ITEM 1. BUSINESS
General
BOE Financial Services of Virginia, Inc. (the “Corporation”) owns all of the stock of its sole direct subsidiary, Bank of Essex (the “Bank”). The Corporation was incorporated under Virginia law in 2000 to become the holding company for the Bank. The headquarters of the Corporation is located in Tappahannock, Virginia. (References herein to the “Corporation” include the “Bank” and its subsidiary unless the context otherwise requires.)
The Bank was established in 1926 and is headquartered in Tappahannock, Virginia. The Bank operates six full-service offices in Virginia, engages in a general commercial banking business and provides a wide range of financial services primarily to individuals and small businesses, including individual and commercial demand and time deposit accounts, commercial and consumer loans, travelers checks, safe deposit box facilities, investment services and fixed rate residential mortgages. Two offices are located in Tappahannock, one in Central Garage, one in West Point, one in Hanover County and one in Henrico County, which is located near Virginia Center Commons, a large shopping center in Central Virginia.
Essex Services, Inc. is a wholly owned subsidiary of the Bank and was formed to sell title insurance to the Bank’s mortgage loan customers. Essex Services, Inc. also offers insurance products through an ownership interest in Bankers Insurance, LLC and investment products through an affiliation with VBA Investments, LLC.
The Corporation recently constructed a new headquarters facility which is located at 1325 Tappahannock Boulevard, approximately one mile from its former Main Office at 323 Prince Street. Upon the opening of this office the Corporation simultaneously closed a branch bank located across the highway from the new headquarters and redesignated the current Main Office as a branch bank. The former Main Office also houses the Bank’s data processing department and loan processing center. The Corporation began operating from this new location and closed the branch bank on June 12, 2006.
Management believes that its most significant profitable growth opportunities will continue to be in the greater metropolitan areas within one hour of Tappahannock. Furthermore, management believes that the trend toward consolidation of the banking industry and the closings and acquisitions of financial institutions in the Corporation’s service area, and in particular the metropolitan areas, have created and will continue to create opportunities for the Corporation to grow its branching network and customer base in these markets.
The Corporation’s expansion efforts have contributed to its growth and improved profitability. Total assets have increased from $115.5 million at the end of 1996 to $281.4 million at December 31, 2006. Net income has grown from $947,000 in 1996 to $3.1 million in 2006. Diluted earnings per share were $1.01 in 1996 versus $2.58 in 2006.
The Corporation’s return on assets was 0.85% in 1996 and 1.15% in 2006. Return on equity was 10.57% in 1996 and 11.47% in 2006.
Loan growth since the Corporation expanded into metropolitan Richmond has come principally from rate sensitive commercial loans which have served to mitigate the Corporation’s interest rate risk. At the same time this growth in commercial loans has increased the Bank’s credit risk.
Employees
At December 31, 2006, the Corporation had 92 full-time equivalent employees. None of its employees is represented by any collective bargaining unit. The Corporation considers relations with its employees to be excellent.
SEC Filings
The Corporation maintains an internet website at www.bankofessex.com. This website contains information relating to the Corporation and its business. Shareholders of the Corporation and the public may access the Corporation’s periodic and current reports, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports, filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, through the “Investors” section of the Corporation’s website. The reports are made available on this website as soon as practicable following the filing of the reports with the SEC. This information is free of charge and may be reviewed, downloaded and printed from the website at any time.
Market Area
The Corporation’s six offices serve a diverse market from the edge of the City of Richmond in Hanover and Henrico Counties to Tappahannock, Virginia on the Rappahannock River in Essex County. From suburban Hanover and Henrico Counties, the market area is primarily rural along Route 360 through King William and King and Queen Counties into Essex County. The Corporation’s management believes Route 360 is a developing growth corridor from Richmond to the east. Tappahannock is approximately 40 miles from downtown Richmond and about one hour from Fredericksburg. Through its Tappahannock branches, the Corporation also serves the central portions of the Middle Peninsula and the upper Northern Neck of Virginia. Through its West Point office, the Corporation serves portions of the Middle Peninsula of Virginia.
The Corporation has made application with the State Corporation Commission’s Bureau of Financial Institutions and received approval to establish two branches in Northumberland County, Virginia. One location will be constructed in Callao and one in Burgess. Route 360 runs through Northumberland County, which is located in the Northern Neck of Virginia and has experienced significant growth in total deposits the last ten years as the area has evolved from an area dependent upon agricultural and industrial seafood production to a growing waterfront retirement community with associated service businesses.
Competition
Within the Richmond, Middle Peninsula and upper Northern Neck areas, the Corporation operates in a highly competitive environment, competing for deposits and loans with commercial corporations, savings and loans and other financial institutions, including non-bank competitors, many of which possess substantially greater financial resources than those available to the Corporation. Many of these institutions have significantly higher lending limits than the Corporation. In addition, there can be no assurance that other financial institutions, with substantially greater resources than the Corporation, will not establish operations in the Corporation’s service area. The financial services industry remains highly competitive and is constantly evolving.
In Essex County, the Corporation commands 45.5% of the deposits in the market, according to the most recently available survey of deposits by the FDIC (June 30, 2006). This represents the highest percentage of deposit market share in Essex County. Serving King William County, the branches at Central Garage and West Point have experienced steady growth, reaching 20.7% of the deposits in the King William County market as of the June 30, 2006 FDIC survey of deposits, while competing with previously established branches. The Corporation’s office located on Route 360 in eastern Hanover County had $41.3 million in total deposits on June 30, 2006. In Henrico County the Corporation’s office located near Virginia Center Commons Mall has experienced strong growth while competing against other community banks and established offices of statewide banks in the vicinity. This office had $36.4 million in total deposits on June 30, 2006.
Factors such as rates offered on loan and deposit products, types of products offered, the number and location of branch offices, as well as the reputation of institutions in the market, affect competition for loans and deposits. The Corporation emphasizes customer service, establishing long-term relationships with its customers, thereby creating customer loyalty, and providing adequate product lines for individuals and small-to-medium size business customers.
The Corporation would not be materially or adversely impacted by the loss of a single customer. The Corporation is not dependent upon a single or a few customers.
Supervision and Regulation
Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulators, including the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Bureau of Financial Institutions of the Virginia State Corporation Commission (the “SCC”). The following description briefly discusses certain provisions of federal and state laws and certain regulations and the potential impact of such provisions on the Corporation and the Bank. These federal and state laws and regulations have been enacted generally for the protection of depositors in national and state banks and not for the protection of stockholders of bank holding companies or banks.
Bank Holding Companies. The Corporation is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and, as a result, is subject to regulation by the Federal Reserve. The Federal Reserve has jurisdiction under the BHCA to approve any bank or nonbank acquisition, merger or consolidation proposed by a bank holding company. The BHCA generally limits the activities of a bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity, which is so closely related to banking or to managing or controlling banks as to be a proper incident thereto. Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve and is required to file periodic reports regarding its operations and any additional information the Federal Reserve may require.
Federal law permits bank holding companies from any state to acquire banks and bank holding companies located in any other state. The law allows interstate bank mergers, subject to “opt-in or opt-out” action by individual states. Virginia adopted early “opt-in” legislation that allows interstate bank mergers. These laws also permit interstate branch acquisitions and de novo branching in Virginia by out-of-state banks if reciprocal treatment is accorded Virginia banks in the state of the acquirer.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositor of such depository institutions and to the FDIC insurance fund in the event the depository institution becomes in danger of default or in default. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund (“SAIF”) or the Bank Insurance Fund (“BIF”) as a result of the default of a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the SAIF or the BIF or both. The FDIC’s claim for reimbursement is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institution.
The Federal Deposit Insurance Act (“FDIA”) also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholders in the event a receiver is appointed to distribute the assets of the Bank.
The Corporation was required to register in Virginia with the SCC under the financial institution holding company laws of Virginia. Accordingly, the Corporation is subject to regulation and supervision by the SCC.
The Corporation is also subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, including but not limited to, filing annual, quarterly, and other current reports with the Securities and Exchange Commission.
The Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the “Act”) was enacted in November 1999. The Act draws new lines between the types of activities that are permitted for banking organizations that are financial in nature and those that are not permitted because they are commercial in nature. The Act imposes Community Reinvestment Act requirements on financial service organizations that seek to qualify for the expanded powers to engage in broader financial activities and affiliations with financial companies that the Act permits.
The Act created a new form of financial organization called a financial holding company that may own and control banks, insurance companies and securities firms. A financial holding company is authorized to engage in any activity that is financial in nature or incidental to an activity that is financial in nature or is a complementary activity. These activities include insurance, securities transactions and traditional banking related activities. The Act establishes a consultative and cooperative procedure between the Federal Reserve and the Secretary of the Treasury for the designation of new activities that are financial in nature within the scope of the activities permitted by the Act for a financial holding company. A financial holding company must satisfy special criteria to qualify for the expanded financial powers authorized by the Act. Among those criteria are requirements that all of the depository institutions owned by the financial holding company be rated as well-capitalized and well-managed and that all of its insured depository institutions have received a satisfactory ratio for Community Reinvestment Act compliance during their last examination. A bank holding company that does not qualify as a financial holding company under the Act is generally limited in the types of activities in which it may engage to those that the Federal Reserve has recognized as permissible for bank holding companies prior to the date of enactment of the Act. The Act also authorizes a state bank to have a financial subsidiary that engages as a principal in the same activities that are permitted for a financial subsidiary of a national bank if the state bank meets eligibility criteria and special conditions for maintaining the financial subsidiary.
The Act repealed the prohibition in the Glass-Steagall Act on bank affiliations with companies that are engaged primarily in securities underwriting activities. The Act authorizes a financial holding company to engage in a wide range of securities activities, including underwriting, broker/dealer activities and investment company and investment advisory activities.
The Act provides additional opportunities for financial holding companies to engage in activities that are financial in nature or incidental to an activity that is financial in nature or complementary thereto provided that any such financial holding company is willing to comply with the conditions, restrictions and limitations placed on financial holding companies contained in the Act and the regulations to be adopted under the Act.
Financial in nature activities include: securities underwriting, dealing and market making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines from time to time to be so closely related to banking or managing or controlling banks as to be proper incidents thereto.
The Corporation has not elected to become a financial holding company under the Act.
Under the Act, federal banking regulators have adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. Pursuant to these rules, effective July 1, 2001, financial institutions must provide: initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates; annual notices of their privacy policies to current customers; and a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties. These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
USA Patriot Act of 2001. In October 2001 the USA Patriot Act was enacted to facilitate information sharing among entities within the government and financial institutions to combat terrorist activities and to expose money laundering. The USA Patriot Act is considered a significant piece of banking law with regard to disclosure of information related to certain customer transactions. Financial institutions are permitted to share information with one another, after notifying the United States Department of the Treasury, in order to better identify and report to the federal government activities that may involve terrorist activities or money laundering. Under the USA Patriot Act financial institutions are obligated to establish anti-money laundering programs, including the development of a customer identification program and to review all customers against any list of the government that contains the manes of known or suspected terrorists. The USA Patriot Act does not have a material or adverse impact on the Bank’s products or service but compliance with this act creates a cost of compliance and a reporting obligation.
Capital Requirements. 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, the Corporation and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain 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 and qualifying perpetual preferred stock, 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. In addition, each of the federal 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 sum, the capital measures used by the federal banking regulators are:
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Total Capital ratio, which is the total of Tier 1 Capital and Tier 2 Capital;
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Tier 1 Capital ratio; and
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Leverage ratio.
Under these regulations, a bank will be:
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“Well Capitalized” if it has a Total Capital ratio of 10% or greater, a Tier 1 Capital ratio of 6% 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;
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“Adequately Capitalized” if it has a Total Capital ratio of 8% or greater, a Tier 1 Capital ratio of 4% or greater, and a leverage ratio of 4% or greater - or 3% in certain circumstances - and is not well capitalized;
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“Undercapitalized” if it has a Total Capital ratio of less than 8% or greater, a Tier 1 Capital ratio of less than 4% - or 3% in certain circumstances;
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“Significantly Undercapitalized” if it has a Total Capital ratio of less than 6%, a Tier 1 Capital ratio of less than 3%, or a leverage ratio of less than 3%; or
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“Critically Undercapitalized” if its tangible equity is equal to or less than 2% of average quarterly tangible assets.
The risk-based capital standards of 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 accepted by 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 bank 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. The Bank presently maintains sufficient capital to remain in compliance with these capital requirements.
Payment of Dividends. The Corporation is a legal entity separate and distinct from the Bank. The majority of the Corporation’s revenues are from dividends paid to the Corporation by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. In addition, both the Corporation and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Banking regulators have indicated that banking organizations should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Corporation does not expect that any of these laws, regulations or policies will materially affect the ability of the Bank to pay dividends. During the year ended December 31, 2006, the Bank paid $900,000 in dividends to the Corporation.
The FDIC has the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. The FDIC has indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice.
Community Reinvestment Act. Under the Community Reinvestment Act (CRA) and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. CRA requires the adoption of a statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries. The Corporation believes it is currently in compliance with CRA.
Fair Lending; Consumer Laws. In addition to CRA, other federal and state laws regulate various lending and consumer aspects of the banking business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums, short of a full trial.
Recently, these governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.
Future Regulatory Uncertainty. Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, the Corporation cannot forecast how federal regulation of financial institutions may change in the future and impact its operations. Although Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, the Corporation fully expects 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.
Credit Policies
The Corporation follows written policies and procedures to enhance management of credit risk. The loan portfolio is managed under a specifically defined credit process. This process includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to estimate loss exposure and ascertain compliance with the Corporation’s policies. Lending authority is granted to individual lending officers with the current highest limit being $350,000 for either secured or unsecured loans. A Loan Committee compromised of five loan officers can approve credits of up to $500,000. Approval of such credits requires a majority vote of the Loan Committee. The Executive Committee of the Board of Directors, meeting monthly, can approve loans up to the Bank’s legal lending limit. The Board of Director meets monthly as well and it too may approve loans up to the Bank’s legal lending limit.
The Corporation’s management generally requires that secured loans have a loan-to-value ratio of 85% or less. Management believes that when a borrower has significant equity in the assets securing the loan, the borrower is less likely to default on the outstanding loan balance.
A major element of credit risk management is diversification. The Corporation’s objective is to maintain a diverse loan portfolio to minimize the impact of any single event or set of circumstances. Concentration parameters are based on factors of individual risk, policy constraints, economic conditions, collateral and product type.
Lending activities include a variety of consumer, real estate and commercial loans with a strong emphasis on serving the needs of customers within the Corporation’s market territory. Consumer loans are made primarily on a secured basis in the form of installment obligations or personal lines of credit. The focus of real estate lending is single family residential mortgages, but also includes home improvement loans, construction lending and home equity lines of credit. Commercial lending is provided to businesses seeking credit for working capital, the purchase of equipment and facilities and commercial development.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our operations are subject to many risks that could adversely impact future financial condition and performance and thus, the market value of our common stock. From time to time, we may make forward-looking statements that relate to future revenues, expenses, loan losses, reserves, market condition(s), strategies or other events that we expect or anticipate will occur in the future. Forward-looking statements are based on our current views and assumptions and, as a result, are subject to risks and uncertainties that could cause actual results to differ materially from those projected.
Set forth below are certain of the important risks we face and that could cause actual results to differ materially from those predicted by forward-looking statements. These risks are not the only ones we face. Our business could be affected by additional factors that are presently unknown to us or that we currently believe are not material.
Fluctuations in interest rates may affect profitability.
Our profitability and cash flows depend substantially upon net interest margin. Net interest margin is the difference between interest earned on loans and investments, and rates paid on deposits and other borrowings. The rates described above are highly sensitive to many factors not in our control, such as general economic conditions and policies of regulatory and governmental agencies. Changes in interest rates will affect net interest margin and thus profitability and cash flows. We attempt to manage our interest rate risk but cannot eliminate this risk.
Our profitability depends upon and may be affected by local economic conditions.
The general economic conditions in the markets in which we operate are a key component to our success. This comes from both the rural Middle Peninsula and urban Richmond markets in which we operate. Changes in the general economic conditions in these markets, caused by inflation, recession, acts of terrorism, unemployment or other factors beyond our control, may influence the rate of growth experienced for both loans and deposits and negatively affect financial condition, performance and profitability.
Our future success is dependent upon our ability to compete effectively in the highly competitive banking industry.
We compete for deposits, loans and other financial services in markets with numerous other banks, thrifts and financial institutions. There are many financial institutions in these markets that have been in business for many years and are significantly larger, have customer bases well established and have higher lending limits and greater financial resources.
Concentrations in loans secured by real estate may increase credit losses, which would have a negative affect on our financial results.
Many of our loans are secured by real estate (both commercial and residential) in our market area. A variety of loans secured by real estate are offered, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. At December 31, 2006, approximately 85.3% of our loans were secured by real estate. A major change in the real estate market, such as deterioration in value of the property, or in the local or national economy, could adversely affect our customer’s ability to pay these loans, which in turn could adversely impact us.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
An essential element of our business is to make loans. We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within the loan portfolio. Experience in the banking industry indicates that some portion of our loans may only be partially repaid or may never be repaid at all. Loan losses occur for many reasons beyond our control. Although we believe that we maintain our allowance for loan losses at a level adequate to absorb losses in our loan portfolio, estimates of loan losses are subjective and their accuracy may depend on the outcome of future events. We
may be required to make significant and unanticipated increases in the allowance for loan and lease losses during future periods, which could materially affect our financial position, results of operations and liquidity. Bank regulatory authorities, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. These regulatory authorities may require adjustments to the allowance for loan losses or may require recognition of additional loan losses or charge-offs based upon their own judgment. Any change in the allowance for loan losses or charge-offs required by bank regulatory authorities could have an adverse effect on our financial condition, results of operations and liquidity.
Our profitability and the value of shareholder’s investments may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.
We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels in the financial services area. Recently enacted, proposed and future legislation and regulations have had, and will continue to have, or may have a significant impact on the financial services industry. These regulations, which are generally intended to protect depositors and not shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably and can be expected to influence earnings and growth. Our success depends on our continued ability to maintain compliance with these regulations. Some of these regulations may increase costs and thus place other financial institutions that are not subject to similar regulation in stronger, more favorable competitive positions.
We depend on key personnel for success.
Our operating results and ability to adequately manage our growth and minimize loan and lease losses are highly dependent on the services, managerial abilities and performance of our current executive officers and other key personnel. We have an experienced management team that the Board of Directors believes is capable of managing and growing our operations. However, losses of or changes in our current executive officers or other key personnel and their responsibilities may disrupt our business and could adversely affect financial condition, results of operations and liquidity. There can be no assurance that we will be successful in retaining our current executive officers or other key personnel.
If additional capital were needed in the future to continue growth, we may not be able to obtain it on terms that are favorable. This could negatively affect performance and the value of our common stock.
Our business strategy calls for continued growth. It is anticipated that we will be able to support this growth through the generation of additional deposits at branch locations as well as investment opportunities. However, we may need to raise additional capital in the future to support continued growth and to maintain capital levels. The 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.
Changes in accounting standards could impact reported earnings.
The accounting standard setters, including the FASB, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some instances, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF CO MMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES.
The principal office of the Corporation and the Bank is located at 1325 Tappahannock Boulevard, Tappahannock, Virginia 22560. The Bank operated a branch in the Tappahannock Towne Center in Tappahannock from 1981-2006. In November 1988, the Bank opened the King William office at Central Garage in King William County. The fourth facility, the East Hanover office, opened in August 1992, on Route 360 east of Mechanicsville in Hanover County. In February of 1996, the Bank opened its fifth office in West Point, Virginia in King William County. In June 1999, the Bank opened its sixth office in Henrico County near Virginia Center Commons. This office houses other lines of business such as the commercial loan department and fixed rate mortgages. In June of 1990, the Bank purchased land in Tappahannock, Virginia. An additional adjoining parcel was purchased in 2004 and the State Corporation Commission Bureau of Financial Institutions approved the building of a new facility that houses executive offices of the Corporation as well as a branch office. When this new facility opened the Tappahannock Towne Center Office was closed and sold. The new facility was opened on June 12, 2006. Simultaneous to the opening of the new Main Office the Prince Street Office was redesignated from the Main Office to a branch. In October of 2002 the Bank purchased a small parcel of land adjoining the King William Office.
The Corporation has made application with the State Corporation Commission’s Bureau of Financial Institutions and received approval to establish two branches in Northumberland County, Virginia. One location will be constructed in Callao and one in Burgess. The Corporation intends to establish temporary facilities on both of these sites and construct permanent full-service facilities adjacent to each temporary office.
The Corporation or the Bank owns all of its properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
In the course of its operations, the Corporation is party to various legal proceedings. Based upon information currently available, and after consultation with its general counsel, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the Corporation’s business, financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to the stockholders for their vote during the quarter ended December 31, 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information. The Corporation’s Common Stock trades on the Nasdaq Capital Market (formerly the Nasdaq Small Cap Market) under the symbol “BSXT”.
The following table indicates the high and low bid prices for the Common Stock as reported on the Nasdaq Capital Market for the quarterly periods indicated:
Holders. At December 31, 2006, there were 1,208,109 shares of Common Stock of the Corporation outstanding held by approximately 1,100 holders of record.
Dividends. The Corporation began paying cash dividends in 1944 and semi-annual cash dividends in 1989. Beginning in 2007, the Corporation intends to begin paying a quarterly cash dividend on the Common Stock when justified by the financial condition of the Corporation. The timing and amount of future dividends, if any, will depend on general business conditions encountered by the Corporation, its earnings, its financial condition and cash and capital requirements, governmental regulations and other such factors as the Board of Directors may deem relevant. The following table sets forth the semi-annual and total cash dividends paid per share for 2006 and 2005.
1) The Corporation has paid its semi-annual dividends in June and December. Beginning in 2007, the Corporation intends to pay a quarterly dividend in March, June, September and December.
Recent Sales of Unregistered Shares.
None.
Use of Proceeds.
Not Applicable.
Issuer Repurchases of Common Stock.
No shares were repurchased by or on behalf of the Corporation during the fourth quarter of 2006.
The following line graph compares the cumulative total return to the shareholders of the Corporation to the returns of the NASDAQ Composite Index, the SNL $250-$500 million Bank Index and the Russell 3000 for the last five years. The amounts in the table represent the value of the investment on December 31st of the year indicated, assuming $100 was initially invested on December 31, 2001 and the reinvestment of dividends.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Selected Financial Data
(Dollars in thousands, except per share data)
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion is intended to assist the readers in understanding and evaluating the financial condition and results of operation of BOE Financial Services of Virginia, Inc. (“the Corporation”) or (“BOE”). This review should be read in conjunction with the Corporation’s consolidated financial statements and accompanying notes included elsewhere in this Annual Report. This analysis provides an overview of the significant changes that occurred during the periods presented.
CRITICAL ACCOUNTING POLICIES
General
The Corporation’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, 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 either when earning income, recognizing expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. 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.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires 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. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates.
The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management’s periodic evaluation of the adequacy of the allowance is based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.
OVERVIEW
The Corporation’s strategic plan is directed toward the enhancement of its franchise value and operating profitability by increasing its asset size and expanding its customer base. The Corporation operates six full service offices mainly between its headquarters in Tappahannock, Virginia and along the U. S. 360 corridor to the Richmond, Virginia metropolitan market. Management believes that its most significant profitable growth opportunities will continue to be within one hour of Tappahannock. (See Part I, Item 1. Business, General for further explanation on the Corporation’s strategic plan.)
Year 2006 Compared to Year 2005
On December 31, 2006, the Corporation had total assets of $281.378 million, total loans of $196.891 million, total deposits of $230.865 million and total stockholder’s equity of $28.047 million. BOE had net income of $3.123 million in 2006, a $22,000, or 0.7% increase from $3.101 million in net income in 2005. This resulted in a return on average equity of 11.47% in 2006 compared to 12.18% in 2005. Return on average assets in 2006 was 1.15%, compared to 1.24% in 2005. BOE’s total loans increased 7.9%, or $14.435 million, in 2006 over 2005. Total loans were $196.891 million at December 31, 2006 compared to $182.456 million at December 31, 2005. Loan increases came from loans secured by real estate, including loans secured by 1 - 4 family properties and commercial lending. This is due to continued growth in and around the
corridor surrounding Richmond, Virginia, including the area in and around Essex County. At December 31, 2006, the ratio of non-performing assets to total assets was 0.62% compared to 0.72% at December 31, 2005. Net recoveries to average loans were 0.01% in 2006 compared to net charge offs of 0.05% in 2005. Loans past due 90 days or more and still accruing interest at December 31, 2006 were $102,000 and $260,000 at December 31, 2005. The Corporation’s allowance for loan losses to period end loans at December 31, 2006 was 1.22% compared to 1.23% at December 31, 2005.
Year 2005 Compared to Year 2004
On December 31, 2005, the Corporation had total assets of $261.931 million, total loans of $182.456 million, total deposits of $223.132 million and total stockholder’s equity of $26.235 million. BOE had net income of $3.101 million in 2005, a $215,000, or 7.5% increase from $2.885 million in net income in 2004. This resulted in a return on average equity of 12.18% in 2005 compared to 12.12% in 2004. Return on average assets in 2005 was 1.24%, compared to 1.23% in 2004. BOE’s total loans increased 14.3%, or $22.896 million, in 2005 over 2004. Total loans were $182.456 million at December 31, 2005 compared to $159.560 million at December 31, 2004. Loan increases came from loans secured by real estate, including loans secured by 1 - 4 family properties, commercial real estate and construction lending. At December 31, 2005, the ratio of non-performing assets to total assets was 0.72% compared to 1.29% at December 31, 2004. Net charge offs to average loans were 0.05% in 2005 compared to 0.21% in 2004. Loans past due 90 days or more and still accruing interest at December 31, 2005 were $260,000 and $100,000 at December 31, 2004. The Corporation’s allowance for loan losses to period end loans at December 31, 2005 was 1.23% compared to 1.31% at December 31, 2004.
RESULTS OF OPERATIONS
NET INCOME
Year 2006 Compared to Year 2005
BOE had net income of $3.123 million in 2006 compared to $3.101 million in 2005. This represented an increase of 0.7%, or $22,000. Diluted earnings per share in 2006 were $2.58, compared to diluted earnings per share in 2005 of $2.58. These earnings per share are based on average shares outstanding of 1,210,922 in 2006 and 1,203,725 in 2005. The increase in net income included a $490,000 increase in total profits (losses) on other properties resulting from a $485,000 gain on the sale of a bank building. Also improving net income was $160,000 in increases in other categories of noninterest income and a $115,000 reduction in provision for loan losses. Offsetting these increases in net income for 2006 compared to 2005 was a decrease of $112,000, or 1.1%, in net interest income. Comprising net interest income was a $2.391 million, or 16.7%, increase in interest income which was offset by an increase of $2.503 million, or 56.0%, in interest expenses caused by fierce competition among banks for funding and an inverted yield curve throughout much of 2006. Also affecting net income was an increase of $631,000, or 8.7%, in noninterest expenses, $93,000 of which was related to the opening of a new headquarters during 2006.
Year 2005 Compared to Year 2004
BOE had net income of $3.101 million in 2005 compared to $2.885 million in 2004. This represented an increase of 7.5%, or $215,000. Diluted earnings per share in 2005 were $2.58, compared to diluted earnings per share in 2004 of $2.42. These earnings per share are based on average shares outstanding of 1,203,725 in 2005 and 1,194,511 in 2004.
BOE’s profitability increased in 2005 in comparison to 2004 due to an increase of $605,000, or 6.5%, in net interest income. Net interest income increased from $9.269 million in 2004 to $9.874 million in 2005. Additionally, provision for loan losses decreased by $65,000, or 21.2%, in 2005 compared to 2004. Provision for loan losses was $240,000 in 2005 compared to $305,000 in 2004. Provision for loan losses decreased in 2005 compared to 2004 due to a reduction in net charged-off loans. Net charged-off loans were $80,000 in 2005 compared to $345,000 in 2004. This combination resulted in a net interest income after provision for loan losses increase of $670,000, or 7.5%.
Offsetting these increases in net income was a $380,000, or 5.5% increase for 2005 compared to 2004 in noninterest expenses. Noninterest expenses were $7.262 million in 2005 and $6.882 million in 2004. Also offsetting net income increases was an increase of $49,000, or 5.9%, in income tax expenses. Income tax expense totaled $872,000 in 2005 and $823,000 in 2004. Noninterest income decreased $26,000, or 1.6%, and was $1.601 million in 2005 compared to $1.627 million in 2004.
NET INTEREST INCOME
Year 2006 Compared to Year 2005
Net interest income is the major component of the Corporation’s earnings and is equal to the amount by which interest income exceeds interest expense. The Corporation’s earning assets are composed primarily of loans and securities, while deposits and short-term borrowings represent the major portion of interest-bearing liabilities. Changes in the volume and mix of these assets and liabilities, as well as changes in the yields earned and rates paid, determine changes in net interest income.
Net interest income, on a fully tax equivalent basis, was $10.514 million in 2006, $53,000 less than the $10.567 million reported for 2005. The Corporation’s level of earning assets increased $16.169 million, or 7.0%, on average, in 2006 to $248.586 million compared to $232.417 million in 2005. Loans receivable were $189.837 million, on average, in 2006 compared to $172.367 million in 2005, an increase of $17.470 million, or 10.1%. The yield on loans receivable increased from 6.93% in 2005 to 7.52% in 2006. On a fully tax equivalent basis the yield on loans receivable increased $2.338 million in 2006, to $14.282 million in 2006 from $11.944 million in 2005. This represents an increase of 19.6%. Investment securities and federal funds sold decreased, on average, 2.2% in 2006 to $58.749 million, down from $60.050 million, on average, in 2005. The tax equivalent yield on investment securities, including equity securities and federal funds sold was 5.45% in 2006 compared to 5.15% in 2005. On a fully taxable equivalent basis, income on investment securities and federal funds sold income increased 3.6%, or $111,000, from $3.092 million in 2005 to $3.203 million in 2006. This earning asset rate and volume activity resulted in a yield on earning assets of 7.03% in 2006 based on $17.485 million in fully taxable equivalent income compared to 6.47% in 2005 based on $15.036 million in fully taxable equivalent income. This is a $2.449 million increase from 2005 to 2006, or 16.3%. The Corporation’s interest-bearing liabilities increased $20.413 million, on average, from $194.364 million in 2005 to $214.777 million in 2006, an increase of 10.5%. The cost of interest-bearing liabilities increased from 2.30% in 2005 to 3.25% in 2006.
The increase in yield on earning assets of 56 basis points coupled with the increased cost of interest-bearing liabilities of 95 basis points resulted in a net interest margin for the Corporation of 4.23% in 2006 compared to a net interest margin of 4.55% in 2005. Net interest margin is calculated by dividing the Corporation’s net interest income on a tax equivalent basis by the average earning assets. Volume increases in loans, coupled with higher rate and volume increases on interest-bearing liabilities resulted in a decrease in the interest spread. The Corporation’s net interest spread decreased 39 basis points from 4.17% in 2005 to 3.78% in 2006. Spread is calculated by subtracting the cost of interest-bearing liabilities from the yield on earning assets.
Year 2005 Compared to Year 2004
Net interest income, on a fully tax equivalent basis, was $10.567 million in 2005, 6.7% higher than the $9.902 million reported for 2004. The Corporation’s level of earning assets increased $14.368 million, or 6.6%, on average, in 2005 to $232.417 million compared to $218.049 million in 2004. Loans receivable were $172.367 million, on average, in 2005 compared to $162.507 million in 2004, an increase of $9.860 million, or 6.1%. The yield on loans receivable increased from 6.56% in 2004 to 6.93% in 2005. On a fully tax equivalent basis the yield on loans receivable increased $1.280 million in 2005, to $11.944 million in 2005 from $10.664 million in 2004. This represents an increase of 12.0%. Investment securities and federal funds sold increased, on average, 8.1% in 2005 to $60.050 million, up from $55.542 million, on average, in 2004. The tax equivalent yield on investment securities, including equity securities and federal funds sold was 5.15% in 2005 compared to 5.12% in 2004. On a fully taxable equivalent basis, income on investment securities and federal funds sold income increased 8.7%, or $248,000, from $2.844 million in 2004 to $3.092 million in 2005. This earning asset rate and volume activity resulted in a yield on earning assets of 6.47% in 2005 based on $15.036 million in fully taxable equivalent income compared to 6.19% in 2004 based on $13.508 million in fully taxable equivalent income. This is a $1.528 million increase from 2004 to 2005, or 11.3%. The Corporation’s interest-bearing liabilities increased $8.971 million, on average, from $185.393 million in 2004 to $194.364 million in 2005. The cost of interest-bearing liabilities increased from 1.95% in 2004 to 2.30% in 2005, an increase of 18.0%.
The increase in yield on earning assets of 28 basis points coupled with the increased cost of interest-bearing liabilities of 35 basis points resulted in a net interest margin for the Corporation of 4.55% in 2005 compared to a net interest margin of 4.54% in 2004. Net interest margin is calculated by dividing the Corporation’s net interest income on a tax equivalent basis by the average earning assets. Volume increases in loans and in securities, coupled with lower rate and volume increases in interest-bearing liabilities resulted in a decrease in the interest spread. The Corporation’s net interest spread decreased 8 basis points from 4.25% in 2004 to 4.17% in 2005. Spread is calculated by subtracting the cost of interest-bearing liabilities from the yield on earning assets.
BOE’s net interest margin is affected by changes in the amount and mix of earning assets and interest-bearing liabilities, referred to as a “volume change.” It is also affected by changes in yields earned on earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “rate change.” The following table sets forth for each category of earning assets and interest-bearing liabilities, the average amounts outstanding, the interest earned or incurred on such amounts and the average rate earned or incurred for the years ended December 31, 2006, 2005 and 2004. The
table also sets forth the average rate earned on total earning assets, the average rate paid on total interest-bearing liabilities, and the net interest margin on average total earning assets for the same periods.
AVERAGE BALANCES, INTEREST INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
Years Ended December 31,
(Dollars in thousands)
(1) Income and yields are reported on a tax-equivalent basis assuming a federal tax rate of 34%.
Net interest income is affected by both (1) changes in the interest rate spread (the difference between the weighted average yield on interest earning assets and the weighted average cost of interest-bearing liabilities) and (2) changes in volume (average balances of interest earning assets and interest-bearing liabilities).
For each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (1) changes in volume of balances outstanding (changes in volume multiplied by prior period interest rate) (2) changes in the interest earned or paid on the balances (changes in rate multiplied by prior period volume) and (3) a combination of changes in volume and rate allocated pro rata.
RATE AND VOLUME ANALYSIS
(Dollars in thousands)
INTEREST RATE SENSITIVITY
An important component of both earnings performance and liquidity is management of interest rate sensitivity. Interest rate sensitivity reflects the potential effect on net interest income of a movement in market interest rates. BOE is subject to interest rate sensitivity to the degree that its interest earning assets mature or reprice at a different time interval from that of its interest-bearing liabilities.
INTEREST SENSITIVITY ANALYSIS
December 31, 2006 (Dollars in thousands)
PROVISION FOR LOAN LOSSES
The provision for loan losses is charged to income to bring the total allowance for loan losses to a level deemed appropriate by management of the Corporation based on such factors as historical experience, the volume and type of lending conducted by the Corporation, the amount of non-performing assets, regulatory policies, generally accepted accounting principles, general economic conditions, and other factors related to the collectibility of loans in the Corporation’s portfolio.
The provision for loan losses was $125,000 in 2006, a decrease of $115,000, or 48.0%, compared to the $240,000 in provision for 2005. The provision for loan losses reflects a decrease in net charged-off loans in 2006. Charged-off loans were in a net recovery position in 2006 of $26,000 after charging off $138,000 and recovering a total of $164,000. This compares to $80,000 in net charge-offs in 2005 after charging off $159,000 in loans and recognizing $79,000 in recoveries.
Management believes the allowance for loan losses is adequate to absorb losses inherent in the loan portfolio. In view of the Corporation’s plans to continue its loan growth, management will continue to closely monitor the performance of its portfolio and make additional provisions as necessary.
NON-INTEREST INCOME
Non-interest income in 2006 was $2.250 million, an increase of 40.6%, or $650,000, from non-interest income of $1.601 million in 2005. Net gains (losses) on sale of premises and equipment was the largest component of this increase, $490,000. Of this amount, $485,000 was the result of the sale of a former branch banking facility. Net gains (losses) on sale of premises and equipment was a loss of $23,000 in 2005 compared to a gain of $467,000 in 2006. Other income increased $114,000, or 19.6%, and was $693,000 in 2006 compared to $579,000 in 2005. Service charge income increased 5.7%, or $56,000, and was $1.043 million in 2006 compared to $986,000 in 2005. Net gains on sales of loans was $61,000, an 8.9%, or $5,000, increase over the 2005 total of $56,000. Net security gains (losses) were $16,000 less in 2006 than 2005. Net security gains (losses) were a loss of $13,000 in 2006 compared to a gain of $3,000 in 2005.
Non-interest income in 2005 was $1.601 million, a decrease of $26,000, or 1.6%, from non-interest income of $1.627 million in 2004. Service charges on deposit accounts decreased $8,000, or 0.8%, to $986,000 in 2005 from $994,000 in 2004. Other income increased 25.4%, or $117,000, in 2005. Other income was $579,000 in 2005 and $462,000 in 2004. Securities gains were $3,000 in 2005, a $63,000 decrease from securities gains of $66,000 in 2004. Gains on sales of loans were $56,000 in 2005 and $57,000 in 2004, a $1,000 decrease. Net gains/(losses) on sales of other properties decreased $72,000, or 147.2%, from a $49,000 gain in 2004 to a $23,000 loss in 2005.
NON-INTEREST EXPENSE
Non-interest expense was $7.893 million in 2006, a $631,000, or 8.7% increase, over non-interest expense of $7.262 million in 2005. Salaries were $3.247 million in 2006 and were the largest component of this increase, $193,000, or 6.3%, over salaries of $3.054 million in 2005. Employee benefits were up $152,000, or 15.5%, higher than employee benefits in 2005 of $982,000. This increase was due to continued increases in health industry costs provided to employees. Data processing expense of $555,000 in 2006 was 4.7%, or $25,000, higher than data processing expense of $530,000 in 2005. Other operating expenses of $1.499 million were $62,000, or 4.3%, higher than other operating expenses of $1.437 million in 2005. Bank franchise tax increased $16,000, or 7.3%, in 2006 and was $238,000 compared to $222,000 in 2005. Stationary and printing expenses increased $34,000, or 24.6%, and were $138,000 in 2005 compared to $172,000 in 2006. Furniture and equipment related expenses were $449,000 in 2006 compared to $415,000 in 2005, an increase of $34,000, or 8.2%. Postage expense increased $22,000, or 14.3%, and was $175,000 in 2006 compared to $153,000 in 2005. Occupancy expenses increased $93,000, or 28.0% and were $423,000 in 2006 compared to $330,000 in 2005.
Non-interest expense was $7.262 million in 2005, a $380,000, or 5.5%, increase, over non-interest expense of $6.882 million in 2004. Salaries were $3.054 million in 2005 and were the largest component of this increase, $196,000, or 6.9%, over salaries of $2.858 million in 2004. This increase was due to an increase in full-time equivalent employees from 88 in 2004 to 93 in 2005. Employee benefits were $982,000, up $178,000, or 22.1% higher than employee benefits in 2004 of $804,000. This increase was due to the increase in full-time equivalent employees described above and continued increases in health industry costs provided to employees. Data processing expense of $530,000 in 2005 was 12.4%, or $59,000, higher than data processing expense of $471,000 in 2004. Other operating expenses of $1.404 million were $32,000, or 2.3%, higher than other operating expenses of $1.437 million in 2004. Bank franchise tax increased $7,000, or 3.5%, in 2005 and was $222,000 compared to $214,000 in 2004.
Analysis of Financial Condition
Loan Portfolio
The loan portfolio is the largest category of the Corporation’s earning assets and is comprised of commercial loans, agricultural loans, real estate loans, home equity loans, construction loans, consumer loans, and participation loans with other financial institutions. The primary markets in which the Corporation makes loans include the counties of Essex, King and Queen, King William, Hanover, Henrico and the City of Richmond. The mix of the loan portfolio is weighted toward loans secured by real estate and commercial loans. In management’s opinion, there are no significant concentrations of credit with particular borrowers engaged in similar activities.
Net loans consist of total loans minus the allowance for loan losses, unearned discounts and deferred loan fees. The Corporation’s net loans were $194.491 million at December 31, 2006, representing an increase of 7.9%, or $14.284 million more than net loans of $180.207 million at December 31, 2005. The average balance of loans as a percentage of average earning assets was 76.4% in 2006, up slightly from 74.2% in 2005.
In the normal course of business, the Corporation makes various commitments and incurs certain contingent liabilities, which are disclosed but not reflected in the consolidated financial statements contained in this Annual Report, including standby letters of credit and commitments to extend credit. At December 31, 2006, commitments for standby letters of credit totaled $4.971 million and commitments to extend credit totaled $45.251 million. Commitments for standby letters of credit totaled $4.602 million at December 31, 2005 and commitments to extend credit totaled $40.381 million.
LOAN PORTFOLIO
December 31, (Dollars in thousands)
Remaining Maturities of Selected Loan Catagories
ASSET QUALITY
Generally, interest on loans is accrued and credited to income based upon the principal balance outstanding. It is typically the Corporation’s policy to discontinue the accrual of interest income and classify a loan on non-accrual when principal or interest is past due 90 days or more and the loan is not well-secured and in the process of collection, or when, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the obligation.
The Corporation will generally charge-off loans after 120 days of delinquency unless they are adequately collateralized, in the process of collection and, based on a probable specific event, management believes that the loan will be repaid or brought current within a reasonable period of time. Loans will not be returned to accrual status until future payments of principal and interest appear certain. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments received are applied to the outstanding principal balance.
Real estate acquired by the Corporation as a result of foreclosure or in-substance foreclosure is classified as other real estate owned (“OREO”). Such real estate is recorded at the lower of cost or fair market value less estimated selling costs, and the estimated loss, if any, is charged to the allowance for loan losses at that time. Further
allowances for losses are recorded as charges to other expenses at the time management believes additional deterioration in value has occurred. The Corporation had no OREO at December 31, 2006 or 2005.
The Corporation’s credit policies generally require a loan-to-value ratio of 85% for secured loans. At December 31, 2006, loans past due 90 days or more and still accruing interest totaled $102,000, of which $7,000 was secured by real estate and the remainder was secured and unsecured commercial and installment loans. As of December 31, 2005, loans past due 90 days or more and still accruing totaled $260,000, all of which was secured by real estate and the remainder was secured and unsecured commercial and installment loans. Non-accrual loans at December 31, 2006 were $0 and at December 31, 2005 non-accrual loans were $174,000.
NON-PERFORMING ASSETS
December 31, (Dollars in thousands)
ALLOWANCE FOR LOAN LOSSES
In originating loans, the Corporation recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for such loan. The Corporation maintains an allowance for loan losses based upon, among other things, historical experience, the volume and type of lending conducted by the Corporation, the amount of non-performing assets, regulatory policies, generally accepted accounting principles, general economic conditions, and other factors related to the collectibility of loans in the Corporation’s portfolios. In addition to general allowances, specific allowances are provided for individual loans when ultimate collection is considered questionable by management after reviewing the current status of loans, which are contractually past due and after considering the net realizable value of any collateral for the loan.
Management actively monitors the Corporation’s asset quality in a continuing effort to charge-off loans against the allowance for loan losses when appropriate and to provide specific loss allowances when necessary. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations. As of December 31, 2006, the allowance for loan losses amounted to $2.400 million, or 1.22% of total loans. The Corporation’s allowance for loan losses was $2.249 million at December 31, 2005, or 1.23% of total loans.
The allowance for loan losses as a percentage of non-performing assets was 136.67% at December 31, 2006. The ratio of allowance for loan losses as a percentage of non-performing assets at December 31, 2005 was 118.93%.
ALLOWANCE FOR LOAN LOSSES
Years ended December 31, (Dollars in thousands)
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
December 31, (Dollars in thousands)
(1) Percent of loans in each category to total loans.
INVESTMENT ACTIVITIES
Securities available-for-sale are used as part of the Corporation’s interest rate risk management strategy and may be sold in response to interest rate, changes in prepayment risk, liquidity needs, the need to increase regulatory capital and other factors. The fair value of the Corporation’s securities available-for-sale totaled $55.963 million at December 31, 2006, compared to $52.393 million at December 31, 2005.
The Company is required to account for the effect of market changes in the value of securities available-for-sale (AFS) under Statement of Financial Accounting Standard #115 (SFAS 115). The market value of the December 31, 2006 securities available-for-sale portfolio was $54,000 less than the associated book value of these securities. On December 31, 2005 the market value of securities available-for-sale exceeded their book value by $121,000.
As of December 31, 2006 the book value of the available-for-sale investment portfolio increased $3.505 million, or 6.7%, from $52.514 million at December 31, 2005 to $56.018 million at December 31, 2006.
SECURITIES PORTFOLIO
(Dollars in thousands)
SECURITIES PORTFOLIO - MATURITY AND YIELDS
December 31, 2006 (Dollars in thousands)
DEPOSITS
The Corporation primarily uses deposits to fund its loans and investment portfolio. In 2006, the Corporation’s deposits grew $7.733 million, or 3.5%. Total deposits at December 31, 2006 were $230.865 million compared to $223.132 million at December 31, 2005. Certificates of deposit increased $14.359 million, or 11.3%, from $127.545 million at December 31, 2005 to $141.910 million at December 31, 2006. This was the largest component of growth in deposits in 2006. Non-interest bearing deposits were $27.809 million at December 31, 2006, a $2.982 million, or 9.7%, decrease from $30.791 million at December 31, 2005. Additionally, there was a $2.048 million, or 9.2%, decrease in savings deposits. Savings deposits were $20.103 million at December 31, 2006 compared to $22.151 million at December 31, 2005. NOW accounts decreased $706,000, or 2.6%, from $27.689 million at December 31, 2005 to $26.983 million at December 31, 2006. Money Market Deposit Accounts (MMDA) decreased $889,000, or 5.9%, from $14.955 million at December 31, 2005 to $14.066 million at December 31, 2006.
In 2005, the Corporation’s deposits grew $16.159 million, or 7.8%. Total deposits at December 31, 2005 were $223.132 million compared to $206.973 million at December 31, 2004. Certificates of deposit increased $14.243 million, or 12.6%, from $113.302 million at December 31, 2004 to $127.545 million at December 31, 2005. This was the largest component of growth in deposits in 2005. Non-interest bearing demand deposits were the only other deposit category experiencing growth in 2005. Non-interest bearing deposits were $30.791 million at December 31, 2005, a $5.186 million, or 20.3%, increase from $25.605 million at December 31, 2004. Offsetting these increases to deposit growth was a $3.165 million, or 12.5%, decrease in savings deposits. Savings deposits were $25.316 million at December 31, 2004 compared to $22.151 million at December 31, 2005. NOW accounts decreased $337,000, or 1.2%, from $28.026 million at December 31, 2004 to $27.689 million at December 31, 2005. Money Market Deposit Accounts (MMDA) increased $232,000, or 1.6%, from $14.723 million at December 31, 2004 to $14.955 million at December 31, 2005.
The Corporation offers a variety of deposit accounts to individuals and small-to-medium sized businesses. Deposit accounts include checking, savings, money market deposit accounts and certificates of deposit. Certificates of deposit of $100,000 or more totaled $43.980 million at December 31, 2006 and $39.864 million at December 31, 2005, an increase of $8.774 million, or 22.0%.
AVERAGE DEPOSITS AND AVERAGE RATES PAID
(Dollars in thousands)
MATURITIES OF CERTIFICATES OF DEPOSIT OF $100,000 OR MORE
AT DECEMBER 31, 2006
(Dollars in thousands)
SHORT-TERM BORROWINGS
BOE occasionally finds it necessary to purchase funds on a short-term basis due to fluctuations in loan and deposit levels. BOE has several arrangements under which it may purchase funds. Federal Funds guidance facilities are maintained with correspondent banks totaling $16.500 million for the year ending December 31, 2006. $3.207 million was drawn on these facilities at December 31, 2005. As another means of borrowing funds, BOE may borrow from the Federal Home Loan Bank of Atlanta. Total expense on Federal Home Loan Bank of Atlanta borrowings in 2006 was $476,000 and in 2005 was $119,000. Total expense on Federal Funds purchased and other borrowings was $102,000 in 2006 and $101,000 in 2005.
CAPITAL REQUIREMENTS
The determination of capital adequacy depends upon a number of factors, such as asset quality, liquidity, earnings, growth trends and economic conditions. The Corporation seeks to maintain a strong capital base to support its growth and expansion plans, provide stability to current operations and promote public confidence in the Corporation.
The Corporation’s capital position exceeds all regulatory minimums. The federal banking regulators have defined three tests for assessing the capital strength and adequacy of banks, based on two definitions of capital. “Tier 1 Capital” is defined as a combination of common and qualifying preferred stockholders’ equity less goodwill. “Tier 2 Capital” is defined as qualifying subordinated debt and a portion of the allowance for loan losses. “Total Capital” is defined as Tier 1 Capital plus Tier 2 Capital. Three risk-based capital ratios are computed using the above capital definitions, total assets and risk-weighted assets and are measured against regulatory minimums to ascertain adequacy. All assets and off-balance sheet risk items are grouped into categories according to degree of risk and assigned a risk-weighting and the resulting total is risk-weighted assets. “Total Risk-based Capital” is Total Capital divided by risk-weighted assets. The Leverage ratio is Tier 1 Capital divided by total average assets.
During the fourth quarter of 2003 the Company engaged in a trust preferred offering, raising $4.124 million in trust preferred subordinated debt which qualifies as capital for regulatory purposes. This trust preferred debt has a 30-year maturity with a 5-year call option and was issued at a rate of three month LIBOR plus 3.00% for a weighted average rate of 8.10% during 2006.
The following table shows the Corporation’s capital ratios:
CAPITAL RATIOS
December 31,
LIQUIDITY
Liquidity represents the Corporation’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, and certain investment securities. As a result of the Corporation’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Corporation maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customer’s credit needs.
As of December 31, 2006, cash, federal funds sold and available-for-sale securities represented 25.90% of deposits and other liabilities compared to 26.37% at December 31, 2005. Managing loan maturities also provides asset liquidity. At December 31, 2006 approximately $95.834 in loans would mature or reprice with a one-year period.
The following table summarizes the Corporation’s liquid assets for the periods indicated:
SUMMARY OF LIQUID ASSETS
December 31,
(Dollars in thousands)
FINANCIAL RATIOS
Financial ratios give investors a way to compare Corporation’s within industries to analyze financial performance. Return on average assets is net income as a percentage of average total assets. It is a key profitability ratio that indicates how effectively a bank has used its total resources. Return on average assets was 1.15% in 2006 and 1.24% in 2005. Return on average equity is net income as a percentage of average shareholders’ equity. It provides a measure of how productively a Corporation’s equity has been employed. BOE’s return on average equity was 11.47% in 2006 and 12.18% in 2005. Dividend payout ratio is the percentage of net income paid to shareholders as cash dividends during a given period. It is computed by dividing dividends per share by net income per share. BOE has a dividend payout ratio of 29.67% in 2006 and 28.13% in 2005. The Corporation utilizes leverage within guidelines prescribed by federal banking regulators as described in the section “Capital Requirements” in the preceding section. Leverage is average stockholders’ equity divided by total quarterly average assets. This ratio was 9.99% in 2006 and 10.19% in 2005.
FINANCIAL RATIOS
Years ended December 31,
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CREDIT RISK AND CONTRACTUAL OBLIGATIONS
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its clients and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
A summary of the contract amount of the Bank’s exposure to off-balance-sheet risk as of December 31, 2006 and 2005, is as follows:
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing clients. Those lines of credit may not be drawn upon to the total extent to which the Bank is committed.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a client to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. The Bank holds certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.
A summary of the Corporation’s contractual obligations at December 31, 2006 is as follows:
The Company does not have any capital lease obligations, as classified under applicable FASB statements, or other purchase or long-term obligations.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 expresses the SEC staff’s views regarding the process of quantifying financial statement misstatements. SAB 108 expresses the SEC staff’s view that a registrants materiality evaluation of an identified unadjusted error should quantify the effects of the error on each financial statement and related financial statement disclosures and that prior year misstatements should be considered in quantifying misstatements in current year financial statements. SAB 108 also states that correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended. Such correction may be made the next time the registrant files the prior year financial statements. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year and the offsetting adjustment should be made to the
opening balance of retained earnings for that year. Registrants will disclose the nature and amount of each individual error being corrected in the cumulative adjustment. The SEC staff encourages early application of the guidance in SAB 108 for interim periods of the first fiscal year ending after November 15, 2006. period ended December 31, 2006, the Corporation does not anticipate the implementation of SAB 108 will have a material impact on its consolidated financial statements.
In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140” (SFAS 155). SFAS 155 permits fair value measurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. The Statement also clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133. It establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. SFAS 155 also clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Corporation does not expect the implementation of SFAS 155 to have a material impact on its consolidated financial statements.
In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140” (SFAS 156). SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into certain servicing contracts. The Statement also requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. SFAS 156 permits an entity to choose between the amortization and fair value methods for subsequent measurements. At initial adoption, the Statement permits a one-time reclassification of available for sale securities to trading securities by entities with recognized servicing rights. SFAS 156 also requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Corporation does not expect the implementation of SFAS 156 to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements but may change current practice for some entities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The Corporation does not expect the implementation of SFAS 157 to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan will be measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. For any other postretirement plan, the benefit obligation is the accumulated postretirement benefit obligation. SFAS 158 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Statement also requires additional disclosure in the notes to financial statements about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. The Corporation is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employers’ fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. See Note 8 for more information on the impact of SFAS 158.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: An Interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109. The Interpretation prescribes a recognition threshold and measurement principles for the financial statement recognition and measurement of tax positions taken or expected to be taken on a tax return that are not certain to be realized. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Corporation does not expect the implementation of FIN 48 to have a material impact on its consolidated financial statements.
In September 2006, the Emerging Issues Task Force issued EITF 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” This consensus concludes that for a split-dollar life insurance arrangement within the scope of this Issue, an employer should recognize a liability for future benefits in accordance with FASB Statement No. 106 (if, in substance, a postretirement benefit plan exits) or APB Opinion No. 12 (if the arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement with the employee. The consensus is effective for fiscal years beginning after December 15, 2007. The Corporation is currently evaluating the effect that EITF No. 06-4 will have on its consolidated financial statements when implemented.
In September 2006, The Emerging Issues Task Force issued EITF 06-5, “Accounting for Purchases of Life Insurance- Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 .” This consensus concludes that a
policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. A consensus also was reached that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). The consensuses are effective for fiscal years beginning after December 15, 2006. The Corporation is currently evaluating the effect that EITF No. 06-5 will have on its consolidated financial statements when implemented.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Corporation’s market risk is composed primarily of interest rate risk. The Corporation’s Asset and Liability Management Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. The Board of Directors reviews and approves the guidelines established by ALCO.
Interest rate risk is monitored through the use of two complimentary modeling tools: earnings simulation modeling and economic value simulation (net present value estimation). Each of these models measures changes in a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Corporation, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Earnings simulation and economic value models, which more effectively measure the cash flow and optionality impacts, are utilized by management on a regular basis and are explained below.
Earnings Simulation Analysis
Management uses simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that management has input, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other potential analyses.
Assumptions used in the model are derived from historical trends and management’s outlook and include loan and deposit growth rates and projected yields and rates. Such assumptions are monitored and periodically adjusted as appropriate. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are reflected in the different rate scenarios.
The Corporation uses its simulation model to estimate earnings in rate environments where rates ramp up or down around a “most likely” rate scenario, based on implied forward rates. The analysis assesses the impact on net interest income over a 12 month time horizon by applying 12-month shock versus the implied forward rates of 200 basis points up and down. The following table represents the interest rate sensitivity on net interest income for the Corporation across the rate paths modeled as of December 31, 2006:
Economic Value Simulation
Economic value simulation is used to determine the estimated fair value of assets and liabilities over different interest rate scenarios. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate scenarios is an indication of the longer term earnings sensitivity capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The economic value simulation uses simultaneous rate shocks to the balance sheet, whereas the earnings simulation uses rate shock over 12 months. The following chart reflects the estimated change in net economic value over different rate environments using economic value simulation as of December 31, 2006:
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are filed as a part of this report following ITEM 15. Exhibits, Financial Statement Schedules.
1. Report of Independent Registered Public Accounting Firm
2. Consolidated Balance Sheets as of December 31, 2006 and 2005
3. Consolidated Statements of Income for the three years ended December 31, 2006
4. Consolidated Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2006
5. Consolidated Statements of Cash Flows for the three years ended December 31, 2006
6. Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A:
ITEM 9A: CONTROLS AND PROCEDURES
As of the end of the period to which this report relates, the Corporation has carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Corporation’s (including its consolidated subsidiaries) required to be included in the Corporation’s periodic SEC filings. There have been no significant changes in the Corporation’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Corporation carried out its evaluation.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
None.
PART III
ITEM 10:
ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
All required information is detailed in the Company’s 2007 definitive proxy statement for the annual meeting of shareholders (“Definitive Proxy Statement”), which is expected to be filed with the SEC within the required time period, and is incorporated herein by reference.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
Information on executive compensation is provided in the Definitive Proxy Statement and is incorporated herein by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information on security ownership of certain beneficial owners and management and related stockholder matters is provided in the Definitive Proxy Statement, and is incorporated herein by reference.
The following table summarizes information, as of December 31, 2006, relating to the Corporation’s stock incentive plans, pursuant to which grants of options to acquire shares of common stock may be granted from time to time.
Equity Compensation Plan Information
Year Ended December 31, 2006
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information on certain relationships and related transactions are detailed in the Definitive Proxy Statement and incorporated herein by reference.
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
Information on principal accounting fees and services is provided in the Definitive Proxy Statement and is incorporated herein by reference.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Exhibit Listing
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, in the town of Tappahannock, State of Virginia, on March 27, 2007.
BOE FINANCIAL SERVICES OF VIRGINIA, INC.
By:
/s/ Bruce E. Thomas
Bruce E. Thomas
Senior Vice President and Chief Financial Officer
Date: March 27, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated.
SIGNATURE
TITLE
/s/ George M. Longest, Jr.
President, Chief Executive Officer and Director (Principal Executive Officer)
George M. Longest, Jr.
/s/ Bruce E. Thomas
Senior Vice President, Chief Financial Officer and Corporate Secretary (Principal Financial and Accounting Officer)
Bruce E. Thomas
/s/ R. Harding Ball
Director
R. Harding Ball
/s/ R. Tyler Bland, III
Director
R. Tyler Bland, III
/s/ L. McCauley Chenault
Director
L. McCauley Chenault
/s/ Frances H. Ellis
Director
Frances H. Ellis
/s/ George B. Elliott
Director
George B. Elliott
/s/ Page Emerson Hughes
Director
Page Emerson Hughes
/s/ Philip T. Minor
Director
Philip T. Minor