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 March 31, 2011
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 April 29, 2011, there were 11,590,212 shares of common stock outstanding.
March 31, 2011
INDEX
Signatures
Certifications
ITEM 1 - FINANCIAL INFORMATION
PART I - FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts) (Unaudited)
ASSETS
Cash and cash equivalents:
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 $40,777 and $43,965, respectively)
Covered loans
Non-covered loans
Total loans
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
LIABILITIES AND STOCKHOLDERS’ EQUITY
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 March 31, 2011 and December 31, 2010
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
For the Three Months Ended
March 31,
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 (loss) on other real estate owned
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
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
Change in FDIC indemnification asset
Other operating expenses
Total noninterest expenses
Income before income taxes
Income tax expense
Net income
Other comprehensive income :
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
Comprehensive income
Earnings per share, basic and diluted
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2011
Balance - January 1, 2011
Comprehensive income:
Change in unrealized gain on available for sale securities (net of tax, $33)
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $15 and accretion, $11 and amounts recorded into other comprehensive income at transfer)
Total comprehensive income
Stock-based compensation expense
Balance - March 31, 2011
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CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
(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
Increase (decrease) in FDIC indemnification asset
Earnings on bank-owned life insurance
Stock based compensation expense
Impairment on securities
Net (gain) loss on other real estate owned
Net (increase) decrease in other assets
Net increase in other liabilities
Net cash and cash equivalents provided by operating activities
Investing activities:
Proceeds from paydowns, maturities and calls of securities available for sale
Proceeds from paydowns, maturities and calls of securities held to maturity
Loan originations and payments, net
Net decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
Proceeds from sale of other real estate owned
Payments received on FDIC indemnification asset
Purchases of bank premises and equipment
Net cash and cash equivalents provided by (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 used in 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
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)
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, 2010.
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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Recent Accounting Pronouncements
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This amendment clarifies the guidance on the evaluation made by a creditor on whether a restructuring constitutes a troubled debt restructuring. It clarifies the guidance related to a creditor’s evaluation of whether it has granted a concession to a debtor and also clarifies the guidance on a creditor’s evaluation of whether the debtor is experiencing financial difficulties. The amendment is effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The disclosures required which were deferred by ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, is effective for interim and annual periods beginning on or after June 15, 2011. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our consolidated financial condition or results of operation.
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 March 31, 2011, options to purchase an aggregate of 302,500 shares of common stock were outstanding and no 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 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 97,750 options during the first three months of 2011. 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 three months ended March 31, 2011:
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.
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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 months ended March 31, 2011 and 2010, stock-based compensation expense was $26 thousand and $17 thousand, respectively. As of March 31, 2011, unrecognized compensation expense associated with the stock options was $721 thousand, which is expected to be recognized over a weighted average period of 4.3 years.
A summary of the activity in the stock option plan during the three months ended March 31, 2011 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
The amortized cost and fair value of securities available-for-sale were as follows (in thousands):
SBA guaranteed loan pools
FHLMC preferred stock
Total
Gross Unrealized
The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):
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Residential government-sponsored mortgage-backed securities
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 March 31, 2011, 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
Securities with a carrying amount of approximately $42.3 million and $45.3 million at March 31, 2011 and December 31, 2010, 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 for indicators of other than temporary impairment. At March 31, 2011 and December 31, 2010, certain securities’ fair values were below cost. As outlined in the table below, there were securities with fair values totaling approximately $8.9 million in the portfolio that are considered temporarily impaired at March 31, 2011. 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 March 31, 2011. The following tables present information regarding securities in a continuous unrealized loss position as of March 31, 2011 and December 31, 2010 (in thousands) by duration of time in a loss position:
December 31, 2010
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As of March 31, 2011, we owned pooled trust preferred securities as follows:
Security
Ratings
When Purchased
% of CurrentDefaults andDeferrals
to Current
ALESCO VII A1B
MMCF II B
MMCF III B
TPREF FUNDING II
TRAP 2007-XII C1
TRAP 2007-XIII D
MMC FUNDING XVIII
ALESCO V C1
ALESCO XV C1
ALESCO XVI C
Each of these securities has been evaluated for other than temporary impairment. In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to estimate expected cash flows and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:
We assume that .5% of the remaining performing collateral will default or defer per annum.
We assume recoveries ranging from 25% to 50% 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.
Additionally banks with assets over $15 billion will no longer be allowed to count down streamed trust preferred proceeds as Tier 1 capital (although it will still be counted as Tier 2 capital). That will incent the large banks to prepay their trust preferred securities if they can or if it is economically desirable. As a consequence we have projected in all of our pools that 25% of the collateral issued by banks with assets over $15 billion will prepay in 2013.
Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve to discount projected cash flows to present values.
These assumptions resulted in OTTI charges related to credit on one of the trust preferred securities in the amount of $32 thousand during the quarter ended March 31, 2011, compared to no OTTI charges related to credit on the trust preferred securities for the quarter ended March 31, 2010.
We also own $1.1 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was originally rated AAA by Standard and Poors. After a series of downgrades this security has been evaluated for potential impairment. Based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support it has been determined that no OTTI charge for credit was required for the quarter ended March 31, 2011. The assumptions used in the analysis included a 5.5% prepayment speed, 15%
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default rate, a 50% loss severity and an accounting yield of 2.60%. We recorded OTTI charges for credit on this security of $7 thousand in the first quarter of 2010.
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 three months ended March 31, 2011 and 2010 (in thousands):
Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1
Amounts related to credit loss for which an other-than-temporary impairment was previously recognized
Amount of cumulative other-than-temporary impairment related to credit loss as of March 31
4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The following table summarizes the composition of our loan portfolio as of March 31, 2011 and December 31, 2010:
Mortgage loans on real estate:
Commercial real estate - owner-occupied
Commercial real estate - non-owner-occupied
Secured by farmland
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
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 not acquired from Greater Atlantic Bank are referred to as “non-covered loans.” The covered loans are 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 allowance for loan loss calculation methodology and a provision for credit losses will be charged to earnings. There has been no incremental provision recorded on covered loans since acquisition. The FDIC indemnification asset is reduced for cash payments received, and adjusted each quarter for changes in expected recoveries from the FDIC based on the expected cash flows from the covered loans. The adjustment amount is recorded through earnings.
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Credit-impaired covered loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, that SNBV will not collect all contractually required principal and interest payments. Generally, acquired loans that meet SNBV’s definition for nonaccrual status fall within the definition of credit-impaired covered loans.
Impaired loans were as follows (in thousands):
With no related allowance recorded
Commercial real estate - owner occupied
Commercial real estate - non-owner occupied (2)
Construction and land development
Other consumer loans
With an allowance recorded
Grand total
The following table presents the average recorded investment and interest income for impaired loans recognized by class of loans for the three months ended March 31, 2011 (in thousands):
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The following tables present the recorded investment in nonaccrual and loans past due over 90 days and still accruing by class of loans as of March 31, 2011 and December 31, 2010 (in thousands):
Commercial real estate - non-owner occupied (1)
Non-covered nonaccrual loans include SBA guaranteed amounts totaling $2.0 million and $1.4 million at March 31, 2011 and December 31, 2010, respectively.
The following tables present the aging of the recorded investment in past due loans by class of loans as of March 31, 2011 and December 31, 2010 (in thousands):
13
Covered loans:
Non-covered loans:
Total loans:
Activity in the allowance for loan and lease losses for the three months ended March 31, 2011, is summarized below (in thousands):
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Allowance for loan losses:
Beginning balance
Charge offs
Recoveries
Provision
Ending balance
The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of March 31, 2011 and December 31, 2010 (in thousands):
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
Total ending allowance
Loans:
Total ending loan balances
It is Sonabank’s practice to charge off collateral dependent loans to recoverable value rather than establish a specific reserve. Charge offs on loans individually evaluated for impairment totaled approximately $1.3 million during the first quarter of 2011.
Troubled Debt Restructurings
At March 31, 2011, we had three restructured loans included in impaired loans totaling $6.6 million with borrowers who experienced deterioration in financial condition. These loans are secured by single-family residential properties or commercial real estate properties. These restructured loans totaled $6.6 million as of December 31, 2010. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. These restructured loans were on accrual status as payments were being made according to the restructured loan terms.
SNBV allocated $72 thousand of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2011.
Credit Quality Indicators
Through its system of internal controls SNBV evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful. Special Mention loans are considered to be criticized. Substandard and Doubtful loans are considered to be classified. SNBV has no loans classified Doubtful.
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Special Mention loans are loans that have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position.
Substandard loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
As of March 31, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
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 $6.6 million and $2.4 million as of March 31, 2011 and December 31, 2010, 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
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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 March 31, 2011 and December 31, 2010, we had unfunded lines of credit and undisbursed construction loan funds totaling $111.9 million and $104.9 million, respectively. Our approved loan commitments were $7.6 million and $35.0 million at March 31, 2011 and December 31, 2010, respectively.
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 March 31, 2011
Basic EPS
Effect of dilutive stock options and warrants
Diluted EPS
For the three months ended March 31, 2010
Anti-dilutive options and warrants totaled 550,365 and 414,766 for the three months ended March 31, 2011and 2010, respectively, as the exercise price exceeded the average share price during the period.
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:
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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 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 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
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 2% to 5%, and the adjusted discount rates ranged from 9.86% to 14.97%. 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.
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Based on our analysis in the first three months of 2011, we recorded OTTI charges related to credit on trust preferred securities in the amount of $32 thousand. There were no OTTI charges on trust preferred securities during the first three months of 2010.
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, it has been determined that no OTTI charge for credit exists for the three months ended March 31, 2011. The assumptions used in the analysis included a 5.5% prepayment speed, 15% default rate, a 50% loss severity and an accounting yield of 2.60%. We recorded OTTI charges for credit on this security of $7 thousand in the first quarter of 2010.
Other Securities Classified as Held-to-Maturity
Our other securities classified as held-to-maturity include residential government sponsored mortgage-backed securities and residential government sponsored collateralized mortgage obligations. There was no OTTI recorded on these securities. Currently, all of SNBV’s other securities classified as held-to-maturity are considered to be level 2 securities.
Impaired Loans
Generally, we measure the impairment for impaired loans considering the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral is determined by appraisals or other 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 totaled $19.3 million as of March 31, 2011 with an allocated allowance for loan losses totaling $499 thousand compared to a carrying amount of $21.8 million with an allocated allowance for loan losses totaling $446 thousand at December 31, 2010. Charge offs related to the impaired loans at March 31, 2011 totaled $1.1 million during the first quarter of 2011, compared to $730 thousand during the three months ended March 31, 2010.
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. At March 31, 2011, the total amount of OREO was $7.9 million, of which $7.2 million was non-covered and $676 thousand was covered.
At December 31, 2010, the total amount of OREO was $4.6 million, of which $3.9 million was non-covered and $676 thousand was covered.
Assets measured at fair value on a non-recurring basis are summarized below:
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Trust preferred securities, held to maturity
Impaired non-covered loans:
Impaired covered loans:
Non-covered other real estate owned:
Covered other real estate owned:
Commercial
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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 non-covered 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
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, savings accounts, money market accounts, 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.
8. FEDERAL HOME LOAN BANK (“FHLB”) ADVANCES
On March 28, 2011, SNBV completed a restructuring of $25 million of convertible advances with the FHLB of Atlanta. These advances had a weighted average interest rate of 4.05% and maturities ranging from August 2012 through October 2012. The existing advances were replaced by $25 million of fixed rate, non-callable advances with a weighted average interest rate of 3.19% and maturities ranging from September 2013 through September 2014. The effect of the restructuring was to reduce the cost of the advances by 86 basis points and increase the duration of the advances from 1.41 to 2.84 years. The restructuring was accounted for as a modification of debt, rather than an extinguishment of debt.
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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, 2010. Results of operations for the three month period ended March 31, 2011 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, 2010, 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;
our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and
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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 Quarterly Report on Form 10-Q. 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 have received regulatory approval and expect to open a new branch in Middleburg, Virginia in May of 2011.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 March 31, 2011 was $1.1 million compared to $1.0 million during the first quarter 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 was $6.1 million for the first quarter of 2011, compared to $6.3 million for the first quarter of 2010. The decline resulted primarily from a decline in average earning assets quarter to quarter as loans were almost flat but the average balance of investment securities declined by over $20.0 million. The accretion of the discount on the Greater Atlantic Bank loan portfolio amounted to $575 thousand in the first quarter of 2011, compared to $667 thousand in the first quarter of 2010. The net interest margin was 4.77% in the quarter ended March 31, 2011, up from 4.62% in the first quarter of 2010. This was the result of two factors. There was a small decline in the yield on earning assets which resulted primarily from the reduction in securities as a percentage of earning assets. The weighted average rate paid on deposits also declined largely as a result of the repricing of certain money market accounts at the beginning of 2011.
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:
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Average Balance Sheets and Net Interest
Analysis For the Three Months Ended
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:
Total liabilites
Stockholders’ equity
Interest rate spread
Net interest margin
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 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, as well as applying management’s judgment.
The provision for loan losses in the first quarter of 2011 was $1.3 million, and the provision was also $1.3 million in the first quarter of 2010. Net charge offs during the quarter ended March 31, 2011 were $1.2 million compared to $1.1 million during the first quarter of 2010. The charge-offs were related to various credits including a C&I loan and a commercial real estate loan.
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Noninterest Income
The following table presents the major categories of noninterest income for the three months ended March 31, 2011 and 2010:
Net impairment losses recognized in earnings
Noninterest income was $308 thousand during the first quarter of 2011, compared to $540 thousand during the same quarter of 2010. The major part of this decline was attributable to a decrease of $111 thousand in fees on letters of credit related to a short-term letter of credit which expired in June 2010. Also, during the first quarter of 2011, there were net losses on other real estate owned (“OREO”) of $39 thousand compared to gains of $20 thousand during the first quarter of 2010. There were other than temporary impairment (“OTTI”) charges of $32 thousand during the quarter ended March 31, 2011, compared to $7 thousand for the same period last year.
Noninterest Expense
The following table presents the major categories of noninterest expense for the three months ended March 31, 2011 and 2010:
Total noninterest expense
Noninterest expense was $3.5 million for the first quarter of 2011 compared to $4.0 million for the first quarter of 2010. During the first quarter of 2011, there has been accretion of the FDIC indemnification asset of $159 thousand. During the first quarter of 2010, the accretion was offset by a charge to the FDIC indemnification asset due to impaired covered loans that paid off.
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The efficiency ratio improved from 58.61% during the quarter ended March 31, 2010, to 53.03% during the first quarter of 2011.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets of Southern National Bancorp of Virginia were $590.4 million as of March 31, 2011 compared to $590.8 million as of December 31, 2010. Net loans receivable increased from $453.8 million at the end of 2010 to $457.3 million at March 31, 2011. Within that total, covered loans declined by $6.7 million while the non-covered loan portfolio increased by $10.3 million. Our loan pipeline is reasonably strong and we expect continued growth going forward, partially offset by continued declines in the covered portfolio.
Total deposits were $432.4 million at March 31, 2011 compared to $431.0 million at December 31, 2010. Certificates of deposit increased $21.6 million during the quarter. This was partially offset by a decrease in money market accounts of $18.9 million during the quarter ended March 31, 2011. We had paid rates in excess of market on large money market accounts for former Greater Atlantic Bank customers to retain them during 2010, and as of the beginning of 2011, we reduced those rates. Brokered certificates of deposit have decreased from $27.0 million at December 31, 2010, to $22.0 million as of March 31, 2011. Noninterest-bearing deposits were $32.6 million at March 31, 2011 and $34.5 million at December 31, 2010.
Loan Portfolio
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.”
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As of March 31, 2011 and December 31, 2010, substantially all of our loans were to customers located in Virginia and Maryland. We are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations.
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.
We maintain appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans. In instances where appraisals reflect reduced collateral values, we make an evaluation of the borrower’s overall financial condition to determine the need, if any, for impairment or write-down to their fair values. If foreclosure occurs, 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 totaled $19.3 million with allocated allowance for loan losses in the amount of $499 thousand as of March 31, 2011, including $6.7 million of nonaccrual loans and $6.6 million of restructured loans. The restructured loans are well secured, but the borrowers were experiencing financial difficulties. As a consequence, we agreed to defer some interest payments, and payments are being made in accordance with the restructured terms. This compares to $21.8 million of impaired loans with allocated allowance for loan losses in the amount of $446 thousand at December 31, 2010, including $9.6 million of nonaccrual loans and $6.6 million of restructured loans. The nonaccrual loans included SBA guaranteed amounts of $2.0 million and $1.4 million at March 31, 2011 and December 31, 2010, respectively. At March 31, 2011 and December 31, 2010, there were no loans past due 90 days or more and accruing interest.
Non-covered nonperforming assets increased from $13.5 million at December 31, 2010 to $13.8 million at March 31, 2011.
Our OREO in the non-covered portfolio is comprised of the Culpeper property, which contains 33 finished 2 to 4 acre lots, the Kluge development property which was a non-performing loan at the end of 2010 which we foreclosed on during the first quarter, two commercial properties and two residential properties. Non-covered OREO at March 31, 2011 was $7.2 million compared to $3.9 million at December 31, 2010.
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
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estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at March 31, 2011.
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 excluding SBA guaranteed loans to total non-covered assets
We do not have a formal loan modification program. Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a customer is unable to make contractual payments, we review the circumstances of the customer’s situation and negotiate a revised payment stream. In other words, we identify performing customers experiencing financial difficulties and through negotiations, we permit them to pay interest only or lesser principal payments. We do not forgive principal payments. Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.
Our loan modifications have taken the form of deferral of interest payments and/or curtailment of scheduled principal payments. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.
At March 31, 2011, we had three restructured loans totaling $6.6 million with borrowers who experienced deterioration in financial condition. These loans were included in impaired loans. All of these loans were granted interest rate deferrals to provide cash flow relief to customers experiencing cash flow difficulties. There were no concessions made to forgive principal or interest relative to these loans. These loans are secured by first liens on single-family residential or commercial real estate properties. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. As such, these restructured loans were on accrual status at the balance sheet date as payments were being made according to the restructured loan terms. These loans have not had a partial charge-off. We continue to report restructured loans as restructured until such time as the loan has developed a reasonable repayment history, the borrower displays the financial capacity to repay, and the loan terms return to the terms in place prior to the restructure. If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loans losses.
We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan a troubled debt restructure (“TDR”). Specifically, we consider a concession involving a modification of the loan terms, such as (i) temporary reduction of the stated interest rate, (ii) temporary reduction or deferral of principal, (iii) temporary reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be TDRs. When a
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modification of terms is made for a competitive reason, we do not consider that to be a TDR. The primary example of a competitive modification would be an interest rate reduction for a performing credit worthy customer to a market rate as the result of a market decline in rates.
Covered Loans and Assets
Covered loans identified as impaired totaled $3.4 million as of March 31, 2011 and $3.5 million at December 31, 2010. Nonaccrual loans were $2.4 million and $2.0 million at March 31, 2011 and December 31, 2010, respectively. At March 31, 2011, there were no loans past due 90 days or more and accruing interest, and at December 31, 2010, there were loans past due 90 days or more and accruing interest in the amount of $234 thousand.
Securities
Investment securities, available for sale and held to maturity, were $52.4 million at March 31, 2011 and $56.0 million at December 31, 2010.
As of March 31, 2011 we owned pooled trust preferred securities as follows:
% of Current
Defaults and
Deferrals
Previously
Recognized
Cumulative
Each of these securities has been evaluated for other than temporary impairment. In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to estimate expected cash flows, and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:
Additionally banks with assets over $15 billion will no longer be allowed to count down streamed trust preferred proceeds as Tier 1 capital (although it will still be counted as Tier 2 capital). That will incent the large banks to prepay their trust preferred securities if they can or if it is economically desirable. As a consequence we
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have projected in all of our pools that 25% of the collateral issued by banks with assets over $15 billion will prepay in 2013.
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.
We also own $1.1 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was originally rated AAA by Standard and Poors. After a series of downgrades this security has been evaluated for potential impairment. Based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support it has been determined that no OTTI charge for credit was required for the quarter ended March 31, 2011. The assumptions used in the analysis included a 5.5% prepayment speed, 15% default rate, a 50% loss severity and an accounting yield of 2.60%. We recorded OTTI charges for credit on this security of $7 thousand in the first quarter of 2010.
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 the sale of 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 months ended March 31, 2011, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At March 31, 2011, we had $111.9 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $7.6 million at March 31, 2011. 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):
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SNBV
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Leverage ratio
Sonabank
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 March 31, 2011 and December 31, 2010, 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 March 31, 2011 and December 31, 2010 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
(a) Evaluation of Disclosure 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.
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.
(b) Changes in Internal Control over Financial Reporting. Other than the remediation of the material weakness related to the misidentification of a subsequent event described in our Annual Report on Form 10-K for the year ended December 31, 2010, there have been no other changes in SNBV’s internal control over financial reporting that occurred during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, SNBV’s internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
SNBV and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business. Sonabank is a party to two small lawsuits considered to be in the ordinary course of business. There are no other proceedings pending, or to management’s knowledge, threatened, against SNBV or Sonabank as of March 31, 2011.
ITEM 1A – RISK FACTORS
As of March 31, 2011 there were no material changes to the risk factors previously disclosed on our Annual Report on Form 10-K for the year ended December 31, 2010.
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
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ITEM 6 - EXHIBITS
Exhibit No.
Description
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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)
/s/ Georgia S. Derrico
(Date)
/s/ William H. Lagos
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