Item 1. Description of Business
Valley Financial Corporation (the “Company”) was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of Valley Bank (the “Bank”). The Company posts all reports required to be filed under the Securities Exchange Act of 1934 on its web site at www.myvalleybank.com.
History
The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank.
The Bank opened for business on May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15, 1997 in the City of Roanoke, its fourth office in the City of Salem on April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of Roanoke on December 8, 2003, and its eighth office in the City of Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23, 2005. During 2008, the Bank relocated its City of Roanoke branch office from 2203 Crystal Spring Avenue to 110 McClanahan Street. The new branch office is a full-service branch with a drive-through window.
Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of the Company for the purpose of issuing trust preferred securities. Effective October 16, 2002, the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary gives the Bank the right to utilize certain federal and state tax credits. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. Effective December 15, 2006, Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the company for the purpose of issuing additional trust preferred securities. These entities raised capital (in the case of the statutory trusts) or investments (in the case of the LLC) for the Company and the Bank. Effective July 13, 2007, VFC Properties, LLC was established as a wholly-owned subsidiary of the Company to provide credit intermediary services for the Bank. This entity was dissolved in July 2008. A new entity, VB Land, LLC was established in September 2008 as a wholly-owned subsidiary of the Bank to provide credit intermediary services for the Bank.
Banking Services
We conduct a general commercial banking business while emphasizing the needs of small-to-medium sized businesses, professional concerns, and individuals.
Deposit Services
We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the Bank’s principal market area at rates competitive to those offered in the area. In addition, we offer certain retirement account services, such as Individual Retirement Accounts. All deposit accounts are insured by the FDIC up to the maximum
amount allowed by law (currently unlimited for all transaction accounts with an interest rate of 0.50% or lower; and $250,000 per depositor for all other accounts, subject to aggregation rules). We solicit accounts from individuals, businesses, associations and organizations and governmental authorities.
The Bank also participates in the Certificate of Deposit Account Registry Service, or CDARS. CDARS gives us the ability to provide our deposit customers access to FDIC insurance in amounts exceeding the existing FDIC limit. This permits our institution to better attract and retain large deposits from businesses, nonprofit organizations, individuals and other customers that require an assurance of safety. Finally, the Bank offers a remote deposit transaction delivery system (“RDC”) which allows the Bank to receive digital information from deposit documents captured at remote locations. These locations may be our branches, ATMs, domestic and foreign correspondents, or locations owned or controlled by commercial or retail customers of the Bank. In substance, RDC is similar to traditional deposit delivery systems; however, it enables customers of financial institutions to deposit items electronically from remote locations. RDC can decrease processing costs, support new and existing banking products, and improve customers' access to their deposits; however, it introduces additional risks to those typically inherent in traditional deposit delivery systems.
Lending Activities
We offer a full range of lending services including commercial loans, residential real estate loans, construction and development loans, and consumer loans.
Credit Policies
The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. In an effort to manage the risk, our loan policy gives loan amount approval limits to individual bankers based on their position and level of experience, and to our loan committees based on the size of the lending relationship. The risk associated with real estate and construction loans, commercial loans and consumer loans varies, based on market employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction.
We have written policies and procedures to help manage credit risk. We utilize an outside third party loan review process that includes regular portfolio reviews to establish loss exposure and to ascertain compliance within our loan policy.
A Senior Loan Committee and a Directors’ Loan Committee are used to approve loans. The Senior Loan Committee is comprised of our Chief Executive Officer, Chief Lending Officer, Chief Credit Officer, Senior Real Estate Finance Officer, Senior Business Banking Manager and Senior Business Banking Officer. The Directors’ Loan Committee is comprised of eight Directors, of which seven are independent Directors. Both Committees approve new, renewed, and modified loans that exceed individual officer loan authorities. The Directors’ Loan Committee also reviews any changes to the Bank’s lending policies, which are then approved by the Board of Directors.
Commercial Lending
We make both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. Loan requests are granted based upon several factors including credit history, past and present relationships with the bank, marketability of collateral and the cash flow of the borrowers. Unsecured commercial loans must be supported by a satisfactory balance sheet, income statement and cash flow statement. Collateralized business loans may be secured by a security interest in marketable equipment, accounts receivable, business equipment and/or general intangibles of the business. In addition, or as an alternative, the loan may be secured by a deed of trust lien on business real estate. The
risks associated with commercial loans are related to the strength of the individual business, the value of loan collateral, and the general health of the economy.
Residential Real Estate Lending
Residential real estate loans are secured by deeds of trust on 1-4 family residential properties. The Bank also serves as a broker for residential real estate loans placed in the secondary market. There are occasions when a borrower or the real estate does not qualify under secondary market criteria, but the loan request represents a reasonable credit risk. Also, an otherwise qualified borrower may choose not to have their mortgage loan sold. On these occasions, if the loan meets the Bank’s internal underwriting criteria, the loan will be closed and placed in the Bank’s portfolio. Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Valley Bank has expanded its mortgage program by becoming an FHA and VA approved lender. In addition, the Bank continues to add additional external wholesale partners to ensure competitive mortgage programs and interest rate pricing.
Construction and Development Lending
The Bank makes loans for the purpose of financing the construction of business and residential structures to financially responsible business entities and individuals. Additionally, the Bank makes loans for the purpose of financing the acquisition and development of commercial and residential projects. These loans are subject to additional underwriting standards as compared to our commercial and residential real estate loans, due to the following inherent risks associated with construction and development loans. Construction loans and acquisition and development loans bear the risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time total less than the principal amount of the loan. Construction loans and acquisition and development loans also bear the risk that the general contractor, who may or may not be the Bank’s loan customer, is unable to finish the construction project as planned because of financial pressures unrelated to the project. Loans to customers that are made as permanent financing of construction loans may likewise under certain circumstances be affected by external financial pressures.
Consumer Lending
The Bank routinely makes consumer loans, both secured and unsecured, for financing automobiles, home improvements, education, and personal investments. The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit decision. Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property. Negative changes in a customer’s financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk. In addition, deterioration in collateral value can add risk to consumer loans.
Other Lending Activities
We will occasionally buy or sell all or a portion of a loan. We will consider selling a loan or a participation in a loan, if: (i) the full amount of the loan will exceed our legal lending limit to a single borrower; (ii) the full amount of the loan, when combined with a borrower’s previously outstanding loans, will exceed our legal lending limit to a single borrower; (iii) the Board of Directors or an internal Loan Committee believes that a particular borrower has a sufficient level of debt with us; (iv) the borrower requests the sale; (v) the loan to deposit ratio is at or above the optimal level as determined by bank management; and/or (vi) the loan may create too great a concentration of loans in one particular location or in one particular type of loan. We will consider purchasing a loan, or a participation in a loan, from another financial institution (including from another subsidiary of the Company) if the loan meets all applicable credit quality standards and (i) the Bank’s loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a common customer requests the purchase.
Additionally, we offer leasing services for our small business, private banking and business banking customers and prospects to access equipment, technology or other capital assets that they need to improve productivity and to facilitate growth without taking on debt or investing significant working capital.
Leasing facilities do generally incorporate above-average risk as they generally require minimal initial equity investments on the part of the lessee and may include residual value risks at the time of lease maturity.
We offer several forms of specialized asset-based lending to our commercial business customers, which include:
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Accounts Receivable Financing - enables small businesses to unlock the cash typically frozen in accounts receivable which provides cash flow to support operations. The Bank utilizes an automated software program to manage and monitor collateral values on a consistent and routine basis.
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Automobile Floor Plan Financing - enables auto-related businesses to carry sufficient levels of inventories to support sales demand.
Asset-based loans require substantial risk management and monitoring processes which should help mitigate collateral exposures; however, these types of financing have inherently higher risk due to the ever changing status of the underlying collateral.
Our lending activities are subject to a variety of lending limits imposed by state and federal laws and regulations. In general, the Bank is subject to a loans-to-one borrower limit of an amount equal to 15% of the total of the Bank’s unimpaired capital, surplus, and allowance for loan loss. We may not make any extensions of credit to any director, executive officer, or principal shareholder of the Bank or the Company, or to any related interest of such person, unless the extension of credit is approved by the Board of Directors of the Bank and the credit is made on terms not more favorable to such person than would be available to an unaffiliated party.
Other Services
Other Bank services include safe deposit boxes, certain cash management services including overnight repurchase agreements, merchant purchase and management programs, traveler’s checks, direct deposit of payroll and social security checks and automatic drafts for various accounts. We operate seven proprietary ATM’s and are associated with the Star, Cirrus and InterCept shared networks of automated teller machines that may be used by bank customers throughout Virginia and other regions. We also offer VISA and MasterCard credit card services as well as a debit-check card. Our lockbox service provides a simple and efficient way to collect accounts receivable payments locally for businesses and non-profit organizations.
Financial Services
On June 23, 2005, Valley Wealth Management Services, Inc., (VWM) a wholly-owned subsidiary of the Bank, began offering non-deposit investment products and insurance products for sale to the public. VWM is working with Infinex Investments, Inc., in which the Company has a small interest due to the 2008 merger of Infinex Investments, Inc. with BI Investments, LLC. Prior to the merger, BI Investments Inc. had been established as a joint effort by a group of Virginia banks through the Virginia Bankers Association to facilitate the sale of securities-related products and services.
We have no immediate plans to obtain or exercise trust powers. We may in the future offer a full-service trust department, but cannot do so without the prior approval of our primary regulators, the Federal Reserve Bank of Richmond and the Virginia State Corporation Commission.
Location and Service Area
Our primary service area is the Roanoke Metropolitan Statistical Area (the “Roanoke MSA”), which is the regional center for southwest Virginia, and is located approximately 165 miles west of Richmond,
Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles east of Charleston, West Virginia and 222 miles southwest of Washington, D.C.
The population in the Roanoke MSA was estimated at 300,856 in 2008 per the Weldon Cooper Center for Public Services, University of Virginia. The Roanoke MSA’s growth typically is slower than that in the Commonwealth overall and in other key Virginia markets in particular. The Virginia Employment Commission reported that the Roanoke MSA had an unemployment rate of 7.3% in December 2009, compared with 9.7% nationally and 6.7% for Virginia.
The business community in the Roanoke MSA is well diversified by industry group. The principal components of the economy are retail trade, services, transportation, manufacturing, finance, insurance, and real estate. The Roanoke MSA’s position as a regional center creates a strong medical, legal and business professional community. Carilion Health System, Advance Auto Parts, Lewis-Gale Hospital, and the Veterans Administration Hospital are among Roanoke’s largest employers. Other large employers include Norfolk Southern Corporation, General Electric Co., Wachovia (a Wells Fargo Company), The Kroger Company - Mid Atlantic, and ITT Industries Night Vision.
Competition
The banking and financial service business in Virginia and in our primary market area specifically, is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems and new competition from non-traditional financial services. We compete for loans and deposits with other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other nonbank financial service providers. In order to compete, we rely upon a service-based business philosophy, personal relationships with customers, specialized services tailored to meet customers’ needs and the convenience of office locations. In addition, we are generally competitive with other financial institutions in our market area with respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts.
Our market area is a highly concentrated, highly branched banking market. Currently, the Bank, Bank of Botetourt, Bank of Fincastle, and Hometown Bank are the only locally owned and operated commercial banks. Most competitors are subsidiaries of large holding companies headquartered in Georgia, Tennessee, Northern Virginia, and California, all of whom have substantially greater resources and lending limits than we do and offer certain services, such as extensive and established branch networks and other services that we cannot provide. Additionally, these larger institutions operating in the Roanoke MSA have access to borrowed funds at a lower cost than we do. Numerous credit unions operate additional offices in the Roanoke MSA. Further, various other financial companies, ranging from local to national firms, provide financial services to residents of the Bank’s market area.
We believe that the Bank will continue to be able to compete effectively in this market, and that the community reacts favorably to our community bank focus and emphasis on service to small businesses, individuals and professional entities.
Employees
As of December 31, 2009 the Company had 130 full-time employees and 6 part-time employees, including executive officers, loan and other banking officers, branch personnel, operations personnel and other support personnel. None of the Company’s employees is represented by a union or covered under a collective bargaining agreement. Management of the Company considers its employee relations to be excellent.
Supervision and Regulation
The Company and the Bank are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. As a result of the substantial regulatory burdens on banking, financial institutions, including the Company, are disadvantaged relative to other competitors who are not as highly regulated, and our costs of doing business are much higher.
The Company
Bank Holding Company Act. In order to acquire the shares of Valley Bank and thereby become a bank holding company within the meaning of the Bank Holding Company Act, we were required to obtain approval from, and register as a bank holding company, with the Federal Reserve Board (the “Board”), and are subject to ongoing regulation, supervision and examination by the Board. As a condition to its approval, the Board required that we agree that we would obtain approval of the Federal Reserve Bank of Richmond prior to incurring any indebtedness. We are required to file with the Board periodic and annual reports and other information concerning our business operations and those of our subsidiaries. In addition, the Bank Holding Company Act requires a bank holding company to obtain Board approval before it acquires, directly or indirectly, ownership or control of any voting shares of a second or subsequent bank if, after such acquisition, it would own or control more than 5% of such shares, unless it already owns or controls a majority of such voting shares. Board approval must also be obtained before a bank holding company acquires all or substantially all of the assets of another bank or merges or consolidates with another bank holding company. Any acquisition by a bank holding company of more than 5% of the voting shares, or of all or substantially all of the assets, of a bank located in another state may not be approved by the Board unless such acquisition is specifically authorized by the laws of that second state.
A bank holding company is prohibited under the Bank Holding Company Act, with limited exceptions, from acquiring or obtaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank, or from engaging in any activities other than those of banking or of managing or controlling banks or furnishing services to or performing services for its subsidiaries. An exception to these prohibitions permits a bank holding company to engage in, or acquire an interest in a company which engages in, activities which the Board, after due notice and opportunity for hearing by regulation or order, has determined is so closely related to banking or to managing or controlling banks as to be proper incident thereto. A number of such activities have been determined by the Board to be permissible, including servicing loans, performing certain data processing services, and acting as a fiduciary, investment or financial advisor.
A bank holding company may not, without providing notice to the Board, purchase or redeem its own stock if the gross consideration to be paid, when added to the net consideration paid by the Comipany for all purchases or redemptions by the Company of its equity securities within the preceding 12 months, will equal 10% or more of the Company’s consolidated net worth, unless it meets the requirements of a well capitalized and managed organization.
Set forth is a summary of statutes and regulations affecting companies like Valley Bank. Federal and state laws and regulations provide regulatory oversight for virtually all aspects of the Company’s operations. This summary is qualified in its entirety by reference to these statutes and regulations and is not intended to be an exhaustive description of the statutes or regulations which are applicable to the business of the Company and/or the Bank. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of the Company and/or the Bank.
The Bank
General. Our subsidiary, Valley Bank, is a state bank and member of the Federal Reserve System. The Federal Reserve and the Virginia Bureau of Financial Institutions regulate and monitor all significant aspects of our operations. The Federal Reserve requires quarterly reports on our financial condition, and we receive periodic examinations from both federal and state regulators. The cost of complying with these regulations and reporting requirements can be significant. In addition, some of these regulations, such as the ability to pay dividends, impact investors directly.
For member banks like Valley, the Federal Reserve has the authority to prevent the continuance or development of unsound and unsafe banking practices and to approve conversions, mergers and consolidation. Obtaining regulatory approval of these transactions can be expensive, time consuming, and ultimately may not be successful. We are required to have prior regulatory approval to open any additional banking offices. This approval takes into account a number of factors, including, among others, adequate Bank capital to support additional expansion and a finding that public interest will be served by such expansion. While we plan to seek regulatory approval to establish additional banking offices, there can be no assurance when, or if, we will be permitted to so expand.
As a member of the Federal Reserve, the Company and its subsidiary, Valley Bank, are also required to comply with rules that restrict preferential loans by the Company to “insiders”. We are required to keep information on loans to principal shareholders and executive officers, and prohibit certain director and officer interlocks between financial institutions. Our loan operations, particularly for consumer and residential real estate loans, are also subject to numerous legal requirements as are our deposit activities. In addition to regulatory compliance costs, these laws may create the risk of liability to us for noncompliance.
Dividends. The amount of cash dividends we are permitted to pay is limited by federal and state law, regulation and policy and will depend upon our earnings and capital position. Virginia law imposes restrictions on the ability of all banks chartered under Virginia law to pay dividends. Under Virginia law, no dividend may be declared or paid that would impair a bank’s paid-in capital, and payments must be paid from retained earnings. Virginia Banking regulators and the Federal Reserve have the general authority to limit dividends we pay, if such payments are deemed to constitute an unsafe and unsound practice.
Under current supervisory practice, prior approval of the Federal Reserve is required if cash dividends declared in any given year exceed the total of its net profits for such year, plus its retained net profits for the preceding two years. In addition, we may not pay a dividend in an amount greater than our undivided profits on hand after deducting current losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of all loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Federal law further provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements.
In addition, we are subject to restrictions on our ability to pay common stock dividends as a result of our participation in the Capital Purchase Program and our anticipated written agreement with the Federal Reserve Bank of Richmond. See the “Dividends” section under Item 5 for more information.
FDIC Insurance. Through December 31, 2013 interest-bearing deposits are insured by the FDIC for a maximum of $250,000 per depositor. Additionally, we are a participant in the FDIC’s Transaction Account Guarantee Program which provides that through June 30, 2010, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. For this protection, we pay a semi-annual statutory assessment and must comply with the rules and regulations of the FDIC. FDIC assessments can change, affecting our costs, depending on the solvency of the Banking
industry as a whole. On November 12, 2009, the FDIC adopted a rule amending the assessment regulations to require insured depository institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009. This prepayment will not affect the Bank’s capital position on December 31, 2009, as the expense will be incurred in the appropriate period. This same rule implemented the 3 basis point increase in annual assessment rates adopted by the FDIC on September 29, 2009. The cost of complying with FDIC rules and regulations may negatively impact our profitability.
Bank Capital Guidelines. Federal bank regulatory authorities have adopted risk-based capital adequacy guidelines that redefine traditional capital ratios to take into account assessments of risks related to each balance sheet category, as well as off-balance sheet financing activities. This represents an effort to measure capital adequacy in a way that is more sensitive to the individual risk profiles of specific financial institutions. The risk-weighted asset base is equal to the sum of the aggregate dollar value of assets and certain off-balance sheet items (such as currency or interest rate swaps) in each of the four separate risk categories, multiplied by the risk weight assigned to each specific asset category. After the items in each category have been totaled and multiplied by the category’s risk factor, category totals are aggregated to derive the total risk-weighted assets, and the total adjusted capital base is divided by the total risk-weighted assets to derive a ratio.
Under the Federal Reserve’s current risk-based capital guidelines for member banks, we are required to maintain a minimum ratio of total capital to risk-weighted assets of 8%. At least half of the total capital is required to be Tier 1 capital, which consists principally of common and qualifying preferred shareholder’s equity (including Trust Preferred Securities), less certain intangibles and other adjustments. The remainder, Tier 2 capital, consists of a limited amount of subordinated and other qualifying debt (including certain hybrid instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company were 11.7% and 13.0%, respectively, as of December 31, 2009, thus exceeding the minimum requirements.
The federal regulatory agencies have established a minimum leverage capital ratio (Tier 1 capital to average adjusted assets). These guidelines provide for a minimum Tier 1 leverage ratio of 4% for banks and bank holding companies that meet certain specified criteria, including having the highest regulatory examination rating and are not considering significant growth or expansion. The Tier 1 leverage ratio for the Company as of December 31, 2009 was 9.4%, which is above the minimum requirements. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. These regulations can impact Valley by requiring it to hold more capital and may inhibit our ability to grow.
Affiliate Transactions and Branching. The Federal Reserve Act restricts the amount and prescribes conditions with respect to loans, investments, asset purchases and other transactions between the Company and the Bank, including placing collateral requirements and requiring that those transactions are on terms and under conditions substantially the same as those prevailing at the time for comparable transactions with non-affiliates. Subject to receipt of required regulatory approvals, we may branch without geographic restriction in Virginia, and we may acquire branches or banks or merge across state lines in most cases.
Community Reinvestment Act. The federal Community Reinvestment Act (“CRA”) requires that the federal banking regulators evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. We received a “Satisfactory” CRA rating in the Company’s latest CRA examination.
Other Regulations. We are subject to a variety of other regulations. State and federal laws restrict the interest and charges which the Bank may impose for certain loans, potentially affecting our income. The Truth in Lending Act and the Home Mortgage Disclosure Act impose information requirements on the Company in making loans. The Equal Credit Opportunity Act prohibits discrimination in ledning on the basis of race, creed, or other prohibited factors. The Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act govern the use and release of information to credit reporting agencies. The Truth in Savings Act requires disclosure of yields and costs of deposits and deposit accounts. Other acts govern confidentiality of consumer financial records, automatic deposits and withdrawals, check settlement, endorsement and presentment, and disclosure of cash transactions exceeding $10,000 to the Internal Revenue Service. These and other similar laws result in significant costs to financial institutions and create the potential for liability to customers and regulatory authorities. Recently regulatory authorities have imposed significant penalties for inadequate compliance.
The Gramm-Leach-Bliley Act. Effective March 11, 2001, the Gramm-Leach Bliley Act (the “GLB Act”) allows a bank holding company or other company to certify its status as a financial holding company, thereby allowing such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities deemed financial in nature such as underwriting insurance or acting as an insurance principal, agent or broker; underwriting; dealing in or making markets in securities; and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.
The Company meets all of the requirements to become a financial holding company, but currently has not made an election with the Federal Reserve to become a financial holding company.
US Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (“Patriot Act”) was enacted in response to the September 11, 2001 terrorist attacks in New York, Pennsylvania and Northern Virginia. The Patriot Act is intended to strengthen U.S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism. The continuing impact on financial institutions of the Patriot Act and related regulations and policies is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities to identify persons who may be involved in terrorism or money laundering.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (“SOX”) was signed into law on July 30, 2002. The stated goals of SOX are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX is the most far-reaching U.S. securities legislation enacted since the 1930’s. SOX generally applies to all companies that, like Valley, file or are required to file periodic reports under the Securities Exchange Act of 1934. The required implementation of SOX for companies with less than $75 Million in market capitalization was 2007, with a delay until 2010 for our external auditors to test our SOX workpapers and samples.
SOX includes very specific additional disclosure requirements and new corporate governance rules, requires the Securities and Exchange Commission, or SEC, and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specified issues by the SEC. SOX represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
SOX address, among other matters: audit committees; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; a prohibition on insider trading during pension plan black-out periods; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers (subject to certain exceptions for public companies that are financial institutions, like us); disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; “real time” filing of periodic reports; the formation of a public accounting oversight board; auditor independence; and various increased criminal penalties for violations of securities laws.
United States Treasury Department Oversight. In October 2008, the United States Treasury Department, the Federal Reserve Board, and the Federal Deposit Insurance Corporation jointly announced the Capital Purchase Program pursuant to the Emergency Economic Stabilization Act of 2008 (“EESA”) to address instability in the financial markets under the Capital Purchase Program. We applied for additional capital in the form of preferred stock with associated common stock warrants, and were approved for $16.0 million in additional capital. We received this capital on December 12, 2008. We also elected to participate in the Temporary Liquidity Guarantee Program to provide unlimited FDIC insurance coverage for non-interest bearing transaction accounts until the expiration of this program on December 31, 2009. This program has since been extended until its expiration of June 30, 2010. On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 that modified many previously established provisions of the EESA. On June 15, 2009, the Treasury issued regulations implementing the executive compensation and corporate governance standards applicable to Capital Purchase Program participants. These regulations and their implementation may change in the future. In addition, we are prohibited from increasing our common stock dividend or repurchasing our common stock without Treasury approval. Until we repay the investment by the United States Treasury Department under the Capital Purchase Program, we will be subject to these regulations.
Governmental Monetary Policies. Our earnings and growth is affected not only by general economic conditions, but also by the monetary and fiscal policies various governmental regulatory authorities, particularly the board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “Federal Reserve”). The Federal Reserve Board’s Open Market Committee implements national monetary policy in United States government securities, control of the discount rate and establishment of reserve requirements against both member and nonmember financial institutions’ deposits. These actions have a significant effect on the overall growth and distribution of loans, investments, and deposits, as well as the rates earned on loans, or paid on deposits.
Our management is unable to predict the effect of possible changes in monetary policies upon our future operating results.
Access to Filings. We make available all periodic and current reports, free of charge, on our website as soon as reasonably practicable after such material is electronically filed with, or furnished to the Securities and Exchange Commission (SEC). The Company and the Bank maintain a website at www.myvalleybank.com. After accessing the website, the filings are available upon selecting the Shareholder Information menu items. The contents of the website are not incorporated into this report or into Valley’s other filings with the SEC.
Item 1A.
Item 1A. Risk Factors.
An investment in our common stock involves risk, and you should not invest in our common stock unless you can afford to lose some or all of your investment. You should carefully read the risks described below before you decide to buy any of our common stock. Our business, prospects, financial condition, and results of operations could be harmed by any one of the following risks.
Changes in interest rates may impact our net interest margin and profitability.
Our profitability depends in substantial part on our net interest margin, which is the difference between the rates we receive on loans and investments and the rates we pay for deposits and other sources of funds. Our net interest margin depends on many factors that are partly or completely outside of our control, including competition, monetary and fiscal policies, and economic conditions generally. Prior to June of 2004, the Federal Reserve cut short-term interest rates 12 times beginning January 2001. Since June 2004, the Federal Reserve has increased short-term interest rates 17 times. Between September 2007 and December 2008, the Federal Reserve lowered rates 10 times. We believe the Federal Reserve will eventually have no choice but to increase short-term interest rates which will negatively impact our net interest margin due to our large portfolio of floating rate loans that are at the floor interest rate embedded in such loans. In most cases, short-term rates will need to be raised in excess of 100 basis points before the interest rate on the loans will exceed the floor interest rate and positively impact our net interest income.
Our profitability depends significantly on economic conditions in our market area.
Our success depends to a large degree on the general economic conditions in Roanoke, Virginia. A prolonged economic recession in our market area could cause any of the following consequences, each of which could adversely affect our business:
·
Demand for our products and services could decline;
·
Loan delinquencies may increase; and
·
Problem assets and foreclosures may increase
Additionally, the adverse consequences to us in the event of a continued economic recession in our market could be compounded by the fact that the majority of our commercial and real estate loans are secured by real estate located in our market area. A further decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral securing the loans would be diminished. In addition, many of our loans are dependent on the successful completion of real estate projects and the demand for the sale of homes, both of which could be adversely impacted by a continued decline in the real estate markets.
Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation. Adverse changes in economic conditions in our market would likely impair our ability to collect loans and could otherwise have a negative effect on our financial condition.
Difficult market conditions have adversely affected our industry.
Dramatic declines in the housing market over the past two years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have
caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
We expect to be subject to a written agreement with the Federal Reserve Bank of Richmond.
Due to the difficult economic conditions and the effects of these conditions on us, we expect that we will enter into a written agreement with the Federal Reserve. While we do not know precisely what the contents of the written agreement may be, it could, among other things, limit our ability to grow our assets, open new branch offices or pay dividends and may adversely affect our operations and our financial results.
In addition, we expect that our management and board of directors may be required to focus considerable time and attention on taking actions to comply with the terms of the written agreement.
Recently enacted legislation, legislation enacted in the future, or any proposed federal programs subject us to increased regulation and may adversely affect us.
On October 14, 2008, the U.S. Treasury announced a program under the EESA pursuant to which it would make senior preferred stock investments in participating financial institutions (the “CPP”). We have participated in the CPP. Because we participate in the CPP, we are subject to increased regulation, and we face additional regulations or changes to regulations to which we are subject as a result of our participation. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. For example, participation in the CPP limits (without the consent of the U.S. Treasury) our ability to increase our dividend or to repurchase our common stock for so long as any securities issued under such program remain outstanding. In addition, the EESA, contains, among other things, significant restrictions on the payment of executive compensation, which may have an adverse effect on the retention or recruitment of key members of senior management. Also, the cumulative dividend payable under the preferred stock that we issued to the U.S. Treasury pursuant to the CPP increases from 5% to 9% after 5 years. Additionally, we may not deduct interest paid on our preferred stock for income tax purposes.
Additionally, the FDIC has increased premiums on insured accounts because market developments, including the increase of failures in the banking industry, have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
Recently, the Federal Reserve adopted amendments to its Regulation E. These amendments will first apply to us on July 1, 2010. The changes will affect the circumstances surrounding when we will be able to charge our clients overdraft fees.
In 2009, many emergency government programs enacted in 2008 in response to the financial crisis and the recession slowed or wound down, and global regulatory and legislative focus has generally moved to a second phase of broader reform and a restructuring of financial institution regulation. Legislators and regulators in the United States are currently considering a wide range of proposals that, if enacted, could result in major changes to the way banking operations are regulated. Some of these major changes may take effect as early as 2010, and could materially impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk.
Certain reform proposals under consideration could result in our becoming subject to stricter capital requirements and leverage limits, and could also affect the scope, coverage, or calculation of capital, all of which could require us to reduce business levels or to raise capital, including in ways that may adversely impact our shareholders or creditors. In addition, we anticipate the enactment of certain reform proposals under consideration that would introduce stricter substantive standards, oversight and enforcement of rules governing consumer financial products and services, with particular emphasis on retail extensions of credit and other consumer-directed financial products or services. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
We are not able to predict when or whether regulatory or legislative reforms will be enacted or what its contents will be. Accordingly, we cannot predict the impact of any legislation on our businesses or operations.
If we experience greater loan losses than anticipated, it will have an adverse effect on our net income and our ability to fund growth.
While the risk of nonpayment of loans is inherent in banking, if we experience greater nonpayment levels than we anticipate, our earnings and overall financial condition, as well as the value of our common stock, could be adversely affected. We cannot assure you that our monitoring, procedures, and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our shareholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect our profitability. Any loan losses will reduce the loan loss allowance. A reduction in the loan loss allowance may be restored by an increase in our provision for loan losses. This would reduce our earnings, which could have an adverse effect on our stock price.
We may incur losses if we are unable to successfully manage interest rate risk.
Our profitability will depend in substantial part upon the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. We may pay above-market rates to attract deposits as we have done in some of our marketing promotions in the past to fund loan growth. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits, the volume of loan originations and the value we can recognize on the sale of mortgage and home equity loans in the
secondary market. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Based on our asset/liability position at December 31, 2009, a rise in interest rates would negatively impact our net interest income in the short term. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary, and fiscal policies, and economic conditions generally.
Our profitability depends on our ability to manage our balance sheet to minimize the effects of interest rate fluctuation on our net interest margin.
Our results of operations depend on the stability of our net interest margin, which is the difference in the yield we earn on our earning assets and our cost of funds, both of which are influenced by interest rate fluctuations. Interest rates, because they are influenced by, among other things, expectations about future events, including the level of economic activity, federal monetary and fiscal policy and geo-political stability, are not predictable or controllable. In addition, the interest rates we can earn on our loan and investment portfolios and the interest rates we pay on our deposits are heavily influenced by competitive factors. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional, or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin.
Our long-term goal is to maintain a balanced position in terms of the volume of assets and liabilities that mature or re-price during any period so that we may reasonably predict our net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and influence our ability to maintain this neutral position. Generally speaking, our earnings will be more sensitive to fluctuations in interest rates, the greater the variance in the volume of assets and liabilities that mature or re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of interest rates, and whether the Company is more asset sensitive or liability sensitive. Accordingly, we may not be successful in maintaining this position and, as a result, our net interest margin may suffer, which will negatively impact our earnings.
Our future success will depend on our ability to compete effectively in the highly competitive financial services industry.
The banking business is highly competitive, and we face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive financial services environment. Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered banks, national banks and federal savings institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. Some of these competitors are subject to similar regulation, but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, numerous ATMs, greater advertising-marketing budgets and other factors.
Valley Bank encounters strong competition from a variety of bank and non-bank financial service providers. These competitors include commercial banks, savings banks, credit unions, consumer finance companies, money market mutual funds, mortgage banks, leasing, and finance companies., In addition, the delivery of financial services has changed significantly with the telephone, ATM, personal computer and the Internet being used to access information and perform banking transactions.
Competition in our target market area for loans to businesses, professionals, and consumers is very strong. Most of our competitors have substantially greater resources and lending limits than we do and offer certain services, such as extensive and established branch networks and trust services that we cannot provide. Moreover, larger institutions operating in the Roanoke market have access to borrowed funds at lower cost than we will have available. Several community banks are headquartered in our trade area. Several regional and super-regional banks, as well as a number of credit unions, also have banking offices
in our market area. Competition among institutions for checking and savings deposits in the area is intense.
We do not plan to pay cash dividends on common stock in the immediate, foreseeable future.
We do not expect to pay cash dividends on our common stock in the near future. Our ability to declare and pay cash dividends will be dependent upon, among other things, restrictions imposed by the reserve and capital requirements of Virginia and federal banking regulations, our income and financial condition, tax considerations and general business conditions.
We are required, through our participation in the Capital Purchase Program to pay a quarterly 5% dividend on our cumulative perpetual preferred stock, series A, to the United States Department of the Treasury. In accordance with our acceptance of funds from the U.S. Treasury, cash dividends on common stock are not permitted without prior approval from the U.S. Department of Treasury.
Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. 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 deterioration in the value of this collateral, or in the local or national economy, could adversely affect our clients’ ability to pay these loans, which in turn could 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.
Our legal lending limit may limit our growth.
We are limited in the amount we can lend to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. As of December 31, 2009, we were permitted, by law, to lend approximately $11.0 million to any one borrower. However, we have set a “house lending limit” of approximately $7.7 million. This amount is significantly less than many of our competitors and may discourage potential borrowers who have credit needs in excess of our legal lending limit from doing business with us. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We can accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy is not always efficient or always available. We may not be able to attract or maintain clients seeking larger loans or may not be able to sell participations in such loans on terms we consider favorable.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our clients relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rate; that may be beyond our control, and these losses may exceed our current estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we
cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material impact on our financial performance.
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different from those of our management. Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
Our operations depend upon third party vendors that perform services for us.
We outsource many of our operating and banking functions, including our data processing function, our item processing and the interchange and transmission services for our ATM network. As such, our success and our ability to expand our operations depend on the services provided by these third parties. Disputes with these third parties can adversely affect our operations. We may not be able to engage appropriate vendors to adequately service our needs, and the vendors that we engage may not be able to perform successfully.
Our ability to operate profitably may be dependent on our ability to implement various technologies into our operations.
The market for financial services, including banking services and consumer finance services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, internet-based banking and tele-banking. Our ability to compete successfully in our market may depend on the extent to which we are able to exploit such technological changes. If we are not able to afford such technologies, properly or timely anticipate or implement such technologies, or properly train our staff to use such technologies, our business, financial condition or operating results could be adversely affected.
If we need additional capital in the future, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our common stock.
We may need to raise additional capital in the future to support our growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
We may in the future issue additional stock, any or all of which will dilute your percentage ownership and, possibly, the value of your shares.
Our board of directors has the authority to issue all or part of any authorized but unissued common shares without prior shareholder approval and without allowing the shareholders the right to purchase their pro rata portion of such shares. This includes shares authorized to be issued under our equity incentive plans. The issuance of any new common shares will dilute your percentage ownership, and could dilute the value of your shares.
There is a limited trading market for our common stock; it may be difficult to sell our shares after you have purchased them.
Our common stock is currently listed on the NASDAQ Capital Market under the symbol “VYFC.” The volume of trading activity in our stock is relatively limited. Even if a more active market develops, there can be no assurance that such market will continue, or that you will be able to share your shares at or above your purchase price.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2. Properties.
Our main office is located in a seven-story office building at 36 Church Avenue, S.W., in downtown Roanoke, Virginia 24011, in which we lease five floors. We added a sixth floor to the leased space during the first quarter of 2008. The lease on all floors terminates on December 31, 2014 with options to renew for two additional five-year terms at the end of the December 31, 2014 extension period. The Company has entered into a land lease for its new South Roanoke office. The land lease has an initial lease term of twenty-five years with the option to renew for two additional twenty-five year periods.
We own our Starkey Road, Salem, Hershberger, Vinton, and Lewis Gale offices.
In the opinion of management of the Company, its properties are adequate for its current operations and adequately covered by insurance.
Item 3.
Item 3. Legal Proceedings.
None.
Item 4.
Item 4. Reserved.
PART II.
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market information. The Company is authorized to issue up to 10,000,000 shares of Common Stock, no par value, of which 4,680,251 shares were issued and outstanding and held of record by approximately 840 holders on the beneficial side and 404 shareholders on the registered side at March 12, 2010.
The Common Stock is quoted under the symbol VYFC on the NASDAQ Capital Market. According to information obtained by Company management and believed to be reliable, the quarterly high and low sales prices per share for the Common Stock during each quarter of the last two fiscal years and the dividends declared during these periods were as follows:
Dividends. On April 29, 2009 the Company declared a $0.04 per share cash dividend, payable July 2, 2009 to shareholders of record June 1, 2009. On October 29, 2009, the Company’s Board of Directors voted unanimously to suspend common shareholders’ dividends.
The Company anticipates entering into a written agreement with the Federal Reserve and as a result is not able to make any distributions on its Preferred Stock, any interest payments on its Trust Preferred Securities, or declare any common dividends without prior approval from the Federal Reserve.
The Preferred Stock issuance completed to United States Treasury under the Capital Purchase Plan on December 12, 2008 is senior to the Company’s common stock. Dividends must be paid to the preferred stock holder before they can be paid to the common stock holder. The Company has the right to defer distributions on its Preferred Stock for any period of time, during which time no dividends may be paid on its common stock. The dividends declared on the Preferred Stock will reduce the net income to common shareholders and the Company’s earnings per common share.
The securities purchase agreement between the Company and Treasury provides that prior to the earlier of (i) December 12, 2011 and (ii) the date on which all of the shares of the Preferred Stock have been redeemed by the Company or transferred by Treasury to third parties, the Company may not, without the consent of Treasury, (a) increase the cash dividend on its common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of its common stock or preferred stock other than the Preferred Stock or trust preferred securities. In addition, the Company is unable to pay any dividends on its common stock unless it is current in its dividend payments on the Preferred Stock.
Securities authorized for issuance under equity compensation plans.
Equity Compensation Plan Information
* Includes grants of 30,000 restricted stock units that are outstanding and non-vested as of December 31, 2009. The weighted-average exercise price in the table above does not take into account these grants.
As of December 31, 2009 there were no compensation plans, including individual compensation arrangements, under which equity securities of the Company are authorized for issuance that have not been approved by a vote of security holders.
Item 6.
Item 6. Selected Financial Data
Operating Revenue
The following table sets forth, for the two fiscal years ended December 31, 2009 and 2008, the percentage of total operating revenue contributed by each class of similar services which contributed 15 percent or more of total consolidated revenues of the Company during such periods.
Period
Class of Service
% of Total Revenues
December 31, 2009
Interest and fees on loans
82.49%
December 31, 2008
Interest and fees on loans
81.79%
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is management’s discussion and analysis of the financial condition and results of operations of the Company as of and for the years ended December 31, 2009 and 2008. The purpose of this discussion is to focus on important factors affecting our financial condition and results of operations. The discussion should be read in conjunction with the audited consolidated financial statements and related notes to assist in the evaluation of our 2009 performance.
Critical Accounting Policies
The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies that require our most difficult, subjective or complex judgments and uncertainties include (1) the allowance for loan losses and (2) impaired loans. Further information about these critical policies is described below.
Certain credit risks are inherent in making loans. We seek to prudently assess these risks and manage them effectively. We have internal credit policies and procedures in place to reduce repayment risks. These policies and procedures include:
·
officer and customer limits;
·
periodic loan documentation review; and
·
follow-up on exceptions to credit policies.
We establish the allowance for loan losses through charges to earnings through a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb probable losses on existing loans that may become uncollectible. Some of the factors we consider in determining the appropriate level of the allowance for loan losses are as follows:
·
an evaluation of the current loan portfolio;
·
identified loan problems;
·
loan volume outstanding;
·
past loss experience;
·
present and expected industry and economic conditions and, in particular, how such conditions relate to our market area;
·
problem loan trends over a 3-year historical time period; and
·
loan growth trends over a 3-year historical time period
The general component of the reserve 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 our estimate of probable losses. It also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The allowance for loan losses is evaluated on a regular basis by management. On a quarterly basis, we perform a detailed analysis of the allowance for loan losses to verify the adequacy and appropriateness of the allowance in meeting possible losses in the loan portfolio.
We use generally accepted accounting standards related to receivables and contingencies when segregating our portfolio into loans classified as impaired and non-impaired loan pools and in analyzing our current portfolio to determine the appropriate level of the allowance for loan losses. Included in our potentially impaired loan category are our current “watch list” credits plus any additional credits which have been past due three or more times within the past 12-month period. We individually review these potentially impaired loans based on generally accepted accounting standards related to receivables and make a determination if the loan in fact is impaired. We consider a loan impaired when we determine that is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. If it is found to be impaired, an allowance is established when the collateral value, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan. We recognize any impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to bad-debt expense. The valuation allowance becomes our “specific reserve” for the specific loan.
We take the balance of our portfolio and add back to it any loans that were included in the potentially impaired loan category but that were found not to be impaired. We then segregate the remaining portfolio into specific categories based on type of loan and review the groups of loans to estimate loss under generally accepted accounting standards based on contingencies. We apply a specific loss factor to each category based upon our historical loss experience for each category of loans over the current two years ending December 31, 2009. The loss factor is multiplied by the outstanding balance in the loan category to estimate potential loss for our allowance for loan losses. We then evaluate certain environmental and qualitative factors that are relevant to our portfolio and make a risk assessment of low, medium, or high for each factor. An additional loss factor is assigned to the portfolio according to the risk assessment. This evaluation is inherently subjective, because it requires estimates that may be significantly revised as more information becomes available.
Bank regulators also periodically review the loan portfolio and other assets to assess their quality, and we employ independent, third party loan reviewers as well. This evaluation is inherently subjective because it requires estimates that may be significantly revised as more information becomes available.
We believe the allowance for loan losses is adequate to provide for expected losses in the loan portfolio, but there are no assurances that it will be.
Performance Summary
For the year ended December 31, 2009, Valley Financial reported net loss to common shareholders of $6.6 million compared with net income to common shareholders of $1.6 million for the same twelve months of 2008. Our earnings for the year produced an annualized return on average total assets of (0.81%) and an annualized return on average shareholders’ equity of (10.03%), compared to prior year ratios of 0.27% and 3.87%, respectively. Diluted earnings/(losses) per share were down from $0.35 in 2008 to ($1.42) in 2009.
Like most financial institutions, we have increased our allowance for loan and lease losses to unprecedented levels during 2009 as a result of the continued depressed economy and its impact on our local customers and the more conservative approach regulators are taking towards loan loss reserves in this difficult economic environment. The Company’s loan loss provision was $15.2 million for the year ended December 31, 2009, as compared to $3.3 million for the same period last year. We continue to see weaknesses in the residential and commercial real estate markets as sales activity remains stalled in our market. As a result, we charged off $3.8 million in impaired real estate relationships during the fourth quarter of 2009. We believe the increase in our total reserves is adequate given the continued depressed economic environment at December 31, 2009. We anticipate our reserves will remain elevated into 2010, as the general state of the economy will dictate future reserves.
The following table shows our key performance ratios for the years ended December 31, 2009 and 2008:
All percentage calculations are on an annualized basis.
1.
The calculation of return on average equity (“ROE”) excludes the effect of any unrealized gains or losses on investment securities available-for-sale.
2.
Calculated on a fully taxable equivalent basis (“FTE”).
Non-GAAP Financial Measures
The Company measures the net interest margin as an indicator of profitability. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax-equivalent net interest income is considered in the calculation of this ratio. Tax-equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2009 and 2008 is 34%. The reconciliation of tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.
Growth
The following table shows our key growth indicators for the years ended December 31, 2009 and 2008:
Total assets at December 31, 2009 were $713.7 million, up $39.2 million or 5.8% from $674.5 million at December 31, 2008. The principal components of the Company’s assets at the end of the period were $76.7 million in securities available-for-sale, including restricted equity securities, $12.0 million in securities held-to-maturity, and $571.0 million in gross loans. Total assets at December 31, 2008 were $674.5 million, up $73.5 million or 12.2% from $601.0 million at December 31, 2007. The principal components of the Company’s assets at the end of 2008 were $82.9 million in securities available-for-sale, including restricted equity securities, $10.0 million in securities held-to-maturity, and $553.0 million in gross loans.
Total liabilities at December 31, 2009 were $662.2 million, up from $616.0 million at December 31, 2008, an increase of $46.2 million or 7.5%. Deposits increased $86.6 million or 18.6% to $552.9 million from the $466.3 million level at Decemfber 31, 2008. Our deposit growth for 2009 was outstanding due to the innovative and exciting suite of products and exceptional level of customer service offered to our customers. We were successful in growing our core deposits by 46% during 2009 and are heavily focused on continuing this trend in 2010. We have recently rolled out a new savings account that is tied to our My Lifestyle Checking rewards checking account that offers an attractive rate and an automatic method for savings. Our preliminary results with this product have been phenomenal. Total liabilities at December 31, 2008 were $616.0 million, up from $560.3 million at December 31, 2007, an increase of $55.7 million or 9.9%.
Shareholders’ Equity
Total shareholders’ equity at December 31, 2009 was $51.5 million, a decrease of $7.0 million or 12.0% over the $58.5 million level at December 31, 2008, which is primarily attributable to the net loss of $5.7 million and the $0.7 million in preferred dividends declared to the U.S. Treasury. Total shareholders’ equity at December 31, 2008 was $58.5 million, an increase of $17.8 million or 43.7% over the $40.7 million level at December 31, 2007, which is primarily attributable to the issuance of preferred stock and warrants to the Treasury under the Capital Purchase Plan. See table below for details of the change in shareholders’ equity:
Net Income
We recorded net loss of $5.7 million for the year ended December 31, 2009, a decrease of $7.4 million over the $1.7 million net income reported for the same period in 2008. After deducting the dividends and discount accretion on preferred stock, net loss to common shareholders for the year ending December 31, 2009 amounted to $6.6 million. The decline in earnings is largely attributable to the recessionary environment and its impact on asset quality. Loan loss provisions of $15.2 million were recorded in 2009, an increase of $11.8 million over the $3.3 million in loan loss provisions for the same 12 month period in 2008.
Net loss for the three months ended December 31, 2009 was $2.7 million, a decrease of $2.2 million over the net loss of $0.5 million reported for the fourth quarter of 2008. While net interest income was $0.6 million above the amount earned for the fourth quarter of 2008, this increase was offset by additional loan loss provisions of $3.1 million, a loss on the sale of foreclosed assets of $0.5 million, and increased FDIC insurance expense of $0.2 million. After deducting the dividends and discount accretion on preferred stock, net loss to common shareholders for the quarter ending December 31, 2009 amounted to $3.0 million as compared to $0.5 million for the fourth quarter of 2008.
We earned net income $1.7 million for the year ended December 31, 2008, a decrease of $1.2 million as compared to the $2.9 million net income reported for the same period in 2007. Net loss for the three months ended December 31, 2008 was $0.5 million, a decrease of $1.4 million as compared to the net income of $0.9 million reported for the fourth quarter of 2007.
Net Interest Income
Net interest income, our primary source of revenue, is the excess of interest income over interest expense. Net interest income is influenced by a number of factors, including the volume of interest-earning assets and interest-bearing liabilities, the mix of interest-earning assets and interest-bearing liabilities, the interest rates earned on earning assets, and the interest rates paid to obtain funding to support the assets. For analytical purposes, net interest income is adjusted to a taxable equivalent basis to recognize the income tax savings on tax-exempt assets, such as bank owned life insurance (BOLI) and municipal securities and loans. A tax rate of 34% was used in adjusting interest on BOLI, tax-exempt securities and loans to a fully taxable equivalent basis. The difference between rates earned on interest-earning assets (with an adjustment made to tax-exempt income to provide comparability with taxable income, i.e. the “FTE” adjustment) and the cost of the supporting funds is measured by the net interest margin.
Net interest income for the year ended December 31, 2009 was $19.8 million, a $2.6 million, or 15.3%, increase when compared to the $17.2 million reported for the same period in 2008. The Federal Reserve Open Market Committee (“FOMC”), which sets the federal funds rate, kept rates at extremely low levels throughout 2009 due to the global economic recession over the last 24 months, deflating both the yield on our earning assets and our cost of funds. In 2008, the FOMC decreased the target funds rate five times for a total of 400 basis points which resulted in the historically low federal funds rate of 0.25% which was held constant throughout 2009. The tax equivalent yield on earning assets decreased 91 basis points during the year, from 6.05% in 2008 to 5.14% in 2009. The yield on average loans decreased 92 basis points, from 6.18% in 2008 to 5.26% in 2009. The cost of funds (including noninterest bearing deposits) decreased 100 basis points, from 3.26% in 2008 to 2.26% in 2009. As a result of the above movements, our net interest margin improved by 9 basis points to 2.99% for the year ended December 31, 2009 as compared to 2.90% for the same period last year.
Net interest income for the quarter ended December 31, 2009 was $5.2 million, a $0.6 million increase when compared to the $4.6 million reported for the same period in 2008, resulting in a net interest margin for the fourth quarter of 3.00%, up 7 basis points as compared to 2.93% in the fourth quarter of last year. The improvement in our net interest margin for both periods is due primarily to our exceptional core deposit growth in 2009, which afforded us the opportunity to allow our higher cost certificates of deposit to roll-off at maturity.
Net interest income for the year ended December 31, 2008 was $17.2 million, a $1.6 increase when compared to the $15.6 million reported for the same period in 2007. Net interest income for the quarter ended December 31, 2008 was $4.6 million, a $0.6 million increase when compared to the $4.0 million reported for the fourth quarter of 2007.
The following table presents the major categories of interest-earning assets, interest-bearing liabilities and shareholders’ equity with corresponding average balances, related interest income or expense, and resulting yields and rates for the periods indicated. Where appropriate income categories and yields have been adjusted in the table to their fully taxable equivalent basis.
NET INTEREST INCOME AND AVERAGE BALANCES (1)
(in 000’s)
Legends for the table are as follows:
(1)
Averages are daily averages.
(2)
Loan interest income includes loan fees of $0.8 million and $1.0 million for the years ended 2009 and 2008, respectively.
(3)
Nontaxable interest income is adjusted to its fully taxable equivalent basis using a federal tax rate of 34 percent.
(4)
The net interest margin is calculated by dividing net interest income (tax equivalent basis) by average total earning assets.
(5)
Non-accrual loans are included in the above yield calculation.
As discussed above, the Company’s net interest income is affected by the change in the amount and mix of interest-earning assets and interest-bearing liabilities (referred to as “volume change”) as well as by changes in yields earned on interest-earning assets and rates paid on deposits and borrowed funds (referred to as “rate change”). The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities and the amounts of change attributable to variations in volumes and rates. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and rate, respectively. Where appropriate income categories and yields have been adjusted in the table to their fully taxable equivalent basis.
RATE/VOLUME ANALYSIS
(in 000’s)
RATE/VOLUME ANALYSIS
(in 000’s)
Market Risk Management
In 2009 as with 2008, we spent a great deal of time focusing on the management of the balance sheet to maximize net interest income. Our primary component of market risk is interest rate volatility. Our primary objectives for managing interest rate volatility is to identify opportunities to maximize net interest income while ensuring adequate liquidity and carefully managing interest rate risk. The Asset/Liability Management Committee (“ALCO”), which is comprised of executive officers, is responsible for:
·
Monitoring corporate financial performance;
·
Meeting liquidity requirements;
·
Establishing interest rate parameters, indices, and terms for loan and deposit products;
·
Assessing and evaluating the competitive market environment;
·
Monitoring and measuring interest rate risk.
Interest rate risk refers to the exposure of our earnings and market value of portfolio equity (“MVE”) to changes in interest rates. The magnitude of the change in earnings and MVE resulting from interest rate changes is impacted by the time remaining to maturity on fixed-rate obligations, the contractual ability to adjust rates prior to maturity, competition, and the general level of interest rates and customer actions.
There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on our earnings and capital. Repricing risk arises largely from timing differences in the
pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.
In determining the appropriate level of interest rate risk, ALCO reviews the changes in net interest income and MVE given various changes in interest rates. We also consider the most likely interest rate scenarios, local economics, liquidity needs, business strategies, and other factors in determining the appropriate levels of interest rate risk. To effectively measure and manage interest rate risk, simulation analysis is used to determine the impact on net interest income and MVE from changes in interest rates.
Interest rate sensitivity analysis presents the amount of assets and liabilities that are estimated to reprice through specified periods if there are no changes in balance sheet mix. The interest rate sensitivity analysis in the table below reflects our assets and liabilities on December 31, 2009 that will either be repriced in accordance with market rates, mature, or are estimated to mature early or prepay within the periods indicated (in thousands). This is a one-day position that is continually changing and is not necessarily indicative of our position at any other time.
INTEREST RATE SENSITIVITY
MATURITIES / REPRICING
(in 000’s)
At least quarterly, we measure the asset/liability management position using earnings simulation modeling to estimate what assets and liabilities would re-price, and to what extent, within a one-year period in response to an immediate 300, 200 and 100 basis point change in the Prime Rate, as well as in response to more gradual interest rate changes. Our objective is to keep the change in net interest income over twelve months at or below 5% under an immediate 100 basis point interest rate shock scenario and to keep the change in net income at or below 10%, under an immediate 200 basis point interest rate shock scenario. We also estimate interest sensitivity by calculating the net present value of the balance sheet’s cash flows or the residual value of future cash flows ultimately due to shareholders. This calculation is known as Economic Value of Equity or “EVE” and is generally considered a better measure of long-term interest sensitivity than the interest rate shock scenarios. Our objective is for the result to change 25% or less in an immediate 300 basis point interest rate shock scenario.
The model also incorporates management’s forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not necessarily represent management’s view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to our earnings. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates management’s best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.
Derivative Financial Instruments
For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. At December 31, 2009 and 2008 the Company did not have any derivative agreements related to interest rate hedging in place.
Non-interest Income
Non-interest income is made up of the following major components for December 31, 2009 and 2008:
As noted in the above table, non-interest income for the year ended December 31, 2009 was $2.6 million, $142,000 or 6% above the same period last year. We recorded gains on the sale of securities of $1.0 million during the year as the result of an investment portfolio restructuring transaction to increase overall liquidity and to better position our portfolio for a rising rate environment. Offsetting this gain was a loss recorded on the sale of foreclosed assets of $0.7 million. As a result, our core noninterest income (excluding gains/losses on investments, foreclosed assets, and equipment) totaled $2.3 million as compared to $2.4 million for 2008, a decrease of $100,000 or 4%. This decline is largely attributable to a reduction in income earned from our investment subsidiary, Valley Wealth Management Services, Inc.
Non-interest Expense
Non-interest expense for the year ended December 31, 2009 increased by a total of $2.1 million or 15% over the same period in 2008, from $14.0 million to $16.1 million. A few items to note are as follows:
·
Data processing expenses have increased based on an increase in transactional processing costs as a result of the rapid growth of transactional deposits accounts and internet banking.
·
Our advertising and marketing costs decreased from year to year by 33% as a result of the new product advertising that was launched during 2008 for My Lifestyle Checking. We did not launch any new products in 2009.
·
Like most community banks, we experienced significant increases in deposit insurance costs due to the FDIC’s efforts to replenish the deposit insurance fund during the past year. In the second quarter of 2009, the Company accrued $315,000 in expenses related to a special FDIC assessment levied on the entire banking industry during that same time frame. We anticipate these expenses to continue to increase due to the current economic environment and the increasing number of bank failures across the industry.
·
Audit fees increased in 2009 as we moved back to an outsourced internal audit environment at the beginning of 2009. As discussed in the 2008 annual report, this change created a net savings to the Company’s overall non-interest expense due to savings in compensation and software expenses that were greater than the increased audit fees.
·
Legal fees increased dramatically due to issues surrounding the work-out of problem assets and litigation costs.
·
Deposit expenses increased primarily due to program fees related to wholesale and brokered deposits, Certificate of Deposit Account Registry Service (CDARS) certificates of deposits and our MyLifestyle deposit suite of products.
·
The decrease in loan expense is primarily due to the lower loan growth in 2009 as compared to 2008.
·
Foreclosed asset expenses increased in 2009 as we foreclosed on and carried on our balance sheet numerous real estate properties during the year. These expenses include fees incurred to foreclose on the asset and expenses incurred to keep the property in a favorable condition.
Noninterest expense for the year ended December 31, 2008 was $1.3 million over the same period ended December 31, 2007. For the year ended December 31, 2008, we experienced an increase in compensation expenses due to merit increases, new positions in our commercial lending departments and the full year’s impact of our movement to an internal audit environment in early 2007. We renovated and occupied a new floor at our main headquarters in early 2008 resulting in an increase in occupancy expense over the prior period. There was an increase in data processing expense based on the bank’s conversion to an image item processing environment. Audit fees decreased due to our conversion to an internal audit department within the bank. Deposit expenses increased significantly as we experienced elevated participation in our CDARS program that caused increases in related program fees. Computer software expenses increased primarily due to software related to our MyLifestyle product suite as well as new loan documentation software.
Noninterest expenses are expected to continue to increase as a direct result of business growth, the continuation of the depressed local economy, the complexity of banking operations and the potential for increased levels of regulations.
Income Taxes
During 2009 and 2008, the Company recorded federal income tax benefit of $3.3 million and an income tax provision of $0.6 million, respectively. The anticipated federal income tax liability equates to an effective tax rate of (36.5%) and 25.6%, respectively. A few of the factors contributing to the difference between the effective tax rate and the statutory rate of 34 percent include historical tax credits, tax-exempt interest income on municipal securities, net of disallowance, and tax-exempt income earned on bank owned life insurance.
Earning Assets
Average earning assets were $671.8 million at December 31, 2009, an increase of $73.2 million or 12.2% over $598.6 million at December 31, 2008. Total average earning assets were 96.0% of total average assets at December 31, 2009. Average loans represented the largest component of average earning assets and increased $68.6 million or 13.5% to $577.4 million at December 31, 2009 from $508.8 million a year earlier. Average loans were 85.9% of average earning assets and 82.5% of average total assets as of December 31, 2009. Average investment securities, decreased by $4.1 million or (4.7%) as compared to December 31, 2008. Average investment securities were 12.2% of average earning assets and 11.8% of average total assets as of December 31, 2009.
Average earning assets were $598.6 million at December 31, 2008, an increase of $40.9 million or 7.3% over $557.7 million at December 31, 2007. Total average earning assets were 95.3% of total average assets at December 31, 2008. Average loans represented the largest component of average earning assets and increased $29.6 million or 6.2% to $508.7 million at December 31, 2008. Average loans were 85.0% of average earning assets and 81.0% of average total assets as of December 31, 2008. Average investment securities, increased by $10.3 million or 13.5% over December 31, 2007. Average investment securities were 14.4% of average earning assets and 13.8% of average total assets as of December 31, 2008.
Investment Securities
Our investment securities portfolio consists primarily of securities for which an active market exists. Our policy is to invest primarily in securities of the U.S. Government and its agencies and in other high grade fixed income securities to minimize credit risk. Our investment securities portfolio plays a role in the management of interest rate sensitivity and generates additional interest income. In addition, our portfolio serves as a source of liquidity and is used to meet collateral requirements.
Our investment securities portfolio consists of two components, securities held-to-maturity and securities available-for-sale. Securities are classified as held-to-maturity based on our intent and ability, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost. Securities which may be sold in response to changes in market interest rates, changes insecurities’ prepayment risk, increases in loan demand, general liquidity needs, and other similar factors are classified as available-for-sale and are carried at estimated fair value.
Investment securities (available for sale and held to maturity), including restricted equity securities, at December 31, 2009 were $88.6 million, a decrease of $4.3 million or 4.6% from their level of $92.9 million on December 31, 2008. The decrease is attributable to purchases of $88.3 million offset by principal prepayments, called proceeds and sales and net amortization/accretion in the amount of $92.6 million. See Note 3 to the Consolidated Financial Statements.
Investment securities (available for sale and held to maturity), including restricted equity securities, at December 31, 2008 were $92.9 million, an increase of $11.8 million or 14.5% from their level of $81.1 million on December 31, 2007. The increase is attributable to purchases of $38.0 million offset by principal prepayments, called proceeds and sales in the amount of $26.2 million.
AVAILABLE FOR SALE INVESTMENT PORTFOLIO
CATEGORY DISTRIBUTION
(in 000’s)
HELD TO MATURITY INVESTMENT PORTFOLIO
CATEGORY DISTRIBUTION
(in 000’s)
The following table presents the maturity ranges of securities available-for-sale as of December 31, 2009 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.
INVESTMENT PORTFOLIO - MATURITY DISTRIBUTION
(in 000’s)
* Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms due to early repayments of principal.
The following table presents the maturity ranges of securities held-to-maturity as of December 31, 2009 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.
INVESTMENT PORTFOLIO - MATURITY DISTRIBUTION
(in 000’s)
* Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms due to early repayments of principal.
Loan Portfolio
Our total gross loans were $571.0 million at December 31, 2009, an increase of $18.0 million or 3.3% from the $553.0 million reported one year earlier. Our ratio of total loans to total funding sources, excluding the Federal Reserve Discount Window, (customer deposits, securities sold under agreements to repurchase, federal funds purchased, Federal Home Loan Bank advances, and trust preferred securities) stood at 86.7% at December 31, 2009 and 90.7% at December 31, 2008. Management seeks to maintain the ratio of loans to funding sources at or below 90%. In addition to the funding sources noted above, at December 31, 2009 the Company has a secured line of credit with the Federal Reserve Discount Window for $44.4 million.
The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. We adjust the mix of lending and the terms of our loan programs according to economic and market conditions, asset/liability management considerations and other factors. Loans typically are made to businesses and individuals located within our primary market area (target range 85 - 90%), most of whom maintain deposit accounts with the Bank. There is no concentration of loans exceeding 10% of total loans that is not disclosed in the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements or discussed below.
The following table summarizes the loan portfolio by category for the five years ended December 31, 2009.
LOAN PORTFOLIO SUMMARY
(in 000’s)
The following table presents maturity information (based upon interest rate repricing dates) on the loan portfolio based upon scheduled repayments at December 31, 2009.
LOAN MATURITY
(in 000’s)
The following table presents maturity information based upon contractual terms and scheduled repayments at December 31, 2009.
FIXED AND VARIABLE RATE LOANS
(in 000’s)
Loan Category Analysis
Commercial Loans. Commercial loans generally are made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes. The credit worthiness of the borrower is analyzed and re-evaluated on a periodic basis. Most commercial loans are secured with business assets such as accounts receivable, inventory and equipment. Even with substantial collateral, such as all the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.
Commercial Real Estate Loans. Commercial real estate construction and commercial real estate mortgages represent interim and permanent financing of commercial properties that are secured primarily by real estate. The Company prefers to make commercial real estate loans secured by owner-occupied properties. These borrowers are engaged in business activities other than real estate, and the primary source of repayment is not solely dependent on conditions in the real estate market.
Real Estate Construction Loans. Real estate construction loans represent interim financing on residential and commercial properties under construction, and are secured by real estate. This category also includes acquisition and development financing for residential and commercial projects. Once construction is completed and the loan becomes permanent, the loans are reclassified as either commercial real estate loans, which are secured by commercial property, or residential real estate loans, which are secured by first deeds of trust.
Residential Real Estate Loans. Residential real estate loans are secured by deeds of trust on 1-4 family residential properties. To mitigate interest rate risk, the Company usually limits the final maturity of residential real estate loans held for its own portfolio to 15-20 years, although exceptions are made for competitive reasons and under special programs. Residential real estate lending involves risk elements when there is lack of timely payment and/or a decline in the value of the collateral.
Loans to Individuals. We offer various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, letters of credit, and home equity loans.
Higher Risk Loans
Certain types of loans, such as option ARM products, interest-only loans, subprime loans, and loans with initial teaser rates, can have a greater risk of non-collection than other loans. We have not offered option ARM, interest-only, or subprime mortgage loans. The only initial teaser-rate product we have offered have been 80% loan-to-value home equity lines of credit. This teaser-rate product was introduced in mid-2004 to stimulate activity and was terminated in late 2005.
Junior-lien mortgages can also be considered higher risk loans and our junior lien portfolio currently consists of balances totaling $25.4 million (4.4% of total portfolio) at December 31, 2009. Loans included in this category that were initially made with high loan-to-value ratios of 100% or greater have current balances totaling $2.0 million and have current loan-to-value ratios of 80% or less at December 31, 2009. Over the past seven years, we have experienced charge-offs totaling $466,000 in junior lien mortgages.
Additionally, we have residential first mortgages with balances approximating $4.7 million that are at current loan-to-value ratios in excess of 100%. We have not experienced any charge-offs of loans in this category.
Asset Quality
Summary of Allowance for Loan Losses
The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible, although there can be no assurance that this will be so. The provision for loan losses increases the allowance, and loans charged off (net of recoveries) reduce the allowance.
The allowance for loan losses was $14.6 million and $7.6 million as of December 31, 2009 and 2008, respectively. The ratio of the allowance for loan losses to total loans outstanding was approximately 2.56% at December 31, 2009, which compares to approximately 1.37% of total loans at December 31, 2008 (see Note 5 to the Consolidated Financial Statements). These estimates are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $4.3 million in specific reserves was included in the balance of the allowance for loan losses as of December 31, 2009 for impaired loans, which compares to a total of $2.2 million as of December 31, 2008.
A provision for loan losses of $15.2 million was made during 2009, an increase of $11.9 million or 360.6% from the $3.3 million provided during 2008. The increase in the loan loss provision is a result of the following factors:
·
An overall increase in our general reserves of $5.0 million. We included two new environmental factors due to the catastrophic devaluation that is occurring in the real estate market. Like many community banks, we are focused heavily on real estate lending and as such believe it is prudent to recognize an additional environmental factor associated with real estate lending in the current economic environment. We also added a new environmental factor to account for the concentration of larger relationships in our portfolio. These new factors resulted in an increase of $3.3 million to the general reserves. Our historical loss factor increased from 0.24% at December 31, 2008 to 0.59% at December 31, 2009 due to the unprecedented high level of charge-offs during the past two years upon which our analysis is based. This increase added $1.6 million to our general reserves. The remaining increase to our general reserves is the result of provisions made due to our loan growth.
·
An increase in our specific reserves on our impaired assets of $2.0 million. The increase is primarily attributable to the ongoing economic recession throughout the Roanoke Valley and the depressed levels of asset prices. The majority of loans carrying specific reserves for potential losses at December 31, 2009 are residential or commercial real estate relationships.
We believe the increase in our total reserves is adequate and appropriate given the continued depressed economic environment at December 31, 2009. We anticipate provisioning levels to continue to be elevated for 2010 and the levels will depend on the depth and strength of any potential recovery from the current recession.
A provision for loan losses of $3.3 million was made during 2008, an increase of $2.0 million or 153.8% from the $1.3 million provided during 2007. The increase in the loan loss provision was a result of an increase in loan growth as well as large specific reserves on one large commercially oriented credit relationship.
Loans are assigned to our “watch list” based upon our internal risk rating system. There are three levels of accountability in the risk rating process. The primary responsibility for risk identification lies with the account officer. It is the account officer’s responsibility for the initial and ongoing risk rating of all notes and commitments in his or her portfolio. On a monthly basis, each account officer signs a Credit Risk
Rating Certification attesting to the accuracy of the credit risk ratings for the loans in his or her loan portfolio. The Chief Credit Officer is responsible for periodically reviewing the risk rating process employed by the lending officers. The Chief Credit Officer is responsible for the accuracy and timeliness of account officer risk ratings and has the authority to override account officer risk ratings and initiate rating changes, if warranted. Finally, the Bank has a loan review program to provide an independent validation of portfolio quality. This independent review is intended to assess adherence to underwriting guidelines, proper credit analysis and documentation. In addition, the loan review process is required to test the integrity, accuracy and timeliness of account officer risk ratings and to test the effectiveness of the credit administration’s controls over the risk identification process. Risk Management reports its findings to the Board of Directors.
We regularly review asset quality and re-evaluate the allowance for loan losses. However, no assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future. Our current market environment, with a nationwide recession, makes this risk even higher. Additionally, regulatory examiners may require us to recognize additions or reductions to the allowance based upon their judgment about the loan portfolio and other information available to them at the time of their examinations. On a quarterly basis, the Directors’ Loan Committee will review all loans on our watch list to determine proper action and reporting of any loans identified as substandard by the credit quality review. Additionally, the Directors’ Loan Committee and the Audit Committee meet jointly at the end of each quarter to review in detail management’s assessment of the adequacy of the allowance for loan losses. We believe that the above allocated reserves are adequate for the impaired loans in our portfolio based upon a detailed review of the quality and pledged collateral of each individual loans considered impaired at each of the above-referenced periods.
The following table summarizes the loan loss experience for the five years ended December 31, 2009.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(in 000’s)
The following table summarizes the allocation of the allowance for loan losses for the five years ended December 31, 2009. The percentage in the table below refers to the percent of loans in each category to total loans.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(in 000’s)
Non-Performing Assets
Nonperforming assets include nonaccrual loans, loans past due 90 days or more, restructured loans and foreclosed/repossessed property. A loan will be placed on nonaccrual status when collection of all principal or interest is deemed unlikely. A loan will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of being collected. In this case, the loan will continue to accrue interest despite its past due status.
A restructured loan is a loan in which the original contract terms have been modified due to a borrower’s financial condition or there has been a transfer of assets in full or partial satisfaction of the loan. A modification of original contractual terms is generally a concession to a borrower that a lending institution would not normally consider.
Based on generally accepted accounting standards for receivables, a loan is impaired when, based on current information and events, it is likely that a creditor will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement.
For the year ended December 31, 2009, our non-performing assets to total assets ratio increased from 1.48% at December 31, 2008 to 4.36%. Non-performing assets at December 31, 2009 consisted of non-accrual loans of $28.6 million and foreclosed property of $2.5 million. Also included in non-performing assets at December 31, 2009 are loans totaling $24,000 that are past due greater than 90 days. At this time, we believe we are adequately reserved for any potential loss exposure on these relationships. Our ratio of loans past due more than 90 days to total loans decreased from 0.01% at December 31, 2008 to 0.00% at December 31, 2009. Net charge-offs for the year ended December 31, 2009 amounted to $8.1 million in comparison to $0.6 million for the year ended December 31, 2008. Charge-offs of $3.5 million recorded in 2009 are related to one commercial customer who took adversarial actions against the Company during the first half of 2009. For the year ended December 31, 2008, our non-performing assets to total assets ratio increased from 1.24% at December 31, 2007 to 1.48%. Additionally, our ratio of loans past due more than 90 days to total loans increased from 0.00% at December 31, 2007 to 0.01% at December 31, 2008. Net charge-offs for the year ended December 31, 2008 amounted to $0.6 million in comparison to $2.0 million for the year ended December 31, 2007.
Nonperforming assets for the five years ended December 31, 2009 are detailed as follows:
NONPERFORMING ASSETS
(in 000’s)
(1) Other nonperforming loans include impaired loans which are not on nonaccrual status, nor past due 90 days or more.
If the non-accrual loans disclosed above had performed in accordance with their original terms, additional interest income in the amount of $688,681 and $148,953 would have been recorded for the years ended December 31, 2009 and December 31, 2008, respectively.
Other Assets
We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Company’s Supplemental Executive Retirement Plan (“SERP”) and other employee benefit costs including health insurance, dental insurance, life insurance, and 401(k) employer match. Bank owned life insurance was $12.9 million at December 31, 2009, an increase of $0.5 million over the $12.4 million reported as of December 31, 2008. The increase is due to the $0.5 million increase in the cash surrender value of the life insurance contracts record as income.
Deposits
Our major source of funds and liquidity is our deposit base. Deposits provided funding for our investment in loans and securities. Our primary objective is to increase core deposits as a means to fund asset growth at a lower cost. Interest paid for deposits must be managed carefully to control the level of interest expense. We offer individuals and small-to-medium sized businesses a variety of deposit accounts, including checking, savings, money market and certificates of deposits. The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges and the convenience of banking locations. Competition for deposits is intense from other depository institutions and money market funds, some of which offer interest rates higher than we pay. We attempt to identify and implement pricing and marketing strategies designed to control the overall cost of deposits and to maintain a stable deposit mix.
The following table summarizes our total deposits for the years ended December 31, 2009, 2008 and 2007:
We experienced tremendous growth in core deposits in 2009 from customers who prefer dealing with a local, established community bank. Our Prime Money Market account, which has an interest rate tied to the Wall Street Journal Prime rate, continues to attract customers and has accumulated $135.6 million in deposits as of the end of 2009, an increase of 60% over the same period last year. We also saw excellent growth in our MyLifeStyle Checking, launched in the first quarter of 2008, with an increase of $27.9 million or 186% during the year from $15.0 million to $42.9 million at year-end. This account is an example of how smaller community banks such as Valley Bank are finding innovative ways to compete against larger competitors in a crowded market. In addition to a highly competitive interest rate paid on this account, customers get free access to any ATM nation-wide along with many additional rewards.
The following table summarizes average deposits for the years ended December 31, 2009, 2008 and 2007:
We balance our yield on deposits by maintaining a level of both national market certificates of deposit and out-of-market brokered products which allow for more flexibility in pricing and timing of maturities. We use an internet-based rate posting service for our national market certificates of deposit which are not considered brokered. This portfolio at December 31, 2009 totaled $11.4 million, an increase of $8.6 million from the $2.8 million reported at December 31, 2008. At December 31, 2009 our total out-of-market brokered certificates of deposits to total deposits was 6.1% compared to 0.0% at December 31,
2008. The following table presents the maturity schedule of certificates of deposit of $100,000 or more as of December 31, 2009.
MATURITY SCHEDULE OF CERTIFICATES
OF DEPOSIT OF $100,000 OR MORE
(in 000’s)
December 31, 2009
Three months or less
44,801
Over three through 6 months
44,744
Over six through 12 months
23,816
Over 12 months
26,993
Total
140,354
Short-Term Borrowings
Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) decreased by $22.7 million from their level of $64.0 million at December 31, 2008 to a total of $41.3 million as of December 31, 2009. Short-term borrowings at December 31, 2009 include two Federal Home Loan Bank of Atlanta (“FHLB”) advances in the amount of $5.0 million and $15.0 million, and a commercial sweep account program in the amount of $21.3 million. The first FHLB advance of $5.0 million is a fixed rate credit with an interest rate of 6.49% that matures on May 24, 2010. The second FHLB advance of $15.0 million is also a fixed rate credit with an interest rate of 3.79% maturing on December 28, 2010. See the liquidity section for further information on the preceding borrowings.
Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) increased by $14.4 million from their level of $49.6 million at December 31, 2007 to a total of $64.0 million as of December 31, 2008. Short-term borrowings at December 31, 2008 included federal funds purchased and overnight borrowings from the Federal Reserve Bank’s discount window of $11.3 million, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings in the amount of $17.0 million, and a commercial sweep account program in the amount of $35.7 million.
The commercial sweep program involves balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured. The balance in the program decreased 40.3% or $14.4 million from $35.7 million reported at December 31, 2008 to $21.3 million at December 31, 2009. The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight basis subject to repurchase. On the following business day, we repurchase from the customer the securities for an amount equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only once per month. We believe the decrease for 2009 is the result of the continued economic recession and its impact on our commercial customers, as these customers had less cash to invest throughout the year. The balance in the program increased 7.2% or $2.4 million from $33.3 million reported at December 31, 2007 to $35.7 million at December 31, 2008.
Long-Term Borrowings
Federal Home Loan Bank advances are relatively cost-effective funding sources and provide the Company with the flexibility to structure borrowings in a manner that aids in the management of interest rate risk and liquidity. The increase in advances during the year reflects the funding to support investment growth.
The Company had outstanding long-term debt with the Federal Home Bank of Atlanta in the amount of $48.0 million as of December 31, 2009, a decrease of $15.0 million from the $63.0 million reported as of December 31, 2008. This decrease is made up of one new $5.0 million fixed rate advance offset by the movement of $20.0 million in advances from long-term to short-term borrowings as of December 31, 2009. See Footnote 8 of the Company’s Consolidated Financial Statements for more information on the long-term advances.
Capital Adequacy
Our capital levels remain strong during this economic downturn. Our capital ratios are above the required regulatory minimums for a well-capitalized institution. Tier 1 risk-based and total risk-based capital ratios were 11.7% and 13.0%, well above the regulatory well-capitalized capital ratios of 6.0% and 10.0%, respectively. We review the adequacy of our capital on an ongoing basis. We seek to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses and will continue to monitor the Bank capital ratios very closely due to the impact our non-accrual loans have on retained earnings and capital.
For the periods indicated, we had the following risk-based capital and leverage ratios:
Ratio
12/31/09
12/31/08
12/31/07
Tier 1
11.7%
13.1%
10.7%
Total
13.0%
14.4%
12.1%
Leverage
9.4%
11.3%
9.1%
Liquidity
One of the principal goals of the Bank’s asset and liability management strategy is to maintain adequate liquidity. Liquidity measures our ability to meet our maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund our operations and to provide for customers’ credit needs. Liquidity represents a financial institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds from alternative funding sources.
Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and non-pledged securities available-for-sale, increased $41.1 million or 345.4% from $11.9 million at December 31, 2008 to $53.0 million at December 31, 2009. Our funding sources consist of an established federal funds lines with a regional correspondent bank totaling $12.0 million that had no outstanding balance as of December 31, 2009, one established federal funds line with a third party bank totaling $5.0 million that had no outstanding balance as of December 31, 2009, an established line with the FHLB that had $68.0 million outstanding under a total available line of $77.3 million as of December 31, 2009, and an established line with the Federal Reserve Discount Window that had no outstanding balance under a total line of $44.4 million as of December 31, 2009. We believe these arrangements will be renewed at maturity, however the amounts and terms are subject to change.
As of December 31, 2009, we had pledged approximately $83.4 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. As of December 31, 2009, we had pledged approximately $44.4 million of our loan portfolio balances as collateral for borrowings from the Federal Reserve Discount Window
As of December 31, 2008, we had pledged approximately $88.0 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. At December 31,
2008, we had pledged approximately $69.5 million of our loan portfolio balances as collateral for borrowings from the Federal Reserve Discount.
We sell excess funds as overnight federal funds sold to provide an immediate source of liquidity. We had no federal funds sold at December 31, 2009 and December 31, 2008. In the third quarter of 2009, the Company opened an account at the Federal Reserve Bank through our local correspondent bank that pays interest daily on the overnight deposit balance. We also have an interest bearing account at our regional Federal Home Loan Bank in Atlanta, Georgia with a $25,000 minimum balance requirement. As of December 31, 2009, these two interest-bearing deposit accounts totaled $23.7 million, compared to a balance of 26,000 at December 31, 2008.
The Company maintains a liquidity policy as a means to manage liquidity and the associated risk. The policy includes a Liquidity Contingency Plan (“the Liquidity Plan”) that is designed as a tool for the Company to detect liquidity issues in order to protect depositors, creditors and shareholders. The Liquidity Plan includes monitoring various internal and external indicators such as changes in core deposits and changes in the market conditions. It provides for timely responses to a wide variety of funding scenarios ranging from changes in loan demand to a decline in the Company’s quarterly earnings to a decline in market price of the Company’s stock. The Liquidity Plan calls for specific responses designed to meet a wide range of liquidity needs based upon assessments that are performed on a recurring basis by the Company and its Board of Directors.
As a result of our management of liquid assets and our ability to generate liquidity through alternative funding sources, we believe we maintain overall liquidity sufficient to meet our depositors’ requirements and satisfy our customers’ credit needs.
Impact of Inflation
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all the assets and liabilities of the Company and the Bank are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of changes in the general rate of inflation and changes in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as do the prices of goods and services. Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
Recent and Future Accounting Considerations
See Footnote 1 of the Company’s Consolidated Financial Statements for more information on recent and future accounting considerations.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Valley Financial Corporation
Roanoke, Virginia
We have audited the consolidated balance sheets of Valley Financial Corporation and subsidiary as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. These consolidated 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 the Valley Financial Corporation and subsidiary as of December 31, 2009 and 2008 and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
We were not engaged to examine management’s assessment about the effectiveness of Valley Financial Corporation’s internal control over financial reporting as of December 31, 2009 included in the accompanying Form 10-K, item 9A, and accordingly, we do not express an opinion thereon.
Elliott Davis, LLC
Galax, Virginia
March 26, 2010
Valley Financial Corporation
Consolidated Balance Sheets
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Valley Financial Corporation
Consolidated Statements of Operations
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
Valley Financial Corporation
Consolidated Statements of Shareholders’ Equity
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
See accompanying notes to consolidated financial statements
Valley Financial Corporation
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2009 and 2008
(In thousands)
Valley Financial Corporation
Consolidated Statements of Cash Flows, continued
For the Years Ended December 31, 2009 and 2008
(In thousands)
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies
General
Valley Bank (“the Bank”) provides traditional commercial banking services concentrated primarily in the Roanoke Valley of Virginia. However, the Bank does not currently offer trust services. As a state chartered, Federal Reserve member bank, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve. The Bank opened for business on May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15, 1997 in the City of Roanoke, its fourth office in the City of Salem on April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of Roanoke on December 8, 2003, and its eighth office in the City of Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23, 2005.
The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank.
Effective October 16, 2002, the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary gives the Bank the right to utilize certain federal and state tax credits. Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of Valley Financial Corporation (“the Company”) for the purpose of issuing trust preferred securities. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. Effective December 15, 2006, Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. These entities are for raising capital (in the case of the statutory trusts) or investments (in the case of the LLC) for the Company and the Bank. Effective July 13, 2007, VFC Properties, LLC was established as a wholly-owned subsidiary of the Company to provide credit intermediary services for the Bank. The Company dissolved this entity in July 2008. In September 2008, the Bank established VB Land, LLC, a wholly-owned subsidiary to provide to provide credit intermediary services for the Bank.
Critical Accounting Policies
The accounting and reporting policies of the Company, the Bank, and the Company’s Statutory Trusts as discussed in Note 8, conform to generally accepted accounting principles (GAAP) and to general banking industry practices. Our policies, with respect to the methodology for determination of the allowance for loan losses, involve a high degree of complexity. Management must make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions, or estimates would cause reported results to differ materially. These critical policies and their application are reviewed periodically with our Audit Committee and Board of Directors. The following is a summary of the more significant accounting policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and the Bank, thereafter referred to collectively as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.
Business Segments
The Company reports its activities in one business segment. In determining the appropriateness of segment definition, the Company considers the materiality of potential business segments and components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Advertising Costs
The Company expenses all advertising and business promotion costs as incurred.
Use of Estimates
The preparation of financial statements in conformity with 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.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties.
Substantially all of the Bank's loan portfolio consists of loans in the Roanoke Valley. Accordingly, the ultimate collectability 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. The regional economy is reasonably diverse.
While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Bank's allowances for loan and foreclosed real estate losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.
Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption "cash and due from banks."
Interest-Bearing Deposits in Banks
Interest bearing deposits in banks mature within one year and are carried at cost.
Trading Securities
The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio.
Securities Held-to-Maturity
Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates.
Securities Available-for-Sale
Available-for-sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as held-to-maturity securities.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Securities Available-for-Sale, continued
Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of shareholders’ equity. Realized gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates.
Declines in the fair value of individual held-to-maturity and available-for-sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.
Loan origination fees and costs are capitalized and recognized as an adjustment to the yield on the related loan. Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.
Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower is unlikely to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. We apply payments received on nonaccrual loans first to outstanding principal, and the residual amount, if any, is applied to interest. When facts and circumstances indicate the borrower has regained the ability to meet required payments, the loan is returned to accrual status. Past due status of loans is determined based on contractual terms.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that have been sustained in the loan portfolio. The allowance is based on accounting standards for contingencies and receivables. Losses are accrued when it is probable they have occurred and can be estimated.
The allowance consists of specific and general components. The specific component relates to impaired loans. For such loans an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component is based on historical loss experience adjusted for qualitative and environmental factors.
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Allowance for Loan Losses, continued
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, and from time to time, we may evaluate one or more homogeneous loans as impaired. The Bank does not separately identify individual consumer and residential loans for impairment.
Premises and Equipment
Land is carried at cost. The determination as to whether to capitalize a purchase or record as a current expense is based on the nature of the item, the useful life and the cost, but generally any purchase less than $1,000 will be expensed in the current period. Bank premises, furniture and equipment, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:
Years
Buildings and improvements
Computer equipment
Computer software
Furniture and fixtures
Other equipment
3-10
Leasehold improvements
3-15
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the asset is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in foreclosed asset expense.
Share Based Compensation
Based on generally accepted accounting guidance for equity and stock compensation, share based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Share Based compensation, continued
Policy for issuing shares upon option exercise
Options shall be exercised by the delivery of a written notice to the Company in the form prescribed by the Human Resources (HR) Committee setting forth the number of shares with respect to which the option is to be exercised, accompanied by full payment for the shares. The option price shall be payable to the Company in full either in cash, by delivery of shares of stock valued at fair market value at the time of exercise, delivery of a promissory note (in the HR Committee’s sole discretion) or by a combination of the foregoing. As soon as practicable, after receipt of written notice and payment, the Company shall deliver to the participant, stock certificates (new shares) in an appropriate amount based upon the number of options exercised, issued in the participant’s name. No participant who is awarded options shall have rights as a shareholder in connection with the shares subject to such options until the date of exercise of the options.
See Note 13 for further information regarding our share based compensation assumptions and expenses.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Income Taxes
Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities and income earned on bank-owned life insurance) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
It is the company’s policy to recognize interest and/or penalties related to income tax matters in income tax expense. The Company and its wholly-owned subsidiary file a consolidated income tax return. Each entity provides for income taxes based on its contribution to income or loss of the consolidated group.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Basic Earnings (Loss) per Share
Basic earnings per share is computed by dividing income (loss) to common shareholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends.
Diluted Earnings (Loss) per Share
The computation of diluted earnings (loss) per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. These additional common shares would include employee equity share options, nonvested shares and similar equity instruments granted to employees, as well as the shares associated with the common stock warrants issued to the U.S. Treasury Department as part of the preferred stock transaction completed in December 2008. Diluted earnings (loss) per share are based upon the actual number of options or shares granted and not yet forfeited unless doing so would be antidilutive. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.
Comprehensive Income (Loss)
Annual comprehensive income (loss) reflects the change in the Company’s equity during the year arising from transactions and events other than investments by and distributions to shareholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of shareholders’ equity rather than as income or expense.
Financial Instruments
In the ordinary course of business the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Interest Rate Swap Agreements
For asset/liability management purposes, the Company may use interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional amount. The notional amount on which the interest payments are based is not exchanged. These swap agreements are derivative instruments and generally convert a portion of the Company’s variable-rate loans to a fixed rate (cash flow hedge), and convert a portion of its fixed-rate loans to a variable rate (fair value hedge). Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In addition, forwards and option contracts must reduce an exposure’s risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of occurring. All derivative financial instruments held or issued by the Company are held or issued for purposes other than trading. At December 31, 2009 and 2008 the Company did not have any derivative agreements related to interest rate hedging in place.
Cash flows resulting from derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Fair Value of Financial Instruments, continued
Dividends and Discount on Preferred Stock
The Company includes dividends on preferred stock in shareholders’ equity at the time of declaration and includes the dividends and accretion on discount on Preferred Stock in the earnings per share calculation when earned, without regard to declaration.
Reclassification
Certain reclassifications have been made to the financial statements of the prior year to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.
Recent Accounting Pronouncements
The FASB issued new accounting guidance on accounting for transfers of financial assets in June 2009. The guidance limits the circumstances in which a financial asset should be derecognized when the transferor has not transferred the entire financial asset by taking into consideration the transferor’s continuing involvement. The standard requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. The concept of a qualifying special-purpose entity is no longer applicable. The standard is effective for the first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company does not expect the guidance to have any impact on the Company’s financial statements. The accounting standard was amended in December, 2009, to include this guidance.
In October, 2009, updated guidance was issued to provide for accounting and reporting for own-share lending arrangements issued in contemplation of a convertible debt issuance. At the date of issuance, a share-lending arrangement entered into on an entity’s own shares should be measured at fair value in accordance with prior guidance and recognized as an issuance cost, with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs. The amendment also requires several disclosures including a description and the terms of the arrangement and the reason for entering into the arrangement. The effective dates of the amendment are dependent upon the date the share-lending arrangement was entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009. The Company has no plans to issue convertible debt and, therefore, does not expect the update to have an impact on its financial statements.
In January, 2010, guidance was issued to alleviate diversity in the accounting for distributions to shareholders that allow the shareholder to elect to receive their entire distribution in cash or shares but with a limit on the aggregate amount of cash to be paid. The amendment states that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance. The amendment is effective for interim and annual periods ending on or after December 15, 2009 and had no impact on the Company’s financial statements.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued
Recent Accounting Pronouncements, continued
Also in January, 2010, an amendment was issued to clarify the scope of subsidiaries for consolidation purposes. The amendment provides that the decrease in ownership guidance should apply to (1) a subsidiary or group of assets that is a business or nonprofit activity, (2) a subsidiary that is a business or nonprofit activity that is transferred to an equity method investee or joint venture, and (3) an exchange of a group of assets that constitutes a business or nonprofit activity for a non-controlling interest in an entity. The guidance does not apply to a decrease in ownership in transactions related to sales of in substance real estate or conveyances of oil and gas mineral rights. The update is effective for the interim or annual reporting periods ending on or after December 15, 2009 and had no impact on the Company’s financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Note 2. Restrictions on Cash
To comply with Federal Reserve regulations, the Bank is required to maintain certain average reserve balances. The daily cash reserve requirement for the week including December 31, 2009 was $283, which was met by cash on hand. The daily cash reserve requirement for the week including December 31, 2008 was $50, which was met by cash on hand.
As a condition of our correspondent bank agreement, the Bank is also required to maintain a target balance. The target balance as of December 31, 2009 and December 31, 2008 was $250.
Note 3. Securities
The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale (“AFS”) as of December 31, 2009 and 2008 were as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 3. Securities, continued
The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity (“HTM”) as of December 31, 2009 and 2008 were as follows:
*Such as FNMA, FHLMC and FHLB.
The following tables detail unrealized losses and related fair values in the Bank’s available-for-sale investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2009 and 2008, respectively.
Temporarily Impaired Securities in AFS Portfolio
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 3. Securities, continued
Temporarily Impaired Securities in AFS Portfolio
The following tables detail unrealized losses and related fair values in the Bank’s held-to-maturity investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2009 and 2008, respectively.
Temporarily Impaired Securities in HTM Portfolio
Temporarily Impaired Securities in HTM Portfolio
This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2009 and 2008, respectively.
Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 3. Securities, continued
investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are three securities in the portfolio with unrealized losses for a period greater than 12 months. We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.
The amortized costs and approximate fair values of available-for-sale securities as of December 31, 2009, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The amortized costs and approximate fair values of held-to-maturity securities as of December 31, 2009, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities (excluding restricted equity securities) with amortized costs of $61,027 and $82,652 as of December 31, 2009 and 2008, respectively, were pledged as collateral for public deposits and for other purposes as required or permitted by law.
Restricted equity securities consist of Federal Home Loan Bank (“FHLB”) stock in the amount of $4,803 and $4,673, Federal Reserve Bank stock in the amount $1,219 and $784, and Community Bankers Bank stock in the amount of $150 and $150 as of December 31, 2009 and 2008, respectively. Restricted equity securities are carried at cost. The FHLB requires the Bank to maintain stock in an amount equal to 0.20% of total assets as of December 31 of the prior year and 4.5% of outstanding borrowings. Upon request, the stock may be sold back to the FHLB, at cost. Due to regulatory restrictions the FHLB is under, such stock redemptions have been indefinitely put on hold. The Federal Reserve Bank of Richmond requires the Bank to maintain stock with a par value equal to 6% of its
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 3. Securities, continued
outstanding capital; however, the Federal Reserve Bank only requires the Bank to pay 50% of the par value of the stock. Community Bankers Bank stock is restricted in the fact that the stock may only be repurchased by that Company and historically at cost.
Note 4. Loans Receivable
The major components of loans in the consolidated balance sheets at December 31, 2009 and 2008 are as follows:
Substantially all one-four family residential and commercial real estate loans collateralize the line of credit available from the Federal Home Loan Bank and substantially all commercial and construction loans collateralize the line of credit with the Federal Reserve Bank of Richmond Discount Window.
The aggregate amount of deposit overdrafts that have been reclassified as loans and included in the consumer category in the above table as of December 31, 2009 and 2008 was $27 and $168, respectively.
Note 5. Allowance for Loan Losses
Changes in the allowance for loan losses are as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 5. Allowance for Loan Losses, continued
An allowance determined in accordance with accounting standards for receivables is provided for all impaired loans. The total recorded investment in impaired loans and the related allowance for loan losses at December 31, 2009 and 2008 is as follows:
The average annual recorded investment in impaired loans and interest income recognized on impaired loans for the years ended December 31, 2009 and 2008 (all approximate) is summarized below:
Except for adequately secured advances under an asset-based lending program, no additional funds are committed to be advanced in connection with impaired loans.
Nonaccrual loans totaled $28,568 and $9,532 as of December 31, 2009 and 2008, respectively. Loans past due more than ninety days and still accruing totaled $24 and $57 as of December 31, 2009 and 2008, respectively. There were no restructured loans as of December 31, 2009 and 2008.
Note 6. Premises and Equipment
Components of premises and equipment and total accumulated depreciation and amortization as of December 31, 2009 and 2008 are as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 6. Premises and Equipment, continued
Depreciation expense for the years ended December 31, 2009 and 2008 amounted to $743 and $772, respectively.
The Company currently leases its main office location under a non-cancelable operating lease. The lease for the main office has a term of seven years with the option of three additional renewal terms of five years each. In addition, the Company currently leases two of its branch locations. The Company exercised its option on a new location for our Grandin branch in which it will begin occupying in 2010. The option calls for initial term of 5 years with four renewal options of 5 years each.
Additionally, the Company entered into a land lease in 2008 for its South Roanoke office. The land lease has an initial lease term of twenty-five years with the option to renew for two additional twenty-five year periods. Rental expenses under operating leases were approximately $458 and $455 for 2009 and 2008 respectively.
Future minimum lease payments under non-cancelable operating leases at December 31, 2009 were as follows:
Note 7. Time Deposits
At December 31, 2009 the approximate scheduled maturities of time deposits are as follows:
The aggregate amount of time deposits in denominations of $100 or more at December 31, 2009 and 2008 was $140,354 and $105,523 respectively.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 8. Borrowed Funds
Short-term debt
Short-term debt includes Federal Home Loan Bank Advances that mature in 12 months or less, securities sold under agreements to repurchase, federal funds purchased and borrowings for the discount window generally maturing within one to seven days from the transaction date. Short-term Federal Home Loan Bank of Atlanta advances totaled $20,000 and $17,000 at December 31, 2009 and 2008, respectively. The $20,000 balance as of December 31, 2009 is comprised of two fixed rate credits of $5,000 and $15,000. The $5,000 fixed rate advance was borrowed in May 2000 and matures May 24, 2010. The rate at December 31, 2009 was 6.49%. The $15,000 fixed rate credit was borrowed in December of 2007 and matures December 28, 2010. The rate at December 31, 2009 was 3.79%. At December 31, 2009, the Company had $17,000 available under short-term unsecured lines of credit and $53,084 available under short-term secured lines of credit. Additional information is summarized below:
Securities with a fair market value of $45,190 and $54,389 collateralized securities sold under agreements to repurchase at December 31, 2009 and 2008, respectively.
Long-term debt
The Company has outstanding long-term debt with the Federal Home Loan Bank of Atlanta in the amount of $48,000 as of December 31, 2009. There are two convertible advances in the amount of $5,000 each, two convertible advances in the amount of $10,000 each, one fixed-rate advance in the amount of $13,000 and one fixed-rate credit in the amount of $5,000. The Federal Home Loan Bank of Atlanta has the option to convert the two $5,000 convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two business days notice. If converted, these convertible advances will be converted into a 3-month London Interbank Offered Rate (“LIBOR”) based adjustable rate credit (ARC) at 3-month LIBOR. The Federal Home Loan Bank of Atlanta has the option to convert the two $10,000 convertible advances on the conversion dates below, with at least two business days notice. If converted, these advances will be converted into a 3-month LIBOR based adjustable rate credit at 3-month LIBOR plus or minus the then-current spread of such advance. The following table provides more information on the outstanding advances as of December 31, 2009 and 2008:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
LONG-TERM FEDERAL HOME LOAN BANK ADVANCES
(dollars in thousands)
* Included in short-term debt as of December 31, 2009.
Guaranteed Preferred Beneficial Interests in the Company’s Junior Subordinated Debentures
Valley Financial (VA) Statutory Trust I, a statutory business trust (the “Trust”), was created by the Company on June 26, 2003, at which time the Trust issued $4,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature June 26, 2033. Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate (“LIBOR”) plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by the Trust at any time after June 26, 2008. The principal assets of the Trust are $4,124 of the Company’s junior subordinated debentures which mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and which are callable by the Company after June 26, 2008. All $124 in aggregation liquidation amount of the Trust’s common securities are held by the Company.
Valley Financial (VA) Statutory Trust II, a statutory business trust (“Trust II”), was created by the Company on September 26, 2005, at which time Trust II issued $7,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature December 15, 2035. Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any time after December 15, 2010. The principal assets of Trust II are $7,217 of the Company’s junior subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%, and which are callable by the Company after December 15, 2010. All $217 in aggregation liquidation amount of Trust II’s common securities are held by the Company.
Valley Financial Statutory Trust III, a statutory business trust (“Trust III”) was created by the Company on December 15, 2006, at which time Trust III issued $5,000 in aggregate liquidation amount of $1 par value preferred capital trust securities which mature January 30, 2037. Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any time after
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 8. Borrowed Funds, continued
January 20, 2012. The principal assets of Trust III are $5,155 of the Company’s junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%, and which are callable by the Company after January 30, 2012. All $155 in aggregation liquidation amount of Trust III’s common securities are held by the Company.
The preferred securities and common securities of all three trusts are included in the Company’s Tier 1 capital for regulatory capital adequacy purposes as they do not exceed 25% of the Company’s total Tier I capital excluding the securities. The Company’s obligations with respect to the issuance of the preferred securities and common securities of both trusts constitute a full and unconditional guarantee by the Company of the trusts obligations with respect to the preferred securities and common securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on its junior subordinated debentures, which would result in a deferral of distribution payments on the trusts’ preferred trust securities and common securities. As a result of the Company’s adoption of generally accepted accounting standards related to business consolidations, all three Trusts’ common securities have been presented as a component of other assets.
Note 9. Fair Value of Financial Instruments
Fair Value of Financial Instruments
The Company has adopted generally accepted accounting guidance for fair value measurement and disclosures beginning in our 2008 fiscal year and there was no material impact to our first quarter financial statements. Accounting standards based on fair value measurement applies to all assets and liabilities that are being measured and reported on a fair value basis. They require new disclosure that establishes a framework for measuring fair value in GAAP, and expands disclosure about fair value measurements. This statement enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. The statement requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Fair Value Hierarchy
Under generally accepted accounting guidance for fair value measurement and disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1
Valuation is based upon unadjusted quoted prices in active markets for identical assets to the instrument or security being valued, for example stocks trading on the New York Stock Exchange.
Level 2
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 9. Fair Value of Financial Instruments, continued
In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair value accounting standards. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.
The table below presents the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy:
Assets and Liabilities Recorded at Fair Value on a Recurring Basis at December 31, 2009
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis at December 31, 2009
The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below:
Accounting standards for financial instruments require disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. 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 instruments. These accounting standards exclude 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.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 9. Fair Value of Financial Instruments, continued
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Cash and due from banks: The carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.
Interest-bearing deposits in banks: Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.
Federal funds sold: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value.
Investment Securities Available-for-Sale and Held-to-Maturity: Investment securities available-for-sale and held-to-maturity are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans receivable: The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the amount of impairment in accordance with generally accepted accounting standards for receivables. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2008, all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with accounting guidance related to fair value measurement and disclosure, impaired loans where an allowance is established based on the fair value of the collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
Bank owned life insurance: The carrying amount reported in the balance sheet approximate fair value as it represents the cash surrender value of the life insurance.
Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for 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 contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value.
Federal funds purchased and securities sold under agreements to repurchase: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 9. Fair Value of Financial Instruments, continued
Short-term debt: The carrying amounts of short-term debt approximate their fair values.
Other debt: The fair values of other debt is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt.
Guaranteed preferred beneficial interests in the Company’s junior subordinated debentures: The fair values of guaranteed preferred beneficial interests in the Company’s junior subordinated debentures is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt.
Other liabilities: For fixed-rate loan commitments, fair value considers the difference between current levels of interest rates and the committed rates. The carrying amount of other liabilities approximates fair value as the estimated value of loan commitments approximates the fees charged.
Foreclosed Assets: Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When the appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 9. Fair Value of Financial Instruments, continued
The carrying amounts and approximate fair values of the Corporation's financial instruments are as follows at December 31, 2009 and 2008:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 10. Earnings (Loss) per Share
Basic earnings (loss) per share is based upon the weighted average number of common shares outstanding during the period. The weighted average shares outstanding for the diluted earnings per share computations were adjusted to reflect the assumed conversion of shares available under stock options. The following table details the computation of basic and diluted earnings per share for each year ended December 31.
Note 11. Employee Benefit Plan
The Company has a defined contribution plan (the Plan) qualifying under IRS Code Section 401(k). Eligible participants in the Plan can contribute up to the maximum percentage allowable not to exceed the dollar limit under IRC Section 401(k). Employee contributions are matched by the Company based on 100 percent of the first three percent of an employee's contribution and 50 percent of employee contributions which exceed three percent but do not exceed six percent. For the years ended December 31, 2009 and 2008, the Company contributed $238 and $226, to the Plan, respectively.
During 2002, the Company adopted a deferred compensation plan to provide future compensation to certain members of management. Under plan provisions, payments projected to range from $27 to $245 are payable for 15 years certain, generally beginning at age 65. The liability accrued for compensation deferred under the plan was $1,444 at December 31, 2009 and $1,309 at December 31, 2008. Deferred compensation expense, an actuarially determined amount, was $184 during 2009 and $286 during 2008. Assumed discount rate, rate of compensation increase, and expected after-tax long-term rate of return on plan assets were 7.25%, 5%, and 5%, respectively at December 31, 2009 and December 31, 2008.
The Company has purchased and is the beneficiary of life insurance policies that are indirectly related to funding of our employee benefit plans. The cash value totaled approximately $12,930 and $12,390 at December 31, 2009 and 2008, respectively.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 12. Shareholders’ Equity
On October 14, 2008, Treasury Secretary Paulson, after consulting with the Federal Reserve and the FDIC, announced that the Department of the Treasury would purchase equity stakes in certain banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), the Treasury would make $250 billion of capital available to U.S. financial institutions in the form of preferred stock (from the $700 billion authorized by the EESA). In conjunction with the purchase of preferred stock, the Treasury would receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program. Secretary Paulson also announced that nine large financial institutions agreed to participate in the TARP Capital Purchase Program.
On December 12, 2008, as part of the Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement-Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 16,019 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 344,742 shares of the Company’s common stock, no par value per share (the “Common Stock”), at an initial exercise price of $6.97 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $16,019 in cash. A value of $839 was assigned to the common stock warrants based on their relative fair value; accordingly, $15.2 million was originally recorded to Series A Preferred Stock. The discount will be accreted up to the $16,019 over five years.
The Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. The Company may not redeem the Preferred Stock during the first three years except with the proceeds from a “Qualified Equity Offering” (as defined in the Purchase Agreement). After three years, the Company may, at its option, redeem the Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Preferred Stock is generally non-voting. Prior to December 12, 2011, unless the Company has redeemed the Preferred Stock or the Treasury has transferred the Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement.
The Warrant is immediately exercisable. The Warrant provides for the adjustment of the exercise price and the number of shares of Common Stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of Common Stock, and upon certain issuances of Common Stock at or below a specified price relative to the then-current market price of Common Stock. The Warrant expires ten years from the issuance date. If, on or prior to December 31, 2010, the Company receives aggregate gross cash proceeds of not less than the purchase price of the Preferred Stock from one or more “Qualified Equity Offerings” announced after October 13, 2008, the number of shares of common stock issuable pursuant to the Treasury’s exercise of the Warrant will be reduced by one-half of the original number of shares, taking into account all adjustments, underlying the Warrant. Pursuant to the Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.
Upon the request of the Treasury at any time, the Company has agreed to promptly enter into a deposit arrangement pursuant to which the Preferred Stock may be deposited and depositary shares (“Depositary Shares”), representing fractional shares of Preferred Stock, may be issued. The Company registered the Preferred Stock, the Warrant, the shares of Common Stock underlying the Warrant on January 12, 2009.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 13. Share Based Compensation
We account for share based compensation in accordance with generally accepted accounting standards for equity and stock compensation. Under the fair value recognition provisions of this statement, share based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes.
We currently use the Black-Scholes option pricing model to determine the fair value of stock options and restricted stock grants. The determination of the fair value of share based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.
The Company has two share based compensation plans, which are described below. The compensation cost that has been charged against income for those plans was approximately $145 for the year ended December 31, 2009, and $104 for the year ended December 31, 2008. The total recognized tax benefit related to the compensation expense was $0 for the year ended December 31, 2009 and $1 for the year ended December 31, 2008.
Stock Option Plans
The Company has a 2005 Key Employee Equity Award Plan (the 2005 Plan). The 2005 Plan gives the Company flexibility in tailoring equity-based compensation awards for employees from time to time to the continuing objective of aligning employee incentives with the interests of shareholders as the Company grows and develops. In addition to incentive and nonqualified stock options, the 2005 Plan permits the grant of restricted stock, stock appreciation rights and stock units to persons designated as “Key Employees”. The 2005 Plan will remain in effect for ten years, subject to the right of the Board of Directors to terminate the 2005 Plan earlier, except with respect to awards made prior to and outstanding on that date which remain valid in accordance with their terms. The maximum aggregate number of shares of the Company’s common stock (no par value) that may be issued pursuant to awards made under the Plan may not exceed 250,000. Accordingly, 250,000 shares of authorized but unissued common stock are reserved for use in the 2005 Plan. Within the maximum limits, the Plan specifies that stock appreciation rights may not be granted with respect to more than 500 shares per recipient (2,000 shares for a new employee recipient) per year; and restricted shares and stock units, respectively, may not be granted for more than 5,000 shares per year per recipient. Under the 2005 Plan, there are 176,250 incentive stock shares and 30,000 restricted stock shares granted to officers and key employees currently outstanding. There are 43,750 shares available for grant as of December 31, 2009.
Additionally, the Company has a 1995 Incentive Stock Plan (the 1995 Plan) pursuant to which the Human Resources Committee of the Company’s Board of Directors may grant stock options to officers and key employees. The 1995 Plan authorizes grants of options to purchase up to 311,850 shares (adjusted for stock splits) of the Company’s authorized but unissued common stock. Under the 1995 Plan, there are options for 61,600 shares granted to officers and key employees currently outstanding and 65,773 shares available for grant as of December 31, 2009.
All stock options (for both plans) have been granted with an exercise price equal to the stock’s fair market value at the date of the grant. Stock options under the Plan generally have 10-year terms, vest at the rate of 20 percent per year, and become fully exercisable five years from the date of the grant. The share-based awards granted under the aforementioned Plans have similar characteristics, except that some awards have been granted in options and certain awards have been granted in restricted stock. Therefore, the following disclosures have been disaggregated for the stock option and restricted stock awards of the Plans due to their dissimilar characteristics.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 13. Share Based Compensation, continued
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the volatilities of our trading history. The expected life is based on the average life of the options of 10 years and the weighted average vesting period of 5 years, and forfeitures are estimated based on the Company’s history. The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees for the years ended December 31, 2009 and 2008.
Total stock-based compensation recognized as compensation expense on our consolidated statement of income is as follows:
As of December 31, 2009, there was $348 of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based payments granted to employees. A maturity schedule of the unrecognized compensation cost (dollars in thousands) as of December 31, 2009 is as follows:
Total unrecognized compensation cost will be adjusted for future grants and future changes in estimated forfeitures.
General Stock Option Information
A summary of option activity under the stock option plans during the years ended December 31, 2009 and 2008 is presented below:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 13. Share Based Compensation, continued
Cash received from option exercises under all share-based payment arrangements for the twelve-month periods ended December 31, 2009 and 2008 was $7 and $285, respectively.
Information regarding shares vested during the years ended December 31, 2009 and 2008 are as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 13. Share Based Compensation, continued
Information regarding the stock options outstanding at December 31, 2009 is summarized below:
The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2009 was $12 and $0, respectively. The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2008 was $18 and $18, respectively.
A summary of the status of the Company’s non-vested options as of December 31, 2009 and 2008 and changes during the years then ended is presented below:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 13. Share Based Compensation, continued
A summary of the status of the Company’s non-vested restricted stock as of December 31, 2009 and 2008 and changes during the years then ended is presented below:
The fair value of each non-vested restricted stock grant is equal to the stock price on the date of grant and assumes the performance goals will be achieved.
Note 14. Income Taxes
Purchased Tax Credits
The Company periodically invests in tax credits. During the years ended December 31, 2009 and 2008, no tax credit investments were made.
Current and Deferred Income Tax Components
Total income tax expense (benefit) for the years ended December 31, 2009 and 2008 consists of the following:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 14. Income Taxes, continued
Rate Reconciliation
Total income tax expense (benefit) differed from the "expected" amount computed by applying the U.S. Federal income tax rate of 34 percent to income before income taxes as a result of the following:
Deferred Income Tax Analysis
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2009 and 2008 are as follows:
No valuation allowance has been used because we believe that it is more likely than not that we will recognize the full benefit of the deferred tax asset shown above.
The Company had analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions in accordance with generally accepted accounting standards for income tax purposes.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 15. Concentrations of Credit Risk
Concentrations of Credit Risk
The Bank grants commercial, residential and consumer loans to customers primarily in the Roanoke Valley area. The Bank has a diversified loan portfolio which is not dependent upon any particular economic or industry sector. As a whole, the portfolio could be affected by general economic conditions in the Roanoke Valley region.
A detailed composition of the Bank's loan portfolio is provided in the consolidated financial statements. The Bank's commercial loan portfolio is diversified, with no significant concentrations of credit. Commercial real estate loans are generally collateralized by the related property. The residential real estate loan portfolio consists principally of loans collateralized by 1-4 family residential property. The loans to individuals’ portfolio consist of consumer loans primarily for home improvements, automobiles, personal property and other consumer purposes. These loans are generally collateralized by the related property. Overall, the Bank's loan portfolio is not concentrated within a single industry or group of industries, the loss of any one or more of which would generate a materially adverse impact on the business of the Bank.
The Bank has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property. Credit approval is principally a function of collateral and the evaluation of the creditworthiness of the borrower based on available financial information.
Note 16. Commitments and Contingencies
The federal income tax returns of the Company for 2008 remain subject to examination by the IRS, generally for three years after they are filed. The Company will file its 2009 tax return by the legal filing deadline.
Litigation
In the normal course of business the Bank may be involved in various legal proceedings. After consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the financial statements.
Financial Instruments with Off-Balance-Sheet Risk
The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract. The Bank's maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The Bank requires collateral to support financial instruments when it is deemed necessary. The Bank evaluates customers' creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the customer. Collateral may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, real estate, accounts receivable, inventory, and property, plant and equipment. Financial instruments whose contract amounts represent credit risk as of December 31 are as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 16. Commitments and Contingencies, continued
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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments may be at fixed or variable rates and generally expire within one year. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. Unless renewed, substantially all of the Bank's standby credit commitments at December 31, 2009 will expire within one year. Management does not anticipate any material losses as a result of these transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Derivative Financial Instruments
For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flow of the items being hedged. At December 31, 2009 and 2008 the Company did not have any derivative agreements related to interest rate hedging in place.
Employment Agreements
The Company has entered into employment agreements with the Chief Executive Officer and the Chief Financial Officer (“Executives”). The employment agreements provide for a certain minimum salary level that may be increased, but not decreased, by the Board pursuant to an annual evaluation and also contain change-in-control provisions entitling the Executives to certain benefits in the event employment is terminated within three years of a change in control of the Company for reasons other than death, retirement, disability, cause, voluntary resignation other than for good reason, or pursuant to notice of termination given prior to the change in control.
Note 17. Regulatory Restrictions
Dividends
The Company's principal source of funds for dividend payments is dividends received from the Bank. The amount of dividends that may be paid by the Bank to the Company will depend on the Bank’s earnings and capital position and is limited by state law, regulations and policies. A state bank may not pay dividends from its capital; all dividends must be paid out of net undivided profits then on hand. Before any dividend is declared, any deficit in capital funds originally paid in shall have been restored by earnings to their initial level, and no dividend shall be declared or paid by any bank which would impair the paid-in-capital of the bank. As of December 31, 2009 and 2008, the amount available for payment of dividends was $20,142 and $24,211 respectively.
The Company anticipates entering into a written agreement with the Federal Reserve which will include the requirement for prior approval before any distributions can be made on its Preferred Stock, any interest payments can be made on its Trust Preferred Securities, and any common dividends can be declared.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 17. Regulatory Restrictions, continued
Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (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, 2009 and 2008 that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2009 and 2008, the Company and the Bank were categorized as “well capitalized” as defined by applicable regulations. To be categorized as “well capitalized”, the Company and Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that date that management believes have changed the Company's or the Bank's category.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 17. Regulatory Restrictions, continued
Capital Requirements, continued
The Company's and the Bank's actual capital amounts and ratios are also presented in the table below.
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 17. Regulatory Restrictions, continued
Inter-company transactions
Legal lending limits on loans by the Bank to the Company are governed by Federal Reserve Act 23A, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its capital and surplus to its parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least 20% more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers' acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was $11.0 million and $8.8 million at December 31, 2009 and December 31, 2008, respectively. There was one loan from the Bank to the Company totaling $3.4 million at December 31, 2009 and no loans from the bank to the Company at December 31, 2008.
Note 18. Related Party Transactions
The Company has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.
Aggregate 2009 and 2008 loan transactions with directors and executive officers were as follows:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 19. Parent Company Financial Information
Condensed financial information of Valley Financial Corporation is presented below:
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 19. Parent Company Financial Information, continued
Valley Financial Corporation
Notes to Consolidated Financial Statements
For the Years Ended December 31, 2009 and 2008
(In thousands, except share data)
Note 19. Parent Company Financial Information, continued
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
On an on-going basis, senior management monitors and reviews the internal controls established for the various operating activities of the Bank. Additionally, the Company has created a Disclosure Review Committee to review not only internal controls, but the information used by Company’s financial officers to prepare the Company’s periodic SEC filings and corresponding financial statements. The Committee is comprised of the Senior Management Team of the Bank and meets at least quarterly. Internal audits conducted by the Company’s internal audit department are also reviewed by senior officers to assist them in assessing the adequacy of the Company’s internal control structure. These audits are also discussed in detail with the Company’s Audit Committee.
We have carried out an evaluation, under the supervision and the participation of our management, including our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”), as of the end of the fiscal year covered by this report. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Disclosure controls and procedures are our controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goal under every potential condition, regardless of how remote. In addition, the operation of any system of controls and procedures is dependent upon the employees responsible for executing it. While we have evaluated the operation of our disclosure controls and procedures and found them effective, there can be no assurance that they will succeed in every instance to achieve their objective.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that our disclosure controls and procedures will detect or uncover every situation involving the failure of persons within Valley Financial Corporation to disclose material information otherwise required to be set forth in our periodic reports.
Management's Annual Report on Internal Control Over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Rule 13a-15(f) and Rule 15d - 15(f) under the Exchange Act). Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our
management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of the inherent limitations in any internal control, no matter how well designed, misstatements may occur and not be prevented or detected. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, the evaluation of the effectiveness of internal control over financial reporting was made as of a specific date, and continued effectiveness in future periods is subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may decline.
Management conducted an evaluation of the effectiveness of our system of internal control over financial reporting as of December 31, 2009 based on the framework set forth in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management concluded that, as of December 31, 2009, Valley Financial Corporation’s internal control over financial reporting was effective.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting.
There were not any changes in the Company’s internal controls over financial reporting during the fourth fiscal quarter of the fiscal year covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III.
Item 10.
Item 10. Directors and Executive Officers.
The information required by Items 401, 405, and 406 of Regulation S-K is set forth under the captions “Information Concerning Directors and Nominees”, “Certain Relationships and Related Transactions”, “Audit Committee Information”, “Nominating Committee”, “Audit Committee Financial Expert”, “Section 16(a) Beneficial Ownership Reporting Compliance”, and “Code of Ethics” of the Company’s 2010 Proxy Statement and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
The information required by Item 402 of Regulation S-K is set forth under the caption “Executive Compensation” of the Company’s 2010 Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Items 201(d) and 403 of Regulation S-K is set forth under the caption “Security Ownership of Certain Beneficial Owners” of the Company’s 2010 Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 404 of Regulation S-K is set forth under the caption “Certain Relationships and Related Transactions” of the Company’s 2010 Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information required by item 9(e) of Schedule 14A is set forth under the caption “Audit Committee Information” of the Company’s 2010 Proxy Statement and is incorporated herein by reference.
PART IV.
Item 15.
Item 15. Exhibits and Financial Statement Schedules
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on March 26, 2010.
Valley Financial Corporation
/s/ Ellis L. Gutshall
By: Ellis L. Gutshall
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the following persons in the capacities indicated as of March 26, 2010.
Signature
Title
/s/ Ellis L. Gutshall
(Ellis L. Gutshall)
President, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Kimberly B. Snyder
(Kimberly B. Snyder)
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Abney S. Boxley, III *
(Abney S. Boxley, III)
Director
/s/ William D. Elliot *
(William D. Elliot)
Director
/s/ James S. Frantz, Jr.
(James S. Frantz, Jr.)
Director
/s/ Mason Haynesworth *
(Mason Haynesworth)
Director
/s/ Eddie F. Hearp *
(Eddie F. Hearp)
Director
/s/ Anna L. Lawson *
(Anna L. Lawson)
Director
/s/ Barbara B. Lemon *
(Barbara B. Lemon)
Director
/s/ A. Wayne Lewis *
(A. Wayne Lewis)
Director
/s/ Samuel L. Lionberger, Jr. *
(Samuel L. Lionberger, Jr.)
Director
/s/ George W. Logan *
(George W. Logan)
Chairman, Director
/s/ Geoffrey M. Ottaway *
(Geoffrey M. Ottaway)
Director
/s/ John W. Starr *
(John W. Starr)
Director
/s/ Ward W. Stevens *
(Ward W. Stevens)
Director
/s/ Michael E. Warner *
(Michael E. Warner)
Director
/s/ *Edward B. Walker*
(Edward B. Walker)
Director
* By: /s/ Kimberly B. Snyder
(Kimberly B. Snyder)
(Attorney in Fact)
INDEX TO EXHIBITS
3.1
Articles of Incorporation (filed herewith).
3.2
Articles of Amendment with respect to the Preferred Stock (incorporated herein by reference to Exhibit No. 3.1 of Form 8-K filed December 15, 2008, File No. 33-77568).
3.3
Bylaws as amended August 30, 2007 (filed herewith).
4.1
Form of Certificate for the Preferred Stock (incorporated herein by reference to Exhibit No. 4.1 of Form 8-K filed December 15, 2008, File No. 33-77568).
4.2
Warrant for Purchase of Shares of Preferred Stock (incorporated herein by reference to Exhibit No. 4.2 of Form 8-K filed December 15, 2008, File No. 33-77568).
10.1
Letter Agreement, dated December 12, 2008, by and between Valley Financial Corporation and the United States Department of the Treasury (incorporated herein by reference to Exhibit No. 10.1 of Form 8-K filed December 15, 2008, File No. 33-77568).
*10.2
Form of Waiver agreement by and between the Senior Executive Officers and Valley Financial Corporation (incorporated herein by reference to Exhibit No. 10.2 of Form 8-K filed December 15, 2008, File No. 33-77568).
*10.3
Form of Letter Agreement by and between the Senior Executive Officers and Valley Financial Corporation (incorporated herein by reference to Exhibit No. 10.3 of Form 8-K filed December 15, 2008, File No. 33-77568).
*10.4
Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14, 2003, File No. 33-77568).
*10.5
Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.20 of Form 10-KSB filed March 30, 2004, File No. 33-77568).
*10.6
Amended Employment Agreement between the Company and Mr. Ellis L. Gutshall, President and Chief Executive Officer (incorporated herein by reference to Exhibit 10.1 of Form 10-Q, filed November 13, 2008, File No. 33-77568).
*10.7
Employment Agreement between the Company and Ms. Kimberly B. Snyder, Executive Vice President and Chief Financial Officer (incorporated herein by reference to Exhibit 10.2 of Form 10-Q, filed November 13, 2008, File No. 33-77568).
*10.8
Split-Dollar Insurance Agreement between the Company and Ms. Kimberly B. Snyder, Executive Vice President and Chief Financial Officer (incorporated herein by reference to Exhibit 10.3 of Form 10-Q, filed November 13, 2008, File No. 33-77568).
*10.9
Form of Amended Supplemental Executive Retirement Plan between the Company and Mr. Ellis L. Gutshall, President and Chief Executive Officer; Ms. Kimberly B. Snyder, Executive Vice President and Chief Financial Officer; and Mr. John T. McCaleb, Executive Vice President and Chief Lending Officer (incorporated herein by reference to Exhibit 10.5 of Form 10-Q, filed November 13, 2008, File No. 33-77568).
*10.10
Form of Stock Option Agreement (incorporated herein by reference to Exhibit 10.20 of Form 10-K, filed March 27, 2009, File No. 33-77568).
*10.11
Form of Restricted Stock Agreement (incorporated herein by reference to Exhibit 10.21 of Form 10-K, filed March 27, 2009, File No. 33-77568).
*10.12
Amendment to Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis L. Gutshall, amended January 31, 2008 (incorporated herein by reference to Exhibit 10.1 of Form 10-Q, filed May 12, 2008, File No. 33-77568).
*10.13
Amendment to Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis, amended January 31, 2008 (incorporated herein by reference to Exhibit 10.2 of Form 10-Q, filed May 12, 2008, File No. 33-77568).
*10.14
Amendment to Employment Agreement effective December 12, 2008, by and between the Company and Ellis L. Gutshall, President and Chief Executive Officer (incorporated herein by reference to Exhibit 10.1 of Form 8-K, filed March 19, 2009, File No. 33-77568).
*10.15
Amendment to Employment Agreement effective December 12, 2008, by and between the Company and Kimberly B. Snyder, Executive Vice President and Chief Financial Officer (incorporated herein by reference to Exhibit 10.2 of Form 8-K, filed March 19, 2009, File No. 33-77568).
Subsidiaries of the Registrant (filed herewith).
Consent of Elliot Davis, LLC (filed herewith).
Power of Attorney (filed herewith).
31.1
Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2
Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1
Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
99.1
TARP Chief Executive Officer Certification (filed herewith).
99.2
TARP Chief Executive Officer Certification (filed herewith).