Table of Contents
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, 2019
Commission File No. 001‑33037
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)
Virginia
20‑1417448
(State or other jurisdiction
(I.R.S. Employer Identification No.)
of incorporation or organization)
6830 Old Dominion Drive
McLean, Virginia 22101
(Address of principal executive offices) (zip code)
(703) 893‑7400
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading symbol
Name of each exchange on which registered:
Common Stock
SONA
NASDAQ
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 ☒ NO ☐
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted 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 such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b–2 of the Exchange Act:
Large accelerated filer ☐
Accelerated filer ☒
Smaller reporting company ☒
Non-accelerated filer ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒
As of August 2, 2019, there were 24,143,576 shares of common stock outstanding.
FORM 10‑Q
June 30, 2019
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018
Consolidated Statements of Income and Comprehensive Income for the three and six months ended June 30, 2019 and 2018
Consolidated Statement of Changes in Stockholders’ Equity for the three and six months ended June 30, 2019 and 2018
Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018
Notes to Unaudited Consolidated Financial Statements
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
Item 4 – Controls and Procedures
PART II - OTHER INFORMATION
Item 1 – Legal Proceedings
Item 1A – Risk Factors
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 – Defaults Upon Senior Securities
Item 4 – Mine Safety Disclosures
Item 5 – Other Information
Item 6 - Exhibits
Signatures
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts)
June 30,
December 31,
2019
2018
(unaudited)
*
ASSETS
Cash and cash equivalents:
Cash and due from financial institutions
$
6,898
6,939
Interest-bearing deposits in other financial institutions
26,190
20,877
Federal funds sold
—
795
Total cash and cash equivalents
33,088
28,611
Securities available for sale, at fair value
163,860
143,377
Securities held to maturity, at amortized cost (fair value of $86,681 and $89,109, respectively)
86,815
92,462
Total loans
2,172,845
2,178,824
Less allowance for loan losses
(11,613)
(12,283)
Net loans
2,161,232
2,166,541
Stock in Federal Reserve Bank and Federal Home Loan Bank
17,364
19,522
Equity investment in mortgage affiliate
4,405
3,829
Preferred investment in mortgage affiliate
3,305
Bank premises and equipment, net
30,767
32,352
Operating lease right-of-use assets
7,924
Goodwill
101,954
Core deposit intangibles, net
7,884
8,609
Bank-owned life insurance
63,060
62,495
Other real estate owned
5,041
5,077
Deferred tax assets, net
14,475
14,104
Other assets
23,129
19,057
Total assets
2,724,303
2,701,295
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits
335,024
320,043
Interest-bearing deposits:
NOW accounts
361,787
345,597
Money market accounts
444,299
355,469
Savings accounts
143,328
151,050
Time deposits
865,988
925,441
Total interest-bearing deposits
1,815,402
1,777,557
Total deposits
2,150,426
2,097,600
Securities sold under agreements to repurchase - short term
14,319
18,721
Federal Home Loan Bank (FHLB) advances - short term
110,640
163,340
Junior subordinated debt - long term
9,608
9,584
Senior subordinated notes - long term
47,070
47,089
Operating lease liabilities
8,385
Other liabilities
21,063
16,671
Total liabilities
2,361,511
2,353,005
Commitments and contingencies (See Note 6)
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding
Common stock, $0.01 par value. Authorized 45,000,000 shares; 24,117,326 and 24,052,253 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively
241
240
Additional paid in capital
306,049
305,654
Retained earnings
55,983
44,985
Accumulated other comprehensive income (loss)
519
(2,589)
Total stockholders' equity
362,792
348,290
Total liabilities and stockholders' equity
* Derived from audited consolidated financial statements
See accompanying notes to unaudited consolidated financial statements.
2
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(dollars in thousands, except per share amounts) (Unaudited)
For the Three Months Ended
For the Six Months Ended
Interest and dividend income:
Interest and fees on loans
28,378
27,697
56,352
53,602
Interest and dividends on taxable securities
1,475
1,400
2,900
2,882
Interest and dividends on tax exempt securities
152
160
308
319
Interest and dividends on other earning assets
388
412
1,134
879
Interest on federal funds sold
14
21
Total interest and dividend income
30,393
29,683
60,696
57,703
Interest expense:
Interest on deposits
7,654
3,810
15,116
7,080
Interest on repurchase agreements
22
24
45
46
Interest on junior subordinated debt
150
147
300
275
Interest on senior subordinated notes
712
1,424
1,423
Interest on other borrowings
891
1,816
1,895
3,205
Total interest expense
9,429
6,509
18,780
12,029
Net interest income
20,964
23,174
41,916
45,674
Provision for loan losses
1,050
200
2,650
Net interest income after provision for loan losses
22,124
41,716
43,024
Noninterest income:
Account maintenance and deposit service fees
1,788
1,375
3,475
2,783
Income from bank-owned life insurance
385
563
908
870
Equity gain (loss) from mortgage affiliate
558
191
576
(126)
Gain on sales of investment securities
Recoveries related to acquired charged-off loans and investment securities
324
250
915
1,733
Other
136
174
379
372
Total noninterest income
3,191
2,553
6,253
5,632
Noninterest expenses:
Salaries and benefits
7,144
7,007
12,956
13,779
Occupancy expenses
1,801
1,656
3,604
3,306
Furniture and equipment expenses
738
1,448
1,509
Amortization of core deposit intangible
362
361
725
723
Virginia franchise tax expense
492
1,126
856
Data processing expense
571
464
1,083
930
Telephone and communication expense
406
501
781
1,095
Net (gain) loss on other real estate owned
(36)
(40)
(38)
Professional fees
1,381
839
2,985
Other operating expenses
962
1,625
5,512
3,090
Total noninterest expenses
13,892
13,617
30,182
27,236
Income before income taxes
10,263
11,060
17,787
21,420
Income tax expense
944
2,193
2,448
4,294
Net income
9,319
8,867
15,339
17,126
Other comprehensive income (loss):
Unrealized gain (loss) on available for sale securities
2,844
(837)
3,928
(2,713)
Accretion of amounts previously recorded upon transfer to held to maturity from available for sale
3
6
Net unrealized gain (loss)
2,847
(835)
3,934
(2,707)
Tax effect
597
(175)
826
(569)
Other comprehensive income (loss)
2,250
(660)
3,108
(2,138)
Comprehensive income
11,569
8,207
18,447
14,988
Earnings per share, basic
0.39
0.37
0.64
0.71
Earnings per share, diluted
0.38
0.63
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2019 AND 2018
For the Three Months Ended June 30, 2019
Accumulated
Additional
Common
Paid in
Retained
Comprehensive
Stock
Capital
Earnings
Income (Loss)
Total
Balance - March 31, 2019
305,879
48,300
(1,731)
352,689
Changes in other comprehensive income on investment securities (net of tax, $597, and accretion of $3)
Dividends on common stock ($0.18 per share)
(2,171)
Issuance of common stock under Stock Incentive Plan (2,200 shares, net)
7
Impact of adoption of ASU 2016-02
535
Stock-based compensation expense
163
Balance - June 30, 2019
For the Three Months Ended June 30, 2018
Loss
Balance - March 31, 2018
305,360
25,324
(2,859)
328,065
Changes in other comprehensive income on investment securities (net of tax, $826, and accretion of $6)
(1,922)
Issuance of common stock under Stock Incentive Plan (19,450 shares, net)
94
Balance - June 30, 2018
305,460
32,269
(3,519)
334,450
4
For the Six Months Ended June 30, 2019
Balance - December 31, 2018
(4,341)
1
128
129
267
For the Six Months Ended June 30, 2018
Balance - December 31, 2017
239
304,932
18,753
(1,152)
322,772
Changes in other comprehensive loss on investment securities (net of tax, $394, and accretion of $3)
Dividends on common stock ($0.08 per share)
(3,839)
Issuance of common stock under Stock Incentive Plan (51,200 shares, net)
359
360
Reclassification from accumulated other comprehensive loss to retained earnings due to adoption of ASU 2018-02
229
(229)
169
5
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE SIX MONTHS ENDED JUNE 30, 2019 AND 2018
(dollars in thousands) (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation and amortization
3,411
3,732
Amortization of operating lease right-of-use assets
1,275
Accretion of loan discount
(1,788)
(2,453)
Amortization of FDIC indemnification asset
354
350
Earnings on bank-owned life insurance
(908)
(706)
Equity (gain) loss on mortgage affiliate
(576)
126
Gain on bank-owned life insurance death benefit
(164)
(Gain) loss on other real estate owned
Provision for deferred income taxes
(1,197)
Net (increase) decrease in other assets
(4,210)
1,230
Net increase (decrease) in other liabilities
3,362
(2,169)
Net cash and cash equivalents provided by operating activities
15,491
20,051
Investing activities:
Purchases of available for sale investment securities
(25,110)
Proceeds from paydowns, maturities and calls of available for sale investment securities
7,711
7,363
Proceeds from paydowns, maturities and calls of held to maturity investment securities
5,463
2,498
Sales of FRB and FHLB stock
2,158
756
Net (increase) decrease in loans
6,896
(91,728)
Purchase of bank-owned life insurance
(12,000)
Proceeds from bank-owned life insurance death benefit
343
477
Proceeds from sales of other real estate owned, net of improvements
74
1,857
Proceeds from sales of bank premise and equipment and assets held for sale
2,136
Purchases of bank premises and equipment
(73)
(1,805)
Net cash and cash equivalents used in investing activities
(2,538)
(90,446)
Financing activities:
Net increase in deposits
52,837
115,153
Cash dividends paid on common stock
Issuance of common stock under Stock Incentive Plan
Net decrease in short-term borrowings
(57,101)
(14,579)
Net cash and cash equivalents provided by (used in) financing activities
(8,476)
97,095
Increase in cash and cash equivalents
4,477
26,700
Cash and cash equivalents at beginning of period
25,463
Cash and cash equivalents at end of period
52,163
Supplemental disclosure of cash flow information
Cash payments for:
Interest
18,643
11,663
Income taxes
2,937
4,516
Non-cash investing and financing activities:
Initial recognition of operating lease right-of-use assets
8,615
Initial recognition of operating lease liabilities
9,099
1. ACCOUNTING POLICIES
Southern National Bancorp of Virginia, Inc. (“Southern National” or “SNBV” or the “Company”) is a corporation that was formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank” or the “Bank”) a Virginia state-chartered bank which commenced operations on April 14, 2005. As of the close of business on June 23, 2017, SNBV completed its merger with Eastern Virginia Bankshares, Inc. (“EVBS”) and the merger of EVBS’s wholly-owned subsidiary, EVB, with and into SNBV’s wholly-owned subsidiary, Sonabank. Sonabank provides a range of financial services to individuals and small and medium sized businesses. At June 30, 2019, Sonabank had thirty-eight full-service retail branches in Virginia, located in the counties of Chesterfield (2), Essex (2), Fairfax (Reston, McLean and Fairfax), Gloucester (2), Hanover (3), King William, Lancaster, Middlesex (3), New Kent, Northumberland (3), Southampton, Surry, Sussex, and in Charlottesville, Clifton Forge, Colonial Heights, Front Royal, Hampton, Haymarket, Leesburg, Middleburg, New Market, Newport News, Richmond, South Riding, Warrenton, and Williamsburg, and seven full-service retail branches in Maryland, in Rockville, Shady Grove, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.
The consolidated financial statements include the accounts of Southern National and its subsidiaries Sonabank and EVB Statutory Trust I (the “Trust”). Significant inter-company accounts and transactions have been eliminated in consolidation. Southern National consolidates subsidiaries in which it holds, directly or indirectly, more than 50 percent of the voting rights or where it exercises control. Entities where Southern National holds 20 to 50 percent of the voting rights, or has the ability to exercise significant influence, or both, are accounted for under the equity method. Southern National has an interest in one affiliate, Southern Trust Mortgage, LLC (“STM”), which it accounts for as an equity method investment. In addition, Southern National owns the Trust which is an unconsolidated subsidiary. The junior subordinated debt owed to the Trust is reported as a liability of Southern National.
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 Southern National’s Form 10‑K for the year ended December 31, 2018.
Revenue from Contracts with Customers
Southern National records revenue from contracts with customers in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
Our primary sources of revenue are derived from financial instruments, namely loans, investment securities, and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of the Company’s contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income and Comprehensive Income was not necessary. Southern National generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little
judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Operating Leases
The Company leases certain properties and equipment under operating leases. For leases in effect upon adoption of FASB Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) at January 1, 2019 and for any leases commencing thereafter, the Company recognizes a liability to make lease payments, the operating lease liability, and an asset representing the right to use the underlying asset during the lease term, the right-of-use asset. The operating lease liability is measured at the present value of the remaining lease payments, discounted at the Company’s incremental borrowing rate at inception. The right-of-use asset is measured at the amount of the operating lease liability adjusted for the remaining balance of any lease incentives received, any cumulative prepaid or accrued rent if the lease payments are uneven throughout the lease term, any unamortized initial direct costs, and any impairment of the right-of-use-asset. Lease expense consists of a single lease cost calculated so that the remaining cost of the lease is allocated over the remaining lease term on a straight-line basis, variable lease payments not included in the operating lease liability, and any impairment of the right-of-use asset.
Certain of the Company’s leases contain options to renew the lease; however, these renewal options are not included in the calculation of the operating lease liabilities as they are not reasonably certain to be exercised. The Company’s leases do not contain residual value guarantees or material variable lease payments. The Company does not have any material restrictions or covenants imposed by leases that would impact the Company’s ability to pay dividends or cause the Company to incur additional financial obligations.
The Company has made an accounting policy election to not apply the recognition requirements in Topic 842 to short-term leases. The Company has also elected to use the practical expedient to make an accounting policy election for property leases to use the discount rates in effect on January 2, 2019 for the remaining life of the leases.
Use of Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP 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 and the valuation of goodwill and intangible assets.
Recent Accounting Pronouncements
Adoption of New Accounting Standards:
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current U.S. GAAP and disclosing key information about leasing arrangements. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which updates narrow aspects of the guidance issued in ASU 2016-02. The amendments in this ASU were effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption of this ASU was permitted for all entities. The Company adopted ASU 2016-02 in the first quarter of 2019 and inventoried and categorized its lease agreements. Upon adoption, the Company recognized right-of-use assets and associated operating lease liabilities of $8.6 million and $9.1 million, respectively. Right-of-use assets and operating lease liabilities are reflected on our consolidated balance sheets. The company currently does not have any finance leases. See Note 5 – Leases for additional disclosures related to leases.
In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities, which shortens the amortization period for certain
8
callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 became effective for public entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The company adopted ASU 2017-08 in the first quarter of 2019 and it did not have a material impact on the Company’s consolidated financial statements.
In July 2018, the FASB issued ASU 2018-09, Codification Improvements. This ASU makes changes to a variety of topics to clarify, correct errors in, or make minor improvements to the Accounting Standards Codification. The majority of the amendments in ASU 2018-09 were effective for the Company for fiscal years beginning after December 15, 2018. The Company adopted ASU 2018-09 in the first quarter of 2019 and it did not have a material impact on the Company’s consolidated financial statements.
New Accounting Standards Not Yet Adopted:
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which sets forth a “current expected credit loss” ("CECL") model requiring the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. For public business entities that are U.S. Securities and Exchange Commission filers, the amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Southern National has engaged a third-party to collect data that will be needed to produce historical inputs into any models created as a result of adopting this ASU. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates the second step of the previous FASB guidance for testing goodwill for impairment and is intended to reduce cost and complexity of goodwill impairment testing. The amendments in this ASU modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. After determining if the carrying amount of a reporting unit exceeds its fair value, the entity should take an impairment charge of the same amount to the goodwill for that reporting unit, not to exceed the total goodwill amount for that reporting unit. ASU 2017-04 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Southern National is currently evaluating the impact of adopting the new guidance on its consolidated financial statements.
In August 2018, FASB issued ASU 2018-13, Fair Value measurement (Topic 820). This ASU adds, eliminates and modifies certain disclosure requirements for fair value measurements. The amendments in ASU 2018-13 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The disclosures are effective using the prospective method for certain disclosures and retrospective for majority of the disclosures. Southern National is currently in the process of evaluating the impact of adopting the new guidance on its consolidated financial statements and disclosures.
2. STOCK-BASED COMPENSATION
In 2004, the Company’s 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. The 2010 Stock Awards and Incentive Plan (the “2010 Plan”) was approved by the Company’s Board of Directors in January 2010 and approved by the stockholders at the Annual Stockholder Meeting in April 2010. The 2010 Plan
9
authorized the reservation of an additional 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 employment of Southern National and to assist in attracting and retaining of non-employee directors by affording them an opportunity to share in Southern National’s anticipated 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.
At the June 21, 2017 Annual Meeting of Stockholders of Southern National, the 2017 Equity Compensation Plan (the “2017 Plan”) was approved as recommended by the Board of Directors. The 2017 Plan replaced the 2010 Plan and has a maximum number of 750,000 shares reserved for issuance. The purpose of the 2017 Plan is to promote the success of the Company by providing greater incentive to employees, non-employee directors, consultants and advisors to associate their personal interests with the long-term financial success of the Company, including its subsidiaries, and with growth in stockholder value, consistent with the Company’s risk management practices. Because the 2017 Plan was approved, shares under the 2004 stock-option plan or 2010 Plan will no longer be awarded.
A summary of the activity in the stock option plan during the six months ended June 30, 2019 follows:
Weighted
Average
Aggregate
Remaining
Intrinsic
Exercise
Contractual
Value
Shares
Price
Term
(in thousands)
Options outstanding, beginning of period
642,350
9.77
5.0
Forfeited
(2,700)
10.52
Exercised
(19,450)
6.77
Options outstanding, end of period
620,200
9.86
4.6
3,383
Exercisable at end of period
478,050
9.04
3.9
2,856
Stock-based compensation expense associated with stock options was $22 thousand and $39 thousand for the three months ended June 30, 2019 and 2018, respectively and $43 thousand and $78 thousand for the six months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, unrecognized compensation expense associated with stock options was $50 thousand, which is expected to be recognized over a weighted average period of 1.5 years.
As of June 30, 2019, 48,500 shares of restricted stock were granted at a weighted average exercise price of $14.15 to certain officers of Southern National under the 2017 Plan and are subject to vesting in five years. These shares are included in the total shares outstanding at June 30, 2019. As of June 30, 2019, 2,700 shares of restricted stock granted to certain officers of Southern National under the 2017 Plan were forfeited. Restricted stock compensation expense totaled $141 thousand and $55 thousand for the three months ended June 30, 2019 and 2018, respectively and $224 thousand and $61 thousand for the six months ended June 30, 2019 and 2018, respectively. As of June 30, 2019, unrecognized compensation expense associated with restricted stock was $1.3 million, which is expected to be recognized over a weighted average period of 4.2 years.
10
3. INVESTMENT SECURITIES
The amortized cost and fair value of available for sale investment securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):
Amortized
Gross Unrealized
Fair
Cost
Gains
Losses
Residential government-sponsored mortgage-backed securities
45,594
331
(76)
45,849
Obligations of states and political subdivisions
18,166
427
18,593
Corporate securities
2,006
13
2,019
Trust preferred securities
2,589
316
(314)
2,591
Residential government-sponsored collateralized mortgage obligations
40,814
214
(48)
40,980
Government-sponsored agency securities
8,597
37
8,634
Agency commercial mortgage-backed securities
27,839
154
(14)
27,979
SBA pool securities
17,401
(207)
17,215
163,006
1,513
(659)
December 31, 2018
27,945
(643)
27,302
18,305
30
(280)
18,055
2,008
(1)
356
(304)
2,641
44,095
(1,041)
43,057
3,247
(122)
3,125
28,069
(765)
27,304
20,183
(308)
19,885
146,441
400
(3,464)
The amortized cost, unrecognized gains and losses, and fair value of investment securities held to maturity were as follows (in thousands):
Gross Unrecognized
8,957
19
(33)
8,943
20,121
176
(10)
20,287
2,471
124
(2)
2,593
4,607
(16)
4,601
50,659
100
(502)
50,257
429
(563)
86,681
11
9,699
(230)
9,473
21,496
85
(147)
21,434
2,610
2,759
6,001
(91)
5,910
52,656
(3,123)
49,533
(3,592)
89,109
The amortized cost amounts are net of recognized other than temporary impairment on trust preferred securities.
During the three and six months ended June 30, 2019, $9.8 million and $25.1 million, respectively of available for sale investment securities were purchased.
The fair value and carrying amount, if different, of debt investment securities as of June 30, 2019, by contractual maturity were as follows (in thousands). Investment securities not due at a single maturity date are shown separately.
Available for Sale
Held to Maturity
Fair Value
Due in one to five years
3,343
3,366
4,963
4,987
Due in five to ten years
11,923
12,061
18,933
18,917
Due after ten years
16,092
16,410
49,355
49,233
Investment securities with a carrying amount of approximately $152.6 million and $165.7 million at June 30, 2019 and December 31, 2018, respectively, were pledged to secure public deposits, certain other deposits, a line of credit for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta, and repurchase agreements.
Southern National monitors the portfolio for indicators of other than temporary impairment. At June 30, 2019 and December 31, 2018, certain investment securities’ fair values were below cost. As outlined in the table below, there were investment securities with fair values totaling approximately $97.1 million in the portfolio with the carrying value exceeding the estimated fair value that are considered temporarily impaired at June 30, 2019. Because the decline in fair value is attributable to changes in interest rates and market illiquidity, and not credit quality, and because we do not have the intent to sell these investment securities and it is likely that we will not be required to sell the investment securities before their anticipated recovery, management does not consider these investment securities to be other than temporarily impaired as of June 30, 2019.
12
The following tables present information regarding investment securities available for sale and held to maturity in a continuous unrealized loss position as of June 30, 2019 and December 31, 2018 by duration of time in a loss position (in thousands):
Less than 12 months
12 Months or More
Unrealized
value
4,373
14,238
(66)
18,611
1,006
475
(7)
8,973
(41)
9,448
6,190
11,575
4,848
(17)
42,777
(642)
47,625
Unrecognized
3,865
3,731
56
3,365
38,478
49,495
393
(5)
26,910
(638)
27,303
2,220
(78)
13,385
(202)
15,605
1,008
42,598
6,009
(70)
10,546
(238)
16,555
9,630
(154)
124,663
(3,310)
134,293
8,935
3,273
7,187
(137)
10,460
60
49,532
71,624
(3,582)
74,897
As of June 30, 2019, we owned pooled trust preferred securities as follows:
% of
Previously
Current
Recognized
Defaults and
Cumulative
Ratings When
Estimated
Deferrals to
Tranche
Purchased
Current Ratings
Par
Book
Security
Level
Moody's
Fitch
Collateral
Loss (1)
ALESCO VII A1B
Senior
Aaa
AA
Aa1
2,596
2,413
2,537
17
%
219
MMCF III B
Senior Sub
A3
WD
Ba1
BBB
59
58
2,655
223
Cumulative OTTI
Related to
Other Than Temporarily Impaired:
Credit Loss (2)
TPREF FUNDING II
Mezzanine
A1
D
Caa3
1,500
1,099
785
31
ALESCO V C1
A2
C
Caa1
2,150
1,490
1,806
660
3,650
1,060
6,305
5,060
5,184
Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion.
Pre-tax.
Each of these investment securities has been evaluated for other than temporary impairment. In performing a detailed cash flow analysis of each investment 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:
·
0.5% of the remaining performing collateral will default or defer per annum.
Recoveries of 9% with a two year lag on all defaults and deferrals.
No prepayments for 10 years and then 1% per annum for the remaining life of the investment security.
Our investment 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.
We recognized no other than temporary impairment charges during the three and six months ended June 30, 2019 and 2018, respectively.
Changes in accumulated other comprehensive loss by component for the three and six months ended June 30, 2019 and 2018 are shown in the tables below. All amounts are net of tax (in thousands).
Unrealized Holding
Losses on
For the three months ended June 30, 2019
Securities
Beginning balance
(1,563)
(168)
Current period other comprehensive income
2,247
Ending balance
684
(165)
For the three months ended June 30, 2018
(2,680)
(179)
Current period other comprehensive (loss) income
(662)
(3,342)
(177)
For the six months ended June 30, 2019
(2,419)
(170)
Current-period other comprehensive income
3,103
For the six months ended June 30, 2018
(999)
(153)
Amounts reclassified from accumulated other comprehensive loss due to the adoption of ASU 2018-02
(199)
(30)
Subtotal
(1,198)
(183)
(1,381)
(2,144)
15
4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The following table summarizes the composition of our loan portfolio as of June 30, 2019 and December 31, 2018 (in thousands):
Loans secured by real estate:
Commercial real estate - owner occupied
410,832
407,031
Commercial real estate - non-owner occupied
561,732
540,698
Secured by farmland
18,629
20,966
Construction and land loans
158,956
146,654
Residential 1-4 family(1)
572,715
565,083
Multi- family residential
82,593
82,516
Home equity lines of credit(1)
117,298
128,225
Total real estate loans
1,922,755
1,891,173
Commercial loans
220,566
255,441
Consumer loans
29,310
32,347
2,172,631
2,178,961
Plus (less) deferred costs (fees) on loans
Loans, net of deferred fees
Includes $15.8 million and $18.3 million of loans as of June 30, 2019 and December 31, 2018, respectively, acquired in the Greater Atlantic Bank (“GAB”) transaction covered under an FDIC loss-share agreement. The agreement covering single family loans expires in December 2019.
In the first quarter of 2019, $33.9 million of commercial loans were reclassified into loans secured by real estate, upon review and validation of collateral and Call Report codes.
Accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment, and uncertainty in the levels of the allowance required to account for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment, and uncertainty can have on the consolidated financial results.
As part of the GAB acquisition, the Bank and the FDIC entered into loss sharing agreements on approximately $143.4 million (contractual basis) of GAB’s assets. There were two agreements with the FDIC: one for single family loans which is a 10‑year agreement expiring in December 2019, and one for non-single family (commercial) assets which was a 5‑year agreement which expired in December 2014. The Bank will continue to share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement related to single family loans; 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.” Covered loans totaled $15.8 million and $18.3 million at June 30, 2019 and December 31, 2018, respectively.
Accretable discount on the acquired EVBS, GAB, Prince George’s Federal Savings Bank (“PGFSB”), and the HarVest Bank (“HarVest”) loans totaled $13.3 million and $15.1 million at June 30, 2019 and December 31, 2018, respectively. Accretion associated with the acquired loans held for investment of $972 thousand and $1.1 million was recognized in the three months ended June 30, 2019 and 2018, respectively, and $1.8 million and $2.2 million was recognized in the six months ended June 30, 2019 and 2018, respectively.
For the three acquisitions subsequent to the GAB acquisition noted above, management sold the majority of the purchased credit impaired loans immediately after closing of the acquisition.
16
Impaired loans for the covered and non-covered portfolios were as follows (in thousands):
Total Loans
Unpaid
Recorded
Principal
Related
Investment (1)
Balance
Allowance
With no related allowance recorded
5,279
7,019
Commercial real estate - non-owner occupied (2)
4,868
5,011
Construction and land development
338
749
5,442
9,052
Residential 1-4 family (3)
1,635
4,127
Other consumer loans
20
17,562
25,978
With an allowance recorded
2,771
600
1,179
1,463
3,950
4,234
605
Grand total
21,512
30,212
Recorded investment is after cumulative prior charge offs of $1.3 million. These loans also have aggregate SBA guarantees of $3.2 million.
Includes loans secured by farmland and multi-family loans.
(3)
Includes home equity lines of credit.
2,795
4,777
171
333
336
3,450
6,013
1,591
5,911
8,007
17,370
2,626
3,276
612
1,429
1,476
4,055
4,752
618
12,062
22,122
Recorded investment is after cumulative prior charge offs of $1.5 million. These loans also have aggregate SBA guarantees of $3.4 million.
The following tables present the average recorded investment and interest income recognized for impaired loans recognized by class of loans for the three and six months ended June 30, 2019 and 2018 (in thousands):
Income
Three Months Ended June 30, 2019
Investment
5,433
92
Commercial real estate - non-owner occupied (1)
4,901
357
5,524
98
Residential 1-4 family (2)
1,691
48
17,906
352
2,787
49
1,256
4,043
69
21,949
421
Three Months Ended June 30, 2018
668
193
5,109
2,894
8,885
38
________________________________________
18
Six Months Ended June 30, 2019
5,459
158
4,933
137
28
5,547
109
1,703
107
18,004
539
2,819
99
1,257
4,076
22,080
676
Six Months Ended June 30, 2018
670
194
5,032
25
2,733
8,650
101
The following tables present the aging of the recorded investment in past due loans by class of loans as of June 30, 2019 and December 31, 2018 (in thousands):
30 - 59
60 - 89
Days
90 Days
Nonaccrual
Loans Not
Past Due
or More
Loans
Total loans:
265
813
409,754
662,039
662,954
237
158,719
3,052
157
3,209
3,207
214,150
2,827
2,170
4,997
1,180
683,836
690,013
135
149
29,161
7,431
2,341
9,772
5,200
2,157,659
577
344
921
1,284
404,826
581
617
1,198
642,982
644,180
851
145,803
168
487
3,391
251,563
5,523
197
5,720
2,055
685,533
693,308
142
32,187
7,993
1,344
9,337
6,730
2,162,894
Nonaccrual loans include SBA guaranteed amounts totaling $3.2 million and $3.4 million at June 30, 2019 and December 31, 2018, respectively.
Activity in the allowance for non-covered loan and lease losses for the three and six months ended June 30, 2019 and 2018 is summarized below (in thousands):
Commercial
Real Estate
Construction
Owner
Non-owner
and Land
1-4 Family
Consumer
Occupied
Occupied (1)
Development
Residential (2)
Unallocated
Allowance for loan losses:
816
1,831
920
6,106
1,170
253
778
11,874
Provision (recovery)
599
(118)
(481)
(237)
105
76
Charge offs
(782)
(90)
(96)
(968)
Recoveries
209
284
707
833
1,890
802
5,834
1,127
273
854
11,613
859
1,550
804
5,272
1,450
820
10,755
(113)
(257)
1,709
199
(557)
(707)
(95)
(893)
32
27
88
750
1,293
873
6,306
1,579
11,000
1,669
821
7,097
1,106
224
564
12,283
610
680
(19)
(1,368)
(181)
188
290
(462)
(167)
(156)
(1,657)
203
272
292
787
690
1,321
692
4,496
1,586
9,397
53
(28)
181
2,540
165
(261)
(937)
(182)
(1,380)
207
89
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 June 30, 2019 and December 31, 2018 (in thousands):
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
5,234
11,013
Total ending allowance
Loans:
405,553
658,086
158,618
215,124
688,378
2,155,069
Total ending loan balances
6,497
11,683
404,236
644,009
251,991
691,717
2,170,954
Troubled Debt Restructurings
A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently delinquent on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.
Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.
As of June 30, 2019, we had two loans in TDRs. One loan was modified in TDRs during the year ending December 31, 2018. One TDR which had been modified in 2013 defaulted in 2015. This loan, in the amount of $655 thousand, was current as of June 30, 2019.
Credit Quality Indicators
Through its system of internal controls, Southern National 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.
Special Mention loans are loans that have a potential weakness that deserve 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 may be 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. Southern National had no loans classified Doubtful at June 30, 2019 or December 31, 2018.
As of June 30, 2019 and December 31, 2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
Special
Mention
Substandard (3)
Pass
3,939
5,058
401,835
4,311
658,462
731
158,225
3,439
7,173
209,954
471
2,583
686,959
132
29,178
13,023
14,995
2,144,613
6,611
2,810
397,610
4,382
189
639,609
2,373
2,689
250,379
395
1,982
690,931
32,205
13,903
7,670
2,157,388
Includes loans secured by farmland and multi-family residential loans.
Includes SBA guarantees of $3.2 million and $3.4 million as of June 30, 2019 and December 31, 2018, respectively.
23
The amount of foreclosed residential real estate property held at June 30, 2019 and December 31, 2018 was $ $1.2 million. The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $0.5 million and $1.5 million at June 30, 2019 and December 31, 2018, respectively.
5. LEASES
The Company leases certain premises and equipment under operating leases. At June 30, 2019, the Company had operating lease liabilities totaling $8.4 million and right-of-use assets totaling $7.9 million related to these leases. Operating lease liabilities and right-of-use assets are reflected in our consolidated balance sheets. We do not currently have any financing leases. For the three and six months ended June 30, 2019, our net operating lease cost was $693 thousand and $1.3 million, respectively, and was reflected in occupancy expenses on our income statement.
The following table presents other information related to our operating leases:
(in thousands except for percent and period data)
Cash paid for amounts included in the measurement of lease liabilities
2,483
Right-of-use assets obtained in exchange for new operating lease liabilities
Weighted-average remaining lease term - operating leases, in years
6.0
Weighted-average discount rate - operating leases
3.0
The following table summarizes the maturity of remaining lease liabilities:
As of
(dollars in thousands)
Lease payments due:
Less than one year
1,199
One to three years
3,445
Three to five years
2,384
More than five years
2,199
Total lease payments
9,227
Less: lease expense
(842)
Lease liabilities
As of June 30, 2019, the Company does not have or expect any operating leases that have not yet commenced or will create additional lease liabilities and right-of-use assets for the Company.
6. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Southern National 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, standby letters of credit and guarantees of credit card accounts. 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 Southern National 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 $19.6 million and $19.2 million as of June 30, 2019 and December 31, 2018, 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. Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk.
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, 2019 and December 31, 2018, we had unfunded lines of credit and undisbursed construction loan funds totaling $342.0 million and $339.2 million, respectively. Virtually all of our unfunded lines of credit and undisbursed construction loan funds are variable rate.
7. EARNINGS PER SHARE
The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (amounts in thousands, except per share data):
Per Share
(Numerator)
(Denominator)
Amount
Basic EPS
24,025
Effect of dilutive stock options
298
(0.01)
Diluted EPS
24,323
24,038
24,330
24,017
24,315
24,000
282
24,282
The Company did not have any anti-dilutive options in 2019 and 2018.
8. FAIR VALUE
ASC 820 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:
Assets Measured on a Recurring Basis:
Investment Securities Available for Sale
Where quoted prices are available in an active market, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include highly liquid government bonds and mortgage products. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of investment securities with similar characteristics or discounted cash flow. Level 2 investment securities 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, investment securities are classified within Level 3 of the valuation hierarchy. Currently, a majority of Southern National’s available for sale debt investment securities are considered to be Level 2 investment securities, except for a few corporate securities that are classified as Level 3 investment securities.
26
Assets measured at fair value on a recurring basis are summarized below:
Fair Value Measurements Using
Significant
Quoted Prices in
Active Markets for
Observable
Unobservable
Total at
Identical Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Available for sale securities
1,019
1,000
162,860
142,377
Assets and Liabilities Measured on a Non-recurring Basis:
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 an independent appraisal or evaluation less estimated costs related to selling the collateral. In some cases appraised value is net of costs to sell. Estimated selling costs range from 6% to 10% of collateral valuation at June 30, 2019 and December 31, 2018. Fair value is classified as Level 3 in the fair value hierarchy. Loans identified as impaired totaled $21.5 million (including SBA guarantees of $3.2 million) as of June 30, 2019 with $605 thousand allocation made to the allowance for loan losses compared to a carrying amount of $12.1 million (including SBA guarantees of $3.4 million) with $618 thousand allocation made to the allowance for loan losses at December 31, 2018.
Assets held for sale
In connection with the merger with EVBS, SNBV acquired four properties that were either former EVBS administrative locations or previously anticipated to be future EVBS administrative locations. Assets held for sale are
measured at fair value less cost to sell, based on appraisals conducted by an independent, licensed appraiser outside of the Company using observable market data. If the fair value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. Assets held for sale are measured at fair value on a non-recurring basis and are included in other assets in the consolidated balance sheets. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statements of comprehensive income.
Other Real Estate Owned (“OREO”)
OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or evaluation less cost to sell. In some cases appraised value is net of costs to sell. Selling costs have been in the range from 5.0% to 7.6% of collateral valuation at June 30, 2019 and December 31, 2018. Fair value is classified as Level 3 in the fair value hierarchy. OREO is further evaluated quarterly for any additional impairment. At June 30, 2019 and December 31, 2018, the total amount of OREO was $5.0 million and $5.1 million, respectively.
Assets measured at fair value on a non-recurring basis are summarized below:
Impaired loans:
8,213
2,814
Other real estate owned:
Commercial real estate - owner occupied (1)
2,902
1,231
6,076
3,020
2,938
Fair Value of Financial Instruments
The carrying amount, estimated fair values and fair value hierarchy levels (previously defined) of financial instruments were as follows (in thousands) for the periods indicated:
Carrying
Hierarchy Level
Financial assets:
Cash and cash equivalents
Level 1
Securities available for sale
Level 2 & Level 3
Securities held to maturity
Level 2
Level 3
2,139,365
2,134,021
Accrued interest receivable
8,818
8,745
Financial liabilities:
Demand deposits
696,811
665,640
Money market and savings accounts
587,627
506,519
Certificates of deposit
866,127
919,175
Securities sold under agreements to repurchase
FHLB short term advances
Junior subordinated debt
13,034
12,065
Senior subordinated notes
58,785
57,173
Accrued interest payable
Level 1 & Level 3
4,121
3,985
Carrying amount is the estimated fair value for cash and cash equivalents (including federal funds sold), equity investments in our mortgage affiliate, preferred investments in our mortgage affiliate, accrued interest receivable and payable, demand deposits, savings accounts, money market accounts, securities sold under agreements to repurchase, and short-term debt (FHLB short-term advances and securities sold under agreements to repurchase). Fair value of long-term debt is based on current rates for similar financing. Carrying amount of Federal Reserve Bank and FHLB stock is a reasonable estimate of fair value as these securities are not readily marketable and are based on the ultimate recoverability of the par value. The fair value of off-balance-sheet items is not considered material. Fair value of net loans, certificates of deposits, junior subordinated debt, and senior subordinated notes are measured using the exit-price notion in accordance with the adoption of ASU 2016‑01 in 2018.
9. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER SHORT-TERM BORROWINGS
Other short-term borrowings can consist of FHLB of Atlanta overnight advances, other FHLB advances maturing within one year, federal funds purchased and securities sold under agreements to repurchase (“repo”) that mature within one year, which are secured transactions with customers. The balance in repo accounts at June 30, 2019 and December 31, 2018 was $14.3 million and $18.7 million, respectively.
10. JUNIOR SUBORDINATED DEBT AND SENIOR SUBORDINATED NOTES
In connection with our merger with EVBS, the Company assumed $10.3 million (fair value adjustment of $801 thousand) of trust preferred securities that were issued on September 17, 2003 and placed through the Trust in a pooled
29
underwriting totaling approximately $650 million. The trust issuer invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures (“Junior Subordinated Debt”) issued by EVBS. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the three-month LIBOR plus 2.95%. As of June 30, 2019 and December 31, 2018, the interest rate was 5.36% and 5.73%, respectively. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes.
The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. At June 30, 2019, all of the trust preferred securities qualified as Tier 1 capital.
On January 20, 2017, Southern National completed the sale of $27.0 million of its fixed-to-floating rate Subordinated Notes due 2027 (the “SNBV Senior Subordinated Notes”). The SNBV Senior Subordinated Notes will initially bear interest at 5.875% per annum until January 31, 2022; thereafter, the SNBV Senior Subordinated Notes will be payable at an annual floating rate equal to three-month LIBOR plus a spread of 3.95% until maturity or early redemption. At June 30, 2019, all of the SNBV Senior Subordinated Notes qualified as Tier 2 capital. At June 30, 2019, the remaining unamortized debt issuance costs related to the SNBV Senior Subordinated Notes totaled $713 thousand.
Also in connection with our merger with EVBS, the Company assumed the Senior Subordinated Note Purchase Agreement previously entered into by EVBS on April 22, 2015 with certain institutional accredited investors pursuant to which EVBS sold $20.0 million (fair value adjustment of $1.9 million) in aggregate principal amount of its 6.50% Fixed-to-Floating Rate Subordinated Notes due 2025 (the “EVBS Senior Subordinated Notes”) to the investors at a price equal to 100% of the aggregate principal amount of the EVBS Senior Subordinated Notes. At June 30, 2019 all of the EVBS Senior Subordinated Notes qualified as Tier 2 capital.
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, 2018. Results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of results that may be attained for any other period.
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. Forward-looking statements are based on our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account the information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “forecast,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.
Forward-looking statements involve risks and uncertainties that may 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 Factor contained in this Quarterly Report on Form 10‑Q, as well as the Risk Factors previously disclosed in our Annual Report on Form 10‑K for the year ended December 31, 2018, factors that could contribute to those differences include, but are not limited to:
the effects of future economic, business and market conditions and disruptions in the credit and financial markets, domestic and foreign;
changes in the local economies in our market areas which 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, as well as the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs;
a deterioration or downgrade in the credit quality and credit agency ratings of the investment securities in our investment securities portfolio;
impairment concerns and risks related to our investment securities portfolio of collateralized mortgage obligations, agency mortgage-backed securities, obligations of states and political subdivisions and pooled trust preferred securities;
the incurrence and possible impairment of goodwill associated with current or future acquisitions 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;
failure to prevent a breach to our Internet-based system and online commerce security;
changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;
the failure of assumptions and estimates 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 banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;
government intervention in the U.S. financial system, including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection
Bureau, the capital ratios of Basel III as adopted by the federal banking authorities and the Tax Cuts and Jobs Act;
increased competition for deposits and loans adversely affecting rates and terms;
the continued service of key management personnel;
the potential payment of interest on demand deposit accounts to effectively compete for customers;
potential environmental liability risk associated with properties that we assume upon foreclosure;
increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;
risks of current or future mergers and acquisitions, including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings;
increases in regulatory capital requirements for banking organizations generally, which may adversely affect our ability to expand our business or could cause us to shrink our business;
acts of God or of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions;
changes in accounting policies, rules and practices and applications or determinations made thereunder;
fraudulent and negligent acts by loan applicants, mortgage brokers and our employees;
failure to maintain effective internal controls and procedures;
the risk that our deferred tax assets could be reduced if future taxable income is less than currently estimated, if corporate tax rates in the future are less than current rates, or if sales of our capital stock trigger limitations on the amount of net operating loss carryforwards that we may utilize for income tax purposes;
our ability to attract and retain qualified employees; and
other factors and risks described under “Risk Factors” herein and in any of our subsequent reports that we file with the Securities and Exchange Commission (the “Commission” or “SEC”) under the Exchange Act.
Forward-looking statements are not guarantees of performance or results and should not be relied upon as representing management’s views as of any subsequent date. 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 refer to the risk factors and other cautionary statements in this Quarterly Report on Form 10‑Q and in our periodic and current reports filed with the SEC for specific factors that could cause our actual results to be different from those expressed or implied by our forward-looking statements. These statements speak only as of the date of this Quarterly Report on Form 10‑Q (or an earlier date to the extent applicable). Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.
OVERVIEW
SNBV is a corporation that was formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank a Virginia state-chartered bank which commenced operations on April 14, 2005. As of the close of business on June 23, 2017, SNBV completed its merger with EVBS and the merger of EVBS’s wholly-owned subsidiary, EVB, with and into SNBV’s wholly-owned subsidiary, Sonabank. Sonabank provides a range of financial services to individuals and small and medium sized businesses. At June 30, 2019, Sonabank had thirty-eight full-service retail branches in Virginia, located in the counties of Chesterfield (2), Essex (2), Fairfax (Reston, McLean and Fairfax), Gloucester (2), Hanover (3), King William, Lancaster, Middlesex (3), New Kent, Northumberland (3), Southampton, Surry, Sussex, and in Charlottesville, Clifton Forge, Colonial Heights, Front Royal, Hampton, Haymarket, Leesburg, Middleburg, New Market, Newport News, Richmond, South Riding, Warrenton, and Williamsburg, and seven full-service retail branches in Maryland, in Rockville, Shady Grove, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.
We have administrative offices in Warrenton and Glen Allen, Virginia, and executive offices in Georgetown, Washington, D.C. and Glen Allen, Virginia where senior management is located.
RESULTS OF OPERATIONS
Net Income
Three-Month Comparison. Net income for the three months ended June 30, 2019 was $9.3 million, or $0.39 basic and $0.38 diluted earnings per share, compared to net income of $8.9 million, or $0.37 basic and diluted earnings per share, for the three months ended June 30, 2018.
The increase in the net income during the three months ended June 30, 2019 compared to the three months ended June 30, 2018 was primarily driven by an income tax benefit of $1.2 million in the second quarter of 2019 due to the formal assessment and rebooking of the $5.5 million net operating loss carryforward that was written off in the fourth quarter of 2018. The increase was partially offset by a decrease in net interest income as a result of a rising interest rate environment during 2018.
During the three months ended June 30, 2018, net income was impacted positively by the $1.2 million of accretion income from the acquired loan discounts, $732 thousand of interest income recognized on the payout of a $9.9 million nonaccrual loan, and $250 thousand of income from recoveries of legacy investment securities and loans charged off by EVBS before it merged into Southern National in June of 2017.
Six-Month Comparison. Net income for the six months ended June 30, 2019 was $15.3 million, or $0.64 basic and $0.63 diluted earnings per share, compared to net income of $17.1 million, or $0.71 basic and diluted earnings per share, for the six months ended June 30, 2018.
The decrease in the net income during the six months ended June 30, 2019 compared to the six months ended June 30, 2018 was primarily driven by a nonrecurring other loss of $3.2 million and related legal expense of $502 thousand. The decrease was partially offset by an income tax benefit of $1.2 million in the second quarter of 2019 due to the formal assessment and rebooking of the $5.5 million net operating loss carryforward that was written off in the fourth quarter of 2018.
During the six months ended June 30, 2018, the net income was impacted positively by the $2.5 million of accretion income from the acquired loan discounts, $1.7 million of income from recoveries of legacy investment securities and loans charged off by EVBS before it merged into Southern National in June of 2017, and the reduced federal income tax rate of 21% from 34% due to the enactment of the Tax Cuts and Jobs Act of 2017, which became effective on January 1, 2018.
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.
Three-Month Comparison. Net interest income was $21.0 million for the three months ended June 30, 2019 compared to $23.2 million for the three months ended June 30, 2018, which was a direct result of the rising costs of funds including deposits and borrowings. Southern National’s net interest margin for the three months ended June 30, 2019 was 3.40% compared to 3.79% for the three months ended June 30, 2018. Total income on interest-earning assets was $30.3 million and $30.0 million for the three months ended June 30, 2019 and 2018, respectively. The yield on average interest-earning assets was 4.93% and 4.86% for the second quarter of 2019 and 2018, respectively. Interest and fees on loans totaled $28.4 million and $27.7 million for the second quarter of 2019 and 2018, respectively. The accretion of the discount on loans acquired in the acquisitions of EVBS, Greater Atlantic Bank, HarVest and Prince Georges Federal Savings Bank contributed $156 thousand to net interest income during the three months ended June 30, 2019 compared to $1.2 million during the three months ended June 30, 2018. The decrease in accretion was due to the slowdown in acquired loan prepayments and payoffs. Average loans during the second quarter of 2019 were $2.16 billion compared to $2.14 billion during the second quarter of 2018.
33
Total interest expense was $9.4 million and $6.5 million for the three months ended June 30, 2019 and 2018, respectively. Interest on deposits was $7.7 million and $3.8 million for the three months ended June 30, 2019 and 2018, respectively. Total average interest-bearing deposits for the second quarter of 2019 and 2018 were $1.78 billion and $1.56 billion, respectively. The yield on total average interest-bearing deposits was 1.72% and 0.98% for the quarter ended June 30, 2019 and 2018, respectively. Interest expense on total average borrowings, which include securities sold under agreements to repurchase, FHLB advances, junior subordinated debt, and senior subordinated notes, was $1.8 million and $2.7 million for the three months ended June 30, 2019 and 2018, respectively. Total average borrowings were $223.0 million and $451.9 million for the three months ended June 30, 2019 and 2018, respectively.
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:
Average Balance Sheets and Net Interest
Analysis For the Three Months Ended
June 30, 2018
Income/
Yield/
Expense
Rate
(Dollar amounts in thousands)
Assets
Interest-earning assets:
Loans, net of deferred fees (1) (2)
2,161,505
5.27
2,141,966
5.19
Investment securities
248,276
1,627
2.63
250,573
1,560
2.50
Other earning assets
55,824
326
2.34
58,517
426
2.91
Total earning assets
2,465,605
30,331
4.93
2,451,056
4.86
Allowance for loan losses
(12,488)
(11,172)
Total non-earning assets
266,606
262,974
2,719,723
2,702,858
Liabilities and stockholders' equity
Interest-bearing liabilities:
NOW and other demand accounts
357,850
773
0.87
327,459
0.41
432,927
2,058
1.91
330,214
619
0.75
146,073
115
0.32
164,421
848,806
4,709
2.23
739,673
2,723
1.48
1,785,656
7,655
1.72
1,561,767
0.98
Borrowings
223,053
1,774
3.19
451,919
2,699
2.40
Total interest-bearing liabilities
2,008,709
1.88
2,013,686
1.30
Noninterest-bearing liabilities:
331,481
336,849
22,123
19,248
2,362,313
2,369,783
Stockholders' equity
357,410
333,075
20,902
23,172
Interest rate spread
3.05
3.56
Net interest margin
3.40
3.79
Includes loan fees in both interest income and the calculation of the yield on loans.
Calculations include non-accruing loans in average loan amounts outstanding.
Six-Month Comparison. Net interest income was $41.9 million for the six months ended June 30, 2019 compared to $45.7 million for the six months ended June 30, 2018, which was a direct result of the rising costs of funds including deposits and borrowings. Southern National’s net interest margin for the six months ended June 30, 2019 was 3.41% compared to 3.80% for the six months ended June 30, 2018. Total income on interest-earning assets was $60.6 million and $57.7 million for the six months ended June 30, 2019 and 2018, respectively. The yield on average interest-earning assets was 4.94% and 4.81% for the six months ended June 30, 2019 and 2018, respectively. Interest and fees on loans totaled $56.4 million and $53.6 million for the six months ended June 30, 2019 and 2018, respectively. The accretion of the
34
discount on loans acquired in the acquisitions of EVBS, Greater Atlantic Bank, HarVest and Prince Georges Federal Savings Bank contributed $972 thousand to net interest income during the six months ended June 30, 2019 compared to $2.5 million during the six months ended June 30, 2018. The decrease in accretion was due to the slowdown in acquired loan prepayments and payoffs. Average loans during the six months ended June 30, 2019 were $2.16 billion compared to $2.11 billion during the six months ended June 30, 2018.
Total interest expense was $18.8 million and $12.0 million for the six months ended June 30, 2019 and 2018, respectively. Interest on deposits was $15.1 million and $7.1 million for the six months ended June 30, 2019 and 2018, respectively. Total average interest-bearing deposits for the six months ended June 30, 2019 and 2018 were $1.80 billion and $1.55 billion, respectively. The yield on total average interest-bearing deposits was 1.69% and 0.92% for the six months ended June 30, 2019 and 2018, respectively. Interest expense on total average borrowings, which include securities sold under agreements to repurchase, FHLB advances, junior subordinated debt, and senior subordinated notes, was $3.7 million and $4.9 million for the six months ended June 30, 2019 and 2018, respectively. Total average borrowings were $218.5 million and $439.0 million for the six months ended June 30, 2019 and 2018, respectively.
Analysis For the Six Months Ended
2,158,395
5.26
2,109,109
53,603
5.14
242,878
2.66
254,083
3,201
2.54
73,001
1,011
2.79
58,401
899
3.10
2,474,275
60,570
4.94
2,421,593
4.81
(12,393)
(10,781)
261,938
259,039
2,723,820
2,669,851
351,925
1,415
0.81
327,427
652
0.40
417,358
3,886
336,425
146,827
230
163,786
260
887,258
9,585
2.18
719,453
4,989
1.40
1,803,368
1.69
1,547,091
0.92
218,516
3,663
3.38
439,022
4,949
2.27
2,021,884
18,779
1.87
1,986,113
1.22
325,921
333,095
20,818
18,861
2,368,623
2,338,069
355,197
331,782
41,791
3.06
3.58
3.41
3.80
35
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 for inherent probable losses in the loan portfolio 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 historical loss data, peer data, as well as applying management’s judgment.
For the three months ended June 30, 2019 and 2018, the provision for loan losses was zero and $1.1 million, respectively. The provision for loan losses for the six months ended June 30, 2019 and 2018 was $200 thousand and $2.7 million, respectively. Net charge offs for the three and six months ended June 30, 2019 and 2018 was $261 thousand and $870 thousand, respectively, compared to $804 thousand and $1.0 million, respectively for the three and six months ended June 30, 2018.
Noninterest Income
The following table presents the major categories of noninterest income for the three months ended June 30, 2019 and 2018:
Change
413
(178)
Equity income from mortgage affiliate
367
638
Southern National had noninterest income of $3.2 million and $2.6 million during the second quarter of 2019 and 2018, respectively. Account maintenance and deposit service fees, which totaled $1.8 million for the second quarter of 2019, increased $413 thousand compared to prior year. Income from bank-owned life insurance, which totaled $385 thousand for the second quarter of 2019, decreased $178 thousand compared to $563 thousand of income in the second quarter of 2018. The second quarter decrease was driven by death benefits paid in 2018. Income from the investment in STM totaled $558 thousand during the second quarter of 2019 compared to $191 thousand during the second quarter of 2018. The increase was driven by strengthened management and operational improvements within STM. Other noninterest income, which totaled $324 thousand for the second quarter of 2019, increased $74 thousand when compared to the second quarter of the prior year. For the three months ended June 30, 2019, other noninterest income has benefited, from $324 thousand of recoveries of legacy investment securities and loans charged off by EVBS premerger compared to $243 thousand for the three months ended June 30, 2018.
The following table presents the major categories of noninterest income for the six months ended June 30, 2019 and 2018:
Equity income (loss) from mortgage affiliate
702
(818)
621
36
Southern National had noninterest income of $6.3 million and $5.6 million during the six months ended June 30, 2019 and 2018, respectively. The $621 thousand increase was primarily driven by an increase of $692 thousand increase in account maintenance and deposit fees and $702 thousand increase in equity income from mortgage affiliate, partially offset by $818 thousand decrease in recoveries related to acquired charged-off loans and investment securities. Income improved on account maintenance and deposit services fee in the current year compared to the prior year. Income from the investment in STM totaled $576 thousand during the six months ended June 30, 2019 compared to the loss of $126 thousand during the six months ended June 30, 2018. The increase was driven by strengthened management and operational improvements within STM. For the six months ended June 30, 2019, other noninterest income has benefited, from $915 thousand of recoveries of legacy investment securities and loans charged off by EVBS premerger compared to $1.7 million for the six months ended June 30, 2018.
Noninterest Expense
The following table presents the major categories of noninterest expense for the three months ended June 30, 2019 and 2018:
145
71
Net gain on other real estate owned
542
(663)
Noninterest expense was $13.9 million and $13.6 million during the three months ended June 30, 2019 and 2018, respectively. Employee compensation and benefits expense totaled $7.1 million and $7.0 million for the three months ended June 30, 2019 and 2018, respectively. The increase was due to $350 thousand of separation expense recognized in 2019, partially offset by savings from the reduction in staff completed during 2018. Occupancy expenses and equipment increased $145 thousand from prior year primarily due to improvements made to our branch offices.
The following table presents the major categories of noninterest expense for the six months ended June 30, 2019 and 2018:
(823)
(61)
270
153
(198)
1,197
2,422
2,946
Noninterest expense was $30.2 million and $27.2 million during the six months ended June 30, 2019 and 2018, respectively. The increase in noninterest expenses was primarily due to a nonrecurring other loss of $3.2 million with related legal expense of $502 thousand during the first quarter of 2019. Employee compensation and benefits expense totaled $13.0 million and $13.8 million for the six months ended June 30, 2019 and 2018, respectively. The decrease was due to a reduction in staffing. Occupancy expenses and equipment increased $298 thousand from prior year primarily due to improvements made to our branch offices. The Company recognized a gain of $38 thousand on the sale of other real estate owned (“OREO”) during the six months ended June 30, 2019 compared to a $160 thousand loss for the six months ended June 30, 2018. Other expenses totaled $8.5 million and $4.2 million for six months ended June 30, 2019 and 2018, respectively.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets were $2.72 billion and 2.70 billion, respectively as of June 30, 2019 and as of December 31, 2018. Total loans decreased 0.3%, from $2.18 billion at December 31, 2018 to $2.17 billion at June 30, 2019, primarily due to unanticipated large loan payoffs of $50.0 million in the first quarter of 2019, partially offset by growth of $44.0 million during the six months ended June 30, 2019. Total deposits were $2.15 billion at June 30, 2019 compared to $2.10 billion at December 31, 2018 and total equity was $362.8 million and $348.3 million at June 30, 2019 and December 31, 2018, respectively.
Loan Portfolio
Loan demand remains strong in the Company’s markets. Loan growth in the six months ended June 30, 2019 of $44.0 million was offset by $40.0 million in five hospitality loans that paid off due to property sales and under-market rates offered by other financial institutions and a $10.0 million construction loan moved to a competitor on a nonrecourse basis. Additionally, in the first quarter of 2019, $33.9 million of commercial loans were reclassified into loans secured by real estate, upon review and validation of collateral and Call Report codes.
The composition of our loan portfolio consisted of the following at June 30, 2019 and December 31, 2018 (in thousands):
Residential 1-4 family
Multi-family residential
Home equity lines of credit
Gross loans
Less deferred fees on loans
As of June 30, 2019 and December 31, 2018, 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
Asset quality remained high during the first six months of 2019. 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 OREO 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.
Other real estate owned ("OREO") at June 30, 2019 was $5.0 million compared to $5.1 million at December 31, 2018.
Non-covered nonaccrual loans were $1.2 million (excluding $3.2 million of loans fully covered by SBA guarantees) at June 30, 2019 compared to $2.5 million (excluding $3.4 million of loans fully covered by SBA guarantees) as of December 31, 2018. The ratio of non-covered nonperforming assets (excluding the SBA guaranteed loans) to total non-covered assets decreased from 0.28% at December 31, 2018 to 0.26% at June 30, 2019.
Southern National’s allowance for loan losses as a percentage of total non-covered loans at June 30, 2019 was 0.54%, compared to 0.57% at December 31, 2018. The allowance for loan losses as a percentage of non-covered non-acquired loans was 0.78% and 0.85% at June 30, 2019 and December 31, 2018, respectively.
We have 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.
The following table presents a comparison of non-covered nonperforming assets as of June 30, 2019 and December 31, 2018 (in thousands):
Nonaccrual loans
5,201
6,709
Loans past due 90 days and accruing interest
Total nonperforming loans
Total non-covered nonperforming assets
10,242
11,786
Troubled debt restructurings
685
SBA guaranteed amounts included in nonaccrual loans
Allowance for loan losses to nonperforming loans
223.35
207.63
Allowance for loan losses to total non-covered loans
0.54
0.57
Nonperforming assets excluding SBA guaranteed loans to total non-covered assets
0.26
0.28
39
Investment Securities
Investment securities, available for sale and held to maturity, totaled $250.7 million at June 30, 2019 up from $235.8 million at December 31, 2018.
Investment securities in our portfolio as of June 30, 2019 were as follows:
residential government-sponsored collateralized mortgage obligations in the amount of $45.6 million;
agency residential mortgage-backed securities in the amount $54.8 million;
corporate bonds in the amount of $2.0 million;
commercial mortgage-backed securities in the amount of $28.0 million;
SBA loan pool securities in the amount of $17.2 million;
callable agency securities in the amount of $58.9 million;
trust preferred securities in the amount of $5.2 million; and
municipal bonds in the amount of $38.9 million with a taxable equivalent yield of 3.0% and ratings as of June 30, 2019 as follows:
Standard & Poor's
Rating
6,370
AAA
7,100
11,564
AA+
7,631
Aa2
3,197
11,067
Aa3
1,916
AA-
1,811
1,866
A+
1,024
1,531
A
850
Baa1
1,012
BBB+
NA
11,424
38,880
Available for sale investment securities of $25.1 million were purchased during the six months ended June 30, 2019. No investment securities were sold during the first six months of 2019.
At June 30, 2019, we owned pooled trust preferred securities as follows (in thousands):
Ratings
When Purchased
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Each of these investment securities has been evaluated for potential impairment under accounting guidelines. In performing a detailed cash flow analysis of each investment security, Sonabank works with independent third parties to identify the most reflective 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 an investment security (that is, credit loss exists), an other than temporary impairment is considered to have occurred. If there is no credit loss, any impairment is considered temporary.
We recognized no other than temporary impairment charges during the six months ended June 30, 2019 and 2018, respectively.
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 with the FHLB of Atlanta, federal funds lines of credit with three correspondent banks and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.
We prepare a cash flow forecast for one year with the first three months prepared on a weekly basis and on a monthly basis thereafter. The projections incorporate expected cash flows on loans, investment securities, and deposits based on data used to prepare our interest rate risk analyses. To estimate loan growth over the one year period, the projection incorporates the scheduled loan closings in the Loan Pipeline Report along with other management estimates.
During the six months ended June 30, 2019, we funded our financial obligations with deposits, borrowings from the FHLB of Atlanta and the proceeds from issuance of the SNBV Senior Subordinated Notes in January 2018. At June 30, 2019, we had $342.0 million of unfunded commitments. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
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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 Company and the Bank at the dates indicated to the minimum and well-capitalized regulatory standards (dollars in thousands):
Required for Capital
To Be Categorized as
Actual
Adequacy Purposes (1)
Well Capitalized (2)
Ratio
Southern National
Common equity tier 1 capital ratio
250,475
12.00
93,928
4.50
n/a
Tier 1 risk-based capital ratio
260,475
12.48
125,238
6.00
Total risk-based capital ratio
319,088
15.29
166,984
8.00
Leverage ratio
9.93
104,929
4.00
Sonabank
295,654
14.08
95,495
137,938
6.50
127,327
169,769
307,267
14.63
212,212
10.00
11.27
104,359
106,106
5.00
239,554
11.57
93,135
249,554
12.06
124,180
308,838
14.92
165,573
9.57
104,338
288,018
13.64
95,020
137,251
126,693
168,924
300,301
14.22
211,156
11.03
104,420
105,578
When fully phased-in on January 1, 2019, the Basel III capital rules included a capital conservation buffer of 2.5% that is added on top of each of the minimum risk-based capital ratios noted above. Implementation began on January 1, 2016 at the 0.625% level and increased each subsequent January 1, until it reached 2.5% on January 1, 2019.
Prompt corrective action provisions are not applicable at the bank holding company level.
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.
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 net interest income, without having to incur unacceptable levels of credit or investment risk.
We use simulation modeling to manage our interest rate risk, and we review quarterly interest sensitivity reports prepared for us by FTN Financial using the Fiserv Prologue Risk Manager ALM Analysis System. This approach uses a model which generates estimates of the change in our economic value of equity (“EVE”) over a range of interest rate
42
scenarios. EVE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using 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 EVE resulting from instantaneous and sustained parallel shifts in the yield curve (plus 400 basis points or minus 200 basis points, measured in 100 basis point increments) as of June 30, 2019 and as of December 31, 2018. All changes are within our Asset/Liability Risk Management Policy guidelines except for the change resulting from the 100 and 200 basis point decrease in interest rates at June 30, 2019 and December 31, 2018.
Sensitivity of Economic Value of Equity
As of June 30, 2019
Economic Value of
Economic Value of Equity
Equity as a % of
Change in Interest Rates
$ Change
% Change
Equity
in Basis Points (Rate Shock)
From Base
Book Value
(dollar amounts in thousands)
Up 400
344,880
(22,904)
(6.23)
12.66
95.01
Up 300
352,084
(15,700)
(4.27)
12.93
97.00
Up 200
359,580
(8,204)
(2.23)
13.20
99.06
Up 100
365,474
(2,310)
(0.63)
13.42
100.68
Base
367,784
13.50
101.32
Down 100
333,464
(34,320)
(9.33)
12.24
91.87
Down 200
292,700
(75,084)
(20.42)
10.75
80.64
As of December 31, 2018
338,853
(33,298)
(8.95)
12.54
97.03
347,409
(24,742)
(6.65)
12.85
99.48
356,429
(15,722)
(4.22)
13.19
102.07
362,312
(9,839)
(2.64)
13.40
103.75
372,151
0.00
13.77
106.57
341,397
(30,754)
(8.26)
12.63
97.76
303,809
(68,342)
(18.36)
11.24
87.00
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 (“NII”) over a range of interest rate scenarios. NII 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, 2019 and December 31, 2018 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
43
specific assets and liabilities. All changes are within our Asset/Liability Risk Management Policy guidelines at June 30, 2019 and December 31, 2018.
Sensitivity of Net Interest Income
Adjusted Net Interest Income
Net Interest Margin
$Change
Percent
97,048
8,768
3.88
0.31
94,905
6,625
0.23
92,753
4,473
3.73
0.16
90,785
2,505
3.66
0.09
88,280
3.57
87,816
(464)
87,641
(639)
101,121
9,785
4.05
0.35
97,784
6,448
3.97
96,305
4,969
93,719
2,383
3.78
0.07
91,336
3.70
91,719
383
3.72
0.04
91,165
(171)
0.03
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in EVE 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 EVE tables and NII 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 NII. Sensitivity of EVE and NII are modeled using different assumptions and approaches.
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(e) under the Securities Exchange Act of 1934) utilizing the framework established in “Internal Control – Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon 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.
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(b) Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1 – LEGAL PROCEEDINGS
Southern National and Sonabank are from time to time a party, as both plaintiff and defendant, to various claims and proceedings arising in the ordinary course of the Bank’s business, including administrative and/or legal proceedings that may include employment-related claims, as well as claims of lender liability, breach of contract, and other similar lending-related claims. While the ultimate resolution of these matters cannot be determined at this time, the Bank’s management presently believes that such matters, individually and in the aggregate, will not have a material adverse effect on the Bank’s financial condition or results of operations. There are no proceedings pending, or to management’s knowledge, threatened, that represent a significant risk against Southern National or Sonabank as of June 30, 2019.
ITEM 1A – RISK FACTORS
As of June 30, 2019, there have been no material changes to the risk factors faced by Southern National from those previously disclosed on our Annual Report on Form 10‑K for the year ended December 31, 2018.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
ITEM 4 – MINE SAFETY DISCLOSURES
ITEM 5 – OTHER INFORMATION
ITEM 6 - EXHIBITS
(a) Exhibits.
Exhibit No.
Description
3.1
Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to Southern National’s Registration Statement on Form S‑1 (Registration No. 333‑136285))
3.2
Certificate of Amendment to the Articles of Incorporation dated January 31, 2005 (incorporated herein by reference to Exhibit 3.2 to Southern National’s Registration Statement on Form S‑1 (Registration No. 333‑136285))
3.3
Certificate of Amendment to the Articles of Incorporation dated April 13, 2006 (incorporated herein by reference to Exhibit 3.3 to Southern National’s Registration Statement on Form S‑1 (Registration No. 333‑136285))
3.4
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to Southern National’s Annual Report on Form 10‑K for the year ended December 31, 2006)
3.5
Amendment No. 1 to Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.1 to Southern National’s Current Report on Form 8‑K filed on October 14, 2009)
3.6
Amendment No. 2 to Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.1 to Southern National’s Current Report on Form 8‑K filed on April 5, 2017)
10.1+*
Employment Agreement, dated as of February 28, 2019, by and between George C. Sheflett and Southern National Bancorp of Virginia, Inc.
10.2+
Amendment to Employment Agreement, dated as of April 18, 2019, by and between Georgia S. Derrico and Southern National Bancorp of Virginia, Inc. (incorporated herein by reference to Exhibit 10.1 to Southern National’s Current Report on Form 8‑K filed on April 24,2019)
10.3+
Amendment to Employment Agreement, dated as of April 18, 2019, by and between R. Roderick Porter and Southern National Bancorp of Virginia, Inc. (incorporated herein by reference to Exhibit 10.2 to Southern National’s Current Report on Form 8‑K filed on April 24,2019)
10.4+
Supplemental Executive Retirement Plan, dated as of April 2, 2018, by and between Sonabank and Georgia S. Derrico (incorporated herein by reference to Exhibit 10.3 to Southern National’s Current report on Form 8-K filed April 24, 2019)
10.5+
Supplemental Executive Retirement Plan, dated as of April 2, 2018, by and between Sonabank and R. Roderick Porter (incorporated herein by reference to Exhibit 10.4 to Southern National’s Current report on Form 8-K filed April 24, 2019)
10.6+
Supplemental Executive Retirement Plan, dated as of April 2, 2018, by and between Sonabank and Joe A. Shearin (incorporated herein by reference to Exhibit 10.5 to Southern National’s Current report on Form 8-K filed April 24, 2019)
10.7+
Termination Agreement between Southern National Bancorp of Virginia, Inc., Sonabank and Jeffrey H. Culver, dated as of June 20, 2019 (incorporated herein by reference to Exhibit 10.2 to Southern National’s Current Report on Form 8‑K filed on June 21, 2019)
31.1*
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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The following materials from Southern National Bancorp of Virginia, Inc. Quarterly Report on Form 10‑Q for the quarter ended June 30, 2019, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income and Comprehensive Income (unaudited), (iii) Consolidated Statement of Changes in Stockholders’ Equity (unaudited), (iv) Consolidated Statements of Cash Flows (unaudited), and (v) Notes to Consolidated Financial Statements (unaudited).
+ Management contract or compensatory plan or arrangement
* Filed with this Quarterly Report on Form 10‑Q
** Furnished with this Quarterly Report on Form 10‑Q
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.
Southern National Bancorp of Virginia, Inc.
(Registrant)
August 8, 2019
/s/ Joe A. Shearin
(Date)
Joe A. Shearin,
Chief Executive Officer
(Principal Executive Officer)
/s/ Jeffrey L. Karafa
Jeffrey L. Karafa,
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)