ITEM 1.
BUSINESS
General
The Company and the Bank. Central Virginia Bankshares, Inc. (the “Company”) was incorporated as a Virginia corporation on March 7, 1986, solely to acquire all of the issued and outstanding shares of Central Virginia Bank (the “Bank”). The Bank was incorporated on June 1, 1972 under the laws of the Commonwealth of Virginia and, since opening for business on September 17, 1973, its main and administrative office had been located on U.S. Route 60 at Flat Rock, in Powhatan County, Virginia. In May 1996, the administrative offices were relocated to the Corporate Center in the Powhatan Commercial Center on New Dorset Road located off Route 60 less than one mile from the main office. In June 2005, the original main office was closed and relocated nine-tenths of a mile east, to the then just completed new main office building.
The Company maintains an internet website at www.centralvabank.com, which contains information relating to it and its business. The Company makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these documents as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Copies of the Company’s Audit Committee Charter, Nominating Committee Charter and Code of Conduct are available upon written request to the Company’s Corporate Secretary.
Principal Market Area. The Bank’s primary service areas are Powhatan and Cumberland Counties, eastern Goochland County and western Chesterfield and western Henrico Counties. These counties had populations of 22,377; 9,017; 16,863; 259,903 and 262,300 respectively, according to the 2000 census. The growth rate of these counties was 46.0%, 15.2%, 19.1%, 24.2%, and 20.4%, respectively, from the 1990 census. The estimated population in 2005 and the percentage growth from April 1, 2000 to July 1, 2005 according to the US Census Bureau for Powhatan, Cumberland, Goochland, Chesterfield and Henrico Counties is 26,598 - 18.9%; 9,378 - 4.0%; 19,360 - 14.8%; 288,876 - 11.2%; 280,581 - 7.0% respectively. Similar growth rates are expected for the foreseeable future. The Bank’s main office is located near the Village of Flat Rock in Powhatan County, which is on U.S. Route 60, eight miles west of the Village of Midlothian in Chesterfield County. Flat Rock is the commercial hub of Powhatan County. Three of the Bank’s branch offices are located in Chesterfield County, one in the Village Marketplace Shopping Center in the Village of Midlothian, one in the Market Square Shopping Center in Brandermill, and one in the Bellgrade shopping center, two are in Cumberland County on U.S. Route 60 one near the courthouse and the other in Cartersville, and there is one branch in the Wellesley development in the Short Pump area of western Henrico County. The Wellesley location was acquired from another financial institution and opened in July 2001 while the Bellgrade location was acquired from another financial institution in October 2003 and was opened for business in March 2004. The Bank’s present intention is to continue its activities in its current service area, and expand its franchise in the higher growth areas of the markets it serves. The Bank’s primary markets are considered to be an attractive and desirable area in which to operate.
Banking Services. The principal business of the Bank is to attract deposits and to loan or invest those deposits on profitable terms. The Bank engages in a general community and commercial banking business, targeting the banking needs of individuals and small to medium sized businesses in its primary service area. The Bank offers all traditional loan and deposit banking services as well as newer services such as Internet banking, telephone banking, debit cards, and other ancillary services such as the sales of non-deposit investment products through a partnership with Community Bankers Securities, LLC, a registered broker-dealer and member of NASD, SIPC. The Bank makes seasonal and term loans, both alone
and in conjunction with other banks or governmental agencies. The Bank also offers other related services, such as ATMs, travelers’ checks, safe deposit boxes, deposit transfer, notary public, escrow, drive-in facilities and other customary banking services. The Bank’s lending policies, deposit products and related services are intended to meet the needs of individuals and businesses in its market area.
The Bank’s plan of operation for future periods is to continue to operate as a community bank and to focus its lending and deposit activities in its primary service area. As the Bank’s primary service area shifts from rural to suburban in nature, the Bank will compete aggressively for customers through its traditional personal service and extended hours of operation. The Bank will also emphasize the origination of residential mortgages and construction loans as the area becomes more developed. Consistent with its focus on providing community based financial services, the Bank does not plan to diversify its loan portfolio geographically by making significant loans outside of its primary service area. While the Bank and its borrowers will be directly affected by the economic conditions and the prevailing real estate market in the area, the Bank is better able to monitor the financial condition of its borrowers by concentrating its lending activities in its primary service area. The Bank will continue to evaluate the feasibility of entering into other markets as opportunities to do so become available.
Lending Activities
Loan Portfolio. The Company is an active residential mortgage and residential construction lender and also extends consumer loans to individuals and commercial loans to small and medium sized businesses within its primary service area. The Company’s commercial lending activity extends across its primary service area of Powhatan, Cumberland, Goochland, western Chesterfield and western Henrico Counties. Consistent with its focus on providing community-based financial services, the Company does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area, however, there are a number of lending relationships outside of the primary service area. The principal risk associated with each of the categories of loans in the Company’s portfolio is the creditworthiness of borrowers, followed closely by the local economic environment. In an effort to manage this risk, the Bank’s policy gives loan approval limits to individual loan officers based on their level of experience. Loans where the total borrower exposure to the Bank is less than $2,500,000 may be approved by the Bank’s Senior Loan Committee. The Board of Directors of the Bank must approve loans where the total borrower exposure is in excess of $2,500,000. The risk associated with real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of the Company’s primary market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction, the mortgage loan interest rate environment, and the number of speculative properties under construction. The Bank manages that risk by focusing on pre-sold or contract homes, and limiting the number of “speculative” homes in its portfolio.
Residential Mortgage Loans. Residential mortgage loans are made in amounts generally up to 80.0% of the appraised value of the property pledged as security for the loan. Residential mortgage loans are underwritten using specific qualification guidelines that are intended to assure that such loans may be eligible for sale into the secondary mortgage market. The Bank generally requires an appraisal by a licensed outside appraiser for all loans secured by real estate. In some isolated instances where the Bank is familiar with the subject property, the current locality’s tax assessed value or an assessment by Bank lenders may be accepted. The Bank requires that the borrower obtain title, fire and casualty insurance coverage in an amount equal to the loan amount and in a form acceptable to the Bank. The Bank originates residential mortgage loans that are sold in the secondary market, or are carried in the Bank’s loan portfolio. These loans are generally either one-year, three-year, or five-year adjustable rate mortgages (“ARMs”) or fifteen to thirty
year fixed rate mortgages. Substantially all permanent owner occupied residential mortgages made for the Bank’s own portfolio are made as three-year and five-year ARMs.
The Bank’s ARMs generally are subject to interest rate adjustment limitations of 2.0% per three-year period and 6.0% over the life of the loan. All changes in the interest rate are based on the movement of an external index contractually agreed to by the Bank and the borrower at the time the loan is originated.
There are risks to the Bank resulting from increased costs to a borrower as a result of the periodic repricing mechanisms of these loans. Despite the benefits of ARMs to an institution’s asset/liability management, they may pose additional risks, primarily because as interest rates rise, the underlying payments by the borrower rise, increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.
The Bank charges origination fees on its residential mortgage loans. These fees vary among loan products and with market conditions. Generally such fees are from .5% to 3.0% of the loan principal amount. In addition, the Bank charges fees to its borrowers to cover the cost of appraisals, credit reports and certain expenses related to the documentation and closing of loans.
Commercial Mortgage Loans. The Bank does not actively seek permanent commercial mortgage loans on income-producing properties such as apartments, shopping centers, hotels and office buildings. However, any such requests from Bank customers concerning properties in the Bank’s established trade area are considered.
Real Estate Construction Lending. In general, the Bank does not actively solicit construction loans on income-producing properties such as apartments, shopping centers, hotels and office buildings.
In order to promote its permanent mortgage lending business and because of the attractive adjustable interest rates available, the Bank makes construction and small development loans for residential housing purposes. The large majority of the Bank’s construction loans are to experienced builders. Such loans normally carry an interest rate of .5% to 1.5% over the prime bank lending rate, adjusted daily. Construction lending entails significant risk as compared with residential mortgage lending. Construction loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the home under construction, which is of uncertain value prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To minimize risks associated with construction lending, the Bank, as a general rule, limits loan amounts to 75.0% of appraised value on unsold homes and 80.0% of appraised value on pre-sold homes, and performs or causes to be performed periodic inspections of the construction to ensure there are sufficient undisbursed loan proceeds in order to complete the building, in addition to its usual credit analysis of its borrowers. The Bank always obtains a first lien on the property as security for its construction loans.
Consumer Lending. The Bank currently offers most types of consumer demand, time and installment loans for a variety of purposes, including automobile loans, home equity lines of credit, and credit cards.
Commercial Business Lending. As a full-service community bank, the Bank makes commercial loans to qualified businesses in the Bank’s market area. At December 31, 2006, commercial business loans were $40.7 million or 19.5% of the Bank’s total loan portfolio. Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields. To manage
these risks, the Bank secures appropriate collateral and monitors the financial condition of its business borrowers and the concentration of such loans in the Bank’s portfolio. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment income and other sources and are secured by real property whose value tends to be easily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of its business and are either unsecured or secured by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral for secured commercial business loans may depreciate over time, and cannot be appraised with as much precision as residential real estate. At December 31, 2006, the Bank had $144,000 in non-performing commercial loans.
Competition
Based on FDIC deposit statistics as of June 30, 2006, the Bank has a dominate position in both Powhatan and Cumberland Counties with greater than 58% of the deposits in each locality. However, in both Chesterfield and Henrico Counties, the Bank encounters stronger competition for its banking services from larger banks and other community banks located in the Richmond metropolitan area. In addition, financial companies, mortgage companies, credit unions and savings and loan associations also compete with the Bank for loans and deposits. The Bank must also compete for deposits with money market mutual funds that are marketed nationally. Many of the Bank’s competitors have substantially greater resources than the Bank. The internet is also providing an increasing amount of price-oriented competition, which the Bank anticipates to become more intense. The success of the Bank in the past and its plans for success in the future is dependent upon providing superior customer service and convenience.
Employees
The Company and the Bank had 109 full-time and 22 part-time employees at December 31, 2006. Employee relations have and continue to be good. The Bank sponsors a qualified discretionary Profit Sharing/Retirement Plan for its employees as well as a 401(k) plan, in addition, the Company subsidizes a short-term disability plan, group term life insurance, and group medical, dental, and vision insurance.
Regulation and Supervision
General. As a bank holding company, the Company is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. The BHCA also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity, which is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities.
As a state-chartered commercial bank, the Bank is subject to regulation, supervision and examination by the Virginia State Corporation Commission’s Bureau of Financial Institutions. It also is subject to regulation, supervision and examination by the Federal Reserve Board. State and federal law also governs the activities in which the Bank engages the investments that it makes and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Bank’s operations.
The earnings of the Company’s subsidiaries, and therefore the earnings of the Company, are affected by general economic conditions, management policies, changes in state and federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant state and federal laws to which the Company and the Bank are subject. To the extent that statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.
Payment of Dividends. The Company is a legal entity separate and distinct from the Bank. The majority of the Company’s revenue will result from dividends paid to the Company by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends that it can pay. In addition, both the Company 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 Company 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 declared dividends payable of $1,783,500 to the Company.
Insurance of Accounts and Regulation by the FDIC. The deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law. The deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund (“BIF”) of the Federal Deposit Insurance Corporation (the “FDIC”).
The FDIC is authorized to prohibit any BIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances that could result in termination of any Bank’s deposit insurance.
Capital. 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 Company 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 common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles (“Tier 1 capital”). The remainder may consist of specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of loan loss allowance and pre-tax net unrealized holding gains on certain equity securities (“Tier 2 capital,” which, together with Tier 1 capital, composes “total capital”).
On December 17, 2003, Central Virginia Bankshares, Inc. issued a $5 million debenture to its single purpose capital trust subsidiary, which in turn issued $5 million in trust-preferred securities. With the proceeds of this issuance, the Company then made a $5 million capital injection to its principal subsidiary, Central Virginia Bank.
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.
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.
Other Safety and Soundness Regulations. 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 depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. For example, under the requirements of the Federal Reserve Board 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 the FDIC as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds. The FDIC’s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.
The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. As of December 31, 2006, the Company and the Bank were classified as well capitalized.
State banking regulators also have broad enforcement powers over the Bank, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator.
The Bank Secrecy Act. Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 for known suspects, $25,000 for unknown suspects when the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001,
enacted in response to the September 11, 2001 terrorist attacks, requires bank regulators to consider a financial institution’s compliance with the BSA when reviewing applications from a financial institution. As part of its BSA program, the USA PATRIOT Act also requires a financial institution to follow recently implemented customer identification procedures when opening accounts for new customers and to review lists of individuals and entities that are prohibited from opening accounts at financial institutions.
Interstate Banking and Branching. Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Effective June 1, 1997, a bank headquartered in one state was authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date. After a bank has acquired a branch in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the “Act”) covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.
The Act permits unrestricted affiliations between banks and securities firms. The Act also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act rating.
The Act provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain areas identified in the Act. The Act directs the federal bank regulatory agencies to adopt insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.
The Act adopts a system of functional regulation under which the Federal Reserve Board is confirmed as the umbrella regulator for financial holding companies, but financial holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. The Act repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended, but identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker”, and a set of activities in which a bank may engage without being deemed a “dealer”. The Act also makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the investment Advisers Act of 1940, as amended.
The Act contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and
annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The Act provides that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The Act also provides that the states may adopt customer privacy protections that are stricter than those contained in the Act. The Act also makes a criminal offense, except in limited circumstances, obtaining or attempting to obtain customer information of a financial nature by fraudulent or deceptive means.
ITEM 1A.
ITEM 1A.
RISK FACTORS
The Company’s business is subject to various risks. The following are some of the more significant, but not necessarily all, of the risks that could affect the financial condition or performance of the Company. The Company’s business, prospects, financial condition and results of operations could be adversely affected by one or more of the following risks. You should read this section together with the other information, including the consolidated financial statements and related notes to the consolidated financial statements included in this document.
General economic conditions both local and national could adversely affect the Company.
The Company is affected by the general economic conditions in the local markets in which it operates, as well as national economic conditions. A significant decline in the general economic conditions as a result of inflation, recession, excessive and sustained unemployment, natural disasters, or other factors beyond the control of the Company could negatively impact growth in and/or retention of deposits, growth in and/or repayments of loans, the overall quality of the loan portfolio, and the quality of the investment portfolio. The local economic conditions generally have the most affect on the Company’s loan portfolio, whereas national economic conditions tend to have the most affect on the Company’s investment portfolio. A sustained negative environment could adversely affect the Company’s financial condition and performance.
Changes in market interest rates could affect the Company’s cash flows and our ability to successfully manage our interest rate risk.
The Company’s profitability and financial condition depend to a great extent on our ability to manage the net interest margin, which is the difference between the interest income earned on loans and investments and the interest expense paid for deposits and borrowings. The amounts of interest income and interest expense are principally driven by two factors; the market levels of interest rates, and the volumes of earning assets or interest bearing liabilities. The management of the net interest margin is accomplished by the Company’s Asset Liability Management Committee. Short term interest rates are highly sensitive to factors beyond the Company’s control and are effectively set and managed by the Federal Reserve, while longer term rates are generally determined by the market based on investors’ inflationary expectations. Thus, changes in monetary and or fiscal policy will affect both short term and long term interest rates which in turn will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if the Company does not effectively manage the relative sensitivity of its earning assets and interest bearing liabilities to changes in market interest rates. The Company generally attempts to maintain a neutral position in terms of the volume of earning assets and interest bearing liabilities that mature or can re-price within a one year period in order that it may maintain the maximum net interest
margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and greatly influence this ability to maintain a neutral position.
Generally, the Company’s earnings will be more sensitive to fluctuations in interest rates the greater the difference between the volume of earning assets and interest bearing liabilities that mature or are subject to re-pricing in any period. The extent and duration of this sensitivity will depend on the cumulative difference over time, the velocity and direction of interest rate changes, and whether the Company is more asset sensitive or liability sensitive. Additionally, the Asset Liability Management Committee may desire to move the Company’s position to more asset sensitive or more liability sensitive depending upon their expectation of the direction and velocity of future changes in interest rates in an effort to maximize the net interest margin. Should the Company not be successful in maintaining the desired position, or should interest rates not move as anticipated, the Company’s net interest margin may be negatively impacted.
The Company’s concentration in loans secured by real estate could, as a result of adverse market conditions, increase credit losses which could adversely impact earnings.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. A major change in the real estate market, such as a deterioration in the value of this collateral, or in the local or national economy, could adversely affect our customers’ ability to pay these loans, which in turn could impact us. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.
Should the Company’s allowance for loan losses become inadequate, the results of operations may be adversely affected.
The Company maintains an allowance for loan losses that it believes is a reasonable estimate of known and inherent losses within the loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with the Company. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond the Company’s control, and these losses may exceed current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. Although the Company believes the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot fully predict such losses or that the loss allowance will be adequate in the future. Excessive loan losses could have a material impact on financial performance. Consistent with the loan loss reserve methodology, the Company expects to make additions to the loan loss reserve levels as a result of its growth strategy, which may affect the Company’s short-term earnings.
Federal and state regulators periodically review the allowance for loan losses and may require the Company to increase its provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on the Company’s operating results.
The Company’s future success is dependent in our ability to effectively compete in the face of substantial competition from other financial institutions in our primary markets.
The Company encounters significant competition for deposits, loans and other financial services from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions in our market area. A number of these banks and other financial institutions are significantly larger than the Company and have substantially greater access to capital and other resources, larger lending limits, more extensive branch systems, and may offer a wider array of banking services. To a limited extent, the Company competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations any of which may offer more favorable financing rates and terms than the Company. Most of these non-bank competitors are not subject to the same extensive regulations that govern the Company. As a result, these non-bank competitors may have advantages in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
The Company’s inability to successfully implement its strategic plans and manage its growth could adversely impact earnings as well as its overall financial condition.
The Company may not be able to successfully implement its strategic plans and manage its growth if it is unable to identify attractive markets, locations or opportunities for expansion in the future. Successful management of increased growth is contingent upon whether the Company can maintain appropriate levels of capital to support its growth, maintain control over growth in expenses, maintain adequate asset quality, and successfully integrate into the organization, any businesses acquired.
As the Company continues to implement its growth strategy by opening new branches or acquiring existing branches or banks, it expects to incur increased personnel, occupancy and other operating expenses. In the case of branch franchise expansion, it must absorb these higher expenses as it begins to generate new deposits. There is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, the Company’s plans to branch could depress earnings in the short run, even if it efficiently executes a branching strategy leading to long-term financial benefits.
The Company is exposed to both operational and acquisition integration risks that could adversely affect the Company.
The Company is exposed to many types of operational risk, including reputation risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. These risks are not dissimilar to those faced by most other financial institutions.
The Company may not be able to fully achieve its strategic objectives and operating efficiencies in an acquisition. Inherent uncertainties exist in integrating the operations of an acquired entity. In addition, the markets and industries in which the Company and its potential acquisition targets operate, are highly competitive. The Company may lose existing customers or the customers of an acquired entity as a result of its acquisition. The Company also may lose key personnel, either from the acquired entity or from itself, as a result of an acquisition. These factors could contribute to the Company not achieving the expected benefits from its acquisitions within desired time frames, if at all. Future business acquisitions could be material to the Company and it may issue additional shares of common stock to pay for those acquisitions, which would dilute current shareholders’ ownership interest. Acquisitions also could require the Company to use substantial cash or other liquid assets or to incur debt. In such a case, it could become more susceptible to economic downturns and competitive pressures.
Changes in accounting standards could impact reported earnings.
The accounting, disclosure, and reporting standards set by the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation and presentation of the Company’s consolidated financial statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
Significant changes in legislation and or regulations could adversely impact the Company.
The Company is subject to extensive supervision, regulation, and legislation by both state and federal banking authorities. Many of the regulations the Company is governed by, are intended to protect depositors, the public, or the insurance funds maintained by the Federal Deposit Insurance Corporation, not shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain the Company’s rate of growth, and changes in regulations could adversely affect it. The burden imposed by federal and state regulations may place banks in at competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect the Company’s ability to operate profitably.
The Company’s continued success is largely dependent on key management team members.
The Company is a customer-focused and relationship-driven organization. Future growth is expected to be driven by a large part in the relationships maintained with customers. While the Company has assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on the Company’s business and may result in lower revenues or reduced earnings.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
The original main office of the Company and the Bank was a two-story brick building built in 1978 with approximately 8,500 square feet of floor space. It was located on Route 60 in the Village of Flat Rock in Powhatan County. The original main office was replaced in June 2005 by a 16,000 square foot brick building located approximately nine tenths of a mile east of the original building. The new Main Office is located on a 6.95 acre tract of land at the intersection of New Dorset Road and Route 60 in Powhatan County. The building was occupied in June 2005 bringing together all retail and loan personnel from the original main office as well as all lending personnel from the Flatrock branch location. The original main office and the Flatrock branch were closed at this time and the original main office was sold in June 2006.
The Cartersville location, in Cumberland County, which originally opened in 1985, was replaced in mid-1994 with a one-story brick building with approximately 1,600 square feet. The Midlothian branch is located in Chesterfield County at the Village Marketplace shopping center and was built in 1988 and opened in May of that year. It is a one and one-half story building with approximately 3,000 square feet. The Flatrock branch was acquired in 1992 from the Resolution Trust Corporation with the bank assuming approximately $9.0 million in deposit liabilities of the former Coreast Federal Savings Bank. The Flatrock branch facility is located in the Village of Flat Rock across Route 60 from the Bank’s original main office. This branch was closed in June 2005 and is currently used for offsite record storage.In April 1993, the Bank acquired the branch facility of the former Investors Federal Savings Bank located in the Market Square Shopping Center in Brandermill in Chesterfield County, through the Resolution Trust Corporation. This one-story building contains approximately 1,600 square feet and opened for business on November 1, 1993.
In June 1998, the Bank completed construction of and opened a 4,800 square foot branch located on U. S. Route 60 (Anderson Highway) near the courthouse in Cumberland County, Virginia. In July 2001, the Bank acquired a one-story, 2,800 square foot, two-year old branch facility from another financial institution located on Lauderdale Drive in Wellesley in Henrico County. In December 2004, the Bank purchased a 2,800 square foot, seven-year old branch bank building from another financial institution. This branch is located at 2500 Promenade Parkway in the Bellgrade shopping center located in the Midlothian area of Chesterfield County. In May 1996, the Company moved its administrative staff to a 15,000 square foot two-story Corporate Center in the Powhatan Commercial Center located off U.S. Route 60 near the main office. The Corporate Center houses the executive offices, finance and accounting, computer operations, loan administration and bookkeeping departments.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of securities holders through the solicitation of proxies or otherwise during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock and Dividends
Central Virginia Bankshares, Inc. Common Stock trades on The Nasdaq Global Market (“Nasdaq”) under the symbol “CVBK”. As of March 30, 2007, the Company had approximately 792 shareholders of record.
The following table sets forth the high and low trade prices of the Company’s Common Stock on Nasdaq, based on published financial sources, and the dividends paid on the Common Stock for each calendar quarter indicated. Prior period trade prices and dividends per share have been adjusted to reflect the 5% stock dividend paid June 15, 2006 to shareholders of record May 31, 2006.
The Company’s future dividend policy is subject to the discretion of the board of directors and will depend upon a number of factors, including future consolidated earnings, financial condition, liquidity and capital requirements of the Company and the Bank, applicable governmental regulations and policies and other factors deemed relevant by the board of directors.
The Company’s ability to distribute cash dividends will depend primarily on the abilities of its subsidiary bank to pay dividends to the Company. As a state member bank, the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Furthermore, neither the Company nor the Bank may declare or pay a cash dividend on any capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business. For additional information on these limitations, see “Regulation and Supervision - Payment of Dividends” in Item 1 above.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Net income for the year ended December 31, 2006 increased by $194,834, or 3.9%, ending the year at $5,150,002 compared to $4,955,168 in 2005. The increase was primarily due to a combination of a nonrecurring pre-tax gain of $710,733 from the sale of the Company’s former main office branch reflected in other income, and an increase in net interest income, the latter of which increased by $667,396 or 4.6% to $15.1 million versus $14.4 million in 2005 largely as a result of the increases in interest rates throughout the year and to a lesser extent, the increase in volume of loans and investment securities. Total interest income increased by $4.0 million or 17.2% to $27.0 million from $23.0 million in 2005, as the Company’s average interest-earning assets, primarily loans and investment securities, increased by $20.3 million, or 5.6% from December 31, 2005. Interest expense on deposits and borrowings also increased by $3.3 million, or 38.1%, ending the year at $11.9 million from $8.6 million in 2005. The increase in interest expense principally resulted from increases in interest rates on retail
deposits - primarily certificates of deposit, and wholesale borrowings, as well as growth in the volume of interest bearing deposits. The average balances of interest bearing deposits increased by $10.0 million or 3.6% to average $286.0 million for the year, versus $275.9 million for the year 2005. Total other non-interest income totaled $4.4 million, an increase of $1,260,031 or 40.4% versus $3.1 million in 2005. The increase is principally due to $636,296 increase in deposit fees and charges due to a new overdraft protection program introduced in late fourth quarter 2005, and a $710,733 non-recurring gain from the sale of the former main office building in the second quarter 2006. Non-interest expense increased to $12.7 million an increase of $1.7 million or 15.5% compared to $11.0 million in 2005. Of total non-interest expense, salaries and benefits comprised over 56% and totaled $7.1 million up by $863,535 or 13.8% over $6.3 million in 2005. Occupancy and equipment expenses have increased due to the general growth of the Bank, and the full year of occupancy expense associated with the new main office in 2006 versus only six months in 2005. Advertising and public relations expense has increased due to the new marketing and product promotion programs begun in 2006 in conjunction with our emphasis on business development.
Net income for the year ended December 31, 2005 increased by $566,269, or 12.2%, ending the year at $4,955,168 compared to $4,388,899 in 2004. The increase was primarily due to an increase in net interest income, which increased by $1.3 million or 10.1% to $14.4 million versus $13.1 million in 2004 largely as a result of the increases in interest rates throughout the year and to a lesser extent the increase in volume of loans and investment securities. Total interest income increased by $2.7 million or 13.3% to $23.0 million from $20.3 million in 2004, as the Company’s average interest-earning assets, primarily loans and investment securities, increased by $20.5 million or 6.0% from December 31, 2004. Interest expense on deposits and borrowings also increased by $1.4 million, or 19.0%, ending the year at $8.6 million from $7.2 million in 2004. The increase in interest expense resulted from the increases in interest rates paid on interest bearing deposits coupled with their volume increase, and the increases in rates on borrowings. Additionally, the average balances of interest bearing deposits increased by $13.7 million or 5.2% to average $275.9 million for the year, versus $262.2 million for the year 2004. Total other non-interest income increased by $343,503 or 12.4% ending 2005 at $3.1 million versus $2.8 million in 2004. Deposit fees and charges increased by $143,925 or 13.3% totaling $1.2 million largely from increased accounts with service charges assessed and the introduction of a new overdraft protection program in the fourth quarter of 2005. Bank card fees were up $60,382 or 20% to total $362,901 for the year. Investment and insurance commissions declined by $125,434 or 30.6% due in part to the Company’s decision to change Broker-Dealers and the resulting conversion, and a general slow down in investment product demand. Secondary market mortgage loan interest and fees were essentially unchanged from the prior year, increasing by less than 2% from the prior year and totaled $241,980 for 2005. The lack of an appreciable increase is due to general real estate loan refinancing volume slowing due to the increases in interest rates, mostly offset by continued robust construction-permanent financing business. Realized gains on securities available for sale was up 22.7% or $70,461 totaling $380,852 for 2005. These non-recurring gains were taken as a result of sales to generate liquidity to fund increases in loans, coupled with sales and purchases resulting from active portfolio management. Total other non-interest expense increased by 9.8% or $979,698, ending the year at almost $11.0 million primarily due to increases in salaries and benefits. In addition, other areas that contributed to the increase were occupancy expense, advertising, and office supplies principally due to the occupancy and opening of the new Main Office branch in June 2005.
Basic earnings per share in 2006 were $2.14 compared to $2.08 in 2005 and $1.86 in 2004. Diluted earnings per share were $2.11, $2.04, and $1.83 respectively, for the same periods. All per share amounts presented have been adjusted giving effect to the 5% stock dividend paid June 15, 2006.
The Company’s return on average equity was 15.10% in 2006 compared to 15.26% in 2005, and 14.88% in 2004. Return on average assets amounted to 1.26%, 1.26%, and 1.19%, for the same periods respectively.
Net Interest Income. The Company’s net interest income was $15,069,629 in 2006, compared to $14,402,233 and $13,077,497 in the prior years of 2005 and 2004, respectively. The net interest income for 2006 was 4.6% greater than 2005, which in turn was 10.1% greater than 2004. The increase in 2006 was less than the prior year due to the effect of the stabilization of interest rates in the second half of the year following four 25 basis point increases between January and June. The prior year, by contrast, saw eight 25 basis point increases in rates by the Federal Reserve, and five increases also of 25 basis points beginning in the second half of 2004. These increases has taken the overnight funds rate from 1.00% to its current 5.25% and when coupled with the Company’s growth in the average balances of interest-earning assets and interest bearing liabilities over the same period, produced the increases in net interest income.
The improvement in net interest income for 2006 versus 2005 of 4.6% is due to an increase of 17.2% in interest income which totaled $26,972,351, driven by a $20.2 million or 5.6% increase in the average balance of earning assets which averaged $382.6 million in 2006 and the impact of interest rate increases early in the year resulting in a 66 basis point yield improvement to 7.24% from 6.58% in 2005. Correspondingly, interest expense on interest bearing liabilities increased as well, growing by 46.8% to total $11,902,722 due to a $13.3 million or 4.2% increase in the average balance of interest bearing liabilities. The expense yield on average interest bearing liabilities, increased by 89 basis points to 3.63% for the year 2006, compared to 2.74% in the prior year. The fact that the yields increased more on interest bearing liabilities than it did on earning assets is reflective of the lagging effect of a stable rate environment following a period of steady increases to an asset sensitive financial institution. The cost of funds continues to increase as lower rate time deposits automatically renew at the current higher interest rates.
The improvement in net interest income for 2005 versus 2004 of 10.1% is due to an increase of 13.3% in interest income which totaled $23,019,059, driven by a 6% increase in the average balance of earning assets which totaled $362.4 million and the impact of interest rate increases throughout the year resulting in a yield improvement for 2005 to 6.58% from 6.20% in 2004. Interest expense on interest bearing liabilities increased by 19.0% over 2004 and totaled $8,616,826, again due to an increase of 4.83% in the average balance and a 33 basis point increase in the yield to 2.74% from 2.41% in the prior year.
The table below, sets forth the Company’s average interest earning assets (on a tax-equivalent basis) and average interest bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin, all for the periods indicated.
____________________
(1)
Includes securities available for sale and securities held to maturity.
(2)
Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 34%.
(3)
Installment loans are stated net of unearned income.
(4)
Average loan balances include non-accrual loans.
(5)
Interest income on loans includes the earned portion of net deferred loan fees in accordance with FASB 91 of $476,606 in 2006, $485,976 in 2005, and $418,884 in 2004.
(6)
Includes mortgage loans held for sale.
The net interest income figures upon adjustment for the effect of non-taxable income are referred to as Taxable Equivalent Net Interest Income, and totaled $15,792,369 in 2006, $15,232,254 for 2005, $13,944,863 for 2004. The Company’s tax-equivalent net interest margin for 2006 was 4.13% compared to 4.20% in 2005 and 4.08% in 2004. The tax-equivalent net interest margin is a measure of net interest income performance. It represents the difference between interest income with any non-taxable interest adjusted to a fully tax-equivalent basis, including net deferred loan fees earned, and interest expense, on both deposits, and borrowings reflected as a percentage of average interest earning assets. The net interest margin contracted in 2006 as compared to 2005, because despite the rate earned on earning assets increasing 66 basis points (7.24% vs. 6.58%), and the average volume of earning assets increasing by $20.3 million ($382.6 million vs. $362.3 million); the rate paid on interest bearing liabilities increased by a greater increment, 89 basis points (3.63% vs. 2.74%) and although coupled with a smaller increase of $13.4 million in the average volume of interest bearing liabilities ($328.3 million vs. $314.9 million), still resulted in the tax-equivalent net interest margin being lower than the prior year. This condition is referred to as margin compression. By contrast, the net interest margin expanded in 2005 as compared to 2004, because the rate on earning assets increased by 38 basis points (6.58% vs. 6.20%) which was more
than the 33 basis point increase in the rate paid on interest bearing liabilities (2.74% vs. 2.41%), and the average volume of earning assets increased by $20.5 million ($362.3 million vs. $341.8 million) while average volume of interest bearing liabilities increased by $14.5 million ($314.8 million vs. $300.3 million), resulting in the tax-equivalent net interest margin expansion.
The tax-equivalent yield on securities in 2006 was 6.00% a 14 basis point increase over the 5.86% yield in 2005 and slightly better than the 5.99% yield in 2004. This increase is largely attributable to the acquisition of higher coupon agency securities as rates continued to edge up through the first half of 2006. The 2005 decline in yield versus 2004 was principally the result of the low rate environment at that time, where higher coupon securities were called and had to be replaced with lower coupon securities whose yield were in line with the broader market interest rates. In mid 2006, the Fed stopped increasing interest rates. This stabilization continued through the end of the year, and given the longer term orientation of the total portfolio, has allowed the purchase of higher coupon bonds. The Company, due to the composition of its investment portfolio, has continued to maintain its yield at a level considerably better than the majority of its peer institutions, as evidenced by its yield being ranked 49 out of 866 banks in its peer group as of the end of the third quarter 2006.
Net interest income is affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total change in interest income that can be attributed to rate (change in rate multiplied by old volume) and volume (change in volume multiplied by old rate) for the periods indicated. The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the relative size of the rate and volume changes.
____________________
(1) Includes securities available for sale and securities held to maturity.
(2) Fully taxable equivalent basis.
Non-Interest Income. Total other non-interest income totaled $4.4 million, an increase of $1,260,031 or 40.4% versus $3.1 million in 2005. Deposit fees and charges increased by $636,296 or 51.9% and totaled $1.9 million due to the introduction of a new overdraft protection program late in the fourth quarter of 2005 as well as increased numbers of accounts with service charges assessed. Gain on sale of assets totaled $757,416 versus zero in the prior year, as the Company’s principal subsidiary, Central Virginia Bank sold its former main office in the second quarter 2006 generating a non-recurring pre tax gain of $710,733. That plus another unrelated nonrecurring gain on sale of an investment in a trust company generated the total pre-tax gain of $757,416. Investment and insurance commissions totaled $325,156 up $40,384 or 14.2% due to a higher volume of transactions resulting from growth in the program. Bank card fees were up $49,823 or 13.7% to total $412,724 for the year due to higher interchange credit and increased debit card transaction fees. Secondary market mortgage loan interest and fees were $260,946 up $18,966 or 7.8% from the prior year. The lower growth in this category is due to the general slow down in real estate loan originations, coupled with the absence of any significant loan refinancing volume resulting from the relatively flat interest rate environment. Total other non-interest income totaled $363,543, an increase of 7.6% or $25,734, due to the combination of higher check fees, miscellaneous income, and title insurance income. Realized gains on securities available for sale totaled $181,481 down $199,371 or 52.3% compared to $380,852 for 2005. These non-recurring net gains were as a result of active portfolio management, however a lower volume of such transactions occurred in 2006 due in part to a lesser need for funding and the use of other temporary funding sources. The cash surrender value of bank owned life insurance totaled $211,390 down $69,217 or 24.7% largely due to lower net crediting rates from the carriers.
Non-interest income increased $343,503, or 12.4%, totaling $3,115,997 for 2005 compared to $2,772,494 in 2004. Deposit fees and charges increased 13.3% due in part to increases in the volume of overdrafts and the implementation of a new overdraft protection program in the fourth quarter. Bank card fees were $362,901 a 20% increase over the prior year’s $302,519. The higher income was due to the increasing volume of debit card usage, point of sale transaction fees, and interchange credits. Realized gains on securities available for sale totaled $380,852, a 22.7% increase over $310,391 in 2005 and were generated as a result of active portfolio management as well as security sales generating liquidity to partially fund loan growth. Mortgage loan secondary market fees remained largely unchanged from the prior year as the lower volume of refinancing activity that began in 2004 continued through 2005. Investment and insurance commissions declined by $125,434 or 30.6% ending the year at $284,772 in part due to the Company’s decision to change Broker-Dealers and the resulting conversion from Uvest to Community Bankers Securities in the second and third quarters of 2005. The transition and conversion while very successful, had a somewhat detrimental effect on sales efforts, that, when coupled with a general slow down in investment product demand, resulted in a decline in revenues. The remaining categories of non-interest income were generally in line with the prior year.
Non-Interest Expenses. Total non-interest expenses increased by $1,701,610 or 15.5% in 2006 and totaled $12,656,512 compared to $10,954,903 in 2005. The largest dollar increases over the prior year were in salaries and wages which increased $752,035 or 16.4% and totaled $5,347,638 compared to $4,595,603 in 2005. Employee benefits were up by $111,500 or 6.6% totaling $1,792,745 versus $1,681,245 in 2005. These increases can be attributed to the additional lending and business development personnel hired, as well as the tightness in our market for experienced bank retail and support personnel hired as a result of normal turnover. The Company often finds that the cost of a replacement will be greater than the previous incumbent resulting in salaries expense increasing. The Company attempts to improve its overall benefit program for all employees each year to the extent practicable, resulting in increases to expense over and above that attributable to increases in the number of employees. Other miscellaneous operating expenses increased by $461,262 or 31.3% to total $1,935,384 compared to $1,474,122 in 2005. The specific categories with increases included in total other expenses were non-
sufficient funds check charge offs and debit card losses up $100,000, new product service fees up $89,051, write down of a Community Reinvestment Act eligible investment up $72,738, Internet switch fees up $59,176, directors fees up $29,950, service fees related to the Company’s local area network $29,750, and various other operating expenses. The other major categories with the largest percentage increases over the prior year were: occupancy expense which increased by $110,158 or 20% ending the year at $660,897 due largely to the impact of the occupancy of the new main office branch in mid June 2005; advertising and public relations was up $113,134 or 43.7% ending the year at $372,228 due to the Company’s new marketing and product promotion initiative, began in the fourth quarter 2006.
Total non-interest expenses increased by $979,698 or 9.8% in 2005 and totaled $10,954,903 compared to $9,975,205 in 2004. The largest dollar increases over the prior year were in salaries, which increased $351,369 or 8.3% and totaling $4,595,603 and employee benefits up by $220,962 or 15.1% and totaling $1,681,245. As the Company has grown, and in an attempt to gain a larger share of the market for loans, additional commercial lenders, business development, credit support, compliance, and operations personnel have been added resulting in the increase in salaries and benefits. Additionally, the Company seeks to improve its overall employee benefit program for all employees each year to the extent practicable, resulting in increases to expense over and above that attributable to increases in the number of employees. Other expenses increased by $109,712 or 8.0% totaling $1,474,122 versus $1,364,410 in 2004. The principal areas with increases included in total other expenses were outside service fees related to the Company’s local area network, bank insurance, and various other operating expenses. The following categories had the largest percentage increases over the prior year. Occupancy expense increased by $93,115 or 20% ending the year at $550,739 due largely to the impact of the occupancy of Central Virginia Bank’s new main office in late June 2005. Taxes and licenses increased by $37,439 or 16.2% and totaled $268,672 principally due to increases in bank franchise taxes based on the bank’s total capital. Legal and professional fees increased by $25,631 or 14.7% due to higher fees from the Company’s external independent accounting firm and the costs of outsourced internal audits. Equipment repairs and maintenance expense increased $38,257 or 13.4% ending 2006 at $323,125 while depreciation expense increased by $39,230 or 6.1% ending 2005 at $679,498, due to related maintenance expense on existing equipment and additional purchases of computer, security and alarm equipment.
Income Taxes. The Company reported income taxes of $1,639,143 in 2006, $1,405,159 in 2005 and $1,071,387 in 2004. These amounts yielded effective tax rates of 24.1%, 22.1%, and 19.6%, for 2006, 2005, and 2004 respectively. The 2006 and 2005 effective tax rate increased largely due to a consistently lower level of tax-free municipal securities in the investment portfolio. In 2004 the rate was positively impacted by increased investments in various securities where a significant amount of the dividends received were not subject to income taxes and the recognition of certain annual tax credits resulting from the Company’s investment in a Community Reinvestment Act eligible housing project in December 2003.
Financial Condition
Loan Portfolio. The Company is an active residential mortgage and residential construction lender and generally extends commercial loans to small and medium sized businesses within its primary service area. The Company’s commercial lending activity extends across its primary service area of Powhatan, Cumberland, eastern Goochland County, western Chesterfield, and western Henrico Counties. Consistent with its focus on providing community-based financial services, the Company generally does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area.
The principal economic risk associated with each of the categories of loans in the Company’s portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or
decreased depending on prevailing economic conditions. The risk associated with the real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of the Company’s market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction. Many of the Company’s real estate construction loans are for pre-sold or contract homes. Builders are limited as to the number and dollar amount of loans for speculative home construction based on the financial strength of the borrower and the prevailing market conditions.
Net loans outstanding at December 31, 2006 had increased $10.9 million or 5.5% ending the year at $208.6 million compared to the prior year’s growth of $17.6 million or 9.8% ending 2005 at $197.6 million. In 2004, loans grew by $21.2 million or 13.5% ending 2004 at $179.9 million. The loan to deposit ratio was 58.2% at December 31, 2006, compared to 61.3% at December 31, 2005 and 58.1% at December 31, 2004.
The following table summarizes the Company’s loan portfolio, net of unearned income:
As shown in the above table, the total amount of commercial and industrial loans have increased by $4.5 million, $2.9 million, $3.4 million, $3.1 million or 12.5%, 8.7%, 11.6%, and 11.5% in 2006, 2005, 2004, and 2003 respectively. The Company has been focusing on increasing these commercial and industrial loans for several years, as a desirable alternative to real estate related lending. Total real estate related loans outstanding increased by $8.0 million or 5.4% in 2006, $15.1 million or 11.2% in 2005, $17.4 million or 14.8% in 2004 and $15.1 million or 14.8% in 2003. Of the real estate related loans, construction loans have exhibited the greatest growth, having increased by 50.3% from 2002 to 2003, 10.4% from 2003 to 2004, and 20.5% from 2004 to 2005, and 13.7% from 2005 to 2006. As a percentage of total real estate loans, construction loans comprised 29.3% in 2002, 38.4% in 2003, 36.9% in 2004, and 40.0% in 2005, and 43.2% in 2006. Considering the slow down in the real estate markets for new home sales, the Company does not anticipate that growth in construction loans will continue at the same rate in the future as it has in the past. Essentially all construction loans are for residential construction in the principal markets served by the Company. Installment loans declined by $1.6 million in 2006, and $409 thousand in 2005, while in 2004 installment loans increased by $715 thousand, following a decline of $1.3 million in 2003. The balances of traditional installment loans have dropped principally due to the
Company’s unwillingness to effectively compete rate wise with the captive and other finance arms of the major automobile manufacturers, coupled with the tendency of consumers to utilize equity credit lines for purposes that in the past would have been financed with traditional installment loans. The Company expects this trend to continue in the future. Mortgage loans have grown 0.7% in 2003, 14.8% in 2004, and 5.1% in 2005 yet they declined by 2.6% in 2006 largely due to the previously mentioned slow down in the real estate market. Mortgage loans have comprised between 50% and 60% of the total real estate loans for the past five years; however, since 2003 their percentage has been declining. Mortgage loans to total real estate loans were 65.2% in 2002, 57.2% in 2003, 57.2% in 2004, and 54.1% in 2005, and 50.0% in 2006. Home equity loans have grown steadily over the past five years from $5.6 million in 2002 to $10.8 million in 2006; however, they still comprise approximately the same percentage of total real estate loans. Home Equity loans to total real estate loans were 5.5%, 4.4%, 5.9%, 5.9%, and 6.8% in 2002, 2003, 2004, 2005 and 2006, respectively. Bankcard loan balances outstanding have remained relatively level over the same period ranging from $837 thousand in 2002 to $894 thousand in 2006.
All concentrations of loans exceeding 10.0% of total loans at December 31, 2006 were disclosed as a separate category of loans.
The following table shows the contractual maturity distribution of loan balances outstanding as of December 31, 2006. Also provided are the amounts due classified according to the sensitivity to changes in interest rates.
Asset Quality. Non-performing loans include non-accrual loans, loans 90 days or more past due and restructured loans. Non-accrual loans are loans on which interest accruals have been discontinued. Loans which reach non-accrual status, per Company policy, may not be restored to accrual status until all delinquent principal and interest has been paid, or the loan becomes both well secured and in the process of collection. Restructured loans are loans with respect to which a borrower has been granted a concession on the interest rate or the original repayment terms because of financial difficulties.
Non-performing loans totaled $1,000,440 at December 31, 2006 compared to $967,075 at December 31, 2005, $875,329 at December 31, 2004, and $1,820,421 at December 31, 2003. Non-performing loans increased in 2006 primarily due to slight increases of $16,594 and $16,770 in non-accrual loans and loans past due 90 days or more past due respectively. The majority of loans currently in non-accrual are adequately secured by real estate and no significant losses are anticipated regardless of the resolution. Non-performing loans declined from $1.8 million in 2003 to $875,329 in 2004, due to non-accrual loans increasing by $270,546, and 90 day past due loans declining by $1,118,638.
At December 31, 2006, there were no other non-performing assets. The Virginia Small Business Financing Authority Industrial Development Revenue bond carried at December 31, 2005 at a value approximating its anticipated liquidation value of $110,830 was resolved in the third quarter 2006. The original principal investment was $190,000 and had been written down to $140,000, with its value further reduced by the Company’s receipt of its pro-rata portion of the collateral property’s lease payments. Management concluded the principal carrying value, was appropriate, accordingly, no additional write-downs were made. The matter was finally resolved upon the receipt of $163,602 from the sale of the collateral real estate. The Company thus recovered its carrying value plus $59,736 of prior period write downs.
Management forecloses on delinquent real estate loans when all other repayment possibilities have been exhausted. There was no real estate acquired through foreclosure (OREO) at December 31, 2006, 2005, and 2004, compared to $97,000 at December 31, 2003, and 2002. Sales of the properties held at December 31, 2003 resulted in net losses of approximately $1,380. The Bank currently has no OREO, accordingly, it has no 2006 or 2005, period expenses related to OREO. In 2003 carrying costs of $780 were incurred, likewise $1,200 in 2002. The Bank’s practice is to value real estate acquired through foreclosure at the lower of (i) an independent current appraisal or market analysis less anticipated costs of disposal, or (ii) the existing loan balance.
Management does not believe that the level of non-performing loans in 2006 reflects any systemic problem within the Company’s loan portfolio. At December 31, 2006, there were $736,509 in non-accrual loans compared to $719,915 in non-accrual loans at December 31, 2005 and $270,546 at December 31, 2004, and zero at December 31, 2003. Based on our present knowledge of the status of individual and corporate creditors and the overall economy, management does not anticipate a material increase in non-performing assets, although it may move to foreclose on borrowers whose loans are placed on a non-accrual status.
The following table summarizes non-performing assets:
Loans 90 days or more past due generally, are placed on non-accrual status unless well secured and in the process of collection.
In 2006, $10,480 of interest income was reversed when loans were placed in non-accrual status. In 2005, $911 was reversed, in 2004, $8,165 was reversed, and in 2003 and 2002 $0 was reversed. Since the Company operates in a rural to suburban area, it has generally been well acquainted with its principal borrowers and has not had such a large number of problem credits that management has not been able to stay well informed about, and in contact with, troubled borrowers.
The following table sets forth the amounts of contracted interest income and interest income reflected in income on loans accounted for on a non-accrual basis and loans restructured and in compliance with modified terms:
Management is not aware of any other loans at December 31, 2006, which involve serious doubts as to the ability of such borrowers to comply with the existing payment terms.
Management has analyzed the potential risk of loss within the Company’s loan portfolio, given the loan balances, quality trends, value of the underlying collateral, and current local market economic and business conditions and has recognized losses where appropriate. Loans, including non-performing loans are monitored on an ongoing basis as part of the Company’s periodic loan review process. Management reviews the adequacy of its loan loss allowance at the end of each month. Based primarily on the Company’s loan risk classification system, which classifies all loans, including problem credits as substandard, doubtful, or loss, according to a scale of 1-8 with 8 being a loss, additional provisions for losses may be made monthly. In addition, the Company evaluates the general market credit risks inherent in lending, as well as any systemic issues, as part of its enhanced loan loss adequacy analysis. The ratio of the allowance for loan losses to total loans was 1.39% at December 31, 2006, 1.48% at December 31, 2005, compared to 1.50% at December 31, 2004 and 1.55% at December 31, 2003. Management believes that the allowance for loan losses, while not increasing at the same rate as the portfolio grows, is nevertheless adequate to provide for future losses. At December 31, 2006, the ratio of the allowance for loan losses to non-performing assets was 290.4% compared to 270.7% at year end 2005, 269.9% at year end 2004, 125.2% at year end 2003, and 142.3% at December 31, 2002. Management evaluates non-performing loans relative to their collateral value and makes appropriate reductions in the carrying value of those loans based on that review.
The following table summarizes changes in the allowance for loan losses:
For each period presented, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all factors connected with the collectibility of the existing portfolio. Management evaluates the loan portfolio in light of local business and economic conditions, changes in the nature and value of the portfolio, industry standards and other relevant factors. Assumptions and factors considered by management in determining the amounts charged to operations include internally generated loan review reports, previous loan loss experience with the borrower, the status of past due interest and principal payments on the loan, the quality of financial information
supplied by the borrower and the general financial condition of the borrower. Despite management’s best efforts, the reserve may be adjusted in future periods if there are significant changes in the assumptions or factors utilized when making valuations, or conditions differ materially from the assumptions originally utilized. Any such adjustments are made in the reporting period when the relevant factor(s) become known and when applied as part of the analysis indicate a change in the level of potential loss is warranted.
There was no provision for loan losses for the year ended December 31, 2006 versus $203,000 for the year ended December 31, 2005, and compared to $414,500 for the year 2004, $410,000 for the year 2003, and $440,000 for the year 2002. In the opinion of management, the provision charged to operations has been sufficient to absorb the current year’s net loan losses while continuing to provide for potential future loan losses in view of a somewhat uncertain economy.
The following table shows the balance and percentage of the Company’s allowance for loan losses allocated to each category of loans:
The Company has allocated the allowance according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within each of the above categories of loans. The allocation of the allowance as shown in the table above should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio.
Securities
The Company’s investment securities portfolio serves several purposes, primarily, liquidity, safety and yield. Certain of the securities are pledged to secure public deposits and others are specifically identified as collateral for borrowing from the Federal Home Loan Bank of Atlanta, and others for repurchase agreements with commercial customers. The remaining portion of the portfolio is held for investment yield, availability for sale in the event liquidity is needed and for general asset liability management purposes.
For the year ended December 31, 2006, total investment securities were largely unchanged at $165.5 million or 37.8% of total assets, as compared to the prior year’s December 31, 2005 balance of $165.7 million. During the year 2006, the balance of total securities did not change materially as the $35.7 million growth in retail deposits was more than sufficient to fund the $10.9 million in loan growth, with the excess funding reflected as overnight federal funds sold of $30.2 million at December 31, 2006. Securities transactions in 2006 were limited to sales and purchases to enhance yields, and/or to shorten duration. During the year ended December 31, 2005, total securities decreased $3.4 million, or 2.0%, to $165.7 million, or 41.7% of total assets, principally due to the $17.6 million, or 9.8%, increase in loans. The Company, in the past, has increased its marketable securities holdings, if supported by solid deposit growth and/or borrowings, particularly when experiencing lower loan growth, in an effort to increase net interest income. It is anticipated that this practice will continue in the future.
The securities portfolio consists of two components, securities available for sale and securities held to maturity. Securities are classified as held to maturity when management has the intent and the Company has the ability at the time of purchase to hold the securities to maturity. Securities so classified are carried at cost adjusted for amortization of premiums and accretion of discounts. Securities to be held for indefinite periods of time are classified as available for sale and accounted for at market value. Securities available for sale include securities that may be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, general liquidity needs and other similar factors. The Company’s recent purchases of securities have generally been limited to securities of investment grade credit quality with intermediate to long term maturities and many with optional call provisions.
The following table summarizes the book value of the Company’s securities held to maturity at the date indicated:
The following table summarizes the book value of the Company’s securities available for sale at the dates indicated.
The book value and average yield of the Company’s securities, including securities available for sale, at December 31, 2006 by contractual maturity are reflected in the following table. Actual maturities, and the resulting cashflows, can differ significantly from contractual maturities because certain issuers may have the right to call or prepay debt obligations with or without call or prepayment penalties. The table below categorizes securities according to their contractual maturity, without regard for certain issuers having unilateral optional call provisions prior to the bond’s contractual maturity, which they may or may not exercise depending on the overall market level of interest rates at the call date. The Company’s investment in bank eligible government sponsored entities consists largely of FNMA, FHLMC, and SLMA fixed coupon exchange traded preferred stocks. As these securities have no fixed maturity date they are separately identified. Mortgage-backed securities are also reported according to the contractual final maturity, without regard for the pre-payment characteristics of the underlying mortgages.
____________________
(1) Yield on tax-exempt obligations have been computed on a tax-equivalent basis.
As shown in the table above, approximately $1.0 million, or 0.7%, of the total portfolio will mature in one year or less while $22.8 million, or 15.4%, will mature after one year but within five years. The fully taxable equivalent average yield on the entire portfolio was 6.00% for 2006, compared to 5.86% for 2005, and 5.99% for 2004. The book value of the entire portfolio exceeded its market value by approximately $2.3 million at December 31, 2006 compared to $2.7 million at December 31, 2005, and market value exceeded book value by approximately $1.2 million at December 31, 2004.
Deposits and Short-Term Borrowings
The Company’s predominate source of funds is deposit accounts. The Company’s deposit base is comprised of demand deposits, savings and money market accounts and other time deposits. The Company’s deposits are provided by individuals and businesses generally located within the principal markets served.
As shown in the following table, average total deposits grew by 4.0% in 2006 and 6.0% in 2005. The average aggregate interest rate paid on deposits was 2.97% in 2006 compared to 2.26% in 2005 and 1.99% in 2004. The majority (58%) of the Company’s deposits are higher yielding time deposits because many of its customers are individuals who seek higher yields than those offered on savings and demand accounts.
The following table is a summary of average deposits and average rates paid:
The Company does not solicit nor does it have any brokered deposits. The following table is a summary of time deposits of $100,000 or more by remaining maturities at December 31, 2006:
The Company had no short-term borrowings with an average balance outstanding of more than 30% of stockholders’ equity for the years ended December 31, 2006, 2005 and 2004.
Capital Resources
The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance and changing competitive conditions and economic forces. The Company seeks to maintain a strong capital base to support its growth and expansion activities, to provide stability to current operations and to promote public confidence.
The Bank’s capital position continues to exceed regulatory requirements. The primary indicators relied on by the Federal Reserve Board and other bank regulators in measuring strength of capital position are the Tier 1 Capital, Total Capital, and Leverage ratios. Tier 1 Capital consists of common and qualifying preferred stockholders’ equity and minority interests in common equity accounts of consolidated subsidiaries, less goodwill. Total Capital consists of Tier 1 Capital, qualifying subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the allowance for loan losses and pre-tax net unrealized holding gains on certain equity securities. Risk-based capital ratios are calculated with reference to risk-weighted assets, which consist of both on and off-balance sheet risks. The Bank’s Tier 1 Capital ratio was 14.11% as of December 31, 2006 compared to 13.3% as of December 31, 2005, compared to 12.5% at December 31, 2004 and 12.8% at December 31, 2003. The Total Capital ratio was 15.06% at December 31, 2006, versus 14.3% at December 31, 2005, compared to 13.6% and 13.9% at December 31, 2004 and 2003, respectively. These ratios are in excess of the mandated minimum requirements of 4% and 8%, respectively. The Leverage ratio consists of Tier 1 capital divided by quarterly average assets. At December 31, 2006, the Bank’s Leverage ratio was 10.02% compared to 9.6% at December 31, 2005 compared to 8.7% at December 31, 2004 and 8.3% at December 31, 2003. Each of these exceeds the required minimum leverage ratio of 4%. The Company, in view of the significant growth experienced over the past several years and the resulting impact on various capital ratios, recognized the need for additional capital to support further expansion or acquisitions and used the proceeds from the issuance of the $5 million capital trust preferred securities in December 2003 to increase the capital position of the Bank.
The following tables show risk based capital ratios and stockholders equity to total assets for the Company and its principal subsidiary, Central Virginia Bank:
The capital management function is an ongoing process. Central to this process is internal equity generation accomplished by retaining earnings. Total stockholders’ equity increased by $4.18 million in 2006 principally due to earnings retention and a decrease in the unrealized securities losses, net of tax, reflected as accumulated other comprehensive income. In 2005 shareholders equity increased by $1.5 million again due to earnings retention while partially offset by an increase in the unrealized securities losses, net of tax, reflected as accumulated other comprehensive income. At year end 2004 capital increased by $3.0 million again primarily as the result of earnings retention and improvement in accumulated other comprehensive income. At year end 2003, capital increased by $3.8 million once again due to retention of earnings. The return on average equity in 2006 was 15.1% compared to 15.3% in 2005, 14.9% in 2004 and 14.7% in 2003. Total cash dividends of $1,689,562 were paid in 2006 representing 32.8% of net income, compared to $1,422,057 representing 28.7% of net income for 2005. Dividends represented 29.3% of net income for 2004 and 27.1% of net income for 2003. Book value per share was $15.33 at December 31, 2006 compared to $13.71 at December 31, 2005, and $13.21 at December 31, 2004.
The Company’s principal source of cash income is dividend payments from the Bank. Certain limitations exist under applicable law and regulation by regulatory agencies regarding dividend payments to a parent by its subsidiaries. As of December 31, 2006, the Bank had $12.8 million of retained earnings available for distribution to the Company as dividends without prior regulatory approval.
Liquidity and Interest Rate Sensitivity
Liquidity. Liquidity is the 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, investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. As a result of the Company’s management of liquid assets and its ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.
Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates, borrowing from the Federal Home Loan Bank, purchasing of federal funds from correspondent banks, and selling securities under repurchase agreements. To further meet its liquidity needs, the Company also has access to the Federal Reserve System. In the past, growth in deposits and proceeds from the maturity of investment securities has been sufficient to fund the net increase in loans. The Bank, over the past three years, has experienced 35% growth in deposits. During the same period, notwithstanding the $5 million long-term Capital Trust Preferred issue in December 2003, the Bank has increased its borrowings from $21.4 million at the beginning of 2003 to $35.1 million at the end of 2006.
Interest Rate Sensitivity. In conjunction with maintaining a satisfactory level of liquidity, management must also control the degree of interest rate risk assumed on the balance sheet. Managing this risk involves regular monitoring of the interest sensitive assets relative to interest sensitive liabilities over specific time intervals.
At December 31, 2006, the Company had a positive 3 month and 12-month gap position. Since the largest amount of interest sensitive assets and liabilities mature or reprice within 12 months, the Company monitors this area closely. The Company does not emphasize interest sensitivity analysis beyond this time frame because it believes various unpredictable factors could result in erroneous interpretations. Early withdrawal of deposits, prepayments of loans and loan delinquencies are some of the factors that could have such an effect. In addition, changes in rates on interest sensitive assets and liabilities may not be equal, which could result in a change in net interest margin. While the Company
does not match each of its interest sensitive assets against specific interest sensitive liabilities, it does seek to enhance the net interest margin while minimizing exposure to interest rate fluctuations.
Effects of Inflation
Inflation significantly affects industries having high proportions of fixed assets or high levels of inventories. Although the Company is not significantly affected in these areas, inflation does have an impact on the growth of assets. As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios. Traditionally, the Company’s earnings and high capital retention levels have enabled the Company to meet these needs.
The Company’s reported earnings results have been affected by inflation, but isolating the effect is difficult. The different types of income and expense are affected in various ways. Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index. Management actively monitors interest rate sensitivity, as illustrated by the Gap Analysis, in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.
The following table summarizes the Company’s interest earning assets and interest bearing liabilities with respect to the earlier of their contractual repayment date or nearest repricing date at December 31, 2006:
_____________
(1)
Of the amount of loans due after 12 months, $45.4 million had floating or adjustable rates of interest and $37.7 million had fixed rates of interest.
Off-Balance Sheet Arrangements
The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include commitments to extend credit and standby letters of credit which would impact the Company’s liquidity and capital resources to the extent customer’s accept and or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. See Note 13 to the Consolidated Financial Statements for further discussion of the nature, business purpose and elements of risk involved with these off-balance sheet arrangements. The Company has no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors. For further information, see Notes 8, 9 and 13 to the Consolidated Financial Statements.
Contractual Obligations
The following table presents the Company’s contractual obligations at December 31, 2006 and the scheduled payment amounts due at various intervals over the next five years and beyond.
(1)
Federal Home Loan Bank advances generally all callable prior to the maturity date indicated above. If the advance is called, the advance can be, at the option of the Bank, converted to another advance with a different interest structure, while maintaining the same maturity date. See Note 7 in Notes to Consolidated Financial Statements.
Forward-Looking Statements
Certain information contained in this discussion and elsewhere in this filing may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company. Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
Critical Accounting Policies
General. The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, 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 substantially 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. A summary of the significant accounting policies of the Company is set forth in Note 1 to the Company’s consolidated financial statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General
An important element of both earnings performance and liquidity is the management of our interest-sensitive assets and our interest-sensitive liabilities maturing or repricing within specific time intervals and the risks involved with them. Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments in response to changes in interest rates, exchange rates and equity prices. Our market risk is composed primarily of interest rate risk. The asset and liability management committee at the Bank is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. Our board of directors reviews the guidelines established by the committee. Interest rate risk is monitored through the use of four complimentary modeling tools: static gap analysis, dynamic gap simulation modeling, earnings simulation modeling and economic value simulation (net present value estimation). Each of the three simulation models measure changes under 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 our interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap, which measures aggregate repricing values, is less utilized since it does not effectively measure the earnings impact on us. Earnings simulation and economic value models, however, which more effectively reflect the earnings impact, are utilized by management on a regular basis.
Earnings Simulation Analysis
We use simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model utilized by the Company calculates estimated earnings based on and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a more realistic analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.
Assumptions used in the model, including loan and deposit growth rates, are derived from seasonal trends and management’s outlook, as are the assumptions used to project the yields and rates for new loans and deposits. 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 accounted for in the different rate scenarios.
The following table represents the interest rate sensitivity of our net interest income (net interest income at risk) on a 12-month horizon using different rate scenarios as of December 31, 2006. There have been no material changes in quantitative and qualitative disclosures about market risk since this information was developed using December 31, 2006 data.
Change in Yield Curve
Percentage Change in Net Interest Income
Dollar Change in Net Interest Income
(Dollars in Thousands)
+300 basis points
11.7%
$1,911
+200 basis points
9.9%
1,609
+100 basis points
5.0%
Base
-
-
-100 basis points
-5.3%
-200 basis points
-13.6%
-2,210
-300 basis points
-21.2%
-3,463
Economic Value Simulation
We use economic value simulation to calculate the estimated fair value of assets and liabilities under different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation.
The following chart reflects the change in net market value of equity, (economic value of equity at risk), by using December 31, 2006 data, over different rate environments with a one-year horizon.
Change in Yield Curve
Percentage Change in Economic Value of Equity
Dollar Change in Economic Value of Equity
(Dollars in Thousands)
+300 basis points
-4.5%
$-1,732
+200 basis points
-3.0%
-1,161
+100 basis points
-1.3%
Base
-
-
-100 basis points
-7.4%
-2,861
-200 basis points
-11.6%
-4,486
-300 basis points
-16.5%
-6,355
Management of the Interest Sensitivity Gap
The interest sensitivity gap is the difference between interest-sensitive assets and interest-sensitive liabilities maturing or repricing within a specific time interval. The gap can be managed by repricing assets or liabilities, by selling investments, by replacing an asset or liability prior to maturity, or by adjusting the interest rate during the life of an asset or liability. Matching the amounts of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net income due to changes in market interest rates. We evaluate interest rate risk and then formulate guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments in order to decrease sensitivity risk. These guidelines are based upon management’s outlook regarding future interest rate movements, the state of the regional and national economy, and other financial and business risk factors.
Our asset-liability management committee reviews deposit pricing, changes in borrowed money, investment and trading activity, loan sale activities, liquidity levels and the Company’s overall interest sensitivity. The actions of the committee are reported to the board of directors regularly. The periodic monitoring of interest rate risk, investment and trading activity, deposit pricing, funding and liquidity, along with any other significant transactions are managed by the Chief Financial Officer of the Bank with input from other committee members.
The following table summarizes the Company’s dynamic gap model. The dynamic gap model attempts to forecast the cumulative difference between the maturity and repricing characteristics of interest sensitive assets and interest sensitive liabilities measured at various time intervals as well as under various interest rate scenarios
The table below lists the Company’s performance for the years ended December 31, 2006 and 2005 on a quarterly basis.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements and independent auditors’ reports thereon are filed as a part of this report following Item 15:
Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
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 covered by this report, the Company evaluated the effectiveness of the design and operations of its disclosure controls and procedures that are designed to insure that the Company records, processes, summarizes and reports in a timely and effective manner the information required to be disclosed in reports filed with or submitted to the Securities and Exchange Commission. In designing and evaluating the disclosure controls and procedures, management recognizes any controls and procedures, no matter how well designed and operated, can provide on reasonable assurance of achieving the desired control objectives, and management believes it has applied prudent judgment in evaluating the cost-benefit relationship of possible controls and procedures.
The Company carried out its evaluation under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer. Based upon this evaluation, they concluded that, as of the date of this evaluation, the Company’s disclosure controls are effective and adequate to ensure the clarity and material completeness of the Company’s disclosure in its periodic reports filed with or submitted to the Securities and Exchange Commission. There were no changes in the Company’s internal control over financial reporting in the quarter ended December 31, 2006, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information set forth under the heading “ELECTION OF DIRECTORS” “Committees” “Code of Ethics” and “Section 16(a) Beneficial Ownership Reporting Compliance” of the definitive 2007 Proxy Statement of the registrant furnished to shareholders in connection with its Annual Meeting to be held on May 22, 2007 (the “2007 Proxy Statement”) is hereby incorporated by reference.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information set forth under the heading “REMUNERATION” (except for the information set forth under the heading “Compensation Committee Report on Executive Compensation”) of the 2007 Proxy Statement is hereby incorporated by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information set forth under the heading “SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS” and “Equity Compensation Plan Information” of the 2007 Proxy Statement are hereby incorporated by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE
Information set forth under the heading “Certain Transactions” of the 2007 Proxy Statement is hereby incorporated by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information set forth under the heading “Fees of Independent Public Accountants” and “Pre-Approved Services” of the 2007 Proxy Statement is hereby incorporated by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)
The response to this portion of Item 15 is included in Item 8 above.
(a)(2)
The response to this portion of Item 15 is included in Item 8 above.
(a)(3)
Exhibits
The following documents are filed herewith or incorporated herein by reference as Exhibits:
3.1
Articles of Incorporation, including amendments thereto (incorporated herein by reference to Exhibit 2 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
3.2
Bylaws (incorporated herein by reference to Exhibit 3 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
4.1
Specimen of Registrant’s Common Stock Certificate (incorporated herein by reference to Exhibit 1 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
10.1
Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 10-K for the year ended December 31, 2005).
21.1
Subsidiaries of the Registrant (filed herewith).
23.1
Consent of Yount, Hyde & Barbour, P.C. (filed herewith).
23.2
Consent of Mitchell, Wiggins & Company, LLP (filed herewith).
31.1
Rule 13a-14(a) Certification of Chief Executive Officer (filed herewith).
31.2
Rule 13a-14(a) Certification of Chief Financial Officer (filed herewith).
32.1
Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (filed herewith).
(b)
See Item 15(a)(3) above.
(c)
See Item 15(a)(2) above.
CENTRAL VIRGINIA BANKSHARES, INC.
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2006
REPORTS OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Central Virginia Bankshares, Inc.
Powhatan, Virginia
We have audited the accompanying consolidated balance sheets of Central Virginia Bankshares, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended December 31, 2006 and 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Virginia Bankshares, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years ended December 31, 2006 and 2005, in conformity with U.S. generally accepted accounting principles.
Winchester, Virginia
April 12, 2007
REPORTS OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Central Virginia Bankshares, Inc.
Powhatan, Virginia
We have audited the accompanying consolidated statements of income, stockholders’ equity, and cash flows for the year ended December 31, 2004 of Central Virginia Bankshares, Inc., and subsidiary. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Virginia Bankshares, Inc., and subsidiary as of December 31, 2004, and the results of their operations and their cash flows for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.
/s/ Mitchell, Wiggins & Company LLP
Richmond, Virginia
February 2, 2005
See Notes to Consolidated Financial Statements.
(Continued)
See Notes to Consolidated Financial Statements.
(Continued)
See Notes to Consolidated Financial Statements.
CENTRAL VIRGINIA BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Continued)
See Notes to Consolidated Financial Statements.
CENTRAL VIRGINIA BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Restatement of Prior Years: The consolidated financial statements for the years ended 2005 and 2004 have been restated to remove the effect of hedge accounting for the Company’s interest rate swap on its trust preferred securities issued in December 2003. The Company has determined, following the review and analysis of SFAS 133, that the application of the shortcut method of accounting is only permissible in cases where all of the relevant terms of the hedged instrument are mirrored in the corresponding hedge. The interest payment deferral option in the Company’s trust preferred securities was not mirrored in the interest rate swap, as well as shortcut accounting only being permitted for put and call options that are mirrored in the hedged item and the swap. Therefore, the transaction did not meet all the requirements of SFAS 133, paragraph 68. Accordingly, the Company has removed the effect of hedge accounting from its prior year’s financial statements, and made the appropriate adjustments in its December 31, 2006 financials. The Company has conducted an analysis and evaluation of the impact of this misstatement and has concluded the impact of the adjustments to be immaterial, and has made all the appropriate adjustments to the prior periods presented herein.
Principles of consolidation: The accompanying consolidated financial statements include the accounts of Central Virginia Bankshares, Inc., and its subsidiaries, Central Virginia Bank, including its subsidiary, CVB Title Services, Inc and Central Virginia Bankshares Statutory Trust I. All significant intercompany transactions and balances have been eliminated in consolidation. FASB Interpretation No. 46 (R) requires that the Company no longer eliminate through consolidation the equity investment in Central Virginia Bankshares Statutory Trust I by the parent company, Central Virginia Bankshares, Inc., which equaled $155,000 at December 31, 2006. The subordinated debt of the Trust is reflected as a liability on the Company’s balance sheet.
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles.
Nature of operations: Central Virginia Bankshares, Inc. is a one bank holding company headquartered in Powhatan County, Virginia. The Company’s subsidiary, Central Virginia Bank, provides a variety of financial services to individuals and corporate customers through its eight branches located in the Virginia counties of Powhatan, Chesterfield, Henrico, and Cumberland. The Bank’s primary deposit products are checking accounts, savings accounts, and certificates of deposit. Its primary lending products are residential mortgage, construction, installment, and commercial business loans.
Central Virginia Bank’s subsidiary, CVB Title Services, Inc., is a corporation organized under the laws of the Commonwealth of Virginia. CVB Title Services’ primary purpose is to own membership interests in two insurance-related limited liability companies.
Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate and deferred tax assets.
A majority of the Bank’s loan portfolio consists of single-family residential loans in the Virginia counties of Powhatan, Chesterfield, Henrico, and Cumberland. There is also a significant concentration of loans to builders and developers in the region. Accordingly, the ultimate collectibility of a substantial portion of the Bank’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions.
While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses and foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Cash and cash equivalents: For purposes of reporting the consolidated statements of cash flows, the Company includes cash on hand, amounts due from banks, federal funds sold and all highly liquid debt instruments purchased with a maturity of three months or less as cash and cash equivalents on the accompanying consolidated balance sheets. Cash flows from deposits and loans are reported net.
The Bank maintains cash accounts with other commercial banks. The amount of these deposits at December 31, 2006 exceeded the insurance limit of the FDIC by $1,516,811. The Bank has not experienced any losses in such accounts.
The Bank is required to maintain average reserve and clearing balances in cash or on deposit with the Federal Reserve Bank. The total of these balances was approximately $3,840,000 and $3,968,000 at December 31, 2006 and 2005, respectively.
Securities: Securities are classified as held to maturity when management has the intent and the Bank has the ability at the time of purchase to hold them until maturity or on a long-term basis. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Sales of these securities are generally not permitted, however if a sale occurs, gains and losses on the sale of such securities are determined by the specific identification method.
Securities to be held for indefinite periods of time, which may be to maturity or which may be sold as needs arise, are classified as available for sale and accounted for at market value on an individual basis. These include securities used as part of the Company’s asset/liability management strategy and may be sold in response to changes in the Bank’s liquidity requirements due to increases in loan demand, changes in interest rates, prepayment risk, the need or desire to increase capital, to satisfy regulatory requirements and other similar factors. Unrealized gains or losses are reported as increases or decreases in accumulated other comprehensive income, a component of stockholders’ equity, net of the related deferred tax effect. Realized gains and losses of securities available for sale are included in net securities gains (losses) based on the specific identification method.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
Trading securities, which are generally held for the short term in anticipation of market gains, are carried at fair value. Realized and unrealized gains and losses on trading account assets are included in interest income on trading account securities. The Company held no trading securities during the years ended December 31, 2006, 2005, and 2004.
Significant declines for extended periods of time in the fair value of individual securities classified as either held to maturity or available for sale below their amortized cost are evaluated quarterly by the Company to ascertain if the impairment is other than temporary. Should the conclusion be the impairment is other than temporary the securities carrying value will be adjusted down to their fair value with the resulting write-downs included in current earnings as realized losses.
Mortgage loans held for sale: Mortgage loans originated and held for sale in the secondary market are reported at the lower of cost or market determined on an aggregate basis. The Bank does not retain mortgage servicing rights on loans held for sale. Substantially all mortgage loans held for sale are pre-sold to the Bank's mortgage correspondents. All sales are made without recourse.
Rate lock commitments: The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates.
Loans: Loans are stated at the amount of unpaid principal, reduced by unearned discount and an allowance for loan losses.
Unearned interest on discounted loans is amortized to income over the life of the loans, using the interest method. For all other loans, interest is accrued daily on the outstanding balances.
Loan origination and commitment fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related yield. The Bank is amortizing these amounts over the average contractual life.
For impaired loans, accrual of interest is discontinued on a loan when management believes, after considering collection efforts and other factors, that the borrower’s financial condition is such that collection of interest is doubtful. Cash collections on impaired loans are credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
A loan is considered delinquent when payments have not been made according to contractual terms, typically evidenced by nonpayment of a monthly installment by the due date. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well secured and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt.
All interest accrued in the current calendar year but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. Uncollected interest accrued in prior years is charged off to the allowance for loan losses. The interest on these loans is accounted for on the cash basis until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. On charged-off loans, cash receipts in excess of the amount charged to the allowance for loan losses are recognized as income on a cash basis.
Allowance for loan losses: The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectibility of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, credit concentrations, trends in historical loss experience, review of specific problem loans, and current economic conditions.
The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
A loan is impaired when it is probable the creditor will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. Impaired loans are measured based on the present value of payments expected to be received, using the historical effective loan rate as the discount rate. Alternatively, measurement also may be based on observable market prices or, for loans that are solely dependent on the collateral for repayment, measurement may be based on the fair value of the collateral. The Bank does not aggregate loans for risk classification. Loans that are to be foreclosed are measured based on the fair value of the collateral. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. Changes in the allowance for loan losses relating to impaired loans are charged or credited to the provision for loan losses.
Bank premises and equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Expenditures for betterments and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred. Depreciation is not recognized on branches or banking facilities purchased or constructed until the facility is occupied and open for business. Depreciation is computed using the straight-line method over the following estimated useful lives.
Foreclosed real estate: Foreclosed real estate represents properties acquired through foreclosure or other proceedings. Foreclosed real estate is held for sale and is recorded at the lower of the recorded amount of the loan or fair value of the properties less estimated costs of disposal. Any write-down to fair value at the time of transfer to foreclosed real estate is charged to the allowance for loan losses. Property is evaluated regularly to ensure the recorded amount is supported by its current fair value. Valuation allowances to reduce the carrying amount to fair value less estimated costs to dispose are recorded as necessary. At December 31, 2006 and 2005, there was no foreclosed real estate.
Public relations and marketing costs: Public relations and marketing cost are generally expensed over the period of the promotion for which a marketing campaign occurs.
Intangible assets: Intangible assets, which for the Bank are the cost of acquired customer accounts, are amortized on a straight-line basis over the expected periods of benefit.
Income taxes: The provision for income taxes relates to items of revenue and expenses recognized for financial accounting purposes. The actual current liability may be more or less than the charge against earnings due to the effect of deferred income taxes.
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
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 registrant’s 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 should 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. The Company has evaluated SAB 108 and anticipates it will have no 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 Company 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 Company does not expect the implementation of SFAS 156 to have a material impact on its consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
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 Company 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 Company does not have a defined benefit pension plan or other post retirement plan; therefore, the standard will not have an impact on the Company’s consolidated financial statements.
In February 2007, The FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157, “Fair Value Measurements”. The Company is in the process of evaluating the impact this statement may have on its consolidated financial statements but does not intend to adopt early.
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 Company does not believe there will be any material impact from the adoption of this pronouncement
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,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
2007. The Company 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 Company is currently evaluating the effect that EITF No. 06-5 will have on its consolidated financial statements when implemented.
Effective January 1, 2006, the Company adopted SFAS No. 123R (Revised 2004), Share-Based Payment (“SFAS No. 123R”), which replaces SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”). SFAS No. 123R requires the costs resulting from all share-based payments to employees be recognized in the financial statements. Stock-based compensation is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value. The model employs the following assumptions.
•
Dividend yield - calculated as the ratio of historical dividends paid per share of common stock to the stock prices on the date of grant;
•
Expected life (term of the option) - based on the average of the contractual life and vesting schedule for the respective option;
•
Expected volatility - based on the monthly historical volatility of the Company’s stock price over the expected life of the options;
•
Risk-free interest rate - based upon the U.S. Treasury bill yield curve, for periods within the contractual life of the option, in effect at the time of grant.
Under APB Opinion 25, compensation expense was generally not recognized if the exercise price of the option equaled or exceeded the market price of the stock on the date of grant. For the year ended December 31, 2006, the Company recognized no stock-based compensation expense in accordance with SFAS No. 123R. The following table details the effect on net income and earnings per share had the stock-based compensation expense for stock awards been recorded in periods prior to 2006 based on the fair-value method under SFAS No. 123R.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
For purposes of computing the pro forma amounts indicated above, the fair value of each option on the date of grant is estimated using the Black-Scholes option-pricing model with the following assumptions for the grants in 2004: dividend yield of 2.18%, expected volatility of 20%, risk-free interest rate of 3.6%, and an expected option life of 9.5 years. The fair value of each option granted in 2004 was $5.93. There were no options granted in 2005 or 2006.
The Company has elected to adopt the modified prospective method that requires compensation expense to be recorded for the unvested portion of previously issued awards that remained outstanding as of January 1, 2006. In addition, compensation expense is recorded for any awards issued, modified, or settled after the effective date of this standard and prior periods are not restated. For awards granted prior to the effective date, the unvested portion of the awards are recognized in periods subsequent to the adoption based on the grant date fair value determined for pro forma disclosure purposes under SFAS no. 123R.
SFAS 123R requires the company to estimate forfeitures when recognizing compensation expense and that this estimate of forfeitures be adjusted over the requisite service period of vesting schedule based on the extent to which actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment, which is recognized in the period of change, and also will impact the amount of estimated unamortized compensation expense to be recognized in future periods.
Derivative financial instruments: All derivatives are recognized on the balance sheet at their fair value as an asset or liability. On the date the derivative contract is entered into, the Company may designate the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability i.e., “cash flow” hedge. Changes in the fair value of a derivative whose terms mirror all aspects of the hedged instrument, and that has been determined to have no ineffectiveness, and that is designated and qualifies as, a cash-flow hedge are recorded in other
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies (Continued)
comprehensive income. Earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings).
At December 31, 2006 and 2005, the Company’s only derivative financial instrument consisted of a $5,000,000 notional interest-rate swap agreement used to effectively convert the Company’s $5,000,000 floating-rate trust preferred debt incurred in 2003, from a variable rate to fixed rate. The Company has subsequently determined that the terms of the hedged instrument were not mirrored in the swap, as required by SFAS 133. Accordingly, the Company has removed hedge accounting treatment retrospectively to the inception of the swap. The impact of this correction is not material to the Company’s consolidated financial statements.
Note 2. Securities
Carrying amounts and approximate market values of securities available for sale are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2. Securities (Continued)
The amortized cost and approximate market value of securities available for sale at December 31, 2006 by contractual maturity are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary. Additionally, many of the U. S. government agency securities held have one-time, semiannual, quarterly, or continuous call provisions that allow the agency to redeem the debt substantially in advance of the contractual maturity.
Gross gains of $222,726, $659,045 and $337,474 were realized on sales and redemptions of securities available for sale in 2006, 2005 and 2004, respectively. Gross losses of $41,245, $278,193 and $27,083 were realized on the sale of securities available for sale in 2006, 2005 and 2004, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2. Securities (Continued)
Securities with unrealized losses were as follows:
Changes in market interest rates and changes in credit spreads will result in temporary impairment or unrealized losses as the market value of securities will fluctuate in response to these market factors. The majority of the December 31, 2006 gross unrealized losses, $2,755,052 out of total unrealized losses of $3,272,149, have been in a loss position for more than 12 months. This impairment is considered temporary, as it is due primarily to increases in market interest rates on fixed rate securities purchased in prior years. The Company has both the intent and ability to hold these securities until such time as their market value recovers; additionally the Company is a long term investor and as such, is prepared and able to hold securities for indefinite periods of time. The $2,755,052 in unrealized losses which have been in a loss position for more than twelve months are primarily fixed rate bonds and fixed rate bank eligible preferred securities issued by FNMA and FHLMC. The primary relevant factor in the Company’s evaluation to determine if the impairment is other than temporary, is the relationship of current market interest rates as compared to the fixed coupon rate of the securities. There was very little weight given to credit risk as the issuers are either AA- or AAA. In conducting this analysis, the Company determines if the overall evidence suggests that it can recover substantially all of its basis in the securities within a
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2. Securities (Continued)
reasonable period of time. If this determination is affirmative, the impairment is considered temporary. In this instance, the reason for the fair value impairment loss is that the fixed dividend rates on these securities are lower than the current rates. The Company has determined that there was no other than temporary impairment associated with the above securities at December 31, 2006 and 2005.
Carrying amounts and approximate market values of securities being held to maturity are as follows:
The amortized cost and approximate market value of securities being held to maturity at December 31, 2006, by contractual maturity, are shown below.
Securities with an amortized cost of $11,121,865 and $11,115,282 and a market value of $10,989,407 and $10,984,868 at December 31, 2006 and 2005, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3. Loans
Major classifications of loans are summarized as follows:
At December 31, 2006 and 2005, overdraft demand deposit accounts totaling $150,112 and $87,576, respectively, were reclassified as loans.
Changes in the allowance for loan losses were as follows:
The Bank had no impaired loans at December 31, 2006, 2005 and 2004. Non-accruing loans (principally installment, commercial, and mortgage loans) totaled $736,509, $719,915, and $270,546 at December 31, 2006, 2005 and 2004, respectively, which had the effect of reducing net income $60,578, $29,141 and $12,189 for the years then ended, respectively. Loans past due ninety days or more and still accruing interest amounted to $263,931, $247,161, and $604,783 at December 31, 2006, 2005 and 2004, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4. Bank Premises and Equipment
Major classifications of bank premises and equipment and the total accumulated depreciation are summarized as follows:
Note 5. Investment in Bank Owned Life Insurance
The Bank is owner and designated beneficiary on life insurance policies in the face amount of approximately $15,975,810 maintained on certain of its officers and directors. The earnings from these policies are used to offset increases in employee benefit costs. The cash surrender value of these policies of $6,051,549 and $5,840,159 at December 31, 2006 and 2005, respectively, is included in other assets on the accompanying consolidated balance sheets.
Note 6. Maturities of Time Deposits
The scheduled maturities of time deposits at December 31, 2006, are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7. FHLB Borrowings
The borrowings from the Federal Home Loan Bank of Atlanta, Georgia, are secured by qualifying residential and commercial first mortgage loans, qualifying home equity loans and certain specific investment securities. The Company, through its principal subsidiary, Central Virginia Bank, has available unused borrowing capacity from the Federal Home Loan Bank totaling $27.29 million. The borrowings at December 31, 2006 and 2005, consist of the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7. FHLB Borrowings (Continued)
The contractual maturities of FHLB advances as of December 31, 2006 are as follows (dollars in thousands):
Due in 2009
$5,000
Due in 2011
5,000
Due in 2012
5,000
Due in 2013
5,000
Due in 2014
5,000
Due in 2016
10,000
$35,000
Note 8. Long-Term Debt, Capital Trust Preferred Securities
Capital trust preferred securities represent preferred beneficial interests in the assets of Central Virginia Bankshares, Inc. Statutory Trust I (Trust). The Trust holds approximately $5.2 million in floating rate junior subordinated debentures due December 17, 2033, issued by the Company on December 17, 2003. Distributions on the $5.0 million in Preferred Securities are payable quarterly at an annual rate of three-month LIBOR plus 2.85% (8.21% at December 31, 2006). However, the Company has the option to defer distributions for up to five years. Cash distributions on the Preferred Securities are made to the extent interest on the debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Preferred Securities are redeemable in whole. Otherwise, the Preferred Securities are generally redeemable by the Company in whole or in part on or after December 17, 2008, at 100% of the liquidation amount. The Trust’s obligations under the Preferred Securities are fully and unconditionally guaranteed by the Company. For regulatory purposes, the Preferred Securities are considered a component of Tier I capital.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Income Tax Matters
The Corporation and the Bank file a consolidated federal income tax return. The consolidated provision for income taxes for the years ended December 31, 2006, 2005, and 2004, are as follows:
A reconciliation of the expected income tax expense computed at 34% to the income tax expense included in the consolidated statements of income is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Income Tax Matters (Continued)
The components of the net deferred tax asset included in other assets are as follows at December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10. Defined Contribution Plan
The Bank provides a qualified defined contribution plan for all eligible full-time and part-time employees. The plan is governed by ERISA and the plan document. The plan is administered through the Virginia Bankers Association Benefits Corporation and may be amended or terminated by the Board of Directors at any time. The defined contribution plan is comprised of two components, Profit-Sharing and the 401K. Once eligible and participating, employees are 100 percent vested in all employer and employee contributions.
Profit-Sharing: This portion of the plan is discretionary and is based on the profitability of the Company on an annual basis. The Board of Directors approves the Company’s profit-sharing percentage contribution annually. The approved contribution amount is credited to the participant’s individual account during the first quarter of each year for the prior year. Contributions for 2006, 2005, and 2004 represented 6.0 percent, 9.0 percent, and 8.25 percent, respectively of all participants’ eligible wages.
401K: This portion of the plan provides for employee contributions of a portion of their eligible wages on a pre-tax basis subject to statutory limitations. The Bank provides a matching contribution of $1.00 for every $1.00 the participant contributes up to 3 percent of the participant’s eligible wages and $.50 for every $1.00 contributed of the next 2 percent of their eligible wages.
The total contributions to both of the above plans for the years ended December 31, 2006, 2005, and 2004, were $399,936, $472,632, and $390,736, respectively.
Note 11. Supplemental Executive Retirement Agreements
During the year ended December 31, 2002, the Bank established a Supplemental Executive Retirement Plan, (the “SERP”), a nonqualified, unfunded, defined benefit arrangement for selected executive and senior officers of the Bank as designated by the Board of Directors. The participants in the SERP include the four executive officers as well as six other senior officers. The costs associated with this plan, as well as several other general employee benefit plans are partially offset by earnings attributable to the Bank’s purchase of single premium Bank Owned Life Insurance (“BOLI”). The SERP provides an annual award equal to 25 percent of the participant’s final compensation, payable monthly over a 15-year period, following normal retirement at age 65, provided the participant has been employed by the Bank for a minimum of 8 years. A further provision exists for early retirement beginning at age 60, subject to the same 8-year service requirement, but with reduced benefits depending on the number of years preceding age 65 the participant elects to retire. Should the participant’s employment terminate due to disability or death, and the requirements necessary to receive a supplemental benefit under the SERP have otherwise been met, the benefit shall be paid to the participant or the surviving spouse. No benefits are payable should the participant’s employment terminate for any reason other than retirement, disability, death, or a change in control. The Company calculates the adequacy of the total accrued SERP liability as well as the annual expense to be recorded each year.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11. Supplemental Executive Retirement Agreement (Continued)
The accrued liability payable at December 31, 2006 and 2005 totaled $973,255 and $645,753, respectively. The Company’s expense related to the plan was $318,502, $209,722 and $167,753 for 2006, 2005 and 2004, respectively.
Note 12. Commitments and Contingencies
Financial instruments with off-balance-sheet risk: The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
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 they do for on-balance-sheet instruments. A summary of the Bank’s commitments at December 31, 2006 and 2005 is as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. 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 customer’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 party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary.
Borrowing facilities: The Bank has entered into various borrowing arrangements with other financial institutions for federal funds, and other borrowings. The total amount of borrowing facilities at December 31, 2006, was approximately $120,328,421 with $85,328,421 available to borrow.
Concentrations of credit risk: All of the Bank’s loans, commitments to extend credit, and standby letters of credit have been granted to customers within the state and, more specifically, the area surrounding Richmond, Virginia. The concentrations of credit by type of loan are set forth in Note 3. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the agribusiness and construction sectors of the economy.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13. Related Party Transactions
The Company’s subsidiary has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, officers, their immediate families, and affiliated companies in which they are principal stockholders (commonly referred to as related parties), all of which have been, in the opinion of management, on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others.
Aggregate loan transactions with related parties were as follows:
Note 14. Stock Dividend
On June 15, 2006, the Company issued 114,219 shares of common stock pursuant to a 5% stock dividend for stockholders of record as of May 31, 2006. As a result of the stock dividend, common stock was increased by $142,774, surplus was increased by $3,031,372, and retained earnings was decreased by $3,174,146. All references in the accompanying consolidated financial statements to the number of common shares and per-share amounts for prior periods have been restated to reflect this stock dividend.
Note 15. Incentive Stock Option Plan
The Company has a Stock Plan that provides for the grant of Incentive Stock Options up to a maximum of 324,949 shares of common stock of which 157,628 shares have not been issued. This Plan was adopted to foster and promote the long-term growth and financial success of the Company by assisting in recruiting and retaining directors and key employees by enabling individuals who contribute significantly to the Company to participate in its future success and to associate their interests with those of the Company. The options were granted at the market value on the date of each grant. The maximum term of the options is ten years. All shares reported have been restated for the 5% stock dividend in 2006.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 15. Incentive Stock Option Plan (Continued)
The following table presents a summary of options under the Plan at December 31:
(1)
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2006. This amount changes based on changes in the market value of the Company’s stock. The fair value (present value of the estimated future benefit to the option holder) of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.
Information pertaining to options (in thousands) outstanding at December 31, 2006 is as follows:
Options exercisable at December 31, 2006, 2005 and 2004, were 65,969, 73,646 and 90,285, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16. Earnings Per Share
The following data show the amounts used in computing earnings per share and the effect on income and the weighted average number of shares of dilutive potential common stock.
All shares reported have been restated for the 5% stock dividend in 2006.
Note 17. Regulatory Matters
The Company and subsidiary are subject to various regulatory capital requirements administered by its primary federal regulator, the Federal Reserve Bank. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and subsidiary must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios as set forth in the table below of total and Tier I capital as defined in the regulations to risk-weighted assets as defined, and of Tier I capital as defined to average assets as defined. Management believes, as of December 31, 2006, that the Company and subsidiary meet all capital adequacy requirements to which it is subject.
As of December 31, 2006, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17. Regulatory Matters (Continued)
Banking laws and regulations limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency. Under that limitation, the Bank could have declared additional dividends of approximately $12,893,514 or 34.8% of shareholders’ equity in 2006 without regulatory approval.
Note 18. Fair Value of Financial Instruments
FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company and subsidiary.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18. Fair Value of Financial Instruments (Continued)
The following methods and assumptions were used by the Company and subsidiary in estimating the fair value of financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.
Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Mortgage loans held for sale: The carrying amount of mortgage loans held for sale approximate their fair values.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Accrued interest receivable and accrued interest payable: The carrying amounts of accrued interest receivable and accrued interest payable approximate their fair values.
Deposit liabilities: The fair values of demand deposits equal their carrying amounts which represents the amount payable on demand. The carrying amounts for variable-rate fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected maturities on time deposits.
Federal funds purchased and securities sold under repurchase agreements: The carrying amounts for federal funds purchased and securities sold under repurchase agreements approximate their fair values.
FHLB borrowings: The carrying amounts of FHLB borrowings approximate their fair values.
Capital trust preferred securities: The carrying amount of the capital trust preferred securities approximates their fair values.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 18. Fair Value of Financial Instruments (Continued)
The following is a summary of the carrying amounts and estimated fair values of the Company and subsidiary’s financial assets and liabilities at December 31, 2006 and 2005:
At December 31, 2006 and 2005, the Company had outstanding standby letters of credit and commitments to extend credit. These off-balance sheet financial instruments are generally exercisable
at the market rate prevailing at the date the underlying transaction will be completed, and, therefore, they were deemed to have an immaterial effect on the current fair market value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19. Condensed Parent-Only Financial Statements
Financial statements for Central Virginia Bankshares, Inc., (not consolidated) are presented below.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19. Condensed Parent-Only Financial Statements (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19. Condensed Parent-Only Financial Statements (Continued)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CENTRAL VIRGINIA BANKSHARES, INC.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
April 17, 2007
/s/ Ralph Larry Lyons
Ralph Larry Lyons
President and Chief Executive Officer; Director
(Principal Executive Officer)
April 17, 2007
/s/ Charles F. Catlett, III
Charles F. Catlett, III
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
April 17, 2007
/s/ Robert A. Burge
Robert A. Burge
Vice President & Controller
April 17, 2007
/s/ Thomas R. Thornton, Jr.
Thomas R. Thornton, Jr.
Vice President
(Principal Accounting Officer)
April 17, 2007
/s/ Kemper W. Baker, Jr.
Kemper W. Baker, Jr.
Director
April 17, 2007
/s/ John B. Larus
John B. Larus
Director
April 17, 2007
/s/ Elwood C. May
Elwood C. May
Director
April 17, 2007
/s/ James T. Napier
James T. Napier
Chairman of the Board of Directors
April 17, 2007
/s/ Roseleen P. Rick
Roseleen P. Rick
Director
April 17, 2007
/s/ William C. Sprouse, Jr.
William C. Sprouse, Jr.
Director
April 17, 2007
/s/ Larry D. Wallace
Larry D. Wallace
Director
April 17, 2007
/s/ Phoebe P. Zarnegar
Phoebe P. Zarnegar
Director
EXHIBITS INDEX
Item No.
Description
3.1
Articles of Incorporation, including amendments thereto (incorporated herein by reference to Exhibit 2 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
3.2
Bylaws (incorporated herein by reference to Exhibit 3 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
4.1
Specimen of Registrant’s Common Stock Certificate (incorporated herein by reference to Exhibit 1 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
10.1
Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 10-K for the year ended December 31, 2005).
21.1
Subsidiaries of the Registrant (filed herewith).
23.1
Consent of Yount, Hyde & Barbour, P.C. (filed herewith).
23.2
Consent of Mitchell, Wiggins & Company, LLP (filed herewith).
31.1
Rule 13a-14(a) Certification of Chief Executive Officer (filed herewith).
31.2
Rule 13a-14(a) Certification of Chief Financial Officer (filed herewith).
32.1
Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (filed herewith).