, net
703,610,098

 
650,184,162

Property and equipment, net
28,881,536

 
25,447,555

Restricted equity securities, at cost
3,683,250

 
12,363,200

Bank owned life insurance
7,409,436

 
7,173,059

Goodwill
775,000

 
775,000

Intangible assets, net
104,167

 
282,739

Other real estate owned
301,963

 
—

Other assets
18,484,343

 
27,869,038

Total assets
$
1,016,700,660

 
$
1,215,578,153

LIABILITIES:
 
 
 
Deposits:
 
 
 
Demand deposits - non-interest bearing
$
206,891,499

 
$
190,120,495

Demand deposits - interest bearing
55,527,954

 
65,368,503

Savings deposits
22,137,321

 
22,127,493

Money market deposits
374,461,494

 
335,898,654

Time deposits
234,100,222

 
288,266,727

Total deposits
893,118,490

 
901,781,872

Borrowings:
 
 
 
Short term borrowings
—

 
5,000,000

Trust preferred subordinated debt
10,000,000

 
10,000,000

Federal Home Loan Bank advances
1,175,485

 
194,298,523

Total borrowings
11,175,485

 
209,298,523

Other liabilities
14,661,087

 
15,550,917

Total liabilities
918,955,062

 
1,126,631,312

STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock, $5 par value, 1,185,300 shares authorized; none issued
—

 
—

Noncumulative perpetual preferred stock, series B, liquidation value of $20.0 million, $5 par value; 800,000 shares authorized, 0 issued and outstanding at December 31, 2013, 481,123 issued and outstanding at December 31, 2012
—

 
2,405,615

Common stock, $5 par value: 20,000,000 shares authorized; issued and outstanding - 10,502,323 shares ( includes non-vested shares of 215,960) at December 31, 2013 and 8,557,939 shares (includes non-vested shares of 231,460) outstanding at December 31, 2012
51,431,815

 
41,632,395

Additional paid-in capital
7,068,715

 
12,717,727

Retained earnings
39,437,119

 
30,786,208

Accumulated other comprehensive loss
(419,496
)
 
(200,022
)
Total Monarch Financial Holdings, Inc. stockholders’ equity
97,518,153

 
87,341,923

Non-controlling interests
227,445

 
1,604,918

Total equity
97,745,598

 
88,946,841

Total liabilities and stockholders’ equity
$
1,016,700,660

 
$
1,215,578,153


The accompanying notes are an integral part of these consolidated financial statements.

67

MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME 
 
Year Ended December 31,
 
2013
 
2012
 
2011
Interest income:
 
 
 
 
 
Interest and fees on loans
$
43,666,251

 
$
46,032,003

 
$
40,019,749

Interest on investment securities
230,496

 
200,285

 
183,288

Interest on federal funds sold
115,963

 
23,343

 
53,256

Dividends on equity securities
277,700

 
191,396

 
156,986

Interest on other bank accounts
58,027

 
21,438

 
6,048

Total interest income
44,348,437

 
46,468,465

 
40,419,327

Interest expense:
 
 
 
 
 
Interest on deposits
3,936,203

 
4,962,290

 
6,198,080

Interest on trust preferred subordinated debt
491,910

 
494,911

 
492,750

Interest on borrowings
358,345

 
459,032

 
105,625

Total interest expense
4,786,458

 
5,916,233

 
6,796,455

Net interest income
39,561,979

 
40,552,232

 
33,622,872

Provision for loan losses
—

 
4,831,133

 
6,319,887

Net interest income after provision for loan losses
39,561,979

 
35,721,099

 
27,302,985

Non-interest income:
 
 
 
 
 
Mortgage banking income
65,672,402

 
86,337,921

 
51,362,464

Service charges and fees
1,941,926

 
1,830,018

 
1,630,416

Title income
789,253

 
814,487

 
618,114

Investment and insurance income
1,053,429

 
172,667

 
250,461

Gain on sale of assets
58,460

 
5,539

 
37,223

Gain on sale/call of securities
—

 
920

 
3,107

Other
366,801

 
599,254

 
843,653

Total non-interest income
69,882,271

 
89,760,806

 
54,745,438

Non-interest expenses:
 
 
 
 
 
Salaries and employee benefits
34,112,834

 
29,868,159

 
23,236,123

Commissions
28,344,347

 
46,572,529

 
25,093,001

Loan origination expenses
7,891,835

 
8,487,520

 
6,456,864

Occupancy expenses
5,408,567

 
4,683,224

 
3,929,058

Furniture and equipment expenses
3,041,345

 
2,406,533

 
1,982,600

Marketing expense
2,873,259

 
2,412,674

 
1,541,689

Data processing services
1,696,535

 
1,525,401

 
1,197,085

Professional fees
1,053,499

 
1,100,039

 
990,056

Telephone
1,184,894

 
964,777

 
812,403

Foreclosed property expense
10,118

 
502,669

 
848,523

FDIC insurance
567,819

 
698,857

 
751,214

Other
4,725,766

 
5,033,232

 
4,205,750

Total non-interest expenses
90,910,818

 
104,255,614

 
71,044,366

Income before income taxes
18,533,432

 
21,226,291

 
11,004,057

Income tax provision
(6,386,040
)
 
(7,426,785
)
 
(3,418,692
)
Net income
12,147,392

 
13,799,506

 
7,585,365

Less: Net income attributable to non-controlling interests
(1,056,385
)
 
(974,637
)
 
(459,753
)
Net income attributable to Monarch Financial Holdings, Inc.
$
11,091,007

 
$
12,824,869

 
$
7,125,612

Preferred stock dividend and accretion of preferred stock discount
—

 
(1,402,532
)
 
(1,560,000
)
Net income available to common stockholders
$
11,091,007

 
$
11,422,337

 
$
5,565,612

Basic net income per share (1)
$
1.09

 
$
1.54

 
$
0.78

Diluted net income per share (1)
$
1.08

 
$
1.25

 
$
0.70

(1) All shares have been adjusted to reflect the 6 for 5 stock split granted December 7, 2012 and cash in lieu of fractional shares.

The accompanying notes are an integral part of these consolidated financial statements.

68


MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Year Ended December 31,
 
 
2013
 
2012
 
2011
Net Income
 
$
12,147,392

 
$
13,799,506

 
$
7,585,365

Other comprehensive income (loss):
 
 
 
 
 
 
Change in unrealized gain (loss) on interest rate swap, net of income taxes
 
191,332

 
113,854

 
(41,335
)
Change in unrealized (loss) gain on securities available for sale, net of income taxes
 
(271,491
)
 
49,152

 
11,554

Change in unrealized loss on supplemental executive's retirement plan, net of income taxes
 
(139,315
)
 
—

 
—

Other comprehensive income (loss)
 
(219,474
)
 
163,006

 
(29,781
)
Total comprehensive income
 
11,927,918

 
13,962,512

 
7,555,584

Less: Comprehensive income attributable to non-controlling interests
 
(1,056,385
)
 
(974,637
)
 
(459,753
)
Comprehensive income attributable to Monarch Financial Holdings, Inc.
 
$
10,871,533

 
$
12,987,875

 
$
7,095,831

 
 
 
 
 
 
 
Unrealized gain (loss) on interest rate swap
 
$
286,481

 
$
172,505

 
$
(62,628
)
Income tax (expense) benefit
 
(95,149
)
 
(58,651
)
 
21,293

Net unrealized gain (loss) on interest rate swap
 
$
191,332

 
$
113,854

 
$
(41,335
)
 
 
 
 
 
 
 
Unrealized holding (loss) gain on securities available for sale
 
$
(414,465
)
 
$
74,472

 
$
17,506

Income tax benefit (expense)
 
142,974

 
(25,320
)
 
(5,952
)
Net unrealized (loss) gain on securities available for sale
 
$
(271,491
)
 
$
49,152

 
$
11,554

 
 
 
 
 
 
 
Unrealized loss on supplemental executive's retirement plan
 
$
(214,331
)
 
$
—

 
$
—

Income tax benefit
 
75,016

 
—

 
—

Net unrealized loss on supplemental executive's retirement plan
 
$
(139,315
)
 
$
—

 
$
—

 
 
 
 
 
 
 

The accompanying notes are an integral part of these consolidated financial statements.

69




MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
 
Common Stock
 
Additional
Paid-In
Preferred
Retained
Accumulated
Other
Comprehensive
Non-controlling
 
Shares
 
Amount
 
Capital
Stock
Earnings
Income (Loss)
Interest
Total
Balance - December 31, 2010 (1)
7,162,468

 
$
35,812,340

 
$
16,160,912

$
4,000,000

$
15,925,106

$
(333,247
)
$
165,092

$
71,730,203

Net income for year ended December 31, 2011
 
 
 
 
 
 
7,125,612

 
459,753

7,585,365

Other comprehensive loss
 
 
 
 
 
 
 
(29,781
)
 
(29,781
)
Stock-based compensation expense, net of forfeitures and income tax benefit
(25,440
)
 
(127,200
)
 
450,507

 
 
 
 
323,307

Cash dividend declared on Series B noncumulative perpetual preferred stock (7.8%)
 
 
 
 
 
 
(1,560,000
)
 
 
(1,560,000
)
Cash dividend declared on common stock ($0.16 per share)
 
 
 
 
 
 
(952,758
)
 
 
(952,758
)
Common stock repurchases
(37,680
)
 
(188,400
)
 
(53,520
)
 
 
 
 
(241,920
)
Contributions from non-controlling interests
 
 
 
 
 
 
 
 
490,000

490,000

Distributions to non-controlling interests
 
 
 
 
 
 
 
 
(500,882
)
(500,882
)
Balance - December 31, 2011 (1)
7,099,348

 
$
35,496,740

 
$
16,557,899

$
4,000,000

$
20,537,960

$
(363,028
)
$
613,963

$
76,843,534

Net income for year ended December 31, 2012
 
 
 
 
 
 
12,824,869

 
974,637

13,799,506

Other comprehensive income
 
 
 
 
 
 
 
163,006

 
163,006

Stock-based compensation expense, net of forfeitures and income tax benefit
(10,200
)
 
(51,000
)
 
464,855

 
 
 
 
413,855

Stock options exercised, including tax benefit for exercise of options
36,660

 
183,300

 
62,342

 
 
 
 
245,642

Series B noncumulative perpetual preferred shares converted to common stock, less fractional shares
1,195,765

 
5,978,825

 
(4,384,579
)
(1,594,385
)
 
 
 
(139
)
Cash dividend declared on Series B noncumulative perpetual preferred stock (7.8%)
 
 
 
 
 
 
(1,402,532
)
 
 
(1,402,532
)
Cash dividend declared on common stock ($0.19 per share)
 
 
 
 
 
 
(1,174,089
)
 
 
(1,174,089
)
Common stock issued through dividend reinvestment
4,906

 
24,530

 
17,210

 
 
 
 
41,740

Contributions from non-controlling interests
 
 
 
 
 
 
 
 
980,000

980,000

Distributions to non-controlling interests
 
 
 
 
 
 
 
 
(963,682
)
(963,682
)
Balance - December 31, 2012
8,326,479

 
$
41,632,395

 
$
12,717,727

$
2,405,615

$
30,786,208

$
(200,022
)
$
1,604,918

$
88,946,841

Net income for the year ended December 31, 2013
 
 
 
 
 
 
11,091,007

 
1,056,385

12,147,392

Other comprehensive loss
 
 
 
 
 
 
 
(219,474
)
 
(219,474
)
Stock-based compensation expense, net of forfeitures and income taxes
17,400

 
87,000

 
506,721

 
 
 
 
593,721

Stock options exercised, including tax benefit for exercise of options
115,359

 
576,795

 
318,365

 
 
 
 
895,160

Series B noncumulative perpetual preferred shares converted to common stock, less fractional shares
1,804,184

 
9,020,920

 
(6,615,558
)
$
(2,405,615
)
 
 
 
(253
)
Cash dividend declared on common stock ($0.24 per share)
 
 
 
 
 
 
(2,440,096
)
 
 
(2,440,096
)
Common stock issued through dividend reinvestment
22,941

 
114,705

 
141,460

 
 
 
 
256,165

Distributions to non-controlling interests
 
 
 
 
 
 
 
 
(2,433,858
)
(2,433,858
)
Balance— December 31, 2013
10,286,363

 
$
51,431,815

 
$
7,068,715

$
—

$
39,437,119

$
(419,496
)
$
227,445

$
97,745,598

 
 
 
 
 
 
 
 
 
 
 
(1) All shares have been adjusted to reflect the 6 for 5 split granted on December 7, 2012 and cash in lieu of fractional shares.
The accompanying notes are an integral part of these consolidated financial statements.


70

MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS 
 
Year Ended December 31,
 
2013
 
2012
 
2011
Operating activities:
 
 
 
 
 
Net income
$
12,147,392

 
$
13,799,506

 
$
7,585,365

Adjustments to reconcile to net cash used in operating activities:
 
 
 
 
 
Provision for loan losses
—

 
4,831,133

 
6,319,887

Depreciation
2,424,478

 
1,960,822

 
1,709,145

Accretion of discounts and amortization of premiums, net
23,091

 
18,528

 
23,387

Deferral of loan costs, net of deferred fees
(92,506
)
 
(72,190
)
 
978

Amortization of intangible assets
178,572

 
178,572

 
178,572

Stock-based compensation
621,511

 
413,855

 
323,307

Appreciation of bank-owned life insurance
(236,377
)
 
(226,893
)
 
(269,263
)
Loss from rate lock commitments
—

 
—

 
503,986

Net gain on disposition of property and equipment
(58,460
)
 
(5,539
)
 
(37,223
)
Net loss on sale of other real estate
3,020

 
440,619

 
524,472

Net gain on disposition of security investments
—

 
(920
)
 
(3,107
)
Deferred income tax expense (benefit)
849,060

 
(894,794
)
 
(695,572
)
Amortization of deferred gain
—

 
(163,451
)
 
(163,451
)
Changes in:
 
 
 
 
 
Loans held for sale
319,357,304

 
(207,519,995
)
 
(36,166,738
)
Interest receivable
(193,122
)
 
64,864

 
(143,523
)
Other assets
8,800,567

 
(9,445,958
)
 
(1,062,997
)
Other liabilities
(819,660
)
 
4,941,031

 
2,799,923

Net cash provided by (used in) operating activities
343,004,870

 
(191,680,810
)
 
(18,572,852
)
Investing activities:
 
 
 
 
 
Purchases of available-for-sale securities
(38,567,095
)
 
(10,178,538
)
 
(80,272,582
)
Proceeds from sales and maturities of available-for-sale securities
3,941,512

 
4,788,366

 
88,684,829

Proceeds from sale of other real estate
92,054

 
3,653,156

 
3,210,532

Proceeds from sale of assets
381,556

 
44,800

 
20,200

Proceeds from bank owned life insurance
—

 
—

 
1,077,632

Reduction in bank owned life insurance
—

 
—

 
(656,622
)
Purchases of premises and equipment
(5,894,911
)
 
(4,426,891
)
 
(4,171,602
)
Purchase of restricted equity securities, net of redemptions
8,679,950

 
(5,942,700
)
 
2,271,950

Loan originations, net of principal repayments
(53,730,467
)
 
(57,985,734
)
 
(59,531,888
)
Net cash used in investing activities
(85,097,401
)
 
(70,047,541
)
 
(49,367,551
)
Financing activities:
 
 
 
 
 
Net increase in non-interest-bearing deposits
16,771,004

 
56,265,394

 
36,200,506

Net (decrease) increase in interest-bearing deposits
(25,434,386
)
 
105,424,381

 
(1,769,986
)
Cash dividends paid on preferred stock
—

 
(1,402,532
)
 
(1,560,000
)
Cash dividends paid on common stock
(2,440,096
)
 
(1,174,089
)
 
(952,758
)
Net (decrease) increase in FHLB advances
(193,123,038
)
 
123,371,042

 
40,645,280

Net (decrease) increase in short term borrowings
(5,000,000
)
 
5,000,000

 
—

Contributions from non-controlling interests
—

 
980,000

 
490,000

Distributions to non-controlling interests
(2,433,858
)
 
(963,682
)
 
(500,882
)
Proceeds from issuance of common stock, net of issuance costs
256,165

 
41,740

 
—

Proceeds from exercise of stock options
633,737

 
218,524

 
—

Cash paid for fractional shares
(253
)
 
(3,433
)
 
—

Repurchase of common stock, net of repurchase costs
—

 
—

 
(241,920
)
Net cash (used in) provided by financing activities
(210,770,725
)
 
287,757,345

 
72,310,240

CHANGE IN CASH AND CASH EQUIVALENTS
47,136,744

 
26,028,994

 
4,369,837

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
57,774,578

 
31,745,584

 
27,375,747

CASH AND CASH EQUIVALENTS AT END OF YEAR
$
104,911,322

 
$
57,774,578

 
$
31,745,584

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
MONARCH FINANCIAL HOLDINGS, INC.
CONSOLIDATED STATMENTS OF CASH FLOWS - CONTINUED
SUPPLEMENTAL SCHEDULES AND CASH FLOW INFORMATION
 
 
 
 
 
Cash paid for:
 
 
 
 
 
Interest on deposits and other borrowings
$
4,958,111

 
$
5,787,196

 
$
6,819,988

Income taxes
$
7,207,630

 
$
7,321,700

 
$
3,089,372

Loans transferred to foreclosed real estate during the year
$
397,037

 
$
725,075

 
$
5,359,004

Unrealized (loss) gain on securities available for sale
$
(414,465
)
 
$
74,472

 
$
17,506

Unrealized gain (loss) on interest rate swap
$
286,481

 
$
172,505

 
$
(62,628
)
Unrealized loss on supplemental executive's retirement plan
$
(214,331
)
 
$
—

 
$
—

The accompanying notes are an integral part of these consolidated financial statements.




71

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations: Monarch Financial Holdings, Inc. (the “Company” or “Monarch”) is a Virginia chartered Bank Holding Company that offers a full range of banking services, primarily to individuals and businesses in the Hampton Roads area of Virginia and northeastern North Carolina. On June 1, 2006, the Company was created through a reorganization plan, under the laws of the Commonwealth of Virginia, in which Monarch Bank (the “Bank”) became a wholly-owned subsidiary of Monarch Financial Holdings, Inc. Monarch Bank was incorporated on May 1, 1998, and commenced operations on April 14, 1999.
In addition to banking services, we offer financial planning, trust and investment services, under the name Monarch Bank Private Wealth, to high net worth individuals. We originate mortgage loans in both the residential and commercial markets which are then sold with servicing released. Residential services are offered under the name Monarch Mortgage and through joint ventures between Monarch Investment, LLC and minority partners under the names Coastal Home Mortgage, LLC, Regional Home Mortgage, LLC and Monarch Home Funding, LLD. Commercial mortgages are offered by the Bank’s 100% owned subsidiary, Monarch Capital, LLC. Investment services are provided under the name Monarch Investments. Residential and commercial title insurance is offered to our clients through Real Estate Security Agency, LLC, a 75% owned subsidiary.
Principles of Consolidation: Our consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, collectively referred to as the “Company” or “Monarch”. All significant inter-company transactions have been eliminated.
Use of Estimates: Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and general practices within the banking industry which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Our actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the fair value of foreclosed real estate, deferred income taxes, stock based compensation and the fair values of available for sale securities.
Cash and Cash Equivalents: We define cash and cash equivalents to include currency, balances due from banks (including non-interest bearing and interest bearing deposits) and federal funds sold. We are required to maintain certain reserve balances with the Federal Reserve Bank. These required reserves were $15.5 million at December 31, 2013 and $12.5 million at December 31, 2012.
Investment Securities: Investments classified as available-for-sale are stated at fair value with unrealized holding gains and losses excluded from earnings and reported, net of deferred tax, as a component of other comprehensive income until realized. Investments in debt securities classified as held-to-maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Management has the positive intent and ability to hold these securities to maturity and, accordingly, adjustments are not made for temporary declines in their fair value below amortized cost.
Gains and losses on the sale of securities are determined using the specific identification method. Other-than-temporary declines in the fair value of individual available-for-sale and held-to-maturity securities below their cost, if any, are included in earnings as realized losses.
Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or market in the aggregate. Net unrealized losses, if any, are recognized through charges to income.
Loans Held for Investment: Loans are reported at their recorded investment, which is the principal outstanding balance and net of charge-offs, deferred loan fees and costs on originated loans, unearned income, and unamortized premiums or discounts, if any, on purchased loans. Interest income is recognized over the term of the loan and is calculated using the simple-interest method on principal amounts outstanding. Further information on loans is contained in Note 4 to our Consolidated Financial Statements.
Deferred Loan Fees and Costs: Certain fees and costs associated with loans held for investment originations are recognized as an adjustment to interest income over the contractual life of the loans.
Allowance for Loan Losses: The allowance for loan losses reflects management’s judgment of probable losses inherent in the portfolio at the balance sheet date. A loan is considered impaired, based on current information and events, if it is probable we will be unable to collect the scheduled payments of principal and/or interest when due, according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except in the case of collateral-dependent loans

72

which may be measured for impairment based on the fair value of the collateral. Further information on loans is contained in Note 4 to our Consolidated Financial Statements.
The establishment of the allowance for loan losses relies on a consistent process that requires multiple layers of management review and judgment and responds to changes in economic conditions, client behavior, and collateral value, among other influences. Management uses a disciplined process and methodology to establish the allowance for loan losses on a monthly basis. To determine the total allowance for loan losses, the Company estimates the reserves needed for each class of the portfolio, including loans analyzed on a pooled basis and individually.
The allowance for loan losses consists of amounts applicable to three loan types: (i) commercial loans; (ii) real estate loans; (iii) consumer loans. Loans within these types are further separated into classes. Loans are pooled by loan class and modeled utilizing historical loss experience, known and inherent risks, and quantitative techniques which management determined fit the characteristics of that class. Additionally, loans that have been specifically identified as a credit risk due to circumstances that may affect the ability of the borrower to repay interest and/or principal are analyzed on an individual basis. Adverse circumstances may include loss of repayment source, deterioration in the estimated value of collateral, elevated trends of delinquencies, and charge-offs.
We evaluate the adequacy of the allowance for loan losses monthly in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. From time to time, events or economic factors may affect the loan portfolio, causing management to provide additional amounts to or release balances from the allowance for loan losses. The Company’s allowance for loan losses is sensitive to risk ratings assigned to individually evaluated loans, economic assumptions, and delinquency trends driving statistically modeled reserves. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for losses on loans. Such agencies may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of impaired loans, if applicable, are included in the provision for loan losses. A loan is considered impaired when, based on current information and events; it is probable that we will be unable to collect all amounts due to us according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis, by either the present value of expected future cash flows discounted to the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral less costs to sell, if the loan is collateral dependent. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable.
When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance. Subsequent recoveries, if any, are credited to the allowance until fully recaptured, prior to the resumption of recording additional principal curtailments and/or interest.
Loan Charge-off Policies: Our loan charge-off policy delineates between secured and unsecured loans in addition to consumer, residential real estate, and commercial and construction loans.
•
Unsecured loans are to be charged-off when they become 120 days delinquent or when it is determined that the debt is uncollectible, whichever comes first. Overdrafts are to be charged-off when it is determined a recovery is not likely or the overdraft becomes 90 days old, whichever comes first.
•
Secured consumer loans, except those secured by the borrower’s primary or secondary residence, are to be charged-off or charged-down to net recoverable value of collateral on or before becoming 120 days past due, or whenever collection is doubtful, whichever comes first.
•
Residential real estate loans are to be charged-off when they become 365 days delinquent. Home equity and improvement loans are to be reviewed before they become 180 days past due and are to be charged off unless they are well-secured and in process of collection.
•
Charge-offs on commercial, commercial real estate and construction loans are to be taken promptly upon determination that all or a portion of any loan balance is uncollectible. A loan is considered uncollectible when the borrower is delinquent in principal or interest repayment and: a) the loan becomes 90 days past due, b) the borrower is unlikely to have the ability to pay the debt in a timely manner, c) the collateral value of the securing asset is insufficient to cover the outstanding indebtedness, and/or d) the guarantors do not provide adequate support for the debt.

73

•
Charge-offs are taken immediately on any loan graded a “9” or considered statutory bad debt. Statutory bad debt exists when interest on a loan is past due and unpaid for six months and the loan is not well secured and in process of collection.
Income Recognition on Impaired and Nonaccrual Loans: Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal and/or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful, or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual, if repayment in full of principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash receipts of interest in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Restructured Loans: A restructured loan is an impaired loan in which it has been determined the borrower’s financial difficulties will prevent performance under the original contractual terms of the loan agreement and a concession is made with regard to those terms which would not be considered under normal circumstances.
If the value of a restructured loan is determined to be less than the recorded investment in the loan, a valuation allowance is created with a corresponding charge off. Measurement of the value of a restructured loan is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate. Restructured loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.
Collections of interest and principal are recorded as recoveries to the allowance for loan losses until all charged-off balances have been fully recovered.
Other Real Estate Owned: Real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the fair value less estimated selling costs at the date of foreclosure. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Property held and used is considered impaired when the carrying amount of a property exceeds its fair value. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Valuations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its cost or fair value less cost to sell.
Property and Equipment: Land is carried at cost. Property and equipment are stated at cost less accumulated depreciation. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvement, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. For financial reporting purposes, assets are depreciated using the straight-line method over their estimated useful lives, which range from 3 years to 30 years, depending on the asset type and any related contracts. For income tax purposes, the accelerated cost recovery system and the modified accelerated cost recovery system are used.
Restricted Equity Securities: As a requirement for membership, we invest in the stock of the Federal Home Loan Bank of Atlanta (“FHLB”), Community Bankers Bank (“CBB”), and the Federal Reserve Bank (“FRB”). These investments are carried at cost. Due to the redemption provisions of these entities, we estimated that fair value approximates cost and that these investments were not impaired at December 31, 2013.

Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

74

Credit Related Financial Instruments: In the ordinary course of business, we have entered into commitments to extend credit, including commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.
Mortgage Banking Income: We derive our mortgage banking income from discounted fees, or points, collected on loans originated, premiums received on the sale of mortgage loans and their related servicing rights to investors, and other fees. We recognize this income, including discount fees and points, at closing. All of these components determine the gain on sale of the underlying mortgage loans to investors.
Rate Lock Commitments: Through our mortgage banking activities, we commit to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). The period of time between the issuance of a loan commitment and closing and sale of the loan generally ranges between 15 to 90 days. The Company protects itself from changes in interest rates by entering into loan purchase agreements with third party investors that provide for the investor to purchase loans at the same terms, including interest rate, as committed to the borrower. Under the contractual relationship with these third party investors, the Company is obligated to sell the loan to the investor, and the investor is obligated to buy the loan, only if the loan closes. No other obligation exists. The Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates as a result of these contractual relationships with third party investors.
At various times, when the market is favorable, we participate in a “mandatory” delivery program for a portion of our mortgage loans. Under the mandatory delivery program, we commit to deliver a block of loans to an investor at a preset cost prior to the close of such loans. This differs from a “best efforts” delivery, which sets the cost to the investor on a loan by loan basis at the close of the loan. Mandatory delivery creates a higher level of risk for us because it relies on rate lock commitments rather than closed loans, thereby exposing the Company to fluctuations in interest rate and pricing. A rate lock commitment is a binding commitment for us but is not binding to the client. Our client could decide, at any time, between the time of the rate lock and actual closing on their mortgage loan, not to proceed with the commitment. There is a higher occurrence of this during periods of interest rate volatility. To mitigate this risk, we pair the rate lock commitment with the sale of a notional security bearing similar attributes. At the time the loan is delivered to the investor, matched securities are repurchased. Any gains or losses associated with this pairing are recorded in mortgage banking income on our income statement as incurred. We did not participate in a mandatory delivery program in 2013.
Advertising: Advertising costs, which totaled $2,873,259 in 2013, are expensed as incurred.
Income Taxes: Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax basis of the various balance sheet assets and liabilities and includes recognition to changes in current tax rates and laws.
Segment Reporting: Public business enterprises are required to report information about operating segments in financial statements and selected information about operating segments in financial reports issued to shareholders. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by management in determining how to allocate resources and to assess effectiveness of the segments’ performance. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. We have two reporting segments, one for general banking services and one for mortgage banking operations.
Earnings Per Share: Basic earnings per share (EPS) excludes dilution, and is computed by dividing income available to common stockholders by the weighted-average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Reclassifications: Certain immaterial reclassifications have been made to prior year’s information to conform to the current year’s presentation.
Derivative Financial Instruments and Hedging Activities: We use derivatives to manage risks related to interest rate movements. Interest rate swap contracts designated and qualifying as cash flow hedges are reported at fair value. The gain or loss on the effective portion of the hedge is initially included as a component of other comprehensive income and is subsequently reclassified into earnings when interest on the related debt is paid. We document our risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Our interest rate risk management strategy is to stabilize cash flow requirements by maintaining interest rate swap contracts to convert variable-rate debt to a fixed rate and vice versa. We do not hold or issue derivative financial instruments for trading purposes.

75


Periodically, we have participated in a “mandatory” delivery program for mortgage loans. Under the mandatory delivery system, loans with interest rate locks are paired with the sale of a notional security bearing similar attributes. Interim income or loss on the pairing of the loans and securities is recorded in mortgage banking income on our income statement. In addition, at the time the loan is delivered to an investor, matched securities are repurchased and a gain or loss on the pairing is recorded in mortgage banking income on our income statement. Management has elected to limit our exposure to this form of delivery to $50 million in outstanding loans. We were not participating in the mandatory delivery program at December 31, 2013 or 2012.
Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Components of other comprehensive income, which are reported in our consolidated statements of comprehensive income, consist of unrealized gains and losses on available-for-sale securities, unrealized gains and losses on SERP and a derivative financial liability related to an interest rate swap.
 
Stock Compensation Plans: In May 2006, our shareholders ratified the adoption of a new stock-based compensation plan to succeed the Monarch Bank 1999 Incentive Stock Option Plan. The 2006 Equity Incentive Plan authorizes the compensation committee to grant options, stock appreciation rights, stock awards, performance stock awards, and stock units to designated directors, officers, key employees, consultants and advisers to the Company and its subsidiaries. We are authorized through the Plan to issue up to 756,000 split-adjusted shares of our common stock plus the number of shares of our common stock outstanding under the 1999 Plan. The Plan also provides that no award may be granted more than 10 years after the May 2006 ratification date.
On January 1, 2006, we adopted Accounting Standards Codification (“ASC”) 718-10, that addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. ASC 718-10 eliminates the ability to account for share-based compensation transactions using the intrinsic method and requires that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of income.
Fair Value Measurements: Fair Value is the exchange price in an orderly transaction, which is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset/liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset/liability. Fair value focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. The framework for measuring fair value is comprised of a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The three levels of valuation hierarchy are as follows:
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.
For additional information on Fair Value Measurements see Note 19.
We review the appropriateness of our classification of assets/liabilities within the fair value hierarchy on a quarterly basis, which could cause such assets/liabilities to be reclassified among the three hierarchy levels. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced. While we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The methods used to produce a fair value calculation may not be indicative of net realizable value or reflective of future fair values.

76

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. We have included the required disclosures from ASU 2013-02 in our consolidated financial statements.

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or re-designated hedging relationships entered into on or after July 17, 2013. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists.” The amendments in this ASU provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carry-forward, similar tax loss, or tax credit carry-forward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward, except as follows. To the extent a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the dis-allowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the

77

effective date. Retrospective application is permitted. We are currently assessing the impact that ASU 2013-11 will have on our consolidated financial statements.

In January 2014, the FASB issued ASU 2014-01, “Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. We are currently assessing the impact that ASU 2014-01 will have on our consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that if/when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. We are currently assessing the impact that ASU 2014-04 will have on our consolidated financial statements.


NOTE 2 – INVESTMENT SECURITIES
Securities available-for-sale consisted of the following:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
December 31, 2013
 
 
 
 
 
 
 
U.S. government agency obligations
$
45,542,209

 
$
1,653

 
$
(197,951
)
 
$
45,345,911

Mortgage-backed securities
1,572,910

 
10,980

 
(16,729
)
 
1,567,161

Municipal securities
1,912,248

 
42,080

 
(45,640
)
 
1,908,688

Corporate debt securities
—

 
—

 
—

 
—

 
$
49,027,367

 
$
54,713

 
$
(260,320
)
 
$
48,821,760

 
 
 
 
 
 
 
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
December 31, 2012
 
 
 
 
 
 
 
U.S. government agency obligations
$
10,551,084

 
$
38,076

 
$
(15,318
)
 
$
10,573,842

Mortgage-backed securities
1,980,980

 
50,914

 
—

 
2,031,894

Municipal securities
1,392,811

 
129,401

 
—

 
1,522,212

Corporate debt securities
500,000

 
5,785

 
—

 
505,785

 
$
14,424,875

 
$
224,176

 
$
(15,318
)
 
$
14,633,733

The Company did not have any held-to-maturity or trading securities at December 31, 2013 or December 31, 2012.

78

The amortized cost and estimated fair value of securities, all of which are classified as available for sale, at December 31, 2013, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
Securities available-for-sale:
 
 
Amortized
Cost
 
Fair Value
Due in one year or less
$
30,499,810

 
$
30,500,015

Due from one to five years
13,604,377

 
13,428,753

Due from five to ten years
2,598,478

 
2,537,984

Due after ten years
2,324,702

 
2,355,008

Total
$
49,027,367

 
$
48,821,760


The gross unrealized losses in our securities portfolio at December 31, 2013 and December 31, 2012 are as follows:
GROSS UNREALIZED LOSSES AND FAIR VALUE
 
As of December 31, 2013
Less than 12 months
 
12 months or more
 
Total
Securities
Description
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
U.S. government agency obligations
$
45,093,426

 
$
(233,515
)
 
$
973,195

 
$
(26,805
)
 
$
46,066,621

 
$
(260,320
)
Mortgage-backed securities
—

 
—

 
—

 
—

 
—

 
—

Municipal securities
—

 
—

 
—

 
—

 
—

 
—

Corporate bonds
—

 
—

 
—

 
—

 
—

 
—

Total temporarily impaired securities
$
45,093,426

 
$
(233,515
)
 
$
973,195

 
$
(26,805
)
 
$
46,066,621

 
$
(260,320
)
As of December 31, 2012
Less than 12 months
 
12 months or more
 
Total
Securities
Description
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
U.S. government agency obligations
$
5,984,335

 
$
(15,318
)
 
$
—

 
$
—

 
$
5,984,335

 
$
(15,318
)
Mortgage-backed securities
—

 
—

 
—

 
—

 
—

 
—

Municipal securities
—

 
—

 
—

 
—

 
—

 
—

Corporate bonds
—

 
—

 
—

 
—

 
—

 
—

Total temporarily impaired securities
$
5,984,335

 
$
(15,318
)
 
$
—

 
$
—

 
$
5,984,335

 
$
(15,318
)

There are thirty five investments in our securites portfolio that had unrealized losses as of 12/31/2013. Of these, two investments have been in a continuous unrealized loss position for more than 12 months. Both investments are agency securities with a amortized value of $1,000,000 and fair value of $973,195. We have the ability to carry these investments to the final maturity of the instruments. Other-than-temporarily impaired (“OTTI”) guidance for investments states that an impairment is OTTI if any of the following conditions exist: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or, the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). An impaired security identified as OTTI should be separated and losses should be recognized in earnings. Based on this guidance, there were no securities considered OTTI at December 31, 2013 or December 31, 2012 and there were no losses related to OTTI recognized in accumulated other comprehensive income at either, December 31, 2013 or 2012.
All of our mortgage-backed securities are government agency issued. The carrying value of our government agency issued mortgage backed securities was $1,567,161 or 100% of the total mortgage-backed securities at December 31, 2013 and $2,031,894 or 100% at December 31, 2012.
Securities with carrying values of $3,588,667 were pledged to secure public deposits and borrowings from the Federal Home Loan Bank of Atlanta at December 31, 2013 and securities with carrying values of $3,143,405 were pledged to secure bankruptcy deposits, public deposits and borrowings from the Federal Home Loan Bank of Atlanta at December 31, 2012.

79

We recorded a gross realized gain on the call of an available-for-sale investment of $0, $920 and $3,107 in 2013, 2012 and 2011, respectively. Proceeds from maturities, sales, pay downs and calls of investment securities were $3,941,512, $4,788,366 and $88,684,829 for 2013, 2012 and 2011, respectively.

NOTE 3 – ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table presents the changes in accumulated other comprehensive income, by category, net of tax:
Accumulated Other Comprehensive Income
 
Unrealized Loss on Supplemental Executive's Retirement Plan
 
Unrealized (Loss) Gains on Securities
 
Unrealized Loss on Interest Rate Swap
 
Accumulated Other Comprehensive (Loss) Income
Balance at December 31, 2012
$
—

 
$
137,847

 
$
(337,869
)
 
$
(200,022
)
Net change for the year ended December 31, 2013
(139,315
)
 
(271,491
)
 
191,332

 
(219,474
)
Balance at December 31, 2013
$
(139,315
)
 
$
(133,644
)
 
$
(146,537
)
 
$
(419,496
)
 
 
 
 
 
 
 
 
Balance at December 31, 2011
$
—

 
$
88,695

 
$
(451,723
)
 
$
(363,028
)
Net change for the year ended December 31, 2012
—

 
49,152

 
113,854

 
163,006

Balance at December 31, 2012
$
—

 
$
137,847

 
$
(337,869
)
 
$
(200,022
)
 
 
 
 
 
 
 
 
Balance at December 31, 2010
$
—

 
$
77,141

 
$
(410,388
)
 
$
(333,247
)
Net change for the year ended December 31, 2011
—

 
11,554

 
(41,335
)
 
(29,781
)
Balance at December 31, 2011
$
—

 
$
88,695

 
$
(451,723
)
 
$
(363,028
)
 
 
 
 
 
 
 
 
An unrealized loss of $143,176, net of tax, associated with a change in the discount rate on the Company's Supplemental Executive's Retirement Plan ("SERP") from 5.85% to 4.50%, was moved into other comprehensive income in the second quarter of 2013. Expense of $3,861 related to SERP was also re-classed out of other comprehensive income into other expense in earnings during the year ended December 31, 2013. Security gains of 920 and $3,107 were re-classed out of accumulated other comprehensive earnings into gain on sale/call of securities during the years ended December 31, 2012 and 2011.


80

NOTE 4 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans held for investment consisted of the following at December 31: 
 
2013
 
2012
Commercial
$
119,367,962

 
$
91,803,951

Real estate
 
 
 
Construction
155,551,690

 
154,297,386

Residential (1-4 family)
89,846,277

 
92,497,460

Home equity lines
67,177,011

 
71,491,139

Multifamily
27,392,561

 
20,032,586

Commercial
250,178,584

 
227,813,983

Real estate subtotal
590,146,123

 
566,132,554

Consumers
 
 
 
Consumer and installment loans
2,911,397

 
3,025,471

Overdraft protection loans
71,009

 
49,716

Loans to individuals subtotal
2,982,406

 
3,075,187

Total gross loans
712,496,491

 
661,011,692

Allowance for loan losses
(9,061,369
)
 
(10,910,000
)
Loans net of allowance for loan losses
703,435,122

 
650,101,692

Unamortized loan costs, net of deferred fees
174,976

 
82,470

Total net loans
$
703,610,098

 
$
650,184,162

We have certain lending policies and procedures in place that are designed to balance loan growth and income with an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, credit concentrations, policy exceptions, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Our loans held for investment portfolio is divided into three loan types; commercial, real estate and consumer. Some of these loan types are further broken down into classes. The commercial loan portfolio, which is not broken down further, includes commercial and industrial loans which are usually secured by the assets being financed or other business assets. The real estate loan portfolio is broken down into construction, residential 1-4 family, home equity lines, multifamily, and commercial real estate loan segments. The consumer loan portfolio is segmented into consumer and installment loans, and overdraft protection loans.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined the borrower’s management possesses sound ethics and solid business acumen, we examine current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and normally incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation or sale of the income producing property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type. This diversity helps reduce our exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on purpose, collateral, geography, cash flow,

81

loan to value and risk grade criteria. As a general rule, we avoid financing special purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2013, approximately 40% and at December 31, 2012, approximately 48% of the outstanding principal balance of our commercial real estate loan portfolio was secured by owner-occupied properties.
With respect to loans to developers and builders that are secured by non-owner occupied properties that we may originate from time to time, we generally require the borrower to have an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of considerable funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate source of repayment being sensitive to interest rate changes, supply and demand, and governmental regulation of real property, general economic conditions and the availability of long-term financing.
We generally require multifamily real estate loan borrowers to have an existing relationship with the Company, a proven record of success and guarantor financial strength, commensurate with the project size. The underlying feasibility of a multifamily project is stress tested for sensitivity to both capitalization and interest rate changes. Each project is underwritten separately and additional underwriting standards are required for the guarantors, which include, but are not limited to, a maximum loan-to-value percentage, global cash flow analysis and contingent liability analysis. Sources of repayment for these types of loans may be rent rolls or sales of the developed property, either by unit or as a whole.
Consumer and residential loan originations, including home equity lines of credit, utilize analytics to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This monitoring, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend, sensitivity analysis, shock analysis and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

We perform periodic reviews on various segments of our loan portfolio in addition to presenting the majority of our loan relationships for loan committee review. We utilize an independent company to perform a periodic review to evaluate and validate our credit risk program. Results of these reviews are presented to management and our board. Additionally, we are subject to annual examination by our regulators. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.
We have an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. This methodology begins with a look at the three loan types; commercial, real estate, and consumer. Loans within the commercial and real estate types are evaluated on an individual or relationship basis and assigned a risk grade based on the characteristics of the loan or relationship. Loans within the consumer type are assigned risk grades and evaluated as a pool, unless specifically identified through delinquency or other signs of credit deterioration, at which time the identified loan would be individually evaluated.
We designate loans within our loans held for investment portfolio as either "pass" or "watch list" based on nine numerical risk grades which are assigned to loans. These numeric designations represent, from best to worst: minimal, modest, average, acceptable, acceptable with care, special mention, substandard, doubtful and loss. Special mention, substandard, doubtful and loss risk grades are watch list. A loan risk graded as loss is generally charged-off when identified. A loan risk graded as doubtful is considered watch list and classified as nonaccrual. There were no loans in our portfolio classified as doubtful or loss on December 31, 2013 or December 31, 2012. Special mention and substandard loans are considered watch list and may or may not be classified as nonaccrual, based on current performance. Watch list graded loans or relationships are evaluated individually to determine if all, or a portion, of our investment in the borrower is at risk. If a risk is quantified, a specific loss allowance will be assigned to the identified loan or relationship. We evaluate our investment in the borrower using either the present value of expected future cash flows, discounted at the historical effective interest rate of the loan, or for a collateral-dependent loan, the fair value of the underlying collateral.
Beginning with the quarter ended March 31, 2013, we changed the methodology for evaluating additional risk inherent in our satisfactory risk grade groups which should be included in our allowance for loan losses. Under the new methodology,

82

loans within this group are evaluated on a pool basis by loan segment which is further delineated by purpose. Each segment is assigned an expected loss factor which is based on a four-year moving average “look-back” at our historical losses for that particular segment. We believe this change in methodology provides a more accurate evaluation of the potential risk in our portfolio because the additional delineation by purpose establishes a stronger focus on areas of weakness and strength within the portfolio.
This change in methodology for evaluating additional risk inherent in our satisfactory risk groups is applied to December 31, 2013. However, at December 31, 2012 pass loans were evaluated for loss based on risk rating. Loans with a risk rating of modest to acceptable with care were assigned an expected loss factor based on their lower risk profiles. The loss factor, which was multiplied by the outstanding principal within each risk grade to arrive at an overall loss estimate, was based on a three-year moving average “look-back” at our historical losses, adjusted for environmental risk factors described below. We believe a four year average is more indicative of the loss currently remaining in our loan portfolio.
Additional metrics, in the form of environmental risk factors, may be applied to a specific class or risk grade of loans within the portfolio based on local or national trends, identifiable events or other economic factors. For the period ended December 31, 2013, nine environmental factors; five internal and four external, were applied to the general risk grade groups. The five internal environmental factors took into consideration the potential risk due to changes within the Company. These factors addressed any changes in 1.) the strength and depth of management, 2.) lending policies and procedures, 3.) the nature, volume and terms of various portfolios, 4.) the quality of loan review and 5.) the effects of concentrations of credit and changes in those levels. The four external factors considered risks associated with events and circumstances outside of Company control. The first factor addressed the potential impact of legal change, regulatory change and new competition in the market. The second factor took into consideration changes in international, national and local economic conditions. The third looked at changes in risk taken due to competitive pressure. The final external environmental factor addressed the risk associated with the government's management of fiscal policy and its potential impact on our local economy.
At December 31, 2012, there were five external environmental factors. The first of the five external environmental factors was applied to our real estate construction loans due to the concentration in our portfolio. The second environmental factor was applied to our home equity lines based on delinquency rates. The third environmental factor was applied to all satisfactory loans based on economic conditions, including local unemployment and gross regional product. The fourth environmental factor was applied to all pass loans based on trends in our nonperforming assets. The final environmental factor, which was added in the 4th quarter of 2012, was related to Sequestration; automatic cuts in the budgets of both the defense and other discretionary federal programs associated with the Fiscal Cliff. Certain actions to avoid the Fiscal Cliff served to temporarily defer decisions on programs which could have an impact on the local economy.
The assumptions used to determine the allowance are reviewed to ensure that their theoretical foundation, data integrity, computational processes, and reporting practices are appropriate and properly documented.
Summary of changes in our methodology for estimating the allowance for loan losses:
•No change was made to the accounting for impaired credits.
•
Our satisfactory loan methodology was refined to more clearly represent loan characteristics. Loans are pooled by loan class and purpose and a loss factor is assigned to the pool based on a four-year moving loss history for that pool. Our prior methodology was to apply a three-year moving portfolio loss history to all classes.
•
Four internal environmental factors have been added in 2013 to consider risks associated with changes within the Company.
•
The first of the five external environmental factors has moved to an internal factor addressing concentrations in the portfolio.
•
The remaining four external environmental factors have been modified to allow a more comprehensive approach to our loan portfolio rather than a loan type.
 


83

Effect of Changes in Methodology
December 31, 2013
Calculated Provision Based on New Methodology
 
Calculated Provision Based on Prior Methodology
 
Difference
Commercial
$
1,761,697

 
$
2,200,979

 
$
(439,282
)
Real estate
 
 
 
 
 
Construction
(1,421,978
)
 
(1,303,556
)
 
(118,422
)
Residential (1-4 family)
249,346

 
(339,415
)
 
588,761

Home equity lines
1,214,881

 
123,055

 
1,091,826

Multifamily
(230,946
)
 
(60,972
)
 
(169,974
)
Commercial
(1,597,267
)
 
(221,597
)
 
(1,375,670
)
Real estate subtotal
(1,785,964
)
 
(1,802,485
)
 
16,521

Consumers
 
 
 
 
 
Consumer and installment loans
66,251

 
71,727

 
(5,476
)
Overdraft protection loans
582

 
2,322

 
(1,740
)
Loans to individuals subtotal
66,833

 
74,049

 
(7,216
)
Unallocated
(42,566
)
 
(472,543
)
 
429,977

Total provision for (recovery of) loan losses
$
—

 
$
—

 
$
—

 
 
 
 
 
 
We utilize various sources in assessing the economic conditions in our target markets and areas of concentration. We track unemployment trends in both Hampton Roads and Virginia compared to the national average. We monitor trends in our industry and among our peers through reports such as the Uniform Bank Performance Report which are made available to us through the Federal Financial Institutions Examination Council. Additionally, we utilize various industry sources that include information published by CB Richard Ellis, an international firm specializing in commercial real estate reporting and REIS, a provider of commercial real estate information and analytics to monitor local, state and national trends.
We evaluate the adequacy of our allowance for loan losses monthly. A degree of imprecision or uncertainty is inherent in our allowance estimates because it requires that we incorporate a range of probable outcomes which may change from period to period. It requires that we exercise judgment as to the risks inherent in our portfolios, economic uncertainties, historical loss and other subjective factors, including industry trends. No single statistic or measurement determines the adequacy of the allowance for loan loss. Changes in the allowance for loan loss and the related provision expense can materially affect net income.

A summary of our loan portfolio by class and delineated between pass and watch list as of December 31, 2013 and December 31, 2012 is as follows: 

84

 
December 31, 2013
 
 
 
 Watch List
 
 
 
Weighted
Average
 
Pass
 
Special Mention
 
Substandard
 
Total
 
Risk Grade
Commercial
$
112,512,939

 
$
12,891

 
$
6,842,132

 
$
119,367,962

 
3.45

Real estate
 
 
 
 
 
 
 
 
 
Construction
147,478,248

 
978,247

 
7,095,195

 
155,551,690

 
3.77

Residential (1-4 family)
80,560,400

 
3,329,470

 
5,956,407

 
89,846,277

 
4.22

Home equity lines
65,790,766

 
—

 
1,386,245

 
67,177,011

 
4.13

Multifamily
26,078,523

 
1,005,985

 
308,053

 
27,392,561

 
3.70

Commercial
242,167,855

 
2,295,326

 
5,715,403

 
250,178,584

 
3.73

Real estate subtotal
562,075,792

 
7,609,028

 
20,461,303

 
590,146,123

 
3.85

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
2,823,254

 
—

 
88,143

 
2,911,397

 
4.10

Overdraft protection loans
71,009

 
—

 
—

 
71,009

 
4.43

Loans to individuals subtotal
2,894,263

 
—

 
88,143

 
2,982,406

 
4.11

Total gross loans
$
677,482,994

 
$
7,621,919

 
$
27,391,578

 
$
712,496,491

 
3.79

 
 
December 31, 2012
 
 
 
Watch List
 
 
 
Weighted
Average
 
Pass
 
Special Mention
 
Substandard
 
Total
 
Risk Grade
Commercial
$
87,322,926

 
$
1,607,857

 
$
2,873,168

 
$
91,803,951

 
3.72

Real estate
 
 
 
 
 
 
 
 
 
Construction
139,899,273

 
5,779,104

 
8,619,009

 
154,297,386

 
3.99

Residential (1-4 family)
83,633,577

 
2,776,659

 
6,087,224

 
92,497,460

 
4.27

Home equity lines
69,908,614

 
240,209

 
1,342,316

 
71,491,139

 
4.11

Multifamily
17,763,961

 
50,000

 
2,218,625

 
20,032,586

 
4.17

Commercial
220,153,680

 
1,828,487

 
5,831,816

 
227,813,983

 
3.97

Real estate subtotal
531,359,105

 
10,674,459

 
24,098,990

 
566,132,554

 
4.05

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
2,883,660

 
—

 
141,811

 
3,025,471

 
4.16

Overdraft protection loans
49,695

 
—

 
21

 
49,716

 
4.21

Loans to individuals subtotal
2,933,355

 
—

 
141,832

 
3,075,187

 
4.16

Total gross loans
$
621,615,386

 
$
12,282,316

 
$
27,113,990

 
$
661,011,692

 
4.00


There were no loans classified as doubtful or loss included in our loan portfolio at December 31, 2013 or December 31, 2012.

85

An aging of our loan portfolio by class as of December 31, 2013 and December 31, 2012 is as follows:
Age Analysis of Past Due Loans
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater
Than 90
Days
 
Total Past
Due
 
Current
 
Recorded
Investment >
90 days and
Accruing
 
Recorded
Investment
Nonaccrual
Loans
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
15,000

 
$
362,103

 
$
—

 
$
377,103

 
$
118,990,859

 
$
—

 
$
—

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
126,164

 
—

 
231,398

 
357,562

 
155,194,128

 
—

 
357,561

Residential (1-4 family)
2,056,872

 
12,554

 
1,151,809

 
3,221,235

 
86,625,042

 
472,052

 
825,964

Home equity lines
49,338

 
61,526

 
—

 
110,864

 
67,066,147

 
—

 
552,193

Multifamily
—

 
—

 
—

 
—

 
27,392,561

 
—

 
—

Commercial
—

 
—

 
—

 
—

 
250,178,584

 
—

 
—

Real estate subtotal
2,232,374

 
74,080

 
1,383,207

 
3,689,661

 
586,456,462

 
472,052

 
1,735,718

Consumers
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer and installment loans
213,666

 
12,087

 
—

 
225,753

 
2,685,644

 
—

 
4,352

Overdraft protection loans
—

 
—

 
—

 
—

 
71,009

 
—

 
—

Loans to individuals subtotal
213,666

 
12,087

 
—

 
225,753

 
2,756,653

 
—

 
4,352

Total gross loans
$
2,461,040

 
$
448,270

 
$
1,383,207

 
$
4,292,517

 
$
708,203,974

 
$
472,052

 
$
1,740,070

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial:
$
701,397

 
$
56,520

 
$
617,394

 
$
1,375,311

 
$
90,428,640

 
$
—

 
$
617,394

Real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction
295,937

 
—

 
385,805

 
681,742

 
153,615,644

 
—

 
1,028,188

Residential (1-4 family)
1,538,595

 
—

 
525,150

 
2,063,745

 
90,433,715

 
—

 
930,883

Home equity lines
318,108

 
349,914

 
—

 
668,022

 
70,823,117

 
—

 
586,239

Multifamily
—

 
—

 
—

 
—

 
20,032,586

 
—

 
—

Commercial
—

 
—

 
247,954

 
247,954

 
227,566,029

 
152,880

 
95,074

Real estate subtotal
2,152,640

 
349,914

 
1,158,909

 
3,661,463

 
562,471,091

 
152,880

 
2,640,384

Consumers
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer and installment loans
124,073

 
—

 
127,850

 
251,923

 
2,773,548

 
—

 
141,811

Overdraft protection loans
21

 
—

 
—

 
21

 
49,695

 
—

 
—

Loans to individuals subtotal
124,094

 
—

 
127,850

 
251,944

 
2,823,243

 
—

 
141,811

Total gross loans
$
2,978,131

 
$
406,434

 
$
1,904,153

 
$
5,288,718

 
$
655,722,974

 
$
152,880

 
$
3,399,589



86

A summary of the activity in the allowance for loan losses account is as follows:
Allocation of the Allowance for Loan Losses
For the Years Ended December 31, 2013, 2012 and 2011
 
 
 
 
Real Estate
2013
Commercial
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial

Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,749,641

 
$
2,360,707

 
$
1,545,315

 
$
1,402,448

 
$
290,532

 
$
2,882,398

Charge-offs
(2,468,074
)
 
—

 
(148,766
)
 
(582,480
)
 
—

 
—

Recoveries
175,991

 
1,039,591

 
39,607

 
98,067

 
—

 
20,000

Provision
1,761,697

 
(1,421,978
)
 
249,346

 
1,214,881

 
(230,946
)
 
(1,597,267
)
Ending balance
$
1,219,255

 
$
1,978,320

 
$
1,685,502

 
$
2,132,916

 
$
59,586

 
$
1,305,131

Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
712,699

 
$
736,248

 
$
274,259

 
$
510,118

 
$
—

 
$
616,393

Collectively evaluated for impairment
$
506,556

 
$
1,242,072

 
$
1,411,243

 
$
1,622,798

 
$
59,586

 
$
688,738

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
119,367,962

 
$
155,551,690

 
$
89,846,277

 
$
67,177,011

 
$
27,392,561

 
$
250,178,584

Ending balance: individually evaluated for impairment
$
6,842,132

 
$
7,095,195

 
$
5,956,407

 
$
1,386,245

 
$
308,053

 
5,715,403

Ending balance: collectively evaluated for impairment
$
112,525,830

 
$
148,456,495

 
$
83,889,870

 
$
65,790,766

 
$
27,084,508

 
$
244,463,181

 
 
 
 
 
 
 
 
 
 
 
 
  
Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
 
Overdraft protection
 
Unallocated
 
Total
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
55,192

 
$
501

 
$
623,266

 
$
10,910,000

 
 
 
 
Charge-offs
(22,759
)
 
(416
)
 
—

 
(3,222,495
)
 
 
 
 
Recoveries
587

 
21

 
—

 
1,373,864

 
 
 
 
Provision
66,251

 
582

 
(42,566
)
 
—

 
 
 
 
Ending balance
$
99,271

 
$
688

 
$
580,700

 
$
9,061,369

 


 
 
Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
83,792

 
$
—

 
$
—

 
$
2,933,509

 
 
 
 
Collectively evaluated for impairment
$
15,479

 
$
688

 
$
580,700

 
$
6,127,860

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,911,397

 
$
71,009

 
$
—

 
$
712,496,491

 
 
 
 
Ending balance: individually evaluated for impairment
$
88,143

 
$
—

 
$
—

 
$
27,391,578

 
 
 
 
Ending balance: collectively evaluated for impairment
$
2,823,254

 
$
71,009

 
$
—

 
$
685,104,913

 
 
 
 

87

 
 
 
Real Estate
2012
Commercial
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,946,528

 
$
1,426,135

 
$
2,733,263

 
$
1,070,309

 
$
345,770

 
$
2,223,506

Charge-offs
(835,052
)
 
(532,502
)
 
(2,239,163
)
 
(602,058
)
 
—

 
(134,015
)
Recoveries
66,848

 
151,068

 
196,526

 
74,382

 
—

 
119

Provision
571,317

 
1,316,006

 
854,689

 
859,815

 
(55,238
)
 
792,788

Ending balance
$
1,749,641

 
$
2,360,707

 
$
1,545,315

 
$
1,402,448

 
$
290,532

 
$
2,882,398

Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
814,300

 
$
740,003

 
$
635,110

 
$
626,677

 
$
113,094

 
$
512,762

Collectively evaluated for impairment
$
935,341

 
$
1,620,704

 
$
910,205

 
$
775,771

 
$
177,438

 
$
2,369,636

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
91,803,951

 
$
154,297,386

 
$
92,497,460

 
$
71,491,139

 
$
20,032,586

 
$
227,813,983

Ending balance: individually evaluated for impairment
$
2,873,169

 
$
9,172,773

 
$
5,614,836

 
$
1,497,695

 
$
2,218,625

 
$
5,984,697

Ending balance: collectively evaluated for impairment
$
88,930,782

 
$
145,124,613

 
$
86,882,624

 
$
69,993,444

 
$
17,813,961

 
$
221,829,286

 
 
 
 
 
 
 
 
 
 
 
 
  
Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
 
Overdraft protection
 
Unallocated
 
Total
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
27,099

 
$
4,370

 
$
153,020

 
$
9,930,000

 
 
 
 
Charge-offs
—

 
—

 
—

 
(4,342,790
)
 
 
 
 
Recoveries
2,456

 
258

 
—

 
491,657

 
 
 
 
Provision
25,637

 
(4,127
)
 
470,246

 
4,831,133

 
 
 
 
Ending balance
$
55,192

 
$
501

 
$
623,266

 
$
10,910,000

 
 
 
 
Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
24,410

 
$
—

 
$
—

 
$
3,466,356

 
 
 
 
Collectively evaluated for impairment
$
30,782

 
$
501

 
$
623,266

 
$
7,443,644

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
3,025,471

 
$
49,716

 
$
—

 
$
661,011,692

 
 
 
 
Ending balance: individually evaluated for impairment
$
141,811

 
$
21

 
$
—

 
$
27,503,627

 
 
 
 
Ending balance: collectively evaluated for impairment
$
2,883,660

 
$
49,695

 
$
—

 
$
633,508,065

 
 
 
 

88

 
 
 
Real Estate
2011
Commercial
 
Construction
 
Residential
 
Home
Equity
 
Multifamily
 
Commercial
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
919,774

 
$
1,931,797

 
$
2,114,094

 
$
2,443,275

 
$
146,923

 
$
1,308,073

Charge-offs
(907,116
)
 
(798,943
)
 
(983,445
)
 
(3,158,030
)
 
—

 
(276,361
)
Recoveries
55,398

 
65,100

 
196,478

 
367,442

 
—

 
10

Provision
1,878,472

 
228,181

 
1,406,136

 
1,417,622

 
198,847

 
1,191,784

Ending balance
$
1,946,528

 
$
1,426,135

 
$
2,733,263

 
$
1,070,309

 
$
345,770

 
$
2,223,506

Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,306,744

 
$
307,429

 
$
2,073,889

 
$
393,003

 
$
131,601

 
$
570,648

Collectively evaluated for impairment
$
935,341

 
$
1,620,704

 
$
910,205

 
$
775,771

 
$
177,438

 
$
2,369,636

Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
81,209,758

 
$
139,255,002

 
$
85,750,291

 
$
74,870,706

 
$
26,710,732

 
$
196,198,979

Ending balance: individually evaluated for impairment
$
6,631,666

 
$
14,011,766

 
$
9,250,139

 
$
1,947,178

 
$
2,302,727

 
$
7,829,251

Ending balance: collectively evaluated for impairment
$
74,578,092

 
$
125,243,236

 
$
76,500,152

 
$
72,923,528

 
$
24,408,005

 
$
188,369,728

 
 
 
 
 
 
 
 
 
 
 
 
  
Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
 
Overdraft protection
 
Unallocated
 
Total
 
 
 
 
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
84,384

 
$
466

 
$
89,014

 
$
9,037,800

 
 
 
 
Charge-offs
(960
)
 
(1,745
)
 
—

 
(6,126,600
)
 
 
 
 
Recoveries
12,447

 
2,038

 
—

 
698,913

 
 
 
 
Provision
(68,772
)
 
3,611

 
64,006

 
6,319,887

 
 
 
 
Ending balance
$
27,099

 
$
4,370

 
$
153,020

 
$
9,930,000

 
 
 
 
Ending balance
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
—

 
$
—

 
$
—

 
$
4,783,314

 
 
 
 
Collectively evaluated for impairment
$
30,782

 
$
501

 
$
623,266

 
$
7,443,644

 
 
 
 
Financing receivables:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
3,548,466

 
$
58,232

 
$
—

 
$
607,602,166

 
 
 
 
Ending balance: individually evaluated for impairment
$
20,364

 
$
—

 
$
—

 
$
41,993,091

 
 
 
 
Ending balance: collectively evaluated for impairment
$
3,528,102

 
$
58,232

 
$
—

 
$
565,609,075

 
 
 
 

A loan is considered impaired when, based on current information and events; it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. In addition to loans 90 days past due and still accruing and nonaccrual loans, all restructured loans, all loans risk graded doubtful or substandard and a portion of the loans risk graded special mention qualify, by definition, as impaired. Loans 90 days past due and still accruing totaling $472,052 and nonaccrual loans totaling $1,740,070 are included in impaired loans at December 31, 2013. Loans 90 days past due and still accruing totaling $152,880 and nonaccrual loans totaling $3,399,589 are included in impaired loans at December 31, 2012.

89

The following table summarizes our impaired loans at December 31, 2013 and 2012.

Impaired Loans
 
With No Related Allowance
 
Recorded
Investment
 
Unpaid Principal
Balance
 
Average Recorded
Investment
 
Interest Income
Recognized
December 31, 2013
 
 
 
 
 
 
 
Commercial
$
776,894

 
$
776,894

 
$
773,156

 
$
62,141

Real estate
 
 
 
 
 
 
 
Construction
4,790,328

 
4,790,328

 
5,211,772

 
287,107

Residential (1-4 family)
4,800,479

 
5,057,318

 
4,968,002

 
230,432

Home equity lines
666,794

 
714,083

 
714,644

 
4,062

Multifamily
308,053

 
308,053

 
325,385

 
21,972

Commercial
2,725,290

 
2,725,290

 
3,066,767

 
216,296

Consumers
 
 
 
 
 
 
 
Consumer and installment loans
4,351

 
5,543

 
10,700

 
—

Overdraft protection loans
—

 
—

 
—

 
—

Total
$
14,072,189

 
$
14,377,509

 
$
15,070,426

 
$
822,010

December 31, 2012
 
 
 
 
 
 
 
Commercial
$
825,394

 
$
825,394

 
$
760,792

 
$
62,110

Real estate
 
 
 
 
 
 
 
Construction
7,207,772

 
7,210,931

 
6,702,688

 
421,973

Residential (1-4 family)
2,100,256

 
2,168,389

 
2,306,738

 
86,691

Home equity lines
684,193

 
697,436

 
698,055

 
20,719

Multifamily
1,815,531

 
1,815,530

 
1,830,497

 
131,377

Commercial
525,941

 
525,941

 
461,961

 
32,586

Consumers
 
 
 
 
 
 
 
Consumer and installment loans
13,961

 
13,961

 
17,336

 
1,773

Overdraft protection loans
21

 
21

 
202

 
16

Total
$
13,173,069

 
$
13,257,603

 
$
12,778,269

 
$
757,245

 

90

 
With Related Allowance
 
Recorded
Investment
 
Unpaid Principal
Balance
 
Related
Allowance
 
Average Recorded
Investment
 
Interest Income
Recognized
December 31, 2013
 
 
 
 
 
 
 
 
 
Commercial
$
6,065,238

 
$
6,065,238

 
$
712,699

 
$
7,909,717

 
$
516,400

Real estate
 
 
 
 
 
 
 
 
 
Construction
2,304,867

 
2,336,216

 
736,248

 
2,336,327

 
108,594

Residential (1-4 family)
1,155,928

 
1,161,148

 
274,259

 
1,036,338

 
47,930

Home equity lines
719,451

 
719,451

 
510,118

 
720,206

 
41,035

Multifamily
—

 
—

 
—

 
—

 
—

Commercial
2,990,113

 
2,990,113

 
616,393

 
3,097,242

 
443,415

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
83,792

 
83,792

 
83,792

 
11,124

 
472

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Total
$
13,319,389

 
$
13,355,958

 
$
2,933,509

 
$
15,110,954

 
$
1,157,846

December 31, 2012
 
 
 
 
 
 
 
 
 
Commercial
$
2,047,775

 
$
2,063,051

 
$
814,300

 
$
2,216,832

 
$
98,773

Real estate
 
 
 
 
 
 
 
 
 
Construction
1,965,001

 
2,020,509

 
740,003

 
2,214,060

 
84,621

Residential (1-4 family)
3,514,580

 
3,543,639

 
635,110

 
3,540,771

 
205,329

Home equity lines
813,502

 
813,502

 
626,677

 
813,876

 
32,890

Multifamily
403,094

 
403,094

 
113,094

 
407,157

 
22,790

Commercial
5,458,756

 
5,558,755

 
512,762

 
3,803,834

 
486,785

Consumers
 
 
 
 
 
 
 
 
 
Consumer and installment loans
127,850

 
127,850

 
24,410

 
130,015

 
6,160

Overdraft protection loans
—

 
—

 
—

 
—

 
—

Total
$
14,330,558

 
$
14,530,400

 
$
3,466,356

 
$
13,126,545

 
$
937,348

Interest received in cash and recognized on impaired loans was $1,924,008, $1,694,593 and $3,056,490 for 2013, 2012 and 2011, respectively.
Restructured loans are loans for which it has been determined the borrower will not be able to perform under the original terms of the loan agreement and a concession has been made to those terms that would not otherwise have been considered. If the value of a restructured loan is determined to be less than the recorded investment in the loan, a valuation allowance is created with a corresponding charge-off to the allowance for loan losses and any collection of interest and principal are recorded as recoveries to the allowance for loan losses until all charged-off balances are fully recovered. Measurement of the value of a restructured loan is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Restructured loans are reevaluated periodically and additional adjustments to the carrying value may be made. In addition, if it is determined the borrower is unable to perform under the modified terms, further steps, such as a full charge-off or foreclosure may be taken. We did not have any commitments to lend additional funds on restructured loans at December 31, 2013 or 2012.
We currently have five loans classified as restructured loans; two residential 1-4 family loan for $263,624 and two commercial real estate loans for $4,568,883 and one consumer loan for $83,792. At December 31, 2013, all restructured loans, which total $4,716,299 are current. There were three loans restructured during the year ended December 31, 2013. We did not have any defaults on restructured loans within twelve months of restructuring during the years ended December 31, 2013 and 2012.

91

Additional information on restructured loans during the period is as follows:
Troubled Debt Restructurings
 
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
Year Ended December 31, 2013
3
 
$
5,356,097

 
$
3,485,320

Year Ended December 31, 2012
1
 
$
632,670

 
$
632,670

Troubled Debt Restructurings That Subsequently Defaulted
 
 
Number of
Contracts
  
Recorded
Investment
Year Ended December 31, 2013
None
  
$
—

$
—

Year Ended December 31, 2012
None
  
$
—

$
—

NOTE 5 – OTHER REAL ESTATE
Other real estate is real estate properties acquired through or in lieu of loan foreclosure. At foreclosure, these properties are recorded at their fair value less estimated selling costs as a nonperforming asset, with any write-downs to the carrying value of our investment charged to the allowance for loan loss. After foreclosure, periodic evaluations are performed to determine if any decrease in the fair value less estimated selling costs has occurred. Further adjustments to this fair value are charged to operations, in non-interest expense, when identified. Expenses associated with the maintenance of other real estate are charged to operations, as incurred. When a property is sold, any gain or loss on the sale is recorded as non-interest expense.
Information on other real estate:
 
 
2013
 
2012
 
2011
 
Balance
 
Number
 
Balance
 
Number
 
Balance
 
Number
January 1,
$
—

 
—

 
$
3,368,700

 
6

 
$
1,744,700

 
5

Balance moved into other real estate
397,037

 
2

 
725,075

 
3

 
5,359,004

 
15

 
397,037

 
2

 
4,093,775

 
9

 
7,103,704

 
20

Write down of property charged to operations
—

 
 
 
(592,575
)
 
 
 
(574,192
)
 
 
Payments received after foreclosure
—

 
 
 
—

 
 
 
—

 
 
Properties sold
(95,074
)
 
(1
)
 
(3,501,200
)
 
(9
)
 
(3,160,812
)
 
(14
)
Balance December 31,
$
301,963

 
1

 
$
—

 
—

 
$
3,368,700

 
6

Gross gains of sale of other real estate
$
—

 
 
 
$
186,744

 
 
 
$
195,533

 
 
Gross losses on sale of other real estate
(3,020
)
 
 
 
(34,788
)
 
 
 
(145,813
)
 
 
Write down of property charged to operations
—

 
 
 
(592,575
)
 
 
 
(574,192
)
 
 
Rental income, other real estate
—

 
 
 
10,030

 
 
 
—

 
 
Other real estate expense
(7,098
)
 
 
 
(72,080
)
 
 
 
(324,051
)
 
 
Foreclosed property expense
$
(10,118
)
 
 
 
$
(502,669
)
 
 
 
$
(848,523
)
 
 

 


92

NOTE 6 – PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31: 
 
2013
 
2012
Buildings
$
15,524,095

 
$
14,352,110

Land
7,747,480

 
7,748,480

Leasehold improvements
3,556,691

 
1,674,018

Equipment, furniture and fixtures
12,366,665

 
9,650,740

 
39,194,931

 
33,425,348

Less accumulated depreciation
(10,313,395
)
 
(7,977,793
)
Property and equipment, net
$
28,881,536

 
$
25,447,555

Depreciation expense of $2,424,478, $1,960,822 and $1,709,145 was included in occupancy and equipment expense for 2013, 2012 and 2011, respectively.
We have thirty-seven non-cancellable leases for premises. The lease terms are from one to thirty years and have various renewal dates. Rental expense was $3,964,392 , $3,420,539 and $2,776,355 in 2013, 2012 and 2011, respectively. Minimum lease payments for succeeding years pertaining to these non-cancellable operating leases are as follows:
 
 
 
2014
$
3,279,413

2015
2,468,050

2016
2,016,820

2017
1,964,643

2018
1,009,771

Thereafter
7,569,207

 
$
18,307,904

NOTE 7 – GOODWILL AND INTANGIBLE ASSETS
On August 10, 2007, we acquired a Maryland mortgage office plus certain other mortgage related assets from Resource Bank (now Fulton Bank), a Virginia Beach based bank owned by Fulton Financial of Lancaster, Pennsylvania. The assets and results of operations have been included in the consolidated financial statements since that date. The aggregate purchase price was $2.1 million including legal expenses of $53,000. The intangible assets have a weighted-average useful life of seven years.
Information concerning intangible assets and goodwill attributable to the Maryland mortgage office acquired on August 10, 2007 is presented in the following table:
 
 
December 31,
 
Acquisition
 
2013
 
2012
 
Cost
Amortizable intangible assets, net
$
104,167

 
$
282,739

 
$
1,250,000

Goodwill
775,000

 
775,000

 
775,000

Amortization expense
178,572

 
178,572

 
 
 
Estimated Amortization Expense:
 
For the year ended 12/31/2014
104,167

 
$
104,167

Annual impairment review indicated that goodwill was not impaired in 2013 or 2012.







93

NOTE 8 – RESTRICTED EQUITY SECURITIES
Restricted equity securities are securities that do not have a readily determinable fair value and lack a market. Therefore, they are carried at cost. The following table represents balances as of December 31, 2013 and 2012, respectively:
 
 
2013
 
2012
Federal Reserve Bank Stock
$
2,034,550

 
$
2,122,100

Federal Home Loan Bank Stock
1,515,000

 
10,107,400

Community Bankers Bank Stock
133,700

 
133,700

Total restricted equity securities
$
3,683,250

 
$
12,363,200

As a member bank our stock requirement with the Federal Reserve is based on our capital levels as reported on the most recent filing of our Consolidated Reports of Condition and Income and is subject to change when our capital levels increase or decrease. Our stock requirements with the Federal Home Loan Bank consists of two levels; membership stock based on total assets as of December 31st of each year and collateral stock based on our highest borrowing levels which is evaluated for release on a periodic basis. The stock we hold with Community Bankers Bank is membership stock.
NOTE 9 – DEPOSITS
Interest-bearing deposits for the years ending December 31, 2013 and December 31, 2012 are as follows: 
 
2013
 
2012
Interest bearing demand
$
55,527,954

 
$
65,368,503

Money market accounts
374,461,494

 
335,898,654

Savings accounts
22,137,321

 
22,127,493

Certificates of deposit $100,000 and over
174,759,703

 
205,147,049

Other time deposits
59,340,519

 
83,119,678

Total interest-bearing deposits
$
686,226,991

 
$
711,661,377

Scheduled maturities for time deposits as of December 31, 2013 are as follows: 
 
 
Year Maturing
 
2014
$
168,213,434

2015
43,978,333

2016
14,312,740

2017
6,653,228

2018
942,487

Thereafter
—

 
$
234,100,222

Brokered money market balances included in money markets totaled $44,636,438 and $46,050,329 at December 31, 2013 and 2012, respectively. CDARS balances included in certificates of deposit $100,000 and over totaled $59,135,288 and $101,094,466 at year end 2013 and 2012, respectively.
NOTE 10 – BORROWINGS
We have federal funds arrangements with five financial institutions that provide approximately $61.0 million of unsecured short-term borrowing capacity. As of December 31, 2013 and 2012, there were no outstanding balances on these federal funds lines of credits. Information concerning federal funds purchased is summarized, as follows: 
 
2013
 
2012
Average balance during the year
$
32,161

 
$
516,624

Average interest rate during the year
0.79
%
 
0.79
%
Maximum month end balance during the year
$
—

 
$
4,350,000



94

We are a member of the Federal Home Loan Bank of Atlanta (“FHLB”) and as such, we may borrow funds based on criteria established by the FHLB. We are allowed under our lines of credit to borrow up to 30% of assets, or approximately $303,994,645, if collateralized, as of December 31, 2013. We have two borrowing programs with FHLB. Under our primary program, we have pledged blanket liens on our portfolio of 1-4 family residential loans, our home equity lines of credit/loans portfolio, and on qualifying commercial real estate loans. Additionally, investment securities with collateral fair values of $126,312 at December 31, 2013 and $170,608 at December 31, 2012 were also pledged to secure any advances. In February 2009, we negotiated an additional line of credit with FHLB that is secured by a portion of our loans held for sale (“LHFS”). We pledge these loans, which have been sold to FHLB approved investors, as collateral. In return, we are allowed to borrow up to 92% of these loans for 120 days.
As of December 31, 2013, we could borrow approximately $97.8 million, and as of December 31, 2012, we could borrow approximately $85.8 million, under our primary line, based upon collateral pledged. In both years, this line is reduced by $8.0 million, which has been pledged as collateral for public funds. In addition, we had one fixed rate advance outstanding on the line of $1,175,485 at December 31, 2013 and $1,275,462 at December 31, 2012
The fixed rate advance, which totaled $1,175,485 in 2013 and $1,275,462 in 2012, matures September 28, 2015, bears a fixed interest rate of 4.96% throughout the term and was utilized to match fund ten-year amortizing loans to clients.
We could borrow up to $46.8 million under our LHFS line at December 31, 2013 and $220.9 million at December 31, 2012. We had total borrowings of $0 and $193,023,061 at December 31, 2013 and 2012, respectively. The 2012 advance, which was repaid on March 31, 2013, had a variable interest rate that was 0.86% as of December 31, 2012.
Should we ever desire to increase the line of credit beyond the 30% limit, the FHLB would allow borrowings of up to 40% of total assets once we met specific eligibility criteria.
Other information concerning FHLB advances is summarized below:
 
 
2013
 
2012
Average balance during the year
$
48,423,774

 
$
40,770,115

Average interest rate during the year
0.63
%
 
0.93
%
Maximum month end balance during the year
$
148,217,804

 
$
194,298,523


In June 2012, Monarch Financial Holdings, Inc., secured a short term holding company line of credit from PNC Bank of Pittsburgh, PA in the amount of $5.0 million, which expired June 7, 2013. The line was held at the holding company level and was used as a capital infusion into the Bank which qualified as Tier 1 capital for the Bank. PNC Bank renewed the line for six months until December 7, 2013. However, Monarch chose not to utilize the line and did not seek renewal in December.
    
NOTE 11 – TRUST PREFERRED SUBORDINATED DEBT
Monarch Financial Holdings Trust is a wholly-owned special purpose finance subsidiary of Monarch Financial Holdings, Inc., operating in the form of a grantor trust (the Trust). The Trust was created in June 2006 to issue capital securities and remit the proceeds to the Company. We are the sole owner of the common stock securities of the Trust. On July 5, 2006 the Trust issued 10,000 shares of preferred stock capital securities with a stated value of $1,000 per share, bearing a variable dividend rate, reset per quarter, equal to 90 day LIBOR plus 1.60%. The Trust securities have a mandatory redemption date of September 30, 2036, and were subject to varying call provisions at our option beginning September 30, 2011.
We unconditionally guarantee the stated value of the Trust preferred stock on a subordinated basis. Through an inter-company lending transaction, proceeds received by the Trust from the sale of securities were lent to the Company for general corporate purposes.
The Trust preferred stock is senior to our common stock in event of claims against Monarch, but is subordinated to all senior and subordinated debt securities. The shares of the Trust preferred stock are capital securities, which are distinct from the common stock or preferred stock of the Company, and the dividends thereon are tax-deductible. Dividends accrued for payment by the Trust are classified as interest expense on long-term debt in our consolidated statement of income. The Trust preferred stock is shown as “Trust preferred subordinated debt” and classified as a liability in the consolidated balance sheets.


95

NOTE 12 – DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
We entered into an interest rate swap agreement with PNC Bank (“PNC”) of Pittsburgh, PA on July 29, 2009, for our $10,000,000 Trust preferred borrowing, which carries a floating interest rate of 90 day LIBOR plus 160 basis points. The terms of this hedge allows us to mitigate our exposure to interest-rate fluctuations by swapping our floating rate obligation for a fixed rate obligation. The notional amount of the swap agreement is $10,000,000, and has an expiration date of September 30, 2014. Under the terms of our agreement, at the end of each quarter we will swap our floating rate for a fixed rate of 3.26%. Including the additional 160 basis points, the effective fixed rate of interest cost will be 4.86% on our $10,000,000 Trust Preferred borrowing for five years.
The fixed-rate payment feature of this swap is structured to mirror the provisions of the hedged borrowing agreement. This swap qualifies as a cash flow hedge and the underlying liability is carried at fair value in other liabilities, with the tax-effective changes in the fair value of the instrument included in Stockholders’ Equity in accumulated other comprehensive income (loss).
Our credit exposure, if any, on the interest rate swap is limited to the net favorable value (net of any collateral pledged) and interest payments of the swap by the counterparty. Conversely, when an interest rate swap is in a liability position we are required to have collateral on deposit at PNC which is evaluated daily and adjusted based on the fair value of the hedge on the last day of the month. The fair value of this swap instrument was a liability of approximately $225,000 and $512,000 at December 31, 2013 and 2012, respectively. Our collateral requirement on December 31, 2013 and 2012 was $250,000 and $525,000, respectively.
At various times, when the market is favorable, we participate in a “mandatory” delivery program for a portion of our mortgage loans. Under the mandatory delivery program, we commit to deliver a block of loans to an investor at a preset cost prior to the close of such loans. This differs from a “best efforts” delivery, which sets the cost to the investor on a loan by loan basis at the close of the loan. Mandatory delivery creates a higher level of risk for us because it relies on rate lock commitments rather than closed loans, thereby exposing the Company to fluctuations in interest rate and pricing. A rate lock commitment is a binding commitment for us but is not binding to the client. Our client could decide, at any time, between the time of the rate lock and actual closing on their mortgage loan, not to proceed with the commitment. There is a higher occurrence of this during periods of volatility.
To mitigate this risk, we pair the rate lock commitment with the sale of a notional security bearing similar attributes. At the time the loan is delivered to the investor, matched securities are repurchased. Any gains or losses associated with this pairing are recorded in mortgage banking income on our income statement as incurred. Our board approved “mandatory” deliver policy will only allow us to commit $50,000,000 to the program at any given time. We utilize the services of Capital Markets Cooperative (“CMC”) of Ponte Vedra Beach, Florida to help monitor and manage our rate lock activities in this program.
Although, we have board approval to participate in a mandatory delivery program, we did not participate in such a program in 2013 or 2012. We did, however participate in the program early in 2011 but withdrew from the program due to market volatility. Losses associated with the mandatory delivery program in 2011 were $153,000.
NOTE 13 – PUBLIC OFFERING OF PREFERRED STOCK
In November 2009, based on our filing of Form S-1 with the Securities and Exchange Commission, we received formal approval from the Commission to register up to 800,000 shares of Series B noncumulative convertible perpetual preferred stock with a per share dividend rate of 7.80%. On November 30, 2009, we issued and sold 800,000 shares Series B noncumulative convertible perpetual preferred stock at $25.00 per share in a public offering. Proceeds and costs were as follows:
 
Date
Shares Placed
 
Per
Share
Price
 
Offering Proceeds
November 30, 2009
800,000

 
$
25.00

 
$
20,000,000

Less underwriter discount
 
 
 
 
(1,169,275
)
Less other expenses
 
 
 
 
(422,629
)
Net Proceeds
 
 
 
 
$
18,408,096

This stock was convertible at the option of the shareholder into 3.75 shares of common stock (which reflects a split adjusted original conversion price of $6.67 per share of common stock), subject to some adjustments. It also carried a convertible option for the Company that could be exercised if for 20 trading days within any period of 30 consecutive trading days, the closing price of common stock exceeded 130% of the then applicable conversion price (split adjusted price $8.67).

96

The Series B preferred stock was also redeemable by us, in whole or in part, on or after the third anniversary of the issue date, or November 30, 2012, for the liquidation amount of $25.00 per share plus any undeclared and unpaid dividends.
In June 2012, holders of our Series B preferred stock began exercising their option to convert to common stock. On March 8, 2013, the Company force converted all remaining shares of Series B preferred stock. At March 31, 2013, there were no remaining shares of Series B preferred stock outstanding. The table below summarizes conversion activity. There were no dividends paid on Series B preferred stock in 2013. Dividends declared on the outstanding shares of Series B noncumulative convertible perpetual preferred stock were $1,402,532 in 2012.
 
 
(a)
 
(b)
 
(c)
 
(d)
Period
 
Total Number of Shares of Preferred Stock Converted to Common Stock
 
Total Number of Shares of Common Stock After Conversion
 
Total Number of Preferred Shares Remaining to Convert
 
Maximum Number of Post Conversion Whole Shares Remaining That May Yet Be Converted
2013
 
 
 
 
 
 
 
 
March 1, 2013 - March 8, 2013
 
271,020

 
1,016,312

 
—

 
—

February 1, 2013 - February 28, 2013
 
172,074

 
645,264

 
271,020

 
1,016,325

January 1, 2013 - January 31, 2013
 
38,029

 
142,608

 
443,094

 
1,661,602

2012
 
 
 
 
 
 
 
 
December 1, 2012 - December 31, 2012
 
6,966

 
26,121

 
481,123

 
1,804,211

November 1, 2012 - November 30, 2012
 
147,456

 
552,959

 
488,089

 
1,830,333

October 1, 2012 - October 31, 2012
 
153,355

 
575,073

 
635,545

 
2,383,293

June 1, 2012 - June 30, 2012
 
11,100

 
41,623

 
788,900

 
2,958,375


NOTE 14 – INCOME TAXES
The principal components of income tax benefit (expense) for 2013, 2012 and 2011 are as follows:
 
 
2013
 
2012
 
2011
Current
 
 
 
 
 
Federal
$
(4,828,782
)
 
$
(7,817,250
)
 
$
(3,757,662
)
State
(474,564
)
 
(477,209
)
 
(363,556
)
Equity adjustment
(233,634
)
 
(27,120
)
 
6,954

 
(5,536,980
)
 
(8,321,579
)
 
(4,114,264
)
Deferred
 
 
 
 
 
Federal
(846,636
)
 
884,082

 
651,458

State
(2,424
)
 
10,712

 
44,114

 
(849,060
)
 
894,794

 
695,572

Total
 
 
 
 
 
Federal
(5,675,418
)
 
(6,933,168
)
 
(3,106,204
)
State
(476,988
)
 
(466,497
)
 
(319,442
)
Equity adjustment
(233,634
)
 
(27,120
)
 
6,954

 
$
(6,386,040
)
 
$
(7,426,785
)
 
$
(3,418,692
)

97

Differences between income tax expense calculated at the statutory rate and that shown in the statement of income for 2013, 2012 and 2011 are summarized, as follows:
 
 
2013
 
2012
 
2011
Federal income tax expense at statutory rate
$
(6,116,966
)
 
$
(7,088,077
)
 
$
(3,314,026
)
Tax effect of:
 
 
 
 
 
Income taxed at 35%
—

 
—

 
(427,353
)
BOLI cash surrender value (decrease) increase
82,732

 
79,413

 
206,596

Meals and entertainment
(115,058
)
 
(160,890
)
 
(111,522
)
State and local income taxes
(321,475
)
 
(297,768
)
 
(191,894
)
Other
84,727

 
40,537

 
419,507

Income tax expense
$
(6,386,040
)
 
$
(7,426,785
)
 
$
(3,418,692
)

We have the following deferred tax assets and liabilities at December 31, 2013, 2012 and 2011:
 
 
December 31,
 
2013
 
2012
 
2011
Deferred tax assets:
 
 
 
 
 
Bad debt provision
$
3,320,139

 
$
3,967,692

 
$
3,632,576

Available for sale securities
225,883

 
103,042

 
187,014

Deferred gain on sale/leaseback
—

 
—

 
59,794

Deferred compensation
651,386

 
483,580

 
404,432

Reserve for available for sale loan repurchase
1,162,199

 
1,237,049

 
726,568

Premium amortization on securities
8,557

 
734

 
—

Other
744,806

 
588,690

 
676,219

Total deferred tax assets
6,112,970

 
6,380,787

 
5,686,603

Deferred tax liabilities:
 
 
 
 
 
Fixed assets
(1,644,419
)
 
(1,207,059
)
 
(1,337,824
)
Premium amortization on securities
—

 
—

 
(5,424
)
Other
(129,781
)
 
(108,739
)
 
(89,187
)
Total deferred tax liabilities
(1,774,200
)
 
(1,315,798
)
 
(1,432,435
)
Net deferred tax assets
$
4,338,770

 
$
5,064,989

 
$
4,254,168

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax basis. Deferred tax assets and 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 in income. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. Management has evaluated the effect of the guidance provided by U.S. GAAP on Accounting for Uncertainty in Income Taxes, and all other tax positions that could have a significant effect on the financial statements and determined the Company had no uncertain material income tax positions at December 31, 2013.
We file income tax returns in the U.S. federal jurisdiction and the states of Virginia, Maryland, North Carolina and South Carolina. With few possible exceptions, we are no longer subject to U.S. or state income tax examinations by tax authorities for the years prior to 2010.
NOTE 15 – COMMITMENTS AND CONTINGENCIES
We have outstanding at any time a significant dollar amount of commitments to extend credit. To accommodate major customers, we also provide standby letters of credit and guarantees to third parties. Those arrangements are subject to strict credit control assessments. Guarantees and standby letters of credit specify limits to our obligations. The amounts of loan commitments, guarantees and standby letters of credit are set out in the following table as of December 31, 2013 and 2012. Because many commitments and almost all standby letters of credit and guarantees expire without being funded, in whole or in part, the contract amounts are not estimates of future cash flows. The majority of commitments to extend credit have terms up to one year. Interest rates on fixed-rate commitments range from 2.5% to 21.0%. All of the guarantees written and the standby letters of credit at December 31, 2013 expire during 2014.
 

98

 
Commitments
 
2013
 
2012
Commitments to grant loans
$
167,944,704

 
$
291,113,496

Unfunded commitments under lines of credit and similar arrangements
$
237,888,071

 
$
213,204,295

Standby letters of credit and guarantees written
$
19,925,081

 
$
19,281,230

Loan commitments, standby letters of credit and guarantees written have off-balance-sheet credit risk because only origination fees and accruals for probable losses, if any, are recognized in the statement of financial position, until the commitments are fulfilled or the standby letters of credit or guarantees expire. Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. The credit risk amounts are equal to the contractual amounts, assuming that the amounts are fully advanced and that, in accordance with the requirements of FASB guidance for Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, collateral or other security is of no value. Our policy is to require customers to provide collateral prior to the disbursement of approved loans. For retail loans, we usually retain a security interest in the property or products financed, which provides repossession rights in the event of default by the customer. For business loans and financial guarantees, collateral is usually in the form of inventory or marketable securities (held in trust) or property (notations on title).
Concentrations of credit risk relative to capital (whether on or off balance sheet) arising from financial instruments exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. At December 31, 2013, we had two loan concentrations which exceeded 10% in the area of loans to borrowers who are principally engaged in acquisition, development and construction of 1-4 single family homes and developments and to residential home owners with equity lines. A geographic concentration arises because we operate primarily in southeastern Virginia.
The credit risk amounts represent the maximum accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted and any collateral or security proved to be of no value. We have experienced little difficulty in accessing collateral when required. The amounts of credit risk shown, therefore, greatly exceed expected losses, which are included in the allowance for loan losses.
Various legal claims also arise from time to time in the normal course of business that, in the opinion of management, will have no material effect on our consolidated financial statements.
NOTE 16 – STOCK COMPENSATION AND BENEFIT PLANS
In May 2006, our shareholders approved the adoption of a new stock-based compensation plan to succeed the 1999 Incentive Stock Plan ("99ISO"). The 2006 Equity Incentive Plan (“2006EIP”) authorizes the compensation committee to grant options, stock appreciation rights, stock awards, performance stock awards, and stock units to designated directors, officers, key employees, consultants and advisors to the Company and its subsidiaries. The Plan authorizes us to issue up to 756,000 split-issue adjusted shares of Company Common Stock plus the number of shares of Company Common Stock outstanding under the 1999 Plan. The Plan also provides that no award may be granted more than 10 years after the May 2006 ratification date. On September 18, 2006, we issued the first stock awards under the new Plan at a price equal to the stock price on that date with vesting periods of up to three years from issue. Total compensation costs will be recognized over the service period to vesting. At December 31, 2013, there were 212,920 shares available for issue under the plan.
The following is a summary of our stock option activity, and related information. All shares and per share prices have been restated for stock splits and dividends in the years presented:
 

99

 
2013
 
2012
Options
Number
of
Options
 
Weighted
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
 
Number
of
Options
 
Weighted
Average
Exercise
Price
Outstanding - Beginning of year
261,880

 
6.70

 
 
 
306,956

 
6.64

Granted
—

 
—

 
 
 
—

 
—

Exercised
(115,359
)
 
5.49

 
 
 
(36,660
)
 
5.96

Forfeited
—

 
—

 
 
 
(8,416
)
 
7.53

Outstanding - End of year
146,521

 
7.65

 
$
683,194

 
261,880

 
6.70

Options exercisable at year-end
146,521

 
7.65

 
$
683,194

 
227,747

 
6.70

Weighted average fair value per option granted during year
 
 
—

 
 
 
 
 
 
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for those awards that have an exercise price currently below the closing price. There were 115,359 options exercised during the year ended December 31, 2013 and 36,660 options exercised during the year ended December 31, 2012. The total intrinsic value of options exercised during the year ended December 31, 2013 was $683,194. No options were granted under the plan in 2013 or 2012. All options granted in relation to the 99ISO plan are fully vested.

Cash received for option exercise under share-based payment arrangements for 2013 and 2012 was $633,737 and $202,749, respectively. Tax benefits of $261,423 and $42,893 were recognized in 2013 and 2012, respectively.
Other information pertaining to options outstanding at December 31, 2013 is as follows:
 
Range of
Exercise Prices
Number
Outstanding
 
Remaining
Contractual
Life
 
Average
Exercise
Price
$6.78 to $7.85
146,521

 
1.18
 
$
7.65

A summary of the status of the our non-vested shares in relation to our restricted stock awards as of December 31, 2013 and 2012, and changes during the years ended December 31, 2013 and 2012, is presented below; the weighted average price is the weighted average fair value at the date of grant:
 
 
2013
 
2012
Restricted Share Awards
Shares
 
Weighted
Average
Price
 
Shares
 
Weighted
Average
Price
Non-vested - Beginning of year
393,388

 
$
7.11

 
310,788

 
$
6.52

Granted
6,500

 
11.08

 
151,000

 
8.25

Vested
(72,528
)
 
7.60

 
(38,400
)
 
6.52

Forfeited
(4,600
)
 
6.20

 
(30,000
)
 
7.18

Non-vested - End of year
322,760

 
$
7.10

 
393,388

 
$
7.11

Compensation expense related to the restricted stock awards was $621,511, $413,855 and $323,307 for 2013, 2012 and 2011, respectively. The total fair value of awards vested during 2013 and 2012 was $460,266 and $215,400, respectively. As of December 31, 2013 and 2012, there was $1,372,000 and $1,943,721, respectively, of total unrecognized cost related to the non-vested share-based compensation arrangements granted under the 2006EIP. That cost is expected to be recognized over a weighted-average period of 2.6 years. The grant date fair value of common stock is used in determining unused compensation cost.
Other information pertaining to restricted stock at December 31, 2013 is as follows: 
Range of Issuance Prices
Number
Outstanding
 
Remaining
Contractual
Life
$5.21 to $11.25
322,760

 
2.65
We have a 401(k) defined contribution plan applicable to all eligible employees. Contributions to the plan are made at the employee’s election. Employees may contribute up to 91% of their salaries up to IRS limits. We began making contributions in

100

April 2001. We matched 50% of the first 6.0% of employee contributions in 2013, 2012 and 2011. Our expense for 2013, 2012 and 2011 was $960,102, $906,449 and $623,414, respectively.
In addition, Monarch has supplemental retirement benefits provided to its executives under a supplemental executive retirement plan ("SERP") executed in 2006. Although technically unfunded, insurance policies on the lives of the covered executives are available to finance future benefits. The Bank is the owner and beneficiary of these policies. The expense for 2013 and 2012 was $277,779 and $306,118, respectively. Total expected expense for 2013 is $322,080. The following were significant actuarial assumptions used to determine benefit obligations:
 
 
December 31, 2013
 
December 31, 2012
Actuarial Assumptions
 
 
 
 
Weighted average assumed discount rate
 
4.50
%
 
5.85
%
 
 
 
 
 
Changes in Projected Benefit Obligation
 
 
 
 
Projected benefit obligation, January 1
 
$
1,329,703

 
$
1,105,553

Service cost
 
210,729

 
232,630

Interest cost
 
67,070

 
73,488

Actuarial loss due to change in discount rate
 
220,271

 
—

Benefits paid
 
(50,000
)
 
(81,968
)
Projected benefit obligation, December 31,
 
$
1,777,773

 
$
1,329,703

 
 
 
 
 
Amounts Recognized in Accumulated Other Comprehensive Income
 
 
 
 
Actuarial loss due to change in discount rate
 
$
(214,331
)
 
$
—

Deferred income tax benefit
 
75,016

 
—

 
 
$
(139,315
)
 
$
—

The SERP liability, equal to the projected benefit obligation above, is included in other liabilities on the Company's consolidated balance sheet. SERP payments for executives or their beneficiaries are in pre-determined fixed annual payments that begin at age 65 and continue for 10 years.
NOTE 17 – RELATED PARTY TRANSACTIONS
We have loan transactions with our executive officers and directors, and with companies in which our executive officers and directors have a financial interest. Management believes these transactions occurred in the ordinary course of business on substantially the same terms as those prevailing at the time for persons not related to the lender. A summary of related party loan activity is as follows during 2013 and 2012.
 
 
2013
 
2012
Outstanding - Beginning of year
$
24,639,539

 
$
25,060,525

Originations
16,609,938

 
15,516,626

Repayments
(14,734,734
)
 
(15,937,612
)
Outstanding - End of year
$
26,514,743

 
$
24,639,539


Commitments to extend credit and letters of credit to related parties amounted to $11,769,918 and $8,221,267 at December 31, 2013 and 2012, respectively.
At December 31, 2013 and 2012 total deposits held by related parties were $6,286,588 and $8,340,140, respectively.
NOTE 18 – REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve

101

quantitative measures of the bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors.
The Bank, as a Virginia banking corporation, may only pay dividends from retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the Bank. Regulatory agencies place certain restrictions on dividends paid and loans and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. At December 31, 2013, the amount available was approximately $26.0 million. Loans and advances are limited to 10% of the Bank’s common stock and capital surplus. As of December 31, 2013, funds available for loans or advances by the Bank to the Company were approximately $9.8 million.
Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2013, the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2013 the Bank was categorized as “well capitalized”, the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. The Company is also subject to certain capital adequacy ratio requirements. The Company and Bank’s actual capital amounts and ratios are also presented in the table as of December 31, 2013 and 2012.
 
Actual
 
For Capital
Adequacy
Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Action
 
Amounts
 
Ratio
 
Amounts
 
Ratio
 
Amounts
 
Ratio
 
(Dollars in Thousands)
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Total Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
116,120

 
13.91
%
 
$
66,783

 
8.00
%
 
N/A

 
N/A

Bank
$
116,340

 
13.95
%
 
$
66,718

 
8.00
%
 
$
83,397

 
10.00
%
(Total Risk-Based Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,059

 
12.82
%
 
$
33,391

 
4.00
%
 
N/A

 
N/A

Bank
$
107,279

 
12.86
%
 
$
33,359

 
4.00
%
 
$
50,038

 
6.00
%
(Tier 1 Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,059

 
10.81
%
 
$
39,600

 
4.00
%
 
N/A

 
N/A

Bank
$
107,279

 
10.84
%
 
$
39,600

 
4.00
%
 
$
49,501

 
5.00
%
(Tier 1 Capital to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Total Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
107,138

 
12.05
%
 
$
71,154

 
8.00
%
 
N/A

 
N/A

Bank
$
113,179

 
12.73
%
 
$
71,119

 
8.00
%
 
$
88,899

 
10.00
%
(Total Risk-Based Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Capital Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
96,484

 
10.85
%
 
$
35,557

 
4.00
%
 
N/A

 
N/A

Bank
$
102,525

 
11.53
%
 
$
35,559

 
4.00
%
 
$
53,339

 
6.00
%
(Tier 1 Capital to Risk-Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated Company
$
96,484

 
8.29
%
 
$
46,535

 
4.00
%
 
N/A

 
N/A

Bank
$
102,525

 
8.81
%
 
$
46,535

 
4.00
%
 
$
58,169

 
5.00
%
(Tier 1 Capital to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
NOTE 19 – FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair Value Hierarchy and Fair Value Measurement

102

We group our assets and liabilities that are recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
•
Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
•
Level 2 – Valuations based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
•
Level 3 – Valuations based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Valuations are determined using pricing models and discounted cash flow models and includes management judgment and estimation which may be significant.
The methods we use to determine fair value on an instrument specific basis are detailed in the section titled “Valuation Methods” below.
The following table presents the carrying amounts and fair value of our financial instruments at December 31, 2013 and December 31, 2012. GAAP defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than through a forced or liquidation sale for purposes of this disclosure. The carrying amounts in the table are included in the consolidated balance sheet under the indicated captions.

Estimation of Fair Values 
 
Fair Value Measurements at December 31, 2013 using
 
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable
Inputs
 
Significant
Unobservable
Inputs 
 
 
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
104,911,322

 
$
104,911,322

 
$
—

 
$
—

 
$
104,911,322

Investment securities available for sale
48,821,760

 
—

 
48,821,760

 
—

 
48,821,760

Loans held for sale
99,717,785

 
—

 
99,717,785

 
—

 
99,717,785

Loans held for investment (net)
703,610,098

 
—

 
—

 
716,133,189

 
716,133,189

Accrued interest receivable
2,152,132

 
—

 
2,152,132

 
—

 
2,152,132

Restricted equity securities
3,683,250

 
—

 
3,683,250

 
—

 
3,683,250

Bank owned life insurance
7,409,436

 
—

 
7,409,436

 
—

 
7,409,436

Liabilities
 
 
 
 
 
 
 
 
 
Deposits
$
893,118,490

 
$
—

 
$
889,702,779

 
$
—

 
$
889,702,779

Borrowings
11,175,485

 
—

 
11,259,958

 
—

 
11,259,958

Accrued interest payable
58,404

 
—

 
58,404

 
—

 
58,404

Derivative financial liability
225,442

 
—

 
225,442

 
—

 
225,442


103

 
Fair Value Measurements at December 31, 2012 using
 
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable
Inputs
 
Significant
Unobservable
Inputs 
 
 
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
57,774,578

 
$
57,774,578

 
$
—

 
$
—

 
$
57,774,578

Investment securities available for sale
14,633,733

 
—

 
14,633,733

 
—

 
14,633,733

Loans held for sale
419,075,089

 
—

 
419,075,089

 
—

 
419,075,089

Loans held for investment (net)
650,184,162

 
—

 
—

 
662,330,624

 
662,330,624

Accrued interest receivable
1,959,010

 
—

 
1,959,010

 
—

 
1,959,010

Restricted equity securities
12,363,200

 
—

 
12,363,200

 
—

 
12,363,200

Bank owned life insurance
7,173,059

 
—

 
7,173,059

 
—

 
7,173,059

Liabilities
 
 
 
 
 
 
 
 
 
Deposits
$
901,781,872

 
$
—

 
$
897,568,108

 
$
—

 
$
897,568,108

Borrowings
209,298,523

 
—

 
209,429,217

 
—

 
209,429,217

Accrued interest payable
230,057

 
—

 
230,057

 
—

 
230,057

Derivative financial liability
511,923

 
—

 
511,923

 
—

 
511,923

The following notes summarize the significant assumptions used in estimating the fair value of financial instruments:
Short-term financial instruments are valued at their carrying amounts included in the Company’s balance sheet, which are reasonable estimates of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents and overnight borrowings.
Loans held for sale are recorded at their fair value when originated, based on our expected return from the secondary market.
Loans held for investment are valued on the basis of estimated future receipts of principal and interest, which are discounted at various rates. Loan prepayments are assumed to occur at the same rate as in previous periods when interest rates were at levels similar to current levels. Future cash flows for homogeneous categories of consumer loans, such as motor vehicle loans, are estimated on a portfolio basis and discounted at current rates offered for similar loan terms to new borrowers with similar credit profiles.
The carrying amounts of accrued interest approximate fair value.
Restricted equity securities are recorded at cost, which approximates fair value based on the redemption provisions of each entity.

Bank owned life insurance represents insurance policies on officers of the Bank. The cash values of the policies are estimated using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.
The fair value of demand deposits and deposits with no defined maturity is taken to be the amount payable on demand at the reporting date. The fair value of fixed-maturity deposits is estimated using rates currently offered for deposits of similar remaining maturities. The intangible value of long-term relationships with depositors is not taken into account in estimating the fair values disclosed.
The fair value of all borrowings is based on discounting expected cash flows at the interest rate of debt with the same or similar remaining maturities and collateral requirements.
Derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our credit risk and the counterparties' credit quality in determining the fair value of the derivative. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (LIBOR) observable market prices for LIBOR swap rates, and three month LIBOR basis spreads at commonly quoted intervals. Our derivative financial liability consists of an interest rate swap that qualifies as a cash flow hedge.

104

It is not practicable to separately estimate the fair values for off-balance-sheet credit commitments, including standby letters of credit and guarantees written, due to the lack of cost-effective reliable measurement methods for these instruments.
The following table presents our assets and liabilities, which are measured at fair value on a recurring basis for each of the fair value hierarchy levels, as of December 31, 2013 and December 31, 2012:
 
 
Fair Value Measurements at Reporting Date Using
 
Fair Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs (Level 3)
Description
 
 
 
 
 
 
 
Assets at December 31, 2013
 
 
 
 
 
 
 
Investment securities - available for sale
 
 
 
 
 
 
 
U.S. government agency obligations
$
45,345,911

 
$
—

 
$
45,345,911

 
$
—

Mortgage-backed securities
1,567,161

 
—

 
1,567,161

 
—

Municipal securities
1,908,688

 
—

 
1,908,688

 
—

Corporate debt securities
—

 
—

 
—

 
—

Loans held for sale
99,717,785

 
—

 
99,717,785

 
—

Derivative financial liability
$
225,442

 
$
—

 
$
225,442

 
$
—

Assets at December 31, 2012
 
 
 
 
 
 
 
Investment securities - available for sale
 
 
 
 
 
 
 
U.S. government agency obligations
$
10,573,842

 
$
—

 
$
10,573,842

 
$
—

Mortgage-backed securities
2,031,894

 
—

 
2,031,894

 
—

Municipal securities
1,522,212

 
—

 
1,522,212

 
—

Corporate debt securities
505,785

 
—

 
505,785

 
—

Loans held for sale
419,075,089

 
—

 
419,075,089

 
—

Derivative financial liability
$
511,923

 
$
—

 
$
511,923

 
$
—

The following table provides quantitative disclosures about the fair value measurements of our assets related to continuing operations which are measured at fair value on a nonrecurring basis as of December 31, 2013 and 2012:
 
 
Fair Value Measurements at Reporting Date Using
Description
Fair Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs (Level 3)
At December 31, 2013
 
 
 
 
 
 
 
Real estate owned
$
301,963

 
$
—

 
$
—

 
$
301,963

Restructured and impaired loans
$
10,385,880

 
$
—

 
$
—

 
$
10,385,880

At December 31, 2012
 
 
 
 
 
 
 
Real estate owned
$
—

 
$
—

 
$
—

 
$
—

Restructured and impaired loans
$
10,864,202

 
$
—

 
$
—

 
$
10,864,202


105

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2013 and 2012.
 
 
Fair Value Measurement at December 31, 2013
 
 
Fair Value
 
Valuation Technique
Unobservable Inputs
Weighted Average
Commercial
 
$
5,352,539

 
Market comparables
Discount applied to market comparables (1)
18%
Real Estate
 
 
 
 
 
 
Construction
 
1,568,619

 
Market comparables
Discount applied to market comparables (1)
44%
Residential (1-4 family)
 
881,669

 
Market comparables
Discount applied to market comparables (1)
40%
Home equity lines
 
209,333

 
Market comparables
Discount applied to market comparables (1)
26%
Multifamily
 
—

 
Market comparables
Discount applied to market comparables (1)
—%
Commercial
 
2,373,720

 
Market comparables
Discount applied to market comparables (1)
19%
Consumers
 
 
 
 
 
 
Consumer and installment loans
 
—

 
Market comparables
Discount applied to market comparables (1)
100%
Total restructures and impaired loans
 
$
10,385,880

 
 
 
 
Real estate owned
 
$
301,963

 
Market comparables
Discount applied to market comparables (1)
11%
 
 
Fair Value Measurement at December 31, 2012
 
 
Fair Value
 
Valuation Technique
Unobservable Inputs
Weighted Average
Commercial
 
$
1,233,475

 
Market comparables
Discount applied to market comparables (1)
50%
Real Estate
 
 
 
 
 
 
Construction
 
1,224,998

 
Market comparables
Discount applied to market comparables (1)
36%
Residential (1-4 family)
 
2,879,470

 
Market comparables
Discount applied to market comparables (1)
31%
Home equity lines
 
186,825

 
Market comparables
Discount applied to market comparables (1)
51%
Multifamily
 
290,000

 
Market comparables
Discount applied to market comparables (1)
25%
Commercial
 
4,945,994

 
Market comparables
Discount applied to market comparables (1)
16%
Consumers
 
 
 
 
 
 
Consumer and installment loans
 
103,440

 
Market comparables
Discount applied to market comparables (1)
20%
Total restructures and impaired loans
 
$
10,864,202

 
 
 
 
(1) A discount percentage is applied based on age of independent appraisals, current market conditions, and experience within the local markets.
Valuation Methods
Investment securities – available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity then the security would fall to the lowest level of hierarchy (Level 3).
The Company's investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted a third party portfolio accounting service vendor for valuation of its securities. The vendor's primary source for security valuation is Interactive Data Corporation ("IDC"), which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary modes, vast descriptive terms and conditions databases, as well as extensive quality control programs.
The vendor utilized proprietary valuation matrices for valuing all municipal securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance and rating to incorporate additional spreads to the industry benchmark curves.
Real estate owned is carried at the lower of carrying value or fair value less estimated selling costs. Upon foreclosure and through liquidation, we evaluate the property’s fair value as compared to its carrying amount and record a valuation adjustment

106

when the carrying amount exceeds fair value less selling costs. Any valuation adjustments at the time a loan becomes real estate owned is charged to the allowance for loan losses. Fair value is determined through an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data. When evaluating fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (Level 3). Any subsequent valuation adjustments are applied to earnings in our consolidated statements of income. We recorded losses of $0 and $592,575 due to valuation adjustments on real estate owned within foreclosed property expense in non-interest expense in December 31, 2013 and 2012, respectively. The Company had one property in real estate owned at December 31, 2013 and zero properties in real estate owned at December 31, 2012.
Restructured and impaired loans are generally valued based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data. When evaluating fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business' financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Restructured and impaired loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.
Loans held for sale. Loans held for sale are recorded at their fair value when originated, based on our expected return from the secondary market.
Derivative financial instruments. Derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our credit risk and the counterparties’ credit quality in determining the fair value of the derivative. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (LIBOR) observable market prices for LIBOR swap rates, and three month LIBOR basis spreads at commonly quoted intervals. Our derivative financial liability consists of an interest rate swap that qualifies as a cash flow hedge which had an unrealized loss of $225,442 at December 31, 2013 and $511,923 at December 31, 2012.

NOTE 20 – EARNINGS PER SHARE RECONCILIATION
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.
 
 
2013
 
2012
 
2011
Net income
$
11,091,007

 
$
12,824,869

 
$
7,125,612

Less: non-cumulative perpetual preferred dividend
—

 
(1,402,532
)
 
(1,560,000
)
Net Income available for common stock (numerator, basic)
$
11,091,007

 
$
11,422,337

 
$
5,565,612

Weighted average shares outstanding (denominator) (1)
10,167,156

 
7,400,443

 
7,147,290

Income per common share - basic
$
1.09

 
$
1.54

 
$
0.78

Net income
$
11,091,007

 
$
12,824,869

 
$
7,125,612

Weighted average shares - diluted (denominator) (1)
10,299,471

 
10,255,992

 
10,165,105

Income per common share - diluted
$
1.08

 
$
1.25

 
$
0.70

Dilutive effect - average number of common shares (1)
60,999

 
47,646

 
17,815

Dilutive effect - average number of convertible non-cumulative perpetual preferred, if converted (1)
71,316

 
2,807,903

 
3,000,000

Dilutive effect - average number of shares (1)
132,315

 
2,855,549

 
3,017,815


(1) All shares have been split adjusted to reflect the 6 for 5 stock split granted December 7, 2012 and cash in lieu of fractional shares.

The dilutive effect of stock options is 60,999, 47,646 and 17,815 shares for 2013, 2012 and 2011 respectively. The dilutive effect of the conversion to common stock of our convertible non-cumulative perpetual preferred stock is 71,316 in

107

2013, 2,807,903 in 2012 and 3,000,000 in 2011. Anti-dilutive options excluded from the dilutive earnings per share calculation totaled 0 in 2013, 102,567 in 2012 and 184,284 in 2011.
NOTE 21 – SEGMENT REPORTING
Reportable segments include community banking and retail mortgage banking services. Community banking involves making loans to and generating deposits from individuals and businesses in the markets where the Bank has offices. Retail mortgage banking originates residential loans and subsequently sells them to investors. The mortgage banking segment is a strategic business unit that offers different products and services. It is managed separately because the segment appeals to different markets and, accordingly, requires different technology and marketing strategies.
Funding for retail mortgage banking services' loans held for sale (LHFS) portfolio is provided by community banking services. The outstanding LHFS balance and related interest earned for the bank's interim holding period of these loans is recorded in the community banking segment. This interim interest income was $7,021,186 in 2013, $11,257,408 in 2012 and $5,419,426 in 2011. In the event of early payment default, Monarch has recorded a reserve for loan repurchases which was $3,171,891 at December 31, 2013 and $3,401,526 at December 31, 2012, which is not a part of our loan loss reserve and is carried in other liabilities. This reserve is an estimate of the potential for losses at any given time based on investor contracts and are not an indication such loss will occur.
The retail mortgage banking segment's most significant revenue and expense is non-interest income and non-interest expense, respectively. The Bank does not have other reportable operating segments. The accounting policies of the segment are the same as those described in the summary of significant accounting policies. All inter-segment sales prices are market based. The assets and liabilities and operating results of the Bank’s other wholly owned subsidiary, Monarch Capital, LLC, is included in the mortgage banking segment. Monarch Capital, LLC, provides commercial mortgage brokerage services.
Segment information for the years 2013, 2012 and 2011 is shown in the following table. The “Other” column includes corporate related items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments and inter-company eliminations.




108

Selected Financial Information
 
 
Commercial and
Other  Banking
 
Mortgage
Banking
Operations
 
Inter-segment
Eliminations
 
Total
Year Ended December 31, 2013
 
 
 
 
 
 
 
Income:
 
 
 
 
 
 
 
Interest income
$
43,518,266

 
$
830,171

 
$
—

 
$
44,348,437

Non-interest income
5,274,634

 
65,672,402

 
(1,064,765
)
 
69,882,271

Total operating income
48,792,900

 
66,502,573

 
(1,064,765
)
 
114,230,708

Expenses:
 
 
 
 
 
 
 
Interest expense
(4,786,458
)
 
—

 
—

 
(4,786,458
)
Provision for loan losses
—

 
—

 
—

 
—

Personnel expense
(14,118,094
)
 
(48,303,608
)
 
(35,479
)
 
(62,457,181
)
Other non-interest expenses
(14,768,836
)
 
(14,785,045
)
 
1,100,244

 
(28,453,637
)
Total operating expenses
(33,673,388
)
 
(63,088,653
)
 
1,064,765

 
(95,697,276
)
Income before income taxes and non-controlling interest
15,119,512

 
3,413,920

 
—

 
18,533,432

Provision for income taxes
(5,209,710
)
 
(1,176,330
)
 
—

 
(6,386,040
)
Less: Net income attributable to non-controlling interest
(47,305
)
 
(1,009,080
)
 
—

 
(1,056,385
)
Net income
$
9,862,497

 
$
1,228,510

 
$
—

 
$
11,091,007


 
Commercial and
Other  Banking
 
Mortgage
Banking
Operations
 
Inter-segment
Eliminations
 
Total
Year Ended December 31, 2012
 
 
 
 
 
 
 
Income:
 
 
 
 
 
 
 
Interest income
$
45,593,745

 
$
874,720

 
$
—

 
$
46,468,465

Non-interest income
5,222,612

 
86,056,021

 
(1,517,827
)
 
89,760,806

Total operating income
50,816,357

 
86,930,741

 
(1,517,827
)
 
136,229,271

Expenses:
 
 
 
 
 
 
 
Interest expense
(5,916,233
)
 
—

 
—

 
(5,916,233
)
Provision for loan losses
(4,831,133
)
 
—

 
—

 
(4,831,133
)
Personnel expense
(12,792,977
)
 
(63,593,556
)
 
(54,155
)
 
(76,440,688
)
Other non-interest expenses
(11,375,735
)
 
(18,011,173
)
 
1,571,982

 
(27,814,926
)
Total operating expenses
(34,916,078
)
 
(81,604,729
)
 
1,517,827

 
(115,002,980
)
Income before income taxes and non-controlling interest
15,900,279

 
5,326,012

 
—

 
21,226,291

Provision for income taxes
(5,563,287
)
 
(1,863,498
)
 
—

 
(7,426,785
)
Less: Net income attributable to non-controlling interest
(72,207
)
 
(902,430
)
 
—

 
(974,637
)
Net income
$
10,264,785

 
$
2,560,084

 
$
—

 
$
12,824,869






109

Selected Financial Information - continued
 
Commercial and
Other  Banking
 
Mortgage
Banking
Operations
 
Inter-segment
Eliminations
 
Total
Year Ended December 31, 2011
 
 
 
 
 
 
 
Income:
 
 
 
 
 
 
 
Interest income
$
39,693,522

 
$
725,805

 
$
—

 
$
40,419,327

Non-interest income
4,275,449

 
51,018,091

 
(548,102
)
 
54,745,438

Total operating income
43,968,971

 
51,743,896

 
(548,102
)
 
95,164,765

Expenses:
 
 
 
 
 
 
 
Interest expense
(6,796,455
)
 
—

 
—

 
(6,796,455
)
Provision for loan losses
(6,319,887
)
 
—

 
—

 
(6,319,887
)
Personnel expense
(11,057,201
)
 
(37,309,566
)
 
37,643

 
(48,329,124
)
Other non-interest expenses
(9,969,010
)
 
(13,256,691
)
 
510,459

 
(22,715,242
)
Total operating expenses
(34,142,553
)
 
(50,566,257
)
 
548,102

 
(84,160,708
)
Income before income taxes and non-controlling interest
9,826,418

 
1,177,639

 
—

 
11,004,057

Provision for income taxes
(3,052,828
)
 
(365,864
)
 
—

 
(3,418,692
)
Less: Net income attributable to non-controlling interest
(51,542
)
 
(408,211
)
 
—

 
(459,753
)
Net income
$
6,722,048

 
$
403,564

 
$
—

 
$
7,125,612

 
 
 
 
 
 
 
 
Segment Assets
 
 
 
 
 
 
 
December 31, 2013
$
1,015,770,066

 
$
11,991,775

 
$
(11,061,181
)
 
$
1,016,700,660

December 31, 2012
$
1,212,171,772

 
$
25,725,118

 
$
(22,318,737
)
 
$
1,215,578,153

Fixed Asset Purchases by Segment
 
 
 
 
 
 
 
December 31, 2013
$
2,840,449

 
$
3,054,462

 
$
—

 
$
5,894,911

December 31, 2012
$
3,529,129

 
$
897,762

 
$
—

 
$
4,426,891

(1) 2012 has been restated to be consistent with 2013 presentation of segment assets. In 2013, assets and liabilities which were grossed up on the mortgage banking balance sheet in prior years are combined, reducing both the mortgage banking operation segment assets and the inter-segment eliminations.


NOTE 22 – CONDENSED PARENT COMPANY ONLY FINANCIAL INFORMATION
On June 1, 2006, a parent corporation, Monarch Financial Holdings, Inc. was formed through a reorganization plan under the laws of the Commonwealth of Virginia. With this reorganization, Monarch Bank became a wholly-owned subsidiary of Monarch Financial Holdings, Inc.
The condensed financial position as of December 31, 2013 and December 31, 2012 and the condensed results of operations and cash flows for Monarch Financial Holdings, Inc., parent company only, for the years ended December 31, 2013, 2012 and 2011 are presented below.


110

CONDENSED BALANCE SHEET
 
 
December 31,
2013
 
December 31,
2012
ASSETS
 
 
 
Cash
$
505,178

 
$
608,001

Investment in Monarch Bank
107,658,064

 
102,115,933

Investment in Trust
310,000

 
310,000

Due from Monarch Bank
—

 
134,444

Other assets
1,448

 
—

Total assets
$
108,474,690

 
$
103,168,378

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Floating rate subordinated debenture (trust preferred securities)
$
10,310,000

 
$
10,310,000

Short term note
—

 
5,000,000

Valuation adjustment for trust preferred securities
225,442

 
511,923

Due to Monarch Bank
421,095

 
—

Other liabilities
—

 
4,532

Total stockholders’ equity
97,518,153

 
87,341,923

Total liabilities and stockholders’ equity
$
108,474,690

 
$
103,168,378

CONDENSED INCOME STATEMENT
 
 
December 31,
2013
 
December 31,
2012
 
December 31,
2011
INCOME
 
 
 
 
 
Dividends from subsidiaries
$
2,932,006

 
$
3,071,533

 
$
3,005,508

Dividend from non-bank subsidiary
5,906

 
6,516

 
5,990

Total income
2,937,912

 
3,078,049

 
3,011,498

EXPENSES
 
 
 
 
 
Interest on borrowings
552,548

 
575,601

 
498,740

Miscellaneous expense
2,500

 
10,064

 
—

Total expenses
555,048

 
585,665

 
498,740

INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES
2,382,864

 
2,492,384

 
2,512,758

EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES
8,708,143

 
10,332,485

 
4,612,854

NET INCOME
11,091,007

 
12,824,869

 
7,125,612

Preferred stock dividend and accretion of preferred stock discounts
—

 
(1,402,532
)
 
(1,560,000
)
NET INCOME AVAILABLE TO COMMON STOCK HOLDERS
$
11,091,007

 
$
11,422,337

 
$
5,565,612




111

CONDENSED STATEMENTS OF CASH FLOWS
 
 
December 31,
2013
 
December 31,
2012
 
December 31,
2011
Operating activities:
 
 
 
 
 
Net income
$
11,091,007

 
$
12,824,869

 
$
7,125,612

Adjustments to reconcile net cash provided by operating activities:
 
 
 
 
 
Equity in undistributed net income of subsidiaries
(8,708,143
)
 
(10,332,485
)
 
(4,612,854
)
Stock-based compensation
621,511

 
413,855

 
323,307

Changes in:
 
 
 
 
 
Due to (from) Monarch Bank
(957,070
)
 
(631,074
)
 
—

Interest payable and other liabilities
(99,681
)
 
4,532

 
(81,387
)
Net cash from operating activities
1,947,624

 
2,279,697

 
2,754,678

Investing activities:
 
 
 
 
 
Increase in investment in subsidiaries
—

 
—

 
—

Net cash from investing activities
—

 
—

 
—

Financing activities:
 
 
 
 
 
Dividends paid on perpetual preferred stock
—

 
(1,402,532
)
 
(1,560,000
)
Dividends paid on common stock
(2,440,096
)
 
(1,174,089
)
 
(952,758
)
Cash in lieu of fractional shares on perpetual stock conversion to common stock
(243
)
 
(3,434
)
 
—

Repurchase of common stock
—

 
—

 
(241,920
)
Decrease (increase) in investment in subsidiary
4,500,000

 
(8,500,000
)
 
—

Net (decrease) increase in short term borrowing
(5,000,000
)
 
5,000,000

 
—

Proceeds from issuance of common stock
889,892

 
260,264

 
—

Net cash from financing activities
(2,050,447
)
 
(5,819,791
)
 
(2,754,678
)
CHANGE IN CASH AND CASH EQUIVALENTS
(102,823
)
 
(3,540,094
)
 
—

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
608,001

 
4,148,095

 
4,148,095

CASH AND CASH EQUIVALENTS AT END OF YEAR
$
505,178

 
$
608,001

 
$
4,148,095

 
NOTE 23 - SUBSEQUENT EVENTS - COMMON STOCK DIVIDEND AND MANDATORY CONVERSION OF PREFERRED STOCK

On January 30, 2014 the Company announced that the Board of Monarch Financial Holdings, Inc., had approved a quarterly cash dividend of $0.07 per share for shareholders of record on February 10, 2014, payable on February 28, 2014. The total dollar value of this dividend was $690,301.


Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None. 
Item 9A.
Controls and Procedures.
We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), which are designed to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, the Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective.

112

Management’s Report On Internal Control Over Financial Reporting is incorporated herein from Item 8. of this Form 10-K. Yount, Hyde & Barbour, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2013, as stated in their report which is included in this annual report on Form 10-K.

There was no change in the internal control over financial reporting that occurred during the quarter ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.
 
Item 9B.
Other Information.
None.
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance.
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2013 Annual Meeting of Stockholders.
 


Item 11.
Executive Compensation.
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2013 Annual Meeting of Stockholders.
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2013 Annual Meeting of Stockholders.
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2013 Annual Meeting of Stockholders.
 
Item 14.
Principal Accounting Fees and Services.
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2013 Annual Meeting of Stockholders.

PART IV
 
Item 15.
Exhibits and Financial Statements Schedules.
(a)
(1) and (2). The response to this portion of Item 15 is included in Item 8 above.
(3). Exhibits
(a.)The following exhibits are filed on behalf of the Registrant as part of this report:
 
No.
  
Description
 
 
 
3.1
  
Articles of Incorporation of Monarch Financial Holdings, Inc., attached as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 14, 2009, incorporated by reference herein.

113

 
 
 
3.2
  
Form of Articles of Amendment to the Articles of Incorporation of Monarch Financial Holdings, Inc. establishing the Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
3.3
  
Bylaws of Monarch Financial Holdings, Inc., attached as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 6, 2006, incorporated by reference herein.
 
 
 
4.1
  
Specimen of Series B Noncumulative Convertible Perpetual Preferred Stock Certificate, attached as Exhibit 4.1 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
4.2
  
Form of Registration Rights Agreement, attached as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.
 
 
 
4.3
  
Form of Subscription Agreement, attached as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.
 
 
 
4.4
  
Junior Subordinated Debenture between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
4.5
  
Rights of holders of Monarch Financial Holdings, Inc. Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
10.1
  
Guaranty Agreement between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
10.2
  
Amended and Restated Trust Agreement among Monarch Financial Holdings, Inc., Wilmington Trust Company, and the Administrative Trustees Named herein dated as of July 5, 2006, attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
10.3
  
Employment Agreement entered into between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.4
  
Employment Agreement entered into between Monarch Bank and E. Neal Crawford, Jr. attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on March 11, 2008, incorporated by reference herein.
 
 
 
10.5
  
Employment Agreement entered into between Monarch Bank and William T. Morrison attached as Exhibit 10.10 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.6
  
Monarch Bank 2006 Equity Incentive Plan filed by our predecessor Monarch Bank with the Federal Reserve on March 31, 2006, incorporated by reference herein.
 
 
 
10.7
  
Form of Change in Control Agreement between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.8
  
Form of Change in Control Agreement between Monarch Bank and William T. Morrison attached as Exhibit 10.11 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.9
  
Form of Change in Control Agreement between Monarch Bank and E. Neal Crawford attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.1
  
Form of Change in Control Agreement between Monarch Bank and Lynette P. Harris attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.11
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 

114

10.12
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.13
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.12 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.14
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.13 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.15
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and E. Neal Crawford attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.16
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Lynette P. Harris attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.17
 
Committed Line of Credit Note between Monarch Financial Holdings, Inc. and PNC Bank, National Association dated as of June 8, 2012, attached as Exhibit 10.1, filed herewith.
 
 
 
21.1
  
Subsidiaries of Registrant, attached as Exhibit 21.1, filed herewith.
 
 
 
23.1
 
Consent of Yount, Hyde & Barbour, PC., filed herewith.
 
 
 
31.1
  
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a), filed herewith.
 
 
31.2
  
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), filed herewith.
 
 
32.1
  
Certification of the Principal Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
32.2
  
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
101
  
Financial statements and schedules in interactive data format, filed herewith.

(b)
Exhibits
See Item 15(a)(3) above.
(c)
Financial Statement Schedules
See Item 15(a)(2) above.


115


SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
MONARCH FINANCIAL HOLDINGS, INC.
March 13, 2014
 
 
 
 
By:
 
/s/    LYNETTE P. HARRIS        
 
 
 
Lynette P. Harris
Executive Vice President, Secretary, Treasurer
& Chief Financial Officer
(On behalf of the Company and as principal financial and accounting officer)
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 13, 2014.
 
/s/    LAWTON H. BAKER        
 
March 13, 2014
Lawton H. Baker, Director
 
 
 
 
 
/s/    JEFFREY F. BENSON
 
March 13, 2014
Jeffrey F. Benson, Director
 
 
 
 
 
/s/    JOE P. COVINGTON, JR.
 
March 13, 2014
Joe P. Covington, Jr., Director
 
 
 
 
 
/s/    E. NEAL CRAWFORD, JR.
 
March 13, 2014
E. Neal Crawford, Jr.,
President and Director
 
 
 
 
 
/s/    VIRGINIA S. CROSS
 
March 13, 2014
Virginia S. Cross, Director
 
 
 
 
 
/s/    TAYLOR B. GRISSOM
 
March 13, 2014
Taylor B. Grissom, Director
 
 
 
 
 
/s/    WILLIAM T. MORRISON
 
March 13, 2014
William T. Morrison,
Executive Vice President and Director
 
 
 
 
 
/s/    ROBERT M. OMAN
 
March 13, 2014
Robert M. Oman, Director
 
 
 
 
 
/s/    ELIZABETH T. PATTERSON
 
March 13, 2014
Elizabeth T. Patterson, Director
 
 
 
 
 
/s/    DWIGHT C. SCHAUBACH      
 
March 13, 2014
Dwight C. Schaubach, Director
 
 
 
 
 
/s/    BRAD E. SCHWARTZ 
 
March 13, 2014
Brad E. Schwartz, Director, Chief Executive Officer
(as principal executive officer)
 
 







116

EXHIBIT INDEX
Number
  
Description
 
 
 
3.1
  
Articles of Incorporation of Monarch Financial Holdings, Inc., attached as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 14, 2009, incorporated by reference herein.
 
 
 
3.2
  
Form of Articles of Amendment to the Articles of Incorporation of Monarch Financial Holdings, Inc. establishing the Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
3.3
  
Bylaws of Monarch Financial Holdings, Inc., attached as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 6, 2006, incorporated by reference herein.
 
 
 
4.1
  
Specimen of Series B Noncumulative Convertible Perpetual Preferred Stock Certificate, attached as Exhibit 4.1 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
4.2
  
Form of Registration Rights Agreement, attached as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.
 
 
 
4.3
  
Form of Subscription Agreement, attached as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.
 
 
 
4.4
  
Junior Subordinated Debenture between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
4.5
  
Rights of holders of Monarch Financial Holdings, Inc. Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.
 
 
 
10.1
  
Guaranty Agreement between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
10.2
  
Amended and Restated Trust Agreement among Monarch Financial Holdings, Inc., Wilmington Trust Company, and the Administrative Trustees Named herein dated as of July 5, 2006, attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.
 
 
 
10.3
  
Employment Agreement entered into between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.4
  
Employment Agreement entered into between Monarch Bank and E. Neal Crawford, Jr. attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on March 11, 2008, incorporated by reference herein.
 
 
 
10.5
  
Employment Agreement entered into between Monarch Bank and William T. Morrison attached as Exhibit 10.10 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.6
  
Monarch Bank 2006 Equity Incentive Plan filed by our predecessor Monarch Bank with the Federal Reserve on March 31, 2006, incorporated by reference herein.
 
 
 
10.7
  
Form of Change in Control Agreement between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.8
  
Form of Change in Control Agreement between Monarch Bank and William T. Morrison attached as Exhibit 10.11 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.9
  
Form of Change in Control Agreement between Monarch Bank and E. Neal Crawford attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.10
  
Form of Change in Control Agreement between Monarch Bank and Lynette P. Harris attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.

117

 
 
 
10.11
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.12
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.13
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.12 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.14
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.13 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.
 
 
 
10.15
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and E. Neal Crawford attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.16
  
Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Lynette P. Harris attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.
 
 
 
10.17
 
Committed Line of Credit Note between Monarch Financial Holdings, Inc. and PNC Bank, National Association dated as of June 8, 2012, attached as Exhibit 10.1, filed herewith.
 
 
 
21.1
  
Subsidiaries of Registrant, attached as Exhibit 21.1, filed herewith.
 
 
 
23.1
 
Consent of Yount, Hyde & Barbour, PC., filed herewith.
 
 
 
31.1
  
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a), filed herewith.
 
 
31.2
  
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), filed herewith.
 
 
32.1
  
Certification of the Principal Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
32.2
  
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
 
 
101.0
  
Financial statements and schedules in interactive data format, filed herewith.


118