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Primis Financial Corp. - Annual Report: 2007 (Form 10-K)

FORM 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33037

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

 

VIRGINIA   20-1417448

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employee

Identification No.)

1770 Timberwood Boulevard

Suite 100

Charlottesville, Virginia 22911

(Address or principal executive offices) (Zip code)

(434) 973-5242

(Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, $0.01 par value   Nasdaq Global Market
(Title of each class)   (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b – 2 of the Exchange Act. (Check one):

Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2007 was approximately $71,852,000.

The number of shares of common stock outstanding as of February 26, 2008 was 6,798,547.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2008 Annual Meeting of Shareholders are incorporated into Part III, Items 10-14 of this Form 10-K.

 

 

 


Table of Contents

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

FORM 10-K

INDEX

 

PART I   
          Page

Item 1.

  

Business

   1

Item 1A.

  

Risk Factors

   16

Item 1B.

  

Unresolved Staff Comments

   18

Item 2.

  

Properties

   18

Item 3.

  

Legal Proceedings

   19

Item 4.

  

Submission of Matters to a Vote of Security Holders

   19
PART II   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   20

Item 6.

  

Selected Financial Data

   23

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   24

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   45

Item 8.

  

Financial Statements and Supplementary Data

   46

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   75

Item 9A.

  

Controls and Procedures

   75

Item 9B.

  

Other Information

   75
PART III   

Item 10.

  

Directors, Executive Officers and Corporate Governance of the Registrant

   76

Item 11.

  

Executive Compensation

   76

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   76

Item 13.

  

Certain Relationships, Related Transactions and Director Independence

   76

Item 14.

  

Principal Accounting Fees and Services

   76
PART IV   

Item 15.

  

Exhibits and Financial Statement Schedules

   77

 

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PART I

Item 1.—Business

Overview

Southern National Bancorp of Virginia, Inc. (“SNBV”), a Virginia corporation, is the holding company for Sonabank, a nationally chartered commercial bank. We opened Sonabank’s first branch on April 14, 2005. We are headquartered in our Charlottesville, Virginia branch, at 1770 Timberwood Boulevard in the Forest Lakes Shopping Center. We also have a loan production office at 230 Court Square in Charlottesville. Our administrative offices and a loan production office are located at 550 Broadview Avenue in Warrenton, Virginia, where we also opened a full service branch in the second quarter of 2007. We also have executive offices in Georgetown, Washington D.C. where senior management is located.

In December 2005, we closed on the purchase of the First Community Bancorp, Inc. branch in Clifton Forge, Virginia.

As of the close of business on December 1, 2006, we completed the acquisition of 1st Service Bank, which operated three branch offices in Fairfax County, Virginia. These branches are located in McLean, Reston and Fairfax in Northern Virginia. Sonabank has extensive lending and depository relationships in Northern Virginia, and the combined institution has capitalized on those relationships.

On November 6, 2006, SNBV completed the initial public offering of its common stock, $0.01 par value. All 2,000,000 shares of common stock registered in the offering, including 214,000 shares of common stock covered by an over- allotment option granted to the underwriter, were sold at a price to the public of $14.00 per share (equivalent to $12.73 after the stock dividend which was declared in April 2007) for net proceeds of $26.4 million.

On December 19th, 2007, SNBV announced that it had entered into an agreement with Founders Corporation of Leesburg, Virginia to purchase certain assets and to assume its lease at 1 East Market Street in Leesburg in the 100 year old Loudoun National Bank building. Sonabank received approval from the Office of the Comptroller of the Currency to open a branch at that location. The branch was opened February 11, 2008. The Board of Directors of Founders Corp and certain other investors in Founders Corp will become the members of Sonabank’s new Leesburg Advisory Board.

General

Our principal business is the acquisition of deposits from the general public through our branch offices and deposit intermediaries and the use of these deposits to fund our loan and investment portfolios. We seek to be a full service community bank that provides a wide variety of financial services to our middle market corporate clients as well as to our retail clients. We are an active commercial lender, have been designated as a “Preferred SBA Lender” and participate in the Virginia Small Business Financing Authority lending program. In addition, we are an active commercial real estate lender. We also invest funds in mortgage-backed securities, securities sold with an agreement to repurchase, reverse repurchase agreements and securities issued by agencies of the federal government.

The principal sources of funds for our lending and investment activities are deposits, amortization and repayment of loans, prepayments from mortgage-backed securities, repayments of maturing investment securities, Federal Home Loan Bank advances and other borrowed money.

Principal sources of revenue are interest and fees on loans and investment securities, as well as fee income derived from the maintenance of deposit accounts and income from bank-owned life insurance policies. Our principal expenses include interest paid on deposits and advances from the Federal Home Loan Bank of Atlanta (“FHLB”) and other borrowings, and operating expenses.

 

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Available Information

SNBV files annual, quarterly and other reports under the Securities Exchange Act of 1934 with the Securities and Exchange Commission (“SEC”). These reports are posted and are available at no cost on our website, www.sonabank.com, through the Investor Relations link, as soon as reasonably practicable after we file such documents with the SEC. Our filings are also available through the SEC’s website at www.sec.gov.

Lending Activities

Our primary strategic objective is to serve small to medium-sized businesses in our market with a variety of unique and useful services, including a full array of commercial mortgage and non-mortgage loans. These loans include commercial real estate loans, construction to permanent loans, development and builder loans, accounts receivable financing, lines of credit, equipment and vehicle loans, leasing, and commercial overdraft protection. We strive to do business in the areas served by our branches, which is also where our marketing is focused, and the vast majority of our loan customers are located in existing market areas. Virtually all of our loans are from Virginia, Maryland, West Virginia, or Washington D.C. The Small Business Administration may from time to time come to us because of our reputation and expertise as an SBA lender and ask us to review a loan outside of our core counties but within our market area. Prior to making a loan, we obtain loan applications to determine a borrower’s ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations.

The following is a discussion of each of the major types of lending:

Commercial Real Estate Lending

Permanent. Commercial real estate lending includes loans for permanent financing and construction. Commercial real estate lending typically involves higher loan principal amounts and the repayment of loans is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. As a general practice, we require our commercial real estate loans to be secured by well-managed income producing properties with adequate margins and to be guaranteed by responsible parties. We look for opportunities where cash flow from the collateral properties provides adequate debt service coverage and the guarantor’s net worth is strong. At December 31, 2007, our commercial real estate loans for permanent financing totaled $86.1 million.

Our underwriting guidelines for commercial real estate loans reflect all relevant credit factors, including, among other things, the income generated from the underlying property to adequately service the debt, the availability of secondary sources of repayment and the overall creditworthiness of the borrower. In addition, we look to the value of the collateral, while maintaining the level of equity invested by the borrower.

All valuations on property which will secure loans over $250 thousand are performed by independent outside appraisers who are reviewed by our executive vice president of risk management and reported annually to our credit committee. We retain a valid lien on real estate and obtain a title insurance policy (on first trust loans only) that insures the property is free of encumbrances.

Construction. We recognize that construction loans for commercial, multifamily and other non-residential properties can involve risk due to the length of time it may take to bring a finished real estate product to market. As a result, we will only make these types of loans when pre-leasing or pre-sales or other credit factors suggest that the borrower can carry the debt if the anticipated market and property cash flow projections change during the construction phase.

Income producing property loans are supported by evidence of the borrower’s capacity to service the debt. All of our commercial construction loans are guaranteed by the principals or general partners. At December 31, 2007, we had $51.6 million of construction, land and development loans.

 

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Construction loan borrowers are generally pre-qualified for the permanent loan by us or a third party. We obtain a copy of the contract with the general contractor who must be acceptable to us. All plans, specifications and surveys must include proposed improvements. We review feasibility studies and risk analyses showing sensitivity of the project to variables such as interest rates, vacancy rates, lease rates and operating expenses.

Commercial Business Lending

These loans consist of lines of credit, revolving credit facilities, demand loans, term loans, equipment loans, SBA loans, stand-by letters of credit and unsecured loans. Commercial business loans are generally secured by accounts receivable, equipment, inventory and other collateral, such as readily marketable stocks and bonds with adequate margins, cash value in life insurance policies and savings and time deposits at Sonabank. At December 31, 2007, our commercial business loans totaled $53.2 million.

In general, commercial business loans involve more credit risk than residential mortgage loans and real estate-backed commercial loans and, therefore, usually yield a higher return to us. The increased risk for commercial business loans is due to the type of collateral securing these loans. The increased risk also derives from the expectation that commercial loans will be serviced principally from the operations of the business, and that those operations may not be successful. Historical trends have shown that these types of loans do have higher delinquencies than mortgage loans. Because of this, we often utilize the SBA 7(a) program (which guarantees the repayment of up to 85% of the principal and accrued interest to us) to reduce the inherent risk associated with commercial business lending.

Another way that we reduce risk in the commercial loan portfolio is by taking accounts receivable as collateral. Our accounts receivable financing facilities, which provide a relatively high yield with considerable collateral control, are lines of credit under which a company can borrow up to the amount of a borrowing base which covers a certain percentage of the company’s receivables. From our customer’s point of view, accounts receivable financing is an efficient way to finance expanding operations because borrowing capacity expands as sales increase. Customers can borrow from 75% to 90% of qualified receivables. In most cases, the borrower’s customers pay us directly. For borrowers with a good track record for earnings and quality receivables, we will consider pricing based on an increment above the prime rate for transactions in which we lend up to a percentage of qualified outstanding receivables based on reported aging of the receivables portfolio.

We also actively pursue for our customers equipment lease financing opportunities other than on-road rolling stock. We provide financing and use a third party to service the leases. Payment is derived from the cash flow of the borrower, so credit quality may not be any lower than it would be in the case of an unsecured loan for a similar amount and term.

SBA Lending

We have developed an expertise in the federally guaranteed SBA program. The SBA program is an economic development program which finances the expansion of small businesses. We are a Preferred Lender in the Washington D.C. and Richmond Districts of the SBA. As an SBA Preferred lender, our pre-approved status allows us to quickly respond to customers’ needs. Under the SBA program, we originate and fund SBA 7(a) loans which qualify for guarantees up to 85% of principal and accrued interest. We also originate 504 chapter loans in which we generally provide 50% of the financing, taking a first lien on the real property as collateral.

We provide SBA loans to potential borrowers who are proposing a business venture, often with existing cash flow and a reasonable chance of success. We do not treat the SBA guarantee as a substitute for a borrower meeting our credit standards, and except for minimum capital levels or maximum loan terms, the borrower must meet our other credit standards as applicable to loans outside the SBA process.

 

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Residential Mortgage Lending

Permanent. Residential mortgage loans are secured by single-family homes. To a lesser extent, we make fixed and adjustable rate first mortgage loans on residential properties with terms up to 30 years. In the case of conventional loans, we typically lend up to 80% of the appraised value of single-family residences and require mortgage insurance for loans exceeding that amount. We have no sub-prime loans. At December 31, 2007, we had $60.3 million of permanent residential mortgage loans including home equity lines of credit. Of that amount, $48.3 million resulted from the purchase of 1st Service Bank.

We retain a valid lien on real estate and obtain a title insurance policy that insures the property is free of encumbrances. We also require hazard insurance and flood insurance for all loans secured by real property if the real property is in a flood plain as designated by the Department of Housing and Urban Development. We also require most borrowers to advance funds on a monthly basis from which we make disbursements for items such as real estate taxes, private mortgage insurance and hazard insurance.

Construction. We typically make single family residential construction loans to builders/developers in our market areas. Construction loans generally have interest rates of prime plus one to two percent and fees of one to three points, loan-to-value ratios of 80% or less based on current appraisals and terms of generally nine months or less. In most cases, when we make a residential construction loan to a builder, the residence is pre-sold. All plans, specifications and surveys must include proposed improvements. Borrowers must evidence the capacity to service the debt.

Consumer Lending

To a limited extent, we offer various types of secured and unsecured consumer loans. We make consumer loans primarily for personal, family or household purposes as a convenience to our customer base since these loans are not the focus of our lending activities. As a general guideline, a consumer’s debt service should not exceed 40% of his gross income or 45% of net income. For purposes of this calculation, debt includes house payment or rent, fixed installment payments, the estimated payment for the loan being requested and the minimum required payment on any revolving debt. At December 31, 2007, we had $2.5 million of consumer loans.

Credit Approval and Collection Policies

Because future loan losses are so closely intertwined with our underwriting policy, we have instituted what management believes is a stringent loan underwriting policy. Our underwriting guidelines are tailored for particular credit types, including lines of credit, revolving credit facilities, demand loans, term loans, equipment loans, real estate loans, SBA loans, stand-by letters or credit and unsecured loans. We will make extensions of credit based, among other factors, on the potential borrower’s creditworthiness, likelihood of repayment and proximity to market areas served.

We have a standing Credit Committee comprised of certain of our officers, each of whom has a defined lending authority in combination with other officers. These individual lending authorities are determined by our chief executive officer and certain directors and are based on the individual’s technical ability and experience. These authorities must be approved by our board of directors and our credit committee. Our credit committee is comprised of four levels of members: junior, regular, senior, and executive, based on experience. Our executive members are Ms. Derrico and Messrs. Porter and Stevens. Loans over a certain size must be approved by outside director, Neil Call. (See “Management.”) Under our loan approval process, the sponsoring loan officer’s approval is required on all credit submissions. This approval must be included in or added to the individual and joining authorities outlined below. The sponsoring loan officer is primarily responsible for the customer’s relationship with us, including, among other things, obtaining and maintaining adequate credit file information. We require each loan officer to maintain loan files in an order and detail that would enable a disinterested third party to review the file and determine the current status and quality of the credit.

 

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In addition to approval of the sponsoring loan officer, we require approvals from one or more members of the Credit Committee on all loans. The approvals required differ based on the size of the borrowing relationship. At least one senior or one executive member must approve all loans in the amount of $100,000 or more. All three of the executive members of the committee must approve all loans of $1 million or more. Regardless of the number of approvals needed, we encourage each member not to rely on another member’s approval as a basis for approval and to treat his approval as if it were the only approval necessary to approve the loan. Our legal lending limit to one borrower is limited to 15% of our unimpaired capital and surplus. We have an internal guidance line of 97% of the legal lending limit. As of December 31, 2007, our legal lending limit was approximately $8.7 million, although we have no loans to one borrower that approach our legal lending limit to date.

The following collection actions are the minimal procedures which management believes are necessary to properly monitor past due loans and leases. When a borrower fails to make a payment, we contact the borrower in person, in writing or on the telephone. At a minimum, all borrowers are notified by mail when payments of principal and/or interest are 10 days past due. Real estate and commercial loan borrowers are assessed a late charge when payments are 10-15 days past due. Customers are contacted by a loan officer before the loan becomes 60 days delinquent. After 90 days, if the loan has not been brought current or an acceptable arrangement is not worked out with the borrower, we will institute measures to remedy the default, including commencing foreclosure action with respect to mortgage loans and repossessions of collateral in the case of consumer loans.

If foreclosure is effected, the property is sold at a public auction in which we may participate as a bidder. If we are the successful bidder, we include the acquired real estate property in our real estate owned account until it is sold. These assets are carried at the lower of cost or the fair value net of estimated selling costs. To the extent there is a decline in value, that amount is charged to operating expense. At December 31, 2007, we had other real estate owned totaling $3.6 million.

Special Products and Services

To complement our array of loans, we also provide the following special products and services to our commercial customers:

Cash Management Services

Cash Management services are offered that enable the Bank’s business customer to maximize the efficiency of their cash management. Specific products offered in our cash management services program include the following:

 

   

Investment/sweep accounts

 

   

Wire Transfer services

 

   

Employer Services/Payroll processing services

 

   

Zero balance accounts

 

   

Night depository services

 

   

Lockbox services (third party)

 

   

Depository transfers

 

   

Merchant services (third party)

 

   

ACH originations

 

   

Business debit cards

 

   

Controlled disbursement accounts

 

   

SONA 24/7 (Check 21 processing)

 

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Three of the products listed above are described in-depth below.

 

 

SONA 24/7/Check 21: SONA 24/7 is ideal for landlords, property managers, medical professionals, and any other businesses that accept checks. Sonabank is a market leader in banking technology, and has created SONA 24/7 to empower its business customers. Now the customers of Sonabank can have total control over how, when, and where their checks will be deposited. SONA 24/7 uses the new Check Truncation technology outlined by the “Check Clearing for the 21st Century Act”, passed in October 2004 (Check 21). This act allows banks to have a universal technique for processing checks. With Check Truncation, paper checks can now be converted to electronic images and processed between participating banks, vastly speeding up the check clearing process. SONA In-House passes on the benefits of Check Truncation directly to Sonabank’s business customers.

 

 

Lockbox Services: Sonabank will open a lockbox, retrieve incoming checks, and deposit them directly into the customer’s account. The images of the checks will then be available to view online. This makes bookkeeping for the customer fast and easy, and because Sonabank is checking the lockbox daily, funds will often be available sooner. Big businesses have been using lockboxes for decades as a cash management tool. Now Sonabank is making this service cost effective for all small and medium sized businesses as well.

 

 

Employer Services: Sonabank will provide its business clients with software that allows them to generate ACH payroll transactions to their employees’ accounts.

 

 

Other Consumer/Retail Products and Services. Other products and services that are offered by the Bank are primarily directed toward the individual customer and will include the following:

 

   

Debit cards

 

   

ATM services

 

   

Travelers Checks

 

   

Savings bonds

 

   

Money Orders

 

   

Notary service

 

   

Wire transfers

 

   

Telephone banking

 

   

Online banking with bill payment services

 

   

Credit Cards

Competition

The banking business is highly competitive, and our profitability depends principally on our ability to compete in the market areas in which our banking operations are located. We experience substantial competition in attracting and retaining savings deposits and in lending funds. The primary factors we encounter in competing for savings deposits are convenient office locations and rates offered. Direct competition for savings deposits comes from other commercial bank and thrift institutions, money market mutual funds and corporate and government securities which may offer more attractive rates than insured depository institutions are willing to pay. The primary factors we encounter in competing for loans include, among others, interest rate and loan origination fees and the range of services offered. Competition for origination of loans normally comes from other commercial banks, thrift institutions, mortgage bankers, mortgage brokers and insurance companies. We have been able to compete effectively with other financial institutions by:

 

   

emphasizing customer service and technology;

 

   

by establishing long-term customer relationships and building customer loyalty; and

 

   

by providing products and services designed to address the specific needs of our customers.

 

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Employees

At December 31, 2007, we had 59 full-time equivalent employees, four of whom were executive officers. Management considers its relations with its employees to be good. Neither we nor Sonabank are a party to any collective bargaining agreement.

SUPERVISION AND REGULATION

The business of SNBV and the Bank are subject to extensive regulation and supervision under federal banking laws and other federal and state laws and regulations. In general, these laws and regulations are intended for the protection of the customers and depositors of the Bank and not for the protection of SNBV or its shareholders. Set forth below are brief descriptions of selected laws and regulations applicable to SNBV and the Bank. These descriptions are not intended to be a comprehensive description of all laws and regulations to which SNBV and the Bank are subject or to be complete descriptions of the laws and regulations discussed. The descriptions of statutory and regulatory provisions are qualified in their entirety by reference to the particular statutes and regulations. Changes in applicable statutes, regulations or regulatory policy may have a material effect on SNBV, the Bank and their business.

The Bank Holding Company Act of 1956

Under the Bank Holding Company Act of 1956, as amended (BHCA), SNBV is subject to periodic examination by the Federal Reserve Board and required to file periodic reports regarding its operations and any additional information that the FRB may require. Our activities at the bank holding company level will be limited to:

 

   

banking, managing or controlling banks;

 

   

furnishing services to or performing services for our bank subsidiary; and

 

   

engaging in other activities that the FRB has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities.

Some of the activities that the FRB has determined by regulation to be proper incidents to the business of a bank holding company include making or servicing loans and specific types of leases, performing specific data processing services and acting in some circumstances as a fiduciary or investment or financial adviser. SNBV does not currently plan to perform any of these activities, but may do so in the future.

With some limited exceptions, the BHCA requires every bank holding company to obtain the prior approval of the FRB before: (i) acquiring substantially all the assets of any bank; (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or (iii) merging or consolidating with another bank holding company.

In addition, and subject to some exceptions, the BHCA and the Change in Bank Control Act, together with their regulations, require FRB approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either has registered securities under Section 12 of the Exchange Act or no other person owns a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenging this rebuttable control presumption.

In November 1999, Congress enacted the Gramm-Leach-Bliley Act (GLBA), which made substantial revisions to the statutory restrictions separating banking activities from other financial activities. Under the

 

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GLBA, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become “financial holding companies.” As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, travel agency activities, insurance agency activities, merchant banking and other activities that the FRB determines to be financial in nature or complementary to these activities. Financial holding companies continue to be subject to the overall oversight and supervision of the FRB, but the GLBA applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. Although SNBV has not elected to become a financial holding company in order to exercise the broader activity powers provided by the GLBA, SNBV may elect to do so in the future.

Insurance of Deposits. The Bank’s deposit accounts are insured by the FDIC up to a maximum of $100,000 per insured depositor ($250,000 for certain retirement accounts). Under deposit insurance reform legislation which became effective in February 2006, deposit insurance coverage will be increased for inflation every five years beginning in 2011. The FDIC issues regulations, conducts periodic examinations, requires the filing of reports and generally supervises the operations of its insured banks. Any insured bank which is not operated in accordance with, or does not conform to FDIC regulations, policies and directives may be sanctioned for non-compliance. Proceedings may be instituted against any insured bank or any director, officer or employee of such bank engaging in unsafe and unsound practices including the violation of applicable laws and regulations. The FDIC has the authority to terminate insurance of accounts pursuant to procedures established for that purpose.

In February 2006, the Federal Deposit Insurance Reform Act of 2005 (“Deposit Reform Act”) was enacted. The Deposit Reform Act, among other things, consolidates the Bank Insurance Fund and Savings Association Insurance Fund into the DIF, establishes a range for reserves levels for the DIF of 1.15% to 1.50% and creates a mechanism for raising the ceiling on deposit insurance coverage to reflect future inflation. The FDIC has adopted final regulations with respect to the Deposit Reform Act effective as of January 1, 2007. Under the new deposit insurance assessment system, the FDIC will evaluate each institution’s risk, and therefore its assessment rate, based on three primary sources of information: supervisory ratings for all insured institutions, financial ratios for most institutions and long-term debt issuer ratings for large institutions that have them. The FDIC assessment rates effective January 1, 2007 range from 0.05% to 0.43% of deposits. The FDIC also set the designated reserve ratio for the DIF at 1.25% of estimated insured deposits.

Interstate Banking and Branching. Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Effective June 1, 1997, a bank headquartered in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states had opted out of such interstate merger authority prior to such date. For example, as a bank headquartered in Virginia, SNBV may acquire a bank or branch in Maryland, but it cannot simply establish a branch in Maryland. After a bank has acquired a branch in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under applicable federal or state law.

Safety and Soundness. The federal banking agencies, including the OCC and the FDIC have implemented rules and guidelines concerning standards for safety and soundness required in accordance with Section 39 of the Federal Deposit Insurance Act. In general, the standards relate to (i) operational and managerial matters; (ii) asset quality and earnings; and (iii) compensation. If an insured national bank fails to meet any of the standards promulgated by regulation, then such institution will be required to submit a plan within 30 days to the OCC specifying the steps it will take to correct the deficiency. In the event that an insured bank fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the OCC, Section 39 of the FDIA provides that the OCC must order the institution to correct the deficiency and may:

 

   

restrict asset growth;

 

   

require the institution to increase its ratio of tangible equity to assets;

 

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restrict the rates of interest that the bank may pay; or

 

   

take any other action that would better carry out the purpose of prompt corrective action.

There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. These obligations and restrictions are not for the benefit of investors. Regulators may pursue an administrative action against any bank holding company or national bank which violates the law, engages in an unsafe or unsound banking practice or which is about to engage in an unsafe and unsound banking practice. The administrative action could take the form of a cease and desist proceeding, a removal action against the responsible individuals or, in the case of a violation of law or unsafe and unsound banking practice, a civil penalty action. A cease and desist order, in addition to prohibiting certain action, could also require that certain action be undertaken. Under the policies of the FRB, SNBV is required to serve as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where SNBV might not do so otherwise.

Capital Requirements. Each of the OCC and the FRB has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, SNBV and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of “Tier 1 Capital,” which is defined as common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles. The remainder may consist of “Tier 2 Capital,” which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance. In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. In sum, the capital measures used by the federal banking regulators are:

 

   

the Total Risk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital and Tier 2 Capital;

 

   

the Tier 1 Risk-Based Capital ratio; and

 

   

the leverage ratio.

Under these regulations, a national bank will be:

 

   

“well capitalized” if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier 1 Risk-Based Capital ratio of 6% or greater, a leverage ratio of 5% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure;

 

   

“adequately capitalized” if it has a Total Risk-Based Capital ratio of 8% or greater, a Tier 1 Risk-Based Capital ratio of 4% or greater, and a leverage ratio of 4% or greater—or 3% in certain circumstances—and is not well capitalized;

 

   

“undercapitalized” if it has a Total Risk-Based Capital ratio of less than 8% or greater, a Tier 1 Risk-Based Capital ratio of less than 4% (or 3% in certain circumstances), or a leverage ratio of less than 4% (or 3% in certain circumstances);

 

   

“significantly undercapitalized” if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1 Risk-Based Capital ratio of less than 3%, or a leverage ratio of less than 3%; or

 

   

“critically undercapitalized” if its tangible equity is equal to or less than 2% of tangible assets.

 

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The risk-based capital standards of each of the OCC and the FRB explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies (including the OCC and the FDIC) have adopted substantially similar regulations to implement Section 38 of the FDIA. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which the FDIC may reclassify a well capitalized bank as adequately capitalized and may require an adequately capitalized bank or an undercapitalized bank to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized bank as critically undercapitalized).

The OCC and the FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC or the FDIC. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers.

Payment of Dividends. SNBV is a legal entity separate and distinct from Sonabank. The principal sources of SNBV’s cash flow, including cash flow to pay dividends to its stockholders, are dividends that Sonabank pays to its sole shareholder, SNBV. Statutory and regulatory limitations apply to Sonabank’s payment of dividends to us as well as to SNBV’s payment of dividends to its stockholders.

The policy of the Federal Reserve Board that a bank holding company should serve as a source of strength to its subsidiary banks also results in the position of the Federal Reserve Board that a bank holding company should not maintain a level of cash dividends to its stockholders that places undue pressure on the capital of its bank subsidiary or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company’s ability to serve as a source of strength. Sonabank has no present plans to pay dividends to SNBV.

Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. Until capital surplus equals or exceeds capital stock, a national bank must transfer to surplus ten percent of its net income for the preceding four quarters in the case of an annual dividend or ten percent of its net income for the preceding two quarters in the case of a quarterly or semiannual dividend. Without prior approval, a national bank may not declare a dividend if the total amount of all dividends declared by the bank in any calendar year exceeds the total of the bank’s retained net income for the current year and retained net income for the preceding two years. Under federal law, the Bank cannot pay a dividend if, after paying the dividend, the bank will be “undercapitalized.” The OCC may declare a dividend payment to be unsafe and unsound even though the Bank would continue to meet its capital requirements after the dividend.

The ability of SNBV to pay dividends is also subject to the provisions of Virginia law. The payment of dividends by SNBV and Sonabank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is

 

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undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

Because we are a legal entity separate and distinct from our subsidiary Sonabank, our right to participate in the distribution of assets of any subsidiary upon the subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, arising as a result of their status as shareholders, including any depository institution holding company (such as us) or any shareholder or creditor thereof.

Change of Control. State and federal law restricts the amount of voting stock of a bank that a person may acquire without obtaining the prior approval of banking regulators. The overall effect of such laws is to make it more difficult to acquire a bank by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, shareholders of financial institutions are less likely to benefit from the rapid increases in stock prices that often result from tender offers or similar efforts to acquire control of other companies.

Under the federal Change in Bank Control Act and its regulations, a person or group must give advance notice to the OCC before acquiring control of any national bank. Upon receipt of such notice, the OCC may either approve or disapprove the acquisition. Federal law creates a rebuttable presumption of control if a member or group acquires 10% or more of a bank’s voting stock and if one or more other factors are present.

Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (“GLBA”) was signed into law on November 12, 1999. The GLBA covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.

The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a “satisfactory” Community Reinvestment Act rating.

The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in specific areas identified under the law. Under the new law, the federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.

The GLBA adopts a system of functional regulation under which the FRB is designated as the umbrella regulator for financial holding companies, but financial holding company affiliates are principally regulated by functional regulators such as the OCC for national bank affiliates, the SEC for securities affiliates, and state insurance regulators for insurance affiliates. It repeals the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Exchange Act. It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker,” and a set of activities in which a bank may engage without being deemed a “dealer.” Additionally, the new law makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.

 

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The GLBA contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The new law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are stricter than those contained in the act.

Privacy

Under the GLBA, financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. Sonabank has established policies and procedures to assure our compliance with all privacy provisions of the GLBA.

Consumer Credit Reporting

On December 4, 2003, President Bush signed the Fair and Accurate Credit Transactions Act amending the federal Fair Credit Reporting Act. These amendments to the Fair Credit Reporting Act (the FCRA Amendments) became effective in 2004.

The FCRA Amendments include, among other things:

 

   

requirements for financial institutions to develop policies and procedures to identify potential identity theft and, upon the request of a consumer, place a fraud alert in the consumer’s credit file stating that the consumer may be the victim of identity theft or other fraud;

 

   

consumer notice requirements for lenders that use consumer report information in connection with risk-based credit pricing programs;

 

   

for entities that furnish information to consumer reporting agencies (which would include Sonabank), requirements to implement procedures and policies regarding the accuracy and integrity of the furnished information and regarding the correction of previously furnished information that is later determined to be inaccurate; and

 

   

a requirement for mortgage lenders to disclose credit scores to consumers.

The FCRA Amendments also prohibit a business that receives consumer information from an affiliate from using that information for marketing purposes unless the consumer is first provided a notice and an opportunity to direct the business not to use the information for such marketing purposes (the opt-out), subject to certain exceptions. We do not share consumer information among our affiliated companies for marketing purposes, except as allowed under exceptions to the notice and opt-out requirements. Because no affiliate of SNBV is currently sharing consumer information with any other affiliate for marketing purposes, the limitations on sharing of information for marketing purposes do not have a significant impact on us.

Anti-Terrorism and Money Laundering Legislation

Sonabank is subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism of 2001 (the USA PATRIOT Act), the Bank Secrecy Act and rules and

 

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regulations of the Office of Foreign Assets Control (the OFAC). These statutes and related rules and regulations impose requirements and limitations on specific financial transactions and account relationships intended to guard against money laundering and terrorism financing. Sonabank has established a customer identification program under Section 326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise has implemented policies and procedures intended to comply with the foregoing rules.

Virginia Law. Certain state corporation laws may have an anti-takeover affect. Virginia law restricts transactions between a Virginia corporation and its affiliates and potential acquirers. The following discussion summarizes the two Virginia statutes that may discourage an attempt to acquire control of SNBV.

Virginia Code Sections 13.1-725 – 727.1 govern “Affiliated Transactions.” These provisions, with several exceptions discussed below, require approval by the holders of at least two-thirds of the remaining voting shares of material acquisition transactions between a Virginia corporation and any holder of more than 10% of any class of its outstanding voting shares. Affiliated Transactions include mergers, share exchanges, material dispositions of corporate assets not in the ordinary course of business, any dissolution of the corporation proposed by or on behalf of an interested shareholder, or any reclassification, including a reverse stock split, recapitalization, or merger of the corporation with its subsidiaries which increases the percentage of voting shares owned beneficially by any 10% shareholder by more than 5%.

For three years following the time that a shareholder becomes an owner of 10% of the outstanding voting shares, a Virginia corporation cannot engage in an Affiliated Transaction with that shareholder without approval of two-thirds of the voting shares other than those shares beneficially owned by that shareholder, and majority approval of the disinterested directors. A disinterested director is a member of the company’s board of directors who was (i) a member on the date the shareholder acquired more than 10%, and (ii) recommended for election by, or was elected to fill a vacancy and received the affirmative vote of, a majority of the disinterested directors then on the board. At the expiration of the three-year period, the statute requires approval of Affiliated Transactions by two-thirds of the voting shares other than those beneficially owned by the 10% shareholder.

The principal exceptions to the special voting requirement apply to transactions proposed after the three-year period has expired and require either that the transaction be approved by a majority of the corporation’s disinterested directors or that the transaction satisfies the fair-price requirement of the statute. In general, the fair-price requirement provides that in a two-step acquisition transaction, the 10% shareholder must pay the shareholders in the second step either the same amount of cash or the same amount and type of consideration paid to acquire the Virginia corporation’s shares in the first step.

None of the foregoing limitations and special voting requirements applies to a transaction with any 10% shareholder whose acquisition of shares taking him or her over 10% was approved by a majority of the corporation’s disinterested directors.

These provisions were designed to deter certain takeovers of Virginia corporations. In addition, the statute provides that, by affirmative vote of a majority of the voting shares other than shares owned by any 10% shareholder, a corporation can adopt an amendment to its articles of incorporation or bylaws providing that the Affiliated Transactions provisions shall not apply to the corporation. SNBV “opted out” of the Affiliated Transactions provisions when it incorporated.

Virginia law also provides that shares acquired in a transaction that would cause the acquiring person’s voting strength to meet or exceed any of the three thresholds (20%, 33 1/3% or 50%) have no voting rights for those shares exceeding that threshold, unless granted by a majority vote of shares not owned by the acquiring person. This provision empowers an acquiring person to require the Virginia corporation to hold a special meeting of shareholders to consider the matter within 50 days of the request. SNBV also “opted out” of this provision at the time of its incorporation.

 

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Federal Reserve Monetary Policy. The Bank will be directly affected by government monetary and fiscal policy and by regulatory measures affecting the banking industry and the economy in general. The actions of the FRB as the nation’s central bank can directly affect the money supply and, in general, affect the lending activities of banks by increasing or decreasing the cost and availability of funds. An important function of the FRB is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the FRB to implement this objective are open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits, and interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

Reserve Requirements. In 1980, Congress enacted legislation that imposed reserve requirements on all depository institutions that maintain transaction accounts or nonpersonal time deposits. NOW accounts, money market deposit accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to these reserve requirements, as are any nonpersonal time deposits at an institution. For net transaction accounts in 2007, the first $9.3 million will be exempt from reserve requirements. A 3.0% reserve ratio will be assessed on net transaction accounts over $9.3 million to and including $43.9 million. A 10.0% reserve ratio will be applied to net transaction accounts in excess of $43.9 million. These percentages are subject to adjustment by the FRB. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at, or on behalf of, a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets.

Transactions with Affiliates. Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any bank or entity that controls, is controlled by or is under common control with such bank. Generally, Sections 23A and 23B (i) limit the extent to which the bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such institution’s capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the bank as those provided to a nonaffiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. Section 23B applies to “covered transactions” as well as sales of assets and payments of money to an affiliate. These transactions must also be conducted on terms substantially the same, or at least favorable, to the bank as those provided to nonaffiliates.

Loans to Insiders. The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act, loans to a director, an executive officer and to a principal shareholder of a bank, and to entities controlled by any of the foregoing, may not exceed, together with all other outstanding loans to such person and entities controlled by such person, the bank’s loan-to-one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed two times the bank’s unimpaired capital and unimpaired surplus until the bank’s total assets equal or exceed $100 million, at which time the aggregate is limited to the bank’s unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and principal shareholders of a bank or bank holding company, and to entities controlled by such persons, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. The OCC has prescribed the loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, as being the greater of $25,000.00 or 5.0% of capital and surplus (up to $500,000.00). Section 22(h) requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons. Further, Section 402 of the Sarbanes-Oxley Act of 2002, with certain exceptions, prohibits loans to directors and executive officers. We do not have any loans to insiders as of December 31, 2007.

 

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Community Reinvestment Act. Under the Community Reinvestment Act and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. The Community Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries.

The Gramm-Leach-Bliley Act and federal bank regulators have made various changes to the Community Reinvestment Act. Among other changes, Community Reinvestment Act agreements with private parties must be disclosed and annual reports must be made to a bank’s primary federal regulatory. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a “satisfactory” rating in its latest Community Reinvestment Act examination. The Bank received a “satisfactory” rating in the most recent examination for Community Reinvestment Act compliances by the OCC.

Fair Lending; Consumer Laws. In addition to the Community Reinvestment Act, other federal and state laws regulate various lending and consumer aspects of the banking business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums, short of a full trial.

Recently, these governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.

The foregoing is only a brief summary of certain statutes, rules, and regulations that may affect SNBV and the Bank. Numerous other statutes and regulations also will have an impact on the operations of SNBV and the Bank. Supervision, regulation and examination of banks by the regulatory agencies are intended primarily for the protection of depositors, not shareholders.

Future Regulatory Uncertainty. Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. Although Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, SNBV fully expects that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.

 

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Item 1A.—Risk Factors

We have a limited operating history, which makes it difficult to predict our future prospects and financial performance.

We have only been operating as the holding company for Sonabank since April 14, 2005. While we have financial statements for the full years ended December 31, 2007 and 2006, our financial statements for the year ended December 31, 2005 reflect only eight months of operations, during which we spent part of our initial capitalization to fund our start-up costs. Due to this limited operating history, it may be difficult to evaluate our business prospects.

We rely, in part, on external financing to fund our operations and the unavailability of such funds in the future could adversely affect our growth strategy and prospects.

Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes.

We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on deposits obtained through intermediaries, FHLB advances, securities sold under agreements to repurchase and other wholesale funding sources to obtain the funds necessary to implement our growth strategy.

To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.

Our commercial real estate, construction and small business loan portfolios have significant type and geographic concentrations and an economic slowdown or depressed residential real estate market in our primary markets could be detrimental to our financial condition.

A substantial portion of our commercial real estate, construction and business loans are to customers located in Albemarle County and several counties in Northern Virginia including Fairfax County. We anticipate that our business in Northern Virginia will increase substantially as a result of the merger. In addition, we have loan concentrations in certain types of loans, including land subdivision, lessors of non-residential buildings and new home builders. All of these loans are secured by real estate in these markets.

Deterioration in economic conditions in these markets or in the housing market could have a material adverse effect on the quality of these portfolios and the demand for our products and services. In addition, during periods of economic recession, we may experience a decline in collateral values and an increase in delinquencies. Accordingly, the ultimate collectability of a substantial portion of our commercial loan portfolio is susceptible to economic changes in these markets including increases in interest rates. A significant downturn in the commercial or residential real estate market in these areas would be detrimental to our financial condition.

In addition, if any of these developments were to result in losses that materially and adversely affected Sonabank’s capital, we and Sonabank might be subject to regulatory restrictions on operations and growth and to a requirement to raise additional capital.

If the value of real estate in our market areas were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our asset quality, capital structure and profitability.

A significant portion of our loan portfolio is comprised of loans secured by either commercial real estate or single family homes which are under construction. At December 31, 2007, approximately 79% of our loans had

 

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real estate as a component of collateral. In the majority of these loans, real estate was the primary collateral component. In some cases, and out of an abundance of caution, we take real estate as security for a loan even when it is not the primary component of collateral. The real estate collateral that provides an alternate source of repayment in the event of default may deteriorate in value during the term of the loan. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. We are subject to increased lending risks in the form of loan defaults as a result of the high concentration of real estate lending in our loan portfolio should the real estate market in Virginia turn downward.

Our business strategy includes strategic growth, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

We completed the acquisition of 1st Service Bank in December 2006. We intend to continue pursuing a growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies such as the continuing need for infrastructure and personnel, the time and costs inherent in integrating a series of different operations and the ongoing expense of acquiring and staffing new banks or branches. We may not be able to expand our presence in our existing markets or successfully enter new markets and any expansion could adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Our ability to grow successfully will depend on a variety of factors, including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. There can be no assurance of success or the availability of branch or bank acquisitions in the future.

A loss of our executive officers could impair our relationship with our customers and adversely affect our business.

Many community banks attract customers based on the personal relationships that the banks’ officers and customers establish with each other and the confidence that the customers have in the officers. As a relatively new enterprise, we depend on the performance of Ms. Georgia S. Derrico, chairman and chief executive officer, and R. Roderick Porter, who is the president of SNBV and Sonabank, respectively. Ms. Derrico is a well-known banker in our market areas, having operated a successful financial institution there for more than 18 years prior to founding SNBV and Sonabank. We do not have an employment agreement with either individual. The loss of the services of either of these officers or their failure to perform management functions in the manner anticipated by our board of directors could have a material adverse effect on our business. Our success will be dependent upon the board’s ability to attract and retain quality personnel, including these officers. We have attempted to reduce our risk by entering into a change in control agreement that includes a non-competition covenant with Ms. Derrico and Mr. Porter.

Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.

The majority of our assets and liabilities are monetary in nature and subject us to significant risk from changes in interest rates. Fluctuations in interest rates are not predictable or controllable. Like most financial institutions, changes in interest rates can impact our net interest income as well as the valuation of our assets and liabilities. Based on our analysis of the interest rate sensitivity of our assets, an increase in the general level of interest rates may negatively affect the market value of the portfolio equity, but will positively affect our net interest income since most of our assets have floating rates of interest that adjust fairly quickly to changes in market rates of interest. Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest-earning assets, loan origination volume, loan and mortgage-backed securities portfolios, and our overall results.

 

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Our profitability depends significantly on economic conditions in our market area.

Our success depends to a large degree on the general economic conditions in the Charlottesville, Virginia and northern Virginia market areas. The local economic conditions in both of these areas have a significant impact on the loans that we make to our borrowers, the ability of our borrowers to repay these loans, and the value of the collateral securing these loans. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and could negatively affect our financial condition and performance.

In recent years, there has been a proliferation of government contracting, technology and communication businesses in northern Virginia. The last recession in those industries had a significant adverse impact on a number of those businesses. While we do not have significant credit exposure to these businesses, the recession in these industries could have a negative impact on local economic conditions and real estate collateral values generally, which could negatively affect our profitability.

Item 1B.—Unresolved Staff Comments

SNBV does not have any unresolved staff comments to report for the year ended December 31, 2007.

Item 2.—Properties

The following table sets forth the date opened or acquired, ownership status and the total deposits, not including brokered deposits for each of our banking locations as of December 31, 2007:

 

Location

   Date Opened
or Acquired
   Owned or
Leased
   Deposits
(in thousands)
Home Office and Branch:         

1770 Timberwood Boulevard

Charlottesville, Virginia 22911

   April 2005    Leased    $ 20,259
Branch Offices:         

511 Main Street

Clifton Forge, Virginia 24442

   December 2005    Owned    $ 39,799

6830 Old Dominion Drive

McLean, Virginia 22101

   December 2006    Leased    $ 57,892

11527 Sunrise Valley Drive

Reston, Virginia 20191

   December 2006    Leased    $ 9,094

10855 Fairfax Boulevard

Fairfax, Virginia 22030

   December 2006    Leased    $ 4,168

550 Broadview Avenue

Warrenton, Virginia 20186

   April 2007    Leased    $ 4,369
Loan Production Offices:         

230 Court Square

Charlottesville, Virginia 22902

   March 2005    Leased      NA

2217 Princess Anne Street

Fredericksburg, Virginia 22401

   April 2005    Leased      NA

550 Broadview Avenue

Warrenton, Virginia 20186

   September 2005    Leased      NA

2805 McRae Road, Suite 5A

Richmond, Virginia 23235

   July 2007    Leased      NA
Executive Offices:         

1002 Wisconsin Avenue

Washington, D.C. 20007

   April 2005    Leased      NA

 

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Item 3.—Legal Proceedings

While SNBV and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business, there are no proceedings pending, or to management’s knowledge, threatened, against SNBV or Sonabank as of December 31, 2007.

Item 4.—Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2007.

 

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PART II

Item 5.—Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

On November 6, 2006, SNBV closed on the initial public offering of its common stock, $0.01 par value. The shares of common stock sold in the offering were registered under the Securities Act of 1933, as amended on a Registration Statement (Registration No. 333-136285) that was declared effective by the Securities and Exchange Commission on October 31, 2006. The shares of common stock were sold at a price to the public of $14.00 per share (equivalent to $12.73 after the stock dividend).

SNBV’s common stock is traded on the Nasdaq Global Market under the symbol “SONA”. Our common stock began trading on the Nasdaq Capital Market in November 2006, and the exchange listing was upgraded to the Nasdaq Global Market at the open of trading on December 18, 2007.

There were 6,798,547 shares of our common stock outstanding at the close of business on February 26, 2008, which were held by 250 shareholders of record.

On April 19, 2007, SNBV’s Board of Directors approved a 10% stock dividend payable May 18, 2007 to shareholders of record as of May 2, 2007. All share and per share amounts have been adjusted to reflect the stock dividend. There have been no cash dividends paid.

The following table summarizes the high and low closing sales prices for quarterly periods during 2007 and 2006:

 

     Market Values
     2007    2006
     High    Low    High    Low

First Quarter

   $ 15.20    $ 13.95    $ —      $ —  

Second Quarter

     14.82      13.25      —        —  

Third Quarter

     13.95      12.05      —        —  

Fourth Quarter

     12.44      9.00      15.48      13.95

Recent Sales of Unregistered Securities

None

Issuer Purchases of Equity Securities

None

 

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Securities Authorized for Issuance under Equity Compensation Plans

As of December 31, 2007, the Company had outstanding stock options granted under its Stock Option Plan, which is approved by the Company’s shareholders. The following table provides information as of December 31, 2007 regarding the Company’s equity compensation plans under which the Company’s equity securities are authorized for issuance:

 

Plan category

   Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
   Weighted-average
exercise price of
outstanding options
(b)
   Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)

Equity compensation plans approved by security holders

   256,025    $ 9.21    128,975

Equity compensation plans not approved by security holders

   —        —      —  
                

Total

   256,025    $ 9.21    128,975
                

 

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Performance Graph

The following chart compares the cumulative total shareholder return on SNBV common stock for the period from November 1, 2006, when the common stock was first listed on the Nasdaq Capital Market, to December 31, 2007, with the cumulative total return of the SNL Bank $250M-$500M Index, the SNL Bank <$500M Index, the SNL Southeast Bank Index, and the SNL Small Cap Bank Index for the same period. Dividend reinvestment has been assumed. This comparison assumes $100 invested on November 1, 2006 in SNBV common stock, SNL Bank $250M-$500M Index, the SNL Bank <$500M Index, the SNL Southeast Bank Index, and the SNL Small Cap Bank Index. The historical stock price performance for SNBV common stock shown on the graph below is not necessarily indicative of future stock performance.

LOGO

 

     Period Ending

Index

   11/01/06    12/31/06    03/31/07    06/30/07    09/30/07    12/31/07

Southern National Bancorp of Virginia, Inc.

   100.00    108.14    101.95    100.97    89.29    64.50

SNL Bank $250M-$500M Index

   100.00    101.25    101.46    99.89    93.06    82.29

SNL Bank <$500M Index

   100.00    100.88    101.19    99.39    92.70    81.91

SNL Southeast Bank Index

   100.00    102.11    99.33    96.36    95.13    76.92

SNL Small Cap Bank Index

   100.00    104.63    96.13    89.71    86.74    75.65

Source: SNL Financial LC, Charlottesville, VA© 2008

 

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Item 6.—Selected Financial Data

The following table sets forth selected financial data for SNBV as of December 31, 2007, 2006 and 2005, and for the years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005:

 

     2007     2006     2005  
     (in thousands, except per share amounts)  

Results of Operations:

      

Interest income

   $ 21,749     $ 10,784     $ 2,395  

Interest expense

     11,086       4,860       605  
                        

Net interest income

     10,663       5,924       1,790  

Provision for loan losses

     1,290       546       1,020  
                        

Net interest income after provision for loan losses

     9,373       5,378       770  

Noninterest income

     357       249       51  

Noninterest expenses

     7,886       4,618       3,077  
                        

Income (loss) before income taxes

     1,844       1,009       (2,256 )

Income tax expense

     108       —         —    
                        

Net income (loss)

   $ 1,736     $ 1,009     $ (2,256 )
                        

Per Share Data (1):

      

Earnings (loss) per share—Basic

   $ 0.26     $ 0.24     $ (0.59 )

Earnings (loss) per share—Diluted

   $ 0.25     $ 0.23     $ (0.59 )

Book value per share

   $ 10.19     $ 10.04     $ 8.39  

Tangible book value per share

   $ 8.34     $ 7.83     $ 7.61  

Weighted average shares outstanding—Basic

     6,798,547       4,244,957       3,850,000  

Weighted average shares outstanding—Diluted

     6,875,559       4,323,620       3,850,000  

Shares outstanding at end of period

     6,798,547       6,798,547       3,850,000  

Selected Performance Ratios and Other Data:

      

Return on average assets

     0.54 %     0.65 %     (5.35 %)

Return on average equity

     2.51 %     2.74 %     (9.89 %)

Yield on earning assets

     7.45 %     7.29 %     5.88 %

Cost of funds

     4.75 %     4.44 %     3.58 %

Cost of funds including non-interest bearing deposits

     4.42 %     4.15 %     3.17 %

Net interest margin

     3.65 %     4.01 %     4.40 %

Efficiency ratio (2)

     68.81 %     74.81 %     167.14 %

Net charge-offs to average loans

     0.24 %     0.21 %     0.00 %

Allowance for loan losses to total loans

     1.33 %     1.33 %     1.36 %

Stockholders’ equity to total assets

     18.36 %     23.48 %     26.29 %

Tangible stockholders’ equity to total tangible assets

     15.55 %     19.31 %     24.43 %

Financial Condition:

      

Total assets

   $ 377,283     $ 290,574     $ 122,908  

Total loans, net of unearned income

     261,407       204,544       75,031  

Total deposits

     265,469       215,804       77,263  

Stockholders’ equity

     69,275       68,227       32,313  

 

(1) Reflects 10% stock dividend declared April 19, 2007.
(2) Efficiency ratio is calculated by dividing noninterest expense into the sum of net interest income plus noninterest income, excluding any gains/losses on sales of securities.

 

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Item 7. —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.

FORWARD-LOOKING STATEMENTS

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” or other statements concerning opinions or judgment of the Company and its management about future events. Although we believe that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of SNBV will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, and consumer spending and savings habits. We do not update any forward-looking statements that may be made from time to time by or on behalf of SNBV.

CRITICAL ACCOUNTING POLICIES

Our accounting policies are in accordance with U. S. generally accepted accounting principles and with general practices within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during periods presented. Different assumptions in the application of these methods or policies could result in material changes in our financial statements. As such, the following policies are considered “critical accounting policies” for us.

Allowance for Loan Losses

The allowance for loan losses is established and maintained at levels management and the board of directors deem adequate to absorb probable incurred credit losses from identified and otherwise inherent risks in the portfolio as of the balance sheet date. In assessing the adequacy of the allowance, we review the quality of, and risks in, loans in the portfolio. We also consider such factors as:

 

   

composition of the loan portfolio;

 

   

value and adequacy of the collateral;

 

   

current economic conditions;

 

   

historical loan loss experience; and

 

   

other known internal and external factors that affect collectability as of the report date.

An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by our executive credit officer and presented to our board of directors for review and approval on at least a quarterly basis. We may determine, based on our analysis, which includes risk factors such as charge-off rates, past dues, portfolio composition and loan growth, that our future loan loss provision needs to increase or decrease in order for us to maintain the allowance at a level sufficient to absorb probable incurred credit losses. If

 

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we become aware that any of these factors has materially changed, our estimate of credit losses in the loan portfolio and the related allowance could also change. The allowance consists of general and unallocated components. The value of the general reserve is based on historical loss experience adjusted for qualitative factors.

While it is our policy to charge off loans in the current period when a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

Based on management’s calculation, an allowance of $3.5 million, or 1.33% of total loans was an adequate estimate of losses within the loan portfolio as of December 31, 2007. This estimate resulted in provision for loan losses on the income statement of $1.3 million during 2007. If the mix and amount of future charge off percentages differ significantly from those assumptions used by management in making its determination, an adjustment to the allowance for loan losses and the resulting effect on the income statement could be material.

Goodwill and Intangible Assets

When a company acquires a business, the purchased assets and liabilities are recorded at fair value. The fair value of most financial assets and liabilities are determined by estimating the discounted anticipated cash flows from or for the instrument using current market rates applicable to each category of instrument. Excess of consideration paid to acquire a business over the fair value of the net assets is recorded as goodwill. Errors in the estimation process of the fair value of acquired assets and liabilities will result in an overstatement or understatement of goodwill. This in turn will result in overstatement or understatement of income and expenses and, in the case of an overstatement of goodwill, could make SNBV subject to an impairment charge when the overstatement is discovered in its annual assessment for impairment.

At a minimum, management is required to assess goodwill and other intangible assets annually for impairment. This assessment involves estimating cash flows for future periods, preparing analyses of market multiples for similar operations, and estimating the fair value of the reporting unit to which the goodwill is allocated. If the future cash flows were materially less than the estimates, SNBV would be required to take a charge against earnings to write down the asset to the lower fair value. Based on its assessment, SNBV believes its goodwill of $8.7 million and other identifiable intangibles of $3.9 million are not impaired and are properly recorded in the consolidated financial statements as of December 31, 2007.

Valuation of Deferred Tax Asset

Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus changes in deferred taxes related primarily to differences between the basis of the net operating losses carryforward and allowance for loan losses. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Until the second quarter of 2007, SNBV maintained a valuation allowance against its deferred tax assets. During the second quarter of 2007, the valuation allowance on the net deferred tax assets was no longer necessary given the sustained income and growth over the past six calendar quarters. The tax valuation allowance reversal was $2.5 million, of which $1.9 million was related to the net deferred tax assets obtained in the 1st Service Bank acquisition and reduced goodwill.

 

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SNBV adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. The adoption of FIN 48 had no effect on our consolidated financial statements. We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during the next twelve months. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income tax accounts; no such accruals exist as of December 31, 2007. SNBV and its subsidiary file a consolidated U. S. federal tax return and a Virginia state income tax return. These returns are subject to examination by taxing authorities for all years after 2004.

OVERVIEW

Sonabank commenced operations in April 2005, and we had our first profitable quarter in the period ended December 31, 2005.

In December 2005, we closed on the purchase of a branch in Clifton Forge where we acquired $42.5 million in deposits, $7.1 million in loans and $2.4 million in retail repurchase agreements as well as the branch banking center and other assets in the amount of $2.2 million. As part of the purchase price allocation, Sonabank recorded $3.1 million in core deposit intangibles. The core deposit intangible assets are being amortized over 7 years.

On November 6, 2006, SNBV closed on the initial public offering of its common stock, $0.01 par value. All 2,000,000 shares of common stock registered in the offering, including 214,000 shares of common stock covered by an over- allotment option granted to the underwriter, were sold at a price to the public of $14.00 per share (equivalent to $12.73 after the stock dividend). The aggregate gross proceeds from the shares of common stock sold by SNBV were $28.0 million. The aggregate net proceeds to SNBV from the offering were approximately $26.4 million after deducting an aggregate of $866 thousand in underwriting commissions and $713 thousand in other expenses incurred in connection with the offering.

SNBV contributed most of the net proceeds of this offering to Sonabank to provide capital to support its internal asset growth as well as the asset growth expected to result from the three branches acquired in the merger with 1st Service. We also opened a new branch in Warrenton, Virginia, in April 2007, which generated additional growth, requiring additional capital. The excess net proceeds have been temporarily employed to reduce our higher cost liabilities including institutional certificates of deposit. The precise amounts and timing of our use of the net proceeds will depend upon market conditions and the availability of other funds, among other factors.

On December 1, 2006, we completed the acquisition of 1st Service Bank, which operated three branch offices in Fairfax County, Virginia. 1st Service Bank transactions have been included in our financial results since December 1, 2006. The fair value of the assets acquired as of December 1, 2006 were approximately $118.0 million including $107.1 million in loans, of which approximately $17 million were securitized by the end of December 2006, and reflected on the balance sheet as investment securities. We also acquired approximately $78.9 million in deposits. We also recorded $2.1 million in core deposit intangibles, and goodwill totaled approximately $8.7 million as adjusted. The core deposit intangible asset for this acquisition is being amortized over 7 years.

During 2007, the deferred tax asset valuation allowance reversal of $1.9 million related to the net deferred tax assets obtained in the 1st Service Bank acquisition was recognized as an adjustment to goodwill, and the beginning fair value of acquired loan servicing rights was adjusted in the amount of $177 thousand. Other adjustments to goodwill were made during the allocation period in 2007 in the amount of $58 thousand. As of December 31, 2007, the amount of goodwill is $8.7 million.

On December 19th, 2007, SNBV announced that it had entered into an agreement with Founders Corporation of Leesburg, Virginia to purchase certain assets and to assume its lease at 1 East Market Street in Leesburg in the 100 year old Loudoun National Bank building. Sonabank received approval from the Office of the Comptroller

 

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of the Currency to open a branch at that location. The branch was opened February 11, 2008. The Board of Directors of Founders Corp and certain other investors in Founders Corp will become the members of Sonabank’s new Leesburg Advisory Board.

Because our first year of operations (i.e., the period from inception at April 14, 2005 through December 31, 2005) was a partial calendar period, having less than the full number of business days as in subsequent calendar periods, and because during this period we were engaged in the commencement of operations, we do not believe that a period-to-period comparison with the corresponding 2006 period is meaningful.

RESULTS OF OPERATIONS

Net Income

Net income for the year ended December 31, 2007, was $1.7 million compared to $1.0 million in the year ended December 31, 2006. Income before income taxes for 2007 increased to $1.8 million from $1.0 million in 2006, an increase of 83%. Net interest income for 2007 was $10.7 million, up 80% from 2006.

For the year ended December 31, 2006, net income was $1.0 million compared to a net loss of $2.3 million, for the period from inception at April 14, 2005 through December 31, 2005. Organization costs during the period ending December 31, 2005 amounted to $1.2 million, and we recorded a provision for loan losses of $1.0 million in 2005.

Net Interest Income

Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings.

Net interest income for the year ended December 31, 2007 was $10.7 million compared to $5.9 million for the same period last year. Average interest-earning assets for 2007 increased $144.0 million over 2006. Approximately $122.5 million of this growth was an increase in average loans outstanding, most of which was generated by the acquisition of $90.1 million of loans (net of $17.0 million of securitized loans) from the 1st Service Bank merger in December 2006. Average investment securities increased by $20.4 million in 2007, compared to 2006. The average yield on interest-earning assets increased from 7.29% in 2006 to 7.45% in 2007 primarily because most of the increase in average earning assets was in the higher yielding loans. Average interest-bearing liabilities for 2007 increased $123.7 million compared to 2006. Average interest-bearing deposits increased by $113.5 million compared to the same period in 2006. We acquired $67.3 million in interest-bearing deposits in the merger with 1st Service Bank. The average cost of interest-bearing liabilities increased from 4.44% in 2006 to 4.75% in 2007. The interest rate spread for the year ended December 31, 2007 decreased from 2.85% to 2.70% compared to the same period last year. The net interest margin for 2007 decreased to 3.65% from 4.01% compared to the same period last year.

Our commercial loans, acquisition and development loans, construction loans and SBA loans are predominately priced to a spread over the prime rate. Commercial real estate loans are generally priced at a spread over the one, three or five year constant maturity treasury yield (CMT) or the Bank’s marginal cost of funds and fixed for three to five years. On the liability side of the balance sheet we have a large segment of our funding which floats; however, the prime rate loans reprice virtually immediately, but the liabilities reprice only at maturity resulting in a lag which can adversely affect net interest income when interest rates decline. The decreases in the federal funds target rate during the second half of 2007 had a negative impact on our net interest margin during the year. We have mitigated that somewhat by using convertible advances from the Federal Home Loan Bank of Atlanta (FHLB) beginning in August 2007. These advances have a five year maturity and a fixed rate that is subject to being converted to an adjustable rate after the first year at the option of the FHLB. At the

 

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end of 2007, we had convertible advances totaling $25 million at an average interest rate of 4.05%. This has contributed to the decrease in the cost of borrowings compared to last year.

Net interest income for the year ended December 31, 2006 was $5.9 million compared to $1.8 million for the period from inception through December 31, 2005. Average interest-earning assets for the year ended December 31, 2006 increased $107.1 million over the period from inception in 2005. Approximately $81.4 million of this growth was an increase in average loans, most of which was generated by our loan officers. The average yield on interest-earning assets increased from 5.88% to 7.29% as average loan balances increased. Average interest-bearing liabilities for the year ended December 31, 2006 increased $92.6 million compared to the period from inception in 2005. Approximately $85.4 million of this growth was an increase in deposits. We acquired $42.5 million in deposits in the Clifton Forge branch purchase in December 2005. The average cost of interest-bearing liabilities increased from 3.58% to 4.44%. The interest rate spread for the year ended December 31, 2006 increased from 2.30% to 2.85% compared to the period from inception last year. The net interest margin for the year ended December 31, 2006 decreased to 4.01% from 4.40% compared to the period from inception last year, primarily because most of the growth in loans and investment securities had been funded with time deposits, and the ratio of the average balance of time deposits to average interest-earning assets has increased significantly. At the same time, the ratio of the average balances of noninterest-bearing demand deposits and stockholders’ equity to average interest-earning assets during 2006 has decreased compared to 2005.

 

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The following tables detail 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 Years

Ended December 31, 2007 and 2006 and the Period From Inception

at April 14, 2005 Through December 31, 2005

 

    2007     2006     2005  
    Average
Balance
    Interest
Income/
Expense
  Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
  Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
  Yield/
Rate
 
    (Dollar amounts in thousands)  

Assets

                 

Interest-earning assets:

                 

Loans, net of unearned income

  $ 223,881     $ 17,892   7.99 %   $ 101,411     $ 8,465   8.35 %   $ 20,053     $ 1,534   7.65 %

Investment securities

    62,459       3,552   5.69 %     42,052       2,073   4.93 %     13,672       621   4.54 %

Other earning assets

    5,472       305   5.57 %     4,374       246   5.62 %     6,991       240   3.43 %
                                               

Total earning assets

    291,812       21,749   7.45 %     147,837       10,784   7.29 %     40,716       2,395   5.88 %
                             

Allowance for loan losses

    (2,966 )         (1,360 )         (345 )    

Intangible assets

    13,791           3,301           17      

Other non-earning assets

    19,257           4,852           1,778      
                                   

Total assets

  $ 321,894         $ 154,630         $ 42,166      
                                   

Liabilities and stockholders’ equity

                 

Interest-bearing liabilities:

                 

NOW accounts

  $ 6,569       17   0.26 %   $ 5,545       14   0.25 %   $ 522       1   0.26 %

Money market accounts

    40,855       1,712   4.19 %     16,772       553   3.30 %     6,479       200   3.09 %

Savings accounts

    2,658       12   0.45 %     2,406       13   0.53 %     184       1   0.51 %

Time deposits

    163,531       8,489   5.19 %     75,341       3,826   5.08 %     7,504       312   4.16 %
                                               

Total interest-bearing deposits

    213,613       10,230   4.79 %     100,064       4,406   4.40 %     14,689       514   3.50 %

Borrowings

    19,592       856   4.37 %     9,453       454   4.80 %     2,241       91   4.06 %
                                               

Total interest-bearing liabilities

    233,205       11,086   4.75 %     109,517       4,860   4.44 %     16,930       605   3.58 %
                             

Noninterest-bearing liabilities:

                 

Demand deposits

    17,698           7,666           2,170      

Other liabilities

    1,798           577           262      
                                   

Total liabilities

    252,701           117,760           19,362      

Stockholders’ equity

    69,193           36,870           22,804      
                                   

Total liabilities and stockholders’ equity

  $ 321,894         $ 154,630         $ 42,166      
                                   

Net interest income

    $ 10,663       $ 5,924       $ 1,790  
                             

Interest rate spread

      2.70 %       2.85 %       2.30 %

Net interest margin

      3.65 %       4.01 %       4.40 %

 

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The following table summarizes changes in net interest income attributable to changes in the volume of interest-bearing assets and liabilities compared to changes in interest rates. The change in interest, due to both rate and volume, has been proportionately allocated between rate and volume.

 

    Year Ended December 31, 2007 vs. 2006     Year Ended December 31, 2006 vs. the
Period From Inception at
April 14, 2005 Through December 31, 2005
    Increase (Decrease) Due to Change in:     Increase (Decrease) Due to Change in:
      Volume       Rate       Net
  Change  
      Volume         Rate       Net
  Change  
    ( in thousands)

Interest-earning assets:

           

Loans, net of unearned income

  $ 9,772   $ (345 )   $ 9,427     $ 6,779     $ 152     $ 6,931

Investment securities

    1,123     356       1,479       1,395       57       1,452

Other earning assets

    61     (2 )     59       (9 )     15       6
                                           

Total interest-earning assets

    10,956     9       10,965       8,165       224       8,389
                                           

Interest-bearing liabilities:

           

NOW accounts

    3     —         3       13       (0 )     13

Money market accounts

    975     184       1,159       338       15       353

Savings accounts

    2     (3 )     (1 )     12       0       12

Time deposits

    4,576     87       4,663       3,430       84       3,514
                                           

Total interest-bearing deposits

    5,556     268       5,824       3,793       98       3,892

Borrowings

    439     (37 )     402       343       20       363
                                           

Total interest-bearing liabilities

    5,995     231       6,226       4,137       118       4,255
                                           

Change in net interest income

  $ 4,961   $ (222 )   $ 4,739     $ 4,028     $ 106     $ 4,134
                                           

Provision for Loan Losses

The provision for loan losses is a current charge to earnings made in order to increase the allowance for loan losses to a level deemed appropriate by management based on an evaluation of the loan portfolio, current economic conditions, changes in the nature and volume of lending, historical loan experience and other known internal and external factors affecting loan collectablity. Our loan loss allowance is calculated by segmenting the loan portfolio by loan type and applying risk factors to each segment. The risk factors are determined by considering peer data, as well as applying management’s judgment.

The provision for loan losses charged to operations for the years ended December 31, 2007, 2006 and the period from April 15, 2005 through December 31, 2005 were $1.3 million, $546 thousand, and $1.0 million, respectively. We had charge-offs totaling $540 thousand during 2007, and charge-offs during 2006 were $214 thousand. There were no charge-offs in 2005. The increase in the provision for loan losses during 2007 was due to overall growth in the loan portfolio and adverse economic factors.

 

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Noninterest Income

The following table presents the major categories of noninterest income for the years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005 (in thousands):

 

     2007     2006    Change  

Account maintenance and deposit service fees

   $ 338     $ 188    $ 150  

Income from bank-owned life insurance

     347       —        347  

Loss on securities

     (440 )     —        (440 )

Other

     112       61      51  
                       

Total noninterest income

   $ 357     $ 249    $ 108  
                       
     2006     2005    Change  

Account maintenance and deposit service fees

   $ 188     $ 27    $ 161  

Other

     61       24      37  
                       

Total noninterest income

   $ 249     $ 51    $ 198  
                       

The increase in noninterest income was largely attributable to two factors. First, account maintenance and deposit service fees increased reflecting the impact of the increased number of accounts due in part to the acquisition of 1st Service Bank in the fourth quarter of 2006, and the acquisition of the Clifton Forge Branch in the fourth quarter of 2005. Second, we purchased a bank-owned life insurance (BOLI) policy during the first quarter of 2007, and we purchased a second policy in July 2007. We owned no BOLI during 2006 and 2005.

SNBV owns 80,000 shares of FHLMC perpetual preferred 5.57% stock Series V. Management recognized a $440 thousand other than temporary loss in the fourth quarter. In accordance with SFAS 115, when a decline in fair value below cost is deemed other than temporary, the unrealized loss must be recognized as a charge to earnings. While the security has the potential to perform very well over the long-term period, management found it difficult to precisely forecast a time period for the security to fully recover.

Securities with significant declines in fair value are evaluated on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under Securities and Exchange Commission Codification Staff Accounting Bulletins, Topic 5: Miscellaneous Accounting – Item M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, which provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer specific factors, the holder must assess whether the impairment is other-than-temporary. SNBV determined, based on their methodology, that a forecasted recovery period could not be precisely predicted for the FHLMC preferred stock and as such determined the loss to be other-than-temporary.

 

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Noninterest Expense

The following table presents the major categories of noninterest expense for the years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005 (in thousands):

 

     2007    2006    Change  

Salaries and benefits

   $ 3,346    $ 2,284    $ 1,062  

Occupancy expenses

     1,086      416      670  

Furniture and equipment expenses

     439      303      136  

Amortization of core deposit intangible

     727      458      269  

Virginia franchise tax expense

     550      211      339  

Data processing expense

     224      171      53  

Telephone and communication expense

     222      176      46  

Other operating expenses

     1,292      599      693  
                      

Total noninterest expense

   $ 7,886    $ 4,618    $ 3,268  
                      
     2006    2005    Change  

Salaries and benefits

   $ 2,284    $ 1,079    $ 1,205  

Occupancy expenses

     416      154      262  

Furniture and equipment expenses

     303      135      168  

Organizational costs

     —        1,212      (1,212 )

Amortization of core deposit intangible

     458      36      422  

Virginia franchise tax expense

     211      —        211  

Data processing expense

     171      16      155  

Telephone and communication expense

     176      104      72  

Other operating expenses

     599      341      258  
                      

Total noninterest expense

   $ 4,618    $ 3,077    $ 1,541  
                      

Despite the rapid growth of the Bank’s assets and the addition of a branch in Warrenton and a loan production office in Richmond, our operating expenses were well controlled. The efficiency ratio declined to 68.81% during 2007 from 74.81% in 2006 and 167.14% in 2005.

Much of the increase of $3.3 million in noninterest expense is attributable to the acquisition of 1st Service Bank in December 2006 and the opening of the Warrenton branch office and the loan production office in Richmond during 2007. As of December 31, 2007 we had 59 full-time equivalent employees compared to 50 at December 31, 2006, following the 1st Service acquisition. At September 30, 2006, we had 32 full-time equivalent employees. We had six branches at year end 2007, compared to two branches a year ago.

Noninterest expense for the year ended December 31, 2006 increased by $1.6 compared to the period from inception at April 14, 2005 through December 31, 2005. Approximately $1.0 million of the increase is attributable to the Clifton Forge acquisition in December 2005. Approximately $118 thousand is attributable to the operation of the three branches acquired in the 1st Service Bank merger in December 2006. Organization expenses were $1.2 million during the period from inception at April 14, 2005 through December 31, 2005, and the fact that this period has fewer business days than the year ended December 31, 2006 makes a comparison of the two periods less meaningful.

FINANCIAL CONDITION

Total assets were $377.3 million as of December 31, 2007, up from $290.6 million as of December 31, 2006. Net loans receivable grew from $201.8 million at the end of 2006 to $257.9 million at the end of 2007. Total securities increased to $75.0 million at December 31, 2007, from $56.5 million at the end of 2006. We also purchased bank-owned life insurance policies in the amount of $12.5 million during 2007.

 

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Total deposits rose from $215.8 million at December 31, 2006, to $265.5 million as of December 31, 2007. The growth was attributable to an increase in brokered certificates of deposit and money market accounts. Brokered certificates of deposit were $101.3 million at December 31, 2007, compared to $78.1 million at December 31, 2006. Brokered money market deposits were $27.2 million at the end of 2007; there were none at December 31, 2006.

Loan Portfolio

Loans, net of unearned income, grew from $204.5 million at the end of 2006 to $261.4 million at the end of 2007. Commercial real estate loans grew 24% from $69.3 million at year end 2006 to $86.1 million at the end of 2007. Non-real estate commercial loans increased 172% from $19.6 million at the end of 2006 to $53.2 million at the end of 2007. Construction and development loans grew 44% from $35.8 million at the end of 2006 to $51.6 million at year end 2007.

Our residential mortgage loan portfolio declined from $63.1 million at December 31, 2006, to $51.9 million at December 31, 2007. Sonabank is not in the business of originating residential mortgages, except as an accommodation to our business banking customers. The vast majority of these loans resulted from our acquisition of 1st Service Bank in December 2006. None of them were sub-prime at origination. They are predominantly 5/1 hybrid adjustable rate mortgages (ARMs).

The balances outstanding in home equity lines of credit and consumer loans both declined in absolute terms as well as in the percentage of the total portfolio. Neither one of these is a business line Sonabank wants to be in except as an accommodation to our business clients.

Our commercial real estate lending program includes both loans closed under the Small Business Administration (“SBA”) 7(a) and 504 loan programs and loans closed outside of the SBA programs that serve both the investor and owner-occupied facility market. The 504 loan program is used to finance long-term fixed assets, primarily real estate and heavy equipment and gives borrowers access to up to 90% financing for a project. SBA 7(a) loans may be used for the purchase of real estate, construction, renovation or leasehold improvements, as well as machinery, equipment, furniture, fixtures, inventory and in some instances, working capital and debt refinancing. The SBA guarantees up to 85% of the loan balance in the 7(a) program, and start-up businesses are eligible to participate in the program. During 2007 we closed loans totaling $9.6 million through the SBA’s 7(a) program and $10.2 million under the SBA’s 504 program. During 2006 we closed loans totaling $3.5 million through the SBA’s 7(a) program and $4.9 million under the SBA’s 504 program.

The following table summarizes the composition of our loans, net of unearned income at the dates indicated:

 

     2007     2006     2005  
     Amount     Percent     Amount     Percent     Amount     Percent  
     (in thousands)  

Mortgage loans on real estate:

            

Commercial

   $ 86,099     32.9 %   $ 69,338     33.8 %   $ 41,644     55.3 %

Construction, land and other loans

     51,561     19.7 %     35,822     17.5 %     15,978     21.2 %

Residential 1-4 family

     51,862     19.8 %     63,141     30.8 %     7,814     10.4 %

Multi- family residential

     8,273     3.2 %     3,720     1.8 %     —       0.0 %

Equity lines of credit

     8,428     3.2 %     10,509     5.1 %     1,125     1.5 %
                                          

Total real estate loans

     206,223     78.8 %     182,530     89.0 %     66,561     88.4 %

Commercial loans

     53,208     20.3 %     19,581     9.6 %     6,720     8.9 %

Consumer loans

     2,476     0.9 %     2,861     1.4 %     2,011     2.7 %
                                          

Gross loans

     261,907     100.0 %     204,972     100.0 %     75,292     100.0 %

Less unearned income on loans

     (500 )       (428 )       (261 )  
                              

Loans, net of unearned income

   $ 261,407       $ 204,544       $ 75,031    
                              

 

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As of December 31, 2007, substantially all of our loans were to customers located in Virginia. We are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations.

The following table sets forth the contractual maturity ranges of the commercial business and construction loan portfolio and the amount of those loans with fixed and floating interest rates in each maturity range as of December 31, 2007 (in thousands):

 

          After 1 Year
Through 5 Years
   After 5 Years     
     One Year
or Less
   Fixed
Rate
   Floating
Rate
   Fixed
Rate
   Floating
Rate
   Total

Real estate construction

   $ 27,600    $ 2,119    $ 19,076    $ 148    $ 2,618    $ 51,561

Commercial and industrial

     24,490      10,325      5,131      2,302      10,960      53,208
                                         

Total

   $ 52,090    $ 12,444    $ 24,207    $ 2,450    $ 13,578    $ 104,769
                                         

Past Due Loans and Non-performing Assets

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 non-performing 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 possible write-down to their net realizable values. We record other real estate owned at the lower of our recorded investment in the loan or fair value less our estimated costs to sell.

Our loss and delinquency experience on our loan portfolio has been limited by a number of factors, including our underwriting standards and the relatively short period of time since the loans were originated. Whether our loss and delinquency experience in the area of our portfolio will increase significantly depends upon the value of the real estate securing loans and economic factors such as the overall economy of the region.

In accordance with Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (SFAS 114) the Bank employs systems and processes necessary to identify and revalue “impaired loans.” After charge-offs, loans identified as impaired in accordance with SFAS 114 totaled $4.2 million as of December 31, 2007 and $7.5 million at December 31, 2006. There were no impaired loans as of December 31, 2005. Interest income recognized during impairment was $292 thousand for 2007 and $80 thousand for 2006. Cash-basis interest income recognized was $282 thousand for 2007 and $46 thousand for 2006. Nonaccrual loans were $371 thousand at December 31, 2007 (two residential mortgage loans), and there were no nonaccrual loans at December 31, 2006 .There were no loans past due 90 days or more and accruing interest at December 31, 2007 and 2006.

Other Real Estate Owned

At December 31, 2007, we had other real estate owned (OREO) in the amount of $3.6 million. The OREO is comprised of the finished lots Sonabank foreclosed on in early 2007 and one single family home.

Allowance for Loan Losses

We are very focused on the asset quality of our loan portfolio, both before and after the loan is made. We have established underwriting standards that have proven to be effective in maintaining high credit quality in our loan portfolio. We have experienced loan officers who take personal responsibility for the loans they underwrite,

 

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a standing credit committee that reviews each loan application carefully, and a requirement that loans that are 60% or more of our legal lending limit must be approved by three executive members of our standing credit committee and an outside director. We have implemented standardized underwriting and credit analysis.

Our allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Management evaluates the allowance at least quarterly. In addition, on a quarterly basis our board of directors reviews our loan portfolio, evaluates credit quality, reviews the loan loss provision and the allowance for loan and lease losses and makes changes as may be required. In evaluating the allowance, management and the Board of directors consider the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels and all other known factors affecting loan collectability.

The allowance for loan losses represents management’s estimate of an amount appropriate to provide for probable losses in the loan portfolio in the normal course of business. We make specific allowances for each loan based on its type and classification as discussed below. However, there are additional factors contributing to losses that cannot be quantified precisely or attributed to particular loans or categories of loans, including general economic and business conditions and credit quality trends. We have established an unallocated portion of the allowance based on our evaluation of these factors, which management believes is prudent and consistent with regulatory requirements. Due the uncertainty of risks in the loan portfolio, management’s judgment of the amount necessary to absorb loan losses is approximate. The allowance is also subject to regulatory examinations and determination by the regulatory agencies as the appropriate level of the allowance.

Our loan review program is conducted by a third party consultant who reports directly to the Audit Committee of the Board of Directors. In 2007 loan review reviewed more than 60% of the non-consumer and non-residential loan portfolio outstanding as of December 31, 2006. In 2008 loan review will review at least 60% of the non-consumer and non-residential loan portfolio outstanding as of December 31, 2007. The purpose of loan review is to validate management’s assessment of risk of the individual loans in the portfolio and to determine whether the loan was approved, underwritten and is being monitored in accordance with the bank’s credit policy and regulatory guidance. Management’s risk assessment of individual loans takes into consideration among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and current payment status.

The following table presents an analysis of the allowance for loan losses for the periods indicated (in thousands):

 

     For the Year Ended
December 31, 2007
    For the Year Ended
December 31, 2006
    For the Period
From Inception at
April 14, 2005
Through
December 31, 2005

Balance, beginning of period

   $ 2,726     $ 1,020     $ —  

Allowance from acquired bank

     —         1,374       —  

Provision charged to operations

     1,290       546       1,020

Recoveries credited to allowance

     —         —         —  
                      

Total

     4,016       2,940       1,020

Loans charged off:

      

Real estate—commercial

     50       —         —  

Real estate—construction, land and other

     400       200       —  

Real estate—residential 1-4 family

     75       —         —  

Consumer

     15       14       —  
                      

Total loans charged off

     540       214       —  
                      

Balance, end of period

   $ 3,476     $ 2,726     $ 1,020
                      

Net charge-offs to average loans, net of unearned income

     0.24 %     0.21 %     —  

 

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The following table describes the allocation of the allowance for loan losses among various categories of loans and certain other information for the dates indicated. The allocation is made for analytical purposes only and is not necessarily indicative of the categories in which future losses may occur.

 

     As of December 31, 2007     As of December 31, 2006     As of December 31, 2005  
     Amount    Percent of
Loans in Each
Category to
Total Loans
    Amount    Percent of
Loans in Each
Category to
Total Loans
    Amount    Percent of
Loans in Each
Category to
Total Loans
 
     (in thousands)  

Commercial

   $ 700    20.3 %   $ 270    9.6 %   $ 75    8.9 %

Consumer

     82    0.9 %     98    1.4 %     21    2.7 %

Real estate—commercial

     1,080    32.9 %     907    33.8 %     120    55.3 %

Real estate—multifamily residential

     104    3.2 %     48    1.8 %     —      —    

Real estate—Construction, land and other

     1,080    19.7 %     927    17.5 %     234    21.2 %

Real estate—residential 1-4 family

     301    23.0 %     394    35.9 %     7    11.9 %

Unallocated

     129    —         82    —         563    —    
                                       

Total

   $ 3,476    100.0 %   $ 2,726    100.0 %   $ 1,020    100.0 %
                                       

Because there are additional risks of losses that cannot be quantified precisely or attributed to particular loans or types of loans, including general economic and business conditions and credit quality trends, we have established an unallocated portion of the allowance for loan losses based on our evaluation of these risks. The unallocated portion of our allowance is determined based on various factors including, but not limited to, general economic conditions of our market area, the growth, composition and diversification of our loan portfolio and types of collateral securing our loans. Due to the relative stability of many of the factors listed above, the unallocated portion of our allowance for loan losses has been somewhat consistent for 2007 and 2006. During 2005, as a de novo bank, we did not have net loss experience of our own so we considered the net loss experience of other commercial banks headquartered in Virginia to determine the unallocated portion of the allowance for loan losses.

We believe that the allowance for loan losses at December 31, 2007 is sufficient to absorb probable credit losses in our loan portfolio based on our assessment of all known factors affecting the collectability of our loan portfolio. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant additions to the allowance for loan losses.

Investment Securities

Our securities portfolio composition is meant to provide a rate-sensitive, stable source of income until we can deploy a large portion of these assets into underwritten loans. Our securities portfolio also provides us with required liquidity and securities to pledge as required collateral for certain governmental deposits and borrowed funds.

Our securities portfolio is managed by our president and our treasurer, both of whom have significant experience in this area, with the concurrence of our Asset/Liability Committee. In addition to our president (who is chairman of the Asset/Liability Committee) and our treasurer, this committee is comprised of two outside directors. Investment management is performed in accordance with our investment policy, which is approved annually by the Asset/Liability Committee and the board of directors. Our investment policy addresses our investment strategies, approval process, approved securities dealers and authorized investments. Our investment policy authorizes us to invest in:

 

   

Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC) mortgage-backed securities (MBS)

 

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Collateralized mortgage obligations

 

   

Treasury securities

 

   

Agency securities

 

   

Pooled trust preferred securities comprised of a minimum of 80% bank collateral with an investment grade rating or a minimum of 60% bank collateral with a AAA rating

 

   

Other corporate debt securities rated Aa3/AA- or better

Mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages and which are principally issued by government sponsored entities (GSE’s) such as the GNMA, FNMA and FHLMC. These securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and interest are guaranteed by the issuing agencies.

Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed securities which are purchased at a premium will generally suffer decreasing net yields as interest rates drop because homeowners tend to refinance their mortgages. Thus, the premium paid must be amortized over a shorter period. Conversely, mortgage-backed securities purchased at a discount will obtain higher net yields in a decreasing interest rate environment. As interest rates rise, the opposite will generally be true. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal, and consequently the average life of these securities will be lengthened. If interest rates begin to fall, prepayments will increase.

Collateralized mortgage obligations (CMOs) are bonds that are backed by pools of mortgages. The pools can be GNMA, FNMA or FHLMC pools or they can be private-label pools. The CMOs are designed so that the mortgage collateral will generate a cash flow sufficient to provide for the timely repayment of the bonds. The mortgage collateral pool can be structured to accommodate various desired bond repayment schedules, provided that the collateral cash flow is adequate to meet scheduled bond payments. This is accomplished by dividing the bonds into classes to which payments on the underlying mortgage pools are allocated. The bond’s cash flow, for example, can be dedicated to one class of bondholders at a time, thereby increasing call protection to bondholders. In private-label CMOs, losses on underlying mortgages are directed to the most junior of all classes and then to the classes above in order of increasing seniority, which means that the senior classes have enough credit protection to be given the highest credit rating by the rating agencies.

We classify our securities as either: “held-to-maturity” or “available-for-sale.” Securities totaling $34.3 million were in the held-to-maturity portfolio at December 31, 2007, compared to $35.6 million at December 31, 2006. Securities totaling $40.7 million were in the available-for-sale portfolio at December 31, 2007, compared to $20.9 million at December 31, 2006. The increase in the investment portfolio during 2007 is the result of the purchase of floating rate pooled trust preferred securities and fixed-rate agency mortgage-backed securities. The purchases were made to replace the securities in our portfolio that were being repaid prior to maturity.

Securities with significant declines in fair value are evaluated on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under Securities and Exchange Commission Codification Staff Accounting Bulletins, Topic 5: Miscellaneous Accounting—Item M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, which provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer specific factors, the holder must assess whether the impairment is other-than-temporary. SNBV determined, based on their methodology, that a forecasted recovery period could not be accurately predicted for the FHLMC preferred stock and as such determined the loss to be other-than-temporary.

SNBV owns 80,000 shares of FHLMC perpetual preferred 5.57% stock Series V. This stock was purchased in April 2007 for $25 a share or a total of $2 million. It is an attractive investment since there is a 70% dividend

 

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exclusion for tax purposes. The stock is owned by hundreds of banks and thrifts. In November and December 2007, FHLMC issued approximately $6 billion in preferred stock with higher yields than the one SNBV owns. The market price on the stock SNBV owns declined to a low of $17.25. By year end it had recovered to $19.50. FHLMC is rated AA3 by Moody’s, AA- by Standard and Poors and A+ by Fitch. It has a U.S. Government mandated minimum capital ratio of 30%. Management recognized a $440 thousand other than temporary loss in the fourth quarter. In accordance with SFAS 115, when a decline in fair value below cost is deemed other than temporary, the unrealized loss must be recognized as a charge to earnings. While the security has the potential to perform very well over the long-term period, management found it difficult to precisely forecast a time period for the security to fully recover.

Unrealized losses on corporate bonds have not been recognized into income because the bonds are of investment-grade quality (rated A- or higher), the bonds continue to perform according to the contractual terms, all interest payments are current, and management has the intent and ability to hold for the foreseeable future. The fair value is expected to recover as the bonds approach maturity.

The following table sets forth a summary of the investment securities available for sale and held to maturity as of the dates indicated (in thousands):

 

     December 31, 2007    December 31, 2006
     Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value

Available for sale:

           

Mortgage-backed securities

   $ 13,053    $ 13,345    $ 8,129    $ 8,129

Collateralized mortgage obligations

     3,834      3,814      5,937      5,900

Corporate bonds

     23,375      22,015      6,853      6,853

FHLMC preferred stock

     1,560      1,560      —        —  
                           
   $ 41,822    $ 40,734    $ 20,919    $ 20,882
                           

Held to maturity:

           

Mortgage-backed securities

   $ 25,329    $ 25,663    $ 21,807    $ 21,599

Collateralized mortgage obligations

     8,938      8,934      13,816      13,732
                           
   $ 34,267    $ 34,597    $ 35,623    $ 35,331
                           

The following table sets forth the amortized cost and estimated fair value of our investment securities by contractual maturity at December 31, 2007. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).

 

     Securities Available for Sale  
     Amortized
Cost
   Estimated
Fair
Value
   Weighted
Average
Yield
 

Mortgage-backed securities:

        

Due after ten years

   $ 13,054    $ 13,345    6.12 %
                

Collateralized mortgage obligations:

        

Due within one year

     1      1    2.64 %

Due after ten years

     3,833      3,813    4.28 %
                

Total collateralized mortgage obligations

     3,834      3,814    4.28 %
                

Corporate bonds:

        

Due after ten years

     23,375      22,015    6.68 %
                

FHLMC preferred stock

     1,560      1,560    7.12 %
                
   $ 41,823    $ 40,734    6.30 %
                

 

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     Securities Held to Maturity  
     Amortized
Cost
   Estimated
Fair
Value
   Weighted
Average
Yield
 

Mortgage-backed securities:

        

Due after ten years

   $ 25,329    $ 25,663    5.46 %
                

Collateralized mortgage obligations:

        

Due after ten years

     8,938      8,934    5.36 %
                
   $ 34,267    $ 34,597    5.43 %
                

Deposits and Other Borrowings

The market for deposits is competitive. We offer a line of traditional deposit products that currently includes non-interest-bearing and interest-bearing checking (or NOW accounts), commercial checking, money market accounts, savings accounts and certificates of deposit. We compete for deposits through our banking branches with competitive pricing, advertising and online banking. We use deposits as a principal source of funding for our lending, purchasing of investment securities and for other business purposes.

Non-interest bearing deposits decreased from $19.2 million at December 31, 2006, to $18.1 million at December 31, 2007.

Interest bearing deposits rose from $196.6 million at December 31, 2006, to $247.4 million as of December 31, 2007. The growth was attributable to an increase in brokered certificates of deposit and money market accounts. Brokered certificates of deposit were $101.3 million at December 31, 2007, compared to $78.1 million at December 31, 2006. Brokered money market deposits were $27.2 million at the end of 2007; there were none at December 31, 2006.

We utilize brokered deposits and will continue to utilize these sources for deposits when they can be cost-effective. At December 31, 2007 and 2006, brokered deposits constituted approximately 48.4% and 36.2% of our total deposits, respectively. The brokered deposits we typically obtain have terms to maturity of three months to two years. These deposits generally have the effect of slightly increasing our cost of funds and slightly decreasing our net interest margin when compared to our local deposit base.

The following table sets forth the average balance and average rate paid on each of the deposit categories for the years ended December 31, 2007 and 2006 and for the period from inception at April 14, 2005 through December 31, 2005:

 

     2007     2006     2005  
     Average
Balance
   Average
Rate
    Average
Balance
   Average
Rate
    Average
Balance
   Average
Rate
 
     (in thousands)  

Noninterest-bearing deposits

   $ 17,698      $ 7,666      $ 2,170   

Interest-bearing deposits:

               

Savings accounts

     2,658    0.45 %     2,406    0.53 %     184    0.51 %

Money market accounts

     40,855    4.19 %     16,772    3.30 %     6,479    3.09 %

NOW accounts

     6,569    0.26 %     5,545    0.25 %     522    0.26 %

Time deposits

     163,531    5.19 %     75,341    5.08 %     7,504    4.16 %
                           

Total interest-bearing deposits

     213,613    4.79 %     100,064    4.40 %     14,689    3.50 %
                           

Total deposits

   $ 231,311      $ 107,730      $ 16,859   
                           

 

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The following table sets forth the maturities of certificates of deposit of $100 thousand and over as of December 31, 2007 (in thousands):

 

Within 3 Months      3 to 6 Months        6 to 12 Months        Over 12 Months        Total  
$ 8,467    $ 8,977    $ 11,597    $ 9,882    $ 38,923

The variety of deposit accounts we offered has allowed us to be competitive in obtaining funds and in responding to the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and maintain deposits, and the effect of such retention on our cost of funds, has been, and will continue to be, significantly affected by the general economy and market rates of interest.

We use borrowed funds, primarily on a short term basis, to support our liquidity needs and to temporarily satisfy our funding needs from increased loan demand and for other shorter term purposes. One source of these borrowed funds is securities sold under agreements to repurchase, which are reflected at the amount of cash received in connection with the transactions, and may require additional collateral based on the fair value of the underlying securities pledged. We engage in these transactions with retail customers and with established third parties, primarily large securities brokerage firms. We also are a member of the FHLB and are authorized to obtain advances from the FHLB from time to time to as needed. The FHLB has a credit program for members with different maturities and interest rates, which may be fixed or variable. We are required to collateralize our borrowings from the FHLB with our FHLB stock and other collateral acceptable to the FHLB. At December 31, 2007 and 2006, total borrowed funds were $40.5 million and $5.0 million, respectively. At December 31, 2007, we had $36.8 million of unused and available FHLB lines of credit.

Interest Rate Sensitivity and 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 borrowing. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-earning assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. We have employed asset/liability management policies that seek to manage our interest income, without having to incur unacceptable levels of credit or investment risk.

We use a duration gap of equity approach to manage our interest rate risk, and we review quarterly interest sensitivity reports prepared for us by FTN Financial using the Sendero ALM Analysis System. This approach uses a model which generates estimates of the change in our market value of portfolio equity (MVPE) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using standard industry assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

 

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The following tables are based on an analysis prepared by FTN Financial setting forth an analysis of our interest rate risk as measured by the estimated change in MVPE resulting from instantaneous and sustained parallel shifts in the yield curve (plus or minus 300 basis points, measured in 100 basis point increments) as of December 31, 2007 and 2006:

 

     Sensitivity of Market Value of Portfolio Equity
As of December 31, 2007
 
     Market Value of Portfolio Equity     Market Value of
  Portfolio Equity as a % of  
 

Change in Interest Rates in Basis Points (Rate Shock)

   Amount    $ Change
From Base
    % Change
From Base
    Total Assets     Portfolio
Equity
Book Value
 
     (Dollar amounts in thousands)  

Up 300

   $ 77,007    $ 2,366     3.17 %   20.41 %   111.16 %

Up 200

     76,473      1,832     2.45 %   20.27 %   110.39 %

Up 100

     75,713      1,072     1.44 %   20.07 %   109.29 %

Base

     74,641      —       0.00 %   19.78 %   107.75 %

Down 100

     72,501      (2,140 )   -2.87 %   19.22 %   104.66 %

Down 200

     69,495      (5,146 )   -6.89 %   18.42 %   100.32 %

Down 300

     66,479      (8,162 )   -10.94 %   17.62 %   95.96 %
     Sensitivity of Market Value of Portfolio Equity
As of December 31, 2006
 
     Market Value of Portfolio Equity     Market Value of
  Portfolio Equity as a % of  
 

Change in Interest Rates in Basis Points (Rate Shock)

   Amount    $ Change
From Base
    % Change
From Base
    Total Assets     Portfolio
Equity
Book Value
 
     (Dollar amounts in thousands)  

Up 300

   $ 72,383    $ (641 )   -0.86 %   24.91 %   106.09 %

Up 200

     72,810      (214 )   -0.29 %   25.06 %   106.72 %

Up 100

     73,021      (3 )   0.00 %   25.13 %   107.03 %

Base

     73,024      —       0.00 %   25.13 %   107.03 %

Down 100

     72,542      (482 )   -0.65 %   24.97 %   106.32 %

Down 200

     71,475      (1,549 )   -2.08 %   24.60 %   104.76 %

Down 300

     70,112      (2,912 )   -3.90 %   24.13 %   102.76 %

Our interest rate sensitivity is also monitored by management through the use of a model run by FTN Financial that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. In this regard, the model assumes that the composition of our interest sensitive assets and liabilities existing at December 31, 2007 and December 31, 2006 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.

 

     Sensitivity of Net Interest Income
As of December 31, 2007
 
       Adjusted Net Interest Income       Net Interest Margin  

Change in Interest Rates in Basis Points (Rate Shock)

   Amount    $ Change
From Base
    Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 12,733    $ 2,675     3.67 %   0.76 %

Up 200

     11,859      1,801     3.42 %   0.51 %

Up 100

     10,971      913     3.17 %   0.26 %

Base

     10,058      —       2.91 %   0.00 %

Down 100

     8,980      (1,078 )   2.60 %   -0.31 %

Down 200

     7,780      (2,278 )   2.26 %   -0.65 %

Down 300

     6,574      (3,484 )   1.91 %   -1.00 %

 

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     Sensitivity of Net Interest Income
As of December 31, 2006
 
       Adjusted Net Interest Income       Net Interest Margin  

Change in Interest Rates in Basis Points (Rate Shock)

   Amount    $ Change
From Base
    Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 12,409    $ 1,492     4.56 %   0.54 %

Up 200

     11,918      1,001     4.38 %   0.36 %

Up 100

     11,429      512     4.21 %   0.19 %

Base

     10,917      —       4.02 %   0.00 %

Down 100

     10,318      (599 )   3.80 %   -0.22 %

Down 200

     9,586      (1,331 )   3.54 %   -0.48 %

Down 300

     8,917      (2,000 )   3.29 %   -0.73 %

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in MVPE requires the making of certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Accordingly, although the MVPE tables and Sensitivity of Net Interest Income tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net worth and net interest income.

Liquidity and Funds Management

The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity and the ability to fund commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. As a result, we have sought funding from additional sources, including institutional certificates of deposit and available-for-sale investment securities. In addition, we maintain lines of credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.

We prepare a monthly cash flow report which forecasts weekly cash needs and availability for the coming three months, based on forecasts of loan closings from our pipeline report and other factors.

During the year ended December 31, 2007, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At December 31, 2007, we had $54.5 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $10.8 million at December 31, 2007. The amount of certificate of deposit accounts maturing in 2008 is $142.9 million as of December 31, 2007. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.

Capital Resources

Capital management consists of providing equity to support both current and future operations. We are subject to capital adequacy requirements imposed by the Federal Reserve and the Bank is subject to capital adequacy requirements imposed by the OCC. The Federal Reserve and the OCC have adopted risk-based capital requirements for assessing bank holding company and member bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profiles among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance

 

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sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

The risk-based capital standards issued by the Federal Reserve require all bank holding companies to have “Tier 1 capital” of at least 4.0% and “total risk-based” capital (Tier 1 and Tier 2) of at least 8.0% of total risk-adjusted assets. “Tier 1 capital” generally includes common stockholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings, less deductions for goodwill and various other intangibles. “Tier 2 capital” may consist of a limited amount of intermediate-term preferred stock, a limited amount of term subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock not qualifying as Tier 1 capital, and a limited amount of the general valuation allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.”

The Federal Reserve has also adopted guidelines which supplement the risk-based capital guidelines with a minimum ratio of Tier 1 capital to average total consolidated assets, or “leverage ratio,” of 3.0% for institutions with well diversified risk, including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings; and that are generally considered to be strong banking organizations, rated composite 1 under applicable federal guidelines, and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4.0%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets.

Under the Federal Deposit Insurance Corporation Improvement Act of 1991, each federal banking agency revised its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. As a national bank, the bank is subject to capital adequacy guidelines of the OCC. Also under that statute, the Federal Deposit Insurance Corporation has promulgated regulations setting the levels at which an insured institution such as the bank would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” The bank is classified “well capitalized” for purposes of the FDIC’s prompt corrective action regulations. See “Supervision and Regulation—Capital Requirements.”

The following table provides a comparison of our leverage and risk-weighted capital ratios and the leverage and risk-weighted capital ratios of the bank at the periods indicated to the minimum and well-capitalized regulatory standards:

 

     Minimum
Required for
Capital
Adequacy

Purposes
    To Be Categorized
as Well Capitalized
Under Prompt
Corrective

Action Provisions
    Actual Ratio at
December 31,
 
         2007     2006  

SNBV

        

Tier 1 risk-based capital ratio

   4.00 %   N/A     18.50 %   24.69 %

Total risk-based capital ratio

   8.00 %   N/A     19.63 %   25.94 %

Leverage ratio

   4.00 %   N/A     16.03 %   28.46 %

Sonabank

        

Tier 1 risk-based capital ratio

   4.00 %   6.00 %   17.71 %   23.53 %

Total risk-based capital ratio

   8.00 %   10.00 %   18.84 %   24.78 %

Leverage ratio

   4.00 %   5.00 %   15.35 %   27.13 %

Impact of Inflation and Changing Prices

The financial statements and related financial data presented in this prospectus concerning SNBV have been prepared in accordance with accounting principles generally accepted in the United States of America, which

 

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require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant impact on our performance than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.

Our interest rate risk management is the responsibility of Sonabank’s Asset/Liability Management Committee (the Asset/Liability Committee). The Asset/Liability Committee has established policies and limits for management to monitor, measure and coordinate our sources, uses and pricing of funds. The Asset/Liability Committee makes reports to the board of directors on a quarterly basis.

Seasonality and Cycles

We do not consider our commercial banking business to be seasonal.

Contractual Obligations

The following table reflects the contractual maturities of our term liabilities as of December 31, 2007. The amounts shown do not reflect any early withdrawal or prepayment assumptions.

 

     Contractual Obligations
As of December 31, 2007
     Less Than
One Year
   One to
Three Years
   Three to
Five Years
   More Than
Five Years
   Total
     ( in thousands)

Certificates of deposit (1)

   $ 142,925    $ 33,967    $ 3,355    $ —      $ 180,247

Securities sold under agreements to repurchase

     10,001      —        —        —        10,001

FHLB overnight advances

     5,500      —        —        —        5,500

FHLB long-term advances

     —        —        25,000      —        25,000

Operating leases

     691      1,325      1,246      1,927      5,189
                                  

Total

   $ 159,117    $ 35,292    $ 29,601    $ 1,927    $ 225,937
                                  

 

(1) Certificates of deposit give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal.

Off-Balance Sheet Arrangements

SNBV is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit written are conditional commitments issued by SNBV to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $1.2 million and $477 thousand as of December 31, 2007 and 2006, respectively.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk.

 

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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 generally have fixed expiration dates or other termination clauses and may 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 December 31, 2007 and 2006, we had unfunded loan commitments approximating $65.3 million and $54.6 million, respectively.

Item 7A.—Quantitative and Qualitative Disclosures About Market Risk

This information is incorporated herein by reference from Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, on pages 40 through 42 of this Form 10-K.

 

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Item 8.—Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

Shareholders and Board of Directors

Southern National Bancorp of Virginia, Inc.

Charlottesville, Virginia

We have audited the accompanying balance sheet of Southern National Bancorp of Virginia, Inc. as of December 31, 2007 and the related statements of income, changes in stockholders’ equity, and cash flows for the year ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007, and the results of its operations and its cash flows for the year ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

 

LOGO

Crowe Chizek and Company LLC

Louisville, Kentucky

March 7, 2008

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Southern National Bancorp of Virginia, Inc.

Charlottesville, Virginia

We have audited the accompanying consolidated balance sheet of Southern National Bancorp of Virginia, Inc. and subsidiary as of December 31, 2006 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2006 and the period from inception (April 14, 2005) through December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southern National Bancorp of Virginia, Inc. and subsidiary at December 31, 2006, and the results of its operations and its cash flows for the year ended December 31, 2006 and the period from inception (April 14, 2005) through December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

LOGO

BDO Seidman, LLP

Richmond, Virginia

February 23, 2007

 

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Table of Contents

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

     December 31,
2007
    December 31,
2006
 

ASSETS

    

Cash and cash equivalents:

    

Cash and due from financial institutions

   $ 1,299     $ 3,306  

Interest-bearing deposits in other financial institutions

     9       4,820  
                

Total cash and cash equivalents

     1,308       8,126  
                

Securities available for sale, at fair value

     40,734       20,882  
                

Securities held to maturity, at amortized cost (fair value of $34,597 and $35,331, respectively)

     34,267       35,623  
                

Loans, net of unearned income

     261,407       204,544  

Less allowance for loan losses

     (3,476 )     (2,726 )
                

Net loans

     257,931       201,818  
                

Stock in Federal Reserve Bank and Federal Home Loan Bank

     3,908       2,446  

Bank premises and equipment, net

     3,496       3,499  

Goodwill

     8,713       10,423  

Core deposit intangibles, net

     3,867       4,594  

Bank-owned life insurance

     12,847       —    

Other real estate owned

     3,648       —    

Deferred tax assets, net

     3,292       12  

Other assets

     3,272       3,151  
                

Total assets

   $ 377,283     $ 290,574  
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Noninterest-bearing demand deposits

   $ 18,097     $ 19,216  

Interest-bearing deposits:

    

NOW accounts

     7,259       9,639  

Money market accounts

     57,466       32,567  

Savings accounts

     2,400       2,853  

Time deposits

     180,247       151,529  
                

Total interest-bearing deposits

     247,372       196,588  
                

Total deposits

     265,469       215,804  
                

Other borrowings

     15,501       5,033  

Federal Home Loan Bank (FHLB) advances

     25,000       —    

Other liabilities

     2,038       1,510  
                

Total liabilities

     308,008       222,347  
                

Commitments and contingencies (see note 15)

     —         —    

Stockholders’ equity:

    

Common stock, $.01 par value. Authorized 45,000,000 shares; issued and outstanding, 6,798,547 shares at December 31, 2007 and December 31, 2006

     68       62  

Additional paid in capital

     69,436       69,436  

Retained earnings (accumulated deficit)

     489       (1,247 )

Accumulated other comprehensive loss

     (718 )     (24 )
                

Total stockholders’ equity

     69,275       68,227  
                

Total liabilities and stockholders’ equity

   $ 377,283     $ 290,574  
                

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share amounts)

 

     For the Year Ended    For the Period
From Inception
at April 14, 2005
Through
December 31, 2005
 
     December 31,
2007
    December 31,
2006
  

Interest and dividend income :

       

Interest and fees on loans

   $ 17,892     $ 8,465    $ 1,534  

Interest and dividends on taxable securities

     3,552       2,073      621  

Interest and dividends on other earning assets

     305       246      240  
                       

Total interest and dividend income

     21,749       10,784      2,395  
                       

Interest expense:

       

Interest on deposits

     10,230       4,406      514  

Interest on borrowings

     856       454      91  
                       

Total interest expense

     11,086       4,860      605  
                       

Net interest income

     10,663       5,924      1,790  
                       

Provision for loan losses

     1,290       546      1,020  
                       

Net interest income after provision for loan losses

     9,373       5,378      770  
                       

Noninterest income:

       

Account maintenance and deposit service fees

     338       188      27  

Income from bank-owned life insurance

     347       —        —    

Loss on securities

     (440 )     —        —    

Other

     112       61      24  
                       

Total noninterest income

     357       249      51  
                       

Noninterest expenses:

       

Salaries and benefits

     3,346       2,284      1,079  

Occupancy expenses

     1,086       416      154  

Furniture and equipment expenses

     439       303      135  

Organizational costs

     —         —        1,212  

Amortization of core deposit intangible

     727       458      36  

Virginia franchise tax expense

     550       211      —    

Data processing expense

     224       171      16  

Telephone and communication expense

     222       176      104  

Other operating expenses

     1,292       599      341  
                       

Total noninterest expenses

     7,886       4,618      3,077  
                       

Income (loss) before income taxes

     1,844       1,009      (2,256 )

Income tax expense

     108       —        —    
                       

Net income (loss)

   $ 1,736     $ 1,009    $ (2,256 )
                       

Earnings (loss) per share, basic

   $ 0.26     $ 0.24    $ (0.59 )
                       

Earnings (loss) per share, diluted

   $ 0.25     $ 0.23    $ (0.59 )
                       

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006 AND

FOR THE PERIOD FROM INCEPTION AT APRIL 14, 2005 THROUGH DECEMBER 31, 2005

(dollars in thousands)

 

    Common
Stock
  Additional
Paid in
Capital
    Retained
Earnings
(Accumulated
Deficit)
    Accumulated
Other
Comprehensive
Loss
    Comprehensive
Income (Loss)
    Total  

Balance—April 14, 2005

  $ —     $ —       $ —       $ —         $ —    

Comprehensive loss:

           

Net loss

        (2,256 )     $ (2,256 )     (2,256 )

Change in unrealized gain (loss) on available for sale securities (net of tax, $2)

          (3 )     (3 )     (3 )
                 

Total comprehensive loss

          $ (2,259 )  
                 

Issuance of common stock (3,500,000 shares), net

    35     34,537             34,572  
                                       

Balance—December 31, 2005

    35     34,537       (2,256 )     (3 )       32,313  

Comprehensive income:

           

Net income

        1,009       $ 1,009       1,009  

Change in unrealized gain (loss) on available for sale securities (net of tax, $10)

          (21 )     (21 )     (21 )
                 

Total comprehensive income

          $ 988    
                 

Issuance of common stock (2,000,000 shares), net

    20     26,400             26,420  

Issuance of common stock in exchange for net assets in acquisition (680,449 shares)

    7     8,499             8,506  
                                       

Balance—December 31, 2006

    62     69,436       (1,247 )     (24 )       68,227  

Comprehensive income:

           

Net income

        1,736       $ 1,736       1,736  
                 

Change in unrealized gain (loss) on available for sale securities (net of tax, $358)

          (694 )     (694 )     (694 )
                 

Total comprehensive income

          $ 1,042    
                 

Stock-based compensation expense

      6             6  

Issuance of common stock for stock dividend

    6     (6 )           —    
                                       

Balance—December 31, 2007

  $ 68   $ 69,436     $ 489     $ (718 )     $ 69,275  
                                       

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

     For the Year Ended     For the Period
From Inception
at April 14, 2005
Through
December 31, 2005
 
     December 31,
2007
    December 31,
2006
   

Operating activities:

      

Net income (loss)

   $ 1,736     $ 1,009     $ (2,256 )

Adjustments to reconcile net income (loss) to net cash and cash equivalents provided (used) in operating activities:

      

Depreciation

     456       306       113  

Amortization , net

     559       461       (2 )

Provision for loan losses

     1,290       546       1,020  

Income on bank-owned life insurance

     (347 )     —         —    

Stock option expense

     6       —         —    

Loss on securities

     440       —         —    

Gain on sale of other real estate owned

     (21 )     —         —    

Net (increase) decrease in other assets

     (1,374 )     121       (760 )

Net increase (decrease) in other liabilities

     725       (1,740 )     926  
                        

Net cash and cash equivalents provided (used) by operating activities

     3,470       703       (959 )
                        

Investing activities:

      

Purchases of securities available for sale

     (26,135 )     (7,588 )     (7,835 )

Proceeds from paydowns of securities available for sale

     4,951       2,033       669  

Purchases of securities held to maturity

     (9,471 )     (1,967 )     (33,697 )

Proceeds from paydowns of securities held to maturity

     10,982       6,405       2,000  

Net increase in loans

     (61,653 )     (37,764 )     (67,941 )

Purchase of bank-owned life insurance

     (12,500 )     —         —    

Cash received in branch acquisition

     —         —         32,464  

Net cash paid in bank acquisition

     —         (863 )     —    

Net (increase) decrease in stock in Federal Reserve Bank and Federal Home Loan Bank

     (1,462 )     654       (1,088 )

Proceeds from sale of other real estate owned

     320       —         —    

Purchases of bank premises and equipment

     (453 )     (132 )     (1,302 )
                        

Net cash and cash equivalents used in investing activities

     (95,421 )     (39,222 )     (76,730 )
                        

Financing activities:

      

Net increase in deposits

     49,665       59,615       34,798  

Proceeds from Federal Home Loan Bank convertible advances

     25,000       —         —    

Net increase (decrease) in other borrowings

     10,468       (41,053 )     9,982  

Issuance of common stock, net of issuance costs

     —         26,420       34,572  
                        

Net cash and cash equivalents provided by financing activities

     85,133       44,982       79,352  
                        

Increase (decrease) in cash and cash equivalents

     (6,818 )     6,463       1,663  

Cash and cash equivalents at beginning of period

     8,126       1,663       —    
                        

Cash and cash equivalents at end of period

   $ 1,308     $ 8,126     $ 1,663  
                        

Supplemental Disclosure of Cash Flow Information

      

Cash payments for:

      

Interest

   $ 10,485     $ 4,394     $ 419  

Income taxes

     1,154       —         —    

Supplemental schedule of noncash investing and financing activities

      

Transfer from loans to other real estate owned

   $ 4,251     $ —       $ —    

Transfer from deferred tax valuation allowance to goodwill

     1,945       —         —    

Securitization of residential mortgage loans

     —         17,045       —    

Issuance of common stock in exchange for net assets in acquisition

     —         8,506       —    

See accompanying notes to consolidated financial statements.

 

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1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank, N. A. (“Sonabank”) a national bank chartered on April 14, 2005, under the laws of the United States of America. The principal activities of Sonabank are to attract deposits and originate loans as permitted for federally chartered national banks under the laws of the United States of America. Sonabank conducts full-service banking operations in Charlottesville, Clifton Forge, and Fairfax County in Virginia.

The accounting policies and practices of SNBV and subsidiary conform to U. S. generally accepted accounting principles and to general practice within the banking industry. Major policies and practices are described below:

Principles of Consolidation

The consolidated financial statements include the accounts of SNBV and its wholly owned subsidiary. SNBV is a bank holding company that owns all of the outstanding common stock of its banking subsidiary, Sonabank, N. A. All material intercompany balances and transactions have been eliminated in consolidation.

Investment Securities

Debt securities that SNBV has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost.

Securities classified as available for sale are those debt and equity securities that may be sold in response to changes in interest rates, liquidity needs or other similar factors. Securities available for sale are reported at fair value, with unrealized gains or losses net of deferred taxes, included in accumulated other comprehensive income (loss) in stockholders’ equity.

Purchased premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

SNBV purchases amortizing investment securities in which the underlying assets are residential mortgage loans subject to prepayments. The actual principal reduction on these assets varies from the expected contractual principal reduction due to principal prepayments resulting from the borrowers’ election to refinance the underlying mortgage based on market and other conditions. The purchase premiums and discounts associated with these assets are amortized or accreted to interest income over the estimated life of the related assets. The estimated life is calculated by projecting future prepayments and the resulting principal cash flows until maturity. Prepayment rate projections utilize actual prepayment speed experience and available market information on like-kind instruments. The prepayment rates form the basis for income recognition of premiums and discounts on the related assets. Changes in prepayment estimates may cause the earnings recognized on these assets to vary over the term that the assets are held, creating volatility in the net interest margin. Prepayment rate assumptions are monitored and updated monthly to reflect actual activity and the most recent market projections.

Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of SNBV to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

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Loans

SNBV grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by non-residential mortgage loans throughout its market area. The ability of SNBV’s debtors to honor their contracts is in varying degrees dependent upon the real estate market conditions and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method without anticipating prepayments.

The accrual of interest on all loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal and interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan and Lease Losses (ALLL)

The allowance for loan losses is a valuation allowance for probable incurred losses. Loan losses are charged against the allowance when management believes the collection of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on historical loss experience adjusted for current industry and economic conditions and estimates of their affect on loan collectability. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values.

A loan is considered impaired when, based on current information and events, it is probable that SNBV will be unable to collect the scheduled payments of principal or interest when due according to the terms of the loan documentation. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Individual consumer and residential loans are evaluated for impairment based on regulatory guidelines.

Servicing Rights

Servicing rights were acquired in connection with the acquisition of 1st Service Bank in December 2006, and were recorded at fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in

 

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estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. SNBV compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If SNBV later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported with other noninterest income on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Servicing fee income which is reported on the income statement as other noninterest income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Net servicing fee income totaled $26 thousand and $3 thousand for the years ended December 31, 2007 and 2006. There was no net servicing fee income in 2005. Late fees and ancillary fees related to loan servicing are not material.

Bank Premises and Equipment

Bank premises and equipment are carried at cost less accumulated depreciation and amortization, and land is carried at cost. Depreciation and amortization are computed using the straight-line method. It is the policy of SNBV to capitalize additions and improvements and to depreciate the cost thereof over their estimated useful lives ranging from 3 to 30 years. Maintenance and repairs are expensed as they are incurred.

Goodwill and Intangible Assets

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified.

Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized over their estimated useful lives, which range from 7 to 10 years.

Bank-owned Life Insurance

SNBV has purchased life insurance policies on certain key executives. Upon adoption of EITF 06-5, which is discussed further below, bank-owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance){Issue}. This Issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based

 

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on the assumption that policies will be surrendered on an individual basis. Lastly, the Issue requires disclosure when there are contractual restrictions on the Company’s ability to surrender a policy. The adoption of EITF 06-5 on January 1, 2007 had no impact on the Company’s financial condition or results of operation, as SNBV owned no life insurance prior to 2007.

Foreclosed Assets

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Foreclosed assets of $3.6 million are included in other assets as of December 31, 2007. No foreclosed assets were owned at December 31, 2006.

Federal Home Loan Bank (FHLB) Stock

The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

Long-term Assets

Premises and equipment, core deposit intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Retirement Plans

Employee 401(k) plan expense is the amount of matching contributions. Deferred compensation plan expense allocates the benefits over years of service.

Loss Contingencies

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.

Equity

Stock dividends in excess of 20% are reported by transferring the par value of the stock issued from retained earnings to common stock. Stock dividends for 20% or less are reported by transferring the fair value, as of the ex-dividend date, of the stock issued from retained earnings to common stock and additional paid-in capital. Stock dividends for 20% or less are reported by transferring the par amount from additional paid in capital to common stock when there is an accumulated deficit. Fractional share amounts are paid in cash with a reduction in retained earnings.

Dividend Restriction

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders.

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant

 

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judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Operating Segments

While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a company-wide basis. Discrete financial information is not available other than on a company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

Reclassifications

Some items in the prior year financial statements were reclassified to conform to the current presentation.

Income Taxes

Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of the net operating losses carryforward and allowance for loan losses. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Until the second quarter of 2007, SNBV maintained a valuation allowance against its deferred tax assets. During the second quarter of 2007, the valuation allowance on the net deferred tax assets was no longer necessary given the sustained income and growth over the past six calendar quarters. The tax valuation allowance reversal was $2.5 million, of which $1.9 million was related to the net deferred tax assets obtained in the 1st Service Bank acquisition.

SNBV adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. The adoption of FIN 48 had no effect on our consolidated financial statements.

Consolidated Statements of Cash Flows

For purposes of reporting cash flows, SNBV defines cash and cash equivalents as cash due from banks and interest-bearing deposits in other banks with maturities less than 90 days. Net cash flows are reported for customer loan and deposit transactions and short-term borrowings.

Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the year. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by SNBV relate solely to outstanding stock options and warrants and are determined using the treasury stock method. Earnings per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

 

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Comprehensive Income (Loss)

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as a separate component of equity.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of goodwill and intangible assets, mortgage servicing rights, foreclosed real estate and deferred tax assets.

Off Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, SNBV has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded when they are funded.

Stock Compensation Plan

SNBV accounts for the plan under the fair value method of FASB Statement No 123 Revised (“SFAS 123R”), “Share Based Payment,” which was adopted January 1, 2006. In 2005 the plan was measured under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Prior to 2006, employee compensation expense under stock options was reported using the intrinsic value method. No stock-based compensation cost was reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. In addition, all options granted prior to 2006 were fully vested as of December 31, 2005, and no options were granted during 2006. Therefore, in 2006, no share-based compensation expense was recognized for the outstanding options. The following table details the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123R to stock-based compensation during the period from inception at April 14, 2005 through December 31, 2005:

 

(dollars in thousands except per share data)    For the Period
From Inception
at April 14, 2005
Through
December 31, 2005
 

Net loss, as reported

   $ (2,256 )

Total stock-based compensation expense determined under fair value based method for all awards

     (619 )
        

Pro forma net loss

   $ (2,875 )
        

Loss per share:

  

Basic—as reported

   $ (0.59 )
        

Basic—pro forma

   $ (0.75 )
        

Diluted—as reported

   $ (0.59 )
        

Diluted—pro forma

   $ (0.75 )
        

Recent Accounting Pronouncements

In September 2006 the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS No. 157), which defines fair value, establishes a framework for measuring fair value under U. S. generally accepted accounting

 

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principles (“GAAP”), and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but the application of this Statement may change current practice. Adoption is required as of the beginning of the first fiscal year that begins after November 15, 2007. We are assessing the effect that SFAS No. 157 will have on our consolidated financial statements.

In September 2006, the FASB Emerging Issues Task Force (“EITF”) finalized Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. We have not completed our evaluation of the impact of the adoption of this standard.

In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”) which provides companies with an option to report selected financial assets and liabilities at fair value. This statement requires companies to display on the face of the balance sheet the fair value of those assets and liabilities for which they have chosen to use fair value. SFAS 159 also requires companies to provide additional information that will help investors and other users of financial statements to easily understand the effect on earnings of the choice to use fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. This statement is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Adopting SFAS No. 159 will not have a material impact on our consolidated financial statements.

On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). Previously, SAB 105, Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. SNBV does not expect the impact of this standard to be material.

Branch Acquisition

On December 2, 2005, Sonabank completed its acquisition of a branch office located in Clifton Forge, Virginia from First Community Bank, N. A. Cash in the amount of $32.5 million was received in the acquisition. Sonabank acquired $42.5 million in deposits, $7.1 million in loans, and $2.4 million in retail reverse repurchase agreements. The branch banking center and other assets were also purchased in the amount of $2.2 million. As part of the purchase price allocation, Sonabank recorded $3.1 million in core deposit intangibles. The core deposit intangible assets are being amortized over 7 years.

Business Combination

As of the close of business on December 1, 2006, SNBV completed its acquisition of 1st Service Bank, which operated three branch offices in Fairfax County, Virginia. This acquisition was accounted for using the purchase method of accounting. The total consideration paid to 1st Service stockholders was approximately $13.2 million consisting of $4.7 million in cash and 680,449 shares of SNBV’s common stock. 1st Service Bank transactions have been included in our financial results since December 1, 2006. We recorded $2.1 million in core deposit intangibles, and goodwill totaled approximately $10.4 million (including costs of approximately

 

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$300 thousand). The goodwill is not deductible for federal income tax purposes. The core deposit intangible asset for this acquisition is being amortized over 7 and 15 years for financial reporting and income tax purposes, respectively. A summary of the transaction follows (in thousands):

 

Total purchase price

   $ 13,508

Fair value of assets acquired

  

Loans

     107,080

Investment securities

     2,011

Other assets

     6,863

Core deposit intangible

     2,061
      

Total assets acquired

     118,015
      

Fair value of liabilities assumed:

  

Noninterest-bearing deposits

     11,609

Interest-bearing deposits

     67,317

Borrowings

     33,680

Other liabilities

     2,324
      

Total liabilities assumed

     114,930
      

Goodwill

   $ 10,423
      

During 2007, the deferred tax asset valuation allowance reversal of $1.9 million related to the net deferred tax assets obtained in the 1st Service Bank acquisition was recognized as an adjustment to goodwill, and the beginning fair value of acquired loan servicing rights was adjusted in the amount of $177 thousand. Other adjustments to goodwill were made during the allocation period in 2007 in the amount of $58 thousand. As of December 31, 2007, the amount of goodwill is $8.7 million.

 

2. SECURITIES

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):

 

      Fair
Value
   Gross Unrealized  
         Gains    Losses  

December 31, 2007

        

Mortgage-backed securities

   $ 13,345    $ 292    $ —    

Collateralized mortgage obligations

     3,814      —        (20 )

Corporate Bonds

     22,015      —        (1,360 )
                      

Total debt securities

     39,174      292      (1,380 )

FHLMC preferred stock

     1,560      —        —    
                      

Total

   $ 40,734    $ 292    $ (1,380 )
                      
      Fair
Value
   Gross Unrealized  
          Gains      Losses   

December 31, 2006

        

Mortgage-backed securities

   $ 8,129    $ —      $ —    

Collateralized mortgage obligations

     5,900      —        (37 )

Corporate Bonds

     6,853      —        —    
                      

Total

   $ 20,882    $ —      $ (37 )
                      

 

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The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows (in thousands):

 

     Carrying
Amount
   Gross Unrecognized     Fair
Value
         Gains    Losses    

December 31, 2007

          

Mortgage-backed securities

   $ 25,329    $ 353    $ (19 )   $ 25,663

Collateralized mortgage obligations

     8,938      15      (19 )     8,934
                            
   $ 34,267    $ 368    $ (38 )   $ 34,597
                            
     Carrying
Amount
   Gross Unrecognized     Fair
Value
         Gains    Losses    

December 31, 2006

          

Mortgage-backed securities

   $ 21,807    $ —      $ (208 )   $ 21,599

Collateralized mortgage obligations

     13,816      7      (91 )     13,732
                            
   $ 35,623    $ 7    $ (299 )   $ 35,331
                            

The fair value of debt securities and carrying amount, if different, at year end 2007 by contractual maturity were as follows (in thousands). Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.

 

     Held to Maturity    Available
for Sale
     Carrying
Amount
   Fair
Value
   Fair
Value

Due after ten years

   $ —      $ —      $ 22,015

Mortgage-backed securities

     25,329      25,663      13,345

Collateralized mortgage obligations

     8,938      8,934      3,814
                    

Total

   $ 34,267    $ 34,597    $ 39,174
                    

Securities with a carrying amount of approximately $45.2 million and $25.7 million at December 31, 2007 and 2006, respectively, were pledged to secure public deposits, repurchase agreements and a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

There were no sales of securities during the years ended December 31, 2007 and 2006 and the period from April 14, 2005 through December 31, 2005.

 

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SNBV monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. There are 16 securities totaling approximately $34.1 million in the portfolio that are considered temporarily impaired at December 31, 2007. Management has concluded that these losses are not individually significant, or in the aggregate; the fair value is expected to recover as the securities approach their maturity date and/or market conditions improve, and management has the positive intent and ability to hold to recovery. The following tables present information regarding securities in a continuous unrealized loss position as of December 31, 2007 and December 31, 2006 (in thousands) by duration of time in a loss position:

 

    Less than 12 months     12 Months or More     Total  
    Fair
value
  Unrealized
Losses
    Fair
value
  Unrealized
Losses
    Fair
value
  Unrealized
Losses
 

December 31, 2007

           

Mortgage-backed securities

  $ 2,597   $ (9 )   $ 2,805   $ (10 )   $ 5,402   $ (19 )

Collateralized mortgage obligations

    —       —         6,713     (39 )     6,713     (39 )

Corporate bonds

    22,015     (1,360 )     —       —         22,015     (1,360 )
                                         
  $ 24,612   $ (1,369 )   $ 9,518   $ (49 )   $ 34,130   $ (1,418 )
                                         
    Less than 12 months     More than 12 months     Total  
    Fair
value
  Unrealized
Losses
    Fair
value
  Unrealized
Losses
    Fair
value
  Unrealized
Losses
 

December 31, 2006

           

Mortgage-backed securities

  $ 2,113   $ (21 )   $ 11,124   $ (187 )   $ 13,237   $ (208 )

Collateralized mortgage obligations

    3,544     (40 )     14,226     (88 )     17,770     (128 )
                                         
  $ 5,657   $ (61 )   $ 25,350   $ (275 )   $ 31,007   $ (336 )
                                         

SNBV owns 80,000 shares of FHLMC perpetual preferred 5.57% stock Series V. Management recognized a $440 thousand other than temporary loss in the fourth quarter. In accordance with SFAS 115, when a decline in fair value below cost is deemed other than temporary, the unrealized loss must be recognized as a charge to earnings. As current market conditions make it difficult to precisely forecast a time period for the security to fully recover, an impairment charge was recorded.

Securities with significant declines in fair value are evaluated on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under Securities and Exchange Commission Codification Staff Accounting Bulletins, Topic 5: Miscellaneous Accounting—Item M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, which provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer specific factors, the holder must assess whether the impairment is other-than-temporary. SNBV determined, based on their methodology, that a forecasted recovery period could not be accurately predicted for the FHLMC preferred stock and as such determined the loss to be other-than-temporary.

Unrealized losses on corporate bonds have not been recognized into income because the bonds are of investment-grade quality (rated A- or higher), the bonds continue to perform according to the contractual terms, all interest payments are current, and management has the intent and ability to hold for the foreseeable future. The fair value is expected to recover as the bonds approach maturity.

 

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3. LOANS

Loans are stated at their face amount, net of unearned income, and consist of the following at December 31, 2007 and 2006 (in thousands):

 

     December 31,
2007
    December 31,
2006
 

Mortgage loans on real estate:

    

Commercial

   $ 86,099     $ 69,338  

Construction, land and other loans

     51,561       35,822  

Residential 1-4 family

     51,862       63,141  

Multi- family residential

     8,273       3,720  

Equity lines of credit

     8,428       10,509  
                

Total real estate loans

     206,223       182,530  

Commercial loans

     53,208       19,581  

Consumer loans

     2,476       2,861  
                

Gross loans

     261,907       204,972  

Less unearned income on loans

     (500 )     (428 )
                

Loans, net of unearned income

   $ 261,407     $ 204,544  
                

The recorded investment in loans which have been identified as impaired loans, in accordance with Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (SFAS 114) totaled $4.2 million and $7.5 million as of December 31, 2007 and 2006, respectively. All of the impaired loans at year end 2007 and 2006 had allocated allowance for loan losses in the amount of $61 thousand and $158 thousand, respectively. There were no impaired loans as of December 31, 2005. The average investment in impaired loans during the year ended December 31, 2007 and 2006 was $4.8 million and $610 thousand, respectively. Interest income recognized during impairment was $292 thousand for 2007 and $80 thousand for 2006. Cash-basis interest income recognized was $282 thousand for 2007 and $46 thousand for 2006. Nonaccrual loans were $371 thousand at December 31, 2007, and there were no nonaccrual loans at December 31, 2006 .There were no loans past due 90 days or more and accruing interest at December 31, 2007 and 2006.

Residential 1-4 family mortgage loans in the amount of approximately $50.0 and $53.7 million were pledged as collateral for Federal Home Loan Bank of Atlanta (“FHLB”) Advances as of December 31, 2007 and 2006, respectively.

 

4. ALLOWANCE FOR LOAN AND LEASE LOSSES

Activity in the allowance for loan and lease losses for the years ended December 31, 2007 and 2006 and the period from inception at April 14, 2005 through December 31, 2005 is summarized below (in thousands):

 

     For the Year Ended    For the Period
From Inception
at April 14, 2005
Through

December 31, 2005
     December 31,
2007
   December 31,
2006
  

Balance, beginning of period

   $ 2,726    $ 1,020    $ —  

Allowance from acquired bank

     —        1,374      —  

Provision charged to operations

     1,290      546      1,020

Recoveries credited to allowance

     —        —        —  
                    

Total

     4,016      2,940      1,020

Loans charged off

     540      214      —  
                    

Balance, end of period

   $ 3,476    $ 2,726    $ 1,020
                    

 

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5. LOAN SERVICING

Mortgage loans serviced for other investors, such as FNMA and other financial institutions, are not reported as assets. These loans are serviced by a sub-servicer. The principal balances of these loans were $58.1 million and $71.7 million as of December 31, 2007 and 2006, respectively.

Activity for mortgage servicing rights follows (in thousands):

 

     2007     2006     2005

Servicing rights:

      

Beginning of year

   $ 701     $ —       $ —  

Adjustment of acquired servicing rights beginning fair value

     (177 )     —         —  

Acquired in merger

     —         707       —  

Amortized to expense

     (119 )     (6 )     —  
                      

End of year

   $ 405     $ 701     $ —  
                      

The adjustment to the beginning fair value of acquired servicing rights was made to goodwill during the allocation period and resulted from the finalization of the estimated fair value analysis.

Fair value of servicing rights was $690 thousand and $707 at year-end 2007 and 2006. Fair value at 2007 was determined using discount rates ranging from 12.50% to 15.86% and prepayment speeds ranging from 174.8% to 287.0%. Fair value at 2006 was determined using discount rates ranging from 10.25% to 11.25% and prepayment speeds ranging from 333.0% to 500.0%.

The weighted average amortization period is 4.77 years. Estimated amortization expense for each of the next five years is (in thousands):

 

2008

   $ 67

2009

     60

2010

     50

2011

     43

2012

     37

 

6. BANK PREMISES AND EQUIPMENT

Bank premises and equipment as of December 31, 2007 and 2006 are as follows (in thousands):

 

     2007    2006

Land

   $ 38    $ 38

Building and improvements

     1,546      1,542

Leasehold improvements

     1,170      929

Furniture and equipment

     1,617      1,409
             
     4,371      3,918

Less accumulated depreciation and amortization

     875      419
             

Bank premises and equipment, net

   $ 3,496    $ 3,499
             

 

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Depreciation and amortization expense for 2007, 2006 and for the period since Sonabank commenced operations through December 31, 2005, was $456 thousand, $306 thousand and $113 thousand, respectively. Future minimum rental payments required under non-cancelable operating leases for bank premises that have initial or remaining terms in excess of one year as of December 31, 2007 are as follows (in thousands):

 

2008

   $ 691

2009

     705

2010

     620

2011

     618

2012

     628

Thereafter

     1,927
      
   $ 5,189
      

The leases contain options to extend for periods of 2 to 6 years. Rental expense for 2007, 2006 and for the period since Sonabank commenced operations through December 31, 2005, was $707 thousand, $231 thousand and $110 thousand, respectively.

 

7. GOODWILL AND INTANGIBLE ASSETS

Goodwill

The change in the balance for goodwill during the year follows (in thousands):

 

     2007     2006

Beginning of year

   $ 10,423     $ —  

Acquired goodwill

       10,423

Adjustment related to deferred tax assets obtained in 1st Service Bank acquisition

     (1,945 )     —  

Other adjustments related to 1st Service Bank acquisition

     235       —  
              

End of year

   $ 8,713     $ 10,423
              

During 2007, the deferred tax asset valuation allowance reversal of $1.9 million related to the net deferred tax assets obtained in the 1st Service Bank acquisition was recognized as an adjustment to goodwill, and the beginning fair value of acquired loan servicing rights was adjusted in the amount of $177 thousand. Other adjustments to goodwill were made during the allocation period in 2007 in the amount of $58 thousand.

Acquired Intangible Assets

Acquired intangible assets were as follows at year end (in thousands):

 

     December 31, 2007
     Gross Carrying
Value
   Accumulated
Amortization
    Net Carrying
Value

Amortizable core deposit intangibles

   $ 5,089    $ (1,222 )   $ 3,867
     December 31, 2006
     Gross Carrying
Value
   Accumulated
Amortization
    Net Carrying
Value

Amortizable core deposit intangibles

   $ 5,089    $ (495)     $ 4,594

 

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Amortization expense of intangibles for the years ended December 31, 2007 and 2006 and for the period from April 14, 2005 through December 31, 2005 was $727 thousand, $458 thousand and $36 thousand, respectively. Estimated amortization expense of intangibles for the years ended December 31 follows (in thousands):

 

2008

   $ 727

2009

     727

2010

     727

2011

     727

2012

     691

 

8. DEPOSITS

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2007 and 2006 was $ 38.9 million and $36.3 million, respectively. At December 31, 2007, the scheduled maturities of time deposits are as follows (in thousands):

 

2008

   $ 142,925

2009

     29,764

2010

     4,203

2011

     1,247

2012

     2,108
      
   $ 180,247
      

 

9. OTHER BORROWINGS

Other borrowings can consist of Federal Home Loan Bank (FHLB) overnight advances and securities sold under agreements to repurchase that mature within one year, which are secured transactions with customers or broker/dealers. Other borrowings consist of the following (in thousands):

 

     2007     2006     2005  

FHLB overnight advances

   $ 5,500     $ —       $ —    

Securities sold under agreements to repurchase

     10,001       5,033       12,406  
                        

Total

   $ 15,501     $ 5,033     $ 12,406  
                        

Weighted average interest rate at year end

     3.91 %     4.07 %     4.14 %

For the periods ended December 31, 2007, 2006 and 2005:

      

Average outstanding balance

   $ 11,729     $ 9,453     $ 2,241  

Average interest rate during the year

     4.53 %     4.80 %     4.09 %

Maximum month-end outstanding balance

   $ 26,607     $ 14,337     $ 15,724  

 

10. FEDERAL HOME LOAN BANK ADVANCES

At year end, other advances from the Federal Home Loan Bank were as follows (in thousands):

 

     2007    2006

FHLB convertible advances maturing August 2012 through October 2012, fixed rates from 3.86% to 4.20%, averaging 4.05%

   $ 25,000    $ —  

 

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These advances mature in 2012 and are convertible to adjustable rate advances at the option of the FHLB of Atlanta after the first year and quarterly thereafter. If converted, the adjustable rate advance will be priced at a spread to 3-month LIBOR.

 

11. STOCKHOLDERS’ EQUITY

SNBV completed its common stock offering in a private placement on April 14, 2005. SNBV issued 3,500,000 shares of common stock with a par value of $0.01 per share at a price of $10.00 per share. The proceeds to SNBV amounted to approximately $34.5 million, net of costs of $428 thousand.

The organizers of SNBV advanced to SNBV $1.5 million to cover a substantial portion of the organizational and pre-opening expenses. In the event that the bank did not open, these persons would have borne the risk of loss with respect to these advances. In recognition of the financial risks undertaken, these individuals have received warrants to purchase shares of SNBV’s common stock. Warrants to purchase an aggregate of 82,500 shares of SNBV’s common stock were issued. The warrants are exercisable at a price of $10.00 per share (equivalent to $9.09 after the stock dividend) and must be exercised within 10 years of the date the bank opened.

On November 6, 2006, SNBV closed on the initial public offering of its common stock, $0.01 par value. All 2,000,000 shares of common stock registered in the offering, including 214,000 shares of common stock covered by an over- allotment option granted to the underwriter, were sold at a price to the public of $14.00 per share (equivalent to $12.73 after the stock dividend). The aggregate gross proceeds from the shares of common stock sold by SNBV were $28.0 million. The aggregate net proceeds to SNBV from the offering were approximately $26.4 million after deducting an aggregate of $866 thousand in underwriting commissions and $713 thousand in other expenses incurred in connection with the offering.

 

12. INCOME TAXES

Net deferred tax assets consist of the following components as of December 31, 2007 and 2006 (in thousands):

 

     2007    2006  

Deferred tax assets:

     

Allowance for loan losses

   $ 1,001    $ 828  

Organization costs

     323      356  

Unearned loan fees and other

     170      146  

Core deposit intangible amortization

     —        89  

Net operating loss carryover

     1,306      1,408  

Purchase accounting

     725      —    

Other than temporary impairment charge

     150      —    

Net unrealized loss on securities available for sale

     370      12  

Other

     24      —    
               

Total deferred tax assets

     4,069      2,839  

Deferred tax liabilities:

     

Core deposit intangible amortization

     430      —    

Depreciation

     163      106  
               

Total deferred tax liabilities

     593      106  
     3,476      2,733  

Valuation allowance

     —        (2,721 )
               

Net deferred tax assets

   $ 3,476    $ 12  
               

 

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Until the second quarter of 2007, SNBV maintained a valuation allowance against its deferred tax assets. During the second quarter of 2007, the valuation allowance on the net deferred tax assets was no longer necessary given the sustained income and growth over the past six calendar quarters. The tax valuation allowance reversal was $2.5 million, of which $1.9 million was related to the net deferred tax assets obtained in the 1st Service Bank acquisition.

At December 31, 2007, SNBV had net operating loss carryforwards of approximately $3.8 million which expire in 2026. We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during the next twelve months. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income tax accounts; no such accruals exist as of December 31, 2007. SNBV and its subsidiary file a consolidated U. S. federal tax return, and SNBV files a Virginia state income tax return. These returns are subject to examination by taxing authorities for all years after 2003.

The provision for income taxes consists of the following for the years ended December 31, 2007 and 2006 and for the period from inception at April 14, 2005 through December 31, 2005 (in thousands):

 

     2007     2006     2005

Current tax expense

   $ 877     $ 423     $ —  

Deferred tax benefit

     (385 )     (423 )     —  

Change in valuation allowance

     (384 )     —         —  
                      

Income tax expense

   $ 108     $ —       $ —  
                      

The income tax expense differed from the amount of income tax determined by applying the U.S. Federal income tax rate of 34% to pretax income for the years ended December 31, 2007 and 2006 and for the period from inception at April 14, 2005 through December 31, 2005 due to the following (in thousands):

 

     2007     2006     2005  

Computed expected tax expense (benefit)

   $ 627     $ 343     $ (770 )

Reduction in tax expense resulting from:

      

Change in valuation allowance

     (384 )     (343 )     770  

Income from bank-owned life insurance

     (118 )     —         —    

Other, net

     (17 )     —         —    
                        

Income tax expense

   $ 108     $ —       $ —    
                        

 

13. EMPLOYEE BENEFITS

SNBV has a 401(k) plan that allows employees to make pre-tax contributions for retirement. The 401(k) plan provides for discretionary matching contributions by SNBV. Expense for 2007 was $52 thousand. In 2006 and 2005, there were no matching contributions made by SNBV. The 401(k) does not provide for investment in SNBV stock.

A deferred compensation plan that covers two executive officers was established in 2007. Under the plan, the Bank pays each participant, or their beneficiary, the amount of compensation deferred plus accrued interest over 10 years, beginning with the individual’s retirement. A liability is accrued for the obligation under these plans. The expense incurred for the deferred compensation in 2007 was $65 thousand, resulting in a deferred compensation liability of $65 thousand as of December 31, 2007.

 

14. STOCK-BASED COMPENSATION

In 2004, the Board of Directors adopted a stock options plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and

 

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employees. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options. The purpose of the plan is to afford key employees an incentive to remain in the employ of SNBV and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in SNBV’s future success. Under the plans, the option’s exercise price cannot be less than the fair market value of the stock on the grant date. The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.

SNBV accounts for the plan under the fair value method of FASB Statement No 123 Revised (“SFAS 123R”), “Share Based Payment,” which was adopted January 1, 2006. In 2005 the plan was measured under the intrinsic value method. Prior to 2006, 168,025 options were granted under the plan. No stock-based compensation cost was reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. In addition, all options granted prior to 2006 were fully vested as of December 31, 2005. There were no options granted in 2006; therefore, in 2006, no share-based compensation expense was recognized. Share-based compensation expense for 2007 was $6 thousand.

The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value options granted:

 

     2007     2006    2005  

Dividend yield

     0.00 %   —        0.00 %

Expected life

     10 years     —        10 years  

Expected volatility

     18.23 %   —        11.45 %

Risk-free interest rate

     4.81 %   —        4.38 %

Weighted average fair value per option granted

   $ 6.32     —      $ 3.68  

 

   

We have paid no dividends.

 

   

Due to SNBV’s short existence, the volatility was estimated using historical volatility of comparative publicly traded financial institutions in the Virginia market for periods approximating the expected option life.

 

   

The risk-free interest rate was developed using the U. S. Treasury yield curve for periods equal to the expected life of the options on the grant date. An increase in the risk-free interest rate will increase stock compensation expense on future option grants.

A summary of the activity in the stock option plan for 2007 follows:

 

     Shares    Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregatge
Intrinsic
Value

Options outstanding, beginning of period

   168,025    $ 9.09      

Granted

   5,500      14.73      

Forfeited

   —        —        

Exercised

   —        —        
             

Options outstanding, end of period

   173,525    $ 9.27    7.5    $ —  
                       

Vested or expected to vest

   173,525    $ 9.27    7.5    $ —  

Exercisable at end of period

   168,025    $ 9.09    7.4    $ —  

As of December 31, 2007, unrecognized compensation expense associated with stock options was $29 thousand which is expected to be recognized over a weighted average period of 4 years.

 

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15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

SNBV is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit are written conditional commitments issued by SNBV to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $1.2 million and $477 thousand as of December 31, 2007 and 2006, respectively.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as it does 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 December 31, 2007 and 2006, we had unfunded lines of credit and undisbursed construction loan funds totaling $54.5 million and $45.8 million, respectively. Our approved loan commitments were $10.8 million and $8.8 million at December 31, 2007 and 2006, respectively.

 

16. EARNINGS PER SHARE

The following is a reconciliation of the denominators of the basic and diluted EPS computations for 2007, 2006 and 2005 (in thousands, except per share data):

 

     Income (Loss)
(Numerator)
    Weighted
Average
Shares
(Denominator)
   Per Share
Amount
 

For the year ended December 31, 2007

       

Basic EPS

   $ 1,736     6,799    $ 0.26  

Effect of dilutive stock options and warrants

     —       77      —    
                     

Diluted EPS

   $ 1,736     6,876    $ 0.25  
                     

For the year ended December 31, 2006

       

Basic EPS

   $ 1,009     4,245    $ 0.24  

Effect of dilutive stock options and warrants

     —       79      —    
                     

Diluted EPS

   $ 1,009     4,324    $ 0.23  
                     

For the period from inception at April 14, 2005 through December 31, 2005

       

Basic EPS

   $ (2,256 )   3,850    $ (0.59 )

Effect of dilutive stock options and warrants

     —       —        —    
                     

Diluted EPS

   $ (2,256 )   3,850    $ (0.59 )
                     

There were 5,500 anti-dilutive options during 2007, and there were no anti-dilutive options during 2006 and 2005.

 

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17. REGULATORY MATTERS

SNBV and its subsidiary bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on SNBV’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (PCA), SNBV must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. At December 31, 2007 and 2006, the most recent regulatory notifications categorized the Bank as well capitalized under regulatory framework for prompt corrective action.

Quantitative measures established by regulation to ensure capital adequacy require SNBV to maintain minimum amounts and ratios of Total and Tier I capital (as defined in the regulations) to average assets (as defined). Management believes, as of December 31, 2007, that SNBV meets all capital adequacy requirements to which it is subject.

The capital amounts and ratios for SNBV and Sonabank at year end are presented in the following table (in thousands):

 

     Actual     Required
For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  

2007

               

SNBV

               

Tier 1 risk-based capital ratio

   $ 56,662    18.50 %   $ 12,253    4.00 %     N/A    N/A  

Total risk-based capital ratio

     60,138    19.63 %     24,506    8.00 %     N/A    N/A  

Leverage ratio

     56,662    16.03 %     14,136    4.00 %     N/A    N/A  

Sonabank

               

Tier 1 risk-based capital ratio

   $ 54,237    17.71 %   $ 12,251    4.00 %   $ 18,376    6.00 %

Total risk-based capital ratio

     57,713    18.84 %     24,502    8.00 %     30,628    10.00 %

Leverage ratio

     54,237    15.35 %     14,136    4.00 %     17,670    5.00 %

2006

               

SNBV

               

Tier 1 risk-based capital ratio

   $ 52,534    24.69 %   $ 8,510    4.00 %     N/A    N/A  

Total risk-based capital ratio

     55,194    25.94 %     17,019    8.00 %     N/A    N/A  

Leverage ratio

     52,534    28.46 %     7,383    4.00 %     N/A    N/A  

Sonabank

               

Tier 1 risk-based capital ratio

   $ 50,066    23.53 %   $ 8,510    4.00 %   $ 12,765    6.00 %

Total risk-based capital ratio

     52,726    24.78 %     17,019    8.00 %     21,274    10.00 %

Leverage ratio

     50,066    27.13 %     7,383    4.00 %     9,229    5.00 %

SNBV’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. During 2008, the Bank could, without prior approval, declare dividends of approximately $489 thousand plus any 2008 net profits retained to the date of the dividend declaration.

 

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18. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for SNBV’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instruments. Statement of Financial Accounting Statement (“SFAS”) No. 107, “Disclosures about Fair Value of Financial Instruments,” excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of SNBV.

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of long-term debt is based on current rates for similar financing. The fair value of off-balance-sheet items is not considered material.

The carrying amounts and estimated fair values of SNBV’s financial instruments as of December 31, 2007 and 2006 are as follows (in thousands):

 

     2007    2006
     Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value

Financial assets:

           

Cash and cash equivalents

   $ 1,308    $ 1,308    $ 8,126    $ 8,126

Securities available for sale

     40,734      40,734      23,328      23,328

Securities held to maturity

     34,267      34,597      35,623      35,331

Net loans

     257,931      259,240      201,818      202,911

Accrued interest receivable

     1,546      1,546      1,250      1,250

Financial liabilities:

           

Deposits:

           

Checking accounts

     25,356      25,356      28,855      28,855

Money market and savings accounts

     59,866      59,866      35,420      35,420

Certificates of deposit

     180,247      181,215      151,529      150,726

Other borrowings

     15,501      15,501      5,033      5,033

FHLB advances

     25,000      24,057      —        —  

Accrued interest payable

     1,253      1,253      652      652

 

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19. PARENT COMPANY FINANCIAL INFORMATION

SNBV owns all of the outstanding shares of Sonabank. Condensed financial information of the parent company follows (in thousands):

CONDENSED BALANCE SHEETS

DECEMBER 31,

 

     2007     2006  

ASSETS

    

Cash

   $ 2,375     $ 2,468  

Investment in subsidiary

     66,850       65,759  

Other assets

     50       —    
                

Total assets

   $ 69,275     $ 68,227  
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Stockholders’ equity:

    

Common stock

   $ 68     $ 62  

Additional paid in capital

     69,436       69,436  

Retained earnings (Accumulated deficit)

     489       (1,247 )

Accumulated other comprehensive loss

     (718 )     (24 )
                

Total stockholders’ equity

     69,275       68,227  
                

Total liabilities and stockholders’ equity

   $ 69,275     $ 68,227  
                

CONDENSED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006 AND

FOR THE PERIOD FROM INCEPTION AT APRIL 14, 2005 THROUGH DECEMBER 31, 2005

(in thousands)

 

     2007     2006    2005  

Equity in undistributed net income (loss) of subsidiary

   $ 1,785     $ 1,009    $ (2,256 )

Other operating expenses

     74       —        —    
                       

Income (loss) before income taxes

     1,711       1,009      (2,256 )

Income tax benefit

     (25 )     —        —    
                       

Net income (loss)

   $ 1,736     $ 1,009    $ (2,256 )
                       

 

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CONDENSED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006 AND

FOR THE PERIOD FROM INCEPTION AT APRIL 14, 2005 THROUGH DECEMBER 31, 2005

( in thousands)

 

    2007     2006     2005  

Operating activities:

     

Net income (loss)

  $ 1,736     $ 1,009     $ (2,256 )

Adjustments to reconcile net income (loss) to net cash and cash equivalents provided by operating activities:

     

Equity in undistributed net income (loss) of subsidiary

    (1,785 )     (1,009 )     2,256  

Other, net

    (44 )     —         —    
                       

Net cash and cash equivalents used by operating activities

    (93 )     —         —    
                       

Investing activities:

     

Investment in subsidiary

    —         (24,002 )     (34,522 )
                       

Net cash and cash equivalents used in investing activities

    —         (24,002 )     (34,522 )
                       

Financing activities:

     

Issuance of common stock

    —         26,420       34,572  
                       

Net cash and cash equivalents provided by financing activities

    —         26,420       34,572  
                       

Increase (decrease) in cash and cash equivalents

    (93 )     2,418       50  

Cash and cash equivalents at beginning of period

    2,468       50       —    
                       

Cash and cash equivalents at end of period

  $ 2,375     $ 2,468     $ 50  
                       

Supplemental schedule of noncash investing and financing activities

     

Issuance of common stock in exchange for net assets in acquisition

    $ 8,506     $ —    

 

20. OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) components and related tax effects were as follows (in thousands):

 

     2007     2006     2005  

Change in unrealized loss on available for sale securities

   $ (1,492 )   $ (31 )   $ (5 )

Reclassification adjustment for loss realized in income

     440       —         —    
                        

Net unrealized loss

     (1,052 )     (31 )     (5 )

Tax effect

     358       10       2  
                        

Net-of-tax amount

   $ (694 )   $ (21 )   $ (3 )
                        

 

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21. QUARTERLY FINANCIAL DATA (UNAUDITED)

 

     Interest
Income
   Net Interest
Income
   Income
Before Taxes
   Net
Income
   Earnings Per Share
                   Basic        Diluted  
     (dollars in thousands)

2007

                 

First quarter

   $ 4,854    $ 2,466    $ 474    $ 474    $ 0.07    $ 0.07

Second quarter

     5,248      2,647      594      647      0.10      0.09

Third quarter

     5,549      2,670      636      467      0.07      0.07

Fourth quarter

     6,098      2,880      140      147      0.02      0.02

2006

                 

First quarter

   $ 2,085    $ 1,260    $ 82    $ 82    $ 0.02    $ 0.02

Second quarter

     2,363      1,345      239      239      0.06      0.06

Third quarter

     2,717      1,412      307      307      0.08      0.08

Fourth quarter

     3,618      1,907      381      381      0.07      0.07

 

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Item 9.—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Previously reported under Item 4.01 in a Current Report on Form 8-K filed on March 7, 2007.

Item 9A.—Controls and Procedures

Evaluation of Disclosure Controls and Procedures. SNBV maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, the Chief Executive Officer and Chief Financial Officer have concluded that SNBV’s disclosure controls and procedures were effective.

Management’s Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of SNBV’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on the assessment using those criteria, management concluded that the internal control over financial reporting was effective as of December 31, 2007. This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.

Changes in Internal Control over Financial Reporting. There was no change in the internal control over financial reporting that occurred during the quarter ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

Item 9B.—Other Information

None.

 

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PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information under the captions “Election of Directors”, “Continuing Directors and Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance”, “Corporate Governance—Committees of the Board—Audit Committee, “Corporate Governance—Director Nominations Process” and “Corporate Governance—Code of Ethics” in the Company’s definitive Proxy Statement for its 2008 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days after December 31, 2007 pursuant to Regulation 14A under the Exchange Act (the “2008 Proxy Statement”), is incorporated herein by reference in response to this item.

Item 11. Executive Compensation

The information under the captions “Executive Compensation and Other Matters” and “Director Compensation” in the 2008 Proxy Statement is incorporated herein by reference in response to this item.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

The information under the caption “Beneficial Ownership of Common Stock by Management of the Company and Principal Stockholders” in the 2008 Proxy Statement is incorporated herein by reference in response to this item.

Item 13. Certain Relationships, Related Transactions and Director Independence

The information under the captions “Corporate Governance—Director Independence” and “Certain Relationships and Related Party Transactions” in the 2008 Proxy Statement is incorporated herein by reference in response to this item.

Item 14. Principal Accounting Fees and Services

The information under the caption “Fees and Services of Independent Registered Public Accounting Firm” in the 2008 Proxy Statement is incorporated herein by reference in response to this item.

 

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PART IV

Item 15.—Exhibits and Financial Statement Schedules

The following documents are filed as part of this report:

 

  (a)(1) Financial Statements

The following consolidated financial statements and report of independent registered public accounting firm are in Part II, Item 8 on pages 46 through 74

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets—December 31, 2007 and 2006

Consolidated Statements of Income—Years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005

Consolidated Statements of Changes in Stockholders’ Equity—Years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005

Consolidated Statements of Cash Flows—Years ended December 31, 2007 and 2006, and the period from inception at April 14, 2005 through December 31, 2005

Notes to Consolidated Financial Statements

 

  (a)(2) Financial Statement Schedules

All schedules are omitted since they are not required, are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.

 

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  (a)(3) Exhibits

The following are filed or furnished, as noted below, as part of this Form 10-K and this list includes the Exhibit Index.

 

Exhibit No.

  

Description

  3.1        Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
  3.2        Certificate of Amendment to the Articles of Incorporation dated February 1, 2005 (incorporated herein by reference to Exhibit 3.2 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
  3.3        Certificate of Amendment to the Articles of Incorporation dated May 16, 2006 (incorporated herein by reference to Exhibit 3.3 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
  3.4        Amended and Restated Bylaws (incorporated by reference to SNBV’s Annual Report on Form 10-K for the year ended December 31, 2006)
  4.1        Specimen Stock Certificate of SNBV (incorporated herein by reference to Exhibit 4.1 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
  4.2        Form of Warrant Agreement (incorporated herein by reference to Exhibit 4.2 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
  4.3        Form of Amendment to Warrant Agreement (incorporated herein by reference to Exhibit 4.3 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
10.1+      2004 Stock Option Plan (incorporated herein by reference to Exhibit 10.1 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
10.2+      Form of Change in Control Agreement with Ms. Derrico and Mr. Porter (incorporated herein by reference to Exhibit 10.2 to SNBV’s Registration Statement on Form S-1 (Registration No. 333-136285))
11.0        Statement re: Computation of Per Share Earnings (incorporated by reference to Note 13 of the notes to consolidated financial statements included in this report
21.0*      Subsidiaries of the Registrant
23.1*      Consent of BDO Seidman, LLP
23.2*      Consent of Crowe Chizek and Company LLC
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

 

+ Management contract or compensatory plan or arrangement
* Filed herewith
** Furnished herewith

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.    
By:   /s/    GEORGIA S. DERRICO               Date: March 19, 2008
  Georgia S. Derrico      
  Chairman of the Board and Chief Executive Officer      

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 19, 2008.

 

Signature

  

Title

/s/    GEORGIA S. DERRICO        

Georgia S. Derrico

  

Chairman of the Board and Chief Executive

Officer

/s/    R. RODERICK PORTER        

R. Roderick Porter

   President and Director

/s/    NEIL J. CALL        

Neil J. Call

   Director

/s/    CHARLES A. KABASH        

Charles A. Kabash

   Director

/s/    FREDERICK L. BOLLERER        

Frederick L. Bollerer

   Director

/s/    ROBIN R. SHIELD        

Robin R. Shield

   Director

/s/    JOHN J. FORCH        

John J. Forch

   Director

/s/    WILLIAM H. LAGOS        

William H. Lagos

   Sr. Vice President and Chief Financial Officer

 

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