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 March 31, 2020
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 April 30, 2020, there were 24,297,703 shares of common stock outstanding.
March 31, 2020
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019
2
Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2020 and 2019
3
Consolidated Statement of Changes in Stockholders’ Equity for the three months ended March 31, 2020 and 2019
4
Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019
5
Notes to Unaudited Consolidated Financial Statements
6
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
39
Item 4 – Controls and Procedures
41
PART II - OTHER INFORMATION
Item 1 – Legal Proceedings
Item 1A – Risk Factors
42
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
43
Item 3 – Defaults Upon Senior Securities
Item 4 – Mine Safety Disclosures
Item 5 – Other Information
Item 6 - Exhibits
44
Signatures
46
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts)
March 31,
December 31,
2020
2019
(unaudited)
*
ASSETS
Cash and cash equivalents:
Cash and due from financial institutions
$
10,145
7,909
Interest-bearing deposits in other financial institutions
45,720
24,019
Total cash and cash equivalents
55,865
31,928
Securities available for sale, at fair value
168,520
164,820
Securities held to maturity, at amortized cost (fair value of $60,426 and $72,666, respectively)
59,234
72,448
Total loans
2,212,538
2,186,047
Less allowance for loan losses
(12,722)
(10,261)
Net loans
2,199,816
2,175,786
Stock in Federal Reserve Bank and Federal Home Loan Bank
21,396
17,832
Equity investment in mortgage affiliate
5,251
5,020
Preferred investment in mortgage affiliate
3,305
Bank premises and equipment, net
31,079
31,184
Operating lease right-of-use assets
7,664
8,013
Goodwill
101,954
Core deposit intangibles, net
6,850
7,191
Bank-owned life insurance
64,236
63,850
Other real estate owned
5,876
6,224
Deferred tax assets, net
11,154
11,788
Other assets
20,363
20,827
Total assets
2,762,563
2,722,170
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits
338,095
339,153
Interest-bearing deposits:
NOW accounts
380,977
391,172
Money market accounts
477,660
466,867
Savings accounts
151,406
144,486
Time deposits
727,216
783,040
Total interest-bearing deposits
1,737,259
1,785,565
Total deposits
2,075,354
2,124,718
Securities sold under agreements to repurchase - short term
13,179
12,883
Federal Home Loan Bank (FHLB) advances
205,140
121,640
Junior subordinated debt - long term
9,645
9,632
Senior subordinated notes - long term
47,041
47,051
Operating lease liabilities
8,509
8,469
Other liabilities
24,873
20,536
Total liabilities
2,383,741
2,344,929
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; 24,297,703 and 24,181,534 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
242
241
Additional paid in capital
308,352
306,755
Retained earnings
67,061
69,462
Accumulated other comprehensive income
3,167
783
Total stockholders' equity
378,822
377,241
Total liabilities and stockholders' equity
* Derived from audited consolidated financial statements
See accompanying notes to unaudited consolidated financial statements.
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
Interest and dividend income:
Interest and fees on loans
26,741
27,974
Interest and dividends on taxable securities
1,244
1,425
Interest and dividends on tax exempt securities
117
156
Interest and dividends on other earning assets
379
748
Total interest and dividend income
28,481
30,303
Interest expense:
Interest on deposits
6,503
7,462
Interest on repurchase agreements
19
23
Interest on junior subordinated debt
139
150
Interest on senior subordinated notes
712
Interest on other borrowings
593
1,004
Total interest expense
7,966
9,351
Net interest income
20,515
20,952
Provision for loan losses
3,450
200
Net interest income after provision for loan losses
17,065
20,752
Noninterest income:
Account maintenance and deposit service fees
1,698
1,687
Income from bank-owned life insurance
386
523
Equity gain from mortgage affiliate
231
18
Recoveries related to acquired charged-off loans and investment securities
184
591
Other
321
243
Total noninterest income
2,820
3,062
Noninterest expenses:
Salaries and benefits
12,309
5,812
Occupancy expenses
1,939
1,803
Furniture and equipment expenses
619
710
Amortization of core deposit intangible
341
363
Virginia franchise tax expense
570
563
Data processing expense
707
512
Telephone and communication expense
368
375
Net (gain) loss on other real estate owned
71
(2)
Professional fees
1,193
1,093
Other operating expenses
1,735
5,061
Total noninterest expenses
19,852
16,290
Income before income taxes
33
7,524
Income tax expense
1,504
Net income
27
6,020
Other comprehensive income:
Unrealized gain on available for sale securities
3,014
1,084
Accretion of amounts previously recorded upon transfer to held to maturity from available for sale
Net unrealized gain
3,018
1,087
Tax effect
634
229
Other comprehensive income
2,384
858
Comprehensive income
2,411
6,878
Earnings per share, basic
0.00
0.25
Earnings per share, diluted
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
For the Three Months Ended March 31, 2020
Accumulated
Additional
Common
Paid in
Retained
Comprehensive
Stock
Capital
Earnings
Income
Total
Balance - December 31, 2019
Changes in other comprehensive income on investment securities (net of tax $634)
Dividends on common stock ($0.10 per share)
(2,428)
Issuance of common stock under Stock Incentive Plan (44,600 shares)
1
193
194
Stock-based compensation expense
1,404
Balance - March 31, 2020
For the Three Months Ended March 31, 2019
Loss
Balance - December 31, 2018
240
305,654
44,985
(2,589)
348,290
Changes in other comprehensive loss on investment securities (net of tax $229)
Dividends on common stock ($0.09 per share)
(2,170)
Issuance of common stock under Stock Incentive Plan (17,250 shares)
121
122
Impact of adoption of ASU 2016-02
(535)
104
Balance - March 31, 2019
305,879
48,300
(1,731)
352,689
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
For the Years Ended March 31,
Operating activities:
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation and amortization
1,364
1,741
Amortization of operating lease right-of-use assets
1,038
586
Accretion of loan discount
(597)
(816)
Amortization of FDIC indemnification asset
177
Earnings on bank-owned life insurance
(386)
(523)
Equity gain on mortgage affiliate
(231)
(18)
(Gain) loss on other real estate owned
Net (increase) decrease in other assets
464
(4,420)
Net increase in other liabilities
3,687
8,641
Net cash and cash equivalents provided by operating activities
10,291
11,690
Investing activities:
Purchases of held to maturity investment securities
(15,197)
Purchases of available for sale investment securities
(9,980)
(15,313)
Proceeds from paydowns, maturities and calls of available for sale investment securities
8,907
3,172
Proceeds from paydowns, maturities and calls of held to maturity investment securities
28,271
1,778
Net (increase) decrease of FRB and FHLB stock
(3,564)
1,095
Net (increase) decrease in loans
(26,883)
21,815
Proceeds from bank-owned life insurance death benefit
344
Sales of other real estate owned, net of improvements
277
38
Purchases of bank premises and equipment
(383)
(7)
Net cash and cash equivalents provided by (used in) investing activities
(18,552)
12,922
Financing activities:
Net increase (decrease) in deposits
(49,364)
13,464
Cash dividends paid on common stock
Issuance of common stock under Stock Incentive Plan
Net decrease (increase) in short-term borrowings
83,796
(32,798)
Net cash and cash equivalents provided by (used in) financing activities
32,198
(21,382)
Increase in cash and cash equivalents
23,937
3,230
Cash and cash equivalents at beginning of period
28,611
Cash and cash equivalents at end of period
31,841
Supplemental disclosure of cash flow information
Cash payments for:
Interest
7,848
8,989
Non-cash investing and financing activities:
Initial recognition of operating lease right-of-use assets
8,296
Initial recognition of operating lease liabilities
9,305
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. 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 March 31, 2020, Sonabank had forty-five full-service branches. Thirty-eight full-service retail branches are in Virginia, located in Ashland, Burgess, Callao, Central Garage, Charlottesville, Chester, Clifton Forge, Colonial Heights, Courtland, Deltaville, Fairfax, Front Royal, Gloucester, Gloucester Point, Hampton, Hartfield, Haymarket, Heathsville, Kilmarnock, Leesburg, McLean, Mechanicsville (2), Middleburg, Midlothian, New Market, Newport News, Quinton, Reston, Richmond, South Riding, Surry, Tappahannock (2), Urbanna, Warrenton, Waverly, and Williamsburg, and seven full-service retail branches in Maryland, located in Bethesda, Brandywine, Huntingtown, Owings, Rockville, Shady Grove, and Upper Marlboro. 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.
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, 2019.
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 include: the determination of the allowance for loan losses, the fair value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, other real estate owned (“OREO”) and deferred taxes.
Risks and Uncertainties
The outbreak of the novel Corona Virus Disease 2019 (“COVID-19”) has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to
the Company. In March 2020, the World Health Organization declared COVID-19 to be a global pandemic. The spread of COVID-19 has caused significant uncertainty, volatility and disruption in the U.S. and global economy and has disrupted banking and other financial activity in the areas in which the Company operates. Given the ongoing and dynamic nature COVID-19, it is not possible to accurately predict the extent, severity or duration of these conditions or when normal economic and operating conditions will resume. For this reason, the extent to which the COVID-19 pandemic affects our business, operations and financial condition, as well as our regulatory capital and liquidity ratios and credit ratings, is highly uncertain and unpredictable and depends on, among other things, new information that may emerge concerning the scope, duration and severity of the COVID-19 pandemic and actions taken by governmental authorities and other parties in response to the pandemic. If the pandemic is prolonged, the adverse impact on the markets in which we operate and on our business, operations and financial condition could deepen.
Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on the Company’s operations. The CARES Act includes provisions that temporarily delay the required implementation date of Financial Accounting Standards Board (“FASB”) ASC Topic 326, Financial Instruments—Credit Losses, and suspend the requirements related to accounting for a troubled debt restructuring (“TDR”), for certain entities.
The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Financial position and results of operations
The Company’s fee income could be reduced due to COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, the Company is unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact its fee income in future periods.
The Company’s interest income could be reduced due to COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.
Capital and liquidity
While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to service its debt.
7
The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession caused large number of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.
Asset valuation
Goodwill is evaluated for impairment on an annual basis or more frequently if events or circumstances warrant. Our annual assessment timing is during the third calendar quarter. Considering the effects of COVID-19, management determined there to be a triggering event in the first quarter of 2020. For the 2020 assessment, we performed a qualitative assessment to determine if it was more likely than not that the fair value of our single reporting unit is less than its carrying amount. We concluded that the fair value of our single reporting unit exceeded its carrying amount and that it was not necessary to perform the quantitative impairment test pursuant to ASC 350-20. Our qualitative assessment considered many factors including, but not limited to, our actual and projected operating performance and profitability, as well as consideration of recent bank merger and acquisition transaction metrics. No impairment losses were considered necessary based on management’s assessment.
Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.
COVID-19 could cause a further and sustained decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform another goodwill impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
It is possible that the lingering effects of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform an intangible asset impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its intangible assets are impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
Processes, controls and business continuity plan
The Company has invoked its Board approved Pandemic Preparedness Plan that includes a remote working strategy. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date. The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19. The Company does not currently face any material resource constraint through the implementation of its business continuity plans.
Lending operations and accommodations to borrowers
As the health crisis unfolded, the Company’s markets and businesses experienced disruptions in normal operations. In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company provided certain modifications, including interest only or principal and interest deferments. As of April 30, 2020, total modified loans or loans with requests for modifications were $548.1 million and the Company anticipates additional amounts throughout the second quarter of 2020.
With the passage of the Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”), the Company is actively participating in assisting its customers with applications for resources through the
8
program. PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of April 30, 2020, the Company has approved and secured funds with the SBA 250 PPP loans representing $52.5 million in funding. An additional 1,726 loans for $202.7 million have been approved for SBA PPP pending funding. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for credit loss through additional credit loss expense charged to earnings.
Credit
The Company is working with customers directly affected by COVID-19. The Company is prepared to offer short-term assistance in accordance with regulator guidelines. As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.
Recent Accounting Pronouncements
Adoption of New Accounting Standards:
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 were effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption was permitted. The Company adopted ASU 2018-13 in the first quarter of 2020. The disclosures were effective using the prospective method for certain disclosures and retrospective for a majority of the disclosures. The Company adopted ASU 2018-13 in the first quarter of 2020 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 along with several other subsequent codification updates related to accounting for credit losses, sets forth a “current expected credit loss” ("CECL") model requiring the Company to measure all expected credit losses for financial instruments recorded at amortized cost held at the reporting date. The estimate is to be based on historical experience, current conditions and reasonable and 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. The amendments were effective for the Company beginning January 1, 2020. The initial adoption of this ASU will result in an increase of approximately $11.3 million in our allowance for loan losses, including transfers of non-accretable discount on purchased credit-impaired loans. The increase is a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The adoption of this ASU requires that we establish an allowance for expected credit losses for certain debt securities and other financial assets which are not material. We plan to elect the federal banking agencies’ rule providing for an optional three-year phase-in period for the day-one adverse regulatory capital effects upon adopting the standard. The Company elected to defer adoption of CECL until the termination date of the current national emergency, declared by the President on March 31, 2020, under the National Emergencies Act concerning the COVID-19 outbreak, or December 31, 2020.
In December 2019, FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (Topic 740). This ASU simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. This ASU also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 is effective for annual periods beginning after December 15, 2020, including
9
interim periods within those annual periods. Early adoption is permitted. Southern National is currently in the process of evaluating the impact of adopting the new guidance on its consolidated financial statements and disclosures.
In March 2020, FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. The ASU is intended to help stakeholders during the global market-wide reference rate transition period. ASU 2020-04 is effective upon issuance and can be applied through December 31, 2022. 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
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 was 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 were to be no longer awarded.
A summary of the activity in the stock option plan during the three months ended March 31, 2020 follows:
Weighted
Average
Aggregate
Remaining
Intrinsic
Exercise
Contractual
Value
Shares
Price
Term
(in thousands)
Options outstanding, beginning of period
555,750
10.02
4.3
3,518
Exercised
(44,600)
7.32
Options outstanding, end of period
511,150
10.25
(212)
Exercisable at end of period
392,730
9.45
3.7
Stock-based compensation expense associated with stock options was $95 thousand and $21 thousand for the three months ended March 31, 2020 and 2019, respectively. As of March 31, 2020, unrecognized compensation expense associated with stock options was $24 thousand, which is expected to be recognized over a weighted average period of 1.1 year.
A summary of the activity in the restricted stock plan for 2020 follows:
Unvested restricted stock outstanding, beginning of period
86,500
14.85
3.8
Granted
80,000
15.87
Vested
(89,900)
14.54
Unvested restricted stock outstanding, end of period
76,600
15.50
4.5
10
Restricted stock compensation expense totaled $1.3 million and $83 thousand for the three months ended March 31, 2020 and 2019, respectively. As of March 31, 2020, unrecognized compensation expense associated with restricted stock was $1.2 million, which is expected to be recognized over a weighted average period of 4.5 years.
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
48,523
1,804
(48)
50,279
Obligations of states and political subdivisions
16,248
592
(11)
16,829
Corporate securities
2,002
12
2,014
Trust preferred securities
2,530
101
(365)
2,266
Residential government-sponsored collateralized mortgage obligations
34,591
1,240
35,831
Government-sponsored agency securities
19,796
179
19,975
Agency commercial mortgage-backed securities
27,424
821
28,245
SBA pool securities
13,199
49
(167)
13,081
164,313
4,798
(591)
December 31, 2019
48,540
455
(16)
48,979
17,041
541
17,582
2,004
2,012
283
(245)
2,568
36,511
217
(39)
36,689
14,823
47
14,822
27,557
192
27,731
14,622
11
(196)
14,437
163,628
1,755
(562)
The amortized cost, unrecognized gains and losses, and fair value of investment securities held to maturity were as follows (in thousands):
Gross Unrecognized
36,953
853
(3)
37,803
12,983
151
13,134
1,783
(25)
1,758
2,515
51
2,566
5,000
165
5,165
1,220
(28)
60,426
22,925
62
(52)
22,935
15,071
(1)
15,235
1,938
99
2,035
3,128
(9)
3,129
29,386
108
(162)
29,332
444
(226)
72,666
During the three months ended March 31, 2020, $10.0 million and $15.2 million, respectively, of available for sale investment securities and held to maturity investment securities were purchased. No investment securities were sold during the three months ended March 31, 2020 and 2019.
The fair value and carrying amount, if different, of debt investment securities as of March 31, 2020, 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
2,569
2,669
3,418
3,495
Due in five to ten years
13,768
13,963
2,188
2,230
Due after ten years
24,239
24,452
14,160
14,332
Investment securities with a carrying amount of approximately $114.7 million and $120.5 million at March 31, 2020 and December 31, 2019, 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 its securities portfolio for indicators of other than temporary impairment. At March 31, 2020 and December 31, 2019, certain investment securities’ fair values were below cost. As outlined in the tables below, there were investment securities with fair values totaling approximately $16.1 million in the portfolio with the carrying value exceeding the estimated fair value that were considered temporarily impaired at March 31, 2020. 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 March 31, 2020.
The following tables present information regarding investment securities available for sale and held to maturity in a continuous unrealized loss position as of March 31, 2020 and December 31, 2019 by duration of time in a loss position (in thousands):
Less than 12 months
12 Months or More
Unrealized
value
3,556
759
675
766
8,459
(166)
9,225
5,081
(60)
9,134
(531)
14,215
Unrecognized
146
1,904
2,686
4,444
795
4,253
3,133
(14)
7,386
4,924
2,833
(6)
3,126
(12)
5,959
1,148
9,420
(194)
10,568
15,844
(88)
18,232
(474)
34,076
14,978
(41)
1,402
16,380
2,011
53
1,162
571
1,733
20,833
18,151
(45)
22,859
(181)
41,010
13
As of March 31, 2020, we owned pooled trust preferred investment securities as follows (in thousands):
% 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
AAA
Aa1
AA
1,910
17
%
219
Cumulative OTTI
Other Than
Related to
Temporarily Impaired:
Credit Loss (2)
TPREF FUNDING II
Mezzanine
A1
A-
Caa3
WD
1,500
1,040
32
400
ALESCO V C1
A2
A
Caa1
C
2,150
1,490
1,591
15
660
3,650
1,060
5,560
4,313
4,024
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. There have been no changes to our cash flow analyses and assumptions as of March 31, 2020.
There were no other than temporary impairment charges related to credit losses or sales of these securities during the three months ended March 31, 2020 and 2019.
Changes in accumulated other comprehensive income (loss) by component for the three months ended March 31, 2020 and 2019 are shown in the tables below. All amounts are net of tax (in thousands).
Unrealized Holding
Gains on
For the three months ended March 31, 2020
Securities
Beginning balance
943
(160)
Current period other comprehensive income
2,382
Ending balance
3,325
(158)
Losses on
For the three months ended March 31, 2019
(2,419)
(170)
856
(1,563)
(168)
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4. LOANS AND ALLOWANCE FOR LOAN LOSSES
The following table summarizes the composition of our loan portfolio as of March 30, 2020 and December 31, 2019 (in thousands):
Loans secured by real estate:
Commercial real estate - owner occupied
409,739
414,479
Commercial real estate - non-owner occupied
599,987
559,195
Secured by farmland
16,608
17,622
Construction and land loans
115,144
150,750
Residential 1-4 family (1)
624,119
604,777
Multi- family residential
90,652
82,055
Home equity lines of credit (1)
106,820
109,006
Total real estate loans
1,963,069
1,937,884
Commercial loans
223,433
221,447
Consumer loans
25,708
26,304
Subtotal
2,212,210
2,185,635
Plus deferred costs on loans
328
412
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 Company’s consolidated financial results.
Accretable discount on the acquired loans totaled $10.6 million and $11.2 million at March 31, 2020 and December 31, 2019, respectively. Accretion associated with the acquired loans held for investment of $597 thousand and $816 thousand was recognized during the three months ended March 31, 2020 and 2019, respectively.
Impaired loans for the portfolio were as follows (in thousands):
Total Loans
Unpaid
Recorded
Principal
Related
Investment (1)
Balance
Allowance
With no related allowance recorded
5,986
6,956
Commercial real estate - non-owner occupied (2)
3,231
3,327
Construction and land development
357
802
5,276
6,513
Residential 1-4 family (3)
5,103
6,222
Other consumer loans
20
19,973
23,840
With an allowance recorded
2,415
2,480
1,309
Grand total
22,388
26,320
6,890
8,530
3,120
3,363
345
747
5,049
8,490
1,021
2,719
16,425
23,849
176
281
2,498
2,533
957
2,841
3,243
92
5,554
6,096
1,051
21,979
29,945
16
The following tables present the average recorded investment and interest income recognized for impaired loans recognized by class of loans for the three months ended March 31, 2020 and 2019 (in thousands):
Three Months Ended March 31, 2020
Investment
6,987
91
Commercial real estate - non-owner occupied (1)
3,341
815
3,646
Residential 1-4 family (2)
6,229
37
21,038
234
3,581
24,619
Three Months Ended March 31, 2019
6,034
66
4,435
370
5,011
5,305
59
40
21,195
187
4,712
50
984
5,696
68
26,891
255
________________________________________
The following tables present the aging of the recorded investment in past due loans by class of loans as of March 31, 2020 and December 31, 2019 (in thousands):
30 - 59
60 - 89
90
Days
Nonaccrual
Loans Not
Past Due
or More
Loans (3)
Loans (4)
Total loans:
8,716
942
9,658
400,081
10,837
867
11,704
695,543
707,247
114,057
109
680
5,358
217,395
14,531
394
14,925
3,563
712,451
730,939
211
25,471
35,953
2,318
38,271
8,941
2,164,998
Loans
813
413,666
936
657,936
658,872
746
275
149,729
296
6,337
214,814
4,060
2,524
707,199
713,783
107
26,158
6,896
337
7,233
8,900
2,169,502
Activity in the allowance for loan and lease losses by class of loan for the three months ended March 31, 2020 and 2019 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:
810
1,720
683
5,418
1,266
190
174
10,261
Provision (recovery) for non-purchased loans
253
971
(307)
822
1,387
74
(100)
3,100
Provision for purchase credit impaired loans
350
Total provision (recovery)
1,172
Charge offs
(822)
(32)
(1,099)
Recoveries
65
31
110
1,068
2,693
376
5,833
2,439
239
12,722
1,669
7,097
1,106
224
564
12,283
Provision (recovery)
624
(887)
56
83
214
(462)
(689)
63
80
816
1,831
920
6,106
1,170
778
11,874
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2020 and 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 December 31, 2019 (in thousands):
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
4,524
11,413
Total ending allowance
Loans:
403,753
704,016
114,787
218,157
725,836
25,688
2,192,237
Total ending loan balances
85
1,042
4,461
1,181
9,219
7,544
1,443
19,342
407,589
655,752
150,405
213,903
712,340
2,166,293
Troubled Debt Restructurings
A modification is classified as a 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 rates 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.
There were no TDRs during the three months ended March 31, 2020 and there have been no defaults of TDRs modified during the past twelve months.
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 March 31, 2020 or December 31, 2019.
As of March 31, 2020 and December 31, 2019, 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
3,795
4,192
401,752
173
703,511
667
114,477
3,487
4,212
215,734
661
1,308
728,970
116
25,592
11,622
10,552
2,190,036
3,821
3,975
406,683
4,193
654,503
690
150,060
3,432
4,462
213,553
666
1,194
711,923
26,182
12,234
10,497
2,162,904
The amount of foreclosed residential real estate property held at March 31, 2020 and December 31, 2019 was $1.2 million and $1.4 million, respectively. The recorded investment in consumer mortgage loans collateralized by residential
21
real estate property that are in the process of foreclosure was $2.0 million and $1.9 million at March 31, 2020 and December 31, 2019, respectively.
5. LEASES
The Company leases certain premises and equipment under operating leases. In recognizing lease right-of-use assets and related liabilities, we account for lease and non-lease components (such as taxes, insurance, and common area maintenance costs) separately as such amounts are generally readily determinable under our lease contracts. At March 31, 2020, the Company had operating lease liabilities totaling $8.5 million and right-of-use assets totaling $7.7 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 months ended March 31, 2020 and 2019, our net operating lease cost was $1.0 million and $586 thousand, respectively and was reflected in occupancy expenses on our income statement.
The following table presents supplemental cash flow and other information related to our operating leases:
(in thousands except for percent and period data)
March 31, 2019
Supplemental cash flow information:
Cash paid for amounts included in the measurement of lease liabilities
1,241
1,262
Right-of-use assets obtained in exchange for new operating lease liabilities
155
Other information:
Weighted-average remaining lease term - operating leases, in years
5.6
6.1
Weighted-average discount rate - operating leases
2.8
3.0
The following table summarizes the maturity of remaining lease liabilities:
As of
(dollars in thousands)
Lease payments due:
Less than one year
2,305
One to three years
3,323
Three to five years
2,043
More than five years
1,586
Total lease payments
9,257
Less: imputed interest
(748)
Lease liabilities
As of March 31, 2020, the Company did not have any operating leases that have not yet commenced that 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 $17.6 million and $17.7 million as of March 31, 2020 and December 31, 2019, respectively.
22
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 March 31, 2020 and December 31, 2019, we had unfunded lines of credit and undisbursed construction loan funds totaling $341.0 million and $324.8 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
24,168
Effect of dilutive stock options and unvested restricted stock
220
Diluted EPS
24,388
24,012
299
24,311
The Company did not have any anti-dilutive options in 2020 and 2019.
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.
24
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
1,014
1,000
167,520
1,012
163,820
No corporate securities that are classified as Level 3 above were purchased or sold during 2020 or 2019. These corporate securities did not have a material impact on the income statement for the three months ended March 31, 2020 and 2019.
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 5% to 10% of collateral valuation at March 31, 2020 and December 31, 2019. Fair value is classified as Level 3 in the fair value hierarchy. Loans identified as impaired totaled $22.4 million (including SBA guarantees of $3.1 million) as of March 31, 2020 with $1.3 million allocation made to the allowance for loan losses compared to a carrying amount of $22.0 million (including SBA guarantees of $4.4 million) with $1.1 million allocation made to the allowance for loan losses at December 31, 2019.
25
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. As of March 31, 2020, all four of these properties have been sold. 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% to 10% of collateral valuation at March 31, 2020 and December 31, 2019. Fair value is classified as Level 3 in the fair value hierarchy. OREO is further evaluated quarterly for any additional impairment. At March 31, 2020 and December 31, 2019, the total amount of OREO was $5.9 million and $6.2 million, respectively.
Assets measured at fair value on a non-recurring basis are summarized below:
Impaired loans:
7,691
Other real estate owned:
Commercial real estate - owner occupied (1)
1,984
2,666
1,226
26
3,296
7,547
3,862
2,874
1,366
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
2,217,962
2,180,487
Accrued interest receivable
8,548
8,210
Financial liabilities:
Demand deposits and NOW accounts
719,072
730,325
Money market and savings accounts
629,066
611,353
736,513
786,420
Securities sold under agreements to repurchase
FHLB short term advances
Junior subordinated debt
8,787
9,206
Senior subordinated notes
48,044
48,156
Accrued interest payable
Level 1 & Level 3
5,025
4,907
Carrying amount is the estimated fair value for cash and cash equivalents (including federal funds sold), accrued interest receivable and payable, demand deposits, savings accounts, money market accounts and short-term debt (FHLB short-term advances and securities sold under agreements to repurchase).
The investment in common stock of our mortgage affiliate is accounted for using the equity method. Under the equity method, the carrying value of Southern National’s investment in STM was originally recorded at cost but is adjusted periodically to record Southern National’s proportionate share of STM’s earnings or losses through noninterest income and decreased by the amount of cash dividends or similar distributions received from STM. The investment in preferred stock of our mortgage affiliate is considered to be a non-marketable equity security that does not have a readily determinable fair value. Non-marketable equity securities with no recurring market value data available are reviewed periodically and any observable market value change are adjusting through noninterest income. Southern National evaluates its investments in this non-marketable equity security for impairment and recoverability of the recorded investment by considering positive and negative evidence, including the profitability and asset quality of STM, dividend payment history and recent redemption experience. Impairment is assessed at each reporting period and if identified, is recognized in noninterest income. No impairment was recorded for the three month periods ended March 31, 2020 and 2019.
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, time deposits, junior subordinated debt, and senior subordinated notes are measured using the exit-price notion.
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 March 31, 2020 and December 31, 2019 was $13.2 million and $12.9 million, respectively.
10. JUNIOR SUBORDINATED DEBT AND SENIOR SUBORDINATED NOTES
In connection with our merger with EVBS, the Company assumed $10.3 million of trust preferred securities that were issued on September 17, 2003 and placed through the Trust in a pooled underwriting totaling approximately $650 million. The trust issuer has 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. At March 31, 2020 and December 31, 2019, we had $9.6 million of Junior Subordinated Debt. 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 March 31, 2020 and December 31, 2019, the interest rate was 3.79% and 4.85%, 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 March 31, 2020, 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 March 31, 2020, all of the SNBV Senior Subordinated Notes qualified as Tier 2 capital. At March 31, 2020, the remaining unamortized debt issuance costs related to the SNBV Senior Subordinated Notes totaled $643 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
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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 March 31, 2020 all of the EVBS Senior Subordinated Notes qualified as Tier 2 capital.
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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2019. Results of operations for the three months ended March 31, 2020 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 not historical facts and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control, particularly with regard to developments related to the novel coronavirus (“COVID-19”). Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. 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, 2019, factors that could contribute to those differences include, but are not limited to:
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. 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.
RESULTS OF OPERATIONS
Net Income
Three-Month Comparison. Net income for the three months ended March 31, 2020 was $27 thousand, or $0.00 basic and diluted earnings per share, compared to net income of $6.0 million, or $0.25 basic and diluted earnings per share for the three months ended March 31, 2019.
Net income declined $6.0 million during the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The decline in net income was driven by a one-time charge of $4.4 million, net of taxes of salary and benefits expense related to the restructuring of executive management and a $378 thousand, net of taxes, one-time charge to occupancy for the pending closure of three underperforming branch offices. During the three months ended March 31, 2020, the Company made certain adjustments to its qualitative factors in response to the impact of COVID-19 that increased the provision by $3.1 million. Net income was also impacted by lower income tax expenses in the current year.
During the three months ended March 31, 2019, net income was impacted by a nonrecurring other loss of $2.5 million and related legal expense of $397 thousand, net of taxes.
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 $20.5 million for the three months ended March 31, 2020 compared to $21.0 million for the three months ended March 31, 2019. Southern National’s net interest margin for the three months ended March 31, 2020 was 3.32% compared to 3.41% for the three months ended March 31, 2019. Total income on interest-earning assets was $28.5 million and $30.3 million for the three months ended March 31, 2020 and 2019, respectively. The yield on average interest-earning assets decreased 33 basis points to 4.61% during the three months ended March 31, 2020 compared to the 4.94% yield on average interest-earning assets during the three months ended March 31, 2019. The cost of average interest-bearing liabilities decreased 26 basis points to 1.60% during the three months ended March 31, 2020 when comparing to the 1.86% cost on average interest-bearing liabilities during the three months ended March 31, 2019. Interest and fees on loans totaled $26.7 million and $28.0 million for the first quarters of 2020 and 2019, 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 $597 thousand to net interest income during the three months ended March 31, 2020 compared to $816 thousand during the three months ended March 31, 2019. The decrease in accretion was due to the slowdown in the volume of acquired loan prepayments and payoffs. Average loans during the first quarter of 2020 were $2.20 billion compared to $2.16 billion during the first quarter of 2019.
Total interest expense was $8.0 million and $9.4 million for the three months ended March 31, 2020 and 2019, respectively. Interest on deposits was $6.5 million and $7.5 million for the three months ended March 31, 2020 and 2019, respectively. Total average interest-bearing deposits for the first quarter of 2020 and 2019 were $1.75 billion and $1.82 billion, respectively. The yield on total average interest-bearing deposits was 1.49% and 1.66% for the quarter ended March 31, 2020 and 2019, 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 $1.5 million and
$1.9 million for the three months ended March 31, 2020 and 2019, respectively. Total average borrowings were $251.8 million and $214.0 million for the three months ended March 31, 2020 and 2019, 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
Income/
Yield/
Expense
Rate
(Dollar amounts in thousands)
Assets
Interest-earning assets:
Loans, net of deferred fees (1) (2)
2,200,926
4.89
2,155,252
5.26
Investment securities
231,794
1,361
2.36
237,420
1,581
2.70
Other earning assets
54,800
2.79
90,370
3.36
Total earning assets
2,487,520
4.61
2,483,041
4.94
Allowance for loan losses
(10,928)
(12,296)
Total non-earning assets
263,627
257,217
2,740,220
2,727,963
Liabilities and stockholders' equity
Interest-bearing liabilities:
NOW and other demand accounts
379,531
786
0.83
345,935
642
0.75
469,651
1,575
1.35
401,615
1,828
1.85
147,697
0.32
147,589
115
756,055
4,026
2.14
926,137
4,877
1,752,934
1.49
1,821,276
1.66
Borrowings
251,830
1,463
2.34
213,929
1,889
3.58
Total interest-bearing liabilities
2,004,764
1.60
2,035,205
1.86
Noninterest-bearing liabilities:
Demand deposits
333,408
320,299
21,781
19,414
2,359,953
2,374,919
Stockholders' equity
380,267
353,044
Interest rate spread
3.01
3.08
Net interest margin
3.32
3.41
Provision for Loan Losses
The provision for loan losses is a current charge to earnings made in order to adjust the allowance for loan losses to an appropriate 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 allowance for loan losses 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.
The Company elected to defer adoption of the CECL model until the earlier of the national emergency being lifted or December 31, 2020, as provided for by the CARES Act. During the three months ended March 31, 2020, the Company made certain adjustments to its qualitative factors in response to the impact of COVID-19 that increased the provision by $3.1 million. For the three months ended March 31, 2020 and 2019, the provision for loan losses was $3.5 million and
$200 thousand, respectively. Net charge offs for the three months ended March 31, 2020 and 2019 was $990 thousand and $609 thousand, respectively.
Noninterest Income
The following table presents the major categories of noninterest income for the three months ended March 31, 2020 and 2019:
Change
(137)
213
(407)
78
(242)
Noninterest income decreased 7.9% to $2.8 million for the three months ended March 31, 2020 compared to $3.1 million for the three months ended March 31, 2019. The $242 thousand decrease was primarily driven by a $407 thousand decrease in recoveries related to acquired charged-off loans and investment securities. The decrease was also attributable to a $137 thousand decrease in income from bank-owned life insurance due to death benefits paid in the first quarter of 2019. These decreases were partially offset by an increase of $213 thousand in equity gain from mortgage affiliate. Other noninterest income benefited from $321 thousand in income on other equity investments during the three months ended March 31, 2020 compared to $243 thousand for the three months ended March 31, 2019.
Noninterest Expense
The following table presents the major categories of noninterest expense for the three months ended March 31, 2020 and 2019:
6,497
136
(91)
(22)
195
73
6,154
(4,419)
3,562
Noninterest expenses were $19.9 million during the three months ended March 31, 2020, compared to $16.3 million during the three months ended March 31, 2019. The 21.9% increase in noninterest expenses was primarily due to an increase in employee compensation and benefits expense and higher legal and professional services expense, partially offset by lower other operating expenses. Employee compensation and benefits expense totaled $12.3 million and $5.8 million for the three months ended March 31, 2020 and 2019, respectively. The increase was associated with a pre-tax management restructuring expenses of $5.6 million in the current year. Professional fees increased $1.2 million for the three months ended March 31, 2020, when compared to the three months ended March 31, 2019 mainly due to costs incurred as part of our implementation efforts for the 2020 adoption of the CECL accounting standard, enhancements to
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our compliance and Bank Secrecy Act programs, and general legal expense for corporate matters in 2020. The decrease in other operating expenses was driven by a pre-tax nonrecurring loss of $3.2 million with related legal expense of $502 thousand during the first quarter of 2019, that did not recur.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets were $2.76 billion as of March 31, 2020 and $2.72 billion as of December 31, 2019. Total loans increased 1.21%, from $2.19 billion at December 31, 2019 to $2.21 billion at March 31, 2020 with loan production in the quarter centered mostly on the Company’s adjustable rate mortgage offerings with 1-4 family mortgages. Total deposits were $2.08 billion at March 31, 2020 compared to $2.12 billion at December 31, 2019 and total equity was $378.8 million and $377.2 million at March 31, 2020 and December 31, 2019, respectively.
Loan Portfolio
Total loans were $2.21 billion and $2.19 billion at March 31, 2020 and December 31, 2019, respectively. Loan production in the first quarter of 2020 centered mostly on the Company’s adjustable rate mortgage offerings with 1-4 family mortgages. The Company experienced no overall growth in its combined commercial real estate portfolio and construction and development loans during the three months ended March 31, 2020 and were only $1.12 billion or 50.84% of total loans as of March 31, 2020.
As of March 31, 2020, the Company had hotel loans of $279.7 million. For the year ended December 31, 2019, the portfolio of hotel loans had debt coverage of approximately 147% and weighted average loan to value of approximately 68%. 99% of the Company’s hotel loans are to national brands (Marriott, Hilton, Choice, IHG, Best Western, and Wyndham) with 93% of the portfolio being to limited service hotels with historically lower operating costs.
The composition of our loan portfolio consisted of the following at March 31, 2020 and December 31, 2019 (in thousands):
Residential 1-4 family
Multi-family residential
Home equity lines of credit
As of March 31, 2020 and December 31, 2019, 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.
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Asset Quality
Asset quality remained high during the first quarter of 2020. The outbreak of COVID-19 will likely have an impact on our asset quality, but it is unknown to what extent at this point. 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.
OREO at March 31, 2020 was $5.9 million compared to $6.2 million at December 31, 2019. The decrease was driven by a write-down on OREO during the first quarter of 2020.
Loans acquired in the GAB transaction covered under an FDIC loss-share agreement expired on December 31, 2019 and therefore any references to “non-covered” do not apply to any periods after December 31, 2019. Nonaccrual loans were $6.1 million (excluding $2.9 million of loans fully covered by SBA guarantees) at March 31, 2020 compared to $4.8 million (non-covered and excluding $4.1 million of loans fully covered by SBA guarantees) at December 31, 2019. The ratio of non-covered nonperforming assets (excluding the SBA guaranteed loans) to total non-covered assets was 0.41% at December 31, 2019 and the ratio of nonperforming assets (excluding the SBA guaranteed loans) to total assets was 0.43% at March 31, 2020, an increase of 2 basis points.
Southern National’s allowance for loan losses as a percentage of total loans at March 31, 2020 was 0.58%, compared to 0.47% at December 31, 2019 (based on total non-covered loans).
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.
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The following table presents a comparison of nonperforming assets as of March 31, 2020 and December 31, 2019 (in thousands):
2019 (1)
Nonaccrual loans
Loans past due 90 days and accruing interest
Total nonperforming loans
Total nonperforming assets
14,817
15,124
Troubled debt restructurings
694
697
SBA guaranteed amounts included in nonaccrual loans
2,889
4,129
Allowance for loan losses to nonperforming loans
142.28
115.30
Allowance for loan losses to total loans
0.58
0.47
Nonperforming assets excluding SBA guaranteed loans to total assets
0.43
0.41
Investment Securities
Investment securities, available for sale and held to maturity, totaled $227.8 million at March 31, 2020 down from $237.3 million at December 31, 2019.
Investment securities in our portfolio as of March 31, 2020 were as follows:
Standard & Poor's
Rating
5,997
5,571
6,567
AA+
6,636
Aa2
3,917
8,533
Aa3
693
AA-
1,798
2,346
A+
1,003
842
Baa1
BBB+
NA
9,441
5,581
29,964
During the three months ended March 31, 2020, $10.0 million of available for sale investment securities and $15.2 million of held to maturity investment securities were purchased. No investment securities were sold during the first quarter of 2020 and 2019.
At March 31, 2020, we owned pooled trust preferred securities as follows (in thousands):
Ratings
When Purchased
Other Than Temporarily Impaired:
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 three months ended March 31, 2020 and 2019, respectively.
Liquidity and Funds Management
The objective of our liquidity management is to ensure 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 on a 30, 60 and 90 day basis along with a one and a two year basis. 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, the projection incorporates the scheduled loan closings in the Loan Pipeline Report along with other management estimates.
During the three months ended March 31, 2020, we funded our financial obligations with deposits and borrowings from the FHLB of Atlanta. At March 31, 2020, we had $341.0 million of unfunded lines of credit and undisbursed construction loan funds. The amount of certificate of deposit accounts maturing in 2020 is $540.8 million as of March 31,
2020. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
Capital Resources
The following table provides a comparison of the leverage and risk-weighted capital ratios of Sonabank at the periods indicated to the minimum and well-capitalized required regulatory standards:
Minimum
Required for
Actual Ratio at
Adequacy
To Be Categorized
Purposes
as Well Capitalized (1)
Sonabank
Common equity tier 1 capital ratio
4.50
6.50
14.44
14.81
Tier 1 risk-based capital ratio
6.00
8.00
Total risk-based capital ratio
10.00
15.04
15.29
Leverage ratio
4.00
5.00
11.86
12.07
Sonabank’s capital position is consistent with being well- capitalized under the regulatory framework for prompt corrective action.
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 review quarterly interest sensitivity. This approach uses a model which generates estimates of the change in our economic value of equity (“EVE”) over a range of interest rate 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 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 100 basis points, measured in 100 basis point increments) as of March 31, 2020 and as of December 31, 2019. All changes are within
our Asset/Liability Risk Management Policy guidelines except for the change resulting from the 100 basis point decrease in interest rates at March 31, 2020 and December 31, 2019.
Sensitivity of Economic Value of Equity
As of March 31, 2020
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
306,663
(39,915)
(11.52)
11.10
80.95
Up 300
320,069
(26,509)
(7.65)
11.59
84.49
Up 200
332,231
(14,347)
(4.14)
12.03
87.70
Up 100
345,560
(1,018)
(0.29)
12.51
91.22
Base
346,578
12.55
91.49
Down 100
311,696
(34,882)
(10.06)
11.28
82.28
As of December 31, 2019
323,871
(45,102)
(12.22)
11.90
85.85
336,822
(32,151)
(8.71)
12.37
89.29
349,192
(19,781)
(5.36)
12.83
92.56
363,935
(5,038)
(1.37)
13.37
96.47
368,973
13.55
97.81
353,371
(15,602)
(4.23)
12.98
93.67
Our interest rate sensitivity is also monitored by management through the use of a model 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 March 31, 2020 and December 31, 2019 remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. All changes are within our Asset/Liability Risk Management Policy guidelines at March 31, 2020 and December 31, 2019.
Sensitivity of Net Interest Income
Adjusted Net Interest Income
Net Interest Margin
Percent
72,221
(8,822)
2.92
(0.36)
74,682
(6,361)
3.02
(0.26)
76,962
(4,081)
3.11
(0.16)
79,482
(1,561)
3.21
(0.06)
81,043
3.27
80,892
(151)
(0.01)
74,096
(8,158)
3.00
(0.33)
76,355
(5,899)
3.09
(0.24)
78,458
(3,796)
3.18
(0.15)
80,649
(1,605)
(0.07)
82,254
3.33
81,273
(981)
3.29
(0.04)
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.
(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 March 31, 2020.
ITEM 1A – RISK FACTORS
The Company disclosed risk factors in its Annual Report on Form 10-K for the year ended December 31, 2019. The risks described may not be the only risks facing us. Additional risks and uncertainties not currently known to us or that are currently considered to not be material also may materially adversely affect our business, financial condition, and/or operating results. The following risk factors have been included in this Quarterly Report on Form 10-Q in response to the global market disruptions that have resulted from the COVID-19 pandemic.
The ongoing COVID-19 pandemic and measures intended to prevent its spread could have a material adverse effect on our business, results of operations and financial condition, and such effects will depend on future developments, which are highly uncertain and are difficult to predict.
Global health concerns relating to the COVID-19 outbreak and related government actions taken to reduce the spread of the virus have been weighing on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty and reduced economic activity. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act, but there can be no assurance that such steps will be effective or achieve their desired results in a timely fashion.
The outbreak has adversely impacted and is likely to further adversely impact our workforce and operations and the operations of our borrowers, customers and business partners. In particular, we may experience financial losses due to a number of operational factors impacting us or our borrowers, customers or business partners, including but not limited to:
These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the COVID-19 outbreak has subsided.
The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, and developing work from home and social distancing plans for our employees), and we may take further actions as may be required by government authorities or as we determine are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or will otherwise be satisfactory to government authorities.
The extent to which the coronavirus outbreak impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.
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+*
Separation Agreement, dated as of February 20, 2020, by and between Joe A. Shearin and Southern National Bancorp of Virginia, Inc.
10.2+*
Employment Agreement, dated as of February 20, 2020, by and between Dennis J. Zember and Southern National Bancorp of Virginia, Inc.
10.3+*
Separation Agreement, dated as of March 30, 2020, by and between Georgia S. Derrico and Southern National Bancorp of Virginia, Inc.
10.4+*
Separation Agreement, dated as of March 30, 2020, by and between R. Roderick Porter and Southern National Bancorp of Virginia, Inc.
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.
The following materials from Southern National Bancorp of Virginia, Inc. Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in Inline 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).
The cover Page Interactive Data File (the cover page XBRL tags are embedded in the Inline XBRL document).
+ 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
45
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)
May 8, 2020
/s/ Dennis J. Zember
(Date)
Dennis J. Zember,
Chief Executive Officer
(President and Executive Officer)
/s/ Jeffrey L. Karafa
Jeffrey L. Karafa,
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)