UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2010
Commission File No. 001-33037
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
6830 Old Dominion Drive
McLean, Virginia 22101
(Address of principal executive offices) (zip code)
(703) 893-7400
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ¨ NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b–2 of the Exchange Act:
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of August 2, 2010, there were 11,590,212 shares of common stock outstanding.
June 30, 2010
INDEX
Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009
Consolidated Statements of Income and Comprehensive Income (Loss) for the three and six months ended June 30, 2010 and 2009
Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2010
Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009
Notes to Consolidated Financial Statements
ITEM I - FINANCIAL INFORMATION
PART I - FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts) (Unaudited)
Cash and due from financial institutions
Interest-bearing deposits in other financial institutions
Total cash and cash equivalents
Securities available for sale, at fair value
Securities held to maturity, at amortized cost (fair value of $53,746 and $57,841, respectively)
Total loans, net of unearned income
Less allowance for loan losses
Net loans
Stock in Federal Reserve Bank and Federal Home Loan Bank
Bank premises and equipment, net
Goodwill
Core deposit intangibles, net
FDIC indemnification asset
Bank-owned life insurance
Other real estate owned
Deferred tax assets, net
Other assets
Total assets
Noninterest-bearing demand deposits
Interest-bearing deposits:
NOW accounts
Money market accounts
Savings accounts
Time deposits
Total interest-bearing deposits
Total deposits
Securities sold under agreements to repurchase and other short-term borrowings
Federal Home Loan Bank (FHLB) advances
Other liabilities
Total liabilities
Commitments and contingencies (See Note 5)
Stockholders’ equity:
Preferred stock, $.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding
Common stock, $.01 par value. Authorized 45,000,000 shares; issued and outstanding, 11,590,212 shares at June 30, 2010 and December 31, 2009
Additional paid in capital
Retained earnings
Accumulated other comprehensive loss
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)
Interest and dividend income :
Interest and fees on loans
Interest and dividends on taxable securities
Interest and dividends on other earning assets
Total interest and dividend income
Interest expense:
Interest on deposits
Interest on borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income:
Account maintenance and deposit service fees
Income from bank-owned life insurance
Net gain on other real estate owned
Gain on sales of securities available for sale
Total other-than-temporary impairment losses
Portion of loss recognized in other comprehensive income (before taxes)
Net credit impairment losses recognized in earnings
Other
Total noninterest income (loss)
Noninterest expenses:
Salaries and benefits
Occupancy expenses
Furniture and equipment expenses
Amortization of core deposit intangible
Virginia franchise tax expense
FDIC assessment
Data processing expense
Telephone and communication expense
Decrease in FDIC indemnification asset
Other operating expenses
Total noninterest expenses
Income (loss) before income taxes
Income tax expense (benefit)
Net income
Other comprehensive income (loss):
Unrealized gain on available for sale securities
Realized amount on securities sold, net
Non-credit component of other-than-temporary impairment on held-to-maturity securities
Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale
Net unrealized gain (loss)
Tax effect
Other comprehensive income (loss)
Comprehensive income (loss)
Earnings per share, basic and diluted
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2010
Balance—January 1, 2010
Stock-based compensation expense
Additional cost of 2009 common stock issuance
Comprehensive income:
Change in unrealized gain on available-for-sale securities (net of tax, $75)
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $16 and accretion, $61 and amounts recorded into other comprehensive income at transfer)
Total comprehensive income
Balance—June 30, 2010
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CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(dollars in thousands) (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation
Other amortization , net
Earnings on bank-owned life insurance
Stock based compensation expense
Gain on sales of securities
Impairment on securities
Net increase in other assets
Net decrease in other liabilities
Net cash and cash equivalents provided by operating activities
Investing activities:
Proceeds from sales of securities available for sale
Proceeds from paydowns, maturities and calls of securities available for sale
Purchases of securities held to maturity
Proceeds from paydowns, maturities and calls of securities held to maturity
Loan originations and payments, net
Net increase in stock in Federal Reserve Bank and Federal Home Loan Bank
Proceeds from sale of other real estate owned
Purchases of bank premises and equipment
Net cash and cash equivalents used in investing activities
Financing activities:
Net increase (decrease) in deposits
Proceeds from Federal Home Loan Bank advances
Net decrease in securities sold under agreement to repurchase and other short-term borrowings
Net cash and cash equivalents provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest
Income taxes
Supplemental schedule of noncash investing and financing activities
Transfer from non-covered loans to other real estate owned
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Notes to Consolidated Financial Statements (Unaudited)
1. ACCOUNTING POLICIES
Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state chartered bank which commenced operations on April 14, 2005. The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations. Sonabank operates 12 branches in Virginia located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Leesburg (2), South Riding, Front Royal, New Market and Clifton Forge, and we also have a branch in Rockville, Maryland.
The consolidated financial statements include the accounts of Southern National Bancorp of Virginia, Inc. and its subsidiary. Significant inter-company accounts and transactions have been eliminated in consolidation.
The unaudited consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles (“U. S. GAAP”) for interim financial information and instructions for Form 10-Q and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by U. S. GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in SNBV’s Form 10-K for the year ended December 31, 2009.
Use of Estimates
The preparation of the consolidated 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 at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these 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 carrying value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, the FDIC indemnification asset, mortgage servicing rights, other real estate owned and deferred tax assets.
Reclassifications
Some items in the prior year financial statements were reclassified to conform to the current presentation, and the reclassifications had no impact on prior period net income or shareholders’ equity.
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Notes to Consolidated Financial Statements (Unaudited)—Continued
Recent Accounting Pronouncements
In June 2009, the FASB issued ASC 860-10, “Accounting for Transfers of Financial Assets—an amendment of ASC 860.” This statement removes the concept of a qualifying special-purpose entity from Statement 140 and removes the exception from applying ASC 810 (revised December 2003), Consolidation of Variable Interest Entities, to qualifying special-purpose entities. The objective in issuing this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The participating interest definition in this statement applies to transfers of government-guaranteed portions of loans, such as those guaranteed by the Small Business Administration (“SBA”). In this regard, if a seller transfers the guaranteed portion on an SBA loan at a premium, the seller is obligated by the SBA to refund the premium to the purchaser if the loan is repaid within 90 days of the transfer. Under this statement, this premium refund obligation is a form of recourse, which means that the transferred guaranteed portion the loan does not meet the definition of a participating interest for the 90-day period that the premium refund obligation exists. As a result, the transfer must be accounted for as a secured borrowing during this period. After the 90 day period, assuming the transferred guaranteed portion and the retained unguaranteed portion of the SBA loan now meet the definition of a participating interest, the transfer of the guaranteed portion can accounted for as a sale if all of the conditions for sale accounting in the statement are met. Adoption of this statement will result in a 90 day delay in recognizing the sale and gain on sale of the guaranteed portions of any SBA loans.
On June 12, 2009, the FASB issued ASC 810-10, Amendments to FASB Interpretation No. 46(R). this guidance amends ASC 810 to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity (VIE) that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Unlike ASC 810, this Statement requires ongoing reconsideration of whether (1) an entity is a VIE and (2) an enterprise is the primary beneficiary of a VIE. It is expected that the amendments will result in more entities consolidating VIEs that previously were not consolidated The Statement will also require additional disclosures about an enterprise’s involvement in variable interest entities. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The impact of adoption was not material to our results of operations or financial position.
2. STOCK- BASED COMPENSATION
In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees. As of December 31, 2009, options to purchase an aggregate of 281,675 shares of common stock were outstanding and 20,825 shares remained available for issuance . The 2010 Stock Awards and Incentive Plan was approved by the Board of Directors in January 2010 and approved by the stockholders at the Annual Meeting in April 2010. The 2010 plan authorized the reservation of 700,000 shares of common stock for the granting of stock
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awards. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options. The purpose of the plan is to afford key employees an incentive to remain in the employ of SNBV and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in SNBV’s future success. Under the plan, the option’s price cannot be less than the fair market value of the stock on the grant date. The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.
SNBV granted 4,000 options during the first six months of 2010. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value options granted in the six months ended June 30, 2010:
Dividend yield
Expected life
Expected volatility
Risk-free interest rate
Weighted average fair value per option granted
We have paid no dividends.
Due to SNBV’s short existence, the volatility was estimated using historical volatility of comparative publicly traded financial institutions in the Virginia market combined with that of SNBV for periods approximating the expected option life.
The risk-free interest rate was developed using the U. S. Treasury yield curve for periods equal to the expected life of the options on the grant date. An increase in the risk-free interest rate will increase stock compensation expense on future option grants.
For the three and six months ended June 30, 2010, stock-based compensation expense was $18 thousand and $35 thousand, respectively, compared to $13 thousand and $25 thousand for the same periods last year. As of June 30, 2010, unrecognized compensation expense associated with the stock options was $233 thousand which is expected to be recognized over a weighted average period of 3.4 years.
A summary of the activity in the stock option plan during the three months ended June 30, 2010 follows (dollars in thousands):
Options outstanding, beginning of period
Granted
Forfeited
Exercised
Options outstanding, end of period
Vested or expected to vest
Exercisable at end of period
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3. SECURITIES
The amortized cost and fair value of securities available-for-sale were as follows (in thousands):
Residential government-sponsored mortgage-backed securities
SBA guaranteed loan pools
FHLMC preferred stock
Total
December 31, 2009
The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):
Residential government-sponsored collateralized mortgage obligations
Other residential collateralized mortgage obligations
Trust preferred securities
The fair value and carrying amount, if different, of debt securities as of June 30, 2010, by contractual maturity were as follows (in thousands). Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.
Due in one to five years
Due in five to ten years
Due after ten years
During the three and six months ended June 30, 2010, there were no sales of securities. During the first six months of 2009, we sold $9.9 million of available-for-sale mortgage-backed securities resulting in a gross gain of $223 thousand, and the tax provision related to the gain was $76 thousand.
Securities with a carrying amount of approximately $58.4 million and $40.1 million at June 30, 2010 and December 31, 2009, respectively, were pledged to secure public deposits, repurchase agreements and a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”).
SNBV monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. At June 30, 2010 and December 31, 2009, some
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securities’ fair values were below cost. As outlined in the table below, there were securities with stated maturities totaling approximately $8.0 million in the portfolio that are considered temporarily impaired at June 30, 2010. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, management does not consider these securities to be other-than-temporarily impaired as of June 30, 2010. The following tables present information regarding securities in a continuous unrealized loss position as of June 30, 2010 and December 31, 2009 (in thousands) by duration of time in a loss position:
As of June 30, 2010, we owned pooled trust preferred securities as follows:
Security
Investment Grade:
ALESCO VII A1B
MMCF II B
MMCF III B
Other Than Temporarily Impaired:
TPREF FUNDING II
TRAP 2007-XII C1
TRAP 2007-XIII D
MMC FUNDING XVIII
ALESCO V C1
ALESCO XV C1
ALESCO XVI C
We have evaluated each of these securities for potential impairment under ASC 325, and have reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. We have also reviewed the interest and principal coverage of each of the tranches we own. In performing a detailed cash flow analysis of each security, we work with independent third parties to identify our best estimate of the cash flow estimated to be collected. If this estimate results in a present
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value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an other than temporary impairment (“OTTI”) is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:
We assume that 1% of the remaining performing collateral will default or defer in the third quarter of 2010 and 50 basis points per annum thereafter.
We assume recoveries of 25% with a two year lag on all defaults and deferrals.
We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security.
Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve plus original spread to discount projected cash flows to present values.
These assumptions resulted in no OTTI recognition on the trust preferred securities during the second quarter of 2010.
We also own $1.7 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was downgraded from B to CCC by Standard and Poors in September 2009, and it was downgraded from BBB to CC by Fitch in August 2009. The fair market value is $1.4 million. We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, determined that an OTTI does exist as of June 30, 2010 in the amount of $3.5 thousand. The assumptions used in the analysis included a 5% prepayment speed, 10% default rate, a 40% loss severity (which is roughly equivalent to the cumulative severity of the past 12 months) and an accounting yield of 4.75%.
The following table presents a roll forward of the credit losses for the trust preferred securities and the residential collateralized mortgage obligation recognized in earnings for the period ended June 30, 2010 (in thousands):
Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1, 2010
Amounts related to credit loss for which another-than-temporary impairment was not previously recognized
Amount of cumulative other-than-temporary impairment related to credit loss as of June 30, 2010
4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The following table summarizes the composition of our loan portfolio as of June 30, 2010 and December 31, 2009:
Mortgage loans on real estate:
Commercial
Construction loans to residential builders
Other construction and land loans
Residential 1-4 family
Multi- family residential
Home equity lines of credit
Total real estate loans
Commercial loans
Consumer loans
Gross loans
Less unearned income on loans
Loans, net of unearned income
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As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans.”
The covered loans acquired in the Greater Atlantic transaction are and will continue to be subject to our internal and external credit review. As a result, if and when credit deterioration is noted subsequent to the acquisition date, such deterioration will be measured through our loss reserving methodology and a provision for credit losses will be charged to earnings with a partially offsetting noninterest income item reflecting the increase to the FDIC indemnification asset. There has been no provision recorded on covered loans since acquisition.
The following summarizes activity in the allowance for loan losses for the six months ended June 30, 2010 and 2009 (in thousands):
Balance, beginning of period
Provision charged to operations
Recoveries credited to allowance
Loans charged off
Balance, end of period
Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million with allocated allowance for loan losses in the amount of $507 thousand as of June 30, 2010. This compares to $4.2 million of impaired loans with allocated allowance for loan losses in the amount of $554 thousand at December 31, 2009. Nonaccrual loans were $1.9 million and $4.2 million at June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.
Covered loans identified as impaired in accordance with ASC 310 totaled $5.5 million as of June 30, 2010 and $4.9 million at December 31, 2009. Nonaccrual loans were $3.0 million and $5.1 million at June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.
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5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
SNBV is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit are written conditional commitments issued by SNBV to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $3.9 million and $3.8 million as of June 30, 2010 and December 31, 2009, respectively.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis.
At June 30, 2010 and December 31, 2009, we had unfunded lines of credit and undisbursed construction loan funds totaling $115.0 million and $121.7 million, respectively. Our approved loan commitments were $7.2 million and $850 thousand at June 30, 2010 and December 31, 2009, respectively.
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6. EARNINGS PER SHARE
The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):
For the three months ended June 30, 2010
Basic EPS
Effect of dilutive stock options and warrants
Diluted EPS
For the three months ended June 30, 2009
For the six months ended June 30, 2010
For the six months ended June 30, 2009
There were 411,719 and 412,432 anti-dilutive options and warrants during the three and six months ended June 30, 2010, respectively, and there were 397,925 anti-dilutive options and warrants during the three and six months ended June 30, 2009.
7. FAIR VALUE
ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability
The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:
Securities Available for Sale
Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar
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characteristics, or discounted cash flow. Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of SNBV’s available-for-sale debt securities are considered to be level 2 securities.
Assets measured at fair value on a recurring basis are summarized below:
Financial assets:
Available for sale securities
Total available-for-sale securities
Assets and Liabilities Measured on a Non-recurring Basis:
Trust Preferred Securities Classified as Held-to-Maturity
Management utilized guidance in ASC 820-10 to value these securities. The base input in calculating fair value is a Bloomberg Fair Value Index yield curve for single issuer trust preferred securities which correspond to the ratings of the securities we own. We also use composite rating indices to fill in the gaps where the bank rating indices did not correspond to the ratings in our portfolio. When a bank index that matches the rating of our security is not available, we used the bank index that most closely matches the rating, adjusted by the spread between the composite index that most closely matches the security’s rating and the composite index with a rating that matches the bank index used. Then, we use the adjusted index yield, which is further adjusted by a liquidity premium, as the discount rate to be used in the calculation of the present value of the same cash flows used to evaluate the securities for OTTI. The liquidity premiums were derived in consultation with a securities advisor. The liquidity premiums we used ranged from .25% to 5%, and the adjusted discount rates ranged from 6.40% to 16.41%. Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility. We have determined that our trust preferred securities are classified within Level 3 of the fair value hierarchy.
Based on our analysis in the first six months of 2010, there were no OTTI charges on trust preferred securities. There were OTTI charges on trust preferred securities totaling $863 thousand during the first six months of 2009.
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Other Residential Collateralized Mortgage Obligation Classified as Held-to Maturity
The fair value was estimated within Level 2 fair value hierarchy, as the fair value is based on either pricing models, quoted market prices of securities with similar characteristics, or discounted cash flows. We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support. The assumptions used in the analysis included a 5% prepayment speed, 10% default rate, a 40% loss severity and an accounting yield of 4.75%. Based on this analysis, an OTTI existed as of June 30, 2010 in the amount of $3.5 thousand. There was an OTTI on this security in the amount of $10 thousand for the six months ended June 30, 2010, and there was no OTTI for the same period last year.
Other Securities Classified as Held-to-Maturity
Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of SNBV’s other securities classified as held-to-maturity are considered to be level 2 securities.
Impaired Loans
ASC 820-10 applies to loans measured for impairment using the practical expedients permitted by ASC 310 at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. Fair value is classified as Level 3 in the fair value hierarchy. Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million as of June 30, 2010 with an allocated allowance for loan losses totaling $507 thousand compared to a carrying amount of $4.2 million with an allocated allowance for loan losses totaling $554 thousand at December 31, 2009. Provision expense related to the impaired loans at June 30, 2010 totaled $30 thousand and $430 thousand during the three and six months ended June 30, 2010. Provision expense related to impaired loans totaled $140 thousand during the three and six months ended June 30, 2009.
Other Real Estate Owned (OREO)
OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. OREO is further evaluated quarterly for any additional impairment. Fair value is classified as Level 3 in the fair value hierarchy.
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Assets measured at fair value on a non-recurring basis are summarized below:
Impaired non-covered loans
Trust preferred securities, held to maturity
Impaired covered loans
Non-covered other real estate owned
Covered other real estate owned
Fair Value of Financial Instruments
The carrying amount and estimated fair values of financial instruments were as follows (in thousands):
Cash and cash equivalents
Securities available for sale
Securities held to maturity
Net uncovered loans
Net covered loans
Accrued interest receivable
Financial liabilities:
Deposits:
Demand deposits
Money market and savings accounts
Certificates of deposit
FHLB advances
Accrued interest payable
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Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. It was not practicable to determine the fair value of Federal Reserve Bank and Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair value of long-term debt is based on current rates for similar financing. The FDIC indemnification asset was measured at estimated fair value on the date of acquisition. The fair value was determined by discounting estimated future cash flows using the long-term risk free rate plus a premium. Subsequent additions to the asset are valued at par as it is anticipated that these amounts will be shortly received. The fair value of off-balance-sheet items is not considered material.
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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2009. Results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of results that may be attained for any other period.
SPECIAL CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” and similar words, or the negatives of these words, are intended to identify forward-looking statements.
Many possible events or factors could affect our future financial results and performance and could cause our actual results to differ materially from the expectations of future results we express or imply in any forward-looking statements. In addition to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, factors that could contribute to those differences include, but are not limited to:
our limited operating history;
changes in the strength of the United States economy in general and the local economies in our market areas adversely affect our customers and their ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral;
changes in the availability of funds resulting in increased costs or reduced liquidity;
our reliance on brokered deposits;
a deterioration or downgrade in the credit quality and credit agency ratings of the securities in our securities portfolio;
impairment concerns and risks related to our investment portfolio of collateralized mortgage obligations, agency mortgage-backed securities and pooled trust preferred securities;
the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations;
increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of our total loan portfolio;
the concentration of our loan portfolio in loans collateralized by real estate;
our level of construction and land development and commercial real estate loans;
changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;
the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;
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our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;
changes in interest rates and market prices, which could reduce our net interest margins, asset valuations and expense expectations;
increased competition for deposits and loans adversely affecting rates and terms;
increases in FDIC deposit insurance premiums and assessments;
the continued service of key management personnel;
increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;
our ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; and
fiscal and governmental policies of the United States federal government.
Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this prospectus. These statements speak only as of the date of this Quarterly Report on Form 10-Q. Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.
OVERVIEW
Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state bank. Sonabank was originally chartered as a national bank under the laws of the United States of America on April 14, 2005. On January 1, 2009, Sonabank converted from a nationally chartered bank to a state chartered bank and moved its headquarters from Charlottesville to McLean, Virginia. Sonabank is now regulated by the State Corporation Commission of Virginia and the Federal Reserve Bank of Richmond. Sonabank conducts full-service banking operations in Charlottesville, Clifton Forge, Leesburg, Warrenton, New Market, Front Royal, South Riding and Fairfax County in Virginia and in Rockville, Maryland. We also have loan production offices in Charlottesville, Fredericksburg, Warrenton and Richmond in Virginia. We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.
RESULTS OF OPERATIONS
Net Income
Net income for the quarter ended June 30, 2010 was $1.0 million and $2.1 million for the six months ended June 30, 2010, compared to $23 thousand and $549 thousand during the second quarter and the first six months of 2009. Earnings in the three and six months ended June 30, 2010 were positively affected by the Greater Atlantic Bank and Millennium loan purchase transactions. Earnings in the second quarter and first half of 2009 were adversely impacted by OTTI charges of $863 thousand before tax on several of Sonabank’s trust preferred securities. There were no OTTI charges on the trust preferred securities during the first six months of 2010.
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Net Interest Income
Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings.
Net interest income for the three months ended June 30, 2010 was $6.4 million compared to $3.5 million for the same period last year. Average interest-earning assets for the three months ended June 30, 2010 increased $150.4 million over the same period in 2009. Average loans outstanding increased by $140.9 million in the second quarter of 2010 compared to the second quarter of 2009. Average investment securities increased by $8.2 million in the quarter ended June 30, 2010, compared to the same period last year. The average yield on interest-earning assets increased from 5.60% in 2009 to 6.25% in 2010. Average interest-bearing liabilities for the three months ended June 30, 2010 increased $132.4 million compared to the same period in 2009. Average interest-bearing deposits increased by $126.9 million, while average borrowings increased by $5.5 million compared to the second quarter of 2009. The average cost of interest-bearing liabilities decreased from 2.44% in 2009 to 1.79% in 2010. The interest rate spread for the three months ended June 30, 2010 increased from 3.16% to 4.46% compared to the same period last year. The net interest margin for the three months ended June 30, 2010 increased to 4.70% from 3.51% compared to the same period last year.
Net interest income for the six months ended June 30, 2010 was $12.7 million compared to $6.5 million for the same period last year. Average interest-earning assets for the six months ended June 30, 2010 increased $152.0 million over the same period in 2009. Average loans outstanding increased by $145.4 million in the first half of 2010 compared to the first six months of 2009. Average investment securities increased by $7.8 million in the six months ended June 30, 2010, compared to the same period last year. The average yield on interest-earning assets increased from 5.58% in 2009 to 6.22% in 2010. Average interest-bearing liabilities for the six months ended June 30, 2010 increased $135.7 million compared to the same period in 2009. Average interest-bearing deposits increased by $131.2 million, while average borrowings increased by $4.5 million compared to the first six months of 2009. The average cost of interest-bearing liabilities decreased from 2.64% in 2009 to 1.80% in 2010. The interest rate spread for the six months ended June 30, 2010 increased from 2.94% to 4.42% compared to the same period last year. The net interest margin for the six months ended June 30, 2010 increased to 4.66% from 3.32% compared to the same period last year.
The significant improvement in the net interest income was attributable to:
The impact of the Greater Atlantic Bank and Millennium loan purchase transactions. The accretion of the discount on the Greater Atlantic Bank loans contributed $635 thousand to second quarter net interest income and $1.3 million to net interest income for the six months ended June 30, 2010.
The bottoming of the decline in interest rates in the first quarter of 2009. The prime rate was 3.25% at the end of the first quarter of 2009 and it remained at that level at the end of the second quarter of 2010.
Our practice of establishing floor rates on loans as they mature or roll over notwithstanding the index rates. On non-SBA loans we have been establishing floors ranging from 6% to 7 1/2%.
The cost of funds decreased from 1.81% in the first quarter of 2010 to 1.79% in the second quarter despite the implementation of a strategy of encouraging customers to purchase certificates of deposit (cds) with longer maturities to protect against possible future rises in interest rates. In addition, there has been a change in the deposit mix from cds into money market accounts which have a lower cost of funds.
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We have reduced rates on deposit accounts as much as we can without harming relationships. Moreover, we are concerned with the probability that rates will rise and to the extent possible have positioned ourselves for this eventuality.
The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
Assets
Interest-earning assets:
Loans, net of unearned income (1) (2)
Investment securities
Other earning assets
Total earning assets
Allowance for loan losses
Total non-earning assets
Liabilities and stockholders’ equity
Interest-bearing liabilities:
Borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Stockholders’ equity
Interest rate spread
Net interest margin
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Provision for Loan Losses
The provision for loan losses is a current charge to earnings made in order to increase the allowance for loan losses to a level deemed appropriate by management based on an evaluation of the loan portfolio, current economic conditions, changes in the nature and volume of lending, historical loan loss experience and other known internal and external factors affecting loan collectability. Our loan loss allowance is calculated by segmenting the loan portfolio by loan type and applying risk factors to each segment. The risk factors are determined by considering peer data, internal and external factors affecting loan collectability, as well as applying management’s judgment.
The provision for loan losses was $1.5 million for the quarter ended June 30, 2010 compared to $545 thousand for the second quarter of 2009. For the six months ended June 30, 2010, the provision for loan losses was $2.8 million compared to $1.0 million for the same period last year.
Net charge-offs during the second quarter were $1.4 million and $2.5 million for the first half of 2010 compared to $435 thousand and $672 thousand during the same periods in 2009 as credit quality continued to be a challenge for our loan portfolio. $1.0 million of the second quarter charge-offs related to a commercial property that was charged down to the appraised value contained in a new appraisal report dated May 25, 2010.
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Noninterest Income
The following table presents the major categories on noninterest income for the three and six months ended June 30, 2010 and 2009:
Net impairment losses recognized in earnings
Gain on securities
Total noninterest income
During the second quarter of 2010 Sonabank had noninterest income of $535 thousand compared to noninterest loss of $502 thousand during the second quarter of 2009. Noninterest income for the second quarter of 2010 included account maintenance and deposit service fees of $235 thousand compared to $138 thousand for the same period last year resulting from the increased number of deposit accounts acquired from the Greater Atlantic Bank and Millennium Branch acquisitions. Other noninterest income included fees in the amount of $105 thousand earned on short-term letters of credit which expired in June 2010 for the three months ended June 30, 2010, compared to $0 for the same period last year. The second quarter of 2009 included OTTI charges of $863 thousand.
Noninterest income increased to $1.1 million in the first six months of 2010 from $92 thousand in the first six months of 2009. Noninterest income for the first six months of 2010 included account maintenance and deposit service fees of $476 thousand compared to $270 thousand for the same period last year resulting from the increased number of deposit accounts acquired from the Greater Atlantic Bank and Millennium Branch acquisitions. Other noninterest income included fees in the amount of $227 thousand earned on short-term letters of credit which expired in June 2010 for the six months ended June 30, 2010, compared to $1 thousand for the same period last year. During the six months ended June 30, 2009, we recognized OTTI charges in the amount of $863 thousand, partially offset by a gain on the sale of available-for-sale securities in the amount of $223 thousand.
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Noninterest Expense
The following table presents the major categories on noninterest expense for the three and six months ended June 30, 2010 and 2009:
Total noninterest expense
Noninterest expenses were $4.0 million and $8.0 million during the second quarter and the first half of 2010, respectively, compared to $2.5 million and $4.9 million during the same periods in 2009. The decrease in the FDIC indemnification asset resulting from loans identified with evidence of credit deterioration at acquisition that paid off in 2010 added $406 thousand during the second quarter and $650 thousand during the first half of 2010 to noninterest expense. The amortization of the Greater Atlantic Bank core deposit intangible added $50 thousand during the second quarter and $100 thousand during the first half of 2010. The remaining increases were primarily attributable to the costs of operating a thirteen branch system rather than an eight branch system. At June 30, 2010, we had 107 full-time equivalent employees compared to 64 at June 30, 2009. FDIC assessment expense decreased by $101 thousand during the second quarter
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of 2010 compared to the same period last year, and it decreased by $86 thousand for the six months ended June 30, 2010 compared to last year. The FDIC assessment expense for 2009 included a special assessment in the amount of $190 thousand in the second quarter. The lack of a special assessment in 2010 was offset by the growth in deposits primarily from the Greater Atlantic Bank and Millennium branch acquisitions. Data processing, on-line banking and ATM-related expenses increased by $112 thousand for the second quarter and $252 thousand for the six months ended June 30, 2010, compared to the same periods last year. Virginia franchise tax expense increased by $44 thousand and $86 thousand for the quarter and the first six months of 2010, respectively, compared to last year. Consulting and legal expense also increased by $50 thousand and $107 thousand for the three and six months ended June 30, 2010, respectively, compared to the same periods last year.
Despite the costs associated with the acquisitions of Greater Atlantic Bank and the Millennium Branch, noninterest expenses were well controlled, and our efficiency ratio improved to 53.5% in the first half of 2010 compared to 68.6% in the same period last year.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets of Southern National Bancorp of Virginia were $613.2 million as of June 30, 2010 up from $610.7 million as of December 31, 2009. Net loans receivable increased from $457.1 million at the end of 2009 to $458.0 million at June 30, 2010. Two large loans in the non-covered portfolio totaling approximately $6.4 million were paid off, one on a project completed and refinanced and the other as a result of our borrower being acquired by a larger company. Loans in the amount of $2.4 million were transferred from the non-covered loan portfolio to OREO. There were also principal repayments in the covered portfolio acquired in the Greater Atlantic transaction, including large repayments on three loans totaling approximately $3.2 million.
The increase in bank premises and equipment was due to the purchase of certain fixed assets of Greater Atlantic from the FDIC in the amount of $1.6 million.
Total deposits were $455.7 million at June 30, 2010 compared to $455.8 million at December 31, 2009. Brokered certificates of deposit decreased from $70.0 million as of December 31, 2009 to $50.0 million at June 30, 2010, while other certificates of deposit decreased by $12.4 million. Money market accounts increased by $34.6 million during the six months ended June 30, 2010. Noninterest-bearing deposits were $33.4 million at June 30, 2010 and $33.3 million at December 31, 2009.
Loan Portfolio
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Asset Quality
We will generally place a loan on nonaccrual status when it becomes 90 days past due. Loans will also be placed on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Cash payments received while a loan is categorized as nonaccrual will be recorded as a reduction of principal as long as doubt exists as to future collections.
In accordance with regulatory guidance we obtain appraisals, prior to closing, on all real estate loans. In the event that a real estate loan becomes non-performing or a problem loan, collateral fair market value is reassessed either by obtaining a new appraisal or an internal evaluation, and our exposure is reduced, if necessary, to fair market value, less cost to sell, either through a charge off or by establishing a specific reserve. In accordance with regulatory guidance a new appraisal is obtained in the event of foreclosure and we record other real estate owned at the lower of our recorded investment in the loan or fair value less our estimated costs to sell.
Our loss and delinquency experience on our loan portfolio has been limited by a number of factors, including our underwriting standards and the relatively short period of time since the loans were originated. Whether our loss and delinquency experience in the area of our portfolio will increase significantly depends upon the value of the real estate securing loans and economic factors such as the overall economy of the region.
Non-covered Loans and Assets
Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million with allocated allowance for loan losses in the amount of $507 thousand as of June 30, 2010. This compares to $4.2 million of impaired loans with allocated allowance for loan losses in the amount of $554 thousand at December 31, 2009. Nonaccrual loans were $1.9 million and $4.2 million at June 30, 2010 and December 31, 2009, respectively. The decrease in impaired and nonaccrual loans is due to the transfer of a commercial real estate loan in the amount of $1.9 million from loans to OREO and additional charge offs totaling $400 thousand on commercial loans that were impaired at December 31, 2009. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.
Non-covered nonperforming assets decreased slightly from $7.0 million at December 31, 2009 to $6.9 million at June 30, 2010.
There was a migration from non-accrual loans to OREO during the quarter as Sonabank foreclosed on one commercial property and two residential properties in the non-covered portfolio. The rest of our non-covered OREO balance continues to be comprised of one property, which contains 33 finished 2 to 4 acre lots in Culpeper, Virginia. There are no new developments on that property. We continue to monitor the fair value of this property to ensure our carrying value is realizable.
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Sonabank has an internal loan review and a loan committee, both of which provide on-going monitoring to identify and address issues with problem loans. The loan loss provision is determined after consideration of all known relevant internal and external factors affecting loan collectability to maintain the allowance for loan and lease losses at a level necessary to absorb estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at June 30, 2010.
The following table sets forth selected asset quality ratios as of the dates indicated:
Allowance for loan losses to total non-covered loans
Non-covered nonperforming assets to total non-covered assets
Non-covered nonperforming assets total non-covered loans
Covered Loans and Assets
In the Greater Atlantic covered OREO portfolio we have a property with several apartment units in Georgia with a current carrying value of $197 thousand. Two single family residential properties in the amount of $271 thousand in the covered portfolio have been sold at an immaterial gain.
Securities
Investment securities, available for sale and held to maturity, were $70.1 million at June 30, 2010 and $76.2 million at December 31, 2009.
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As of June 30, 2010 we owned pooled trust preferred securities as follows:
Current
We have evaluated each of these securities for potential impairment under ASC 325, and have reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. We have also reviewed the interest and principal coverage of each of the tranches we own. In performing a detailed cash flow analysis of each security, we work with independent third parties to identify our best estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an other than temporary impairment (“OTTI”) is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:
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Liquidity and Funds Management
The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity and the ability to fund commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. As a result, we have sought funding from additional sources, including institutional certificates of deposit and available-for-sale investment securities. In addition, we maintain lines of credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.
We prepare a monthly cash flow report which forecasts weekly cash needs and availability for the coming three months, based on forecasts of loan closings from our pipeline report and other factors.
During the three and six month periods ended June 30, 2010, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At June 30, 2010, we had $115.0 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $7.2 million at June 30, 2010. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
Capital Resources
The following table provides a comparison of our leverage and risk-weighted capital ratios and the leverage and risk-weighted capital ratios of the bank at the dates indicated to the minimum and well-capitalized regulatory standards (dollars in thousands):
SNBV
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Leverage ratio
Sonabank
The increase in the risk-based capital ratios as of June 30, 2010 compared to December 31, 2009, is primarily the result of assigning a 20% risk weight to the assets covered under the FDIC loss-sharing
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agreement. A Financial Institution Letter was issued in the first quarter of 2010 which clarified that exposures that are covered under an FDIC loss-sharing agreement may be assigned a 20% risk weight.
The most recent regulatory notification categorized Sonabank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed Sonabank’s category.
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are engaged primarily in the business of investing funds obtained from deposits and borrowings into interest-earning loans and investments. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between the interest income on loans and other investments and the interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-earning assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. We have employed asset/liability management policies that seek to manage our interest income, without having to incur unacceptable levels of credit or investment risk.
We use a duration gap of equity approach to manage our interest rate risk, and we review quarterly interest sensitivity reports prepared for us by FTN Financial using the Sendero ALM Analysis System. This approach uses a model which generates estimates of the change in our market value of portfolio equity (MVPE) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using standard industry assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.
The following tables are based on an analysis prepared by FTN Financial setting forth an analysis of our interest rate risk as measured by the estimated change in MVPE resulting from instantaneous and sustained parallel shifts in the yield curve (plus or minus 300 basis points, measured in 100 basis point increments) as of June 30, 2010 and December 31, 2009, and all changes are within our ALM Policy guidelines:
Change in Interest Rates in Basis Points (Rate Shock)
Up 300
Up 200
Up 100
Base
Down 100
Down 200
Down 300
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Our interest rate sensitivity is also monitored by management through the use of a model run by FTN Financial that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. In this regard, the model assumes that the composition of our interest sensitive assets and liabilities existing at June 30, 2010 and December 31, 2009 remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. All changes are within our ALM Policy guidelines.
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Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in MVPE requires the making of certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Accordingly, although the MVPE tables and Sensitivity of Net Interest Income tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net worth and net interest income.
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ITEM 4 – CONTROLS AND PROCEDURES
As of the end of the period covered by this quarterly report on Form 10-Q under the supervision and with the participation of management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(c) under the Securities Exchange Act of 1934). Based on that evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter covered by this report that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting.
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
While SNBV and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business, there are no proceedings pending, or to management’s knowledge, threatened, against SNBV or Sonabank at this time.
ITEM 1A – RISK FACTORS
In addition to the other information set forth in this report, the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009 should be considered.
The impact of financial reform legislation is uncertain.
The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act institutes a wide range of reforms that will have an impact on all financial institutions. The Act includes, among other things, changes to the deposit insurance and financial regulatory systems, enhanced bank capital requirements and new requirements designed to protect consumers in financial transactions. Many of these provisions are subject to rule making procedures and studies that will be conducted in the future and the full effects of the legislation on SNBV cannot yet be determined. However, these provisions, or any other aspects of current proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities or change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose SNBV to additional costs, including increased compliance costs. These changes also may require SNBV to invest significant management attention and resources to make any necessary changes to our operations in order to comply, and could therefore also materially adversely affect our business, financial condition, and results of operations.
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ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. – DEFAULTS UPON SENIOR SECURITIES
ITEM 4. – (REMOVED AND RESERVED)
ITEM 5. – OTHER INFORMATION
ITEM 6 – EXHIBITS
(a) Exhibits.
ExhibitNo.
Description
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
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