ITEM 1.
BUSINESS
General
The Company and the Bank. Central Virginia Bankshares, Inc. (the “Company”) was incorporated as a Virginia corporation on March 7, 1986, solely to acquire all of the issued and outstanding shares of Central Virginia Bank (the “Bank”). The Bank was incorporated on June 1, 1972 under the laws of the Commonwealth of Virginia and, since opening for business on September 17, 1973, its main and administrative office had been located on U.S. Route 60 at Flat Rock, in Powhatan County, Virginia. In May 1996, the administrative offices were relocated to the Corporate Center in the Powhatan Commercial Center on New Dorset Road located off Route 60 less than one mile from the main office. In June 2005, the original main office was closed and relocated nine-tenths of a mile east, to the then just completed new main office building.
We maintain an internet website at www.centralvabank.com, which contains information relating to us and our business. We make available free of charge through our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these documents as soon as reasonably practicable after we electronically file such material with, or furnishes it to, the Securities and Exchange Commission. Copies of our Audit Committee Charter, Nominating Committee Charter, Compensation Committee Charter and Code of Conduct are included on our website and are therefore available to the public.
Principal Market Area. Our primary service areas are Powhatan and Cumberland Counties, western Chesterfield and western Henrico Counties. The table below reflects the 2010 population of our market and growth rates from the 2000 census to the 2010 census from the U.S. Census Bureau. Similar growth rates are expected for the foreseeable future.
The table below reflects the total deposits for the locality as of June 30, 2011 and our deposits per locality at June 30, 2011.
The table below reflects our various operating properties:
Property
Property Location
Operating Purpose
Powhatan Office
Flat Rock, Powhatan County
Main Office and Branch
Village Marketplace
Village of Midlothian, Chesterfield County
Branch
Market Square Shopping Center
Brandermill, Chesterfield County
Branch
Bellgrade Shopping Center
Chesterfield County
Branch
Cumberland County Courthouse
Cumberland County
Branch
Cartersville
Cumberland County
Branch
Wellesley
Short Pump, Henrico County
Branch
Our present intention is to continue our activities in our current market area which we consider to be an attractive and desirable area in which to operate.
Banking Services. Our principal business is to attract deposits and to loan or invest those deposits on profitable risk adjusted terms. We engage in a general community and commercial banking business, targeting the banking needs of individuals and small to medium sized businesses in our primary service area. We offer most traditional loan and deposit banking services as well as newer services such as Internet banking, telephone banking, debit cards, and other ancillary services such as the sales of non-deposit investment products through a partnership with Infinex, Inc. a registered broker-dealer a member of FINRA and SIPC. We make term loans, both alone and in conjunction with other banks or governmental agencies. We also offer other related services, such as ATMs, travelers’ checks, safe deposit boxes, deposit transfer, notary public, escrow, drive-in facilities and other customary banking services. Our lending policies, deposit products and related services are intended to meet the needs of individuals and businesses in our market area.
Our plan of operation for future periods is to continue to operate as a community bank and to focus our lending and deposit activities in our primary service area. As our primary service area continues to shift from rural to suburban in nature, we will compete aggressively for customers through our traditional personal service and hours of operation. Consistent with our focus on providing community based financial services, we do not plan to diversify our loan portfolio geographically by making significant loans outside of our primary service area. While we and our borrowers are directly affected by the economic conditions and the prevailing real estate market in the area, we are better able to monitor the financial condition of our borrowers by concentrating our lending activities in our primary service area. We will continue to evaluate the feasibility of entering into other markets as opportunities to do so become available.
Regulatory Agreement. Over the past four years, our capital position has been negatively impacted by deteriorating economic conditions that in turn has caused losses in our investment and loan portfolios. As a result of a 2009 examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, we entered into a written agreement with the Bureau of Financial Institutions and the Federal Reserve on June 30, 2010. The written agreement is available on the Federal Reserve’s website at http://www.federalreserve.gov/newsevents/press/enforcement/20100706a.htm. The written agreement requires us to significantly exceed the capital level required to be classified as “well capitalized.” It also provides that we shall:
·
submit written plans to the Bureau of Financial Institutions and the Federal Reserve to strengthen corporate governance and board and management structure;
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strengthen board oversight of the management and operations of Central Virginia Bank;
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strengthen credit risk management and administration;
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establish ongoing independent review and grading of our loan portfolio;
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enhance internal audit processes;
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improve asset quality;
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review and revise our methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;
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maintain sufficient capital;
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establish a revised contingency funding plan;
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establish a revised investment policy; and
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improve our earnings and overall condition.
The written agreement also restricts the payment of dividends and any payments on trust preferred securities or subordinated debt, and any reduction in capital or the purchase or redemption of stock without the prior approval of the Bureau of Financial Institutions and the Federal Reserve. We have complied with the requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as “well capitalized”, improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality. We continue to address the requirements of the written agreement, and with the exception of completing a capital raise, we are substantially in compliance with a majority of the requirements.
Lending Activities
Loan Portfolio. We actively extend consumer loans to individuals and commercial loans to small and medium sized businesses within our primary service area. During 2010, we were an active residential mortgage lender; however, as of January 1, 2011 we ceased the origination of residential mortgage loans. In addition, based on the requirements of the written agreement with the Bureau of Financial Institutions and the Federal Reserve, we are not actively seeking acquisition, development, or construction loans; however, we may consider such a loan on a limited basis. Our commercial lending activity extends across our primary service area of Powhatan, Cumberland, Goochland, western Chesterfield and western Henrico Counties. Consistent with our focus on providing community-based financial services, we do not attempt to diversify our loan portfolio geographically by making significant amounts of loans to borrowers outside of our primary service area; however, a number of loans had previously been made to existing customers for vacation properties located outside of the primary service area. The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of borrowers, followed closely by the local economic environment. In an effort to manage this risk, our policy gives loan approval limits of no more than $300,000 to the CEO, no more than $150,000 to the Senior Loan and Credit Officer, and no more than $50,000 to select retail officers. Loans where the total borrower exposure to us is less than $3,000,000 may be approved by our Senior Loan Committee. Our Board of Directors must approve loans where the total borrower exposure is in excess of $3,000,000. The risk associated with real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of our primary market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction, the mortgage loan interest rate environment, and the number of speculative properties under construction. We manage that risk by focusing on pre-sold or contract homes, and significantly limiting the number of “speculative” construction loans in our portfolio.
Consumer Lending. We currently offer most types of consumer demand, time and installment loans for a variety of purposes, including automobile loans, home equity lines of credit, and credit cards. At December 31, 2011, consumer loans were $28.7 million or 13% of our total loan portfolio.
Commercial Business Lending. As a full-service community bank, we make commercial loans to qualified businesses in our market area. Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields. To manage these risks, we obtain appropriate collateral and monitor the financial condition of our business borrowers and the concentration of such loans in our portfolio. Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of its business and are generally secured by business assets, such as accounts receivable, equipment, inventory, and/or real estate. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself; in addition, the collateral for secured commercial business loans may depreciate over time. At December 31, 2011, commercial business loans were $23.6 million or 11% of our total loan portfolio.
Commercial Mortgage Loans. We offer commercial mortgage loans secured by liens on properties such as commercial office condos or commercial warehouses. The characteristics of commercial real estate loans vary based on the type of property, purpose of the loan, and other factors. Generally, the loans involve larger loan amounts and greater risk to the lender than single-family residential loans since repayment is from the cash flow of the business or sale of the real estate property. Our commercial mortgage loans are made in amounts generally up to 80.0% of the appraised value of the property pledged as security for the loan. Additional underwriting includes primary and secondary sources of repayment to include cash flow of business operations generating a debt service coverage ratio of generally 1.25x. These loans are generally either three-year, or five-year adjustable rate mortgages (“ARMs”) with up to a 20 year amortization and are either owner occupied or non-owner occupied. We generally require an appraisal by a licensed outside appraiser for all loans secured by real estate. We require that the borrower obtain title, fire and casualty insurance coverage in an amount equal to the loan amount and in a form acceptable to us. At December 31, 2011, real estate commercial mortgage loans were $62.5 million or 28% of our total loan portfolio. 72% of the commercial mortgage loans were owner-occupied.
Our ARMs are subject to changes in the interest rate based on a spread over the movement of an external index contractually agreed to by us and the borrower at the time the loan is originated. Despite the benefits of ARMs to an institution’s asset/liability management, they may pose additional risks, primarily because as interest rates rise and loans reprice, the underlying payments by the borrower may rise, increasing the potential for default.
We generally charge origination fees on our commercial mortgage loans. These fees vary among loan products and with market conditions. Generally such fees were from 0.25% to 1.0% of the loan principal amount. In addition, we charged fees to our borrowers to cover the cost of appraisals, credit reports and certain expenses related to the documentation and closing of loans.
Real Estate Construction Lending. In general, we do not actively solicit construction loans on income-producing properties such as apartments, shopping centers, hotels and office buildings. However, any such requests from our customers concerning properties in our established trade area may be considered.
The large majority of our construction loans are to experienced builders. Such loans normally carry an interest rate of 1% to 2% over the prime bank lending rate, adjusted daily with a floor (minimum) rate established at loan inception. Construction lending entails significant risk as compared with residential mortgage lending. Construction loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the security of the home under construction. To minimize risks associated with construction lending, we, as a general rule, limit loan amounts to 80.0% of appraised value on homes, and perform or cause to be performed, periodic inspections of the construction to ensure there are sufficient undisbursed loan proceeds in order to complete the building, in addition to its usual credit analysis of its borrowers. We always obtain a first lien on the property as security for our construction loans. At December 31, 2011, real estate construction loans were $42.8 million or 19% of our total loan portfolio.
Residential Mortgage Loans. During 2010, we were an active residential mortgage lender; however, as of January 1, 2011, we ceased the origination of residential mortgage loans. During a portion of 2011, we were party to an agreement with a third party mortgage originator to rent space within the branches. We referred customers to the third party for any residential mortgage origination needs. We had no commitment or obligation to the third party to refer customers and did not receive any origination fees. In addition, we had no obligation to the customers for any residential mortgage loan originated with the third party. Our arrangement with the third party originator ceased on December 31, 2011 and we are in the process of entering into a similar arrangement with a different third party mortgage originator. Management continues to actively monitor loan activity to determine the future strategic decision. At December 31, 2011, residential mortgage loans were $66.6 million or 30% of our total loan portfolio.
Historically, residential mortgage loans were made in amounts up to 80.0% of the appraised value of the property pledged as security for the loan. Most residential mortgage loans were underwritten using specific qualification guidelines that were intended to assure that such loans may be eligible for sale into the secondary mortgage market at a later point in time. We generally required an appraisal by a licensed outside appraiser for all loans secured by real estate. We required that the borrower obtain title, fire and casualty insurance coverage in an amount equal to the loan amount and in a form acceptable to us. We originated residential mortgage loans that were sold in the secondary market, or were carried in our loan portfolio. These loans were generally either three-year, or five-year adjustable rate mortgages (“ARMs”) or fifteen to thirty year fixed rate mortgages. As a general rule, the majority of all permanent owner occupied residential mortgages made for our own portfolio were made as three-year and five-year ARMs where the interest rate resets were based on an index every three or five years as the case may be. We did not offer ARM loans with “teaser” interest rates. The remainder of loans were traditional fifteen and thirty year amortized mortgages.
Our ARMs generally are subject to interest rate adjustment limitations of 2.0% per each three or five year period and 6.0% over the life of the loan. All changes in the interest rate are based on the movement of an external index contractually agreed to by us and the borrower at the time the loan was originated.
Despite the benefits of ARMs to an institution’s asset/liability management, they may pose additional risks, primarily because as interest rates rise, the underlying payments by the borrower may rise, increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.
We charged origination fees on our residential mortgage loans. These fees varied among loan products and with market conditions. Generally such fees were from 0.25% to 2.0% of the loan principal amount. In addition, we charged fees to our borrowers to cover the cost of appraisals, credit reports and certain expenses related to the documentation and closing of loans.
Competition
Based on FDIC deposit statistics as of June 30, 2011, we have a dominant position in both Powhatan and Cumberland Counties with greater than 46% and 75% of the deposits, respectively, in each locality. However, in both Chesterfield and Henrico Counties, we encounter stronger competition for our banking services from large banks and other community banks located in the Richmond metropolitan area. In addition, financial companies, mortgage companies, credit unions and savings and loan associations also compete with us for loans and deposits. We must also compete for deposits with money market mutual funds that are marketed nationally. Many of our competitors have substantially greater resources than us. The internet is also providing an increasing amount of price-oriented competition, which we anticipate to become more intense. Our success in the past and our plans for success in the future is dependent upon providing superior customer service and convenience.
Employees
We had 73 full-time and 16 part-time employees at December 31, 2011. Employee relations have been and continue to be good. We sponsor a qualified discretionary Profit Sharing/Retirement Plan combined with a qualified 401(k) Plan, for our employees. We did not make a profit-sharing contribution in 2010 or 2011, and effective November 1, 2010 we suspended employer contributions to the 401K plan. In addition, we subsidize a short-term disability plan, group term life insurance, and group medical, dental, and vision insurance.
Regulation and Supervision
General. As a bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. The BHCA also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity, which is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities.
As a state-chartered commercial bank, we are subject to regulation, supervision and examination by the Virginia State Corporation Commission’s Bureau of Financial Institutions. We are also subject to regulation, supervision and examination by the Federal Reserve Board. State and federal law also governs the activities in which we engage the investments that we make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect our operations.
The earnings of our subsidiaries, and therefore our earnings, are affected by general economic conditions, management policies, changes in state and federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant state and federal laws to which we are subject. To the extent that statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.
Payment of Dividends. The Company is a legal entity separate and distinct from our subsidiary Bank. The Company is organized under the Virginia Stock Corporation Act, which has restrictions prohibiting the payment of dividends if after giving effect to the dividend payment, the Company would not be able to pay its debts as they become due in the usual course of business, or if the Company’s total assets would be less than the sum of its total liabilities plus the amount that would be required, if the Company were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
The majority of the Company’s revenue results from dividends paid to the Company by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends that it can pay without permission from its primary regulator, the Federal Reserve. In addition, both the Company and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Banking regulators have indicated that banking organizations should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. During the year ended December 31, 2011, the Bank declared and paid no dividends to the Company.
In connection with our participation in the Capital Purchase Program established by the U.S. Department of the Treasury (the "Treasury") under the Emergency Economic Stabilization Act of 2008 ("EESA"), we issued preferred stock to the Treasury on January 30, 2009. The Preferred Stock is in a superior ownership position compared to common stock. Dividends must be paid to the preferred stockholder before they can be paid to the common stockholders. If the dividends on the Preferred Stock have not been paid for an aggregate of six (6) quarterly dividend periods or more, whether or not consecutive, the Company's authorized number of directors will be automatically increased by two (2) and the holders of the Preferred Stock will have the right to elect those directors at the Company's next annual meeting or at a special meeting called for that purpose; these two directors will be elected annually and will serve until all accrued and unpaid dividends for all past dividend periods have been declared and paid in full.
The Company has entered into a written agreement with the Virginia Bureau of Financial Institutions and 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 Bureau of Financial Institutions and the Federal Reserve. As of December 31, 2011, the Company has not paid dividends on its Preferred Stock for eight quarterly dividend periods, and the Treasury Department has been in contact with the Company. At this time, the Treasury has indicated they are not sending an observer to the Company’s Board meetings; however, they have not indicated as to their intention of electing additional Board members to the Company’s Board of Directors.
Insurance of Accounts and Regulation by the FDIC. Our deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the limits set forth under applicable law. Our deposits are subject to the deposit insurance assessments of the Deposit Insurance Fund (“DIF”) of the FDIC.
The FDIC is authorized to prohibit any DIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances that could result in termination of any Bank’s deposit insurance.
Capital. The Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, the Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles (“Tier 1 capital”). The remainder may consist of specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of loan loss allowance and pre-tax net unrealized holding gains on certain equity securities (“Tier 2 capital,” which, together with Tier 1 capital, composes “total capital”).
In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness.
The risk-based capital standards of the Federal Reserve Board explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy. The Company has entered into a written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve and as a result we are required to significantly exceed the capital level required to be classified as “well capitalized.” As of December 31, 2011, the most recent notification from the Federal Reserve Bank categorized the Bank as adequately capitalized.
On December 17, 2003, Central Virginia Bankshares, Inc. issued a $5 million debenture to its single purpose capital trust subsidiary, which in turn issued $5 million in trust-preferred securities. With the proceeds of this issuance, the Company then made a $5 million capital injection to its principal subsidiary, Central Virginia Bank.
The Company, on January 30, 2009, as part of the Capital Purchase Program, 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) 11,385 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $1.25 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 263,542 shares of the Company’s common stock, par value $1.25 per share (the “Common Stock”), at an initial exercise price of $6.48 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $11,385,000 in cash.
American Recovery and Reinvestment Act of 2009 (“ARRA”). The ARRA was enacted on February 17, 2009. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposed certain executive compensation and corporate governance obligations on all current and future Capital Purchase Program recipients, including the Company, until the institution has redeemed the preferred stock, which Capital Purchase Program recipients are permitted to do subject to approval of its primary federal regulator.
The ARRA amends Section 111 of the EESA to require the Secretary of the Treasury (the “Secretary”) to adopt standards with respect to executive compensation and corporate governance for Capital Purchase Program recipients. The standards required include, in part, (1) prohibitions on making golden parachute payments to senior executive officers and the next five most highly-compensated employees during such time as any obligation arising from financial assistance provided under the Capital Purchase Program remains outstanding (the “Restricted Period”), (2) prohibitions on paying or accruing bonuses or other incentive awards for certain senior executive officers and employees, except for awards of long-term restricted stock with a value equal to no greater than 1/3 of the subject employee’s annual compensation that do not fully vest during the Restricted Period or unless such compensation is pursuant to a valid written employment contract prior to February 11, 2009, (3) requirements that Capital Purchase Program participants provide for the recovery of any bonus or incentive compensation paid to senior executive officers and the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria later found to be materially inaccurate, and (4) a review by the Secretary of all bonuses and other compensation paid by Capital Purchase Program participants to senior executive employees and the next 20 most highly-compensated employees before the date of enactment of the ARRA to determine whether such payments were inconsistent with the purposes of the Act with the Secretary having authority to negotiate for reimbursement.
The ARRA also sets forth additional corporate governance obligations for Capital Purchase Program recipients, including standards that provide for semi-annual meetings of compensation committees of the board of directors to discuss and evaluate employee compensation plans in light of an assessment of any risk posed from such compensation plans. Capital Purchase Program recipients are further required by the ARRA to have in place company-wide policies regarding excessive or luxury expenditures, permit non-binding shareholder “say-on-pay” proposals to be included in proxy materials, as well as require written certifications by the chief executive officer and chief financial officer with respect to compliance.
Other Safety and Soundness Regulations. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. For example, under the requirements of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds. The FDIC’s claim for reimbursement under the cross guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.
The federal banking agencies also have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. As of December 31, 2011, the Company and the Bank were classified as adequately capitalized.
State banking regulators also have broad enforcement powers over the Bank, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator.
The Bank Secrecy Act. Under the Bank Secrecy Act (“BSA”), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 for known suspects, $25,000 for unknown suspects when the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001, enacted in response to the September 11, 2001 terrorist attacks, requires bank regulators to consider a financial institution’s compliance with the BSA when reviewing applications from a financial institution. As part of its BSA program, the USA PATRIOT Act also requires a financial institution to implement customer identification procedures when opening accounts for new customers and to review lists of individuals and entities that are prohibited from opening accounts at financial institutions.
Interstate Banking and Branching. Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Effective June 1, 1997, a bank headquartered in one state was authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date. After a bank has acquired a branch in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the “Act”) covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.
The Act permits unrestricted affiliations between banks and securities firms. The Act also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, brokerage, investment and merchant banking; and insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act rating.
The Act provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain areas identified in the Act. The Act directs the federal bank regulatory agencies to adopt insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.
The Act adopts a system of functional regulation under which the Federal Reserve Board is confirmed as the umbrella regulator for financial holding companies, but financial holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the Securities and Exchange Commission for securities affiliates and state insurance regulators for insurance affiliates. The Act repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended, but identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker”, and a set of activities in which a bank may engage without being deemed a “dealer”. The Act also makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the investment Advisers Act of 1940, as amended.
The Act contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The Act provides that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The Act also provides that the states may adopt customer privacy protections that are stricter than those contained in the Act. The Act also makes a criminal offense, except in limited circumstances, obtaining or attempting to obtain customer information of a financial nature by fraudulent or deceptive means.
Dodd-Frank Act. In July 2010, the Dodd-Frank Act was signed into law, incorporating numerous financial institution regulatory reforms. Many of these reforms will be implemented over the course of 2011 and beyond through regulations to be adopted by various federal banking and securities regulatory agencies. The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions. Many of its provisions do not directly impact community-based institutions like the Bank. For instance, provisions that regulate derivative transactions and limit derivative trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of the Bank’s operations. Provisions that could impact the Bank include the following:
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FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity.
In addition, it increases the minimum size of the DIF and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
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Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance and provides unlimited federal deposit insurance until December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions.
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Interest on Demand Deposits. The Dodd- Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits, including business transaction and other accounts.
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Interchange Fees. The Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. While banks with less than $10 billion in assets, such as the Bank, are exempted from this measure, it is likely that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers.
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Consumer Financial Protection Bureau. The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
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Mortgage Lending. New requirements are imposed on mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special
consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
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Holding Company Capital Levels. Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks. In addition, all trust preferred securities issued after May 19, 2010 will be counted as Tier 2 capital, but the Company’s currently outstanding trust preferred securities will continue to qualify as Tier 1 capital.
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De Novo Interstate Branching. National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
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Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
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Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
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Corporate Governance. The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted.
Regarding capital requirements. The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements. Under the Collins Amendment to the Dodd-Frank Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis. These minimum requirements can’t be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions. The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets. Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013. Accordingly, our trust preferred securities will continue to qualify as Tier 1 capital.
Regarding FDIC insurance and assessments. The FDIC is required to maintain a designated minimum ratio of the DIF to insured deposits in the United States. The Dodd-Frank Act requires the FDIC to assess insured depository institutions to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. The FDIC has recently adopted new regulations that establish a long-term target DIF ratio of greater than two percent. As a result of the ongoing instability in the economy and the failure of other U.S. depository institutions, the DIF ratio is currently below the required targets and the FDIC has adopted a restoration plan that will result in substantially higher deposit insurance assessments for all depository institutions with assets above $10 billion over the coming years. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole.
Pursuant to the Dodd-Frank Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer. The Dodd-Frank Act also provides for unlimited FDIC insurance coverage for noninterest-bearing demand deposit accounts for a two year period beginning on December 31, 2010 and ending on December 31, 2012.
The Dodd-Frank Act also changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. On February 7, 2011, the FDIC issued a new regulation implementing revisions to the assessment system mandated by the Dodd-Frank Act. The new regulation became effective April 1, 2011 and was reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.
Regarding transactions with insiders. The Dodd-Frank Act also provides that banks may not “purchase an asset from, or sell an asset to” a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the bank, it has been approved in advance by a majority of the bank’s non-interested directors.
Regarding debit card interchange fees. One provision of the Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. In June 2011, the Federal Reserve issued a final rule that states the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction will be the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction, which is well below the average that banks currently charge. This provision regarding debit card interchange fees was effective October 1, 2011. While banks with less than $10 billion in assets (such as the Bank) are exempted from this measure, as a practical matter we expect that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential rejection of their cards by retailers. As a result, our debit card revenue could be adversely impacted.
ITEM 1A.
ITEM 1A.
RISK FACTORS
We are subject to various risks, including the risks described below. Our business, results of operations and financial condition could be materially and adversely affected by any of these risks or additional risks not presently known or that we currently deem immaterial.
General economic conditions in our market area could adversely affect us.
We are affected by the general economic conditions in the local markets in which we operate. Our market has experienced a significant downturn in which we have seen falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies. If economic conditions in our market do not improve, we could experience any of the following consequences, each of which could further adversely affect our business:
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demand for our products and services could decline;
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loan losses may increase; and
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problem assets and foreclosures may increase.
We could experience further adverse consequences in the event of a prolonged economic downturn, which could impact collateral values or cash flows of the borrowing businesses and, as a result, our primary source of repayment could be insufficient to service their debt. 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.
Our concentration in loans secured by real estate could, as a result of adverse market conditions, increase credit losses which could adversely impact earnings.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area, which could result in adverse consequences to us in the event of a prolonged economic downturn in our market. As of December 31, 2011, approximately 88% of our loans had real estate as a primary or secondary component of collateral. A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets. We could experience credit losses that adversely affect our earnings.
Should our allowance for loan losses become inadequate, our results of operations may be adversely affected.
Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. In addition, we maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within our loan portfolio. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. At December 31, 2011, our non-performing loans were $32.0 million, a decrease of $6.9 million from $39.0 million at December 31, 2010. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. During fiscal 2011, our provision for loan losses was $2.4 million and our loan loss allowance to total loans was 4.16% at December 31, 2011.
The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot fully predict such losses or that the loss allowance will be adequate in the future. Additional problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase further, which could adversely affect our results of operations and financial condition.
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
We have entered into a written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, which will require us to dedicate a significant amount of resources to comply with the agreement.
We entered into a written agreement with the Bureau of Financial Institutions and Federal Reserve on June 30, 2010. Among other things, the written agreement requires us to significantly exceed the capital level required to be classified as “well capitalized,” to develop and implement written plans to improve our credit risk management and compliance systems, oversight functions, operating and financial management and capital plans. While subject to the written agreement, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms. We also will hire third party consultants and advisors to assist us in complying with the written agreement, which could increase our non-interest expense and reduce our earnings. Our expense associated with third party consultants in relation to complying with the written agreement was $34 thousand for the year ended December 31, 2011 and $527 thousand for the year ended December 31, 2010.
We have complied with the requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as “well capitalized”, improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality. We continue to address the requirements of the written agreement, and with the exception of completing a capital raise, we are substantially in compliance with a majority of the requirements of the written agreement.
There also is no guarantee that we will successfully address the Bureau of Financial Institution’s and Federal Reserve’s concerns in the written agreement or that we will be able to comply with it. If we do not comply with the written agreement, we could be subject to civil monetary penalties, further regulatory sanctions and/or other regulatory enforcement actions, including, ultimately, a regulatory takeover of the Bank.
An inability to improve our regulatory capital position could adversely affect our operations.
At December 31, 2011, we were classified as “adequately capitalized” for regulatory capital purposes. Until we become “well capitalized” for regulatory capital purposes, we cannot renew or accept brokered deposits without prior regulatory approval and we may not offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it may be more difficult for us to attract new deposits and to retain or increase non-brokered deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we will pay higher insurance premiums to the FDIC, which will reduce our earnings.
We may need to raise additional capital.
Our written agreement with the Virginia Bureau of Financial Institutions and the Federal Reserve will require us to develop a written plan to maintain sufficient capital, and we may have to sell additional securities in order to generate additional capital. We may seek to raise capital through offerings of our common stock, preferred stock, securities convertible into common stock, or rights to acquire such securities or our common stock. Under our articles of incorporation, we have additional authorized shares of common stock and preferred stock that we can issue from time to time at the discretion of our board of directors, without further action by the shareholders, except where shareholder approval is required by law or the Nasdaq Stock Market. The issuance of any additional shares of common stock, preferred stock or convertible securities could be substantially dilutive to shareholders of our common stock, and the market price of our common stock could decline as a result of any such sales. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings.
We may be subject to prompt corrective action by our regulators if capital ratios decline below “adequately capitalized” levels.
Section 38 of the Federal Deposit Insurance Act requires insured depository institutions and federal banking regulators to take certain actions promptly to resolve capital deficiencies at insured depository institutions. If we fail to remain adequately capitalized such actions could include: submissions and implementations of acceptable capital plans, restrictions on the payment of dividends and certain management fees, increased supervisory monitoring, restrictions as to asset growth, and branching and new business lines without regulatory approval.
Difficult market conditions have adversely affected our industry.
Dramatic declines in the housing market, 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.
Our small-to-medium sized business target market may have fewer financial resources to weather a downturn in the economy.
We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.
Changes in market interest rates could affect our cash flows and our ability to successfully manage our interest rate risk.
Our profitability and financial condition depend to a great extent on our ability to manage the net interest margin, which is the difference between the interest income earned on loans and investments and the interest expense paid for deposits and borrowings. The amounts of interest income and interest expense are principally driven by two factors; the market levels of interest rates, and the volumes of earning assets or interest bearing liabilities. The management of the net interest margin is accomplished by our Asset Liability Management Committee. Short term interest rates are highly sensitive to factors beyond our control and are effectively set and managed by the Federal Reserve, while longer term rates are generally determined by the market based on investors’ inflationary expectations. Thus, changes in monetary and or fiscal policy will affect both short term and long term interest rates which in turn will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if we do not effectively manage the relative sensitivity of our earning assets and interest bearing liabilities to changes in market interest rates. We generally attempt to maintain a neutral position in terms of the volume of earning assets and interest bearing liabilities that mature or can re-price within a one year period in order that we may maintain the maximum net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and greatly influence this ability to maintain a neutral position.
Generally, our earnings will be more sensitive to fluctuations in interest rates the greater the difference between the volume of earning assets and interest bearing liabilities that mature or are subject to re-pricing in any period. The extent and duration of this sensitivity will depend on the cumulative difference over time, the velocity and direction of interest rate changes, and whether we are more asset sensitive or liability sensitive. Additionally, the Asset Liability Management Committee may desire to move our position to more asset sensitive or more liability sensitive depending upon their expectation of the direction and velocity of future changes in interest rates in an effort to maximize the net interest margin. Should we not be successful in maintaining the desired position, or should interest rates not move as anticipated, our net interest margin may be negatively impacted.
Significant market declines and/or the absence of normal orderly purchases and sales may adversely affect the “market” valuations of our investment portfolio securities.
The capital and credit markets have been experiencing volatility and disruption for more than 12 months. Recently, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. We could be subject to further significant and material depreciation of our investment portfolio securities if we utilize only previous market sales prices in a disorderly or nonfunctioning market, where the only transactions have been distressed or forced sales. We will rely on alternative valuation methods in accordance with guidance from the FASB and other regulatory agencies such as the Federal Reserve and the Securities and Exchange Commission. This market valuation process could significantly reduce our capital and/or profitability. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which could have a material adverse effect on our net income and capital levels.
Our future success is dependent on our ability to effectively compete in the face of substantial competition from other financial institutions in our primary markets.
We encounter significant competition for deposits, loans and other financial services from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions in our market area. A number of these banks and other financial institutions are significantly larger than us and have substantially greater access to capital and other resources, larger lending limits, more extensive branch systems, and may offer a wider array of banking services. To a limited extent, we compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations any of which may offer more favorable financing rates and terms than us. Most of these non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors may have advantages in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
The 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.
Our continued success is largely dependent on key management team members.
We are a customer-focused and relationship-driven organization. Future growth is expected to be driven by a large part in the relationships maintained with customers. While we have assembled an experienced and talented senior management team, maintaining this team, while at the same time developing other managers in order that management succession can be achieved, is not assured. The unexpected loss of key employees could have a material adverse effect on our business and may result in lower revenues or reduced earnings.
Our inability to successfully implement our strategic plans could adversely impact earnings as well as our overall financial condition.
A key aspect of our long-term business strategy is our continued growth and expansion. However, we expect to curtail asset growth and focus on improving our profitability until our capital levels are restored to acceptable levels. It is uncertain when, or if, we will be able to successfully increase our capital levels and resume our long-term growth strategy.
Even if we are able to restore our capital levels, we may not be able to successfully implement our strategic plans and manage our growth if we are unable to identify attractive markets, locations or opportunities for expansion in the future. Successful management of increased growth is contingent upon whether we can maintain appropriate levels of capital to support our growth, maintain control over growth in expenses, maintain adequate asset quality, and successfully integrate into the organization, any businesses acquired. In the event that we do open new branches or acquire existing branches or banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of branch franchise expansion, we must absorb these higher expenses as we begin to generate new deposits. There is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, we may not be able to implement our long-term growth strategy, and our plans to branch could depress earnings in the short run, even if we are able to efficiently execute our branching strategy.
Changes in accounting standards could impact reported earnings.
The accounting, disclosure, and reporting standards set by the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation and presentation of the our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
Significant changes in legislation and or regulations could adversely impact us.
We are subject to extensive supervision, regulation, and legislation by both state and federal banking authorities. Many of the regulations we are governed by are intended to protect depositors, the public, or the insurance funds maintained by the Federal Deposit Insurance Corporation, not shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth, and changes in regulations could adversely affect it. The burden imposed by federal and state regulations may place banks in at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably.
The trading volume in our common stock is lower than that of other financial services companies.
Although our common stock is traded on the Nasdaq Capital Market, the trading volume in our common stock is lower than that of other financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.
Our common stock could be delisted for failure to satisfy a continued listing rule or standard.
On November 22, 2011, we received a notice from the Nasdaq Stock Market that we are currently not in compliance with Nasdaq’s Marketplace Rule 5550(a)(2), which requires our common stock to maintain a minimum bid price of $1.00 per share. We are provided a grace period of 180 calendar days, or until May 21, 2012, in which to regain compliance with the minimum bid price rule. If at anytime during the grace period the closing price of our common stock is at least $1.00 for a minimum of ten consecutive business days, we will have complied with the rule and the matter will be closed. If compliance with the rule cannot be demonstrated by May 21, 2012, Nasdaq may grant us an additional 180-day grace period if we meet all other listing standards for the Nasdaq Capital Market and provide written notice of our intention to cure the deficiency during the second compliance period. If we are not eligible for the additional grace period, or if it appears to the Nasdaq staff that we will not be able to cure the deficiency during the additional grace period, Nasdaq will provide us written notification that our common stock will be delisted, at which time we may appeal the determination. We intend to actively monitor the bid price for our common stock between now and May 21, 2012, and will consider available options to regain compliance with the minimum bid price requirement. If our common stock is no longer listed on Nasdaq, our common stock could experience a decrease in liquidity.
Our ability to pay dividends is limited and we suspended payment of dividends during 2010. As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future.
Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient capital, and by contractual restrictions under the agreement with the U.S. Treasury in connection with the issuance of our Series A Preferred Stock under the TARP Capital Purchase Program. The ability of our banking subsidiary to pay dividends to us is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to our banking subsidiary. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our common stock. Holders of our common stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. In the first quarter of 2010, we suspended payment of dividends on our common stock. We also suspended payment of dividends on our preferred stock in the first quarter of 2010, so we will be required to pay all accrued and unpaid dividends on our preferred stock before we will be able to resume payment of dividends on our common stock. The total arrearage on such preferred stock as of December 31, 2011 is $1.1 million. In addition, we are subject to regulatory restrictions that do not permit us to declare or pay any dividend without the prior written approval of our banking regulators. Although we can seek to obtain a waiver of this prohibition, banking regulators may choose not to grant such a waiver, and we would not expect to be granted a waiver or be released from this obligation until our financial performance improves significantly. Therefore, we may not be able to resume payments of dividends in the future.
Government measures to regulate the financial industry, including the recently enacted Dodd-Frank Act, subject us to increased regulation and could adversely affect us.
As a financial institution, we are heavily regulated at the state and federal levels. As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act includes significant changes in the financial regulatory landscape and will impact all financial institutions, including us. Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next several months and years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rulemaking and interpretation, we cannot predict the full effect of this legislation on our businesses, financial condition or results of operations. Among other things, the Dodd-Frank Act and the regulations implemented thereunder could limit debit card interchange fees, increase FDIC assessments, impose new requirements on mortgage lending, and establish more stringent capital requirements on bank holding companies. As a result of these and other provisions in the Dodd-Frank Act, we could experience additional costs, as well as limitations on the products and services we offer and on our ability to efficiently pursue business opportunities, which may adversely affect our businesses, financial condition or results of operations.
Concerns regarding downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity.
On August 5, 2011, Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+. On August 8, 2011, Standard & Poor’s downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. These downgrades could have a material adverse impact on financial markets and economic conditions in the United States generally, the market value of such instruments and the credit risk associated with State governments such as Virginia that have significant economic relationships with the U.S. government. Debt instruments of this nature are key assets on the balance sheets of financial institutions, including ours. In turn, the market’s anticipation of these impacts could have a material adverse effect on our business, financial condition and liquidity and could exacerbate the other risks to which we are subject, including those disclosed herein.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
Our current corporate center office is a two-story brick building with a fully finished basement, built in 1994 with approximately 15,000 square feet of office space. It houses deposit and loan operations, information technology and data center, accounting and finance, human resources and training, and general facilities services. It is located at 2036 New Dorset Road in Powhatan County. The current main office was constructed in 2004 and occupied in June 2005. It is a two story brick building with 16,000 square feet of office space located on a 6.95 acre tract of land at the intersection of New Dorset Road and Route 60 in Powhatan County. The main office building houses a branch, executive offices, several retail and most all commercial, mortgage and construction loan personnel. The present new main office replaced the original main office and an adjacent branch facility at Flatrock, both of which were closed in 2005. The original main office building and land were sold in June 2006.
The Cartersville location, in Cumberland County, which originally opened in 1985, was replaced in mid-1994 with a one-story brick building with approximately 1,600 square feet. The Midlothian branch is located in Chesterfield County at the Village Marketplace shopping center and was built in 1988 and opened in May of that year. It is a one and one-half story building with approximately 3,000 square feet. The Flatrock branch was acquired in 1992 from the Resolution Trust Corporation with us assuming approximately $9.0 million in deposit liabilities of the former CorEast Federal Savings Bank. The Flatrock branch facility is located in the Village of Flat Rock across Route 60 from our original main office, and was closed in June 2005 and is currently used for offsite record storage. In April 1993, we acquired the branch facility of the former Investors Federal Savings Bank located in the Market Square Shopping Center in Brandermill in Chesterfield County, through the Resolution Trust Corporation. This one-story building contains approximately 1,600 square feet and opened for business on November 1, 1993.
In June 1998, we completed construction of and opened a 4,800 square foot branch located on U. S. Route 60 (Anderson Highway) near the courthouse in Cumberland County, Virginia. In July 2001, we acquired a one-story, 2,800 square foot, two-year old branch facility from another financial institution located on Lauderdale Drive in Wellesley in Henrico County. In December 2004, we purchased a 2,800 square foot, seven-year old branch bank building from another financial institution. This branch is located at 2500 Promenade Parkway in the Bellgrade shopping center located in the Midlothian area of Chesterfield County.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which we are a party or of which our property is subject.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock and Dividends
Central Virginia Bankshares, Inc. Common Stock trades on The Nasdaq Capital Market (“Nasdaq”) under the symbol “CVBK”. As of March 26, 2012 we had approximately 739 shareholders of record.
The following table sets forth the high and low trade prices of our Common Stock on Nasdaq, based on published financial sources, and the dividends paid on the Common Stock for each calendar quarter indicated.
In the first quarter of 2010, we suspended payment of dividends on our common stock. We currently are subject to regulatory restrictions that do not permit us to make any distributions on our Preferred Stock, any interest payments on our trust preferred securities or declare any common stock dividends without prior approval from our banking regulators. We expect that we will not be permitted to declare or pay any dividends until our financial performance improves significantly.
In January 2009, we issued preferred stock to the U.S. Treasury pursuant to the TARP Capital Purchase Program. Under the terms of the preferred stock, we are required to pay dividends on the preferred stock before they can be paid on our common stock. We also suspended payment of dividends on our preferred stock in the first quarter of 2010, so we will be required to pay all accrued and unpaid dividends on our preferred stock before we will be able to resume payment of dividends on our common stock. The total arrearage on such preferred stock as of December 31, 2011 was $1.1 million.
As a result of these regulatory and contractual restrictions on our ability to pay dividends on our common stock, we are unable to predict when we may be able to resume payment of dividends on our common stock.
When we are able to resume dividend payments, our future dividend policy will be subject to the discretion of the board of directors and will depend upon a number of factors, including future consolidated earnings, financial condition, liquidity and capital requirements of the Company and the Bank, applicable governmental regulations and policies and other factors deemed relevant by the board of directors. Our ability to distribute cash dividends will depend primarily on the amount of cash and liquid assets held as well as the ability of the Bank to declare and pay dividends to the Company. As a state member bank, the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Furthermore, neither the Company nor the Bank may declare or pay a cash dividend on any capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business.
For additional information on these limitations, see “Regulation and Supervision - Payment of Dividends” in Item 1 above.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Current Environment update
Beginning in the summer of 2007, significant adverse changes in financial market conditions resulted in a deleveraging of the entire global financial system. As part of this process, residential and commercial mortgage markets in the United States have experienced a variety of difficulties including loan defaults, credit losses and reduced liquidity. In response to these unprecedented events, the U.S. Government has taken a number of actions to improve stability in the financial markets and encourage lending. One such program is the Troubled Assets Relief Program, or TARP.
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (or the Dodd-Frank Act). The Dodd-Frank Act provides for new regulations on financial institutions and creates new supervisory and advisory bodies, including the new Consumer Financial Protection Bureau. The Dodd-Frank Act tasks many agencies with issuing a variety of new regulations, including rules related to mortgage origination and servicing, securitization and derivatives. As the Dodd-Frank Act has only recently been enacted and because a significant number of regulations have yet to be proposed, it is not possible for us to predict how the Dodd-Frank Act will impact our business.
On February 12, 2010, we notified the U.S. Department of the Treasury that our Board of Directors determined that the payment of the quarterly cash dividend of $142 thousand due during the first quarter of 2010, and subsequent quarterly payments on the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, should be deferred. The total arrearage on such preferred stock as of December 31, 2011 is $1.1 million.
Impact of Income Tax Valuation
We determined that as of December 31, 2011, a $14.8 million valuation allowance on our deferred tax asset is required. During 2010, we decided to establish a valuation allowance against the deferred tax asset because it is uncertain when we will realize this asset and accordingly recorded a tax expense of $9.7 million. The valuation allowance does not impact our Tier 1 Capital for regulatory purposes because net deferred tax assets were already excluded from that calculation.
Factors Impacting Our Operating Results
In addition to the prevailing market conditions, we expect that the results of our operations will be affected by a number of factors and will primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, commercial and residential mortgage loans, commercial real estate debt, mortgage-backed securities and other financial assets in the marketplace. Our net interest income includes the actual payments we receive and is also impacted by the level of loans that are not accruing interest due to their delinquency level. Our net interest income varies over time, primarily as a result of changes in interest rates, volume and levels of interest earning assets and interest paying deposits and liabilities. Interest rates vary according to the type of asset, conditions in the financial markets, credit worthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of the amounts that we have provided for at December 31, 2011.
Credit Risk. We may be exposed to various levels of credit risk, depending on the nature of our underlying assets. Our Loan Committee will approve and monitor credit risk and other risks associated with our loan portfolio and our Asset Liability Committee (“ALCO”) will approve and monitor credit risk associated with our investment portfolio. Our Board of Directors monitors credit risk through their monthly Board of Directors meetings.
Amount and Mix of Earning Assets. The amount and mix of our earning assets, as measured by the aggregate unpaid principal balance of our loan and our investment portfolios, is a key revenue driver. During 2010, we strategically began to decrease the balances of our investment portfolio and borrowings and certificates of deposits in order to improve our capital position. During 2011, our earning assets continued to decrease as the loan portfolio has declined with minimal new loan originations. Additionally, we continue to shift portions of our investment portfolio into government backed securities or municipal bonds. These securities historically have generally had low credit risk and carry lower returns. Generally, as the size of our earning assets decrease, the amount of interest income we receive decreases. The decline in our interest income has been greater than the decrease in our interest expense which, in total, has reduced our net interest income.
Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may over time cause:
·
the interest expense associated with our borrowings to increase;
·
the value of our fixed rate investment securities to decline;
·
the interest expense associated with our variable rate deposits to increase;
·
coupons on our variable rate loans to reset, although on a delayed basis, to higher interest rates to the extent allowed by individual loan floors and caps; and
·
to the extent applicable under the terms of our assets, prepayments on our mortgage loan portfolio and mortgage-backed securities to slow thus increasing the
duration of these assets.
Conversely, decreases in interest rates, in general, may over time cause:
·
to the extent applicable under the terms of our assets, prepayments on our mortgage loans and mortgage-backed securities to increase thus shortening the duration of these assets;
·
the interest expense associated with our variable rate deposits and borrowings to decrease;
·
the value of our fixed rate investment securities to increase; and
·
coupons on our adjustable-rate loans to reset, although on a delayed basis, to lower interest rates subject to interest rate floors on the individual loan.
Since changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to effectively manage interest rate risks.
Results of Operations
For the year ended December 31, 2011, we reported net income of $0.8 million. After the accrued, but unpaid dividend of $0.6 million to the Treasury on preferred stock, the net income available to common shareholders was $0.1 million. On a per share basis, the net income was $0.05 per common share. The return on average assets and return on average equity excluding the effective dividend on preferred stock was 0.19% and 6.06%, respectively. The improvement in income in 2011 was primarily due to a decrease of $5.4 million in the provisions for future loan losses, an increase of $0.3 million in realized security gains, and a decrease of $2.5 million in non-interest expense. Partially offsetting these improvements in 2011 was a decrease of $4.0 million in interest income due to a decline in interest-earning assets and decreasing interest rates.
For the year ended December 31, 2010, we reported a net loss of $15.3 million. After the accrued, but unpaid dividend of $0.6 million to the Treasury on preferred stock, the net loss to common shareholders was $15.9 million. On a per share basis, the net loss was $(6.06) per common share while the return on average assets and return on average equity was (3.41)% and (60.19)% excluding the effective dividends on preferred stock, respectively. The loss in 2010 was primarily due to the addition of $7.8 million in provisions for future loan losses given the level of non-performing loans and a deferred tax asset valuation allowance of $14.3 million. Also impacting the loss in 2010 was a decrease of $4.4 million in interest income due to increasing non-performing loans, decreasing interest rates and a decline in interest-earning assets.
Our return on average equity was (30.18)% in 2009 and the return on average assets excluding the effective dividends on preferred stock, amounted to (1.85)% in 2009.
Net Interest Income. In 2011, our net interest income was $10.7 million, a decline of $1.5 million or 13% compared to 2010. The 2011 net interest margin was 2.87% compared to 2.99% in 2010 and 2.79% in 2009. Interest and fees on loans decreased 14% in 2011 from 2010 as the loan portfolio decreased from $261.5 million at December 31, 2010 to $224.2 million at December 31, 2011. The yield on loans fell to 5.69% in 2011 from 5.74% in 2010 primarily due to the loan portfolio decline. Interest income on securities decreased $1.6 million from $4.8 million in 2010 to $3.2 million in 2011. The yield on securities decreased to 2.93% from 4.25% in 2010 as we shifted our investment mix towards lower yielding and lower regulatory capital risk weighted securities such as Government National Mortgage Association, (“GNMA”), US Treasury securities, and municipal bonds. This shift to lower risk weighted investments was done in order to reduce risk weighted assets, improve our risk based capital ratio and to improve the credit quality of the portfolio. As the yields on loans and investments were decreasing, so too were the rates paid on deposits. Interest expense on deposits decreased $2.3 million or 33% in 2011 compared to 2010. The yield on deposits was 1.53% in 2011 compared to 2.11% in 2010, mainly reflecting a reduction of 36% in certificates of deposit balances, lower rates paid on new certificates of deposit and interest bearing deposits. Interest expense on borrowings decreased $0.1 million from $1.8 million in 2010 to $1.7 million in 2011 while the cost of these funds increased from 3.50% in 2010 to 3.63% in 2011. The net interest margin is a measure of net interest income performance. It represents the difference between interest income, including net deferred loan fees earned, and interest expense, on both deposits, and borrowings reflected as a percentage of average interest earning assets.
Net interest income for 2010 was $12.2 million, a decline of $0.8 million or 6% compared to 2009. Our net interest income was $13.0 million in 2009 and $14.3 million in 2008. The 2010 net interest margin was 2.99% compared to 2.79% in 2009. Interest and fees on loans decreased 9.9% in 2010 from 2009 as the amount of non-accrual loans rose from $21.7 million at December 31, 2009 to $31.0 million at December 31, 2010. The amount of interest income “lost” on these loans was approximately $1.2 million in 2010. The yield on loans fell to 5.74% in 2010 from 6.00% in 2009 primarily due to the effect of non-accrual loans. Interest income on securities decreased $2.7 million from $7.5 million in 2009 to $4.8 million in 2010 due to a shift in our investment mix towards lower yielding and lower regulatory capital risk weighted GNMA and US Treasury securities. This shift to lower risk weighted investments was done in order to reduce risk weighted assets, improve our risk based capital ratio and to improve the credit quality of the portfolio. The yield on securities decreased to 4.25% from 4.76% in 2009. As the yields on loans and investments were decreasing, so too were the rates paid on deposits. Interest expense on deposits decreased $3.2 million or 31.4% in 2010 compared to 2009. The rate on deposits was 2.11% in 2010 compared to 3.0% in 2009 mainly reflecting a reduction of 9.1% in certificates of deposit balances and lower rates paid on new certificates of deposit. Interest expense on borrowings decreased $0.5 million from $2.3 million in 2009 to $1.8 million in 2010 while the cost of these funds increased from 2.68% in 2009 to 3.50% in 2010.
The table below, sets forth our average interest earning assets and average interest bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin, all for the periods indicated.
____________________
(1)
Includes securities available for sale and securities held to maturity.
(2)
Installment loans are stated net of unearned income.
(3)
Average loan balances include non-accrual loans.
(4)
Interest income on loans includes the earned portion of net deferred loan fees in accordance with FASB 91 of $220 thousand in 2011, $380 thousand in 2010, and $551 thousand in 2009.
(5)
Includes mortgage loans held for sale and SBA loans held for resale.
(6)
Net interest margin is calculated as interest income less interest expense divided by average earning assets.
Net interest income is affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total change in interest income that can be attributed to rate (change in rate multiplied by old volume) and volume (change in volume multiplied by old rate) for the periods indicated. The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the relative size of the rate and volume changes.
____________________
(1) Includes securities available for sale and securities held to maturity.
Non-Interest Income. At December 31, 2011, non-interest income increased $15 thousand or less than 1% primarily due to a $343 thousand increase in realized gain (loss) on sale of securities, offset by a decrease in deposit fees and charges of $281 thousand in 2011 due to primarily lower overdraft fees due to changes in regulations. Secondary mortgage market fees decreased 78% to $31 thousand due to the cessation of residential mortgage originations effective January 1, 2011. Bank card fees increased 5% to $626 thousand as the fees received from credit card usage and related fees increased. The increase in cash surrender value of bank owned life insurance totaled $394 thousand versus $440 thousand a decrease of $46 thousand or 10% as a result of lower investment yields on the underlying insurance policies.
At December 31, 2010, non-interest income increased $1.6 million or 48.9% primarily due to a $1.8 million increase in realized gain (loss) on sale of securities available for sale. Secondary mortgage market fees decreased 38.5% to $142 thousand due to lower mortgage loan origination volume. Deposit fees and charges declined by 9.7% in 2010 due to regulatory changes impacting overdraft fees. Bank card fees increased 12.8% to $598 thousand as the fees received from credit card usage increased as the usage of credit cards increased. The increase in cash surrender value of bank owned life insurance totaled $440 thousand versus $434 thousand an increase of $6 thousand or 1.4% as a result of higher net crediting rates paid by the insurance companies.
Non-Interest Expenses. Non-interest expense totaled $12.3 million in 2011 compared to $14.7 million, a decrease of $2.5 million or 17%. Salary and benefit expense decreased by $0.8 million in 2011 primarily due to management driven expense reductions. The loss on other than temporary impairment, (“OTTI”) write-down of securities totaled $13 thousand in 2011 compared to $255 thousand in 2010 due to improving credit markets which have not led to new material OTTI impairments on our collateralized debt obligation (“CDO”) securities. Legal, professional and consulting fees decreased $232 thousand or 33% primarily related to decreased fees associated with our written agreement with the Federal Reserve and Virginia Bureau of Financial Institutions and regulatory compliance. The loss on devaluation of real estate owned decreased to $282 thousand in 2011 from $834 thousand in 2010 due to real estate values stabilizing and now declining at a slower rate. FDIC insurance premiums decreased $141 thousand in 2011 compared to 2010 due to the decrease in total assets and deposits and due to changes in the way in which FDIC premiums are calculated.
Non-interest expense totaled $14.7 million in 2010 compared to $20.0 million, a decrease of $5.3 million or 26.5%. Salary and benefit expense decreased by $1.0 million in 2010 primarily due to management driven headcount reductions. The loss on OTTI write-down of securities totaled $255 thousand in 2010 compared to $6.7 million in 2009 due to improving credit markets which have not led to new material OTTI impairments on our CDO securities. Legal, professional and consulting fees increased $935 thousand or 159.3% primarily related to increased fees associated with our written agreement with the Federal Reserve and Virginia Bureau of Financial Institutions and regulatory compliance. The loss on devaluation of real estate owned increased to $834 thousand in 2010 from zero in 2009 due to an increase in foreclosed assets and deteriorating real estate values. FDIC insurance premiums increased $10 thousand in 2010 compared to 2009.
Income Taxes. We reported income tax expense of zero in 2011 and $9.7 million in 2010, and a benefit of $4.2 million in 2009. The 2010 effective tax rate is primarily the result of the establishment of a valuation allowance on our deferred tax asset. The 2009 effective tax rate benefit is the result of the write-down of other than temporary impairment on securities, increased FDIC premiums, and lower net interest income. Management assesses the realizability of the deferred tax asset on a quarterly basis, considering both positive and negative evidence in determining whether it is more likely than not that some portion or all of the gross deferred tax asset would not be realized. At September 30, 2010, management conducted such an analysis and determined that an establishment of a 100% valuation allowance against our deferred tax asset was prudent given our historical losses. There was no impact on our calculation of Tier 1 Capital for regulatory purposes given the net deferred tax assets were already excluded from the calculation.
Financial Condition
Total assets declined $13.7 million at December 31, 2011 to $395.4 million from $409.1 million at December 31, 2010. Total cash and cash equivalents increased $32.5 million to $46.3 million, total loans decreased $37.4 million, securities available for sale decreased $9.5 million, and total deposits decreased $13.2 million. The decrease in deposits is primarily due to a decline in our certificates of deposit as we have continued to lower deposit interest rates. At December 31, 2011, the book value of a share of common stock was $0.36 compared to $0.03 at December 31, 2010.
Total assets declined $64.1 million at December 31, 2010 to $409.1 million from $473.2 million at December 31, 2009. Total cash and cash equivalents increased $1.4 million to $13.9 million as total deposits decreased $39.5 million, total loans decreased $30.9 million, securities available for sale decreased $14.2 million, and total borrowings decreased $9.8 million from $57.9 million in 2009 to $48.1 million in 2010. The decrease in deposits is primarily due to a decline in our certificates of deposit as we have continued to lower deposit interest rates. Funds received from the sale, maturity, and calls of investment securities allowed us to pay down our borrowings by $10 million. At December 31, 2010, the book value of a share of common stock was $0.03 compared to $5.64 at December 31, 2009.
Loan Portfolio. We actively extend consumer loans to individuals and commercial loans to small and medium sized businesses within our primary service area. Our commercial lending activity extends across our primary service area of Powhatan, Cumberland, eastern Goochland County, western Chesterfield, and western Henrico Counties. Consistent with our focus on providing community-based financial services, we generally do not attempt to diversify our loan portfolio geographically by making significant amounts of loans to borrowers outside of our primary service area.
The principal economic risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased depending on prevailing economic conditions. The risk associated with the real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of our market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction. Many of our real estate construction loans were for pre-sold or contract homes. The economy has had an impact on each of our loan categories to varying degrees. We have seen the decline in residential home sales and values negatively impact our various loan portfolios. We expect to see resumption of some economic growth in our markets in the future, which would improve the quality of our loan portfolio.
Total loans outstanding at December 31, 2011 decreased by $37 million or 14% from 2010, ending the year at $224.2 million. In 2010, loans decreased by $30.9 million or 10.6% from 2009, ending the year at $261.4 million. In 2009, loans decreased by $1.1 million or 0.38% ending the year at $292.3 million, and in 2008 loan growth was $27.5 million or 10.4% ending the year at $293.4 million. The loan to deposit ratio was 67.3% at December 31, 2011, 75.5% at December 31, 2010, 75.8% at December 31, 2009, and 84.3% at December 31, 2008. We anticipate that the loan portfolio will continue to decline in 2012.
The following table summarizes our loan portfolio, net of unearned income:
As the table above indicates, the total amount of commercial loans have decreased by $11.0 million, decreased by $10.2 million, increased by $5.1 million, and increased by $4.1 million, or (32)%, (23)%, 13%, and 12%, in 2011, 2010, 2009, and 2008, respectively. Total real estate related loans outstanding decreased by $24.5 million or 11% in 2011, decreased by $18.5 million or 8% in 2010, decreased by $5.8 million or 2% in 2009, and increased by $25.8 million or 12% in 2008. Of the real estate related loans in 2011 residential loans decreased $8.2 million or 11%, commercial loans decreased $3.0 million or 5%, home equity loans increased by $2.1 million or 9%, and construction loans decreased by $15.4 million or 26%. In 2010 residential loans decreased $0.7 million or 1%, commercial loans decreased $2.4 million or 3%, home equity loans decreased by $760 thousand or 3%, and construction loans decreased by $14.7 million or 20%. In 2009, mortgage loans increased $2.1 million or 1%, home equity loans increased by $2.6 million or 13%, and construction loans decreased by $10.6 million or 13%. In 2008, residential loans increased by $13.0 million or 20%, commercial loans increased by $15.0 million or 30%, followed by home equity at $4.5 million or 27%, and construction loans declined $6.6 million or 7%. Residential and commercial loans have comprised between 52% to 66% of the total real estate loans for the past five years. Residential and commercial loans to total real estate loans were 66% in 2011, 63% in 2010, 60% in 2009, 58% in 2008, and 52% in 2007. Home equity loans have grown over the past five years from $16.3 million in 2007 to $24.7 million in 2011. Home equity loans to total real estate loans were 13% in 2011, 10% in 2010, 10% in 2009, 8% in 2008, and 7% in 2007. Bankcard loan balances outstanding were $1.0 million in 2011, and have remained relatively level over the period from 2007 through 2011.
The shift from construction to mortgage loan growth was accomplished in part by the decision in early 2007 not to sell as many mortgage loans in the secondary market. Instead those loans which met our underwriting criteria were recorded on our books as residential loans. In addition, most of these loans were 30 and 15 year fixed rate loans, which given the composition of bank’s portfolio of mortgage loans being mostly 3/3 and 5/5 year adjustable rate loans, the addition of fixed rate loans was desirable from an asset liability standpoint at a time when interest rates were flat and expected to trend down in the future. As a percentage of total real estate loans, construction loans comprised 22% in 2011, 26% in 2010, 30 % in 2009, 34% in 2008, and 41% in 2007. Considering the current state of the real estate market for new home sales, we anticipate that our construction loan portfolio will continue to decline in the future. Substantially all construction loans are for residential construction in our principal market areas. Effective January 1, 2011, we ceased the origination of residential mortgage loans. In addition, based on the requirements of the written agreement with the Bureau of Financial Institutions and the Federal Reserve, we are not actively seeking acquisition, development, or construction loans; however, we may consider such a loan on a limited basis.
Installment loans decreased by $1.7 million or 37% in 2011, decreased by $2.1 million or 30% in 2010, decreased by $0.5 million or 6% in 2009, and decreased by $2.5 million or 25% in 2008. The balances of traditional installment loans declined primarily due to reduced demand resulting from the current economic environment. The balances have also dropped principally due to our unwillingness to effectively compete on an interest rate basis with the captive and other finance arms of the major automobile manufacturers, coupled with the tendency of consumers to utilize equity credit lines for purposes that in the past would have been financed with traditional installment loans. We anticipate this atmosphere surrounding installment lending to continue in the future as long as the automobile manufacturers effectively subsidize the sale of vehicles through offering below market financing.
All concentrations of loans exceeding 10.0% of total loans at December 31, 2011 were disclosed as a separate category of loans. The following table shows the contractual maturity distribution of loan balances outstanding as of December 31, 2011. Also provided are the amounts due classified according to the sensitivity to changes in interest rates.
Asset Quality. Non-performing loans include non-accrual loans, loans 90 days or more past due and restructured loans. Non-accrual loans are loans on which interest accruals have been discontinued. Loans which reach non-accrual status, per Company policy, may not be restored to accrual status until all delinquent principal and interest has been paid and future payments are reasonably assured, or the loan becomes both well secured and in the process of collection. Restructured loans are loans with respect to which a borrower has been granted a concession on the interest rate or the original repayment terms because of financial difficulties. Non-performing assets also include other real estate owned, (“OREO”), which is real estate acquired through foreclosure. We have no mortgages within our mortgage loan portfolios that are defined as “sub-prime”.
Management forecloses on delinquent real estate loans when all other repayment possibilities have been exhausted. Our practice is to value real estate acquired through foreclosure at the lower of (i) an independent current appraisal or market analysis less anticipated costs of disposal, or (ii) the existing loan balance. The current extended decline in the national economy and unemployment rates from 2007 to the end of the third quarter of 2011 has also negatively affected the local real estate market. The majority of the non-performing loans are real estate related. We believe that the majority of nonperforming loans are adequately secured by collateral. The following table summarizes activity related to other real estate owned:
Management is diligently monitoring the increase in non-performing assets; however, we believe that the level of non-performing loans in 2011 is a reflection of the current depressed real estate markets and the generally weak economic environment. Based on our present knowledge of the status of individual and corporate borrowers and the overall state of the local economy, management reasonably anticipates that the level of non-performing assets is likely to decrease from its current level. Management will move to foreclose on borrowers whose loans are placed on a non-accrual status in order to resolve the credit; therefore, it is reasonable to anticipate an increase in OREO. The following table summarizes non-performing assets:
Loans 90 days or more past due are placed on non-accrual status unless they are well secured and in the process of collection.
Our policy with respect to past due interest on nonaccrual loans requires that any interest accrued in the current year and unpaid should be reversed from the receivable and current year’s income. With regard to interest accrued in the prior year, and yet unpaid, such accrued interest should be reversed from the receivable and reserve for loan losses. Since we operate in a rural to suburban area, we have generally been well acquainted with our principal borrowers and have not had such a large number of problem credits that management has not been able to stay well informed about, and in contact with, troubled borrowers. Management is not aware of any other material loans at December 31, 2011, which involve significant doubts as to the ability of the borrowers to comply with their existing payment terms.
The following table sets forth the amounts of contracted interest income and interest income reflected in income on loans accounted for on a non-accrual basis and loans restructured and in compliance with modified terms:
Management has analyzed the potential risk of loss within its loan portfolio, given the loan balances, quality trends, value of the underlying collateral, and current local market economic and business conditions and has recognized losses where appropriate. Non-performing loans are monitored on an ongoing basis as part of our periodic loan review process. Management believes that the current level of non-performing loans at December 31, 2011 is a reflection of the current economic environment. Management reviews the adequacy of its loan loss allowance at the end of each month. Based primarily on our loan risk classification system, which classifies all commercial loans, including problem credits according to a scale of 1-8 with 8 being a loss, additional provisions for losses may be made monthly. Management may evaluate adversely classified and non-performing loans relative to their collateral value and make appropriate reductions to the carrying value of those loans to approximate fair value based on that review. Should any of the individual classified loans deteriorate further in the future, additional write downs may be required. Management believes that the allowance for loan losses, which may or may not increase at the same rate as the portfolio grows, is adequate as of December 31, 2011 to provide for loan losses inherent in the portfolio. However, considering the current state of the local real estate markets, and the risk identified by periodic qualitative and quantitative analysis, it is possible that additions to our reserve for possible loan losses may be necessary in the future.
The following table summarizes changes in the allowance for loan losses:
For each period presented, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all factors connected with the collectability of the existing portfolio. Management evaluates the loan portfolio in light of local business and economic conditions, changes in the nature and value of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include internally generated loan review reports as well as reports from an outside loan reviewer, previous loan loss experience with the borrower, the status of past due interest and principal payments on the loan, the quality of financial information supplied by the borrower, the general financial condition of the borrower, and the value of any collateral securing the loan. Despite management’s best efforts, the reserve may be adjusted in future periods if there are significant changes in the assumptions or factors utilized when making valuations, or conditions differ materially from the assumptions originally utilized. Any such adjustments are made in the reporting period when the relevant factor(s) become known and when applied as part of the analysis indicate a change in the level of potential loss is warranted.
For the year ended December 31, 2011, the provision for loan losses was $2.4 million and in 2010 the provision for loan losses was $7.8 million. We have seen the underlying development projects related to these loans delayed as the real estate market has deteriorated. There was a $9.5 million provision for loan losses for the year ended December 31, 2009, a $1.2 million provision for loan losses for the year ended December 31, 2008, and a $180 thousand provision for loan losses for the year ended December 31, 2007. In management’s opinion, the provision charged to operations has been sufficient to absorb the current year’s net loan losses and generally provide a reserve for potential future loan losses considering the financial condition of borrowers and collateral values in view of the uncertainties in our local economy.
The following table shows the balance and percentage of our allowance for loan losses allocated to each category of loans:
We have allocated the allowance according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within each of the above categories of loans. The allocation of the allowance as shown in the table above should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loss trends. Furthermore, the portion allocated to each loan category may vary from period to period due to changes in the financial ability of borrowers to service their debt and repay principal; changes in the estimated value of collateral, in particular real estate. These allocations are not necessarily the total amount available for future losses that might occur within such categories, since a portion of the total allowance is a general allowance applicable to the entire portfolio.
Securities. Our investment securities portfolio serves several purposes, primarily liquidity and yield. Certain of the securities are pledged to secure public deposits and others are specifically identified as collateral for borrowing from the Federal Home Loan Bank of Atlanta, and others for repurchase agreements with correspondent banks and commercial customers. The remaining portion of the portfolio is held for investment yield, availability for sale in the event liquidity is needed, and for general asset liability management purposes.
At December 31, 2011, investment securities totaled $100.8 million representing 26% of total assets and a decrease of $10.5 million or 9% compared to $111.3 million in 2010. The largest decreases occurred in the U. S. Treasury category, government agencies category, and the corporate and other debt category. For the total portfolio in 2011, $81.1 million in securities were from calls or maturities, purchases were $200.6 million, proceeds from sales were $131.5 million, and $13 thousand was written down as OTTI.
At December 31, 2010, investment securities totaled $111.3 million representing 27.2% of total assets and a decrease of $16.1 million or 12.6% compared to $127.4 million in 2009. The largest decreases occurred in the government agencies category, and the corporate and other debt category as we shifted our mix of securities into investments with less risk associated with them, such as Ginnie Mae mortgage backed securities and US Treasury securities. For the total portfolio in 2010, $43.6 million in securities were from calls or maturities, purchases were $79.9 million, proceeds from sales were $55.4 million, and $255 thousand was written down as OTTI.
We review and evaluate all securities quarterly or more frequently as necessary for possible impairment. If, in the judgment of management, there is serious doubt as to the probability of collecting substantially all our basis in a security within a reasonable period of time, an impairment write down will be recognized. We conducted impairment reviews as of December 31, 2011 for all securities where cash flow information was obtainable. Our analysis indicated that we expect to recover the entire amortized cost basis of the security. We also determined that we would not be required to sell the securities before the recovery of the entire amortized cost basis of the security. We presently hold the following securities with credit ratings that, subsequent to purchase, have declined below minimum investment grade:
·
$175 thousand Ally Bank (formerly GMAC) Perpetual Preferred Stock,
·
$1 million MBIA Global Funding 5.07% maturing 6/15/2015,
·
$2 million Bank Boston Capital 1.007% maturing 1/15/2027,
·
$2 million Bank of America Capital .8213% maturing 1/15/2027,
·
$2 million in Sallie Mae preferred stock.
Additionally, we hold eleven CDO securities where the underlying pooled collateral is various bank and insurance company trust preferred debt. OTTI in the amount of $13 thousand has been recognized on seven of these securities in 2011. Subsequent to purchase, seven of these securities have revised ratings that are below minimum investment grade (refer to Note 3 of the financial statements for further discussion). We use an independent valuation firm that specializes in valuing debt securities. The independent firm evaluates all relevant credit and structural aspects of each debt security, determining appropriate performance assumptions and performing discounted cash flow analysis. The following topics are covered in their evaluation:
·
Detailed credit and structural evaluation for each piece of collateral in the debt security;
·
Collateral performance projections for each piece of collateral in the debt security;
·
Terms of the debt security structure; and
·
Discounted cash flow modeling.
Following the quarterly evaluation of these securities, management has concluded that, with the exception of the previously noted non-cash charge, the impairment within the CDO securities is considered temporary as of December 31, 2011. We do not own any securities collateralized by “sub-prime” or “alt A” mortgage loans.
The following table summarizes the book value of our securities held to maturity at the dates indicated:
The table below summarizes the amortized cost of our securities available for sale at the dates indicated.
The book value and average yield of our securities, including securities available for sale, at December 31, 2011 by contractual maturity are reflected in the following table. Actual maturities, and the resulting cash flows, can differ significantly from contractual maturities because certain issuers may have the right to call or prepay debt obligations with or without call or prepayment penalties. The table below categorizes securities according to their contractual maturity, without regard for certain issuers having unilateral optional call provisions prior to the bond’s contractual maturity, which they may or may not exercise depending on the overall market level of interest rates at the call date. Our investment in bank eligible government sponsored entities, (“GSE”) consists of Fannie Mae, Freddie Mac and Sallie Mae fixed coupon exchange traded preferred stocks. During 2008, Fannie Mae and Freddie Mac preferred stocks were written-down by $18.9 million. These securities carry no book value. As these securities have no fixed maturity date they are separately identified. Mortgage-backed securities are also reported according to the contractual final maturity, without regard for the pre-payment characteristics of the underlying mortgages.
The table below summarizes the maturity distribution of our available for sale and our held to maturity securities at December 31, 2011.
As shown in the table above, no securities will mature in one year or less while $1.8 million, or 2%, will mature after one year but within five years. The average yield on the entire portfolio was 2.76% for 2011, compared to 3.42% for 2010, and 4.95% for 2009. The book value of the entire portfolio exceeded its market value by approximately $4.9 million at December 31, 2011, compared to $5.0 million at December 31, 2010, and $8.5 million at December 31, 2009.
Deposits and Short-Term Borrowings. Our predominate source of funds has been retail deposit accounts. Our deposit base is comprised of demand deposits, savings and money market accounts and other time deposits. Our deposits are provided by individuals and businesses generally located within the principal markets served.
As shown in the following table, average total deposits decreased by 8% in 2011, compared to a decrease of 2% in 2010, and a 5% increase in 2009. The average aggregate interest rate paid on deposits was 1.37% in 2011, versus 1.89% in 2010, and 2.69% in 2009. The majority (51%) of our deposits are higher yielding time deposits because many of our customers are individuals who seek higher yields than those offered on savings and demand accounts.
The following table is a summary of average deposits and average rates paid:
We do not solicit nor do we have any brokered deposits. Due to our “adequately capitalized” status, we are not permitted to accept brokered deposits without prior regulatory approval or offer interest rates on deposits that are significantly higher than the average rates in our market area. The following table is a summary of time deposits of $100,000 or more by remaining maturities at December 31, 2011:
Capital Resources
The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance and changing competitive conditions and economic forces. We seek to maintain a strong capital base to provide stability to current operations and to promote public confidence. In addition, we are evaluating strategies regarding capital enhancements. Such strategies could include capital offerings, continued reduction in assets, or further management of the securities portfolio.
The Bank was considered “adequately capitalized” for regulatory purposes as of December 31, 2011. The primary indicators relied on by the Federal Reserve Board and other bank regulators in measuring strength of capital position are the Tier 1 Capital, Total Capital, and Leverage ratios. Tier 1 Capital consists of common and qualifying preferred stockholders’ equity and minority interests in common equity accounts of consolidated subsidiaries, less goodwill. Total Capital consists of Tier 1 Capital, qualifying subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the allowance for loan losses and pre-tax net unrealized holding gains on certain equity securities. Risk-based capital ratios are calculated with reference to risk-weighted assets, which consist of both on and off-balance sheet risks.
The following tables show risk based capital ratios and stockholders’ equity to total assets for the Company and its principal subsidiary, Central Virginia Bank:
The capital management function is an ongoing process. Central to this process is internal equity generation accomplished by retaining earnings. During 2011, we recorded $0.8 million in net income, which has had a positive impact to capital; however, the losses incurred in 2010, 2009 and 2008 have reduced the capital such that the Bank is now considered “adequately capitalized”. The primary reason for the increase in our capital ratios for 2011 is due to the net income recorded and the reduction in our risk-weighted assets as a result of the change in the asset mix in our investment portfolio and the decline in our loan portfolio. The primary reason for the decrease in the Bank’s capital ratios during 2010 was due to the pretax net loss for 2010.
At December 31, 2011, total stockholders’ equity increased by $1.0 million to $12.6 million principally due to the recording of net income. Total stockholders’ equity decreased $14.6 million in 2010 to $11.6 million from $26.2 million in 2009 principally due to the recordation of the deferred tax asset valuation allowance. The deferred tax asset valuation allowance is not considered in the capital ratios calculation. Total stockholders’ equity increased $5.9 million to $26.2 million in 2009 from $20.3 million in 2008 principally due to the issuance of preferred shares in January 2009. Total stockholders’ equity decreased by $16.6 million to $20.3 million in 2008 from $36.9 million in 2007 principally due to write-down, net of tax, of the GSE and Lehman Brothers securities and an increase in the unrealized securities losses, net of tax, reflected in accumulated other comprehensive income. Due to the impact on the Bank’s capital ratios of the write-down of the GSE investments during 2008 and 2009 as well as the increase in provision for loan losses in 2009 and 2010, and also due to the requirements of our written agreement with the Federal Reserve and the Bureau of Financial Institutions, we may raise additional capital in the future. At this time, we do not know what the nature of any capital raise will be, but we expect that it could be substantially dilutive to current shareholders. In addition to the capital raise, we are evaluating strategies regarding capital enhancements. Such strategies could include continued reduction in assets or further management of the securities portfolio.
In January 2009, we elected to participate in the TARP Capital Purchase Program and issued $11,385,000 of 5% Cumulative Senior Preferred Stock to the U.S. Treasury. This additional capital partially replaced the reduction in capital as a result of the $19 million impairment write downs in 2008. The cost of the Senior Preferred dividend is approximately $570 thousand annually, which is currently being deferred.
There were no cash dividends on common stock paid in 2011 or 2010, compared to $436 thousand in 2009. Tangible book value per common share was $0.36 at December 31, 2011, compared to $0.03 at December 31, 2010, and $5.64 at December 31, 2009.
As of September 30, 2010, management determined that an establishment of a 100% valuation allowance against our net deferred tax assets was prudent given our historical losses. The valuation allowance totaled $14.8 million at December 31, 2011. There is no impact on our calculation of Tier 1 Capital for regulatory purposes given the net deferred tax assets were already excluded from the calculation.
The Company’s principal source of cash income is dividend payments from the Bank. Certain limitations exist under applicable law and regulation by regulatory agencies regarding dividend payments to a parent by its subsidiaries. As a result of the losses reported for 2010 and 2009, as of December 31, 2011, without prior regulatory approval, the Bank would not have had sufficient retained earnings available for distribution to the Company as dividends.
Liquidity and Interest Rate Sensitivity
Liquidity. Liquidity is the ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments and loans maturing within one year. Our ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. As a result of our management of liquid assets and our ability to generate liquidity through liability funding, management believes that we maintain overall liquidity sufficient to satisfy our depositors’ requirements and meet our customers’ credit needs.
Additional sources of liquidity available to us include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates, borrowing from the Federal Home Loan Bank, purchasing of federal funds from correspondent banks, and selling securities under repurchase agreements to correspondent banks as well as commercial customers. To further meet our liquidity needs, we also have access to the Federal Reserve System. In the past, growth in deposits and proceeds from the maturity of investment securities have been sufficient to fund the net increase in assets. We, over the past five years, have experienced 6% growth in average year to date deposits - from $286.0 million in 2006 to $302.2 million in 2011. During the same period, we have increased our borrowings 11% from an average of $42.3 million for 2006 to an average of $47.1 million for 2011. Finally over the same five year period we decreased our assets by 2% from an average of $409.7 million for 2006 to an average of $401.5 million for 2011. For the past 12 months, we have decreased the average deposits to $302.2 million compared to $329.6 million in 2010, a 8% decrease. During the same period, we have decreased our borrowings to $47.1 million compared to $52.5 million in 2010, a 10% decrease. Finally, during the same 12 month period, we have decreased our assets to $401.5 million compared to $446.9 million in 2010, a 10% decrease.
Interest Rate Sensitivity. In conjunction with maintaining a satisfactory level of liquidity, management must also control the degree of interest rate risk assumed on the balance sheet. Managing this risk involves regular monitoring of the interest sensitive assets relative to interest sensitive liabilities over specific time intervals.
At December 31, 2011, we had a positive 3 month and a negative12-month period gap position, the cumulative gap to the one year point was positive. Since the largest amount of interest sensitive assets and liabilities mature or reprice within 12 months, we monitor this area closely. We do not emphasize interest sensitivity analysis beyond this time frame because we believe various unpredictable factors could result in erroneous interpretations. Early withdrawal of deposits, prepayments of loans and loan delinquencies are some of the factors that could have such an effect. In addition, changes in rates on interest sensitive assets and liabilities may not be equal, which could result in a change in net interest margin. While we do not match each of our interest sensitive assets against specific interest sensitive liabilities, we do seek to enhance the net interest margin while minimizing exposure to interest rate fluctuations.
Effects of Inflation
Inflation significantly affects industries having high proportions of fixed assets or high levels of inventories. Although we are not significantly affected in these areas, inflation does have an impact on the growth of assets. As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios. Traditionally, our earnings and high capital retention levels have enabled us to meet these needs.
Our reported earnings results have been affected by inflation, but isolating the effect is difficult. The different types of income and expense are affected in various ways. Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index. Management actively monitors interest rate sensitivity, as illustrated by the Gap Analysis, in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.
The following table summarizes our interest earning assets and interest bearing liabilities with respect to the earlier of their contractual repayment date or nearest repricing date at December 31, 2011:
(1)
Of the amount of loans due after 12 months, $105.2 million had floating or adjustable rates of interest and $61.1 million had fixed rates of interest.
Off-Balance Sheet Arrangements
We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. These off-balance sheet arrangements include unfunded commitments to extend credit and standby letters of credit which would impact our liquidity and capital resources to the extent customer’s accept and or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. See Note 15 to the Consolidated Financial Statements for further discussion of the nature, business purpose and elements of risk involved with these off-balance sheet arrangements. We have no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors.
Contractual Obligations
The following table presents our contractual obligations at December 31, 2011 and the scheduled payment amounts due at various intervals over the next five years and beyond.
(1)
Federal Home Loan Bank advances generally are callable prior to the maturity date indicated above. If the advance is called, the advance can be, at our option, converted to another advance with a different interest structure, while maintaining the same maturity date. See Note 9 in Notes to Consolidated Financial Statements. If the Company were to prepay the FHLB advances, the prepayment fee would have been approximately $3.7 million as of December 31, 2011.
Forward-Looking Statements
Certain information contained in this discussion and elsewhere in this filing may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “we expect,” “we believe,” “it is anticipated,” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by us, changing trends in customer profiles and changes in laws and regulations applicable to us. Although we believe that our expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results, our performance or achievements will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
Critical Accounting Policies
General. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we may use historical loss factors as one of the many factors and estimates utilized in determining the inherent losses that may be present in our loan portfolio. Actual losses could differ substantially from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. A summary of our significant accounting policies is set forth in Note 1 to our consolidated financial statements.
Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of 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 any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.
Impairment of Loans: We measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan (or, as a practical expedient, at the loan’s observable market price) or the fair value of the collateral if the loan is collateral dependent. We consider a loan impaired when it is probable that the Corporation 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. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment.
Impairment of Securities: Impairment of investment securities results in a write-down that must be included in net income when a market decline below cost is other-than-temporary. We regularly review each investment security for impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer and our ability and intention with regard to holding the security to maturity.
Other Real Estate Owned (OREO): Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of the loan balance or the fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time the properties have been held, and our ability and intention with regard to continued ownership of the properties. We may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further other-than-temporary deterioration in market conditions.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General
An important element of both earnings performance and liquidity is the management of our interest-sensitive assets and our interest-sensitive liabilities maturing or repricing within specific time intervals and the risks involved with them. Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments in response to changes in interest rates, exchange rates and equity prices. Our market risk is composed primarily of interest rate risk. Our asset-liability management committee is comprised of the CEO, CFO, Senior Credit Officer and an independent director, and is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposures to this risk. Our board of directors reviews the guidelines established by the committee. Interest rate risk is monitored through the use of four complimentary modeling tools: static gap analysis, dynamic gap simulation modeling, earnings simulation modeling and economic value simulation (net present value estimation). Each of the three simulation models measure changes under a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of our interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap, which measures aggregate repricing values, is less utilized or relied upon, since it does not effectively capture or measure the optionality characteristics of earning assets and funding sources nor does it effectively measure the earnings impact of changes in volumes and mix of these components on us. Earnings simulation and economic value models, however, which more effectively reflect the earnings impact, are utilized by management on a regular basis.
Earnings Simulation Analysis
We use simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model utilized by us calculates estimated earnings based on projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a more realistic analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.
Assumptions used in the model, including loan and deposit growth rates, are derived from seasonal trends and management’s outlook, as are the assumptions used to project the yields and rates for new loans and deposits. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios.
The following table represents the interest rate sensitivity of our net interest income (net interest income at risk) on a 12-month horizon using different rate scenarios as of December 31, 2011. There have been no material changes in quantitative and qualitative disclosures about market risk since this information was developed using December 31, 2011 data.
Change in Yield Curve
Cumulative Percentage
Change in Net Interest
Income from Base
Cumulative Dollar
Change in Net Interest
Income from Base
(Dollars in Thousands)
+300 basis points
18.1%
$1,780
+200 basis points
12.0%
1,175
+100 basis points
6.3%
Base $9,828
-
-
-100 basis points
1.7%
-200 basis points
3.8%
-300 basis points
4.7%
Economic Value Simulation
We use economic value simulation to calculate the estimated fair value of assets and liabilities under different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation.
The following chart reflects the change in net market value of equity, (economic value of equity at risk), by using December 31, 2011 data, over different rate environments with a one-year horizon.
Change in Yield Curve
Cumulative Percentage
Change in Economic
Value of Equity
Cumulative Dollar Change
in Economic Value of Equity
(Dollars in Thousands)
+300 basis points
(15.0)%
$(1,987)
+200 basis points
(7.7)%
(1,025)
+100 basis points
(0.4)%
(51)
Base $13,277
-
-
-100 basis points
(14.9)%
(1,976)
-200 basis points
(6.3)%
(831)
-300 basis points
8.9%
1,176
Management of the Interest Sensitivity Gap
The interest sensitivity gap is the difference between interest-sensitive assets and interest-sensitive liabilities maturing or repricing within a specific time interval. The gap can be managed by repricing assets or liabilities, selling investment securities, replacing an earning asset or funding liability prior to maturity, or by adjusting the interest rate during the life of an asset or liability. Matching the amounts of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net income due to changes in market interest rates. We evaluate interest rate risk and then formulate guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments in order to modify sensitivity risk. These guidelines are based upon management’s outlook regarding future interest rate movements, the state of the regional and national economy, and other financial and business risk factors.
Our asset-liability management committee reviews deposit pricing, changes in borrowed money, investment and trading activity, loan sale activities, liquidity levels and our overall interest sensitivity. The minutes of the committee are reported to the board of directors regularly. The periodic monitoring of interest rate risk, investment and trading activity, deposit pricing, funding and liquidity, along with any other significant transactions are managed by our Chief Financial Officer with input from other committee members.
The following table summarizes our dynamic gap model. The dynamic gap model attempts to forecast the cumulative difference between the maturity and repricing characteristics of interest sensitive assets and interest sensitive liabilities measured at various time intervals as well as under various interest rate scenarios
The table below lists our performance for the years ended December 31, 2011 and 2010 on a quarterly basis.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements and report of independent registered public accounting firm thereon are filed as a part of this report following Item 15:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2011 and 2010
Consolidated Statements of Operations for the Years Ended December 31, 2011, 2010 and 2009
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2011, 2010, and 2009
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and 2009
Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures
As of the end of the period covered by this report, we have evaluated the effectiveness of and documented the design and operations of our disclosure controls and procedures that are designed to insure that we record, process, summarize and report in a timely and effective manner the information required to be disclosed in reports filed with or submitted to the Securities and Exchange Commission. In designing and evaluating the disclosure controls and procedures, management recognizes that no control or procedure, no matter how well designed and operated, can provide absolute assurance that the desired control objectives will be achieved. However, management believes it has both appropriate and effective controls over financial disclosure and reporting, and has applied prudent judgment in evaluating the cost-benefit relationship of these controls and procedures.
We carried out an evaluation, as required by Exchange Act Rule 13a-5(b), under the supervision of and the participation with our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this annual report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the date of this evaluation, our disclosure controls were effective.
Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the chief executive officer and chief financial officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our evaluation of internal control over financial reporting includes using the COSO framework, an integrated framework for the evaluation of internal controls issued by the Committee of Sponsoring Organizations of the Treadway Commission, to identify the risks and control objectives related to the evaluation of our control environment.
Based on our evaluation under the framework described above, our management has concluded that our internal control over financial reporting was effective as of December 31, 2011.
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 requirements by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in its annual report.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting during the fourth quarter of the year ended December 31, 2011, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2012 Annual Meeting of Shareholders.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2012 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2012 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2012 Annual Meeting of Shareholders.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item will be provided by being incorporated herein by reference to the Company’s definitive proxy statement for the 2012 Annual Meeting of Shareholders..
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)
The response to this portion of Item 15 is included in Item 8 above.
(a)(2)
The response to this portion of Item 15 is included in Item 8 above.
(a)(3)
Exhibits
The following documents are filed herewith or incorporated herein by reference as Exhibits:
3.1
Amended and Restated Articles of Incorporation, as amended January 27, 2009 (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008).
3.2
Articles of Amendment to the Amended and Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
3.3
Bylaws as Amended and Restated (incorporated herein by reference to Exhibit 3.1 to theRegistrant’s Current Report on Form 8-K filed with the SEC on December 21, 2007).
4.1
Specimen of Registrant’s Common Stock Certificate (incorporated herein by reference toExhibit 1 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
4.2
Specimen of Registrant’s Certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
4.3
Warrant to Purchase Shares of Common Stock, dated January 30, 2009 (incorporated herein by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.1
Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).
10.2
Letter Agreement, dated as of January 30, 2009, by and between Central Virginia Bankshares, Inc. and the United States Department of the Treasury (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.3
Form of Waiver agreement between the Senior Executive Officers and Central Virginia Bankshares, Inc. (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.4
Form of Consent agreement between the Senior Executive Officers and Central Virginia Bankshares, Inc. (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.5
Change of Control Agreement dated as of April 21, 2009, by and between Central Virginia Bankshares, Inc. and Leslie S. Cundiff (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on April 24, 2009).
10.6
Written Agreement dated June 30, 2010 by and among Central Virginia Bankshares, Inc., Central Virginia Bank, the Federal Reserve Bank of Richmond, and the Commonwealth of Virginia State Corporation Commission, Bureau of Financial Institutions, (incorporated herein by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on July 6, 2010).
10.7
Employment Agreement, dated as of December 21, 2010, by and between Central Virginia Bankshares, Inc., Central Virginia Bank, and Herbert E. Marth, Jr. (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 30, 2010).
10.8
Form of Stock Award Agreement (incorporated herein by reference to Exhibit 10.10 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2010).
10.9
Compensation Agreement, effective May 1, 2011, between Central Virginia Bank and Charles F. Catlett, III (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
10.10
Compensation Agreement, effective November 1, 2011, between Central Virginia Bank and Charles F. Catlett, III (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
21.1 Subsidiaries of the Registrant (filed herewith).
23.1
Consent of Yount, Hyde & Barbour, P.C. (filed herewith).
31.1
Rule 13a-14(a) Certification of Chief Executive Officer (filed herewith
31.2
Rule 13a-14(a) Certification of Chief Financial Officer (filed herewith).
32.1
Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (filed herewith).
99.1
TARP Certification of Chief Executive Officer (filed herewith).
99.2
TARP Certification of Chief Financial Officer (filed herewith).
The following materials from the Central Virginia Bankshares, Inc. Annual Report on Form 10-K for the year ended December 31, 2011 formatted in
eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations,
(iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity,
(v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements.
(b)
See Item 15(a)(3) above.
(c)
See Item 15(a)(2) above.
CENTRAL VIRGINIA BANKSHARES, INC.
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2011
To the Shareholders and Board of Directors
Central Virginia Bankshares, Inc.
Powhatan, VA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheets of Central Virginia Bankshares, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, comprehensive income and cash flows for the three years ended December 31, 2011, 2010 and 2009. 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. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Virginia Bankshares, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of its operations and its cash flows for the three years ended December 31, 2011, 2010 and 2009 in conformity with U.S. generally accepted accounting principles.
Winchester, Virginia
March 30, 2012
See Notes to Consolidated Financial Statements.
CENTRAL VIRGINIA BANKSHARES, INC
Consolidated Balance Sheets
(Dollars in thousands except share and per share amounts)
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
(1)
Loss on write-down of securities consists of other-than-temporary impairment losses of $1.5 million, $2.4 million and $9.1 million of which $1.4 million, $2.1 million and $2.3 million is recognized in other comprehensive income and a net impairment loss of $13 thousand, $255 thousand and $6.7 million is recognized in earnings for 2011, 2010 and 2009, respectively.
CENTRAL VIRGINIA BANKSHARES, INC.
Consolidated Statements of Comprehensive Income (Loss)
(Dollars in thousands)
CENTRAL VIRGINIA BANKSHARES, INC
Consolidated Statements of Stockholders’ Equity
(dollars in thousands, except share and per share amounts)
CENTRAL VIRGINIA BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
See Notes to Consolidated Financial Statements.
(Continued)
CENTRAL VIRGINIA BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
See Notes to Consolidated Financial Statements.
CENTRAL VIRGINIA BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Principles of consolidation: The accompanying consolidated financial statements include the accounts of Central Virginia Bankshares, Inc., and its subsidiaries, Central Virginia Bank, including its subsidiary, CVB Title Services, Inc., and Central Virginia Bankshares Statutory Trust I. All significant intercompany transactions and balances have been eliminated in consolidation. ASC Topic 810 Consolidations requires that the Company no longer eliminate through consolidation the equity investment in Central Virginia Bankshares Statutory Trust I by the parent company, Central Virginia Bankshares, Inc., which equaled $155 thousand at December 31, 2011. The subordinated debt of the Trust is reflected as a liability on the Company’s consolidated balance sheet.
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles.
Nature of operations: Central Virginia Bankshares, Inc. (the “Company”) is a one-bank holding company headquartered in Powhatan County, Virginia. The Company’s subsidiary, Central Virginia Bank, (the “Bank”) provides a variety of financial services to individuals and corporate customers through its seven branches located in the Virginia counties of Powhatan, Chesterfield, Henrico, and Cumberland. The Bank’s primary deposit products are checking accounts, savings accounts, and certificates of deposit. Its primary lending products are residential mortgage, construction, installment, and commercial business loans.
Central Virginia Bank’s subsidiary, CVB Title Services, Inc., is a corporation organized under the laws of the Commonwealth of Virginia. CVB Title Services’ primary purpose is to own membership interests in two insurance-related limited liability companies.
Change in accounting policy: Effective January 1, 2011, the Company changed its accounting policy with respect to non-accrual loans. When a loan is classified as non-accrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a non-accrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Correction of an immaterial error: During the first quarter of 2011, the Company discovered an immaterial error in the accounting for the deferral of quarterly dividends on the Fixed Rate Cumulative Preferred Stock, Series A. It was determined that a liability for the payment of such deferred dividends should not have been accrued since the dividend had not been declared to be paid. Correction of this error would have decreased accrued interest payable and increased retained earnings in the amount of $569 thousand as of December 31, 2010. Correction of this error would not have impacted net income, earnings per share or any bank capital ratio calculations. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 108 (SAB 108), the Company has determined this error to be immaterial and has therefore chosen to revise the December 31, 2010 Consolidated Balance Sheet and the Consolidated Statement of Stockholders’ Equity for the year ended December 31, 2010 presented in this document. SAB 108 does not require restatement of previously filed financial statements for corrections of immaterial errors.
Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate, the valuation of securities, deferred tax assets and liabilities and fair value measurements.
A significant portion of the Bank’s loan portfolio consists of single-family residential loans in the Virginia counties of Powhatan, Chesterfield, Henrico, and Cumberland. There is also a significant concentration of loans to builders and developers in the region. Accordingly, the ultimate 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.
While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses and foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses and foreclosed real estate may change materially in the near term.
Cash and cash equivalents: For purposes of reporting the consolidated statements of cash flows, the Company includes cash on hand, amounts due from banks, federal funds sold and all highly liquid debt instruments purchased with a maturity of three months or less as cash and cash equivalents on the accompanying consolidated balance sheets. Cash flows from deposits and loans are reported net.
The Bank maintains cash accounts with other commercial banks. The amount of these deposits at December 31, 2011 exceeded the insurance limit of the FDIC by $1.7 million. The Bank has not experienced any losses in such accounts. The Bank is required to maintain average reserve and clearing balances in cash or on deposit with the Federal Reserve Bank. The total of these balances was approximately $50 thousand at both December 31, 2011 and 2010.
Securities: Investments in debt and equity securities with readily determinable fair values are classified as either held to maturity, available for sale, or trading, based on management’s intent. Currently all of the Company’s investment securities are classified as either held to maturity or available for sale. Securities are classified as held to maturity when management has the intent and the Company has the ability at the time of purchase to hold them until maturity or on a long-term basis. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Sales of these securities are generally not permitted, however if a sale occurs, gains and losses on the sale of such securities are determined by the specific identification method. A sale of a held to maturity security could occur if the security’s investment grade rating fell below the Company’s acceptable investment policy standards. Available for sale securities are carried at estimated fair value with the corresponding unrealized gains and losses excluded from earnings and reported in other comprehensive income. Gains or losses are recognized in earnings on the trade date using the amortized cost of the specific security sold. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more -likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is credit loss, the loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on the Company’s ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. Management regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the best estimate of the present value of cash flows expected to be collected from debt securities, its intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.
Mortgage loans held for sale: Mortgage loans originated and held for sale in the secondary market are reported at the lower of cost or market determined on an aggregate basis. The Bank does not retain mortgage servicing rights on loans held for sale. Substantially all mortgage loans held for sale are pre-sold to the Bank's mortgage correspondents. All sales are made without recourse. The Bank ceased all mortgage banking activities on January 1, 2011. At December 31, 2010, $1.5 million in mortgage loans held for sale were awaiting funding from the investor.
United States SBA Loan Certificates held for sale: The Company, through a business arrangement with Community Bankers Securities (“CBS”), provides temporary short-term financing for United States Government Small Business Administration Guaranteed Interest Certificates (“Certificates”) until such times as the Certificates can be aggregated into a U.S. Small Business Administration Guaranteed Loan Pool (“Pool”) by CBS. Upon assembling the requisite number of Certificates that aggregate the desired principal amount and yield, CBS repurchases the Certificates from the Bank, transferring them to the exclusive Fiscal and Transfer Agent (“FTA”) receiving in exchange, a security backed by the pool of Certificates, which is then sold by CBS to the end investor. As the Certificates represent the guaranteed portion of SBA loans, they are reported as loans held for sale. SBA loans held for sale were $307 thousand and $339 thousand as of December 31, 2011 and 2010, respectively.
Rate lock commitments: As of January 1, 2011 the Company ceased the origination of residential mortgage loans; however, during 2010, the Company was an active residential mortgage lender. The Company occasionally entered into a commitment to originate residential mortgage loans whereby the interest rate on the loan was determined prior to funding (i.e., rate lock commitments). The period of time between issuance of a loan commitment and closing and sale of the loan generally ranged from 15 to 90 days. The Company protected itself from changes in interest rates by simultaneously entering into loan purchase agreements with third party investors that provided for the investor to purchase loans at the same terms (including interest rate) as committed to the borrower. Under the contractual relationship with the purchaser of each loan, the Company was obligated to sell the loan to the purchaser only if the loan closed. No other obligation existed. As a result of those contractual relationships with purchasers of loans, the Company was not exposed to losses nor would it realize gains related to its rate lock commitments due to changes in interest rates.
Loans: Loans are stated at the amount of unpaid principal, reduced by unearned discount, partial charge-offs and an allowance for loan losses.
Unearned interest on discounted loans is amortized to income over the life of the loans, using the interest method. For all other loans, interest is accrued daily on the outstanding balances.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs and the allowance for loan losses. Interest income is accrued on the unpaid principal balance.
Loan origination and commitment fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related yield. The Bank is amortizing these amounts over the life of the loan.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Interest payments on non-accruing impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Interest payments on accruing impaired loans are recognized as interest income. Impaired loans include loans that are on non-accrual but may also include loans that are performing and paying per the terms of the loan agreement.
All current year interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. All prior year accrued interest not collected is charged off against the allowance for loan losses. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for loan losses: The allowance for loan losses reflects management’s judgment of probable loan losses inherent in the portfolio at the balance sheet date. Management uses a disciplined process and methodology to establish the allowance for loan losses each quarter. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. The allowance for loan losses consists of amounts applicable to the following portfolio segments: (1) the commercial loan portfolio, (2) the construction loan portfolio, (3) the residential real estate portfolio (mortgage and home equity), (4) the commercial real estate portfolio, and (5) the consumer loan portfolio (installment and bank cards). Each segment of loan requires significant judgment to determine the estimation method that fits the credit risk characteristics of its portfolio segment. 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 collectability of a loan balance is doubtful. 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.
The allowance consists of specific and general components. The specific component is related to doubtful and certain substandard loans. The general component covers non-classified, special mention, and certain sub-standard loans and is based on historical loss experience adjusted for qualitative factors.
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 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, construction and commercial mortgage loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogenous loans are collectively evaluated for impairment.
To determine the balance of the allowance account, loans are pooled by portfolio segment and losses are modeled using historical experience, quantitative and other mathematical techniques over the loss emergence period. Each loan segment exercises significant judgment to determine the estimation method that fits the credit risk characteristics of its portfolio segment. The Company uses a vendor supplied model in this process. Management must use judgment in establishing additional input metrics, as described below, for the modeling process. The model and assumptions used to determine the allowance are reviewed by the Asset and Liability Committee. The Board provides final approval on the methodology used for the model.
The following is how management determines the balance of the allowance account for each segment or class of loans.
Commercial loans. Commercial loans are pooled by portfolio segment and a historical loss percentage as well as an estimated years for impairment is applied. Historical loss percentages are based on actual loan charge-offs weighted over a three year period, with the most recent quarter weighted more heavily. In addition, adversely rated non-impaired loans are applied a higher percentage of the historical loss percentage as the risk rating worsens. The estimated years for impairment are based on historical loss experience over the loss emergence period. At December 31, 2011, the estimated years for impairment for commercial loans were 24 months.
Based on credit risk assessment and management’s analysis of leading predictors of losses, additional adjustment factors may be applied to loan balances. At December 31, 2011, management did not apply additional adjustment factors since the historical loss factors accurately reflected expected future losses.
Construction loans. Construction loans are pooled by portfolio class and a historical loss percentage, as well as an estimated years for impairment, is applied to each class. Historical loss percentages are based on actual loan charge-offs weighted over a three year period, with the most recent quarter weighted more heavily. In addition, adversely rated non-impaired loans are applied a higher percentage of the historical loss percentage as the risk rating worsens. The estimated years for impairment are based on historical loss experience modeling over the loss emergence period. At December 31, 2011, the estimated years for impairment for construction loans were 12 - 15 months.
Based on credit risk assessment and management’s analysis of leading predictors of losses, adjustment factors may be applied to loan balances. At December 31, 2011, management applied additional adjustment factors based on the collateral position of the Company in relation to the loan portfolio, seasoning of the portfolio with little to no new originations, historical loss trends, and management’s estimates on expected losses.
Residential real estate loans. Residential real estate loans consist of real estate residential mortgages and home equity loans and are pooled by portfolio class and a historical loss percentage, as well as an estimated years for impairment is applied to each class. Historical loss percentages are based on actual loan charge-offs weighted over a three year period, with the most recent quarter weighted more heavily. In addition, past due loans are applied a higher rate of the historical loss percentage as the past due status worsens. The estimated years for impairment are based on historical loss experience over the loss emergence period. At December 31, 2011, the estimated years for impairment for each class were as follows:
Mortgages - 12 Months
Home Equity - 12 Months
Based on management’s analysis of leading predictors of losses, adjustment factors may be applied to loan balances. At December 31, 2011, management did not apply additional adjustment factors since the historical loss factors accurately reflected expected future losses.
Commercial real estate loans: Commercial real estate loans consist of loans secured by property and may be either owner occupied or non-owner occupied, and is pooled by portfolio class and a historical loss percentage, as well as an estimated years for impairment is applied to each class. Historical loss percentages are based on actual loan charge-offs weighted over a three year period, with the most recent quarter weighted more heavily. In addition, adversely rated non-impaired loans are applied a higher rate of the historical loss percentage as the risk rating worsens. The estimated years for impairment are based on historical loss experience over the loss emergence period. At December 31, 2011, the estimated years for impairment for commercial real estate loans was 12 - 24 months.
Based on management’s analysis of leading predictors of losses, adjustment factors may be applied to loan balances. At December 31, 2011, management applied additional adjustment factors based on deterioration of performance in the market and management’s estimates on expected losses.
Installment and Bank Cards. Consumer loans (installment and bank cards) are pooled by portfolio class and an historical loss percentage is applied to each class. Historical loss percentages are based on actual loan charge-offs weighted over a three year period, with the most recent quarter weighted more heavily. In addition, past due loans are applied a higher rate of the historical loss percentage as the past due status worsens. The estimated years for impairment are based on historical loss experience modeling over the loss emergence period. At December 31, 2011, the estimated years for impairment for consumer loans was 18 months.
Based on credit risk assessment and management’s analysis of leading predictors of losses, adjustment factors may be applied to loan balances. At December 31, 2011, management applied adjustments based on risks inherent with consumer loans, current unemployment rate for the region and management’s estimates on expected losses.
The establishment of the allowance for loan losses relies on a consistent process that requires multiple layers of management review and judgment and responds to changes in economic conditions and collateral value, among other influences. From time to time, events or economic factors may affect the loan losses. The Company’s allowance for loan losses is sensitive to risk ratings assigned to individually evaluated loans and economic assumptions and delinquency trends driving statistically modeled reserves. Outsourced independent loan review periodically evaluates these risk ratings.
Management monitors differences between estimated and actual incurred loan losses. This monitoring process includes periodic assessments by senior management of loan segments and the models used to estimate incurred losses in those segments.
Reflected in the portions of the allowance previously described is an amount for imprecision or uncertainty that incorporates the range of probable outcomes inherent in estimates used for the allowance, which may change from period to period. This amount is the result of the Company’s judgment of risks inherent in the portfolios, economic uncertainties, historical loss experience and other subjective factors, including industry trends, calculated to better reflect the Company’s view of risk in each loan portfolio. No single statistic or measurement determines the adequacy of the allowance for loan loss. Changes in the allowance for loan loss and the related provision expense can materially affect net income.
Loan Charge-off Policies. The amount of the loan to be charged off determines the level of review and approval. Charge-offs (aggregated by loan number) will be reviewed and approved as designated below:
Charge-Off Amount Required Approval
No more than $9,999 Senior Credit Officer or President/CEO
$10,000 up to $300,000 Senior Loan Committee
More than $300,000 Board of Directors
The Board of Directors will receive and review a report of all charged-off loans and the total amount of charge-offs at each monthly meeting of the Board.
Troubled debt restructurings: In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.
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 - put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (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 or the ability to unilaterally cause the holder to return specific assets.
Bank premises and equipment: Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation. Expenditures for improvements and major renewals are capitalized and ordinary maintenance and repairs are charged to operations as incurred. Depreciation is not recognized on branches or banking facilities purchased or constructed until the facility is occupied and open for business. Depreciation is computed using the straight-line method over the following estimated useful lives:
Years
Buildings and improvements
5 - 39
Furniture and equipment
3 - 10
Other real estate owned: Other real estate owned represents properties acquired through foreclosure or other proceedings. Other real estate is initially recorded at the lower of the carrying amount or fair value less estimated costs to sell and any deficiency is recorded through the allowance for loan losses. Foreclosed real estate is evaluated periodically to ensure the carrying amount is supported by its current net realizable fair value. Subsequent declines in value are recorded as a loss on devaluation of other real estate owned. At December 31, 2011 the Bank held other real estate owned totaling $6.8 million and held $2.4 million at December 31, 2010. Revenue and expenses from operations are included in loss on other real estate owned.
Public relations and marketing costs: Public relations and marketing costs are generally expensed as incurred.
Intangible assets: Intangible assets, which for the Bank are the cost of acquired customer accounts, are amortized on a straight-line basis over the expected periods of benefit. The balance of intangible assets, net of accumulated amortization was $67 thousand and $82 thousand as of December 31, 2011 and 2010, respectively.
Income taxes: The provision for income taxes relates to items of revenue and expenses recognized for financial accounting purposes. The actual current liability may be more or less than the charge against earnings due to the effect of deferred income taxes.
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of December 31, 2011 and 2010, the Company has no liability accrued for unrecognized tax benefits.
Interest and penalties associated with unrecognized tax benefits would be classified as additional income taxes in the consolidated statement of operations. The Company had IRS examinations completed through 2009 that resulted in no change.
Stock Compensation Plans: The compensation cost relating to share-based payment transactions is recognized in the financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. The Company measures the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and recognizes the cost over the period the employee is required to provide services for the award.
Earnings (Loss) Per Common Share: Basic earnings (loss) per common share represents income (loss) available to common stockholders, which includes the effective dividend on preferred stock, divided by the weighted-average number of common shares outstanding during the period. Diluted (loss) earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. See Note 19.
Comprehensive Income (Loss): Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains (losses) on securities available for sale, and unrealized losses related to factors other than credit on debt securities, recognized as separate components of equity.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 21. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
Reclassifications: Certain items in the prior year consolidated financial statements have been reclassified to conform to the current year presentation.
Recent accounting pronouncements: In January 2010, the FASB issued Accounting Standards Update No. 2010-06, "Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements." ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on our consolidated financial statements.
In July 2010, the FASB issued ASU 2010-20, "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses." The new disclosure guidance significantly expands the existing requirements and lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures, will be required for periods beginning after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.
In December 2010, the FASB issued ASU 2010-28, "Intangible - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In December 2010, the FASB issued ASU 2010-29, "Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations." The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2011, the FASB issued ASU 2011-01, "Receivables Topic 310 - Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20." The amendments in this ASU temporarily delayed the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay was intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring was effective for interim and annual periods ending after June 15, 2011. The Company has adopted ASU 2011-01 and included the required disclosures in its consolidated financial statements.
The Securities Exchange Commission (SEC) has issued Final Rule No. 33-9002, "Interactive Data to Improve Financial Reporting", which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The Company has submitted financial statements in extensible business reporting language (XBRL) format with their SEC filings in accordance with the phased-in schedule.
In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In April 2011, the FASB issued ASU 2011-02, "Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring." The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company has adopted ASU 2011-02 and included the required disclosures in its consolidated financial statements.
In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company adopted ASU 2011-05 during the second quarter of 2011 and has included the required disclosures in its consolidated financial statements.
In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.” The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification. The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act. The Release was effective as of August 12, 2011. The adoption of the release did not have a material impact on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, “Intangible - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company is currently assessing the impact that ASU 2011-08 will have on its consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company is currently assessing the impact that ASU 2011-11 will have on its consolidated financial statements.
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Company is currently assessing the impact that ASU 2011-12 will have on its consolidated financial statements.
Note 2. Regulatory Matters
Over the past four years, the Company’s capital position has been negatively impacted by deteriorating economic conditions that in turn has caused losses in its investment and loan portfolios. As a result of a 2009 examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank of Richmond, the Company entered into a written agreement with the Bureau of Financial Institutions and the Federal Reserve. The written agreement requires the Company to significantly exceed the capital level required to be classified as “well capitalized.” It also provides that the Company shall:
·
submit written plans to the Bureau of Financial Institutions and the Federal Reserve to strengthen corporate governance and board and management structure;
·
strengthen board oversight of the management and operations of the Company;
·
strengthen credit risk management and administration;
·
establish ongoing independent review and grading of the Company’s loan portfolio;
·
enhance internal audit processes;
·
improve asset quality;
·
review and revise our methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;
·
maintain sufficient capital;
·
establish a revised contingency funding plan;
·
establish a revised investment policy; and
·
improve the Company’s earnings and overall condition.
The written agreement also restricts the payment of dividends and any payments on trust preferred securities or subordinated debt, and any reduction in capital or the purchase or redemption of stock without the prior approval of the Bureau of Financial Institutions and the Federal Reserve.
The Company has complied with the requirements of the written agreement, including submitting plans to significantly exceed the capital level required to be classified as “well capitalized”, improve corporate governance, strengthen board oversight of management and operations, strengthen credit risk management and administration, and improve asset quality. The Company continues to address the requirements of the written agreement, and with the exception of completing a capital raise, the Company is substantially in compliance with a majority of the requirements of the written agreement.
In addition, the Company is evaluating strategies regarding capital enhancements. Such strategies could include capital offerings, continued reduction in assets, or further management of the securities portfolio.
Note 3. Securities
The amortized cost, gross unrealized gains and losses and approximate fair value of securities available for sale at December 31, 2011 and 2010 are summarized as follows:
(1)
At December 31, 2011 and 2010, GNMA securities represented 90% and 86% of the total market value of mortgage-backed securities, respectively.
The following table presents the amortized cost and approximate fair value of securities available for sale as of December 31, 2011, by contractual maturity. 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 gross realized gains, losses and tax effect of such sales and redemptions of securities in 2011, 2010 and 2009, respectively, are shown below.
The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio includes fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary cause of temporary impairments was the increase in spreads over comparable Treasury bonds. As of December 31, 2011, there were $10.2 million in securities related to 19 individual securities that had been in a continuous loss position for more than 12 months. Additionally, these 19 securities had an unrealized loss of $5.6 million and consisted primarily of corporate and other debt. In the second quarter of 2009, the Company adopted ASC 320-10-65 Transition Related to FSP FAS 115-2 and FAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments that amended other-than-temporary impairment (“OTTI”) guidance for debt securities regarding recognition and disclosure. The major change in the guidance was that an impairment is other-than-temporary if any of the following conditions exists: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other-than-temporary and should be separated into a credit portion to be recognized in earnings and the remaining amount relating to all other factors recognized as other comprehensive loss.
During each quarter and at year-end, the Company conducts an assessment of the securities portfolio for OTTI consideration. The assessment considers factors such as external credit ratings, delinquency coverage ratios, market price, managements’ judgment, expectations of future performance and relevant industry research and analysis.
The following tables present the gross unrealized losses and fair values as of December 31, 2011 and 2010, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position:
As of December 31, 2011, the Company had three pooled trust preferred securities that were deemed to be completely OTTI based on a present value analysis of expected future cash flows. These securities had a fair value of $1 thousand and an unrealized loss of $3.6 million, of which $1 thousand was recognized in other comprehensive loss and $3.6 million which has been recognized in earnings. The following table provides further information on these three securities as of December 31, 2011:
As of December 31, 2011, the Company had five pooled trust preferred securities that were deemed to be partially OTTI based on a present value analysis of expected future cash flows. These securities had a fair value of $1.9 million and an unrealized loss of $4.9 million, of which $1.4 million was recognized in other comprehensive loss and $3.4 million which has been recognized in earnings. The following table provides further information on these five securities as of December 31, 2011:
(Dollars in 000’s)
Security
Class
Current
Moody’s
Ratings
(Lowest
Assigned
Rating)
Amortized Cost
Fair
Value
Unrealized
Loss
Current Defaults and Deferrals
% of Current Defaults and Deferrals to Current Collateral
Excess
Sub (1)
Estimated Incremental Defaults Required to Break Yield (2)
Cumulative
Other
Comprehensive
(Gain) Loss
Amount of
OTTI
Related to
Credit
Loss
PreTSL II
Mez
Ca
$2,310
$571
$1,739
$119,000
48.3%
(69.94)%
BROKEN
$363
$1,376
PreTSL XII
B-3
Ca
2,011
1,507
$247,100
33.9%
(37.33)%
BROKEN
PreTSL XXIII
D-1
NR
1,000
$343,500
26.8%
(26.37)%
BROKEN
(56)
1,000
Preferred CPO Ltd
B/C
Ba3
$26,100
43.2%
(22.69)%
BROKEN
Reg Div Fund
Senior
Ca
1,088
$53,000
35.0%
(30.00)%
BROKEN
$ 6,753
$ 1,884
$ 4,869
$ 1,447
$ 3,422
(1)
Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are otherwise the same and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.
(2)
A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.
As of December 31, 2011, the Company had three pooled trust preferred securities that were deemed to be temporarily impaired based on a present value analysis of expected future cash flows. The securities had a fair value of $1.2 million. The following table provides further information on these securities as of December 31, 2011:
(Dollars in 000’s)
Security
Class
Current
Moody’s
Ratings
(Lowest
Assigned
Rating)
Amortized Cost
Fair
Value
Unrealized
Loss
Current Defaults and Deferrals
% of Current Defaults and Deferrals to Current Collateral
Excess
Sub (1)
Estimated Incremental Defaults Required to Break Yield (2)
Cumulative
Other
Comprehensive
Loss
Amount of
OTTI
Related to
Credit
Loss
PreTSL XXIII (3)
C-2
C
$498
$154
$344
$343.500
26.8%
(14.71)%
BROKEN
$344
$ -
i-PreTSL III
B-3
B2
1,500
$58,400
18.0%
7.56%
$21,474
-
i-PreTSL IV
B-2
Ba2
1,000
$23,000
8.4%
10.46%
$26,114
-
$ 2,998
$1,167
$1,831
$1,831
$ -
(1)
Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are otherwise the same and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.
(2)
A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.
(3)
While there is a negative excess subordination, the projected discounted cash flows at contractual rate exceed the amortized cost of the security; therefore, there is no OTTI on the security.
During 2009, the Company recorded OTTI related to its investments in Collateralized Debt Obligations (CDO’s) of $6.7 million.
The Company’s investment in Federal Home Loan Bank (FHLB) stock totaled $2.7 million at December 31, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider this investment to be other-than-temporarily impaired at December 31, 2011 and no impairment has been recognized. FHLB stock is included with other assets on the balance sheet and is not a part of the available for sale securities portfolio.
The following table presents a roll-forward of the cumulative credit loss component amount of OTTI recognized in earnings:
Available for Sale Securities with an amortized cost of $18.0 million and $4.5 million and a market value of $18.1 million and $4.5 million and Held to Maturity Securities with an amortized cost of $1.4 million and $1.8 million and a market value of $1.4 million and $1.8 million at December 31, 2011 and 2010, respectively, were pledged as collateral for repurchase agreement borrowings with correspondent banks and for public deposits and for other purposes as required or permitted by law.
Securities Held to Maturity
The amortized cost, gross unrealized gains and losses and estimated fair value of securities being held to maturity at December 31, 2011 and 2010 are summarized as follows:
The amortized cost and approximate fair value of securities being held to maturity at December 31, 2011, by contractual maturity, are shown below.
During the year ended December 31, 2011, the Company sold a held to maturity municipal security with a carrying value of $501 thousand. The Company sold the security because the security’s investment grade rating fell below the Company’s acceptable investment policy standards. The security was sold for $498 thousand and a loss of $3 thousand was recorded relating to the sale.
Note 4. Loans
Major classification of gross loans, unearned discount and allowance for loan losses at December 31, 2011 and 2010 are as follows:
At December 31, 2011 and 2010, overdraft demand deposit accounts totaling $111 thousand and $89 thousand, respectively, were reclassified as loans within the Installment loan category.
Credit Quality. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans. For consumer and residential loans, the Company believes that performance and delinquency status is a better indicator of credit quality; therefore, the Company does not generally risk grade consumer or residential loans. In general, commercial loans are risk graded; however, there may be certain instances whereby these loans are not risk graded, such as when loans are approved by branch lenders under their loan authority. In general, construction loans are risk graded; however, in instances where construction loans are for residential purposes, these loans are considered to be consumer loans and are not risk graded.
The Company’s internally assigned grades are as follows:
Pass - No change in credit rating of borrower and loan-to-value ratio of asset;
Weak Pass - Weakening of borrower’s debt capacity, earnings and cash flows;
Special Mention - Deterioration in the credit rating of borrower;
Sub-Standard - Deteriorating financial position of borrower, possibility of loss exists if corrective action is not taken;
Doubtful - Bankruptcy exists or is highly probable; and
Loss - Borrowers deemed incapable of repayment of debt.
The following table represents credit exposures by internally assigned grades for the year ended December 31, 2011.
The following table shows a breakdown of loans that are not risk rated in the table above:
The following table represents credit exposures by internally assigned grades for the year ended December 31, 2010.
The following table shows a breakdown of loans that are not risk rated in the table above:
Changes in the allowance for loan losses for the years ended December 31, 2010 and 2009 were as follows:
The following table details activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2011 and the Company’s recorded investment in loans as of December 31, 2011 related to each balance in the allowance for loan losses. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
The following table details activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2010 and the Company’s recorded investment in loans as of December 31, 2010 related to each balance in the allowance for loan losses. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
Impaired Loans. Impaired loans include loans that are on non-accrual but may also include loans that are performing and paying per the terms of the loan agreement. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on non-accruing impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Interest payments on accruing impaired loans are recognized as interest income. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Year-end impaired loans as of December 31, 2011 are set forth in the following table.
Year-end impaired loans as of December 31, 2010 are set forth in the following table.
Generally, no additional funds are committed to be advanced in connection with our impaired loans. Impaired loans include loans that are on non-accrual but may also include loans that are performing and paying per the terms of the loan agreement. The Company has identified performing loans as impaired because either (1) they are related to construction and development loans where the underlying project is delayed, or (2) the fair value of the collateral supporting the loan may be less than the loan amount even though the loan is current. At the time that the loan becomes ninety days past due, the Company will generally put the loan on non-accrual, unless the loan is well-secured and in the process of collection.
Troubled Debt Restructurings (TDRs): In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). When loans are modified under the terms of a TDR, the Company typically offers the borrower an extension of the loan, maturity date and/or a reduction in the original contractual interest rate.
The number and outstanding recorded investment of loans entered into under the terms of a TDR during the year ended December 31, 2011, by type of concession granted, are set forth in the following table:
Troubled debt restructured loans are considered to be in default if the borrower fails to make timely payments under the terms of the restructure and repayment possibilities have been exhausted. The table below shows troubled debt restructurings that defaulted within one year during the year ended December 31, 2011:
As of December 31, 2011, loans classified as troubled debt restructurings and included as impaired loans in the impaired disclosure above totaled $9.3 million. At December 31, 2011, $7.8 million of the loans classified as troubled debt restructurings are in compliance with the modified terms, and $1.3 million have paid per the terms of the restructuring; however, they remain on non-accrual. There were $8.5 million in troubled debt restructurings at December 31, 2010. There were no troubled debt restructurings at December 31, 2009.
Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The following is a table which includes an aging analysis of the recorded investment of past due loans as of December 31, 2011.
The following is a table which includes an aging analysis of the recorded investment of past due loans as of December 31, 2010.
The following is a summary of information pertaining to impaired and nonaccrual loans at December 31, 2009:
The following is a summary of the average investment in impaired loans and interest income recognized on impaired loans for the year ended December 31, 2009:
(Dollars in 000’s)
December 31,
Average investment in impaired loans
$ 8,307
Interest income recognized on a cash basis on impaired loans
$387
Interest in the amount of $1.2 million, $1.2 million and $0.9 million would have been recognized if non-accrual loans had been current and in paying in accordance with their terms during the years ended December 31, 2011, 2010 and 2009, respectively.
Note 5. Other Real Estate Owned
Other real estate owned represents properties acquired through foreclosure or other proceedings. Other real estate owned is recorded at the lower of the carrying amount or fair value less estimated costs to sell. Other real estate owned is evaluated periodically to ensure the carrying amount is supported by its current fair value. The table below presents a summary of the activity related to other real estate owned:
Expenses applicable to other real estate owned included the following:
Note 6. Bank Premises and Equipment
Major classifications of bank premises and equipment and the total accumulated depreciation at December 31, 2011 and 2010 are as follows:
Depreciation expense for the years ending December 2011, 2010 and 2009 was $572 thousand, $676 thousand and $759 thousand, respectively.
Note 7. Investment in Bank Owned Life Insurance
The Bank is owner and designated beneficiary on life insurance policies maintained on certain of its officers and directors. The earnings from these policies are used to offset increases in employee benefit costs. The cash surrender value of these policies was $10.6 million and $10.2 million at December 31, 2011 and 2010, respectively.
Note 8. Maturities of Time Deposits
The aggregate amount of time deposits in denominations of $100,000 or more as of December 31, 2011 and 2010 was $48.9 million and $60.6 million, respectively. As of December 31, 2011, the scheduled maturities of time deposits are as follows:
Note 9. FHLB and Other Borrowings
Federal Home Loan Bank borrowings: The borrowings from the Federal Home Loan Bank of Atlanta, Georgia, are secured by qualifying residential and commercial first mortgage loans, qualifying home equity loans and certain specific investment securities. The borrowings with the FHLB have prepayment fees associated with them; therefore, the Company cannot prepay without incurring fees. The Company, through its principal subsidiary, Central Virginia Bank, has available unused borrowing capacity from the Federal Home Loan Bank totaling $0.9 million. The borrowings at December 31, 2011 and 2010, consist of the following and had a weighted-average interest rate of 3.60%:
The contractual maturities of FHLB advances as of December 31, 2011 are as follows (dollars in thousands):
Other borrowings: Total short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. Federal funds purchased would also be included in our short-term borrowings; however, no federal funds were purchased at December 31, 2011 or 2010.
Securities sold under agreements to repurchase amounted to zero and $2.0 million at December 31, 2011 and 2010, respectively. These borrowings matured daily and were secured by U.S. Government Agency securities with fair values of $2.2 million at December 31, 2010. The rates of interest were 0.75% for the year ended December 31, 2010. Repurchase agreements for customers total $1.4 million at December 31, 2011 and $1.0 million at December 31, 2010. These borrowings mature daily and are secured by U.S. Government Agency securities with fair values of $2.0 million at December 31, 2011 and $2.0 million at December 31, 2010. Interest rates of 0.125% and 0.35% were paid on these borrowings for the years ended December 31, 2011 and 2010, respectively.
(Dollars in 000’s)
Securities sold under agreements to repurchase
$1,393
$2,973
Maximum month-end outstanding balance
$3,753
$8,120
Average outstanding balance during the year
$1,927
$3,566
Average interest rate during the year
0.40%
0.62%
Average interest rate at end of year
0.125%
0.62%
Borrowing facilities: The Bank has entered into various borrowing arrangements with other financial institutions for federal funds and other borrowings. The total amount of borrowing facilities available as of December 31, 2011 totaled $126.6 million, of which $85.2 million remained available to borrow. The total amount of borrowing facilities as of December 31, 2010 totaled $121.1 million, of which $79.1 million remains available to borrow.
Note 10. Capital Trust Preferred Securities
Capital trust preferred securities represent preferred beneficial interests in the assets of Central Virginia Bankshares Statutory Trust I (Trust). The Trust holds $5.2 million in floating rate junior subordinated debentures due December 17, 2033, issued by the Company on December 17, 2003. Distributions on the $5.0 million in Preferred Securities are payable quarterly at an annual rate of three-month LIBOR plus 2.85% (3.43% and 3.14% at December 31, 2011 and 2010 respectively). However, the Company has the option to defer distributions for up to five years. Cash distributions on the Preferred Securities are made to the extent interest on the debentures is received by the Trust. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the Preferred Securities are redeemable in whole. Otherwise, the Preferred Securities are generally redeemable by the Company in whole or in part on or after December 17, 2008, at 100% of the liquidation amount. The Trust’s obligations under the Preferred Securities are fully and unconditionally guaranteed by the Company. For regulatory purposes, the Preferred Securities are considered a component of Tier I capital.
On March 4, 2010 the Company notified U.S. Bank, National Association that pursuant to Section 2.11 of the Indenture dated December 17, 2003 among Central Virginia Bankshares, Inc. as Issuer and U.S. Bank, National Association, as Trustee for the $5.2 million Floating Rate Junior Subordinated Deferrable Interest Debentures due 2033, (CUSIP 155793AA0), the Board of Directors of Central Virginia Bankshares, Inc. had determined to defer the regular quarterly Interest Payments on such Debentures, effective March 31, 2010. As of December 31, 2011 the total arrearage on such interest payments is $341 thousand, which is included in accrued interest payable.
Note 11. Income Tax Matters
The Company files income tax returns in the U.S. federal jurisdiction and the Commonwealth of Virginia. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2008. The Company and the Bank file a consolidated federal income tax return. The Company has federal net operating losses of $15.8 million available to offset future taxable income, which portions thereof will expire at various times through 2031. The consolidated income tax (benefit) for the years ended December 31, 2011, 2010, and 2009, are as follows:
A reconciliation of the expected income tax expense computed at 34% to the income tax expense (benefit) included in the consolidated statements of operations for the years ended December 31, 2011, 2010 and 2009 follows:
The components of the net deferred tax asset are as follows at December 31, 2011 and 2010:
As of both December 31, 2011 and 2010, the Company had recorded net deferred income tax assets (DTA) of zero. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is ‘more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Management’s assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company’s core earnings capacity and its prospects to generate core earnings in the future. Projections of core earnings and taxable income are inherently subject to uncertainty and estimates that may change given an uncertain economic outlook, banking industry conditions and other factors. Management is considering certain transactions that would increase the likelihood that a DTA will be realized. Execution of certain transactions may be considered viable but changing market conditions, tax laws, and other factors could affect the success thereof. At December 31, 2011, management conducted such an analysis and determined that an establishment of a valuation allowance of $14.8 million was prudent given our recent three year operating losses.
Note 12. Other Operating Expenses
The following table summarizes the details of other operating expenses for the years ended December 31, 2011, 2010 and 2009:
Note 13. Defined Contribution Plan
The Bank provides a qualified defined contribution plan for all eligible full-time and part-time employees. The plan is governed by ERISA and the plan document. The plan is administered through the Virginia Bankers Association Benefits Corporation and may be amended or terminated by the Board of Directors at any time. The defined contribution plan is comprised of two components, Profit-Sharing and the 401K. Once eligible and participating, employees are 100% vested in all employer and employee contributions.
Profit-Sharing: This portion of the plan is discretionary and is based on the profitability of the Company on an annual basis. The Board of Directors approves the Company’s profit-sharing contribution percentage annually. The approved contribution amount is credited to the participant’s individual account during the first quarter of each year for the prior year. The Company did not make a profit-sharing contribution in 2009, 2010 or 2011.
401K: This portion of the plan provides for employee contributions of a portion of their eligible wages on a pre-tax basis subject to statutory limitations. Prior to November 1, 2010, the Bank provided a matching contribution of $1.00 for every $1.00 the participant contributes up to 3% of the participant’s eligible wages and $.50 for every $1.00 contributed of the next 2% of their eligible wages. Effective November 1, 2010, the Company suspended employer 401K contributions to the plan.
The total contributions to both of the above plans for the years ended December 31, 2011, 2010, and 2009, were zero, $119 thousand and $161 thousand, respectively.
Note 14. Supplemental Executive Retirement Agreements
The Bank has established a Supplemental Executive Retirement Plan, (the “SERP”), a nonqualified, unfunded, defined benefit arrangement for selected executive and senior officers of the Bank as designated by the Board of Directors. The participants in the SERP as of December 31, 2011 include the three executive officers as well as four other senior officers. The costs associated with this plan, as well as several other general employee benefit plans are partially offset by earnings attributable to the Bank’s purchase of single premium Bank Owned Life Insurance (“BOLI”). The SERP provides an annual award equal to 25 percent of the participant’s final compensation, payable monthly over a 15-year period, following normal retirement at age 65, provided the participant has been employed by the Bank for a minimum of 8 years. A further provision exists for early retirement beginning at age 60, subject to the same 8-year service requirement, but with reduced benefits depending on the number of years preceding age 65 the participant elects to retire. Should the participant’s employment terminate due to disability or death, and the requirements necessary to receive a supplemental benefit under the SERP have otherwise been met, the benefit shall be paid to the participant or the surviving spouse. No benefits are payable should the participant’s employment terminate for any reason other than retirement, disability, death, or a change in control. The Company calculates the adequacy of the total accrued SERP liability as well as the annual expense to be recorded each year.
The accrued liability payable at December 31, 2011 and 2010 totaled $1.9 million and $1.8 million, respectively. The Company recorded expense related to the plan of $163 thousand, income of $97 thousand and expense of $249 thousand for 2011, 2010, and 2009, respectively.
Note 15. Commitments and Contingencies
Financial instruments with off-balance-sheet risk: The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. A summary of the Bank’s commitments at December 31, 2011 and 2010 is as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Unfunded commitments under commercial lines-of-credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines-of-credit are uncollateralized and usually do not contain a specified maturity date and ultimately may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary.
Concentrations of credit risk: All of the Bank’s loans, commitments to extend credit, and standby letters of credit have been granted to customers within the state and, more specifically, the area surrounding Richmond, Virginia. The concentrations of credit by type of loan are set forth in Note 4. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the agribusiness and construction sectors of the economy.
Note 16. Related Party Transactions
The Company’s banking subsidiary has had, and may be expected to have in the future, banking transactions in the ordinary course of business with directors, officers, their immediate families, and affiliated companies in which they are principal stockholders (commonly referred to as related parties), all of which have been, in the opinion of management, on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Total related party deposits were $1.9 million and $1.5 million at December 31, 2011 and 2010, respectively.
Aggregate loan transactions with related parties for the year ended December 31, 2011 and 2010 were as follows:
Note 17. Preferred Stock and Warrant
On January 22, 2009, the Company held a Special Meeting of Shareholders for the purpose of approving an amendment and restatement of the Articles of Incorporation of Central Virginia Bankshares, Inc. to authorize the issuance of preferred stock. The primary purpose of authorizing preferred stock was to allow participation in the Capital Purchase Program (“Capital Purchase Program”) established by the U.S. Department of the Treasury (“Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”). At the meeting, affirmative votes were received from not less than two-thirds of the shares of common stock then outstanding thereby approving the amendment of the Articles of Incorporation and authorizing the Company to issue up to 1,000,000 shares of preferred stock.
On January 30, 2009, as part of the Capital Purchase Program, the Company issued and sold to Treasury for an aggregate purchase of $11,385,000 in cash (i) 11,385 shares of the Company’s fixed rate cumulative perpetual preferred stock, Series A, par value $1.25 per share, having a liquidation preference of $1,000 per share (“Series A Preferred Stock”) and (ii) a ten-year warrant to purchase up to 263,542 shares of the Company’s common stock, par value $1.25 per share (“Common Stock”), at an initial exercise price of $6.48 per share (“Warrant”). The Series A Preferred Stock may be treated as Tier 1 capital for regulatory capital adequacy determination purposes.
Cumulative dividends on the Series A Preferred Stock will accumulate on the liquidation preference at a rate of 5% per annum until January 30, 2014, and at a rate of 9% per annum thereafter. The Series A Preferred Stock has no maturity date and ranks senior to the Common Stock with respect to the payment of dividends. The Company may redeem the Series A Preferred Stock at 100% of their liquidation preference (plus any accrued and unpaid dividends).
The purchase agreement pursuant to which the Series A Preferred Stock and the Warrant were sold subjects the Company to certain of the executive compensation limitations included in the EESA until such time as Treasury no longer owns any debt or equity securities acquired through the Capital Purchase Program.
On February 12, 2010, the Company notified the U.S. Department of the Treasury that the Board of Directors of the Company determined that the payment of the quarterly cash dividend of $142 thousand due on February 16, 2010, and subsequent quarterly payments on the Fixed Rate Cumulative Preferred Stock, Series A, should be deferred. The total arrearage on such preferred stock as of December 31, 2011 is $1.1 million.
Note 18. Stock-Based Compensation
The Company has a Stock Plan that provides for the grant of Stock Options up to a maximum of 341,196 shares of common stock of which 162,958 shares have not been issued. This Plan was adopted to foster and promote the long-term growth and financial success of the Company by assisting in recruiting and retaining directors and key employees by enabling individuals who contribute significantly to the Company to participate in its future success and to associate their interests with those of the Company. The options were granted at the market value on the date of each grant. The maximum term of the options is ten years.
The following table presents a summary of options under the Plan at December 31, 2011:
Shares
Weighted Average Exercise Price
Aggregate Intrinsic Value(1)
Outstanding at beginning of year
19,331
$18.46
$ -
Granted
-
-
Exercised
-
-
Forfeited
(8,328)
18.18
$ -
Outstanding at end of year
11,003
$18.67
$ -
Options exercisable at year-end
11,003
$18.67
$ -
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2011. This amount changes based on changes in the market value of the Company’s stock.
Information pertaining to options outstanding at December 31, 2011 is as follows:
Restricted Stock: During the year ended December 31, 2011, the Company granted 48,439 restricted stock under the Company’s Stock Incentive Plan to the Company’s Officers. The restricted stock will vest over a three year period from the date of grant. All grantees of restricted stock are entitled to receive all dividends and distributions (also known as “dividend equivalent rights”) paid with respect to the common shares of the Company underlying such restricted stock at the time such dividends or distributions are paid to holders of common shares.
The Company recognizes compensation expense for outstanding restricted stock over their vesting periods for an amount equal to the fair value of the restricted stock at grant date. Fair value is determined by the price of the common shares underlying the restricted stock on the grant date. As of December 31, 2011, there was $59 thousand of total unrecognized compensation cost related to non-vested restricted stock granted under the Stock Plan. That cost is expected to be recognized over a weighted-average period of 3 years. The Company recorded $25 thousand of compensation expense related to restricted stock during the year ended December 31, 2011.
A summary of the status of the Company’s non-vested restricted stock as of December 31, 2011, and changes during the year ended December 31, 2011, is presented below:
Note 19. Earnings (Loss) Per Common Share
The following data show the amounts used in computing income or loss per common share and the effect on income and the weighted average number of shares of dilutive potential common stock for the years ended December 31, 2011, 2010 and 2009.
(1) The weighted average number of common shares includes the effect of 47,689 restricted shares.
For 2011, 2010 and 2009, stock options for 11,003, 19,331 and 21,789 shares of common stock, respectively, were not considered in computing diluted earnings per common share because they were anti-dilutive.
Note 20. Regulatory Capital Requirements
The Company (on a consolidated basis) and Bank are subject to various regulatory capital requirements administered by its primary federal regulator, the Federal Reserve Bank. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios as set forth in the table below of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2011, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2011, the most recent notification from the Federal Reserve Bank categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as such, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.
Because the Bank’s total risk-based capital ratio was below 10% as of December 31, 2011, we are considered to be only “adequately capitalized” under the regulatory framework for prompt corrective action. Similarly, the Bank is considered to be “adequately capitalized” under applicable regulations as of December 31, 2011. Section 29 of the Federal Deposit Insurance Act limits the use of brokered deposits by institutions that are less than “well-capitalized” and allows the FDIC to place restrictions on interest rates that institutions may pay.
On May 29, 2009, the FDIC approved a final rule to implement new interest rate restrictions on institutions that are not “well-capitalized”. The rule, which became effective on January 1, 2010, limits the interest rate paid by such institutions to 75 basis points above a national rate, as derived from the interest rate average of all institutions. On December 4, 2009, the FDIC issued a Financial Institution Letter, FIL-69-2009, which requires institutions that are not well-capitalized to request a determination from the FDIC whether they are operating in an area where rates paid on deposits are higher than the national rate. The Financial Institution Letter allows the institutions that submit determination requests by December 31, 2009 to follow the national rate for local customers by March 1, 2010, if determined not to be operating in a high rate area. Regardless of the determination, institutions must use the national rate caps to determine conformance for all deposits outside the market area beginning January 1, 2010.
Although there can be no assurance that we will be successful, the Board and management will make their utmost efforts to regain “well-capitalized” status at all levels, and we are continuing to explore options for raising additional capital as well as other strategies including continued reduction in assets or further management of the securities portfolio.
Banking laws and regulations limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency. Under that limitation, the Bank could have declared no additional dividends in 2011 or 2010 without regulatory approval.
Note 21. Fair Value Measurements
As required by FASB ASC Topic 820, the Company must record fair value adjustments to certain assets and liabilities required to be measured at fair value and to determine fair value disclosures. Topic 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
ASC 820-10-35 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:
Level 1 -
Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 -
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 -
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or substantially similar securities by using pricing models that consider observable market data (Level 2). The Company uses an independent valuation firm that specializes in valuing debt securities (Level 3). The independent firm evaluates all relevant credit and structural aspects of each debt security, determining appropriate performance assumptions and performing discounted cash flow analysis. The following topics are covered in their evaluation:
·
Detailed credit and structural evaluation for each piece of collateral in the debt security;
·
Collateral performance projections for each piece of collateral in the debt security;
·
Terms of the debt security structure; and
·
Discounted cash flow modeling.
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 and December 31, 2010:
The table below presents reconciliation and statements of income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2011:
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Other real estate owned: Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at the lesser of book value or fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by Management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation are included in net expenses from foreclosed assets. Level 2 for other real estate owned is determined in a manner similar to that described below for impaired loans.
Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market and SBA loan certificates held pending being pooled into an SBA security. Fair value is based on the price secondary markets are currently offering for similar loans and SBA certificates using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the year ended December 31, 2011. Gains and losses on the sale of loans are recorded within other service charges, commissions and fees on the Consolidated Statements of Operations.
Impaired loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period.
ASC 820-10-50 “Disclosures about Fair Value of Financial Instruments,” requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.
The following methods and assumptions were used by the Company and subsidiary in estimating the fair value of financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.
Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable or substantially similar instruments or pricing models that consider observable market data.
Mortgage and SBA loans held for sale: Fair values for loans held for sale are based on quoted market prices.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Accrued interest receivable and accrued interest payable: The carrying amounts of accrued interest receivable and accrued interest payable approximate their fair values.
Deposit liabilities: The fair values of demand deposits equal their carrying amounts which represents the amount payable on demand. The carrying amounts for variable-rate fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected maturities on time deposits.
Federal funds purchased and securities sold under repurchase agreements: The carrying amounts for federal funds purchased and securities sold under repurchase agreements approximate their fair values.
FHLB borrowings: The fair value of FHLB borrowings is estimated by discounting its future cash flows using net rates offered for similar borrowings.
Capital trust preferred securities: The carrying amount of the capital trust preferred securities approximates their fair values as they are variable based securities. The Company’s estimate assumes a current spread to LIBOR similar to its existing debt because there is no current market for similar borrowings.
At December 31, 2011 and 2010, the Company had outstanding standby letters of credit and commitments to extend credit. These off-balance sheet financial instruments are generally exercisable at the market rate prevailing at the date the underlying transaction will be completed, and, therefore, they were deemed to have an immaterial affect on the current fair market value.
Note 22. Condensed Parent-Only Financial Statements
Financial statements for Central Virginia Bankshares, Inc., are presented below.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
March 30, 2012
/s/ Herbert E. Marth, Jr.
Herbert E. Marth, Jr.
President and Chief Executive Officer; Director
(Principal Executive Officer)
March 30, 2012
/s/ Robert B. Eastep
Robert B. Eastep
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
March 30, 2012
/s/ James T. Napier
James T. Napier
Chair of the Board of Directors
March 30, 2012
/s/ Roseleen P. Rick
Roseleen P. Rick
Vice Chair of the Board of Directors
March 30, 2012
/s/ Elwood C. May
Elwood C. May
Secretary of the Board of Directors
March 30, 2012
/s/ Kemper W. Baker, Jr.
Kemper W. Baker, Jr.
Director
March 30, 2012
/s/ Clarke C. Jones
Clarke C. Jones
Director
March 30, 2012
/s/ William C. Sprouse, Jr.
William C. Sprouse, Jr.
Director
March 30, 2012
/s/ Phoebe P. Zarnegar
Phoebe P. Zarnegar
Director
EXHIBITS INDEX
Item No.
Description
3.1
Amended and Restated Articles of Incorporation, as amended January 27, 2009 (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008).
3.2
Articles of Amendment to the Amended and Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
3.3
Bylaws as Amended and Restated (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 21, 2007).
4.1
Specimen of Registrant’s Common Stock Certificate (incorporated herein by reference to Exhibit 1 to the Registrant’s Form 8-A filed with the SEC on May 2, 1994).
4.2
Specimen of Registrant’s Certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
4.3
Warrant to Purchase Shares of Common Stock, dated January 30, 2009 (incorporated herein by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.1
Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).
10.2
Letter Agreement, dated as of January 30, 2009, by and between Central Virginia Bankshares, Inc. and the United States Department of the Treasury (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.3
Form of Waiver agreement between the Senior Executive Officers and Central Virginia Bankshares, Inc. (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.4
Form of Consent agreement between the Senior Executive Officers and Central Virginia Bankshares, Inc. (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 4, 2009).
10.5
Change of Control Agreement dated as of April 21, 2009, by and between Central Virginia Bankshares, Inc. and Leslie S. Cundiff (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on April 24, 2009).
10.6
Written Agreement dated June 30, 2010, by and among Central Virginia Bankshares, Inc., Central Virginia Bank, the Federal Reserve Bank of Richmond, and the Commonwealth of Virginia State Corporation Commission, Bureau of Financial Institutions, (incorporated herein by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on July 6, 2010).
10.7
Employment Agreement dated as of December 21, 2010, by and between Central Virginia Bankshares, Inc., Central Virginia Bank, and Herbert E. Marth, Jr. (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 31, 2010).
10.8
Form of Stock Award Agreement (incorporated herein by reference to Exhibit 10.10 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2010).
10.9
Compensation Agreement, effective May 1, 2011, between Central Virginia Bank and Charles F. Catlett, III (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
10.10
Compensation Agreement, effective November 1, 2011, between Central Virginia Bank and Charles F. Catlett, III (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
21.1
Subsidiaries of the Registrant (filed herewith).
23.1
Consent of Yount, Hyde & Barbour, P.C. (filed herewith).
31.1
Rule 13a-14(a) Certification of Chief Executive Officer (filed herewith).
31.2
Rule 13a-14(a) Certification of Chief Financial Officer (filed herewith).
32.1
Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (filed herewith).
99.1
TARP Certification of Chief Executive Officer (filed herewith).
99.2
TARP Certification of Chief Financial Officer (filed herewith).
The following materials from the Central Virginia Bankshares, Inc. Annual Report on Form 10-K for the year ended December 31, 2011 formatted in eXtensible Business Reporting Language (XBRL); (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.